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
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



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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.

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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.


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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.

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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.

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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.

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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