10-Q 1 a20130630-10xq.htm 10-Q 2013.06.30-10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

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

For the quarterly period ended June 30, 2013
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File No. 000-51401

FEDERAL HOME LOAN BANK OF CHICAGO
(Exact name of registrant as specified in its charter)
 
 
Federally chartered corporation
  
36-6001019
 
 
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer
Identification No.)
 
 
200 East Randolph Drive
Chicago, IL
  
60601
 
 
(Address of principal executive offices)
  
(Zip Code)
 

Registrant's telephone number, including area code: (312) 565-5700
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. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
 
Large accelerated filer   o
 
Accelerated filer  o
 
Non-accelerated filer   x  (Do not check if a smaller reporting company)
 
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).  Yes o No x


As of July 31, 2013, including mandatorily redeemable capital stock, registrant had 15,326,138 total outstanding shares of Class B Capital Stock.


1


TABLE OF CONTENTS

Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
Item 1.
 68
Item 1A.
 68
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 
Signatures
 




2

Federal Home Loan Bank of Chicago

PART I - FINANCIAL INFORMATION
Item 1.    Financial Statements.
Statements of Condition (unaudited)
(Dollars in millions, except capital stock par value)
 
June 30, 2013
 
December 31, 2012
Assets
 
 
 
Cash and due from banks
$
315

 
$
3,564

Federal Funds sold
2,186

 

Securities purchased under agreements to resell
4,525

 
6,500

Investment securities -
 
 
 
Trading, $11 and $0 pledged
266

 
1,229

Available-for-sale
22,231

 
23,454

Held-to-maturity, $8,935 and $10,482 fair value
8,190

 
9,567

Total investment securities
30,687

 
34,250

Advances, $29 and $9 carried at fair value
16,663

 
14,530

MPF Loans held in portfolio, net of allowance for credit losses of $(34) and $(42)
8,870

 
10,432

Accrued interest receivable
101

 
116

Derivative assets
23

 
47

Software and equipment, net of accumulated amortization/depreciation of $(160) and $(157)
30

 
32

Other assets
102

 
113

Total assets
$
63,502

 
$
69,584

Liabilities
 
 
 
Deposits - Interest bearing
$
653

 
$
728

Deposits - Non-interest bearing
63

 
88

Total deposits
716

 
816

Consolidated obligations, net -
 
 
 
Discount notes, $75 and $0 carried at fair value
21,583

 
31,260

Bonds, $2,548 and $1,251 carried at fair value
36,239

 
32,569

Total consolidated obligations, net
57,822

 
63,829

Accrued interest payable
161

 
156

Mandatorily redeemable capital stock
3

 
6

Derivative liabilities
110

 
82

Affordable Housing Program assessment payable
88

 
78

Other liabilities
114

 
169

Subordinated notes
1,000

 
1,000

Total liabilities
60,014

 
66,136

Commitments and contingencies - Note 15
 
 
 
Capital
 
 
 
Class B1 Capital stock - putable $100 par value - 1 million and 1 million shares issued and outstanding at June 30, 2013 and December 31, 2012
151

 
122

Class B2 Capital stock - putable $100 par value - 14 million and 15 million shares issued and outstanding at June 30, 2013 and December 31, 2012
1,389

 
1,528

Total Capital stock
1,540

 
1,650

Retained earnings - unrestricted
1,775

 
1,584

Retained earnings - restricted
142

 
107

Total retained earnings
1,917

 
1,691

Accumulated other comprehensive income (loss)
31

 
107

Total capital
3,488

 
3,448

Total liabilities and capital
$
63,502

 
$
69,584


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

3

Federal Home Loan Bank of Chicago

Statements of Income (unaudited)
(Dollars in millions)
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2013
 
2012
 
2013
 
2012
Interest income
 
$
380

 
$
485

 
$
783

 
$
1,010

Interest expense
 
282

 
347

 
572

 
713

Net interest income before provision for credit losses
 
98

 
138

 
211

 
297

Provision for (reversal of) credit losses
 
(2
)
 
2

 
(2
)
 
8

Net interest income
 
100

 
136

 
213

 
289

 
 
 
 
 
 
 
 
 
Non-interest gain (loss) on -
 
 
 
 
 
 
 
 
Total other-than-temporary impairment
 

 

 

 
(2
)
Net non-credit portion reclassified to (from) statements of comprehensive income
 

 
(14
)
 

 
(13
)
Net other-than-temporary impairment (OTTI) charges, credit portion
 

 
(14
)
 

 
(15
)
Trading securities
 
(3
)
 
(11
)
 
(9
)
 
(25
)
Derivatives and hedging activities
 
28

 
(8
)
 
30

 
3

Instruments held under fair value option
 
2

 
2

 
3

 
8

Other, net
 
8

 
4

 
12

 
8

Total non-interest gain (loss)
 
35

 
(27
)
 
36

 
(21
)
 
 
 
 
 
 
 
 
 
Non-interest expense -
 
 
 
 
 
 
 
 
Compensation and benefits
 
14

 
16

 
28

 
31

Other operating expenses
 
11

 
7

 
20

 
16

FHFA
 
1

 
2

 
2

 
4

Office of Finance
 
1

 
1

 
2

 
2

Other community investment
 
(50
)
 

 
(50
)
 

Other
 
(2
)
 
6

 
(2
)
 
9

Total non-interest expense
 
(25
)
 
32

 

 
62

 
 
 
 
 
 
 
 
 
Income before assessments
 
160

 
77

 
249

 
206

 
 
 
 
 
 
 
 
 
Affordable Housing Program assessment
 
11

 
8

 
20

 
21

 
 
 
 
 
 
 
 
 
Net income
 
$
149

 
$
69

 
$
229

 
$
185


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

 

4

Federal Home Loan Bank of Chicago

Statements of Comprehensive Income (unaudited)
(Dollars in millions)

 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2013
 
2012
 
2013
 
2012
Net income
 
$
149

 
$
69

 
$
229

 
$
185

 
 
 
 
 
 
 
 
 
Other comprehensive income -
 
 
 
 
 
 
 
 
Net unrealized gain (loss) on available-for-sale securities
 
(352
)
 
244

 
(437
)
 
212

Net change in fair value non-credit OTTI on available-for-sale securities
 
2

 

 
8

 
5

Net unrealized gain (loss) on held-to-maturity securities transferred from available-for-sale securities
 

 
1

 
1

 
2

Non-credit OTTI on held-to-maturity securities
 

 
 
 
 
 
 
Reclassification of net non-credit portion to (from) statements of income
 

 
14

 

 
13

Accretion of non-credit portion to HTM asset
 
16

 
17

 
31

 
37

Total non-credit OTTI on held-to-maturity securities
 
16

 
31

 
31

 
50

Net unrealized gain (loss) on cash flow hedges
 

 
 
 
 
 
 
Unrealized gains (losses)
 
239

 
(110
)
 
327

 
(58
)
Reclassification of net realized (gains) losses to net interest income
 
(2
)
 

 
(4
)
 
1

Reclassification of net realized (gains) losses to non-interest gain (loss)
 
(2
)
 

 
(3
)
 
(2
)
Total net unrealized gain (loss) on cash flow hedges
 
235

 
(110
)
 
320

 
(59
)
Post retirement plans - reclassification to net income
 

 

 
1

 

Total other comprehensive income (loss)
 
(99
)
 
166

 
(76
)
 
210

 
 

 
 
 
 
 
 
Total comprehensive income
 
$
50

 
$
235

 
$
153

 
$
395



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



5

Federal Home Loan Bank of Chicago

Statements of Capital (unaudited)
(Dollars and shares in millions)
 
  Capital Stock -   Putable
 
Retained
Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Total Capital  
 
Shares a
 
Par Value
 
Unrestricted
 
Restricted
 
Total
 
 
Balance, December 31, 2011
24

b 
$
2,402

b 
$
1,289

 
$
32

 
$
1,321

 
$
(431
)
 
$
3,292

Comprehensive income
 
 
 
 
148

 
37

 
185

 
210

 
395

Proceeds from issuance of capital stock
1

 
125

 
 
 
 
 
 
 
 
 
125

Repurchases of capital stock
(6
)
 
(645
)
 
 
 
 
 
 
 
 
 
(645
)
Capital stock reclassified to mandatorily redeemable capital stock

 
(32
)
 
 
 
 
 
 
 
 
 
(32
)
Cash dividends on capital stock (0.10% annualized)
 
 
 
 
(2
)
 

 
(2
)
 
 
 
(2
)
Balance, June 30, 2012
19

 
$
1,850

 
$
1,435

 
$
69

 
$
1,504

 
$
(221
)
 
$
3,133

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2012
16

 
$
1,650

 
$
1,584

 
$
107

 
$
1,691

 
$
107

 
$
3,448

Comprehensive income
 
 
 
 
194

 
35

 
229

 
(76
)
 
153

Proceeds from issuance of capital stock
2

 
159

 
 
 
 
 
 
 
 
 
159

Repurchases of capital stock
(2
)
 
(213
)
 
 
 
 
 
 
 
 
 
(213
)
Capital stock reclassified to mandatorily redeemable capital stock
(1
)
 
(56
)
 
 
 
 
 
 
 
 
 
(56
)
Cash dividends on capital stock (0.30% annualized)
 
 
 
 
(3
)
 

 
(3
)
 
 
 
(3
)
Balance, June 30, 2013
15

 
$
1,540

 
$
1,775

 
$
142

 
$
1,917

 
$
31

 
$
3,488


a 
Excludes outstanding shares reclassified to mandatorily redeemable capital stock.
b 
On January 1, 2012 Capital Stock, shares and par value, were converted to B1 and B2 shares under our new capital plan.

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

6

Federal Home Loan Bank of Chicago

Condensed Statements of Cash Flows (unaudited)
(Dollars in millions)
 
 
Six months ended June 30,
 
2013
 
2012
 
Operating
Net cash provided by (used in) operating activities
 
$
486

 
$
(8
)
 
Investing
Net change Federal Funds sold
 
(2,186
)
 
(747
)
 
 
Net change securities purchased under agreements to resell
 
1,975

 
(1,275
)
 
 
Advances -
 
 
 
 
 
 
    Principal collected
 
142,943

 
83,077

 
 
    Issued
 
(145,168
)
 
(83,577
)
 
 
MPF Loans held in portfolio-
 
 
 
 
 
 
    Principal collected
 
1,596

 
1,952

 
 
    Purchases
 
(33
)
 
(34
)
 
 
Trading securities -
 
 
 
 
 
 
    Proceeds from maturities, sales, and paydowns
 
2,008

 
1,548

 
 
    Purchases
 
(1,060
)
 
(687
)
 
 
Held-to-maturity securities-
 
 
 
 
 
 
    Short-term held-to-maturity securities, net
 
487

a 
(50
)
a 
 
    Proceeds from maturities
 
946

a 
1,003

a 
 
    Purchases
 
(7
)
a 
(18
)
a 
 
Available-for-sale securities -
 
 
 
 
 
 
    Proceeds from maturities and sales
 
561

 
714

 
 
Proceeds from sale of foreclosed assets
 
53

 
35

 
 
Capital expenditures for software and equipment
 
(4
)
 
(4
)
 
 
Net cash provided by (used in) investing activities
 
2,111

 
1,937

 
Financing
Net change deposits
 
(100
)
 
79

 
 
Net change securities sold under agreements to repurchase
 

 
(400
)
 
 
Net proceeds from issuance of consolidated obligations -
 
 
 
 
 
 
    Discount notes
 
397,096

 
191,476

 
 
    Bonds
 
12,865

 
22,620

 
 
Payments for maturing and retiring consolidated obligations -
 
 
 
 
 
 
    Discount notes
 
(406,772
)
 
(193,443
)
 
 
    Bonds
 
(8,784
)
 
(22,655
)
 
 
Net proceeds (payments) on derivative contracts with financing element
 
(35
)
 
(36
)
 
 
Proceeds from issuance of capital stock
 
159

 
125

 
 
Repurchase or redemption of capital stock
 
(213
)
 
(645
)
 
 
Redemptions of mandatorily redeemable capital stock
 
(59
)
 
(26
)
 
 
Cash dividends paid
 
(3
)
 
(2
)
 
 
Net cash provided by (used in) financing activities
 
(5,846
)
 
(2,907
)
 
 
Net increase (decrease) in cash and due from banks
 
(3,249
)
 
(978
)
 
 
Cash and due from banks at beginning of year
 
3,564

 
1,002

 
 
Cash and due from banks at end of period
 
$
315

 
$
24

 
Supplemental
Capital stock reclassified to mandatorily redeemable capital stock
 
$
56

 
$
32

 
 
Transfer of MPF Loans to real estate owned
 
44

 
41

 
a 
Short-term held-to-maturity securities, net consist of investment securities that have a maturity of less than 90 days when purchased. Proceeds from maturities and purchases consist of securities with maturities of 90 days or more.

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

7

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)


Note 1 – Background and Basis of Presentation

The Federal Home Loan Bank of Chicago a is a federally chartered corporation and one of 12 Federal Home Loan Banks (the FHLBs) that, with the Office of Finance, comprise the Federal Home Loan Bank System (the System).  The FHLBs are government-sponsored enterprises (GSE) of the United States of America and were organized under the Federal Home Loan Bank Act of 1932, as amended (FHLB Act), in order to improve the availability of funds to support home ownership.  We are supervised and regulated by the Federal Housing Finance Agency (FHFA), an independent federal agency in the executive branch of the United States government. We provide credit to members principally in the form of secured loans called advances. We also provide liquidity for home mortgage loans to members approved as Participating Financial Institutions (PFIs) through the Mortgage Partnership Finance® (MPF®) Program b.

Our accounting and financial reporting policies conform to generally accepted accounting principles in the United States of America (GAAP). The preparation of financial statements in conformity with GAAP requires the extensive use of management's estimates and assumptions that affect the reported amounts of assets and liabilities, as well as the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses. Actual results could differ from those estimates. Prior period amounts have been reclassified to conform to the current period presentation.

In the opinion of management, all normal recurring adjustments have been included for a fair statement of this interim financial information. These unaudited financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2012, included in our Annual Report on Form 10-K (2012 Form 10-K) filed with the SEC.
We do not consolidate any of our investments in variable interest entities. Our investments in variable interest entities include, but are not limited to, senior interests in private label mortgage backed securities (MBS), and Family Federal Education Loan Program (FFELP) asset backed securities (ABS). We have evaluated our investments in variable interest entities as of the periods presented to determine whether or not we are a primary beneficiary in any of them. The primary beneficiary is required to consolidate a variable interest entity. The primary beneficiary is the enterprise that has both of the following characteristics:
 
The power to direct the activities of a variable interest entity that most significantly impact the entity's economic performance.
 
The obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity.
Based on these characteristics, we have determined that consolidation accounting is not required for our variable interest entities. Further, we have not provided financial or other support (explicitly or implicitly) during the periods presented in our financial statements to these variable interest entities that we were not previously contractually required to provide nor do we intend to provide such support in the future.
The carrying amounts and classification of the assets that relate to these variable interest entities are shown in investment securities in our statements of condition. We have no liabilities related to these variable interest entities. Our maximum loss exposure for our variable interest entities is limited to the carrying amount.

We present restricted retained earnings resulting from the Joint Capital Enhancement Agreement as a separate line item in the Capital section of our statement of condition. This restricted retained earnings amount does not represent expenses or losses determined under GAAP. Further, we do not charge our expenses or losses to this restricted retained earnings amount nor do we transfer any of the restricted retained earnings amount to net income. Refer to Note 15 - Capital Stock and Mandatorily Redeemable Capital Stock (MRCS) on page F-56 in our 2012 Form 10-K for further details.

In April of 2013, we received approval from the FHFA and our Board of Directors to implement the Community First TM Fund, which is structured as an on-balance sheet revolving pool of funds, with a mission to provide access to capital that supports meeting economic development and affordable housing needs in the communities that our members serve in Illinois and Wisconsin. As a result, we recognized the reversal of the $50 million charge we previously recognized in the fourth quarter of 2011 through "Non-interest expense - Other community investment” in our Statement of Income. The reversal will not be included in our AHP assessment for 2013 since we already have paid our AHP assessment attributable to the $50 million charge in 2011.

For purposes of the statements of cash flows, we consider only cash and due from banks as cash and cash equivalents.


                                                                        
a 
Unless otherwise specified, references to we, us, our, and the Bank are to the Federal Home Loan Bank of Chicago.
b 
“Mortgage Partnership Finance”, “MPF”, and “MPF Xtra” are registered trademarks of the Federal Home Loan Bank of Chicago. “Community First” is a trademark of the Federal Home Loan Bank of Chicago.

8

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 2 – Summary of Significant Accounting Policies

Our Summary of Significant Accounting Policies can be found in our 2012 Form 10-K starting on page F-11. There have been no significant changes in accounting policies since 2012.


Note 3 – Recently Issued but Not Yet Adopted Accounting Standards

Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest rate for Hedge Accounting Purposes
In July of 2013, the FASB issued amendments to existing accounting guidance that permits the Fed Funds Effective Swap Rate (OIS rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes and removes the restriction on using different benchmark rates for similar hedges. The OIS rate is the fixed rate on a U.S. dollar, constant-notional interest rate swap that has its variable-rate leg referenced to the Fed Funds effective rate with no additional spread over the Fed Funds effective rate on that variable-rate leg. That fixed rate is the derived rate that would result in the swap having a zero fair value at inception because the present value of fixed cash flows, based on that rate, equates to the present value of the variable cash flows. The amendments were effective prospectively for qualifying new or redesignated hedging relationships that were entered into on or after July 17, 2013.  We are in the process of evaluating the potential effect the amendments may have on our hedging strategies.
Joint and Several Liability Arrangements
In February of 2013, the FASB issued new accounting guidance for obligations resulting from joint and several liability arrangements, except for obligations otherwise accounted for elsewhere within GAAP, such as guarantees. The new guidance requires us to measure obligations from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. Further, any additional estimated amount we expect to pay on behalf of other FHLBs also would be recognized at the reporting date. The accounting for guarantee obligations involving joint and several liability arrangements is not within the scope of the new guidance as the FASB decided to retain existing GAAP accounting guidance for such guarantees. Accordingly, our existing accounting for our guarantee to other FHLBs involving our joint and several liability arrangement with them will not change. The new guidance becomes effective January 1, 2014 and is required to be applied retrospectively to all prior periods presented for our obligations that exist as of January 1, 2014. Earlier adoption is permitted. The new guidance is not expected to have an effect on our operating activities or financial statements. For further discussion of our joint and several liability see Note 11 - Consolidated Obligations to the financial statements in our 2012 Form 10-K.
Asset Classification and Charge-off Provisions
On April 9, 2012, the FHFA 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). 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. On December 3, 2012, the FHFA issued questions and answers regarding AB 2012-02 that clarified various implementation issues. Advisory Bulletin 2012-02 was effective upon issuance; however, on May 13, 2013, the FHFA issued AB 2013-02, Clarification of Implementation for Advisory Bulletin 2012-02, Framework for Adversely Classifying Loans, Other Real Estate Owned, and Other Assets and Listing Assets for Special Mention, which clarified that implementation of the asset classification framework may occur in two phases. The asset classification provisions in Advisory Bulletin 2012-02 should be implemented by January 1, 2014. The charge-off provisions have been extended and should be implemented no later than January 1, 2015.
AB 2012-02 establishes a standard and uniform methodology for classifying assets, prescribes the timing of asset charge-offs (excluding investment securities), provides measurement guidance with respect to determining our allowance for credit losses, and fair value measurement guidance for real estate owned or “REO” (e.g., use of appraisals). We are in the process of determining the financial statement effects of implementing AB 2012-02, including whether or not to adopt charge-off provisions concurrently with the asset classification provisions. In this regard, we believe that the charge-off provisions represent a change in accounting principle. Consistent with guidance in the SEC's Financial Reporting Manual, a preferability letter is not required given that the change represents a mandatory change in accounting principle resulting from regulatory guidance. Additionally, our transition to these charge-off provisions is anticipated to be on a prospective basis since we deem it impracticable to retrospectively apply these charge-off provisions. Specifically, we do not believe it is possible to distinguish objectively the information required to estimate charge-offs under these provisions that both:
Provides evidence of circumstances that existed on the date(s) at which those amounts would be recognized, measured, or disclosed under retrospective application.

Would have been available when the financial statements for that prior period were issued.


9

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 4 – Interest Income and Interest Expense
The following table presents interest income and interest expense for the periods indicated:
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2013
 
2012
 
2013
 
2012
Interest income -
 
 
 
 
 
 
 
Federal Funds sold
$

 
$

 
$
1

 
$
1

Securities purchased under agreements to resell
2

 
1

 
4

 
2

Interest bearing deposits

 
1

 
1

 
1

 

 
 
 
 
 
 
Investment securities -

 
 
 
 
 
 
Trading
3

 
14

 
9

 
31

Available-for-sale
148

 
161

 
297

 
326

Held-to-maturity
82

 
110

 
172

 
224

Total investment securities
233

 
285

 
478

 
581

 

 
 
 
 
 
 
Advances-
 
 
 
 
 
 
 
Advances interest income
34

 
46

 
70

 
94

Advance prepayment fees, net of fair value hedge adjustments of
 $0, $(2), $0, and $(24)
8

 
9

 
13

 
35

Total Advances
42

 
55

 
83

 
129

 


 
 
 
 
 
 
MPF Loans held in portfolio, net
103

 
143

 
216

 
296

 


 
 
 
 
 
 
Total interest income
380

 
485

 
783

 
1,010

 

 
 
 
 
 
 
Interest expense -

 
 
 
 
 
 
Consolidated obligations -

 
 
 
 
 
 
Discount notes
74

 
77

 
151

 
153

Bonds
193

 
255

 
392

 
531

Total consolidated obligations
267

 
332

 
543

 
684

 

 
 
 
 
 
 
Subordinated notes
15

 
15

 
29

 
29

Total interest expense
282

 
347

 
572

 
713

 

 
 
 
 
 
 
Net interest income before provision for credit losses
98

 
138

 
211

 
297

Provision for (reversal of) credit losses
(2
)
 
2

 
(2
)
 
8

Net interest income
$
100

 
$
136

 
$
213

 
$
289


 


10

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 5 – Investment Securities

Our major security types presented in the tables below are defined as follows:

U.S. Government & other government related consists of the sovereign debt of the United States; debt issued by Fannie Mae, Freddie Mac, and the Federal Farm Credit Banks Funding Corporation; and non mortgage-backed securities of the Small Business Administration, Federal Deposit Insurance Corporation (FDIC), and Tennessee Valley Authority.
Federal Family Education Loan Program - asset backed securities (FFELP ABS).
Government Sponsored Enterprises (GSE) residential consists of mortgage-backed securities (MBS) issued by Fannie Mae and Freddie Mac.
Government-guaranteed residential consists of MBS issued by Ginnie Mae.
Private-label residential MBS.

Gains and losses on sales of securities are determined using the specific identification method and are included in non-interest gain (loss) on the statements of income.


Pledged Collateral

We transact most of our derivatives with large banks and major broker-dealers. Derivative transactions may be entered into either through an over-the-counter bilateral agreement with an individual counterparty or through a Futures Commission Merchant (FCM or clearing member) with a derivatives clearing organization (clearinghouse). We may pledge investment securities as collateral under these agreements, and in such cases, the amount pledged will be noted on the face of the Statements of Condition. We pledged trading securities as collateral for our initial margin with derivative clearing organizations as of June 30, 2013. We did not pledge any investment securities as collateral as of December 31, 2012. See Note 9 - Derivatives and Hedging Activities for further details.

Trading Securities

The following table presents the fair value of our trading securities:

As of
 
June 30, 2013
 
December 31, 2012
U.S. Government & other government related
 
$
174

 
$
1,106

MBS:
 
 
 
 
GSE residential
 
89

 
120

Government-guaranteed residential
 
3

 
3

Total MBS
 
92

 
123

Total trading securities
 
$
266

 
$
1,229



At June 30, 2013, and 2012, we had net year-to-date unrealized gains (losses) of $(9) million and $(25) million on trading securities still held at period end.


11

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Amortized Cost Basis and Fair Value – Available-for-Sale Securities (AFS)

 
Amortized Cost Basis
 
Non-Credit OTTI Recognized in AOCI (Loss)
 
Gross Unrealized Gains in AOCI
 
Gross Unrealized Losses in AOCI
 
Carrying Amount and Fair
Value
As of June 30, 2013
 
 
 
 
 
 
 
 
 
U.S. Government & other government related
$
629

 
$

 
$
37

 
$
(1
)
 
$
665

FFELP ABS
6,664

 

 
439

 
(22
)
 
7,081

 
 
 
 
 
 
 
 
 
 
MBS:
 
 
 
 
 
 
 
 
 
GSE residential
11,034

 

 
570

 
(41
)
 
11,563

Government-guaranteed residential
2,692

 

 
154

 

 
2,846

Private-label residential
73

 

 
3

 

 
76

Total MBS
13,799

 

 
727

 
(41
)
 
14,485

Total
$
21,092

 
$

 
$
1,203

 
$
(64
)
 
$
22,231

 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
 
U.S. Government & other government related
$
690

 
$

 
$
64

 
$

 
$
754

FFELP ABS
6,958

 

 
508

 
(13
)
 
7,453

 
 
 
 
 
 
 
 
 
 
MBS:
 
 
 
 
 
 
 
 
 
GSE residential
11,402

 

 
880

 
(54
)
 
12,228

Government-guaranteed residential
2,758

 

 
192

 

 
2,950

Private-label residential
78

 
(8
)
 

 
(1
)
 
69

Total MBS
14,238

 
(8
)
 
1,072

 
(55
)
 
15,247

Total
$
21,886

 
$
(8
)
 
$
1,644

 
$
(68
)
 
$
23,454



12

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Amortized Cost, Carrying Amount, and Fair Value - Held-to-Maturity Securities (HTM)

 
Amortized
Cost Basis
 
Non-credit OTTI Recognized in AOCI (Loss)
 
Carrying
Amount
 
Gross
Unrecognized
Holding 
Gains
 
Gross
Unrecognized
Holding 
Losses
 
Fair Value
As of June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
U.S. Government & other government related
$
1,933

 
$

 
$
1,933

 
$
75

 
$
(1
)
 
$
2,007

State or local housing agency
23

 

 
23

 

 

 
23

 
 
 
 
 
 
 
 
 
 
 
 
MBS:
 
 
 
 
 
 
 
 
 
 
 
GSE residential
3,616

 

 
3,616

 
218

 

 
3,834

Government-guaranteed residential
1,302

 

 
1,302

 
41

 

 
1,343

Private-label residential
1,666

 
(350
)
 
1,316

 
415

 
(3
)
 
1,728

Total MBS
6,584

 
(350
)
 
6,234

 
674

 
(3
)
 
6,905

Total
$
8,540

 
$
(350
)
 
$
8,190

 
$
749

 
$
(4
)
 
$
8,935

 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
U.S. Government & other government related
$
2,487

 
$

 
$
2,487

 
$
139

 
$

 
$
2,626

State or local housing agency
24

 

 
24

 

 

 
24

 
 
 
 
 
 
 
 
 
 
 
 
MBS:
 
 
 
 
 
 
 
 
 
 
 
GSE residential
4,282

 

 
4,282

 
377

 

 
4,659

Government-guaranteed residential
1,340

 

 
1,340

 
57

 

 
1,397

Private-label residential
1,815

 
(381
)
 
1,434

 
348

 
(6
)
 
1,776

Total MBS
7,437

 
(381
)
 
7,056

 
782

 
(6
)
 
7,832

Total
$
9,948

 
$
(381
)
 
$
9,567

 
$
921

 
$
(6
)
 
$
10,482



 


13

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Aging of Unrealized Temporary Losses

The following tables present unrealized temporary losses on our AFS and HTM portfolio for periods less than 12 months and for 12 months or more. We recognized no OTTI charges on these unrealized loss positions because we expect to recover the entire amortized cost basis, we do not intend to sell these securities, and we believe it is more likely than not that we will not be required to sell them prior to recovering their amortized cost basis. In the tables below, in cases where the gross unrealized losses for an investment category is less than $1 million, the balance is not reported.


Available-for-Sale Securities

 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
 
Fair Value
 
Gross Unrealized Losses
 
Fair Value
 
Gross Unrealized Losses
 
Fair Value
 
Gross Unrealized Losses
 
As of June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government & other government related
 
$
42

 
$
(1
)
 
$

 
$

 
$
42

 
$
(1
)
 
FFELP ABS
 
$
34

 
$

 
$
1,027

 
$
(22
)
 
$
1,061

 
$
(22
)
 
 
 
 
 
 
 

 
 
 
 
 
 
 
MBS:
 
 
 
 
 

 
 
 
 
 
 
 
GSE residential
 
38

 

 
3,347

 
(41
)
 
3,385

 
(41
)
 
Private-label residential
 

 

 
17

 

 
17

 

 
Total MBS
 
38

 

 
3,364

 
(41
)
 
3,402

 
(41
)
 
Total
 
$
114

 
$
(1
)
 
$
4,391

 
$
(63
)
 
$
4,505

 
$
(64
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
FFELP ABS
 
$

 
$

 
$
1,079

 
$
(13
)
 
$
1,079

 
$
(13
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
MBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
GSE residential
 
40

 

 
3,540

 
(54
)
 
3,580

 
(54
)
 
Private-label residential
 

 

 
69

 
(9
)
a 
69

 
(9
)
a 
Total MBS
 
40

 

 
3,609

 
(63
)
 
3,649

 
(63
)
 
Total
 
$
40

 
$

 
$
4,688

 
$
(76
)
 
$
4,728

 
$
(76
)
 

a 
Includes $45 million of gross unrealized/unrecognized recoveries in fair value at December 31, 2012.

14

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)



Held-to-Maturity Securities

 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
 
Fair Value
 
Gross Unrealized Losses
 
Fair Value
 
Gross Unrealized Losses
 
Fair Value
 
Gross Unrealized Losses
 
As of June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government & other government related
 
$
7

 
$
(1
)
 
$

 
$

 
$
7

 
$
(1
)
 
State or local housing agency
 
10

 

 

 

 
10

 

 
MBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
GSE residential
 
9

 

 

 

 
9

 

 
Private-label residential
 
29

 

 
1,600

 
(353
)
 
1,629

 
(353
)
 
Total MBS
 
38

 

 
1,600

 
(353
)
 
1,638

 
(353
)
 
Total
 
$
55

 
$
(1
)
 
$
1,600

 
$
(353
)
 
$
1,655

 
$
(354
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
Private-label residential MBS Held-to-maturity
 
$

 
$

 
$
1,640

 
$
(387
)
 
$
1,640

 
$
(387
)
 



Contractual Maturity Terms

The table below presents the amortized cost basis and fair value of AFS and HTM securities by contractual maturity, excluding ABS and MBS securities. These securities are excluded because their expected maturities may differ from their contractual maturities if borrowers of the underlying loans elect to prepay their loans.

 
 
Available-for-Sale
 
Held-to-Maturity
As of June 30, 2013
 
Amortized Cost Basis
 
Fair 
Value
 
Carrying Amount
 
Fair 
Value
Year of Maturity -
 
 
 
 
 
 
 
 
Due in one year or less
 
$

 
$

 
$
280

 
$
281

Due after one year through five years
 
84

 
88

 
53

 
53

Due after five years through ten years
 
97

 
103

 
473

 
495

Due after ten years
 
448

 
474

 
1,150

 
1,201

ABS and MBS without a single maturity date
 
20,463

 
21,566

 
6,234

 
6,905

Total securities
 
$
21,092

 
$
22,231

 
$
8,190

 
$
8,935




Other-Than-Temporary Impairment

We recognize credit losses into earnings on securities in an unrealized loss position for which we do not expect to recover the entire amortized cost basis. Non-credit losses are recognized in AOCI since we do not intend to sell these securities and we believe it is more likely than not that we will not be required to sell any investment security before the recovery of its amortized cost basis. The non-credit loss in AOCI on HTM securities are accreted back into the HTM securities over their remaining lives as an increase to the carrying amount, since we ultimately expect to collect these amounts. See Statements of Comprehensive Income on page 5.


15

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Significant Inputs Used to Determine OTTI

Our analysis for OTTI on our private-label MBS includes key modeling assumptions, significant inputs, and methodologies provided by an FHLB System OTTI Committee. We use the information provided to generate cash flow projections used in analyzing credit losses and determining OTTI for private-label MBS. The OTTI Committee was formed by the FHLBs to achieve consistency among the FHLBs in their analyses of the OTTI of private-label MBS. We are responsible for making our own determination of impairment, which includes determining the reasonableness of assumptions, significant inputs, and methodologies used, and performing the required present value calculations using appropriate historical cost bases and yields. 

In cases where the fair value of a private-label MBS is less than its amortized cost basis at the balance sheet date, we assess whether its entire amortized cost basis will be recovered. Specifically, we perform a cash flow analysis for substantially all of these securities that utilizes two models provided by independent third parties.

The first model considers borrower characteristics and the particular attributes of the loans underlying the securities, in conjunction with assumptions about future changes in home prices and interest rates, prepayment rates, default rates, and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core based statistical areas (CBSAs), which are based upon an assessment of the individual housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget; as currently defined, a CBSA must contain at least one urban area with a population of 10,000 or more people.

The second model uses the month-by-month projections of future loan performance derived from the first model and allocates the projected loan level cash flows and losses to the various security classes in the securitization structure in accordance with its prescribed cash flow and loss allocation rules.

As of June 30, 2013, we developed a short-term housing price forecast with projected changes ranging from -5.0% to +7.0% over the twelve month period beginning April 1, 2013. For the vast majority of markets, the short-term forecast has changes ranging from -3.0% to +5.0%.  Thereafter, home prices were projected to recover using one of five different recovery paths.

The following table presents the projected home price recovery by future month.

 
 
Recovery Range Annualized %
As of June 30, 2013
 
Low
 
High
1 - 6 months
 
0.0%
 
3.0%
7 - 12 months
 
1.0%
 
4.0%
13 - 18 months
 
2.0%
 
4.0%
19 - 30 months
 
2.0%
 
5.0%
31 - 54 months
 
2.0%
 
6.0%
Thereafter
 
2.3%
 
5.6%


Based on these inputs and assumptions for the three months ended June 30, 2013, we had no OTTI charges. We also had no OTTI charges for the three months ended March 31, 2013.
 
 
 
 
 
 
 
 
 
 
 

16

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Unpaid Principal Balance, Amortized Cost, Carrying Amount, and Fair Value - OTTI Private-Label MBS

The table below presents only private-label MBS that have incurred OTTI. Each private-label MBS presented below is classified as either prime, subprime, or Alt-A. Such classification depends upon the nature of the majority of underlying mortgages collateralizing each private-label MBS based on the issuer's classification, or as published by a nationally recognized statistical rating organization (NRSRO), at the time of issuance of the MBS.  On October 15, 2010, we instituted litigation relating to sixty-four private label MBS bonds purchased by us in an aggregate original principal amount of approximately $4.29 billion. Our complaints assert claims for untrue or misleading statements in the sale of securities, and it is possible that the classifications of private-label MBS, as well as other statements made about the securities by the issuer, are inaccurate. 

As of June 30, 2013
 
Unpaid Principal Balance
 
Amortized Cost Basis
 
Non-Credit OTTI
 
Gross Unrealized Gains
 
Carrying Amount
 
Fair Value
OTTI AFS Securities-
Private-label residential MBS:
 
 
 
 
 
 
 
 
 
 
 
 
     Alt-A
 
$
110

 
$
71

 

 
$
3

 
$
74

 
$
74

 
 
 
 
 
 
 
 
 
 
 
 
 
OTTI HTM Securities-
Private-label residential MBS:
 
 
 
 
 
 
 
 
 
 
 
 
     Prime
 
$
1,255

 
$
977

 
$
(249
)
 
$

 
$
728

 
$
991

     Subprime
 
772

 
492

 
(101
)
 

 
391

 
541

Total OTTI HTM securities
 
$
2,027

 
$
1,469

 
$
(350
)
 
$

 
$
1,119

 
$
1,532


 
 
 
 
 
 
 
 
 
 
 
 


17

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 6 – Advances

We offer a wide range of fixed- and variable-rate advance products with different maturities, interest rates, payment characteristics and optionality. The following table presents our advances by callable/putable features:

As of
 
June 30, 2013
 
December 31, 2012
Noncallable/nonputable
 
$
13,749

 
$
11,616

Callable
 
891

 
776

Putable
 
1,925

 
1,948

Total par value
 
16,565

 
14,340

Hedging adjustments
 
71

 
166

Other adjustments
 
27

 
24

Total advances
 
$
16,663

 
$
14,530



The following table presents our advances by redemption terms:

As of June 30, 2013
 
Amount  
 
Weighted Average Interest Rate
 
Next Maturity or Call Date  
 
Next Maturity or Put Date  
Due in one year or less
 
$
7,441

 
0.38
%
 
$
8,325

 
$
9,354

One to two years
 
1,093

 
1.86
%
 
1,098

 
1,090

Two to three years
 
1,188

 
2.33
%
 
888

 
722

Three to four years
 
1,632

 
3.41
%
 
1,475

 
1,097

Four to five years
 
4,213

 
1.18
%
 
3,836

 
3,424

More than five years
 
998

 
2.89
%
 
943

 
878

Total par value
 
$
16,565

 
1.27
%
 
$
16,565

 
$
16,565





Credit Risk Concentration and Collateral Pledged

The following advance borrowers exceeded 10% of our total advances outstanding:

As of June 30, 2013
 
Par Value Outstanding
 
% of Total Outstanding
BMO Harris Bank N.A.
 
$
2,375

 
14
%
Associated Bank, N.A.
 
2,150

 
13
%
The Northern Trust Company
 
1,815

 
11
%


We lend to members within our district according to Federal statutes, including the FHLB Act. The FHLB Act requires us to hold, or have access to, collateral to secure our advances, and we do not expect to incur any credit losses on advances. We have policies and procedures in place that are designed to manage our credit risk, including requirements for physical possession or control of pledged collateral, restrictions on borrowing, verifications of collateral and continuous monitoring of borrowings and the member's financial condition. We continue to monitor the collateral and creditworthiness of our borrowers. Based on the collateral pledged as security for advances and our credit analyses of our members' financial condition and our credit extension and collateral policies, we expect to collect all amounts due according to the contractual terms of our advances. See Note 8 - Allowance for Credit Losses for information related to our credit risk on advances and allowance methodology for credit losses.

18

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 7 – MPF Loans

We developed the MPF Program to allow us to invest in mortgages to help fulfill our housing mission and provide an additional source of liquidity to our members. The MPF Program is a secondary mortgage market structure under which we acquired and funded eligible mortgage loans from or through PFIs, and in some cases we purchased participations in pools of eligible mortgage loans from other FHLBs (MPF Banks). MPF Loans are defined as conforming conventional and Government fixed-rate mortgage loans secured by one-to-four family residential properties with maturities ranging from 5 years to 30 years or participations in such mortgage loans.

The following table presents information on MPF Loans held in our portfolio by contractual maturity at time of purchase. All are fixed-rate. Government is comprised of loans insured by the Federal Housing Administration (FHA) or the Department of Housing and Urban Development (HUD) and loans guaranteed by the Department of Veteran Affairs (VA) or Department of Agriculture Rural Housing Service (RHS). MPF Loans outstanding continue to decrease as a result of our ongoing strategy to not add MPF Loans to our balance sheet, except for loans being acquired under our affordable housing programs.
 
As of
 
June 30, 2013
 
December 31, 2012
Medium term (15 years or less)
 
$
2,059

 
$
2,557

Long term (greater than 15 years)
 
6,736

 
7,783

Total unpaid principal balance
 
8,795

 
10,340

Net premiums, credit enhancement and deferred loan fees
 
30

 
37

Hedging adjustments
 
79

 
97

Total before allowance for credit losses
 
8,904

 
10,474

Allowance for credit losses
 
(34
)
 
(42
)
Total MPF Loans held in portfolio, net
 
$
8,870

 
$
10,432

 
 
 
 
 
Conventional mortgage loans
 
$
6,954

 
$
8,260

Government insured mortgage loans
 
1,841

 
2,080

Total unpaid principal balance
 
$
8,795

 
$
10,340



See Note 8 - Allowance for Credit Losses for information related to our credit risk on MPF Loans and allowance for credit losses methodology.


19

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 8 – Allowance for Credit Losses

We have established an allowance methodology for each of our portfolio segments:

credit products (advances, letters of credit and other extensions of credit to borrowers);
conventional MPF Loans held for portfolio;
government MPF Loans held for portfolio; and
term Federal Funds sold and term securities purchased under agreements to resell.

For detailed information on these methodologies and our accounting policies please see Note 8 - Allowance for Credit Losses to the financial statements in our 2012 Form 10-K.

Credit Products

For the periods presented, we had no credit products that were past due, on nonaccrual status, or considered impaired. In addition, there have been no troubled debt restructurings related to our credit products during the periods then ended. Based upon the collateral we held as security, our credit extension and collateral policies, our credit analysis and the repayment history on credit products, we do not believe that any credit losses have been incurred on our credit products; accordingly, we have not recorded any allowance for credit losses for our credit products. Additionally, no liability was recorded to reflect credit losses for our credit products with off-balance sheet credit exposures.


Conventional MPF Loans
MPF Risk Sharing Structure

For a definition of MPF Risk Sharing Structure see page F-36 in our 2012 Form 10-K. We share the risk of credit losses on conventional MPF Loan products with our PFIs (excluding the MPF Xtra product) by structuring potential losses on conventional MPF Loans into layers with respect to each master commitment (MC). We require that conventional MPF Loans held in our portfolio be credit enhanced at inception so that our risk of loss is limited to be equivalent to the losses of an investor in an AA rated mortgage backed security. As a part of our methodology to determine the amount of credit enhancement necessary, we analyze the risk characteristics of each MPF Loan using a model licensed from an NRSRO. We use the model to evaluate loan data provided by the PFI as well as other relevant information.

The table below presents the impact of the MPF Risk Sharing Structure and severity rates on our allowance for credit losses. For detailed definitions of how Total Severity Rate and Credit Loss Severity Rate are calculated, see Loss Severity on page F-38 in our 2012 Form 10-K.
  
As of
 
June 30, 2013
 
December 31, 2012
 
Total Severity Rate
 
36.0
%
 
38.0
%
 
Credit Loss Severity Rate
 
20.0
%
 
22.0
%
 
Total estimated losses outstanding
 
$
72

 
$
88

 
Less: losses expected to be absorbed by MPF Risk Sharing Structure
 
(18
)
a 
(23
)
a 
Our share of total losses
 
54

 
65

 
Less: non-credit losses
 
(24
)
 
(27
)
 
Credit losses
 
30

 
38

 
Plus: other estimated credit losses in the remaining portfolio
 
4

 
4

 
Allowance for credit losses on conventional MPF Loans
 
$
34

 
$
42

 

a 
Represents aggregate of credit enhancements across all master commitments expected to be recovered. Credit enhancement from one master commitment may not be used to offset credit losses incurred by another master commitment.





20

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

The following table presents the changes in the allowance for credit losses on conventional MPF Loans.

 
 
June 30, 2013
 
June 30, 2012
For the three months ended
 
 
 
 
Balance, beginning of period
 
$
40

 
$
49

Losses charged to the allowance
 
(4
)
 
(3
)
Provision for (reversal of) credit losses
 
(2
)
 
2

Balance, end of period
 
$
34

 
$
48

For the six months ended
 
 
 
 
Balance, beginning of period
 
$
42

 
$
45

Losses charged to the allowance
 
(6
)
 
(5
)
Provision for (reversal of) credit losses
 
(2
)
 
8

Balance, end of period
 
$
34

 
$
48



The following table presents the recorded investment by impairment methodology.

As of
 
June 30, 2013
 
December 31, 2012
Specifically identified and individually evaluated for impairment
 
$
23

 
$
30

Homogeneous pools of loans and collectively evaluated for impairment
 
11

 
12

Allowance assigned to conventional MPF Loans
 
$
34

 
$
42

 
 
 
 
 
Individually evaluated for impairment - with an allowance
 
$
202

 
$
230

Collectively evaluated for impairment
 
6,881

 
8,190

Recorded investment in conventional MPF Loans
 
$
7,083

 
$
8,420



Government MPF Loans Held for Portfolio

We invest in fixed-rate government MPF Loans which are insured or guaranteed by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Rural Housing Service of the Department of Agriculture (RHS), and/or by the Department of Housing and Urban Development (HUD). The PFI provides and maintains insurance or a guaranty from these agencies. The PFI is responsible for compliance with all government agency requirements and for obtaining the benefit of the applicable insurance or guaranty with respect to defaulted government MPF Loans. Any losses incurred on such loans that are not recovered from the issuer or guarantor, are absorbed by the servicing PFIs. Therefore, we only have credit risk for these loans if the servicing PFI fails to pay for losses not covered by FHA or HUD insurance, or VA or RHS guarantees. In this regard, based on our assessment of our servicing PFIs, we did not establish an allowance for credit losses for our government MPF Loan portfolio as of the periods presented. Further, due to the government guarantee or insurance, these loans are not placed on nonaccrual status or disclosed as troubled debt restructurings.


21

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Credit Quality Indicators - MPF Loans

The table below summarizes our recorded investment in MPF Loans by our key credit quality indicators.

 
 
June 30, 2013
 
December 31, 2012
As of
 
Conventional
 
Government
 
Total
 
Conventional
 
Government
 
Total
Past due 30-59 days
 
$
147

 
$
94

 
$
241

 
$
180

 
$
116

 
$
296

Past due 60-89 days
 
46

 
26

 
72

 
59

 
42

 
101

Past due 90 days or more
 
222

 
182

 
404

 
254

 
208

 
462

Total past due
 
415

 
302

 
717

 
493

 
366

 
859

Total current
 
6,668

 
1,565

 
8,233

 
7,927

 
1,741

 
9,668

Total recorded investment
 
$
7,083

 
$
1,867

 
$
8,950

 
$
8,420

 
$
2,107

 
$
10,527

In process of foreclosure
 
$
113

 
$
62

 
$
175

 
$
149

 
$
76

 
$
225

Serious delinquency rate a
 
3.16
%
 
9.70
%
 
4.53
%
 
3.03
%
 
9.86
%
 
4.40
%
Past due 90 days or more still accruing interest b
 
$
63

 
$
181

 
$
244

 
$
67

 
$
208

 
$
275

On nonaccrual status
 
$
207

 
$

 
$
207

 
$
234

 
$

 
$
234

a 
MPF Loans that are 90 days or more past due or in the process of foreclosure as a percentage of the total recorded investment.
b 
Consists of MPF Loans that are either government mortgage loans or conventional mortgage loans that are well secured (by collateral that have a realizable value sufficient to discharge the debt or by the guarantee or insurance, such as PMI, of a financially responsible party) and in the process of collection.


Troubled Debt Restructurings

Effective December 31, 2012, we began characterizing MPF Loans as troubled debt restructurings (TDRs) in cases where they were discharged under Chapter 7 bankruptcy and they were not reaffirmed by the borrower, except for cases in which we expect to collect the recorded investment in full because of credit enhancements or government insurance or guarantees. In such cases, we have not granted a concession since we expect to collect all amounts due, including interest accrued at the original contract rate. We did not previously report these MPF Loans as troubled debt restructurings unless they were modified under our troubled debt restructuring modification program. In prior reporting periods, we reported these MPF Loans on nonaccrual status within 60 days of receipt of the notification of filing from the bankruptcy court. Further, we continue to include the recorded investment of these MPF Loans in our nonaccrual status reported amount, which means these MPF Loans are included in both categories for footnote disclosure purposes.

In the event a borrower qualifies for a troubled debt restructuring under our program, we modify the borrower's monthly payment for a period of up to 36 months to try to achieve a target housing expense ratio of not more than 31% of their monthly qualifying income.   Any and all delinquent interest on the loan may be capitalized as long as the resulting principal balance does not exceed the original principal balance, otherwise all delinquent interest is written off.  Next, we re-amortize the new outstanding balance to reflect a principal and interest payment for a term not to exceed 40 years and attempt to achieve the target housing expense ratio. This results in a balloon payment at the original maturity date of the loan as the maturity date and number of remaining monthly payments are not adjusted.  If the target housing expense ratio is still not met, we reduce the interest rate in 0.125% increments below the original note rate, to a floor rate of 3.00% for up to 36 months, in an effort to further reduce principal and interest payments again, until the target housing expense ratio is met.

The table below presents our recorded investment balance in TDRs as of the dates presented. The recorded investment balances for modified loans still in their trial period were immaterial. Performing includes modified loans that are accruing interest. Nonperforming includes modified loans that are on nonaccrual status. The increase in TDRs is primarily due to the inclusion of Chapter 7 bankruptcies effective January 1, 2013, as discussed above.

 
 
June 30, 2013
 
December 31, 2012
As of
 
Performing
 
Nonperforming
 
Total
 
Performing
 
Nonperforming
 
Total
Recorded investment in conventional MPF Loan TDRs
 
$
17

 
$
28

 
$
45

 
$
14

 
$
3

 
$
17



During the three and six months ended June 30, 2013, we made troubled debt restructurings on our conventional MPF Loans of $12 million and $19 million, compared to $4 million and $5 million for the same periods in 2012. These amounts represent both

22

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

the pre- and post- modification recorded investment as of the date the troubled debt restructurings were consummated. Specifically, the modified terms do not fully take effect until after a three month trial period in which the borrower demonstrates an ability to pay under the modified terms during the trial period; however, we consider the conventional MPF Loan a troubled debt restructuring at the inception of the trial period. If the borrower fails to pay during the trial period, the payment terms revert back to the original agreement with the borrower. The pre- and post- modification amounts are the same as we did not record any write-offs either due to the forgiveness of principal or a direct write-off due to a confirmed loss.

Troubled debt restructurings from the previous 12 months that subsequently defaulted during the three months ended June 30, 2013, and 2012 were $7 million and $4 million; and for the six months ending June 30, 2013, and 2012, were $8 million and $8 million. A borrower is considered to have defaulted on a troubled debt restructuring if contractually due principal or interest payment is sixty days past due at any time during the past 12 months. The amount of nonperforming troubled debt restructurings are less than the amount that have subsequently defaulted either because a defaulted troubled debt restructuring subsequently became current or was transferred to REO.

Individually Evaluated Impaired Loans

The following table summarizes the recorded investment, unpaid principal balance, and related allowance of impaired MPF Loans individually assessed for impairment, which includes impaired collateral dependent MPF Loans and troubled debt restructurings. We had no impaired MPF Loans without an allowance for either date.

 
 
June 30, 2013
 
December 31, 2012
As of
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
Impaired conventional MPF Loans with an allowance
 
$
202

 
$
197

 
$
23

 
$
230

 
$
224

 
$
30


The following table summarizes the average recorded investment of impaired MPF Loans and related interest recognized.

 
 
June 30, 2013
 
June 30, 2012
For the periods ended
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
Three months
 
$
210

 
$

 
$
199

 
$
2

Six months
 
217

 

 
201

 
5



Term Federal Funds Sold and Term Securities Purchased Under Agreements to Resell

These financing receivables are short-term and the recorded balance approximates fair value. All federal funds sold were repaid according to the contractual terms. Federal Funds are only evaluated for purposes of an allowance for credit losses if the investment is not paid when due.

Securities purchased under agreements to resell are considered collateralized financing arrangements and effectively represent short-term loans with highly rated counterparties. The terms of these loans are structured such that if the market values of the underlying securities decrease 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, or the dollar value of the resale agreement will be decreased 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 is charged to earnings. Based upon the collateral held as security, we have determined that no allowance for credit losses was needed for our securities purchased under agreements to resell. All securities purchased under agreements to resell were repaid according to the contractual terms.


23

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 9 – Derivatives and Hedging Activities


Refer to Note 2 - Summary of Significant Accounting Polices to the financial statements in our 2012 Form 10-K for our accounting policies for derivatives.

In December of 2011, and as amended in January 2013, the FASB issued new disclosure requirements pertaining to offsetting (netting) of assets and liabilities. We adopted these new disclosure requirements retrospectively for all comparative periods presented effective January 1, 2013. The requirements require disclosure of both gross information and net information related to only derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing regardless of whether we offset these transactions in our statement of condition. A description of the rights of setoff related to these financial instruments, including the nature of those rights, also are required to be disclosed. We do not have repurchase agreements and reverse repurchase agreements or securities borrowing and securities lending transactions that are subject to offset in our statement of condition. As a result, we are only providing the required disclosures related to derivative instruments, which can be found below.

We transact most of our derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute consolidated obligations. Derivative transactions may be entered into through an over-the-counter bilateral agreement with an individual counterparty. Additionally, the Dodd-Frank Act's new statutory and regulatory requirements for cleared derivatives transactions, including those we utilize to hedge our interest rate and other risks, became effective June 10, 2013. As a result, we began to clear derivatives transactions as required through an FCM with a derivatives clearing organization (clearinghouse). We are not a derivative dealer and do not trade derivatives for speculative purposes.

Managing Credit Risk on Derivative Agreements

We are subject to credit risk due to the risk of nonperformance by counterparties to our derivative agreements. For bilateral derivative agreements, the degree of counterparty risk depends on the extent to which master netting arrangements are included in such contracts to mitigate the risk. We manage counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in our policies and FHFA regulations. We require collateral agreements on all derivatives that establish collateral delivery thresholds. Additionally, collateral related to derivatives with member institutions includes collateral assigned to us, as evidenced by a written security agreement, and held by the member institution for our benefit. Based on credit analyses and collateral requirements, we do not anticipate any credit losses on our derivative agreements. See Note 18 - Fair Value Accounting to the financial statements in our 2012 Form 10-K for discussion regarding our fair value methodology for derivative assets and liabilities, including an evaluation of the potential for the fair value of these instruments to be affected by counterparty credit risk.

Our over-the-counter bilateral derivative agreements contain provisions that require us to post additional collateral with our counterparties if there is deterioration in our credit rating, except for those derivative agreements with a zero unsecured collateral threshold for both parties, in which case positions are required to be fully collateralized regardless of credit rating. If our credit rating is lowered by a major credit rating agency, such as Standard and Poor's or Moody’s, we would be required to deliver additional collateral on derivatives in net liability positions. If our credit rating had been lowered from its current rating to the next lower rating, we would have been required to deliver up to an additional $107 million of collateral at fair value to our derivatives counterparties at June 30, 2013.

Cleared swaps are subject to initial and variation margin requirements established by the clearinghouse and its clearing members. We post initial and variation margin through the clearing member, on behalf of the clearinghouse, which could expose us to institutional credit risk in the event that a clearing member or the clearinghouse fail to meet their obligations. Clearing derivatives through a clearinghouse mitigates counterparty credit risk exposure because a central clearinghouse counterparty is substituted for individual counterparties and collateral is posted daily for changes in the value of cleared derivatives through an FCM.


24

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

The table below presents, as of June 30, 2013 and December 31, 2012, our gross and net derivative assets and liabilities by contract type and amount for our derivative agreements for which offsetting is permissible under U.S. GAAP. We present our derivative assets and liabilities on a net basis in our statement of condition. The net amount includes cash collateral and related accrued interest in cases where we have a legal right of setoff, by contract (e.g., master netting agreement) or otherwise, to discharge all or a portion of the debt owed to our counterparty by applying against the debt an amount that our counterparty owes to us. In addition to the cash collateral as noted in the following table, we also posted $11 million of trading securities, of which $3 million can be sold or repledged, as part of our initial margin related to cleared derivative transactions. A right of setoff exists when all of the following conditions are met:

We and our counterparty owe each other determinable amounts.
We have the right to set off the amount owed with the amount owed by the other party.
We intend to set off.
Our right of setoff is enforceable at law. In this regard, we believe that offsetting is appropriate based on evidence available to us, both positive and negative, that provides us with reasonable assurance that our right of setoff would be upheld in bankruptcy.
  
 
 
June 30, 2013
 
December 31, 2012
As of
 
Notional Amount  
 
Derivative Assets  
 
Derivative Liabilities  
 
Notional Amount  
 
Derivative Assets  
 
Derivative Liabilities  
Derivatives in hedge accounting relationships-
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
30,510

 
$
89

 
$
1,830

 
$
24,678

 
$
103

 
$
2,107

Total
 
30,510

 
89

 
1,830

 
24,678

 
103

 
2,107

Derivatives not in hedge accounting relationships-
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
14,915

 
446

 
355

 
13,352

 
691

 
656

Interest rate swaptions
 
5,795

 
124

 

 
8,690

 
160

 

Interest rate caps or floors
 
1,663

 
164

 

 
1,913

 
223

 

Mortgage delivery commitments
 
675

 
2

 
2

 
992

 
15

 
15

Total
 
23,048

 
736

 
357

 
24,947

 
1,089

 
671

Total before adjustments
 
$
53,558

 
825

 
2,187

 
$
49,625

 
1,192

 
2,778

Netting adjustments excluding cash collateral
 
 
 
(796
)
 
(796
)
 
 
 
(1,120
)
 
(1,120
)
Exposure at fair value
 
 
 
29

a 
1,391

 
 
 
72

a 
1,658

Cash collateral and related accrued interest on the collateral
 
 
 
(6
)
 
(1,281
)
 
 
 
(25
)
 
(1,576
)
Derivative assets and liabilities
 
 
 
$
23

 
$
110

 
 
 
$
47

 
$
82

a 
Includes derivative net accrued interest receivable of $5 million as of June 30, 2013, and $1 million as of December 31, 2012.


25

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

The table below shows the offsetting of derivative assets and liabilities for derivative instruments with legal right of offset as well as derivative instruments without the legal right of offset (i.e., mortgage delivery commitments). As of June 30, 2013, we held an immaterial amount of cleared derivative contracts.

 
 
June 30, 2013
 
December 31, 2012
As of
 
Derivative Assets  
 
Derivative Liabilities  
 
Derivative Assets  
 
Derivative Liabilities  
Gross recognized amount
 
$
823

 
$
2,185

 
$
1,177

 
$
2,763

Gross amounts of netting adjustments and cash collateral
 
(802
)
 
(2,077
)
 
(1,145
)
 
(2,696
)
Net amounts after offsetting adjustments
 
21

 
108

 
32

 
67

Derivatives and cash collateral without legal right of offset
 
2

 
2

 
15

 
15

Total derivatives recorded in Statements of Condition
 
23

 
110

 
47

 
82

Noncash collateral received or pledged and not offset-
 
 
 
 
 
 
 
 
Cannot be sold or repledged
 
20

 

 
30

 

Net unsecured amount
 
$
3

 
$
110

 
$
17

 
$
82



The tables below present the components of derivatives and hedging activities as presented in the statements of income.

 
 
Three months ended June 30,
 
Six months ended June 30,
 
For the periods ending
 
2013
 
2012
 
2013
 
2012
 
Fair value hedges -
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
9

 
$
(7
)
 
$
11

 
$
(3
)
 
Other
 

 

 

 
1

 
Fair value hedges - ineffectiveness net gain (loss)
 
9

 
(7
)
 
11

 
(2
)
 
Cash flow hedges - ineffectiveness net gain (loss)
 
2

 

 
3

 
2

 
Economic hedges -
 

 
 
 
 
 
 
 
Interest rate swaps
 
53

 
(44
)
 
64

 
(46
)
 
Interest rate swaptions
 
(11
)
 
18

 
(17
)
 
18

 
Interest rate caps/floors
 
(39
)
 
4

 
(58
)
 
(9
)
 
Mortgage delivery commitments
 
1

 

 
1

 

 
Net interest settlements
 
13

 
21

 
26

 
40

 
Economic hedges - net gain (loss)
 
17

 
(1
)
 
16

 
3

 
Net gains (losses) on derivatives and hedging activities
 
$
28

 
$
(8
)
 
$
30

 
$
3

 



26

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Fair Value Hedges

The following table presents, 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 our net interest income.

 
 
Gain (Loss) on Derivative
 
Gain (Loss) on Hedged Item
 
Total Ineffectiveness Gain (Loss) Recognized in Derivatives and Hedging Activities
 
Net Interest Settlements Effect on Net Interest Income a
 
Hedge Adjustments Amortized into Net Interest Income b
 
Three months ended
June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
Hedged item type -
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale securities
 
$
178

 
$
(172
)
 
$
6

 
$
(35
)
 
$

 
Advances
 
72

 
(69
)
 
3

 
(17
)
 
(1
)
 
MPF Loans held for portfolio
 

 

 

 

 
(9
)
 
Consolidated obligation bonds
 
(329
)
 
329

 

 
55

 
(6
)
 
Total
 
$
(79
)
 
$
88

 
$
9

 
$
3

 
$
(16
)
 
Three months ended
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Hedged item type -
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale securities
 
$
(113
)
 
$
109

 
$
(4
)
 
$
(33
)
 
$

 
Advances
 
(16
)
 
19

 
3

 
(21
)
 
(1
)
 
MPF Loans held for portfolio
 
2

 
(2
)
 

 
(1
)
 
(13
)
 
Consolidated obligation bonds
 
31

 
(37
)
 
(6
)
 
42

 
(7
)
 
Total
 
$
(96
)
 
$
89

 
$
(7
)
 
$
(13
)
 
$
(21
)
 
Six months ended
June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
Hedged item type -
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale investments
 
$
234

 
$
(227
)
 
$
7

 
$
(69
)
 
$

 
Advances
 
98

 
(92
)
 
6

 
(34
)
 
(2
)
 
MPF Loans held for portfolio
 

 

 

 

 
(19
)
 
Consolidated obligation bonds
 
(416
)
 
414

 
(2
)
 
102

 
(13
)
 
Total
 
$
(84
)
 
$
95

 
$
11

 
$
(1
)
 
$
(34
)
 
Six months ended
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Hedged item type -
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale investments
 
$
(77
)
 
$
75

 
$
(2
)
 
$
(65
)
 
$

 
Advances
 
(8
)
 
14

 
6

 
(45
)
 
(24
)
 
MPF Loans held for portfolio
 
1

 

 
1

 
(2
)
 
(27
)
 
Consolidated obligation bonds
 
7

 
(14
)
 
(7
)
 
80

 
(16
)
 
Total
 
$
(77
)
 
$
75

 
$
(2
)
 
$
(32
)
 
$
(67
)
 
a 
Represents the effect of net interest settlements attributable to existing derivative hedging instruments on net interest income. The effect of derivatives on net interest income is included in the interest income/expense line item of the respective hedged item type.
b 
Amortization of hedge adjustments is included in the interest income/expense line item of the respective hedged item type.


27

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Cash Flow Hedges

The following table presents our gains (losses) on our cash-flow hedging relationships recorded in income and other comprehensive income (loss). In cases where amounts are insignificant in the aggregate, we do not report a balance.

 
 
Amortization of Effective Portion Reclassified From AOCI to Interest
 
Ineffective Portion Reclassified to Derivatives and Hedging Activities
 
Total Reclassified Into Statements of Income
 
Effective Portion Recorded in AOCI
 
Change in OCI
 
Net Interest Settlements Effect on Net Interest Income a
Three months ended June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Advances -
interest rate floors
 
$
4

 
$

 
$
4

 
$

 
$
(4
)
 
$

Discount notes -
interest rate caps
 
(1
)
 

 
(1
)
 

 
1

 

Discount notes -
interest rate swaps
 

 
2

 
2

 
239

 
237

 
(67
)
Bonds -
interest rate swaps
 
(1
)
 

 
(1
)
 

 
1

 

Total
 
$
2

 
$
2

 
$
4

 
$
239

 
$
235

 
$
(67
)
Three months ended June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
Advances -
interest rate floors
 
$
4

 
$

 
$
4

 
$

 
$
(4
)
 
$

Discount notes -
interest rate caps
 
(2
)
 

 
(2
)
 

 
2

 

Discount notes -
interest rate swaps
 
(1
)
 

 
(1
)
 
(110
)
 
(109
)
 
(68
)
Bonds -
interest rate swaps
 
(1
)
 

 
(1
)
 

 
1

 

Total
 
$

 
$

 
$

 
$
(110
)
 
$
(110
)
 
$
(68
)
Six months ended June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Advances -
interest rate floors
 
$
7

 
$


$
7

 
$

 
$
(7
)
 
$

Discount notes -
interest rate caps
 
(1
)
 

 
(1
)
 

 
1

 

Discount notes -
interest rate swaps
 
(1
)
 
3

 
2

 
327

 
325

 
(134
)
Bonds -
interest rate swaps
 
(1
)
 

 
(1
)
 

 
1

 

Total
 
$
4

 
$
3

 
$
7

 
$
327

 
$
320

 
$
(134
)
Six months ended June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
Advances -
interest rate floors
 
$
8

 
$

 
$
8

 
$

 
$
(8
)
 
$

Discount notes -
interest rate caps
 
(4
)
 

 
(4
)
 

 
4

 

Discount notes -
interest rate swaps
 
(2
)
 
2

 

 
(58
)
 
(58
)
 
(135
)
Bonds -
interest rate swaps
 
(3
)
 

 
(3
)
 

 
3

 

Total
 
$
(1
)
 
$
2

 
$
1

 
$
(58
)
 
$
(59
)
 
$
(135
)
a 
Represents the effect of net interest settlements attributable to open derivative hedging instruments on net interest income. The effect of     derivatives on net interest income is included in the interest income/expense line item of the respective hedged item type.

There were no amounts reclassified from AOCI into earnings for the periods presented as a result of the discontinuance of cash-flow hedges because the original forecasted transactions failed to occur by the end of the originally specified time period or within a two-month period thereafter. The deferred net gains on derivative instruments in AOCI that are expected to be reclassified to earnings during the next twelve months were $10 million as of June 30, 2013. The maximum length of time over which we are hedging our exposure to the variability in future cash flows for forecasted transactions, excluding those forecasted transactions related to the payment of variable interest on existing financial instruments, is 7 years.

28

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 10 – Consolidated Obligations

The following table presents our consolidated obligation bonds, for which we are the primary obligor, including callable bonds that are redeemable in whole, or in part, at our discretion on predetermined call dates.

As of June 30, 2013
 
Contractual Maturity
 
Weighted Average Interest Rate
 
Next Maturity or Call Date
Due in one year or less
 
$
7,874

 
2.86
%
 
$
26,192

One to two years
 
2,338

 
3.25
%
 
2,923

Two to three years
 
3,923

 
3.55
%
 
3,453

Three to four years
 
1,890

 
3.31
%
 
1,250

Four to five years
 
6,429

 
1.83
%
 
1,551

Thereafter
 
14,271

 
2.11
%
 
1,356

Total par value
 
$
36,725

 
2.51
%
 
$
36,725



The following table presents our consolidated obligation discount notes for which we are the primary obligor. All are due in one year or less.

 
 
Carrying Amount
 
Par Value
 
Weighted Average Interest Rate
As of June 30, 2013
 
$
21,583

 
$
21,585

 
0.08
%
As of December 31, 2012
 
31,260

 
31,269

 
0.13
%


The following table presents consolidated obligation bonds outstanding by call feature:

As of
 
June 30, 2013
 
December 31, 2012
Noncallable
 
$
16,903

 
$
19,179

Callable
 
19,822

 
13,480

Par value
 
36,725

 
32,659

Bond premiums (discounts), net
 
22

 
13

Hedging adjustments
 
(506
)
 
(104
)
Fair value option adjustments
 
(2
)
 
1

Total consolidated obligation bonds
 
$
36,239

 
$
32,569



Note 11 – Subordinated Notes

Our subordinated notes outstanding mature on June 13, 2016. The subordinated notes are not obligations of, and are not guaranteed by, the United States government or any FHLBs other than us. The subordinated notes are unsecured obligations and rank junior in priority of payment to our senior liabilities. Senior liabilities include all of our existing and future liabilities, such as deposits, consolidated obligations for which we are the primary obligor and consolidated obligations of the other FHLBs for which we are jointly and severally liable. For further description of our subordinated notes see Note 13 - Subordinated Notes to the financial statements in our 2012 Form 10-K.

29

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)


Note 12 – Capital and Mandatorily Redeemable Capital Stock

Capital Rules

Under our capital plan our stock consists of two sub-classes of stock, Class B1 stock and Class B2 stock (together, Class B stock), both with a par value of $100 and redeemable on five years' written notice, subject to certain conditions. Under the capital plan, each member is required to own capital stock in an amount equal to the greater of a membership stock requirement or an activity stock requirement. Class B1 stock is available for purchase only to support a member's activity stock requirement. Class B2 stock is available to be purchased to support a member's membership stock requirement and any activity stock requirement.

Certain amendments to our capital plan became effective July 1, 2013, which among other things, allow our Board of Directors to set a threshold of between $5 million and $250 million on the amount of Class B2 stock that would otherwise be held for membership if a member has advances outstanding that have an activity stock requirement in excess of the threshold amount. In that case, the amount of Class B2 stock that exceeds such threshold and is necessary to support advance activity is automatically converted into Class B1 stock. This new threshold was initially set at $5 million, which means that we will convert to Class B1 capital stock any capital stock supporting advances that exceeds the lesser of the member's membership requirement or $5 million.

Under our capital plan, the Board of Directors may now periodically adjust members' activity stock requirement for certain new types of advances within a range of 2.0% and 6.0% of a member's outstanding advances. Each member's activity stock requirement remains at 5.0% of outstanding advances until the Board implements this provision.

Finally, under the capital plan, the cap on the membership stock requirement for each member is now $163.4 million. Under the plan, the cap on membership stock is equal to the lesser of (1) a cap set by the Board within a range of $25 million and $250 million, and (2) 9.9% of our total capital stock outstanding as of the prior December 31. Although the Board set an initial cap of $250 million, the operative cap under the plan of $163.4 million is based on the level of the Bank's capital stock at December 31, 2012.

Membership stock requirements will continue to be recalculated annually, whereas the activity stock requirement and any automatic conversion of Class B2 stock to Class B1 stock related to the new threshold will apply on a daily basis. We may only redeem or repurchase capital stock from a member if, following the redemption or repurchase, the member will continue to meet its minimum investment requirement and we remain in compliance with our regulatory capital requirements.

During the six months ended June 30, 2013, we repurchased excess capital stock totaling $189 million as part of our quarterly repurchase opportunities in February and May, as discussed in Note 14 - Regulatory Actions to the financial statements in our 2012 Form 10-K. Effective May 28, 2013, we announced completion of our quarterly excess capital stock repurchases program initiated in 2012 and our current practice of repurchasing excess capital stock held by members within three business days of receiving a repurchase request, subject to regulatory requirements and prudent business practices.


Minimum Capital Requirements

For details on our minimum capital requirements, see Minimum Capital Requirements after Conversion to New Capital Structure on page F-55 of our 2012 Form 10-K. We complied with our minimum regulatory capital requirements as shown below:

 
 
June 30, 2013
 
December 31, 2012
 
 
Requirement
 
Actual
 
Requirement
 
Actual
Risk-based capital
 
$
1,560

 
$
3,460

 
$
1,545

 
$
3,347

Total regulatory capital
 
$
2,540

 
$
3,460

 
$
2,783

 
$
3,347

Total regulatory capital ratio
 
4.00
%
 
5.45
%
 
4.00
%
 
4.81
%
Leverage capital
 
$
3,175

 
$
5,191

 
$
3,479

 
$
5,021

Leverage capital ratio
 
5.00
%
 
8.17
%
 
5.00
%
 
7.22
%

Total regulatory capital and leverage capital do not include accumulated other comprehensive income (loss). Under the FHFA regulation on capital classifications and critical capital levels for the FHLBs, we are adequately capitalized.


30

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Capital Concentration

As of June 30, 2013, BMO Harris Bank N.A. held $170 million, or 11%, of our total capital stock outstanding. No other members had capital stock exceeding 10%.


Mandatorily Redeemable Capital Stock

We reclassify capital stock from equity to mandatorily redeemable capital stock (MRCS) in our Statements of Condition and Statements of Cash Flows under conditions as further described in Mandatorily Redeemable Capital Stock on page F-56 in our 2012 Form 10-K.


Note 13 - Accumulated Other Comprehensive Income (Loss)

AOCI Reclassification Disclosures
In February of 2012, the FASB amended existing accounting guidance to enhance the transparency of reporting amounts reclassified out of AOCI into net income. We adopted this amended guidance on a prospective basis effective January 1, 2013. The effects on the line items of net income of significant amounts reclassified out of AOCI in their entirety within the same reporting are presented below. Additionally, cross-references to other disclosures currently required for other reclassification items that are not required to be reclassified directly to net income in their entirety in the same reporting period also are presented below. The amendments do not change the current requirements for reporting net income or other comprehensive income. As a result, the amendments did not have any effect on our operating activities or financial statements at the time of adoption.
The following table summarizes the income (loss) in AOCI for the periods indicated:

 
 
Net Unrealized on AFS
 
Non-credit OTTI on 
AFS
 
Net Unrealized on HTM
 
Non-credit OTTI on HTM
 
Net Unrealized on Cash Flow Hedges
 
Post-Retirement Plans
 
Total
Balance, December 31, 2011
 
$
1,113

 
$
(26
)
 
$
(5
)
 
$
(466
)
 
$
(1,049
)
 
$
2

 
$
(431
)
Net change in the period
 
212

 
5

 
2

 
50

 
(59
)
 

 
210

Balance, June 30, 2012
 
$
1,325

 
$
(21
)
 
$
(3
)
 
$
(416
)
 
$
(1,108
)
 
$
2

 
$
(221
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2012
 
$
1,576

 
$
(8
)
 
$
(3
)
 
$
(381
)
 
$
(1,078
)
 
$
1

 
$
107

Change in the period before reclassifications to net income
 
(437
)
 
8

 

 
31

 
327

 

 
(71
)
Period amounts reclassified from other comprehensive income (loss) to:
 
 
 
 
 
 
 
 
 
 
 
 
 


Net interest income
 

 

 
1

 

 
(4
)
 

 
(3
)
Non-interest gain (loss)
 

 

 

 

 
(3
)
 

 
(3
)
Non-interest expense
 

 

 

 

 

 
1

 
1

Net change in the period
 
(437
)
 
8

 
1

 
31

 
320

 
1

 
(76
)
Balance, June 30, 2013
 
$
1,139

 
$

 
$
(2
)
 
$
(350
)
 
$
(758
)
 
$
2

 
$
31




31

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 14- Fair Value Accounting


Fair Value Measurement
For our accounting policies regarding fair values see Note 2 - Summary of Significant Accounting Policies to the financial statements in our 2012 Form 10-K.


Fair Value Hierarchy
The fair value hierarchy is used to prioritize the valuation techniques as well as the inputs used to measure fair value for assets and liabilities carried at fair value on the statements of condition. The fair value hierarchy requires us 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.
Outlined below is the application of the fair value hierarchy to our financial assets and financial liabilities that are carried at fair value or disclosed in the notes to the financial statements:
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that we can access at the measurement date.
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable 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:

a. Quoted prices for similar assets or liabilities in active markets
b. Quoted prices for identical or similar assets or liabilities in markets that are not active
c. Inputs other than quoted prices that are observable for the asset or liability, for example:
1. Interest rates and yield curves observable at commonly quoted intervals
2. Implied volatilities
3. Credit spreads
d. Market-corroborated inputs.

Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs are used to measure fair value to the extent that relevant observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. However, the fair value measurement objective remains the same, that is, an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability. Therefore, unobservable inputs shall reflect the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk.

For instruments carried at fair value, we review the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of financial assets or liabilities from one level to another. Such reclassifications are reported as transfers in/out at fair value as of the beginning of the quarter in which the changes occur. We had no such transfers for the periods presented.

Valuation Techniques and Significant Inputs

A description of the valuation techniques and significant inputs is disclosed in Note 18 - Fair Value Accounting to the financial statements in our 2012 Form 10-K. There have been no significant changes in our valuation techniques since then.

Financial instruments carried at fair value in our statements of condition using Level 3 inputs were immaterial at June 30, 2013.


32

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Fair Value Estimates for Financial Instruments

The tables below are a summary of the fair value estimates and related levels in the fair value hierarchy. The carrying amounts are as recorded in the statements of condition under the indicated captions. These tables do not represent an estimate of the overall market value of us as a going concern; as they do not take into account future business opportunities and future net profitability of assets and liabilities.  The tables below are presented in the following order:

Financial instruments carried at amortized cost on our statements of condition.
Financial instruments carried at fair value on a recurring basis on our statements of condition.
Assets carried at fair value on a nonrecurring basis on our statements of condition.
 
 
 
 
 
Fair Value Hierarchy
 
 
Carrying Amount
 
Total Fair Value
 
Level 1
 
Level 2
 
Level 3
 
June 30, 2013
 
 
 
 
 
 
 
 
 
 
Financial Assets-
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
315

 
$
315

 
$
315

 
$

 
$

 
Federal Funds sold
2,186

 
2,186

 

 
2,186

 

 
Securities purchased under agreements to resell
4,525

 
4,525

 

 
4,525

 

 
Held-to-maturity securities
8,190

 
8,935

 

 
7,207

 
1,728

 
Advances
16,663

 
16,812

 

 
16,812

 

 
MPF Loans held in portfolio, net
8,870

 
9,474

 

 
9,287

 
187

 
Accrued interest receivable
101

 
101

 

 
101

 

 
Financial Liabilities-
 
 
 
 
 
 

 
 
 
Deposits
$
(716
)
 
$
(716
)
 
$

 
$
(716
)
 
$

 
Consolidated obligation discount notes
(21,583
)
 
(21,583
)
 

 
(21,583
)
 

 
Consolidated obligation bonds
(36,239
)
 
(37,254
)
 

 
(37,180
)
 
(74
)
a 
Accrued interest payable
(161
)
 
(161
)
 

 
(161
)
 

 
Mandatorily redeemable capital stock
(3
)
 
(3
)
 
(3
)
 

 

 
Subordinated notes
(1,000
)
 
(1,136
)
 

 
(1,136
)
 

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
 
 
 
 
 
Financial Assets-
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
3,564

 
$
3,564

 
$
3,564

 
$

 
$

 
Securities purchased under agreements to resell
6,500

 
6,500

 

 
6,500

 

 
Held-to-maturity securities
9,567

 
10,482

 

 
8,706

 
1,776

 
Advances
14,530

 
14,802

 

 
14,802

 

 
MPF Loans held in portfolio, net
10,432

 
11,227

 

 
11,015

 
212

 
Accrued interest receivable
116

 
116

 

 
116

 

 
Financial Liabilities-
 
 
 
 
 
 
 
 
 
 
Deposits
$
(816
)
 
$
(816
)
 
$

 
$
(816
)
 
$

 
Consolidated obligation discount notes
(31,260
)
 
(31,262
)
 

 
(31,262
)
 

 
Consolidated obligation bonds
(32,569
)
 
(34,323
)
 

 
(34,241
)
 
(82
)
a 
Accrued interest payable
(156
)
 
(156
)
 

 
(156
)
 

 
Mandatorily redeemable capital stock
(6
)
 
(6
)
 
(6
)
 

 

 
Subordinated notes
(1,000
)
 
(1,162
)
 

 
(1,162
)
 

 
a 
Amount represents debt carried at fair value under a fair value hedge strategy, not at fair value under the fair value option.



33

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Financial Instruments Measured at Fair Value on a Recurring Basis
The following table presents, for each hierarchy level, our assets and liabilities that are measured at fair value on the statements of condition on a recurring basis.
 
As of June 30, 2013
Level 1  
 
Level 2  
 
Level 3  
 
Netting Adjustment a
 
Total  
Assets -
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
U.S. Government & other government related
$

 
$
174

 
$

 
$

 
$
174

GSE residential MBS

 
89

 

 

 
89

Governmental-guaranteed residential MBS

 
3

 

 

 
3

Total Trading Securities

 
266

 

 

 
266

AFS securities:
 
 

 
 
 
 
 
 
U.S. Government & other government related

 
665

 

 

 
665

FFELP ABS

 
7,081

 

 

 
7,081

GSE residential MBS

 
11,563

 

 

 
11,563

Government-guaranteed residential MBS

 
2,846

 

 

 
2,846

Private-label residential MBS

 

 
76

 

 
76

Total AFS Securities

 
22,155

 
76

 

 
22,231

Advances

 
29

 

 

 
29

Derivative assets

 
801

b 
24

b 
(802
)
 
23

Total assets at fair value
$

 
$
23,251

 
$
100

 
$
(802
)
 
$
22,549

Level 3 as a percent of total assets at fair value
 
 
 
 
0.4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities -
 
 
 
 
 
 
 
 
 
Consolidated obligation discount notes
$

 
$
(75
)
 
$

 
$

 
$
(75
)
Consolidated obligation bonds

 
(2,548
)
 
(74
)
c 

 
(2,622
)
Derivative liabilities

 
(2,187
)
b 

 
2,077

 
(110
)
Total liabilities at fair value
$

 
$
(4,810
)
 
$
(74
)
 
$
2,077

 
$
(2,807
)
Level 3 as a percent of total liabilities at fair value
 
 
 
 
2.6
%
 
 
 
 

a 
The netting adjustment amount includes cash collateral (either received or paid by us) and related accrued interest in cases where we have a legal right of setoff, by contract (e.g., master netting agreement) or otherwise, to discharge all or a portion of the debt owed to our counterparty by applying against the debt an amount that our counterparty owes to us. See Note 9 - Derivatives and Hedging Activities for further details.
b 
Our derivative assets are, in part secured with cash collateral (Level 1) as described in Note 9 - Derivatives and Hedging Activities. However, we view our net derivative assets or liabilities as a single unit of account for purposes of classifying the total balance within the fair value hierarchy. Accordingly, we classify our derivative assets and liabilities as either Level 2 or Level 3 within the fair value hierarchy.
c 
Amount represents debt carried at fair value under a fair value hedge strategy, not at fair value under the fair value option.

34

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

As of December 31, 2012
 
Level 1  
 
Level 2  
 
Level 3  
 
Netting Adjustment a
 
Total  
Assets -
 
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
 
U.S. Government & other government related
 
$

 
$
1,106

 
$

 
$

 
$
1,106

GSE residential MBS
 

 
120

 

 

 
120

Governmental-guaranteed residential MBS
 

 
3

 

 

 
3

Total Trading Securities
 

 
1,229

 

 

 
1,229

AFS securities:
 
 
 
 
 
 
 
 
 
 
U.S. Government & other government related
 

 
754

 

 

 
754

FFELP ABS
 

 
7,453

 

 

 
7,453

GSE residential MBS
 

 
12,228

 

 

 
12,228

Government-guaranteed residential MBS
 

 
2,950

 

 

 
2,950

Private-label residential MBS
 

 

 
69

 

 
69

Total AFS Securities
 

 
23,385

 
69

 

 
23,454

Advances
 

 
9

 

 

 
9

Derivative assets
 

 
1,160

b 
32

b 
(1,145
)
 
47

Total assets at fair value
 
$

 
$
25,783

 
$
101

 
$
(1,145
)
 
$
24,739

Level 3 as a percent of total assets at fair value
 
 
 
 
 
0.4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities -
 
 
 
 
 
 
 
 
 
 
Consolidated obligation bonds
 

 
(1,251
)
 
(82
)
c 

 
(1,333
)
Derivative liabilities
 

 
(2,778
)
b 

 
2,696

 
(82
)
Total liabilities at fair value
 
$

 
$
(4,029
)
 
$
(82
)
 
$
2,696

 
$
(1,415
)
Level 3 as a percent of total liabilities at fair value
 
 
 
 
 
5.8
%
 
 
 
 

a 
The netting adjustment amount includes cash collateral (either received or paid by us) and related accrued interest in cases where we have a legal right of setoff, by contract (e.g., master netting agreement) or otherwise, to discharge all or a portion of the debt owed to our counterparty by applying against the debt an amount that our counterparty owes to us. See Note 9 - Derivatives and Hedging Activities for further details.
b 
Our derivative assets are, in part secured with cash collateral (Level 1) as described in Note 9 - Derivatives and Hedging Activities. However, we view our net derivative assets or liabilities as a single unit of account for purposes of classifying the total balance within the fair value hierarchy. Accordingly, we classify our derivative assets and liabilities as either Level 2 or Level 3 within the fair value hierarchy.
c 
Amount represents debt carried at fair value under a fair value hedge strategy, not at fair value under the fair value option.


35

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Level 3 Disclosures for Assets and Liabilities that are Measured at Fair Value on a Recurring Basis
The following table presents a reconciliation of assets and liabilities that are measured at fair value on the statements of condition using significant unobservable inputs (Level 3):
 
 
Level 3 Assets/Liabilities
 
Available-For-Sale
Private-Label MBS
 
Derivative Assets Interest-Rate Related
 
Consolidated Obligation Bonds
For the six months ended June 30, 2013
 
 
 
 
 
Balance at beginning of period
$
69

 
$
32

 
$
(82
)
Gains (losses) realized and unrealized:
 
 
 
 
 
Change in fair value recorded in earnings - Instruments held under fair value option

 

 
8

Recorded in earnings in interest income
2

 

 

Change in fair value recorded in OCI -
Non-credit OTTI on AFS securities
11

 

 

Change in fair value recorded in earnings - Derivatives and hedging activities

 
(8
)
 

Paydowns and settlements
(6
)
 

 

Balance at end of period
$
76

 
$
24

 
$
(74
)
Total unrealized gains (losses) recorded in earnings (derivatives and hedging activities) and attributable to instruments still held at period end
$
1

 
$

 
$
8

 
 
 
 
 
 
For the six months ended June 30, 2012
 
Balance at beginning of period
$
63

 
$
37

 
$
(87
)
Gains (losses) realized and unrealized:
 
 
 
 
 
Change in fair value recorded in earnings - Derivatives and hedging activities
1

 
(1
)
 
2

Change in fair value recorded in OCI -
Non-credit OTTI on AFS securities
5

 

 

Paydowns and settlements
(7
)
 

 

Balance at end of period
$
62

 
$
36

 
$
(85
)
Total unrealized gains (losses) recorded in earnings (derivatives and hedging activities) and attributable to instruments still held at period end
$
1

 
$
(1
)
 
$
2



Assets Measured at Fair Value on a Nonrecurring Basis

The table below presents assets that are measured at fair value on a nonrecurring basis in our statements of condition only as of the dates shown. These assets are subject to being measured at fair value as a result of becoming impaired during the reporting period or in the case of REO when fair value declines during the reporting period. Held-to-maturity, private-label residential MBS are measured at fair value using the same methodology and significant assumptions utilized for available-for-sale private-label residential MBS. If available, broker price opinions are used to measure impaired MPF Loans or REO. If a current broker price opinion is not available, we estimate fair value based on current actual loss severity rates we have incurred on sales, excluding any estimated selling costs. See Note 8 - Allowance for Credit Losses for further details. Significant increases (decreases) in the loss severity rate input in isolation may result in a significantly lower (higher) fair value measurement.

 
 
June 30, 2013
 
December 31, 2012
 
 
  Level  3
 
  Level  3
Impaired MPF Loans
 
$
187

 
$
212

Real estate owned
 
11

 
18

Total non-recurring assets
 
$
198

 
$
230


36

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)



Fair Value Option
We elected the fair value option for advances, discount notes, and short-term consolidated obligation bonds for which hedge accounting treatment may not be achieved. Specifically, hedge accounting may not be achieved in cases where it may be difficult to pass prospective or retrospective effectiveness testing under derivative hedge accounting guidance even though the interest rate swaps used to hedge these financial instruments have matching terms. Accordingly, electing the fair value option allows us to better match the change in fair value of the advance, discount note, and short-term consolidated obligation bonds with the interest rate swap economically hedging it.

Under the fair value option, fair value is used for both the initial and subsequent measurement of the designated assets and liabilities, with the changes in fair value recognized in non-interest gain (loss). Interest income and interest expense carried on other financial assets or liabilities carried at fair value is recognized under the interest method based solely on the contractual amount of interest due or unpaid. Any transaction fees or costs are immediately recognized into other non-interest gain (loss) or other non-interest expense.

The following tables summarize the activity related to financial assets and liabilities for which we elected the fair value option: 

 
 
June 30, 2013
 
June 30, 2012
 
 
 
 
Consolidated Obligation
 
 
 
Consolidated Obligation
 
 
 Advances  
 
Bonds  
 
Discount Notes
 
 Advances  
 
Bonds  
 
Discount Notes
For the three months ended
 
 
 
 
Balance beginning of period
 
$
9

 
$
(1,250
)
 
$
(75
)
 
$
9

 
$
(3,132
)
 
$
(9,268
)
New transactions elected for fair value option
 
20

 
(2,300
)
 

 

 
(6,565
)
 

Maturities and extinguishments (if any)
 

 
1,000

 

 

 
2,680

 
5,136

Net gain (loss) on instruments held at fair value
 

 
2

 

 

 
2

 

Change in accrued interest and other
 

 

 

 

 
(2
)
 
(3
)
Balance end of period
 
$
29

 
$
(2,548
)
 
$
(75
)
 
$
9

 
$
(7,017
)
 
$
(4,135
)
For the six months ended
 
 
 
 
 
 
 
 
 
 
 
 
Balance beginning of period
 
$
9

 
$
(1,251
)
 
$

 
$
9

 
$
(2,631
)
 
$
(11,466
)
New transactions elected for fair value option
 
20

 
(2,550
)
 
(75
)
 

 
(8,890
)
 

Maturities and extinguishments (if any)
 

 
1,250

 

 

 
4,500

 
7,336

Net gain (loss) on instruments held at fair value
 

 
3

 

 

 
6

 
2

Change in accrued interest and other
 

 

 

 

 
(2
)
 
(7
)
Balance end of period
 
$
29

 
$
(2,548
)
 
$
(75
)
 
$
9

 
$
(7,017
)
 
$
(4,135
)
For items recorded under the fair value option, the related contractual interest income and contractual interest expense is recorded as part of net interest income on the statements of income. The remaining change in fair value for instruments in which the fair value option has been elected is recorded in non-interest gain (loss) on instruments held under fair value option in the statements of income. We determined that no adjustments to the fair values of our instruments recorded under the fair value option for instrument-specific credit risk were necessary as of the dates presented.
The following table reflects the difference between the aggregate unpaid principal balance (UPB) outstanding and the aggregate fair value for advances and consolidated obligation bonds for which the fair value option has been elected. None of the advances were 90 days or more past due and none were on nonaccrual status.
 
 
June 30, 2013
 
December 31, 2012
As of
 
Unpaid Principal Balance
 
Fair
Value  
 
Fair Value Over (Under) UPB
 
Unpaid Principal Balance
 
Fair
Value  
 
Fair Value Over (Under) UPB
Advances
 
$
29

 
$
29

 
$

 
$
9

 
$
9

 
$

Consolidated obligation bonds
 
2,550

 
2,548

 
(2
)
 
1,250

 
1,251

 
1

Consolidated obligation discount notes
 
75

 
75

 

 

 

 


37

Federal Home Loan Bank of Chicago
Notes to Financial Statements - (Unaudited)
(Dollars in millions except per share amounts unless otherwise indicated)

Note 15 – Commitments and Contingencies

The table below shows our commitments outstanding but not yet incurred or recorded in our statements of condition. The MPF Program mortgage purchase commitments in the table below primarily relate to the MPF Xtra product and will be concurrently resold to Fannie Mae. Unresolved repurchase requests and indemnifications are requests that we believe may occur from Fannie Mae; however, it is still uncertain whether or not Fannie Mae will request us to repurchase these mortgage loans.

As of
 
June 30, 2013
 
December 31, 2012
 
 
Expire within one year
 
Expire after one year
 
Total
 
Expire within one year
 
Expire after one year
 
Total
Unsettled consolidated obligation bonds
 
$
800

 
$

 
$
800

 
$
175

 
$

 
$
175

Member standby letters of credit
 
1,025

 
772

 
1,797

 
689

 
725

 
1,414

Housing authority standby bond purchase agreements
 
124

 
242

 
366

 
50

 
382

 
432

MPF Program mortgage purchase commitments
 
341

 

 
341

 
497

 

 
497

Unresolved repurchasable loans and indemnifications to Fannie Mae for MPF Xtra loans a
 
54

 

 
54

 
39

 

 
39

Advance commitments
 
477

 
232

 
709

 

 
285

 
285

Commitments
 
$
2,821

 
$
1,246

 
$
4,067

 
$
1,450

 
$
1,392

 
$
2,842

a 
These unresolved repurchase requests and indemnifications are classified in the expire within one year category since such repurchases and indemnifications are made upon request by Fannie Mae.  However, these unresolved repurchase requests and indemnifications do not have an expiration date, and accordingly, our repurchases and indemnifications to Fannie Mae may occur after one year from the reporting date.


Note 16 – Transactions with Members and Other FHLBs

We are a member-owned cooperative. We define related parties as members that own 10% or more of our capital stock or members whose officers or directors also serve on our Board of Directors. Capital stock ownership is a prerequisite to transacting any member business with us. Members and former members own all of our capital stock.

We conduct our advances business and the MPF Program almost exclusively with members. Therefore, in the normal course of business, we extend credit to members whose officers and directors may serve as our directors. We extend credit to them on market terms that are no more favorable than the terms of comparable transactions with other members who are not considered related parties (as defined above). In addition, we may purchase short-term investments, sell Federal Funds to, and purchase MBS from members (or affiliates of members) whose officers or directors serve as our directors. All such investments are market rate transactions and all such MBS are purchased through securities brokers or dealers. As an additional service to our members, including those whose officers or directors serve as our directors, we may enter into interest rate derivatives with members and offset these derivatives with non-member counterparties. These transactions are executed at market rates.


Members

The table below summarizes balances we had with our members as defined above as related parties (including their affiliates) as reported in the statements of condition as of the dates indicated. Members represented in these tables may change between periods presented, to the extent that our related parties change, based on changes in the composition of our Board membership.

 
 
June 30, 2013
 
December 31, 2012
Assets - Advances
 
$
2,522

 
$
2,500

Liabilities - Deposits
 
44

 
106

Equity - Capital Stock
 
188

 
239



Other FHLBs

Material amounts of transactions with other FHLBs, if any, are parenthetically identified on the face of our Financial Statements.

38

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Selected Financial Data
As of or for the three months ended
 
June 30, 2013
 
March 31, 2013
 
December 31, 2012
 
September 30, 2012
 
June 30,
2012
Selected statements of condition data
 
 
 
 
 
 
 
 
 
 
Total investments a
 
$
37,398

 
$
40,138

 
$
40,750

 
$
41,301

 
$
40,336

Advances
 
16,663

 
14,403

 
14,530

 
13,531

 
15,797

MPF Loans held in portfolio
 
8,904

 
9,693

 
10,474

 
11,310

 
12,210

Allowance for credit losses
 
(34
)
 
(40
)
 
(42
)
 
(44
)
 
(48
)
Total assets
 
63,502

 
64,922

 
69,584

 
66,444

 
68,641

Consolidated obligations -
 
 
 
 
 
 
 
 
 
 
Discount notes
 
21,583

 
24,292

 
31,260

 
27,231

 
23,439

Bonds
 
36,239

 
34,751

 
32,569

 
33,366

 
39,872

Total consolidated obligations, net
 
57,822

 
59,043

 
63,829

 
60,597

 
63,311

Mandatorily redeemable capital stock
 
3

 
4

 
6

 
10

 
10

Capital stock
 
1,540

 
1,549

 
1,650

 
1,702

 
1,850

Total retained earnings
 
1,917

 
1,770

 
1,691

 
1,593

 
1,504

Accumulated other comprehensive income (loss)
 
31

 
130

 
107

 
37

 
(221
)
Total capital
 
3,488

 
3,449

 
3,448

 
3,332

 
3,133

Other selected data at period end
 
 
 
 
 
 
 
 
 
 
MPF Xtra loan volume funded - total system
 
$
1,436

 
$
1,691

 
$
2,410

 
$
2,027

 
$
1,334

MPF Xtra loan volume funded - Chicago PFIs
 
714

 
834

 
1,200

 
1,044

 
709

MPF Xtra loans outstanding b
 
13,219

 
12,301

 
11,348

 
9,861

 
8,630

Regulatory capital to assets ratio
 
5.45
%
 
5.12
%
 
4.81
%
 
4.97
%
 
4.90
%
Market value of equity to book value of equity
 
110
%
 
106
%
 
102
%
 
103
%
 
97
%
All FHLBs consolidated obligations outstanding (par)
 
$
704,504

 
$
665,975

 
$
687,902

 
$
674,487

 
$
685,195

Number of members
 
750

 
758

 
762

 
764

 
767

Total employees (full and part time)
 
350

 
336

 
329

 
318

 
312

Total investments as a percent of total assets
 
59
%
 
62
%
 
59
%
 
62
%
 
59
%
Advances as a percent of total assets
 
26
%
 
22
%
 
21
%
 
20
%
 
23
%
MPF Loans as a percent of total assets
 
14
%
 
15
%
 
15
%
 
17
%
 
18
%
Selected statements of income data
 
 
 
 
 
 
 
 
 
 
Net interest income before provision for credit losses
 
$
98

 
$
113

 
$
135

 
$
140

 
$
138

Provision for (reversal of) credit losses
 
(2
)
 

 
1

 

 
2

OTTI (loss), credit portion
 

 

 

 

 
(14
)
Other non-interest gain (loss) excluding OTTI
 
35

 
1

 
(2
)
 
(12
)
 
(13
)
Non-interest expense
 
(25
)
 
25

 
21

 
28

 
32

Net income
 
149

 
80

 
100

 
90

 
69

Cash dividends
 
2

 
1

 
2

 
1

 
1

Selected annualized ratios and data
 
 
 
 
 
 
 
 
 
 
Return on average assets - Quarter
 
0.90
%
 
0.46
%
 
0.59
%
 
0.53
%
 
0.39
%
Return on average assets - Year to date
 
0.68
%
 
0.46
%
 
0.54
%
 
0.52
%
 
0.52
%
Return on average equity - Quarter
 
16.77
%
 
9.36
%
 
12.43
%
 
14.25
%
 
9.28
%
Return on average equity - Year to date
 
13.14
%
 
9.36
%
 
12.90
%
 
13.08
%
 
12.57
%
Average equity to average assets
 
5.35
%
 
4.96
%
 
4.74
%
 
3.71
%
 
4.21
%
Non-interest expense to average assets
 
0.15
%
 
0.15
%
 
0.12
%
 
0.16
%
 
0.18
%
Net yield on average interest-earning assets
 
0.60
%
 
0.67
%
 
0.81
%
 
0.84
%
 
0.80
%
Return on average Regulatory Capital spread to three month LIBOR index
 
17.10
%
 
9.50
%
 
11.67
%
 
10.34
%
 
7.76
%
Dividend payout ratio
 
1.34
%
 
1.57
%
 
1.56
%
 
1.59
%
 
1.92
%

a 
Total investments includes investment securities, Federal Funds sold, and securities purchased under agreements to resell.
b 
MPF Xtra outstanding loans are not held on our statements of condition. MPF Xtra loans purchased from PFIs are concurrently sold to Fannie Mae. See MPF Program Design beginning on page 8 in our 2012 Form 10-K.


39

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Forward-Looking Information
 

Statements contained in this report, including statements describing the objectives, projections, estimates, or future predictions of management, may be “forward-looking statements.” These statements may use forward-looking terminology, such as “anticipates,” “believes,” “expects,” “could,” “estimates,” “may,” “should,” “will,” their negatives, or other variations of these terms. We caution that, by their nature, forward-looking statements involve risks and uncertainties related to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. These risks and uncertainties could cause actual results to differ materially from those expressed or implied in these forward-looking statements and could affect the extent to which a particular objective, projection, estimate, or prediction is realized. As a result, undue reliance should not be placed on such statements.

These forward-looking statements involve risks and uncertainties including, but not limited to, the following:

our ability to meet required conditions to repurchase and redeem capital stock from our members (including maintaining compliance with our minimum regulatory capital requirements and determining that our financial condition is sound enough to support such repurchases), and the amount and timing of such repurchases or redemptions;

the effect of the resolution by our Board of Directors impacting the level of our dividends and retained earnings;

changes in the demand by our members for advances, including the impact of the availability of other sources of funding for our members, such as deposits; 

limits on our investments in long-term assets;

the impact of new business strategies, including our ability to develop and implement business strategies focused on maintaining net interest income; the impact of our efforts to simplify our balance sheet on our market risk profile and future hedging costs; our ability to successfully transition to a new business model, implement business process improvements and scale our size to our members' borrowing needs; the extent to which our members use our advances as part of their core financing rather than just as a back-up source of liquidity;

the extent to which amendments to our capital plan, including our ability to start paying enhanced dividends, impact borrowing by our members;

general economic and market conditions, including the timing and volume of market activity, inflation/deflation, unemployment rates, housing prices, the condition of the mortgage and housing markets, increased delinquencies and/or loss rates on mortgages, prolonged or delayed foreclosure processes, and the effects on, among other things, mortgage-backed securities; volatility resulting from the effects of, and changes in, various monetary or fiscal policies and regulations, such as those determined by the Federal Reserve Board and Federal Deposit Insurance Corporation; impacts from various measures to stimulate the economy and help borrowers refinance home mortgages and student loans; disruptions in the credit and debt markets and the effect on future funding costs, sources, and availability;

volatility of market prices, rates, and indices, or other factors, such as natural disasters, that could affect the value of our investments or collateral; changes in the value or liquidity of collateral securing advances to our members;

changes in the value of and risks associated with our investments in mortgage loans, mortgage-backed securities, and FFELP ABS and the related credit enhancement protections;

changes in our ability or intent to hold mortgage-backed securities to maturity;

changes in mortgage interest rates and prepayment speeds on mortgage assets;

membership changes, including the withdrawal of members due to restrictions on our dividends or the loss of members through mergers and consolidations; changes in the financial health of our members, including the resolution of some members; risks related to expanding our membership to include more institutions with regulators and resolution processes with which we have less experience;

40

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)



changes in investor demand for consolidated obligations and/or the terms of interest rate derivatives and similar agreements, including changes in the relative attractiveness of consolidated obligations as compared to other investment opportunities; changes in our cost of funds due to Congressional deliberations on the overall U.S. debt burden, including concerns over U.S. fiscal policy and the statutory debt limit, and any related rating agency actions impacting FHLB consolidated obligations;

political events, including legislative, regulatory, judicial, or other developments that affect us, our members, our counterparties and/or investors in consolidated obligations, including, among other things, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and related regulations and proposals and legislation related to housing finance and GSE reform; changes by our regulator and changes in the FHLB Act or applicable regulations as a result of the Housing and Economic Recovery Act of 2008 (Housing Act) or as may otherwise be issued by our regulator; the potential designation of us as a nonbank financial company for supervision by the Federal Reserve;

the ability of each of the other FHLBs to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which we have joint and several liability;

the pace of technological change and our ability to develop and support technology and information systems; our ability to attract and retain skilled employees;

the impact of new accounting standards and the application of accounting rules, including the impact of regulatory guidance on our application of such standards and rules;

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

our ability to identify, manage, mitigate, and/or remedy internal control weaknesses and other operational risks.

For a more detailed discussion of the risk factors applicable to us, see Risk Factors in our 2012 Form 10-K on page 22.

These forward-looking statements are representative only as of the date they are made, and we undertake no obligation to update any forward-looking statement as a result of new information, future events, changed circumstances, or any other reason.


41

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Executive Summary


Second Quarter 2013 Financial Highlights


We recorded net income of $149 million for the second quarter of 2013, compared to $80 million in the first quarter of 2013. Interest income and interest expense are down from one year ago due to the combination of lower interest rates and the continued run-off of our MPF Loan and investment portfolios, along with the debt used to fund those portfolios. Other non-interest gain (loss) increased from the first quarter of 2013, due primarily to gains on derivatives and hedging activities as rates rose just before quarter-end June 30, 2013.

The approvals for our Community First Fund resulted in the Bank recognizing $50 million into earnings in the second quarter of 2013, which represents the reversal of the $50 million charge previously recognized in the fourth quarter of 2011.
 
Total assets were $63.5 billion at June 30, 2013, down from $64.9 billion at March 31, 2013, and from $69.6 billion at December 31, 2012. Advances outstanding at June 30, 2013, were $16.7 billion, up 15% since December 31, 2012. As part of our amended capital plan, the Bank now has the ability to reduce capital stock requirements for certain future advance offerings. When we implement this part of the plan as expected later this year, we hope members will take advantage of this benefit to lower their cost of borrowing.

MPF Loans held in portfolio declined to $8.9 billion at June 30, 2013, from $9.7 billion at March 31, 2013, and $10.4 billion at December 31, 2012. The MPF outstanding loan balance has steadily declined as a result of paydowns and our 2008 decision to stop adding MPF Loans to our balance sheet. The MPF Xtra product, however, continues to gain popularity with both participating members and other FHLBs. The FHLB of Seattle joined the MPF Program in early July to offer the MPF Xtra product, the second FHLB to join this year. The MPF Xtra product enables financial institutions that are members of participating FHLBs to sell fixed-rate, conforming mortgage loans in the secondary market. Through MPF Xtra, we purchase these loans from PFIs at competitive rates and sell them to Fannie Mae. In the second quarter of 2013, MPF Xtra loan volume for the program overall was $1.4 billion; for our PFIs alone it was $714 million.

Total investment securities were down 10% to $30.7 billion this quarter from $34.3 billion at the end of 2012. Restrictions on our investments limit us from purchasing new longer-term investments at this time.

Retained earnings continued to grow as a result of our strong net income; at June 30, 2013, we recorded a record-high $1.9 billion in retained earnings-up 13% from December 31, 2012.

We remained in compliance with all of our regulatory capital requirements.


42

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Summary and Outlook


On July 23, 2013, our Board of Directors declared a cash dividend at an annualized rate of 0.30% per share, based on the Bank's preliminary financial results for the second quarter of 2013. Beginning with financial results for the third quarter of 2013, we expect the Board of Directors to consider paying an enhanced dividend on activity stock (B1) relative to stock required for membership (B2) as permitted under our amended capital plan and as appropriate based on quarterly earnings. We anticipate that paying a higher dividend on activity stock will effectively lower the cost of borrowing from the Bank and represents another way to provide increased value to our members.

Our growing financial strength, supported by $1.9 billion in retained earnings, has allowed us to introduce a number of key initiatives that we believe enhance the value proposition of membership in our Bank.

The goals of these member-focused initiatives are to:

Lower the overall cost of borrowing for members that use advances for long-term funding and short-term liquidity. The amendments to our capital plan, which became effective July 1, 2013, are designed to reduce the cost of advances for members using the Bank for borrowing by providing those members the opportunity to receive a higher dividend on their activity stock. See Capital Resources on page 54.

Restore full liquidity to member stock. In late May, the Bank completed the quarterly excess capital stock repurchase program initiated in 2012 and now repurchases excess stock held by members within three business days of receiving the request, subject to regulatory requirements and prudent business practices.

Enhance the collateral capacity of our members. As part of our commitment to meet member funding and liquidity needs, we published revised Collateral Guidelines in early July that include significant changes to our Commercial Real Estate (CRE) collateral policies. These changes should make more member-owned CRE eligible as collateral and simplify the CRE pledging process.

Introduce technology that makes it easier for members to use the Bank. Members can now initiate certain types of advances and wire transfers through our member-only website, eBanking. We also streamlined the competitive Affordable Housing Program (AHP) application process by implementing a new system called AHP Online. More than 50 members partnered with local community organizations this year to submit 143 online applications. We anticipate awarding $26.5 million in grants later this year.

Support member communities in new and sustainable ways. This April we received approval for the Community First Fund, a $50 million revolving loan fund designed to support affordable housing and economic development in Illinois and Wisconsin. The focus of this fund will be to provide unsecured low-interest loans, rather than one-time grants, to selected partner community organizations. Also this spring we completed a survey of potential partners and selected a subset that responded with a number of proposals; we are currently evaluating the proposals and anticipate making commitments on a rolling basis over the next year with the first commitment expected to be completed by the end of 2013.


43

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Results of Operations


Net Interest Income
 
Net interest income is the difference between interest income that we receive on our interest earning assets and the interest expense we pay on interest bearing liabilities after accounting for the following in accordance with GAAP:

Net interest paid or received on interest rate swaps that are accounted for as fair value or cash flow hedges;
Amortization of premiums;
Accretion of discounts;
Amortization of hedge adjustments;
Advance prepayment fees; and
MPF credit enhancement fees.

The tables below present the increase or decrease in interest income and expense before the provision for credit losses due to volume or rate variances. Any change due to the combined volume/rate variance has been allocated ratably to volume and rate. The calculation of these components includes the following considerations:
 
Average daily balances are computed using historical amortized cost balances except for items carried under the fair value option which include changes in fair value.

MPF Loans held in portfolio that are on nonaccrual status are included in average daily balances used to determine the effective yield/rate. Interest income on MPF Loans includes amortization as detailed in MPF Loans Held in Portfolio, net on page 51. 

Interest and effective yield/rate includes all components of net interest income as discussed above. Yields/rates are calculated on an annualized basis.

 
June 30, 2013
 
June 30, 2012
 
Increase (decrease) due to
For the three months ended
Average Balance
 
Total Interest  
 
Yield/ Rate
 
Average Balance
 
Total Interest  
 
Yield/ Rate
 
Volume
 
Rate
 
Net Change
Federal Funds sold, securities purchased under agreements to resell and/or deposit income
$
10,882

 
$
2

 
0.07
%
 
$
5,992

 
$
2

 
0.13
%
 
$
2

 
$
(2
)
 
$

Investment securities
29,517

 
233

 
3.16
%
 
35,585

 
285

 
3.20
%
 
(49
)
 
(3
)
 
(52
)
Advances
15,437

 
42

 
1.09
%
 
15,332

 
55

 
1.43
%
 

 
(13
)
 
(13
)
MPF Loans held in portfolio
9,087

 
103

 
4.53
%
 
12,407

 
143

 
4.61
%
 
(38
)
 
(2
)
 
(40
)
Total Interest Income on Assets
64,923

 
380

 
2.34
%
 
69,316

 
485

 
2.80
%
 
(85
)
 
(20
)
 
(105
)
Consolidated obligation discount notes
24,862

 
74

 
1.19
%
 
25,021

 
77

 
1.23
%
 

 
(3
)
 
(3
)
Consolidated obligation bonds
35,901

 
193

 
2.15
%
 
40,146

 
255

 
2.54
%
 
(27
)
 
(35
)
 
(62
)
Subordinated notes
1,000

 
15

 
6.00
%
 
1,000

 
15

 
6.00
%
 

 

 

Total Interest Expense on Liabilities
61,763

 
282

 
1.83
%
 
66,167

 
347

 
2.10
%
 
(27
)
 
(38
)
 
(65
)
Net yield on interest-earning assets
$
64,923

 
$
98

 
0.60
%
 
$
69,316

 
$
138

 
0.80
%
 
$
(58
)
 
$
18

 
$
(40
)


44

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)



 
June 30, 2013
 
June 30, 2012
 
Increase (decrease) due to
For the six months ended
Average Balance
 
Total Interest  
 
Yield/ Rate
 
Average Balance
 
Total Interest  
 
Yield/ Rate
 
Volume
 
Rate
 
Net Change
Federal Funds sold, securities purchased under agreements to resell and/or deposit income
$
11,097

 
$
6

 
0.11
%
 
$
5,275

 
$
4

 
0.15
%
 
$
4

 
$
(2
)
 
$
2

Investment securities
30,780

 
478

 
3.11
%
 
36,359

 
581

 
3.20
%
 
(89
)
 
(14
)
 
(103
)
Advances
14,664

 
83

 
1.13
%
 
15,148

 
129

 
1.70
%
 
(4
)
 
(42
)
 
(46
)
MPF Loans held in portfolio
9,468

 
216

 
4.56
%
 
12,879

 
296

 
4.60
%
 
(78
)
 
(2
)
 
(80
)
Total Interest Income on Assets
66,009

 
783

 
2.37
%
 
69,661

 
1,010

 
2.90
%
 
(167
)
 
(60
)
 
(227
)
Consolidated obligation discount notes
27,081

 
151

 
1.12
%
 
25,801

 
153

 
1.19
%
 
8

 
(10
)
 
(2
)
Consolidated obligation bonds
34,902

 
392

 
2.25
%
 
39,458

 
531

 
2.69
%
 
(61
)
 
(78
)
 
(139
)
Subordinated notes
1,000

 
29

 
5.80
%
 
1,000

 
29

 
5.80
%
 

 

 

Total Interest Expense on Liabilities
62,983

 
572

 
1.82
%
 
66,259

 
713

 
2.15
%
 
(53
)
 
(88
)
 
(141
)
Net yield on interest-earning assets
$
66,009

 
$
211

 
0.64
%
 
$
69,661

 
$
297

 
0.85
%
 
$
(114
)
 
$
28

 
$
(86
)

Net interest income changed mainly due to the following:
 
Investment income declined primarily due to the decline in average investment balances as securities matured or paid down. These proceeds were primarily used to pay down consolidated obligations as well as to redeem our capital stock. Yields on investment securities also declined as a result of purchasing shorter-term, lower yielding securities. In connection with the approval of our capital plan the FHFA now requires, and our Board has passed, a resolution requiring us to obtain FHFA approval for any new investments that have a term to maturity in excess of 270 days until such time as our MBS portfolio is less than three times our total regulatory capital and our advances represent more than 50% of our total assets. For further discussion, see Investments on page 12 in our 2012 Form 10-K. We expect our investment portfolio to continue to decline over time as a result of this limitation.

Interest income from advances decreased compared to the prior year primarily due to the decline in average yield on advances, driven mostly by a decline in advance prepayment fees recorded in 2013 as detailed in Note 4 - Interest Income and Interest Expense to the financial statements. Throughout 2012, we recognized higher prepayment fee income as many members elected to restructure their outstanding advances to take advantage of the extended low interest rate environment. The majority of these restructured advances were treated as new advances for accounting purposes and therefore, the related prepayment fees were immediately recognized as prepayment fee income in the period of termination.

Interest income from MPF Loans continued to decline as expected relative to the decreased level of MPF Loans outstanding as a result of our ongoing strategy to not add MPF Loans to our balance sheet, except for immaterial amounts of government MPF Loans that primarily support affordable housing programs. We expect these trends to continue.

The decline in interest income was partially offset by the reduction in interest expense on our consolidated obligations. This reduction resulted as the overall level of debt outstanding declined, along with the average interest rates being charged on the debt. We were able to fund a greater percentage of our balance sheet with shorter term consolidated obligation discount notes at lower interest rates, relative to the same periods in 2012. During the second quarter of 2013, we began to fund more of our balance sheet with longer-term callable bonds, but this impact was minimal on the averages for the quarter and year to date.

Net interest income is also impacted by fair value and cash flow hedging activity. Specifically, the low interest rate environment continued to result in negative net interest settlements attributable to open derivative hedging activity and the amortization of hedge adjustments of closed derivative hedging activity into net interest income also reduced net interest income. For further details see the tables of Trading Securities, Derivatives and Hedging Activities, and Instruments Held at Fair Value Option on page 47.


45

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)



Non-Interest Gain (Loss) 

 
 
Three months
 
Six months
For the periods ended June 30,
 
2013
 
2012
 
2013
 
2012
Net other-than-temporary impairment (OTTI) charges, credit portion
 
$

 
$
(14
)
 
$

 
$
(15
)
Trading securities
 
(3
)
 
(11
)
 
(9
)
 
(25
)
Derivatives and hedging activities
 
28

 
(8
)
 
30

 
3

Instruments held under fair value option
 
2

 
2

 
3

 
8

Other, net
 
8

 
4

 
12

 
8

Total non-interest gain (loss)
 
$
35

 
$
(27
)
 
$
36

 
$
(21
)


OTTI impairment charges, credit portion

As the economic conditions, and thus the significant inputs used to value our securities, have stabilized, we have not recorded additional OTTI in 2013 to date. Although we actively monitor the credit quality of our MBS, it is not possible to predict whether we will have additional OTTI charges in the future. Future changes will depend on many factors including economic, financial market, and housing market conditions; and the actual and projected performance of the loan collateral underlying our MBS. If delinquency and/or loss rates on mortgages loans continue to increase, and/or there is a further decline in residential real estate values, we could experience reduced yields or additional losses on these investment securities. Further, increases in the time period for processing foreclosures and foreclosure delays by several major mortgage servicers may result in loss severities beyond current expectations. See Critical Accounting Estimates on page 56 for a discussion on the sensitivity of OTTI to significant inputs based on an adverse case scenario.



46

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Trading Securities, Derivatives and Hedging Activities, and Instruments Held at Fair Value Option

Details on the impact of these items, which include hedge ineffectiveness and economic hedge activity, are detailed in the following tables. 

 
 
 
 
 
 
 
 
Consolidated Obligation
 
 
 
 
Advances
 
Investments
 
MPF Loans
 
Discount Notes
 
Bonds
 
Total  
Three months ended June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Amortization/accretion of fair value hedges
 
$
(1
)
 
$

 
$
(9
)
 
$

 
$
(6
)
 
$
(16
)
Amortization/accretion of cash flow hedges
 
4

 

 

 
(1
)
 
(1
)
 
2

Total amortization/accretion
 
3

 

 
(9
)
 
(1
)
 
(7
)
 
(14
)
Net interest settlements fair value hedges
 
(17
)
 
(35
)
 

 

 
55

 
3

Net interest settlements cash flow hedges
 

 

 

 
(67
)
 

 
(67
)
Total net interest settlements a
 
(17
)
 
(35
)
 

 
(67
)
 
55

 
(64
)
Total hedging activities recorded in
net interest income
 
(14
)
 
(35
)
 
(9
)
 
(68
)
 
48

 
(78
)
Fair value hedges
 
3

 
6

 

 

 

 
9

Cash flow hedges
 

 

 

 
2

 

 
2

Economic hedges
 

 

 
17

 

 

 
17

Total gains (losses) recorded in
derivatives & hedging activities
 
3

 
6

 
17

 
2

 

 
28

Other derivative related amounts recorded in non-interest gain (loss)
 
 
 
 
 
 
 
 
 
 
 
 
Instruments held under fair value option
 

 

 

 

 
2

 
2

Total net effect gain (loss) of hedging activities
 
$
(11
)
 
$
(29
)
 
$
8

 
$
(66
)
 
$
50

 
$
(48
)
Trading securities - unhedged
 
 
 
(3
)
 
 
 
 
 
 
 
(3
)
Total trading securities
 
 
 
$
(3
)
 
 
 
 
 
 
 
$
(3
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
Amortization/accretion of hedging activities
 
$
3

 
$

 
$
(13
)
 
$
(3
)
 
$
(8
)
 
$
(21
)
Net interest settlements a
 
(21
)
 
(33
)
 
(1
)
 
(68
)
 
42

 
(81
)
Total hedging activities recorded in
net interest income
 
(18
)
 
(33
)
 
(14
)
 
(71
)
 
34

 
(102
)
Fair value hedges
 
2

 
(4
)
 

 

 
(5
)
 
(7
)
Economic hedges
 

 

 
(5
)
 

 
4

 
(1
)
Total gains (losses) recorded in
derivatives & hedging activities
 
2

 
(4
)
 
(5
)
 

 
(1
)
 
(8
)
Other derivative related amounts recorded in non-interest gain (loss)
 
 
 
 
 
 
 
 
 
 
 
 
Trading securities - hedged
 

 
(11
)
 

 

 

 
(11
)
Instruments held under fair value option
 

 

 

 

 
2

 
2

Total net effect gain (loss) of hedging activities
 
$
(16
)
 
$
(48
)
 
$
(19
)
 
$
(71
)
 
$
35

 
$
(119
)
Total trading securities
 
 
 
$
(11
)
 
 
 
 
 
 
 
$
(11
)
a 
Represents interest income or expense on derivatives included in net interest income of the hedged item.


47

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


 
 
 
 
 
 
 
 
Consolidated Obligation
 
 
 
 
Advances
 
Investments
 
MPF Loans
 
Discount Notes
 
Bonds
 
Total  
Six months ended June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Amortization/accretion of fair value hedges
 
$
(2
)
 
$

 
$
(19
)
 
$

 
$
(13
)
 
$
(34
)
Amortization/accretion of cash flow hedges
 
7

 

 

 
(2
)
 
(1
)
 
4

Total amortization/accretion
 
$
5

 
$

 
$
(19
)
 
$
(2
)
 
$
(14
)
 
$
(30
)
Net interest settlements fair value hedges
 
(34
)
 
(69
)
 

 

 
102

 
(1
)
Net interest settlements cash flow hedges
 

 

 

 
(134
)
 

 
(134
)
Total net interest settlements a
 
(34
)
 
(69
)
 

 
(134
)
 
102

 
(135
)
Total hedging activities recorded in
net interest income
 
(29
)
 
(69
)
 
(19
)
 
(136
)
 
88

 
(165
)
Fair value hedges
 
6

 
7

 

 

 
(2
)
 
11

Cash flow hedges
 

 

 

 
3

 

 
3

Economic hedges
 

 

 
16

 

 

 
16

Total gains (losses) recorded in
derivatives & hedging activities
 
6

 
7

 
16

 
3

 
(2
)
 
30

Other derivative related amounts recorded in non-interest gain (loss)
 
 
 
 
 
 
 
 
 
 
 
 
Trading securities - hedged
 

 
(4
)
 

 

 

 
(4
)
Instruments held under fair value option
 

 

 

 

 
3

 
3

Total net effect gain (loss) of hedging activities
 
$
(23
)
 
$
(66
)
 
$
(3
)
 
$
(133
)
 
$
89

 
$
(136
)
Trading securities - unhedged
 
 
 
(5
)
 
 
 
 
 
 
 
(5
)
Total trading securities
 
 
 
$
(9
)
 
 
 
 
 
 
 
$
(9
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
Amortization/accretion of hedging activities
 
$
(16
)
 
$

 
$
(27
)
 
$
(6
)
 
$
(19
)
 
$
(68
)
Net interest settlements a
 
(45
)
 
(65
)
 
(2
)
 
(135
)
 
80

 
(167
)
Total hedging activities recorded in
net interest income
 
(61
)
 
(65
)
 
(29
)
 
(141
)
 
61

 
(235
)
Fair value hedges
 
5

 
(2
)
 
1

 

 
(6
)
 
(2
)
Cash flow hedges
 

 

 

 
2

 

 
2

Economic hedges
 

 

 
(7
)
 
6

 
4

 
3

Total gains (losses) recorded in
derivatives & hedging activities
 
5

 
(2
)
 
(6
)
 
8

 
(2
)
 
3

Other derivative related amounts recorded in non-interest gain (loss)
 
 
 
 
 
 
 
 
 
 
 
 
Trading securities - hedged
 

 
(24
)
 

 

 

 
(24
)
Instruments held under fair value option
 

 

 

 
2

 
6

 
8

Total net effect gain (loss) of hedging activities
 
$
(56
)
 
$
(91
)
 
$
(35
)
 
$
(131
)
 
$
65

 
$
(248
)
Trading securities - unhedged
 
 
 
(1
)
 
 
 
 
 
 
 
(1
)
Total trading securities
 
 
 
$
(25
)
 
 
 
 
 
 
 
$
(25
)
a 
Represents interest income or expense on derivatives included in net interest income of the hedged item.


Most of our total net effect loss of hedging activities were recorded as components of net interest income. This was primarily due to the low interest rate environment resulting in negative net interest settlements on derivative contracts in active hedge accounting relationships. Net interest income was also reduced by the amortization of negative hedge adjustments from previously active hedge relationships.

Offsetting a portion of these losses were gains recorded in derivatives and hedging activities on our economic hedge portfolio as market volatility increased, especially towards the end of the second quarter of 2013.


48

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Trading securities - hedged showed a decline in value as these securities, which were acquired at a premium, move closer to par upon maturity. As these securities approach par value, the related premiums are expected to continue to be recognized as losses, although the rate of losses will decline as the securities approach par.

We recorded gains on our consolidated obligation bonds held under fair value option as those instruments' fair values benefited from the rising interest rate environment during the period.


Non-Interest Expense
 
 
 
Three months
 
Six months
For the periods ended June 30,
 
2013
 
2012
 
2013
 
2012
Compensation and benefits
 
14

 
16

 
28

 
31

Other operating expenses
 
11

 
7

 
20

 
16

FHFA
 
1

 
2

 
2

 
4

Office of Finance
 
1

 
1

 
2

 
2

Other community investment
 
(50
)
 

 
(50
)
 

Other
 
(2
)
 
6

 
(2
)
 
9

Total non-interest expense
 
(25
)
 
32

 

 
62



The approvals for our Community First Fund resulted in our recognizing $50 million in earnings in the second quarter of 2013, which represents the reversal of the $50 million charge previously recognized in the fourth quarter of 2011. This reversal was recognized through non-interest expenses, the same account where the original charge was recorded.

Compensation and benefits declined primarily as the result of our reduced pension expense in 2013, after enactment of the Moving Ahead for Progress in the 21st Century Act (MAP-21) in July 2012, which contained provisions that stabilized the interest rates used to calculate required pension contributions. We anticipate that the overfunded status of our pension may remain through 2013 before pension costs begin to increase again.

Other operating expense increased primarily due to outsourced contract services to support expansion and updating of our information technology, primarily for MPF Program systems.

The majority of the other decline in non-interest expense was caused by a decline in losses on REO sales, which resulted from an overall improvement in housing prices throughout many geographical areas.


Other Comprehensive Income

Total other comprehensive income (loss) was $(99) million and $(76) million for the three and six months ended June 30, 2013, compared to $166 million and $210 million for the same periods of 2012. The decrease was primarily due to unrealized losses recorded on our AFS securities portfolio during 2013 compared to unrealized gains in 2012. The unrealized losses were the result of an increase in market interest rates during 2013 compared to the same periods in 2012. This decrease was partially offset by an increase in unrealized gains on our cash flow hedges of our discount notes, also caused by the increase in market interest rates between the two periods.

On a cumulative basis, however, we still have substantial unrealized gains on our AFS securities portfolio. These unrealized gains would only be reclassified into net income if we sold our AFS securities.
 
We also recorded accretion of the non-credit portion of other-than-temporary impairment on our held-to-maturity securities. Since the non-credit portion of the losses was due to non credit-related declines, as these securities approach maturity or increase in fair value, these unrealized losses are expected to ultimately reverse, barring any further credit-related impairments.


49

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)



Statements of Condition
 
 
 
June 30, 2013
 
December 31, 2012
Cash and due from banks
 
$
315

 
$
3,564

Federal Funds sold and securities purchased under agreements to resell
 
6,711

 
6,500

Investment securities
 
30,687

 
34,250

Advances
 
16,663

 
14,530

MPF Loans held in portfolio, net
 
8,870

 
10,432

Other
 
256

 
308

Total assets
 
$
63,502

 
$
69,584

Consolidated obligation discount notes
 
$
21,583

 
$
31,260

Consolidated obligation bonds
 
36,239

 
32,569

Subordinated notes
 
1,000

 
1,000

Other
 
1,192

 
1,307

Total liabilities
 
60,014

 
66,136

Capital stock
 
1,540

 
1,650

Total retained earnings
 
1,917

 
1,691

Accumulated other comprehensive income (loss)
 
31

 
107

Total capital
 
3,488

 
3,448

Total liabilities and capital
 
$
63,502

 
$
69,584



Cash and due from banks, Federal Funds sold, and securities purchased under agreements to resell

Amounts held in cash and due from banks, Federal Funds sold and securities purchased under agreements to resell will vary each day based on the following:

Interest rate spreads between Federal Funds sold and securities purchased under agreements to resell and our debt;
Liquidity requirements;
Counterparties available; and
Collateral availability on securities purchased under agreements to resell.

At the end of 2012, we increased our liquidity position in an effort to protect against potential short-term funding challenges posed by the political and economic climate.

Overnight rates for Federal Funds sold and securities purchased under agreements to resell have remained low. In addition, as a result of the European debt crisis we have reduced our exposure to counterparties in certain countries; see Short-Term Investments Unsecured Credit Exposure on page 58 for further details.

Investment Securities
Investment securities overall declined as securities matured or paid down and the proceeds were primarily used to pay down our consolidated obligations and to redeem a portion of our excess capital stock. In addition, a majority of our investment securities are classified as available-for-sale. As market rates climbed at the end of the second quarter, we incurred a reduction in unrealized gains on this portfolio, as previously discussed in Other Comprehensive Income on page 49.
In connection with the approval of our capital plan and termination of the Consent Cease and Desist Order, the FHFA now requires, and our Board has passed, a resolution requiring us to obtain FHFA approval for any new investments that have a term to maturity in excess of 270 days until such time as our MBS portfolio is less than three times our total regulatory capital and our advances represent more than 50% of our total assets. For further discussion, see Investments on page 12 in our 2012 Form 10-K. We expect our investment portfolio to continue to decline over time as a result of this limitation and as we continue to make repurchases and redemptions of excess capital stock.


50

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Advances

Member demand for advances increased during the first six months of 2013, leading to growth in advances outstanding at June 30, 2013, compared to December 31, 2012. As we continue to work to enhance our member collateral capacity and improve technological member borrowing tools, and plan to reduce capital stock requirements for certain future advance offerings as part of our amended capital plan, we anticipate members may continue to take advantage of these benefits to lower their cost of borrowing.

The following table sets forth the current period par amount of advances outstanding for the borrowers with the five largest advance balances:
 
 
As of June 30, 2013
BMO Harris Bank N.A.
 
$
2,375

 
14
%
Associated Bank, N.A.
 
2,150

 
13
%
The Northern Trust Company
 
1,815

 
11
%
Cole Taylor Bank
 
1,360

a 
8
%
State Farm Bank, F.S.B
 
1,300

 
8
%
All other borrowers
 
7,565

 
46
%
Total par value
 
$
16,565

 
100
%
a 
MB Financial Inc., the holding company of our member MB Financial Bank NA, has announced that it will acquire Taylor Capital Group Inc., the holding company of our member Cole Taylor Bank.

MPF Loans Held in Portfolio, net

MPF Loans outstanding continue to decline as a result of paydowns and our ongoing strategy to not add MPF Loans to our balance sheet, except for an immaterial amount of loans being acquired under our affordable housing programs. Thus, the rate of decline in our MPF Loan balance is dependent upon the speed at which borrowers prepay their mortgages.

The speed of prepayments on a percentage basis has slowed compared to longer term historical measures. Though mortgage rates have remained historically low, borrowers are not moving or refinancing at the same rates as before the financial crisis. Should market mortgage rates rise in future periods, we could expect prepayment rates to decline further. Should rates fall further, additional prepayments may occur. If an MPF Loan prepays, any remaining closed basis adjustment related to that loan is immediately recognized. This may cause volatility in interest income as mortgage prepayment activity fluctuates as interest rates rise or fall. We cannot predict the extent to which future mortgage rates will rise or fall, or the extent of prepayment activity that will accompany the mortgage rate movement.

The following table summarizes information related to our net premium and hedge accounting basis adjustments on MPF Loans.

For the three months ended
 
June 30, 2013
 
June 30, 2012
Net premium amortization
 
$
3

 
$
4

Net amortization of closed basis adjustments
 
10

 
11

 
 
 
 
 
For the six months ended
 
 
 
 
Net premium amortization
 
$
6

 
$
7

Net amortization of closed basis adjustments
 
19

 
22

 
 
 
 
 
As of
 
June 30, 2013
 
December 31, 2012
Net premium balance on MPF Loans
 
$
33

 
$
38

Cumulative basis adjustments closed portion
 
79

 
97

MPF Loans, unpaid principal balance
 
8,795

 
10,340

Premium balance as a percent of MPF Loans
 
0.37
%
 
0.36
%


In addition to MPF Loans we hold in portfolio, we also buy, and concurrently resell to Fannie Mae, MPF Xtra loans on behalf of our PFIs and the PFIs of other MPF Banks. For more details see Selected Financial Data on page 39.

51

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Liquidity, Funding, & Capital Resources

Liquidity
For the period ending June 30, 2013, we have maintained a liquidity position in accordance with FHFA regulations and guidance, and policies established by our Board of Directors. Based upon our excess liquidity position described below, we anticipate remaining in compliance with our liquidity requirements. See Liquidity, Funding, & Capital Resources on page 53 in our 2012 Form 10-K for a detailed description of our liquidity requirements.
We use different measures of liquidity as follows:
Overnight Liquidity – Our policy requires us to maintain overnight liquid assets at least equal to 3.5% of total assets. As of June 30, 2013, our overnight liquidity was $8.3 billion or 13% of total assets, giving us an excess overnight liquidity of $6.1 billion.
Deposit Coverage – To support our member deposits, FHFA regulations require us to have an amount equal to the current deposits invested in obligations of the United States government, deposits in eligible banks or trust companies, or advances with maturities not exceeding five years. As of June 30, 2013, we had excess liquidity of $23.2 billion to support member deposits.

Contingency Liquidity – The cumulative five business day liquidity measurement assumes there is a localized credit crisis for all FHLBs where the FHLBs do not have the ability to issue new consolidated obligations or borrow unsecured funds from other sources (e.g., purchasing Federal Funds or customer deposits). Our net liquidity in excess of our total uses and reserves over a cumulative five-business-day period was $22.7 billion as of June 30, 2013.

In addition to the liquidity measures discussed above, the FHFA requires all 12 FHLBs to maintain liquidity through short-term investments in an amount at least equal to anticipated cash outflows under two different scenarios. We may fund overnight or shorter term investments and advances with discount notes that have maturities that extend beyond the maturities of the related investments or advances. For a discussion of how this may impact our earnings, see page 26 in the Risk Factors section of our 2012 Form 10-K.

Funding
Cash flows from operating activities

Our operating assets and liabilities support our mission to provide our member shareholders competitively priced funding, a reasonable return on their investment in our capital stock, and support for community investment activities.  Operating assets and liabilities can vary significantly in the normal course of business due to the amount and timing of cash flows, which are affected by member-driven activities and market conditions. We believe cash flows from operations, available cash balances and our ability to generate cash through short- and long-term borrowings are sufficient to fund our operating liquidity needs.  For the six months ended June 30, 2013, net cash provided (used) by operating activities was $487 million. This resulted from net income adjusted for non-cash adjustments, primarily gains due to the change in net fair value adjustments on derivatives and hedging activities.
Cash flows from investing activities

Our investing activities predominantly include advances, MPF Loans held for investment, investment securities, and other short-term interest-earning assets. For the six months ended June 30, 2013, net cash provided (used) by investing activities was $2.1 billion. This resulted primarily from principal collected on MPF Loans and net proceeds from the maturities and paydowns of investment securities, offset by an increase in advances to our members. 
Cash flows from financing activities

Our financing activities primarily reflect cash flows related to issuing and repaying consolidated obligations. For the six months ended June 30, 2013, net cash provided (used) in our financing activities was $(5.8) billion. This was primarily driven by paydowns of our consolidated obligation discount notes offset by increased issuances of our consolidated obligation bonds.

Consolidated Obligation Bonds and Discount Notes

We fund our assets principally with consolidated obligations (bonds and discount notes) issued through the Office of Finance, and capital stock. Consolidated obligations have GSE status although they are not obligations of the United States and the United States does not guarantee them.

Shorter term discount notes declined significantly during the first six months as we turned to more attractively-priced, longer-termed consolidated obligation bonds for funding.

52

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)




The following shows our net cash flow issuances (redemptions) by type of consolidated obligation:

For the six months ended
 
2013
 
2012
Discount notes
 
$
(9,676
)
 
$
(1,967
)
Bonds
 
4,081

 
(35
)
Total consolidated obligations
 
$
(5,595
)
 
$
(2,002
)


The following table summarizes par values of the consolidated obligations of the FHLBs and those for which we are the primary obligor:

 
 
June 30, 2013
 
December 31, 2012
Par values as of
 
  Bonds  
 
Discount
Notes
 
Total
 
  Bonds  
 
Discount
Notes
 
Total
FHLB System
 
$
483,057

 
$
221,447

 
$
704,504

 
$
471,567

 
$
216,335

 
$
687,902

FHLB Chicago as primary obligor
 
36,725

 
21,585

 
58,310

 
32,659

 
31,269

 
63,928

As a percent of the FHLB System
 
8
%
 
10
%
 
8
%
 
7
%
 
14
%
 
9
%


Conditions in Financial Markets

Following the general market stability of the first quarter, volatility and rates increased significantly during the latter half of the second quarter of 2013. Market participants focused less on the debt ceiling and more on the possibility of a near-term reduction in Federal Reserve quantitative easing in the form of Treasury and MBS securities purchases that currently total $85 billion combined per month.

The temporary suspension of the U.S. debt ceiling limit, agreed to in February by Congress, expired May 18, 2013. The U.S. Treasury announced on May 17, 2013, that it planned to begin employing extraordinary measures at that time to allow the government to continue to fulfill its obligations. Lower government expenditures, higher tax revenues and higher payments from Fannie Mae and Freddie Mac related to the Preferred Stock Purchase Agreement have been reducing the U.S. Government's need to borrow additional money. According to current analyst estimates, Congress now has until October or November of 2013 to negotiate a budget compromise that addresses the debt ceiling issue. To the extent that Congressional debates about deficit reduction and the debt ceiling adversely affect the financial markets, FHLB funding levels and costs may be impacted as discussed on page 28 of the Risk Factors section of our 2012 Form 10-K.

On May 22, Federal Reserve Chairman Bernanke testified before the Joint Economic Committee, noting that the Federal Reserve was evaluating whether a “recalibration of the pace of its purchases is warranted.” The market interpretation of this comment was that the Federal Reserve could take a first step towards removing quantitative easing support at one of the next few Federal Open Market Committee meetings. As a result, investors sold bonds, driving Treasury rates higher with the 10-year Treasury increasing 45 basis points during the month of May. At the meeting of the Federal Open Market Committee on June 18-19, it appeared that the Federal Reserve still felt strongly about its position on U.S. economic growth, unemployment and inflation and therefore, market participants strengthened their belief that quantitative easing tapering could begin as early as September 2013, driving rates even higher during the remainder of the second quarter. The 10-year Treasury rate rose an additional 36 basis points during the month of June.

We continued to have ready access to funding during the second quarter of 2013.



53

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Capital Resources

Capital Rules and Minimum Capital Requirements

For a description of our current capital rules, including recent amendments to our capital plan, and minimum capital requirements, see Note 12 – Capital Stock and Mandatorily Redeemable Capital Stock to the financial statements. As of the date of this filing, we have managed our capital base and assets to remain in compliance with our minimum capital requirements.

Capital Amounts

The following table presents our five largest holdings of regulatory capital stock and reconciles our capital reported in our statements of condition to the amount of capital stock reported for regulatory purposes. MRCS is included in the calculation of the regulatory capital and leverage ratios but is recorded as a liability in the statements of condition.

As of June 30, 2013
 
Capital Stock
 
MRCS
BMO Harris Bank N.A.
 
$
170

 
11
%
 
$

The Northern Trust Company
 
142

 
9
%
 

Associated Bank, N.A.
 
110

 
7
%
 

Cole Taylor Bank
 
68

a 
4
%
 

State Farm Bank, F.S.B
 
65

 
4
%
 

All other members
 
985

 
65
%
 
3

Total
 
$
1,540

 
100
%
 
$
3

 
 
 
 
 
 
 
 
 
June 30, 2013
 
December 31, 2012
 
Change
Capital stock
 
$
1,540

 
$
1,650

 
$
(110
)
Total retained earnings
 
1,917

 
1,691

 
226

Total permanent capital
 
3,457

 
3,341

 
116

Accumulated other comprehensive income (loss)
 
31

 
107

 
(76
)
Total GAAP capital
 
$
3,488

 
$
3,448

 
$
40

 
 
 
 
 
 


Capital Stock
 
$
1,540

 
$
1,650

 
$
(110
)
MRCS
 
3

 
6

 
(3
)
Total retained earnings
 
1,917

 
1,691

 
226

Regulatory capital
 
$
3,460

 
$
3,347

 
$
113

a 
MB Financial Inc., the holding company of our member MB Financial Bank NA, has announced that it will acquire Taylor Capital Group Inc., the holding company of our member Cole Taylor Bank.

Components of total GAAP capital changed for the following reasons:

Capital stock decreased primarily due to repurchases or redemptions of excess member capital stock as further discussed in Note 12 - Capital and Mandatorily Redeemable Capital Stock to the financial statements.
Total retained earnings increased due to our income less dividends paid, see Statements of Capital on page 6.
Our unrealized income in AOCI increased due to several factors. For details see Other Comprehensive Income on page 49.

Although we had no OTTI in the first half of 2013, credit deterioration may continue to negatively impact our private-label MBS portfolio.  We believe that future impairments of this portfolio are possible if unemployment rates, default, delinquency, or loss rates on mortgages continue to increase, or there is a further decline in residential real estate value. We cannot predict if or when such impairments will occur, or the impact such impairments may have on our retained earnings and capital position. See page 30 of the Risk Factors section of our 2012 Form 10-K.

We may not pay dividends if we fail to satisfy our minimum capital and liquidity requirements under the FHLB Act and FHFA regulations. As discussed in Note 14 - Regulatory Actions to the financial statements in our 2012 Form 10-K, dividends paid for any given quarter of 2013 must not exceed the following rates on an annualized basis: (1) the average of three-month LIBOR plus 350 basis points on Class B1 capital stock, and (2) the average of three-month LIBOR plus 100 basis points on Class B2 capital stock. The Board has also resolved that payment of any dividend may not result in our retained earnings falling below the

54

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


level of retained earnings at the previous year-end. Our Board may not pay dividends above these limits or otherwise modify or terminate this resolution without written consent by the Director of the FHFA.

On July 23, 2013, our Board declared a cash dividend at an annualized rate of 0.30% per share based on our preliminary financial results for the second quarter of 2013.

The completion of our quarterly repurchase program initiated in 2012 and the implementation of amendments to our capital plan, as further discussed in Note 12 - Capital Stock and Mandatorily Redeemable Capital Stock to the financial statements, positions us to begin differentiating the dividend paid on Class B1 (activity) and Class B2 (membership) with a goal of encouraging members to increase advance borrowings. Beginning with the financial results for the third quarter of 2013, we expect our Board of Directors to consider paying an enhanced dividend on activity stock (B1) relative to stock required for membership (B2) as permitted under our capital plan and as appropriate based on quarterly earnings. We anticipate that paying a higher dividend on activity stock will effectively lower the cost of borrowing from the Bank and represents another way to provide increased value to our members. Although we continue to work to build our financial strength to support a reasonable dividend, any future dividend determination by our Board will be at our Board's sole discretion and will depend on future operating results and any other factors the Board determines to be relevant, and be reviewed in accordance with the Board's resolution and our Retained Earnings and Dividend Policy.

On March 28, 2013, our Board of Directors amended our Retained Earnings and Dividend Policy to increase our retained earnings target in an effort to mitigate the impact to our capital of the repurchase risk that arises from obligations to third party investors for loans originated under the MPF Program. For further discussion of our repurchase liability, see page 31 in the Risk Factors section of our 2012 Form 10-K. For further information about our Retained Earnings and Dividend Policy, see Retained Earnings and Dividend Policy on page 62 in our 2012 Form 10-K.
  
We continue to allocate 20% of our net income each quarter to a restricted retained earnings account in accordance with the Joint Capital Enhancement Agreement that we entered into with the other FHLBs, as further discussed in Joint Capital Enhancement Agreement on page F-56 in our 2012 Form 10-K.


Critical Accounting Policies and Estimates

The table below identifies our critical accounting policies and estimates and the page number where a detailed description of each can be found in our 2012 Form 10-K. 

Other-Than-Temporary Impairment (OTTI)
Page 65
Significant Inputs Used on all residential private-label MBS securities
Page 66
Estimating Fair Value
Page 66
Controls over Valuation Methodologies
Page 66
Controls over Third Party Pricing Services
Page 67
Fair Value Measurement Effect on Liquidity and Capital
Page 67
Allowance for Credit Losses - Conventional MPF Loan Assumptions
Page 67
Overnight Indexed Swaps (OIS)
Page 68

Critical Accounting Policies

Significant changes in our critical accounting policies from our 2012 Form 10-K are outlined below. Also see
Note 2 - Summary of Significant Accounting Policies and Note 3 - Recently Issued but Not Yet Adopted Accounting Standards to the financial statements for the impact of changes in accounting policies and recently issued accounting standards on our financial results.


55

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Supplement to Affordable Housing and Community Investment Programs

In April of 2013, we received approval from the FHFA and our Board of Directors to implement the Community First Fund, which is structured as an on-balance sheet revolving pool of funds, with a mission to provide access to capital that supports meeting economic development and affordable housing needs in the communities that our members serve in Illinois and Wisconsin. As a result, we recognized the reversal of the $50 million charge we previously recognized in the fourth quarter of 2011 through "Non-interest expense - Other community investment” in our Statement of Income. The reversal will not be included in our AHP assessment for 2013 since we already have paid our AHP assessment attributable to the $50 million charge in 2011. Refer to our Critical Accounting Polices and Estimates section on page 66 in our 2012 Form 10-K for further details

Critical Accounting Estimates

Other-Than-Temporary Impairment (OTTI)

Adverse Case Scenario. In addition to evaluating our private-label MBS under a base case best estimate scenario as discussed in Note 5 - Investment Securities to the financial statements, we performed a cash flow analysis for each of these securities under a more stressful housing price scenario. This stress test adverse case scenario was based on a short-term housing price forecast that was decreased five percentage points followed by a recovery path that is 33.0% lower than the base case.

The following table presents what the impact to net income from credit-related OTTI charges would have been under this adverse scenario based on the classification (prime, Alt-A, or subprime) at the time of origination.  In the table below, in cases where the credit-related OTTI for an investment category is less than $1 million, the amount is not reported. We recorded no actual OTTI in the second quarter of 2013 based on the base case scenario.

 
 
Adverse Scenario
 
As of and for the quarter ended
June 30, 2013
 
# of
Securities
 
Unpaid
Principal
Balance  
 
Credit-
Related OTTI
 
Prime
 
2

 
$
3

 
$

 
Subprime
 
7

 
96

 
(1
)
 
Total private-label MBS
 
9

 
$
99

 
$
(1
)
 


In the preceding table, we classify our private-label MBS as prime, subprime, or Alt-A based upon the nature of the majority of underlying mortgages collateralizing each security using the issuer's classification, or as published by an NRSRO, at the time of issuance of the MBS.  On October 15, 2010, we instituted litigation relating to sixty-four private label MBS bonds purchased by us in an aggregate original principal amount of approximately $4.29 billion. Our complaints assert claims for untrue or misleading statements in the sale of securities, and it is possible that the classifications of private-label MBS, as well as other statements made about the securities by the issuer, are inaccurate.

Significant Inputs Used on all residential private-label MBS securities

We perform cash flow analyses on substantially all of our private-label MBS, impaired or not, from our two independent model services.


56

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


The following table summarizes the significant inputs for all our private-label MBS, except for securities for which the underlying collateral data is not readily available. These were evaluated for OTTI using alternative procedures. The classification in this table (prime, Alt-A, and subprime) is based on the model used to run the estimated cash flows for the CUSIP, which may not necessarily be the classification at the time of issuance.

As of June 30, 2013
 
Unpaid Principal Balance
 
Prepayment Rate Weighted
Average %
 
Default Rates Weighted
Average %
 
Loss Severity Weighted
Average %
 
Credit Enhancement Weighted Average %
2006
 
$
717

 
9.4
 
24.6
 
39.3
 
0.1
2004 & prior
 
17

 
12.2
 
6.2
 
27.7
 
12.4
Total Prime
 
734

 
9.4
 
24.1
 
39.1
 
0.4
2006
 
617

 
8.9
 
38.3
 
46.7
 
0.8
2005
 
28

 
7.9
 
34.4
 
47.4
 
2004 & prior
 
2

 
13.1
 
25.1
 
31.6
 
23.4
Total Alt-A
 
647

 
8.9
 
38.1
 
46.7
 
0.8
2007
 
9

 
4.2
 
63.6
 
64.5
 
43.2
2006
 
798

 
4.4
 
65.2
 
65.8
 
21.3
2005
 
46

 
5.0
 
60.0
 
62.5
 
44.8
2004 & prior
 
15

 
7.4
 
26.3
 
66.8
 
40.3
Total Subprime
 
868

 
4.5
 
64.3
 
65.6
 
23.1
Total
 
2,249

 
7.3
 
43.6
 
51.5
 
9.3
Analyzed by alternative procedures
 
88

 
 
 
 
 
 
 
 
Total MBS
 
$
2,337

 
 
 
 
 
 
 
 


.

57

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Risk Management - Credit Risk


We track total credit risk with our members, including credit risk on advances plus risks in any of the other categories as described on page 69 in our December 31, 2012 Form 10-K. As of June 30, 2013, we had total credit risk concentrated with members with 10% or more of our total member credit outstanding as follows:

As of June 30, 2013
 
Total Member Credit Outstanding
 
% of Total
Associated Bank, N.A.
 
$2,914
 
15%
BMO Harris Bank N.A.
 
2,375
 
13%


Short-Term Investments Unsecured Credit Exposure

We maintain a short-term investment portfolio to provide funds to meet the credit needs of our members and to maintain liquidity. See Liquidity on page 52 for a discussion of our liquidity management.

Within our portfolio of short-term investments, we face credit risk from unsecured exposures to counterparties and members. Excluding investments in U.S. government and agency debt, our unsecured credit investments can have maturities that range between overnight and nine months and can consist of commercial paper, certificates of deposit, and Federal Funds sold. We are not currently entering into short-term unsecured investments beyond overnight and are transacting in Federal Funds only.

We actively monitor our credit exposures and the credit quality of our counterparties, including an assessment of each counterparty's financial performance, capital adequacy, sovereign support and the current market perceptions of the counterparties. General macro-economic, political and market conditions may also be considered when deciding on unsecured exposure. As a result of these monitoring activities, we may limit or suspend existing unsecured credit limits.
Under current Bank policy, eligible counterparties for short-term investments, including Federal Funds sold, are:

(i)
other FHLBs;
(ii)
other U.S. GSEs; and
(iii)
FDIC-insured financial institutions, including U.S. subsidiaries of foreign commercial banks, or U.S. branches of foreign commercial banks whose most recently published financial statements exhibit at least $250 million of Tier 1 (or total) capital. Foreign banks must be domiciled in a country whose sovereign rating is at least Aa3 from Moody's or AA- from Standard & Poor's.

In addition, our non-member counterparties must have a rating from an NRSRO of at least Baa or BBB in order to be eligible for an unsecured credit line. Our members who are FDIC-insured financial institutions discussed in (iii) above are eligible Federal Funds counterparties, although our members do not have to meet the NRSRO ratings requirement in order to be eligible for an unsecured credit line. While from time to time we may enter into Federal Funds transactions with our members that meet the qualifications outlined above, the majority of our Federal Funds transaction tend to be with non-member counterparties. As of June 30, 2013, we had $11 million in Federal Funds outstanding to members.

FHFA regulations include limits on the amount of unsecured credit we may extend to any member or non-member counterparty or to a group of affiliated counterparties. Our Board-approved policy limits are lower than those permitted by regulation, and actual limits granted to counterparties may be lower than our internal policy limits. The FHFA limit is based on a percentage of eligible regulatory capital and the counterparty's overall credit rating. Under FHFA 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 stated percentage that we may offer for term extensions of unsecured credit ranges from 1% to 15% based on a counterparty's credit rating.

FHFA regulations also permit us to extend additional unsecured credit for overnight extensions of credit and for sales of Federal Funds subject to continuing contracts that renew automatically. Our total unsecured exposure to a counterparty may not exceed twice the regulatory limit for term exposures, or a total of 2% to 30% of the eligible amount of regulatory capital, based on the counterparty's credit rating. We were in compliance with the regulatory limits established for our unsecured credit as of and for the periods presented.

We are prohibited by FHFA regulation 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 or 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

58

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


to foreign counterparties. We are in compliance with the regulation and did not own any financial instruments issued by foreign sovereign governments, including those countries that are members of the European Union, as of and for the periods presented.

The following table presents the credit ratings of our unsecured investment credit exposures presented by the domicile of the counterparty or the domicile of the counterparty's parent for U.S. branches and agency offices of foreign commercial banks based on the NRSRO used by us. This table does not reflect the foreign sovereign government's credit rating. We mitigate this risk by investing in unsecured investments with highly-rated counterparties and/or well-capitalized members. The unsecured investment credit exposure presented in the table may not reflect the average or maximum exposure during the period as the balances presented reflect the balances at period end.

As of June 30, 2013
 
AA
 
A
 
BBB
 
Unrated
 
Total
Domestic U.S.
 
$

 
$

 
$
175

 
$
11

 
$
186

U.S. branches and agency offices of foreign commercial banks:
 
 
 
 
 
 
 
 
 
 
Canada
 

 
1,500

 

 

 
1,500

Australia
 
500

 

 

 

 
500

Total unsecured credit exposure
 
$
500

 
$
1,500

 
$
175

 
$
11

 
$
2,186


We mitigate the credit risk on investments by investing in investments that have short-term maturities. All investments in the above table were of overnight duration.


Investment Securities

In addition to private-label MBS, we also hold a variety of other investment securities we believe are low risk and mostly government backed or insured such as GSE debt, and FFELP ABS. There was no material change in the credit ratings of these AA or better rated securities since December 31, 2012, and except for private-label MBS as noted below, we have never taken an impairment charge on these securities. For further details see page 72 in our 2012 Form 10-K.

Our private label MBS are predominantly variable rate securities rated below investment grade BBB. There was no material change in overall credit quality since December 31, 2012, nor have we acquired any new private label MBS or had any other-than-temporary impairment (OTTI) to date in 2013. For further details see page 75 in our 2012 Form 10-K. The following table presents the components of amortized cost of our private label MBS and the life-to-date OTTI credit impairment taken at some point in time on these securities.

As of June 30, 2013
 
Unpaid Principal Balance
 
Life-To-Date OTTI Credit Impairment a
 
Other Adjustments b
 
Amortized Cost
Private label MBS
 
$2,337
 
$(742)
 
$
144

 
$1,739
a 
Life-to-date OTTI credit impairment excludes certain adjustments, such as increases in cash flows expected to be collected that have been recognized into net income.
b 
Other Adjustments primarily consists of principal shortfalls and life-to-date accretion of interest related to the discounted present value of previously recognized credit-related impairment losses.


Member Credit Outstanding

The following table presents the number of borrowers and credit outstanding to our borrowers by rating. Our internal rating is utilized in determining our members' borrowing capacity and is not a reflection of the credit risk on the credit outstanding to an individual member. Credit outstanding consists of outstanding advances, letters of credit, MPF credit enhancement obligations, member derivative exposures, and other obligations. Collateral loan value describes the borrowing capacity assigned to the types of collateral we accept for advances. Collateral loan value does not imply fair value.

 
 
June 30, 2013
 
December 31, 2012
Rating
 
Number of Borrowers
 
% of Total
 
Credit Outstanding
 
% of Total
 
Collateral Loan Value
 
Number of Borrowers
 
% of Total
 
Credit Outstanding
 
% of Total
 
Collateral Loan Value
1-3
 
437

 
87
%
 
$
17,713

 
96
%
 
$
38,714

 
453

 
87
%
 
$
14,573

 
92
%
 
$
36,671

4
 
26

 
5
%
 
266

 
1
%
 
662

 
26

 
5
%
 
718

 
4
%
 
1,255

5
 
41

 
8
%
 
628

 
3
%
 
1,087

 
43

 
8
%
 
715

 
4
%
 
1,320

Total
 
504

 
100
%
 
$
18,607

 
100
%
 
$
40,463

 
522

 
100
%
 
$
16,006

 
100
%
 
$
39,246


59

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)




The majority of borrowers assigned a 4 rating in the above table were required to submit specific collateral listings and the majority of borrowers assigned a 5 rating were required to deliver collateral to us or a third party custodian on our behalf. The method by which a borrower reports collateral is dependent upon the collateral status to which it is assigned, as well as the type of collateral being pledged. We assign borrowers to a borrowing base (blanket-lien) status, listing-collateral status, or delivery-collateral status. Under a blanket lien status, a borrower may report collateral pledged under a summary borrowing base. For members or a class of collateral on listing status, the member must provide us with loan-level detail of the collateral. For members or a class of collateral on delivery status, the member must deliver the collateral to us or an approved custodian for our benefit. Members must report their collateral at least quarterly. For insurance company members we took delivery of collateral for all advances outstanding regardless of credit rating for the periods presented.

As a result of the collateral and other credit risk mitigation efforts, we believe we are sufficiently well collateralized on our credit outstanding and we have not recorded an allowance for credit losses on our advances or other credit products as of the periods presented, nor have we ever incurred a credit loss on advances or our other credit products to date. We had two borrowers placed into receivership by their regulator during the year to date period ended June 30, 2013, and at the time of failure their total advances outstanding were $3 million. All outstanding advances were either repaid or were assumed by the acquirer. No credit losses were incurred on these advances.

In addition to providing advances, we also offer standby letters of credit to our members and standby bond purchase agreements with state housing authorities within our district, as disclosed in Note 15 - Commitments and Contingencies to the financial statements. To secure letter of credit risks, we require collateral as we do on advances.


MPF Loans

We record provisions for credit losses for MPF Loans based on portfolio and market trends related to delinquency rates, loss severities, and prepayment speeds consistent with the percentages of delinquent, nonaccrual, and impaired MPF Loans to total conventional MPF Loans. Our provision declined during the first six months of 2013 compared to 2012 primarily as a result of a decline in our total outstanding delinquent MPF Loans. For details on our allowance for credit losses, please see Note 8 - Allowance for Credit Losses to the financial statements.

We are exposed to mortgage repurchases in connection with our sale of MPF Xtra loans to Fannie Mae under the MPF Xtra product. If a loan eligibility requirement or other warranty is breached, Fannie Mae could require us to repurchase an ineligible MPF Xtra loan or provide an indemnity. If the PFI from which we purchased an ineligible MPF Xtra loan is viable, we may require the PFI to repurchase that loan from us or indemnify us for related losses. For the six-month period ending June 30, 2013, we have repurchased $8 million of unpaid principal balances related to MPF Xtra loans sold to Fannie Mae. These repurchases represent repurchase requests that have been resolved during the reporting period. We incurred no material losses on these loans. As of June 30, 2013, we have $54 million in unpaid principal balances outstanding related to mortgage loans that represent unresolved claims with Fannie Mae, see Note 15 - Commitments and Contingencies to the financial statements. Specifically, we believe a repurchase request from Fannie Mae may occur; however, it is still uncertain if or when Fannie Mae will request us to repurchase these mortgage loans.

Our mortgage repurchase liability is intended to cover losses associated with all mortgage loans previously sold in connection with the MPF Xtra product for which a breach or representation or warranty has occurred, regardless of when those losses occur or how they are ultimately resolved (e.g., repurchase, make-whole payment). Our mortgage repurchase liability does not represent the unpaid principal balance for repurchase requests made by Fannie Mae. To estimate our mortgage repurchase liability, we consider the factors outlined below, which are predominantly based on our historical repurchase experience.

We only include mortgage loans for which we deem it probable that Fannie Mae will require us to either repurchase the mortgage loan or indemnify them for a loss on the mortgage loan. The fact that a mortgage loan may have a representations and warranties issue does not mean Fannie Mae will request us to repurchase it from or indemnify them; for example, Fannie Mae may decide to retain a performing loan. Our estimate of such mortgage loans is initially based upon outstanding repurchase and indemnification requests related to breaches of representations and warranties discovered during our quality control review process as further discussed in Quality Assurance Process on page 10 in our 2012 Form 10-K. This estimate incorporates Fannie Mae, PFI, and other third party behavior, potential defects or breaches with the mortgage loans, as well as the performing versus nonperforming status of the mortgage loans;
Our potential ability to cure the defects identified in the repurchase demands;
The estimated loss severity upon repurchase of the loan or collateral, make-whole settlement or indemnification; and
We estimate probable recoveries on these losses from PFIs and other FHLBs. In making this assessment, we factor in cases in which we require PFIs to collateralize repurchase obligations and indemnifications given their credit condition and size of their repurchase obligation or indemnification.


60

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Based on these factors we recognized a mortgage repurchase liability to Fannie Mae of $1 million as of June 30, 2013. We also recognized $1 million as of June 30, 2013, as an offsetting receivable due from our PFIs, since we deem it probable that we will recover any losses from third parties (i.e., PFIs). As a result, we did not recognize a loss in our statement of income related to MPF Xtra loan repurchase or indemnification risk to Fannie Mae.

While we use the best information available to us in estimating our mortgage repurchase liability, the estimation process is inherently uncertain and imprecise. Factors that may lead to imprecise estimates of our mortgage repurchase liability include, but are not limited to, the following:

The mortgage repurchase liability may be influenced by third party (e.g., PFI) servicing practices, the potential actions of Fannie Mae, and the financial condition of our PFIs. These influences are continuing to evolve and may necessitate revising our estimate of the mortgage repurchase liability.
Our ability to estimate probable repurchase or indemnification requests from Fannie Mae on pools of mortgage loans is limited due to our lack of extended historical experience with repurchase/ indemnification demand activity related to the MPF Xtra product. As a result, for purposes of our analysis, we've only assumed probable repurchase or indemnification requests from Fannie Mae in cases where both an actual breach attributable to a mortgage loan has been specifically identified and where we believe Fannie Mae will request us to repurchase or indemnify them (e.g., the mortgage loan is nonperforming). Mortgage loans in the remaining pool in which an actual breach has not yet been identified or where we do not expect Fannie Mae to request us to repurchase or indemnify them for the mortgage loan are excluded from our analysis.
Repurchase requests from Fannie Mae may be made up until full repayment of a loan rather than when a purported defect is first identified, repurchase requests as of a particular date may not reflect total repurchase liability for loans outstanding as of that date as further described in Note 15 - Commitments and Contingencies.
Additional repurchase requests and indemnifications not yet identified may result from our quality assurance review of MPF Xtra loans.

As of June 30, 2013, we believe the estimate of reasonably possible losses is zero, as we believe it is probable that we would recover such reasonably possible losses from third parties. We require PFIs to collateralize repurchase obligations and indemnifications on the basis of their credit condition and size of their repurchase obligation or indemnification. See “Risk Factors” on page 31 of our 2012 10-K Report for a further description of risks and trends related to our repurchase liability.

Additionally, PFIs also are required to repurchase ineligible MPF Loans we hold in our portfolio and the repurchase requirement is a factor in determining our allowance for credit losses. If a PFI is unable to repurchase ineligible MPF Loans, we would incur a loss to the extent a credit loss is not expected to be recovered from either collateral or a blanket lien provided by the PFI or alternatively the FDIC. In this regard, we have not recorded an allowance for credit losses for repurchase requests or indemnifications related to MPF Loans held in our portfolio, as we do not expect to incur any losses after factoring in our recovery claims from PFIs.


Derivative counterparties

We transact most of our derivatives with large banks and major broker-dealers. Derivative transactions may be either over-the-counter with a counterparty (bilateral derivatives) or over-the-counter cleared through an FCM with a derivatives clearing organization (clearinghouse). As of June 30, 2013, we held an immaterial amount of cleared derivative contracts.

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, collateral requirements and other credit enhancements are used and are effective in mitigating the risk. We manage credit risk through credit analysis, collateral management and other credit enhancements. We are also required to follow the requirements set forth by applicable regulation.

Bilateral Derivatives. We are subject to non-performance by counterparties to derivative agreements. We 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 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 with counterparties as of June 30, 2013.

Cleared Derivatives. We are subject to credit risk due to nonperformance by the clearinghouse. The requirement that we post initial and variation margin through the FCM, on behalf of the clearinghouse, exposes us to institutional credit risk in the event that the FCM or the clearinghouse fails to meet their obligations. Clearing derivatives through a clearinghouse mitigates counterparty credit risk exposure because a central clearinghouse counterparty is substituted for individual counterparties and collateral is posted daily for changes in the value of cleared derivatives through an FCM. We do not anticipate any credit losses on our cleared derivatives as of June 30, 2013.


61

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


We actively monitor our counterparties' exposure to European sovereign debt and consider this exposure as a component of our credit risk review process. Due to the significant European sovereign credit concerns, we have suspended or reduced new derivatives transactions with European counterparties to reduce our exposure to these counterparties. We may further suspend or limit derivatives transactions with other European counterparties in accordance with our risk management policies and regulatory requirements.

The contractual or notional amount of derivative agreements reflects our involvement in the various classes of financial instruments. Our maximum credit risk with respect to derivative agreements is the estimated cost of replacing interest-rate swaps, forward agreements and purchased caps and floors if the counterparty defaults, minus the value of any related collateral. In determining maximum credit risk, we consider, with respect to each counterparty, accrued interest receivables and payables as well as the legal right to net assets and liabilities.

The following table presents the derivative positions with non-member counterparties and member institutions to which we had credit exposure at June 30, 2013. Rating shown is the lowest rating among the three largest NRSROs. Of our net exposure after collateral, $1 million was with institutions outside of the U.S.

 
 
Derivative Asset Exposure at Fair Value Net of Cash Collateral
 
Securities Collateral Held
 
Net Exposure After Collateral
As of June 30, 2013
 
 
 
 
 
 
A rated
 
$
21

 
$
20

 
$
1

Member institutions and MPF delivery commitments
 
2

 

 
2

Total derivatives
 
$
23

 
$
20

 
$
3

 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
AA rated
 
$
1

 
$

 
$
1

A rated
 
31

 
30

 
1

Member institutions and MPF delivery commitments
 
15

 

 
15

Total derivatives
 
$
47

 
$
30

 
$
17



Legislative and Regulatory Developments

FHFA Developments

Interim Final Rule Regarding Executive Compensation. On May 14, 2013, the FHFA published an interim final rule setting forth requirements and processes with respect to compensation provided to executive officers by FHLBs and the Office of Finance. The Executive Compensation interim final rule addresses the authority of the FHFA Director to approve, disapprove, modify, prohibit, or withhold compensation of executive officers of the FHLBs and the Office of Finance. The interim final rule also addresses the FHFA Director's authority to approve, in advance, agreements or contracts of executive officers that provide compensation in connection with termination of employment. The interim final rule prohibits an FHLB or the Office of Finance from paying compensation to an executive officer that is not reasonable and comparable with compensation paid by similar businesses for similar duties and responsibilities. Our failure to comply with the rule may result in supervisory action by the FHFA. The interim final rule became effective on June 13, 2013, with comments due by July 15, 2013.

Proposed Rule Regarding Golden Parachute and Indemnification Payments. On May 14, 2013, the FHFA re-proposed a proposed rule setting forth the standards that the FHFA would take into consideration when limiting or prohibiting golden parachute and indemnification payments if adopted as proposed. The primary impact of this proposed rule would be to better conform existing FHFA regulations on golden parachutes with Federal Deposit Insurance Corporation (FDIC) golden parachute regulations and to further refine limitations on golden parachute payments to further limit any such payments made by an FHLB or the Office of Finance that is assigned a less than satisfactory composite FHFA examination rating. Comments on the proposed rule were due by July 15, 2013.


62

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Other Significant Developments

Housing Finance and Housing GSE Reform. Congress continues to consider reforms for the U.S. housing finance system and the housing GSEs, including the resolution of Fannie Mae and Freddie Mac (together, the Enterprises). So far, several new proposals have been offered that would wind down the Enterprises and replace them with a new finance system to support the secondary mortgage market. On June 25, 2013, a bill entitled the Housing Finance Reform and Taxpayer Protection Act of 2013 (the Housing Finance Reform Act) was introduced in the Senate with bipartisan support. On July 11, 2013, Republican leaders of the House Financial Services Committee submitted a proposal entitled the Protecting American Taxpayers and Homeowners Act of 2013 (the PATH Act), which was approved by the Committee on July 24, 2013. Both proposals would have direct implications for the FHLBs if enacted.

While both proposals reflect the efforts over the past year to lay the groundwork for a new U.S. housing finance structure by creating a single securitization platform and establishing national standards for mortgage securitization, they differ on the role of the Federal government in the revamped housing finance structure. The Housing Finance Reform Act would establish the Federal Mortgage Insurance Corporation (the FMIC) as an independent agency in the Federal government, replacing the FHFA as the primary Federal regulator of the FHLBs. The FMIC would facilitate the securitization of eligible mortgages by insuring covered securities, in a catastrophic risk position. The FHLBs, or a subsidiary, would be allowed to apply to become an approved issuer of covered securities to facilitate access to the secondary market for smaller community mortgage lenders, although any covered MBS issued by the FHLBs or subsidiary would not be issued as a consolidated obligation and would not be treated as a joint and several obligation of any FHLB that has not elected to participate in such issuance.

By contrast, the PATH Act would effectively eliminate any government guarantee of conventional, conforming mortgages except for FHA, VA and similar loans designed to serve first-time homebuyers and low- and moderate-income borrowers. The FHLBs would be authorized to act as aggregators of mortgages for securitization through a newly established common market utility.

The PATH Act would also revamp the statutory provisions governing the board composition of FHLBs. Among other things, the number of directors would be capped at 15, which could be an important factor in the context of two FHLBs merging. Special provisions would govern mergers, capping the number of member directors allocated to a state at two until each state has at least one member director. In addition, the FHFA would be given the authority, consistent with the authority of other banking regulators, to regulate and examine vendors of an FHLB or an Enterprise. Also, the PATH Act would remove the requirement that the FHFA adopt regulations establishing standards of community investment or service for FHLBs' members.

Any fundamental changes to the U.S. housing finance system could have consequences for the FHLB System and our ability to provide readily accessible liquidity to our members. However, it is impossible to determine at this time whether or when legislation would be enacted for housing GSE or housing finance reform. The ultimate effects of these efforts on the FHLBs are unknown and will depend on the legislation or other changes, if any, that ultimately are implemented.

Final Rule and Guidance on the Supervision and Regulation of Certain Nonbank Financial Companies. The Financial Stability Oversight Council (the Oversight Council) issued a final rule and guidance effective May 11, 2012 on the standards and procedures the Oversight Council employs in determining whether to designate a nonbank financial company for supervision by the Federal Reserve Board and to be subject to certain enhanced prudential standards and additional requirements. The guidance issued with this final rule provides that the Oversight Council expects generally to follow a three-stage process in making its determinations consisting of:

A first stage that will identify those nonbank financial companies that have $50 billion or more of total consolidated assets and exceed any one of five threshold indicators of interconnectedness or susceptibility to material financial distress, including whether a company has $20 billion or more in total debt outstanding;

A second stage involving a robust analysis by the Oversight Council of the potential threat that the nonbank financial companies identified in the first stage could pose to U.S. financial stability, based on additional quantitative and qualitative factors that are both industry and company specific; and

A third stage during which the Oversight Council will consider qualitative factors about the nonbank financial companies identified in the second stage as meriting further review, including using information collected directly from that nonbank financial company.

The final rule provides that, in making its determinations, the Oversight Council will consider as one factor whether the nonbank financial company is subject to oversight by a primary financial regulatory agency (for the FHLBs, the FHFA). A nonbank financial company that the Oversight Council proposes to designate for additional supervision (for example, periodic stress testing) and prudential standards (such as heightened liquidity or capital requirements) under this rule has the opportunity to contest the designation. If we are designated by the Oversight Council for supervision by the Federal Reserve and subject to additional Federal Reserve prudential standards, then our operations and business could be adversely impacted by any resulting additional costs, liquidity or capital requirements, and/or restrictions on business activities.


63

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


On April 5, 2013, the Federal Reserve System published a final rule that establishes the requirements for determining when a company is “predominately engaged in financial activities." The final rule provides that a company is “predominantly engaged
in financial activities” and thus a “nonbank financial company” if:

as determined in accordance with applicable accounting standards, (i) the consolidated annual gross financial revenues of the company in either of its two most recently completed fiscal years represent 85% or more of the company's consolidated annual gross revenues in that fiscal year, or (ii) the company's consolidated total financial assets as of the end of either of its two most recently completed fiscal years represent 85% or more of the company's consolidated total assets as of the end that fiscal year; or

based on all the facts and circumstances, it is determined by the Oversight Council, with respect to the definition of a “nonbank financial company,” or the Federal Reserve Board, with respect to the definition of a “significant nonbank financial company,” that (i) the consolidated annual gross financial revenues of the company represent 85 % or more of the company's consolidated annual gross revenues, or (ii) the consolidated total financial assets of the company represent 85% or more of the company's consolidated total assets.

Under the final rule, we would likely be a nonbank financial company.

The final rule also defines the terms "significant nonbank financial company" to mean (i) any nonbank financial company supervised by the Federal Reserve Board; and (ii) any other nonbank financial company that had $50 billion or more in total consolidated assets as of the end of its most recently completed fiscal year. If we are designated by the Oversight Council for supervision by the Federal Reserve Board (and therefore a significant nonbank financial company), we would be subject to increased supervision and oversight as described above.

Money Market Mutual Fund (MMF) Reform. The Oversight Council has issued certain proposed recommendations for structural reforms of MMFs, stating that such reforms are intended to address the structural vulnerabilities of MMFs. In addition, on June 19, 2013 the SEC proposed two alternatives for amending rules that govern MMFs under the Investment Company Act of 1940. The first alternative proposal would require non-government institutional MMFs to sell and redeem shares based on the current market-based value of the securities in their underlying portfolios. The second alternative proposal would require non-government MMFs to generally impose a liquidity fee if a fund's liquidity levels fell below a specified threshold and would permit the funds to suspend redemptions temporarily. The demand for FHLB System consolidated obligations may be impacted by the structural reform ultimately adopted.
Basel Committee on Banking Supervision - Capital Framework. In July 2013, the Federal Reserve Board and the Office of the Comptroller of the Currency adopted a final rule and the FDIC adopted an interim final rule establishing new minimum capital standards for financial institutions to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision. The new capital framework includes, among other things:
a new minimum ratio of common equity tier 1 capital to risk-weighted assets, a higher minimum ratio of tier 1 capital to risk-weighted assets and a common equity tier 1 capital conservation buffer;

revised methodologies for calculation of risk-weighted assets to enhance risk sensitivity; and

a minimum supplementary leverage ratio for financial institutions subject to the “advanced approaches” risk-based capital rules.
The new framework could require some FHLB members to divest assets in order to comply with the more stringent capital and liquidity requirements, thereby tending to decrease their need for advances. The requirements may also adversely impact investor demand for consolidated obligations to the extent that impacted institutions divest or limit their investments in consolidated obligations. Conversely, the new requirements could incentivize FHLB members to use term advances to create and maintain balance sheet liquidity. Most FHLB members must begin compliance with the final rule by January 1, 2015, although some larger members must begin to comply by January 1, 2014.


 




64

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Item 3. Quantitative and Qualitative Disclosures About Market Risk.


The FHFA's regulations, its Financial Management Policy, and our internal asset and liability management policies all establish guidelines for our use of interest rate derivatives. These regulations and policies prohibit the speculative use of financial instruments authorized for hedging purposes. They also limit the amount of counterparty credit risk allowed. For additional information please see Item 7A Quantitative and Qualitative Disclosures about Market Risk on page 85 in our 2012 Form 10-K.

Measurement of Market Risk Exposure
To measure our exposure, we discount the cash flows generated from modeling the terms and conditions of all interest rate-sensitive securities using current interest rates to determine their fair values or spreads to the swap curve for securities where third party prices are used. This includes considering explicit and embedded options using a lattice model or Monte Carlo simulation. We estimate yield curve, option, and basis risk exposures by calculating the fair value change in relation to various parallel changes in interest rates, implied volatility, prepayment speeds, spreads to the swap curve and mortgage rates.
 
The table below summarizes our sensitivity to various interest rate risk exposures in terms of changes in market value.

 
 
 
Option Risk
 
Basis Risk
 
Yield Curve Risk
 
Implied Volatility
 
Prepayment Speeds
 
Spread to Swap Curve
 
Mortgage Spread
As of June 30, 2013
 
 
 
 
 
 
 
 
 
Advances
$
(2
)
 
$

 
$

 
$
(4
)
 
$

MPF Loans
(2
)
 
(6
)
 
(3
)
 
(3
)
 
1

Mortgage Backed Securities
(8
)
 
(2
)
 
(1
)
 
(9
)
 

Other interest earning assets
(1
)
 

 

 
(4
)
 

Interest-bearing liabilities
14

 
23

 

 
13

 

Derivatives

 
(17
)
 

 

 

Total
$
1

 
$
(2
)
 
$
(4
)
 
n/m

 
$
1

 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
 
Advances
$
(3
)
 
$

 
$

 
$
(4
)
 
$

MPF Loans
(2
)
 
(2
)
 
(6
)
 
(3
)
 
1

Mortgage Backed Securities
(9
)
 
(1
)
 
(2
)
 
(10
)
 

Other interest earning assets
(1
)
 

 

 
(5
)
 

Interest-bearing liabilities
10

 
8

 

 
9

 

Derivatives
5

 
(5
)
 

 

 

Total
$

 
$

 
$
(8
)
 
n/m

 
$
1

n/m
Spread movements to the swap curve within each category are independent of the other categories and therefore a total is not meaningful.

Yield curve risk – Change in market value for a one basis point parallel increase in the swap curve.
Option risk (implied volatility) – Change in market value for a one percent parallel increase in the swaption volatility.
Option risk (prepayment speeds) – Change in market value for a one percent increase in prepayment speeds.
Basis risk (spread to swap curve) – Change in market value for a one basis point parallel increase in the spread to the swap curve.
Basis risk (mortgage rates) – Change in market value for a one basis point increase in mortgage rates.


As of June 30, 2013, our sensitivity to changes in implied volatility was $(2) million, compared to none at December 31, 2012. These sensitivities are limited in that they do not incorporate other risks, including but not limited to, non-parallel changes in yield curves, implied volatility, prepayment speeds, and basis risk related to differences between the swap and the other curves. Option positions embedded in our mortgage assets and callable debt impact our yield curve risk profile, such that swap curve changes significantly greater than one basis point cannot be linearly interpolated from the table above.


65

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Duration of equity is another measure to express interest rate sensitivity. We report the results of our duration of equity calculations to the FHFA each quarter. We measure duration of equity in a base case using the actual yield curve as of a specified date and then shock it with an instantaneous shift of the entire curve. The following table presents the duration of equity reported by us to the FHFA in accordance with the FHFA's guidance, which prescribes that down and up interest-rate shocks equal 200 basis points. However, the applicable regulation restricts the down rate from assuming a negative interest rate. Therefore, we adjust the down rate accordingly in periods of very low levels of interest rates. The results are shown in years of duration equity.

As of June 30, 2013
 
As of December 31, 2012
Down 200 bps
 
Base
 
Up 200 bps
 
Down 200 bps
 
Base
 
Up 200 bps
4.7
 
-0.7
 
-0.5
 
2.4
 
0.8
 
-3.5

Duration gap is another measure of interest rate sensitivity. Duration gap is calculated by dividing the dollar duration of equity by the fair value of assets. A positive duration gap indicates an exposure to rising interest rates. As of June 30, 2013, our duration gap was -0.5 months, compared to 0.4 months as of December 31, 2012.

As of June 30, 2013, on a U.S. GAAP basis, our fair value surplus (relative to book value) was $334 million, and our market value of equity to book value of equity ratio was 110%. At December 31, 2012, our fair value surplus was $65 million and our market value of equity to book value of equity ratio was 102%. These improvements were primarily because spreads tightened for mortgages and consolidation obligation spreads widened. Our market to book value of total capital for regulatory risk-based capital purposes differs from this GAAP calculation, as discussed starting on page F-55 in our 2012 Form 10-K.
Our Asset/Liability Management Committee provides oversight of risk management practices and policies. This includes routine reporting to senior management and the Board of Directors, as well as maintaining the Market Risk Policy, which defines our interest rate risk limits. The table below reflects the change in market risk limits under the Market Risk Policy.

 
 
June 30, 2013
 
December 31, 2012
Scenario as of
 
Change in Market Value of Equity
 
Loss Limit
 
Change in Market Value of Equity
 
Loss Limit
-200 bp
 
$
54.2

 
$
(185.0
)
 
$
115.2

 
$
(185.0
)
-100 bp
 
(9.7
)
 
(77.5
)
 
72.4

 
(77.5
)
-50 bp
 
(8.8
)
 
(30.0
)
 
42.5

 
(30.0
)
-25 bp
 
(5.7
)
 
(15.0
)
 
19.8

 
(15.0
)
+25 bp
 
6.7

 
(30.0
)
 
6.7

 
(30.0
)
+50 bp
 
11.4

 
(60.0
)
 
28.6

 
(60.0
)
+100 bp
 
11.6

 
(155.0
)
 
107.4

 
(155.0
)
+200 bp
 
19.1

 
(370.0
)
 
248.5

 
(370.0
)



66

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Item 4. Controls and Procedures.


Disclosure Controls and Procedures

Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report (the Evaluation Date). Based on this evaluation, the principal executive officer and principal financial officer concluded as of the Evaluation Date that the disclosure controls and procedures were effective such that information relating to us that is required to be disclosed in reports filed with the SEC (i) is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.


Changes in Internal Control Over Financial Reporting

For the current year quarter presented in this Form 10-Q, 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.


Consolidated Obligations

Our disclosure controls and procedures include controls and procedures for accumulating and communicating information relating to our joint and several liability for the consolidated obligations of other FHLBs. For further information, see Item 9A. Controls and Procedures on page 92 of our 2012 Form 10-K.


67

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

On October 15, 2010, the Bank instituted litigation relating to 64 private label MBS bonds purchased by the Bank in an aggregate original principal amount of $4.29 billion. The Bank's complaints assert claims for untrue or misleading statements in the sale of securities, signing or circulating securities documents that contained material misrepresentations, negligent misrepresentation, market manipulation, untrue or misleading statements in registration statements, controlling person liability, and rescission of contract. In these actions, the Bank seeks the remedies of rescission, recovery of damages, recovery of purchase consideration plus interest (less income received to date) and recovery of reasonable attorneys' fees and costs of suit. The litigation was brought in state court in the states of Washington, California and Illinois.
Defendants in the litigation include the following entities and affiliates thereof: American Enterprise Investment Services, Inc.; Ameriprise Financial Services, Inc.; Bank of America Corporation; Barclays Capital Inc.; Citigroup, Inc.; Countrywide Financial Corporation, Credit Suisse Securities (USA) LLC; GMAC Mortgage Group LLC, Goldman Sachs & Co., RBS Securities Inc., Sand Canyon Acceptance Corporation, N.A., J.P. Morgan Acceptance Corporation; Long Beach Securities Corp.; Merrill Lynch, Pierce Fenner & Smith Incorporated; Morgan Stanley & Co., Incorporated; Mortgage Asset Securitization Transactions, Inc.; PNC Investments LLC; Sequoia Residential Funding, Inc.; UBS Securities LLC; WaMu Capital Corp.; and Wells Fargo Bank, N.A. One Mortgage Partners Corp., which is affiliated with J.P. Morgan Acceptance Corporation but is not a defendant in these actions, held less than 1% of the Bank's capital stock as of June 30, 2013.  
In the Washington action, defendants filed a motion to dismiss on March 4, 2011, which was denied in its entirety on June 17, 2011. The action is proceeding in discovery. In the Illinois action, defendants filed motions to dismiss on May 27, 2011, oral argument was heard on the motions on June 5, 2012, and the court denied defendants' motions in their entirety on September 19, 2012. Sequoia Residential Funding, Inc. and its affiliates have filed with the Illinois appellate court a petition for leave to appeal the Cook County Circuit Court's denial of its motion to dismiss for lack of personal jurisdiction. This petition was denied. Certain defendants also filed with the Circuit Court a Motion to Certify Questions of Law for Interlocutory Appeal and to Stay Discovery. This petition was also denied. In the California action, defendants filed demurrers asserting statutes of limitations arguments on December 1, 2011, which were denied in their entirety on June 26, 2012. On August 31, 2012, defendants in the California action filed a second round of demurrers. Briefing on these issues is closed and oral argument on the motion is scheduled for August 2013. 
The Bank may also be subject to various other legal proceedings arising in the normal course of business. After consultation with legal counsel, management is not aware of any other proceedings that might have a material effect on the Bank's financial condition or results of operations.

Item 1A. Risk Factors.

In addition to the information presented in this report, readers should carefully consider the factors set forth in the Risk Factors section on page 22 in our 2012 Form 10-K, which could materially affect our business, financial condition, or future results. These risks are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also severely affect us.


68

Federal Home Loan Bank of Chicago


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.
 

Item 6. Exhibits.

4.1
Amended and Restated Capital Plan of the Federal Home Loan Bank of Chicago, effective as of July 1, 20131
 
 
10.1
 Federal Home Loan Bank of Chicago President and Executive Team Incentive Compensation Plan, effective January 1, 2013
 
 
31.1
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Executive Officer
 
 
31.2
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Financial Officer
 
 
32.1
Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by the Principal Executive Officer
 
 
32.2
Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by the Principal Financial Officer
 
 
101.INS
XBRL Instance Document
 
 
101.SCH
XBRL Taxonomy Extension Schema Document
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document

1 Filed with our Current Report on Form 8-K on May 30, 2013

69

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Glossary of Terms

Advances: Secured loans to members.
 
ABS: Asset-backed-securities.
 
AFS: Available-for-sale securities.

AHP: Affordable Housing Program.

AOCI: Accumulated Other Comprehensive Income.
 
Capital plan: The Federal Home Loan Bank of Chicago capital plan, as amended, effective July 1, 2013.
 
CE Amount: A PFI's assumption of credit risk on conventional MPF Loan products that are funded by, or sold to, an MPF Bank by providing credit enhancement either through a direct liability to pay credit losses up to a specified amount or through a contractual obligation to provide SMI. Does not apply to the MPF Xtra product.

Consolidated Obligations (CO): FHLB debt instruments (bonds and discount notes) which are the joint and several liability of all FHLBs; issued by the Office of Finance.
Consolidated obligation bonds: Consolidated obligations that make periodic interest payments with a term generally over one year, although we have issued for terms of less than one year.
 
Core Based Statistical Areas (CBSA): Refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget. As currently defined, a CBSA must contain at least one urban area of 10,000 or more people.

Discount notes: Consolidated obligations with a term of one year or less, which sell at less than their face amount and are redeemed at par value when they mature.
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted July 21, 2010.
 
Excess capital stock: Capital stock held by members in excess of their minimum investment requirement.
 
Fannie Mae: Federal National Mortgage Association.
 
FASB: Financial Accounting Standards Board.

FCM: Futures Commission Merchant.
 
FDIC: Federal Deposit Insurance Corporation.
 
Federal Reserve: Federal Reserve Bank of New York.
 
FFELP: Federal Family Education Loan Program.
 
FHA: Federal Housing Administration.
 
FHFA: Federal Housing Finance Agency - The Housing and Economic Recovery Act of 2008 enacted on July 30, 2008 created the Federal Housing Finance Agency which became the regulator of the FHLBs.
 
FHLB Act: The Federal Home Loan Bank Act of 1932, as amended.
 
FHLBs: The 12 Federal Home Loan Banks or subset thereof.
 
FHLB System: The 12 FHLBs and the Office of Finance.
 
Freddie Mac: Federal Home Loan Mortgage Corporation.
 
GAAP: Generally accepted accounting principles in the United States of America.
 
Ginnie Mae: Government National Mortgage Association.
 

70

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


Government Loans: MPF Loans held in our portfolio comprised of loans insured by the Federal Housing Administration (FHA) or the Department of Housing and Urban Development (HUD) and loans guaranteed by the Department of Veteran Affairs (VA) or Department of Agriculture Rural Housing Service (RHS).
 
GSE: Government sponsored enterprise.

Housing Act: Housing and Economic Recovery Act of 2008, enacted July 30, 2008.

HUD: Department of Housing and Urban Development.
 
HTM: Held-to-maturity securities.

LIBOR: London Interbank Offered Rate.

Master Commitment (MC): Pool of MPF Loans purchased or funded by an MPF Bank.
 
MBS: Mortgage-backed securities.

Moody's: Moody's Investors Service.
 
MPF®: Mortgage Partnership Finance.
 
MPF Banks: FHLBs that participate in the MPF program.

MPF Loans: Conforming conventional and government fixed-rate mortgage loans secured by one-to-four family residential properties with maturities from five to 30 years or participations in such mortgage loans that are acquired under the MPF Program.

MPF Program: A secondary mortgage market structure that provides liquidity to FHLB members that are PFIs through the purchase or funding by an FHLB of MPF Loans.

MPF Xtra® product: The MPF Program product under which we acquire MPF Loans from PFIs without any CE Amount and concurrently resell them to Fannie Mae.

MRCS: mandatorily redeemable capital stock. 

NRSRO: Nationally Recognized Statistical Rating Organization.
 
Office of Finance: A joint office of the FHLBs established to facilitate issuing and servicing of consolidated obligations.

OIS: Fed Funds Effective Swap Rate (or Overnight Index Swap Rate).

OTTI: Other-than-temporary impairment.
 
PFI: Participating Financial Institution. A PFI is a member (or eligible housing associate) of an MPF Bank that has applied to and been accepted to do business with its MPF Bank under the MPF Program.
 
PMI: Primary Mortgage Insurance.
 
Regulatory capital: Regulatory capital stock plus retained earnings.

Regulatory capital stock: The sum of the paid-in value of capital stock and mandatorily redeemable capital stock.
 
REO: Real estate owned.

RHS: Department of Agriculture Rural Housing Service.

SMI: Supplemental mortgage insurance.
 
System: The Federal Home Loan Bank System consisting of the 12 Federal Home Loan Banks and the Office of Finance.

VA: Department of Veteran's Affairs.

71

Federal Home Loan Bank of Chicago
(Dollars in millions except per share amounts unless otherwise indicated)


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 CHICAGO
 
 
 
 
 
 
 
/s/    Matthew R. Feldman
 
 
By:
 
Matthew R. Feldman
 
 
Title:
 
President and Chief Executive Officer
Date:
August 8, 2013
(Principal Executive Officer)
 
 
 
 
 
 
 
/s/   Roger D. Lundstrom
 
 
By:
 
Roger D. Lundstrom
 
 
Title:
 
Executive Vice President and Chief Financial Officer
Date:
August 8, 2013
(Principal Financial Officer and Principal Accounting Officer)


S-1