10-K 1 a201610kfhlbsf.htm 10-K Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
  ____________________________________
FORM 10-K
____________________________________
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
Commission File Number: 000-51398
FEDERAL HOME LOAN BANK OF SAN FRANCISCO
(Exact name of registrant as specified in its charter)
  ____________________________________
 
Federally chartered corporation
 
94-6000630
 
 
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. employer
identification number)
 
 
 
 
 
 
 
600 California Street
San Francisco, CA
 
94108
 
 
(Address of principal executive offices)
 
(Zip code)
 
(415) 616-1000
(Registrant's telephone number, including area code)
  ____________________________________
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class B Stock, par value $100
(Title of class)
  ____________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o  Yes    x  No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o  Yes    x  No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.    x  Yes    o  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    o  No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
o
  
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
x  (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).    o  Yes    x  No
Registrant's capital stock is not publicly traded and is only issued to members of the registrant. Such capital stock is issued and redeemed at par value, $100 per share, subject to certain regulatory and statutory limits. At June 30, 2016, the aggregate par value of the capital stock held by shareholders of the registrant was approximately $3,006 million. At February 28, 2017, the total shares of capital stock outstanding, including mandatorily redeemable capital stock, totaled 28,684,786.
DOCUMENTS INCORPORATED BY REFERENCE: None.



Federal Home Loan Bank of San Francisco
2016 Annual Report on Form 10-K
Table of Contents
PART I.
 
 
  
 
 
 
 
 
 
Item 1.
 
  
 
 
 
 
 
Item 1A.
 
  
 
 
 
 
 
Item 1B.
 
  
 
 
 
 
 
Item 2.
 
  
 
 
 
 
 
Item 3
 
  
 
 
 
 
 
Item 4
 
  
 
 
 
 
 
PART II.
 
 
 
 
Item 5.
 
 
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
Item 7.
 
  
 
 
  
 
 
  
 
 
  
 
 
  
 
 
  
 
 
  
 
 
 
 
 
  
 
 
  
 
 
 
 
 
Item 7A.
 
  
 
 
 
 
 
Item 8.
 
 
 
 
 
 
 
Item 9.
 
 
 
 
 
 
 
Item 9A.
 
  
 
 
 
 
 
Item 9B.
 
 
 
 
 
 
 
PART III.
 
 
  
 
 
 
 
 
 
Item 10.
 
  
 
 
 
 
 
Item 11.
 
  
 
 
 
 
 
Item 12.
 
  
 
 
 
 
 
Item 13.
 
  
 
 
 
 
 
Item 14.
 
  
 
 
 
 
 
PART IV.
 
 
  
 
 
 
 
 
 
Item 15.
 
  
 
 
 
 
 
  




PART I. FINANCIAL INFORMATION

ITEM 1.
BUSINESS

At the Federal Home Loan Bank of San Francisco (Bank), our purpose is to enhance the availability of credit for residential mortgages and economic development by providing a readily available, competitively priced source of funds for housing and community lenders. We are a wholesale bank—we link our customers to the global capital markets and seek to manage our own liquidity so that funds are available when our customers need them. By providing needed liquidity and financial risk management tools, our credit programs enhance competition in the mortgage market and benefit homebuyers and communities.

We are one of 11 regional Federal Home Loan Banks (FHLBanks) that serve the United States as part of the Federal Home Loan Bank System. Each FHLBank operates as a separate federally chartered corporation with its own board of directors, management, and employees. The FHLBanks were organized under the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), and are government-sponsored enterprises (GSEs). The FHLBanks are not government agencies and do not receive financial support from taxpayers. The U.S. government does not guarantee, directly or indirectly, the debt securities or other obligations of the Bank or the FHLBank System. The FHLBanks are regulated by the Federal Housing Finance Agency (Finance Agency), an independent federal agency.

We have a cooperative ownership structure. To access our products and services, a financial institution must be approved for membership and purchase capital stock in the Bank. The member's capital stock requirement is generally based on its use of Bank products, subject to a minimum asset-based membership requirement that is intended to reflect the value to the member of having ready access to the Bank as a reliable source of competitively priced funds. Bank capital stock is issued, transferred, redeemed, and repurchased at its par value of $100 per share, subject to certain regulatory and statutory limits. It is not publicly traded.

Our members may include federally insured and regulated financial depositories, regulated insurance companies that are engaged in residential housing finance, community development financial institutions (CDFIs) that have been certified by the CDFI Fund of the U.S. Treasury Department, and privately insured, state-chartered credit unions. Financial depositories may include commercial banks, credit unions, industrial loan companies, and savings institutions. CDFIs may include community development loan funds, community development venture capital funds, and privately insured, state-chartered credit unions. All members have a principal place of business located in Arizona, California, or Nevada, the three states that make up the Eleventh District of the FHLBank System. Our members range in size from $6 million to over $176 billion in assets.

Our primary business is providing competitively priced, collateralized loans, known as advances, to our members and certain qualifying housing associates. Advances may be fixed or adjustable rate, with terms ranging from one day to 30 years. We accept a wide range of collateral types, some of which cannot be readily pledged elsewhere or readily securitized. Members use their access to advances to support their mortgage loan portfolios, lower their funding costs, facilitate asset-liability management, reduce on-balance sheet liquidity, offer a wider range of mortgage products to their customers, and improve profitability.

As of December 31, 2016, we had advances and capital stock, including mandatorily redeemable capital stock, outstanding to the following types of institutions:


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Advances
(Dollars in millions)
Total Number of Institutions

 
Capital Stock Outstanding

 
Number of Institutions

 
Par Value of Advances Outstanding

Commercial banks
175

 
$
1,345

 
90

 
$
28,215

Savings institutions
11

 
188

 
6

 
962

Credit unions
127

 
792

 
40

 
5,417

Industrial loan companies
3

 
2

 
3

 
48

Insurance companies
9

 
39

 
3

 
223

Community development financial institutions
6

 
4

 
3

 
60

Total member institutions
331

 
2,370

 
145

 
34,925

Housing associates eligible to borrow
2

 

 
1

 
10

Other nonmember institutions(1)
6

 
457

 
5

 
14,922

Total
339

 
$
2,827

 
151

 
$
49,857


(1)
Nonmember institutions may be former members or may have acquired the advances and capital stock of a former member. Capital stock held by nonmember shareholders is classified as mandatorily redeemable capital stock, a liability. Nonmember shareholders with advances outstanding are required to meet the Bank's applicable credit, collateral, and capital stock requirements, including requirements regarding creditworthiness and collateral borrowing capacity. Nonmembers (including former members and member successors) are not eligible to borrow new advances from the Bank or renew existing advances as they mature.

To fund their operations, the FHLBanks issue debt in the form of consolidated obligation bonds and discount notes (jointly referred to as consolidated obligations) through the FHLBanks’ Office of Finance, the fiscal agent for the issuance and servicing of consolidated obligations on behalf of the FHLBanks. Because the FHLBanks’ consolidated obligations are rated Aaa/P-1 by Moody’s Investors Service (Moody’s) and AA+/A-1+ by S&P Global Ratings (S&P) and because of the FHLBanks' GSE status, the FHLBanks are generally able to raise funds at rates that are typically at a small to moderate spread above U.S. Treasury security yields. Our cooperative ownership structure allows us to pass along the benefit of these low funding rates to our members.

Members also benefit from our affordable housing and economic development programs, which provide grants and below-market-rate loans that support members’ involvement in creating affordable housing and revitalizing communities.

Our Business Model

Our cooperative ownership structure has led us to develop a business model that is different from that of a typical financial services firm. Our business model is based on the premise that we maintain a balance between our objective to promote housing, homeownership, and community and economic development through our activities with members and our objective to provide a return on the private capital provided by our members through their investment in the Bank's capital stock. We achieve this balance by delivering low-cost credit to help our members meet the credit needs of their communities while striving to pay members a reasonable return on their investment in the Bank's capital stock.

As a cooperatively owned wholesale bank, we require our members to purchase capital stock to support their activities with the Bank. We leverage this capital by using our GSE status to borrow funds in the capital markets at rates that are generally at a small to moderate spread above U.S. Treasury security yields. We lend these funds to our members at rates that are competitive with the cost of most wholesale borrowing alternatives available to our largest members.

We may also invest in residential mortgage-backed securities (MBS) up to the regulatory policy limit of three times capital. Our MBS investments include agency-issued MBS that are guaranteed through the direct obligation of or are supported by the U.S. government and private-label residential MBS (PLRMBS) that were AAA-rated at the time of purchase. We also have a portfolio of residential mortgage loans purchased from members. Earnings on these mortgage assets have historically provided us with the financial flexibility to continue providing cost-effective

2



credit and liquidity to our members. While the mortgage assets we hold are intended to increase our earnings, they also modestly increase our credit and interest rate risk.

Additional information about our investments is provided in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments.”

Our financial strategies are designed to enable us to safely expand and contract our assets, liabilities, and capital as our member base and our members' credit needs change. Our capital increases when members are required to purchase additional capital stock as they increase their advances borrowings, and it contracts when we repurchase excess capital stock from members as their advances decline. As a result of these strategies, we have been able to achieve our mission by meeting member credit needs and maintaining our strong regulatory capital position, while paying dividends (including dividends on mandatorily redeemable capital stock) and repurchasing and redeeming excess capital stock. Throughout 2016, the Bank continued to monitor the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the payment of dividends and the repurchase of excess capital stock. Additional information regarding the Bank’s dividends and the repurchase of excess capital stock is provided in “Item 8. Financial Statements and Supplementary Data Note 15 – Capital – Excess Stock Repurchase, Retained Earnings, and Dividend Framework.”

Products and Services

Advances. We offer our members a wide array of fixed and adjustable rate loans, called advances, with maturities ranging from one day to 30 years. Our advance products are designed to help members compete effectively in their markets and meet the credit needs of their communities. For members that choose to retain the mortgage loans they originate as assets (portfolio lenders), advances serve as a funding source for a variety of conforming and nonconforming mortgage loans, including multifamily mortgage loans. As a result, advances support an array of housing market segments, including those focused on low- and moderate-income households. For members that sell or securitize mortgage loans and other assets, advances can provide interim funding.

Our credit products also help members with their asset-liability management. Members can use a wide range of advance types, with different maturities and payment characteristics, to match the characteristics of their assets and reduce their interest rate risk. We offer advances that are callable at the member's option and advances with embedded option features (such as caps and floors), which can reduce the interest rate risk associated with holding fixed rate mortgage loans and adjustable rate mortgage loans with interest rate caps in the member's portfolio.

We offer both standard and customized advance structures. Standard advances include fixed and adjustable rate advance products with different maturities, interest rates, and payment characteristics. Fixed rate advances generally have maturities ranging from one day to 30 years. Adjustable rate advances generally have maturities ranging from less than 30 days to 10 years, with the interest rates resetting periodically at a fixed spread to the London Interbank Offered Rate (LIBOR) or to another specified index. Customized advances may include:
advances with non-standard indices;
advances with embedded option features (such as interest rate caps, floors, and call and put options);
amortizing advances; and
advances with partial prepayment symmetry. (Partial prepayment symmetry is a product feature under which the Bank may charge a prepayment fee or pay a prepayment credit, depending on certain circumstances, such as movements in interest rates, if the advance is prepaid.)

For each customized advance, we typically execute a derivative to enable us to offset the customized features embedded in the advance.

We manage the credit risk of advances and other credit products by setting the credit and collateral terms available to individual members and housing associates based on their creditworthiness and the quality and value of the assets

3



they pledge as collateral. We also have procedures to assess the mortgage loan quality and documentation standards of institutions that pledge mortgage loan collateral. In addition, we have collateral policies and restricted lending procedures in place to help manage our exposure to institutions that experience difficulty in meeting their capital requirements or other standards of creditworthiness. These credit and collateral policies balance our dual goals of meeting the needs of members and housing associates as a reliable source of liquidity and mitigating credit risk by adjusting credit and collateral terms in view of changes in member creditworthiness.

All advances must be fully collateralized. To secure advances, borrowers may pledge one- to four-family first lien residential mortgage loans, multifamily mortgage loans, MBS, U.S. government and agency securities, deposits in the Bank, and certain other real estate-related collateral, such as commercial real estate loans and second lien residential mortgage loans. We may also accept small business, small farm, and small agribusiness loans that are fully secured by collateral (such as real estate, equipment and vehicles, accounts receivable, and inventory) as eligible collateral from members that are community financial institutions. The Housing and Economic Recovery Act of 2008 (Housing Act) added secured loans for community development activities as a type of collateral that we may accept from community financial institutions. The Housing Act defined community financial institutions as depository institutions insured by the Federal Deposit Insurance Corporation with average total assets over the preceding three-year period of $1 billion or less, to be adjusted for inflation annually by the Finance Agency. The average total asset cap for 2016 was $1,128 million.

Pursuant to our lending agreements with our borrowers, including members, housing associates, and nonmember institutions with credit outstanding, we limit extensions of credit to a borrower to a percentage of the market value or unpaid principal balance of the borrower’s pledged collateral, known as the borrowing capacity. The borrowing capacity percentage varies according to several factors, including the charter type of the institution, the collateral type, the value assigned to the collateral, the results of our collateral field review of the borrower’s collateral, the pledging method used for loan collateral (specific identification or blanket lien), the amount of loan data provided (detailed or summary reporting), the data reporting frequency (monthly or quarterly), the borrower’s financial strength and condition, and any institution-specific collateral risks. Under the terms of our lending agreements, the aggregate borrowing capacity of a borrower’s pledged eligible collateral must meet or exceed the total amount of the borrower’s outstanding advances, other extensions of credit, and certain other borrower obligations and liabilities. We monitor each borrower’s aggregate borrowing capacity and collateral requirements on a daily basis, by comparing the institution's borrowing capacity to its obligations to us.

In addition, the total amount of advances made available to each member or housing associate may be limited by the financing availability assigned by the Bank, which is generally expressed as a percentage of the member’s or housing associate’s assets. The amount of financing availability is generally determined by the creditworthiness of the member or housing associate.

We regularly review and adjust our lending parameters in light of changing market conditions, both negative and positive, and periodically adjust the maximum borrowing capacity of certain collateral types. When necessary, we require additional collateral to fully secure advances.

Based on the collateral pledged as security for advances, our credit analyses of our borrowers' financial condition, and our credit extension and collateral policies, we expect to collect all amounts due according to the contractual terms of the advances. Therefore, no allowance for losses on advances was deemed necessary by the Bank in 2016. We have never experienced any credit losses on advances.

When a borrower prepays an advance prior to its original maturity, we may charge the borrower a prepayment fee, depending on certain circumstances, such as movements in interest rates, at the time the advance is prepaid. For an advance with partial prepayment symmetry, we may charge the borrower a prepayment fee or pay the member a prepayment credit, depending on certain circumstances at the time the advance is prepaid. Our prepayment fee policy is designed to recover at least the net economic costs, if any, associated with the reinvestment of the advance prepayment proceeds or the cost to terminate the funding associated with the prepaid advance, which generally enables us to be financially indifferent to the prepayment of the advance.

4




Because of the funding alternatives available to our largest borrowers, we establish advances prices that take into account the cost of alternative market choices available to our largest members each day. We offer the same advances prices to all members each day, which means that all members benefit from this pricing strategy. In addition, if further price concessions are negotiated with any member to reflect market conditions on a given day, those price concessions are also made available to all members for the same product with the same terms on the same day.

Standby Letters of Credit. We issue standby letters of credit to support certain obligations of members to third parties. Members may use standby letters of credit issued by the Bank to facilitate residential housing finance and community lending, to achieve liquidity and asset-liability management goals, to secure certain state and local agency deposits, and to provide credit support to certain tax-exempt bonds. Our underwriting and collateral requirements for standby letters of credit are generally the same as our underwriting and collateral requirements for advances, but may differ in cases where member creditworthiness is impaired.

Investments. We invest in high-quality non-MBS investments to facilitate our role as a cost-effective provider of credit and liquidity to members and to enhance the Bank's earnings. We have adopted credit policies and exposure limits for investments that support liquidity and diversification of risk. These policies restrict the amounts and terms of our investments according to our own capital position as well as the capital and creditworthiness of the individual counterparties, with different unsecured credit limit policies for members and nonmembers. When we execute non-MBS investments with members, we may give consideration to their secured credit availability with the Bank and our advances price levels.

We may invest in short-term unsecured interest-bearing deposits, Federal funds sold, negotiable certificates of deposit, and commercial paper. We may also invest in short-term secured transactions, such as U.S. Treasury resale agreements. Our investments also include bonds issued by the Federal Farm Credit Banks, all of which are rated Aaa by Moody’s and AA+ by S&P. In addition, we may invest in housing finance agency bonds issued by housing finance agencies located in Arizona, California, and Nevada, the three states that make up the Eleventh District of the FHLBank System. These bonds are federally taxable mortgage revenue bonds, collateralized by pools of first lien residential mortgage loans and credit-enhanced by bond insurance. The bonds we hold are issued by the California Housing Finance Agency.

In addition, our investments include PLRMBS, all of which were AAA-rated at the time of purchase, and agency residential MBS, which are guaranteed through the direct obligation of, or are supported by, the U.S. government. Some of these PLRMBS were issued by and/or purchased from members, former members, or their respective affiliates. We execute all MBS investments without preference to the status of the counterparty or the issuer of the investment as a nonmember, member, or affiliate of a member.

Additional information about our investments and OTTI charges associated with our PLRMBS is provided in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk – Investments” and in “Item 8. Financial Statements and Supplementary Data Note 7 – Other-Than-Temporary Impairment Analysis.”

Mortgage Loans. Under the Mortgage Partnership Finance® (MPF®) Program, the Bank may purchase from members, for its own portfolio, conventional conforming fixed rate mortgage loans under the MPF Original product and mortgage loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA) under the MPF Government product. In addition, the Bank may facilitate the purchase of conforming fixed rate mortgage loans from members for concurrent sale to Fannie Mae under the MPF Xtra® product; of jumbo fixed rate mortgage loans for concurrent sale to Redwood Residential Acquisition Corporation, a subsidiary of Redwood Trust, Inc., a real estate investment trust, under the MPF Direct product; and of government-insured or government-guaranteed mortgage loans that will be packaged into securities backed by the mortgage loans and guaranteed by Ginnie Mae under the MPF Government MBS product. (“Mortgage Partnership Finance,” “MPF,” and “MPF Xtra” are registered trademarks of the FHLBank of Chicago.)

5




The Bank has approved 19 members as participating financial institutions since renewing its participation in the MPF Program in 2013. We previously purchased conventional conforming fixed rate residential mortgage loans from participating financial institutions from May 2002 to October 2006. The MPF Program allows us to further serve the needs of our members by offering them a competitive alternative secondary market channel for their mortgage originations. The MPF Government product also allows us to offer members a new mechanism to help low- and moderate-income homeowners and first-time homebuyers.

Affordable Housing Program. Through our Affordable Housing Program (AHP), we provide subsidies to assist in the purchase, construction, or rehabilitation of housing for households earning up to 80% of the median income for the area in which they live. Each year, to fund the AHP, we set aside 10% of the current year's net earnings (income before interest expense related to dividends paid on mandatorily redeemable capital stock and the assessment for the AHP), to be awarded in the following year. Since 1990, we have awarded $956 million in AHP subsidies to support the purchase, development, or rehabilitation of approximately 125,000 affordable homes.

We allocate at least 65% of our annual AHP subsidy to our competitive AHP, under which applications for specific owner-occupied and rental housing projects are submitted by members and are evaluated and scored by the Bank in an annual competitive process. All subsidies for the competitive AHP are funded to affordable housing sponsors or developers through our members in the form of direct subsidies or subsidized advances.

We allocate the remainder of our annual AHP subsidy, up to 35%, to our two homeownership set-aside programs, the Individual Development and Empowerment Account Program and the Workforce Initiative Subsidy for Homeownership Program. Under these programs, members reserve funds from the Bank to be used as matching grants for eligible first-time homebuyers.

Access to Housing and Economic Assistance for Development (AHEAD) Program. AHEAD Program grants, funded annually at the discretion of our Board of Directors, provide early-stage funding for targeted economic development projects and non-AHP-eligible affordable housing initiatives that create or preserve jobs, facilitate improvements to public or private infrastructure, or deliver social services, training or education programs, or other services and programs that benefit lower-income neighborhoods. AHEAD Program applications are submitted by members working with local community groups, and awards are based on project eligibility and evaluation of the applications. In 2016, the Bank awarded $1.5 million in AHEAD Program grants.

Discounted Credit Programs. We offer members two discounted credit programs available in the form of advances and standby letters of credit. Members may use the Community Investment Program to fund mortgages for low- and moderate-income households, to finance first-time homebuyer programs, to create and maintain affordable housing, and to support other eligible lending activities related to housing for low- and moderate-income families. Members may use the Advances for Community Enterprise (ACE) Program to fund projects and activities that create or retain jobs or provide services or other benefits for low- and moderate-income people and communities. Members may also use ACE Program funds to support eligible community lending and economic development, including small business, community facilities, and public works projects.

Funding Sources

We obtain most of our funds from the sale of the FHLBanks' debt instruments (consolidated obligations), which consist of consolidated obligation bonds and discount notes. The consolidated obligations are issued through the Office of Finance using authorized securities dealers and are backed only by the financial resources of the FHLBanks. As provided by the FHLBank Act or regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations. The joint and several liability regulation authorizes the Finance Agency to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The regulations provide a general framework for addressing the possibility that an FHLBank may be unable to repay the consolidated obligations for which it is the primary obligor. For more information, see “Item 8. Financial Statements and

6



Supplementary Data Note 20 – Commitments and Contingencies.” We have never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of December 31, 2016, and through the date of this report, we do not believe that it is probable that we will be asked to do so.

The Bank’s status as a GSE is critical to maintaining its access to the capital markets. Although consolidated obligations are backed only by the financial resources of the FHLBanks and are not guaranteed by the U.S. government, the capital markets have traditionally treated the FHLBanks’ consolidated obligations as comparable to federal agency debt, providing the FHLBanks with access to funding at relatively favorable rates. As of December 31, 2016, S&P rated the FHLBanks’ consolidated obligations AA+/A-1+, and Moody’s rated them Aaa/P-1. As of December 31, 2016, S&P assigned each of the FHLBanks a long-term credit rating of AA+ with a stable outlook, and Moody's assigned each of the FHLBanks a long-term credit rating of Aaa with a stable outlook. Changes in the long-term credit ratings of individual FHLBanks do not necessarily affect the credit rating of the consolidated obligations issued on behalf of the FHLBanks. Rating agencies may change or withdraw a rating from time to time because of various factors, including operating results or actions taken, business developments, or changes in their opinion regarding, among other factors, the general outlook for a particular industry or the economy.

Regulations govern the issuance of debt on behalf of the FHLBanks and related activities. All new debt is jointly issued by the FHLBanks through the Office of Finance, which serves as their fiscal agent in accordance with the FHLBank Act and applicable regulations. Pursuant to these regulations, the Office of Finance, often in conjunction with the FHLBanks, has adopted policies and procedures for consolidated obligations that may be issued by the FHLBanks. The policies and procedures relate to the frequency and timing of issuance, issue size, minimum denomination, selling concessions, underwriter qualifications and selection, currency of issuance, interest rate change or conversion features, call or put features, principal amortization features, and selection of clearing organizations and outside counsel. The Office of Finance has responsibility for facilitating and approving the issuance of the consolidated obligations in accordance with these policies and procedures. In addition, the Office of Finance has the authority to redirect, limit, or prohibit the FHLBanks' requests to issue consolidated obligations that are otherwise allowed by its policies and procedures if it determines that its action is consistent with: (i) the regulatory requirement that consolidated obligations be issued efficiently and at the lowest all-in cost over time, consistent with prudent risk management practices, prudent debt parameters, short- and long-term market conditions, and the FHLBanks' status as GSEs; (ii) maintaining reliable access to the short-term and long-term capital markets; and (iii) positioning the issuance of debt to take advantage of current and future capital markets opportunities. The authority of the Office of Finance to redirect, limit, or prohibit the Bank's requests for issuance of consolidated obligations has never adversely affected the Bank's ability to finance its operations. The Office of Finance also services all outstanding FHLBank debt, serves as a source of information for the FHLBanks on developments in the capital markets, and prepares the FHLBanks' quarterly and annual combined financial reports. In addition, it administers the Resolution Funding Corporation and the Financing Corporation, two corporations established by Congress in the 1980s to provide funding for the resolution and disposition of insolvent savings institutions.

Consolidated Obligation Bonds. Consolidated obligations are generally issued with either fixed rate payment terms or adjustable rate payment terms, which use a variety of indices for interest rate resets, including LIBOR. In addition, to meet the specific needs of certain investors, fixed rate and adjustable rate consolidated obligation bonds may contain certain embedded features, which may result in call options and complex coupon payment terms. In general, when such consolidated obligation bonds are issued for which the Bank is the primary obligor, we simultaneously enter into interest rate exchange agreements containing offsetting features to, in effect, convert the terms of the bond to the terms of a simple adjustable rate bond (tied to an index, such as those listed above). Typically, the maturities of these securities range from 6 months to 15 years, but the maturities are not subject to any statutory or regulatory limit. Consolidated obligation bonds may be issued and distributed daily through negotiated or competitively bid transactions with approved underwriters or selling group members.
 
We receive 100% of the net proceeds of a bond issued through direct negotiation with underwriters of debt when we are the only FHLBank involved in the negotiation. In these cases, the Bank is the sole primary obligor on the

7



consolidated obligation bond. When the Bank and one or more other FHLBanks jointly negotiate the issuance of a bond directly with underwriters, we receive the portion of the proceeds of the bond agreed upon with the other FHLBank(s); in those cases, the Bank is the primary obligor for a pro rata portion of the bond, including all customized features and terms, based on the proceeds received.

We may also request specific amounts of specific consolidated obligation bonds to be offered by the Office of Finance for sale in a competitive auction conducted with the underwriters in a bond selling group. One or more other FHLBanks may also request amounts of those same bonds to be offered for sale for their benefit in the same auction. We may receive zero to 100% of the proceeds of the bonds issued in a competitive auction depending on: (i) the amounts of and costs for the consolidated obligation bonds bid by underwriters; (ii) the maximum costs we or other FHLBanks participating in the same issue, if any, are willing to pay for the bonds; and (iii) guidelines for the allocation of bond proceeds among multiple participating FHLBanks administered by the Office of Finance.

Consolidated Obligation Discount Notes. The FHLBanks also issue consolidated obligation discount notes with maturities ranging from one day to one year, which may be offered daily through a consolidated obligation discount note selling group and through other authorized underwriters. Discount notes are issued at a discount and mature at par.

On a daily basis, we may request specific amounts of discount notes with specific maturity dates to be offered by the Office of Finance at a specific cost for sale to underwriters in the discount note selling group. One or more other FHLBanks may also request amounts of discount notes with the same maturities to be offered for sale for their benefit the same day. The Office of Finance commits to issue discount notes on behalf of the participating FHLBanks when underwriters in the selling group submit orders for the specific discount notes offered for sale. We may receive zero to 100% of the proceeds of the discount notes issued through this sales process depending on: (i) the maximum costs we or other FHLBanks participating in the same discount note issuance, if any, are willing to pay for the discount notes; (ii) the order amounts for the discount notes submitted by underwriters; and (iii) guidelines for the allocation of discount note proceeds among multiple participating FHLBanks administered by the Office of Finance.

Twice weekly, we may also request specific amounts of discount notes with fixed terms to maturity ranging from 4 to 26 weeks to be offered by the Office of Finance for sale in a competitive auction conducted with underwriters in the discount note selling group. One or more other FHLBanks may also request amounts of those same discount notes to be offered for sale for their benefit in the same auction. The discount notes offered for sale in a competitive auction are not subject to a limit on the maximum costs the FHLBanks are willing to pay. We may receive zero to 100% of the proceeds of the discount notes issued in a competitive auction depending on: (i) the amounts of and costs for the discount notes bid by underwriters and (ii) guidelines for the allocation of discount note proceeds among multiple participating FHLBanks administered by the Office of Finance.

Debt Investor Base. The FHLBanks’ consolidated obligations have traditionally had a diversified funding base of domestic and foreign investors. Purchasers of the FHLBanks' consolidated obligations include fund managers, commercial banks, pension funds, insurance companies, foreign central banks, state and local governments, and retail investors. These purchasers are also diversified geographically, with a significant portion of investors historically located in the United States, Europe, and Asia.

Segment Information

We use an analysis of the Bank’s financial results based on the financial components and adjusted net interest income of two operating segments, the advances-related business and the mortgage-related business, as well as other financial information, to review and assess financial performance and determine financial management strategies related to the operations of these two business segments. For purposes of segment reporting, adjusted net interest income includes interest income and expenses associated with net settlements from economic hedges that are recorded in “Net gain/(loss) on derivatives and hedging activities” in other income and excludes interest expense that is recorded in “Mandatorily redeemable capital stock.” Other key financial information, such as any credit-

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related OTTI charges on our PLRMBS or other expenses and assessments, is not included in the segment reporting analysis, but is incorporated into our overall assessment of financial performance.

The advances-related business consists of advances and other credit products, related financing and hedging instruments, liquidity and other non-MBS investments associated with our role as a liquidity provider, and capital stock. Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on all assets associated with the business activity in this segment and the cost of funding those activities, including the net settlements from associated interest rate exchange agreements, and from earnings on invested capital.

The mortgage-related business consists of MBS investments, mortgage loans acquired through the MPF Program, the consolidated obligations specifically identified as funding those assets, and the related hedging instruments. Adjusted net interest income for this segment is derived primarily from the difference, or spread, between the yield on the MBS and mortgage loans and the cost of the consolidated obligations funding those assets, including the net settlements from associated interest rate exchange agreements, less the provision for credit losses on mortgage loans.

Additional information about business segments is provided in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Segment Information” and in “Item 8. Financial Statements and Supplementary Data Note 17 – Segment Information.”

Use of Interest Rate Exchange Agreements

We use interest rate exchange agreements, also known as derivatives, as part of our risk management and funding strategies to reduce funding costs and interest rate risk inherent in the ordinary course of business. The types of derivatives we may use include interest rate swaps (including callable, putable, and basis swaps); swaptions; and interest rate cap and floor agreements.

The regulations governing the operations of the FHLBanks and the Bank's Risk Management Policy establish guidelines for our use of derivatives. These regulations and guidelines prohibit trading in derivatives for profit and any other speculative purposes and limit the amount of credit risk allowable from derivative counterparties.

We primarily use derivatives to manage our exposure to changes in interest rates. The goal of our interest rate risk management strategy is not to eliminate interest rate risk, but to manage it within appropriate limits that are consistent with the financial strategies approved by the Board of Directors. One key way we manage interest rate risk is to acquire and maintain a portfolio of assets and liabilities, which, together with their associated derivatives, are conservatively matched with respect to the expected maturities or repricings of the assets and the liabilities. We may also use derivatives to adjust the effective maturity, repricing frequency, or option characteristics of financial instruments (such as advances and consolidated obligations) to achieve risk management objectives.

We measure the Bank’s market risk at the enterprise level, as well as on a portfolio basis, taking into account all financial instruments. The market risk of the derivatives and the hedged items is included in the measurement of our various market risk measures. The Bank’s low interest rate risk profile reflects our conservative asset-liability mix, which is supported by integrated use of derivatives in our daily financial management.

Additional information about our interest rate exchange agreements is provided in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Market Risk – Total Bank Market Risk – Interest Rate Exchange Agreements” and in “Item 8. Financial Statements and Supplementary Data Note 18 – Derivatives and Hedging Activities.”


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Capital

From its enactment in 1932, the FHLBank Act provided for a subscription-based capital structure for the FHLBanks. The amount of capital stock that each FHLBank issued was determined by a statutory formula establishing how much FHLBank capital stock each member was required to purchase. With the enactment of the Gramm-Leach-Bliley Act of 1999, Congress replaced the statutory subscription-based member capital stock purchase formula with requirements for total capital, leverage capital, and risk-based capital for the FHLBanks and required the FHLBanks to develop new capital plans to replace the previous statutory structure.

We implemented our capital plan on April 1, 2004. The capital plan bases the stock purchase requirement on the level of activity a member has with the Bank, subject to a minimum membership requirement that is intended to reflect the value to the member of having access to the Bank as a funding source. With the approval of the Board of Directors, we may adjust these requirements from time to time within the ranges established in the capital plan. Any changes to our capital plan must be approved by our Board of Directors and the Finance Agency.
 
Bank capital stock cannot be publicly traded, and under the capital plan, may be issued, transferred, redeemed, and repurchased only at its par value of $100 per share, subject to certain regulatory and statutory limits. Under the capital plan, a member's capital stock will be redeemed by the Bank upon five years' notice from the member, subject to certain conditions. In addition, we have the discretion to repurchase excess capital stock from members.

Dividends and Retained Earnings. The Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework (Framework) summarizes the Bank’s capital management principles and objectives, as well as its policies and practices with respect to restricted retained earnings, dividend payments, and the repurchase of excess capital stock.

As required by the regulations governing the operations of the FHLBanks, the Framework is reviewed at least annually by the Bank’s Board of Directors. The Board of Directors may amend the Framework from time to time. In January 2017, the Framework was amended and approved by the Bank’s Board of Directors to include the Bank’s dividend philosophy to endeavor to pay a quarterly dividend at an annualized rate between 5% and 7%, which is intended to be considered by the Bank’s Board of Directors beginning with the Bank’s second quarter 2017 dividend recommendation. The decision to declare any dividend and the dividend rate are at the discretion of the Bank’s Board of Directors, which may choose to follow the dividend philosophy as guidance in the dividend declaration. The Bank’s historical dividend rates and the dividend philosophy are not indicative of future dividend declarations. The Bank’s dividend policy may be revised or eliminated in the future and there can be no assurance as to future dividends.

In accordance with the Framework, the Bank retains certain amounts in restricted retained earnings, which are not made available for dividends in the current dividend period. The Bank may be restricted from paying dividends if it is not in compliance with any of its minimum capital requirements or if payment would cause the Bank to fail to meet any of its minimum capital requirements. In addition, the Bank may not pay dividends if any principal or interest due on any consolidated obligation has not been paid in full or is not expected to be paid in full, or, under certain circumstances, if the Bank fails to satisfy certain liquidity requirements under applicable regulations.

The regulatory liquidity requirements state that each FHLBank must: (i) maintain eligible high quality assets (advances with a maturity not exceeding five years, U.S. Treasury securities investments, and deposits in banks or trust companies) in an amount equal to or greater than the deposits received from members, and (ii) hold contingent liquidity in an amount sufficient to meet its liquidity needs for at least five business days without access to the consolidated obligations markets. At December 31, 2016, advances maturing within five years totaled $48.4 billion, significantly in excess of the $169 million of member deposits on that date. In addition, as of December 31, 2016, the Bank held estimated total sources of funds in an amount that would have allowed the Bank to meet its liquidity needs for more than five consecutive business days without issuing new consolidated obligations, subject to certain conditions. For more information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk.”

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The Bank’s Risk Management Policy limits the payment of dividends based on the ratio of the Bank’s estimated market value of total capital to par value of capital stock. If this ratio at the end of any quarter is less than 100% but greater than or equal to 70%, any dividend would be limited to an annualized rate no greater than the daily average of the three-month London Interbank Offered Rate (LIBOR) for the applicable quarter (subject to certain conditions), and if this ratio is less than 70%, the Bank would be restricted from paying a dividend. For more information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Market Risk.”

Restricted Retained Earnings – In accordance with the Framework, the Bank retains in restricted retained earnings the following:
cumulative net gains in earnings (net of applicable assessments) resulting from valuation adjustments;
amounts related to loss protection and capital compliance, including amounts intended to protect paid-in capital from the effects of an extremely adverse credit event, an extremely adverse operations risk event, a cumulative net loss related to the Bank’s derivatives and associated hedged items and financial instruments carried at fair value, an extremely adverse change in the market value of the Bank’s capital, a significant amount of additional credit-related OTTI on PLRMBS, or some combination of these effects, especially in periods of extremely low net income, and amounts required to maintain capital compliance, including compliance with the FHLBank’s Joint Capital Enhancement Agreement. This restricted retained earnings requirement may be changed at any time. The Board of Directors periodically reviews the retained earnings methodology and analysis to determine whether any adjustments are appropriate.

In 2011, the FHLBanks entered into a Joint Capital Enhancement Agreement, as amended (JCE Agreement), intended to enhance the capital position of each FHLBank by allocating a portion of each FHLBank’s earnings to a separate retained earnings account at that FHLBank. In accordance with the JCE Agreement, each FHLBank is required to allocate 20% of its net income each quarter to a separate restricted retained earnings account until the balance of the account equals at least 1% of that FHLBank’s average balance of outstanding consolidated obligations for the previous quarter. Under the JCE Agreement, these restricted retained earnings will not be available to pay dividends.

Dividend Payments – Finance Agency rules state that FHLBanks may declare and pay dividends only from previously retained earnings or current net earnings, and may not declare or pay dividends based on projected or anticipated earnings. There is no requirement that the Board of Directors declare and pay any dividend. A decision by the Board of Directors to declare or not declare a dividend is a discretionary matter and is subject to the requirements and restrictions of the FHLBank Act and applicable requirements under the regulations governing the operations of the FHLBanks.

In addition, Finance Agency rules do not permit the Bank to pay dividends in the form of capital stock if its excess
capital stock exceeds 1% of its total assets. Excess capital stock is defined as the aggregate of the capital stock held by each shareholder in excess of its minimum capital stock requirement, as established by the Bank’s capital plan. Additional information about our capital, including dividends and retained earnings, is provided in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital.”

Competition

Demand for Bank advances is affected by many factors, including the availability and cost of other sources of funding for members, including retail and brokered deposits. We compete with our members' other suppliers of wholesale funding, both secured and unsecured. These suppliers may include securities dealers, commercial banks, and other FHLBanks for members with affiliated institutions that are members of other FHLBanks.

Under the FHLBank Act and regulations governing the operations of the FHLBanks, affiliated institutions in different FHLBank districts may be members of different FHLBanks. Members may have access to alternative funding sources through sales of securities under agreements to resell. Some members, particularly larger members,

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may have access to many more funding alternatives, including independent access to the national and global credit markets. The availability of alternative funding sources for members can significantly influence the demand for our advances and can vary as a result of many factors, including market conditions, members' creditworthiness, members' strategic objectives, and the availability of collateral.

Our ability to compete successfully for the advances business of our members depends primarily on our advances prices, ability to fund advances through the issuance of consolidated obligations at competitive rates, credit and collateral terms, prepayment terms, product features such as embedded option features, ability to meet members' specific requests on a timely basis, capital stock requirements, retained earnings policy, excess capital stock repurchase policies, and dividends.

In addition, the FHLBanks compete with the U.S. Treasury, Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities, for funds raised through the issuance of unsecured debt in the national and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lower amounts of debt issued at the same cost.

Regulatory Oversight, Audits, and Examinations

The FHLBanks are supervised and regulated by the Finance Agency, an independent agency in the executive branch of the U.S. government. The Finance Agency is also responsible for supervising and regulating Fannie Mae and Freddie Mac. The Finance Agency is supported entirely by assessments from the FHLBanks, Fannie Mae, and Freddie Mac. With respect to the FHLBanks, the Finance Agency is charged with ensuring that the FHLBanks carry out their housing finance mission, remain adequately capitalized and able to raise funds in the capital markets, and operate in a safe and sound manner. The Finance Agency also establishes regulations governing the operations of the FHLBanks.

The Finance Agency has broad supervisory authority over the FHLBanks, including, but not limited to, the power to suspend or remove any entity-affiliated party (including any director, officer, or employee) of an FHLBank who violates certain laws or commits certain other acts; to issue and serve a notice of charges upon an FHLBank or any entity-affiliated party; to obtain a cease and desist order, or a temporary cease and desist order, to stop or prevent any unsafe or unsound practice or violation of law, order, rule, regulation, or condition imposed in writing; to issue civil money penalties against an FHLBank or an entity-affiliated party; to require an FHLBank to take certain actions, or refrain from certain actions, under the prompt corrective action provisions that authorize or require the Finance Agency to take certain supervisory actions, including the appointment of a conservator or receiver for an FHLBank under certain conditions; and to require any one or more of the FHLBanks to repay the primary obligations of another FHLBank on outstanding consolidated obligations.

Pursuant to the Housing Act, the Finance Agency exercises prompt corrective action authority over the FHLBanks. The Capital Classification and Prompt Corrective Action rule establishes the criteria for each of the following capital classifications for the FHLBanks specified in the Housing Act: adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under the rule, unless the Finance Agency has reclassified an FHLBank based on factors other than its capital levels, an FHLBank is adequately capitalized if it has sufficient total and permanent capital to meet or exceed both its risk-based and minimum capital requirements; is undercapitalized if it fails to meet one or more of its risk-based or minimum capital requirements, but is not significantly undercapitalized; is significantly undercapitalized if its total or permanent capital is less than 75% of what is required to meet any of its requirements, but it is not critically undercapitalized; and is critically undercapitalized if its total capital is equal to or less than 2% of its total assets.

By letter dated December 14, 2016, the Director of the Finance Agency notified the Bank that, based on September 30, 2016, financial information, the Bank met the definition of adequately capitalized under the Finance Agency's Capital Classification and Prompt Corrective Action rule.


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The Housing Act and Finance Agency regulations govern capital distributions by an FHLBank, which include cash dividends, capital stock dividends, capital stock repurchases, or any transaction in which the FHLBank purchases or retires any instrument included in its capital. Under the Housing Act and Finance Agency regulations, an FHLBank may not make a capital distribution if after doing so it would not be adequately capitalized or would be reclassified to a lower capital classification, or if such distribution violates any statutory or regulatory restriction, and, in the case of a significantly undercapitalized FHLBank, an FHLBank may not make any capital distribution without approval from the Director of the Finance Agency.

To assess the safety and soundness of the Bank, the Finance Agency conducts an annual on-site examination of the Bank and other periodic reviews of its financial operations. In addition, we are required to submit information on our financial condition and results of operations each month to the Finance Agency.

Finance Agency regulations require that the Bank’s strategic business plan describe how our business activities will achieve our mission, consistent with the Finance Agency’s core mission assets (CMA) guidance. The Finance Agency will assess annually each FHLBank’s core mission achievement by determining the ratio of primary mission assets, which includes the average par balances of advances and mortgage loans acquired from members, to the average par balance of consolidated obligations. Our core mission activities primarily include the issuance of advances. In addition, we acquire member assets through the MPF program. The Bank’s CMA ratio was 73.72% for the year ended December 31, 2016, which exceeded the Finance Agency’s recommended minimum ratio of 70%.

The Bank’s capital stock is registered with the Securities and Exchange Commission (SEC) under Section 12(g)(1) of the Securities Exchange Act of 1934 (1934 Act) and, as a result, we are required to comply with the disclosure and reporting requirements of the 1934 Act and to file annual, quarterly, and current reports with the SEC, as well as meet other SEC requirements.

Our Board of Directors has an audit committee, and we have an internal audit department. An independent registered public accounting firm audits our annual financial statements. The independent registered public accounting firm conducts these audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).

Like other federally chartered corporations, the FHLBanks are subject to general congressional oversight. Each FHLBank must submit annual management reports to Congress, the President, the Office of Management and Budget, and the Comptroller General. These reports include a statement of financial condition, a statement of operations, a statement of cash flows, a statement of internal accounting and administrative control systems, and the report of the independent registered public accounting firm on the financial statements.

The U.S. Commodity Futures Trading Commission (CFTC) has been given regulatory authority over derivative transactions pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the FHLBanks are subject to the rules promulgated by the CFTC with respect to their derivatives activities. These rules affect all aspects of the Bank’s derivatives activities by establishing requirements relating to derivatives recordkeeping and reporting, clearing, execution, and margining of uncleared derivative transactions.

The Comptroller General has authority under the FHLBank Act to audit or examine the Finance Agency and the FHLBanks and to determine the extent to which they fairly and effectively fulfill the purposes of the FHLBank Act. Furthermore, the Government Corporations Control Act provides that the Comptroller General may review any audit of the financial statements conducted by an independent registered public accounting firm. If the Comptroller General conducts such a review, then he or she must report the results and provide his or her recommendations to Congress, the Office of Management and Budget, and the relevant FHLBank. The Comptroller General may also conduct his or her own audit of any financial statements of an FHLBank.

The U.S. Treasury, or a permitted designee, is authorized under the combined provisions of the Government Corporations Control Act and the FHLBank Act to prescribe: the form, denomination, maturity, interest rate, and conditions to which FHLBank debt will be subject; the way and time FHLBank debt is issued; and the price for

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which FHLBank debt will be sold. The U.S. Treasury may purchase FHLBank debt up to an aggregate principal amount of $4.0 billion pursuant to the standards and terms of the FHLBank Act.

All of the FHLBanks' financial institution members are subject to federal or state laws and regulations, and changes to these laws or regulations or to related policies might adversely or favorably affect the business of the FHLBanks.

Available Information

The SEC maintains a website at www.sec.gov that contains all electronically filed or furnished SEC reports, including our annual reports on Form 10-K, our quarterly reports on Form 10-Q, and our current reports on Form 8-K, as well as any amendments. On our website at www.fhlbsf.com, we provide a link to the page on the SEC website that lists all of these reports. These reports may also be read and copied at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. (Further information about the operation of the Public Reference Room may be obtained at 1-800-SEC-0330.) In addition, we provide direct links from our website to our annual report on Form 10-K and our quarterly reports on Form 10-Q on the SEC website as soon as reasonably practicable after electronically filing or furnishing the reports to the SEC. (Note: The website addresses of the SEC and the Bank have been included as inactive textual references only. Information on those websites is not part of this report.)

Employees

We had 274 employees at December 31, 2016. Our employees are not represented by a collective bargaining unit, and we consider our relationship with our employees to be satisfactory.

ITEM 1A.
RISK FACTORS

The following discussion summarizes certain of the risks and uncertainties that the Federal Home Loan Bank of San Francisco (Bank) faces. The list is not exhaustive and there may be other risks and uncertainties that are not described below that may also affect our business. Any of these risks or uncertainties, if realized, could negatively affect our financial condition or results of operations or limit our ability to fund advances, pay dividends, or redeem or repurchase capital stock.

Economic weakness could adversely affect the business of many of our members and our business and results of operations.

Our business and results of operations are sensitive to conditions in the housing and mortgage markets, as well as general business and economic conditions. In 2016, there continued to be challenges to the ongoing economic and housing recovery because of tight credit standards and financial market volatility. If economic and housing market conditions deteriorate, the Bank’s business and results of operations could be adversely affected.

If adverse trends reappear in the mortgage lending sector, including declines in housing prices or deterioration in loan performance trends, a reduction could occur in the value of collateral pledged to the Bank to secure member credit and in the fair value of the Bank’s mortgage-backed securities (MBS) investments.

Adverse economic conditions may contribute to deterioration in the credit quality of our MBS and mortgage loan portfolios and could have an adverse impact on our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

During 2008 and continuing through 2011, the U.S. housing market experienced significant adverse trends, including significant price depreciation in some markets and high mortgage loan delinquency and default rates, which contributed to high delinquency rates on the mortgage loans underlying our private-label residential MBS (PLRMBS) portfolio. Credit-related other-than-temporary impairment (OTTI) charges on certain of our PLRMBS adversely affected our earnings as a result of these conditions. If significant adverse trends in the housing markets

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reappear, there may be further adverse impacts on the performance of the Bank’s PLRMBS and mortgage loans, which may adversely affect the Bank’s financial condition, results of operations, ability to pay dividends, and ability to redeem or repurchase capital stock. Furthermore, economic deterioration, either in the U.S. as a whole or in specific regions of the country, could result in rising mortgage loan delinquencies and increased risk of credit losses, and adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

Market uncertainty and volatility may adversely affect our business, profitability, or results of operations.

Adverse conditions in the housing and mortgage markets could result in a decrease in the availability of corporate credit and liquidity within the mortgage industry, causing disruptions in the operations of mortgage originators, including some of our members. We continue to be subject to potential adverse effects on our financial condition, results of operations, ability to pay dividends, and ability to redeem or repurchase capital stock should economic conditions deteriorate.

Weaknesses in the housing and mortgage markets may undermine the need for wholesale funding and have a negative impact on the demand for advances.

Low yields on mortgage loans relative to other investment opportunities, ongoing aversion to risk, emphasis on the origination of government-sponsored enterprise (GSE) conforming products, and a focus on improving credit quality rather than expanding production may result in low levels of residential portfolio lending activity for some members, which could reduce the need for wholesale mortgage funding. A negative trend in the housing and mortgage markets could result in a decline in advance levels and adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

Changes in or limits on our ability to access the capital markets could adversely affect our financial condition, results of operations, or ability to fund advances, pay dividends, or redeem or repurchase capital stock.

Our primary source of funds is the sale of Federal Home Loan Bank (FHLBank) System consolidated obligations in the capital markets. Our ability to obtain funds through the sale of consolidated obligations depends in part on prevailing conditions in the capital markets, such as investor demand and liquidity in the financial markets. The sale of FHLBank System consolidated obligations can also be influenced by factors other than conditions in the capital markets, including legislative and regulatory developments and government programs and policies that affect the relative attractiveness of FHLBank System consolidated obligations. In addition, the level of dealer participation and support also affect liquidity in the agency debt markets. Based on these factors, we may not be able to obtain funding on acceptable terms. If we cannot access funding on acceptable terms when needed, our ability to support and continue our operations could be adversely affected, which could negatively affect our financial condition, results of operations, or ability to fund advances, pay dividends, or redeem or repurchase capital stock.

Limitations on the payment of dividends and repurchase of excess capital stock may adversely affect the attractiveness to members of the Bank's business model.

Our business model is based on the premise that we maintain a balance between our objective to promote housing, homeownership, and community and economic development through our activities with members and our objective to provide a return on the private capital provided by our members. We achieve this balance by delivering low-cost credit to help our members meet the credit needs of their communities while striving to pay members a reasonable return on their investment in the Bank’s capital stock. Our financial strategies are designed to enable us to safely expand and contract our assets, liabilities, and capital as our member base and our members' credit needs change. Our capital increases when members are required to purchase additional capital stock as they increase their advances, and it contracts when we repurchase excess capital stock from members as their advances decline. In addition, the Bank manages its retained earnings to ensure compliance with regulatory capital requirements in the event of significant growth in member business. As a result of these strategies, we have historically been able to achieve our mission by meeting member credit needs and maintaining our strong regulatory capital position while

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paying dividends (including dividends on mandatorily redeemable capital stock) and repurchasing and redeeming excess capital stock. Limitations on the payment of dividends and the repurchase of excess capital stock may diminish the value of membership from the perspective of a member.

Changes in the credit ratings on FHLBank System consolidated obligations may adversely affect the cost of consolidated obligations.

FHLBank System consolidated obligations are rated Aaa/P-1 with a stable outlook by Moody's Investors Service (Moody's) and AA+/A-1+ with a stable outlook by S&P Global Ratings (S&P). Rating agencies may from time to time change a rating or issue negative reports. Because all of the FHLBanks have joint and several liability for all FHLBank consolidated obligations, negative developments at any FHLBank may affect these credit ratings or result in the issuance of a negative report regardless of our own financial condition and results of operations. In addition, because of the FHLBanks' GSE status, the credit ratings of the FHLBank System and the FHLBanks are generally constrained by the long-term sovereign credit rating of the United States, and any downgrade in that sovereign credit rating may result in a corresponding downgrade to the credit ratings of FHLBank System consolidated obligations. Any adverse rating change or negative report may adversely affect our cost of funds and the FHLBanks' ability to issue consolidated obligations on acceptable terms, which could also adversely affect our financial condition or results of operations or restrict our ability to make advances on acceptable terms, pay dividends, or redeem or repurchase capital stock.

Changes in federal fiscal and monetary policy could adversely affect our business or results of operations.

Our business and results of operations are significantly affected by the fiscal and monetary policies of the federal government and its agencies, including the Federal Reserve Board, which regulates the supply of money and credit in the United States. The Federal Reserve Board's policies directly and indirectly influence the yield on interest-earning assets and the cost of interest-bearing liabilities, which could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

Changes in interest rates could adversely affect our financial condition, results of operations, or ability to fund advances on acceptable terms, pay dividends, or redeem or repurchase capital stock.

We realize income primarily from the spread between interest earned on our outstanding advances and investments and interest paid on our consolidated obligations and other liabilities. Although we use various methods and procedures to monitor and manage our exposure to changes in interest rates, we may experience instances when our interest-bearing liabilities will be more sensitive to changes in interest rates than our interest-earning assets, or vice versa. In either case, interest rate movements contrary to our position could negatively affect our financial condition, results of operations, or ability to fund advances on acceptable terms, pay dividends, or redeem or repurchase capital stock. Moreover, the impact of changes in interest rates on mortgage-related assets can be exacerbated by prepayment risks, which are the risk that the assets will be refinanced by the obligor in low interest rate environments and the risk that the assets will remain outstanding longer than expected at below-market yields when interest rates increase.

Our exposure to credit risk could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

We assume secured and unsecured credit risk associated with the risk that a borrower or counterparty could default, and we could suffer a loss if we were not able to fully recover amounts owed to us on a timely basis. In addition, we have exposure to credit risk because the market value of an obligation may decline as a result of deterioration in the creditworthiness of the obligor or the credit quality of a security instrument. We have a high concentration of credit risk exposure to financial institutions. Credit losses could have an adverse effect on our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.


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We depend on institutional counterparties to provide credit obligations that are critical to our business. Defaults by one or more of these institutional counterparties on their obligations to the Bank could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

We face the risk that one or more of our institutional counterparties may fail to fulfill contractual obligations to us. The primary exposures to institutional counterparty risk are with derivative counterparties, mortgage servicers that service the loans we hold as collateral for advances, and third-party providers of supplemental or primary mortgage insurance for mortgage loans purchased under the Mortgage Partnership Finance® (MPF®) Program. A default by a counterparty could result in losses to the Bank if our credit exposure to the counterparty was under-collateralized or our credit obligations to the counterparty were over-collateralized, and could also adversely affect our ability to conduct our operations efficiently and at cost-effective rates, which in turn could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock. (“Mortgage Partnership Finance” and “MPF” are registered trademarks of the FHLBank of Chicago.)

We rely on derivative transactions to reduce our interest rate risk and funding costs, and changes in our credit ratings or the credit ratings of our derivative counterparties or changes in the legislation or the regulations affecting how derivatives are transacted may adversely affect our ability to enter into derivative transactions on acceptable terms.

Our financial strategies are highly dependent on our ability to enter into derivative transactions on acceptable terms to reduce our interest rate risk and funding costs. We currently have a long-term credit rating of Aaa with a stable outlook from Moody's and AA+ with a stable outlook from S&P. All of our derivative counterparties or guarantors currently have investment grade long-term credit ratings from Moody's and S&P. Rating agencies may from time to time change a rating or issue negative reports, or other factors may raise questions regarding the creditworthiness of a counterparty, which may adversely affect our ability to enter into derivative transactions with acceptable counterparties on satisfactory terms in the quantities necessary to manage our interest rate risk and funding costs effectively. Changes in legislation or regulations affecting how derivatives are transacted may also adversely affect our ability to enter into derivative transactions with acceptable counterparties on satisfactory terms. Any of these changes could negatively affect our financial condition, results of operations, or ability to make advances on acceptable terms, pay dividends, or redeem or repurchase capital stock.

Insufficient collateral protection could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

We require that all outstanding advances be fully collateralized. In addition, for mortgage loans that we purchase under the MPF Program, we require that the participating financial institutions fully collateralize the outstanding credit enhancement obligations not covered through the purchase of supplemental mortgage insurance. We evaluate the types of collateral pledged by borrowers and participating financial institutions and assign borrowing capacities to the collateral based on the risks associated with each type of collateral. If we have insufficient collateral before or after an event of payment default by the borrower, or we are unable to liquidate the collateral for the value we assigned to it in the event of a payment default by a borrower, we could experience a credit loss on advances, which could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

We may not be able to meet our obligations as they come due or meet the credit and liquidity needs of our members in a timely and cost-effective manner.

We seek to be in a position to meet our members' credit and liquidity needs and pay our obligations without maintaining excessive holdings of low-yielding liquid investments or having to incur unnecessarily high borrowing costs. In addition, we maintain a contingency liquidity plan designed to enable us to meet our obligations and the credit and liquidity needs of members in the event of operational disruptions or short-term disruptions in the capital markets. Our efforts to manage our liquidity position, including our contingency liquidity plan, may not enable us to

17



meet our obligations and the credit and liquidity needs of our members, which could have an adverse effect on our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

We face competition for advances and access to funding, which could adversely affect our business.

Our primary business is making advances to our members. We compete with other suppliers of wholesale funding, both secured and unsecured, including investment banks, commercial banks, the Federal Reserve Banks, and, in certain circumstances, other FHLBanks. Our members may have access to alternative funding sources, including independent access to the national and global credit markets. These alternative funding sources may offer more favorable terms than we do on our advances, including more flexible credit or collateral standards. In addition, many of our competitors are not subject to the same regulations as the FHLBanks, which may enable those competitors to offer products and terms that we are not able to offer.

The FHLBanks also compete with the U.S. Treasury, Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities, for funds raised through the issuance of unsecured debt in the national and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lower amounts of debt issued at the same cost. Increased competition could adversely affect our ability to access funding, reduce the amount of funding available to us, or increase the cost of funding available to us. Any of these results could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

Our efforts to make advances pricing attractive to our members may affect earnings.

A decision to lower advances prices to maintain or gain volume or increase the benefits to borrowing members could result in lower earnings, which could adversely affect the amount of dividends on our capital stock.

We have a high concentration of advances and capital with five institutions and their affiliates, and a loss or change of business activities with any of these institutions could adversely affect our results of operations, financial condition, or ability to pay dividends or redeem or repurchase capital stock.

We have a high concentration of advances and capital with five institutions and their affiliates. All of the institutions may prepay or repay advances as they come due. If no other advances or investments are made to replace the prepaid and repaid advances of these institutions, it would result in a significant reduction of our total assets. The reduction in advances could result in a reduction of capital as the Bank repurchases the resulting excess capital stock, at the Bank’s discretion, or redeems the excess capital stock after the expiration of the relevant five-year redemption period. The reduction in assets and capital could reduce the Bank’s net income.

The timing and magnitude of the impact of a reduction in the amount of advances to these institutions would depend on a number of factors, including:
the amount and period of time over which the advances are prepaid or repaid,
the amount and timing of any corresponding decreases in capital stock,
the profitability of the advances,
the amount and profitability of our investments,
the extent to which consolidated obligations mature as the advances are prepaid or repaid, and
our ability to extinguish consolidated obligations or transfer them to other FHLBanks and the associated costs of extinguishing or transferring the consolidated obligations.

The prepayment or repayment of a large amount of advances could also affect our ability to pay dividends or our ability to redeem or repurchase capital stock. (See “Item 8. Financial Statements and Supplementary Data – Note 8 – Advances – Credit and Concentration Risk” for further information on concentration risk.)

A material and prolonged decline in advances could adversely affect our results of operations, financial condition, or ability to pay dividends or redeem or repurchase capital stock.

18




If members continue to experience high levels of liquidity, we could experience decreases in members’ use of Bank advances. Also, nonmembers (including former members and member successors) are not eligible to borrow new advances from the Bank or renew existing advances as they mature. Although the Bank’s business model is designed to enable us to safely expand and contract our assets, liabilities, and capital as our members’ credit needs change, a prolonged material decline in advances could affect our results of operations, financial condition, or ability to pay dividends or redeem or repurchase capital stock.

Volatile market conditions increase the risk that our financial models will produce unreliable results.

We use market-based information as inputs to our financial models, which we use to inform our operational decisions and to derive estimates for use in our financial reporting processes. While we regularly adjust our models in view of changes in economic conditions and expectations, sudden significant changes in these conditions may increase the risk that our models could produce unreliable results or estimates that vary widely or prove to be inaccurate.

We may become liable for all or a portion of the consolidated obligations for which other FHLBanks are the primary obligors.

As provided by the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), or regulations governing the operations of the FHLBanks, all FHLBanks have joint and several liability for all FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Federal Housing Finance Agency (Finance Agency) to require any FHLBank to repay all or any portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor, whether or not the other FHLBank has defaulted in the payment of those obligations and even though the FHLBank making the repayment received none of the proceeds from the issuance of the obligations. The likelihood of triggering the Bank's joint and several liability obligation depends on many factors, including the financial condition and financial performance of the other FHLBanks. If we are required by the Finance Agency to repay the principal or interest on consolidated obligations for which another FHLBank is the primary obligor, our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock could be adversely affected.

If the Bank or any other FHLBank has not paid the principal or interest due on all consolidated obligations, we may not be able to pay dividends or redeem or repurchase any shares of our capital stock.

If the principal or interest due on any consolidated obligations has not been paid in full or is not expected to be paid in full, we may not be able to pay dividends on our capital stock or redeem or repurchase any shares of our capital stock. If another FHLBank defaults on its obligation to pay principal or interest on any consolidated obligations, the regulations governing the operations of the FHLBanks provide that the Finance Agency may allocate outstanding principal and interest payments among one or more of the remaining FHLBanks on a pro rata basis or any other basis the Finance Agency may determine. Our ability to pay dividends or redeem or repurchase capital stock could be affected not only by our own financial condition, but also by the financial condition of one or more of the other FHLBanks.

We are affected by federal laws and regulations, which could change or be applied in a manner detrimental to our operations.

The FHLBanks are GSEs, organized under the authority of and governed by the FHLBank Act, and, as such, are also governed by the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 and other federal laws and regulations. From time to time, Congress has amended the FHLBank Act and adopted other legislation in ways that have significantly affected the FHLBanks and the manner in which the FHLBanks carry out their housing finance mission and business operations. New or modified legislation enacted by Congress or regulations or policies of the Finance Agency could have a negative effect on our ability to conduct business or on our cost of doing

19



business. In addition, new or modified legislation or regulations governing our members may affect our ability to conduct business or our cost of doing business with our members. Because of the recent change in the leadership of the U.S. government administration, there are additional uncertainties in the legislative and regulatory environment as well.

Changes in statutory or regulatory requirements or policies or in their application could result in changes in, among other things, the FHLBanks' cost of funds, capital requirements, accounting policies, debt issuance, permissible business activities, and the size, scope, and nature of the FHLBanks' lending, investment, and mortgage purchase program activities. These changes could negatively affect our financial condition, results of operations, ability to pay dividends, or ability to redeem or repurchase capital stock. In addition, given the Bank's relationship with other FHLBanks, we could be affected by events other than another FHLBank's default on a consolidated obligation. Events that affect other FHLBanks, such as member failures, capital deficiencies, and OTTI charges, could lead the Finance Agency to require or request that an FHLBank provide capital or other assistance to another FHLBank, purchase assets from another FHLBank, or impose other forms of resolution affecting one or more of the other FHLBanks. If the Bank were called upon by the Finance Agency to take any of these steps, it could affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

We could change our policies, programs, and agreements affecting our members.

We may change our policies, programs, and agreements affecting our members from time to time, including, without limitation, policies, programs, and agreements affecting the availability of and conditions for access to our advances and other credit products, the Affordable Housing Program (AHP), and other programs, products, and services. These changes could cause our members to obtain financing from alternative sources, which could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock. In addition, changes to our policies, programs, and agreements affecting our members could adversely affect the value of membership from the perspective of a member.

The failure of the FHLBanks to set aside, in the aggregate, at least $100 million annually for the AHP could result in an increase in our AHP contribution, which could adversely affect our results of operations or ability to pay dividends or redeem or repurchase capital stock.

The FHLBank Act requires each FHLBank to establish and fund an AHP. Annually, the FHLBanks are required to set aside, in the aggregate, the greater of $100 million or 10% of their current year's net earnings (income before interest expense related to dividends paid on mandatorily redeemable capital stock and the assessment for the AHP) for their AHPs. If the FHLBanks do not make the minimum $100 million annual AHP contribution in a given year, we could be required to contribute more than 10% of our current year’s net earnings to the AHP. An increase in our AHP contribution could adversely affect our results of operations or ability to pay dividends or redeem or repurchase capital stock.

Our members are governed by federal and state laws and regulations, which could change in a manner detrimental to their ability or motivation to invest in the Bank or to use our products and services.

Most of our members are highly regulated financial institutions, and the regulatory environment affecting members could change in a manner that would negatively affect their ability or motivation to acquire or own our capital stock or use our products and services. Statutory or regulatory changes that make it less attractive to hold our capital stock or use our products and services could negatively affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

Changes in the status, regulation, and perception of the housing GSEs or in policies and programs relating to the housing GSEs may adversely affect our business activities, future advances balances, the cost of debt issuance, or future dividend payments.


20



Changes in the status of Fannie Mae and Freddie Mac during the next phases of their conservatorships may result in higher funding costs for the FHLBanks, which could negatively affect our business and financial condition. In addition, negative news articles, industry reports, and other announcements pertaining to GSEs, including Fannie Mae, Freddie Mac, and any of the FHLBanks, could create pressure on all GSE debt pricing, as investors may perceive their debt instruments as bearing increased risk.

As a result of these factors, the FHLBank System may have to pay higher rates on consolidated obligations to make them attractive to investors. If we maintain our current approach to pricing advances, an increase in the cost of issuing consolidated obligations could reduce our net interest spread (the difference between the interest rate received on advances and the interest rate paid on consolidated obligations) and cause our advances to be less profitable. If we increase the price of our advances to avoid a decrease in the net interest spread, the advances may be less attractive to our members, and our outstanding advances balances may decrease. In addition, an increase in the cost of issuing consolidated obligations could reduce our net interest spread on other interest-earning assets. As a result, an increase in the cost of issuing consolidated obligations could negatively affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

We rely heavily on information systems and other technology. A failure, interruption, or security breach, including events caused by cyber attacks, of our information systems or those of critical vendors and third parties could disrupt the Bank’s business or adversely affect our financial condition, results of operations, or reputation.

We rely heavily on our information systems and other technology to conduct and manage our business, and we rely on vendors and other third parties to perform certain critical services. If we or one of our critical vendors experiences a failure, interruption, or security breach in any information systems or other technology, including events caused by cyber attacks, we may be unable to conduct and manage our business effectively. In addition, such failure or breach could result in significant losses, a loss of personal and confidential information, or reputational damage. In addition, significant initiatives undertaken by the Bank to replace information systems or other technology infrastructures may subject the Bank to a temporary risk of failure or interruption while the Bank is in the process of implementing these new systems or technology infrastructures. Although we have implemented a business continuity plan, we may not be able to prevent, timely and adequately address, or mitigate the negative effects of any failure or interruption. Any failure or interruption could adversely affect our member business, member relations, risk management, reputation, or profitability, which could negatively affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

Restrictions on the redemption, repurchase, or transfer of the Bank's capital stock could result in an illiquid investment for the holder.

Under the Gramm-Leach-Bliley Act of 1999, Finance Agency regulations, and our capital plan, our capital stock must be redeemed upon the expiration of the relevant five-year redemption period, subject to certain conditions. Capital stock may become subject to redemption following a five-year redemption period after a member provides a written redemption notice to the Bank; gives notice of intention to withdraw from membership; attains nonmember status by merger or acquisition, charter termination, or other involuntary membership termination; or after a receiver or other liquidating agent for a member transfers the member's Bank capital stock to a nonmember entity. Only capital stock that is not required to meet the membership capital stock requirement of a member or nonmember shareholder or to support a member or nonmember shareholder's outstanding activity with the Bank (excess capital stock) may be redeemed at the end of the redemption period. In addition, we may elect to repurchase some or all of the excess capital stock of a shareholder at any time at our sole discretion.

There is no guarantee, however, that we will be able to redeem capital stock held by a shareholder even at the end of the redemption period or to repurchase excess capital stock. If the redemption or repurchase of the capital stock would cause us to fail to meet our minimum regulatory capital requirements or cause the shareholder to fail to maintain its minimum investment requirement, then the redemption or repurchase is prohibited by Finance Agency regulations and our capital plan. In addition, since our capital stock may only be owned by our members (or, under certain circumstances, former members and certain successor institutions), and our capital plan requires our

21



approval before a member or nonmember shareholder may transfer any of its capital stock to another member or nonmember shareholder, we cannot provide assurance that a member or nonmember shareholder would be allowed to transfer any excess capital stock to another member or nonmember shareholder at any time.


ITEM 1B.
UNRESOLVED STAFF COMMENTS

Not applicable.


ITEM 2.
PROPERTIES

The Federal Home Loan Bank of San Francisco (Bank) maintains its principal offices in leased premises totaling 108,569 square feet of space at 600 California Street in San Francisco, California, and 580 California Street in San Francisco, California. The Bank also leases other offices totaling 9,858 square feet of space at 1155 15th Street NW in Washington, D.C., as well as off-site business continuity facilities located in Rancho Cordova, California. The Bank believes these facilities are adequate for the purposes for which they are currently used and are well maintained.

ITEM 3.
LEGAL PROCEEDINGS

The Federal Home Loan Bank of San Francisco (Bank) may be subject to various legal proceedings arising in the normal course of business.

In 2010, the Bank filed two complaints in the Superior Court of the State of California, County of San Francisco (San Francisco Superior Court), relating to the purchase of private-label residential mortgage-backed securities (PLRMBS) and seeking rescission and asserting claims for and violations of the California Corporate Securities Act and common law rescission of contract. During 2016, the Bank entered into settlement agreements with certain defendants for an aggregate amount of $510 million (after netting certain legal fees and expenses). In January 2017, t

22



he Bank entered into a settlement agreement with a defendant for an amount of $119 million (after netting certain legal fees and expenses).

As of the date of this report, the Bank has settled or entered into settlement agreements with all the defendants in connection with the Bank’s PLRMBS litigation.

After consultation with legal counsel, the Bank is not aware of any other legal proceedings that are expected to have a material effect on its financial condition or results of operations or that are otherwise material to the Bank.

ITEM 4.
MINE SAFETY DISCLOSURES

Not applicable.

PART II. OTHER INFORMATION

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

The Federal Home Loan Bank of San Francisco (Bank) has a cooperative ownership structure. The members and certain nonmembers own all the capital stock of the Bank, the majority of the directors of the Bank are officers or directors of members, and the directors are elected by members (or selected by the Board of Directors to fill mid-term vacancies). There is no established marketplace for the Bank's capital stock. The Bank’s capital stock is not publicly traded. The Bank issues only one class of capital stock, Class B stock, which, under the Bank’s capital plan, may be redeemed at par value, $100 per share, upon five years’ notice from the member to the Bank, subject to certain statutory and regulatory requirements and to the satisfaction of any ongoing capital stock investment requirements applying to the member.

At the Bank’s discretion and at any time, the Bank may repurchase shares held by a member in excess of the member’s required capital stock holdings. The Bank’s Excess Stock Repurchase, Retained Earnings, and Dividend Framework summarizes the Bank’s capital management principles and objectives, as well as its policies and practices with respect to restricted retained earnings, dividend payments, and the repurchase of excess capital stock. For information on the Bank’s policies and practices with respect to dividend payments, see “Part I. Financial Information, Item 1.Business – Capital – Dividend and Retained Earnings,” which is herein incorporated by reference.

The information regarding the Bank’s capital requirements is set forth in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital.” At February 28, 2017, the Bank had 24,113,093 shares of Class B stock held by 336 members and 4,571,693 shares of Class B stock held by 6 nonmembers. Class B stock held by nonmembers is classified as mandatorily redeemable capital stock.

Federal Housing Finance Agency (Finance Agency) rules state that FHLBanks may declare and pay dividends only from previously retained earnings or current net earnings, and may not declare or pay dividends based on projected or anticipated earnings. In addition, Finance Agency rules do not permit the Bank to pay dividends in the form of capital stock if its excess capital stock exceeds 1% of its total assets. Excess capital stock is defined as the aggregate of the capital stock held by each shareholder in excess of its minimum capital stock requirement, as established by the Bank’s capital plan.

There is no requirement that the Board of Directors declare and pay any dividend. A decision by the Board of Directors to declare or not declare a dividend is a discretionary matter and is subject to the requirements and restrictions of the Federal Home Loan Bank Act and applicable requirements under the regulations governing the operations of the FHLBanks.

The Bank’s dividend rates declared (annualized) and amounts paid during the respective periods indicated are listed in the table below; the rates and amounts are not indicative of dividends to be paid in the future.


23



 
2016
 
2015
 
Amount of Cash Dividends
 
 
 
Amount of Cash Dividends
 
 
(Dollars in millions)
Capital Stock –
Class B – Putable

 
Mandatorily
Redeemable
Capital Stock

 
Annualized Rate(1)

 
Capital Stock –
Class B – Putable

 
Mandatorily
Redeemable
Capital Stock

 
Annualized Rate(1)

First quarter
$
45

 
$
10

 
7.99
%
 
$
59

 
$
15

 
7.11
%
Second quarter(2)
49

 
12

 
8.90

 
182

 
38

 
22.65

Third quarter
52

 
11

 
9.17

 
72

 
7

 
10.01

Fourth quarter(3)
138

 
27

 
22.51

 
56

 
5

 
8.79


(1)
Reflects the annualized rate paid on all of the Bank's average capital stock outstanding regardless of its classification for reporting purposes as either capital stock or mandatorily redeemable capital stock (a liability), based on the par value of $100 per share.
(2)
In the second quarter of 2015, the amount includes a special dividend at an annualized rate of 14.98%, totaling $145 million, including $120 million in dividends on capital stock and $25 million in dividends on mandatorily redeemable capital stock.
(3)
In the fourth quarter of 2016, the amount includes a special dividend at an annualized rate of 13.57%, totaling $100 million, including $83 million in dividends on capital stock and $17 million in dividends on mandatorily redeemable capital stock.

Additional information regarding the Bank’s dividends is set forth in “Item 1. Business” and in “Item 8. Financial Statements and Supplementary Data – Note 15 – Capital.”



24



ITEM 6.
SELECTED FINANCIAL DATA

The following selected financial data of the Federal Home Loan Bank of San Francisco (Bank) should be read in conjunction with the financial statements and notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein.

(Dollars in millions)
2016

 
2015

 
2014

 
2013

 
2012

Selected Statement of Condition Data at Yearend
 
 
 
 
 
 
 
 
 
Total Assets
$
91,941

 
$
85,698

 
$
75,807

 
$
85,774

 
$
86,421

Advances
49,845

 
50,919

 
38,986

 
44,395

 
43,750

Mortgage Loans Held for Portfolio, Net
826

 
655

 
708

 
905

 
1,289

Investments(1)
40,986

 
32,275

 
31,949

 
35,260

 
40,528

Consolidated Obligations:(2)
 
 
 
 
 
 
 
 
 
Bonds
50,224

 
51,827

 
47,045

 
53,207

 
70,310

Discount Notes
33,506

 
27,647

 
21,811

 
24,194

 
5,209

Mandatorily Redeemable Capital Stock
457

 
488

 
719

 
2,071

 
4,343

Capital Stock —Class B —Putable
2,370

 
2,253

 
3,278

 
3,460

 
4,160

Unrestricted Retained Earnings
888

 
610

 
294

 
317

 
246

Restricted Retained Earnings
2,168

 
2,018

 
2,065

 
2,077

 
2,001

Accumulated Other Comprehensive Income/(Loss) (AOCI)
111

 
15

 
56

 
(145
)
 
(794
)
Total Capital
5,537

 
4,896

 
5,693

 
5,709

 
5,613

Selected Operating Results for the Year
 
 
 
 
 
 
 
 
 
Net Interest Income
$
471

 
$
477

 
$
539

 
$
482

 
$
848

Provision for/(Reversal of) Credit Losses on Mortgage Loans

 
1

 

 
(1
)
 
(1
)
Other Income/(Loss)
485

 
388

 
(154
)
 
5

 
(164
)
Other Expense
158

 
148

 
144

 
128

 
134

Assessments
86

 
78

 
36

 
52

 
60

Net Income/(Loss)
$
712

 
$
638

 
$
205

 
$
308

 
$
491

Selected Other Data for the Year
 
 
 
 
 
 
 
 
 
Net Interest Margin(3)
0.52
%
 
0.57
%
 
0.64
%
 
0.56
%
 
0.84
%
Operating Expenses as a Percent of Average Assets
0.16

 
0.16

 
0.16

 
0.13

 
0.11

Return on Average Assets
0.77

 
0.76

 
0.24

 
0.35

 
0.48

Return on Average Equity
13.63

 
11.68

 
3.58

 
5.36

 
9.44

Annualized Dividend Rate
12.33

 
12.39

 
7.02

 
3.99

 
0.97

Dividend Payout Ratio(4)
39.98

 
57.81

 
117.29

 
52.29

 
9.41

Average Equity to Average Assets Ratio
5.68

 
6.52

 
6.75

 
6.55

 
5.09

Selected Other Data at Yearend
 
 
 
 
 
 
 
 
 
Regulatory Capital Ratio(5)
6.40

 
6.26

 
8.38

 
9.24

 
12.44

Duration Gap (in months)
1

 
1

 

 
1

 
(1
)

(1)
Investments consist of interest-bearing deposits, securities purchased under agreements to resell, Federal funds sold, trading securities, available-for-sale securities, and held-to-maturity securities.
(2)
As provided by the Federal Home Loan Bank Act of 1932, as amended, or regulations governing the operations of the FHLBanks, all of the FHLBanks have joint and several liability for FHLBank consolidated obligations, which are backed only by the financial resources of the FHLBanks. The joint and several liability regulation authorizes the Federal Housing Finance Agency (Finance Agency) to require any FHLBank to repay all or a portion of the principal or interest on consolidated obligations for which another FHLBank is the primary obligor. The Bank has never been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank, and as of December 31, 2016, and through the filing date of this report, does not believe that it is probable that it will be asked to do so. The par value of the outstanding consolidated obligations of all FHLBanks at the dates indicated was as follows:


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Yearend
Par Value
(In millions)

2016
$
989,311

2015
905,202

2014
847,175

2013
766,837

2012
687,902


(3)
Net interest margin is net interest income divided by average interest-earning assets.
(4)
This ratio is calculated as dividends per share divided by net income per share.
(5)
This ratio is calculated as regulatory capital divided by total assets. Regulatory capital includes retained earnings, Class B capital stock, and mandatorily redeemable capital stock (which is classified as a liability), but excludes AOCI.

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

Statements contained in this annual report on Form 10-K, including statements describing the objectives, projections, estimates, or predictions of the future of the Federal Home Loan Bank of San Francisco (Bank) or the Federal Home Loan Bank System (FHLBank System), are “forward-looking statements.” These statements may use forward-looking terms, such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “likely,” “may,” “probable,” “project,” “should,” “will,” or their negatives or other variations on these terms, and include statements related to, among others, gains and losses on derivatives, plans to pay dividends and repurchase excess capital stock, future other-than-temporary impairment losses, future classification of securities, and reform legislation. The Bank cautions that by their nature, forward-looking statements involve risk or uncertainty that could cause actual results to differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These risks and uncertainties include, among others, the following:
changes in economic and market conditions, including conditions in the mortgage, housing, and capital markets;
the volatility of market prices, rates, and indices;
the timing and volume of market activity;
political events, including legislative, regulatory, judicial, or other developments that affect the Bank, its members, counterparties, or investors in the consolidated obligations of the Federal Home Loan Banks (FHLBanks), such as the impact of any government-sponsored enterprises (GSE) legislative reforms, changes in the Federal Home Loan Bank Act of 1932, as amended (FHLBank Act), changes in applicable sections of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, or changes in other statutes or regulations applicable to the FHLBanks;
changes in the Bank’s capital structure;
the ability of the Bank to pay dividends or redeem or repurchase capital stock;
membership changes, including changes resulting from mergers or changes in the principal place of business of Bank members;
the soundness of other financial institutions, including Bank members, nonmember borrowers, other counterparties, and the other FHLBanks;
changes in Bank members’ demand for Bank advances;
changes in the value or liquidity of collateral underlying advances to Bank members or nonmember borrowers or collateral pledged by the Bank’s derivative counterparties;
changes in the fair value and economic value of, impairments of, and risks associated with the Bank’s investments in mortgage loans and mortgage-backed securities (MBS) or other assets and the related credit enhancement protections;
changes in the Bank’s ability or intent to hold MBS and mortgage loans to maturity;
competitive forces, including the availability of other sources of funding for Bank members;
the willingness of the Bank’s members to do business with the Bank;
changes in investor demand for consolidated obligations (including the terms of consolidated obligations) and/or the terms of interest rate exchange or similar agreements;

26



the ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the Bank has joint and several liability;
changes in key Bank personnel;
technology changes and enhancements, and the Bank’s ability to develop and support technology and information systems sufficient to manage the risks of the Bank’s business effectively; and
changes in the FHLBanks’ long-term credit ratings.

Readers of this report should not rely solely on the forward-looking statements and should consider all risks and uncertainties addressed throughout this report, as well as those discussed under “Item 1A. Risk Factors”.

Overview

The Bank serves eligible financial institutions in Arizona, California and Nevada, the three states that make up the Eleventh District of the FHLBank System. The Bank’s primary business is providing competitively priced, collateralized loans, known as advances, to its member institutions and certain qualifying housing associates. The Bank's principal source of funds is debt issued in the capital markets. All 11 FHLBanks issue debt in the form of consolidated obligations through the Office of Finance as their agent, and all 11 FHLBanks are jointly and severally liable for the repayment of all consolidated obligations.

The Bank experienced strong earnings in 2016. Net income for the year was $712 million, compared with net income of $638 million for 2015. Earnings in both years were significantly enhanced by settlements related to the Bank’s private-label residential mortgage-backed securities (PLRMBS) litigation. The Bank’s strong earnings resulted in continued improvement in its financial strength, supported the Bank’s ability to offer cost-effective ownership to its members, and increased funding for its Affordable Housing Program. Retained earnings grew to $3.1 billion at December 31, 2016, from $2.6 billion at December 31, 2015, and the Bank paid dividends at an annualized rate of 12.33% during 2016.

The $74 million increase in net income for 2016 relative to the prior-year period primarily reflected an increase in gains (after netting certain legal fees and expenses) on settlements relating to the Bank's PLRMBS litigation and an increase in net fair value gains associated with derivatives, hedged items, and financial instruments carried at fair value.

Net interest income for 2016 was $471 million, down from $477 million for 2015. The decrease was primarily due to a decrease in earnings on mortgage-related assets because of lower average mortgage-related asset balances, partially offset by an increase in earnings on advances because of higher average advance balances.

Other income/(loss) for 2016 was income of $485 million, compared with income of $388 million for 2015. The change in other income/(loss) reflected a $51 million increase in gains from settlements relating to the Bank's PLRMBS litigation. In addition, net fair value gains associated with derivatives, hedged items, and financial instruments carried at fair value were $5 million for 2016, compared with net fair value losses of $50 million for 2015. The change in net fair value gains/losses was primarily due to the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors during the period. The change in other income/(loss) also reflected a partially offsetting impact of expense of $32 million on derivative instruments used in economic hedges, compared with expense of $18 million for 2015. Income/expense on derivative instruments used in economic hedges is generally offset by interest expense/income on the economically hedged assets and liabilities.

During 2016, total assets increased $6.2 billion, to $91.9 billion at December 31, 2016, from $85.7 billion at December 31, 2015. Investments increased $8.7 billion, to $41.0 billion at December 31, 2016, from $32.3 billion at December 31, 2015, primarily reflecting an increase in securities purchased under agreements to resell, agency securities, and certificates of deposit. Advances remained relatively stable, decreasing to $49.8 billion at December 31, 2016, from $50.9 billion at December 31, 2015.

Accumulated other comprehensive income increased by $96 million during 2016, to $111 million at December 31, 2016, from $15 million at December 31, 2015, primarily as a result of improvement in the fair value of PLRMBS classified as available-for-sale.

On November 14, 2016, the Bank paid a special cash dividend of $100 million on the capital stock outstanding during the third quarter of 2016, including $83 million in dividends on capital stock and $17 million in dividends on mandatorily redeemable capital stock that was reflected as interest expense in the fourth quarter of 2016. Combined with the quarterly cash dividend of $66 million paid on November 14, 2016, the annualized rate for dividends paid during the fourth quarter of 2016 was 22.51%.


27



On February 21, 2017, the Bank’s Board of Directors declared a quarterly cash dividend on the capital stock outstanding during the fourth quarter of 2016 at an annualized rate of 9.08%. The dividend will total $65 million, including $11 million in dividends on mandatorily redeemable capital stock that will be reflected as interest expense in the first quarter of 2017. The Bank recorded the dividend on February 21, 2017, and expects to pay the dividend on or about March 16, 2017.

As of December 31, 2016, the Bank was in compliance with all of its regulatory capital requirements. The Bank’s total regulatory capital ratio was 6.4%, exceeding the 4.0% requirement. The Bank had $5.9 billion in permanent capital, exceeding its risk-based capital requirement of $2.2 billion.

The Bank plans to repurchase the surplus capital stock of all members and the excess capital stock of all nonmember shareholders on March 17, 2017. Surplus capital stock is defined as any stock holdings in excess of 115% of a member’s minimum capital stock requirement.

The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the payment of dividends and the repurchase of excess capital stock in future quarters.

Results of Operations

Comparison of 2016 and 2015

Net Interest Income. The primary source of the Bank’s earnings is net interest income, which is the interest earned on advances, mortgage loans, and investments, less interest paid on consolidated obligations, deposits, mandatorily redeemable capital stock, and other borrowings. The Average Balance Sheets tables that follow present the average balances of interest-earning asset categories and the sources that funded those interest-earning assets (liabilities and capital) for the years ended December 31, 2016 and 2015, together with the related interest income and expense. They also present the average rates on total interest-earning assets and the average costs of total funding sources.


28



Average Balance Sheets
 
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
2015
(Dollars in millions)
Average
Balance

 
Interest
Income/
Expense

 
Average
Rate

 
Average
Balance

 
Interest
Income/
Expense

 
Average
Rate

Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
603

 
$
2

 
0.38
%
 
$
719

 
$

 
0.01
%
Securities purchased under agreements to resell
3,120

 
12

 
0.37

 
2,513

 
3

 
0.10

Federal funds sold
7,010

 
29

 
0.41

 
6,847

 
9

 
0.13

Trading securities:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities (MBS)
9

 

 
1.91

 
10

 

 
1.68

Other investments
1,537

 
10

 
0.61

 
2,439

 
5

 
0.21

Available-for-sale (AFS) securities:(1)
 
 
 
 
 
 
 
 
 
 
 
MBS(2)
4,839

 
262

 
5.42

 
5,809

 
264

 
4.54

Held-to-maturity (HTM) securities:(1)
 
 
 
 
 
 
 
 
 
 
 
MBS
10,756

 
247

 
2.30

 
11,783

 
292

 
2.48

Other investments
466

 
4

 
0.90

 
297

 
1

 
0.51

Mortgage loans held for portfolio
662

 
30

 
4.50

 
675

 
33

 
4.91

Advances(3)
62,168

 
482

 
0.78

 
51,899

 
299

 
0.58

Loans to other FHLBanks
3

 

 
0.40

 
5

 

 
0.11

Total interest-earning assets
91,173

 
1,078

 
1.18

 
82,996

 
906

 
1.09

Other assets(4)(5)
768

 

 
 
 
829

 

 
 
Total Assets
$
91,941

 
$
1,078

 
 
 
$
83,825

 
$
906

 
 
Liabilities and Capital
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Consolidated obligations:
 
 
 
 
 
 
 
 
 
 
 
Bonds(3)
$
51,606

 
$
410

 
0.79
%
 
$
47,481

 
$
317

 
0.67
%
Discount notes
33,504

 
136

 
0.41

 
28,853

 
46

 
0.16

Deposits and other borrowings
342

 
1

 
0.19

 
1,107

 
1

 
0.05

Mandatorily redeemable capital stock
494

 
60

 
12.25

 
421

 
65

 
15.49

Borrowings from other FHLBanks
13

 

 
0.46

 
15

 

 
0.11

Total interest-bearing liabilities
85,959

 
607

 
0.71

 
77,877

 
429

 
0.55

Other liabilities(4)
756

 

 
 
 
485

 

 
 
Total Liabilities
86,715

 
607

 
 
 
78,362

 
429

 
 
Total Capital
5,226

 

 
 
 
5,463

 

 
 
Total Liabilities and Capital
$
91,941

 
$
607

 
 
 
$
83,825

 
$
429

 
 
Net Interest Income
 
 
$
471

 
 
 
 
 
$
477

 
 
Net Interest Spread(6)
 
 
 
 
0.47
%
 
 
 
 
 
0.54
%
Net Interest Margin(7)
 
 
 
 
0.52
%
 
 
 
 
 
0.57
%
Interest-earning Assets/Interest-bearing Liabilities
106.07
%
 
 
 
 
 
106.57
%
 
 
 
 

(1)
The average balances of AFS securities and HTM securities are reflected at amortized cost. As a result, the average rates do not reflect changes in fair value or non-credit-related OTTI losses.
(2)
Interest income on AFS securities includes accretion of yield adjustments on other-than-temporarily impaired PLRMBS (resulting from improvement in expected cash flows) totaling $81 million and $74 million in 2016 and 2015, respectively.
(3)
Interest income/expense and average rates include the effect of associated interest rate exchange agreements, as follows:





29



 
2016
 
2015
(In millions)
(Amortization)/
Accretion of
Hedging
Activities

 
Net Interest
Settlements

 
Total Net Interest
Income/(Expense)

 
(Amortization)/
Accretion of
Hedging
Activities

 
Net Interest
Settlements

 
Total Net Interest
Income/(Expense)

Advances
$
(1
)
 
$
(55
)
 
$
(56
)
 
$
(2
)
 
$
(106
)
 
$
(108
)
Consolidated obligation bonds
4

 
180

 
184

 
5

 
257

 
262


(4)
Includes forward settling transactions and valuation adjustments for certain cash items.
(5)
Includes non-credit-related OTTI losses on AFS and HTM securities.
(6)
Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(7)
Net interest margin is net interest income (annualized) divided by average interest-earning assets.

Net interest income in 2016 was $471 million, a 1% decrease from $477 million in 2015. The following table details the changes in interest income and interest expense for 2016 compared to 2015. Changes in both volume and interest rates influence changes in net interest income, net interest spread, and net interest margin.

Change in Net Interest Income: Rate/Volume Analysis
2016 Compared to 2015
 
 
 
 
 
 
 
Increase/
(Decrease)

 
Attributable to Changes in(1)
(In millions)
 
Average Volume

 
Average Rate

Interest-earning assets:
 
 
 
 
 
Interest-bearing deposits
$
2

 
$

 
$
2

Securities purchased under agreements to resell
9

 
1

 
8

Federal funds sold
20

 

 
20

Trading securities: Other investments
5

 
(2
)
 
7

AFS securities:
 
 
 
 
 
MBS
(2
)
 
(48
)
 
46

HTM securities:
 
 
 
 
 
MBS
(45
)
 
(25
)
 
(20
)
Other investments
3

 
1

 
2

Mortgage loans held for portfolio
(3
)
 
(1
)
 
(2
)
Advances(2) 
183

 
66

 
117

Total interest-earning assets
172

 
(8
)
 
180

Interest-bearing liabilities:
 
 
 
 
 
Consolidated obligations:
 
 
 
 
 
Bonds(2)
93

 
29

 
64

Discount notes
90

 
9

 
81

Deposits and other borrowings


 
(1
)
 
1

Mandatorily redeemable capital stock
(5
)
 
10

 
(15
)
Total interest-bearing liabilities
178

 
47

 
131

Net interest income
$
(6
)
 
$
(55
)
 
$
49


(1)
Combined rate/volume variances, a third element of the calculation, are allocated to the rate and volume variances based on their relative sizes.
(2)
Interest income/expense and average rates include the interest effect of associated interest rate exchange agreements.

Net interest income included $5 million of advance prepayment fees in 2016 compared to $8 million in 2015.

The net interest margin was 52 basis points for 2016, 5 basis points lower than the net interest margin for 2015, which was 57 basis points. The net interest spread was 47 basis points for 2016, 7 basis points lower than the net interest spread for 2015, which was 54 basis points. These decreases were primarily due to lower average balances of mortgage-related assets, partially offset by lower dividends on mandatorily redeemable capital stock, which are classified as interest expense.

30




For securities previously identified as other-than-temporarily impaired, the Bank updates its estimate of future
estimated cash flows on a regular basis. If there is no additional impairment on the security, the yield of the security
is adjusted upward on a prospective basis and accreted into interest income when there is a significant increase in
the expected cash flows. As a result of improvements in the estimated cash flows of securities previously identified as other-than-temporarily impaired, the accretion of yield adjustments is likely to continue to be a
positive source of net interest income in future periods.

Member demand for wholesale funding from the Bank can vary greatly depending on a number of factors, including economic and market conditions, competition from other wholesale funding sources, member deposit inflows and outflows, the activity level of the primary and secondary mortgage markets, and strategic decisions made by individual member institutions. As a result, Bank asset levels and operating results may vary significantly from period to period.

Other Income/(Loss). The following table presents the components of “Other Income/(Loss)” for the years ended December 31, 2016 and 2015.
Other Income/(Loss)
 
 
 
 
(In millions)
2016

 
2015

Other Income/(Loss):
 
 
 
Total OTTI loss
$
(26
)
 
$
(31
)
Net amount of OTTI loss reclassified to/(from) AOCI
10

 
16

Net OTTI loss, credit-related
(16
)
 
(15
)
Net gain/(loss) on trading securities(1)

4

 
(2
)
Net gain/(loss) on advances and consolidated obligation bonds held under fair value option
(40
)
 
(50
)
Net gain/(loss) on derivatives and hedging activities
9

 
(16
)
Gains on litigation settlements, net
510

 
459

Other
18

 
12

Total Other Income/(Loss)
$
485

 
$
388


(1) The net gain/(loss) on trading securities that were economically hedged totaled $1 million and a de minimis amount in 2016 and 2015, respectively.

Net Other-Than-Temporary Impairment Loss, Credit-Related – Each quarter, the Bank updates its OTTI analysis to reflect current housing market conditions, changes in anticipated housing market conditions, observed and anticipated borrower behavior, and updated information on the loans supporting the Bank’s PLRMBS.

Additional information about the OTTI loss is provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Investments” and in “Item 8. Financial Statements and Supplementary DataNote 7 – Other-Than-Temporary Impairment Analysis.”

Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held Under Fair Value Option – The following table presents the net gain/(loss) on advances and consolidated obligation bonds held under the fair value option for the years ended December 31, 2016 and 2015.
 
Net Gain/(Loss) on Advances and Consolidated Obligation Bonds Held Under Fair Value Option
 
 
 
 
(In millions)
2016

 
2015

Advances
$
(27
)
 
$
(31
)
Consolidated obligation bonds
(13
)
 
(19
)
Total
$
(40
)
 
$
(50
)

31




Under the fair value option, the Bank elected to carry certain assets and liabilities at fair value. In general, transactions elected for the fair value option are in economic hedge relationships. Gains or losses on these transactions are generally offset by losses or gains on the derivatives that economically hedge these instruments.

The net gains/(losses) on advances and consolidated obligation bonds held under the fair value option were primarily driven by the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors relative to the actual terms on the advances and consolidated obligation bonds during the period.

Additional information about advances and consolidated obligation bonds held under the fair value option is provided in “Item 8. Financial Statements and Supplementary DataNote 19 – Fair Value.”

Net Gain/(Loss) on Derivatives and Hedging Activities – Under the accounting for derivative instruments and hedging activities, the Bank is required to carry all of its derivative instruments on the Statement of Condition at fair value. If derivatives meet the hedging criteria, including effectiveness measures, the carrying value of the underlying hedged instruments may also be adjusted to reflect changes in the fair value attributable to the risk being hedged so that some or all of the unrealized gain or loss recognized on the derivative is offset by a corresponding unrealized loss or gain on the underlying hedged instrument. The unrealized gain or loss on the “ineffective” portion of all hedges, which represents the amount by which the change in the fair value of the derivative differs from the change in the fair value of the hedged item or the variability in the cash flows of the forecasted transaction, is recognized in current period earnings. In addition, certain derivatives are associated with assets or liabilities but do not qualify as fair value hedges under the accounting for derivative instruments and hedging activities. These economic hedges are recorded on the Statement of Condition at fair value with the unrealized gain or loss recorded in earnings without any offsetting unrealized loss or gain from the associated asset or liability.

The following table shows the accounting classification of hedges and the categories of hedged items that contributed to the gains and losses on derivatives and hedged items that were recorded in “Net gain/(loss) on derivatives and hedging activities” in 2016 and 2015.
Sources of Gains/(Losses) Recorded in Net Gain/(Loss) on Derivatives and Hedging Activities
2016 Compared to 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
2016
 
2015
 
Gain/(Loss)
 

Income/
(Expense) on

 
 
 
Gain/(Loss)
 

Income/
(Expense) on

 
 
Hedged Item
Fair Value
Hedges, Net

 
Economic
Hedges

 
Economic
Hedges

 
Total

 
Fair Value
Hedges, Net

 
Economic
Hedges

 
Economic
Hedges

 
Total

Advances:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Elected for fair value option
$

 
$
44

 
$
(43
)
 
$
1

 
$

 
$
19

 
$
(73
)
 
$
(54
)
Not elected for fair value option
1

 
(9
)
 
3

 
(5
)
 
(1
)
 
1

 
1

 
1

Consolidated obligation bonds:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Elected for fair value option

 
(1
)
 
13

 
12

 

 
8

 
49

 
57

Not elected for fair value option
(3
)
 
(18
)
 
23

 
2

 
(9
)
 
(19
)
 
35

 
7

Consolidated obligation discount notes:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not elected for fair value option

 
23

 
(28
)
 
(5
)
 

 
4

 
(30
)
 
(26
)
MBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not elected for fair value option

 

 

 

 

 
(3
)
 

 
(3
)
Non-MBS investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not elected for fair value option

 
(1
)
 

 
(1
)
 

 

 

 

Mortgage delivery commitment:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not elected for fair value option

 
5

 

 
5

 

 
2

 

 
2

Total
$
(2
)
 
$
43

 
$
(32
)
 
$
9

 
$
(10
)
 
$
12

 
$
(18
)
 
$
(16
)

32




During 2016, net gains on derivatives and hedging activities totaled $9 million compared to net losses of $16 million in 2015. These amounts included expense of $32 million and expense of $18 million resulting from net settlements on derivative instruments used in economic hedges in 2016 and 2015, respectively. Excluding the impact of income or expense from net settlements on derivative instruments used in economic hedges, the net gains or losses on fair value and economic hedges were primarily associated with the effects of changes in market interest rates, interest rate spreads, interest rate volatility, and other market factors during the period.

The ongoing impact of these valuation adjustments on the Bank cannot be predicted and the effects of these valuation adjustments may lead to significant volatility in future earnings, including earnings available for dividends.

Additional information about derivatives and hedging activities is provided in “Item 8. Financial Statements and Supplementary DataNote 18 – Derivatives and Hedging Activities.”

Gains on Litigation Settlements, Net – During 2016 and 2015, gains relating to settlements with certain defendants in connection with the Bank’s PLRMBS litigation (after netting certain legal fees and expenses) totaled $510 million and $459 million, respectively.

Other Expense. Other expenses were $158 million in 2016 compared to $148 million in 2015, reflecting higher compensation and benefits and operating expenses in 2016.

Affordable Housing Program. The FHLBank Act requires each FHLBank to establish and fund an Affordable Housing Program (AHP). Each FHLBank’s AHP provides subsidies to members, which use the funds to assist in the purchase, construction, or rehabilitation of housing for very low-, low-, and moderate-income households. Subsidies may be in the form of direct grants or below-market interest rate advances.

To fund the AHP, the FHLBanks must set aside, in the aggregate, the greater of $100 million or 10% of the current year's net earnings (income before interest expense related to dividends paid on mandatorily redeemable capital stock and the assessment for the AHP). To the extent that the aggregate 10% calculation is less than $100 million, the FHLBank Act requires that each FHLBank contribute such prorated sums as may be required to ensure that the aggregate contribution of the FHLBanks equals $100 million. The proration would be made on the basis of the income of the FHLBanks for the previous year. In the aggregate, the FHLBanks set aside $392 million, $332 million, and $269 million for their AHPs in 2016, 2015, and 2014, respectively, and there was no AHP shortfall in any of those years.

The Bank’s total AHP assessments equaled $86 million in 2016, compared to $78 million in 2015. The increase in the AHP assessments reflected higher earnings in 2016.

Return on Average Equity. Return on average equity (ROE) was 13.63% in 2016, compared to 11.68% in 2015. The increase primarily reflected higher net income in 2016, and the decrease in average equity from $5.5 billion for 2015 to $5.2 billion for 2016.

Dividends and Retained Earnings. In 2016, the Bank paid dividends at an annualized rate of 12.33%, totaling $344 million, including $284 million in dividends on capital stock and $60 million in dividends on mandatorily redeemable capital stock. The dividends included four quarterly dividends and a special dividend in the amount of $100 million, including $83 million in dividends on capital stock and $17 million in dividends on mandatorily redeemable capital stock. In 2015, the Bank paid dividends at an annualized rate of 12.39%, totaling $434 million, including $369 million in dividends on capital stock and $65 million in dividends on mandatorily redeemable capital stock. The dividends included four quarterly dividends and a special dividend in the amount of $145 million, including $120 million in dividends on capital stock and $25 million in dividends on mandatorily redeemable capital stock.


33



The Bank paid these dividends in cash. Dividends on capital stock are recognized as dividends on the Statements of Capital Accounts, and dividends on mandatorily redeemable capital stock are recognized as interest expense on the Statements of Income.

On February 21, 2017, the Bank’s Board of Directors declared a quarterly cash dividend on the capital stock outstanding during the fourth quarter of 2016 at an annualized rate of 9.08% totaling $65 million, including $54 million in dividends on capital stock and $11 million in dividends on mandatorily redeemable capital stock. The Bank recorded the quarterly dividend on February 21, 2017. The Bank expects to pay the quarterly dividend on March 16, 2017. Dividends on mandatorily redeemable capital stock will be recognized as interest expense in the first quarter of 2017.

Retained earnings related to valuation adjustments totaled $18 million and $10 million at December 31, 2016 and 2015, respectively. Retained earnings related to the JCE Agreement totaled $500 million and $358 million at December 31, 2016 and 2015, respectively. Restricted retained earnings for loss protection and capital compliance were $2.2 billion as of December 31, 2016.

The Bank will continue to monitor the condition of its PLRMBS portfolio, the ratio of the Bank’s estimated market value of total capital to par value of capital stock, its overall financial performance and retained earnings, developments in the mortgage and credit markets, and other relevant information as the basis for determining the payment of dividends in future quarters.

For more information, see “Item 1. Business – Dividends and Retained Earnings” and “Item 8. Financial Statements and Supplementary Data Note 15 – Capital – Excess Stock Repurchase, Retained Earnings, and Dividend Framework.”

Comparison of 2015 to 2014

Net Interest Income. The Average Balance Sheets table that follows presents the average balances of interest-earning asset categories and the sources that funded those interest-earning assets (liabilities and capital) for the years ended December 31, 2015 and 2014, together with the related interest income and expense. It also presents the average rates on total interest-earning assets and the average costs of total funding sources.


34



Average Balance Sheets
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
2014
(Dollars in millions)
Average
Balance

 
Interest
Income/
Expense

 
Average
Rate

 
Average
Balance

 
Interest
Income/
Expense

 
Average
Rate

Assets
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
719

 
$

 
0.01
%
 
$
325

 
$

 
0.01
%
Securities purchased under agreements to resell
2,513

 
3

 
0.10

 
1,436

 
1

 
0.06

Federal funds sold
6,847

 
9

 
0.13

 
9,602

 
11

 
0.12

Trading securities:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities (MBS)
10

 

 
1.68

 
12

 

 
1.63

Other investments
2,439

 
5

 
0.21

 
3,432

 
6

 
0.18

Available-for-sale (AFS) securities:(1)
 
 
 
 
 
 
 
 
 
 
 
MBS(2)
5,809

 
264

 
4.54

 
6,700

 
278

 
4.15

Held-to-maturity (HTM) securities:(1)
 
 
 
 
 
 
 
 
 
 
 
MBS
11,783

 
292

 
2.48

 
14,338

 
358

 
2.49

Other investments
297

 
1

 
0.51

 
2,111

 
4

 
0.20

Mortgage loans held for portfolio
675

 
33

 
4.91

 
806

 
42

 
5.16

Advances(3)
51,899

 
299

 
0.58

 
45,104

 
305

 
0.68

Loans to other FHLBanks
5

 

 
0.11

 
3

 

 
0.07

Total interest-earning assets
82,996

 
906

 
1.09

 
83,869

 
1,005

 
1.20

Other assets(4)(5)
829

 

 

 
929

 

 

Total Assets
$
83,825

 
$
906

 
1.08
%
 
$
84,798

 
$
1,005

 
1.19
%
Liabilities and Capital
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Consolidated obligations:
 
 
 
 
 
 
 
 
 
 
 
Bonds(3)
$
47,481

 
$
317

 
0.67
%
 
$
52,805

 
$
326

 
0.62
%
Discount notes
28,853

 
46

 
0.16

 
23,582

 
20

 
0.09

Deposits and other borrowings
1,122

 
1

 
0.05

 
835

 

 
0.05

Mandatorily redeemable capital stock
421

 
65

 
15.49

 
1,348

 
120

 
8.88

Total interest-bearing liabilities
77,877

 
429

 
0.55

 
78,570

 
466

 
0.59

Other liabilities(4)
485

 

 

 
501

 

 

Total Liabilities
78,362

 
429

 
0.55

 
79,071

 
466

 
0.59

Total Capital
5,463

 

 

 
5,727

 

 

Total Liabilities and Capital
$
83,825

 
$
429

 
0.51
%
 
$
84,798

 
$
466

 
0.55
%
Net Interest Income
 
 
$
477

 
 
 
 
 
$
539

 
 
Net Interest Spread(6)
 
 
 
 
0.54
%
 
 
 
 
 
0.61
%
Net Interest Margin(7)
 
 
 
 
0.57
%
 
 
 
 
 
0.64
%
Interest-earning Assets/Interest-bearing Liabilities
106.57
%
 
 
 
 
 
106.74
%
 
 
 
 

(1)
The average balances of AFS securities and HTM securities are reflected at amortized cost. As a result, the average rates do not reflect changes in fair value or non-credit-related OTTI losses.
(2)
Interest income on AFS securities includes accretion of yield adjustments on other-than-temporarily impaired PLRMBS (resulting from improvement in expected cash flows) totaling $74 million and $68 million in 2015 and 2014, respectively.
(3)
Interest income/expense and average rates include the effect of associated interest rate exchange agreements, as follows:

 
2015
 
2014
(In millions)
(Amortization)/
Accretion of
Hedging
Activities

 
Net Interest
Settlements

 
Total Net Interest
Income/(Expense)

 
(Amortization)/
Accretion of
Hedging
Activities

 
Net Interest
Settlements

 
Total Net Interest
Income/(Expense)

Advances
$
(2
)
 
$
(106
)
 
$
(108
)
 
$
(4
)
 
$
(128
)
 
$
(132
)
Consolidated obligation bonds
5

 
257

 
262

 
5

 
260

 
265


(4)
Includes forward settling transactions and valuation adjustments for certain cash items.

35



(5)
Includes non-credit-related OTTI losses on AFS and HTM securities.
(6)
Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(7)
Net interest margin is net interest income (annualized) divided by average interest-earning assets.

Net interest income in 2015 was $477 million, a 12% decrease from $539 million in 2014. The following table details the changes in interest income and interest expense for 2015 compared to 2014. Changes in both volume and interest rates influence changes in net interest income, net interest spread, and net interest margin.

Change in Net Interest Income: Rate/Volume Analysis
2015 Compared to 2014
 
 
 
 
 
 
 
Increase/
(Decrease)

 
Attributable to Changes in(1)
(In millions)
 
Average Volume

 
Average Rate

Interest-earning assets:
 
 
 
 
 
Securities purchased under agreements to resell
$
2

 
$
1

 
$
1

Federal funds sold
(2
)