10-K 1 fhlb12311210k.htm FORM 10-K FHLB 123112 10K
 
 
 
 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
 
 
 
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2012
OR
 
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
Commission File Number: 000-51999
 

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


50309
(Zip code)
 

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

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
Name of Each Exchange on Which Registered: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer x
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Registrant's stock is not publicly traded and is only issued to members of the registrant. Such stock is issued and redeemed at par value, $100 per share, subject to certain regulatory and statutory limits. At June 30, 2012, the aggregate par value of the stock held by current and former members of the registrant was $2,074,632,300. At February 28, 2013, 20,029,622 shares of stock were outstanding.



TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



2

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Statements contained in this annual report on Form 10-K, including statements describing the objectives, projections, estimates, or future predictions in our operations, may be forward-looking statements. These statements may be identified by the use of forward-looking terminology, such as believes, projects, expects, anticipates, estimates, intends, strategy, plan, could, should, may, and will or their negatives or other variations on these terms. By their nature, forward-looking statements involve risk or uncertainty, and actual results could differ materially from those expressed or implied or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These risks and uncertainties include, but are not limited to, the following:

•
political or economic events, including legislative, regulatory, monetary, judicial, or other developments that affect us, our members, our counterparties, and/or our investors in the consolidated obligations of the 12 Federal Home Loan Banks (FHLBanks);

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

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

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

•
changes in our capital structure and capital requirements;

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

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

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

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

•
increases in delinquency or loss severity on mortgage loans;

•
member failures, mergers, and consolidations;

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

•
the ability to develop and support technology and information systems that effectively manage the risks we face; and

•
the ability to attract and retain key personnel.

We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. A detailed discussion of the more important risks and uncertainties that could cause actual results and events to differ from such forward-looking statements is included under “Item 1A. Risk Factors."



3

PART I

ITEM 1. BUSINESS
OVERVIEW
The Federal Home Loan Bank of Des Moines (the Bank, we, us, or our) is a federally chartered corporation organized on October 31, 1932, that is exempt from all federal, state, and local taxation (except real property taxes) and is one of 12 district FHLBanks. The FHLBanks were created under the authority of the Federal Home Loan Bank Act of 1932 (FHLBank Act). With the passage of the Housing and Economic Recovery Act of 2008 (Housing Act), the Federal Housing Finance Agency (Finance Agency) was established and became the new independent federal regulator of Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, Enterprises), as well as the FHLBanks and FHLBanks' Office of Finance (Office of Finance), effective July 30, 2008. The Finance Agency's mission is to provide effective supervision, regulation, and housing mission oversight of the Enterprises and FHLBanks to promote their safety and soundness, support housing finance and affordable housing, and support a stable and liquid mortgage market. The Finance Agency establishes policies and regulations governing the operations of the Enterprises and FHLBanks. Each FHLBank operates as a separate entity with its own management, employees, and board of directors.
We are a cooperative. This means we are owned by our customers, whom we call members. Our members include commercial banks, thrifts, credit unions, insurance companies, and community development financial institutions (CDFIs) in Iowa, Minnesota, Missouri, North Dakota, and South Dakota. While not considered members, we also conduct our primary business activities with state and local housing associates meeting certain statutory criteria.
BUSINESS MODEL
Our mission is to provide funding and liquidity to our members and eligible housing associates so that they can meet the housing, economic development, and business needs of the communities they serve. We strive to achieve our mission within an operating principle that balances the trade-off between attractively priced products, reasonable returns on capital investments, and maintaining adequate capital and retained earnings to support safe and sound business operations.
We are capitalized primarily through the purchase of capital stock by our members. As a condition of membership, all of our members must purchase and maintain membership capital stock based on a percentage of their total assets as of the preceding December 31st subject to a cap of $10.0 million and a floor of $10,000. Each member is also required to purchase and maintain activity-based capital stock to support certain business activities with us. Member demand for our products expands and contracts with economic and market conditions. Our self-capitalizing capital structure, which allows us to repurchase or require additional capital stock based on member activity, provides us with the flexibility to effectively and efficiently meet the changing needs of our membership. While eligible to borrow, housing associates are not members and, as such, are not permitted to purchase capital stock.
Our capital stock is not publicly traded. It is purchased and redeemed by members or repurchased by us at a par value of $100 per share. Our current members own nearly all of our outstanding capital stock. Former members own the remaining capital stock, included in mandatorily redeemable capital stock, to support business transactions still carried on our Statements of Condition. All stockholders, including current and former members, may receive dividends on their capital stock investment to the extent declared by our Board of Directors.
Our primary business activities are providing collateralized loans, known as advances, to members and housing associates and acquiring residential mortgage loans from or through our members. Our primary source of funding and liquidity is the issuance of debt securities, referred to as consolidated obligations, in the capital markets. Consolidated obligations are the joint and several obligations of all FHLBanks and are backed only by the financial resources of the FHLBanks. A critical component to the success of our operations is the ability to issue consolidated obligations regularly in the capital markets under a wide range of maturities, structures, and amounts, and at relatively favorable spreads to market interest rates.
Our net income is primarily attributable to the difference between the interest income we earn on our advances, mortgage loans, and investments, and the interest expense we pay on our consolidated obligations and member deposits, as well as components of other (loss) income (e.g., gains and losses on derivatives and hedging activities). Because we are a cooperative, we operate with narrow margins and expect to be profitable over the long-term based on our prudent lending standards, conservative investment strategies, and diligent risk management practices. Because we operate with narrow margins, our net income is sensitive to changes in market conditions that can impact the interest we earn and pay and introduce volatility in other (loss) income.

4

A portion of our annual net income is used to fund our Affordable Housing Program (AHP), which provides grants and subsidized advances to members to support housing for very low to moderate income households. By regulation, we are required to contribute ten percent of our net earnings each year to the AHP. For purposes of the AHP assessment, net earnings is defined as net income before assessments, plus interest expense related to mandatorily redeemable capital stock. For additional details on our AHP, refer to the "Assessments" section of Item 1.
We have risk management policies that monitor and control our exposure to market, liquidity, credit, operational, and business risk. Our primary objective is to manage assets, liabilities, and derivative exposures in ways that protect the par redemption value of our capital stock. For additional information on our risk management practices, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management.”

MEMBERSHIP
Our membership is diverse and includes both small and large commercial banks, thrifts, credit unions, insurance companies, and CDFIs. The majority of institutions in our five-state district that are eligible for membership are currently members.
The following table summarizes our membership by type of institution:
 
 
December 31,
Institutional Entity
 
2012
 
2011
 
2010
Commercial banks
 
992

 
1,005

 
1,029

Thrifts
 
61

 
69

 
73

Credit unions
 
102

 
92

 
71

Insurance companies
 
51

 
48

 
46

Community development financial institutions
 
1

 
1

 
—

Total
 
1,207

 
1,215

 
1,219


The following table summarizes our membership by asset size:
 
 
December 31,
Membership Asset Size
 
2012
 
2011
 
2010
Depository institutions1
 

 

 

Less than $100 million
 
40.2
%
 
42.5
%
 
43.3
%
$100 million to $500 million
 
44.4

 
42.6

 
42.5

Greater than $500 million
 
11.1

 
10.9

 
10.4

Insurance companies
 

 

 
 
Less than $100 million
 
0.4

 
0.4

 
0.4

$100 million to $500 million
 
0.9

 
0.8

 
0.8

Greater than $500 million
 
2.9

 
2.7

 
2.6

Community development financial institutions
 


 


 


Less than $100 million
 
0.1

 
0.1

 
—

Total
 
100.0
%
 
100.0
%
 
100.0
%

1
Depository institutions consist of commercial banks, thrifts, and credit unions.

Our membership level declined slightly during 2012 due to eight bank failures, four dissolved charters, and 19 mergers or consolidations, partially offset by 23 new members. We did not experience any credit losses on advances outstanding with failed or dissolved member institutions during the year. At December 31, 2012, approximately 83 percent of our members were Community Financial Institutions (CFIs). For 2012, CFIs are defined under the Housing Act to include all Federal Deposit Insurance Corporation (FDIC) insured institutions with average total assets over the previous three-year period of less than $1.076 billion. CFIs are eligible to pledge certain collateral types that non-CFIs cannot pledge, including small business, small agri-business, and small farm loans.


5

BUSINESS SEGMENTS
We manage our operations as one business segment. Management and our Board of Directors review enterprise-wide financial information in order to make operating decisions and assess performance.
PRODUCTS AND SERVICES
Advances
We carry out our mission primarily through lending funds, which we call advances, to our members and eligible housing associates (collectively, borrowers). Our advance products are designed to help borrowers compete effectively in their markets and meet the credit needs of their communities. Borrowers generally use our advance products as sources of wholesale funding for mortgage lending, affordable housing and other community lending (including economic development), and general asset-liability management.
Our advance products include the following:

•
Overnight Advances. These advances are used primarily to fund the short-term liquidity needs of our borrowers and are renewed automatically until the borrower pays off the advance. Interest rates are set daily.

•
Fixed Rate Advances. These advances are available over a variety of terms in amortizing and non-amortizing structures and are used to fund both the short- and long-term liquidity needs of our borrowers. Using an amortizing advance, a borrower makes predetermined principal payments at scheduled intervals throughout the term of the advance to manage the interest rate risk associated with long-term fixed rate amortizing assets.
 
•
Variable Rate Advances. These advances have interest rates that reset periodically to a specified interest rate index such as London Interbank Offered Rate (LIBOR) and are used to fund both the short- and long-term liquidity needs of our borrowers. Capped LIBOR advances are a type of variable rate advance in which the interest rate cannot exceed a specified maximum interest rate.

•
Callable Advances. These advances may be prepaid by borrowers on pertinent dates (call dates) and therefore provide borrowers a source of long-term financing with prepayment flexibility. Included in callable advances are fixed and variable rate member-owned option advances that are non-amortizing and certain amortizing advance structures that contain specific call features.

•
Putable Advances. These advances may, at our discretion, be terminated on predetermined dates prior to the stated maturity of the advances, requiring the borrower to repay the advance. Should an advance be terminated, replacement funding at the prevailing market rates and terms will be offered, based on our available advance products and subject to our normal credit and collateral requirements. A putable advance carries an interest rate lower than a comparable maturity advance that does not have the putable feature.

•
Community Investment Advances. These advances are below-market rate funds used by borrowers in both affordable housing projects and community development. Interest rates on these advances represent our cost of funds plus a mark-up to cover our administrative expenses. This mark-up is determined by our Asset-Liability Committee. On an annual basis, our Board of Directors establishes limits on the total amount of funds available for community investment advances.
For the years ended December 31, 2012, 2011, and 2010, advances represented 53, 52, and 53 percent of our total average assets and generated 35, 30, and 44 percent of our total interest income. At December 31, 2012 and 2011, approximately 58 and 62 percent of our members had outstanding advances. Our top five borrowers accounted for 39 and 44 percent of total advances outstanding at December 31, 2012 and 2011. For additional information on our advances, including our top five borrowers, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Advances.” In addition, refer to “Item 1A. Risk Factors” for a discussion on our exposure to customer concentration risk.

6

COLLATERAL
We are required by regulation to obtain and maintain a security interest in eligible collateral at the time we originate or renew an advance and throughout the life of the advance to ensure a fully collateralized position. Eligible collateral includes (i) whole first mortgages on improved residential real property or securities representing a whole interest in such mortgages, (ii) loans and securities issued, insured, or guaranteed by the U.S. Government or any agency thereof, including mortgage-backed securities (MBS) issued or guaranteed by Fannie Mae, Freddie Mac, or Government National Mortgage Association (Ginnie Mae) and Federal Family Education Loan Program (FFELP) guaranteed student loans, (iii) cash deposited with us, and (iv) other real estate-related collateral acceptable to us provided such collateral has a readily ascertainable value and we can perfect a security interest in such property. CFIs may also pledge collateral consisting of secured small business, small agri-business, or small farm loans. As additional security, the FHLBank Act provides that we have a lien on each member's capital stock investment; however, capital stock cannot be pledged as collateral to secure credit exposures.
Borrowers may pledge collateral to us by executing a blanket lien, specifically assigning collateral, or placing physical possession of collateral with us or our custodians. We perfect our security interest in all pledged collateral by filing Uniform Commercial Code financing statements or taking possession or control of the collateral. Under the FHLBank Act, any security interest granted to us by our members, or any affiliates of our members, has priority over the claims and rights of any party (including any receiver, conservator, trustee, or similar party having rights of a lien creditor), unless those claims and rights would be entitled to priority under otherwise applicable law and are held by actual purchasers or by parties that have perfected security interests.
Under a blanket lien, we are granted a security interest in all financial assets of the borrower to fully secure the borrower's obligation. Other than securities and cash deposits, we do not initially take delivery of collateral pledged by blanket lien borrowers. In the event of deterioration in the financial condition of a blanket lien borrower, we have the ability to require delivery of pledged collateral sufficient to secure the borrower's obligation. With respect to non-blanket lien borrowers that are federally insured, we generally require collateral to be specifically assigned. With respect to non-blanket lien borrowers that are not federally insured (typically insurance companies, CDFIs, and housing associates), we generally take control of collateral through the delivery of cash, securities, or loans to us or our custodians.
For additional information on our collateral requirements, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Advances.”
HOUSING ASSOCIATES
The FHLBank Act permits us to make advances to eligible housing associates. Housing associates are approved mortgagees under Title II of the National Housing Act that meet certain criteria, including: (i) chartered under law and have succession, (ii) subject to inspection and supervision by some governmental agency, and (iii) lend their own funds as their principal activity in the mortgage field. The same regulatory lending requirements that apply to our members generally apply to housing associates. Because housing associates are not members, they are not subject to certain provisions of the FHLBank Act applicable to members and cannot own our capital stock. In addition, they may only pledge certain types of collateral including: (i) Federal Housing Administration (FHA) mortgages, (ii) Ginnie Mae securities backed by FHA mortgages, (iii) certain residential mortgage loans, and (iv) cash deposited with us. As of December 31, 2012, we had one housing associate with an outstanding advance of $23.1 million, which represents less than one percent of total advances outstanding.
PREPAYMENT FEES
We charge a prepayment fee for advances that a borrower elects to terminate prior to the stated maturity or outside of a predetermined call or put date. The fees charged are priced to make us financially indifferent to the prepayment of the advance.
Standby Letters of Credit
We may issue standby letters of credit on behalf of our members, certain other FHLBank members (through a master participation agreement), and housing associates to facilitate business transactions with third parties. These letters of credit are generally used to facilitate residential housing finance and community lending, assist with asset-liability management, or provide liquidity or other funding. Standby letters of credit must be fully collateralized with eligible collateral at the time of issuance.

7

Mortgage Loans
We invest in mortgage loans through the Mortgage Partnership Finance (MPF) program (Mortgage Partnership Finance and MPF are registered trademarks of the FHLBank of Chicago), a secondary mortgage market structure developed by the FHLBank of Chicago to help fulfill the housing mission of the FHLBanks. Under the MPF program, we purchase or fund eligible mortgage loans (MPF loans) from or through participating financial institutions (PFIs). We may also acquire MPF loans through participations with other FHLBanks. MPF loans are conforming conventional or government-insured fixed rate mortgage loans secured by one-to-four family residential properties with maturities ranging from five to 30 years. For the years ended December 31, 2012, 2011, and 2010, mortgage loans represented 15, 14, and 12 percent of our total average assets and generated 37, 36, and 28 percent of our total interest income.
MPF PROVIDER
The FHLBank of Chicago serves as the MPF Provider for the MPF program. In its role as MPF Provider, the FHLBank of Chicago provides the infrastructure and operational support for the MPF program and is responsible for publishing and maintaining the MPF Guides, which detail the requirements PFIs must follow in originating, selling, and servicing MPF loans. The MPF Provider is also responsible for establishing the base price of MPF loan products utilizing the agreed upon methodologies determined by the participating MPF FHLBanks. In exchange for providing these services, the MPF Provider receives a fee from each of the FHLBanks participating in the MPF program. The MPF Provider has engaged Wells Fargo Bank N.A. (Wells Fargo) as the master servicer for the MPF program.
MPF GOVERNANCE COMMITTEE
The MPF Governance Committee, which consists of representatives from each of the FHLBanks participating in the MPF program, is responsible for implementing strategic MPF program decisions, including, but not limited to, pricing methodology changes.

Effective March 28, 2011, based on a decision of the MPF Governance Committee, participating MPF FHLBanks are allowed to adjust the base price of MPF loan products established by the FHLBank of Chicago. As a result of this change, we monitor daily market conditions and make price adjustments to our MPF loan products when necessary. This allows us to impact the level of member demand in our MPF program as well as our profitability in these investments.
PARTICIPATING FINANCIAL INSTITUTIONS
Our members and eligible housing associates must apply to become a PFI. In order to do MPF business with us, each member or eligible housing associate must meet certain eligibility standards and sign a PFI Agreement. The PFI Agreement provides the terms and conditions for the sale or funding of MPF loans, including the servicing of MPF loans.
PFIs may either retain the servicing of MPF loans or sell the servicing to an approved third-party provider. If a PFI chooses to retain the servicing, it receives a servicing fee to manage the servicing activities. If a PFI chooses to sell the servicing rights to an approved third-party provider, the servicing is transferred concurrently with the sale of the MPF loans and a servicing fee is paid to the third-party provider. Throughout the servicing process, the master servicer monitors the PFI's compliance with MPF program requirements and makes periodic reports to the MPF Provider.
MPF LOAN TYPES
There are six MPF loan products under the MPF program: Original MPF, MPF 100, MPF 125, MPF Plus, MPF Government, and MPF Xtra (MPF Xtra is a trademark of the FHLBank of Chicago). While still held in our Statements of Condition, we currently do not offer the MPF 100 or MPF Plus loan products. The discussion below outlines characteristics of our MPF loans products.
Original MPF, MPF 125, MPF Plus, and MPF Government are closed loan products in which we purchase loans acquired or closed by the PFI. MPF 100 is a loan product in which we "table fund" MPF loans; that is, we provide the funds through the PFI as our agent to make the MPF loan to the borrower. MPF Xtra is an off-balance sheet loan product in which we assign 100 percent of our interest in PFI master commitments to the FHLBank of Chicago. The FHLBank of Chicago then purchases mortgage loans from our PFIs and sells those loans to Fannie Mae. We receive a small fee for our continued management of the PFI relationship under MPF Xtra.

8

The PFI performs all traditional retail loan origination functions on our MPF loan products. With respect to the MPF 100 loan product, we are considered the originator of the MPF loan for accounting purposes since the PFI is acting as our agent when originating the MPF loan; however, we do not collect any origination fees.
We are responsible for managing the interest rate risk, including mortgage prepayment risk, and liquidity risk associated with the MPF loans we purchase and carry on our Statements of Condition. In order to limit our credit risk exposure to that of an investor in an MBS that is rated the equivalent of AA by a nationally recognized statistical rating organization (NRSRO), we require a credit risk sharing arrangement with the PFI on all MPF loans at the time of purchase.
For additional discussion on our mortgage loans and their related credit risk, refer to “Item 8. Financial Statements and Supplementary Data — Note 10 — Allowance for Credit Losses” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Mortgage Assets.”
MPF LOAN VOLUME
Over the years, our customer base for MPF loans has evolved from large-volume loan purchases from a small number of large PFIs to purchasing the majority of our MPF loans from a diverse base of community financial institutions. Our ability to adjust the base pricing on MPF loans, coupled with the low interest rate environment, has allowed us to serve the liquidity needs of a broad range of members and maintain relatively stable mortgage loan volumes. During the years ended December 31, 2012, 2011, and 2010, we purchased $2.1 billion, $1.4 billion, and $1.5 billion of MPF loan products (excluding MPF Xtra). In addition, our members delivered $2.0 billion, $0.6 billion, and $0.4 billion of MPF Xtra loans during the years ended December 31, 2012, 2011, and 2010.
The growth of our MPF loan portfolio is currently affected by Finance Agency regulation. If we exceed $2.5 billion in MPF loan purchases in a calendar year (excluding MPF Xtra), we will become subject to housing goals as specified by the Finance Agency and may be required to implement an affordable housing plan for the MPF program in addition to our current AHP. We believe that these goals may be difficult to implement and could potentially change the credit profile of the MPF program.
For additional information on our mortgage loans, including concentrations held with PFIs, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Mortgage Loans.”
TEMPORARY LOAN MODIFICATION PLAN
Effective August 1, 2009, we introduced a temporary loan payment modification plan for participating PFIs, with a scheduled expiration date of December 31, 2011. Homeowners in default or imminent danger of default with conventional loans secured by their primary residence and originated prior to January 1, 2009 were eligible for the plan. On December 13, 2011, we extended the modification plan until December 31, 2013. Homeowners in default or imminent danger of default with conventional loans secured by their primary residence, regardless of loan origination date, are now eligible for the plan. At December 31, 2012, 15 modified loans totaling $2.8 million were outstanding in our Statements of Condition under this plan.
Investments
We maintain an investment portfolio primarily to provide investment income and liquidity. Our investment portfolio is comprised of both short- and long-term investments. Our short-term investments may include, but are not limited to, interest-bearing deposits, Federal funds sold, securities purchased under agreements to resell, certificates of deposit, and commercial paper. Our long-term investments may include, but are not limited to, other U.S. obligations, government-sponsored enterprise (GSE) obligations, state or local housing agency obligations, and MBS. Our long-term investments generally provide higher returns than our short-term investments. For the years ended December 31, 2012, 2011, and 2010, investments represented 31, 33, and 35 percent of our total average assets and generated 29, 34, and 29 percent of our total interest income.
We do not have any subsidiaries. With the exception of a limited partnership interest in a Small Business Investment Company (SBIC), we have no equity position in any partnerships, corporations, or off-balance sheet special purpose entities. We limit new investments in MBS to those guaranteed by the U.S. Government, issued by a GSE, or that carry the highest investment grade rating by an NRSRO at the time of purchase. Our Enterprise Risk Management Policy (ERMP) prohibits new purchases of private-label MBS.

9

The Finance Agency also prohibits us from investing in certain types of securities, including:

•
instruments that provide an ownership interest in an entity, other than stock in an SBIC and certain investments targeted at low-income persons or communities;

•
instruments issued by non-U.S. entities, other than those issued by U.S. branches and agency offices of foreign commercial banks;

•
non-investment grade debt instruments, other than certain investments targeted at low-income persons or communities and instruments that were downgraded to a below investment grade after acquisition;

•
whole mortgages or other whole loans, or interests in mortgages or loans, other than: (i) those acquired under the FHLBank mortgage purchase programs; (ii) certain investments targeted at low-income persons or communities; (iii) certain marketable direct obligations of state, local, or tribal government units or agencies, having at least the second highest credit rating from an NRSRO; (iv) MBS or asset-backed securities collateralized by manufactured housing loans or home equity loans; and (v) certain foreign housing loans authorized under the FHLBank Act;

•
non-U.S. dollar denominated securities;

•
interest-only or principal-only stripped securities;

•
residual-interest or interest-accrual classes of securities; and

•
fixed or variable rate MBS that, on trade date, are at rates equal to their contractual cap and that have average lives that vary by more than six years under an assumed instantaneous interest rate change of 300 basis points.
The Finance Agency further limits our investments in MBS by requiring that the total book value of our MBS not exceed three times regulatory capital at the time of purchase. For details on our compliance with this regulatory requirement, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Investments.” For additional discussion on our investments and their related credit risk, refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Investments."
Standby Bond Purchase Agreements
We currently hold standby bond purchase agreements with housing associates within our district whereby, for a fee, we agree to serve as a standby liquidity provider if required, to purchase and hold the housing associate's bonds until the designated marketing agent can find a suitable investor or the housing associate repurchases the bonds according to a schedule established by the agreement. Each standby bond purchase agreement includes the provisions under which we would be required to purchase the bonds. If purchased, the bonds would be classified as available-for-sale (AFS) securities in our Statements of Condition. On a go forward basis, we will only enter into new standby bond purchase agreements where we serve as a replacement standby liquidity provider on variable rate demand obligations issued prior to 2009. For additional details on our standby bond purchase agreements, refer to “Item 8. Financial Statements and Supplementary Data — Note 19 — Commitments and Contingencies.”
Deposits
We accept deposits from our members and eligible housing associates. We offer several types of deposit programs, including demand, overnight, and term deposits. Deposit programs provide us funding while providing members a low-risk interest-earning asset.
Consolidated Obligations
Our primary source of funding and liquidity is the issuance of debt securities, referred to as consolidated obligations, in the capital markets. Consolidated obligations (bonds and discount notes) are the joint and several obligations of all 12 FHLBanks and are backed only by the financial resources of the 12 FHLBanks. They are not obligations of the U.S. Government, and the U.S. Government does not guarantee them. At February 28, 2013, Standard & Poor's Ratings Services (S&P) and Moody's Investors Service, Inc. (Moody's) rated the consolidated obligations AA+/A-1+ and Aaa/P-1.

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The Office of Finance issues all consolidated obligations on behalf of the 12 FHLBanks. It is also responsible for servicing all outstanding debt, coordinating transfers of debt between the FHLBanks, serving as a source of information for the FHLBanks on capital market developments, managing the FHLBank System's relationship with the rating agencies with respect to consolidated obligations, and preparing and making available the FHLBank System's Combined Financial Reports.
Although we are primarily responsible for the portion of consolidated obligations issued on our behalf, we are also jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all consolidated obligations. The Finance Agency, at its discretion, may require any FHLBank to make principal and/or interest payments due on any consolidated obligation, whether or not the primary obligor FHLBank has defaulted on the payment of that consolidated obligation. The Finance Agency has never exercised this discretionary authority.
To the extent that an FHLBank makes any payment on a consolidated obligation on behalf of another FHLBank, the paying FHLBank is entitled to reimbursement from the FHLBank otherwise responsible for the payment. However, if the Finance Agency determines that an FHLBank is unable to satisfy its obligations, then it may allocate the outstanding liability among the remaining FHLBanks on a pro-rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding, or on any other basis that it may determine.

The Finance Agency also requires each FHLBank to maintain unpledged qualifying assets, as defined by regulation, in an amount at least equal to the amount of that FHLBank’s participation in the total consolidated obligations outstanding. For details on our compliance with this regulatory requirement, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Liquidity Requirements.”

BONDS
Bonds are generally issued to satisfy our intermediate- and long-term funding needs. Typically, they have maturities ranging up to 30 years, although there is no statutory or regulatory limitation as to their maturity. Periodically, index amortizing notes may be issued that pay down consistent with a specified reference pool of mortgages determined at issuance and have a final stated maturity of up to 15 years. Bonds are issued with either fixed or variable rate payment terms that use a variety of indices for interest rate resets including, but not limited to, LIBOR and the Federal funds rate. To meet the specific needs of certain investors, both fixed and variable rate bonds may also contain certain embedded features, which result in complex coupon payment terms and call features. When bonds are issued on our behalf, we may concurrently enter into a derivative agreement to effectively convert the fixed rate payment stream to variable or to offset the embedded features in the bond.
Depending on the amount and type of funding needed, bonds may be issued through negotiated or competitively bid transactions with approved underwriters or selling group members (i.e., TAP Issue Program, auction, and Global Debt Program), or through debt transfers between FHLBanks.
The TAP Issue Program is used to issue fixed rate, noncallable bonds with standard maturities of two, three, five, seven, or ten years. The goal of the TAP Issue Program is to aggregate frequent smaller bond issues into a larger bond issue that may have greater market liquidity.
An auction process is used to issue fixed rate, callable bonds. Auction structures are determined by the FHLBanks in consultation with the Office of Finance and the securities dealer community. We may receive zero to 100 percent of the proceeds of the bonds issued via the callable auction depending on (i) the amounts and costs for the 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 obligations, and (iii) the guidelines for allocation of bond proceeds among multiple participating FHLBanks administered by the Office of Finance.
The Global Debt Program allows the FHLBanks to diversify their funding sources to include overseas investors. Global Debt Program bonds may be issued in maturities ranging up to 30 years and can be customized with different terms and currencies. The FHLBanks approve the terms of the individual issues under the Global Debt Program.
For additional information on our bonds, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Consolidated Obligations” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Sources of Liquidity.”

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DISCOUNT NOTES
Discount notes are generally issued to satisfy our short-term funding needs. They have maturities of up to 365/366 days and are offered daily through a discount note selling group and other authorized underwriters. Discount notes are sold at a discount and mature at par.
On a daily basis, we may request that specific amounts of discount notes with specific maturity dates be offered by the Office of Finance for sale through certain securities dealers. We may receive zero to 100 percent of the proceeds of the discount notes issued via this sales process depending on (i) the time of the request, (ii) the maximum costs we or other FHLBanks participating in the same issue, if any, are willing to pay for the discount notes, and (iii) the amount of orders for the discount notes submitted by dealers.
Twice weekly, we may request that specific amounts of discount notes with fixed maturities of four to 26 weeks be offered by the Office of Finance through competitive auctions conducted with securities dealers in the discount note selling group. One or more of the FHLBanks may also request that amounts of those same discount notes be offered for sale for their benefit through the same auction. The discount notes offered for sale through competitive auction are not subject to a limit on the maximum costs the FHLBanks are willing to pay. We may receive zero to 100 percent of the proceeds of the discount notes issued through a competitive auction depending on the amounts of the discount notes bid by underwriters and the guidelines for allocation of discount note proceeds among multiple participating FHLBanks administered by the Office of Finance.
For additional information on our discount notes, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Consolidated Obligations” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Sources of Liquidity.”
Derivatives
We use derivatives to manage interest rate risk, including mortgage prepayment risk, in our Statements of Condition. Finance Agency regulations and our ERMP establish guidelines for derivatives, prohibit trading in or the speculative use of derivatives, and limit credit risk arising from derivatives.
The goal of our interest rate risk management strategy is not to eliminate interest rate risk, but to manage it within appropriate limits. 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 repricings.
We can use interest rate swaps, swaptions, interest rate caps and floors, options, and future/forward contracts as part of our interest rate risk management strategies. These derivatives can be used as either a fair value hedge of a financial instrument or firm commitment or an economic hedge to manage certain defined risks in our Statements of Condition.
Additional information on our derivatives can be found in "Item 8. Financial Statements and Supplementary Data — Note 11 — Derivatives and Hedging Activities” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Derivatives.”
CAPITAL AND DIVIDENDS
Capital
We issue a single class of capital stock (Class B capital stock). Our capital stock has a par value of $100 per share, and all shares are issued, redeemed, or repurchased by us at the stated par value. We have two subclasses of capital stock: membership and activity-based. Each member must purchase and maintain membership capital stock in an amount equal to 0.12 percent of its total assets as of the preceding December 31st subject to a cap of $10.0 million and a floor of $10,000. Each member must also maintain activity-based capital stock in an amount equal to 4.45 percent of its total advances and mortgage loans outstanding in our Statements of Condition.
The investment requirements established in our Capital Plan are designed so that we remain adequately capitalized as member activity changes. To ensure we remain adequately capitalized, our Board of Directors may make adjustments to the investment requirements within ranges established in our Capital Plan. All capital stock issued is subject to a five year notice of redemption period.

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Capital stock owned by members in excess of their investment requirement is deemed excess capital stock. Under our Capital Plan, we, at our discretion and upon 15 days' written notice, may repurchase excess membership capital stock. In addition, we, at our discretion, may repurchase excess activity-based capital stock to the extent that (i) the excess capital stock balance exceeds an operational threshold set forth in the Capital Plan or (ii) a member submits a notice to redeem all or a portion of the excess activity based capital stock.
For additional information on our capital, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital.”
Retained Earnings
Our ERMP requires a minimum retained earnings level based on the level of market risk, credit risk, and operational risk within the Bank. If realized financial performance results in actual retained earnings below the minimum level, we, as determined by our Board of Directors, will establish an action plan to enable us to return to our targeted level of retained earnings within twelve months. At December 31, 2012, our actual retained earnings were above the minimum level, and therefore no action plan was necessary.
In 2011, the 12 FHLBanks entered into a Joint Capital Enhancement Agreement (JCE Agreement), as amended. The intent of the JCE Agreement is to enhance the capital position of each FHLBank by allocating that portion of each FHLBank's earnings historically paid to satisfy the Resolution Funding Corporation (REFCORP) obligation to a separate restricted retained earnings account (RREA). Under the JCE Agreement, beginning in the third quarter of 2011, each FHLBank allocates 20 percent of its quarterly net income to a RREA until the balance of that account equals at least one percent of its average balance of outstanding consolidated obligations for the previous quarter. The restricted retained earnings are not available to pay dividends and are presented separately in our Statements of Condition. At December 31, 2012 and 2011, our RREA totaled $28.8 million and $6.5 million. To review the JCE Agreement, as amended, see Exhibit 99.1 of our Form 8-K filed with the Securities and Exchange Commission (SEC) on August 5, 2011.
Dividends
Our Board of Directors may declare and pay different dividends for each subclass of capital stock. Dividend payments may be made in the form of cash and/or additional shares of capital stock. Historically, we have only paid cash dividends. By regulation, we may pay dividends from current earnings or retained earnings, but we may not declare a dividend based on projected or anticipated earnings. We are prohibited from paying a dividend in the form of additional shares of capital stock if, after the issuance, the outstanding excess capital stock would be greater than one percent of our total assets. In addition, we may not declare or pay a dividend if the par value of our capital stock is impaired or is projected to become impaired after paying such dividend. Our Board of Directors may not declare or pay dividends if it would result in our non-compliance with regulatory capital requirements.
Prior to 2012, we paid the same dividend for both membership and activity-based capital stock. Beginning with the dividend for the first quarter of 2012, declared and paid in the second quarter of 2012, we differentiated dividend payments between membership and activity-based capital stock. Our Board of Directors believes any excess returns on capital stock above an appropriate benchmark rate that are not retained for capital growth should be returned to members that utilize our product and service offerings. Our current philosophy is to pay a membership capital stock dividend similar to a benchmark rate of interest, such as average-three month LIBOR, and an activity-based capital stock dividend, when possible, at least 50 basis points in excess of the membership capital stock dividend. Our actual dividend payout continues to be determined quarterly by our Board of Directors, based on policies, regulatory requirements, financial projections, and actual performance.
For additional information on our dividends, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital — Dividends.”

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COMPETITION
Advances
Our primary business is making advances to our members and eligible housing associates. Demand for our advances is affected by, among other things, the cost of other available sources of funding for our borrowers. We compete with other suppliers of secured and unsecured wholesale funding including, but not limited to, investment banks, commercial banks, other GSEs, and U.S. Government agencies. We may also compete with other FHLBanks to the extent that member institutions have affiliated institutions located outside of our district. Furthermore, our members typically have access to brokered deposits and resale agreements, each of which represent competitive alternatives to our advances. Many of our competitors are not subject to the same body of regulation that we are, which enables those competitors to offer products and terms that we may not be able to offer. Efforts to effectively compete with other suppliers of wholesale funding by changing the pricing of our advances may result in a decrease in the profitability of our advance business.
Mortgage Loans
The purchase of mortgage loans through the MPF program is subject to competition on the basis of prices paid for mortgage loans, customer service, and ancillary services, such as automated underwriting and loan servicing options. We compete primarily with other GSEs, such as Fannie Mae, Freddie Mac, and other financial institutions and private investors for acquisition of conventional fixed rate mortgage loans.
Consolidated Obligations
Our primary source of funding is through the issuance of consolidated obligations. We compete with the U.S. Government, Fannie Mae, Freddie Mac, and other GSEs as well as corporate, sovereign, and supranational entities for funds raised through the issuance of debt in the national and global debt markets. In the absence of increased demand, increased supply of competing debt products may result in higher debt costs or lesser amounts of debt issued at the same cost. Although our debt issuances have kept pace with the funding needs of our members, there can be no assurance that this will continue.
TAXATION
We are exempt from all federal, state, and local taxation except real property taxes.
AFFORDABLE HOUSING PROGRAM ASSESSMENTS
The FHLBank Act requires each FHLBank to establish and fund an AHP, which provides subsidies in the form of direct grants and below-market interest rate advances to members who use the funds to assist in the purchase, construction, or rehabilitation of housing for very low to moderate income households. Annually, the FHLBanks must set aside for the AHP the greater of ten percent of their current year net earnings or their pro-rata share of an aggregate $100 million to be contributed in total by the FHLBanks. For purposes of the AHP assessment, net earnings is defined as net income before assessments, plus interest expense related to mandatorily redeemable capital stock. The exclusion of interest expense related to mandatorily redeemable capital stock is a regulatory interpretation of the Finance Agency. We accrue the AHP assessment on a monthly basis and reduce our AHP liability as program funds are distributed. For additional information on our AHP, refer to “Item 8. Financial Statements and Supplementary Data — Note 14 — Affordable Housing Program.”
AVAILABLE INFORMATION
We are required to file with the SEC an annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. The SEC maintains a website containing these reports and other information regarding our electronic filings located at www.sec.gov. 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 SEC's Public Reference Room may be obtained by calling 1-800-SEC-0330.
We also make our annual reports, quarterly reports, current reports, and amendments to all such reports filed with or furnished to the SEC available, free of charge, on our internet website at www.fhlbdm.com as soon as reasonably practicable after such reports are available. Annual and quarterly reports for the FHLBanks on a combined basis are also available, free of charge, at the website of the Office of Finance as soon as reasonably practicable after such reports are available. The internet website address to obtain these reports is www.fhlb-of.com.

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Information contained in the previously mentioned websites, or that can be accessed through those websites, is not incorporated by reference into this annual report on Form 10-K and does not constitute a part of this or any report filed with the SEC.
PERSONNEL
As of February 28, 2013, we employed 214 full-time and seven part-time employees. Our employees are not covered by a collective bargaining agreement.

ITEM 1A. RISK FACTORS

The following discussion summarizes some of the more important risks we face. This discussion is not exhaustive, and there may be other risks we face, which are not described below. The risks described below, if realized, could negatively affect our business operations, financial condition, and future results of operations and, among other things, could result in our inability to pay dividends on our capital stock or repurchase capital stock.
WE ARE SUBJECT TO A COMPLEX BODY OF LAWS AND REGULATIONS THAT COULD CHANGE IN A MANNER DETRIMENTAL TO OUR BUSINESS OPERATIONS
The FHLBanks are GSEs, organized under the authority of the FHLBank Act, and as such, are governed by federal laws and regulations adopted and applied by the Finance Agency. From time to time, Congress may amend the FHLBank Act or other statutes in ways that affect the rights and obligations of 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 adopted by the Finance Agency or other financial services regulators could adversely impact our ability to conduct business or the cost of doing business.
We cannot predict when new regulations will be promulgated by the Finance Agency or whether Congress will enact new legislation, and we cannot predict the effect of any new regulations or legislation on our business operations. Changes in regulatory or statutory requirements could result in, among other things, changes to the eligibility criteria of our membership, changes to the types of business activities that we are permitted to engage in, an increase in our cost of funding, or a decrease in the size, scope, or nature of our lending, investment, or MPF program activities, which could negatively affect our financial condition and results of operations.

Our legislative and regulatory environment continues to change as financial regulators issue proposed and/or final rules to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and Congress continues to debate proposals for housing finance and GSE reform. For a discussion of recent legislative and regulatory activity that could affect us, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Legislative and Regulatory Developments.”

WE FACE COMPETITION FOR ADVANCES, MORTGAGE LOANS, AND FUNDING
Our primary business activities are providing advances to members and housing associates and acquiring residential mortgage loans from or through our members. Demand for our advances is affected by, among other things, the cost of other available sources of funding for our borrowers. We compete with other suppliers of secured and unsecured wholesale funding including, but not limited to, investment banks, commercial banks, other GSEs, and U.S. Government agencies. We may also compete with other FHLBanks to the extent that member institutions have affiliated institutions located outside of our district. Furthermore, our members typically have access to brokered deposits and resale agreements, each of which represent competitive alternatives to our advances. Many of our competitors are not subject to the same body of regulation that we are, which enables those competitors to offer products and terms that we may not be able to offer. Efforts to effectively compete with other suppliers of wholesale funding by changing the pricing of our advances may result in a decrease in the profitability of our advance business. A decrease in the demand for advances or a decrease in the profitability on advances would negatively affect our financial condition and results of operations.
The purchase of mortgage loans through the MPF program is subject to competition on the basis of prices paid for mortgage loans, customer service, and ancillary services, such as automated underwriting and loan servicing options. We compete primarily with other GSEs, such as Fannie Mae, Freddie Mac, and other financial institutions and private investors for acquisition of conventional fixed rate mortgage loans. Increased competition could result in a reduction in the amount of mortgage loans we are able to purchase, which could negatively affect our financial condition and results of operations.

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We also compete with the U.S. Government, Fannie Mae, Freddie Mac, and other GSEs as well as corporate, sovereign, and supranational entities for funds raised through the issuance of debt in the national and global markets. In the absence of increased demand, increased supply of competing debt products may result in higher debt costs or lesser amounts of debt issued at the same cost. An increase in funding costs would negatively affect our financial condition and results of operations.
WE ARE JOINTLY AND SEVERALLY LIABLE FOR THE CONSOLIDATED OBLIGATIONS OF OTHER FHLBANKS AND MAY BE REQUIRED TO PROVIDE FINANCIAL ASSISTANCE TO OTHER FHLBANKS
Each of the FHLBanks relies upon the issuance of consolidated obligations as a primary source of funds. Consolidated obligations are the joint and several obligations of the 12 FHLBanks and are backed only by the financial resources of the FHLBanks. They are not obligations of the U.S. Government, and the U.S. Government does not guarantee them. The Finance Agency, at its discretion, may require any FHLBank to make principal and/or interest payments due on any consolidated obligation, whether or not the primary obligor FHLBank has defaulted on the payment of that consolidated obligation. Furthermore, if the Finance Agency determines that an FHLBank is unable to satisfy its obligations, it may allocate the outstanding liability among the remaining FHLBanks on a pro-rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding, or on any other basis that it may determine. Accordingly, we could incur liability beyond our primary obligation under consolidated obligations, which could negatively affect our financial condition and results of operations. Moreover, we may not pay dividends to, or redeem or repurchase capital stock from, any of our members if timely payment of principal and interest on all FHLBank consolidated obligations has not been made. Accordingly, our ability to pay dividends or to redeem or repurchase capital stock may be affected not only by our financial condition, but by the financial condition of the other FHLBanks.
Due to our relationship with other FHLBanks, we could also be impacted by events other than the default on a consolidated obligation. Events that impact other FHLBanks include, but are not limited to, member failures, capital deficiencies, and other-than-temporary impairment charges. These events may cause the Finance Agency, at its discretion, to require any FHLBank to either provide capital to or buy assets of any other FHLBank. If we were called upon by the Finance Agency to do either of these items, it may impact our financial condition.
Additionally, 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 ten percent of their current year net earnings. If the FHLBanks do not make the minimum $100 million AHP contribution in a given year, we could be required to contribute more than ten percent of our current year net earnings. An increase in our AHP contributions could adversely impact our financial condition and results of operations.
ACTUAL OR PERCEIVED CHANGES IN THE FHLBANK'S CREDIT RATINGS AS WELL AS THE U.S. GOVERNMENT'S CREDIT RATING COULD ADVERSELY AFFECT OUR BUSINESS
Our consolidated obligations are currently rated AA+/A-1+ by S&P and Aaa/P-1 by Moody's. These ratings are subject to reduction or withdrawal at any time by an NRSRO, and the FHLBank System may not be able to maintain these credit ratings. Adverse rating agency actions on the FHLBank System or U.S. Government may reduce investor confidence and negatively affect our cost of funds and ability to issue consolidated obligations on acceptable terms, which could adversely impact our financial condition and results of operations.
A reduction in our credit rating would also trigger additional collateral posting requirements under our derivative agreements. At December 31, 2012, if our credit rating had been lowered from its current rating of AA+ to the next lower rating, we would have been required to deliver up to an additional $63.0 million of collateral to our derivative counterparties. Further, demand for certain Bank products, including, but not limited to, standby letters of credit and standby bond purchase agreements, is influenced by our credit rating. A reduction in our credit rating could weaken or eliminate demand for such products.

We cannot predict future impacts on our financial condition, results of operations, and business model resulting from actions taken by the rating agencies and/or the U.S. Government's fiscal health. To the extent we cannot access funding and derivatives when needed on acceptable terms or demand for our products declines, our financial condition and results of operations could be adversely affected.


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WE COULD BE ADVERSELY AFFECTED BY OUR INABILITY TO ACCESS THE CAPITAL MARKETS
Our primary source of funds is through the issuance of consolidated obligations in the capital markets. Our ability to obtain funds through the issuance of consolidated obligations depends in part on prevailing market conditions in the capital markets and rating agency actions, both of which are beyond our control. We cannot make any assurance that we will be able to obtain funding on terms acceptable to us, if at all. If we cannot access funding when needed, our ability to support and continue business operations, including our compliance with regulatory liquidity requirements, could be adversely impacted, which would thereby adversely impact our financial condition and results of operations. Although our debt issuances have kept pace with the funding needs of our members and eligible housing associates, there can be no assurance that this will continue.
FAILURE TO MEET MINIMUM REGULATORY CAPITAL REQUIREMENTS COULD ADVERSELY AFFECT OUR ABILITY TO REDEEM OR REPURCHASE CAPITAL STOCK, PAY DIVIDENDS, AND ATTRACT NEW MEMBERS
We are required to maintain capital to meet specific minimum requirements, as defined by the Finance Agency. Historically, our capital has exceeded all capital requirements and we have maintained adequate capital and leverage ratios. If we fail to meet any of these requirements or if our Board of Directors or the Finance Agency determines that we have incurred, or are likely to incur, losses resulting in, or losses that are expected to result in, a charge against capital, we would not be able to redeem or repurchase any capital stock while such charges are continuing or expected to continue. In addition, failure to meet our capital requirements could result in the Finance Agency's imposition of restrictions pertaining to dividend payments, lending, investing, or other business activities. Additionally, the Finance Agency could require that we call upon our members to purchase additional capital stock to meet our minimum regulatory capital requirements. Members may be unable or unwilling to satisfy such calls for additional capital, thereby affecting their desire to continue business with us.
WE COULD BE ADVERSELY AFFECTED BY OUR EXPOSURE TO CUSTOMER CONCENTRATION RISK
We are subject to customer concentration risk as a result of our reliance on a relatively small number of member institutions for a large portion of our total advances and resulting interest income. As of December 31, 2012 and 2011, advances outstanding to our top five borrowers totaled $10.3 billion and $11.2 billion, representing 39 and 44 percent of our total advances outstanding. If, for any reason, we were to lose, or experience a decrease in the amount of our business relationships with any of our top five borrowers, our financial condition and results of operations could be negatively affected. Refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Advances” for additional information on our top five borrowers.
WE COULD BE ADVERSELY AFFECTED BY OUR EXPOSURE TO CREDIT RISK
We are exposed to credit risk if the market value of an obligation declines as a result of deterioration in the creditworthiness of the obligor or the credit quality of a security instrument. We assume unsecured and secured credit risk exposure in that a borrower or counterparty could default and we may suffer a loss if we are not able to fully recover amounts owed to us in a timely manner.
We attempt to mitigate unsecured credit risk by limiting the terms of unsecured investments and the borrowing capacity of our counterparties. We attempt to mitigate secured credit risk through collateral requirements and credit analysis of our borrowers and counterparties. We require collateral on advances, standby letters of credit, certain mortgage loan credit enhancements provided by PFIs, certain investments, and derivatives. All advances, standby letters of credit, and applicable mortgage loan credit enhancements are required to be fully collateralized. We evaluate the types of collateral pledged by our borrowers and counterparties and assign a borrowing capacity to the collateral, generally based on a percentage of its unpaid principal balance or estimated market value, if available. We generally have the ability to call for additional or substitute collateral during the life of an obligation to ensure we are fully collateralized.
If a borrower or counterparty fails, we have the right to take ownership of the collateral covering the obligation. However, if the liquidation value of the collateral is less than the value of the outstanding obligation, we may incur losses that could adversely affect our financial condition and results of operations. If we are unable to secure the obligations of borrowers and counterparties, our lending, investing, and hedging activities could decrease, which would negatively impact our financial condition and results of operations.

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CHANGES IN ECONOMIC CONDITIONS OR FEDERAL FISCAL AND MONETARY POLICY COULD ADVERSELY IMPACT OUR BUSINESS
As a cooperative, we operate with narrow margins and expect to be profitable over the long-term based on our prudent lending standards, conservative investment strategies, and diligent risk management practices. Because we operate with narrow margins, our net income is sensitive to changes in market conditions that can impact the interest we earn and pay and introduce volatility in other (loss) income. These conditions include, but are not limited to, changes in interest rates and the money supply, inflation, fluctuations in both debt and equity capital markets, and the strength of the U.S. economy and the local economies in which we conduct business. Our financial condition, results of operations, and ability to pay dividends could be negatively affected by changes in economic conditions.
Additionally, our business and results of operations may be affected by the fiscal and monetary policies of the federal government and its agencies, including the Federal Reserve, which regulates the supply of money and credit in the U.S. The Federal Reserve'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, and ability to pay dividends.
WE COULD BE ADVERSELY AFFECTED BY OUR INABILITY TO ENTER INTO DERIVATIVE INSTRUMENTS ON ACCEPTABLE TERMS
We use derivatives to manage interest rate risk, including mortgage prepayment risk, in our Statements of Condition. Our effective use of derivative instruments depends upon management's ability to determine the appropriate hedging positions in light of our assets and liabilities as well as prevailing and anticipated market conditions. In addition, the effectiveness of our hedging strategies depends upon our ability to enter into derivatives with acceptable counterparties, on terms desirable to us, and in quantities necessary to hedge our corresponding assets and liabilities. If we are unable to manage our hedging positions properly, or are unable to enter into derivative instruments on desirable terms, we may incur higher funding costs and be unable to effectively manage our interest rate risk and other risks, which could negatively affect our financial condition and results of operations.
One factor that could impact our ability to manage our hedging positions properly or enter into derivative instruments on desirable terms is the Dodd-Frank Act. The Dodd-Frank Act provides for new statutory and regulatory requirements for derivative transactions, including those utilized by us to hedge our interest rate and other risks. As a result of these requirements, certain derivative transactions will be required to be cleared through a third-party central clearinghouse and traded on regulated exchanges or new swap execution facilities. These new requirements could materially affect our ability or cost to hedge our risk exposures and achieve our risk management objectives.
For additional discussion on how the Dodd-Frank Act will affect our derivative and hedging activities, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Legislative and Regulatory Developments.”
EXPOSURE TO OPTION RISK IN OUR FINANCIAL ASSETS AND LIABILITIES COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS
Our mortgage assets provide homeowners the option to prepay their mortgages prior to maturity. The effect of changes in interest rates can exacerbate prepayment or extension risk, which is the risk that mortgage assets will be refinanced by the mortgagor in low interest rate environments or will remain outstanding longer than expected at below-market yields when interest rates increase. Our advances, consolidated obligations, and derivatives may provide us, the borrower, the issuer, or the counterparty with the option to call or put the asset or liability. These options leave us susceptible to unpredictable cash flows associated with our financial assets and liabilities. The exercise of the option and the prepayment or extension risk is dependent on general market conditions and if not managed appropriately, could have a material adverse effect on our financial condition and results of operations.

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A DELAY IN THE INITIATION OR COMPLETION OF FORECLOSURE PROCEEDINGS ON OUR MPF LOANS COUPLED WITH AN INCREASE IN DELINQUENCY OR LOSS SEVERITY MAY HAVE AN ADVERSE IMPACT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The housing market experienced a significant slowdown in foreclosure activity throughout 2011 and 2012 due primarily to delays in reviewing and processing foreclosure paperwork. A continued delay in the initiation or completion of foreclosure proceedings could impact the amount of losses we incur on our mortgage loans. During 2012, we observed some signs of improvement in the U.S. housing market and therefore, we did not increase our allowance for credit losses on mortgage loans. To the extent that economic conditions weaken and result in increased unemployment and a decline in home prices, we could see an increase in delinquency or loss severity and decide to increase our allowance for credit losses on mortgage loans. In addition, to the extent that mortgage insurance providers fail to fulfill their obligations to pay us for claims, we could bear additional losses on certain mortgage loans with outstanding mortgage insurance coverage. As a result, our financial condition and results of operations could be adversely impacted.
U.S. GOVERNMENT MANDATED LOAN MODIFICATION PROGRAMS COULD ADVERSELY IMPACT THE VALUE OF OUR INVESTMENTS IN MBS AND MORTGAGE LOANS
Loan modification programs, as well as future legislative, regulatory, or other actions, including amendments to bankruptcy laws, could result in the modification of outstanding mortgage loans. Such modifications could adversely impact the value of and the returns from our investments in MBS and mortgage loans.
MEMBER FAILURES, MERGERS, AND CONSOLIDATIONS COULD ADVERSELY AFFECT OUR BUSINESS
Over the last several years, the financial services industry has experienced increasing defaults on, among other things, home mortgages, commercial real estate, and credit card loans, which caused increased regulatory scrutiny and required capital to cover non-performing loans. These factors have led to an increase in the number of financial institution failures, mergers, and consolidations. During 2012, our membership level experienced eight bank failures and 19 mergers or consolidations, three of which were outside our district. The number of current and potential members in our district may continue to decline if these trends continue. The resulting loss of business could negatively impact our business operations, financial condition, and results of operations.
THE IMPACT OF FINANCIAL MODELS AND THE UNDERLYING ASSUMPTIONS USED TO VALUE FINANCIAL INSTRUMENTS AND COLLATERAL MAY HAVE AN ADVERSE IMPACT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The degree of management judgment involved in determining the fair value of financial instruments or collateral is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments and collateral that are actively traded and have quoted market prices or parameters readily available, there is little to no subjectivity in determining fair value. If market quotes are not available, fair values are based on discounted cash flows using market estimates of interest rates and volatility or on dealer prices or prices of similar instruments. We utilize external and internal pricing models to determine the fair value of certain financial instruments and collateral. For external pricing models, we review the vendors' pricing processes, methodologies, and control procedures for reasonableness. For internal pricing models, the underlying assumptions are based on management's best estimates for discount rates, prepayments, market volatility, and other factors. The assumptions used in both external and internal pricing models could have a significant effect on the reported fair values of assets and liabilities or collateral, the related income and expense, and the expected future behavior of assets and liabilities or collateral. While models used by us to value financial instruments and collateral are subject to periodic validation by independent parties, rapid changes in market conditions could impact the value of our financial instruments and collateral. The use of different models and assumptions, as well as changes in market conditions, could impact our financial condition and results of operations as well as the amount of collateral we require from borrowers and counterparties.
The information provided by our internal financial models is also used in making business decisions relating to strategies, initiatives, transactions, and products. We have adopted controls, procedures, and policies to monitor and manage assumptions used in our internal models. However, models are inherently imperfect predictors of actual results because they are based on assumptions about future performance or activities. Changes in any models or in any of the assumptions, judgments, or estimates used in the models may cause the results generated by the model to be materially different. If the results are not reliable due to inaccurate assumptions, we could make poor business decisions, including asset and liability management, or other decisions, which could result in an adverse financial impact.

19

OUR RELIANCE ON INFORMATION SYSTEMS AND OTHER TECHNOLOGY COULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS
We rely heavily upon information systems and other technology to conduct and manage our business. To the extent that we experience a technical failure or interruption in any of these systems or other technology, including those caused by a breach of our information systems, we may be unable to conduct and manage our business effectively. During the third quarter of 2011, we began the process of replacing our core banking system. This implementation, which is expected to take several years, could subject us to a higher level of operational risk or risk of technical failure or interruption. Although we have implemented a disaster recovery and business continuity plan, we can make no assurance that it will be able to prevent, timely and adequately address, or mitigate the negative effects of any technical failure or interruption. Any technical failure or interruption could harm our customer relations, risk management, and profitability, and could adversely impact our financial condition and results of operations.
THE INABILITY TO ATTRACT AND RETAIN KEY PERSONNEL COULD ADVERSELY IMPACT OUR BUSINESS
We rely heavily upon our employees in order to successfully execute our business and strategies. The success of our business mission depends, in large part, on our ability to attract and retain certain key personnel with required talents and skills. Should we be unable to hire or retain effective key personnel with the needed talents or skills, our business operations could be adversely impacted.
RELIANCE ON THE FHLBANK OF CHICAGO, AS MPF PROVIDER, AND FANNIE MAE, AS THE ULTIMATE INVESTOR IN THE MPF XTRA PRODUCT, COULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS
As part of our business, we participate in the MPF program with the FHLBank of Chicago. In its role as MPF Provider, the FHLBank of Chicago provides the infrastructure and operational support for the MPF program and is responsible for publishing and maintaining the MPF Guides, which detail the requirements PFIs must follow in originating, selling, and servicing MPF loans. If the FHLBank of Chicago changes its MPF Provider role, ceases to operate the MPF program, or experiences a failure or interruption in its information systems and other technology, our mortgage purchase business could be adversely affected, and we could experience a related decrease in our net interest margin and profitability. In the same way, we could be adversely affected if any of the FHLBank of Chicago's third-party vendors supporting the operation of the MPF program were to experience operational or technical difficulties.
Additionally, under the MPF Xtra loan product, we assign 100 percent of our interest in PFI master commitments to the FHLBank of Chicago, who then purchases mortgage loans from our PFIs and sells those loans to Fannie Mae. Should the FHLBank of Chicago or Fannie Mae experience any operational difficulties or inability to continue to do business, those difficulties could have a negative impact on the value of the Bank to our membership.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES
On January 2, 2007, we executed a 20 year lease with an affiliate of our member, Wells Fargo, for approximately 43,000 square feet of office space. The office space is located at 801 Walnut Street, Suite 200, Des Moines, Iowa and used for all primary business functions.
On June 10, 2011, we executed a three year lease with Tomorrow 30 Des Moines, Limited Partnership, for approximately 6,000 square feet of office space. The office space is located at 666 Walnut Street, Suite 1910, Des Moines, Iowa and is used for general business functions.

We also maintain a leased, off-site back-up facility with approximately 4,100 square feet in Urbandale, Iowa.

ITEM 3. LEGAL PROCEEDINGS

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


20

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
We are a cooperative. This means we are owned by our customers, whom we call members. Our current and former members own all of our outstanding capital stock. Our capital stock is not publicly traded and has a par value of $100 per share. All shares are issued, redeemed, or repurchased by us at the stated par value. Our capital stock may be redeemed with a five year notice from the member or voluntarily repurchased by us at par value, subject to certain limitations set forth in our Capital Plan. At February 28, 2013, we had 1,201 current members that held 20.0 million shares of capital stock and 8 former members that held 0.1 million shares of mandatorily redeemable capital stock.
We paid the following quarterly cash dividends (dollars in millions):
 
 
2012
 
2011
Quarter Declared and Paid
 
Amount1
 
Annualized Rate3
 
Amount2
 
Annualized Rate3
First Quarter
 
$
15.9

 
3.00
%
 
$
16.9

 
3.00
%
Second Quarter
 
15.5

 
3.02

 
15.8

 
3.00

Third Quarter
 
13.6

 
2.64

 
16.0

 
3.00

Fourth Quarter
 
13.5

 
2.62

 
16.2

 
3.00


1
Amounts exclude $51,000, $61,000, $58,000, and $60,000 of cash dividends paid on mandatorily redeemable capital stock for the first, second, third, and fourth quarters of 2012. For financial reporting purposes, these dividends were classified as interest expense.

2
Amounts exclude $40,000, $50,000, $48,000, and $49,000 of cash dividends paid on mandatorily redeemable capital stock for the first, second, third, and fourth quarters of 2011. For financial reporting purposes, these dividends were classified as interest expense.

3
Reflects the annualized rate paid on our average capital stock outstanding during the prior quarter regardless of its classification for financial reporting purposes as either capital stock or mandatorily redeemable capital stock.
For additional information regarding our dividends, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital — Dividends.”


21

ITEM 6. SELECTED FINANCIAL DATA

The following tables present selected financial data for the periods indicated (dollars in millions):
 
December 31,
Statements of Condition
2012
 
2011
 
2010
 
2009
 
2008
Investments1
$
13,433

 
$
14,637

 
$
18,639

 
$
20,790

 
$
15,369

Advances
26,614

 
26,591

 
29,253

 
35,720

 
41,897

Mortgage loans held for portfolio, gross
6,968

 
7,157

 
7,434

 
7,719

 
10,685

Allowance for credit losses
(16
)
 
(19
)
 
(13
)
 
(2
)
 
—

Total assets
47,367

 
48,733

 
55,569

 
64,657

 
68,129

Consolidated obligations
 
 
 
 
 
 
 
 
 
Discount notes
8,675

 
6,810

 
7,208

 
9,417

 
20,061

Bonds
34,345

 
38,012

 
43,791

 
50,495

 
42,723

Total consolidated obligations2
43,020

 
44,822

 
50,999

 
59,912

 
62,784

Mandatorily redeemable capital stock
9

 
6

 
7

 
8

 
11

Capital stock — Class B putable
2,063

 
2,109

 
2,183

 
2,461

 
2,781

Retained earnings
622

 
569

 
556

 
484

 
382

Accumulated other comprehensive income (loss)
149

 
134

 
91

 
(34
)
 
(146
)
Total capital
2,834

 
2,812

 
2,830

 
2,911

 
3,017


 
Years Ended December 31,
Statements of Income
2012
 
2011
 
2010
 
2009
 
2008
Net interest income3
$
240.6

 
$
235.6

 
$
414.9

 
$
197.4

 
$
245.6

Provision for credit losses on mortgage loans
—

 
9.2

 
12.1

 
1.5

 
0.3

Other (loss) income4
(57.3
)
 
(71.9
)
 
(161.5
)
 
55.8

 
(27.8
)
Other expense
59.5

 
56.9

 
60.2

 
53.1

 
44.1

Net income
111.4

 
77.8

 
133.0

 
145.9

 
127.4


 
Years Ended December 31,
Selected Financial Ratios5
2012
 
2011
 
2010
 
2009
 
2008
Net interest spread6
0.42
%
 
0.36
%
 
0.59
%
 
0.17
%
 
0.18
%
Net interest margin7
0.49

 
0.44

 
0.67

 
0.28

 
0.35

Return on average equity
3.98

 
2.78

 
4.57

 
4.46

 
3.88

Return on average capital stock
5.44

 
3.66

 
5.76

 
5.05

 
4.27

Return on average assets
0.23

 
0.15

 
0.22

 
0.21

 
0.18

Average equity to average assets
5.69

 
5.27

 
4.70

 
4.63

 
4.71

Regulatory capital ratio8
5.69

 
5.51

 
4.94

 
4.57

 
4.66

Dividend payout ratio9
52.46

 
83.34

 
45.92

 
30.05

 
83.81


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

2
The total par value of outstanding consolidated obligations of the 12 FHLBanks was $687.9 billion, $691.8 billion, $796.3 billion, $930.5 billion, and $1,251.5 billion at December 31, 2012, 2011, 2010, 2009, and 2008.

3
Represents net interest income before the provision for credit losses on mortgage loans.

4
Other (loss) income includes, among other things, net gains (losses) on investment securities, net gains (losses) on derivatives and hedging activities, and net gains (losses) on the extinguishment of debt.

5
Amounts used to calculate selected financial ratios are based on numbers in thousands. Accordingly, recalculations using numbers in millions may not produce the same results.

6
Represents yield on total interest-earning assets minus cost of total interest-bearing liabilities.

7
Represents net interest income expressed as a percentage of average interest-earning assets.

8
Represents period-end regulatory capital expressed as a percentage of period-end total assets. Regulatory capital includes all capital stock, mandatorily redeemable capital stock, and retained earnings.

9
Represents dividends declared and paid in the stated period expressed as a percentage of net income in the stated period.

22

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

Our Management's Discussion and Analysis (MD&A) is designed to provide information that will help the reader develop a better understanding of our financial statements, changes in our financial statements from year to year, and the primary factors driving those changes. Our MD&A is organized as follows:

CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


23

FORWARD-LOOKING INFORMATION

Statements contained in this annual report on Form 10-K, including statements describing the objectives, projections, estimates, or future predictions in our operations, may be forward-looking statements. These statements may be identified by the use of forward-looking terminology, such as believes, projects, expects, anticipates, estimates, intends, strategy, plan, could, should, may, and will or their negatives or other variations on these terms. By their nature, forward-looking statements involve risk or uncertainty, and actual results could differ materially from those expressed or implied or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. A detailed discussion of risks and uncertainties is included under “Item 1A. Risk Factors.”

EXECUTIVE OVERVIEW

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

We reported net income of $111.4 million in 2012 compared to $77.8 million in 2011. Our 2012 net income, calculated in accordance with accounting principles generally accepted in the U.S. (GAAP), was primarily impacted by net interest income, losses on debt extinguishments, losses on derivatives and hedging activities, and gains on investment securities.

Net interest income totaled $240.6 million in 2012 compared to $235.6 million in 2011. Our net interest income was primarily impacted by reduced funding costs resulting from a decline in consolidated obligation bond volumes and the lower interest rate environment. Throughout 2012, we called and extinguished higher-costing debt in order to reduce our future interest costs. Our net interest income was also impacted by a decline in investment and mortgage loan interest income resulting from lower average investment and mortgage loan volumes and the lower interest rate environment. As a member-owned cooperative, we endeavor to operate with a low but stable net interest margin. As a result, our net interest margin was 0.49 percent for 2012 compared with 0.44 percent for 2011.

Our net income was reduced by losses on the extinguishment of debt. During 2012 and 2011, we extinguished $556.1 million and $33.0 million of higher-costing consolidated obligations and recorded losses on these debt extinguishments of $76.8 million and $4.6 million through "Net loss on extinguishment of debt" in the Statements of Income, which is a component of other (loss) income. These debt extinguishment losses were partially offset by net advance prepayment fee income recorded in net interest income of $28.1 million in 2012 and $10.7 million in 2011, as well as gains on sales of investment securities recorded in other (loss) income of $13.6 million in 2012 and $8.2 million in 2011.

Net income was further reduced by losses on derivatives and hedging activities. We utilize derivative instruments to manage interest rate risk, including mortgage prepayment risk, in our Statements of Condition. Accounting rules require all derivatives to be recorded at fair value in our Statements of Condition; therefore, we may be subject to income statement volatility. During 2012, we recorded net losses of $24.8 million on our derivatives and hedging activities compared to net losses of $110.8 million in 2011. These losses were recorded as a component of other (loss) income in the Statements of Income and were primarily attributed to economic derivatives that do not qualify for fair value hedge accounting. During 2012, we recorded losses of $26.5 million on economic derivatives compared to losses of $121.7 million in 2011. These losses were primarily due to the effect of changes in interest rates on interest rate swaps economically hedging our trading securities portfolio and interest rate caps economically hedging our mortgage asset portfolio. Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Hedging Activities" for additional discussion on our derivatives and hedging activities, including the net impact of economic hedge relationships.

Our net income was positively impacted by gains on investment securities. Trading securities are recorded at fair value with changes in fair value reflected through other (loss) income in our Statements of Income. During 2012, we recorded gains on trading securities of $23.1 million compared to gains of $38.7 million in 2011. In addition, we sold AFS securities with a par value of $67.8 million and realized gains of $12.6 million during 2012. We did not sell any AFS securities during 2011. 



24

Our total assets decreased to $47.4 billion at December 31, 2012 from $48.7 billion at December 31, 2011 due primarily to a decline in investment securities. Investment securities declined mainly due to the maturity of Temporary Liquidity Guarantee Program (TLGP) investments and principal paydowns on MBS. Our advances totaled $26.6 billion at both December 31, 2012 and 2011. Total capital was $2.8 billion at December 31, 2012 and 2011. Refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition” for additional discussion on our financial condition.

Adjusted Earnings

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

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

The following table summarizes the reconciliation between GAAP net interest income and adjusted net interest income (dollars in millions):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
GAAP net interest income (before provision for credit losses)
$
240.6

 
$
235.6

 
$
414.9

Exclude:
 
 
 
 
 
Prepayment fees on advances, net
28.1

 
10.7

 
174.0

Prepayment fees on investments
—

 
14.6

 
—

Fair value hedging adjustments
0.1

 
1.6

 
1.3

Total adjustments
28.2

 
26.9

 
175.3

Include items reclassified from other (loss) income:
 
 
 
 
 
Net interest (expense) income on economic hedges
(11.9
)
 
0.8

 
6.7

Adjusted net interest income (before provision for credit losses)
$
200.5

 
$
209.5

 
$
246.3

Adjusted net interest margin
0.41
%
 
0.39
%
 
0.40
%

Our adjusted net interest income decreased $9.0 million during 2012 when compared to 2011. The decline in adjusted net interest income was primarily due to lower average balances of interest-earning assets and higher interest expense on economic hedges. During 2012, our interest income on interest rate swaps economically hedging our consolidated obligations decreased $11.4 million when compared to 2011, primarily due to fewer economic hedge relationships. Despite a decline in adjusted net interest income, our net interest margin was 0.41 percent and 0.39 percent during 2012 and 2011. During 2011, our adjusted net interest income decreased $36.8 million when compared to 2010 due to lower interest income on advances and investments, partially offset by lower interest expense on consolidated obligations.


25

The following table summarizes the reconciliation between GAAP net income and adjusted net income (dollars in millions):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
GAAP net income (before assessments)
$
123.8

 
$
97.6

 
$
181.1

Exclude:
 
 
 
 
 
Adjustments to net interest income
28.2

 
26.9

 
175.3

Net gain on trading securities
23.1

 
38.7

 
37.4

Net gain on sale of available-for-sale securities
12.6

 
—

 
—

Net gain on sale of held-to-maturity securities
1.0

 
7.2

 
—

Net gain (loss) on consolidated obligations held at fair value
4.2

 
(6.5
)
 
5.7

Net loss on derivatives and hedging activities
(24.8
)
 
(110.8
)
 
(52.6
)
Net loss on extinguishment of debt
(76.8
)
 
(4.6
)
 
(163.7
)
Include:
 
 
 
 
 
Net interest (expense) income on economic hedges
(11.9
)
 
0.8

 
6.7

Amortization of hedging costs1
(7.2
)
 
(6.1
)
 
—

Adjusted net income (before assessments)
$
137.2

 
$
141.4

 
$
185.7


1
Represents the straight line amortization of upfront fee payments on derivative instruments.

Our adjusted net income decreased $4.2 million during 2012 when compared to 2011. The decrease was primarily due to a decline in adjusted net interest income and losses on real estate owned (REO), partially offset by a decreased provision for credit losses on mortgage loans. Our adjusted net income decreased $44.3 million during 2011 when compared to 2010 due to a decline in adjusted net interest income and losses on REO.

For additional discussion on items impacting our GAAP earnings, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations.”

CONDITIONS IN THE FINANCIAL MARKETS

Economy and Capital Markets

Economic and market data received since the Federal Open Market Committee (FOMC) meeting in October of 2012 suggests a moderate pace of economic expansion. However, growth in the labor market has been slow and the unemployment rate remains elevated. Business fixed investments have slowed, but household spending and the housing sector have showed signs of improvement. Inflation has remained subdued and long-term inflation expectations have remained stable.

In its December 12, 2012 statement, the FOMC stated that it is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in the labor market. Furthermore, strains in global financial markets continue to pose significant downside risk to the economic outlook. The FOMC anticipates that inflation over the medium-term will run at or below the rate it judges to be consistent with its mandate to foster maximum employment and price stability.

Mortgage Markets

Signs of stabilization in the housing market have surfaced throughout 2012, as indicated by modestly rising home prices and housing construction activity. Improved homebuilder sentiment is being translated into modest increases in residential construction, although the actual amount of new construction remains fairly low by historical standards. The outlook for a sustainable recovery in residential sales and home prices continues to be hampered by tight mortgage credit and the prospect of ongoing liquidation of foreclosed and distressed properties.


26

Interest Rates

The following table shows information on key average market interest rates:
 
2012
3-Month
Average
 
2011
3-Month
Average
 
2012
12-Month
Average
 
2011
12-Month
Average
 
2012
Ending
Rate
 
2011
Ending
Rate
Federal funds1
0.16
%
 
0.07
%
 
0.14
%
 
0.10
%
 
0.09
%
 
0.04
%
Three-month LIBOR1
0.32

 
0.47

 
0.43

 
0.33

 
0.31

 
0.58

2-year U.S. Treasury1
0.26

 
0.26

 
0.27

 
0.44

 
0.25

 
0.28

10-year U.S. Treasury1
1.69

 
2.04

 
1.78

 
2.77

 
1.76

 
2.02

30-year residential mortgage note1
3.36

 
4.00

 
3.65

 
4.47

 
3.35

 
3.95


1
Source is Bloomberg.

The Federal Reserve's key targeted interest rate, the Federal funds rate, maintained a range of 0.00 to 0.25 percent throughout 2012. In its December 12, 2012 statement, the FOMC noted that it anticipates that economic conditions are likely to warrant exceptionally low levels of the Federal funds rate for at least as long as unemployment remains above 6.5 percent and inflation projections for the next one to two years are no more than a half percentage point above the FOMC's long-run goal of two percent. During the last quarter of 2011, as the Federal Reserve implemented its program (termed "Operation Twist") of purchasing long-term U.S. Treasuries and selling an equal amount of short-term U.S. Treasuries, three-month LIBOR began to steadily increase. However, after hitting a peak at the beginning of 2012, three-month LIBOR has decreased. Since a portion of our assets and liabilities are directly tied to short-term interest rates, our interest income and interest expense were affected by changes in short-term interest rates throughout 2012. Average U.S. Treasury yields were lower during 2012 when compared to 2011. Mortgage rates generally moved in tandem with the U.S. Treasury market during 2012.

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the Federal Reserve's dual mandate, the FOMC indicated its intent to purchase additional agency MBS at a pace of $40.0 billion per month at its meeting in December of 2012. The FOMC also decided to extend the average maturity of its holdings of securities. This program, known as "QE III", was implemented by the Federal Reserve to help make broader financial conditions more accommodative. The FOMC will monitor incoming information on economic and financial developments in future months. If the outlook for the labor market does not improve, the FOMC will continue its purchases of agency MBS, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved.

Funding Spreads

The following table reflects our funding spreads to LIBOR (basis points)1:
 
2012
3-Month
Average
 
2011
3-Month
Average
 
2012
12-Month
Average
 
2011
12-Month
Average
 
2012
Ending Spread
 
2011
Ending Spread
3-month
(17.0
)
 
(41.9
)
 
(29.2
)
 
(13.5
)
 
(19.6
)
 
(53.0
)
2-year
(6.0
)
 
(20.9
)
 
(13.3
)
 
(10.3
)
 
(7.3
)
 
(31.4
)
5-year
2.1

 
(0.8
)
 
(0.4
)
 
3.5

 
1.6

 
(8.7
)
10-year
23.6

 
44.1

 
30.4

 
41.9

 
25.1

 
36.5


1
Source is the Office of Finance.

Throughout the second half of 2012, our short-term funding spreads relative to LIBOR deteriorated to a point where, by year-end, spreads were less favorable compared to spreads at December 31, 2011, but still remained favorable when compared to long-term historical levels. During the second half of 2011, investors sought highly-rated assets following the downgrade of the U.S. Government's long-term sovereign rating. This sentiment continued through most of the first half of 2012, where investors remained in short-term, highly-rated assets. Due to the funding environment, we utilized callable, step-up, and short-term consolidated obligation bonds throughout the first six months of 2012. However, during the third quarter of 2012, the FOMC announced its intent to start a third round of quantitative easing to keep long-term interest rates low and issued guidance for short-term interest rates out to 2015. As a result, we saw deteriorating funding spreads for short-term consolidated obligation bonds and increased our utilization of discount notes. During the fourth quarter of 2012, we also expanded our utilization of floating rate LIBOR debt and swapped consolidated obligation bonds.


27

RESULTS OF OPERATIONS

Net Income

The following table presents comparative highlights of our net income for the years ended December 31, 2012, 2011, and 2010 (dollars in millions). See further discussion of these items in the sections that follow.
 
 
 
 
 
2012 vs. 2011
 
 
 
2011 vs. 2010
 
2012
 
2011
 
$ Change
 
% Change
 
2010
 
$ Change
 
% Change
Net interest income before provision
$
240.6

 
$
235.6

 
$
5.0

 
2.1
 %
 
$
414.9

 
$
(179.3
)
 
(43.2
)%
Provision for credit losses on mortgage loans
—

 
9.2

 
(9.2
)
 
(100.0
)
 
12.1

 
(2.9
)
 
(24.0
)
Other (loss) income
(57.3
)
 
(71.9
)
 
14.6

 
20.3

 
(161.5
)
 
89.6

 
55.5

Other expense
59.5

 
56.9

 
2.6

 
4.6

 
60.2

 
(3.3
)
 
(5.5
)
Assessments
12.4

 
19.8

 
(7.4
)
 
(37.4
)
 
48.1

 
(28.3
)
 
(58.8
)
Net income
$
111.4

 
$
77.8

 
$
33.6

 
43.2
 %
 
$
133.0

 
$
(55.2
)
 
(41.5
)%


28

Net Interest Income

Our net interest income is impacted by changes in average interest-earning asset and interest-bearing liability balances, and the related yields and costs. The following table presents average balances and rates of major asset and liability categories (dollars in millions):
 
 
For the Years Ended December 31,
 
 
2012
 
2011
 
2010
 
 
Average Balance1
 
Yield/Cost
 
Interest Income/
Expense
 
Average Balance1
 
Yield/Cost
 
Interest Income/
Expense
 
Average Balance1
 
Yield/Cost
 
Interest Income/
Expense
 
 
 
 
 
 
 
 
 
 
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
$
461

 
0.15
%
 
$
0.7

 
$
353

 
0.12
%
 
$
0.4

 
$
125

 
0.29
%
 
$
0.4

Securities purchased under agreements to resell
 
2,810

 
0.16

 
4.6

 
1,533

 
0.08

 
1.3

 
1,345

 
0.18

 
2.4

Federal funds sold
 
1,971

 
0.12

 
2.3

 
2,552

 
0.10

 
2.5

 
3,021

 
0.16

 
4.8

Short-term investments
 
165

 
0.15

 
0.3

 
146

 
0.13

 
0.2

 
456

 
0.41

 
1.9

Mortgage-backed securities2
 
7,235

 
1.98

 
142.9

 
9,802

 
2.34

 
229.8

 
12,635

 
2.18

 
275.8

Other investments2,3,5
 
2,568

 
2.74

 
70.4

 
3,215

 
2.25

 
72.3

 
3,826

 
2.17

 
82.9

Advances4,5
 
26,266

 
1.03

 
270.6

 
27,773

 
0.98

 
271.0

 
32,476

 
1.73

 
561.8

Mortgage loans6
 
7,152

 
3.97

 
284.1

 
7,256

 
4.48

 
325.0

 
7,557

 
4.73

 
357.3

Loans to other FHLBanks
 
—

 
—

 
—

 
3

 
0.04

 
—

 
—

 
—

 
—

Total interest-earning assets
 
48,628

 
1.60

 
775.9

 
52,633

 
1.71

 
902.5

 
61,441

 
2.10

 
1,287.3

Non-interest-earning assets
 
564

 
—

 
—

 
477

 
—

 
—

 
415


—

 
—

Total assets
 
$
49,192

 
1.58
%
 
$
775.9

 
$
53,110

 
1.70
%
 
$
902.5

 
$
61,856

 
2.08
%
 
$
1,287.3

Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
$
992

 
0.04
%
 
$
0.4

 
$
988

 
0.05
%
 
$
0.5

 
$
1,370

 
0.09
%
 
$
1.2

Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Discount notes5
 
8,839

 
0.13

 
11.4

 
7,104

 
0.09

 
6.1

 
7,146

 
0.15

 
10.4

Bonds5
 
35,510

 
1.47

 
523.3

 
41,256

 
1.60

 
660.1

 
49,283

 
1.75

 
860.7

Other interest-bearing liabilities7
 
10

 
2.45

 
0.2

 
8

 
2.65

 
0.2

 
8

 
2.10

 
0.1

Total interest-bearing liabilities
 
45,351

 
1.18

 
535.3

 
49,356

 
1.35

 
666.9

 
57,807

 
1.51

 
872.4

Non-interest-bearing liabilities
 
1,041

 
—

 
—

 
956

 
—

 
—

 
1,139

 
—

 
—

Total liabilities
 
46,392

 
1.15

 
535.3

 
50,312

 
1.33

 
666.9

 
58,946

 
1.48

 
872.4

Capital
 
2,800

 
—

 
—

 
2,798

 
—

 
—

 
2,910

 
—

 
—

Total liabilities and capital
 
$
49,192

 
1.09
%
 
$
535.3

 
$
53,110

 
1.26
%
 
$
666.9

 
$
61,856

 
1.41
%
 
$
872.4

Net interest income and spread8
 
 
 
0.42
%
 
$
240.6

 
 
 
0.36
%
 
$
235.6

 
 
 
0.59
%
 
$
414.9

Net interest margin9
 
 
 
0.49
%
 
 
 
 
 
0.44
%
 
 
 
 
 
0.67
%
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
 
107.23
%
 
 
 
 
 
106.64
%
 
 
 
 
 
106.29
%
 
 

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

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

3
Other investments primarily include: other U.S. obligations, GSE obligations, state or local housing agency obligations, and TLGP investments.

4
Advance interest income includes advance prepayment fee income of $28.1 million, $10.7 million, and $174.0 million for the years ended December 31, 2012, 2011, and 2010.

5
Average balances reflect the impact of fair value hedging adjustments and/or fair value option adjustments.

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

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

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

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


29

The following table presents changes in interest income and interest expense. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but rather equally attributable to both volume and rate changes, are allocated to the volume and rate categories based on the proportion of the absolute value of the volume and rate changes (dollars in millions).
 
2012 vs. 2011
 
2011 vs. 2010
 
Total Increase
(Decrease) Due to
 
Total Increase
(Decrease)
 
Total Increase
(Decrease) Due to
 
Total Increase
(Decrease)
 
Volume
 
Rate
 
 
Volume
 
Rate
 
Interest income
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
0.2

 
$
0.1

 
$
0.3

 
$
0.3

 
$
(0.3
)
 
$
—

Securities purchased under agreements to resell
1.5

 
1.8

 
3.3

 
0.3

 
(1.4
)
 
(1.1
)
Federal funds sold
(0.7
)
 
0.5

 
(0.2
)
 
(0.7
)
 
(1.6
)
 
(2.3
)
Short-term investments
—

 
0.1

 
0.1

 
(0.8
)
 
(0.9
)
 
(1.7
)
Mortgage-backed securities
(54.7
)
 
(32.2
)
 
(86.9
)
 
(65.1
)
 
19.1

 
(46.0
)
Other investments
(16.0
)
 
14.1

 
(1.9
)
 
(13.6
)
 
3.0

 
(10.6
)
Advances
(14.5
)
 
14.1

 
(0.4
)
 
(72.8
)
 
(218.0
)
 
(290.8
)
Mortgage loans
(4.6
)
 
(36.3
)
 
(40.9
)
 
(13.9
)
 
(18.4
)
 
(32.3
)
Total interest income
(88.8
)
 
(37.8
)
 
(126.6
)
 
(166.3
)
 
(218.5
)
 
(384.8
)
Interest expense
 
 
 
 
 
 
 
 
 
 
 
Deposits
—

 
(0.1
)
 
(0.1
)
 
(0.3
)
 
(0.4
)
 
(0.7
)
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes
1.9

 
3.4

 
5.3

 
(0.1
)
 
(4.2
)
 
(4.3
)
Bonds
(86.4
)
 
(50.4
)
 
(136.8
)
 
(131.4
)
 
(69.2
)
 
(200.6
)
Other interest-bearing liabilities
—

 
—

 
—

 
—

 
0.1

 
0.1

Total interest expense
(84.5
)
 
(47.1
)
 
(131.6
)
 
(131.8
)
 
(73.7
)
 
(205.5
)
Net interest income
$
(4.3
)
 
$
9.3

 
$
5.0

 
$
(34.5
)
 
$
(144.8
)
 
$
(179.3
)
    
NET INTEREST SPREAD

Net interest spread equals the yield on total interest-earning assets minus the cost of total interest-bearing liabilities. During 2012, our net interest spread was 0.42 percent compared to 0.36 and 0.59 percent in 2011 and 2010. Our 2012 net interest spread was primarily impacted by lower funding costs, partially offset by lower interest income on investments and mortgage loans. The primary components of our interest income and interest expense are discussed below.

Bonds

Interest expense on bonds decreased 21 percent during 2012 when compared to 2011 and 23 percent during 2011 when compared to 2010. The decrease in 2012 was due to lower average bond volumes and lower interest rates. Average bond volumes declined primarily due to a reduction in funding needs resulting from a decline in average assets and a change in our funding strategy during the second half of 2012. Throughout the first half of 2012, we utilized callable, step-up, and short-term fixed rate bonds to capture attractive funding. However, during the second half of 2012, our long-term spreads became less favorable and, as a result, we began utilizing discount notes to manage our funding needs. We also called and extinguished certain higher-costing bonds in order to reduce future interest costs, which caused a further decline in our average bond volumes. The decrease in interest expense on bonds in 2011 was also due to lower average bond volumes and lower interest rates. Average bond volumes declined due to a reduction in advance demand and limited investment opportunities.

Investments

Interest income on investments decreased 28 percent during 2012 when compared to 2011 primarily due to lower average volumes and lower interest rates on MBS. Average investment volumes decreased due primarily to MBS principal paydowns. In addition, the low interest rate environment drove down interest income on our variable rate MBS, which represented approximately 62 percent of our total MBS portfolio at December 31, 2012. Interest income on investments decreased 17 percent during 2011 when compared to 2010. The decrease was primarily due to lower average volumes resulting from MBS principal paydowns and limited investment opportunities. The decrease was partially offset by our receipt of a $14.6 million fee for the prepayment of an AFS MBS during the first quarter of 2011.

30

Mortgage Loans

Interest income on mortgage loans decreased 13 percent during 2012 when compared to 2011 and 9 percent during 2011 when compared to 2010. The decrease during both periods was due to lower interest rates and lower average mortgage loan volumes. Average mortgage loan volumes declined due primarily to principal paydowns exceeding mortgage loan purchases.

Advances

Interest income on advances (including prepayment fees on advances, net) remained fairly stable during 2012 when compared to 2011 and decreased 52 percent during 2011 when compared to 2010. The decrease in interest income on advances in 2011 was due to lower advance prepayment fee income, lower average advance volumes, and lower interest rates. Advance prepayment fee income declined $163.3 million due to fewer advance prepayments by members. Average advance volumes declined $4.7 billion due to reduced member demand, scheduled maturities, and prepayments.

Provision for Credit Losses on Mortgage Loans

During 2012, we recorded no provision for credit losses on our mortgage loans compared to a provision of $9.2 million in 2011 and $12.1 million in 2010. We believe the current allowance for credit losses of $15.8 million remained adequate to absorb estimated losses in our conventional mortgage loan portfolio at December 31, 2012. In 2011 and 2010, the provisions recorded were driven by increased estimated losses resulting primarily from increased loss severities and higher levels of loans migrating to REO.

Other (Loss) Income

The following table summarizes the components of other (loss) income (dollars in millions):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Net gain on trading securities
$
23.1

 
$
38.7

 
$
37.4

Net gain on sale of available-for-sale securities
12.6

 
—

 
—

Net gain on sale of held-to-maturity securities
1.0

 
7.2

 
—

Net gain (loss) on consolidated obligations held at fair value
4.2

 
(6.5
)
 
5.7

Net loss on derivatives and hedging activities
(24.8
)
 
(110.8
)
 
(52.6
)
Net loss on extinguishment of debt
(76.8
)
 
(4.6
)
 
(163.7
)
Other, net
3.4

 
4.1

 
11.7

Total other (loss) income
$
(57.3
)
 
$
(71.9
)
 
$
(161.5
)
    
Other (loss) income can be volatile from period to period depending on the type of financial activity recorded, including the impact of fair value adjustments on instruments carried at fair value. During 2012, 2011, and 2010, other (loss) income was primarily impacted by losses on debt extinguishments, losses on derivatives and hedging activities, and gains on investment securities.
 
We may extinguish higher-costing debt from time to time in an effort to reduce our future interest costs. During 2012, 2011, and 2010, we extinguished bonds with a total par value of $556.1 million, $33.0 million, and $1.3 billion and recorded losses of $76.8 million, $4.6 million, and $163.7 million, respectively. These debt extinguishment losses were offset by net advance prepayment fee income recorded in net interest income of $28.1 million in 2012, $10.7 million in 2011, and $174.0 million in 2010. In addition, during 2012 these losses were partially offset by gains on the sale of investment securities of $13.6 million.

We use derivatives to manage interest rate risk, including mortgage prepayment risk, in our Statements of Condition. Derivatives are recorded at fair value with changes in fair value reflected through other (loss) income. During 2012, we recorded net losses of $24.8 million on our derivatives and hedging activities compared to net losses of $110.8 million and $52.6 million in 2011 and 2010. These net losses were primarily due to economic derivatives. During 2012, we recorded net losses of $26.5 million on economic derivatives compared to net losses of $121.7 million and $57.3 million in 2011 and 2010. The majority of these losses were due to the effect of changes in interest rates on interest rate swaps economically hedging our trading securities portfolio and interest rate caps economically hedging our mortgage asset portfolio. Refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Hedging Activities” for additional discussion on our derivatives and hedging activities, including the net impact of economic hedge relationships.

31

Trading securities are recorded at fair value with changes in fair value reflected through other (loss) income. During 2012, 2011, and 2010, we recorded net gains on trading securities of $23.1 million, $38.7 million, and $37.4 million. Net gains on trading securities include both realized gains from the sale of trading securities and holding gains. We did not sell any trading securities in 2012. In 2011 and 2010, we sold trading securities and realized gains of $1.0 million and $28.6 million. Holding gains on trading securities amounted to $23.1 million, $37.7 million, and $8.8 million during 2012, 2011, and 2010. The decrease in holding gains during 2012 when compared to 2011 and the increase in holding gains during 2011 when compared to 2010 were primarily due to the effect of changes in interest rates. In addition, we sold AFS securities with a par value of $67.8 million and realized gains of $12.6 million during 2012. We did not sell any AFS securities during 2011. We sold an AFS security at par value of $91.0 million in 2010 and therefore recognized no gain or loss on the sale. 

Hedging Activities

We use derivatives to manage interest rate risk, including mortgage prepayment risk, in our Statements of Condition. Accounting rules affect the timing and recognition of income or expense on derivatives and therefore we may be subject to income statement volatility.
  
If a hedging activity qualifies for hedge accounting treatment (fair value hedge), we include the periodic cash flow components of the hedging instrument related to interest income or expense in the relevant income statement caption consistent with the hedged asset or liability. We also record the amortization of basis adjustments from terminated hedges in interest income or expense or other (loss) income. Changes in the fair value of both the hedging instrument and the hedged item are recorded as a component of other (loss) income in “Net loss on derivatives and hedging activities."

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

The following tables categorize the net effect of hedging activities on net income by product (dollars in millions):
 
 
For the Year Ended December 31, 2012
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Discount Notes
 
Balance
Sheet
 
Total
Net Interest Income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net (amortization) accretion1
 
$
(373.2
)
 
$
—

 
$
(5.1
)
 
$
50.6

 
$
—

 
$
—

 
$
(327.7
)
Net interest settlements
 
(195.7
)
 
(12.7
)
 
—

 
123.9

 
—

 
—

 
(84.5
)
Total net interest income
 
(568.9
)
 
(12.7
)
 
(5.1
)
 
174.5

 
—

 
—

 
(412.2
)
Net Gain (Loss) on Derivatives and Hedging Activities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
3.4

 
1.1

 
—

 
(2.8
)
 
—

 
—

 
1.7

(Losses) gains on economic hedges
 
(0.3
)
 
(23.4
)
 
(1.5
)
 
8.9

 
2.9

 
(13.1
)
 
(26.5
)
Total net gain (loss) on derivatives and hedging activities
 
3.1

 
(22.3
)
 
(1.5
)
 
6.1

 
2.9

 
(13.1
)
 
(24.8
)
Subtotal
 
(565.8
)
 
(35.0
)
 
(6.6
)
 
180.6

 
2.9

 
(13.1
)
 
(437.0
)
Net gain on trading securities2
 
—

 
23.6

 
—

 
—

 
—

 
—

 
23.6

Net gain on consolidated obligations held at fair value
 
—

 
—

 
—

 
2.8

 
1.4

 
—

 
4.2

Net accretion3
 
—

 
—

 
—

 
4.1

 
—

 
—

 
4.1

Total net effect of hedging activities
 
$
(565.8
)
 
$
(11.4
)
 
$
(6.6
)
 
$
187.5

 
$
4.3

 
$
(13.1
)
 
$
(405.1
)

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

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

3
Represents the amortization/accretion of basis adjustments on closed bond hedge relationships included in other (loss) income as a result of debt extinguishments.


32

 
 
For the Year Ended December 31, 2011
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Discount Notes
 
Balance
Sheet
 
Total
Net Interest Income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net (amortization) accretion1
 
$
(33.0
)
 
$
—

 
$
(3.2
)
 
$
43.2

 
$
—

 
$
—

 
$
7.0

Net interest settlements
 
(313.9
)
 
(11.8
)
 
—

 
265.2

 
—

 
—

 
(60.5
)
Total net interest income
 
(346.9
)
 
(11.8
)
 
(3.2
)
 
308.4

 
—

 
—

 
(53.5
)
Net Gain (Loss) on Derivatives and Hedging Activities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
8.5

 
(2.7
)
 
—

 
5.1

 
—

 
—

 
10.9

(Losses) gains on economic hedges
 
(0.3
)
 
(59.9
)
 
(0.8
)
 
7.3

 
(0.9
)
 
(67.1
)
 
(121.7
)
Total net gain (loss) on derivatives and hedging activities
 
8.2

 
(62.6
)
 
(0.8
)
 
12.4

 
(0.9
)
 
(67.1
)
 
(110.8
)
Subtotal
 
(338.7
)
 
(74.4
)
 
(4.0
)
 
320.8

 
(0.9
)
 
(67.1
)
 
(164.3
)
Net gain on trading securities2
 
—

 
40.2

 
—

 
—

 
—

 
—

 
40.2

Net loss on consolidated obligations held at fair value
 
—

 
—

 
—

 
(5.1
)
 
(1.4
)
 
—

 
(6.5
)
Net amortization3
 
—

 
—

 
—

 
(0.5
)
 
—

 
—

 
(0.5
)
Total net effect of hedging activities
 
$
(338.7
)
 
$
(34.2
)
 
$
(4.0
)
 
$
315.2

 
$
(2.3
)
 
$
(67.1
)
 
$
(131.1
)

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

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

3
Represents the amortization/accretion of basis adjustments on closed bond hedge relationships included in other (loss) income as a result of debt extinguishments.

The following table categorizes the net effect of hedging activities on net income by product (dollars in millions):
 
 
For the Year Ended December 31, 2010
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Discount Notes
 
Balance
Sheet
 
Total
Net Interest Income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net (amortization) accretion1
 
$
(99.8
)
 
$
—

 
$
(2.7
)
 
$
33.2

 
$
—

 
$
—

 
$
(69.3
)
Net interest settlements
 
(392.3
)
 
(7.1
)
 
—

 
335.9

 
—

 
—

 
(63.5
)
Total net interest income
 
(492.1
)
 
(7.1
)
 
(2.7
)
 
369.1

 
—

 
—

 
(132.8
)
Net Gain (Loss) on Derivatives and Hedging Activities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
5.0

 
1.6

 
—

 
(1.9
)
 
—

 
—

 
4.7

(Losses) gains on economic hedges
 
(0.8
)
 
(70.5
)
 
(0.9
)
 
27.5

 
—

 
(12.6
)
 
(57.3
)
Total net gain (loss) on derivatives and hedging activities
 
4.2

 
(68.9
)
 
(0.9
)
 
25.6

 
—

 
(12.6
)
 
(52.6
)
Subtotal
 
(487.9
)
 
(76.0
)
 
(3.6
)
 
394.7

 
—

 
(12.6
)
 
(185.4
)
Net gain on trading securities2
 
—

 
34.4

 
—

 
—

 
—

 
—

 
34.4

Net gain on consolidated obligations held at fair value
 
—

 
—

 
—

 
5.7

 
—

 
—

 
5.7

Net accretion3
 
—

 
—

 
—

 
10.4

 
—

 
—

 
10.4

Total net effect of hedging activities
 
$
(487.9
)
 
$
(41.6
)
 
$
(3.6
)
 
$
410.8

 
$
—

 
$
(12.6
)
 
$
(134.9
)

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

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

3
Represents the amortization/accretion of basis adjustments on closed bond hedge relationships included in other (loss) income as a result of debt extinguishments.


33

NET AMORTIZATION/ACCRETION

Amortization/accretion varies from period to period depending on our hedge relationship termination activities. The change in advance amortization over the past three years has been due primarily to advance prepayments. When an advance prepays, we terminate the hedge relationship and fully amortize the remaining basis adjustment through earnings. During 2012, we fully amortized basis adjustments on prepaid advances of $347.5 million compared to $8.9 million in 2011 and $67.6 million in 2010. This amortization was offset by the receipt of gross advance prepayment fee income of $374.7 million, $19.1 million, and $241.4 million during 2012, 2011, and 2010. The net effect of hedging activity tables do not include the impact of gross advance prepayment fee income.

NET INTEREST SETTLEMENTS

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

GAINS (LOSSES) ON FAIR VALUE HEDGES

Gains (losses) on fair value hedges are driven by hedge ineffectiveness. Hedge ineffectiveness occurs when changes in the fair value of the derivative and the related hedged item do not perfectly offset each other. The primary drivers of hedge ineffectiveness are changes in the benchmark interest rate and volatility. During 2012, 2011, and 2010, gains (losses) on fair value hedges remained fairly stable and were the result of normal market activity.
 
GAINS (LOSSES) ON ECONOMIC HEDGES

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

Investments

We utilize interest rate swaps and in certain instances, TBAs, to economically hedge a portion of our trading securities against changes in fair value. Gains and losses on these economic derivatives are due primarily to changes in interest rates. The following table summarizes losses on these economic derivatives as well as gains on the related trading securities (dollars in millions):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Losses on interest rate swaps
$
(6.4
)
 
$
(44.9
)
 
$
(47.0
)
Losses on forward settlement agreement (TBA)
(2.5
)
 
—

 
—

Interest settlements
(14.5
)
 
(15.0
)
 
(23.5
)
Net losses on investment derivatives
(23.4
)
 
(59.9
)
 
(70.5
)
Net gains on related trading securities
23.6

 
40.2

 
34.4

Net losses on investment hedge relationships
$
0.2

 
$
(19.7
)
 
$
(36.1
)


34

Balance Sheet

We utilize interest rate caps and floors to economically hedge our mortgage assets against increases or decreases in interest rates. Gains and losses on these economic derivatives are due to changes in interest rates and volatility. The following table summarizes losses on these economic derivatives (dollars in millions):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Losses on interest rate caps
$
(13.1
)
 
$
(65.7
)
 
$
(6.6
)
Losses on interest rate floors
—

 
(1.4
)
 
(6.5
)
Interest settlements on interest rate floors
—

 
—

 
0.5

Net losses on balance sheet derivatives
$
(13.1
)
 
$
(67.1
)
 
$
(12.6
)

At December 31, 2012, 2011, and 2010, the fair value of interest rate caps outstanding in our Statements of Condition was $2.9 million, $15.9 million, and $96.4 million. The losses recorded on interest rate caps during 2012, 2011, and 2010 were primarily due to changes in fair value resulting from changes in interest rates and volatility. We paid $75.3 million in premiums to acquire the interest rate caps outstanding at December 31, 2012. This premium cost is effectively amortized over the life of the derivative contracts through the monthly fair value adjustments. We sold all of our interest rate floors during the first quarter of 2011 and have not held any interest rate floors since that time.

Consolidated Obligations

We utilize interest rate swaps primarily to economically hedge our consolidated obligations for which we elected the fair value option against changes in fair value. Gains and losses on these economic derivatives are due primarily to changes in interest rates. In addition, derivatives being used to hedge consolidated obligations in a fair value hedge relationship that fail retrospective hedge effectiveness testing are required to be accounted for as economic derivatives. The following table summarizes gains and losses on these economic derivatives as well as gains and losses on the related consolidated obligations elected under the fair value option (dollars in millions):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Gains (losses) on interest rate swaps
$
8.7

 
$
(8.1
)
 
$
(3.8
)
Losses on interest rate swaps in ineffective fair value hedge relationships
(0.7
)
 
(2.3
)
 
(0.7
)
Interest settlements
3.8

 
16.8

 
32.0

Net gains on consolidated obligation derivatives
11.8

 
6.4

 
27.5

Net gains (losses) on related consolidated obligations elected under the fair value option
4.2

 
(6.5
)
 
5.7

Net gains (losses) on consolidated obligation hedge relationships
$
16.0

 
$
(0.1
)
 
$
33.2


Other Expense
The following table shows the components of other expense (dollars in millions):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Compensation and benefits
$
32.0

 
$
31.4

 
$
38.1

Other operating expenses
20.2

 
17.7

 
16.9

Total operating expenses
52.2

 
49.1

 
55.0

Finance Agency
4.5

 
5.0

 
3.0

Office of Finance
2.8

 
2.8

 
2.2

Total other expense
$
59.5

 
$
56.9

 
$
60.2



35

Other expense increased $2.6 million during 2012 when compared to 2011 and decreased $3.3 million during 2011 when compared to 2010. The increase during 2012 was primarily due to higher professional fees related to our core banking system replacement project and an increase in contractual services due to various vendor price increases for services, financial information subscriptions, and software license maintenance fees. The decrease during 2011 was primarily due to lower funding and administrative costs on our Pentegra Defined Benefit Plan for Financial Institutions (DB Plan). During 2011, we made contributions to the DB Plan of $3.9 million compared to $11.6 million in 2010. Our contributions in 2010 included a discretionary contribution of $8.4 million.

Assessments

The FHLBanks fully satisfied their REFCORP obligation during the third quarter of 2011. As a result, our assessment expense for 2012 only related to the AHP assessment, while the expense for 2011 and 2010 included both AHP and REFCORP. Total assessment expense during 2012 was $12.4 million compared to $19.8 million and $48.1 million in 2011 and 2010.

STATEMENTS OF CONDITION

Financial Highlights

Our total assets decreased to $47.4 billion at December 31, 2012 from $48.7 billion at December 31, 2011. Our total liabilities decreased to $44.6 billion at December 31, 2012 from $45.9 billion at December 31, 2011. Total capital was $2.8 billion at December 31, 2012 and 2011. See further discussion of changes in our financial condition in the appropriate sections that follow.

Advances

The following table summarizes our advances by type of institution (dollars in millions):
 
December 31,
 
2012
 
2011
Commercial banks
$
8,983

 
$
11,215

Thrifts
1,011

 
963

Credit unions
663

 
746

Insurance companies
15,243

 
12,586

Total member advances
25,900

 
25,510

Housing associates
23

 
17

Non-member borrowers
132

 
136

Total par value
$
26,055

 
$
25,663


Our advances remained relatively stable at December 31, 2012 when compared to December 31, 2011. Advance demand remained weak throughout 2012 as a result of high deposit levels and low loan demand at depository member institutions.

The following table summarizes our advances by product type (dollars in millions):
 
 
December 31,
 
 
2012
 
2011
 
 
Amount
 
% of Total
 
Amount
 
% of Total
Variable rate
 
$
8,800

 
33.8
 
$
7,704

 
30.0
Fixed rate
 
16,820

 
64.5
 
17,547

 
68.4
Amortizing
 
435

 
1.7
 
412

 
1.6
Total par value
 
26,055

 
100.0
 
25,663

 
100.0
Discounts
 
(3
)
 
 
 
—

 
 
Fair value hedging adjustments
 
562

 
 
 
928

 
 
Total advances
 
$
26,614

 
 
 
$
26,591

 
 
    

36

Fair value hedging adjustments decreased $365.8 million at December 31, 2012 when compared to December 31, 2011 due primarily to a decrease in cumulative fair value gains on advances in existing hedge relationships. During 2012, certain advances in hedging relationships prepaid. At the time of prepayment, these hedged advances were in a fair value gain position and therefore the termination of the advances caused a reduction in the cumulative fair value gains on advances in existing hedge relationships in our Statements of Condition at December 31, 2012.

The following table summarizes advances outstanding to our five largest member borrowers (dollars in millions):
 
 
December 31, 2012
 
 
Amount
 
% of Total
Transamerica Life Insurance Company1
 
$
2,875

 
11.0
HICA Education Loan Corporation

 
2,100

 
8.1
Aviva Life and Annuity Company
 
1,961

 
7.5
Principal Life Insurance Company
 
1,800

 
6.9
TCF National Bank
 
1,550

 
5.9
Total par value
 
$
10,286

 
39.4

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

The FHLBank Act requires that we obtain sufficient collateral on advances to protect against losses. We have never experienced a credit loss on an advance to a member or eligible housing associate. Bank management has policies and procedures in place to manage this credit risk. Accordingly, we have not recorded any allowance for credit losses on our advances. See additional discussion regarding our collateral requirements in “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Advances.”

Mortgage Loans

The following table summarizes information on our mortgage loans held for portfolio (dollars in millions):
 
December 31,
 
2012
 
2011
Fixed rate conventional loans
$
6,373

 
$
6,678

Fixed rate government-insured loans
513

 
426

Total unpaid principal balance
6,886

 
7,104

Premiums
86

 
71

Discounts
(21
)
 
(31
)
Basis adjustments from mortgage loan commitments
17

 
13

Total mortgage loans held for portfolio
6,968

 
7,157

Allowance for credit losses
(16
)
 
(19
)
Total mortgage loans held for portfolio, net
$
6,952

 
$
7,138


Our mortgage loans decreased three percent at December 31, 2012 when compared to December 31, 2011. The decrease was primarily due to principal paydowns exceeding mortgage loan purchases. Throughout 2012, our MPF purchase activity increased as mortgage rates remained low and borrowers had incentive to refinance existing loans or purchase homes. However, we were able to impact the level of member demand in the MPF program by adjusting the base price of our MPF loan products when necessary.

Over the years, our customer base for MPF loans has evolved from large-volume loan purchases from a small number of large PFIs, including Superior Guaranty Insurance Company (Superior), to purchasing the majority of our MPF loans from a diverse base of community financial institutions. At December 31, 2012 and 2011, mortgage loans outstanding from Superior amounted to $2.0 billion and $2.7 billion. We have not purchased any mortgage loans from Superior since 2004.

During 2012, we recorded no provision for credit losses on our mortgage loans. We believe the current allowance for credit losses of $15.8 million remained adequate to absorb estimated losses in our conventional mortgage loan portfolio at December 31, 2012. For additional discussion on our mortgage loan credit risk, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Mortgage Assets.”


37

Investments

The following table summarizes the carrying value of our investments (dollars in millions):
 
December 31,
 
2012
 
2011
 
Amount
 
% of Total
 
Amount
 
% of Total
Short-term investments
 
 
 
 
 
 
 
Interest-bearing deposits
$
1

 
—
 
$
1

 
—
Securities purchased under agreements to resell
3,425

 
25.5
 
600

 
4.1
Federal funds sold
960

 
7.1
 
2,115

 
14.5
Certificates of deposit
—

 
—
 
340

 
2.3
Total short-term investments
4,386

 
32.6
 
3,056

 
20.9
Long-term investments
 
 
 
 
 
 
 
Interest-bearing deposits
2

 
—
 
5

 
—
Mortgage-backed securities
 
 
 
 
 
 
 
GSE - residential
6,798

 
50.6
 
8,198

 
56.0
Other U.S. obligations - residential
8

 
0.1
 
11

 
0.1
Other U.S. obligations - commercial
3

 
—
 
3

 
—
Private-label - residential
41

 
0.3
 
49

 
0.3
Total mortgage-backed securities
6,850

 
51.0
 
8,261

 
56.4
Non-mortgage-backed securities
 
 
 
 
 
 
 
GSE obligations
929

 
6.9
 
930

 
6.4
Other U.S. obligations
473

 
3.6
 
181

 
1.2
State or local housing agency obligations
96

 
0.7
 
102

 
0.7
Temporary Liquidity Guarantee Program debentures
—

 
—
 
1,572

 
10.7
Other
697

 
5.2
 
530

 
3.7
Total non-mortgage-backed securities
2,195

 
16.4
 
3,315

 
22.7
Total long-term investments
9,047

 
67.4
 
11,581

 
79.1
Total investments
$
13,433

 
100.0
 
$
14,637

 
100.0

Our investments decreased eight percent at December 31, 2012 when compared to December 31, 2011. The decrease was primarily due to the maturity of TLGP investments and principal paydowns on our MBS. Beginning in the second quarter of 2012, as a result of heightened counterparty credit concerns, we also limited our unsecured credit risk exposure to overnight investments, which caused a decline in our Federal funds sold balance at December 31, 2012. To manage our liquidity, this decline in Federal funds sold was fully offset by an increase in secured resale agreements.

The Finance Agency limits our investments in MBS by requiring that the total carrying value of our MBS not exceed three times regulatory capital at the time of purchase. Since March of 2010, our MBS exceeded three times regulatory capital and, as such, we were precluded from purchasing any additional MBS. However, in the second quarter of 2012, our ratio of MBS to regulatory capital fell below the three times regulatory capital threshold and we began purchasing additional MBS. At December 31, 2012 and 2011, our ratio of MBS to regulatory capital was 250 percent and 304 percent. At December 31, 2012, we had MBS investment purchases with a total par value of $141.3 million that had traded but not yet settled. These investments have been recorded in "trading securities" in our Statement of Condition with a corresponding payable recorded in "other liabilities".

We evaluate AFS and HTM securities in an unrealized loss position for other-than-temporary impairment (OTTI) on at least a quarterly basis. As part of our OTTI evaluation, we consider our intent to sell each debt security and whether it is more likely than not that we will be required to sell the security before its anticipated recovery. If either of these conditions is met, we will recognize an OTTI charge to earnings equal to the entire difference between the security's amortized cost basis and its fair value at the reporting date. For securities in an unrealized loss position that meet neither of these conditions, we perform an analysis to determine if any of these securities are other-than-temporarily impaired. Refer to “Item 8. Financial Statements and Supplementary Data — Note 7 — Other-Than-Temporary Impairment” for a discussion of our OTTI analysis performed at December 31, 2012. As a result of our analysis, we determined that all gross unrealized losses on our investment portfolio are temporary. We do not intend to sell these securities, and it is not more likely than not that we will be required to sell these securities before recovery of their amortized cost bases. As a result, we did not consider any of these securities to be other-than-temporarily impaired at December 31, 2012.

38

Consolidated Obligations

Consolidated obligations, which include bonds and discount notes, are the primary source of funds to support our advances, investments, and mortgage loans. At December 31, 2012 and 2011, the carrying value of consolidated obligations for which we are primarily liable totaled $43.0 billion and $44.8 billion.

BONDS

The following table summarizes information on our bonds (dollars in millions):
 
December 31,
 
2012
 
2011
Total par value
$
34,155

 
$
37,796

Premiums
25

 
32

Discounts
(19
)
 
(24
)
Fair value hedging adjustments
182

 
203

Fair value option adjustments
2

 
5

Total bonds
$
34,345

 
$
38,012


Our bonds decreased 10 percent at December 31, 2012 when compared to December 31, 2011. The decrease was primarily due to a reduction in funding needs resulting from a decline in average assets and a change in our funding strategy during the second half of 2012. Throughout the first half of 2012, we utilized callable, step-up, and short-term fixed rate bonds to capture attractive funding. During the second half of 2012, our long-term spreads became less favorable and, as a result, we began utilizing discount notes as well as floating rate LIBOR debt and swapped consolidated obligation bonds to manage our funding needs. We also called and extinguished certain higher-costing bonds in order to reduce future interest costs, which caused a further decline in our bond balances.

Fair Value Hedging Adjustments

Fair value hedging adjustments decreased $20.0 million at December 31, 2012 when compared to December 31, 2011 due primarily to a decrease in cumulative fair value losses on consolidated obligation bonds in existing hedge relationships, partially offset by an increase in basis adjustments from terminated or ineffective hedges. During 2012, we extinguished bonds in hedging relationships that were in a fair value loss position at the time of extinguishment. As such, the extinguishment of this debt caused a reduction in the cumulative fair value losses on hedges existing in our Statements of Condition at December 31, 2012. In addition, basis adjustments from terminated or ineffective hedges increased due primarily to us unwinding certain interest rate swaps. These unwind activities resulted in new basis adjustments that are amortized using the level-yield method over the remaining life of the bonds.

Fair Value Option Bonds

The Bank elected the fair value option for certain bonds that did not qualify for hedge accounting, primarily in an effort to mitigate the potential income statement volatility that can arise from economic hedging relationships in which the carrying value of the hedged item is not adjusted for changes in fair value. At December 31, 2012 and 2011, approximately $1.9 billion and $2.7 billion of our bonds were recorded under the fair value option. During 2012, we recorded fair value adjustment gains on these bonds of $2.8 million compared to losses of $5.1 million during 2011 and gains of $5.7 million during 2010. Refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations —Hedging Activities” for the impact of the related economic derivatives.

For additional information on our bonds, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Sources of Liquidity.”


39

DISCOUNT NOTES

The following table summarizes our discount notes, all of which are due within one year (dollars in millions):
 
December 31,
 
2012
 
2011
Par value
$
8,677

 
$
6,812

Discounts
(2
)
 
(4
)
Fair value option adjustments
—

 
2

Total
$
8,675

 
$
6,810

    
Our discount notes increased 27 percent at December 31, 2012 when compared to December 31, 2011. The increase was primarily due to us utilizing discount notes in place of certain callable, step-up, and short-term fixed rate bonds to manage our funding needs throughout the second half of 2012 as spreads and investor demand for structured debt declined relative to discount notes.

Fair Value Option Discount Notes

The Bank elected the fair value option for certain discount notes that did not qualify for hedge accounting, primarily in an effort to mitigate the potential income statement volatility that can arise from economic hedging relationships in which the carrying value of the hedged item is not adjusted for changes in fair value. At December 31, 2012, all of our fair value option discount notes had matured. At December 31, 2011, $3.5 billion of our discount notes were recorded under the fair value option. During 2012, we recorded fair value adjustment gains of $1.4 million on these discount notes compared to losses of $1.4 million during 2011. Refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Hedging Activities” for the impact of the related economic derivatives.

For additional information on our discount notes, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Sources of Liquidity.”

Deposits

Deposit levels will vary based on member alternatives for short-term investments. Our deposits increased 45 percent at December 31, 2012 when compared to December 31, 2011 due primarily to an increase in term deposits. The following table summarizes our term deposits with a denomination of $100,000 or more by remaining maturity (dollars in millions):
 
December 31,
 
2012
 
2011
Three months or less
$
218

 
$
35

Over three months but within six months
7

 
1

Over six months but within 12 months
2

 
7

Total
$
227

 
$
43


Capital

Our capital (including capital stock, retained earnings, and accumulated other comprehensive income) was $2.8 billion at December 31, 2012 and 2011. Although capital levels remained stable between periods, the composition of capital changed. Capital stock decreased two percent due primarily to the repurchase of excess activity-based capital stock. Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital — Capital Stock" for additional information on our excess capital stock activity. Retained earnings increased nine percent due to net income earned during 2012, partially offset by the payment of dividends. Accumulated other comprehensive income increased 11 percent due primarily to an increase in unrealized gains on AFS securities resulting from a decrease in interest rates.

As discussed in "Item 1. Business — Capital and Dividends — Retained Earnings," we entered into a JCE Agreement in 2011 that requires us to allocate 20 percent of our quarterly net income to a RREA.


40

Derivatives

We use derivatives to manage interest rate risk, including mortgage prepayment risk, in our Statements of Condition. The notional amount of derivatives serves as a factor in determining periodic interest payments or cash flows received and paid. However, the notional amount of derivatives represents neither the actual amounts exchanged nor our overall exposure to credit and market risk. The following table categorizes the notional amount of our derivatives (dollars in millions):
 
December 31,
 
2012
 
2011
Interest rate swaps
 
 
 
Noncallable
$
23,765

 
$
27,522

Callable by counterparty
4,218

 
9,874

Callable by the Bank
35

 
35

Total interest rate swaps
28,018

 
37,431

Interest rate caps
3,450

 
3,450

Forward settlement agreements (TBAs)
93

 
91

Mortgage delivery commitments
96

 
90

Total notional amount
$
31,657

 
$
41,062

    
The notional amount of our derivative contracts decreased 23 percent at December 31, 2012 when compared to December 31, 2011. The decrease was primarily due to us shifting our funding strategy during the second half of 2012 out of LIBOR structured debt, including callable, step-up, and short-term fixed rate bonds, and into discount notes and LIBOR floating rate debt, both of which are generally not swapped.

LIQUIDITY AND CAPITAL RESOURCES

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

Liquidity

SOURCES OF LIQUIDITY

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

Our primary source of liquidity is proceeds from the issuance of consolidated obligations (bonds and discount notes) in the capital markets. Although we are primarily liable for the portion of consolidated obligations that are issued on our behalf, we are also jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all consolidated obligations issued by the FHLBank System. At December 31, 2012 and 2011, the total par value of outstanding consolidated obligations for which we are primarily liable was $42.8 billion and $44.6 billion. At December 31, 2012 and 2011, the total par value of outstanding consolidated obligations issued on behalf of other FHLBanks for which we are jointly and severally liable was approximately $645.1 billion and $647.3 billion.

During 2012, proceeds from the issuance of bonds and discount notes were $24.1 billion and $324.7 billion compared to $35.6 billion and $325.1 billion in 2011. Our debt issuances were lower in 2012 than in 2011 primarily due to a reduction in funding needs resulting from a decline in average assets. Throughout the first half of 2012, we utilized callable, step-up, and short-term fixed rate bonds to capture attractive funding. However, during the second half of 2012, our long-term spreads became less favorable and, as a result, we began issuing discount notes to meet our liquidity needs. During the fourth quarter of 2012, we also expanded our utilization of floating rate LIBOR debt and swapped consolidated obligation bonds.


41

Our ability to raise funds in the capital markets as well as our cost of borrowing may be affected by our credit ratings. In 2011, S&P downgraded the long-term sovereign rating of the U.S. Government from AAA to AA+ with a negative outlook and affirmed the A-1+ short-term rating. It also lowered its long-term credit rating on 10 of the 12 FHLBanks and the consolidated obligations issued by the FHLBank System from AAA to AA+ with a negative outlook. The ratings of the FHLBanks of Chicago and Seattle were not affected by this action (both had previously been rated AA+), although the outlook on their rating was revised to negative. These rating actions did not have a material adverse impact on our financial condition, results of operations, or business model. As of February 28, 2013, the Bank, as well as the consolidated obligations of the FHLBank System, were rated AA+/A-1+ by S&P and Aaa/P-1 by Moody's. For further discussion of how ratings agency actions may impact us in the future, refer to “Item 1A. Risk Factors”.

The Office of Finance and FHLBanks have contingency plans in place that prioritize the allocation of proceeds from the issuance of consolidated obligations during periods of financial distress when consolidated obligations cannot be issued in sufficient amounts to satisfy all FHLBank demand. In the event of significant market disruptions or local disasters, our President or his designee is authorized to establish interim borrowing relationships with other FHLBanks. To provide further access to funding, the FHLBank Act also authorizes the U.S. Treasury to directly purchase new issue consolidated obligations of the GSEs, including FHLBanks, up to an aggregate principal amount of $4.0 billion. As of February 28, 2013, no purchases had been made by the U.S. Treasury under this authorization.

USES OF LIQUIDITY

We use our available liquidity, including proceeds from the issuance of consolidated obligations, primarily to repay consolidated obligations, fund advances, and purchase investments. During 2012, payments on consolidated obligations totaled $350.6 billion compared to $366.8 billion in 2011. A portion of these payments were due to us calling and extinguishing certain higher-costing par value bonds in an effort to reduce future interest costs. During 2012 and 2011, we called bonds with a total par value of $13.7 billion and $28.9 billion and extinguished bonds with a total par value of $556.1 million and $33.0 million.

Advance disbursements totaled $48.4 billion during 2012 compared to $38.0 billion in 2011. Although advance disbursement levels increased between periods, our overall advance balance remained fairly stable as a result of increased maturities and prepayment activity.

Investment purchases (excluding overnight investments) totaled $51.2 billion during 2012 compared to $22.1 billion in 2011. The increase was primarily due to us purchasing secured resale agreements throughout the year in an effort to manage our liquidity while reducing counterparty credit risk.

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

LIQUIDITY REQUIREMENTS
Finance Agency regulations mandate three liquidity requirements. First, we are required to maintain contingent liquidity sufficient to meet our liquidity needs, which shall, at a minimum, cover five calendar days of inability to access the consolidated obligation debt markets. The following table shows our compliance with this requirement (dollars in billions):
 
December 31,
 
2012
 
2011
Unencumbered marketable assets maturing within one year
$
4.6

 
$
4.9

Advances maturing in seven days or less
0.8

 
0.7

Unencumbered assets available for repurchase agreement borrowings
7.9

 
8.7

Total contingent liquidity
13.3

 
14.3

Liquidity needs for five calendar days
3.3

 
1.1

Excess contingent liquidity
$
10.0

 
$
13.2



42

Second, we are required to have available at all times an amount greater than or equal to members' current deposits invested in advances with maturities not to exceed five years, deposits in banks or trust companies, and obligations of the U.S. Treasury. The following table shows our compliance with this requirement (dollars in billions):
 
December 31,
 
2012
 
2011
Advances with maturities not exceeding five years
$
19.5

 
$
17.8

Deposits in banks or trust companies
—

 
0.3

Total
19.5

 
18.1

Deposits1
1.1

 
0.8

Excess liquidity
$
18.4

 
$
17.3


1 
Amount does not reflect the effect of derivative master netting arrangements with counterparties. 

Third, we are required to maintain, in the aggregate, unpledged qualifying assets in an amount at least equal to the amount of our participation in total consolidated obligations outstanding. The following table shows our compliance with this requirement (dollars in billions):
 
December 31,
 
2012
 
2011
Qualifying assets free of lien or pledge
$
47.3

 
$
48.7

Consolidated obligations outstanding
43.0

 
44.8

Excess liquidity
$
4.3

 
$
3.9


At December 31, 2012 and 2011 and throughout 2012 and 2011, we were in compliance with all three of the Finance Agency liquidity requirements.

In addition to the liquidity measures previously discussed, the Finance Agency has provided us with guidance to maintain sufficient liquidity in an amount at least equal to our anticipated cash outflows under two different scenarios. One scenario (roll-off scenario) assumes that we cannot access the capital markets to issue debt for a period of 10 to 20 days with initial guidance set at 15 days and that during that time members do not renew any maturing, prepaid, and called advances. The second scenario (renew scenario) assumes that we cannot access the capital markets to issue debt for a period of three to seven days with initial guidance set at five days and that during that time we will automatically renew maturing and called advances for all members except very large, highly-rated members. This guidance is designed to protect against temporary disruptions in the debt markets that could lead to a reduction in market liquidity and thus the inability for us to provide advances to our members. At December 31, 2012 and 2011 and throughout 2012 and 2011, we were in compliance with this liquidity guidance.

Capital
CAPITAL REQUIREMENTS

We are subject to three regulatory capital requirements. First, the FHLBank Act requires that we maintain at all times permanent capital greater than or equal to the sum of our credit, market, and operations risk capital requirements, all calculated in accordance with Finance Agency regulations. Only permanent capital, defined as Class B capital stock and retained earnings, can satisfy this risk-based capital requirement. Second, the FHLBank Act requires a minimum four percent capital-to-asset ratio, which is defined as total capital divided by total assets. Third, the FHLBank Act imposes a five percent minimum leverage ratio, which is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 times, divided by total assets. For purposes of compliance with the regulatory minimum capital-to-asset and leverage ratios, capital includes all capital stock, mandatorily redeemable capital stock, and retained earnings. At December 31, 2012 and 2011 and throughout 2012 and 2011, we were in compliance with all three of the Finance Agency's regulatory capital requirements. Refer to "Item 8. Financial Statements and Supplementary Data — Note 16 — Capital" for additional information.

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CAPITAL STOCK
Our capital stock has a par value of $100 per share, and all shares are issued, redeemed, and repurchased only at the stated par value. We have two subclasses of capital stock: membership and activity-based. Each member must purchase and hold membership capital stock in an amount equal to 0.12 percent of its total assets as of the preceding December 31st, subject to a cap of $10.0 million and a floor of $10,000. Each member is also required to purchase activity-based capital stock equal to 4.45 percent of its advances and mortgage loans outstanding in our Statements of Condition.
The capital stock requirements established in our Capital Plan are designed so that we remain adequately capitalized as member activity changes. To ensure we remain adequately capitalized, our Board of Directors may make adjustments to the capital stock requirements within ranges established in our Capital Plan. All capital stock issued is subject to a five year notice of redemption period.
Capital stock owned by members in excess of their investment requirement is deemed excess capital stock. Under our Capital Plan, we, at our discretion and upon 15 days' written notice, may repurchase excess membership capital stock. We, at our discretion, may also repurchase excess activity-based capital stock to the extent that (i) the excess capital stock balance exceeds an operational threshold set forth in the Capital Plan or (ii) a member submits a notice to redeem all or a portion of the excess activity-based capital stock. On January 4, 2012, we reduced our operational threshold for repurchasing excess activity-based capital stock from $50,000 to zero. In addition, effective April 27, 2012, we began repurchasing all excess activity-based capital stock on a daily basis. As a result, we had no excess capital stock at December 31, 2012. At December 31, 2011, our excess capital stock (including excess mandatorily redeemable capital stock) totaled $80.7 million.
Because membership is voluntary, a member can provide a notice of withdrawal from membership at any time. If a member provides a notice of withdrawal from membership, we will not repurchase or redeem any membership stock until five years from the date of receipt of a notice of withdrawal. If a member that withdraws from membership owns any activity-based capital stock, we will redeem the required activity-based capital stock consistent with the level of activity outstanding.
A member may cancel any pending notice of redemption before the completion of the five-year redemption period by providing a written notice of cancellation. We charge a cancellation fee, which is currently set at a range of one to five percent of the par value of the shares of capital stock subject to redemption. Our Board of Directors retains the right to change the cancellation fee at any time. We will provide at least 15 days' written notice to each member of any adjustment or amendment to our cancellation fee.
We cannot repurchase or redeem any membership or activity-based capital stock if the repurchase or redemption would cause a member to be out of compliance with its required investment. In addition, there are statutory and regulatory restrictions on our obligation or right to redeem outstanding capital stock.
First, in no case may we redeem any capital stock if, following such redemption, we would fail to satisfy our minimum regulatory capital requirements. By law, all member holdings of our capital stock immediately become nonredeemable if we become undercapitalized.
Second, in no case may we redeem any capital stock without the prior approval of the Finance Agency if either our Board of Directors or the Finance Agency determines that we incurred or are likely to incur losses resulting in or likely to result in a charge against capital.
Third, we cannot redeem shares of capital stock from any member if the principal or interest on any consolidated obligation of the FHLBank System is not paid in full when due, or under certain circumstances if (i) we project, at any time, that we will fail to comply with statutory or regulatory liquidity requirements, or will be unable to timely and fully meet all of our current obligations, (ii) we actually fail to comply with statutory or regulatory liquidity requirements or to timely and fully meet all of our current obligations, or enter or negotiate to enter into an agreement with one or more other FHLBanks to obtain financial assistance to meet our current obligations, or (iii) the Finance Agency determines that we will cease to be in compliance with statutory or regulatory liquidity requirements, or will lack the capacity to timely or fully meet all of our current obligations.
If we are liquidated, after payment in full to our creditors, our stockholders will be entitled to receive the par value of their capital stock as well as any retained earnings, in an amount proportional to the stockholder's share of the total shares of capital stock. In the event of a merger or consolidation, our Board of Directors shall determine the rights and preferences of our stockholders, subject to applicable Finance Agency regulations, as well as any terms and conditions imposed by the Finance Agency.

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The following table summarizes our regulatory capital (dollars in millions):
 
December 31,
 
2012
 
2011
Commercial banks
$
891

 
$
1,018

Thrifts
97

 
109

Credit unions
109

 
112

Insurance companies
966

 
870

Total GAAP capital stock
2,063

 
2,109

Mandatorily redeemable capital stock
9

 
6

Total regulatory capital stock1
2,072

 
2,115

Retained earnings
622

 
569

Total regulatory capital
$
2,694

 
$
2,684


1
Approximately 71 and 73 percent of our total regulatory capital stock outstanding at December 31, 2012 and 2011 was activity-based capital stock that fluctuates with the outstanding balances of advances made to members and mortgage loans purchased from members.

Mandatorily Redeemable Capital Stock
We reclassify capital stock subject to redemption from equity to a liability (mandatorily redeemable capital stock) at the time shares meet the definition of a mandatorily redeemable financial instrument. This occurs after a member provides written notice of redemption, gives notice of intention to withdraw from membership, or attains non-member status by merger or acquisition, charter termination, or other involuntary termination from membership.
Shares meeting this definition are reclassified to a liability at fair value. The fair value of mandatorily redeemable capital stock is generally par value as all shares are issued, redeemed, or repurchased by us at the stated par value. Fair value also includes an estimated dividend earned at the time of reclassification from equity to a liability (if applicable), until such amount is paid. Dividends on mandatorily redeemable capital stock are classified as interest expense in the Statements of Income.
If a member cancels its written notice of redemption or notice of withdrawal, we will reclassify mandatorily redeemable capital stock from a liability to equity. After the reclassification, dividends on the capital stock will no longer be classified as interest expense.
For GAAP purposes, mandatorily redeemable capital stock is not included as a component of capital. For determining compliance with our regulatory capital requirements, the Finance Agency requires that such outstanding capital stock be considered capital. At December 31, 2012 and 2011, we had $9.6 million and $6.2 million of mandatorily redeemable capital stock. For additional information on our mandatorily redeemable capital stock, refer to "Item 8. Financial Statements and Supplementary Data — Note 16 — Capital."
RETAINED EARNINGS
Our ERMP requires a minimum retained earnings level based on the level of market risk, credit risk, and operational risk within the Bank. If realized financial performance results in actual retained earnings below the minimum level, we, as determined by our Board of Directors, will establish an action plan to enable us to return to our targeted level of retained earnings within twelve months. At December 31, 2012, our actual retained earnings were above the minimum level, and therefore no action plan was necessary.
In 2011, to enhance our capital position, we entered into a JCE Agreement with the other 11 FHLBanks. The JCE Agreement requires each FHLBank to allocate that portion of its earnings historically paid to satisfy the REFCORP obligation to a separate RREA until the balance of that account equals at least one percent of its average balance of outstanding consolidated obligations for the previous quarter. At December 31, 2012 and 2011, we maintained a RREA balance of $28.8 million and $6.5 million. For more information relating to the JCE Agreement, see "Item 1. Business — Capital and Dividends — Retained Earnings."

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DIVIDENDS
Our Board of Directors may declare and pay different dividends for each subclass of capital stock. Dividend payments may be made in the form of cash and/or additional shares of capital stock. Historically, we have only paid cash dividends. By regulation, we may pay dividends from current earnings or retained earnings, but we may not declare a dividend based on projected or anticipated earnings. We are prohibited from paying a dividend in the form of additional shares of capital stock if, after the issuance, the outstanding excess capital stock would be greater than one percent of our total assets. In addition, we may not declare or pay a dividend if the par value of our capital stock is impaired or is projected to become impaired after paying such dividend. Our Board of Directors may not declare or pay dividends if it would result in our non-compliance with regulatory capital requirements.
Prior to 2012, we paid the same dividend for both membership and activity-based capital stock. Beginning with the dividend for the first quarter of 2012, declared and paid in the second quarter of 2012, we differentiated dividend payments between membership and activity-based capital stock. Our Board of Directors believes any excess returns on capital stock above an appropriate benchmark rate that are not retained for capital growth should be returned to members that utilize our product and service offerings. Our current philosophy is to pay a membership capital stock dividend similar to a benchmark rate of interest, such as average-three month LIBOR, and an activity-based capital stock dividend, when possible, at least 50 basis points in excess of the membership capital stock dividend. Our actual dividend payout continues to be determined quarterly by our Board of Directors, based on policies, regulatory requirements, financial projections, and actual performance.
During 2012, 2011, and 2010, we paid aggregate cash dividends of $58.5 million, $64.9 million, and $61.1 million. The effective combined annualized dividend rate paid on both subclasses of capital stock during 2012, 2011, and 2010 was 2.82 percent, 3.00 percent, and 2.50 percent. The annualized dividend rates paid on membership and activity-based capital stock during 2012 were 1.12 percent and 3.50 percent. Average three-month LIBOR was 0.43 percent, 0.33 percent, and 0.34 percent for 2012, 2011, and 2010.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of our financial statements in accordance with GAAP requires management to make a number of judgments and assumptions that affect our reported results and disclosures. Several of our accounting policies are inherently subject to valuation assumptions and other subjective assessments and are more critical than others to our financial results. Given the assumptions and judgment used, we have identified the following accounting policies as critical to understanding our financial condition and results of operations:

•
fair value measurements;

•
derivatives and hedging activities;

•
allowance for credit losses; and

•
other-than-temporary impairment.

We evaluate our critical accounting policies and estimates on an ongoing basis. While management believes our estimates and assumptions are reasonable based on historical experience and other factors, actual results could differ from those estimates and differences could be material to the financial statements.

Fair Value Measurements

We record trading securities, AFS securities, derivative assets and liabilities, certain other assets, and certain consolidated obligations for which the fair value option has been elected at fair value in the Statements of Condition on a recurring basis and on occasion, certain impaired MPF loans and REO on a non-recurring basis. Fair value is a market-based measurement and is defined as the price received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date under current market conditions. In general, the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition. In determining whether a transaction price represents the fair value of the asset or liability at initial recognition, we are required to consider factors specific to the asset or liability, the principal or most advantageous market for the asset or liability, and market participants with whom we would transact in that market.


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Fair values play an important role in our valuation of certain assets, liabilities, and hedging transactions. Fair value is first determined based on quoted market prices or market-based prices, where available. If quoted market prices or market-based prices are not available, fair values are determined based on external or internal pricing models that use discounted cash flows using market estimates of interest rates and volatility, dealer prices, or prices of similar instruments.
For external pricing models, we annually review the vendors' pricing processes, methodologies, and control procedures for reasonableness. For internal pricing models, the underlying assumptions are based on management's best estimates for discount rates, prepayments, market volatility, and other factors. The assumptions used in both external and internal pricing models could have a significant effect on the reported fair values of assets and liabilities, including the related income and expense. The use of different assumptions, as well as changes in market conditions, could result in materially different values.

We categorize our financial instruments carried at fair value into a three-level hierarchy. The hierarchy is based upon the transparency (observable or unobservable) of inputs used to value the asset or liability as of the measurement date. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. At December 31, 2012 and 2011, we did not carry any financial assets or liabilities, measured on a recurring basis, at fair value in our Statements of Condition based on unobservable inputs.

VALUATION OF DERIVATIVES

Prior to December 31, 2012, we utilized the LIBOR Swap curve and a volatility assumption to estimate the fair value of our interest-related derivatives. During the fourth quarter of 2012, we observed an increasing trend in the use of the overnight-index swap (OIS) curve by other market participants to value collateralized derivative contracts. We performed an assessment of market participants and determined the OIS curve was the appropriate curve to be used for valuation of our collateralized interest rate derivatives. As such, effective December 31, 2012, we utilized the OIS curve and a volatility assumption to estimate the fair value of our interest-related derivatives. This change in valuation was not material to the overall fair value measurement of interest-related derivatives. 

Refer to “Item 8. Financial Statements and Supplementary Data — Note 18 — Fair Value” for additional discussion on our fair value measurements.

Derivatives and Hedging Activities

All derivatives are recognized in the Statements of Condition at their fair values and reported as either “Derivative assets” or “Derivative liabilities,” net of cash collateral and accrued interest from counterparties.
Each derivative is designated as one of the following:
•
a fair value hedge of an associated financial instrument or firm commitment; or
•
an economic hedge to manage certain defined risks in our Statements of Condition.
FAIR VALUE HEDGES
If hedging relationships meet certain criteria, including, but not limited to, formal documentation of the hedging relationship and an expectation to be highly effective, they qualify for fair value hedge accounting and the offsetting changes in fair value of the hedged items are recorded in earnings. Two approaches to fair value hedge accounting include:
•
Long-haul hedge accounting. The application of long-haul hedge accounting requires us to formally assess (both at the hedge's inception and at least quarterly) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value of hedged items due to benchmark interest rate changes and whether those derivatives are expected to remain effective in future periods.
•
Short-cut hedge accounting. Transactions that meet certain criteria qualify for short-cut hedge accounting in which an assumption can be made that the change in fair value of a hedged item due to changes in the benchmark interest rate exactly offsets the change in fair value of the related derivative. Under the short-cut method, the entire change in fair value of the interest rate swap is considered to be effective at achieving offsetting changes in fair value of the hedged asset or liability.


47

Derivatives are typically executed at the same time as the hedged item, and we designate the hedged item in a fair value hedge relationship at the trade date. In many hedging relationships, we may designate the hedging relationship upon our commitment to disburse an advance or trade a consolidated obligation in which settlement occurs within the shortest period of time possible for the type of instrument based on market settlement conventions. We then record the changes in fair value of the derivative and the hedged item beginning on the trade date.

Changes in the fair value of a derivative that is designated as a fair value hedge, along with changes in the fair value of the hedged item are recorded in other (loss) income as “Net loss on derivatives and hedging activities.” The amount by which the change in fair value of the derivative differs from the change in fair value of the hedged item is known as hedge ineffectiveness.

ECONOMIC HEDGES
An economic hedge is defined as a derivative hedging specific or non-specific underlying assets, liabilities, or firm commitments that does not qualify or was not designated for fair value hedge accounting, but is an acceptable hedging strategy under our risk management program. Changes in the fair value of a derivative that is designated as an economic hedge are recorded in other (loss) income as “Net loss on derivatives and hedging activities” with no offsetting fair value adjustments for the underlying assets, liabilities, or firm commitments, unless changes in the fair value of the asset or liability are normally marked to fair value through earnings (e.g., trading securities and fair value option instruments). As a result, economic hedges introduce the potential for earnings variability.
ACCRUED INTEREST RECEIVABLES AND PAYABLES
The net settlements of interest receivables and payables related to derivatives designated as fair value hedges are recognized as adjustments to the interest income or interest expense of the designated hedged item. The net settlements of interest receivables and payables related to derivatives designated as economic hedges are recognized in other (loss) income as “Net loss on derivatives and hedging activities.”
DISCONTINUANCE OF HEDGE ACCOUNTING
We discontinue fair value hedge accounting prospectively when either (i) we determine that the derivative is no longer effective in offsetting changes in the fair value of a hedged item due to changes in the benchmark interest rate, (ii) the derivative and/or the hedged item expires or is sold, terminated, or exercised, (iii) a hedged firm commitment no longer meets the definition of a firm commitment, or (iv) management determines that designating the derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued, we either terminate the derivative or continue to carry the derivative in the Statements of Condition at its fair value. For any remaining hedged item, we cease to adjust the hedged item for changes in fair value and amortize the cumulative basis adjustment on the hedged item into earnings over the remaining contractual life of the hedged item using a level-yield methodology.

When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, we continue to carry the derivative in the Statements of Condition at its fair value, removing from the Statements of Condition any hedged item that was recorded to recognize the firm commitment and recording it as a gain or loss in current period earnings.

EMBEDDED DERIVATIVES

We may issue debt, make advances, or purchase financial instruments in which a derivative instrument is “embedded.” Upon execution of these transactions, we assess whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the debt, advance, or purchased financial instrument (the host contract) and whether a separate, non-embedded instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. If we determine that the embedded derivative has economic characteristics that are not clearly and closely related to the economic characteristics of the host contract and a separate, stand-alone instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and designated as an economic derivative instrument. However, if we elect to carry the entire contract (the host contract and the embedded derivative) at fair value in the Statements of Condition, changes in fair value of the entire contract will be reported in current period earnings.


48

Allowance for Credit Losses

We have an allowance for credit losses methodology for each of our financing receivable portfolio segments: advances, letters of credit, and other extensions of credit to borrowers (collectively, credit products), government-insured mortgage loans held for portfolio, conventional mortgage loans held for portfolio, term securities purchased under agreements to resell, and term Federal funds sold. The following discussion highlights those methodologies that we consider critical to our financial results. For a complete discussion of our allowance methodologies, refer to “Item 8. Financial Statements and Supplementary Data — Note 10 — Allowance for Credit Losses.”

CREDIT PRODUCTS

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

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

Taking into consideration each borrower's financial strength, we consider the types and level of collateral to be the primary indicator of credit quality on our credit products. At December 31, 2012 and 2011, we had rights to collateral on a borrower-by-borrower basis with an unpaid principal balance or market value, if available, in excess of our outstanding extensions of credit.

Based upon our collateral and lending policies, the collateral held as security, and the repayment history on our credit products, management has determined that there are no probable credit losses on our credit products as of December 31, 2012 and 2011. Accordingly, we have not recorded any allowance for credit losses.

GOVERNMENT-INSURED MORTGAGE LOANS

We invest in government-insured fixed rate mortgage loans secured by one-to-four family residential properties. Government-insured mortgage loans are insured by the Federal Housing Administration, the Department of Veterans Affairs, and/or the Rural Housing Service of the Department of Agriculture. The servicer provides and maintains insurance or a guaranty from the applicable government agency. The servicer is responsible for compliance with all government agency requirements and for obtaining the benefit of the applicable insurance or guaranty with respect to defaulted government mortgage loans. Any principal losses incurred on such mortgage loans that are not recovered from the guarantor are absorbed by the servicers. As a result, we did not establish an allowance for credit losses for our government-insured mortgage loans at December 31, 2012 and 2011. Furthermore, none of these mortgage loans have been placed on non-accrual status because of the U.S. Government guarantee or insurance on these loans and the contractual obligation of the loan servicer to repurchase the loans when certain criteria are met.

CONVENTIONAL MORTGAGE LOANS

We have several layers of legal loss protection on our conventional mortgage loans that are defined in agreements among us and our participating PFIs. These loss layers may vary depending on the MPF product alternatives selected and consist of (i) homeowner equity, (ii) primary mortgage insurance (PMI), (iii) a first loss account, and (iv) a credit enhancement obligation of the PFI.
 

49

We utilize an allowance for credit losses to reserve for estimated losses in our conventional mortgage loan portfolio at the balance sheet date. At December 31, 2012 and 2011, our allowance for credit losses on conventional mortgage loans was $15.8 million and $19.0 million. The measurement of our allowance for credit losses is determined by (i) reviewing similar conventional mortgage loans for impairment on a collective basis, (ii) reviewing conventional mortgage loans for impairment on an individual basis, (iii) estimating additional credit losses in the conventional mortgage loan portfolio, and (iv) considering the recapture of performance-based credit enhancement fees from the PFI, if available.

Collectively Evaluated Conventional Mortgage Loans

We collectively evaluate the majority of our conventional mortgage loan portfolio for impairment and estimate an allowance for credit losses based upon factors that vary by MPF product. These factors include, but are not limited to, (i) loan delinquencies, (ii) loans migrating to REO, (iii) actual historical loss severities, and (iv) certain quantifiable economic factors, such as unemployment rates and home prices. We utilize a roll-rate methodology when estimating our allowance for credit losses. This methodology projects loans migrating to REO status based on historical average rates of delinquency. We then apply a loss severity factor to calculate an estimate of credit losses.

Individually Identified Conventional Mortgage Loans

We individually evaluate certain conventional mortgage loans for impairment, including troubled debt restructurings (TDRs) and collateral-dependent loans. TDRs occur when we grant a concession to a borrower that we would not otherwise consider for economic or legal reasons related to the borrower's financial difficulties. Our TDRs include loans granted under our temporary loan modification plan and loans discharged under Chapter 7 bankruptcy. We generally measure impairment of TDRs based on the present value of expected future cash flows discounted at the loan's effective interest rate. Collateral-dependent loans are loans in which repayment is expected to be provided solely by the sale of the underlying collateral. We consider TDRs where principal or interest is 60 days or more past due to be collateral-dependent. We measure impairment of collateral-dependent loans based on the estimated fair value of the underlying collateral less selling costs.

Estimating Additional Credit Loss in the Conventional Mortgage Loan Portfolio

We may make an adjustment for certain limitations in our estimation of credit losses. This adjustment recognizes the imprecise nature of an estimate and represents a subjective management judgment that is intended to cover losses resulting from other macroeconomic factors that may not be captured in the collective methodology previously described at the balance sheet date.

Performance-Based Credit Enhancement Fees

We reserve for estimated credit losses after taking into consideration performance-based credit enhancement fees available for recapture from the PFI. Performance-based credit enhancement fees available for recapture consist of accrued performance-based credit enhancement fees to be paid to the PFIs and projected performance-based credit enhancement fees to be paid to the PFIs over the next 12 months, less any losses incurred that are in the process of recapture.

Other-Than-Temporary Impairment

We evaluate our individual AFS and HTM securities in an unrealized loss position for OTTI on a quarterly basis. A security is considered impaired when its fair value is less than its amortized cost basis. We consider an OTTI to have occurred under any of the following circumstances:
•
we have an intent to sell the impaired debt security;
•
based on available evidence, we believe it is more likely than not that we will be required to sell the impaired debt security before the recovery of its amortized cost basis; or
•
we do not expect to recover the entire amortized cost basis of the impaired debt security.

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If either of the first two conditions is met, we recognize an OTTI charge in earnings equal to the entire difference between the security's amortized cost basis and its fair value as of the reporting date. If neither of the first two conditions is met, we perform an analysis to determine if we will recover the entire amortized cost basis of the debt security, which includes a cash flow analysis for private-label MBS. The present value of the cash flows expected to be collected is compared to the amortized cost basis of the debt security to determine whether a credit loss exists. If there is a credit loss (the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security), the carrying value of the debt security is adjusted to its fair value. However, rather than recognizing the entire difference between the amortized cost basis and fair value in earnings, only the amount of the impairment representing the credit loss (i.e., the credit component) is recognized in earnings, while the amount related to all other factors is recognized in accumulated other comprehensive income. The credit loss on a debt security is limited to the amount of that security's unrealized loss. The total OTTI is presented in the Statements of Income with an offset for the amount of the non-credit portion of OTTI that is recognized in accumulated other comprehensive income, if applicable. To date, we have never experienced an OTTI loss.

LEGISLATIVE AND REGULATORY DEVELOPMENTS
 
The legislative and regulatory environment in which we operate continues to undergo rapid change driven principally by reforms under the Housing Act and the Dodd-Frank Act. We expect the Housing Act and the Dodd-Frank Act as well as plans for housing finance and GSE reform to result in still further changes to this environment. Business operations, funding costs, rights, obligations, and/or the environment in which we carry out our housing finance mission are likely to continue to be significantly impacted by these changes. Significant regulatory actions and developments for the period covered by this report are summarized below.

Developments Under the Dodd-Frank Act Impacting Derivative Transactions

The Dodd-Frank Act provides for new statutory and regulatory requirements for derivative transactions, including those utilized by us to hedge our interest rate and other risks. As a result of these requirements, beginning on June 10, 2013, certain derivative transactions will be required to be cleared through a third-party central clearinghouse and traded on regulated exchanges or new swap execution facilities. Derivative transactions that are not required to be cleared will be subject to mandatory reporting, documentation, minimum margin and capital, and other requirements.

MANDATORY CLEARING
The Commodity Futures Trading Commission (CFTC) issued its first set of mandatory clearing determinations on November 29, 2012 (first mandatory clearing determination), which will subject four classes of interest rate swaps and two classes of credit default swaps to mandatory clearing beginning in the first quarter of 2013.
Certain interest rate swaps in which we transact fall within the scope of the first mandatory clearing determination and, as such, we will be required to clear those swaps. Implementation of the first mandatory clearing determination will be phased in; we are classified as a "category 2 entity" and therefore have to comply with the mandatory clearing requirement for the specified interest rate swaps that we execute on or after June 10, 2013. The CFTC is expected to issue additional mandatory clearing determinations in the future with respect to other types of derivative transactions, which could include certain interest rate swaps entered into by us that are not within the scope of the first mandatory clearing determination.
The CFTC has approved an end-user exception to mandatory clearing that would exempt derivative transactions that we may intermediate for our members with $10 billion or less in assets; the exception applies only if the member uses the swaps to hedge or mitigate its commercial risk and the reporting counterparty for such swaps complies with certain additional reporting requirements. As a result, any such intermediated swaps may be subject to mandatory clearing or may be subject to applicable new requirements for derivative transactions that are not subject to mandatory clearing requirements (uncleared trades).
COLLATERAL REQUIREMENTS FOR CLEARED SWAPS
Cleared swaps will be subject to initial and variation margin requirements established by the clearinghouse and its clearing members. While clearing swaps may reduce counterparty credit risk, the margin requirements for cleared swaps have the potential of making derivative transactions more costly. In addition, mandatory clearing has required us to enter into new relationships and accompanying documentation with clearing members and additional documentation with our swap counterparties.

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The CFTC has issued a final rule requiring that collateral posted by swap customers to a clearinghouse in connection with cleared swaps be legally segregated on a customer-by-customer basis (the LSOC Model). Pursuant to the LSOC Model, although customer collateral must be segregated on an individual customer basis on the books of a futures commission merchant (FCM) and derivatives clearing organization, it may be commingled with the collateral of other customers of the same FCM in one physical account. The LSOC model affords greater protection to collateral posted for cleared swaps than is currently afforded to collateral posted for futures contracts. However, because of operational and investment risks inherent in the LSOC Model, and because of certain provisions applicable to FCM insolvencies under the U.S. Bankruptcy Code, the LSOC Model does not afford complete protection to cleared swaps customer collateral in the event of an FCM insolvency. Accordingly, a major consideration in our decision to establish and maintain a clearing relationship with an FCM is our assessment of the financial soundness of the FCM.
DEFINITION OF CERTAIN TERMS UNDER NEW DERIVATIVE REQUIREMENTS

The Dodd-Frank Act requires swap dealers and certain other large users of derivatives to register as “swap dealers” or “major swap participants,” as the case may be, with the CFTC and/or the SEC. Although we have a substantial portfolio of derivative transactions that are entered into for hedging purposes, and may engage in intermediated swaps with our members in the future, based on the definitions in the final rules jointly issued by the CFTC and the SEC in April 2012, we do not expect to be required to register as either a major swap participant or as a swap dealer.
Based on the final rules and accompanying interpretive guidance jointly issued by the CFTC and the SEC in July 2012 to further define the term “swap,” call and put optionality in certain advances to our members will not be treated as “swaps” so long as the optionality relates solely to the interest rate on the advance. Accordingly, we do not expect the new derivative regulations to affect our ability to offer these advances to members.
MARGIN FOR UNCLEARED DERIVATIVE TRANSACTIONS

The Dodd-Frank Act will also change the regulatory landscape for derivative transactions that are not subject to mandatory clearing requirements (uncleared trades). While we expect to continue to enter into uncleared trades on a bilateral basis, such trades will be subject to new regulatory requirements, including mandatory reporting, documentation, minimum margin and capital, and other requirements. The CFTC, the Finance Agency, and other federal bank regulators proposed margin requirements for uncleared trades in 2011. Under the proposed margin rules, we would have to post both initial margin and variation margin to our swap dealers and major swap participant counterparties, but may be eligible in both instances for modest unsecured thresholds as a “low-risk financial end user.” Pursuant to additional Finance Agency provisions, we would be required to collect both initial margin and variation margin from our swap dealer counterparties, without any unsecured thresholds. These margin requirements and any related capital requirements could adversely impact the liquidity and pricing of certain uncleared derivative transactions entered into by us, making such trades more costly. Final margin rules are not expected until the second quarter of 2013 at the earliest and, accordingly, it is not likely that we will have to comply with such requirements until the end of 2013.
DOCUMENTATION FOR UNCLEARED TRANSACTIONS

Certain of the CFTC's final rules, once effective, will require us to amend our existing bilateral swap documentation with swap dealers. To facilitate amendment of the agreements, the International Swap and Derivatives Association (ISDA) has initiated a protocol process, which allows multiple counterparty adherents to the same protocol to amend existing bilateral documentation with other adhering counterparties without having to negotiate changes to individual agreements. The first of these protocols is the August 2012 Protocol, which addressed documentation changes required by the CFTC's adoption in February 2012 of final external business conduct standards and other requirements imposed on swap dealers and major swap participants when dealing with counterparties. The external business conduct standards rules prohibit certain abusive practices and require disclosure of certain material information to counterparties. In addition, swap dealers and major swap participants must conduct due diligence relating to their dealings with counterparties. We adhered to the August 2012 Protocol in December 2012 and have effectively amended agreements with all of our swap dealer counterparties by completing the exchange of questionnaires with those required by the protocol.


52

In September 2012, the CFTC finalized rules regarding certain new documentation requirements for uncleared trades, including requirements for new dispute resolution and portfolio valuation and reconciliation provisions, new representations regarding applicable insolvency regimes, and possible changes to our existing credit support arrangements with our swap dealer counterparties. ISDA has published a second protocol in draft to address these new documentation requirements, and we are currently evaluating the protocol's provisions. Our swap documentation with swap dealers must comply with certain requirements contained in the September 2012 CFTC rules by July 1, 2013. The final rules also impose requirements with respect to when swap dealers and major swap participants must deliver acknowledgments of, and execute confirmations for, uncleared trades with us. These timing requirements will be phased in between December 31, 2012 and March 1, 2014.

Additional changes to our swap documentation are expected to be required by additional Dodd-Frank Act rules, including the margin requirements for uncleared swaps, that have not yet been finalized. We will consider adhering to future ISDA protocols to address the foregoing requirements.
RECORDKEEPING AND REPORTING

Compliance dates for the new recordkeeping and reporting requirements for all of our cleared and uncleared swaps have now been established. We currently comply with recordkeeping requirements for our swaps that were in effect on or after July 21, 2010 and, beginning on April 10, 2013, we will have to comply with new recordkeeping requirements for swaps entered into on or after April 10, 2013. For interest rate swaps that we enter into with swap dealers, the swap dealers are currently required to comply with reporting requirements applicable to such swaps, including real-time reporting requirements. We will be required to comply with reporting requirements, including real-time reporting requirements, for any swaps that we may intermediate for our members beginning on April 10, 2013.
We, together with the other FHLBanks, will continue to monitor the Dodd-Frank Act rulemakings and the overall regulatory process to implement the derivative reforms prescribed by that legislation. We will also continue to work with the other FHLBanks to implement the processes and documentation necessary to comply with the Dodd-Frank Act's new requirements for derivatives.
Developments Impacting Systemically Important Nonbank Financial Companies
FINAL RULE AND GUIDANCE ON THE SUPERVISION AND REGULATION OF CERTAIN NONBANK FINANCIAL COMPANIES

The Financial Stability Oversight Council (the Oversight Council) issued a final rule and guidance effective May 11, 2012 on the standards and procedures the Oversight Council employs in determining whether to designate a nonbank financial company for supervision by the Federal Reserve and to be subject to certain prudential standards. The guidance issued with this final rule provides that the Oversight Council expects to use a process in making its determinations consisting of:
•
a first stage that will identify those nonbank financial companies that have $50 billion or more of total consolidated assets (as of December 31, 2012, we had $47.4 billion in total assets) and exceed any one of five threshold indicators of interconnectedness or susceptibility to material financial distress, including whether a company has $20 billion or more in total debt outstanding. As of December 31, 2012, we had $43.0 billion in total outstanding consolidated obligations, our principal form of outstanding debt;
•
a second stage involving a robust analysis of the potential threat that the subject nonbank financial company could pose to U.S. financial stability based on additional quantitative and qualitative factors that are both industry and company specific; and
•
a third stage analyzing the subject nonbank financial company using information collected directly from it.
The final rule provides that, in making its determinations, the Oversight Council will consider as one factor whether the nonbank financial company is subject to oversight by a primary financial regulatory agency (for us, the Finance Agency). A nonbank financial company that the Oversight Council proposes to designate for additional supervision (for example, periodic stress testing) and prudential standards (such as heightened liquidity or capital requirements) under this rule has the opportunity to contest the designation. If we were designated by the Oversight Council for supervision by the Federal Reserve and subject to additional Federal Reserve prudential standards, our operations and business could be adversely impacted by any resulting additional costs, liquidity or capital requirements, and/or restrictions on business activities.

53

OVERSIGHT COUNCIL RECOMMENDATIONS REGARDING MONEY MARKET MUTUAL FUND (MMF) REFORM

The Oversight Council requested comments with a comment deadline of February 15, 2013 on certain proposed recommendations for structural reforms of MMFs. The Oversight Council has stated that such reforms are intended to address the structural vulnerabilities of MMFs. The demand for FHLBank System consolidated obligations may be impacted by the structural reform ultimately adopted. Accordingly, such reforms could cause our funding costs to rise or otherwise adversely impact market access and, in turn, adversely impact our results of operations.
Developments Under the Finance Agency

FINANCE AGENCY FINAL RULE ON PRUDENTIAL MANAGEMENT AND OPERATIONS STANDARDS

On June 8, 2012, the Finance Agency issued a final rule, as required by the Housing Act, regarding prudential standards for the operation and management of the FHLBanks, including among other things, internal controls and information systems, internal audit systems, market and interest rate risks, liquidity, asset growth, investments, credit and counterparty risk management, and records maintenance. The rule requires an FHLBank that fails to meet a standard to file a corrective action plan with the Finance Agency within 30 calendar days or such other time period established by the Finance Agency. If an acceptable corrective action plan is not submitted by the deadline or the terms of such a plan are not complied within material respects, the Director of the Finance Agency can impose sanctions, such as limits on asset growth, increases in the level of retained earnings, and prohibitions on dividends or the redemption or repurchase of capital stock. The final rule became effective August 7, 2012.

PROPOSED GUIDANCE ON COLLATERALIZATION OF ADVANCES AND OTHER CREDIT PRODUCTS PROVIDED TO INSURANCE COMPANY MEMBERS

On October 5, 2012, the Finance Agency published a notice requesting comments with a comment deadline of December 4, 2012 on a proposed Advisory Bulletin which sets forth standards to guide the Finance Agency in its supervision of secured lending to insurance company members by the FHLBanks. The Finance Agency's notice states that the proposed standards are intended to address the risks inherent in FHLBank lending to insurance company members, which arise from the different state's statutory and regulatory regimes and statutory accounting principles and reporting practices applicable to insurance companies. The proposed standards include consideration of, among other things:

•
the level of an FHLBank's exposure to insurance companies in relation to its capital structure and retained earnings;
•
an FHLBank's control of pledged securities collateral and ensuring it has a first-priority perfected security interest;
•
the use of funding agreements between an FHLBank and an insurance company member to document advances and whether such an FHLBank would be recognized as a secured creditor with a first-priority security interest in the collateral; and
•
an FHLBank's documented framework, procedures, methodologies and standards to evaluate an insurance company member's creditworthiness and financial condition, its valuation of the pledged collateral and whether it has a written plan for the liquidation of insurance company member collateral.
ADVANCE NOTICE OF PROPOSED RULEMAKING ON STRESS-TESTING REQUIREMENTS

On October 5, 2012, the Finance Agency issued a notice of proposed rulemaking with a comment deadline of December 4, 2012 that would implement a provision in the Dodd-Frank Act that requires all financial companies with assets over $10 billion to conduct annual stress tests, which will be used to evaluate an institution's capital adequacy under various economic conditions and financial conditions. The Finance Agency proposes to issue annual guidance to describe the baseline, adverse, and severely adverse scenarios and methodologies that the FHLBanks must follow in conducting their stress tests, which, as required by the Dodd-Frank Act, would be generally consistent and comparable to those established by the Federal Reserve. An FHLBank would be required to provide an annual report on the results of the stress tests to the Finance Agency and the Federal Reserve and to then publicly disclose a summary of such report within 90 days.


54

Other Significant Developments
CONSUMER FINANCIAL PROTECTION BUREAU (CFPB) FINAL QUALIFIED MORTGAGE RULE
The CFPB issued a final rule with an effective date of January 14, 2014, establishing new standards for mortgage lenders to follow during the loan approval process to determine whether a borrower can afford to repay the mortgage. Lenders are not required to consider whether a borrower has the ability to repay certain types of loans, such as home equity lines of credit, timeshare plans, reverse mortgages, and temporary loans.
The final rule provides for a rebuttable safe harbor from consumer claims that a lender did not adequately consider whether a consumer can afford to repay the lender's mortgage, provided that the mortgage meets the requirements to be considered a Qualified Mortgage Loan (QM). QMs are home loans that are either eligible for Fannie Mae or Freddie Mac to purchase or otherwise satisfy certain underwriting standards. The standards require lenders to consider, among other factors, the borrower's current income, current employment status, credit history, monthly payment for mortgage, monthly payment for other loan obligations, and the borrower's total debt-to-income ratio. Further, the underwriting standards for a QM prohibit loans with excessive points and fees, interest-only or negative-amortization features (subject to limited exceptions), or terms greater than 30 years. On the same date as it issued the final QM standards, the CFPB also issued a proposal that would allow small creditors (generally those with assets under $2 billion) in rural or under-served areas to treat first lien balloon mortgage loans that they offer as QMs. Many of our members offer balloon mortgages. If such mortgages are not treated as QMs under final CFPB regulation, this is likely going to reduce mortgage lending by our members. Comments were due February 25, 2013.
The safe harbor from liability for QMs could incent lenders, including our members, to limit their mortgage lending to QMs or otherwise reduce their origination of mortgage loans that are not QMs. This could reduce the overall level of members' mortgage loan lending and, in turn, reduce demand for FHLBank advances. Additionally, the value and marketability of mortgage loans that are not QMs, including those pledged as collateral to secure member advances, may be adversely affected.

BASEL COMMITTEE ON BANKING SUPERVISION LIQUIDITY FRAMEWORK

On January 6, 2013, the Basel Committee on Banking Supervision (the Basel Committee) announced amendments to the Basel liquidity standards, including the Liquidity Coverage Ratio (LCR). The amendments include the following: (i) revisions to the definition of high-quality liquid assets (HQLA) and net cash outflows, (ii) a timetable for phase-in of the standard, (iii) a reaffirmation of the usability of the stock of liquid assets in periods of stress, including during the transition period, and (iv) an agreement for the Basel Committee to conduct further work on the interaction between the LCR and the provision of central bank facilities. Under the amendments, the LCR buffer could rest at 60 percent of outflows over a 30-day period when the rule becomes effective in 2015, and then increase steadily until reaching 100 percent four years later. The definition of HQLA has been amended to expand the eligible assets, including residential mortgage assets. In late February 2013, it was reported that the U.S. banking regulators expect to customize the Basel III liquidity rules to an extent and expect to issue their final rules later in 2013.

BASEL COMMITTEE ON BANKING SUPERVISON CAPITAL FRAMEWORK

In September 2010, the Basel Committee approved a new capital framework for internationally active banks. Banks subject to the new framework will be required to have increased amounts of capital with core capital being more strictly defined to include only common equity and other capital assets that are able to fully absorb losses. On June 7, 2012, the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (the Agencies) concurrently published three joint notices of proposed rulemaking (NPRs) seeking comments on comprehensive revisions to the Agencies' capital framework to incorporate the Basel Committee's new capital framework. These revisions, among other things, would have:

•
implemented the Basel Committee's capital standards related to minimum requirements, regulatory capital, and additional capital buffers;
•
revised the methodologies for calculation risk-weighted assets in the general risk-based capital rules, including residential mortgage assets; and
•
revised the approach by which large banks determine their capital adequacy.
On November 9, 2012, the federal banking regulators announced that they were indefinitely delaying the effective date for the implementation of the Basel III capital requirements.


55

NATIONAL CREDIT UNION ADMINISTRATION PROPOSED RULE ON ACCESS TO EMERGENCY LIQUIDITY

On July 30, 2012, the National Credit Union Administration (NCUA) published a proposed rule with a comment deadline of September 28, 2012, requiring, among other things, that federally-insured credit unions of $100 million or larger must maintain access to at least one federal liquidity source for use in times of financial emergency and distressed circumstances. This access must be demonstrated through direct or indirect membership in the Central Liquidity Facility (a U.S. Government corporation created to improve the general financial stability of credit unions by serving as a liquidity lender to credit unions) or by establishing access to the Federal Reserve's discount window. The proposed rule does not include FHLBank membership as an emergency liquidity source. If the rule is issued as proposed, it may adversely impact our results of operations if it causes our federally-insured credit union members to favor these federal liquidity sources over FHLBank membership or advances.
Other Significant Developments
HARP, HAMP AND OTHER FORECLOSURE PREVENTION EFFORTS
In 2012, the Finance Agency, Fannie Mae, and Freddie Mac announced a series of changes that were intended to assist more eligible borrowers who can benefit from refinancing their home mortgages. The changes include lowering or eliminating certain risk-based fees, removing the current 125 percent loan-to-value ceiling on fixed-rate mortgages that are purchased by Fannie Mae and Freddie Mac, waiving certain representations and warranties, eliminating the need for a new property appraisal, and extending the end date for the program until December 31, 2013 for loans originally sold to Fannie Mae and Freddie Mac on or before May 31, 2009.
Other federal agencies have also implemented other programs during the past few years intended to prevent foreclosure. These programs focus on lowering a homeowner's monthly payments through mortgage modifications or refinancings, providing temporary reductions or suspensions of mortgage payments, and helping homeowners transition to more affordable housing. Other proposals, such as expansive principal write-downs or principal forgiveness (including new short-sale or deed in lieu of foreclosure programs), or converting delinquent borrowers into renters and conveying the properties to investors, have gained some popularity as well. If the Finance Agency requires us to offer a similar refinancing option for our investments in mortgage loans, our income from those investments could decline.
Further, settlements announced in 2012 and 2013 with the banking regulators, the federal government and the nation's largest mortgage servicers and states attorneys' general are also likely to focus on loan modifications and principal write-downs. In late January 2013, the U.S. Treasury Department (Treasury Department) announced that it is expanding refinancing programs for homeowners whose mortgages are greater than their home value to include mortgages underlying private-label MBS. These programs, proposals, and settlements could ultimately impact the value of and the returns from our investments in MBS and mortgage loans.
HOUSING FINANCE AND HOUSING GSE REFORM

The new Congress is expected to continue consideration of possible reforms to the secondary mortgage market, including the resolution of the Enterprises. During the last Congress, at least ten separate bills were introduced in the House of Representatives that would have affected the Enterprises in a variety of significant ways. While none of the bills would have directly impacted the FHLBanks, it is expected that legislation to reform housing finance and housing GSEs (including the FHLBanks) will again be a high priority in the House Financial Services Committee and the Senate Banking Committee. Any changes to the U.S. housing finance system could have consequences for the FHLBanks as we seek to provide access to liquidity for our members.

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Outside of Congress, several federal agencies have taken action over the past year to lay the groundwork for a new U.S. housing finance structure. In February 2012, the Finance Agency announced a Strategic Plan that declared the Enterprises are no longer “financially viable” and unveiled plans to create a single securitization platform and establish national standards for mortgage securitization. In the summer of 2012, the Treasury Department announced a set of modifications to the preferred stock purchase agreements between the Treasury Department and the Finance Agency as conservator of Fannie Mae and Freddie Mac to help expedite the wind down of the Enterprises. The changes require all future earnings from the Enterprises to be turned over to the Treasury Department and require the accelerated wind down of their retained mortgage portfolios. By not allowing the Enterprises to retain any profits, these changes effectively ensure that the Enterprises will never be allowed to recapitalize themselves and return to the market in their previous structure. While it is unclear how quickly the Enterprises might be wound down, it is apparent from these actions that changes to the U.S. mortgage finance system could occur in the not too distant future. However, it is impossible to determine at this time whether or when Congress or the Administration may act on housing GSE or housing finance reform. The ultimate effects of these efforts on the FHLBanks are unknown and will depend on the legislation or other changes, if any, that ultimately are implemented.

OFF-BALANCE SHEET ARRANGEMENTS
Our significant off-balance sheet arrangements consist of the following:

•
joint and several liability for consolidated obligations issued on behalf of the other 11 FHLBanks;
 
•
standby letters of credit; and

•
standby bond purchase agreements.
 
For a complete discussion of our off-balance sheet arrangements, refer to "Item 8 — Financial Statements and Supplementary Data — Note 19 — Commitments and Contingencies."

CONTRACTUAL OBLIGATIONS
The following table shows our contractual obligations due by payment period at December 31, 2012 (dollars in millions):
 
 
Payments Due by Period
 
 
< 1 Year
 
1 to 3 Years
 
>3 to 5 Years
 
>5 Years
 
Total
Bonds1
 
$
21,492

 
$
4,862

 
$
3,510

 
$
4,291

 
$
34,155

Operating leases
 
1

 
2

 
2

 
9

 
14

Mandatorily redeemable capital stock
 
—

 
5

 
3

 
1

 
9

Commitments to purchase mortgage loans
 
96

 
—

 
—

 
—

 
96

Pension and postretirement contributions2
 
1

 
1

 
1

 
2

 
5

Total
 
$
21,590

 
$
4,870

 
$
3,516

 
$
4,303

 
$
34,279


1
Excludes contractual interest payments related to bonds. Total is based on contractual maturities; the actual timing of payments could be impacted by factors affecting redemptions.

2
Represents the future funding contribution for our DB Plan and the scheduled benefit payments for our other unfunded benefit plans.

RISK MANAGEMENT

We have risk management policies, established by our Board of Directors, that monitor and control our exposure to market, liquidity, credit, operational, and business risk. Our primary objective is to manage assets, liabilities, and derivative exposures in ways that protect the par redemption value of our capital stock from risks, including fluctuations in market interest rates and spreads. In line with this objective, our ERMP establishes risk measures to monitor our market and liquidity risk. The following is a list of the risk measures in place at December 31, 2012 and whether or not they are monitored by a policy limit:
 
 
Market Risk:
Market Value of Capital Stock Sensitivity (policy limit)
 
Estimate of Daily Market Value Sensitivity (policy limit)
 
Projected 12-month GAAP Income Sensitivity (policy limit)
 
Economic Value of Capital Stock
Liquidity Risk:
Regulatory Liquidity (policy limit)


57

We periodically evaluate our risk management policies in order to respond to changes in our financial position and general market conditions.

Market Risk

We define market risk as the risk that Market Value of Capital Stock (MVCS) or net income will change as a result of changes in market conditions, such as interest rates, spreads, and volatilities. Interest rate risk, including mortgage prepayment risk, was our predominant type of market risk exposure during 2012 and 2011. Our general approach toward managing interest rate risk is to acquire and maintain a portfolio of assets, liabilities, and derivatives, which, taken together, limit our expected exposure to interest rate risk. Management regularly reviews our sensitivity to interest rate changes by monitoring our market risk measures in parallel and non-parallel interest rate shifts and spread and volatility movements. Our key market risk measures are MVCS Sensitivity and Economic Value of Capital Stock (EVCS).

VALUATION MODELS
We use sophisticated risk management systems to evaluate our financial position and risk exposure. These systems employ various mathematical models and valuation techniques to measure interest rate risk. For example, we use valuation techniques designed to model explicit and embedded options and other cash flow uncertainties across a number of hypothetical interest rate environments. The techniques used to model options rely on:
•
understanding the contractual and behavioral features of each instrument;
•
using appropriate market data, such as yield curves and implied volatilities; and
•
using appropriate option valuation models and prepayment functions to describe the evolution of interest rates over time and the expected cash flows of financial instruments in response.
The method for calculating fair value is dependent on the instrument type. Option-free instruments, such as plain vanilla interest rate swaps, bonds, and advances require an assessment of the future course of interest rates. Once the course of interest rates has been specified and the expected cash flows determined, the appropriate forward rates are used to discount the future cash flows to a fair value. Options and option-embedded instruments, such as cancelable interest rate swaps, swaptions, interest rate caps and floors, callable bonds, and mortgage-related instruments, are typically evaluated using an interest rate tree (lattice) or Monte Carlo simulations that generate a large number of possible interest rate scenarios.
Models are inherently imperfect predictors of actual results because they are based on assumptions about future performance. Changes in any models or in any of the assumptions, judgments, or estimates used in the models may cause the results generated by the model to be materially different. Our risk computations require the use of instantaneous shifts in assumptions, such as interest rates, spreads, volatilities, and prepayment speeds. These computations may differ from our actual interest rate risk exposure because they do not take into account any portfolio re-balancing and hedging actions that are required to maintain risk exposures within our policies and guidelines. Management has adopted controls, procedures, and policies to monitor and manage assumptions used in these models.

MARKET VALUE OF CAPITAL STOCK SENSITIVITY

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

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

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


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

The policy limits for MVCS are 2.2 percent, 5 percent, and 12 percent declines from the base case in the up and down 50, 100, and 200 basis point parallel interest rate shift scenarios and 4.4 percent, 10 percent, and 24 percent declines from the base case in the up and down 50, 100, and 200 basis point non-parallel interest rate shift scenarios. Any breach of policy limits requires an immediate action to bring the exposure back within policy limits, as well as a report to the Board of Directors.

During the first quarter of 2008, due to the low interest rate environment, our Board of Directors suspended indefinitely the policy limit pertaining to the down 200 basis point parallel interest rate shift scenario. In October 2012, our Board of Directors amended the suspension by approving a rule for compliance to the down 200 basis point scenario that reinstates/suspends the associated policy limit when the 10-year swap rate increases above/drops below 2.50 percent. At December 31, 2012, the 10-year swap rate was 1.82 percent and therefore the suspension remained in effect. During the third quarter of 2011, Bank management temporarily suspended the policy limits pertaining to the down 50 and 100 basis point parallel interest rate shift scenarios while it reviewed the current MVCS sensitivity methodology. This suspension was lifted during the first quarter of 2012.

The following tables show our base case and change from base case MVCS in dollars per share and percent change respectively, based on outstanding shares, including shares classified as mandatorily redeemable, assuming instantaneous parallel shifts in interest rates at December 31, 2012 and 2011:
 
Market Value of Capital Stock (dollars per share)
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
2012
$
108.0

 
$
111.7

 
$
114.9

 
$
116.6

 
$
117.6

 
$
116.6

 
$
110.3

2011
$
99.6

 
$
102.5

 
$
105.1

 
$
105.8

 
$
106.8

 
$
105.0

 
$
97.5

 
% Change from Base Case
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
2012
(7.4
)%
 
(4.3
)%
 
(1.5
)%
 
—
%
 
0.8
%
 
—
 %
 
(5.4
)%
2011
(5.8
)%
 
(3.2
)%
 
(0.7
)%
 
—
%
 
0.9
%
 
(0.7
)%
 
(7.8
)%

The following tables show our base case and change from base case MVCS in dollars per share and percent change respectively, based on outstanding shares, including shares classified as mandatorily redeemable, assuming instantaneous non-parallel shifts in interest rates at December 31, 2012 and 2011:
 
Market Value of Capital Stock (dollars per share)
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
2012
$
112.0

 
$
114.8

 
$
116.0

 
$
116.6

 
$
117.3

 
$
116.6

 
$
112.1

2011
$
103.6

 
$
104.9

 
$
105.5

 
$
105.8

 
$
106.8

 
$
106.5

 
$
100.4

 
% Change from Base Case
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
2012
(4.0
)%
 
(1.5
)%
 
(0.5
)%
 
—
%
 
0.5
%
 
—
%
 
(3.9
)%
2011
(2.0
)%
 
(0.9
)%
 
(0.3
)%
 
—
%
 
0.9
%
 
0.7
%
 
(5.1
)%


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The increase in base case MVCS at December 31, 2012 when compared to December 31, 2011 was primarily attributable to the following factors:

•
Adjusted net income earned, net of dividend. During 2012, our adjusted net income earned, net of dividend, increased our equity position, thereby increasing MVCS. For additional information on our adjusted net income measure, refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Executive Overview — Adjusted Earnings."

•
Decreased advance pricing spread. The spreads we charged over our funding costs on new advances decreased at December 31, 2012 when compared to December 31, 2011. This had a positive impact on MVCS as it increased the value of existing advances.

•
Decreased interest rate volatility. Decreased interest rate volatility during 2012 had a positive impact on MVCS primarily through its impact on the value of mortgage-related assets. As interest rate volatility decreased, the value of the prepayment option to homeowners embedded in the mortgage-related assets decreased, thereby increasing the value of the assets.

•
Increased funding costs relative to LIBOR and swap rates. During 2012, our funding costs relative to LIBOR and swap rates increased, thereby decreasing the present value of our liabilities that fund mortgage assets and increasing MVCS.

ECONOMIC VALUE OF CAPITAL STOCK

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

The following table shows EVCS in dollars per share based on outstanding shares, including shares classified as mandatorily redeemable, at December 31, 2012 and 2011:
Economic Value of Capital Stock (dollars per share)
2012
 
$
126.0

2011
 
$
119.9


The increase in our EVCS at December 31, 2012 when compared to December 31, 2011 was primarily attributable to the following factors:
 
•
Updated internal prepayment model. During the third quarter of 2012, we updated our internal prepayment model in order to generate prepayment speeds that were more aligned with actual prepayment experience. This model change had a positive impact on EVCS as it slowed down the projected speed of mortgage prepayments and extended our future cash flows.

•
Decreased interest rate volatility. Decreased interest rate volatility during 2012 had a positive impact on EVCS primarily through its impact on the value of mortgage-related assets. As interest rate volatility decreased, the value of the prepayment option to homeowners embedded in the mortgage-related assets decreased, thereby increasing the value of the assets.

The increase in our EVCS was partially offset by increased funding costs relative to LIBOR and swap rates during 2012. This had a negative impact on EVCS as the value of our assets decreased more than the value of our liabilities.

DERIVATIVES
We use derivatives to manage the interest rate risk, including mortgage prepayment risk, in our Statements of Condition. Finance Agency regulations and our ERMP establish guidelines for derivatives, prohibit trading in or the speculative use of derivatives, and limit credit risk arising from derivatives.


60

Our current hedging strategies include hedges of specific assets and liabilities that qualify for fair value hedge accounting and economic hedges that are used to reduce overall market risk exposure in our Statements of Condition. All hedging strategies are approved by our Asset-Liability Committee. The following table summarizes our approved and utilized derivative hedging strategies (dollars in millions):
 
 
 
 
 
 
December 31,
Hedged Item / Hedging Instrument
 
Hedging Objective
 
Hedge Accounting Designation
 
2012
 Notional Amount
 
2011
Notional Amount
Advances
 
 
 
 
 
 
 
 
Pay-fixed, receive floating interest rate swap (without options)1
 
Converts the advance's fixed rate to a variable rate index.
 
Fair Value
 
$
6,009

 
$
6,766


 

 
Economic
 
42

 
—

Pay-fixed, receive floating interest rate swap (with options)1
 
Converts the advance's fixed rate to a variable rate index and offsets option risk in the advance.
 
Fair Value
 
2,720

 
3,468

Pay float, receive floating basis swap2
 
Reduces interest rate sensitivity and repricing gaps by converting the advance's variable rate to a different variable rate index.
 
Economic
 
200

 
200

Investments
 
 
 
 
 
 
 
 
Pay-fixed, receive floating interest rate swap3
 
Converts the investment's fixed rate to a variable rate index.
 
Fair Value
 
588

 
452

 
 
 
 
Economic
 
1,049

 
594

Mortgage Loans
 
 
 
 
 
 
 
 
Forward settlement agreement
 
Protects against changes in market value of fixed rate mortgage delivery commitments resulting from changes in interest rates.
 
Economic
 
93

 
91

Bonds
 
 
 
 
 
 
 
 
Receive-fixed, pay floating interest rate swap (without options)4
 
Converts the bond's fixed rate to a variable rate index.
 
Fair Value
 
12,799

 
12,757

 
 
 
 
Economic
 
1,213

 
607

Receive-fixed, pay floating interest rate swap (with options)4
 
Converts the bond's fixed rate to a variable rate index and offsets option risk in the bond.
 
Fair Value
 
1,533

 
6,426

 
 
 
 
Economic
 
—

 
15

Receive float, pay floating basis swap5
 
Reduces interest rate sensitivity and repricing gaps by converting the bond's variable rate to a different variable rate index.
 
Economic
 
1,865

 
2,675

Discount Notes
 
 
 
 
 
 
 
 
Receive-fixed, pay floating interest rate swap6
 
Converts the discount note's fixed rate to a variable rate index.
 
Economic
 
—

 
3,471

Balance Sheet
 
 
 
 
 
 
 
 
Interest rate cap
 
Protects against changes in income of certain assets due to increases in interest rates.
 
Economic
 
3,450

 
3,450

Stand-Alone Derivatives
 
 
 
 
 
 
 
 
Mortgage delivery commitment
 
Protects against fair value risk associated with fixed rate mortgage purchase commitments.
 
Economic
 
96

 
90

Total
 
 
 
 
 
$
31,657

 
$
41,062


1
At December 31, 2012 and 2011, the par value of fixed rate advances outstanding was $17.3 billion and $18.0 billion, of which 51 and 57 percent were swapped to a variable rate index.

2
At December 31, 2012 and 2011, the par value of variable rate advances outstanding was $8.8 billion and $7.7 billion, of which two and three percent were swapped to a variable rate index.

3
At December 31, 2012 and 2011, the fair value of fixed rate trading securities outstanding was $1.1 billion and $0.7 billion and all of these trading securities were swapped to a variable rate index. At December 31, 2012 and 2011, the amortized cost of fixed rate AFS securities outstanding was $1.5 billion and $1.4 billion, of which 43 and 34 percent were swapped to a variable rate index.

4
At December 31, 2012 and 2011, the par value of fixed rate bonds outstanding was $26.1 billion and $35.1 billion, of which 60 and 56 percent were swapped to a variable rate index.

5
At December 31, 2012 and 2011, the par value of variable rate bonds outstanding was $8.1 billion and $2.7 billion, of which 23 and 100 percent were swapped to a variable rate index.

6
At December 31, 2011, the par value of fixed rate discount notes outstanding was $6.8 billion, of which 51 percent was swapped to a variable rate index.

61

Advances
We make advances to our members and eligible housing associates on the security of eligible collateral. We issue fixed and variable rate advances, callable advances, and putable advances. The optionality embedded in certain advances can create additional interest rate risk. When a borrower prepays an advance, we could suffer lower future income if the principal portion of the prepaid advance was reinvested in lower-yielding assets that continue to be funded by higher-costing debt. To protect against this risk, we charge a prepayment fee that makes us financially indifferent to a borrower's decision to prepay an advance. When we offer advances (other than overnight advances) that a borrower may prepay without a prepayment fee, we generally finance such advances with callable debt or otherwise hedge the embedded option.
Mortgage Assets
We manage the interest rate risk, including mortgage prepayment risk, associated with mortgage assets using a combination of debt issuance and derivatives. We may use derivative agreements to transform the characteristics of mortgage assets to more closely match the characteristics of the related funding.
The prepayment options embedded in mortgage assets can result in extensions or contractions in the expected maturities of these investments, depending on changes in and levels of interest rates. The Finance Agency limits this source of interest rate risk by restricting the types of MBS we may own to those with limited average life changes under certain interest rate shock scenarios.
We enter into commitments to purchase mortgages from our participating members. We may establish an economic hedge of these commitments by selling MBS “to-be-announced” (TBA) for forward settlement. A TBA represents a forward contract for the sale of MBS at a future agreed upon date. Upon expiration of the mortgage purchase commitment, we purchase the TBA to close the hedged position.
Non-Mortgage Investments
We manage the risk of changing market prices of certain fixed rate non-mortgage assets by using derivative agreements to transform the fixed rate characteristics to more closely match the characteristics of the related funding.
Consolidated Obligations
We manage the risk of changing market prices of a consolidated obligation by matching the cash inflows on the derivative agreement with the cash outflows on the consolidated obligation. While consolidated obligations are the joint and several obligations of the FHLBanks, each FHLBank serves as sole counterparty to derivative agreements associated with specific debt issues for which it is the primary obligor.
In a typical transaction, fixed rate consolidated obligations are issued for us by the Office of Finance and we simultaneously enter into a matching derivative agreement in which the counterparty pays us fixed cash flows designed to mirror in timing, optionality, and amount of the cash outflows paid by us on the consolidated obligation. In this typical transaction, we pay a variable cash flow that closely matches the interest payments we receive on short-term or variable rate assets. This intermediation between the capital and derivative markets permits us to raise funds at lower costs than would otherwise be available through the issuance of variable rate consolidated obligations in the capital markets.
We may enter into derivative agreements on variable rate consolidated obligations. For example, we may enter into a derivative agreement where the counterparty pays us variable rate cash flows and we pay a different variable rate linked to LIBOR. This type of hedge allows us to manage our repricing risk between assets and liabilities.
We may also enter into interest rate swaps with an upfront payment in a comparable amount to the discount on the hedged consolidated obligation. This cash payment equates to the initial fair value of the interest rate swap and is amortized over the estimated life of the interest rate swap to net interest income as the discount on the bond is expensed.
Balance Sheet
We enter into certain economic derivatives as macro balance sheet hedges to protect against changes in interest rates, including prepayments on mortgage assets. These economic derivatives may include interest rate caps, floors, swaps, and swaptions.
See additional discussion regarding our derivative contracts in “Item 8. Financial Statements and Supplementary Data — Note 11 — Derivatives and Hedging Activities.”

62

Liquidity Risk

We define liquidity risk as the risk that we will be unable to meet our obligations as they come due or meet the credit needs of our members and housing associates in a timely and cost efficient manner. To manage this risk, we maintain liquidity in accordance with Finance Agency regulations. Refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Liquidity Requirements” for additional details on our liquidity management.

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

ADVANCES

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

We are required by regulation to obtain sufficient collateral to fully secure our advances and other credit products. Eligible collateral includes (i) whole first mortgages on improved residential real property or securities representing a whole interest in such mortgages, (ii) loans and securities issued, insured, or guaranteed by the U.S. Government or any agency thereof, including MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae and FFELP guaranteed student loans, (iii) cash deposited with us, and (iv) other real estate-related collateral acceptable to us provided such collateral has a readily ascertainable value and we can perfect a security interest in such property. CFIs may also pledge collateral consisting of secured small business, small agri-business, or small farm loans. As additional security, the FHLBank Act provides that we have a lien on each borrower's capital stock investment; however, capital stock cannot be pledged as collateral to secure credit exposures.
Borrowers may pledge collateral to us by executing a blanket lien, specifically assigning collateral, or placing physical possession of collateral with us or our custodians. We perfect our security interest in all pledged collateral by filing Uniform Commercial Code financing statements or taking possession or control of the collateral. Under the FHLBank Act, any security interest granted to us by our members, or any affiliates of our members, has priority over the claims and rights of any party (including any receiver, conservator, trustee, or similar party having rights of a lien creditor), unless those claims and rights would be entitled to priority under otherwise applicable law and are held by actual purchasers or by parties that have perfected security interests.
Under a blanket lien, we are granted a security interest in all financial assets of the borrower to fully secure the borrower's obligation. Other than securities and cash deposits, we do not initially take delivery of collateral pledged by blanket lien borrowers. In the event of deterioration in the financial condition of a blanket lien borrower, we have the ability to require delivery of pledged collateral sufficient to secure the borrower's obligation. With respect to non-blanket lien borrowers that are federally insured, we generally require collateral to be specifically assigned. With respect to non-blanket lien borrowers that are not federally insured (typically insurance companies, CDFIs, and housing associates), we generally take control of collateral through the delivery of cash, securities, or loans to us or our custodians.

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

At December 31, 2012 and 2011, borrowers pledged $123.0 billion and $103.1 billion of collateral (net of applicable discounts) to support activity with us, including advances. Borrowers pledge collateral in excess of their collateral requirement mainly to demonstrate available liquidity and to borrow additional amounts in the future.


63

The following table shows the amount of collateral pledged to us (net of applicable discounts) by collateral type (dollars in billions):    
 
 
December 31,
 
 
2012
 
2011
Collateral Type
 
Discount Range1
 
Amount
 
% of Total
 
Discount Range1
 
Amount
 
% of Total
Single-family loans
 
      19-48%
 
$
71.5

 
58.1
 
      19-56%
 
$
57.9

 
56.2
Multi-family loans
 
   45-57
 
2.4

 
2.0
 
   45-57
 
1.4

 
1.5
Other real estate
 
   26-64
 
24.2

 
19.7
 
   26-64
 
22.3

 
21.6
Securities
 
 
 
 
 
 
 
 
 
 
 
 
Cash, agency and RMBS2
 
     0-52
 
14.2

 
11.5
 
     0-52
 
11.7

 
11.3
CMBS3
 
   13-40
 
4.8

 
3.9
 
   13-35
 
5.5

 
5.3
Government-insured loans
 
     6-13
 
3.5

 
2.8
 
     8-21
 
2.4

 
2.3
Secured small business and agribusiness loans
 
   26-46
 
2.4

 
2.0
 
   26-64
 
1.9

 
1.8
Total
 
 
 
$
123.0

 
100.0
 
 
 
$
103.1

 
100.0

1
Represents the range of discounts applied to the unpaid principal balance or market value of collateral pledged.
2
Represents cash, agency securities and residential mortgage-backed securities (RMBS).
3
Represents commercial mortgage-backed securities (CMBS).

Based upon our collateral and lending policies, the collateral held as security, and the repayment history on credit products, management has determined that there are no probable credit losses on our credit products as of December 31, 2012 and 2011. Accordingly, we have not recorded any allowance for credit losses.

MORTGAGE ASSETS

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

MPF Loans

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

The following table presents the unpaid principal balance of our MPF portfolio by product type (dollars in millions):
 
 
December 31,
Product Type
 
2012
 
2011
Original MPF
 
$
810

 
$
683

MPF 100
 
48

 
72

MPF 125
 
3,534

 
3,252

MPF Plus
 
1,981

 
2,671

MPF Government
 
513

 
426

Total unpaid principal balance
 
$
6,886

 
$
7,104


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


64

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

Conventional Mortgage Loans. For our conventional mortgage loans, we have several layers of legal loss protection that are defined in agreements among us and our PFIs. These loss layers may vary depending on the MPF product alternatives selected and consist of (i) homeowner equity, (ii) PMI, (iii) a first loss account, and (iv) a credit enhancement obligation of the PFI. For a detailed discussion of these loss layers, refer to “Item 8. Financial Statements and Supplementary Data — Note 10 — Allowance for Credit Losses.”

The following tables shows characteristics of our conventional MPF portfolio:
 
 
December 31,
FICO® Score1
 
2012
 
2011
<620
 
2.1
%
 
2.4
%
620 to < 660
 
5.7

 
6.0

660 to < 700
 
11.9

 
12.3

700 to < 740
 
18.1

 
18.6

>= 740
 
62.2

 
60.7

Total
 
100.0
%
 
100.0
%
Weighted average FICO score
 
743

 
741


1
Represents the original FICO® score of the primary borrower for the related loan.
 
 
December 31,
Loan-to-Value1
 
2012
 
2011
<= 60%
 
18.1
%
 
19.3
%
> 60% to 70%
 
16.4

 
16.5

> 70% to 80%
 
29.6

 
30.2

> 80% to 90%2
 
31.3

 
27.0

> 90%2
 
4.6

 
7.0

Total
 
100.0
%
 
100.0
%
Weighted average loan-to-value
 
70.3
%
 
69.4
%

1
Represents the loan-to-value at origination for the related loan.

2
These conventional loans were required to have primary mortgage insurance at origination.
The following table shows the state concentrations of our conventional MPF portfolio. State concentrations are calculated based on unpaid principal balances.
 
December 31,
 
2012
 
2011
Iowa
31.5
%
 
27.4
%
Minnesota
17.8

 
18.3

Missouri
15.7

 
12.9

California
4.2

 
5.2

South Dakota
4.0

 
3.7

All others
26.8

 
32.5

Total
100.0
%
 
100.0
%


65

Mortgage Insurance. The following table summarizes the unpaid principal balance and maximum coverage outstanding of our seriously delinquent conventional mortgage loans (those 90 days or more past due or in the process of foreclosure) with PMI at December 31, 2012 (dollars in thousands):
Insurance Provider
 
Unpaid Principal Balance
 
Maximum Coverage Outstanding1
Mortgage Guaranty Insurance Co.
 
$
2,801

 
$
568

Genworth Mortgage Insurance
 
4,902

 
1,032

United Guaranty Residential Insurance
 
3,369

 
646

Republic Mortgage Insurance2
 
2,146

 
497

PMI Mortgage Insurance Co.2
 
1,082

 
268

CMG Mortgage Insurance Co.
 
1,475

 
270

Triad Guaranty Insurance Co.2
 
1,369

 
237

Radian Guaranty, Inc.
 
2,243

 
541

Total
 
$
19,387

 
$
4,059


1
Represents the estimated contractual limit for reimbursement of principal losses assuming PMI at origination is still in effect. The amount of expected claims under these insurance contracts is substantially less than the contractual limit for reimbursement.

2
These PMI providers have been directed to only pay out 50 to 60 percent of their claim amounts as a result of their current financial condition. The remainder of the claim payments have been deferred to a later date.

In order to limit our loss exposure to that of an investor in an MBS that is rated the equivalent of AA by an NRSRO, under the credit enhancement obligation of the PFI loss layer, we require PFIs to absorb losses in excess of the first loss account by either pledging collateral to us or purchasing supplemental mortgage insurance (SMI) from mortgage insurers. All of our utilized SMI mortgage insurers have had their external ratings for claims-paying insurer financial strength downgraded below AA. These rating downgrades imply an increased risk that the SMI providers will be unable to fulfill their obligations to reimburse us for claims under insurance policies. The Finance Agency has granted a waiver for the AA rating requirement of SMI providers for existing loans and commitments in the MPF program and requires us to evaluate the claims-paying ability of our SMI providers and hold retained earnings or take other steps necessary to mitigate the risks associated with using an SMI provider having a rating below AA.

On October 19, 2012, we obtained approval from the Finance Agency to cancel all outstanding SMI policies. Following receipt of this approval, we provided a notice of cancellation to our SMI providers. As of February 28, 2013, we canceled four of our five SMI policies. Upon cancellation of these policies, the respective PFI was no longer required to retain a portion of the credit risk on the underlying master loan commitments. As such, we stopped paying credit enhancement fees to this PFI. To further mitigate our exposure to credit risk under the respective master loan commitments, we began holding additional retained earnings in December of 2012.

Allowance for Credit Losses. We utilize an allowance for credit losses to reserve for estimated losses in our conventional mortgage portfolio after considering the recapture of performance-based credit enhancement fees from PFIs, if available. We do not factor expected proceeds from PMI or SMI into our allowance for credit losses. During 2012, we recorded no provision for credit losses. We believe the current allowance remained adequate to absorb estimated losses in our conventional mortgage loan portfolio at December 31, 2012. Refer to “Item 8. Financial Statements and Supplementary Data — Note 10 — Allowance for Credit Losses” for additional information on our allowance for credit losses.

The following table presents a rollforward of the allowance for credit losses on our conventional mortgage loans (dollars in millions):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Balance, beginning of period
$
19

 
$
13

 
$
2

Charge-offs
(3
)
 
(3
)
 
(1
)
Provision for credit losses
—

 
9

 
12

Balance, end of period
$
16

 
$
19

 
$
13



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Non-Accrual Loans and Delinquencies. We place a conventional mortgage loan on non-accrual status if it is determined that either the collection of interest or principal is doubtful or interest or principal is 90 days or more past due. We do not place a government-insured mortgage loan on non-accrual status due to the U.S. Government guarantee of the loan and contractual obligation of the loan servicer to repurchase the loan when certain criteria are met. Refer to “Item 8. Financial Statements and Supplementary Data — Note 10 — Allowance for Credit Losses” for a summary of our non-accrual loans and mortgage loan delinquencies.

Mortgage-Backed Securities

We limit our investments in MBS to those guaranteed by the U.S. Government, issued by a GSE, or that carry the highest investment grade rating by an NRSRO at the time of purchase. We are exposed to credit risk to the extent these MBS fail to perform adequately. We perform ongoing analysis on these investments to determine potential credit issues. At December 31, 2012 and 2011, we owned $6.9 billion and $8.3 billion of MBS, of which approximately 99.4 percent were guaranteed by the U.S. Government or issued by GSEs and 0.6 percent were private-label MBS at each period-end.

Our private-label MBS are variable rate securities backed by prime loans that were securitized prior to 2004. We record these investments as HTM. The following table summarizes characteristics of our private-label MBS (dollars in millions):
 
 
December 31, 2012
Credit rating:
 
 
AAA1
 
$
13

AA2
 
1

A
 
16

BBB
 
11

Total unpaid principal balance
 
$
41

 
 
 
Amortized cost
 
$
41

Gross unrealized gains
 
—

Gross unrealized losses
 
(1
)
Fair value
 
$
40

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

Original weighted average credit support3
 
4
%
Weighted average credit support4
 
11
%
Weighted average collateral delinquency rate5
 
6
%

1
On February 6, 2013, S&P downgraded the credit rating on this private-label MBS to single-A.

2
On February 6, 2013, S&P downgraded the credit rating on this private-label MBS to triple-B.

3
Based on credit support at the time of issuance and is calculated using the unpaid principal balance of the individual securities and their respective original credit support.

4
Based on credit support as of December 31, 2012 and is calculated using the unpaid principal balance of the individual securities and their respective credit support as of December 31, 2012.

5
Represents the percentage of underlying loans that are 60 days or more past due.

The following table shows the state concentrations of our private-label MBS. State concentrations are calculated based on unpaid principal balances.
 
 
December 31, 2012
California
 
10.0
%
Florida
 
9.0

Georgia
 
8.9

New York
 
6.8

Ohio
 
5.2

All other
 
60.1

Total
 
100.0
%


67

At December 31, 2012, we did not consider any of our private-label MBS to be other-than-temporarily impaired. For more information on our evaluation of OTTI, refer to “Item 8. Financial Statements and Supplementary Data — Note 7 — Other-Than-Temporary Impairment.”

INVESTMENTS

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

Finance Agency regulations limit the type of investments we may purchase. We are prohibited from investing in financial instruments issued by non-U.S. entities other than those issued by U.S. branches and agency offices of foreign commercial banks. Our unsecured credit exposures to U.S. branches and agency offices of foreign commercial banks include the risk that, as a result of political or economic conditions in a country, the counterparty may be unable to meet their contractual repayment obligations. Our unsecured credit exposures to domestic counterparties and U.S. subsidiaries of foreign commercial banks include the risk that these counterparties have extended credit to foreign counterparties. We were in compliance with the above regulation and did not own any financial instruments issued by foreign sovereign governments, including those countries that are members of the European Union, as of December 31, 2012.

Finance Agency regulations also include limits on the amount of unsecured credit we may extend to a counterparty or to a group of affiliated counterparties. This limit is based on a percentage of eligible regulatory capital and the counterparty's overall credit rating. Under these regulations, the level of eligible regulatory capital is determined as the lesser of our total regulatory capital or the eligible amount of regulatory capital of the counterparty. The eligible amount of regulatory capital is then multiplied by a stated percentage. The percentage that we may offer for term extensions of unsecured credit ranges from one to 15 percent based on the counterparty's credit rating. Our total overnight unsecured exposure to a counterparty may not exceed twice the regulatory limit for term exposures, or a total of two to 30 percent of the eligible amount of regulatory capital, based on the counterparty's credit rating. As of December 31, 2012, we were in compliance with the regulatory limits established for unsecured credit.

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

Beginning in the second quarter of 2012, as a result of heightened credit concerns, we limited our unsecured credit exposure to the following overnight investment types:

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

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

At December 31, 2012, our unsecured investment exposure consisted of overnight Federal funds sold. The following table presents our unsecured investment exposure by counterparty credit rating and domicile at December 31, 2012 (excluding accrued interest receivable) (dollars in millions):
 
 
Credit Rating1
Domicile of Counterparty
 
A
Domestic
 
$
180

U.S. subsidiaries of foreign commercial banks
 
520

Subtotal
 
700

U.S. branches and agency offices of foreign commercial banks
 
 
Canada
 
260

Total unsecured investment exposure
 
$
960


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

68

The following tables summarizes the carrying value of our investments by credit rating (dollars in millions):
 
December 31, 2012
 
Credit Rating1
 
AAA
 
AA
 
A
 
BBB
 
Unrated
 
Total
Interest-bearing deposits2
$
—

 
$
3

 
$
—

 
$
—

 
$
—

 
$
3

Securities purchased under agreements to resell
—

 
—

 
2,500

 
—

 
925

 
3,425

Federal funds sold
—

 
—

 
960

 
—

 
—

 
960

Investment securities:
 
 
 
 
 
 
 
 
 
 
 
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
—

 
473

 
—

 
—

 
—

 
473

GSE obligations
—

 
929

 
—

 
—

 
—

 
929

State or local housing agency obligations
8

 
88

 
—

 
—

 
—

 
96

Other3
374

—

321

 
—

 
—

 
2

 
697

Total non-mortgage-backed securities
382

 
1,811

 
—

 
—

 
2

 
2,195

Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE - residential
—

 
6,798

 
—

 
—

 
—

 
6,798

Other U.S. obligations - residential
—

 
8

 
—

 
—

 
—

 
8

Other U.S. obligations - commercial
—

 
3

 
—

 
—

 
—

 
3

Private-label - residential4
13

 
1

 
16

 
11

 
—

 
41

Total mortgage-backed securities
13

 
6,810

 
16

 
11

 
—

 
6,850

Total investments5
$
395

 
$
8,624

 
$
3,476

 
$
11

 
$
927

 
$
13,433


 
 
December 31, 2011
 
 
Credit Rating1
 
 
AAA
 
AA
 
A
 
BBB
 
Unrated
 
Total
Interest-bearing deposits2
 
$
—

 
$
6

 
$
—

 
$
—

 
$
—

 
$
6

Securities purchased under agreements to resell
 
—

 
—

 
600

 
—

 
—

 
600

Federal funds sold
 
—

 
725

 
1,390

 
—

 
—

 
2,115

Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
 
—

 
—

 
340

 
—

 
—

 
340

Other U.S. obligations
 
—

 
181

 
—

 
—

 
—

 
181

GSE obligations
 
—

 
930

 
—

 
—

 
—

 
930

State or local housing agency obligations
 
—

 
102

 
—

 
—

 
—

 
102

Temporary Liquidity Guarantee Program debentures2
 
—

 
1,572

 
—

 
—

 
—

 
1,572

Other3
 
361

 
168

 
—

 
—

 
1

 
530

Total non-mortgage-backed securities
 
361

 
2,953

 
340

 
—

 
1

 
3,655

Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
 
GSE - residential
 
—

 
8,198

 
—

 
—

 
—

 
8,198

Other U.S. obligations - residential
 
—

 
11

 
—

 
—

 
—

 
11

Other U.S. obligations - commercial
 
—

 
3

 
—

 
—

 
—

 
3

Private-label - residential
 
18

 
2

 
17

 
12

 
—

 
49

Total mortgage-backed securities
 
18

 
8,214

 
17

 
12

 
—

 
8,261

Total investments5
 
$
379

 
$
11,898

 
$
2,347

 
$
12

 
$
1

 
$
14,637


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

2
Interest bearing deposits and TLGP investments are rated AA because they are guaranteed by the FDIC up to $250,000 or by the U.S. Government.

3
Other "unrated" investments represents an equity investment in a Small Business Investment Company.

4
On February 6, 2013, S&P downgraded the credit rating on our triple-A private-label MBS to single-A and our double-A private-label MBS to triple-B.

5
At December 31, 2012 and 2011, seven and 17 percent of our total investments were unsecured.


69

Our total investments decreased at December 31, 2012 when compared to December 31, 2011 due primarily to the maturity of TLGP investments and principal paydowns on MBS. As a result of heightened counterparty credit concerns, we also limited our unsecured credit risk exposure to overnight investments throughout the second half of 2012, which caused a decline in our Federal funds sold balance. This decline in Federal funds sold was fully offset by an increase in secured resale agreements to manage our liquidity.

DERIVATIVES

Most of our hedging strategies use over-the-counter derivative instruments that expose us to counterparty credit risk because the transactions are executed and settled between two parties. When an over-the-counter derivative has a market value above zero, the counterparty owes us that value over the remaining life of the derivative. Credit risk arises from the possibility the counterparty will not be able to fulfill its commitment to pay the amount owed to us.

We manage this credit risk by spreading our transactions among many highly rated counterparties, by entering into collateral exchange agreements with counterparties that include minimum collateral thresholds, and by monitoring our exposure to each counterparty on a daily basis. In addition, all of our collateral exchange agreements include master netting arrangements whereby the fair values of all interest rate derivatives (including accrued interest receivables and payables) with each counterparty are offset for purposes of measuring credit exposure. The collateral exchange agreements require the delivery of collateral consisting of cash or very liquid, highly-rated securities if credit risk exposures rise above the established or negotiated minimum thresholds.

The following tables show our derivative counterparty credit exposure (dollars in millions):
 
 
December 31, 2012
Credit Rating1
 
Notional Amount
 
Net Derivatives Fair Value Before Collateral
 
Cash Collateral Pledged To (From) Counterparty
 
Net Credit Exposure to Counterparties
Asset positions with credit exposure
 
 
 
 
 
 
 
 
AA2
 
$
150

 
$
—

 
$
—

 
$
—

A
 
2,672

 
3

 
—

 
3

Liability positions with credit exposure
 
 
 
 
 
 
 


A
 
2,558

 
(89
)
 
90

 
1

Total derivative positions with credit exposure
 
5,380

 
(86
)
 
90

 
4

Member institutions2,3
 
54

 
—

 
—

 
—

Total
 
5,434

 
$
(86
)
 
$
90

 
$
4

Derivative positions without credit exposure
 
26,223

 
 
 
 
 
 
Total notional
 
$
31,657

 
 
 
 
 
 
 
 
December 31, 2011
Credit Rating1
 
Notional Amount
 
Net Derivatives Fair Value Before Collateral
 
Cash Collateral Pledged To (From) Counterparty
 
Net Credit Exposure to Counterparties
Asset positions with credit exposure
 
 
 
 
 
 
 
 
AA
 
$
496

 
$
1

 
$
—

 
$
1

Liability positions with credit exposure
 
 
 
 
 
 
 
 
A2
 
286

 
(11
)
 
11

 
—

Total derivative positions with credit exposure
 
782

 
(10
)
 
11

 
1

Member institutions3
 
87

 
1

 
—

 
1

Total
 
869

 
$
(9
)
 
$
11

 
$
2

Derivative positions without credit exposure
 
40,193

 
 
 
 
 
 
Total notional
 
$
41,062

 
 
 
 
 
 

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

2
Net credit exposure to counterparties is less than $1.0 million.

3
Represents asset position of mortgage delivery commitments with our member institutions.


70

Operational Risk

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

Business Risk

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Market Risk” and the sections referenced therein for quantitative and qualitative disclosures about market risk.


71

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

AUDITED FINANCIAL STATEMENTS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Note 1 - Summary of Significant Accounting Policies
 
 
 
 
Note 2 - Recently Adopted and Issued Accounting Guidance
 
 
 
 
Note 3 - Cash and Due from Banks
 
 
 
 
Note 4 - Trading Securities
 
 
 
 
Note 5 - Available-for-Sale Securities
 
 
 
 
Note 6 - Held-to-Maturity Securities
 
 
 
 
Note 7 - Other-Than-Temporary Impairment
 
 
 
 
Note 8 - Advances
 
 
 
 
Note 9 - Mortgage Loans Held for Portfolio
 
 
 
 
Note 10 - Allowance for Credit Losses
 
 
 
 
Note 11 - Derivatives and Hedging Activities
 
 
 
 
Note 12 - Deposits
 
 
 
 
Note 13 - Consolidated Obligations
 
 
 
 
Note 14 - Affordable Housing Program
 
 
 
 
Note 15 - Resolution Funding Corporation
 
 
 
 
Note 16 - Capital
 
 
 
 
Note 17 - Pension and Postretirement Benefit Plans
 
 
 
 
Note 18 - Fair Value
 
 
 
 
Note 19 - Commitments and Contingencies
 
 
 
 
Note 20 - Activities with Stockholders
 
 
 
 
Note 21 - Activities with Other FHLBanks
 

SUPPLEMENTARY DATA:
Supplementary Financial Data (Unaudited)
 

72

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of the Federal Home Loan Bank of Des Moines:

In our opinion, the accompanying statements of condition and the related statements of income, comprehensive income, capital, and cash flows present fairly, in all material respects, the financial position of the Federal Home Loan Bank of Des Moines (the "Bank") at December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Bank maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Bank's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Bank's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Minneapolis, MN
March 13, 2013


73

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

 
December 31,
 
2012
 
2011
ASSETS
 
 
 
Cash and due from banks (Note 3)
$
252,113

 
$
240,156

Interest-bearing deposits
3,238

 
6,337

Securities purchased under agreements to resell
3,425,000

 
600,000

Federal funds sold
960,000

 
2,115,000

Investment securities
 
 
 
Trading securities (Note 4)
1,145,430

 
1,365,121

Available-for-sale securities (Note 5)
4,859,806

 
5,355,564

Held-to-maturity securities (fair value of $3,198,129 and $5,380,021) (Note 6)
3,039,721

 
5,195,200

Total investment securities
9,044,957

 
11,915,885

Advances (Note 8)
26,613,915

 
26,591,023

Mortgage loans held for portfolio, net
 
 
 
Mortgage loans held for portfolio (Note 9)
6,967,603

 
7,156,933

Allowance for credit losses on mortgage loans (Note 10)
(15,793
)
 
(18,963
)
Total mortgage loans held for portfolio, net
6,951,810

 
7,137,970

Accrued interest receivable
66,410

 
73,009

Premises, software, and equipment, net
13,534

 
12,391

Derivative assets (Note 11)
3,813

 
1,452

Other assets
32,486

 
40,090

TOTAL ASSETS
$
47,367,276

 
$
48,733,313

LIABILITIES
 
 
 
Deposits (Note 12)
 
 
 
Interest-bearing
$
872,852

 
$
643,428

Non-interest-bearing
211,892

 
106,667

Total deposits
1,084,744

 
750,095

Consolidated obligations (Note 13)
 
 
 
Discount notes (includes $0 and $3,474,596 at fair value under the fair value option)
8,674,370

 
6,809,766

Bonds (includes $1,866,985 and $2,694,687 at fair value under the fair value option)
34,345,183

 
38,012,320

Total consolidated obligations
43,019,553

 
44,822,086

Mandatorily redeemable capital stock (Note 16)
9,561

 
6,169

Accrued interest payable
106,611

 
155,241

Affordable Housing Program payable (Note 14)
36,720

 
38,849

Derivative liabilities (Note 11)
100,700

 
116,806

Other liabilities
175,086

 
31,653

TOTAL LIABILITIES
44,532,975

 
45,920,899

Commitments and contingencies (Note 19)

 

CAPITAL (Note 16)
 
 
 
Capital stock - Class B putable ($100 par value); 20,627 and 21,089 shares issued and outstanding
2,062,714

 
2,108,878

Retained earnings
 
 
 
Unrestricted
593,129

 
562,442

Restricted
28,820

 
6,533

Total retained earnings
621,949

 
568,975

Accumulated other comprehensive income
149,638

 
134,561

TOTAL CAPITAL
2,834,301

 
2,812,414

TOTAL LIABILITIES AND CAPITAL
$
47,367,276

 
$
48,733,313

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

74

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

 
For the Years Ended December 31,
 
2012
 
2011
 
2010
INTEREST INCOME
 
 
 
 
 
Advances
$
242,541

 
$
260,355

 
$
387,838

Prepayment fees on advances, net
28,091

 
10,693

 
173,986

Interest-bearing deposits
692

 
414

 
363

Securities purchased under agreements to resell
4,577

 
1,263

 
2,403

Federal funds sold
2,340

 
2,460

 
4,818

Investment securities
 
 
 
 
 
Trading securities
24,170

 
24,870

 
39,795

Available-for-sale securities
75,704

 
96,155

 
97,235

Held-to-maturity securities
113,729

 
181,285

 
223,576

Mortgage loans held for portfolio
284,104

 
325,019

 
357,326

Loans to other FHLBanks
—

 
1

 
—

Total interest income
775,948

 
902,515

 
1,287,340

INTEREST EXPENSE
 
 
 
 
 
Consolidated obligations
 
 
 
 
 
Discount notes
11,405

 
6,071

 
10,415

Bonds
523,305

 
660,138

 
860,691

Deposits
368

 
492

 
1,179

Borrowings from other FHLBanks
1

 
1

 
3

Mandatorily redeemable capital stock
238

 
211

 
164

Total interest expense
535,317

 
666,913

 
872,452

NET INTEREST INCOME
240,631

 
235,602

 
414,888

Provision for credit losses on mortgage loans
—

 
9,155

 
12,118

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
240,631

 
226,447

 
402,770

OTHER (LOSS) INCOME
 
 
 
 
 
Net gain on trading securities
23,077

 
38,699

 
37,420

Net gain on sale of available-for-sale securities
12,644

 
—

 
—

Net gain on sale of held-to-maturity securities
1,007

 
7,246

 
—

Net gain (loss) on consolidated obligations held at fair value
4,187

 
(6,480
)
 
5,657

Net loss on derivatives and hedging activities
(24,847
)
 
(110,831
)
 
(52,589
)
Net loss on extinguishment of debt
(76,781
)
 
(4,602
)
 
(163,681
)
Other, net
3,421

 
4,060

 
11,650

Total other loss
(57,292
)
 
(71,908
)
 
(161,543
)
OTHER EXPENSE
 
 
 
 
 
Compensation and benefits
32,017

 
31,392

 
38,069

Other operating expenses
20,218

 
17,689

 
16,902

Federal Housing Finance Agency
4,430

 
4,969

 
2,999

Office of Finance
2,833

 
2,876

 
2,180

Total other expense
59,498

 
56,926

 
60,150

INCOME BEFORE ASSESSMENTS
123,841

 
97,613

 
181,077

ASSESSMENTS
 
 
 
 
 
Affordable Housing Program
12,408

 
8,670

 
14,798

Resolution Funding Corporation
—

 
11,129

 
33,256

Total assessments
12,408

 
19,799

 
48,054

NET INCOME
$
111,433

 
$
77,814

 
$
133,023

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

75

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

 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Net income
$
111,433

 
$
77,814

 
$
133,023

Other comprehensive income
 
 
 
 
 
Net unrealized gain on available-for-sale securities
 
 
 
 
 
Unrealized gain
28,185

 
45,018

 
124,755

Reclassification of realized net gain included in net income
(12,644
)
 
—

 
—

Total net unrealized gain on available-for-sale securities
15,541

 
45,018

 
124,755

Pension and postretirement benefits
(464
)
 
(988
)
 
(289)

Total other comprehensive income
15,077

 
44,030

 
124,466
TOTAL COMPREHENSIVE INCOME
$
126,510

 
$
121,844

 
$
257,489

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




76

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

 
Capital Stock
Class B (putable)
 
Retained Earnings
 
Accumulated Other Comprehensive (Loss) Income
 
 
 
Shares
 
Par Value
 
Unrestricted
 
Restricted
 
Total
 
 
Total
Capital
BALANCE DECEMBER 31, 2009
24,604

 
$
2,460,419

 
$
484,071

 
$
—

 
$
484,071

 
$
(33,935
)
 
$
2,910,555

Proceeds from issuance of capital stock
4,811

 
481,130

 
—

 
—

 
—

 
—

 
481,130

Repurchase/redemption of capital stock
(7,371
)
 
(737,127
)
 
—

 
—

 
—

 
—

 
(737,127
)
Net shares reclassified to mandatorily redeemable capital stock
(214
)
 
(21,394
)
 
—

 
—

 
—

 
—

 
(21,394
)
Comprehensive income
—

 
—

 
133,023

 
—

 
133,023

 
124,466

 
257,489

Cash dividends on capital stock
—

 
—

 
(61,081
)
 
—

 
(61,081
)
 
—

 
(61,081
)
BALANCE DECEMBER 31, 2010
21,830

 
2,183,028

 
556,013

 
—

 
556,013

 
90,531

 
2,829,572

Proceeds from issuance of capital stock
4,156

 
415,606

 
—

 
—

 
—

 
—

 
415,606

Repurchase/redemption of capital stock
(4,830
)
 
(483,074
)
 
—

 
—

 
—

 
—

 
(483,074
)
Net shares reclassified to mandatorily redeemable capital stock
(67
)
 
(6,682
)
 
—

 
—

 
—

 
—

 
(6,682
)
Comprehensive income
—

 
—

 
71,281

 
6,533

 
77,814

 
44,030

 
121,844

Cash dividends on capital stock
—

 
—

 
(64,852
)
 
—

 
(64,852
)
 
—

 
(64,852
)
BALANCE DECEMBER 31, 2011
21,089

 
2,108,878

 
562,442

 
6,533

 
568,975

 
134,561

 
2,812,414

Proceeds from issuance of capital stock
12,304

 
1,230,404

 
—

 
—

 
—

 
—

 
1,230,404

Repurchase/redemption of capital stock
(12,671
)
 
(1,267,120
)
 
—

 
—

 
—

 
—

 
(1,267,120
)
Net shares reclassified to mandatorily redeemable capital stock
(95
)
 
(9,448
)
 
—

 
—

 
—

 
—

 
(9,448
)
Comprehensive income
—

 
—

 
89,146

 
22,287

 
111,433

 
15,077

 
126,510

Cash dividends on capital stock
—

 
—

 
(58,459
)
 
—

 
(58,459
)
 
—

 
(58,459
)
BALANCE DECEMBER 31, 2012
20,627

 
$
2,062,714

 
$
593,129

 
$
28,820

 
$
621,949

 
$
149,638

 
$
2,834,301

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




77

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

 
For the Years Ended December 31,
 
2012
 
2011
 
2010
OPERATING ACTIVITIES
 
 
 
 
 
Net income
$
111,433

 
$
77,814

 
$
133,023

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
 
 
Depreciation and amortization
345,823

 
6,030

 
68,018

Net gain on trading securities
(23,077
)
 
(38,699
)
 
(37,420
)
Net gain on sale of available-for-sale securities
(12,644
)
 
—

 
—

Net gain on sale of held-to-maturity securities
(1,007
)
 
(7,246
)
 
—

Net (gain) loss on consolidated obligations held at fair value
(4,187
)
 
6,480

 
(5,657
)
Net change in derivatives and hedging activities
(252,407
)
 
251,813

 
(86,040
)
Net loss on extinguishment of debt
76,781

 
4,602

 
163,681

Other adjustments
(2,338
)
 
1,322

 
8,188

Net change in:
 
 
 
 
 
Accrued interest receivable
6,667

 
6,283

 
2,377

Other assets
8,351

 
12,215

 
(1,640
)
Accrued interest payable
(48,547
)
 
(34,095
)
 
(56,957
)
Other liabilities
1,024

 
(17,928
)
 
9,636

Total adjustments
94,439

 
190,777

 
64,186

Net cash provided by operating activities
205,872

 
268,591

 
197,209

INVESTING ACTIVITIES
 
 
 
 
 
Net change in:
 
 
 
 
 
Interest-bearing deposits
249,499

 
(560,218
)
 
(54,749
)
Securities purchased under agreements to resell
(2,825,000
)
 
950,000

 
(1,550,000
)
Federal funds sold
1,155,000

 
(90,000
)
 
1,108,000

Premises, software, and equipment
(4,431
)
 
(5,315
)
 
(2,668
)
Trading securities
 
 
 
 
 
Proceeds from sales and maturities of long-term
1,014,576

 
210,973

 
2,999,400

Purchases of long-term
(631,229
)
 
(64,853
)
 
—

Available-for-sale securities
 
 
 
 
 
Net increase in short-term
—

 
(152
)
 
—

Proceeds from sales and maturities of long-term
2,035,916

 
1,226,700

 
1,953,332

Purchases of long-term
(1,503,591
)
 
(143,234
)
 
(446,390
)
Held-to-maturity securities
 
 
 
 
 
Net decrease (increase) in short-term
340,000

 
(5,000
)
 
(335,000
)
Proceeds from sales and maturities of long-term
1,816,267

 
2,055,353

 
2,491,468

Purchases of long-term
—

 
(11,500
)
 
(3,904,199
)
Advances
 
 
 
 
 
Principal collected
47,984,315

 
40,835,627

 
46,271,517

Originated
(48,376,241
)
 
(37,996,024
)
 
(39,741,529
)
Mortgage loans held for portfolio
 
 
 
 
 
Principal collected
2,262,571

 
1,634,583

 
1,768,830

Originated or purchased
(2,114,487
)
 
(1,397,347
)
 
(1,519,366
)
Proceeds from sales of foreclosed assets
28,081

 
35,414

 
23,771

Net cash provided by investing activities
1,431,246

 
6,675,007

 
9,062,417

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

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

 
For the Years Ended December 31,
 
2012
 
2011
 
2010
FINANCING ACTIVITIES
 
 
 
 
 
Net change in deposits
338,249

 
(439,059
)
 
(38,787
)
Net (payments) proceeds on derivative contracts with financing elements
(8,963
)
 
(9,883
)
 
18,365

Net proceeds from issuance of consolidated obligations
 
 
 
 
 
Discount notes
324,661,807

 
325,050,230

 
338,200,273

Bonds
24,089,562

 
35,575,286

 
43,833,982

Payments for maturing and retiring consolidated obligations
 
 
 
 
 
Discount notes
(322,795,668
)
 
(325,450,815
)
 
(340,404,656
)
Bonds
(27,381,008
)
 
(41,395,274
)
 
(50,220,629
)
Bonds transferred to other FHLBanks
(427,909
)
 
—

 
(501,291
)
Proceeds from issuance of capital stock
1,230,404

 
415,606

 
481,130

Payments for repurchase/redemption of mandatorily redeemable capital stock
(6,056
)
 
(7,348
)
 
(22,905
)
Payments for repurchase/redemption of capital stock
(1,267,120
)
 
(483,074
)
 
(737,127
)
Cash dividends paid
(58,459
)
 
(64,852
)
 
(61,081
)
Net cash used in financing activities
(1,625,161
)
 
(6,809,183
)
 
(9,452,726
)
Net increase (decrease) in cash and due from banks
11,957

 
134,415

 
(193,100
)
Cash and due from banks at beginning of the period
240,156

 
105,741

 
298,841

Cash and due from banks at end of the period
$
252,113

 
$
240,156

 
$
105,741

 
 
 
 
 
 
SUPPLEMENTAL DISCLOSURES
 
 
 
 
 
Interest paid
$
1,136,948

 
$
1,431,911

 
$
1,762,103

Affordable Housing Program payments
$
14,537

 
$
14,329

 
$
10,769

Resolution Funding Corporation assessments
$
—

 
$
23,596

 
$
30,913

Transfers of mortgage loans to real estate owned
$
21,025

 
$
32,088

 
$
28,486

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


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FEDERAL HOME LOAN BANK OF DES MOINES

NOTES TO THE FINANCIAL STATEMENTS

Background Information

The Federal Home Loan Bank of Des Moines (the Bank) is a federally chartered corporation organized on October 31, 1932, that is exempt from all federal, state, and local taxation (except real property taxes) and is one of 12 district Federal Home Loan Banks (FHLBanks). The FHLBanks were created under the authority of the Federal Home Loan Bank Act of 1932 (FHLBank Act). With the passage of the Housing and Economic Recovery Act of 2008 (Housing Act), the Federal Housing Finance Agency (Finance Agency) was established and became the new independent federal regulator of Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, Enterprises), as well as the FHLBanks and FHLBanks' Office of Finance, effective July 30, 2008. The Finance Agency's mission is to provide effective supervision, regulation, and housing mission oversight of the Enterprises and FHLBanks to promote their safety and soundness, support housing finance and affordable housing, and support a stable and liquid mortgage market. The Finance Agency establishes policies and regulations governing the operations of the Enterprises and FHLBanks. Each FHLBank operates as a separate entity with its own management, employees, and board of directors.

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

The Bank is a cooperative. This means the Bank is owned by its customers, whom the Bank calls members. As a condition of membership in the Bank, all members must purchase and maintain membership capital stock based on a percentage of their total assets as of the preceding December 31st subject to a cap of $10.0 million and a floor of $10,000. Each member is also required to purchase and maintain activity-based capital stock to support certain business activities with the Bank.

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

Note 1 — Summary of Significant Accounting Policies
BASIS OF PRESENTATION
The Bank prepares its financial statements in accordance with accounting principles generally accepted in the U.S. (GAAP).
Use of Estimates
The preparation of financial statements in accordance with GAAP requires management to make subjective assumptions and estimates that may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expense. The most significant of these estimates include the allowance for credit losses on mortgage loans and the fair value of derivatives, certain investment securities, and certain consolidated obligations that are reported at fair value in the Statements of Condition. Actual results could significantly differ from these estimates.
Reclassifications and Revisions to Prior Period Amounts
Certain amounts in the Bank's 2011 notes to the financial statements have been reclassified to conform to the presentation as of December 31, 2012. Additionally, certain prior period amounts have been revised and will not agree to the Bank's previously issued 2011 financial statements and footnotes. These amounts were not deemed to be material.

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During the first quarter of 2012, the Bank identified certain classification errors in its previously reported Statement of Cash Flows for the year ended December 31, 2011 contained in the 2011 Form 10-K. Management determined after evaluating the quantitative and qualitative aspects of the classification errors that such errors were not material individually or in the aggregate to the previously issued Statement of Cash Flows. Accordingly, these classification errors have been corrected in this annual report on Form 10-K. The adjustments had no impact on the Bank's results of operations for any period.

The following table summarizes the revisions made to the Bank's Statement of Cash Flows for the year ended December 31, 2011 included in this annual report on Form 10-K (dollars in thousands):
 
Previously Reported
 
Revised
Operating Activities
 
 
 
Net change in other assets
$
(5,158
)
 
$
12,215

Net cash provided by operating activities
251,218

 
268,591

Financing Activities
 
 
 
Net proceeds from issuance of discount notes
325,051,279

 
325,050,230

Net proceeds from issuance of bonds
35,592,738

 
35,575,286

Payments for maturing discount notes
(325,451,943
)
 
(325,450,815
)
Net cash used in financing activities
(6,791,810
)
 
(6,809,183
)

SIGNIFICANT ACCOUNTING POLICIES

Fair Value
The fair value amounts, recorded in the Bank's Statements of Condition and presented in the footnote disclosures, have been determined by the Bank using available market information and management's best judgment of appropriate valuation methods. Although management uses its best judgment in estimating the fair value of financial instruments, there are inherent limitations in any valuation technique. Therefore, these fair values may not be indicative of the amounts that would have been realized in market transactions at the reporting dates. See “Note 18 — Fair Value” for more information.
Interest-Bearing Deposits, Securities Purchased Under Agreements to Resell, and Federal Funds Sold
These investments provide short-term liquidity and are carried at cost. Interest-bearing deposits include certificates of deposit not meeting the definition of a security. The Bank treats securities purchased under agreements to resell as short-term secured investments. These secured investments are held in safekeeping in the name of the Bank by third-party custodians approved by the Bank. Should the market value of the underlying securities decrease below the market value required as collateral, the counterparty must either place an equivalent amount of additional securities in safekeeping in the name of the Bank or remit an equivalent amount of cash. Otherwise, the dollar value of the resale agreement will be decreased accordingly. Federal funds sold consist of short-term, unsecured loans made to investment-grade counterparties.
Investment Securities
The Bank classifies investment securities as trading, available-for-sale (AFS), and held-to-maturity (HTM) at the date of acquisition. Purchases and sales of investment securities are recorded on a trade date basis.
Trading. Securities classified as trading are carried at fair value and generally entered into for liquidity purposes. In addition, the Bank classifies certain securities as trading that do not qualify for hedge accounting, primarily in an effort to mitigate the potential income statement volatility that can arise from economic hedging relationships in which the carrying value of the hedged item is not adjusted for changes in fair value. The Bank records changes in the fair value of these securities through other (loss) income as “Net gain on trading securities.” Finance Agency regulation prohibits trading in or the speculative use of these instruments.
Available-for-Sale. Securities that are not classified as trading or HTM are classified as AFS and carried at fair value. The Bank records changes in the fair value of these securities through accumulated other comprehensive income as “Net unrealized gain on available-for-sale securities.” For AFS securities that have been hedged and qualify as a fair value hedge, the Bank records the portion of the change in fair value related to the risk being hedged together with the related change in fair value of the derivative through other (loss) income as “Net loss on derivatives and hedging activities.” The Bank records the remainder of the change in fair value through accumulated other comprehensive income as “Net unrealized gain on available-for-sale securities.”

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Held-to-Maturity. Securities that the Bank has both the ability and intent to hold to maturity are classified as HTM and carried at amortized cost, which represents the amount at which an investment is acquired, adjusted for periodic principal repayments, amortization of premiums, and accretion of discounts.
Certain changes in circumstances may cause the Bank to change its intent to hold a security to maturity without calling into question its intent to hold other debt securities to maturity in the future. Thus, the sale or transfer of a HTM security due to certain changes in circumstances, such as evidence of significant deterioration in the issuer's creditworthiness or changes in regulatory requirements, is not considered to be inconsistent with its original classification. Other events that are isolated, non-recurring, and unusual for the Bank that could not have been reasonably anticipated may cause the Bank to sell or transfer a HTM security without necessarily calling into question its intent to hold other debt securities to maturity. In addition, the sale of a debt security that meets either of the following two conditions would not be considered inconsistent with the original classification of that security: (i) the sale occurs near enough to its maturity date (or call date if exercise of the call is probable) that interest rate risk is substantially eliminated as a pricing factor and the changes in market interest rates would not have a significant effect on the security's fair value or (ii) the sale of a security occurs after the Bank has already collected a substantial portion (at least 85 percent) of the principal outstanding at acquisition due either to prepayments on the debt security or to scheduled payments on a debt security payable in equal installments (both principal and interest) over its term.
Premiums and Discounts. The Bank amortizes premiums and accretes discounts on investment securities using the contractual level-yield method (level-yield method). The level-yield method recognizes the income effects of premiums and discounts over the contractual life of the securities based on the actual behavior of the underlying assets, including adjustments for actual prepayment activities, and reflects the contractual terms of the securities without regard to changes in estimated prepayments based on assumptions about future borrower behavior.
Gains and Losses on Sales. The Bank computes gains and losses on sales of investment securities using the specific identification method and includes these gains and losses in other (loss) income.
Investment Securities - Other-Than-Temporary Impairment

The Bank evaluates its individual AFS and HTM securities in an unrealized loss position for other-than-temporary impairment (OTTI) on a quarterly basis. A security is considered impaired when its fair value is less than its amortized cost basis. The Bank considers an OTTI to have occurred under any of the following circumstances:

•it has an intent to sell the impaired debt security;

•
if, based on available evidence, it believes it is more likely than not that it will be required to sell the impaired debt security before the recovery of its amortized cost basis; or

•
it does not expect to recover the entire amortized cost basis of the impaired debt security.
Recognition of OTTI. If either of the first two conditions is met, the Bank recognizes an OTTI charge in earnings equal to the entire difference between the security's amortized cost basis and its fair value as of the reporting date. If neither of the first two conditions is met, the Bank performs an analysis to determine if it will recover the entire amortized cost basis of the debt security, which includes a cash flow analysis for private-label mortgage-backed securities (MBS). The present value of the cash flows expected to be collected is compared to the amortized cost basis of the debt security to determine whether a credit loss exists. If there is a credit loss (the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security), the carrying value of the debt security is adjusted to its fair value. However, rather than recognizing the entire difference between the amortized cost basis and fair value in earnings, only the amount of the impairment representing the credit loss (i.e., the credit component) is recognized in earnings, while the amount related to all other factors is recognized in accumulated other comprehensive income. The credit loss on a debt security is limited to the amount of that security's unrealized loss. The total OTTI is presented in the Statements of Income with an offset for the amount of the non-credit portion of OTTI that is recognized in accumulated other comprehensive income, if applicable. See "Note 7 — Other-Than-Temporary Impairment" for additional information.
Variable Interest Entities
The Bank has determined its investments in private-label MBS to be variable interest entities (VIEs). These securities are classified as HTM in the Bank's Statements of Condition. The Bank has no liabilities related to these VIEs and the maximum loss exposure for these VIEs is limited to the carrying value of the securities.


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If the Bank determines it is the primary beneficiary of a VIE, it would be required to consolidate that VIE. On an ongoing basis, the Bank performs a quarterly evaluation to determine whether it is the primary beneficiary in any of its VIEs. To perform this evaluation, the Bank considers whether it possesses both of the following characteristics: (i) the power to direct the VIEs activities that most significantly affect the VIEs economic performance and (ii) the obligation to absorb the VIEs losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.

Based on an evaluation of the above characteristics, the Bank has determined that consolidation is not required for its VIEs for the periods presented. The Bank has not provided financial or other support (explicitly or implicitly) to its VIEs and does not intend to provide that support in the future.
Advances
The Bank reports advances (secured loans to members, former members, or eligible housing associates) at amortized cost, net of premiums, discounts, and fair value hedging adjustments. The Bank amortizes/accretes premiums, discounts, and fair value hedging adjustments on advances to interest income using the level-yield method over the contractual life of the advances. The Bank records interest on advances to interest income as earned.

Advance Modifications. In cases in which the Bank funds a new advance concurrent with or within a short period of time before or after the prepayment of an existing advance, the Bank evaluates whether the new advance meets the accounting criteria to qualify as a modification of an existing advance or whether it constitutes a new advance. The Bank compares the present value of cash flows on the new advance to the present value of cash flows remaining on the existing advance. If there is at least a ten percent difference in the cash flows, the advance is accounted for as a new advance. In all other instances, the new advance is accounted for as a modification.

Prepayment Fees. The Bank charges a prepayment fee for advances that terminate prior to their stated maturity or outside of a predetermined call or put date. Prepayment fees are recorded net of fair value hedging adjustments through "Prepayment fees on advances, net” in the Statements of Income. If a new advance does not qualify as a modification of an existing advance, it is treated as an advance termination and any net prepayment fee is recorded immediately through “Prepayment fees on advances, net” in the Statements of Income. If a new advance qualifies as a modification of an existing advance, any net prepayment fee is deferred, recorded in the basis of the modified advance, and amortized using the level-yield method over the contractual life of the modified advance to “Prepayment fees on advances, net” in the Statements of Income.

Mortgage Loans Held for Portfolio
The Bank classifies mortgage loans that it has the intent and ability to hold for the foreseeable future or until maturity or payoff as held for portfolio. Accordingly, these mortgage loans are reported net of premiums, discounts, basis adjustments from mortgage loan commitments, and the allowance for credit losses.
Premiums and Discounts. The Bank amortizes/accretes premiums, discounts, and basis adjustments on mortgage loans to interest income using the level-yield method over the contractual life of the mortgage loans.
Credit Enhancement Fees. The Bank is responsible for managing the interest rate risk, including mortgage prepayment risk, and liquidity risk associated with the mortgage loans it purchases and carries in its Statements of Condition. The Bank requires a credit risk sharing arrangement with the participating financial institution (PFI) on all mortgage loans at the time of purchase in order to limit its credit risk exposure to that of an investor in an MBS that is rated the equivalent of AA by a nationally recognized statistical rating organization (NRSRO). For conventional mortgage loans, PFIs retain a portion of the credit risk by having a credit enhancement obligation to the Bank. To secure this obligation, a PFI may either pledge collateral or purchase supplemental mortgage insurance (SMI). PFIs are paid a credit enhancement fee for assuming this credit risk and in some instances, all or a portion of the credit enhancement fee may be performance-based. Credit enhancement fees are paid monthly or accrued based on the remaining unpaid principal balance of the loans in a master commitment. Credit enhancement fees are recorded as an offset to mortgage loan interest income. To the extent the Bank experiences losses in a master commitment, it may be able to recapture performance-based credit enhancement fees paid to the PFIs to offset these losses. If at any time the Bank cancels all or a portion of its SMI policies, the respective PFI is no longer required to retain a portion of the credit risk on the mortgage loans purchased by the Bank. In those instances, the Bank holds additional retained earnings to mitigate its exposure to credit risk and no credit enhancement fees are paid to the PFI.

83

Other Fees. The Bank may receive other non-origination fees, such as delivery commitment extension fees, pair-off fees, and price adjustment fees. Delivery commitment extension fees are received when a PFI requests to extend the delivery commitment period beyond the original stated maturity. These fees compensate the Bank for lost interest as a result of late funding and are recorded in other (loss) income. Pair-off fees represent a make-whole provision and are received when the amount funded is less than a specific percentage of the delivery commitment amount. These fees are also recorded in other (loss) income. Price adjustment fees are received when the amount funded is greater than a specified percentage of the delivery commitment amount. These fees are recorded as a part of the loan basis.
Allowance for Credit Losses

An allowance for credit losses is a valuation allowance separately established for each identified portfolio segment to provide for probable losses inherent in the Bank's portfolio of financing receivables as of the reporting date. To the extent necessary, an allowance for credit losses for off-balance sheet credit exposures is recorded as a liability. See "Note 10 — Allowance for Credit Losses" for details on each of the Bank's allowance methodologies.

Portfolio Segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. The Bank has developed and documented a systematic methodology for determining an allowance for credit losses for credit products (advances, letters of credit, and other extensions of credit to borrowers), government-insured mortgage loans held for portfolio, conventional mortgage loans held for portfolio, term securities purchased under agreements to resell, and term Federal funds sold.

Classes of Financing Receivables. Classes of financing receivables generally are a disaggregation of a portfolio segment to the extent that it is needed to understand the exposure to credit risk arising from the financing receivables. The Bank assesses and measures its credit risk arising from financing receivables at the portfolio segment level. As such, it has determined that no further disaggregation of the portfolio segments identified above is needed.

Non-Accrual Loans. The Bank places a conventional mortgage loan on non-accrual status if it is determined that either the collection of interest or principal is doubtful or interest or principal is 90 days or more past due. The Bank does not place a government-insured mortgage loan on non-accrual status due to the U.S. Government guarantee of the loan and contractual obligation of the loan servicer to repurchase the loan when certain criteria are met. For those mortgage loans placed on non-accrual status, accrued but uncollected interest is reversed against interest income and cash payments received are recorded as a reduction of principal. A loan on non-accrual status may be restored to accrual status when none of its contractual principal and interest is due and unpaid and the Bank expects repayment of the remaining contractual principal and interest.

Impairment Methodology. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Bank considers all troubled debt restructurings (TDRs), including loans granted under the Bank's temporary loan modification plan and loans discharged under Chapter 7 bankruptcy, to be impaired. The Bank also considers all collateral-dependent loans to be impaired. Collateral-dependent loans are loans in which repayment is expected to be provided solely by the sale of the underlying collateral. The Bank considers TDRs where principal or interest is 60 days or more past due to be collateral-dependent. The Bank generally measures impairment of TDRs based on the present value of expected future cash flows discounted at the loan's effective interest rate. The Bank measures impairment of collateral-dependent loans based on the estimated fair value of the underlying collateral less selling costs. Interest income on impaired loans is recognized in the same manner as non-accrual loans noted above.

Charge-Off Policy. The Bank evaluates whether to record a charge-off on a conventional mortgage loan upon the occurrence of a confirming event. Confirming events include, but are not limited to, the transfer of a mortgage loan to real estate owned (REO). A charge-off is recorded if it is estimated that the recorded investment in the loan will not be recovered.

Real Estate Owned

REO includes assets received in satisfaction of debt through foreclosures. REO is recorded at the lower of cost or estimated fair value less selling costs. At the date of transfer of a loan to REO, if it is estimated that the recorded investment in the asset will not be recovered, the Bank will either recognize a charge-off of unrecoverable amounts to the allowance for credit losses or set up a credit enhancement fee receivable if there are performance-based credit enhancement fees available for recapture. Subsequent gains and losses on REO are recorded in other (loss) income in the Statements of Income. REO is recorded as a component of "Other assets" in the Statements of Condition.


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Derivatives
All derivatives are recognized in the Statements of Condition at their fair values and reported as either “Derivative assets” or “Derivative liabilities,” net of cash collateral and accrued interest from counterparties. The fair values of derivatives are netted by counterparty pursuant to the provisions of the Bank's master netting arrangements. If these netted amounts are positive, they are classified as an asset and, if negative, they are classified as a liability. Cash flows associated with derivatives are reflected as cash flows from operating activities in the Statements of Cash Flows unless the derivative meets the criteria to be a financing derivative.
Derivative Designations. Each derivative is designated as one of the following:
•
a fair value hedge of an associated financial instrument or firm commitment; or
•
an economic hedge to manage certain defined risks in the Bank's Statements of Condition.
Accounting for Fair Value Hedges. If hedging relationships meet certain criteria, including, but not limited to, formal documentation of the hedging relationship and an expectation to be highly effective, they qualify for fair value hedge accounting and the offsetting changes in fair value of the hedged items are recorded in earnings. Two approaches to fair value hedge accounting include:
•
Long-haul hedge accounting. The application of long-haul hedge accounting requires the Bank to formally assess (both at the hedge's inception and at least quarterly) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value of hedged items due to benchmark interest rate changes and whether those derivatives are expected to remain effective in future periods.
•
Short-cut hedge accounting. Transactions that meet certain criteria qualify for short-cut hedge accounting in which an assumption can be made that the change in fair value of a hedged item due to changes in the benchmark interest rate exactly offsets the change in fair value of the related derivative. Under the short-cut method, the entire change in fair value of the interest rate swap is considered to be effective at achieving offsetting changes in fair value of the hedged asset or liability.

Derivatives are typically executed at the same time as the hedged item, and the Bank designates the hedged item in a fair value hedge relationship at the trade date. In many hedging relationships, the Bank may designate the hedging relationship upon its commitment to disburse an advance or trade a consolidated obligation in which settlement occurs within the shortest period of time possible for the type of instrument based on market settlement conventions. The Bank then records the changes in fair value of the derivative and the hedged item beginning on the trade date.

Changes in the fair value of a derivative that is designated as a fair value hedge, along with changes in the fair value of the hedged item, are recorded in other (loss) income as “Net loss on derivatives and hedging activities.” The amount by which the change in fair value of the derivative differs from the change in fair value of the hedged item is known as hedge ineffectiveness.
Accounting for Economic Hedges. An economic hedge is defined as a derivative hedging specific or non-specific underlying assets, liabilities, or firm commitments that does not qualify or was not designated for fair value hedge accounting, but is an acceptable hedging strategy under the Bank’s risk management program. Changes in the fair value of a derivative that is designated as an economic hedge are recorded in other (loss) income as “Net loss on derivatives and hedging activities” with no offsetting fair value adjustments for the underlying assets, liabilities, or firm commitments, unless changes in the fair value of the asset or liability are normally marked to fair value through earnings (e.g., trading securities and fair value option instruments). As a result, economic hedges introduce the potential for earnings variability.
Accrued Interest Receivables and Payables. The net settlements of interest receivables and payables related to derivatives designated as fair value hedges are recognized as adjustments to the interest income or interest expense of the designated hedged item. The net settlements of interest receivables and payables related to derivatives designated as economic hedges are recognized in other (loss) income as “Net loss on derivatives and hedging activities.”
Discontinuance of Hedge Accounting. The Bank discontinues fair value hedge accounting prospectively when either (i) it determines that the derivative is no longer effective in offsetting changes in the fair value of a hedged item due to changes in the benchmark interest rate, (ii) the derivative and/or the hedged item expires or is sold, terminated, or exercised, (iii) a hedged firm commitment no longer meets the definition of a firm commitment, or (iv) management determines that designating the derivative as a hedging instrument is no longer appropriate.

85

When fair value hedge accounting is discontinued, the Bank either terminates the derivative or continues to carry the derivative on the Statements of Condition at its fair value. For any remaining hedged item, the Bank ceases to adjust the hedged item for changes in fair value and amortizes the cumulative basis adjustment on the hedged item into earnings over the remaining contractual life of the hedged item using a level-yield methodology.

When fair value hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the Bank continues to carry the derivative on the Statements of Condition at its fair value, removing from the Statements of Condition any hedged item that was recorded to recognize the firm commitment and recording it as a gain or loss in current period earnings.

Embedded Derivatives. The Bank may issue debt, make advances, or purchase financial instruments in which a derivative instrument is “embedded.” Upon execution of these transactions, the Bank assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the debt, advance, or purchased financial instrument (the host contract) and whether a separate, non-embedded instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. If the Bank determines that the embedded derivative has economic characteristics that are not clearly and closely related to the economic characteristics of the host contract and a separate, stand-alone instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and designated as an economic derivative instrument. However, if the Bank elects to carry the entire contract (the host contract and the embedded derivative) at fair value in the Statements of Condition, changes in fair value of the entire contract will be reported in current period earnings.
Premises, Software, and Equipment
The Bank records premises, software, and equipment at cost less accumulated depreciation and amortization and computes depreciation using the straight-line method over the estimated useful lives of assets, which range from two to 15 years. The Bank amortizes leasehold improvements using the straight-line method over the shorter of the estimated useful life of the improvement or the remaining term of the lease. The Bank may capitalize improvements and major renewals but expenses ordinary maintenance and repairs when incurred. The Bank includes gains and losses on the disposal of premises, software, and equipment in other (loss) income.
Software. The cost of computer software developed or obtained for internal use is capitalized and amortized over future periods. At December 31, 2012 and 2011, the Bank had $5.0 million and $1.9 million in unamortized computer software costs. Amortization of computer software costs charged to expense was $1.5 million, $0.8 million, and $0.5 million for the years ended December 31, 2012, 2011, and 2010.
Accumulated Depreciation and Amortization. At December 31, 2012 and 2011, accumulated depreciation and amortization related to premises, software, and equipment was $10.4 million and $8.5 million.
Depreciation and Amortization Expense. For the years ended December 31, 2012, 2011, and 2010, the depreciation and amortization expense for premises, software, and equipment was $2.5 million, $2.1 million, and $1.9 million.
Consolidated Obligations
The Bank reports consolidated obligations at amortized cost, net of premiums, discounts, and fair value hedging adjustments unless the Bank has elected the fair value option, in which case, the consolidated obligations are carried at fair value.
Premiums and Discounts. The Bank amortizes/accretes premiums, discounts, and fair value hedging adjustments on consolidated obligations to interest expense using the level-yield method over the contractual life of the consolidated obligations.
Concessions. The Bank pays concessions to dealers in connection with the issuance of certain consolidated obligations. The Office of Finance prorates the amount of the concession to each FHLBank based upon the percentage of the debt issued that is assumed by the FHLBank. Concessions paid on consolidated obligations designated under the fair value option are expensed as incurred and recorded in other (loss) income. Concessions paid on consolidated obligations not designated under the fair value option are deferred and amortized over the contractual life of the consolidated obligations using the level-yield method. Unamortized concessions are included in “Other assets” in the Statements of Condition and the amortization of such concessions is included in consolidated obligation interest expense.

86

Mandatorily Redeemable Capital Stock
The Bank reclassifies capital stock subject to redemption from equity to a liability (mandatorily redeemable capital stock) at the time shares meet the definition of a mandatorily redeemable financial instrument. This occurs after a member provides written notice of redemption, gives notice of intention to withdraw from membership, or attains non-member status by merger or acquisition, charter termination, or other involuntary termination from membership. Shares meeting this definition are reclassified to a liability at fair value. Dividends on mandatorily redeemable capital stock are classified as interest expense in the Statements of Income. The repurchase or redemption of mandatorily redeemable capital stock is reflected as a cash outflow in the financing activities section of the Statements of Cash Flows.
If a member cancels its written notice of redemption or notice of withdrawal, the Bank will reclassify mandatorily redeemable capital stock from a liability to equity. After the reclassification, dividends on the capital stock will no longer be classified as interest expense.
Restricted Retained Earnings
In 2011, the 12 FHLBanks entered into a Joint Capital Enhancement Agreement (JCE Agreement), as amended. The intent of the JCE Agreement is to enhance the capital position of each FHLBank by allocating that portion of each FHLBank's earnings historically paid to satisfy the Resolution Funding Corporation (REFCORP) obligation to a separate restricted retained earnings account. Under the JCE Agreement, beginning in the third quarter of 2011, each FHLBank allocates 20 percent of its quarterly net income to a restricted retained earnings account until the balance of that account equals at least one percent of its average balance of outstanding consolidated obligations for the previous quarter. The restricted retained earnings are not available to pay dividends and are presented separately in the Bank's Statements of Condition.
Finance Agency Expenses
The FHLBanks are assessed for a portion of the costs of operating the Finance Agency. Each FHLBank is required to pay their pro-rata share of the annual assessment based on the ratio between each FHLBank's minimum required regulatory capital and the minimum required regulatory capital of all 12 FHLBanks.
Office of Finance Expenses
The Bank is assessed for a portion of the costs of operating the Office of Finance. Effective January 1, 2011, the Office of Finance allocates its operating and capital expenditures to the FHLBanks as follows: (i) two-thirds based on each FHLBank's share of total consolidated obligations outstanding and (ii) one-third based upon an equal pro-rata allocation.
Prior to January 1, 2011, the Office of Finance allocated its operating and capital expenditures to the FHLBanks based equally on each FHLBank's percentage of the following components: (i) capital stock, (ii) consolidated obligations issued, and (iii) consolidated obligations outstanding.
Assessments
Affordable Housing Program (AHP). The FHLBank Act requires each FHLBank to establish and fund an AHP, which provides subsidies in the form of direct grants and below-market interest rate advances to members who use the funds to assist in the purchase, construction, or rehabilitation of housing for very low to moderate income households. Annually, the FHLBanks must set aside for the AHP the greater of ten percent of their current year net earnings or their pro-rata share of an aggregate $100 million to be contributed in total by the FHLBanks. For purposes of the AHP assessment, net earnings is defined as net income before assessments, plus interest expense related to mandatorily redeemable capital stock, less the assessment for REFCORP, if applicable. The Bank may issue AHP advances at below-market interest rates. Discounts on AHP advances are accreted to advance interest income using the level-yield method over the contractual life of the advances. For additional information on the Bank's AHP, see "Note 14 — Affordable Housing Program."
Resolution Funding Corporation. Although the FHLBanks are exempt from all federal, state, and local taxation (except real property taxes), they were required to make quarterly payments to REFCORP through the second quarter of 2011, after which the obligation expired. These payments represented a portion of the interest on bonds that were issued by REFCORP. REFCORP is a corporation established by Congress in 1989 that provided funding for the resolution and disposition of insolvent savings institutions. For additional information on REFCORP, see "Note 15 — Resolution Funding Corporation."


87

Note 2 — Recently Adopted and Issued Accounting Guidance

Joint and Several Liability Arrangements

On February 28, 2013, the Financial Accounting Standards Board (FASB) issued guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date. Certain obligations (e.g., guarantees, including an individual FHLBank's guarantee related to the FHLBanks' consolidated obligations) are excluded from this guidance because they are addressed by other accounting guidance. This guidance is effective for interim and annual periods beginning on or after December 15, 2013 and should be applied retrospectively. This guidance is not expected to affect the Bank's financial condition, results of operations or cash flows.

Finance Agency Advisory Bulletin on Asset Classification

On April 9, 2012, the Finance Agency issued Advisory Bulletin 2012-02, Framework for Adversely Classifying Loans, Other Real Estate Owned, and Other Assets and Listing Assets for Special Mention (AB 2012-02). AB 2012-02 establishes a standard and uniform methodology for classifying assets and prescribes the timing of asset charge-offs, excluding investment securities. The guidance in AB 2012-02 is generally consistent with the Uniform Retail Credit Classification and Account Management Policy issued by the federal banking regulators in June 2000. AB 2012-02 states that it was effective upon issuance. However, the Finance Agency issued additional guidance that extends the effective date of AB 2012-02 to January 1, 2014. The Bank is currently assessing the provisions of AB 2012-02 and has not yet determined the effect that this guidance will have on its financial condition, results of operations, or cash flows.

Disclosures about Offsetting Assets and Liabilities

On December 16, 2011, the FASB and the International Accounting Standards Board (IASB) issued common disclosure requirements intended to help investors and other financial statement users better assess the effect or potential effect of offsetting arrangements on a company's financial position, whether a company's financial statements are prepared on the basis of GAAP or International Financial Reporting Standards (IFRS). This guidance was amended on January 31, 2013 to clarify that its scope includes only certain financial instruments that are either offset on the balance sheet or are subject to an enforceable master netting arrangement or similar agreement. An entity will be required to disclose both gross and net information about derivative, repurchase, and security lending instruments, which meet these criteria. This guidance, as amended, is effective for interim and annual periods beginning on January 1, 2013 and will be applied retrospectively for all comparative periods presented. The adoption of this guidance will result in increased interim and annual financial statement disclosures, but will not affect the Bank's financial condition, results of operations, or cash flows.

Presentation of Comprehensive Income

On June 16, 2011, the FASB issued guidance to increase the prominence of other comprehensive income in financial statements. This guidance requires an entity that reports items of other comprehensive income to present comprehensive income in either a single financial statement or in two consecutive financial statements. In a single continuous statement, an entity is required to present the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, as well as total comprehensive income. In a two-statement approach, an entity is required to present the components of net income and total net income in its statement of income. A statement of other comprehensive income should follow immediately and include the components of other comprehensive income as well as totals for both other comprehensive income and comprehensive income. This guidance eliminated the option to present the components of other comprehensive income in the statement of changes in stockholders' equity. The Bank elected the two-statement approach on January 1, 2012 and applied this guidance retrospectively for all periods presented. The adoption of this guidance was limited to the presentation of the Bank's interim and annual financial statements and did not affect its financial condition, results of operations, or cash flows.


88

On February 5, 2013, the FASB issued guidance to improve the transparency of reporting reclassifications out of accumulated other comprehensive income. This guidance does not change the current requirements for reporting net income or comprehensive income in financial statements. However, it does require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the financial statements where net income is presented or in the footnotes, significant amounts reclassified out of accumulated other comprehensive income. These amounts would be presented based on the respective lines of net income only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity would be required to cross-reference to other required disclosures that provide additional detail about these amounts. This guidance is effective for interim and annual periods beginning on January 1, 2013 and will be applied prospectively. The adoption of this guidance will result in increased interim and annual financial statement disclosures, but will not affect the Bank's financial condition, results of operations, or cash flows.

Fair Value Measurements and Disclosures

On May 12, 2011, the FASB and the IASB issued substantially converged guidance on fair value measurement and disclosure requirements. This guidance clarifies how fair value accounting should be applied where its use is already required or permitted by other guidance within GAAP or IFRS; these amendments do not require additional fair value measurements. This guidance generally represents clarifications to the application of existing fair value measurement and disclosure requirements, as well as some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This guidance became effective for the Bank on January 1, 2012 and was applied prospectively. The adoption of this guidance resulted in increased financial statement disclosures, but did not affect the Bank's financial condition, results of operations, or cash flows.

Reconsideration of Effective Control for Repurchase Agreements

On April 29, 2011, the FASB issued guidance to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. This guidance amends the existing criteria for determining whether or not a transferor has retained effective control over financial assets transferred under a repurchase agreement. A secured borrowing is recorded when effective control over the transferred financial assets is maintained, while a sale is recorded when effective control over the transferred financial assets has not been maintained. The new guidance removes from the assessment of effective control: (i) the criterion requiring the transferor to have the ability to repurchase or redeem financial assets before their maturity on substantially the agreed terms, even in the event of the transferee’s default, and (ii) the collateral maintenance implementation guidance related to that criterion. This guidance became effective for the Bank on January 1, 2012 and was applied prospectively to transactions or modifications of existing transactions occurring on or after that date. The Bank's adoption of this guidance did not affect its financial condition, results of operations, or cash flows.

Note 3 — Cash and Due from Banks
Compensating Balances
The Bank maintains collected cash balances with commercial banks in return for certain services. These arrangements contain no legal restrictions on the withdrawal of funds. Average collected cash balances were $123.8 million and $90.8 million for the years ended December 31, 2012 and 2011.

Effective July 12, 2012, the Federal Reserve eliminated its Contractual Clearing Balance Program. Prior to July 12, 2012, the Bank maintained average required balances with the Federal Reserve Bank of Chicago for this program. For the year ended December 31, 2011, these average required balances totaled $87.8 million.

Pass-Through Deposit Reserves

The Bank acts as a pass-through correspondent for certain member institutions required to deposit reserves with the Federal Reserve Bank of Chicago. At December 31, 2012 and 2011, pass-through deposit reserves amounted to $7.7 million and $7.1 million.


89

Note 4 — Trading Securities

Major Security Types

Trading securities were as follows (dollars in thousands):
 
December 31,
 
2012
 
2011
Non-mortgage-backed securities
 
 
 
Other U.S. obligations
$
309,540

 
$
8,521

GSE obligations
64,445

 
63,718

Temporary Liquidity Guarantee Program debentures
—

 
1,006,883

Other1
294,933

 
285,999

Total non-mortgage-backed securities
668,918

 
1,365,121

Mortgage-backed securities
 
 
 
GSE - residential
476,512

 
—

Total fair value
$
1,145,430

 
$
1,365,121


1
Consists of taxable municipal bonds.

Interest Rate Payment Terms

The following table summarizes the Bank's trading securities by interest rate payment terms (dollars in thousands):
 
December 31,
 
2012
 
2011
Fixed rate
$
1,145,430

 
$
659,626

Variable rate
—

 
705,495

Total fair value
$
1,145,430

 
$
1,365,121


Net Gain on Trading Securities

The following table summarizes the components of "Net gain on trading securities" as presented in the Statements of Income (dollars in thousands):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Net holding gain on trading securities
$
23,077

 
$
37,726

 
$
8,833

Net realized gain on sale of trading securities
—

 
973

 
28,587

Net gain on trading securities
$
23,077

 
$
38,699

 
$
37,420


The Bank did not sell any trading securities during the year ended December 31, 2012. During the year ended December 31, 2011, the Bank sold a trading security with a par value of $10.0 million and realized a gain of $1.0 million. During the year ended December 31, 2010, the Bank sold trading securities with a total par value of $3.0 billion and realized net gains of $28.6 million.


90

Note 5 — Available-for-Sale Securities

Major Security Types

AFS securities at December 31, 2012 were as follows (dollars in thousands):
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 

Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations
$
151,764

 
$
11,451

 
$
—

 
$
163,215

GSE obligations
509,941

 
46,637

 
(747
)
 
555,831

State or local housing agency obligations
8,351

 
50

 
—

 
8,401

Other2
391,814

 
8,596

 
—

 
400,410

Total non-mortgage-backed securities
1,061,870

 
66,734

 
(747
)
 
1,127,857

Mortgage-backed securities
 
 
 
 
 
 
 
GSE - residential
3,645,155

 
88,595

 
(1,801
)
 
3,731,949

Total
$
4,707,025

 
$
155,329

 
$
(2,548
)
 
$
4,859,806


AFS securities at December 31, 2011 were as follows (dollars in thousands):
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 

Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations
$
165,221

 
$
6,916

 
$
—

 
$
172,137

GSE obligations
509,793

 
46,973

 
(97
)
 
556,669

Temporary Liquidity Guarantee Program debentures
563,989

 
405

 
—

 
564,394

Other2
241,235

 
2,265

 
(721
)
 
242,779

Total non-mortgage-backed securities
1,480,238

 
56,559

 
(818
)
 
1,535,979

Mortgage-backed securities
 
 
 
 
 
 
 
GSE - residential
3,738,086

 
83,767

 
(2,268
)
 
3,819,585

Total
$
5,218,324

 
$
140,326

 
$
(3,086
)
 
$
5,355,564


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

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

Interest Rate Payment Terms

The following table summarizes the Bank's AFS securities by interest rate payment terms (dollars in thousands):
 
December 31,
 
2012
 
2011
Fixed rate
$
1,505,071

 
$
1,437,386

Variable rate
3,201,954

 
3,780,938

Total amortized cost
$
4,707,025

 
$
5,218,324



91

Unrealized Losses

The following table summarizes AFS securities with unrealized losses at December 31, 2012. The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE obligations
$
39,483

 
$
(357
)
 
$
22,095

 
$
(390
)
 
$
61,578

 
$
(747
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE - residential
154,914

 
(1,395
)
 
257,974

 
(406
)
 
412,888

 
(1,801
)
Total
$
194,397

 
$
(1,752
)
 
$
280,069

 
$
(796
)
 
$
474,466

 
$
(2,548
)

The following table summarizes AFS securities with unrealized losses at December 31, 2011. The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE obligations
$
—

 
$
—

 
$
22,942

 
$
(97
)
 
$
22,942

 
$
(97
)
Other
105,222

 
(721
)
 
—

 
—

 
105,222

 
(721
)
Total non-mortgage-backed securities
105,222

 
(721
)
 
22,942

 
(97
)
 
128,164

 
(818
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE - residential
115,477

 
(39
)
 
384,044

 
(2,229
)
 
499,521

 
(2,268
)
Total
$
220,699

 
$
(760
)
 
$
406,986

 
$
(2,326
)
 
$
627,685

 
$
(3,086
)

Redemption Terms

The following table summarizes the amortized cost and fair value of AFS securities categorized by contractual maturity (dollars in thousands). Expected maturities of some securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
 
 
December 31,
 
 
2012
 
2011
Year of Contractual Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
Due in one year or less
 
$
—

 
$
—

 
$
563,989

 
$
564,394

Due after one year through five years
 
314,601

 
332,189

 
157,805

 
169,702

Due after five years through ten years
 
542,448

 
583,674

 
356,277

 
392,426

Due after ten years
 
204,821

 
211,994

 
402,167

 
409,457

Total non-mortgage-backed securities
 
1,061,870

 
1,127,857

 
1,480,238

 
1,535,979

Mortgage-backed securities
 
3,645,155

 
3,731,949

 
3,738,086

 
3,819,585

Total
 
$
4,707,025

 
$
4,859,806

 
$
5,218,324

 
$
5,355,564


Prepayment Fees

During the year ended December 31, 2012, the Bank did not receive any prepayment fees on AFS securities. During the year ended December 31, 2011, an AFS MBS with an outstanding par value of $119.0 million was prepaid and the Bank received a $14.6 million prepayment fee. The prepayment fee was recorded as interest income on AFS securities in the Statements of Income. During the year ended December 31, 2010, the Bank did not receive any prepayment fees on AFS securities.


92

Net Gain on Sale of AFS Securities

During the year ended December 31, 2012, the Bank received $80.3 million in proceeds from the sale of AFS securities and recognized gross gains of $12.6 million. During the year ended December 31, 2011, the Bank did not sell any AFS securities. During the year ended December 31, 2010, the Bank sold an AFS security at par of $91.0 million and therefore recognized no gain or loss on the sale.

Note 6 — Held-to-Maturity Securities

Major Security Types

HTM securities at December 31, 2012 were as follows (dollars in thousands):
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
GSE obligations
$
308,496

 
$
86,601

 
$
—

 
$
395,097

State or local housing agency obligations
87,659

 
8,930

 
—

 
96,589

Other2
1,795

 
—

 
—

 
1,795

Total non-mortgage-backed securities
397,950

 
95,531

 
—

 
493,481

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations - residential
7,756

 
32

 
—

 
7,788

Other U.S. obligations - commercial
2,884

 
10

 
—

 
2,894

GSE - residential
2,590,195

 
63,902

 
(226
)
 
2,653,871

Private-label - residential
40,936

 
480

 
(1,321
)
 
40,095

Total mortgage-backed securities
2,641,771

 
64,424

 
(1,547
)
 
2,704,648

Total
$
3,039,721

 
$
159,955

 
$
(1,547
)
 
$
3,198,129

 
HTM securities at December 31, 2011 were as follows (dollars in thousands):
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Certificates of deposit
$
340,000

 
$
—

 
$
(36
)
 
$
339,964

GSE obligations
310,060

 
74,243

 
—

 
384,303

State or local housing agency obligations
101,547

 
7,897

 
—

 
109,444

Temporary Liquidity Guarantee Program debentures
1,250

 
7

 
—

 
1,257

Other2
1,196

 
—

 
—

 
1,196

Total non-mortgage-backed securities
754,053

 
82,147

 
(36
)
 
836,164

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations - residential
10,729

 
26

 
—

 
10,755

Other U.S. obligations - commercial
3,380

 
12

 
—

 
3,392

GSE - residential
4,378,340

 
108,604

 
(1,716
)
 
4,485,228

Private-label - residential
48,698

 
205

 
(4,421
)
 
44,482

Total mortgage-backed securities
4,441,147

 
108,847

 
(6,137
)
 
4,543,857

Total
$
5,195,200

 
$
190,994

 
$
(6,173
)
 
$
5,380,021


1
Amortized cost includes adjustments made to the cost basis of an investment for principal repayments, amortization, and accretion.

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


93

Interest Rate Payment Terms

The following table summarizes the Bank's HTM securities by interest rate payment terms (dollars in thousands):
 
December 31,
 
2012
 
2011
Fixed rate
$
1,982,168

 
$
3,741,246

Variable rate
1,057,553

 
1,453,954

Total amortized cost
$
3,039,721

 
$
5,195,200


Unrealized Losses

The following table summarizes the HTM securities with unrealized losses at December 31, 2012. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE - residential
$
—

 
$
—

 
$
156,945

 
$
(226
)
 
$
156,945

 
$
(226
)
Private-label - residential
—

 
—

 
26,277

 
(1,321
)
 
26,277

 
(1,321
)
Total mortgage-backed securities
$
—

 
$
—

 
$
183,222

 
$
(1,547
)
 
$
183,222

 
$
(1,547
)
 
The following table summarizes the HTM securities with unrealized losses at December 31, 2011. The unrealized losses are aggregated by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
$
339,964

 
$
(36
)
 
$
—

 
$
—

 
$
339,964

 
$
(36
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE - residential
—

 
—

 
326,162

 
(1,716
)
 
326,162

 
(1,716
)
Private-label - residential
—

 
—

 
26,118

 
(4,421
)
 
26,118

 
(4,421
)
Total mortgage-backed securities
—

 
—

 
352,280

 
(6,137
)
 
352,280

 
(6,137
)
Total
$
339,964

 
$
(36
)
 
$
352,280

 
$
(6,137
)
 
$
692,244

 
$
(6,173
)

Redemption Terms

The following table summarizes the amortized cost and fair value of HTM securities categorized by contractual maturity (dollars in thousands). Expected maturities of some securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
 
 
December 31,
 
 
2012
 
2011
Year of Contractual Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
Due in one year or less
 
$
—

 
$
—

 
$
341,250

 
$
341,221

Due after one year through five years
 
1,795

 
1,795

 
1,196

 
1,196

Due after ten years
 
396,155

 
491,686

 
411,607

 
493,747

Total non-mortgage-backed securities
 
397,950

 
493,481

 
754,053

 
836,164

Mortgage-backed securities
 
2,641,771

 
2,704,648

 
4,441,147

 
4,543,857

Total
 
$
3,039,721

 
$
3,198,129

 
$
5,195,200

 
$
5,380,021



94

Net Gain on Sale of HTM Securities

During the year ended December 31, 2012, the Bank sold an HTM security with a par value of $25.0 million and realized a gain of $1.0 million. During the year ended December 31, 2011, the Bank sold HTM securities with a total par value of $299.0 million and realized net gains of $7.2 million. The HTM securities sold in both 2012 and 2011 had less than 15 percent of the acquired principal outstanding at the time of sale. As such, the sales were considered maturities for purposes of security classification and did not impact the Bank's ability and intent to hold the remaining HTM securities through their stated maturities. During the year ended December 31, 2010, the Bank did not sell any HTM securities.

Note 7 — Other-Than-Temporary Impairment

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

Private-Label MBS

On a quarterly basis, the Bank engages other designated FHLBanks to perform cash flow analyses on its private-label MBS in order to determine whether the entire amortized cost bases of these securities are expected to be recovered. To ensure consistency in the determination of OTTI, an OTTI Governance Committee, comprised of representation from all 12 FHLBanks, is responsible for reviewing and approving the key modeling assumptions, inputs, and methodologies used by the designated FHLBanks when generating the cash flow projections.

As of December 31, 2012, the Bank obtained cash flow analyses for all of its private-label MBS from its designated FHLBanks. The cash flow analyses used two third-party models. The first third-party model considered borrower characteristics and the particular attributes of the loans underlying the Bank's securities, in conjunction with assumptions about future changes in home prices and interest rates, to project prepayments, defaults, and loss severities. A significant input to the first model was the forecast of future housing price changes for the relevant states and core based statistical areas (CBSAs), which is based upon an assessment of the individual housing markets. CBSAs refer collectively to metropolitan and micropolitan statistical areas as defined by the U.S. Office of Management and Budget. A CBSA must contain at least one urban area with a population of 10,000 or more people. For the vast majority of housing markets, the housing price forecast as of December 31, 2012 assumed home price changes for the fourth quarter of 2012 ranging from declines of two percent to increases of two percent. Beginning January 1, 2013, home prices in these markets were projected to recover (or continue to recover) using one of four different recovery paths that vary by housing market.

The following table presents projected home price recovery by months at December 31, 2012:
 
 
Recovery Range % (Annualized Rates)
Months
 
Minimum
 
Maximum
1 - 6
 
0.0
 
2.8
7 - 12
 
0.0
 
3.0
13 - 18
 
1.0
 
3.0
19 - 30
 
2.0
 
4.0
31 - 42
 
2.8
 
5.0
43 - 66
 
2.8
 
6.0
Thereafter
 
2.8
 
5.6


95

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

The Bank compared the present value of the cash flows expected to be collected with respect to its private-label MBS to the amortized cost bases of the securities to determine whether a credit loss existed. At December 31, 2012 and 2011, the Bank's cash flow analyses for private-label MBS did not project any credit losses. Even under an adverse scenario that delays recovery of the housing price index, no credit losses were projected. The Bank does not intend to sell its private-label MBS and it is not more likely than not that the Bank will be required to sell its private-label MBS before recovery of their amortized cost bases. As a result, the Bank did not consider any of its private-label MBS to be other-than-temporarily impaired at December 31, 2012 and 2011.

All Other Investment Securities

On a quarterly basis, the Bank reviews all remaining AFS and HTM securities in an unrealized loss position. At December 31, 2012 and 2011, the Bank determined that the unrealized losses on these securities were due primarily to interest rate volatility. Because the Bank expects to recover the amortized cost bases on these securities and neither intends to sell these securities nor considers it more likely than not that it will be required to sell these securities before recovery of their amortized cost bases, it did not consider any of its other investment securities to be other-than-temporarily impaired at December 31, 2012 and 2011.

In addition, the Bank determined the following for its other investment securities in an unrealized loss position at December 31, 2012 and 2011:

•
GSE securities. The strength of the issuers' guarantees through direct obligations or support from the U.S. Government was sufficient to protect the Bank from losses based on current expectations.

•
Certificates of deposit. The creditworthiness of the issuers was sufficient to protect the Bank from losses based on current expectations.

•
Other - Taxable municipal bonds. The creditworthiness of the issuers and the strength of the underlying collateral and credit enhancements were sufficient to protect the Bank from losses based on current expectations.


96

Note 8 — Advances

The Bank offers a wide range of fixed and variable rate advance products with different maturities, interest rates, payment characteristics, and optionality. Fixed rate advances generally have maturities ranging from overnight to 20 years. Variable rate advances generally have maturities ranging from 1 year to 20 years, where the interest rates reset periodically to a specified interest rate index such as London Interbank Offered Rate (LIBOR). At December 31, 2012 and 2011, the Bank had advances outstanding with interest rates ranging from 0.20 percent to 8.25 percent.

Redemption Terms

The following table summarizes the Bank's advances outstanding by year of contractual maturity (dollars in thousands):
 
 
December 31,
 
 
2012
 
2011
Year of Contractual Maturity
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Overdrawn demand deposit accounts
 
$
35

 
3.32
 
$
397

 
3.39
Due in one year or less
 
10,306,571

 
1.03
 
6,156,242

 
1.42
Due after one year through two years
 
1,900,515

 
1.59
 
5,640,451

 
1.78
Due after two years through three years
 
2,289,104

 
1.62
 
1,175,120

 
2.53
Due after three years through four years
 
2,096,668

 
2.34
 
1,744,798

 
2.20
Due after four years through five years
 
2,893,016

 
2.49
 
3,057,813

 
2.95
Thereafter
 
6,568,855

 
1.58
 
7,888,017

 
2.62
Total par value
 
26,054,764

 
1.53
 
25,662,838

 
2.15
Premiums
 
169

 
 
 
186

 
 
Discounts
 
(3,247
)
 
 
 
(1
)
 
 
Fair value hedging adjustments
 
562,229

 
 
 
928,000

 
 
Total
 
$
26,613,915

 
 
 
$
26,591,023

 
 

The following table summarizes advances at December 31, 2012 and 2011, by year of contractual maturity or next call date for callable advances, and by year of contractual maturity or next put date for putable advances (dollars in thousands):
 
 
Year of Contractual Maturity
or Next Call Date
 
Year of Contractual Maturity
or Next Put Date
 
 
2012
 
2011
 
2012
 
2011
Overdrawn demand deposit accounts
 
$
35

 
$
397

 
$
35

 
$
397

Due in one year or less
 
14,848,959

 
11,196,078

 
12,913,471

 
9,256,042

Due after one year through two years
 
1,982,005

 
4,533,270

 
1,885,515

 
5,455,551

Due after two years through three years
 
2,302,694

 
1,243,768

 
2,215,104

 
1,160,120

Due after three years through four years
 
1,593,463

 
1,735,818

 
1,813,868

 
1,609,798

Due after four years through five years
 
2,346,809

 
2,162,776

 
1,794,016

 
2,710,013

Thereafter
 
2,980,799

 
4,790,731

 
5,432,755

 
5,470,917

Total par value
 
$
26,054,764

 
$
25,662,838

 
$
26,054,764

 
$
25,662,838


The Bank offers advances to members and eligible housing associates that may be prepaid on pertinent dates (call dates) without incurring prepayment fees (callable advances). In exchange for receiving the right to call the advance on a predetermined call date, the borrower pays a higher fixed rate for the advance relative to an equivalent maturity, noncallable, fixed rate advance. If the call option is exercised, replacement funding may be available. Other advances may only be prepaid by paying a fee to the Bank (prepayment fee) that makes the Bank financially indifferent to the prepayment of the advance. At December 31, 2012 and 2011, the Bank had callable advances outstanding totaling $5.7 billion and $5.6 billion.

The Bank also offers putable advances. With a putable advance, the Bank has the right to terminate the advance at predetermined exercise dates, which the Bank typically would exercise when interest rates increase, and the borrower may then apply for a new advance at the prevailing market rate. At December 31, 2012 and 2011, the Bank had putable advances outstanding totaling $2.9 billion and $3.7 billion.


97

Interest Rate Payment Terms

The following table summarizes the Bank's advances by interest rate payment terms and contractual maturity (dollars in thousands):
 
December 31,
 
2012
 
2011
Fixed rate
 
 
 
Due in one year or less
$
7,824,471

 
$
5,466,192

Due after one year
9,430,132

 
12,493,214

Total fixed rate
17,254,603

 
17,959,406

Variable rate
 
 
 
Due in one year or less
2,482,135

 
690,447

Due after one year
6,318,026

 
7,012,985

Total variable rate
8,800,161

 
7,703,432

Total par value
$
26,054,764

 
$
25,662,838


Prepayment Fees

The Bank charges a prepayment fee for advances that a borrower elects to terminate prior to the stated maturity or outside of a predetermined call or put date. The fees charged are priced to make the Bank financially indifferent to the prepayment of the advance. These prepayment fees are recorded net of fair value hedging adjustments and deferrals on advance modifications through "Prepayment fees on advances, net" in the Statements of Income.

The following table summarizes the Bank's prepayment fees on advances, net (dollars in thousands):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Gross prepayment fees
$
374,744

 
$
19,084

 
$
241,365

Amortization of fair value hedging adjustments1
(347,544
)
 
(8,901
)
 
(67,608
)
Amortization of deferrals on advance modifications
891

 
510

 
229

Prepayment fees on advances, net
$
28,091

 
$
10,693

 
$
173,986


1
When an advance prepays, the Bank terminates the hedge relationship and fully amortizes the remaining basis adjustment through earnings. The increase in basis adjustment amortization on advance prepayments in 2012 was primarily due to one member prepaying certain advances during the first quarter.

For information related to the Bank's credit risk exposure on advances, refer to "Note 10 — Allowance for Credit Losses."

Note 9 — Mortgage Loans Held for Portfolio

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


98

Mortgage loans with a contractual maturity of 15 years or less are classified as medium-term, and all other mortgage loans are classified as long-term.

The following table presents information on the Bank's mortgage loans held for portfolio (dollars in thousands):
 
December 31,
 
2012
 
2011
Fixed rate, medium-term single family mortgages
$
1,880,646

 
$
1,795,914

Fixed rate, long-term single family mortgages
5,005,194

 
5,308,476

Total unpaid principal balance
6,885,840

 
7,104,390

Premiums
86,112

 
70,844

Discounts
(21,277
)
 
(30,666
)
Basis adjustments from mortgage loan commitments
16,928

 
12,365

Total mortgage loans held for portfolio
6,967,603

 
7,156,933

Allowance for credit losses
(15,793
)
 
(18,963
)
Total mortgage loans held for portfolio, net
$
6,951,810

 
$
7,137,970


The following table presents the Bank's mortgage loans held for portfolio by type (dollars in thousands):
 
December 31,
 
2012
 
2011
Conventional loans
$
6,372,542

 
$
6,678,048

Government-insured loans
513,298

 
426,342

Total unpaid principal balance
$
6,885,840

 
$
7,104,390

    
For information related to the Bank's credit risk exposure on mortgage loans held for portfolio, refer to "Note 10 — Allowance for Credit Losses."

Note 10 — Allowance for Credit Losses

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

Credit Products

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

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


99

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

Borrowers may pledge collateral to the Bank by executing a blanket lien, specifically assigning collateral, or placing physical possession of collateral with the Bank or its custodians. The Bank perfects its security interest in all pledged collateral by filing Uniform Commercial Code financing statements or taking possession or control of the collateral. Under the FHLBank Act, any security interest granted to the Bank by its members, or any affiliates of its members, has priority over the claims and rights of any party (including any receiver, conservator, trustee, or similar party having rights of a lien creditor), unless those claims and rights would be entitled to priority under otherwise applicable law and are held by actual purchasers or by parties that have perfected security interests.
Under a blanket lien, the Bank is granted a security interest in all financial assets of the borrower to fully secure the borrower's obligation. Other than securities and cash deposits, the Bank does not initially take delivery of collateral pledged by blanket lien borrowers. In the event of deterioration in the financial condition of a blanket lien borrower, the Bank has the ability to require delivery of pledged collateral sufficient to secure the borrower's obligation. With respect to non-blanket lien borrowers that are federally insured, the Bank generally requires collateral to be specifically assigned. With respect to non-blanket lien borrowers that are not federally insured (typically insurance companies, CDFIs, and housing associates), the Bank generally takes control of collateral through the delivery of cash, securities, or loans to it or its custodians.
Taking into consideration each borrower's financial strength, the Bank considers the types and level of collateral to be the primary indicator of credit quality on its credit products. At December 31, 2012 and 2011, the Bank had rights to collateral on a borrower-by-borrower basis with an unpaid principal balance or market value, if available, in excess of its outstanding extensions of credit.

At December 31, 2012 and 2011, none of the Bank's credit products were past due, on non-accrual status, or considered impaired. In addition, none of the Bank's credit products were TDRs at December 31, 2012 and 2011.

Based upon the Bank's collateral and lending policies, the collateral held as security, and the repayment history on credit products, management has determined that there are no probable credit losses on its credit products as of December 31, 2012 and 2011. Accordingly, the Bank has not recorded any allowance for credit losses.

Government-Insured Mortgage Loans

The Bank invests in government-insured fixed rate mortgage loans secured by one-to-four family residential properties. Government-insured mortgage loans are insured by the Federal Housing Administration, the Department of Veterans Affairs, and/or the Rural Housing Service of the Department of Agriculture. The servicer provides and maintains insurance or a guaranty from the applicable government agency. The servicer is responsible for compliance with all government agency requirements and for obtaining the benefit of the applicable insurance or guaranty with respect to defaulted government mortgage loans. Any principal losses incurred on such mortgage loans that are not recovered from the guarantor are absorbed by the servicers. As a result, the Bank did not establish an allowance for credit losses for its government-insured mortgage loans at December 31, 2012 and 2011. Furthermore, none of these mortgage loans have been placed on non-accrual status because of the U.S. Government guarantee or insurance on these loans and the contractual obligation of the loan servicer to repurchase the loans when certain criteria are met.


100

Conventional Mortgage Loans

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

•
Homeowner Equity.

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

•
First Loss Account. The first loss account (FLA) is a memorandum account used to track the Bank's potential loss exposure under each master commitment prior to the PFI's credit enhancement obligation. For absorbing certain losses in excess of the FLA, PFIs are paid a credit enhancement fee, a portion of that may be performance-based. The Bank records credit enhancement fees paid to PFIs as a reduction to mortgage loan interest income. Credit enhancement fees paid totaled $7.4 million, $10.0 million, and $11.6 million during the years ended December 31, 2012, 2011, and 2010. To the extent the Bank experiences losses under the FLA, it may be able to recapture performance-based credit enhancement fees paid to the PFI to offset these losses. The FLA balance for all master commitments was $126.0 million and $124.4 million at December 31, 2012 and 2011.

•
Credit Enhancement Obligation of PFI. PFIs have a credit enhancement obligation at the time a mortgage loan is purchased to absorb certain losses in excess of the FLA in order to limit the Bank's loss exposure to that of an investor in an MBS that is rated the equivalent of AA by an NRSRO. PFIs may either pledge collateral or purchase SMI from mortgage insurers to secure this obligation. If at any time the Bank cancels all or a portion of its SMI policies, the respective PFI is no longer required to retain a portion of the credit risk on the mortgage loans purchased by the Bank. In those instances, the Bank holds additional retained earnings to mitigate its exposure to credit risk and no credit enhancement fees are paid to the PFI.

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

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

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

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


101

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

Available performance-based credit enhancement fees cannot be shared between master commitments and, as a result, some master commitments may have sufficient performance-based credit enhancement fees to recapture losses while other master commitments may not. At December 31, 2012, the Bank determined that the amount of performance-based credit enhancement fees available for recapture from the PFIs at the master commitment level was immaterial. As such, it did not factor credit enhancement fees into its estimate of the allowance for credit losses.

The following table shows the impact of performance-based credit enhancement fees available for recapture on the Bank's estimate of the allowance for credit losses (dollars in thousands):
 
December 31,
 
2012
 
2011
Estimate of credit losses before performance-based credit enhancement fees
$
15,793

 
$
19,549

Less: Performance-based credit enhancement fees available for recapture
—

 
(586
)
Allowance for credit losses
$
15,793

 
$
18,963


Allowance for Credit Losses on Conventional Mortgage Loans.

The following table presents a rollforward of the allowance for credit losses on the Bank's conventional mortgage loan portfolio (dollars in thousands):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Balance, beginning of year
$
18,963

 
$
13,000

 
$
1,887

Charge-offs
(3,170
)
 
(3,192
)
 
(1,005
)
Provision for credit losses
—

 
9,155

 
12,118

Balance, end of year
$
15,793

 
$
18,963

 
$
13,000


The following table summarizes the allowance for credit losses and recorded investment of the Bank's conventional mortgage loan portfolio by impairment methodology (dollars in thousands):
 
December 31,
 
2012
 
2011
Allowance for credit losses
 
 
 
Collectively evaluated for impairment
$
5,444

 
$
6,431

Individually evaluated for impairment
10,349

 
12,532

Total allowance for credit losses
$
15,793

 
$
18,963

Recorded investment1
 
 
 
Collectively evaluated for impairment
$
6,415,718

 
$
6,690,878

Individually evaluated for impairment, with or without a related allowance
59,344

 
68,825

Total recorded investment
$
6,475,062

 
$
6,759,703


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


102

Credit Quality Indicators. Key credit quality indicators for mortgage loans include the migration of past due loans, loans in process of foreclosure, and non-accrual loans.

The tables below summarize the Bank's key credit quality indicators for mortgage loans (dollar amounts in thousands):
 
December 31, 2012
 
Conventional
 
Government Insured
 
Total
Past due 30 - 59 days
$
77,568

 
$
17,582

 
$
95,150

Past due 60 - 89 days
24,809

 
4,849

 
29,658

Past due 90 -179 days
21,483

 
2,193

 
23,676

Past due 180 days or more
64,920

 
3,099

 
68,019

Total past due loans
188,780

 
27,723

 
216,503

Total current loans
6,286,282

 
500,112

 
6,786,394

Total recorded investment of mortgage loans1
$
6,475,062

 
$
527,835

 
$
7,002,897

 
 
 
 
 
 
In process of foreclosure (included above)2
$
56,692

 
$
878

 
$
57,570

Serious delinquency rate3
1.4
%
 
1.0
%
 
1.3
%
Past due 90 days or more and still accruing interest4
$
—

 
$
5,292

 
$
5,292

Non-accrual mortgage loans5
$
88,992

 
$
—

 
$
88,992


 
December 31, 2011
 
Conventional
 
Government Insured
 
Total
Past due 30 - 59 days
$
90,394

 
$
15,706

 
$
106,100

Past due 60 - 89 days
28,823

 
4,731

 
33,554

Past due 90 -179 days
26,154

 
1,982

 
28,136

Past due 180 days or more
70,177

 
2,445

 
72,622

Total past due loans
215,548

 
24,864

 
240,412

Total current loans
6,544,155

 
411,251

 
6,955,406

Total recorded investment of mortgage loans1
$
6,759,703

 
$
436,115

 
$
7,195,818

 
 
 
 
 
 
In process of foreclosure (included above)2
$
67,679

 
$
766

 
$
68,445

Serious delinquency rate3
1.4
%
 
1.0
%
 
1.4
%
Past due 90 days or more and still accruing interest4
$
—

 
$
4,427

 
$
4,427

Non-accrual mortgage loans5
$
97,477

 
$
—

 
$
97,477


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

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

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

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

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


103

Individually Evaluated Impaired Loans. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Bank considers all TDRs and collateral-dependent loans (i.e., loans in which repayment is expected to be provided solely by the sale of the underlying collateral) to be impaired.

The following table summarizes the recorded investment and related allowance of the Bank's individually evaluated impaired loans (dollars in thousands):
 
December 31,
 
2012
 
2011
 
Recorded Investment
 
Related Allowance
 
Recorded Investment
 
Related Allowance
Impaired loans with an allowance
$
58,145

 
$
10,349

 
$
68,107

 
$
12,532

Impaired loans without an allowance
1,199

 
—

 
718

 
—

Total
$
59,344

 
$
10,349

 
$
68,825

 
$
12,532


The Bank did not recognize any interest income on impaired loans during the years ended December 31, 2012 and 2011. The average recorded investment on impaired loans with an allowance was $63.5 million and $5.7 million during the years ended December 31, 2012 and 2011. The average recorded investment on impaired loans without an allowance was $0.8 million and $0.1 million during the years ended December 31, 2012 and 2011.

Real Estate Owned. At December 31, 2012 and 2011, the Bank had $16.4 million and $18.3 million of REO recorded as a component of "Other assets" in the Statements of Condition.

Term Securities Purchased Under Agreements to Resell

Term securities purchased under agreements to resell are considered collateralized financing agreements and represent short-term investments with investment-grade counterparties. The terms of these investments are structured such that if the market value of the underlying securities decreases below the market value required as collateral, the counterparty must place an equivalent amount of additional securities in safekeeping in the name of the Bank or remit an equivalent amount of cash. Otherwise, the dollar value of the resale agreement will decrease accordingly. If a resale agreement is deemed impaired, the difference between the fair value of the collateral and the amortized cost of the agreement will be charged to earnings. At December 31, 2012 and 2011, based upon the collateral held as security, the Bank determined that no allowance for credit losses was needed for term securities purchased under agreements to resell.

Term Federal Funds Sold

The Bank may invest in term Federal funds sold with investment-grade counterparties. These investments are generally short-term and their carrying value approximates fair value. If term Federal funds sold are not paid when due, the Bank will evaluate whether or not an allowance for credit losses is necessary. As of December 31, 2012, the Bank did not own any term Federal funds sold. At December 31, 2011, all investments in term Federal funds sold were repaid or expected to be repaid according to their contractual terms. As a result, the Bank determined that no allowance for credit losses was needed for term Federal funds sold.

Off-Balance Sheet Credit Exposures

At December 31, 2012 and 2011, the Bank did not record a liability to reflect an allowance for credit losses for off-balance sheet credit exposures. For additional information on the Bank's off-balance sheet credit exposure, see "Note 19 — Commitments and Contingencies."


104

Note 11 — Derivatives and Hedging Activities

Nature of Business Activity

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

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

The most common ways in which the Bank uses derivatives are to:
 
•
reduce the interest rate sensitivity and repricing gaps of assets and liabilities;

•
reduce funding costs by combining a derivative with a consolidated obligation, as the cost of a combined funding structure can be lower than the cost of a comparable consolidated obligation;

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

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

•
manage embedded options in assets and liabilities.

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

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

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


105

Types of Derivatives

The Bank may use the following derivative instruments:

•
Interest Rate Swaps. An interest rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional amount at a predetermined fixed rate for a given period of time. In return for this promise, this party receives cash flows equivalent to the interest on the same notional amount at a variable interest rate index for the same period of time. The variable interest rate received or paid by the Bank in most derivative agreements is the LIBOR.

•
Swaptions. A swaption is an option on a swap that gives the buyer the right to enter into a specified interest rate swap at a certain time in the future. When used as a hedge, a swaption can protect the Bank against future interest rate changes. The Bank may purchase both payer and receiver swaptions. A payer swaption is the option to make fixed interest payments at a later date and a receiver swaption is the option to receive fixed interest payments at a later date.

•
Interest Rate Caps and Floors. In an interest rate cap agreement, a cash flow is generated if the price or interest rate of an underlying variable rises above a certain threshold (or “cap”) price. In an interest rate floor agreement, a cash flow is generated if the price or interest rate of an underlying variable falls below a certain threshold (or “floor”) price. Interest rate caps and floors are designed as protection against the interest rate on a variable rate asset or liability falling below or rising above a certain level.
 
•
Options. An option is an agreement between two entities that conveys the right, but not the obligation, to engage in a future transaction on some underlying security or other financial asset at an agreed upon price during a certain period of time or on a specific date. Premiums or swap fees paid to acquire options are considered the fair value of the option at inception of the hedge and are reported in “Derivative assets” or “Derivative liabilities” in the Statements of Condition.

•
Futures/Forwards Contracts. The Bank may use futures and forward contracts to hedge interest rate risk. For example, certain mortgage purchase commitments entered into by the Bank are considered derivatives. The Bank may hedge these commitments by selling “to-be-announced” (TBA) MBS for forward settlement. A TBA represents a forward contract for the sale of MBS at a future agreed upon date for an established price.

Types of Hedged Items

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


106

The following are types of hedged items:

•
Advances. The Bank offers a wide range of fixed and variable rate advance products with different maturities, interest rates, payment characteristics, and optionality. The Bank may use derivatives to adjust the repricing and/or option characteristics of advances in order to more closely match the characteristics of its funding liabilities. In general, whenever a borrower executes a fixed rate advance or a variable rate advance with embedded options, the Bank will simultaneously execute a derivative with terms that offset the terms and embedded options, if any, in the advance. For example, the Bank may hedge a fixed rate advance with an interest rate swap where the Bank pays a fixed rate coupon and receives a variable rate coupon, effectively converting the fixed rate advance to a variable rate advance. This type of hedge is typically treated as a fair value hedge. In addition, the Bank may hedge a putable advance, which gives the borrower the option to put or extinguish the fixed rate advance, by entering into a cancelable interest rate swap.

•
Investment Securities. The Bank primarily invests in other U.S. obligations, GSE obligations, state or local housing agency obligations, and MBS, and classifies them as either trading, AFS, or HTM. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and derivatives. The Bank may fund investment securities with callable consolidated obligations or utilize interest rate swaps, caps, floors, or swaptions to manage interest rate and prepayment risk. The Bank manages the risk arising from changing market prices of trading securities by entering into economic derivatives that generally offset the changes in fair value of the securities. The fair value changes of both the trading securities and the associated derivatives are included in other (loss) income as “Net gain on trading securities” and “Net loss on derivatives and hedging activities.” The Bank manages the risk arising from changing market prices on AFS securities by entering into fair value derivatives that generally offset the changes in fair value of the securities. The Bank records the portion of the change in fair value related to the risk being hedged together with the related change in fair value of the derivative through other (loss) income as “Net loss on derivatives and hedging activities.” The Bank records the remainder of the change in fair value through accumulated other comprehensive income as “Net unrealized gain on available-for-sale securities.”
       
•
Mortgage Loans. The Bank invests in fixed rate mortgage loans. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected repayment of these investments, depending on changes in actual and estimated prepayment speeds. The Bank manages the interest rate and prepayment risk associated with mortgage loans through a combination of debt issuance and derivatives. The Bank may issue both callable and noncallable debt and prepayment-linked consolidated obligations to achieve cash flow patterns and liability durations similar to those expected on the mortgage loans. The Bank may also purchase interest rate caps, floors, or swaptions to minimize the interest rate risk, including prepayment risk, embedded in mortgage assets. Although these derivatives are valid economic hedges, they are not specifically linked to individual mortgage assets and, therefore, do not receive fair value hedge accounting. These derivatives are recorded through earnings with no offsetting hedged item fair value adjustment. As a result, they introduce the potential for earnings variability.
  
•
Consolidated Obligations. The Bank may enter into derivatives to hedge the interest rate risk associated with its consolidated obligations. For example, the Bank may issue and hedge a fixed rate consolidated obligation with an interest rate swap where the Bank receives a fixed rate coupon and pays a variable rate coupon, effectively converting the fixed rate consolidated obligation to a variable rate consolidated obligation. This type of hedge is typically treated as a fair value hedge. The Bank may also issue variable interest rate consolidated obligations indexed to LIBOR, the U.S. Prime rate, or the Federal funds rate and simultaneously execute interest rate swaps to hedge the basis risk of the variable interest rate debt. Interest rate swaps used to hedge the basis risk of variable interest rate debt do not qualify for hedge accounting. As a result, this type of hedge is treated as an economic hedge. This strategy of issuing consolidated obligations while simultaneously entering into derivatives enables the Bank to offer a wider range of attractively priced advances to its borrowers and may allow the Bank to reduce its funding costs.
  
•
Firm Commitments. Certain mortgage purchase commitments are considered derivatives. The Bank normally hedges these commitments by selling TBA MBS for forward settlement. A TBA represents a forward contract for the sale of MBS at a future agreed upon date for an established price. The mortgage purchase commitment and the TBA used in the firm commitment hedging strategy (economic hedge) are recorded as a derivative asset or derivative liability at fair value, with changes in fair value recognized in current period earnings. When the mortgage purchase commitment derivative settles, the current market value of the commitment is included with the basis of the mortgage loan and amortized over the contractual life of the mortgage loan using the level-yield method.


107

Financial Statement Effect and Additional Financial Information

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

The following tables summarize the Bank's fair value of derivative instruments (dollars in thousands). For purposes of this disclosure, the derivative values include fair value of derivatives and related accrued interest.
 
 
December 31, 2012
Fair Value of Derivative Instruments
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
Derivatives designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
$
23,648,999

 
$
118,157

 
$
604,525

Derivatives not designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
4,368,562

 
32,702

 
71,330

Interest rate caps
 
3,450,000

 
2,868

 
—

Forward settlement agreements (TBAs)
 
93,500

 
58

 
128

Mortgage delivery commitments
 
96,220

 
104

 
54

Total derivatives not designated as hedging instruments
 
8,008,282

 
35,732

 
71,512

Total derivatives before netting and collateral adjustments
 
$
31,657,281

 
153,889

 
676,037

Netting adjustments
 
 
 
(146,474
)
 
(146,474
)
Cash collateral and related accrued interest
 
 
 
(3,602
)
 
(428,863
)
Total netting adjustments and cash collateral1
 
 
 
(150,076
)
 
(575,337
)
Derivative assets and liabilities
 
 
 
$
3,813

 
$
100,700


 
 
December 31, 2011
Fair Value of Derivative Instruments
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
Derivatives designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
$
29,869,150

 
$
202,729

 
$
944,514

Derivatives not designated as hedging instruments
 
 
 
 
 
 
Interest rate swaps
 
7,562,011

 
3,587

 
68,169

Interest rate caps
 
3,450,000

 
15,948

 
—

Forward settlement agreements (TBAs)
 
90,500

 
—

 
647

Mortgage delivery commitments
 
89,971

 
543

 
73

Total derivatives not designated as hedging instruments
 
11,192,482

 
20,078

 
68,889

Total derivatives before netting and collateral adjustments
 
$
41,061,632

 
222,807

 
1,013,403

Netting adjustments
 
 
 
(221,355
)
 
(221,355
)
Cash collateral and related accrued interest
 
 
 
—

 
(675,242
)
Total netting adjustments and cash collateral1
 
 
 
(221,355
)
 
(896,597
)
Derivative assets and liabilities
 
 
 
$
1,452

 
$
116,806


1
Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same counterparties.


108

The following table summarizes the components of “Net loss on derivatives and hedging activities” as presented in the Statements of Income (dollars in thousands):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Derivatives designated as hedging instruments
 
 
 
 
 
Interest rate swaps
$
1,707

 
$
10,848

 
$
4,680

Derivatives not designated as hedging instruments
 
 
 
 
 
Interest rate swaps
2,450

 
(54,503
)
 
(50,509
)
Interest rate caps and floors
(13,080
)
 
(67,073
)
 
(13,122
)
Forward settlement agreements (TBAs)
(13,242
)
 
(9,738
)
 
(6,126
)
Mortgage delivery commitments
9,247

 
8,891

 
5,264

Net interest settlements
(11,929
)
 
744

 
7,224

Total net loss related to derivatives not designated as hedging instruments
(26,554
)
 
(121,679
)
 
(57,269
)
Net loss on derivatives and hedging activities
$
(24,847
)
 
$
(110,831
)
 
$
(52,589
)

The following tables summarize, by type of hedged item, the gain (loss) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the Bank's net interest income (dollars in thousands):

 
 
For the Year Ended December 31, 2012
Hedged Item Type
 
(Loss) Gain on
Derivatives
 
Gain (Loss) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
(9,575
)
 
$
10,676

 
$
1,101

 
$
(12,730
)
Advances
 
(7,222
)
 
10,628

 
3,406

 
(195,719
)
Bonds
 
31,922

 
(34,722
)
 
(2,800
)
 
123,918

Total
 
$
15,125

 
$
(13,418
)
 
$
1,707

 
$
(84,531
)

 
 
For the Year Ended December 31, 2011
Hedged Item Type
 
(Loss) Gain on
Derivatives
 
Gain (Loss) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
(43,164
)
 
$
40,465

 
$
(2,699
)
 
$
(11,753
)
Advances
 
(202,666
)
 
211,186

 
8,520

 
(313,845
)
Bonds
 
80,681

 
(75,654
)
 
5,027

 
265,148

Total
 
$
(165,149
)
 
$
175,997

 
$
10,848

 
$
(60,450
)

 
 
For the Year Ended December 31, 2010
Hedged Item Type
 
(Loss) Gain on
Derivatives
 
Gain (Loss) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
(1,359
)
 
$
2,926

 
$
1,567

 
$
(7,132
)
Advances
 
(125,593
)
 
130,590

 
4,997

 
(392,278
)
Bonds
 
61,929

 
(63,813
)
 
(1,884
)
 
335,918

Total
 
$
(65,023
)
 
$
69,703

 
$
4,680

 
$
(63,492
)

1
The net interest on derivatives in fair value hedge relationships is presented in the interest income/expense line item of the respective hedged item.

109

Managing Credit Risk on Derivatives

The Bank is subject to credit risk due to nonperformance by counterparties to the derivative contracts. The degree of counterparty credit risk depends on the extent to which collateral agreements are included in such contracts to mitigate the risk. The Bank manages counterparty credit risk through credit analyses, collateral requirements, and adherence to the requirements set forth in Bank policies and Finance Agency regulations. The Bank requires collateral agreements on all derivative contracts that establish collateral delivery thresholds. Based on credit analyses and collateral requirements, the Bank does not anticipate any credit losses on its derivatives at December 31, 2012. See "Note 18 — Fair Value" for a discussion on the Bank's fair value methodology for derivatives.

The following table presents the Bank's credit risk exposure to derivative instruments (dollars in thousands):
 
December 31,
 
2012
 
2011
Net accrued interest receivable
$
1,725

 
$
851

Other credit risk exposure
3,243

 
601

Total credit risk exposure
4,968

 
1,452

Less: Cash collateral held and related accrued interest
(1,155
)
 
—

Credit risk exposure after collateral
$
3,813

 
$
1,452


A majority of the Bank's derivative contracts contain provisions that require the Bank to deliver additional collateral on derivatives in net liability positions to counterparties if there is deterioration in the Bank's credit rating. At December 31, 2012, the aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a net liability position (before cash collateral and related accrued interest) was $526.5 million, for which the Bank posted cash collateral (including accrued interest) of $428.9 million in the normal course of business. If the Bank's credit rating had been lowered by an NRSRO from its current rating to the next lower rating, the Bank would have been required to deliver up to an additional $63.0 million of collateral to its derivative counterparties at December 31, 2012.

Note 12 — Deposits
The Bank offers demand and overnight deposits to members and qualifying non-members. In addition, the Bank offers short-term interest bearing deposit programs to members. Deposits classified as demand and overnight pay interest based on a daily interest rate. Short-term interest bearing deposits pay interest based on a fixed rate determined at the issuance of the deposit. Average interest rates paid on interest-bearing deposits were 0.04 percent, 0.05 percent, and 0.09 percent for the years ended December 31, 2012, 2011, and 2010.
The following table details the Bank's interest bearing and non-interest bearing deposits (dollars in thousands):
 
December 31,
 
2012
 
2011
Interest-bearing
 
 
 
Demand and overnight
$
645,330

 
$
600,801

Term
227,522

 
42,627

Non-interest-bearing
 
 
 
Demand
211,892

 
106,667

Total
$
1,084,744

 
$
750,095


The aggregate amount of term deposits with a denomination of $100 thousand or more was $227.5 million and $42.5 million at December 31, 2012 and 2011.


110

Note 13 — Consolidated Obligations

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

Although the Bank is primarily liable for the portion of consolidated obligations issued on its behalf, it is also jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all consolidated obligations. The Finance Agency, at its discretion, may require any FHLBank to make principal and/or interest payments due on any consolidated obligation, whether or not the primary obligor FHLBank has defaulted on the payment of that consolidated obligation. The Finance Agency has never exercised this discretionary authority. At December 31, 2012 and 2011, the total par value of outstanding consolidated obligations of the 12 FHLBanks was approximately $687.9 billion and $691.9 billion.

BONDS

The following table summarizes the Bank's bonds outstanding by year of contractual maturity (dollars in thousands):
 
 
December 31,
 
 
2012
 
2011
Year of Contractual Maturity
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Due in one year or less
 
$
21,491,480

 
0.62
 
$
13,808,650

 
1.05
Due after one year through two years
 
2,317,015

 
1.89
 
7,388,560

 
1.57
Due after two years through three years
 
2,213,990

 
3.40
 
3,048,490

 
1.99
Due after three years through four years
 
1,507,905

 
4.47
 
2,994,040

 
3.38
Due after four years through five years
 
2,002,060

 
4.36
 
2,669,535

 
3.32
Thereafter
 
4,291,205

 
3.35
 
6,809,420

 
3.74
Index amortizing notes
 
331,300

 
5.21
 
1,077,716

 
5.12
Total par value
 
34,154,955

 
1.67
 
37,796,411

 
2.17
Premiums
 
24,544

 
 
 
32,445

 
 
Discounts
 
(18,746
)
 
 
 
(23,678
)
 
 
Fair value hedging adjustments
 
182,445

 
 
 
202,455

 
 
Fair value option adjustments
 
1,985

 
 
 
4,687

 
 
Total
 
$
34,345,183

 
 
 
$
38,012,320

 
 

The following table summarizes the Bank's bonds outstanding by call features (dollars in thousands):
 
December 31,
 
2012
 
2011
Noncallable or nonputable
$
32,272,455

 
$
28,640,411

Callable
1,882,500

 
9,156,000

Total par value
$
34,154,955

 
$
37,796,411



111

The following table summarizes the Bank's bonds outstanding by year of contractual maturity or next call date (dollars in thousands):
 
 
December 31,
Year of Contractual Maturity or Next Call Date
 
2012
 
2011
Due in one year or less
 
$
23,123,980

 
$
21,774,650

Due after one year through two years
 
1,882,015

 
5,478,560

Due after two years through three years
 
2,171,490

 
1,358,490

Due after three years through four years
 
1,477,905

 
2,134,040

Due after four years through five years
 
1,862,060

 
1,444,535

Thereafter
 
3,306,205

 
4,528,420

Index amortizing notes
 
331,300

 
1,077,716

Total par value
 
$
34,154,955

 
$
37,796,411

Bonds are issued with fixed or variable rate payment terms that use a variety of indices for interest rate resets including, but not limited to, LIBOR and the Federal funds rate. To meet the specific needs of certain investors, both fixed and variable rate bonds may also contain certain embedded features, which result in complex coupon payment terms and call features. When bonds are issued on the Bank's behalf, it may concurrently enter into a derivative agreement to effectively convert the fixed rate payment stream to variable or to offset the embedded features in the bond.
Beyond having fixed or variable rate payment terms, bonds may also have the following broad terms regarding either principal repayment or interest payments:
•
Indexed Principal Redemption Bonds (Index Amortizing Notes). These notes repay principal according to predetermined amortization schedules that are linked to the level of a certain index and have fixed rate coupon payment terms. Usually, as market interest rates rise (fall), the average life of the index amortizing notes extends (contracts); and
•
Optional Principal Redemption Bonds (Callable Bonds). These bonds may be redeemed by the Bank in whole or in part at its discretion on predetermined call dates according to the terms of the bond offerings.
With respect to interest payments, bonds may also have the following terms:
•
Step-Up Bonds. These bonds pay interest at increasing fixed rates for specified intervals over the life of the bond. These bonds generally contain provisions enabling the Bank to call the bonds at its option on the step-up dates.
•
Step-Down Bonds. These bonds pay interest at decreasing fixed rates for specified intervals over the life of the bond. These bonds generally contain provisions enabling the Bank to call the bonds at its option on the step-down dates.

Interest Rate Payment Terms

The following table summarizes the Bank's bonds by interest rate payment terms (dollars in thousands):
 
December 31,
 
2012
 
2011
Fixed rate
$
24,979,955

 
$
31,145,411

Simple variable rate
8,090,000

 
2,675,000

Step-up
1,085,000

 
3,761,000

Step-down
—

 
215,000

Total par value
$
34,154,955

 
$
37,796,411


Extinguishment of Debt

During the year ended December 31, 2012, the Bank extinguished bonds with a total par value of $556.1 million and recognized losses of $76.8 million in other (loss) income. During the year ended December 31, 2011, the Bank extinguished bonds with a total par value of $33.0 million and recognized losses of $4.6 million in other (loss) income. During the year ended December 31, 2010, the Bank extinguished bonds with a total par value of $1.3 billion and recognized losses of $163.7 million.


112

DISCOUNT NOTES

The following table summarizes the Bank's discount notes (dollars in thousands):
 
December 31,
 
2012
 
2011
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Par value
$
8,676,903

 
0.13
 
$
6,811,999

 
0.09
Discounts
(2,533
)
 
 
 
(3,636
)
 
 
Fair value option adjustments
—

 
 
 
1,403

 
 
Total
$
8,674,370

 
 
 
$
6,809,766

 
 

CONCESSIONS ON CONSOLIDATED OBLIGATIONS
Unamortized concessions on consolidated obligations are included as a component of "Other assets" in the Statements of Condition and totaled $3.0 million and $7.1 million at December 31, 2012 and 2011. Amortization of such concessions is recorded as consolidated obligation interest expense in the Statements of Income and totaled $7.7 million, $14.8 million, and $12.9 million for the years ended December 31, 2012, 2011, and 2010.
 
Note 14 — Affordable Housing Program

The FHLBank Act requires each FHLBank to establish and fund an AHP, which provides subsidies in the form of direct grants and below-market interest rate advances to members who use the funds to assist in the purchase, construction, or rehabilitation of housing for very low to moderate income households. Annually, the FHLBanks must set aside for the AHP the greater of 10 percent of their current year net earnings or their pro-rata share of an aggregate $100 million to be contributed in total by the FHLBanks. For purposes of the AHP assessment, net earnings is defined as net income before assessments, plus interest expense related to mandatorily redeemable capital stock, less the assessment for REFCORP, if applicable. The exclusion of interest expense related to mandatorily redeemable capital stock is a regulatory interpretation of the Finance Agency. The Bank accrues the AHP assessment on a monthly basis and reduces the AHP liability as program funds are distributed.

On August 5, 2011, the Finance Agency certified that the FHLBanks had fully satisfied their REFCORP obligation with their payments made on July 15, 2011. The FHLBanks entered into a JCE Agreement, as amended, which requires each FHLBank to allocate 20 percent of its quarterly net income to a restricted retained earnings account, beginning in the third quarter of 2011. Because the REFCORP assessment reduced the amount of net earnings used to calculate the AHP assessment, it had the effect of reducing the total amount of funds allocated to the AHP. The amounts allocated to the new restricted retained earnings account are not treated as an assessment and do not reduce the Bank's net earnings. As a result, the Bank's AHP contributions as a percentage of pre-assessment earnings have increased because the REFCORP obligation has been fully satisfied.

If the Bank experienced a net loss during a quarter, but still had net earnings for the year, the Bank's obligation to the AHP would be calculated based on its year-to-date net earnings. If the Bank had net earnings in subsequent quarters, it would be required to contribute additional amounts to meet its calculated annual obligation. If the Bank experienced a net loss for a full year, it would have no obligation to the AHP for the year, because its required annual AHP contribution is limited to its annual net earnings. If the aggregate 10 percent AHP calculation previously discussed was less than $100 million for all 12 FHLBanks, each FHLBank would be required to assure that the aggregate contribution of the FHLBanks equals $100 million. The pro-ration would be made on the basis of an FHLBank's income in relation to the income of all FHLBanks for the previous year, subject to the annual earnings limitation previously discussed.

There was no shortfall, as described above, in 2012, 2011, or 2010. If an FHLBank finds that its required contributions are contributing to its financial instability, it may apply to the Finance Agency for a temporary suspension of its contributions. The Bank did not make any such application in 2012, 2011, or 2010. At December 31, 2012 and 2011, the Bank had no outstanding AHP advances.


113

The following table presents a rollforward of the Bank’s AHP liability (dollars in thousands):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Balance, beginning of year
$
38,849

 
$
44,508

 
$
40,479

Assessments
12,408

 
8,670

 
14,798

Disbursements
(14,537
)
 
(14,329
)
 
(10,769
)
Balance, end of year
$
36,720

 
$
38,849

 
$
44,508


Note 15 — Resolution Funding Corporation

On August 5, 2011, the Finance Agency certified that the FHLBanks had fully satisfied their REFCORP obligation with their payments made on July 15, 2011. The FHLBanks entered into a JCE Agreement, as amended, which requires each FHLBank to allocate 20 percent of its quarterly net income to a separate restricted retained earnings account, beginning in the third quarter of 2011. Refer to "Note 16 — Capital" for additional information on the JCE Agreement. As a result of fully satisfying the REFCORP obligation, the Bank did not record a REFCORP assessment for the year ended December 31, 2012 and in each of the last two quarters of 2011.
Prior to the satisfaction of the REFCORP obligation, each FHLBank was required to pay 20 percent of its quarterly net income (before the REFCORP assessment and after the AHP assessment) to REFCORP until the total amount of payments actually made was equivalent to a $300 million annual annuity whose final maturity date was April 15, 2030.

Note 16 — Capital

The Bank is subject to three regulatory capital requirements:

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

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

•
Leverage capital. The Bank is required to maintain a minimum five percent leverage ratio, which is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 times, divided by total assets. At December 31, 2012 and 2011, the Bank did not have any nonpermanent capital.

If the Bank's capital falls below the required levels, the Finance Agency has authority to take actions necessary to return it to safe and sound business operations.

The following table shows the Bank's compliance with the Finance Agency's three regulatory capital requirements (dollars in thousands):
 
December 31,
 
2012
 
2011
 
Required
 
Actual
 
Required
 
Actual
Regulatory capital requirements
 
 
 
 
 
 
 
Risk-based capital
$
372,277

 
$
2,694,224

 
$
540,735

 
$
2,684,022

Regulatory capital
$
1,894,691

 
$
2,694,224

 
$
1,949,333

 
$
2,684,022

Leverage capital
$
2,368,364

 
$
4,041,335

 
$
2,436,666

 
$
4,026,032

Capital-to-asset ratio
4.00
%
 
5.69
%
 
4.00
%
 
5.51
%
Leverage ratio
5.00
%
 
8.53
%
 
5.00
%
 
8.26
%

114

The Bank issues a single class of capital stock (Class B capital stock). The Bank's capital stock has a par value of $100 per share, and all shares are issued, redeemed, or repurchased by the Bank at the stated par value. The Bank has two subclasses of capital stock: membership and activity-based. Each member must purchase and maintain membership capital stock in an amount equal to 0.12 percent of its total assets as of the preceding December 31st subject to a cap of $10.0 million and a floor of $10,000. Each member must also maintain activity-based capital stock in an amount equal to 4.45 percent of its total advances and mortgage loans outstanding in the Bank's Statements of Condition.

The capital stock requirements established in the Bank's Capital Plan are designed so that the Bank can remain adequately capitalized as member activity changes. To ensure the Bank remains adequately capitalized, the Bank's Board of Directors may make adjustments to the investment requirements within ranges established in the Capital Plan. All capital stock issued is subject to a five year notice of redemption period.

Capital Classification Determination

The Bank is subject to the Finance Agency's regulation on FHLBank capital classification and critical capital levels (the Capital Rule). The Capital Rule, among other things, establishes criteria for four capital classifications (adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized) and corrective action requirements for FHLBanks that are classified in any classification other than adequately capitalized. An adequately capitalized FHLBank is one that has sufficient permanent and total capital to satisfy its risk-based and minimum capital requirements. The Bank satisfied these requirements at December 31, 2012. If the Bank becomes classified into a capital classification other than adequately capitalized, it will be subject to the corrective action requirements for that capital classification in addition to being subject to prohibitions on declaring dividends and redeeming or repurchasing capital stock.

Excess Stock

Capital stock owned by members in excess of their investment requirement is deemed excess capital stock. Under its Capital Plan, the Bank, at its discretion and upon 15 days' written notice, may repurchase excess membership capital stock. The Bank, at its discretion, may also repurchase excess activity-based capital stock to the extent that (i) the excess capital stock balance exceeds an operational threshold set forth in the Capital Plan or (ii) a member submits a notice to redeem all or a portion of the excess activity-based capital stock. On January 4, 2012, the Bank reduced its operational threshold for repurchasing excess activity-based capital stock from $50,000 to zero. In addition, effective April 27, 2012, the Bank began repurchasing all excess activity-based capital stock on a daily basis. At December 31, 2012, the Bank had no excess capital stock. At December 31, 2011, the Bank had excess capital stock (including excess mandatorily redeemable capital stock) of $80.7 million.

Mandatorily Redeemable Capital Stock

The Bank reclassifies capital stock subject to redemption from equity to a liability (mandatorily redeemable capital stock) when a member engages in any of the following activities: (i) submits a written notice to redeem all or part of its capital stock, (ii) submits a written notice of its intent to withdraw from membership, or (iii) terminates its membership voluntarily as a result of a merger or consolidation into a non-member or into a member of another FHLBank. Dividends on mandatorily redeemable capital stock are classified as interest expense in the Statements of Income.

If a member cancels its written notice of redemption or notice of withdrawal, the Bank will reclassify mandatorily redeemable capital stock from a liability to equity. After the reclassification, dividends on the capital stock will no longer be classified as interest expense. The Bank recorded interest expense on mandatorily redeemable capital stock of $0.2 million for each of the years ended December 31, 2012, 2011, and 2010.


115

The following table summarizes the Bank's mandatorily redeemable capital stock by year of contractual redemption (dollars in thousands):
 
 
December 31,
Year of Contractual Redemption
 
2012
 
2011
Due in one year or less
 
$
—

 
$
341

Due after one year through two years
 
172

 
—

Due after two years through three years
 
5,162

 
270

Due after three years through four years
 
87

 
5,172

Due after four years through five years
 
3,634

 
98

Past contractual redemption date due to outstanding activity with the Bank
 
506

 
288

Total
 
$
9,561

 
$
6,169


The following table summarizes a rollforward of the Bank's mandatorily redeemable capital stock (dollars in thousands):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Balance, beginning of year
$
6,169

 
$
6,835

 
$
8,346

Mandatorily redeemable capital stock issued
—

 
6

 
4

Capital stock subject to mandatory redemption reclassified from capital stock
9,448

 
6,682

 
21,394

Redemption of mandatorily redeemable capital stock
(6,056
)
 
(7,354
)
 
(22,909
)
Balance, end of period
$
9,561

 
$
6,169

 
$
6,835


Restricted Retained Earnings

The JCE Agreement, as amended, is intended to enhance the capital position of the Bank. The JCE Agreement provides that the Bank will allocate 20 percent of its quarterly net income to a separate restricted retained earnings account until the balance of that account equals at least one percent of its average balance of outstanding consolidated obligations for the previous quarter. The restricted retained earnings will not be available to pay dividends. At December 31, 2012 and 2011, the Bank's restricted retained earnings account totaled $28.8 million and $6.5 million.

Accumulated Other Comprehensive Income

The following table summarizes a rollforward of the Bank's accumulated other comprehensive income (dollars in thousands):
 
Net unrealized (loss) gain on available-for-sale securities
 
Pension and postretirement benefits
 
Total accumulated
other comprehensive (loss) income
Balance December 31, 2009
$
(32,533
)
 
$
(1,402
)
 
$
(33,935
)
Other comprehensive income (loss)
124,755

 
(289
)
 
124,466

Balance December 31, 2010
92,222

 
(1,691
)
 
90,531

Other comprehensive income (loss)
45,018

 
(988
)
 
44,030

Balance December 31, 2011
137,240

 
(2,679
)
 
134,561

Other comprehensive income (loss)
15,541

 
(464
)
 
15,077

Balance December 31, 2012
$
152,781

 
$
(3,143
)
 
$
149,638



116

Note 17 — Pension and Postretirement Benefit Plans
Qualified Defined Benefit Multiemployer Plan
The Bank participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra DB Plan), a tax-qualified defined benefit pension plan. The Pentegra DB Plan is treated as a multiemployer plan for accounting purposes, but operates as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code. As a result, certain multiemployer plan disclosures, including the certified zone status, are not applicable to the Pentegra DB Plan. Under the Pentegra DB Plan, contributions made by a participating employer may be used to provide benefits to employees of other participating employers because assets contributed by an employer are not segregated in a separate account or restricted to provide benefits only to employees of that employer. Also, in the event a participating employer is unable to meet its contribution requirements, the required contributions for the other participating employers could increase proportionately.
The Pentegra DB Plan covers all officers and employees of the Bank that meet certain eligibility requirements if hired on or before December 31, 2010. The Pentegra DB Plan operates on a fiscal year from July 1 through June 30. The Pentegra DB Plan files one Form 5500 on behalf of all employers who participate in the plan. The Employer Identification Number is 13-5645888 and the three-digit plan number is 333. There are no collective bargaining agreements in place that require contributions to the plan.
The Pentegra DB Plan's annual valuation process includes calculating the plan's funded status and separately calculating the
funded status of each participating employer. The funded status is defined as the market value of assets divided by the funding target (100 percent of the present value of all benefit liabilities accrued at that date). As permitted by ERISA, the Pentegra DB Plan accepts contributions for the prior plan year up to eight and a half months after the asset valuation date. As a result, the
market value of assets at the valuation date (July 1) will increase by any subsequent contributions designated for the immediately preceding plan year ended June 30.

The most recent Form 5500 available for the Pentegra DB Plan is for the year ended June 30, 2011. The Bank's contributions for the plan year ended June 30, 2011 were not more than five percent of the total contributions to the Pentegra DB Plan. The Bank's contributions for the plan year ended June 30, 2010 were more than five percent of the total contributions to the Pentegra DB Plan.

The following table summarizes the net pension cost and funded status of the Pentegra DB Plan (dollars in thousands):
 
2012
 
2011
 
2010
Net pension cost1
$
4,032

 
$
3,900

 
$
11,550

Pentegra DB Plan funded status as of July 1
108.2
%

90.3
%

88.0
%
Bank's funded status as of July 12
116.3
%
 
96.6
%
 
100.0
%

1
Represents the net pension cost charged to compensation and benefits expense in the Statements of Income for the year ended December 31.

2
The Bank's funded status as of July 1, 2012 increased when compared to prior plan years due to the legislation discussed below. This funded status was preliminary and increased to 123.8 percent as of December 31, 2012 due to the Bank making a discretionary contribution of $3.9 million towards the plan year ended June 30, 2012.

The Pentegra DB Plan's funded status as of July 1, 2012 increased when compared to prior plan years due to an increase in the discount rate resulting from provisions of the "Moving Ahead for Progress in the 21st Century Act" enacted by the U.S. Government in June of 2012. This funded status is preliminary and may further increase because plan participants are permitted to make contributions for the plan year ended June 30, 2012 through March 15, 2013. Contributions made on or before March 15, 2013, and designated for the plan year ended June 30, 2012, will be included in the final valuation as of July 1, 2012. The final funded status as of July 1, 2012 will not be available until the Form 5500 for the plan year July 1, 2012 through June 30, 2013 is filed (this Form 5500 is due to be filed no later than April 2014).

The Pentegra DB Plan's funded status as of July 1, 2011 includes all contributions made by plan participants through March 15, 2012. The final funded status as of July 1, 2011 will not be available until the Form 5500 for the plan year July 1, 2011 through June 30, 2012 is filed (this Form 5500 is due to be filed no later than April 2013).



117

Qualified Defined Contribution Plan
The Bank participates in the Pentegra Defined Contribution Plan for Financial Institutions (Pentegra DC Plan), a tax-qualified defined contribution plan. The Pentegra DC Plan covers all officers and employees of the Bank that meet certain eligibility requirements. The Bank contributes a percentage of participants’ compensation by making a matching contribution equal to a percentage of the participant's voluntary contributions, subject to certain limitations. For the years ended December 31, 2012, 2011, and 2010, the Bank contributed $1.1 million, $1.0 million, and $0.8 million.
Nonqualified Supplemental Defined Contribution and Defined Benefit Retirement Plans
The Bank offers the Benefit Equalization Plan (BEP). The BEP is a nonqualified retirement plan that restores defined contributions and defined benefits offered under the qualified plans that have been limited by laws governing such plans. The BEP covers selected officers of the Bank. The BEP is made up of two parts: BEP Defined Contribution Plan and BEP Defined Benefit Plan. There are no funded plan assets that have been designated to provide benefits under this plan.
BEP Defined Contribution Plan. For each of the years ended December 31, 2012, 2011, and 2010, the Bank contributed $0.1 million to the BEP Defined Contribution Plan.
BEP Defined Benefit Plan. The benefit obligation was as follows (dollars in thousands):
 
For the Years Ended December 31,
 
2012
 
2011
Benefit obligation at beginning of year
$
7,996

 
$
6,412

Service cost
494

 
384

Interest cost
341

 
335

Actuarial loss
255

 
103

Benefits paid
(266
)
 
(263
)
Increase due to decrease in the discount rate
592

 
1,025

Benefit obligation at end of year
$
9,412

 
$
7,996

The measurement date used to determine the current year's benefit obligation was December 31, 2012.
The following amounts were recognized in the Statements of Condition (dollars in thousands):
 
December 31,
 
2012
 
2011
Accrued benefit liability
$
9,412

 
$
7,996

Accumulated other comprehensive loss
(3,377
)
 
(2,936
)
Net amount recognized
$
6,035

 
$
5,060


The accumulated benefit obligation was $8.5 million and $7.3 million at December 31, 2012 and 2011.

Components of net periodic benefit cost were as follows (dollars in thousands):
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Service cost
$
494

 
$
384

 
$
310

Interest cost
341

 
335

 
318

Amortization of prior service cost
23

 
23

 
42

Amortization of net loss
383

 
199

 
141

Total net periodic benefit cost
$
1,241

 
$
941

 
$
811



118

The following table details the change in accumulated other comprehensive income (dollars in thousands):
 
For the Year Ended December 31, 2012
 
Prior Service Cost
 
Net Loss (Gain)
 
Total
Balance at beginning of year
$
67

 
$
2,869

 
$
2,936

Net loss on defined benefit plan
—

 
847

 
847

Amortization
(23
)
 
(383
)
 
(406
)
Balance at end of year
$
44

 
$
3,333

 
$
3,377


Amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost during 2013 are (dollars in thousands):
Projected amortization of prior service cost
$
23

Projected amortization of net loss
478

Total projected amortization of amounts in accumulated other comprehensive income
$
501


Key assumptions used for the actuarial calculations to determine the benefit obligation are as follows:
 
December 31,
 
2012
 
2011
Discount rate
3.71
%
 
4.20
%
Salary increases
5.00
%
 
4.80
%

Key assumptions used for the actuarial calculations to determine the net periodic benefit cost are as follows:
 
For the Years Ended December 31,
 
2012
 
2011
 
2010
Discount rate
4.20
%
 
5.25
%
 
5.75
%
Salary increases
4.80
%
 
4.80
%
 
4.80
%

The 2012 discount rate used to determine the benefit obligation was determined using a discounted cash flow approach, which incorporates the timing of each expected future benefit payment. Future benefit payments were estimated based on census data, benefit formulas and provisions, and valuation assumptions reflecting the probability of decrement and survival. The present value of the future benefit payments was calculated using duration-based interest rate yields from the Citibank Pension Discount Curve as of December 31, 2012, and solving for the single discount rate that produced the same present value.
The Bank estimates that its required contributions for the year ended December 31, 2013 will be $0.3 million.
Estimated future benefit payments reflecting expected future services for the years ending after December 31, 2012 are (dollars in thousands):
Year
 
Amount
2013
 
$
315

2014
 
342

2015
 
454

2016
 
484

2017
 
498

2018 through 2022
 
2,853



119

Note 18 — Fair Value

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

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

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

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

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

The Bank reviews its fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation inputs may result in a reclassification of certain assets or liabilities. These reclassifications are reported as transfers in/out as of the beginning of the quarter in which the changes occur. There were no such transfers during the years ended December 31, 2012, 2011, and 2010.


120

The following table summarizes the carrying value, fair value, and fair value hierarchy of the Bank's financial instruments at December 31, 2012 (dollars in thousands). The fair values do not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of assets versus liabilities.
 
 
 
 
Fair Value
Financial Instruments
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 

Cash and due from banks
 
$
252,113

 
$
252,113

 
$
—

 
$
—

 
$
—

 
$
252,113

Interest-bearing deposits
 
3,238

 
—

 
3,203

 
—

 
—

 
3,203

Securities purchased under agreements to resell
 
3,425,000

 
—

 
3,425,000

 
—

 
—

 
3,425,000

Federal funds sold
 
960,000

 
—

 
960,000

 
—

 
—

 
960,000

Trading securities
 
1,145,430

 
—

 
1,145,430

 
—

 
—

 
1,145,430

Available-for-sale securities
 
4,859,806

 
—

 
4,859,806

 
—

 
—

 
4,859,806

Held-to-maturity securities
 
3,039,721

 
—

 
3,158,034

 
40,095

 
—

 
3,198,129

Advances
 
26,613,915

 
—

 
26,828,132

 
—

 
—

 
26,828,132

Mortgage loans held for portfolio, net
 
6,951,810

 
—

 
7,323,009

 
48,995

 
—

 
7,372,004

Accrued interest receivable
 
66,410

 
—

 
66,410

 
—

 
—

 
66,410

Derivative assets
 
3,813

 
58

 
153,831

 
—

 
(150,076
)
 
3,813

Other assets
 
8,261

 
8,261

 
—

 
—

 
—

 
8,261

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
(1,084,744
)
 
—

 
(1,084,738
)
 
—

 
—

 
(1,084,738
)
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 

Discount notes
 
(8,674,370
)
 
—

 
(8,675,102
)
 
—

 
—

 
(8,675,102
)
Bonds
 
(34,345,183
)
 
—

 
(35,570,458
)
 
—

 
—

 
(35,570,458
)
Total consolidated obligations
 
(43,019,553
)

—


(44,245,560
)
 
—

 
—

 
(44,245,560
)
Mandatorily redeemable capital stock
 
(9,561
)
 
(9,561
)
 
—

 
—

 
—

 
(9,561
)
Accrued interest payable
 
(106,611
)
 
—

 
(106,611
)
 
—

 
—

 
(106,611
)
Derivative liabilities
 
(100,700
)
 
(128
)
 
(675,909
)
 
—

 
575,337

 
(100,700
)
Other
 
 
 
 
 
 
 
 
 
 
 
 
Standby letters of credit
 
(1,522
)
 
—

 
—

 
(1,522
)
 
—

 
(1,522
)
Standby bond purchase agreements
 
—

 
—

 
2,136

 
—

 
—

 
2,136


1
Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral and the related accrued interest held of placed with the same counterparties.


121

The following table summarizes the carrying value and fair value of the Bank's financial instruments at December 31, 2011 (dollars in thousands):
Financial Instruments
 
Carrying
Value
 
 Fair
Value
Assets
 
 
 
 
Cash and due from banks
 
$
240,156

 
$
240,156

Interest-bearing deposits
 
6,337

 
6,297

Securities purchased under agreements to resell
 
600,000

 
600,000

Federal funds sold
 
2,115,000

 
2,115,000

Trading securities
 
1,365,121

 
1,365,121

Available-for-sale securities
 
5,355,564

 
5,355,564

Held-to-maturity securities
 
5,195,200

 
5,380,021

Advances
 
26,591,023

 
26,867,150

Mortgage loans held for portfolio, net
 
7,137,970

 
7,597,462

Accrued interest receivable
 
73,009

 
73,009

Derivative assets
 
1,452

 
1,452

Liabilities
 
 
 
 
Deposits
 
(750,095
)
 
(750,089
)
Consolidated obligations
 
 
 
 
Discount notes
 
(6,809,766
)
 
(6,809,872
)
Bonds
 
(38,012,320
)
 
(39,501,654
)
Total consolidated obligations
 
(44,822,086
)
 
(46,311,526
)
Mandatorily redeemable capital stock
 
(6,169
)
 
(6,169
)
Accrued interest payable
 
(155,241
)
 
(155,241
)
Derivative liabilities
 
(116,806
)
 
(116,806
)
Other
 
 
 
 
Standby letters of credit
 
(1,604
)
 
(1,604
)
Standby bond purchase agreements
 
—

 
2,199


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

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

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

Federal Funds Sold. For overnight and term Federal funds sold with less than three months to maturity, the fair value approximates the carrying value. For term Federal funds sold with more than three months to maturity, the fair value is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for Federal funds with similar terms.

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

122

The Bank's valuation technique for estimating the fair values of its investment securities first requires the establishment of a “median” price for each security. If four prices are received, the average of the middle two prices is the median price; if three prices are received, the middle price is the median price; if two prices are received, the average of the two prices is the median price; and if one price is received, it is the median price (and also the final price) subject to some type of validation. All prices that are within a specified tolerance threshold of the median price are included in the cluster of prices that are averaged to compute a default price. All prices that are outside the threshold (outliers) are subject to further analysis (including, but not limited to, comparison to prices provided by an additional third-party valuation service, prices for similar securities, and/or non-binding dealer estimates) to determine if an outlier is a better estimate of fair value. If an outlier (or some other price identified in the analysis) is determined to be a better estimate of fair value, then the outlier (or the other price as appropriate) is used as the final price rather than the default price. Alternatively, if the analysis confirms that an outlier (or outliers) is (are) in fact not representative of fair value and the default price is the best estimate, then the default price is used as the final price. In all cases, the final price is used to determine the fair value of the security. In limited instances, when no prices are available from the four designated pricing services, the Bank obtains prices from dealers.

As an additional step, the Bank reviews the final fair value estimates of its private-label MBS holdings quarterly for reasonableness using an implied yield test. The Bank calculated an implied yield for each of its private-label MBS using the estimated fair value derived from the process previously described and the security's projected cash flows and compared such yield to the yield for comparable securities according to dealers and/or other third-party sources. No significant variances were noted. Therefore, the Bank determined that its fair value estimates for private-label MBS were appropriate at December 31, 2012.

As of December 31, 2012 and 2011, three or four prices were received for substantially all of the Bank's investment securities and the final prices for substantially all of those securities were computed by averaging the prices received. Based on the Bank's review of the pricing methods and controls employed by the third-party pricing vendors and the relative lack of dispersion among the vendor prices, the Bank believes its final prices are representative of the prices that would have been received if the assets had been sold at the measurement date (i.e., exit prices) and further, that the fair value measurements are classified appropriately in the fair value hierarchy.

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

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

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

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

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

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

Impaired Mortgage Loans Held for Portfolio. The fair value of impaired mortgage loans held for portfolio is estimated by either applying a historical loss severity rate incurred on sales to the underlying property value or calculating the present value of expected future cash flows discounted at the loan's effective interest rate.

123

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

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

Derivative Assets and Liabilities. The fair value of derivatives is generally estimated using standard valuation techniques such as discounted cash flow analyses and comparisons to similar instruments. In limited instances, fair value estimates for interest-rate related derivatives may be obtained using an external pricing model that utilizes observable market data. The Bank is subject to credit risk in derivatives transactions due to the potential nonperformance of its derivatives counterparties, which are generally highly rated institutions. To mitigate this risk, the Bank has entered into master netting agreements for derivatives with its counterparties. In addition, the Bank has entered into bilateral security agreements with all of its active derivatives counterparties that provide for the delivery of collateral at specified levels tied to those counterparties' credit ratings to limit its net unsecured credit exposure to those counterparties. The Bank has evaluated the potential for the fair value of the derivatives to be affected by counterparty credit risk and its own credit risk and has determined that no adjustments were significant to the overall fair value measurements.

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

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

•
Discount rate assumption. Prior to December 31, 2012, the Bank utilized the LIBOR swap curve. At December 31, 2012, the Bank utilized the overnight-index swap curve. This change was not material to the overall fair value measurement of interest-related derivatives. 

•
Forward interest rate assumption. The Bank utilizes the LIBOR swap curve.

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

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

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

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

Mandatorily Redeemable Capital Stock. The fair value of capital stock subject to mandatory redemption is generally reported at par value. Fair value also includes an estimated dividend earned at the time of reclassification from equity to a liability (if applicable), until such amount is paid. Capital stock can only be acquired by members at par value and redeemed at par value. Capital stock is not publicly traded and no market mechanism exists for the exchange of stock outside the cooperative structure.
 

124

Standby Letters of Credit. The fair value of standby letters of credit is based on either (i) the fees currently charged for similar agreements or (ii) the estimated cost to terminate the agreement or otherwise settle the obligation with the counterparty.

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

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

Fair Value on a Recurring Basis

The following table summarizes, for each hierarchy level, the Bank's assets and liabilities that are measured at fair value in the Statements of Condition at December 31, 2012 (dollars in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
Other U.S. obligations
$
—

 
$
309,540

 
$
—

 
$
—

 
$
309,540

GSE obligations
—

 
64,445

 
—

 
—

 
64,445

Other non-MBS
—

 
294,933

 
—

 
—

 
294,933

GSE MBS - residential
—

 
476,512

 
—

 
—

 
476,512

Total trading securities
—

 
1,145,430

 
—

 
—

 
1,145,430

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

 
163,215

 
—

 
—

 
163,215

GSE obligations
—

 
555,831

 
—

 
—

 
555,831

State or local housing agency obligations
—

 
8,401

 
—

 
—

 
8,401

Other non-MBS
—

 
400,410

 
—

 
—

 
400,410

GSE MBS - residential
—

 
3,731,949

 
—

 
—

 
3,731,949

Total available-for-sale securities
—

 
4,859,806

 
—

 
—

 
4,859,806

Derivative assets
 
 
 
 
 
 
 
 
 
Interest rate related
—

 
153,727

 
—

 
(150,076
)
 
3,651

Forward settlement agreements (TBAs)
58

 
—

 
—

 
—

 
58

Mortgage delivery commitments
—

 
104

 
—

 
—

 
104

Total derivative assets
58

 
153,831

 
—

 
(150,076
)
 
3,813

Other assets
8,261

 
—

 
—

 
—

 
8,261

Total recurring assets at fair value
$
8,319

 
$
6,159,067

 
$
—

 
$
(150,076
)
 
$
6,017,310

Liabilities
 
 
 
 
 
 
 
 
 
Consolidated obligation bonds2
$
—

 
$
(1,866,985
)
 
$
—

 
$
—

 
$
(1,866,985
)
Derivative liabilities
 
 
 
 
 
 
 
 
 
Interest rate related
—

 
(675,855
)
 
—

 
575,337

 
(100,518
)
Forward settlement agreements (TBAs)
(128
)
 
—

 
—

 
—

 
(128
)
Mortgage delivery commitments
—

 
(54
)
 
—

 
—

 
(54
)
Total derivative liabilities
(128
)
 
(675,909
)
 
—

 
575,337

 
(100,700
)
Total recurring liabilities at fair value
$
(128
)
 
$
(2,542,894
)
 
$
—

 
$
575,337

 
$
(1,967,685
)

1
Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral and the related accrued interest held or place with the same counterparties.

2
Represents bonds recorded under the fair value option.
 
    

125

The following table summarizes, for each hierarchy level, the Bank's assets and liabilities that are measured at fair value in the Statements of Condition at December 31, 2011 (dollars in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
Other U.S. obligations
$
—

 
$
8,521

 
$
—

 
$
—

 
$
8,521

GSE obligations
—

 
63,718

 
—

 
—

 
63,718

Temporary Liquidity Guarantee Program debentures
—

 
1,006,883

 
—

 
—

 
1,006,883

Other non-MBS
—

 
285,999

 
—

 
—

 
285,999

Total trading securities
—

 
1,365,121

 
—

 
—

 
1,365,121

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

 
172,137

 
—

 
—

 
172,137

GSE obligations
—

 
556,669

 
—

 
—

 
556,669

Temporary Liquidity Guarantee Program debentures
—

 
564,394

 
—

 
—

 
564,394

Other non-MBS
—

 
242,779

 
—

 
—

 
242,779

GSE MBS - residential
—

 
3,819,585

 
—

 
—

 
3,819,585

Total available-for-sale securities
—

 
5,355,564

 
—

 
—

 
5,355,564

Derivative assets
 
 
 
 
 
 
 
 
 
Interest rate related
—

 
222,264

 
—

 
(221,355
)
 
909

Mortgage delivery commitments
—

 
543

 
—

 
—

 
543

Total derivative assets
—

 
222,807

 
—

 
(221,355
)
 
1,452

Total recurring assets at fair value
$
—

 
$
6,943,492

 
$
—

 
$
(221,355
)
 
$
6,722,137

Liabilities
 
 
 
 
 
 
 
 
 
Consolidated obligations
 
 
 
 
 
 
 
 
 
Discount notes2
$
—

 
$
(3,474,596
)
 
$
—

 
$
—

 
$
(3,474,596
)
Bonds3
—

 
(2,694,687
)
 
—

 
—

 
(2,694,687
)
Total consolidated obligations
—

 
(6,169,283
)
 
—

 
—

 
(6,169,283
)
Derivative liabilities
 
 
 
 
 
 
 
 
 
Interest rate related
—

 
(1,012,683
)
 
—

 
896,597

 
(116,086
)
Forward settlement agreements (TBAs)
(647
)
 
—

 
—

 
—

 
(647
)
Mortgage delivery commitments
—

 
(73
)
 
—

 
—

 
(73
)
Total derivative liabilities
(647
)
 
(1,012,756
)
 
—

 
896,597

 
(116,806
)
Total recurring liabilities at fair value
$
(647
)
 
$
(7,182,039
)
 
$
—

 
$
896,597

 
$
(6,286,089
)

1
Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same counterparties.

2
Represents discount notes recorded under the fair value option.

3
Represents bonds recorded under the fair value option.

Fair Value on a Non-Recurring Basis

The Bank measures certain impaired mortgage loans held for portfolio and REO at Level 3 fair value on a non-recurring basis. These assets are subject to fair value adjustments in certain circumstances. In the case of impaired mortgage loans, the Bank estimates fair value based on historical loss severity rates incurred on sales or discounted cash flows. At December 31, 2012, the historical loss severity rate used to estimate the fair value of a majority of impaired mortgage loans held for portfolio was 16.0 percent. Significant increases/decreases in this loss severity rate may result in significantly lower/higher fair value measurements. In the case of REO, the Bank estimates fair value based on a current property value from the MPF Servicer or a broker price opinion adjusted for estimated selling costs.


126

The following table summarizes impaired mortgage loans held for portfolio and REO that were recorded at fair value as a result of a non-recurring change in fair value having been recorded in the quarter then ended (dollars in thousands):
 
December 31,
 
2012
 
2011
Impaired mortgage loans held for portfolio
$
48,995

 
$
55,575

Real estate owned
941

 
1,089

Total non-recurring assets
$
49,936

 
$
56,664


Fair Value Option

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

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

The following table summarizes the activity related to consolidated obligations in which the fair value option has been elected (dollars in thousands):
 
 
For the Years Ended December 31,
Bonds
 
2012
 
2011
 
2010
Balance, beginning of year
 
$
2,694,687

 
$
2,816,850

 
$
5,997,867

New bonds elected for fair value option
 
100,000

 
2,690,000

 
5,800,000

Maturities and terminations
 
(925,000
)
 
(2,815,000
)
 
(8,975,000
)
Net (gain) loss on bonds held at fair value
 
(2,784
)
 
5,077

 
(5,657
)
Change in accrued interest
 
82

 
(2,240
)
 
(360
)
Balance, end of year
 
$
1,866,985

 
$
2,694,687

 
$
2,816,850


 
 
For the Years Ended December 31,
Discount Notes
 
2012
 
2011
Balance, beginning of year
 
$
3,474,596

 
$
—

New discount notes elected for fair value option
 
—

 
3,606,239

Maturities and terminations
 
(3,476,631
)
 
(135,279
)
Net (gain) loss on discount notes held at fair value
 
(1,403
)
 
1,403

Change in unaccreted balance
 
3,438

 
2,233

Balance, end of year
 
$
—

 
$
3,474,596


For consolidated obligations recorded under the fair value option, the related contractual interest expense as well as the discount amortization on fair value option discount notes is recorded as part of net interest income in the Statements of Income. The remaining changes are recorded as “Net gain (loss) on consolidated obligations held at fair value” in the Statements of Income. At December 31, 2012 and 2011, the Bank determined no credit risk adjustments for nonperformance were necessary to the consolidated obligations recorded under the fair value option. Concessions paid on consolidated obligations under the fair value option are expensed as incurred and recorded in other (loss) income.

127

The following table summarizes the difference between the unpaid principal balance and fair value of outstanding consolidated obligations for which the fair value option has been elected (dollars in thousands):
 
December 31,
 
2012
 
2011
 
Bonds
 
Bonds
 
Discount Notes
Unpaid principal balance
$
1,865,000

 
$
2,690,000

 
$
3,476,631

Fair value
1,866,985

 
2,694,687

 
3,474,596

Fair value over (under) unpaid principal balance
$
1,985

 
$
4,687

 
$
(2,035
)

Note 19 — Commitments and Contingencies

Joint and Several Liability. The 12 FHLBanks have joint and several liability for all consolidated obligations issued. Accordingly, if an FHLBank were unable to repay any consolidated obligation for which it is the primary obligor, each of the other FHLBanks could be called upon by the Finance Agency to repay all or part of such obligations. No FHLBank has ever been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank. At December 31, 2012 and 2011, the total par value of outstanding consolidated obligations issued on behalf of other FHLBanks for which the Bank is jointly and severally liable was approximately $645.1 billion and $647.3 billion.

The following table summarizes additional off-balance sheet commitments for the Bank (dollars in thousands):
 
December 31,
 
2012
 
2011
 
Expire within one year
 
Expire
after one year
 
Total
 
Total
Standby letters of credit outstanding
$
2,853,245

 
$
802,156

 
$
3,655,401

 
$
3,696,007

Standby bond purchase agreements outstanding
—

 
680,119

 
680,119

 
671,460

Commitments to purchase mortgage loans
96,220

 
—

 
96,220

 
89,971

Commitments to issue bonds
—

 
—

 
—

 
93,135

Other commitments
—

 
—

 
—

 
138,500


Standby Letters of Credit. Standby letters of credit are executed with members for a fee. A standby letter of credit is a financing arrangement between the Bank and a member. If the Bank is required to make payment for a beneficiary's draw, the payment is withdrawn from the member's demand account. Any resulting overdraft is converted into a collateralized advance to the member. The original terms of standby letters of credit range from less than one month to 20 years, currently no later than 2031. Unearned fees for standby letters of credit are recorded in “Other liabilities” in the Statements of Condition and amounted to $1.5 million and $1.6 million at December 31, 2012 and 2011.

The Bank monitors the creditworthiness of its standby letters of credit based on an evaluation of its borrowers. The Bank has established parameters for the measurement, review, classification, and monitoring of credit risk related to these standby letters of credit. Based on management's credit analyses and collateral requirements, the Bank does not deem it necessary to have any provision for credit losses on these standby letters of credit. All standby letters of credit are fully collateralized at the time of issuance. The estimated fair value of standby letters of credit at December 31, 2012 and 2011 is reported in “Note 18 — Fair Value.”

Standby Bond Purchase Agreements. The Bank has entered into standby bond purchase agreements with state housing associates within its district whereby, for a fee, it agrees to serve as a standby liquidity provider if required, to purchase and hold the housing associate's bonds until the designated marketing agent can find a suitable investor or the housing associate repurchases the bonds according to a schedule established by the agreement. Each standby bond purchase agreement includes the provisions under which the Bank would be required to purchase the bonds. The standby bond purchase commitments entered into by the Bank have original expiration periods of up to seven years, currently no later than 2016. At December 31, 2012 and 2011, the Bank had standby bond purchase agreements with four housing associates. During the years ended December 31, 2012, 2011, and 2010, the Bank was not required to purchase any bonds under these agreements. For the years ended December 31, 2012, 2011, and 2010, the Bank received fees for the guarantees that amounted to $2.1 million, $1.8 million, and $1.7 million. The estimated fair value of standby bond purchase agreements at December 31, 2012 and 2011 is reported in “Note 18 — Fair Value.”


128

Commitments to Purchase Mortgage Loans. The Bank enters into commitments that unconditionally obligate it to purchase mortgage loans. Commitments are generally for periods not to exceed 45 days. These commitments are considered derivatives and their estimated fair value at December 31, 2012 and 2011 is reported in “Note 11 — Derivatives and Hedging Activities” as mortgage delivery commitments.

Lease Commitments. The Bank charged to operating expenses net rental costs of $1.3 million, $1.1 million, and $1.3 million for the years ended December 31, 2012, 2011, and 2010.

Future minimum lease payments for premises and equipment at December 31, 2012 were as follows (dollars in thousands):
Year
 
Amount
2013
 
$
1,201

2014
 
1,117

2015
 
962

2016
 
869

2017
 
956

Thereafter
 
8,604

Total
 
$
13,709

Lease agreements for Bank premises generally provide for increases in the basic rentals resulting from increases in property taxes and maintenance expenses. Such increases are not expected to have a material effect on the Bank.

Other Commitments. The Bank is contractually obligated to pay the FHLBank of Chicago a service fee for its participation in the MPF program. This service fee expense is recorded as an offset to other (loss) income. Refer to “Note 21 — Activities with Other FHLBanks” for additional details.

As described in “Note 10 — Allowance for Credit Losses”, the FLA is a memorandum account used to track the Bank's potential loss exposure under each master commitment prior to the PFI's credit enhancement obligation. For absorbing certain losses in excess of the FLA, PFIs are paid a credit enhancement fee, a portion of which may be performance-based. To the extent the Bank experiences losses under the FLA, it may be able to recapture performance-based credit enhancement fees paid to the PFI to offset these losses. The FLA balance for all master commitments was $126.0 million and $124.4 million at December 31, 2012 and 2011.
In conjunction with its sale of certain mortgage loans to Fannie Mae through the FHLBank of Chicago in 2009, the Bank entered into an agreement with the FHLBank of Chicago on June 11, 2009 to indemnify the FHLBank of Chicago for potential losses on mortgage loans remaining in four master commitments from which the mortgage loans were sold. The Bank agreed to indemnify the FHLBank of Chicago for any losses not otherwise recovered through credit enhancement fees, subject to an indemnification cap of $1.2 million by December 31, 2012, $0.8 million by December 31, 2015, and $0.3 million by December 31, 2020. At December 31, 2012, the FHLBank of Chicago had not requested any indemnification payments from the Bank pursuant to this agreement.

Legal Proceedings. The Bank is not currently aware of any material pending legal proceedings other than ordinary routine litigation incidental to the business, to which it is a party or of which any of its property is the subject.

Note 20 — Activities with Stockholders

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

Transactions with Directors' Financial Institutions

In the normal course of business, the Bank extends credit to its members whose directors and officers serve as Bank directors (Directors' Financial Institutions). Finance Agency regulations require that transactions with Directors' Financial Institutions be subject to the same eligibility and credit criteria, as well as the same terms and conditions, as all other transactions.


129

The following table summarizes the Bank's outstanding transactions with Directors' Financial Institutions (dollars in thousands):
 
 
December 31,
 
 
2012
 
2011
 
 
Amount
 
% of Total
 
Amount
 
% of Total
Interest-bearing deposits
 
$
239

 
7.4
 
$
239

 
3.8
Advances
 
587,643

 
2.3
 
611,033

 
2.4
Mortgage loans
 
83,227

 
1.2
 
74,628

 
1.1
Deposits
 
5,338

 
0.5
 
12,616

 
1.7
Capital stock
 
41,172

 
2.0
 
40,892

 
1.9

Business Concentrations

The Bank considers itself to have business concentrations with stockholders owning 10 percent or more of its total capital stock outstanding (including mandatorily redeemable capital stock). At December 31, 2012 and 2011, the Bank concluded that it did not have any business concentrations with stockholders.

Note 21 — Activities with Other FHLBanks

MPF Mortgage Loans. The Bank pays a service fee to the FHLBank of Chicago for its participation in the MPF program. This service fee expense is recorded as an offset to other (loss) income. For the years ended December 31, 2012, 2011, and 2010, the Bank recorded $2.5 million, $2.1 million, and $1.7 million in service fee expense to the FHLBank of Chicago.

Overnight Funds. The Bank may lend or borrow unsecured overnight funds to or from other FHLBanks. All such transactions are at current market rates. The Bank did not make any loans to other FHLBanks during the year ended December 31, 2012.

The following table summarizes loan activity to other FHLBanks during the years ended December 31, 2011 and 2010 (dollars in thousands):
Other FHLBank
 
Beginning
Balance
 
Advance
 
Principal
Repayment
 
Ending
Balance
2011
 
 
 
 
 
 
 
 
Atlanta
 
$
—

 
$
1,000,000

 
$
(1,000,000
)
 
$
—

Topeka
 
—

 
35,000

 
(35,000
)
 
—

 
 
$
—

 
$
1,035,000

 
$
(1,035,000
)
 
$
—

2010
 
 
 
 
 
 
 
 
Chicago
 
$
—

 
$
5,000

 
$
(5,000
)
 
$
—



130

The following table summarizes borrowing activity from other FHLBanks during the years ended December 31, 2012, 2011, and 2010 (dollars in thousands):
Other FHLBank
 
Beginning
Balance
 
Borrowing
 
Principal
Payment
 
Ending
Balance
2012
 
 
 
 
 
 
 
 
Chicago
 
$
—

 
$
125,000

 
$
(125,000
)
 
$
—

 
 
 
 
 
 
 
 
 
2011
 
 
 
 
 
 
 
 
Atlanta
 
$
—

 
$
100,000

 
$
(100,000
)
 
$
—

Chicago
 
—

 
140,000

 
(140,000
)
 
—

Cincinnati
 
—

 
100,000

 
(100,000
)
 
—

Dallas
 
—

 
50,000

 
(50,000
)
 
—

Topeka
 
—

 
75,000

 
(75,000
)
 
—

 
 
$
—

 
$
465,000

 
$
(465,000
)
 
$
—

2010
 
 
 
 
 
 
 
 
Chicago
 
$
—

 
$
500,000

 
$
(500,000
)
 
$
—

Cincinnati
 
—

 
25,000

 
(25,000
)
 
—

 
 
$
—

 
$
525,000

 
$
(525,000
)
 
$
—


At December 31, 2012 and 2011, none of the previous transactions were outstanding on the Bank's Statements of Condition.

Debt Transfers. Occasionally, the Bank transfers debt that it no longer needs to other FHLBanks. These transfers are accounted for in the same manner as debt extinguishments. In connection with these transactions, the assuming FHLBanks become the primary obligors for the transferred debt. During the year ended December 31, 2012, the Bank transferred $380.0 million of par value bonds to the FHLBank of Boston and recorded aggregate net losses of $49.0 million through "Net loss on extinguishment of debt" in the Statements of Income. During the year ended December 31, 2011, the Bank did not transfer any debt to other FHLBanks. During the year ended December 31, 2010, the Bank transferred $140.0 million, $100.0 million, and $193.9 million of par value bonds to the FHLBanks of Atlanta, Boston, and New York and recorded aggregate net losses of $54.1 million through "Net loss on extinguishment of debt" in the Statements of Income.



131

SUPPLEMENTARY FINANCIAL DATA (UNAUDITED)
Selected Quarterly Financial Information
The following table presents a summary of our Statements of Condition data (dollars in millions):
 
2012
Statements of Condition
December 31,
 
September 30,
 
June 30,
 
March 31,
Investments1
$
13,433

 
$
15,377

 
$
12,738

 
$
14,146

Advances
26,614

 
25,831

 
26,561

 
26,608

Mortgage loans held for portfolio, gross
6,968

 
7,132

 
7,271

 
7,173

Allowance for credit losses
(16
)
 
(16
)
 
(17
)
 
(18
)
Total assets
47,367

 
48,659

 
46,938

 
48,345

Consolidated obligations
 
 
 
 
 
 
 
Discount notes
8,675

 
14,158

 
5,956

 
5,727

Bonds
34,345

 
30,108

 
36,396

 
38,482

Total consolidated obligations2
43,020

 
44,266

 
42,352

 
44,209

Mandatorily redeemable capital stock
9

 
10

 
10

 
7

Capital stock — Class B putable
2,063

 
2,024

 
2,064

 
2,074

Retained earnings
622

 
606

 
601

 
599

Accumulated other comprehensive income
149

 
168

 
150

 
131

Total capital
2,834

 
2,798

 
2,815

 
2,804


1
Investments include: interest-bearing deposits, securities purchased under agreements to resell, Federal funds sold, trading securities, AFS securities, and HTM securities.

2
The total par value of outstanding consolidated obligations of the 12 FHLBanks was $687.9 billion, $674.5 billion, $685.2 billion, and $658.0 billion at December 31, 2012, September 30, 2012, June 30, 2012, and March 31, 2012.

The following table presents a summary of our Statements of Income data (dollars in millions):
 
For the Three Months Ended
 
2012
Statements of Income
December 31,
 
September 30,
 
June 30,
 
March 31,
Net interest income1
$
56.4

 
$
59.3

 
$
55.0

 
$
69.9

Provision for credit losses on mortgage loans
—

 
—

 
—

 
—

Other (loss) income2
(8.1
)
 
(24.5
)
 
(19.8
)
 
(4.9
)
Other expense
15.1

 
14.6

 
15.0

 
14.8

Net income
29.9

 
18.1

 
18.2

 
45.2


1
Represents net interest income before the provision for credit losses on mortgage loans.

2
Other (loss) income includes, among other things, net gains (losses) on investment securities, net gains (losses) on derivatives and hedging activities, and net gains (losses) on the extinguishment of debt.


132

The following table presents a summary of our Statements of Condition data (dollars in millions):
 
2011
Statements of Condition
December 31,
 
September 30,
 
June 30,
 
March 31,
Investments1
$
14,637

 
$
14,696

 
$
15,601

 
$
17,381

Advances
26,591

 
27,069

 
27,939

 
27,963

Mortgage loans held for portfolio, gross
7,157

 
7,351

 
7,244

 
7,220

Allowance for credit losses
(19
)
 
(20
)
 
(19
)
 
(18
)
Total assets
48,733

 
49,557

 
51,575

 
52,841

Consolidated obligations
 
 
 
 
 
 
 
Discount notes
6,810

 
5,672

 
8,602

 
3,928

Bonds
38,012

 
39,782

 
38,568

 
44,289

Total consolidated obligations2
44,822

 
45,454

 
47,170

 
48,217

Mandatorily redeemable capital stock
6

 
7

 
7

 
7

Capital stock — Class B putable
2,109

 
2,107

 
2,140

 
2,118

Retained earnings
569

 
552

 
568

 
565

Accumulated other comprehensive income
134

 
135

 
93

 
64

Total capital
2,812

 
2,794

 
2,801

 
2,747


1
Investments include: interest-bearing deposits, securities purchased under agreements to resell, Federal funds sold, trading securities, AFS securities, and HTM securities.

2
The total par value of outstanding consolidated obligations of the 12 FHLBanks was $691.8 billion, $696.6 billion, $727.4 billion, and $765.9 billion at December 31, 2011, September 30, 2011, June 30, 2011, and March 31, 2011.

The following table presents a summary of our Statements of Income data (dollars in millions):
 
For the Three Months Ended
 
2011
Statements of Income
December 31,
 
September 30,
 
June 30,
 
March 31,
Net interest income1
$
59.2

 
$
65.4

 
$
48.9

 
$
62.1

Provision for credit losses on mortgage loans
—

 
2.0

 
1.6

 
5.6

Other (loss) income2
(8.0
)
 
(49.9
)
 
(7.5
)
 
(6.5
)
Other expense
14.2

 
14.2

 
13.9

 
14.6

Net income (loss)
33.3

 
(0.6
)
 
19.1

 
26.0


1
Represents net interest income before the provision for credit losses on mortgage loans.

2
Other (loss) income includes, among other things, net gains (losses) on investment securities, net gains (losses) on derivatives and hedging activities, and net gains (losses) on the extinguishment of debt.





133

Investment Portfolio Analysis
The following table summarizes the carrying value of our investment portfolio (dollars in millions):
 
December 31,
 
2012
 
2011
 
2010
Trading securities
 
 
 
 
 
Other U.S. obligations
$
309

 
$
8

 
$
—

GSE obligations
64

 
64

 
—

Temporary Liquidity Guarantee Program debentures
—

 
1,007

 
1,213

Other1
295

 
286

 
259

Mortgage-backed securities
 
 
 
 
 
GSE - residential
477

 
—

 
—

Total trading securities
1,145

 
1,365

 
1,472

Available-for-sale securities
 
 
 
 
 
Other U.S. obligations
163

 
172

 
176

GSE obligations
556

 
557

 
523

State or local housing agency obligations
8

 
—

 
—

Temporary Liquidity Guarantee Program debentures
—

 
564

 
566

Other2
401

 
243

 
165

Mortgage-backed securities
 
 
 
 
 
GSE - residential
3,732

 
3,820

 
4,927

Total available-for-sale securities
4,860

 
5,356

 
6,357

Held-to-maturity securities
 
 
 
 
 
Certificates of deposit
—

 
340

 
335

GSE obligations
308

 
310

 
312

State or local housing agency obligations
88

 
102

 
107

Temporary Liquidity Guarantee Program debentures
—

 
1

 
1

Other3
2

 
1

 
4

Mortgage-backed securities
 
 
 
 
 
Other U.S. obligations - residential
8

 
11

 
30

Other U.S. obligations - commercial
3

 
3

 
4

GSE - residential
2,590

 
4,378

 
6,374

Private-label - residential
41

 
49

 
59

Total held-to-maturity securities
3,040

 
5,195

 
7,226

Interest-bearing deposits
3

 
6

 
9

Securities purchased under agreements to resell
3,425

 
600

 
1,550

Federal funds sold
960

 
2,115

 
2,025

Total investments
$
13,433

 
$
14,637

 
$
18,639


1
Consists of taxable municipal bonds.

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

3
Consists of an investment in a Small Business Investment Company.






134

The following table summarizes the carrying value and yield characteristics of our investment portfolio on the basis of remaining terms to contractual maturity at December 31, 2012 (dollars in millions):
 
Due in one year or less
 
Due after one year through five years
 
Due after five years through 10 years
 
Due after 10 years
 
Total
Trading securities
 
 
 
 
 
 
 
 
 
Other U.S. obligations
$
—

 
$
—

 
$
42

 
$
267

 
$
309

GSE obligations
—

 
—

 
—

 
64

 
64

Other1
—

 
—

 
116

 
179

 
295

Mortgage-backed securities
 
 
 
 
 
 
 
 
 
GSE - residential
—

 
—

 
305

 
172

 
477

Total trading securities
—

 
—

 
463

 
682

 
1,145

Yield on trading securities
—
%
 
—
%
 
2.74
%
 
3.49
%
 
 
Available-for-sale securities
 
 
 
 
 
 
 
 
 
Other U.S. obligations
—

 
—

 
163

 
—

 
163

GSE obligations
—

 
291

 
233

 
32

 
556

State or local housing agency obligations
—

 
—

 
—

 
8

 
8

Other2
—

 
41

 
188

 
172

 
401

Mortgage-backed securities
 
 
 
 
 
 
 
 
 
GSE - residential
—

 
—

 
660

 
3,072

 
3,732

Total available-for-sale securities
—

 
332

 
1,244

 
3,284

 
4,860

Yield on available-for-sale securities
—
%
 
3.57
%
 
3.43
%
 
1.05
%
 
 
Held-to-maturity securities
 
 
 
 
 
 
 
 
 
GSE obligations
—

 
—

 
—

 
308

 
308

State or local housing agency obligations
—

 
—

 
—

 
88

 
88

Other3
—

 
2

 
—

 
—

 
2

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

 
—

 
1

 
7

 
8

Other U.S. obligations - commercial
—

 
—

 
3

 
—

 
3

GSE - residential
—

 
—

 
—

 
2,590

 
2,590

Private-label - residential
—

 
—

 
—

 
41

 
41

Total held-to-maturity securities
—

 
2

 
4

 
3,034

 
3,040

Yield on held-to-maturity securities
—
%
 
1.10
%
 
0.79
%
 
2.86
%
 
 
Total investment securities
—

 
334

 
1,711

 
7,000

 
9,045

Interest-bearing deposits
3

 
—

 
—

 
—

 
3

Securities purchased under agreements to resell
3,425

 
—

 
—

 
—

 
3,425

Federal funds sold
960

 
—

 
—

 
—

 
960

Total investments
$
4,388

 
$
334

 
$
1,711

 
$
7,000

 
$
13,433


1
Consists of taxable municipal bonds.

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

3
Consists of an investment in a Small Business Investment Company.



135

At December 31, 2012, we had investments with a carrying value greater than 10 percent of our total capital with the following issuers (excluding GSEs and U.S. Government agencies) (dollars in millions):
 
Carrying
Value
 
Fair
Value
Barclays Bank PLC
$
1,250

 
$
1,250

Merrill Lynch
1,215

 
1,215

Nomura Securities International, Inc.
925

 
925

Total
$
3,390

 
$
3,390


Loan Portfolio Analysis
The following table presents supplemental information on our mortgage loans held for portfolio (dollars in thousands):
 
December 31,
 
2012
 
2011
 
2010
 
2009
 
2008
Past due 90 days or more and still accruing interest1
$
5,292

 
$
4,427

 
$
4,675

 
$
5,306

 
$
7,333

Non-accrual mortgage loans2
$
88,992

 
$
97,477

 
$
111,064

 
$
102,028

 
$
48,439

Allowance for credit losses
 
 
 
 
 
 
 
 
 
Balance, beginning of year
$
18,963

 
$
13,000

 
$
1,887

 
$
500

 
$
300

Charge-offs3
(3,170
)
 
(3,192
)
 
(1,005
)
 
(88
)
 
(95
)
Provision for credit losses
—

 
9,155

 
12,118

 
1,475

 
295

Balance, end of year
$
15,793

 
$
18,963

 
$
13,000

 
$
1,887

 
$
500

Non-accrual mortgage loans
 
 
 
 
 
 
 
 
 
Gross interest income that would have been recorded based on original terms during the year
$
3,796

 
 
 
 
 
 
 
 
Interest actually recognized into net income during the year
—

 
 
 
 
 
 
 
 
Interest shortfall
$
3,796

 
 
 
 
 
 
 
 

1
Represents the unpaid principal balance of government-insured mortgage loans that are 90 days or more past due. A government-insured mortgage loan that is 90 days or more past due is not placed on non-accrual status because of the U.S. Government guarantee of the loan and contractual obligation of the loan servicer to repurchase the loan when certain criteria are met.

2
Represents the unpaid principal balance of conventional mortgage loans that are 90 days or more past due and/or troubled debt restructurings.

3
The ratio of charge-offs to average mortgage loans outstanding was one percent or less for the years ended December 31, 2012, 2011, 2010, 2009, and 2008.

Short-Term Borrowings
Borrowings with original maturities of one year or less are classified as short-term. The following table summarizes our short-term borrowings for the years ended December 31, 2012, 2011, and 2010 (dollars in millions):
 
Discount Notes
 
Bonds
 
2012
 
2011
 
2010
 
2012
 
2011
 
2010
Outstanding at end of the period
$
8,675

 
$
6,810

 
$
7,208

 
$
14,375

 
$
8,785

 
$
625

Weighted-average rate at end of the period
0.13
%
 
0.09
%
 
0.12
%
 
0.19
%
 
0.19
%
 
0.42
%
Daily-average outstanding for the period
$
8,839

 
$
7,104

 
$
7,146

 
$
9,725

 
$
4,414

 
$
6,983

Weighted-average rate for the period
0.13
%
 
0.09
%
 
0.15
%
 
0.19
%
 
0.19
%
 
0.44
%
Highest outstanding at any month-end
$
14,158

 
$
12,151

 
$
12,397

 
$
14,375

 
$
9,035

 
$
13,081



136

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.

ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures

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

Management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) with the participation of the president and CEO and CFO as of the end of the annual period covered by this report. Based on that evaluation, the president and CEO and the CFO have concluded that our disclosure controls and procedures were effective as of December 31, 2012.
Report of Management on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting process is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are made only in accordance with authorizations of management and directors, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2012, based on the framework established in "Internal Control — Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, management concluded that we maintained effective internal control over financial reporting as of December 31, 2012.
Additionally, our internal control over financial reporting as of December 31, 2012 has been audited by our independent registered public accounting firm, PricewaterhouseCoopers, LLP (PwC). Refer to “Item 8. Financial Statements and Supplementary Data — Audited Financial Statements” for their audit report.
Changes in Internal Control over Financial Reporting
For the fourth quarter of 2012, there were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.


137

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors
The Board of Directors is responsible for monitoring our compliance with Finance Agency regulations and establishing policies and programs that carry out our housing finance mission. The Board of Directors adopts, reviews, and oversees the implementation of policies governing our advance, mortgage loan, investment, and funding activities. Additionally, the Board of Directors adopts, reviews, and oversees the implementation of policies that manage our exposure to market, liquidity, credit, operational, and business risks.
Our Board is comprised of Member Directors elected by our member institutions on a state-by-state basis and Independent Directors elected by a plurality of our members. Our Board currently includes nine Member Directors and seven Independent Directors, two of which serve as public interest directors. Under the FHLBank Act, the only matters submitted to shareholders for votes are (i) the annual election of our Directors and (ii) any proposed agreement to merge with one or more FHLBanks. Finance Agency regulations require all of our Directors to be elected by our members. No member of management may serve as a director of an FHLBank.
Pursuant to the passage of the Housing Act, both Member and Independent Directors serve four-year terms. If any person has been elected to three consecutive full terms as a Member or Independent Director of our Board of Directors, the individual is not eligible for election to a Member or Independent Directorship for a term which begins earlier than two years after the expiration of the last expiring four-year term.
Member Directorships are allocated by the Finance Agency to the five states in our district and a member institution is eligible to participate in the election for the state in which it is located. Candidates for Member Directorships are not nominated by the Board. As provided for in the FHLBank Act, Member Directors are nominated by the members eligible to participate in the election in the relevant state. A member is entitled to cast, for each applicable Member Directorship, one vote for each share of capital stock that the member is required to hold as of the record date for voting, subject to a statutory limitation. Under this limitation, the total number of votes that each member may cast is limited to the average number of shares of our capital stock that were required to be held by all members in that state as of the record date for voting.
Member Directors are required, by statute and regulation, to meet certain eligibility requirements to serve as a director. To qualify as a Member Director an individual must (i) be an officer or director of a member institution in compliance with the minimum capital requirements established by its regulator and located in the state in which there is an open directorship and (ii) be a U.S. citizen. We are not permitted to establish additional qualifications to define eligibility criteria for Member Directors or nominees. Because of the structure of FHLBank Member Director nominations and elections, we may not know what factors our member institutions considered in selecting Member Director nominees or electing Member Directors.
Independent Directors are nominated by our Board of Directors after consultation with our Advisory Council, and then voted upon by all members within our five-state district. For each Independent Directorship, a member is entitled to cast the same number of votes as it would for a Member Directorship.
In order to be eligible to serve as an Independent Director on our Board, an individual must (i) be a U.S. citizen and (ii) maintain a principal residence in a state in our district (or own or lease a residence in the district and be employed in the district). In addition, the individual may not be an officer of any FHLBank or a director, officer, or employee of any member institution or of any recipient of our advances. By regulation, each public interest Independent Director must have more than four years of personal experience in representing consumer or community interests in banking services, credit needs, housing, or financial consumer protection. Each Independent Director, other than a public interest Independent Director, must have knowledge of, or experience in, financial management, auditing or accounting, risk management practices, derivatives, project development, organizational management, or the law.

138

On an annual basis, our Board of Directors performs an assessment that includes consideration of the directors’ backgrounds, expertise, qualifications, and other factors. The Board of Directors also annually reviews its Corporate Governance Principles, which include a statement of the skills and qualifications it desires on the Board of Directors. Furthermore, each director annually provides us a certification that the director continues to meet all applicable statutory and regulatory eligibility and qualification requirements. In connection with the election or appointment of an Independent Director, the Independent Director completes an application to serve on the Board of Directors. As a result of the annual assessment and as of the filing date of this Form 10-K, nothing has come to the attention of the Board of Directors or management to indicate that any of the current directors do not continue to possess the necessary experience, qualifications, attributes, or skills expected of the directors that serve on our Board of Directors, as described in each director’s biography below.
Information regarding our current directors and executive officers is provided in the following sections. There are no family relationships among our directors or executive officers.
The table below shows membership information for the Bank’s Board of Directors at February 28, 2013:
 
 
 
 
 
 
 
 
Expiration of
 
 
 
 
 
 
 
 
 
 
Current Term As
 
 
 
 
 
 
Member or
 
 
 
Director as of
 
Board
Director
 
Age
 
Independent
 
Director Since
 
December 31
 
Committees
Dale E. Oberkfell (chair)
 
57
 
Member
 
January 1, 2007
 
2013
 
a, c, e, f
Eric A. Hardmeyer (vice chair)
 
53
 
Member
 
January 1, 2008
 
2014
 
a, c, d, g
Johnny A. Danos
 
73
 
Independent
 
May 14, 2007
 
2014
 
b, e, g
Gerald D. Eid*
 
72
 
Independent
 
January 23, 2004
 
2014
 
c, d, g
Michael J. Finley
 
57
 
Member
 
January 1, 2005
 
2014
 
b, d, g
Van D. Fishback
 
66
 
Member
 
January 1, 2009
 
2016
 
a, c, e, f
Chris D. Grimm
 
54
 
Member
 
January 1, 2010
 
2015
 
a, c, d, g
Labh S. Hira, Ph.D.
 
64
 
Independent
 
May 14, 2007
 
2013
 
b, d, f
Teresa J. Keegan
 
50
 
Member
 
January 1, 2012
 
2015
 
b, e, g
John F. Kennedy, Sr.*
 
57
 
Independent
 
May 14, 2007
 
2016
 
a, b, e, g
Ellen Z. Lamale
 
59
 
Independent
 
January 1, 2012
 
2015
 
a, c, d, f
Clair J. Lensing
 
78
 
Member
 
January 1, 2004
 
2013
 
b, d, g
Paula R. Meyer
 
58
 
Independent
 
May 14, 2007
 
2016
 
a, b, d, g
John P. Rigler II
 
61
 
Member
 
January 1, 2013
 
2016
 
c, e, f
John H. Robinson
 
62
 
Independent
 
May 14, 2007
 
2015
 
a, b, e, f
Joseph C. Stewart III
 
43
 
Member
 
January 1, 2008
 
2013
 
c, d, f

a)  
Executive and Governance Committee 
b) 
Audit Committee 
c) 
Risk Committee 
d) 
Mission, Member, and Housing Committee 
e) 
Finance and Planning Committee 
f) 
Human Resources and Compensation Committee (Compensation Committee) 
g) 
Business Operations and Technology Committee 
* 
Public Interest Independent Director 


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The following describes the principal occupation, business experience, qualifications, and skills, among other matters of the 16 directors who currently serve on our Board of Directors. Except as otherwise indicated, each Director has been engaged in the principal occupation indicated for at least the past five years.
Dale E. Oberkfell, the Board's chair, has served in a variety of banking positions during his 30 years in the financial services industry. Mr. Oberkfell currently serves as executive vice president and CFO of Midwest BankCentre and treasurer and board secretary of Midwest BankCentre, Inc. Prior to joining Midwest BankCentre in January of 2012, he held various executive-level positions at Reliance Bank in Des Peres, Missouri, including president, chief operating officer (COO) and CFO. During this period, he also served as executive vice president and CFO of Reliance Bancshares, Inc. in Des Peres, Missouri, and as an executive officer of Reliance Bank, FSB in Fort Myers, Florida. Mr. Oberkfell was also a partner at the certified public accounting firm of Cummings, Oberkfell & Ristau, P.C. in St. Louis, Missouri. He is a licensed certified public accountant (CPA) and is active in the American Institute of Certified Public Accountants. He currently serves on several non-profit boards, including Good Shepard Family and Children's Services and Washington University Alumni Boards. Mr. Oberkfell's position as an officer of a member institution and his involvement in and knowledge of accounting, auditing, internal controls, and financial management, as indicated by his background, support his qualifications to serve on our Board of Directors. Mr. Oberkfell also serves as chair of the Executive and Governance Committee.
Eric A. Hardmeyer, the Board's vice chair, joined the Bank of North Dakota in 1985 and served as senior vice president of lending before becoming president and CEO in 2001. Mr. Hardmeyer is the past chairman of the North Dakota Bankers Association and also serves on the board of trustees of the Bismarck-Mandan Chamber of Commerce Foundation and the Missouri Valley YMCA. He is a member of the Federal Reserve Bank of Minneapolis Community Depository Institutions Advisory Council. Mr. Hardmeyer's position as an officer of a member institution and his involvement in and knowledge of economic development, accounting, auditing, and financial management, as indicated by his background, support his qualifications to serve on our Board of Directors. Mr. Hardmeyer also serves as vice chair of the Executive and Governance Committee.
Johnny A. Danos has served as Director of Strategic Development for LWBJ Financial in West Des Moines, Iowa since 2008. For more than 10 years, Mr. Danos was president of the Greater Des Moines Community Foundation in Des Moines, Iowa. He is the retired managing partner of the accounting firm of KPMG located in Des Moines, Iowa, and has more than 30 years of public accounting experience serving commercial, retail, and financial institutions. He serves on the board of directors of Casey's General Stores and Wright Tree Service. Mr. Danos’ involvement and experience in auditing, accounting, and organizational management, as indicated by his background, support his qualifications to serve as an Independent Director on our Board of Directors. Mr. Danos also serves as vice chair of the Business Operations and Technology Committee.
Gerald D. Eid has served as CEO of Eid-Co Buildings, Inc. in Fargo, North Dakota, since 1973. A second-generation builder, Mr. Eid has been in the building business and licensed as a realtor for more than 30 years. Founded in 1951, Eid-Co Buildings, Inc. is one of the largest single-family home builders in North Dakota. Mr. Eid has served as a member of the North Dakota Housing Finance Agency Advisory Board since 1998 and is currently its chair. He also represented North Dakota on the executive committee of the National Association of Homebuilders. Mr. Eid's involvement and experience in representing community interests in housing as well as housing finance, as indicated by his background, support his qualifications to serve as a public interest Independent Director on our Board of Directors.
Michael J. Finley has served since 1992 as president of Janesville State Bank in Janesville, Minnesota. Mr. Finley serves on the Political Action Committee Board and the Government Relations Committee of the Minnesota Bankers Association. He is a founding member of the Minnesota Financial Group, a peer group of 15 bankers founded in 1988, and is also currently the vice chairman of the Janesville Economic Development Authority. Mr. Finley's position as an officer of a member institution and his involvement in and knowledge of bank regulation, financial management, auditing, and credit administration, as indicated by his background, support his qualifications to serve on our Board of Directors. Mr. Finley also serves as the vice chair of the Audit Committee.
Van D. Fishback is vice chairman of First Bank & Trust in Brookings, South Dakota. Mr. Fishback joined First Bank & Trust in 1972 and has previously served as its president and CEO. Mr. Fishback currently serves as vice chair of Fishback Financial Corporation, one of South Dakota's largest privately held bank holding companies. In addition, he is a board member of First Bank & Trust, N.A. in Pipestone, Minnesota and First Bank & Trust in Milbank, South Dakota. Mr. Fishback is a licensed attorney and has been a member of the South Dakota bar since 1972. Mr. Fishback's position as an officer of a member institution and his involvement in and knowledge of financial management, community development, and the law, as indicated by his background, support his qualifications to serve on our Board of Directors. Mr. Fishback also serves as chair of the Finance and Planning Committee.

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Chris D. Grimm joined Iowa State Bank as its president and CEO in 2001. Prior to accepting his current role at Iowa State Bank, Mr. Grimm held a number of positions unrelated to the financial services industry. Mr. Grimm's position as an officer of a member institution and his involvement in and knowledge of financial management, as indicated by his background, support his qualifications to serve on our Board of Directors. Mr. Grimm also serves as chair of the Mission, Member, and Housing Committee.
Labh S. Hira, Ph.D., is Dean Emeritus and Professor of Accounting at the College of Business at Iowa State University (ISU) in Ames, Iowa. Dr. Hira recently returned to the accounting faculty after serving as the interim president of the ISU Foundation during 2012. He has held a variety of positions at ISU since 1982, including accounting professor, department chair, associate dean and Dean of the College of Business. Dr. Hira's involvement and experience in financial management, auditing, and accounting, as indicated by his background, support his qualifications to serve as an Independent Director on our Board of Directors. Dr. Hira also serves as vice chair of the Compensation Committee.
Teresa J. Keegan has served since 2002 as the senior vice president and CFO of Fidelity Bank in Edina, Minnesota. Ms. Keegan has over 25 years of financial management experience, including 19 years as a CFO in various financial institutions. Ms. Keegan is currently active in several peer groups, has served on the board of the Minnesota Bankers Association Insurance and Services, Inc., and previously chaired the Minnesota Bankers Association Operations and Technology Committee. Her position as an officer of a member institution and her involvement in and knowledge of financial management, as indicated by her background, support her qualifications to serve on our Board of Directors. Ms. Keegan also serves as vice chair of the Finance and Planning Committee.
John F. Kennedy, Sr. has served since 2012 as executive vice president and CFO for the St. Louis Equity Fund, Inc. in St. Louis, Missouri. St. Louis Equity Fund, Inc. which invests in affordable rental housing developments financed through corporate and bank investment and in cooperation with federal, state, and local governments. Mr. Kennedy has been with the St. Louis Equity Fund since 1998 and has more than 30 years of experience in affordable rental housing development and financing, residential homebuilding, public accounting, auditing, financial management, and representing low income individuals and families through the St. Louis Equity Fund, Inc. and the Gateway Community Development Fund, Inc., a certified CDFI. Mr. Kennedy’s involvement in and knowledge of accounting, auditing, financial management, and representing community interests in housing, as indicated by his background, support his qualifications to serve as a public interest Independent Director on our Board of Directors. Mr. Kennedy also serves as chair of the Audit Committee.
Ellen Z. Lamale retired from her position as senior vice president and chief risk officer (CRO) of The Principal Financial Group (The Principal Financial Group is a registered trademark) (Principal) in March of 2011. Ms. Lamale held executive positions at Principal for more than 10 years, and her responsibilities during her 34-year career at Principal included risk management, financial analysis, capital management, strategic planning, and auditing. Ms. Lamale has served on several community boards, including West Des Moines Youth Soccer Club, Iowa United Soccer Club, Des Moines Symphony Second Strings, and Des Moines Public Library Foundation. Currently, she is a volunteer with the West Des Moines Youth Justice Initiative. Her involvement in and knowledge of accounting, auditing, financial, and risk management, as indicated by her background, support her qualifications to serve as an Independent Director on our Board of Directors. Ms. Lamale also serves as chair of the Risk Committee.
Clair J. Lensing has served as the president, CEO, and owner of Security State Bank in Waverly, Iowa, since 1999. He also owns the Citizens Savings Bank in Hawkeye, Iowa, and the Maynard Savings Bank in Maynard, Iowa. Previously, he served as president and CEO of Farmers State Bank in Marion, Iowa, and as a bank examiner with the Iowa Division of Banking. Mr. Lensing has served as president of the Iowa Bankers Association, chairman of the Board of Shazam Network, and board member of the Community Bankers of Iowa. Mr. Lensing's position as an officer of a member institution and his involvement in and knowledge of economic development and financial management, as indicated by his background, support his qualifications to serve on our Board of Directors. Mr. Lensing also serves as vice chair of the Mission, Member, and Housing Committee.
Paula R. Meyer has over 30 years of experience in the financial services industry as a senior executive encompassing marketing, operations, and management of mutual funds, investments, and insurance companies. She retired in 2006 as president of the mutual fund and certificate businesses at Ameriprise Financial and has focused on board service since 2007. Prior to that, Ms. Meyer was president of Piper Capital Management. Ms. Meyer also serves on the board of directors of Mutual of Omaha in Omaha, Nebraska, First Command Financial Services in Fort Worth, Texas, and is board chair emeritus of Luther College in Decorah, Iowa. Ms. Meyer's involvement in and knowledge of risk management, marketing, and financial management, as indicated by her background, support her qualifications to serve as an Independent Director on our Board of Directors. Ms. Meyer also serves as chair of the Business Operations and Technology Committee.

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John P. Rigler II has served as president and CEO of State Bank and Trust Company since 2005. Mr. Rigler has been in the banking industry for 40 years and has experience in correspondent banking, trusts and investments, mergers and acquisitions, and government relations, including lobbying efforts with the Iowa Legislature. He has also been active in economic development in Iowa for more than 20 years. Currently, Mr. Rigler is serving as Chairman of Iowa Community Development, L.C. (ICD). He assisted ICD with a tax credit application and received $200 million in new market tax credits. Mr. Rigler's position as an officer of a member institution and his involvement in and knowledge of financial management, as indicated by his background, support his qualifications to serve on our Board of Directors.
John H. Robinson has served as chairman of Hamilton Ventures, LLC, a consulting and investment company in Kansas City, Missouri since 2004. Mr. Robinson is an engineer with international experience as chairman of EPCglobal Ltd in Sheffield, England, from 2003 to 2004, and executive director of Amey Plc in London, England, from 2000 to 2002. He was managing partner and vice chairman of Black & Veatch, Inc. from 1989 to 2000. He serves on the board of directors of Olsson Associates, Alliance Resources MLP, and Coeur Precious Metals. Mr. Robinson's involvement in and knowledge of financial management, project development, and organizational management, as indicated by his background, support his qualifications to serve as an Independent Director on our Board of Directors. Mr. Robinson also serves as chair of the Compensation Committee.
Joseph C. Stewart III has served as chairman of the board of BancStar, Inc., a three-bank holding company in St. Louis, Missouri, and as CEO and director of Bank Star in Pacific, Missouri since 2004. In addition, Mr. Stewart has worked in various other capacities since joining the Bank Star Companies in 1994 and also serves as CEO and director for Bank Star One in Fulton, Missouri and Bank Star of the BootHeel in Steele, Missouri. Mr. Stewart has held board positions for several organizations including the Missouri Bankers Association and the Missouri Independent Bankers Association and is currently serving on the government relations committee of the American Bankers Association. Mr. Stewart's position as an officer of a member institution and his knowledge of accounting, risk management, and financial management, as indicated by his background, support his qualifications to serve on our Board of Directors. Mr. Stewart also serves as vice chair of the Risk Committee.
Executive Officers
The following persons currently serve as executive officers of the Bank:
 
 
 
 
 
 
Position Held
Executive Officer
 
Age
 
Position Held
 
Since
Richard S. Swanson
 
62
 
President and Chief Executive Officer
 
June 2006
Steven T. Schuler
 
61
 
Executive Vice President and Chief Financial Officer
 
September 2006
Edward J. McGreen
 
45
 
Executive Vice President and Chief Capital Markets Officer
 
July 2005
Dusan Stojanovic
 
53
 
Executive Vice President and Chief Risk Officer
 
February 2010
Daniel D. Clute
 
47
 
Executive Vice President and Chief Business Officer
 
October 2012

Richard S. Swanson has served as the Bank's president and CEO since June of 2006. Mr. Swanson joined the Bank following a career in bank management, corporate and financial law practice, and public service based in Seattle, Washington. From 2004 to 2006, he advised companies in the areas of corporate governance and finance, banking law, and SEC regulation as a principal of the law firm of Hillis, Clark, Martin & Peterson. From 1990 to 2003, Mr. Swanson was CEO and a director of HomeStreet Bank. He also served the FHLBank of Seattle as a member director from 1998 to 2003 and as vice chair from 2002 to 2003. Throughout his career, Mr. Swanson has been a director of public and private companies, as well as non-profit organizations and industry associations. He is recognized as a Board Leadership Fellow by the National Association of Corporate Directors, and currently serves on the Board of Directors of the FHLBanks' Office of Finance and, by appointment of the U.S. Department of the Treasury, as director and vice chair of the Resolution Funding Corporation. Mr. Swanson received his undergraduate degree from Harvard College, was a Marshall Scholar at Cambridge University and earned his law degree from Stanford Law School.

Steven T. Schuler has served as executive vice president and CFO since September of 2006. In his role, Mr. Schuler has management responsibility for accounting, information technology, project management, and business process management. Prior to joining the Bank, Mr. Schuler served in various accounting and financial management positions in the commercial banking and wireless technology industries. From 2001 to 2006, Mr. Schuler served as CFO, treasurer and secretary for Iowa Wireless Services, Inc. From 1977 to 2001, Mr. Schuler had a long career with Brenton Banks, Inc., a publicly traded regional commercial banking company which was sold to Wells Fargo in 2001. He served in various capacities eventually serving as corporate senior vice president, CFO, secretary and treasurer. Mr. Schuler received a Bachelors degree in Accounting from Iowa State University.

142

Edward J. McGreen was appointed executive vice president and chief capital markets officer (CCMO) in July of 2005. His management responsibilities include treasury and portfolio strategy. Mr. McGreen joined the Bank as director of mortgage portfolio management in November of 2004. Prior to joining the Bank, he held various finance and portfolio management positions at Fannie Mae from 1996 to 2001 and 2002 to 2004. From 2001 to 2002, Mr. McGreen was senior interest rate risk manager for GE Asset Management. Mr. McGreen received his undergraduate degree in Business Administration from Ohio State University and a Masters of Science in Finance from George Washington University. He also holds the Chartered Financial Analyst designation from the CFA institute and the Financial Risk Manager designation from Global Association of Risk Professionals.

Dusan Stojanovic has been with the Bank since March of 2008 and is currently serving as executive vice president and CRO, a position he has held since February 2010. Mr. Stojanovic has management responsibility for enterprise risk management, including credit risk, market risk, operational risk, and model risk. Prior to joining the Bank, Mr. Stojanovic held a variety of regulatory risk management and model validation positions with the Federal Reserve Bank of Chicago from 2006 to 2008, Federal Reserve Bank of Richmond from 2005 to 2006, and Federal Reserve Bank of St. Louis from 1995 to 2003. From 2003 to 2004, Mr. Stojanovic served as the vice governor for banking supervision at the National Bank of Serbia. Mr. Stojanovic received his undergraduate degree in Economics from the University of Belgrade and his M.A. and Ph.D. degrees in Economics from Washington University in St. Louis, Missouri. He also holds the Chartered Financial Analyst designation from the CFA institute.

Daniel D. Clute has been executive vice president and chief business officer (CBO) since October of 2012. Mr. Clute is responsible for the Bank's credit sales, communications, community investment, external relations, and member financial services. He joined the bank in August 2011 as senior vice president and director of communications and external relations. Prior to joining the Bank, his career included senior roles in treasury, corporate finance, public relations, and public service. From 2007 to 2011, he served as vice president and treasurer of Wells Fargo Financial, Inc., a unit of Wells Fargo & Company, where he was responsible for funding, treasury operations, and asset-liability management for the international finance company. From 2000 to 2007, Mr. Clute served in several roles at Citigroup, including the senior finance and administrative officer for a Citi Cards operations center and the state director of public affairs for Citigroup businesses in Iowa. From 1989 to 2000, he served in various management roles in the Wells Fargo Financial, Inc. Treasury Operations Department. Mr. Clute served as an elected member of the Iowa House of Representatives from 2007 to 2009 and prior to that was an elected member of the Clive, Iowa, City Council from 2002 to 2007. He also has a long history of non-profit board of director leadership, including his current position as immediate past president of the board of directors of Habitat for Humanity of Iowa, Inc. He was appointed by the governor of Iowa in 2012 to a four-year term on the Board of Directors of the Iowa Student Loan Liquidity Corporation. Mr. Clute received his undergraduate and Masters of Business Administration degrees from the University of Iowa in 1988 and 1989, respectively.

Code of Ethics
We have adopted a Code of Ethics that sets forth the guiding principles and rules of conduct by which we operate and conduct our daily business with our customers, vendors, shareholders, and fellow employees. The Code of Ethics applies to all of our directors, officers, and employees. The purpose of the Code of Ethics is to promote honest and ethical conduct and compliance with the law, particularly as it relates to the maintenance of our financial books and records and the preparation of our financial statements. The Code of Ethics can be found on our website at www.fhlbdm.com. We disclose on our website any amendments to, or waivers of, the Code of Ethics. The information contained in or connected to our website is not incorporated by reference into this annual report on Form 10-K and should not be considered part of this or any report filed with the SEC.

143

Audit Committee
The purpose of the Audit Committee is to assist the Board of Directors in fulfilling its review and oversight responsibilities for (i) the integrity of the Bank's financial statements and financial reporting process and systems of internal accounting and financial reporting controls, (ii) the independence, scope of audit services, and performance of the Bank's internal audit function as well as the appointment or replacement of the Bank's chief audit executive, (iii) the selection and replacement, qualifications, independence, scope of audit, and performance of the Bank's external auditor, (iv) the Bank's compliance with laws, regulations and policies, including the Code of Ethics, as applicable to the Committee's duties and responsibilities, (v) the procedures for complaints regarding questionable accounting, internal accounting controls, and auditing matters, and oversight of fraud investigations, and (vi) the Bank's and Audit Committee's compliance with the Finance Agency's Examination Guidance for the examination of accounting practices. The Audit Committee has adopted a charter outlining its roles and responsibilities, which is available on our website at www.fhlbdm.com. The information contained in or connected to our website is not incorporated by reference into this annual report on Form 10-K and should not be considered part of this or any report filed with the SEC. The members of our Audit Committee for 2013 are John Kennedy (chair), Michael Finley (vice chair), Johnny Danos, Labh Hira, Teresa Keegan, Clair Lensing, Paula Meyer, and John Robinson. The Audit Committee held a total of seven in-person meetings and four telephonic meetings in 2012. As of February 28, 2013, the Audit Committee has held one in-person meeting and one telephonic meeting and is scheduled to hold five in-person meetings and five telephonic meetings throughout the remainder of 2013. Refer to Exhibit 99.1 of this 2012 Annual Report for the Audit Committee Report.
Audit Committee Financial Expert
Our Board of Directors determined that the following members of its Audit Committee qualify as audit committee financial experts under Item 407(d)(5) of Regulation S-K: Johnny Danos, Labh Hira, John Kennedy, and Paula Meyer. Refer to “Item 13. Certain Relationships and Related Transactions, and Director Independence” for details on our director independence. For information concerning the experience through which these individuals acquired the attributes required to be deemed financial experts, refer to the biographical information in Item 10.


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ITEM 11. EXECUTIVE COMPENSATION

COMPENSATION DISCUSSION AND ANALYSIS

This Compensation Discussion and Analysis section provides information related to the administration of our executive compensation policies and programs. We believe we have historically taken a prudent and effective approach to executive compensation with practices aligned with the Finance Agency's guidance on FHLBank executive compensation.
 
This Compensation Discussion and Analysis includes the following parts:
 
i.
Compensation Philosophy - provides detail on the framework we use when making executive compensation decisions.
 
ii.
Elements of Executive Compensation - provides a discussion of each element of compensation payable to our named executive officers, comprised of our President and CEO (President), CFO, CCMO, CRO, and CBO (Executives), and provides greater detail on our approach, structure, and practices with regard to executive compensation.

iii.
Finance Agency Oversight - Executive Compensation - provides detail on the Finance Agency regulations relating to executive compensation.
 
iv.
Roles and Responsibilities of the Compensation Committee and Management in Establishing Executive Compensation - provides detail on the role of the Compensation Committee and management in making executive compensation decisions and explains why we determined executive compensation payouts in 2012 were appropriate.
 
v.
Analysis Tools the Compensation Committee Uses - provides detail on how the Compensation Committee utilizes information and tools to arrive at executive compensation decisions.
 
vi.
Compensation Decisions for Executives in 2012 - describes the compensation paid and the benefits made available to our Executives during 2012.
 
vii.
Benefits and Retirement Philosophy - provides detail on the retirement programs offered to Executives.
 
viii.
Potential Payments upon Termination or Change in Control - provides information on the termination payments and benefits that would be payable to each executive, as applicable.
 
ix.
Director Compensation - provides detail on the compensation paid to the members of our Board of Directors in 2012 and the director fee schedule for 2013.

Compensation Philosophy
 
Our compensation philosophy, practices, and principles are an important part of our business strategy. They help attract and retain employees with the skills and talent we need to create value for our members, which is critical to our long-term success. They also provide a framework to ensure an appropriately balanced approach to compensation through a combination of base salary, benefits, and annual and deferred cash incentive awards. Although we refine our compensation programs as economic conditions and competitive practices change, we strive to maintain consistency in our philosophy and approach with respect to executive compensation.
 
We believe our current employees and those individuals in our potential talent pool are highly marketable and can be attracted to opportunities across a broad spectrum of financial services businesses. Our competition for talent primarily includes FHLBanks, commercial banks, mortgage banks, and other financial services companies, such as insurance companies.
 
We have designed our incentive opportunities to motivate our Executives to achieve our objectives for delivering value to our members as customers and as shareholders without taking undue risk. We believe our incentive program should remain a component of our total compensation approach.

 

145

Our executive compensation program is designed to do the following:
 
i.
Attract, motivate, reward, and retain experienced, highly qualified executives critical to our long-term success and enhancement of our member value.
 
ii.
Link executive pay to Bank and individual performance in a way that does not encourage exposing the Bank to unnecessary or excessive risk.
 
iii.
Structure executive total compensation so that it consists of a balance of competitive annual base pay and incentive pay that defers 50 percent of the total incentive award into future periods and is earned only upon satisfaction of a long-term performance goal. Thus, a deferral payout calibrated to the long-term value of the Bank, as measured by the EVCS, is a critical component of our compensation mix and aligns with the principles for executive compensation outlined by the Finance Agency.

In 2012, we proved the value of our executive compensation philosophy by providing competitive compensation opportunities for and payments to our Executives. Compensation opportunities were presented through our Incentive Plan (IP), which provides cash-based awards upon achievement of short and long-term objectives.

For more information on our EVCS, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Market Risk — Economic Value of Capital Stock."

Elements of Executive Compensation

Our executive compensation program is comprised of the following elements: (i) base salary, (ii) incentive plan that includes a 50 percent deferral of the incentive award, (iii) retirement benefits, (iv) health and welfare benefits, (v) payments in the event of termination, and (vi) perquisites. The following discussion provides more detail for each of these elements.
 
BASE SALARY
 
Base salary is a fixed component of our Executives' total compensation that is intended to provide a level of compensation necessary to attract and retain highly qualified executives. The Compensation Committee reviews the level of base salaries annually and approves and recommends to the Board of Directors adjustments to base salaries for our President, and for our other executives based upon recommendations by our President.

Each executive's minimum base salary is established by his respective employment agreement with us. For further information regarding base salary and the terms of the Employment Agreements, see the narrative discussion following the "Summary Compensation Table" in Item 11.

INCENTIVE PLAN
 
In 2012, the Compensation Committee approved combining the annual and long-term incentive plans into one single plan that includes a deferral of a portion of our Executives' compensation into future years. This change stemmed from guidance provided by the Finance Agency. Our 2012 IP includes the following three components of compensation for our Executives: (i) annual cash incentive, (ii) deferred cash incentive, and (iii) gap cash incentive.

Under the IP, our Executives are required to defer 50 percent of their total cash incentive for three years following the end of the performance plan period. Therefore, the 2012 deferred opportunity is payable in 2016. In addition, as a result of the transition from the previous long-term incentive plan to a longer deferral period in the IP, a gap incentive award was created for 2015 attainment. The gap and deferred awards are not finally earned until completion of the respective performance periods and are subject to the quarterly average of our EVCS in 2014 and 2015 and Compensation Committee approval in 2015 and 2016. We believe tying the amount of the final awards to the level of our EVCS ensures that our Executives continue to operate the Bank in a profitable, prudent manner without taking unnecessary or excessive risk. It also sought to discourage our Executives from taking short-term measures in 2012 in order to secure incentive awards payable in 2015 and 2016. The gap incentive award is unique to 2012 and will not be applicable to future periods.


146

On August 3, 2012, we received a non-objection letter from the Finance Agency for our 2012 IP. The IP had previously been approved by our Board of Directors, subject to the Finance Agency's non-objection. The IP was effective as of January 1, 2012. The incentive award for 2012 was based on objective quantitative and qualitative factors tied to bank-wide goals that were focused on business with our members, risk management, and profitability (Part I Goals), as well as on subjective factors derived from individual and/or team achievement of other objectives aimed at improving the Bank's service to the shareholding members and operational effectiveness (Part II Goals). The Part II Goals were linked to our 2012 Strategic Business Plan and individual responsibilities.

For additional information about our Part I and Part II Goals, see “Establishment of Performance Measures for the IP ” in Item 11. For more information relating to estimated IP awards, see “Components of 2012 Non-Equity Incentive Plan Compensation" in Item 11.

RETIREMENT BENEFITS
 
Our Executives participate in the Pentegra Defined Benefit Plan for Financial Institutions (DB Plan) and/or the Pentegra Defined Contribution Plan for Financial Institutions (DC Plan) to the same extent as our other employees. In addition, our Executives participate in our Third Amended and Restated Benefit Equalization Plan (BEP), which is a non-qualified plan that allows them to receive amounts they would have been entitled to receive under the DB Plan and/or the DC Plan had the plans not been subject to Internal Revenue Code contribution limitations. Executives hired on or after January 1, 2011 are not eligible to participate in the DB Plan or the defined benefit component of the BEP.
 
HEALTH AND WELFARE BENEFITS
 
Our Executives are eligible for the same medical, dental, life insurance, and other benefits available to our full-time employees.
 
PAYMENTS IN THE EVENT OF TERMINATION
 
The Employment Agreements we entered into with our Executives governing their compensation for 2012 provide for payments in the event of termination based on certain triggering events. For additional details, see "Potential Payments Upon Termination or Change in Control" in Item 11.

PERQUISITES
 
Our Executives are eligible to receive perquisites in the form of financial planning assistance. In addition, our President receives a monthly car allowance. These perquisites are provided to Executives as a convenience associated with their overall duties and responsibilities and are consistent with the results of the survey data reviewed by the Compensation Committee.
 
Finance Agency Oversight - Executive Compensation
 
Beginning in November of 2008, the FHLBanks were directed to provide all compensation actions affecting their five most highly compensated officers to the Finance Agency for prior review.

Section 1113 of the Housing Act amended the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the Housing Enterprises Act) and requires the Director of the Finance Agency to prohibit any FHLBank from paying compensation to its executive officers that is not reasonable and comparable to that paid for employment in similar businesses involving similar duties and responsibilities. On June 5, 2009, the Finance Agency published a proposed regulation designed to implement these statutory requirements. The proposed regulation covers compensation payable to members of an FHLBank's senior executive team and defines reasonable and comparable compensation. “Reasonable” compensation, taken in total or in part, would be customary and appropriate for the position based on a review of relevant factors, which include the unique duties and responsibilities of the executive's position. “Comparable” compensation, taken in total or in part, does not materially exceed benefits paid at similar institutions for similar duties and responsibilities. Comparable benefit levels are considered to be at or below the median compensation for a given position at similar institutions (i.e., those institutions that are similar in size, complexity, and function). In addition, under the proposed regulation, the Director of the Finance Agency would have authority to approve certain compensation and termination benefits. The comment period on this proposed regulation closed August 4, 2009. A final regulation has not been issued.
 

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On October 27, 2009, the Finance Agency issued a bulletin entitled Principles for Executive Compensation at the Federal Home Loan Banks and the Office of Finance, which established the following principles for executive compensation:
 
i.
executive compensation must be reasonable and comparable to that offered to executives in similar positions at comparable financial institutions;
 
ii.
executive compensation should be consistent with sound risk management and preservation of the par value of the FHLBank's capital stock;
 
iii.
a significant percentage of an executive's incentive-based compensation should be tied to longer-term performance and outcome-indicators and be deferred and made contingent upon performance over several years; and
 
iv.
the Board of Directors should promote accountability and transparency in the process of setting compensation.
 
Finally, on April 14, 2011, the Finance Agency issued a proposed rule along with six other federal financial regulators that could impose additional requirements and restrictions on incentive compensation arrangements, if adopted. This rule would apply to our Executives and would, (i) prohibit excessive compensation, (ii) prohibit incentive compensation that could lead to material financial loss, (iii) require an annual report, (iv) require policies and procedures, and (v) require mandatory deferrals of 50 percent of incentive compensation over three years.
 
Roles and Responsibilities of the Compensation Committee and Management in Establishing Executive Compensation
 
The Compensation Committee approves and recommends to the Board of Directors all compensation decisions for our Executives. Any employment or severance agreement for our President is also approved by the Board of Directors. Throughout the year, the Board of Directors reviews our Part I Goals and achievement levels. When final numbers for a calendar year are determined and audited, the Compensation Committee reviews the performance results to determine if our performance targets have been achieved for purposes of making compensation decisions for our Executives. The Compensation Committee also determines the compensation awards tied to our Part II Goals for our President and approves them for our other executives based on recommendations made by our President. Our Compensation Committee recommends the Part I and II incentive awards to the Board of Directors for their approval.
 
Our President makes recommendations to the Compensation Committee concerning all elements of compensation for our other executives. Throughout the year, our President and Compensation Committee review, on an informal basis, the performance of our other executives, future management changes, and other matters relating to compensation.
 
Merit increases and Part II IP compensation decisions are based upon an evaluation of an individual's overall performance and not solely on a statistical or formulaic analysis of particular results or criterion. Because of our size, the number of Executives involved, and our President's history with the executive team, our President recommends merit increases and Part II IP compensation payouts for the other executives to the Compensation Committee. The Board of Directors completes an evaluation of our President's performance and the Compensation Committee recommends compensation for our President to the Board of Directors. The Compensation Committee and our President consider overall performance in the areas of key role responsibilities, our shared values, individual development and goals, and strategic business plan responsibilities established for the year in analyzing merit increases and Part II IP recommendations.

Analysis Tools the Compensation Committee Uses
 
For 2012 compensation decisions, the Compensation Committee used McLagan Partners' executive compensation benchmarking survey data and further analysis by Towers Watson to evaluate and advise our Board of Directors on whether the objectives of our executive compensation program are being met.
 
MCLAGAN PARTNERS' EXECUTIVE COMPENSATION BENCHMARKING SURVEY DATA
 
We engage McLagan Partners on an annual basis to provide the Compensation Committee with an updated analysis of the compensation of our Executives compared to similar positions in commercial banks, mortgage banks, and the FHLBank System. Their analysis considers all components of the Executives' total compensation except retirement benefits. When using commercial and mortgage bank comparisons, our Executives are compared to divisional positions. For example, a divisional CFO role is compared to our CFO role versus the overall commercial bank CFO role which is larger and broader in scope and responsibility.
 

148

When comparing our executive roles to those of the FHLBank System, we compare the positions to the same position within the FHLBanks. For example, our CFO role is compared to other CFO roles in the FHLBank System.

COMPETITIVE ASSESSMENT BY TOWERS WATSON

The Compensation Committee engaged Towers Watson to provide guidance and counsel on executive compensation matters through the first quarter of 2012. As part of their consultation services to the Compensation Committee, Towers Watson primarily analyzed the comparative position of the total compensation of our Executives to the data from the FHLBank System. Towers Watson's process included a regression analysis that predicted compensation levels for our Executives based on our asset and member size compared to the pay practices observed at the other FHLBanks. We used a range of plus or minus 20 percent around the predicted levels of pay (based on asset and member sizes) as an estimate of FHLBank market pay ranges for our Executives. Our relatively high membership numbers compared to other FHLBanks indicated a level of complexity that was considered when making individual merit increase decisions, especially for our President.

Compensation Decisions for Executives in 2012
 
How we compensate our Executives sets the tone for how we administer pay throughout the entire Bank. For 2012, our Compensation Committee considered numerous factors (including those previously discussed) before deciding on the appropriate total compensation for our Executives, in the context of the current business, operating, and regulatory environment, which are more fully described in the following narrative.

BASE SALARY LEVELS
 
The Compensation Committee followed its historical practice of adjusting base salaries after a review of individual performance and current compensation of our Executives compared to survey data. The Compensation Committee determined increases in our Executives' base salaries between 3.00 percent and 4.55 percent for 2012 were appropriate based on (i) our Executives' individual performance and contributions to the Bank, (ii) a review of the compensation data paid by other FHLBanks, and (iii) a review of the McLagan Partners executive compensation survey data. For 2012, the Compensation Committee approved increases for our Executives effective March 1, 2012. These increases were reviewed by the Finance Agency. The 2012 increase in base salary for our President and CEO, Richard S. Swanson, was 4.00 percent of 2011 base salary and 3.00 percent, 3.09 percent, and 4.55 percent for our CCMO, Edward J. McGreen, CFO, Steven T. Schuler, and CRO, Dusan Stojanovic, respectively. A larger increase for our CRO was a result of market-based changes relative to comparable data for CRO salaries.

For 2013, the Compensation Committee approved increases in base salaries between 2.96 percent and 36.15 percent for all of our Executives, effective January 1, 2013. The larger increase of 36.15 percent was for our CBO, Daniel D. Clute, as a result of his promotion from senior vice president/director of communications and external relations to executive vice president/CBO effective October 2, 2012. Our CBO's salary and promotional increase was retroactive to the date of his promotion, October 2, 2012. These increases were reviewed by the Finance Agency.
 
At its January 2013 meeting, the Compensation Committee determined our Executives' Part II incentive awards for the 2012 performance year. Part I incentive awards were approved in February 2013. The Part I and Part II awards were based on the pay targets, ranges, and performance measures established by the Board of Directors for 2012. The following information provides additional details on the decisions the Compensation Committee made and how they arrived at those decisions.

ESTABLISHMENT OF PAY TARGETS AND RANGES
 
IP pay targets established for each executive take into consideration total compensation practices (base salary, incentives, and benefits) of the survey data reviewed. Our Executives are assigned target award opportunities, stated as percentages of base salary, under the IP. The target award opportunities correspond to the determination made by our Compensation Committee and our President on each executive's level of responsibility and ability to contribute to and influence our overall performance. Awards are paid to our Executives based upon the achievement level of Part I Goals and upon a subjective determination by the Compensation Committee for our President and by our President for our other executives regarding individual performance and achievement of Part II Goals. In addition, 50 percent of the incentive award is deferred for three years following the end of the performance period, and subject to our achievement of requisite EVCS levels and Compensation Committee and Board of Directors approvals at the time of payment.


149

The incentive compensation award opportunity and the 50 percent deferral under the IP for our Executives for 2012 were a percentage of base salary as follows:
Executive
 
Incentive
Plan
 
Threshold
 
Target
 
Maximum
Richard S. Swanson
 
Annual
 
25.0
%
 
37.5
%
 
50.0
%
 
 
Deferred
 
25.0
%
 
37.5
%
 
50.0
%
 
 
Gap
 
25.0
%
 
37.5
%
 
50.0
%
Steven T. Schuler
 
Annual
 
20.0
%
 
30.0
%
 
40.0
%
 
 
Deferred
 
20.0
%
 
30.0
%
 
40.0
%
 
 
Gap
 
20.0
%
 
30.0
%
 
40.0
%
Daniel D. Clute
 
Annual
 
12.5
%
 
22.5
%
 
32.5
%
 
 
Deferred
 
12.5
%
 
22.5
%
 
32.5
%
 
 
Gap
 
12.5
%
 
22.5
%
 
32.5
%
Edward J. McGreen
 
Annual
 
20.0
%
 
30.0
%
 
40.0
%
 
 
Deferred
 
20.0
%
 
30.0
%
 
40.0
%
 
 
Gap
 
20.0
%
 
30.0
%
 
40.0
%
Dusan Stojanovic
 
Annual
 
20.0
%
 
30.0
%
 
40.0
%
 
 
Deferred
 
20.0
%
 
30.0
%
 
40.0
%
 
 
Gap
 
20.0
%
 
30.0
%
 
40.0
%

ESTABLISHMENT OF PERFORMANCE MEASURES FOR THE IP
 
In April of 2012, the Compensation Committee and the Board of Directors approved the following Part I bank-wide goals:
 
i.
Business with Members as measured by member borrowing penetration, member product usage, and customer satisfaction.

ii.
Risk Management as measured by (i) the “preservation of the enterprise value” (measured by the quarterly average of MVCS) and (ii) the “quality of risk management” as assessed by the Risk Committee of the Board of Directors in the areas of credit risk, market risk, operational risk, internal controls, and model validation.

iii.
Profitability as measured by adjusted return on capital stock (AROCS). This is a comprehensive measure of our profitability that we believe is most meaningful to our shareholders. For additional information on our adjusted earnings measure, refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Executive Overview — Adjusted Earnings."

In 2012, our profitability measure was revised from the spread between AROCS and three-month LIBOR to AROCS. While we continue to monitor the spread between AROCS and three-month LIBOR, we believe AROCS is a more meaningful measure for our shareholders.

For 2012, the IP target award opportunity is the same as the combined 2011 annual and long-term incentive target opportunities. The deferral is 50 percent of the total opportunity for our President and our other executives.

Part I Goals are weighted at 60 percent of the award opportunity and Part II Goals are weighted at 40 percent of the award opportunity. These weightings were determined by the Compensation Committee based upon the relative need for our Executives to focus more on bank-wide performance goals.

When establishing the Part I IP performance goals, the Compensation Committee and the Board of Directors anticipated that we would reasonably achieve the target level of performance aligned with objectives contained in the overall Strategic Business Plan. The maximum level provides a goal that is anticipated to be more challenging to reach, based on the previous year's performance results and current market conditions. The Part I incentive awards are paid based on the actual results we achieve. The weightings for each goal area are determined by the Bank's Strategic Business Plan and areas of key focus, such as delivering member value and managing risk.


150

Part II IP performance goals for our Executives are established by our President and our other executives based on the strategic imperatives and outcomes to be accomplished as outlined in the Strategic Business Plan for which each executive has responsibility. Specifically, each executive has primary responsibility for setting, implementing, executing, and achieving action items associated with one or more strategic imperatives as outlined in the Strategic Business Plan. Performance ratings for the Executives are based on a subjective analysis of their contribution and accomplishment of role responsibilities, strategic responsibilities tied to our Strategic Business Plan, the Bank's shared values, and each executive's overall job performance.
 
The 2012 to 2014 Strategic Business Plan was approved by the Board of Directors in December of 2011 and includes the following strategic imperatives for which strategies and action steps were developed that formed the basis for Part II Goals:
 
i.
Strengthen partnership with members.
 
ii.
Disciplined pursuit of long-term business performance.
 
iii.
Stewardship of our public mission.

The Part II IP performance goals for our President are recommended by our President and established by the Board of Directors. As with each of the other executives, our President also has responsibility for setting, implementing, executing, and achieving the overall Strategic Business Plan action items associated with one or more strategic imperatives outlined in the Strategic Business Plan. Performance ratings for our President are subjectively determined based on his contribution to our success, accomplishment of his role responsibilities, strategic responsibilities tied to the Strategic Business Plan, our shared values, and his overall job performance.
 
2012 IP PERFORMANCE RESULTS
 
On a regular basis during 2012, management provided an update to the Board of Directors on the status of performance relative to Part I bank-wide goals. The following table provides the 2012 IP Part I bank-wide goals approved by the Board of Directors in April of 2012, as well as our performance results for 2012:
Bank-Wide Goals
 
 2012 Results
 
Threshold
 
Target
 
Maximum
Profitability (20% Total Weight)
 
 
 
 
 
 
 
 
Adjusted Return on Capital Stock
 
6.03
%
 
4.50
%
 
6.00
%
 
7.50
%
Business with Members (40% Total Weight)
 
 
 
 
 
 
 
 
Member Borrowing Penetration (10% Weight)
 
60.25
%
 
42.00
%
 
53.00
%
 
64.00
%
Member Product Usage Index (“Touch Points”) (10% Weight)
 
2.34

 
1.70

 
2.10

 
2.50

Advances + Letters of Credit to Assets Ratio (10% Weight)
 
3.90
%
 
2.80
%
 
3.50
%
 
4.80
%
Member Satisfaction - % of Members "Very Satisfied" and "Satisfied" (10% Weight)
 
95.00
%
 
88.00
%
 
92.00
%
 
96.00
%
Risk Management (40% Total Weight)
 
 
 
 
 
 
 
 
Preservation of Enterprise Value
(measured by quarterly average of MVCS) (20% Weight)1
 
$
113.6

 
$95.0 or ranking in upper half of FHLBank System

 
$
105.0

 
$
115.0

Quality of Risk Management
(measured by Board's qualitative assessment) (20% Weight)2
 
Successful

 
Moderately Successful

 
Successful

 
Highly Successful


1
In order to exceed "target", the Bank must be ranked in the upper half of the FHLBank System by MVCS. For 2012, the Bank was ranked 7th in the FHLBank System.

2
Qualitative assessment covers the following areas: Credit Risk (6%), Market Risk (6%), Operational Risk (3%), Internal Controls - SOX 404 (3%), and Model Validation (2%). There will be no payout if the assessment is less than "Moderately Successful" (i.e., "Unsuccessful").


151

In January of 2013, the Compensation Committee reviewed results of the annual performance evaluation of our President conducted by the Board of Directors. Based on this review, the Compensation Committee determined our President had exceeded expectations on the strategic imperatives and overall job performance goals established for Part II of the IP. In conjunction with our achievement of Part I performance goals under the IP, the Compensation Committee awarded our President the amounts identified in the following chart.

Additionally, our President reviewed the performance of each of our other four executives with the Compensation Committee in January of 2013. The President determined that each of the other executives had met or exceeded expectations on their respective strategic imperatives and job performance goals established for Part II of the IP. The Bank achieved target or slightly above target on two of the Part I performance goals and exceeded targets for all other Part I performance goals. The overall weighted achievement of the Part I performance goals was 109.6 percent of target. Because of the Bank's aggregate performance and based on achievements related to Part II Goals, the Compensation Committee awarded each executive the amounts identified in the following chart.
Named Executive
 
Part I Award
 
Part II Award
 
Total
Incentive1
 
% of Base
Salary
Richard S. Swanson
 
$
320,522

 
$
240,000

 
$
560,522

 
86.8
%
Steven T. Schuler
 
132,154

 
91,120

 
223,274

 
67.0

Daniel D. Clute
 
58,523

 
40,363

 
98,886

 
51.4

Edward J. McGreen
 
127,025

 
83,720

 
210,745

 
65.8

Dusan Stojanovic
 
113,416

 
74,750

 
188,166

 
65.9


1
Unlike previous years, the total incentive is the sum of the Part I and II awards. The total incentive is then divided equally between the Annual and Deferred portions. This table excludes the gap year incentive award. Refer to the “Components of 2012 Non-Equity Incentive Plan Compensation” table on the next page for details on this award.
 
The following table provides compensation information for the years ended December 31, 2012, 2011 and 2010 for our 2012 Executives:
Summary Compensation Table
Name and Principal Position
 
Year
 

Salary
 
Non-Equity Incentive Plan
Compensation1
 
Change in Pension Value and Nonqualified Deferred Compensation
Earnings2
 
All Other
Compensation3
 
Total
Richard S. Swanson, President and CEO
 
2012
 
$
645,833

 
$
840,784

 
$
443,000

 
$
71,568

 
$
2,001,185

 
2011
 
620,833

 
487,835

 
441,000

 
64,351

 
1,614,019

 
2010
 
597,350

 
460,066

 
308,000

 
55,545

 
1,420,961

Steven T. Schuler, CFO
 
2012
 
333,333

 
334,911

 
196,000

 
28,695

 
892,939

 
2011
 
321,667

 
201,163

 
205,000

 
24,695

 
752,525

 
2010
 
303,183

 
204,445

 
128,000

 
22,095

 
657,723

Daniel D. Clute, CBO4
 
2012
 
192,203

 
148,330

 
—

 
11,519

 
352,052

Edward J. McGreen, CCMO
 
2012
 
320,433

 
316,118

 
156,000

 
25,549

 
818,100

 
2011
 
311,333

 
190,362

 
194,000

 
18,680

 
714,375

 
2010
 
303,183

 
204,445

 
128,000

 
22,095

 
657,723

Dusan Stojanovic, CRO
 
2012
 
285,417

 
282,248

 
129,000

 
22,770

 
719,435

 
2011
 
270,833

 
168,840

 
100,000

 
20,733

 
560,406

 
2010
 
248,333

 
165,078

 
48,000

 
12,588

 
473,999


1
For 2012, "Non-Equity Incentive" includes a Gap Year incentive that will be paid in March of 2015. This amount is in addition to the Annual and Deferred incentives and is described more fully in the section entitled "Establishment of Pay Targets and Ranges." The components of this column for 2012 are provided in the “Components of 2012 Non-Equity Incentive Plan Compensation” table on the next page.

2
Represents the change in value of the DB Plan and BEP DB Plan, if applicable. All earnings on nonqualified deferred compensation are at the market rate.

3
The components of this column for 2012 are provided in the “Components of 2012 All Other Compensation” table on the next page.

4
Mr. Clute was named CBO on October 2, 2012, so only compensation data for 2012 is shown.


152

COMPONENTS OF 2012 NON-EQUITY INCENTIVE PLAN COMPENSATION
Named Executive
 
Annual Incentive
 
Deferred Incentive1
 
Gap Year Incentive2
 
Total
Richard S. Swanson
 
$
280,261

 
$
280,261

 
$
280,262

 
$
840,784

Steven T. Schuler
 
111,637

 
111,637

 
111,637

 
334,911

Daniel D. Clute3
 
49,443

 
49,443

 
49,444

 
148,330

Edward J. McGreen
 
105,373

 
105,372

 
105,373

 
316,118

Dusan Stojanovic
 
94,083

 
94,083

 
94,082

 
282,248


1
The Deferred incentive amounts were earned as of December 31, 2012, but will not be paid until March 2016 and remain subject to modification and forfeiture under the terms of the IP. For more information, see the narrative following the "Grants of Plan-Based Awards" table.

2
The Gap Year incentive amounts were earned as of December 31, 2012, but will not be paid until March 2015 and, like the Deferred incentive amounts, remain subject to modification and forfeiture under the terms of the IP.

3
The incentive amounts calculated for Mr. Clute for 2012 are based on his salary of $176,270 for nine months and $240,000 for three months.

COMPONENTS OF 2012 ALL OTHER COMPENSATION
 
 
Bank Contributions to Vested Defined Contribution Plans
 
 
 
 
 
 
Named Executive
 
DC Plan
 
BEP DC Plan1
 
Car
Allowance
 
Financial
Planning
 
Total
Richard S. Swanson
 
$
14,574

 
$
40,994

 
$
9,000

 
$
7,000

 
$
71,568

Steven T. Schuler
 
14,610

 
12,089

 
—

 
1,996

 
28,695

Daniel D. Clute
 
11,519

 
—

 
—

 
—

 
11,519

Edward J. McGreen
 
15,001

 
10,548

 
—

 
—

 
25,549

Dusan Stojanovic
 
14,609

 
8,161

 
—

 
—

 
22,770


1
Members eligible for participation in the BEP DC Plan must enroll prior to the beginning of the plan year. Mr. Clute was not eligible for the plan until October 2, 2012, therefore, he was not enrolled in the plan during 2012.

The following table provides estimated potential payouts under our IP of non-equity incentive plan awards:
2012 Grants of Plan-Based Awards
 
 
 
 
Estimated Future Payouts Under
Non-Equity Incentive Plan Awards
Named Executive
 
Incentive Plan
 
Threshold
 
Target
 
Maximum
Richard S. Swanson
 
Annual
 
$
162,500

 
$
243,750

 
$
325,000

 
 
Deferred
 
162,500

 
243,750

 
325,000

 
 
Gap
 
162,500

 
243,750

 
325,000

Steven T. Schuler
 
Annual
 
67,000

 
100,500

 
134,000

 
 
Deferred
 
67,000

 
100,500

 
134,000

 
 
Gap
 
67,000

 
100,500

 
134,000

Daniel D. Clute
 
Annual
 
28,830

 
43,246

 
57,661

 
 
Deferred
 
28,830

 
43,246

 
57,661

 
 
Gap
 
28,830

 
43,246

 
57,661

Edward J. McGreen
 
Annual
 
64,400

 
96,600

 
128,800

 
 
Deferred
 
64,400

 
96,600

 
128,800

 
 
Gap
 
64,400

 
96,600

 
128,800

Dusan Stojanovic
 
Annual
 
57,500

 
86,250

 
115,000

 
 
Deferred
 
57,500

 
86,250

 
115,000


 
Gap
 
57,500

 
86,250

 
115,000



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In November of 2011, we entered into Employment Agreements with our President, CFO, CCMO, and CRO. These Employment Agreements were retroactively effective March 1, 2011 and superseded all prior agreements relating to such executive's employment. Refer to our Form 8-K filed with the SEC on November 15, 2011 for these Employment Agreements. Our CBO did not previously have an Employment Agreement. In March of 2013, we entered into an Employment Agreement with the CBO and amended the President, CFO, CCMO, and CRO Employment Agreements, which were retroactively effective January 1, 2013. These agreements are filed as exhibits to this annual report on Form 10-K. Refer to "Item 15. Exhibits and Financial Statement Schedules" for additional information.

The Employment Agreements provide, with respect to each of our executives, that we shall initially pay the respective executive an annualized base salary of not less than the amount set forth in the respective agreement. In each case, base salary may only be adjusted upward from the 2012 base salary based on an annual review by the Compensation Committee and/or President and may not be adjusted downward unless such downward adjustment is part of a nondiscriminatory cost reduction plan applicable to our total compensation budget.

Additionally, the respective agreements provide that each executive is entitled to participate in the IP. Each agreement provides that the incentive targets for the IP are to be established by our Board of Directors and that the target for the IP shall not be set lower than the designated percentage of base salary set forth in the Employment Agreement unless as a result of Board action affecting all Executives. The agreements further provide that each executive is entitled to participate in all eligible retirement benefit programs offered by the Bank.

Refer to the discussion of IP under “2012 IP Performance Results” in Item 11 for additional information on the levels of awards under the plan. Actual non-equity incentive award amounts earned for the year ended December 31, 2012 are included in the non-equity incentive plan compensation column under the “Summary Compensation Table” in Item 11.
 
The 2012 IP provides that unless otherwise directed by the Compensation Committee, payments under Parts I and II shall be made in a lump sum through regular payroll distribution, as soon as possible after the Board approves the payout of a particular award, but in no case more than 75 days after the end of the calendar year for which the performance, deferral, or gap year period is ended.

Under the IP, the Compensation Committee may determine an executive is not eligible to receive all or any part of the deferred incentive if the respective executive (i) has not achieved a performance level of “meets expectations” or higher evaluation of overall performance during a performance period, deferred performance period, or gap year performance period, (ii) has not achieved a “meets expectations” or higher evaluation of overall performance at the time of payout, (iii) is subject to any disciplinary action or probationary status at the time of payout, or (iv) fails to comply with regulatory requirements or standards, internal control standards, the standards of his profession or any internal standard, or fails to perform responsibilities assigned under our Strategic Business Plan.

In addition, under the IP, the Compensation Committee may also consider a variety of other objective and subjective factors to determine the appropriate payouts such as: (i) operational errors or omissions that result in material revisions to the financial results, information submitted to the Finance Agency, or data used to determine incentive payouts, (ii) whether submission of information to the SEC, Office of Finance, or Finance Agency is untimely, and (iii) whether the organization fails to make sufficient and timely progress, as determined by the Finance Agency, in the remediation of examination, monitoring, and other supervisory findings and matters requiring attention.

If one of the above occurs, the Compensation Committee shall consider the facts and circumstances and may reduce incentive awards commensurate with the materiality of the exception relative to our financial and operational performance and financial reporting responsibilities.

Each respective Employment Agreement provides that we or the executive may terminate employment for any reason (other than Good Reason or Cause) on 60 days written notice to the other party. An executive may be entitled to certain payments upon termination or change in control. For more information, see “Potential Payments Upon Termination or Change in Control" in Item 11.

Benefits and Retirement Philosophy

We consider benefits to be an important aspect of our ability to hire and retain qualified employees and therefore we design our programs to be competitive with other financial services businesses. The following is a summary of the retirement benefits our Executives receive.


154

QUALIFIED DEFINED BENEFIT PLAN
 
All employees who have met the eligibility requirements participate in our DB Plan, administered by Pentegra, which is a tax-qualified multiemployer defined benefit plan. In November of 2010, the Compensation Committee approved an amendment to our DB Plan. Under the amendment, new employees hired on or after January 1, 2011, including any executive, are not eligible to participate in the DB Plan. The plan requires no employee contributions. All of our executives, with the exception of our CBO, participate in the DB Plan.

The pension benefits payable under the DB Plan are determined under a pre-established formula that provides a retirement benefit payable at age 65 or normal retirement under the DB Plan. The benefit formula is 2.25 percent per each year of the benefit service multiplied by the highest three consecutive years' average compensation. Average compensation is defined as the total taxable compensation as reported on the IRS Form W-2 (excluding deferred or gap award payouts). In the event of retirement prior to attainment of age 65, a reduced pension benefit is payable under the plan. Upon termination of employment prior to age 65, participants meeting the five-year vesting and age 55 early retirement eligibility criteria are entitled to an early retirement benefit. The regular form of retirement benefits provides a single life annuity, with a guaranteed 12-year payment, or additional payment options are also available. The benefits are not subject to offset for Social Security or any other retirement benefits received.
 
NON-QUALIFIED DEFINED BENEFIT PLAN
 
Our BEP DB Plan is an unfunded, non-qualified pension plan similar to the DB Plan. In March of 2011 and effective January 1, 2011, the Compensation Committee approved an amendment to the BEP DB Plan. The amendment states that executives hired on or after January 1, 2011 are not eligible to participate in the BEP DB Plan. All of our executives, with the exception of our CBO, participate in the BEP DB Plan.
 
In determining whether a restoration of retirement benefits is due to our Executives, the BEP DB Plan utilizes the identical benefit formulas applicable to our DB Plan; however, the BEP DB Plan does not limit the annual earnings or benefits of our Executives. Rather, if the benefits payable from the DB Plan have been reduced or otherwise limited, our Executives' lost benefits are payable under the terms of the BEP DB Plan. As a non-qualified plan, the benefits received from the BEP DB Plan do not receive the same tax treatment and funding protection as with our qualified plans. Payment options under the BEP DB Plan include a lump-sum distribution, annuity payments, or installment payment options.

CURRENT ACCRUED RETIREMENT BENEFITS
 
The following table provides the present value of the current accrued benefits payable to our Executives upon retirement at age 65 from the DB Plan and the BEP DB Plan, and is calculated in accordance with the formula currently in effect for specified years-of-service and remuneration for participating in both plans. Our pension benefits do not include any reduction for a participant's Social Security benefits. The vesting period for the pension plans is five years. See “Item 8. Financial Statements and Supplementary Data — Note 17 — Pension and Postretirement Benefits” for details regarding valuation method and assumptions.
2012 Pension Table
Named Executive1
 
Plan Name
 
Number of Years
Credited Service
 
Present Value of
Accumulated
Benefit
Richard S. Swanson
 
Pentegra DB Plan
 
5.58

 
$
458,000

 
 
BEP DB Plan
 
5.58

 
1,219,000

Steven T. Schuler
 
Pentegra DB Plan
 
5.25

 
410,000

 
 
BEP DB Plan
 
5.25

 
299,000

Edward J. McGreen
 
Pentegra DB Plan
 
7.08

 
307,000

 
 
BEP DB Plan
 
7.08

 
271,000

Dusan Stojanovic
 
Pentegra DB Plan
 
3.75

 
213,000

 
 
BEP DB Plan
 
3.75

 
90,000


1
Mr. Clute was hired during 2011. DB Plan eligibility and BEP DB Plan eligibility require that only employees hired prior to January 1, 2011 are eligible for the pension plans.


155

QUALIFIED DEFINED CONTRIBUTION PLAN
 
All employees who have met the eligibility requirements may elect to participate in our DC Plan, a retirement savings plan qualified under the Internal Revenue Code. Employees (including Executives) may receive a match on employee contributions at 100 percent up to six percent of eligible compensation. Employees are eligible for the match immediately and all matching contributions are immediately 100 percent vested. Employees hired on or after January 1, 2011 receive an additional four percent Bank contribution of eligible compensation to the DC Plan at the end of each calendar year. Vesting in the additional four percent DC Plan contribution is 100 percent at the completion of three years of service.

NON-QUALIFIED DEFINED CONTRIBUTION PLAN
 
Our Executives are eligible to participate in the defined contribution component of the BEP (BEP DC Plan), a non-qualified defined contribution plan that is the same as the DC Plan. The BEP DC Plan ensures, among other things, that participants whose benefits under the DC Plan would otherwise be restricted by certain provisions of the Internal Revenue Code are able to make elective pre-tax deferrals and to receive a matching contribution relating to such deferrals. The investment returns credited to a participating executive's account are at the market rate for the executive's selected investment. The selections may be altered at any time. Aggregate earnings are calculated by subtracting the 2011 year-end balance from the 2012 year-end balance, less the executive's and Bank's contributions. The Bank immediately matches 100 percent of executives' contributions up to six percent of salary for salary and incentive deferrals.
2012 Non-Qualified Deferred Compensation Table
Named Executive1
 
Executive
Contributions
In Last FY2
 
Registrant
Contributions
In Last FY3
 
Aggregate
Earnings
In Last FY
 
Aggregate Withdrawals In Last FY
 
Aggregate
Balance
At Last FYE
Richard S. Swanson
 
$
92,609

 
$
40,994

 
$
43,163

 
$
—

 
$
365,690

Steven T. Schuler
 
63,396

 
12,089

 
36,577

 
—

 
333,404

Edward J. McGreen
 
28,752

 
10,548

 
33,474

 
—

 
550,071

Dusan Stojanovic
 
22,770

 
8,161

 
9,762

 
—

 
89,328


1
Members eligible for participation in the BEP DC Plan must enroll prior to the beginning of the plan year. Mr. Clute was not eligible for the plan until October 2, 2012, therefore, he was not enrolled in the plan during 2012.

2
Amounts shown are included in the "Salary" column of the “Summary Compensation Table” in Item 11.

3
Amounts shown are included in the "All Other Compensation" column of the “Summary Compensation Table” in Item 11.

Potential Payments Upon Termination or Change in Control
 
The following paragraphs set out the material terms relating to termination of each of our Executives and the compensation due to each upon termination under the current Employment Agreements. For purposes of the following discussion regarding potential payments upon termination or change in control, the following are the definitions of “Cause,” “Good Reason,” and “Disability.” These definitions are summaries and each respective Employment Agreement, as amended, between us and each of our Executives sets forth the relevant definition in full. For complete definitions, see copies of these agreements filed as exhibits to this annual report on Form 10-K. “Cause” generally means a felony conviction, a willful act committed in bad faith that materially impairs our business or goodwill, a willful act committed in bad faith that constitutes a continued failure to perform duties, or a willful violation of our Code of Ethics. “Good Reason” generally means an assignment of duties to an executive that are inconsistent with his position, a material diminution in his duties or responsibilities, a reduction in his base salary, or annual and long-term bonus compensation, a material change in our geographic location, or a material breach of the Employment Agreement. “Disability” means the executive is receiving benefits under a disability plan sponsored by the Bank for a period of not less than three months by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than twelve months and which has rendered the executive incapable of performing his duties.
 

156

TERMINATION FOR CAUSE OR WITHOUT GOOD REASON

If an executive's employment is terminated by us for cause or by the executive without good reason, the Employment Agreements entitle the executive to the following:
 
i.
Base Salary through the date of termination.
 
ii.
Accrued but unpaid award(s) under any IP in an amount equal to that which the executive would have received in the year of termination.
 
iii.
Accrued and earned vacation through the date of termination.
 
iv.
All other vested benefits under the terms of our employee benefit plans, subject to the terms of such plans.
    
Assuming one or more of the previously discussed events for the receipt of termination payments occurred as of December 31, 2012, the total amounts payable to our Executives are outlined in the table below:
Named Executive
 
Severance Pay1
 
Annual Incentive
 
Deferred Incentive
 
Gap Year Incentive
 
Vacation Payout2
 
Total
Richard S. Swanson
 
$
—

 
$
280,261

 
$
211,640

 
$
—

 
$
63,959

 
$
555,860

Steven T. Schuler
 
—

 
111,637

 
107,583

 
—

 
58,625

 
277,845

Daniel D. Clute
 
—

 
49,443

 
—

 
—

 
10,307

 
59,750

Edward J. McGreen
 
—

 
105,373

 
107,583

 
—

 
18,473

 
231,429

Dusan Stojanovic
 
—

 
94,083

 
88,183

 
—

 
12,716

 
194,982


1
Termination under these circumstances would not result in severance payments from the Bank but would result in salary earned through December 31, 2012, as reflected under the "Salary" column of the "Summary Compensation Table" in Item 11.

2
This amount represents accrued but unused vacation and would be paid in a lump sum upon termination.

TERMINATION WITHOUT CAUSE, GOOD REASON, OR MERGER/CHANGE IN CONTROL

If, however, the executive's employment is terminated by us without cause, by the executive for good reason, or as a result of a merger or change in control, in addition to the payouts previously mentioned, the executive is entitled to severance payments equal to a certain number times the executive's base salary as follows:
 
i.
Two times the annual base salary for the President and one times the annual base salary for the CBO, CFO, CCMO, and CRO.
 
ii.
One times the executive's targeted non-deferred IP award in effect for the calendar year in which the date of termination occurs.
 
iii.
The IP award for the calendar year in which the date of termination occurs and prorated for the portion of the calendar year in which the executive was employed.
 
iv.
The accrued but unpaid IP awards covering periods prior to the one in which the executive was terminated and calculated in accordance with the terms of the IP as if termination was due to death, disability, or retirement.
 
v.
State of Iowa benefits continuation, provided that we will continue paying our portion of the medical and/or dental insurance premiums for the executive for the one year period following the date of termination.
 
The IP award would be paid at target for Part II individual/team goals and based on the calendar year actual results for Part I bank-wide goals, and would be paid at the regular time that such payments are made to all employees enrolled in the plans. The base salary amount, the IP award for the calendar year in which the date of termination occurs, and the accrued but unpaid IP awards for any performance period ending prior to the year in which the date of termination occurs would be paid in a lump sum within ten days following the executive executing a release of claims against us, which would entitle him to the payments described.


157

Assuming one or more of the previously discussed events for the receipt of termination payments occurred as of December 31, 2012, the total amounts payable to our Executives are outlined in the table below:
Named Executive
 
Severance Pay
 
Annual Incentive
 
Deferred Incentive
 
Gap Year Incentive
 
Vacation Payout1
 
Total
Richard S. Swanson
 
$
1,300,000

 
$
524,011

 
$
736,383

 
$
280,262

 
$
63,959

 
$
2,904,615

Steven T. Schuler
 
335,000

 
212,137

 
330,460

 
111,637

 
58,625

 
1,047,859

Daniel D. Clute
 
240,000

 
92,689

 
49,443

 
49,444

 
10,307

 
441,883

Edward J. McGreen
 
322,000

 
201,973

 
319,951

 
105,373

 
18,473

 
967,770

Dusan Stojanovic
 
287,500

 
180,333

 
276,392

 
94,082

 
12,716

 
851,023


1
This amount represents accrued but unused vacation and would be paid in a lump sum upon termination.

TERMINATION FOR DEATH, DISABILITY, OR RETIREMENT

If the executive's employment is terminated due to death, disability, or qualifying retirement, in addition to the payouts previously mentioned under the section entitled "Termination For Cause or Without Good Reason", the executive is entitled to the following:
 
i.
The IP award for the calendar year in which the date of termination occurs and prorated for the portion of the calendar year in which the executive was employed.
 
ii.
To the extent not already paid to the executive, the accrued but unpaid IP awards covering periods prior to the one in which the executive was terminated.
 
iii.
Other coverage continuation rights that are available to such employees upon death, disability, or retirement, as provided for under the terms of such plans.

Payment of all accrued amounts other than IP award amounts shall be paid in lump sum within ten days or no later than the first payroll date on or after the executive's date of termination. Payment of all IP award amounts, if any, shall be paid as otherwise provided under the applicable IP.

Assuming one or more of the previously discussed events for the receipt of termination payments occurred as of December 31, 2012, the total amounts payable to our Executives are outlined in the table below:
Named Executive
 
Severance Pay
 
Annual Incentive
 
Deferred Incentive
 
Gap Year Incentive
 
Vacation Payout1
 
Total
Richard S. Swanson
 
$
—

 
$
280,261

 
$
715,409

 
$
280,262

 
$
63,959

 
$
1,339,891

Steven T. Schuler
 
—

 
111,637

 
319,798

 
111,637

 
58,625

 
601,697

Daniel D. Clute
 
—

 
49,443

 
49,443

 
49,444

 
10,307

 
158,637

Edward J. McGreen
 
—

 
105,373

 
309,290

 
105,373

 
18,473

 
538,509

Dusan Stojanovic
 
—

 
94,083

 
267,653

 
94,082

 
12,716

 
468,534


1
This amount represents accrued but unused vacation and would be paid in a lump sum upon termination.




158

Director Compensation
 
During 2012, the Board of Directors held seven in-person board meetings and 36 in-person committee meetings. In addition, there were three telephonic board meetings and 20 telephonic committee meetings held throughout the year. Pursuant to our 2012 Director Fee Policy, Directors receive one quarter of the annual compensation following the end of each calendar quarter. If it is determined at the end of the calendar year that a Director has attended less than 75 percent of the meetings the Director was required to attend during the year, the Director will not receive one quarter of the annual compensation for the fourth quarter of the calendar year.

Directors are expected to attend all Board meetings and meetings of the Committees on which they serve, and to remain engaged and actively participate in all meetings. In addition to our right to withhold fourth quarter annual compensation from a Director, the Board of Directors directs the Corporate Secretary to make any other appropriate adjustments in the payments to any Director who regularly fails to attend Board meetings or meetings of Committees on which the Director serves, or who consistently demonstrates a lack of participation in or preparation for such meetings, to ensure that no Director is paid fees that do not reflect that Director's performance of his/her duties. To assist the Board in making such determinations, the Corporate Secretary will, on a quarterly basis and prior to payment of the most recently completed quarter's Director fees, review the attendance of each Director during the quarter and raise any attendance issues identified with the Board Chair. In the event the potential issue involves the Board Chair, the Corporate Secretary will raise such issue with the Board Vice Chair.

The total expenses paid on behalf of the Board of Directors for travel and other reimbursed expenses for 2012 was $193,258 and annual compensation paid to the Board of Directors, by position, for 2012 was as follows:
Board of Director Position
 
2012
Chair
 
$
75,000

Vice Chair
 
65,000

Audit Committee Chair
 
60,000

Committee Chairs
 
55,000

Other Directors
 
50,000


Effective January 1, 2012, Directors may no longer defer and/or contribute a portion of their director's fees to the BEP DC Plan. We do not contribute to the plan on behalf of the Directors.

The following table sets forth each Director's compensation for the year ended December 31, 2012:
Director Compensation
Director Name
 
Fees Earned Or
Paid In Cash
Michael J. Guttau, Chair
 
$
75,000

Eric A. Hardmeyer, Vice Chair
 
65,000

Johnny A. Danos
 
55,000

Gerald D. Eid
 
50,000

Michael J. Finley
 
50,000

Van D. Fishback
 
50,000

Chris D. Grimm
 
50,000

Labh S. Hira
 
55,000

Teresa J. Keegan
 
50,000

John F. Kennedy Sr.
 
60,000

Ellen Z. Lamale
 
50,000

Clair J. Lensing
 
50,000

Paula R. Meyer
 
55,000

Dale E. Oberkfell
 
55,000

John H. Robinson
 
55,000

Joseph C. Stewart III
 
50,000



159

In December of 2012, the Compensation Committee approved the Director Fee Policy for 2013, subject to the review and comment of the Finance Agency. This policy is filed as an exhibit to this annual report on Form 10-K. Refer to "Item 15. Exhibits and Financial Statement Schedules" for additional information. Under the policy, the 2013 Director compensation fees increased. The annual aggregate fees by position are as follows:
Board of Director Position
 
2013
Chair1
 
$
90,000

Vice Chair1
 
85,000

Audit Committee Chair
 
80,000

Committee Chairs
 
75,000

Other Directors
 
65,000


1
Effective January 1, 2013, our Board Chair is Dale Oberkfell and our Board Vice Chair is Eric Hardmeyer.

Compensation Committee Report
 
The Compensation Committee of the Board of Directors furnished the following report for inclusion in this annual report on Form 10-K:
 
The Compensation Committee reviewed and discussed the 2012 Compensation Discussion and Analysis set forth in Item 11 with our management. Based on such review and discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this annual report on Form 10-K. The Compensation Committee includes the following individuals:
Compensation Committee
John H. Robinson, Chair
Labh S. Hira, Ph.D., Vice Chair
Van D. Fishback
Ellen Z. Lamale
Dale E. Oberkfell
John P. Rigler II
Joseph C. Stewart III

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table presents members (or combination of members within the same holding company) holding five percent or more of our outstanding capital stock at February 28, 2013 (shares in thousands):
Name
 
Address
 
City
 
State
 
Shares of Capital Stock
 
% of Total Capital Stock
Transamerica Life Insurance Company
 
4333 Edgewood Rd NE
 
Cedar Rapids
 
IA
 
1,235

 
6.2
%
Monumental Life Insurance Company1
 
4333 Edgewood Rd NE
 
Cedar Rapids
 
IA
 
278

 
1.4

 
 
 
 
 
 
 
 
1,513

 
7.6

All others
 
 
 
 
 
 
 
18,517

 
92.4

Total capital stock
 
 
 
 
 
 
 
20,030

 
100.0
%

1
Monumental Life Insurance Company is an affiliate of Transamerica Life Insurance Company.


160

Additionally, due to the fact that a majority of our Board of Directors is nominated and elected from our membership, these member directors are officers or directors of member institutions that own our capital stock. The following table presents total outstanding capital stock owned by those members who had an officer or director serving on our Board of Directors at February 28, 2013 (shares in thousands):
Name
 
Address
 
City
 
State
 
Shares of Capital Stock
 
% of Total Capital Stock
Bank of North Dakota
 
1200 Memorial Hwy
 
Bismarck
 
ND
 
267

 
1.33
%
Midwest BankCentre
 
2191 Lemay Ferry Road
 
Saint Louis
 
MO
 
41

 
0.20

First Bank & Trust
 
520 6th St.
 
Brookings
 
SD
 
35

 
0.17

First Bank & Trust, N.A.
 
101 2nd St. NW
 
Pipestone
 
MN
 
12

 
0.06

First Bank & Trust
 
110 N Minnesota Ave
 
Sioux Falls
 
SD
 
9

 
0.05

State Bank and Trust Company
 
25 N Chestnut
 
New Hampton
 
IA
 
9

 
0.05

Iowa State Bank
 
409 Hwy 615
 
Wapello
 
IA
 
5

 
0.03

Fidelity Bank
 
7600 Parklawn Ave
 
Edina
 
MN
 
5

 
0.03

Security State Bank
 
933 16th St. SW
 
Waverly
 
IA
 
5

 
0.02

First Bank & Trust of Milbank
 
215 W 4th Ave
 
Milbank
 
SD
 
3

 
0.01

Janesville State Bank
 
210 N Main St.
 
Janesville
 
MN
 
2

 
0.01

Maynard Savings Bank
 
310 Main St. W
 
Maynard
 
IA
 
2

 
0.01

Citizens Savings Bank
 
133 E Main St.
 
Hawkeye
 
IA
 
1

 
0.01

Bank Star of the BootHeel
 
100 S Walnut St.
 
Steele
 
MO
 
1

 
0.01

Bank Star
 
1999 W Osage
 
Pacific
 
MO
 
1

 
*

Bank Star One
 
118 W 5th St.
 
Fulton
 
MO
 
1

 
*

 
 
 
 
 
 
 
 
399

 
1.99

All others
 
 
 
 
 
 
 
19,631

 
98.01

Total capital stock
 
 
 
 
 
 
 
20,030

 
100.00
%

* 
Amount is less than 0.01 percent.  

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
DIRECTOR INDEPENDENCE
General
As of the date of this annual report on Form 10-K, we have 16 directors, all of whom were elected by our member institutions. Pursuant to the passage of the Housing Act, the Finance Agency implemented regulations whereby all new or re-elected directors will be elected by our member institutions. All directors are independent of management from the standpoint they are not our employees, officers, or stockholders. Only member institutions can own our capital stock. Thus, our directors do not personally own our stock. In addition, we are required to determine whether our directors are independent under three distinct director independence standards. Finance Agency regulations and the Housing Act, which applied Section 10A(m) of the Exchange Act to the FHLBanks, provide independence criteria for directors who serve as members of our Audit Committee. Additionally, SEC rules require our Board of Directors to apply the independence criteria of a national securities exchange or automated quotation system in assessing the independence of our directors.
Finance Agency Regulations
The Finance Agency director independence standards prohibit individuals from serving as members of our Audit Committee if they have one or more “disqualifying relationships” with us or our management that would interfere with the exercise of that individual's independent judgment. Disqualifying relationships considered by our Board are (i) employment with us at any time during the last five years, (ii) acceptance of compensation from us other than for service as a director, (iii) being a consultant, advisor, promoter, underwriter, or legal counsel for us at any time within the last five years, and (iv) being an immediate family member of an individual who is or who has been, within the past five years, one of our executive officers. The Board assesses the independence of all directors under the Finance Agency's independence standards, regardless of whether they serve on our Audit Committee. As of February 28, 2013, all of our directors, including all members of our Audit Committee, were independent under these criteria.

161

Exchange Act
Section 10A(m) of the Exchange Act sets forth the independence requirements of directors serving on the Audit Committee of a reporting company. Under Section 10A(m), in order to be considered independent, a member of the Audit Committee may not, other than in his or her capacity as a member of the Board or any other Board Committee (i) accept any consulting, advisory, or other compensation from us or (ii) be an affiliated person of the Bank. As of February 28, 2013, all of our directors, including all members of our Audit Committee, were independent under these criteria.
SEC Rules
In addition, pursuant to SEC rules, we adopted the independence standards of the New York Stock Exchange (NYSE) to determine which of our directors are independent for SEC disclosure purposes. In making an affirmative determination of the independence of each director, the Board first applied the objective measures of the NYSE independence standards to assist the Board in determining whether a particular director has a material relationship with us.
Based upon the fact that each of our Member Directors are officers or directors of member institutions, and that each such member routinely engages in transactions with us, the Board affirmatively determined none of the Member Directors on the Board meet the NYSE independence standards. In making this determination, the Board recognized a Member Director could meet the NYSE objective standards on any particular day. However, because the volume of business between a Member Director's institution and us can change frequently, and because we generally encourage increased business with all members, the Board determined to avoid distinguishing among the Member Directors based upon the amount of business conducted with us and our respective members at a specific time, resulting in the Board's categorical finding that no Member Director is independent under an analysis using the NYSE standards.
With regard to our Independent Directors, the Board affirmatively determined, at February 28, 2013, Johnny Danos, Gerald Eid, Ellen Lamale, Labh Hira, John Kennedy, Paula Meyer, and John Robinson are each independent in accordance with NYSE standards. In concluding our seven Independent Directors are independent under the NYSE rules, the Board first determined all Independent Directors met the objective NYSE independence standards. In further determining none of its Independent Directors had a material relationship with us, the Board noted the Independent Directors are specifically prohibited from being an officer of the Bank or an officer or director of a member.
Our Board has a standing Audit Committee. All Audit Committee members are independent under the Finance Agency's independence standards and the independence standards under Section 10A(m) of the Exchange Act in accordance with the Housing Act. For the reasons described above, our Board determined none of the current Member Directors serving on the Audit Committee are independent using the NYSE independence standards. The Member Directors serving on the Audit Committee are Michael Finley, Teresa Keegan, and Clair Lensing. Our Board determined, however, the Independent Directors serving on the Audit Committee are independent under the NYSE independence standards. The Independent Directors serving on the Audit Committee are Johnny Danos, John Kennedy, Labh Hira, Paula Meyer, and John Robinson.
Compensation Committee
The Board has a standing Compensation Committee. Our Board determined all members of the Compensation Committee are independent under the Finance Agency's independence standards. For the reasons described above, our Board determined none of the current Member Directors serving on the Compensation Committee are independent using the NYSE independence standards. The Member Directors serving on the Compensation Committee are Van Fishback, Dale Oberkfell, John Rigler, and Joseph Stewart. Our Board determined the Independent Directors serving on the Compensation Committee are independent under the NYSE independence standards. The Independent Directors serving on the Compensation Committee are Ellen Lamale, Labh Hira, and John Robinson.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The Audit Committee pre-approves all audit and permitted non-audit services performed by PwC. However, non-audit services for fees payable by us of $5,000 or less may be pre-approved by the Audit Committee Chair with subsequent approval by the Audit Committee.

162

The following table sets forth the aggregate fees billed by PwC (dollars in millions):
 
 
For the Years Ended December 31,
 
 
2012
 
2011
Audit fees1
 
$
0.5

 
$
0.6

Audit-related fees2
 
0.1

 
0.1

All other fees3
 
0.1

 
—

Total
 
$
0.7

 
$
0.7


1
Represents fees incurred in connection with the annual audit of our financial statements and internal control over financial reporting and quarterly review of our financial statements. In addition to these fees, we incurred assessments of $24,000 and $25,000 from the Office of Finance for audit fees on the Combined Financial Report for the years ended December 31, 2012 and 2011.

2
Represents fees related to other audit and attest services and technical accounting consultations.

3
Represents fees related to non-audit services, including a risk assessment of our core banking system project and the annual license for PwC's accounting research software.




163

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Financial Statements

The financial statements are set forth in Item 8 of this annual report on Form 10-K.

(b) Exhibits
3.1
 
Organization Certificate of the Federal Home Loan Bank of Des Moines dated October 13, 19321
3.2
 
Bylaws of the Federal Home Loan Bank of Des Moines, as amended and restated effective February 26, 20092
4.1
 
Federal Home Loan Bank of Des Moines Capital Plan, as amended, approved by the Federal Housing Finance Agency on August 5, 2011 and effective September 5, 20113
10.1
 
Employment Agreement with Richard S. Swanson, effective March 1, 20114
10.2
 
Amendment to Employment Agreement with Richard S. Swanson, effective January 1, 2013
10.3
 
Employment Agreement with Steven T. Schuler, effective March 1, 20114
10.4
 
Amendment to Employment Agreement with Steven T. Schuler, effective January 1, 2013
10.5
 
Employment Agreement with Edward J. McGreen, effective March 1, 20114
10.6
 
Amendment to Employment Agreement with Edward J. McGreen, effective January 1, 2013
10.7
 
Employment Agreement with Dusan Stojanovic, effective March 1, 20114
10.8
 
Amendment to Employment Agreement with Dusan Stojanovic, effective January 1, 2013
10.9
 
Employment Agreement with Daniel D. Clute, effective January 1, 2013
10.10
 
Lease Agreement for 801 Walnut Street between the Federal Home Loan Bank of Des Moines and Wells Fargo Financial, Inc., as amended, dated April 27, 20045
10.11
 
Joint Capital Enhancement Agreement, as amended, effective August 5, 20116
10.12
 
Federal Home Loan Bank of Des Moines Third Amended and Restated Benefit Equalization Plan, effective January 1, 20117
10.13
 
Federal Home Loan Bank of Des Moines Pentegra Defined Benefit Plan for Financial Institutions, effective January 1, 20117
10.14
 
Federal Home Loan Bank of Des Moines Pentegra Defined Contribution Plan for Financial Institutions, effective January 1, 20117
10.15
 
Federal Home Loan Bank of Des Moines 2012 Incentive Plan Document, effective January 1, 20128
10.16
 
2013 Director Fee Policy effective January 1, 2013
12.1
 
Computation of Ratio of Earnings to Fixed Charges
31.1
 
Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
 
Certification of the Executive Vice President and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
 
Certification of the President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
 
Certification of the Executive Vice President and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1
 
Federal Home Loan Bank of Des Moines Audit Committee Report
101
 
The following financial information from the Bank's 2012 Form 10-K, formatted in XBRL (Extensible Business Reporting Language): (i) Statements of Condition at December 31, 2012 and 2011, (ii) Statements of Income for the Years Ended December 31, 2012, 2011, and 2010, (iii) Statements of Comprehensive Income for the Years Ended December 31, 2012, 2011, and 2010, (iv) Statements of Capital for the Years Ended December 31, 2012, 2011, and 2010, (v) Statements of Cash Flows for the Years Ended December 31, 2012, 2011, and 2010, and (vi) Notes to the Financial Statements9

1    Incorporated by reference to the correspondingly numbered exhibit to our Registration Statement on Form 10 filed with the SEC on May 12, 2006.

2    Incorporated by reference to the correspondingly numbered exhibit to our Form 8-K filed with the SEC on March 2, 2009.

3    Incorporated by reference to the correspondingly numbered exhibit to our Form 10-K filed with the SEC on March 14, 2012.

4    Incorporated by reference to the exhibits to our Form 8-K filed with the SEC on November 15, 2011.

5    Incorporated by reference to exhibits 10.3 and 10.3.1 to our Form 10-K filed with the SEC on March 30, 2007.

6    Incorporated by reference to exhibit 99.1 of our Form 8-K filed with the SEC on August 5, 2011.

7    Incorporated by reference to the exhibits to our Form 10-K filed with the SEC on March 18, 2011.

8    Incorporated by reference to exhibit 10.1 of our Form 8-K filed with the SEC on August 7, 2012.

9
In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Annual Report on Form 10-K shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act of 1933 or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference in such filing.

164

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
FEDERAL HOME LOAN BANK OF DES MOINES
(Registrant)
 
March 13, 2013
By:  
/s/ Richard S. Swanson
 
 
Richard S. Swanson 
 
 
President and Chief Executive Officer 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
March 13, 2013
 
 
 
Signature
 
Title
 
 
 
Principal Executive Officer:
 
 
 
 
 
/s/ Richard S. Swanson
 
President & Chief Executive Officer
 
Richard S. Swanson
 
 
 
 
 
Principal Financial Officer and Principal Accounting Officer:
 
 
 
 
 
/s/ Steven T. Schuler
 
Executive Vice President & Chief Financial Officer
 
Steven T. Schuler
 
 
 
 
 
Directors:
 
 
 
 
 
/s/ Dale E. Oberkfell
 
Chairman of the Board of Directors
Dale E. Oberkfell
 
 
 
 
 
/s/ Eric A. Hardmeyer
 
Vice Chairman of the Board of Directors
 
Eric A. Hardmeyer
 
 
 
 
 
/s/ Johnny A. Danos
 
Director
 
Johnny A. Danos
 
 
 
 
 
/s/ Gerald D. Eid
 
Director
 
Gerald D. Eid
 
 
 
 
 
/s/ Michael J. Finley
 
Director
 
Michael J. Finley
 
 


165

 
 
 
Signature
 
Title
 
 
 
 
 
 
/s/ Van D. Fishback
 
Director
 
Van D. Fishback
 
 
 
 
 
/s/ Chris D. Grimm
 
Director
 
Chris D. Grimm
 
 
 
 
 
/s/ Teresa J. Keegan
 
Director
 
Teresa J. Keegan
 
 
 
 
 
/s/ John F. Kennedy, Sr.
 
Director
 
John F. Kennedy, Sr.
 
 
 
 
 
/s/ Ellen Z. Lamale
 
Director
Ellen Z. Lamale
 
 
 
 
 
/s/ Clair J. Lensing
 
Director
Clair J. Lensing
 
 
 
 
 
/s/ Paula R. Meyer
 
Director
 
Paula R. Meyer
 
 
 
 
 
/s/ John H. Robinson
 
Director
 
John H. Robinson
 
 
 
 
 
/s/ Joseph C. Stewart III
 
Director
 
Joseph C. Stewart III
 
 

 


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