10-Q 1 fhlb09301410q.htm FORM 10-Q FHLB 093014 10Q

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

For the quarterly period ended September 30, 2014
OR
 
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 

Commission File Number: 000-51999
 

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


50309
(Zip code)
 

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

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

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

o Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
 
 
Shares outstanding as of October 31, 2014
 
Class B Stock, par value $100
 
34,669,277
 
 
 
 
 
 
 
 
 



Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CONDITION
(Unaudited)

(dollars and shares in thousands, except capital stock par value)
 
September 30,
2014
 
December 31,
2013
ASSETS
 
 
 
 
Cash and due from banks
 
$
9,477,515

 
$
448,278

Interest-bearing deposits
 
1,772

 
1,863

Securities purchased under agreements to resell
 
2,060,000

 
8,200,000

Federal funds sold
 
2,635,000

 
1,200,000

Investment securities
 
 
 
 
Trading securities (Note 3)
 
1,046,748

 
1,018,373

Available-for-sale securities (Note 4)
 
10,878,835

 
7,932,520

Held-to-maturity securities (fair value of $1,404,834 and $1,842,599) (Note 5)
 
1,325,741

 
1,778,306

Total investment securities
 
13,251,324

 
10,729,199

Advances (Note 7)
 
64,220,363

 
45,650,220

Mortgage loans held for portfolio, net
 
 
 
 
Mortgage loans held for portfolio (Note 8)
 
6,529,465

 
6,565,293

Allowance for credit losses on mortgage loans (Note 9)
 
(5,600
)
 
(8,000
)
Total mortgage loans held for portfolio, net
 
6,523,865

 
6,557,293

Accrued interest receivable
 
85,960

 
72,561

Premises, software, and equipment, net
 
19,077

 
18,968

Derivative assets, net (Note 10)
 
95,155

 
93,011

Other assets
 
28,686

 
32,626

TOTAL ASSETS
 
$
98,398,717

 
$
73,004,019

LIABILITIES
 
 
 
 
Deposits
 
 
 
 
Interest-bearing
 
$
395,183

 
$
467,362

Non-interest-bearing
 
76,143

 
231,704

Total deposits
 
471,326

 
699,066

Consolidated obligations (Note 11)
 
 
 
 
Discount notes
 
62,802,758

 
38,136,652

Bonds (includes $0 and $50,033 at fair value under the fair value option)
 
30,387,302

 
30,195,568

Total consolidated obligations
 
93,190,060

 
68,332,220

Mandatorily redeemable capital stock (Note 12)
 
8,400

 
8,719

Accrued interest payable
 
102,201

 
81,420

Affordable Housing Program payable
 
41,400

 
37,688

Derivative liabilities, net (Note 10)
 
52,429

 
57,420

Other liabilities
 
213,371

 
330,619

TOTAL LIABILITIES
 
94,079,187

 
69,547,152

Commitments and contingencies (Note 14)
 

 

CAPITAL (Note 12)
 
 
 
 
Capital stock - Class B putable ($100 par value); 34,557 and 26,916 issued and outstanding shares
 
3,455,729

 
2,691,568

Retained earnings
 
 
 
 
Unrestricted
 
643,306

 
627,473

Restricted
 
68,900

 
50,782

Total retained earnings
 
712,206

 
678,255

Accumulated other comprehensive income
 
151,595

 
87,044

TOTAL CAPITAL
 
4,319,530

 
3,456,867

TOTAL LIABILITIES AND CAPITAL
 
$
98,398,717

 
$
73,004,019

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

3

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

 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 30,
 
September 30,
(dollars in thousands)
 
2014
 
2013
 
2014
 
2013
INTEREST INCOME
 
 
 
 
 
 
 
 
Advances
 
$
59,662

 
$
46,542

 
$
166,525

 
$
140,392

Prepayment fees on advances, net
 
(401
)
 
1,351

 
2,983

 
4,437

Interest-bearing deposits
 
65

 
57

 
174

 
325

Securities purchased under agreements to resell
 
1,251

 
289

 
2,868

 
2,831

Federal funds sold
 
737

 
211

 
1,533

 
909

Trading securities
 
8,231

 
8,370

 
24,714

 
24,920

Available-for-sale securities
 
27,531

 
19,569

 
74,790

 
54,445

Held-to-maturity securities
 
10,253

 
14,619

 
33,892

 
51,414

Mortgage loans held for portfolio
 
60,584

 
62,020

 
184,167

 
190,923

Total interest income
 
167,913

 
153,028

 
491,646

 
470,596

INTEREST EXPENSE
 
 
 
 
 
 
 
 
Consolidated obligations - Discount notes
 
12,314

 
2,431

 
31,705

 
6,114

Consolidated obligations - Bonds
 
91,607

 
99,734

 
283,102

 
309,442

Deposits
 
13

 
28

 
55

 
92

Borrowings from other FHLBanks
 
—

 
1

 
1

 
1

Mandatorily redeemable capital stock
 
43

 
93

 
134

 
235

Total interest expense
 
103,977

 
102,287

 
314,997

 
315,884

NET INTEREST INCOME
 
63,936

 
50,741

 
176,649

 
154,712

Reversal for credit losses on mortgage loans
 
(1,412
)
 
—

 
(1,746
)
 
—

NET INTEREST INCOME AFTER REVERSAL FOR CREDIT LOSSES
 
65,348

 
50,741

 
178,395

 
154,712

OTHER (LOSS) INCOME
 
 
 
 
 
 
 
 
Other-than-temporary impairment losses
 
—

 
(1,293
)
 
—

 
(1,293
)
Net gains (losses) on trading securities
 
641

 
(7,851
)
 
47,175

 
(87,153
)
Net gains from sale of available-for-sale securities
 
—

 
1,094

 
826

 
3,039

Net gains from sale of held-to-maturity securities
 
6,404

 
—

 
8,887

 
—

Net gains on consolidated obligations held at fair value
 
—

 
28

 
2

 
1,001

Net (losses) gains on derivatives and hedging activities
 
(16,833
)
 
2,364

 
(78,793
)
 
72,343

Net losses on extinguishment of debt
 
(9,915
)
 
—

 
(12,651
)
 
(25,742
)
Other, net
 
1,645

 
2,243

 
5,289

 
6,975

Total other loss
 
(18,058
)
 
(3,415
)
 
(29,265
)
 
(30,830
)
OTHER EXPENSE
 
 
 
 
 
 
 
 
Compensation and benefits
 
8,663

 
7,103

 
24,267

 
21,518

Contractual services
 
1,136

 
1,556

 
4,995

 
4,673

Professional fees
 
1,815

 
823

 
3,492

 
2,382

Other operating expenses
 
2,332

 
2,413

 
6,902

 
7,000

Federal Housing Finance Agency
 
720

 
608

 
2,377

 
2,193

Office of Finance
 
1,036

 
685

 
2,797

 
2,141

Other, net
 
2,049

 
671

 
3,633

 
2,766

Total other expense
 
17,751

 
13,859

 
48,463

 
42,673

NET INCOME BEFORE ASSESSMENTS
 
29,539

 
33,467

 
100,667

 
81,209

Affordable Housing Program assessments
 
2,959

 
3,357

 
10,081

 
8,145

NET INCOME
 
$
26,580

 
$
30,110

 
$
90,586

 
$
73,064

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

4


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

 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 30,
 
September 30,
(dollars in thousands)
 
2014
 
2013
 
2014
 
2013
Net income
 
$
26,580

 
$
30,110

 
$
90,586

 
$
73,064

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
Net unrealized gains (losses) on available-for-sale securities
 
 
 
 
 
 
 
 
Unrealized gains (losses)
 
17,531

 
(13,809
)
 
65,190

 
(75,767
)
Reclassification adjustment for other-than-temporary impairment losses on available-for-sale securities included in net income
 
—

 
1,293

 
—

 
1,293

Reclassification of realized net gains included in net income
 
—

 
(1,094
)
 
(826
)
 
(3,039
)
Total net unrealized gains (losses) on available-for-sale securities
 
17,531

 
(13,610
)
 
64,364

 
(77,513
)
Pension and postretirement benefits
 
98

 
141

 
187

 
588

Total other comprehensive income (loss)
 
17,629

 
(13,469
)
 
64,551

 
(76,925
)
TOTAL COMPREHENSIVE INCOME (LOSS)
 
$
44,209

 
$
16,641

 
$
155,137

 
$
(3,861
)
The accompanying notes are an integral part of these financial statements.




5

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CAPITAL
(Unaudited)

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

 
$
2,062,714

 
$
593,129

 
$
28,820

 
$
621,949

 
$
149,638

 
$
2,834,301

Proceeds from issuance of capital stock
 
19,603

 
1,960,276

 
—

 
—

 
—

 
—

 
1,960,276

Repurchases/redemptions of capital stock
 
(13,131
)
 
(1,313,113
)
 
—

 
—

 
—

 
—

 
(1,313,113
)
Net shares reclassified to mandatorily redeemable capital stock
 
(200
)
 
(19,941
)
 
—

 
—

 
—

 
—

 
(19,941
)
Comprehensive income (loss)
 
—

 
—

 
58,451

 
14,613

 
73,064

 
(76,925
)
 
(3,861
)
Cash dividends on capital stock
 
—

 
—

 
(39,058
)
 
—

 
(39,058
)
 
—

 
(39,058
)
BALANCE, SEPTEMBER 30, 2013
 
26,899

 
$
2,689,936

 
$
612,522

 
$
43,433

 
$
655,955

 
$
72,713

 
$
3,418,604

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2013
 
26,916

 
$
2,691,568

 
$
627,473

 
$
50,782

 
$
678,255

 
$
87,044

 
$
3,456,867

Proceeds from issuance of capital stock
 
20,293

 
2,029,303

 
—

 
—

 
—

 
—

 
2,029,303

Repurchases/redemptions of capital stock
 
(12,607
)
 
(1,260,698
)
 
—

 
—

 
—

 
—

 
(1,260,698
)
Net shares reclassified to mandatorily redeemable capital stock
 
(45
)
 
(4,444
)
 
—

 
—

 
—

 
—

 
(4,444
)
Comprehensive income
 
—

 
—

 
72,468

 
18,118

 
90,586

 
64,551

 
155,137

Cash dividends on capital stock
 
—

 
—

 
(56,635
)
 
—

 
(56,635
)
 
—

 
(56,635
)
BALANCE, SEPTEMBER 30, 2014
 
34,557

 
$
3,455,729

 
$
643,306

 
$
68,900

 
$
712,206

 
$
151,595

 
$
4,319,530

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




6

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

 
 
For the Nine Months Ended
 
 
September 30,
(dollars in thousands)
 
2014
 
2013
OPERATING ACTIVITIES
 
 
 
 
Net income
 
$
90,586

 
$
73,064

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
 
Depreciation and amortization
 
10,742

 
2,707

Other-than-temporary impairment losses
 
—

 
1,293

Net (gains) losses on trading securities
 
(47,175
)
 
87,153

Net gains from sale of available-for-sale securities
 
(826
)
 
(3,039
)
Net gains from sale of held-to-maturity securities
 
(8,887
)
 
—

Net gains on consolidated obligations held at fair value
 
(2
)
 
(1,001
)
Net change in derivatives and hedging activities
 
58,227

 
(79,538
)
Net losses on extinguishment of debt
 
12,651

 
25,742

Other adjustments
 
(4,226
)
 
1,280

Net change in:
 
 
 
 
Accrued interest receivable
 
(16,124
)
 
(8,275
)
Other assets
 
2,882

 
1,691

Accrued interest payable
 
20,748

 
(455
)
Other liabilities
 
4,605

 
(1,825
)
Total adjustments
 
32,615

 
25,733

Net cash provided by operating activities
 
123,201

 
98,797

INVESTING ACTIVITIES
 
 
 
 
Net change in:
 
 
 
 
Interest-bearing deposits
 
(50,079
)
 
129,546

Securities purchased under agreements to resell
 
6,140,000

 
975,000

Federal funds sold
 
(1,435,000
)
 
375,000

Premises, software, and equipment
 
(2,645
)
 
(6,197
)
Trading securities
 
 
 
 
Proceeds from maturities of long-term
 
18,800

 
15,928

Purchases of long-term
 
—

 
(140,579
)
Available-for-sale securities
 
 
 
 
Proceeds from sales and maturities of long-term
 
905,699

 
948,144

Purchases of long-term
 
(3,749,223
)
 
(2,277,344
)
Held-to-maturity securities
 
 
 
 
Proceeds from sales and maturities of long-term
 
460,307

 
1,087,245

Advances
 
 
 
 
Principal collected
 
66,484,479

 
46,552,289

Originated
 
(85,144,126
)
 
(65,935,653
)
Mortgage loans held for portfolio
 
 
 
 
Principal collected
 
657,185

 
1,338,707

Originated or purchased
 
(635,972
)
 
(1,011,847
)
Proceeds from sales of foreclosed assets
 
12,498

 
19,763

Net cash used in investing activities
 
(16,338,077
)
 
(17,929,998
)
The accompanying notes are an integral part of these financial statements.

7

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

 
 
For the Nine Months Ended
 
 
September 30,
(dollars in thousands)
 
2014
 
2013
FINANCING ACTIVITIES
 
 
 
 
Net change in deposits
 
(297,163
)
 
(399,416
)
Net payments on derivative contracts with financing elements
 
(6,022
)
 
(5,987
)
Net proceeds from issuance of consolidated obligations
 
 
 
 
Discount notes
 
159,080,542

 
90,857,889

Bonds
 
21,536,831

 
30,389,908

Payments for maturing and retiring consolidated obligations
 
 
 
 
Discount notes
 
(134,416,372
)
 
(71,313,457
)
Bonds
 
(21,360,910
)
 
(32,186,422
)
Bonds transferred to other FHLBanks
 
—

 
(172,741
)
Proceeds from issuance of capital stock
 
2,029,303

 
1,960,276

Payments for repurchases/redemptions of capital stock
 
(1,260,698
)
 
(1,313,113
)
Net payments for repurchases/redemptions of mandatorily redeemable capital stock
 
(4,763
)
 
(16,119
)
Cash dividends paid
 
(56,635
)
 
(39,058
)
Net cash provided by financing activities
 
25,244,113

 
17,761,760

Net increase (decrease) in cash and due from banks
 
9,029,237

 
(69,441
)
Cash and due from banks at beginning of the period
 
448,278

 
252,113

Cash and due from banks at end of the period
 
$
9,477,515

 
$
182,672

 
 
 
 
 
SUPPLEMENTAL DISCLOSURES
 
 
 
 
Interest paid
 
$
602,319

 
$
630,785

Affordable Housing Program payments
 
$
6,369

 
$
7,654

Transfers of mortgage loans to real estate owned
 
$
7,221

 
$
12,465

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


8

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

Background Information

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

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

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

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

Potential Merger

On July 31, 2014, the Bank and the Federal Home Loan Bank of Seattle (Seattle Bank) announced that they had entered into an exclusivity arrangement regarding a potential merger of the two banks. A detailed due diligence process was completed by both banks throughout the third quarter of 2014 for the purpose of weighing the long-term benefits and impact of a potential merger.

On September 25, 2014, the boards of both banks unanimously approved, and the banks executed, a definitive merger agreement. Material details of the merger agreement are included in the Bank’s Form 8-K filed with the Securities and Exchange Commission (SEC) on September 25, 2014. The closing of the merger is subject to certain closing conditions, including approval by the Finance Agency and ratification by the member-owners of both banks. A merger application was sent to the Finance Agency for approval on October 31, 2014.

The boards of both banks believe that a merger would combine two complementary organizations with similar cultures, membership characteristics, and solid financial positions. The combined bank would remain a member-owned and member-centric cooperative, deeply focused on helping its members strengthen their institutions to better serve their customers and communities. It would provide funding solutions for more than 1,500 member financial institutions in 13 states and the U.S. Pacific territories. The combined bank is currently expected to be headquartered in Des Moines. 


9

Note 1 — Basis of Presentation

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

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

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

Reclassifications

Certain amounts in the Bank's 2013 financial statements and footnotes have been reclassified to conform to the presentation for the three and nine months ended September 30, 2014. Additionally, certain other prior period amounts have been revised and may not agree to the Bank's 2013 Form 10-K. These amounts were not deemed to be material.

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

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

 
$
19,719

Impaired loans without an allowance
1,125

 
21,121


The following table summarizes the revisions to be made to the Bank’s allowance for credit losses footnote for the year ended December 31, 2013 in the 2014 Form 10-K filing (dollars in thousands):
 
Previously Reported
 
Revised
Average recorded investment on impaired loans with an allowance
$
48,930

 
$
38,932

Average recorded investment on impaired loans without an allowance
1,162

 
11,160



10

Note 2 — Recently Adopted and Issued Accounting Guidance

ADOPTED ACCOUNTING GUIDANCE

Joint and Several Liability Arrangements

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

ISSUED ACCOUNTING GUIDANCE

Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern

On August 27, 2014, the FASB issued guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. This guidance requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year after the date the financial statements are issued or within one year after the financial statements are available to be issued, when applicable. Substantial doubt exists if it is probable that the entity will be unable to meet its obligations for the assessed period. This guidance becomes effective for the interim and annual periods ending after December 15, 2016, and early application is permitted. Management will be required to make the initial assessment as of December 31, 2016.

Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure

On August 8, 2014, the FASB issued amended guidance relating to the classification and measurement of certain government-guaranteed mortgage loans upon foreclosure. The amendments in this guidance require that a mortgage loan be de-recognized and that a separate other receivable be recognized upon foreclosure if certain conditions are met. This guidance becomes effective for the interim and annual periods beginning after December 15, 2014, and may be adopted using either the modified retrospective transition method or the prospective transition method. The Bank is in the process of evaluating this guidance, and its effect on the Bank's financial condition, results of operations, or cash flows is not expected to be material.

Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures

On June 12, 2014, the FASB issued amended guidance for repurchase-to-maturity transactions and repurchase agreements executed as repurchase financing. This amendment requires secured borrowing accounting treatment for repurchase-to-maturity transactions and provides guidance on accounting for repurchase financing arrangements. In addition, this guidance requires additional disclosures, particularly on transfers accounted for as sales that are economically similar to repurchase agreements and on the nature of collateral pledged in repurchase agreements accounted for as secured borrowings. This guidance becomes effective for the interim or annual period beginning after December 15, 2014, and early adoption is prohibited. The changes in accounting for transactions outstanding on the effective date are required to be presented as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. This guidance is not expected to affect the Bank's financial condition, results of operations, cash flows, or financial statement disclosures.


11

Revenue from Contracts with Customers

On May 28, 2014, the FASB issued guidance on revenue from contracts with customers. This guidance outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. In addition, this guidance amends the existing requirements for the recognition of a gain or loss on the transfer of non-financial assets that are not in a contract with a customer. This guidance applies to all contracts with customers except those that are within the scope of certain other standards, such as financial instruments, certain guarantees, insurance contracts, or lease contracts. This guidance becomes effective for the interim and annual reporting periods beginning after December 15, 2016, and early application is not permitted. The guidance provides entities with the option of using the following two methods upon adoption: a full retrospective method, retrospectively to each prior reporting period presented; or a transition method, retrospectively with the cumulative effect of initially applying this guidance recognized at the date of initial application. The Bank is in the process of evaluating this guidance and its effect on the Bank's financial condition, results of operations, or cash flows is not expected to be material.

Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure

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

Finance Agency Advisory Bulletin on Asset Classification

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

Note 3 — Trading Securities

Major Security Types

Trading securities were as follows (dollars in thousands):
 
September 30,
2014
 
December 31,
2013
Non-mortgage-backed securities
 
 
 
Other U.S. obligations
$
259,097

 
$
266,898

GSE obligations
59,652

 
54,971

Other1
275,248

 
263,354

     Total non-mortgage-backed securities
593,997

 
585,223

Mortgage-backed securities
 
 
 
GSE residential
452,751

 
433,150

Total fair value
$
1,046,748

 
$
1,018,373


1
Consists of taxable municipal bonds.


12

Net Gains (Losses) on Trading Securities

During the three and nine months ended September 30, 2014, the Bank recorded net holding gains of $0.7 million and $47.2 million on its trading securities compared to net holding losses of $7.9 million and $87.2 million for the same periods in 2013.

Note 4 — Available-for-Sale Securities

Major Security Types

Available-for-sale (AFS) securities were as follows (dollars in thousands):
 
September 30, 2014
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 

Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations
$
162,401

 
$
5,639

 
$
—

 
$
168,040

GSE obligations
1,033,937

 
24,730

 
(3,646
)
 
1,055,021

State or local housing agency obligations
25,219

 
55

 
(556
)
 
24,718

Other2
170,153

 
9,312

 
—

 
179,465

Total non-mortgage-backed securities
1,391,710

 
39,736

 
(4,202
)
 
1,427,244

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations residential
1,368,359

 
5,679

 
—

 
1,374,038

GSE residential
7,966,003

 
114,085

 
(2,535
)
 
8,077,553

Total mortgage-backed securities
9,334,362

 
119,764

 
(2,535
)
 
9,451,591

Total
$
10,726,072

 
$
159,500

 
$
(6,737
)
 
$
10,878,835


 
December 31, 2013
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 

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

 
$
6,474

 
$
(23
)
 
$
181,548

GSE obligations
1,101,693

 
27,845

 
(2,663
)
 
1,126,875

State or local housing agency obligations
24,868

 
—

 
(1,897
)
 
22,971

Other2
257,584

 
5,994

 
(4
)
 
263,574

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

 
40,313

 
(4,587
)
 
1,594,968

Mortgage-backed securities
 
 
 
 
 
 
 
GSE residential
6,284,879

 
66,381

 
(13,708
)
 
6,337,552

Total
$
7,844,121

 
$
106,694

 
$
(18,295
)
 
$
7,932,520


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

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

13

Unrealized Losses

The following tables summarize AFS securities with unrealized losses by major security type and length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
September 30, 2014
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE obligations
$
230,884

 
$
(357
)
 
$
110,552

 
$
(3,289
)
 
$
341,436

 
$
(3,646
)
State or local housing agency obligations
—

 
—

 
23,208

 
(556
)
 
23,208

 
(556
)
Total non-mortgage-backed securities
230,884

 
(357
)
 
133,760

 
(3,845
)
 
364,644

 
(4,202
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE residential
788,551

 
(2,301
)
 
188,814

 
(234
)
 
977,365

 
(2,535
)
Total
$
1,019,435

 
$
(2,658
)
 
$
322,574

 
$
(4,079
)
 
$
1,342,009

 
$
(6,737
)
 
December 31, 2013
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
$
38,342

 
$
(23
)
 
$
—

 
$
—

 
$
38,342

 
$
(23
)
GSE obligations
135,655

 
(1,081
)
 
59,061

 
(1,582
)
 
194,716

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

 
(1,897
)
 
—

 
—

 
22,971

 
(1,897
)
Other
10,190

 
(4
)
 
—

 
—

 
10,190

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

 
(3,005
)
 
59,061

 
(1,582
)
 
266,219

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

 
(12,061
)
 
263,983

 
(1,647
)
 
2,419,993

 
(13,708
)
Total
$
2,363,168

 
$
(15,066
)
 
$
323,044

 
$
(3,229
)
 
$
2,686,212

 
$
(18,295
)

Contractual Maturity

The following table summarizes AFS securities by contractual maturity. Expected maturities of some securities may differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment fees (dollars in thousands):
 
 
September 30, 2014
 
December 31, 2013
Year of Contractual Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
Due in one year or less
 
$
12,650

 
$
12,954

 
$
9,981

 
$
10,071

Due after one year through five years
 
960,828

 
980,145

 
1,031,840

 
1,056,323

Due after five years through ten years
 
277,219

 
285,857

 
331,391

 
339,266

Due after ten years
 
141,013

 
148,288

 
186,030

 
189,308

Total non-mortgage-backed securities
 
1,391,710

 
1,427,244

 
1,559,242

 
1,594,968

Mortgage-backed securities
 
9,334,362

 
9,451,591

 
6,284,879

 
6,337,552

Total
 
$
10,726,072

 
$
10,878,835

 
$
7,844,121

 
$
7,932,520


Net Gains from Sale of AFS Securities

During the three months ended September 30, 2014, the Bank did not sell any AFS securities. During the nine months ended September 30, 2014, the Bank received $97.2 million in proceeds from the sale of an AFS security and recognized a gross gain of $0.8 million. During the three and nine months ended September 30, 2013, the Bank received $88.0 million and $100.6 million in proceeds from the sale of AFS securities and recognized gross gains of $1.1 million and $3.0 million.

14

Note 5 — Held-to-Maturity Securities

Major Security Types

Held-to-maturity (HTM) securities were as follows (dollars in thousands):
 
September 30, 2014
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
GSE obligations
$
305,561

 
$
58,633

 
$
—

 
$
364,194

State or local housing agency obligations
64,170

 
5,680

 
—

 
69,850

Other2
211

 
—

 
—

 
211

Total non-mortgage-backed securities
369,942

 
64,313

 
—

 
434,255

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations residential
3,717

 
12

 
—

 
3,729

Other U.S. obligations commercial
1,471

 
—

 
(1
)
 
1,470

GSE residential
924,462

 
15,264

 
(45
)
 
939,681

Private-label residential
26,149

 
52

 
(502
)
 
25,699

Total mortgage-backed securities
955,799

 
15,328

 
(548
)
 
970,579

Total
$
1,325,741

 
$
79,641

 
$
(548
)
 
$
1,404,834


 
December 31, 2013
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
GSE obligations
$
306,853

 
$
30,862

 
$
—

 
$
337,715

State or local housing agency obligations
72,662

 
2,518

 
—

 
75,180

Other2
807

 
—

 
—

 
807

Total non-mortgage-backed securities
380,322

 
33,380

 
—

 
413,702

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

 
22

 
—

 
5,325

Other U.S. obligations commercial
1,985

 
6

 
—

 
1,991

GSE residential
1,360,705

 
31,937

 
(426
)
 
1,392,216

Private-label residential
29,991

 
63

 
(689
)
 
29,365

Total mortgage-backed securities
1,397,984

 
32,028

 
(1,115
)
 
1,428,897

Total
$
1,778,306

 
$
65,408

 
$
(1,115
)
 
$
1,842,599


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

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

15

Unrealized Losses

The following tables summarize HTM securities with unrealized losses by major security type and the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
 
September 30, 2014
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations commercial
$
—

 
$
—

 
$
258

 
$
(1
)
 
$
258

 
$
(1
)
GSE residential
—

 
—

 
54,470

 
(45
)
 
54,470

 
(45
)
Private-label residential
—

 
—

 
17,149

 
(502
)
 
17,149

 
(502
)
Total mortgage-backed securities
$
—

 
$
—

 
$
71,877

 
$
(548
)
 
$
71,877

 
$
(548
)
 
December 31, 2013
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE residential
$
71,023

 
$
(54
)
 
$
113,532

 
$
(372
)
 
$
184,555

 
$
(426
)
Private-label residential
—

 
—

 
19,517

 
(689
)
 
19,517

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

 
$
(54
)
 
$
133,049

 
$
(1,061
)
 
$
204,072

 
$
(1,115
)

Contractual Maturity

The following table summarizes HTM securities by contractual maturity. Expected maturities of some securities may differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment fees (dollars in thousands):
 
 
September 30, 2014
 
December 31, 2013
Year of Contractual Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
Due after one year through five years
 
$
211

 
$
211

 
$
807

 
$
807

Due after ten years
 
369,731

 
434,044

 
379,515

 
412,895

Total non-mortgage-backed securities
 
369,942

 
434,255

 
380,322

 
413,702

Mortgage-backed securities
 
955,799

 
970,579

 
1,397,984

 
1,428,897

Total
 
$
1,325,741

 
$
1,404,834

 
$
1,778,306

 
$
1,842,599


Net Gains from Sale of HTM Securities

During the three months ended September 30, 2014, the Bank sold an HTM security with a carrying amount of $45.7 million and recognized a gross gain of $6.4 million. During the nine months ended September 30, 2014, the Bank sold HTM securities with a carrying amount of $65.7 million and recognized gross gains of $8.9 million. The HTM securities sold had less than 15 percent of the acquired principal outstanding at the time of sale. As such, the sales were considered maturities for purpose of security classification and did not impact the Bank's ability and intent to hold the remaining HTM securities through their stated maturities. During the three and nine months ended September 30, 2013, the Bank did not sell any HTM securities.

Note 6 — Other-Than-Temporary Impairment

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


16

Private-Label Mortgage-Backed Securities

On a quarterly basis, the Bank engages other designated FHLBanks to perform cash flow analyses on its private-label mortgage-backed securities (MBS) using two third-party models in order to assess whether the entire amortized cost bases of these securities will be recovered. For a description of these models, refer to "Item 8. Financial Statements and Supplementary Data - Note 7 - Other-than-Temporary Impairment" in the Bank's 2013 Form 10-K.

The FHLBanks' OTTI Governance Committee developed a short-term housing price forecast with projected changes ranging from a decrease of three percent to an increase of nine percent over the twelve month period beginning July 1, 2014. For the vast majority of markets, the projected short-term housing price changes range from zero percent to an increase of six percent. Thereafter, a unique path is projected for each geographical area based on an internally developed framework derived from historical data. Prior to the second quarter of 2014, home price projections following the short-term period were projected to recover using one of five different recovery paths.

The Bank compared the present value of the cash flows expected to be collected with respect to its private-label MBS to the amortized cost bases of the securities to determine whether a credit loss existed. At September 30, 2014, the Bank's cash flow analyses for private-label MBS did not project any credit losses. Even under an adverse scenario that delays recovery of the housing price index, no credit losses were projected. The Bank does not intend to sell its private-label MBS and it is not more likely than not that the Bank will be required to sell its private-label MBS before recovery of their amortized cost bases. As a result, the Bank did not consider any of its private-label MBS to be other-than-temporarily impaired at September 30, 2014.

All Other AFS and HTM Investment Securities

On a quarterly basis, the Bank reviews all remaining AFS and HTM securities in an unrealized loss position to determine whether they are other-than temporarily impaired. The following was determined for the Bank's other investment securities in an unrealized loss position at September 30, 2014:

•
Other U.S. obligations and GSE securities. The unrealized losses were due primarily to interest rate volatility. The strength of the issuers' guarantees through direct obligations or support from the U.S. Government was sufficient to protect the Bank from losses based on current expectations. The Bank expects to recover the amortized cost bases on these securities and neither intends to sell these securities nor considers it more likely than not that it will be required to sell these securities before recovery of their amortized cost bases. As such, the Bank did not consider these securities to be other-than-temporarily impaired at September 30, 2014.

•
State housing agency obligations. The unrealized losses were due to changes in interest rates, credit spreads, and illiquidity in the credit markets, and not to a significant deterioration in the fundamental credit quality of the obligations. The creditworthiness of the issuers and the strength of the underlying collateral and credit enhancements was sufficient to protect the Bank from losses based on current expectations. The Bank does not intend to sell these securities nor is it more likely than not that it will be required to sell these securities before recovery of their amortized cost bases. As such, the Bank did not consider these securities to be other-than-temporarily impaired at September 30, 2014.


17

Note 7 — Advances

Contractual Maturity

The following table summarizes the Bank's advances outstanding by contractual maturity (dollars in thousands):
 
 
September 30, 2014
 
December 31, 2013
Year of Contractual Maturity
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Overdrawn demand deposit accounts
 
$
722

 
3.28
 
$
—

 
—
Due in one year or less
 
9,620,032

 
0.50
 
6,948,856

 
0.60
Due after one year through two years
 
3,816,682

 
1.52
 
4,479,162

 
0.95
Due after two years through three years
 
4,357,848

 
1.48
 
2,936,056

 
1.76
Due after three years through four years
 
17,925,309

 
0.63
 
3,298,142

 
2.28
Due after four years through five years
 
19,372,056

 
0.35
 
20,558,211

 
0.54
Thereafter
 
8,927,245

 
0.75
 
7,139,820

 
0.85
Total par value
 
64,019,894

 
0.66
 
45,360,247

 
0.84
Premiums
 
141

 
 
 
153

 
 
Discounts
 
(6,762
)
 
 
 
(7,879
)
 
 
Fair value hedging adjustments
 
207,090

 
 
 
297,699

 
 
Total
 
$
64,220,363

 
 
 
$
45,650,220

 
 
 
The Bank offers advances to members and eligible housing associates that may be prepaid on pertinent dates (call dates) prior to maturity without incurring prepayment fees (callable advances). In exchange for receiving the right to call the advance on a predetermined call date, the borrower typically pays a higher fixed rate for the advance relative to an equivalent maturity, noncallable, fixed rate advance. If the call option is exercised, replacement funding may be available. Other advances may only be prepaid by paying a fee to the Bank (prepayment fee) that makes the Bank financially indifferent to the prepayment of the advance. At September 30, 2014 and December 31, 2013, the Bank had callable advances outstanding totaling $41.7 billion and $26.4 billion.

The Bank also offers putable advances. With a putable advance, the Bank has the right to terminate the advance from the borrower on predetermined exercise dates, and the borrower may then apply for a new advance at the prevailing market rate. Generally, put options are exercised when interest rates increase. At September 30, 2014 and December 31, 2013, the Bank had putable advances outstanding totaling $2.2 billion and $2.4 billion.
 
Prepayment Fees

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

The following table summarizes the Bank's prepayment fees on advances, net (dollars in thousands):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Gross prepayment fee income
$
4,643

 
$
1,650

 
$
21,810

 
$
15,460

Fair value hedging adjustments1
(5,044
)
 
(299
)
 
(18,827
)
 
(11,023
)
Prepayment fees on advances, net
$
(401
)
 
$
1,351

 
$
2,983

 
$
4,437


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

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


18

Note 8 — Mortgage Loans Held for Portfolio

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

The following table presents information on the Bank's mortgage loans held for portfolio (dollars in thousands):
 
September 30,
2014
 
December 31,
2013
Fixed rate, long-term single family mortgage loans
$
4,946,728

 
$
4,823,351

Fixed rate, medium-term1 single family mortgage loans
1,504,430

 
1,668,190

Total unpaid principal balance
6,451,158

 
6,491,541

Premiums
81,471

 
80,911

Discounts
(13,001
)
 
(15,652
)
Basis adjustments from mortgage loan commitments
9,837

 
8,493

Total mortgage loans held for portfolio
$
6,529,465

 
$
6,565,293


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

The following table presents the Bank's mortgage loans held for portfolio by collateral or guarantee type (dollars in thousands):
 
September 30,
2014
 
December 31,
2013
Conventional mortgage loans
$
5,884,401

 
$
5,944,999

Government-insured mortgage loans
566,757

 
546,542

Total unpaid principal balance
$
6,451,158

 
$
6,491,541


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

Note 9 — Allowance for Credit Losses

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

Credit Products

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


19

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

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

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

Using a risk-based approach and taking into consideration each borrower's financial strength, the Bank considers the types and level of collateral to be the primary indicator of credit quality on its credit products. At September 30, 2014 and December 31, 2013, the Bank had rights to collateral on a borrower-by-borrower basis with an unpaid principal balance or market value, if available, in excess of its outstanding extensions of credit.

At September 30, 2014 and December 31, 2013, none of the Bank's credit products were past due, on non-accrual status, or considered impaired. In addition, there were no troubled debt restructurings (TDRs) related to credit products during the nine months ended September 30, 2014 and 2013.

The Bank has never experienced a credit loss on its credit products. Based upon the Bank's collateral and lending policies, the collateral held as security, and the repayment history on credit products, management has determined that there were no probable credit losses on its credit products as of September 30, 2014 and December 31, 2013. Accordingly, the Bank has not recorded any allowance for credit losses for its credit products.

Government-Insured Mortgage Loans

The Bank invests in government-insured fixed rate mortgage loans that are insured or guaranteed by the Federal Housing Administration, the Department of Veterans Affairs, and/or the Rural Housing Service of the Department of Agriculture. The servicer or PFI obtains and maintains insurance or a guaranty from the applicable government agency. The servicer or PFI is responsible for compliance with all government agency requirements and for obtaining the benefit of the applicable guarantee or insurance with respect to defaulted government-insured mortgage loans. Any losses incurred on these loans that are not recovered from the insurer/guarantor are absorbed by the servicers. As such, the Bank only has credit risk for these loans if the servicer or PFI fails to pay for losses not covered by the guarantee or insurance. Management views this risk as remote. As a result, the Bank did not establish an allowance for credit losses for its government-insured mortgage loans at September 30, 2014 and December 31, 2013. Furthermore, none of these mortgage loans have been placed on non-accrual status because of the U.S. Government guarantee or insurance on these loans and the contractual obligation of the loan servicer to repurchase the loans when certain criteria are met.

20


Conventional Mortgage Loans

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

•
Homeowner Equity.

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

•
First Loss Account. The first loss account (FLA) is a memorandum account used to track the Bank's potential loss exposure under each master commitment prior to the PFI's credit enhancement obligation. For absorbing certain losses in excess of the FLA, PFIs are paid a credit enhancement fee, a portion of which may be performance-based. The Bank records credit enhancement fees paid to PFIs as a reduction to mortgage loan interest income. Credit enhancement fees paid totaled $3.3 million and $3.2 million during the nine months ended September 30, 2014 and 2013. To the extent the Bank experiences losses under the FLA, it may be able to recapture performance-based credit enhancement fees paid to the PFI to offset these losses. The FLA balance for all master commitments with a PFI credit enhancement obligation was $90.2 million and $87.3 million at September 30, 2014 and December 31, 2013.

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

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

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

Individually Identified Conventional Mortgage Loans. The Bank individually evaluates certain conventional mortgage loans, including TDRs and collateral-dependent loans, for impairment. The Bank's TDRs include loans granted under its temporary loan modification plan and loans discharged under Chapter 7 bankruptcy that have not been reaffirmed by the borrower. The Bank generally measures impairment of TDRs based on the present value of expected future cash flows discounted at the loan's effective interest rate. Collateral-dependent loans are loans in which repayment is expected to be provided solely by the sale of the underlying collateral. The Bank's collateral-dependent loans include loans in process of foreclosure, loans 180 days or more past due, and bankruptcy loans and TDRs 60 days or more past due. The Bank measures impairment of collateral-dependent loans based on the estimated fair value of the underlying collateral, which is determined using property values, less selling costs and expected proceeds from PMI. Prior to January 1, 2014, the Bank only evaluated TDRs and collateral-dependent loans that were in process of foreclosure on an individual basis.

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


21

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

Available performance-based credit enhancement fees cannot be shared between master commitments and, as a result, some master commitments may have sufficient performance-based credit enhancement fees to recapture losses while other master commitments may not. At September 30, 2014 and December 31, 2013, the Bank determined that the amount of performance-based credit enhancement fees available for recapture from the PFIs at the master commitment level was immaterial. As such, it did not factor credit enhancement fees into its estimate of the allowance for credit losses.

PFI Credit Enhancement Obligation. When reserving for estimated credit losses, the Bank may take into consideration the PFI credit enhancement obligation, which is intended to absorb losses in excess of the FLA. At September 30, 2014 and December 31, 2013, the Bank determined that the amount of credit enhancement obligation available to offset losses was immaterial. As such, it did not factor credit enhancement obligation into its estimate of the allowance for credit losses.

Allowance for Credit Losses on Conventional Mortgage Loans. The following table presents a rollforward of the allowance for credit losses on the Bank's conventional mortgage loan portfolio (dollars in thousands):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Balance, beginning of period
$
7,200

 
$
14,656

 
$
8,000

 
$
15,793

Charge-offs
(188
)
 
(416
)
 
(654
)
 
(1,553
)
Reversal for credit losses
(1,412
)
 
—

 
(1,746
)
 
—

Balance, end of period
$
5,600

 
$
14,240

 
$
5,600

 
$
14,240


The following table summarizes the allowance for credit losses and recorded investment of the Bank's conventional mortgage loan portfolio by impairment methodology (dollars in thousands):
 
September 30,
2014
 
December 31,
2013
Allowance for credit losses
 
 
 
Collectively evaluated for impairment
$
1,600

 
$
4,500

Individually evaluated for impairment
4,000

 
3,500

Total allowance for credit losses
$
5,600

 
$
8,000

Recorded investment1
 
 
 
Collectively evaluated for impairment
$
5,929,116

 
$
5,996,590

Individually evaluated for impairment, with or without a related allowance
51,494

 
40,840

Total recorded investment
$
5,980,610

 
$
6,037,430


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


22

Credit Quality Indicators. Key credit quality indicators for mortgage loans include the migration of past due loans, loans in process of foreclosure, and non-accrual loans. The tables below summarize the Bank's key credit quality indicators for mortgage loans (dollars in thousands):
 
September 30, 2014
 
Conventional
 
Government Insured
 
Total
Past due 30 - 59 days
$
74,894

 
$
19,914

 
$
94,808

Past due 60 - 89 days
21,579

 
5,545

 
27,124

Past due 90 - 179 days
13,454

 
4,691

 
18,145

Past due 180 days or more
41,190

 
5,864

 
47,054

Total past due mortgage loans
151,117

 
36,014

 
187,131

Total current mortgage loans
5,829,493

 
546,556

 
6,376,049

Total recorded investment of mortgage loans1
$
5,980,610

 
$
582,570

 
$
6,563,180

 
 
 
 
 
 
In process of foreclosure (included above)2
$
26,880

 
$
3,582

 
$
30,462

Serious delinquency rate3
0.9
%
 
1.8
%
 
1.0
%
Past due 90 days or more and still accruing interest4
$
—

 
$
10,555

 
$
10,555

Non-accrual mortgage loans5
$
58,802

 
$
—

 
$
58,802

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

 
$
19,714

 
$
95,235

Past due 60 - 89 days
21,925

 
7,128

 
29,053

Past due 90 - 179 days
17,864

 
5,515

 
23,379

Past due 180 days or more
50,271

 
4,130

 
54,401

Total past due mortgage loans
165,581

 
36,487

 
202,068

Total current mortgage loans
5,871,849

 
524,947

 
6,396,796

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

 
$
561,434

 
$
6,598,864

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

 
$
1,106

 
$
38,688

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

 
$
9,645

 
$
9,645

Non-accrual mortgage loans5
$
71,221

 
$
—

 
$
71,221


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

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

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

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

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

Individually Evaluated Impaired Loans. As previously described, the Bank evaluates certain conventional mortgage loans for impairment individually. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The following table summarizes the recorded investment and related allowance of the Bank's individually evaluated impaired loans (dollars in thousands):
 
September 30, 2014
 
December 31, 2013
 
Recorded Investment
 
Related Allowance
 
Recorded Investment
 
Related Allowance
Impaired loans with an allowance
$
20,743

 
$
4,000

 
$
19,719

 
$
3,500

Impaired loans without an allowance
30,751

 
—

 
21,121

 
—

Total
$
51,494

 
$
4,000

 
$
40,840

 
$
3,500


The Bank did not recognize any interest income on impaired loans during the three and nine months ended September 30, 2014 and 2013.

23

The following table summarizes the average recorded investment on the Bank's individually evaluated impaired loans (dollars in thousands):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Impaired loans with an allowance
$
21,770

 
$
45,295

 
$
20,231

 
$
50,568

Impaired loans without an allowance
30,933

 
1,350

 
25,936

 
1,269

Total
$
52,703

 
$
46,645

 
$
46,167

 
$
51,837


Real Estate Owned. At September 30, 2014 and December 31, 2013, the Bank had $8.5 million and $12.2 million of REO recorded as a component of "Other assets" in the Statements of Condition.

Term Securities Purchased Under Agreements to Resell

Term securities purchased under agreements to resell are considered collateralized financing agreements and represent short-term investments. The terms of these investments are structured such that if the market value of the underlying securities decreases below the market value required as collateral, the counterparty must place an equivalent amount of additional securities as collateral or remit an equivalent amount of cash. Otherwise, the dollar value of the resale agreement will decrease accordingly. If an agreement to resell is deemed to be impaired, the difference between the fair value of the collateral and the amortized cost of the agreement will be charged to earnings to establish an allowance for credit losses. Based upon the collateral held as security, the Bank determined that no allowance for credit losses was needed for its term securities purchased under agreements to resell at September 30, 2014 and December 31, 2013.

Off-Balance Sheet Credit Exposures

At September 30, 2014 and December 31, 2013, the Bank did not record a liability to reflect an allowance for credit losses for off-balance sheet credit exposures. For additional information on the Bank's off-balance sheet credit exposures, see "Note 14 — Commitments and Contingencies."

Note 10 — Derivatives and Hedging Activities

Nature of Business Activity

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

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

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

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

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

•
mitigate the adverse earnings effects of the shortening or extension of certain assets and liabilities; and

•
manage embedded options in assets and liabilities.


24

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

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

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

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

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

Types of Derivatives

The Bank may use the following derivative instruments:

•
interest rate swaps;

•
options;

•
swaptions;

•
interest rate caps and floors; and

•
future/forward contracts.

Types of Hedged Items

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

The Bank may have the following types of hedged items:

•
investment securities;

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


25

Financial Statement Effect and Additional Financial Information

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

The following table summarizes the Bank's fair value of derivative instruments, including the effect of netting adjustments and cash collateral. For purposes of this disclosure, the derivative values include the fair value of derivatives and the related accrued interest (dollars in thousands):
 
 
September 30, 2014
 
December 31, 2013
 
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
35,709,625

 
$
98,856

 
$
361,673

 
$
32,537,432

 
$
181,724

 
$
391,597

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
1,009,600

 
27,588

 
39,751

 
1,757,673

 
72,439

 
25,102

Forward settlement agreements (TBAs)
 
87,000

 
25

 
126

 
28,000

 
160

 
3

Mortgage delivery commitments
 
90,540

 
164

 
35

 
29,651

 
6

 
124

Total derivatives not designated as hedging instruments
 
1,187,140

 
27,777

 
39,912

 
1,815,324

 
72,605

 
25,229

Total derivatives before netting and collateral adjustments
 
$
36,896,765

 
126,633

 
401,585

 
$
34,352,756

 
254,329

 
416,826

Netting adjustments
 
 
 
(21,877
)
 
(21,877
)
 
 
 
(82,293
)
 
(82,293
)
Cash collateral and related accrued interest
 
 
 
(9,601
)
 
(327,279
)
 
 
 
(79,025
)
 
(277,113
)
Total netting adjustments and cash collateral1
 
 
 
(31,478
)
 
(349,156
)
 
 
 
(161,318
)
 
(359,406
)
Total derivative assets and total derivative liabilities
 
 
 
$
95,155

 
$
52,429

 
 
 
$
93,011

 
$
57,420


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

The following table summarizes the components of “Net (losses) gains on derivatives and hedging activities” as presented in the Statements of Income (dollars in thousands):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
Interest rate swaps
$
(12,114
)
 
$
1,960

 
$
(30,819
)
 
$
8,304

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
Interest rate swaps
892

 
5,083

 
(32,978
)
 
71,177

Interest rate caps
—

 
—

 
—

 
3,992

Forward settlement agreements (TBAs)
(138
)
 
(496
)
 
(3,058
)
 
4,831

Mortgage delivery commitments
133

 
715

 
2,878

 
(4,464
)
Net interest settlements
(5,606
)
 
(4,898
)
 
(14,816
)
 
(11,497
)
Total net (losses) gains related to derivatives not designated as hedging instruments
(4,719
)
 
404

 
(47,974
)
 
64,039

Net (losses) gains on derivatives and hedging activities
$
(16,833
)
 
$
2,364

 
$
(78,793
)
 
$
72,343



26

The following tables summarize, by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair value hedging relationships and the effect of those derivatives on the Bank's net interest income (dollars in thousands):
 
 
For the Three Months Ended September 30, 2014
Hedged Item Type
 
Gains (Losses) on
Derivatives
 
(Losses) Gains on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
7,361

 
$
(22,040
)
 
$
(14,679
)
 
$
(30,235
)
Advances
 
66,115

 
(65,635
)
 
480

 
(40,989
)
Consolidated obligation bonds
 
(21,753
)
 
23,838

 
2,085

 
18,735

Total
 
$
51,723

 
$
(63,837
)
 
$
(12,114
)
 
$
(52,489
)
 
 
For the Three Months Ended September 30, 2013
Hedged Item Type
 
(Losses) Gains on
Derivatives
 
Gains (Losses) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
(7,548
)
 
$
7,933

 
$
385

 
$
(12,429
)
Advances
 
(2,769
)
 
3,289

 
520

 
(39,562
)
Consolidated obligation bonds
 
7,569

 
(6,514
)
 
1,055

 
14,425

Total
 
$
(2,748
)
 
$
4,708

 
$
1,960

 
$
(37,566
)
 
 
For the Nine Months Ended September 30, 2014
Hedged Item Type
 
(Losses) Gains on
Derivatives
 
Gains (Losses) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
(182,908
)
 
$
147,763

 
$
(35,145
)
 
$
(83,608
)
Advances
 
67,342

 
(66,015
)
 
1,327

 
(121,861
)
Consolidated obligation bonds
 
26,414

 
(23,415
)
 
2,999

 
45,659

Total
 
$
(89,152
)
 
$
58,333

 
$
(30,819
)
 
$
(159,810
)
 
 
For the Nine Months Ended September 30, 2013
Hedged Item Type
 
Gains (Losses) on
Derivatives
 
(Losses) Gains on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
90,662

 
$
(86,254
)
 
$
4,408

 
$
(23,911
)
Advances
 
181,256

 
(179,019
)
 
2,237

 
(122,235
)
Consolidated obligation bonds
 
(131,558
)
 
133,217

 
1,659

 
48,009

Total
 
$
140,360

 
$
(132,056
)
 
$
8,304

 
$
(98,137
)
1    The net interest income on derivatives in fair value hedge relationships is included in the interest income or interest expense line item of the respective hedged item type.
 

Managing Credit Risk on Derivatives

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

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


27

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

A majority of the Bank's bilateral derivative contracts contain provisions that require the Bank to post additional collateral with its counterparties if there is deterioration in the Bank's credit rating. If the Bank's credit rating is lowered by an NRSRO, the Bank may be required to deliver additional collateral on bilateral derivative instruments in net liability positions. The aggregate fair value of all bilateral derivative instruments with credit-risk related contingent features that were in a net liability position (before cash collateral and related accrued interest) at September 30, 2014 was $219.2 million, for which the Bank posted collateral of $168.6 million in the normal course of business. If the Bank's credit rating had been lowered from its current rating to the next lower rating that would have triggered additional collateral to be delivered, the Bank would have been required to deliver an additional $35.1 million of collateral to its bilateral derivative counterparties at September 30, 2014.

For cleared derivatives, the Clearinghouse determines initial margin requirements and generally credit ratings are not
factored into the initial margin. However, clearing agents may require additional initial margin to be posted based on credit
considerations, including but not limited to, credit rating downgrades. The Bank was not required to post additional
initial margin by its clearing agents at September 30, 2014.

Offsetting of Derivative Assets and Derivative Liabilities

The Bank presents derivative instruments, related cash collateral, including initial and variation margin, received or pledged, and associated accrued interest on a net basis by clearing agent and/or by counterparty when it has met the netting requirements. The following table presents the fair value of derivative instruments meeting or not meeting the netting requirements, including the related collateral received from or pledged to counterparties (dollars in thousands):
 
September 30, 2014
 
December 31, 2013
 
Derivative Assets
 
Derivative Liabilities
 
Derivative Assets
 
Derivative Liabilities
Derivative instruments meeting netting requirements
 
 
 
 
 
 
 
Gross recognized amount
 
 
 
 
 
 
 
Bilateral derivatives
$
111,811

 
$
314,788

 
$
209,378

 
$
411,289

Cleared derivatives
14,658

 
86,762

 
44,945

 
5,413

Total gross recognized amount
126,469

 
401,550

 
254,323

 
416,702

Gross amounts of netting adjustments and cash collateral
 
 
 
 
 
 
 
Bilateral derivatives
(103,382
)
 
(262,394
)
 
(195,177
)
 
(353,993
)
Cleared derivatives
71,904

 
(86,762
)
 
33,859

 
(5,413
)
Total gross amounts of netting adjustments and cash collateral
(31,478
)
 
(349,156
)
 
(161,318
)
 
(359,406
)
Net amounts after netting adjustments and cash collateral
 
 
 
 
 
 
 
Bilateral derivatives
8,429

 
52,394

 
14,201

 
57,296

Cleared derivatives
86,562

 
—

 
78,804

 
—

Total net amounts after netting adjustments and cash collateral
94,991

 
52,394

 
93,005

 
57,296

Bilateral derivatives instruments not meeting netting requirements1
164

 
35

 
6

 
124

Total derivative assets and derivative liabilities
 
 
 
 
 
 
 
Bilateral derivatives
8,593

 
52,429

 
14,207

 
57,420

Cleared derivatives
86,562

 
—

 
78,804

 
—

Total derivative assets and total derivative liabilities
$
95,155

 
$
52,429

 
$
93,011

 
$
57,420


1
Represents mortgage delivery commitments that are not subject to an enforceable netting agreement.



28

Note 11 — Consolidated Obligations

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

Although the Bank is primarily liable for the portion of consolidated obligations issued on its behalf, it is also jointly and severally liable with the other FHLBanks for the payment of principal and interest on all FHLBank System consolidated obligations. The Finance Agency, at its discretion, may require any FHLBank to make principal and/or interest payments due on any consolidated obligation, whether or not the primary obligor FHLBank has defaulted on the payment of that consolidated obligation. The Finance Agency has never exercised this discretionary authority. At September 30, 2014 and December 31, 2013, the total par value of outstanding consolidated obligations of the 12 FHLBanks was $816.9 billion and $766.8 billion.

DISCOUNT NOTES

The following table summarizes the Bank's discount notes (dollars in thousands):
 
September 30, 2014
 
December 31, 2013
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Par value
$
62,810,000

 
0.07
 
$
38,143,400

 
0.10
Discounts
(7,242
)
 
 
 
(6,748
)
 
 
Total
$
62,802,758

 
 
 
$
38,136,652

 
 

BONDS

The following table summarizes the Bank's bonds outstanding by year of contractual maturity (dollars in thousands):
 
 
September 30, 2014
 
December 31, 2013
Year of Contractual Maturity
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Due in one year or less
 
$
10,180,240

 
0.47
 
$
17,437,015

 
0.33
Due after one year through two years
 
8,704,150

 
1.34
 
2,485,075

 
3.03
Due after two years through three years
 
2,822,505

 
2.87
 
1,864,840

 
3.48
Due after three years through four years
 
1,181,010

 
2.87
 
2,080,710

 
4.21
Due after four years through five years
 
1,928,030

 
2.02
 
582,735

 
1.60
Thereafter
 
5,403,740

 
2.98
 
5,545,470

 
2.96
Index amortizing notes
 
175,710

 
5.21
 
209,600

 
5.21
Total par value
 
30,395,385

 
1.61
 
30,205,445

 
1.56
Premiums
 
20,186

 
 
 
22,027

 
 
Discounts
 
(19,011
)
 
 
 
(17,751
)
 
 
Fair value hedging adjustments
 
(9,258
)
 
 
 
(14,186
)
 
 
Fair value option adjustments
 
—

 
 
 
33

 
 
Total
 
$
30,387,302

 
 
 
$
30,195,568

 
 

The following table summarizes the Bank's bonds outstanding by call features (dollars in thousands):
 
September 30,
2014
 
December 31,
2013
Noncallable or nonputable
$
18,650,385

 
$
26,765,445

Callable
11,745,000

 
3,440,000

Total par value
$
30,395,385

 
$
30,205,445

 
 

29

Extinguishment of Debt

During the three and nine months ended September 30, 2014, the Bank extinguished bonds with a total par value of $91.3 million and $115.0 million and recognized losses of $10.0 million and $12.7 million in other (loss) income. The Bank did not extinguish any debt during the three months ended September 30, 2013; however, during the nine months ended September 30, 2013, the Bank extinguished bonds with a total par value of $162.1 million and recognized losses of $25.7 million.

Note 12 — Capital

The Bank is subject to three regulatory capital requirements:

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

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

•
Leverage capital. The Bank is required to maintain a minimum five percent leverage ratio, which is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 times, divided by total assets. At September 30, 2014 and December 31, 2013, the Bank did not have any nonpermanent capital.

If the Bank's capital falls below the required levels, the Finance Agency has authority to take actions necessary to return it to levels that it deems to be consistent with safe and sound business operations. The following table shows the Bank's compliance with the Finance Agency's regulatory capital requirements (dollars in thousands):
 
September 30, 2014
 
December 31, 2013
 
Required
 
Actual
 
Required
 
Actual
Regulatory capital requirements
 
 
 
 
 
 
 
Risk-based capital
$
593,994

 
$
4,176,335

 
$
676,384

 
$
3,378,542

Regulatory capital
$
3,935,949

 
$
4,176,335

 
$
2,920,161

 
$
3,378,542

Leverage capital
$
4,919,936

 
$
6,264,503

 
$
3,650,201

 
$
5,067,814

Capital-to-assets ratio
4.00
%
 
4.24
%
 
4.00
%
 
4.63
%
Leverage ratio
5.00
%
 
6.37
%
 
5.00
%
 
6.94
%

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

Excess Stock

Capital stock owned by members in excess of their investment requirement is deemed excess capital stock. Under its Capital Plan, the Bank, at its discretion and upon 15 days' written notice, may repurchase excess membership capital stock. The Bank, at its discretion, may also repurchase excess activity-based capital stock to the extent that (i) the excess capital stock balance exceeds an operational threshold set forth in the Capital Plan, which is currently set at zero, or (ii) a member submits a notice to redeem all or a portion of the excess activity-based capital stock. At September 30, 2014, the Bank had excess capital stock of $0.1 million. At December 31, 2013, the Bank had no excess capital stock outstanding.


30

Mandatorily Redeemable Capital Stock

The Bank reclassifies capital stock subject to redemption from equity to a liability (mandatorily redeemable capital stock) when a member engages in any of the following activities: (i) submits a written notice to redeem all or part of its capital stock, (ii) submits a written notice of its intent to withdraw from membership, or (iii) terminates its membership voluntarily as a result of a consolidation into a non-member or into a member of another FHLBank. Dividends on mandatorily redeemable capital stock are classified as interest expense in the Statements of Income. At September 30, 2014 and December 31, 2013, the Bank's mandatorily redeemable capital stock totaled $8.4 million and $8.7 million.

Restricted Retained Earnings
 
 
The Bank entered into a Joint Capital Enhancement Agreement (JCE Agreement) with all of the other FHLBanks in February 2011. The JCE Agreement, as amended, is intended to enhance the capital position of the Bank over time. It requires the Bank to allocate 20 percent of its quarterly net income to a separate restricted retained earnings account until the balance of that account equals at least one percent of its average balance of outstanding consolidated obligations for the previous quarter. The restricted retained earnings are not available to pay dividends. At September 30, 2014 and December 31, 2013, the Bank's restricted retained earnings account totaled $68.9 million and $50.8 million.

Accumulated Other Comprehensive Income

The following table summarizes changes in AOCI for the three months ended September 30, 2014 and 2013 (dollars in thousands):
 
Net unrealized gains on AFS securities (Note 4)
 
Pension and postretirement benefits
 
Total AOCI
Balance, June 30, 2013
$
88,878

 
$
(2,696
)
 
$
86,182

Other comprehensive (loss) income before reclassifications
 
 
 
 
 
Net unrealized losses
(13,809
)
 
—

 
(13,809
)
Reclassifications from other comprehensive (loss) income to net income
 
 
 
 
 
Other-than-temporary impairment losses on securities
1,293

 
—

 
1,293

Net realized gains on sale of securities
(1,094
)
 
—

 
(1,094
)
Amortization - pension and postretirement
—

 
141

 
141

Net current period other comprehensive (loss) income
(13,610
)
 
141

 
(13,469
)
Balance, September 30, 2013
$
75,268

 
$
(2,555
)
 
$
72,713

 
 
 
 
 
 
Balance, June 30, 2014
$
135,232

 
$
(1,266
)
 
$
133,966

Other comprehensive income before reclassifications
 
 
 
 
 
Net unrealized gains
17,531

 
—

 
17,531

Reclassifications from other comprehensive income to net income
 
 
 
 
 
Amortization - pension and postretirement
—

 
98

 
98

Net current period other comprehensive income
17,531

 
98

 
17,629

Balance, September 30, 2014
$
152,763

 
$
(1,168
)
 
$
151,595



31

The following table summarizes changes in AOCI for the nine months ended September 30, 2014 and 2013 (dollars in thousands):
 
Net unrealized gains on AFS securities (Note 4)
 
Pension and postretirement benefits
 
Total AOCI
Balance, December 31, 2012
$
152,781

 
$
(3,143
)
 
$
149,638

Other comprehensive (loss) income before reclassifications
 
 
 
 
 
Net unrealized losses
(75,767
)
 
—

 
(75,767
)
Reclassifications from other comprehensive (loss) income to net income
 
 
 
 
 
Other-than-temporary impairment losses on securities
1,293

 
—

 
1,293

Net realized gains on sale of securities
(3,039
)
 
—

 
(3,039
)
Amortization - pension and postretirement
—

 
588

 
588

Net current period other comprehensive (loss) income
(77,513
)
 
588

 
(76,925
)
Balance, September 30, 2013
$
75,268

 
$
(2,555
)
 
$
72,713

 
 
 
 
 
 
Balance, December 31, 2013
$
88,399

 
$
(1,355
)
 
$
87,044

Other comprehensive income (loss) before reclassifications
 
 
 
 
 
Net unrealized gains
65,190

 
—

 
65,190

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

 
(826
)
Amortization - pension and postretirement
—

 
187

 
187

Net current period other comprehensive income
64,364

 
187

 
64,551

Balance, September 30, 2014
$
152,763

 
$
(1,168
)
 
$
151,595


Note 13 — Fair Value

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

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

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

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

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

The Bank reviews its fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation inputs may result in a reclassification of certain assets or liabilities. These reclassifications are reported as transfers in/out as of the beginning of the quarter in which the changes occur. There were no such transfers during the nine months ended September 30, 2014 and 2013.


32

The following table summarizes the carrying value, fair value, and fair value hierarchy of the Bank's financial instruments at September 30, 2014 (dollars in thousands). The fair values do not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of assets and liabilities.
 
 
 
 
Fair Value
Financial Instruments
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 

Cash and due from banks
 
$
9,477,515

 
$
9,477,515

 
$
—

 
$
—

 
$
—

 
$
9,477,515

Interest-bearing deposits
 
1,772

 
—

 
1,750

 
—

 
—

 
1,750

Securities purchased under agreements to resell
 
2,060,000

 
—

 
2,060,000

 
—

 
—

 
2,060,000

Federal funds sold
 
2,635,000

 
—

 
2,635,000

 
—

 
—

 
2,635,000

Trading securities
 
1,046,748

 
—

 
1,046,748

 
—

 
—

 
1,046,748

Available-for-sale securities
 
10,878,835

 
—

 
10,878,835

 
—

 
—

 
10,878,835

Held-to-maturity securities
 
1,325,741

 
—

 
1,379,135

 
25,699

 
—

 
1,404,834

Advances
 
64,220,363

 
—

 
64,369,400

 
—

 
—

 
64,369,400

Mortgage loans held for portfolio, net
 
6,523,865

 
—

 
6,731,884

 
62,618

 
—

 
6,794,502

Accrued interest receivable
 
85,960

 
—

 
85,960

 
—

 
—

 
85,960

Derivative assets, net
 
95,155

 
25

 
126,608

 
—

 
(31,478
)
 
95,155

Other assets
 
11,522

 
11,522

 
—

 
—

 
—

 
11,522

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
(471,326
)
 
—

 
(471,322
)
 
—

 
—

 
(471,322
)
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
 
Discount notes
 
(62,802,758
)
 
—

 
(62,804,514
)
 
—

 
—

 
(62,804,514
)
Bonds
 
(30,387,302
)
 
—

 
(30,991,406
)
 
—

 
—

 
(30,991,406
)
Total consolidated obligations
 
(93,190,060
)
 
—

 
(93,795,920
)
 
—

 
—

 
(93,795,920
)
Mandatorily redeemable capital stock
 
(8,400
)
 
(8,400
)
 
—

 
—

 
—

 
(8,400
)
Accrued interest payable
 
(102,201
)
 
—

 
(102,201
)
 
—

 
—

 
(102,201
)
Derivative liabilities, net
 
(52,429
)
 
(126
)
 
(401,459
)
 
—

 
349,156

 
(52,429
)
Other
 
 
 
 
 
 
 
 
 
 
 
 
Commitments to fund advances
 
—

 
—

 
(51
)
 
—

 
—

 
(51
)
Standby letters of credit
 
(2,173
)
 
—

 
—

 
(2,173
)
 
—

 
(2,173
)
Standby bond purchase agreements
 
—

 
—

 
2,218

 
—

 
—

 
2,218


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


33

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

 
$
448,278

 
$
—

 
$
—

 
$
—

 
$
448,278

Interest-bearing deposits
 
1,863

 
—

 
1,833

 
—

 
—

 
1,833

Securities purchased under agreements to resell
 
8,200,000

 
—

 
8,200,000

 
—

 
—

 
8,200,000

Federal funds sold
 
1,200,000

 
—

 
1,200,000

 
—

 
—

 
1,200,000

Trading securities
 
1,018,373

 
—

 
1,018,373

 
—

 
—

 
1,018,373

Available-for-sale securities
 
7,932,520

 
—

 
7,932,520

 
—

 
—

 
7,932,520

Held-to-maturity securities
 
1,788,306

 
—

 
1,813,234

 
29,365

 
—

 
1,842,599

Advances
 
45,650,220

 
—

 
45,751,949

 
—

 
—

 
45,751,949

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

 
—

 
6,683,555

 
37,340

 
—

 
6,720,895

Accrued interest receivable
 
72,561

 
—

 
72,561

 
—

 
—

 
72,561

Derivative assets, net
 
93,011

 
160

 
254,169

 
—

 
(161,318
)
 
93,011

Other assets
 
10,529

 
10,529

 
—

 
—

 
—

 
10,529

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
(699,066
)
 
—

 
(699,066
)
 
—

 
—

 
(699,066
)
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
 
Discount notes
 
(38,136,652
)
 
—

 
(38,139,485
)
 
—

 
—

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

 
(30,735,638
)
 
—

 
—

 
(30,735,638
)
Total consolidated obligations
 
(68,332,220
)
 
—

 
(68,875,123
)
 
—

 
—

 
(68,875,123
)
Mandatorily redeemable capital stock
 
(8,719
)
 
(8,719
)
 
—

 
—

 
—

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

 
(81,420
)
 
—

 
—

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

 
359,406

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

 
—

 
(1,849
)
 
—

 
(1,849
)
Standby bond purchase agreements
 
—

 
—

 
3,860

 
—

 
—

 
3,860


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

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

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

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

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


34

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

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

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

As of September 30, 2014 and December 31, 2013, three or four prices were received for substantially all of the Bank's investment securities and the final prices for substantially all of those securities were computed by averaging the prices received. Based on the Bank's review of the pricing methods and controls employed by the third-party pricing vendors and the relative lack of dispersion among the vendor prices, the Bank believes its final prices are representative of the prices that would have been received if the assets had been sold at the measurement date (i.e., exit prices) and further, that the fair value measurements are classified appropriately in the fair value hierarchy.

As an additional step, the Bank reviews the final fair value estimates of its private-label MBS holdings quarterly for reasonableness using an implied yield test. The Bank calculated an implied yield for each of its private-label MBS using the estimated fair value derived from the process previously described and the security's projected cash flows from the Bank's OTTI process. These yields were compared to the market yield of comparable securities according to dealers and/or other third-party sources. This analysis did not indicate any significant variances. Therefore, the Bank determined that its fair value estimates for private-label MBS were appropriate at September 30, 2014.

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

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

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

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

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


35

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

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

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

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

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

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

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

•
Discount rate assumption. The Bank utilizes the Overnight-Index Swap (OIS) curve. 

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

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

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


36

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

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

Mandatorily Redeemable Capital Stock. The fair value of capital stock subject to mandatory redemption is generally reported at par value. Fair value also includes an estimated dividend earned at the time of reclassification from equity to a liability (if applicable), until such amount is paid. Capital stock can only be acquired by members at par value and redeemed at par value. Capital stock is not publicly traded and no market mechanism exists for the exchange of stock outside the cooperative structure.
 
Commitments to Fund Advances. The fair value of advance commitments is based on the present value of fees currently charged for similar agreements, taking into account the remaining terms of the agreement and the difference between current levels of interest rates and the committed rates.

Standby Letters of Credit. The fair value of standby letters of credit is based on either the fees currently charged for similar agreements or the estimated cost to terminate the agreement or otherwise settle the obligation with the counterparty.

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

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


37

Fair Value on a Recurring Basis

The following table summarizes, for each hierarchy level, the Bank's assets and liabilities that are measured at fair value in the Statements of Condition at September 30, 2014 (dollars in thousands):
Recurring Fair Value Measurements
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
 
$
—

 
$
259,097

 
$
—

 
$
—

 
$
259,097

GSE obligations
 
—

 
59,652

 
—

 
—

 
59,652

Other non-MBS
 
—

 
275,248

 
—

 
—

 
275,248

GSE MBS residential
 
—

 
452,751

 
—

 
—

 
452,751

Total trading securities
 
—

 
1,046,748

 
—

 
—

 
1,046,748

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

 
168,040

 
—

 
—

 
168,040

GSE obligations
 
—

 
1,055,021

 
—

 
—

 
1,055,021

State or local housing agency obligations
 
—

 
24,718

 
—

 
—

 
24,718

Other non-MBS
 
—

 
179,465

 
—

 
—

 
179,465

Other U.S. obligations MBS residential
 
—

 
1,374,038

 
—

 
—

 
1,374,038

GSE MBS residential
 
—

 
8,077,553

 
—

 
—

 
8,077,553

Total available-for-sale securities
 
—

 
10,878,835

 
—

 
—

 
10,878,835

Derivative assets, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 
—

 
126,444

 
—

 
(31,453
)
 
94,991

Forward settlement agreements (TBAs)
 
25

 
—

 
—

 
(25
)
 
—

Mortgage delivery commitments
 
—

 
164

 
—

 
—

 
164

Total derivative assets, net
 
25

 
126,608

 
—

 
(31,478
)
 
95,155

Other assets
 
11,522

 
—

 
—

 
—

 
11,522

Total recurring assets at fair value
 
$
11,547

 
$
12,052,191

 
$
—

 
$
(31,478
)
 
$
12,032,260

Liabilities
 
 
 
 
 
 
 
 
 
 
Derivative liabilities, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 
$
—

 
$
(401,424
)
 
$
—

 
$
349,131

 
$
(52,293
)
Forward settlement agreements (TBAs)
 
(126
)
 
—

 
—

 
25

 
(101
)
Mortgage delivery commitments
 
—

 
(35
)
 
—

 
—

 
(35
)
Total derivative liabilities, net
 
(126
)
 
(401,459
)
 
—

 
349,156

 
(52,429
)
Total recurring liabilities at fair value
 
$
(126
)
 
$
(401,459
)
 
$
—

 
$
349,156

 
$
(52,429
)

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



38

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

 
$
266,898

 
$
—

 
$
—

 
$
266,898

GSE obligations
 
—

 
54,971

 
—

 
—

 
54,971

Other non-MBS
 
—

 
263,354

 
—

 
—

 
263,354

GSE MBS residential
 
—

 
433,150

 
—

 
—

 
433,150

Total trading securities
 
—

 
1,018,373

 
—

 
—

 
1,018,373

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

 
181,548

 
—

 
—

 
181,548

GSE obligations
 
—

 
1,126,875

 
—

 
—

 
1,126,875

State or local housing agency obligations
 
—

 
22,971

 
—

 
—

 
22,971

Other non-MBS
 
—

 
263,574

 
—

 
—

 
263,574

GSE MBS residential
 
—

 
6,337,552

 
—

 
—

 
6,337,552

Total available-for-sale securities
 
—

 
7,932,520

 
—

 
—

 
7,932,520

Derivative assets, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 
—

 
254,163

 
—

 
(161,315
)
 
92,848

Forward settlement agreements (TBAs)
 
160

 
—

 
—

 
(3
)
 
157

Mortgage delivery commitments
 
—

 
6

 
—

 
—

 
6

Total derivative assets, net
 
160

 
254,169

 
—

 
(161,318
)
 
93,011

Other assets
 
10,529

 
—

 
—

 
—

 
10,529

Total recurring assets at fair value
 
$
10,689

 
$
9,205,062

 
$
—

 
$
(161,318
)
 
$
9,054,433

Liabilities
 
 
 
 
 
 
 
 
 
 
Bonds2
 
$
—

 
$
(50,033
)
 
$
—

 
$
—

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

 
(416,699
)
 
—

 
359,403

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

 
—

 
3

 
—

Mortgage delivery commitments
 
—

 
(124
)
 
—

 
—

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

 
359,406

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

 
$
359,406

 
$
(107,453
)

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

2
Represents bonds recorded under the fair value option.

Fair Value on a Non-Recurring Basis

The Bank measures certain impaired mortgage loans held for portfolio and REO at level 3 fair value on a non-recurring basis. These assets are subject to fair value adjustments in certain circumstances. In the case of impaired mortgage loans, the Bank estimates fair value based primarily on property values from an external pricing vendor. These values are further adjusted by the Bank to capture certain limitations in the estimation process and take into consideration estimated selling costs and expected PMI proceeds. In the case of REO, the Bank estimates fair value based on a current property value from the MPF Servicer or a broker price opinion adjusted for estimated selling costs and expected PMI proceeds. The following table summarizes impaired mortgage loans held for portfolio and REO that were recorded at fair value as a result of a non-recurring change in fair value having been recorded in the quarter then ended (dollars in thousands):
 
September 30,
2014
 
December 31,
2013
Impaired mortgage loans held for portfolio
$
16,743

 
$
37,340

Real estate owned
474

 
571

Total non-recurring assets
$
17,217

 
$
37,911



39

Fair Value Option

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

The Bank elected the fair value option for certain bonds that did not qualify for hedge accounting, primarily in an effort to mitigate the potential income statement volatility that can arise from economic hedging relationships in which the carrying value of the hedged item is not adjusted for changes in fair value. The following table summarizes the activity related to consolidated obligations for which the fair value option has been elected (dollars in thousands):
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 30,
 
September 30,
Bonds
 
2014
 
2013
 
2014
 
2013
Balance, beginning of period
 
$
—

 
$
100,122

 
$
50,033

 
$
1,866,985

Maturities and terminations
 
—

 
(50,000
)
 
(50,000
)
 
(1,815,000
)
Net gains on bonds held at fair value
 
—

 
(28
)
 
(2
)
 
(1,001
)
Change in accrued interest
 
—

 
(34
)
 
(31
)
 
(924
)
Balance, end of period
 
$
—

 
$
50,060

 
$
—

 
$
50,060

 
For consolidated obligations recorded under the fair value option, the related contractual interest expense is recorded as part of net interest income in the Statements of Income. The remaining changes are recorded as “Net gains on consolidated obligations held at fair value” in the Statements of Income. At September 30, 2014, all bonds previously elected under the fair value option had matured. At December 31, 2013, the Bank determined no credit risk adjustments for nonperformance were necessary to the consolidated obligations recorded under the fair value option. The following table summarizes the difference between the unpaid principal balance and fair value of outstanding bonds for which the fair value option has been elected (dollars in thousands):
 
September 30,
2014
 
December 31,
2013
Unpaid principal balance
$
—

 
$
50,000

Fair value
—

 
50,033

Fair value over unpaid principal balance
$
—

 
$
33


Note 14 — Commitments and Contingencies

Joint and Several Liability. The 12 FHLBanks have joint and several liability for all consolidated obligations issued. Accordingly, if an FHLBank were unable to repay any consolidated obligation for which it is the primary obligor, each of the other FHLBanks could be called upon by the Finance Agency to repay all or part of such obligations. No FHLBank has ever been asked or required to repay the principal or interest on any consolidated obligation on behalf of another FHLBank. At September 30, 2014 and December 31, 2013, the total par value of outstanding consolidated obligations issued on behalf of other FHLBanks for which the Bank is jointly and severally liable was approximately $723.7 billion and $698.5 billion.

The following table summarizes additional off-balance sheet commitments for the Bank (dollars in thousands):
 
September 30, 2014
 
December 31, 2013
 
Expire
within one year
 
Expire
after one year
 
Total
 
Total
Standby letters of credit
$
3,852,074

 
$
61,266

 
$
3,913,340

 
$
4,303,732

Standby bond purchase agreements
172,576

 
386,043

 
558,619

 
619,338

Commitments to purchase mortgage loans
90,540

 
—

 
90,540

 
29,651

Commitments to issue bonds
110,000

 
—

 
110,000

 
29,289

Commitments to issue discount notes
2,000,000

 
—

 
2,000,000

 
399,831

Commitments to fund advances
—

 
14,000

 
14,000

 
—

Other commitments
98,475

 
—

 
98,475

 
100,000


40

Standby Letters of Credit. A standby letter of credit is a financing arrangement between the Bank and a member. Standby letters of credit are executed with members for a fee. If the Bank is required to make payment for a beneficiary's draw, the payment is withdrawn from the member's demand account. Any resulting overdraft is converted into a collateralized advance to the member. The original terms of standby letters of credit range from less than one month to 13 years, currently no later than 2020. Unearned fees for standby letters of credit are recorded in “Other liabilities” in the Statements of Condition and amounted to $2.2 million and $1.8 million at September 30, 2014 and December 31, 2013.

The Bank monitors the creditworthiness of its standby letters of credit based on an evaluation of its borrowers. The Bank has established parameters for the measurement, review, classification, and monitoring of credit risk related to these standby letters of credit. Based on management's credit analyses and collateral requirements, the Bank does not deem it necessary to have any provision for credit losses on these standby letters of credit. All standby letters of credit are fully collateralized at the time of issuance. The estimated fair value of standby letters of credit at September 30, 2014 and December 31, 2013 is reported in “Note 13 — Fair Value.”

Standby Bond Purchase Agreements. The Bank has entered into standby bond purchase agreements with state housing associates within its district whereby, for a fee, it agrees to serve as a standby liquidity provider if required, to purchase and hold the housing associate's bonds until the designated marketing agent can find a suitable investor or the housing associate repurchases the bonds according to a schedule established by the agreement. Each standby bond purchase agreement includes the provisions under which the Bank would be required to purchase the bonds. The standby bond purchase commitments entered into by the Bank have original expiration periods of up to seven years, currently no later than 2017. At September 30, 2014 and December 31, 2013, the Bank had standby bond purchase agreements with four housing associates. During the nine months ended September 30, 2014 and 2013, the Bank was not required to purchase any bonds under these agreements. For the three and nine months ended September 30, 2014, the Bank received fees for the guarantees that amounted to $0.4 million and $1.3 million. For the three and nine months ended September 30, 2013, the Bank received fees for the guarantees that amounted to $0.5 million and $1.5 million. The estimated fair value of standby bond purchase agreements at September 30, 2014 and December 31, 2013 is reported in “Note 13 — Fair Value.”

Commitments to Purchase Mortgage Loans. The Bank enters into commitments that unconditionally obligate it to purchase mortgage loans from its members. Commitments are generally for periods not to exceed 45 days. These commitments are considered derivatives and their estimated fair value at September 30, 2014 and December 31, 2013 is reported in “Note 10 — Derivatives and Hedging Activities” as mortgage delivery commitments.

Commitments to Issue Bonds and Discount Notes. At September 30, 2014, the Bank had commitments to issue $110.0 million of consolidated obligation bonds and $2.0 billion of consolidated obligation discount notes. At December 31, 2013, the Bank had commitments to issue $29.3 million of consolidated obligation bonds and $399.8 million of consolidated obligation discount notes.

Commitments to Fund Advances. The Bank enters into commitments that legally bind it to fund additional advances up to 24 months in the future. At September 30, 2014, the Bank had commitments to fund advances of $14.0 million. At December 31, 2013, the Bank did not have any commitments to fund advances.
 
Other Commitments. On December 30, 2013, the Bank entered into an agreement with the Iowa Finance Authority (IFA) to purchase up to $100.0 million of taxable multi-family mortgage revenue bonds. The agreement expires on June 30, 2015. As of September 30, 2014, the Bank had purchased $1.5 million of bonds under the IFA agreement. These bonds are classified as AFS in the Bank's Statements of Condition.

In conjunction with its sale of certain mortgage loans to Fannie Mae through the FHLBank of Chicago in 2009, the Bank entered into an agreement with the FHLBank of Chicago on June 11, 2009 to indemnify the FHLBank of Chicago for potential losses on mortgage loans remaining in four master commitments from which the mortgage loans were sold. The Bank agreed to indemnify the FHLBank of Chicago for any losses not otherwise recovered through credit enhancement fees, subject to an indemnification cap of $0.8 million by December 31, 2015 and $0.3 million by December 31, 2020. At September 30, 2014, the FHLBank of Chicago had not requested any indemnification payments from the Bank pursuant to this agreement.
Legal Proceedings. The Bank is not currently aware of any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which it is a party or of which any of its property is the subject.


41

Note 15 — Transactions with Stockholders

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

Transactions with Directors' Financial Institutions

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

The following table summarizes the Bank's outstanding transactions with Directors' Financial Institutions (dollars in thousands):
 
 
September 30, 2014
 
December 31, 2013
 
 
Amount
 
% of Total
 
Amount
 
% of Total
Advances
 
$
743,241

 
1.2
 
$
614,566

 
1.4
Mortgage loans
 
201,618

 
3.1
 
94,163

 
1.5
Deposits
 
4,728

 
1.0
 
2,550

 
0.4
Capital stock
 
51,635

 
1.5
 
40,982

 
1.5

Business Concentrations

The Bank considers itself to have business concentrations with stockholders owning 10 percent or more of its total capital stock outstanding (including mandatorily redeemable capital stock). At September 30, 2014, the Bank had the following business concentrations with stockholders (dollars in thousands):
 
 
Capital Stock
 
 
 
Mortgage
 
Interest
Stockholder
 
Amount
 
% of Total
 
Advances
 
Loans
 
Income1
Wells Fargo Bank, N.A.
 
$
1,370,000

 
39.5
 
$
34,000,000

 
$
—

 
$
41,394

Superior Guaranty Insurance Company2
 
50,767

 
1.5
 
—

 
1,246,507

 
—

Total
 
$
1,420,767

 
41.0
 
$
34,000,000

 
$
1,246,507

 
$
41,394


1
Represents interest income earned on advances during the nine months ended September 30, 2014.

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

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

 
28.5
 
$
19,000,000

 
$
—

 
$
14,470

Superior Guaranty Insurance Company2
 
60,130

 
2.2
 
—

 
1,477,856

 
—

Total
 
$
830,130

 
30.7
 
$
19,000,000

 
$
1,477,856

 
$
14,470


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

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

42

Note 16 — Transactions with Other FHLBanks

MPF Mortgage Loans. The Bank pays a service fee to the FHLBank of Chicago for its participation in the MPF program. This service fee expense is recorded in other expense. For the three months ended September 30, 2014 and 2013, the Bank recorded $0.7 million and $0.6 million in service fee expense to the FHLBank of Chicago. For the nine months ended September 30, 2014 and 2013, the Bank recorded $2.0 million and $1.9 million in service fee expense to the FHLBank of Chicago.

Overnight Funds. The Bank may lend or borrow unsecured overnight funds to or from other FHLBanks. All such transactions are at current market rates. The following table summarizes loan activity to other FHLBanks during the nine months ended September 30, 2014 and 2013 (dollars in thousands):
Other FHLBank
 
Beginning
Balance
 
Advance
 
Principal
Repayment
 
Ending
Balance
2014
 
 
 
 
 
 
 
 
Chicago
 
$
—

 
$
10,000

 
$
(10,000
)
 
$
—

Topeka
 
—

 
10,000

 
(10,000
)
 
—

 
 
$
—

 
$
20,000

 
$
(20,000
)
 
$
—

 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
Atlanta
 
$
—

 
$
17,000

 
$
(17,000
)
 
$
—


The following table summarizes borrowing activity from other FHLBanks during the nine months ended September 30, 2014 and 2013 (dollars in thousands):
Other FHLBank
 
Beginning
Balance
 
Borrowing
 
Principal
Payment
 
Ending
Balance
2014
 
 
 
 
 
 
 
 
Atlanta
 
$
—

 
$
70,000

 
$
(70,000
)
 
$
—

Chicago
 
—

 
150,000

 
(150,000
)
 
—

San Francisco
 
—

 
150,000

 
(150,000
)
 
—

 
 
$
—

 
$
370,000

 
$
(370,000
)
 
$
—

 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
Chicago
 
$
—

 
$
200,000

 
$
(200,000
)
 
$
—

New York
 
—

 
200,000

 
(200,000
)
 
—

Topeka
 
—

 
70,000

 
(70,000
)
 
—

 
 
$
—

 
$
470,000

 
$
(470,000
)
 
$
—


At September 30, 2014 and 2013, none of these transactions were outstanding on the Bank's Statements of Condition.

Debt Transfers. The Bank may transfer debt from time to time in an effort to better match its projected asset cash flows or reduce its future interest costs. These transfers are accounted for in the same manner as debt extinguishments. In connection with these transactions, the assuming FHLBanks become the primary obligors for the transferred debt. During the nine months ended September 30, 2014, the Bank did not transfer any debt to other FHLBanks. During the nine months ended September 30, 2013, the Bank transferred $80.0 million and $70.0 million of par value bonds to the FHLBanks of San Francisco and Boston and recorded aggregate net losses of $13.9 million and $10.6 million through "Net losses on extinguishment of debt" in the Statements of Income.


43

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

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


44

Forward-Looking Information

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

•
changes in regulatory requirements regarding the eligibility criteria of our membership;

•
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;

•
the proposed merger with the Federal Home Loan Bank of Seattle is subject to certain closing conditions, may take longer than expected, may involve more expenses than anticipated, and may have an adverse effect on the continuing Bank;

•
changes in our capital structure and capital requirements;

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

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

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

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

•
increases in delinquency or loss severity on mortgage loans;

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

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

•
the ability to attract and retain key personnel; and

•
member consolidations and failures.
 
    


45

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

Executive Overview

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

For the three and nine months ended September 30, 2014, we reported net income of $26.6 million and $90.6 million compared to $30.1 million and $73.1 million for the same periods in 2013. Our net income, calculated in accordance with accounting principles generally accepted in the United States of America (GAAP), was primarily driven by net interest income and other (loss) income.

Net interest income totaled $64.0 million and $176.7 million for the three and nine months ended September 30, 2014 compared to $50.7 million and $154.7 million for the same periods last year. The increase was primarily due to a increase in interest income resulting from higher advance and mortgage-backed security (MBS) volumes.

Our net interest margin was 0.28 percent and 0.30 percent during the three and nine months ended September 30, 2014 compared with 0.39 percent and 0.42 percent during the same periods last year. The decline was primarily due to reduced yields on our interest-earning assets driven by the low interest rate environment and higher volumes of advances and short-term investments that generate lower margins when compared to the majority of our other interest-earning assets. The decline was partially offset by lower yields paid on our interest-bearing liabilities. 

We utilize an allowance for credit losses to reserve for estimated losses in our conventional mortgage loan portfolio. During the three and nine months ended September 30, 2014, we recorded reversals for credit losses on our mortgage loans of $1.4 million and $1.7 million due to a reduction in loan delinquencies and improvements in housing market forecasts. During the three and nine months ended September 30, 2013, we did not record a provision or reversal for credit losses on our mortgage loans.

Our other (loss) income totaled $(18.1) million and $(29.3) million for the three and nine months ended September 30, 2014 compared to $(3.4) million and $(30.8) million for the same periods last year. The primary drivers of other (loss) income were losses on derivatives and hedging activities, gains on investment securities, and losses from the extinguishment of debt as described below.

We utilize derivative instruments to manage interest rate risk, including mortgage prepayment risk. Accounting rules require all derivatives to be recorded at fair value and therefore we may be subject to income statement volatility. During the three and nine months ended September 30, 2014, we recorded losses of $16.8 million and $78.8 million on our derivatives and hedging activities through other (loss) income compared to gains of $2.3 million and $72.3 million during the same periods last year. These fair value changes were primarily attributable to the impact of changes in interest rates on fair value hedge relationships and on interest rate swaps that we utilize to economically hedge our trading securities portfolio as discussed below. Refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Hedging Activities" for additional discussion on our derivatives and hedging activities, including the net impact of economic hedge relationships.


46

Trading securities are recorded at fair value with changes in fair value reflected through other (loss) income. During the three and nine months ended September 30, 2014, we recorded gains on trading securities of $0.7 million and $47.2 million compared to losses of $7.8 million and $87.1 million during the same periods in 2013. These changes in fair value were primarily due to the impact of interest rates and credit spreads on our fixed rate trading securities and were partially offset by changes in fair value on derivatives that we utilize to economically hedge these securities, as noted above. In addition, during the three and nine months ended September 30, 2014, we sold held-to-maturity (HTM) and available-for-sale (AFS) securities and realized gains of $6.4 million and $9.7 million. We sold AFS securities during the three and nine months ended September 30, 2013, and realized gains of $1.1 million and $3.0 million.
    
We extinguish higher-costing debt from time to time in an effort to better match our projected asset cash flows and to reduce our future interest costs. During the three and nine months ended September 30, 2014, we extinguished consolidated obligation bonds with a total par value of $91.3 million and $115.0 million and recognized losses of $10.0 million and $12.7 million through other (loss) income. We did not extinguish any debt during the three months ended September 30, 2013. During the nine months ended September 30, 2013, we extinguished consolidated obligation bonds with a total par value of $162.1 million and recognized losses of $25.7 million.

Our total assets increased to $98.4 billion at September 30, 2014 from $73.0 billion at December 31, 2013 due primarily to an increase in advances, short-term liquid assets, and long-term investments. Advances increased $18.6 billion due to borrowings from a wide range of members, primarily driven by advances to large depository institution members. Short-term liquid assets, including cash and money-market investments, increased $4.3 billion at September 30, 2014 due to an increase in liquidity needs from the higher advance volumes. Long-term investments increased $2.5 billion due to the purchase of government-sponsored enterprise (GSE) and U.S. obligation MBS during the year. Our total liabilities increased to $94.1 billion at September 30, 2014 from $69.5 billion at December 31, 2013 due primarily to an increase in consolidated obligations issued to fund the growth in advances. Total capital increased to $4.3 billion at September 30, 2014 from $3.5 billion at December 31, 2013. The increase was primarily due to additional activity-based capital stock outstanding driven by the growth in advances. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition” for additional discussion on our financial condition.

ADJUSTED EARNINGS

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

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

As a member-owned cooperative, we endeavor to operate with a low but stable adjusted net interest margin. As indicated in the tables that follow, our adjusted net interest income and adjusted net income increased during the three and nine months ended September 30, 2014 when compared to the same periods in 2013. The increase in our adjusted net interest income and adjusted net income was primarily due to an increase in interest income due to higher advance and MBS volumes. Our adjusted net interest margin declined over prior year due to reduced yields on our interest-earning assets driven by the low interest rate environment and higher volumes of advances and short-term investments that generate lower margins when compared to the majority of our other interest-earning assets. The decline was partially offset by lower yields paid on our interest-bearing liabilities. 

47

The following table summarizes the reconciliation between GAAP and adjusted net interest income (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
GAAP net interest income before reversal for credit losses on mortgage loans
$
64.0

 
$
50.7

 
$
176.7

 
$
154.7

Exclude:
 
 
 
 
 
 
 
Prepayment fees on advances, net
(0.4
)
 
1.3

 
3.0

 
4.4

Include items reclassified from other (loss) income:
 
 
 
 
 
 
 
Net interest expense on economic hedges
(5.6
)
 
(4.9
)
 
(14.8
)
 
(11.5
)
Adjusted net interest income
$
58.8

 
$
44.5

 
$
158.9

 
$
138.8

Adjusted net interest margin
0.27
%
 
0.34
%
 
0.27
%
 
0.37
%

The following table summarizes the reconciliation between GAAP net income before assessments and adjusted net income (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
GAAP net income before assessments
$
29.6

 
$
33.4

 
$
100.7

 
$
81.2

Exclude:
 
 
 
 
 
 
 
Prepayment fees on advances, net
(0.4
)
 
1.3

 
3.0

 
4.4

Other-than-temporary impairment losses
—

 
(1.3
)
 
—

 
(1.3
)
Net gains (losses) on trading securities
0.7

 
(7.8
)
 
47.2

 
(87.1
)
Net gains from sale of available-for-sale securities
—

 
1.1

 
0.8

 
3.0

Net gains from sale of held-to-maturity securities
6.4

 
—

 
8.9

 
—

Net gains on consolidated obligations held at fair value
—

 
—

 
—

 
1.0

Net (losses) gains on derivatives and hedging activities
(16.8
)
 
2.3

 
(78.8
)
 
72.3

Net losses on extinguishment of debt
(10.0
)
 
—

 
(12.7
)
 
(25.7
)
Include:
 
 
 
 
 
 
 
Net interest expense on economic hedges
(5.6
)
 
(4.9
)
 
(14.8
)
 
(11.5
)
Amortization of hedging costs1
—

 
(1.5
)
 
—

 
(5.1
)
Adjusted net income
$
44.1

 
$
31.4

 
$
117.5

 
$
98.0


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

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

Conditions in the Financial Markets

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 AND DECEMBER 31, 2013

Economy and Financial Markets

Economic and market data received since the Federal Open Market Committee (FOMC) meeting in September of 2014 indicates that economic activity began increasing in the second and third quarters. Conditions in the labor market showed continued signs of improvement. The unemployment rate, however, has reflected little change and labor market indicators continue to reflect significant underutilization of labor resources. Household spending and business fixed investments have continued to advance while the housing sector, though improved from prior years, has remained slow. Inflation has remained subdued and long-term inflation expectations have remained stable.

In its September 17, 2014 statement, the FOMC stated it expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will improve toward levels the FOMC judges consistent with its dual mandate to foster maximum employment and price stability. The FOMC sees the risks to the outlook for the economy and the labor market as nearly balanced and believes the likelihood of inflation running persistently below its two percent objective has diminished somewhat since earlier this year.

48

Mortgage Markets

The housing market has continued to improve at a slow pace over the past year, as indicated by rising home prices, lower inventories of properties for sale, and increased housing construction activity. The improvement since year-end has been partly attributable to an improvement in employment and a decline in interest rates, but has been offset by tight credit conditions that have limited the amount of first time home buyers. The outlook for a sustainable recovery in residential sales and home prices remains promising, however the regulatory environment related to underwriting and quality control requirements continue to have an impact the pace of recovery.

Interest Rates

The following table shows information on key market interest rates1:
 
Third Quarter 2014
3-Month
Average
 
Third Quarter 2013
3-Month
Average
 
Third Quarter 2014
9-Month
Average
 
Third Quarter 2013
9-Month
Average
 
 September 30, 2014
Ending Rate
 
December 31, 2013
Ending Rate
Federal funds
0.09
%
 
0.09
%
 
0.08
%
 
0.11
%
 
0.07
%
 
0.07
%
Three-month LIBOR
0.23

 
0.26

 
0.23

 
0.28

 
0.24

 
0.25

2-year U.S. Treasury
0.50

 
0.36

 
0.42

 
0.29

 
0.57

 
0.38

10-year U.S. Treasury
2.49

 
2.69

 
2.62

 
2.20

 
2.49

 
3.03

30-year residential mortgage note
4.13

 
4.44

 
4.24

 
3.86

 
4.20

 
4.48


1
Source is Bloomberg.

The Federal Reserve's key target interest rate, the Federal funds rate, maintained a range of 0.00 to 0.25 percent during 2014. In its September 17, 2014 statement, the FOMC reaffirmed that the current exceptionally low target range for the Federal funds rate remains appropriate. The FOMC noted it anticipates that it likely will be appropriate to maintain the current target range for a considerable time after the asset purchase program ends. When the FOMC decides to begin removing the policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and a two percent inflation rate.

Average 10-year U.S. Treasury yields and mortgage rates were lower during the third quarter of 2014 when compared to the prior year. These rates increased during the second half of 2013 as a result of positive labor market data and investor expectations that a brighter outlook of the economy would allow the Federal Reserve to start reducing its asset purchase program by the end of 2014, known as Quantitative Easing III (discussed further below). However, interest rates declined during 2014 due to mixed economic data and additional comments from the FOMC regarding its discussions on when it will consider increasing short-term interest rates.
 
The FOMC noted in its September 17, 2014 statement that the ongoing improvement in economic activity and labor market conditions since it began the asset purchase program over a year ago is consistent with growing underlying strength in the broader economy. In light of the cumulative progress towards maximum employment and the improvement in the outlook of labor market conditions, the FOMC decided to make a further measured reduction in the pace of its asset purchases by $10.0 billion in October of 2014. The FOMC agreed to purchase additional agency MBS at a pace of $5 billion per month rather than $10.0 billion per month, and add to its holdings of longer-term U.S. Treasury securities at a pace of $10.0 billion per month rather than $15.0 billion per month.

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

49

Funding Spreads

The following table reflects our funding spreads to LIBOR (basis points)1:
 
Third Quarter 2014
3-Month
Average
 
Third Quarter 2013
3-Month
Average
 
Third Quarter 2014
9-Month
Average
 
Third Quarter 2013
9-Month
Average
 
 September 30, 2014
Ending Spread
 
December 31, 2013
Ending Spread
3-month
(13.7
)
 
(18.0
)
 
(14.5
)
 
(17.2
)
 
(14.5
)
 
(15.6
)
2-year
(9.0
)
 
(8.9
)
 
(7.7
)
 
(9.3
)
 
(13.6
)
 
(6.7
)
5-year
2.3

 
9.6

 
3.8

 
3.5

 
(2.1
)
 
10.5

10-year
31.6

 
49.0

 
35.8

 
29.9

 
31.1

 
55.8


1
Source is the Office of Finance.

As a result of our credit quality, we generally have ready access to funding at relatively competitive interest rates. During the third quarter of 2014, most of our funding spreads relative to London Interbank Offered Rate (LIBOR) improved when compared to spreads at December 31, 2013. These improvements followed the quick resolution of the debt ceiling debate in February and continued limited competing supply of U.S. Treasury and agency debt issuance. More recently, short-term debt spreads have returned to the levels slightly better than those experienced at year-end. Longer-term spreads widened in the third quarter, but are still at better levels than at year-end. Throughout 2014, we utilized consolidated obligation discount notes in addition to step-up, callable, and term fixed rate consolidated obligation bonds to capture attractive funding, match the repricing structures on advances and investments, and provide additional liquidity.

50

Selected Financial Data

The following tables present selected financial data for the periods indicated (dollars in millions):
Statements of Condition
September 30,
2014
 
June 30,
2014
 
March 31,
2014
 
December 31,
2013
 
September 30,
2013
Cash
$
9,478

 
$
309

 
$
361

 
$
448

 
$
183

Investments1
17,948

 
23,490

 
20,885

 
20,131

 
12,336

Advances
64,220

 
51,714

 
44,924

 
45,650

 
45,787

Mortgage loans held for portfolio, gross
6,530

 
6,493

 
6,492

 
6,565

 
6,603

Allowance for credit losses
(6
)
 
(7
)
 
(7
)
 
(8
)
 
(14
)
Total assets
98,399

 
82,217

 
72,889

 
73,004

 
65,063

Consolidated obligations
 
 
 
 
 
 
 
 
 
Discount notes
62,803

 
59,331

 
42,816

 
38,137

 
28,218

Bonds
30,387

 
18,252

 
25,225

 
30,195

 
32,227

Total consolidated obligations2
93,190

 
77,583

 
68,041

 
68,332

 
60,445

Mandatorily redeemable capital stock
8

 
8

 
8

 
9

 
13

Total liabilities
94,079

 
78,424

 
69,415

 
69,547

 
61,644

Capital stock — Class B putable
3,456

 
2,954

 
2,670

 
2,692

 
2,690

Retained earnings
712

 
705

 
697

 
678

 
656

Accumulated other comprehensive income
152

 
134

 
107

 
87

 
73

Total capital
4,320

 
3,793

 
3,474

 
3,457

 
3,419

 
For the Three Months Ended
Statements of Income
September 30,
2014
 
June 30,
2014
 
March 31,
2014
 
December 31,
2013
 
September 30,
2013
Net interest income
$
64.0

 
$
60.3

 
$
52.4

 
$
58.4

 
$
50.7

Reversal for credit losses on mortgage loans
(1.4
)
 
—

 
(0.3
)
 
(5.9
)
 
—

Other (loss) income3
(18.1
)
 
(14.6
)
 
3.4

 
(3.7
)
 
(3.4
)
Other expense4
17.7

 
15.7

 
15.0

 
19.8

 
13.9

Assessments
3.0

 
3.0

 
4.1

 
4.1

 
3.3

Net income
26.6

 
27.0

 
37.0

 
36.7

 
30.1

 
For the Three Months Ended
Selected Financial Ratios5
September 30,
2014
 
June 30,
2014
 
March 31,
2014
 
December 31,
2013
 
September 30,
2013
Net interest spread6
0.27
%
 
0.30
%
 
0.26
%
 
0.29
%
 
0.34
%
Net interest margin7
0.28

 
0.32

 
0.30

 
0.32

 
0.39

Return on average equity
2.69

 
3.02

 
4.37

 
4.27

 
4.12

Return on average capital stock
3.43

 
3.90

 
5.65

 
5.46

 
5.49

Return on average assets
0.12

 
0.14

 
0.21

 
0.20

 
0.23

Average equity to average assets
4.43

 
4.73

 
4.70

 
4.74

 
5.57

Regulatory capital ratio8
4.24

 
4.46

 
4.63

 
4.63

 
5.16

Dividend payout ratio9
73.13

 
67.91

 
50.97

 
39.31

 
43.39


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

2
The total par value of outstanding consolidated obligations of the 12 FHLBanks was $816.9 billion, $800.0 billion, $753.9 billion, $766.8 billion, and $720.7 billion at September 30, 2014, June 30, 2014, March 31, 2014, December 31, 2013, and September 30, 2013 respectively.

3
Other (loss) income includes, among other things, net gains (losses) on investment securities, net gains (losses) on derivatives and hedging activities, and net losses on the extinguishment of debt.

4
Other expense includes, among other things, compensation and benefits, professional fees, contractual services, and gains and losses on real estate owned (REO).

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.

51

Results of Operations

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013

Net Income

The following table presents comparative highlights of our net income for the three and nine months ended September 30, 2014 and 2013 (dollars in millions). See further discussion of these items in the sections that follow.
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Net interest income
$
64.0

 
$
50.7

 
$
13.3

 
26.2
 %
 
$
176.7

 
$
154.7

 
$
22.0

 
14.2
 %
Reversal for credit losses on mortgage loans
(1.4
)
 
—

 
(1.4
)
 
(100.0
)
 
(1.7
)
 
—

 
(1.7
)
 
(100.0
)
Other (loss) income
(18.1
)
 
(3.4
)
 
(14.7
)
 
(432.4
)
 
(29.3
)
 
(30.8
)
 
1.5

 
4.9

Other expense
17.7

 
13.9

 
3.8

 
27.3

 
48.4

 
42.7

 
5.7

 
13.3

Assessments
3.0

 
3.3

 
(0.3
)
 
(9.1
)
 
10.1

 
8.1

 
2.0

 
24.7

Net income
$
26.6

 
$
30.1

 
$
(3.5
)
 
(11.6
)%
 
$
90.6

 
$
73.1

 
$
17.5

 
23.9
 %

52

Net Interest Income

Our net interest income is impacted by changes in average interest-earning asset and interest-bearing liability balances, and the related yields and costs. The following table presents average balances and rates of major asset and liability categories (dollars in millions):    
 
For the Three Months Ended September 30,
 
2014
 
2013
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
354

 
0.07
%
 
$
0.1

 
$
255

 
0.09
%
 
$
—

Securities purchased under agreements to resell
9,599

 
0.05

 
1.3

 
2,822

 
0.04

 
0.4

Federal funds sold
3,856

 
0.08

 
0.7

 
1,160

 
0.07

 
0.2

Mortgage-backed securities2,3
10,403

 
1.17

 
30.6

 
6,981

 
1.23

 
21.6

    Other investments2,3,4
2,366

 
2.59

 
15.4

 
2,019

 
4.11

 
20.9

Advances3,5
54,770

 
0.43

 
59.3

 
31,649

 
0.60

 
47.9

Mortgage loans6
6,513

 
3.69

 
60.6

 
6,660

 
3.69

 
62.0

Total interest-earning assets
87,861

 
0.76

 
168.0

 
51,546

 
1.18

 
153.0

Non-interest-earning assets
699

 
—

 
—

 
503

 
—

 
—

Total assets
$
88,560

 
0.75
%
 
$
168.0

 
$
52,049

 
1.17
%
 
$
153.0

Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
447

 
0.01
%
 
$
0.1

 
$
656

 
0.02
%
 
$
—

Consolidated obligations
 
 
 
 
 
 
 

 
 

 
 

Discount notes
63,289

 
0.08

 
12.3

 
13,820

 
0.07

 
2.4

Bonds3
20,135

 
1.81

 
91.6

 
33,833

 
1.17

 
99.8

Other interest-bearing liabilities7
8

 
2.06

 
—

 
18

 
2.05

 
0.1

Total interest-bearing liabilities
83,879

 
0.49

 
104.0

 
48,327

 
0.84

 
102.3

Non-interest-bearing liabilities
761

 
—

 
—

 
821

 
—

 
—

Total liabilities
84,640

 
0.49

 
104.0

 
49,148

 
0.83

 
102.3

Capital
3,920

 
—

 
—

 
2,901

 
—

 
—

Total liabilities and capital
$
88,560

 
0.47
%
 
$
104.0

 
$
52,049

 
0.78
%
 
$
102.3

Net interest income and spread8
 
 
0.27
%
 
$
64.0

 
 
 
0.34
%
 
$
50.7

Net interest margin9
 
 
0.28
%
 
 
 
 
 
0.39
%
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
104.75
%
 
 
 
 
 
106.66
%
 
 

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

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

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

4
Other investments primarily include other U.S. obligations, GSE obligations, state or local housing agency obligations, and taxable municipal bonds.

5
Advance interest income includes prepayment fee income of $(0.4) million and $1.3 million for the three months ended September 30, 2014 and 2013.

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

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

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

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

53

The following table presents average balances and rates of major asset and liability categories (dollars in millions):    
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
339

 
0.07
%
 
$
0.2

 
$
343

 
0.13
%
 
$
0.3

Securities purchased under agreements to resell
7,915

 
0.05

 
2.9

 
4,011

 
0.09

 
2.9

Federal funds sold
2,903

 
0.07

 
1.5

 
1,250

 
0.10

 
0.9

Short-term investments
1

 
0.12

 
—

 
4

 
0.10

 
—

Mortgage-backed securities2,3
9,425

 
1.23

 
86.4

 
6,856

 
1.59

 
81.4

    Other investments2,3,4
2,389

 
2.63

 
47.0

 
2,079

 
3.18

 
49.4

Advances3,5
49,086

 
0.46

 
169.5

 
27,652

 
0.70

 
144.8

Mortgage loans6
6,502

 
3.79

 
184.2

 
6,759

 
3.78

 
190.9

Total interest-earning assets
78,560

 
0.84

 
491.7

 
48,954

 
1.29

 
470.6

Non-interest-earning assets
670

 
—

 
—

 
514

 
—

 
—

Total assets
$
79,230

 
0.83
%
 
$
491.7

 
$
49,468

 
1.27
%
 
$
470.6

Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
558

 
0.01
%
 
$
0.1

 
$
792

 
0.02
%
 
$
0.1

Consolidated obligations
 
 
 
 
 
 
 

 
 

 
 

Discount notes
50,733

 
0.08

 
31.7

 
8,419

 
0.10

 
6.1

Bonds3
23,407

 
1.62

 
283.1

 
36,408

 
1.14

 
309.5

Other interest-bearing liabilities7
10

 
1.84

 
0.1

 
14

 
2.27

 
0.2

Total interest-bearing liabilities
74,708

 
0.56

 
315.0

 
45,633

 
0.93

 
315.9

Non-interest-bearing liabilities
873

 
—

 
—

 
1,001

 
—

 
—

Total liabilities
75,581

 
0.56

 
315.0

 
46,634

 
0.91

 
315.9

Capital
3,649

 
—

 
—

 
2,834

 
—

 
—

Total liabilities and capital
$
79,230

 
0.53
%
 
$
315.0

 
$
49,468

 
0.85
%
 
$
315.9

Net interest income and spread8
 
 
0.28
%
 
$
176.7

 
 
 
0.36
%
 
$
154.7

Net interest margin9
 
 
0.30
%
 
 
 
 
 
0.42
%
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
105.16
%
 
 
 
 
 
107.28
%
 
 

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

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

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

4
Other investments primarily include other U.S. obligations, GSE obligations, state or local housing agency obligations, and taxable municipal bonds.

5
Advance interest income includes prepayment fee income of $3.0 million and $4.4 million for the nine months ended September 30, 2014 and 2013.

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

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

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

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


54

The following table presents changes in interest income and interest expense. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but rather equally attributable to both volume and rate changes, are allocated to the volume and rate categories based on the proportion of the absolute value of the volume and rate changes (dollars in millions).
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2014 vs. September 30, 2013
 
September 30, 2014 vs. September 30, 2013
 
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
$
0.1

 
$
—

 
$
0.1

 
$
—

 
$
(0.1
)
 
$
(0.1
)
Securities purchased under agreements to resell
0.8

 
0.1

 
0.9

 
1.6

 
(1.6
)
 
—

Federal funds sold
0.5

 
—

 
0.5

 
0.9

 
(0.3
)
 
0.6

Mortgage-backed securities
10.1

 
(1.1
)
 
9.0

 
26.1

 
(21.1
)
 
5.0

Other investments
3.2

 
(8.7
)
 
(5.5
)
 
6.8

 
(9.2
)
 
(2.4
)
Advances
27.7

 
(16.3
)
 
11.4

 
86.0

 
(61.3
)
 
24.7

Mortgage loans
(1.4
)
 
—

 
(1.4
)
 
(7.2
)
 
0.5

 
(6.7
)
Total interest income
41.0

 
(26.0
)
 
15.0

 
114.2

 
(93.1
)
 
21.1

Interest expense
 
 
 
 
 
 
 
 
 
 
 
Deposits
—

 
0.1

 
0.1

 
—

 
—

 
—

Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes
9.5

 
0.4

 
9.9

 
27.0

 
(1.4
)
 
25.6

Bonds
(49.9
)
 
41.7

 
(8.2
)
 
(132.1
)
 
105.7

 
(26.4
)
Other interest-bearing liabilities
(0.1
)
 
—

 
(0.1
)
 
(0.1
)
 
—

 
(0.1
)
Total interest expense
(40.5
)
 
42.2

 
1.7

 
(105.2
)
 
104.3

 
(0.9
)
Net interest income
$
81.5

 
$
(68.2
)
 
$
13.3

 
$
219.4

 
$
(197.4
)
 
$
22.0

    
NET INTEREST SPREAD

Net interest spread equals the yield on total interest-earning assets minus the cost of total interest-bearing liabilities. For the three and nine months ended September 30, 2014, our net interest spread was 0.27 percent and 0.28 percent compared to 0.34 percent and 0.36 percent during the same periods in 2013. Our net interest spread was primarily impacted by lower yields on advances and investments, partially offset by improved yields on our consolidated obligations. The primary components of our interest income and interest expense are discussed below.

Advances

Interest income on advances (including prepayment fees on advances, net) increased 24 and 17 percent during the three and nine months ended September 30, 2014 when compared to the same periods in 2013 due primarily to higher average volumes, partially offset by the low interest rate environment. Average advance volumes increased due primarily to borrowings from larger depository institution members.

Investments

Interest income on investments increased 11 and two percent during the three and nine months ended September 30, 2014 when compared to the same periods in 2013 due primarily to higher average volumes of MBS, partially offset by the low interest rate environment. Average MBS volumes increased due to the purchase of GSE MBS and other U.S. obligation MBS during the year.



55

Mortgage Loans

Interest income on mortgage loans decreased two and four percent during the three and nine months ended September 30, 2014 when compared to the same periods in 2013. The decrease was due to lower average mortgage loan volumes. Average mortgage loan volumes declined due to principal paydowns exceeding mortgage loan purchases.

Discount Notes

Interest expense on discount notes increased 407 and 419 percent during the three and nine months ended September 30, 2014 when compared to the same periods in 2013 due to higher average volumes. Discount notes were utilized to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Bonds

Interest expense on bonds decreased eight and nine percent during the three and nine months ended September 30, 2014 when compared to the same periods in 2013 due to lower average bond volumes. Average bond volumes declined due to our increased utilization of discount notes to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Reversal for Credit Losses on Mortgage Loans

During the three and nine months ended September 30, 2014, we recorded reversals for credit losses on our mortgage loans of $1.4 million and $1.7 million due to a reduction in loan delinquencies and improvements in housing market forecasts. During the three and nine months ended September 30, 2013, we did not record a provision or reversal for credit losses on our mortgage loans.

Other (Loss) Income

The following table summarizes the components of other (loss) income (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Other-than-temporary impairment losses
$
—

 
$
(1.3
)
 
$
—

 
$
(1.3
)
Net gains (losses) on trading securities
0.7

 
(7.8
)
 
47.2

 
(87.1
)
Net gains from sale of available-for-sale securities
—

 
1.1

 
0.8

 
3.0

Net gains from sale of held-to-maturity securities
6.4

 
—

 
8.9

 
—

Net gains on consolidated obligations held at fair value
—

 
—

 
—

 
1.0

Net (losses) gains on derivatives and hedging activities
(16.8
)
 
2.3

 
(78.8
)
 
72.3

Net losses on extinguishment of debt
(10.0
)
 
—

 
(12.7
)
 
(25.7
)
Other, net
1.6

 
2.3

 
5.3

 
7.0

Total other loss
$
(18.1
)
 
$
(3.4
)
 
$
(29.3
)
 
$
(30.8
)
    
Other (loss) income can be volatile from period to period depending on the type of financial activity recorded. During the three and nine months ended September 30, 2014, other (loss) income was primarily impacted by losses on derivatives and hedging activities, gains on investment securities, and losses on the extinguishment of debt.

56

We use derivatives to manage interest rate risk, including mortgage prepayment risk. During the three and nine months ended September 30, 2014 and 2013, gains and losses on our derivatives and hedging activities were primarily attributable to the impact of changes in interest rates on fair value hedge relationships and on interest rate swaps that we utilize to economically hedge our trading securities portfolio as discussed below. We recorded losses on fair value hedge relationships of $12.1 million and $30.8 million during the three and nine months ended September 30, 2014 through other (loss) income compared to gains of $1.9 million and $8.3 million during the same periods in 2013. In addition, we recorded losses on interest rate swaps that we utilize to economically hedge our trading securities portfolios of $4.7 million and $60.2 million during the three and nine months ended September 30, 2014 through other (loss) income compared to losses of $1.4 million and gains of $61.2 million during the same periods in 2013. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Hedging Activities” for additional discussion on our derivatives and hedging activities, including the net impact of economic hedge relationships.

Trading securities are recorded at fair value with changes in fair value reflected through other (loss) income. During the three and nine months ended September 30, 2014, we recorded gains on trading securities of $0.7 million and $47.2 million compared to losses of $7.8 million and $87.1 million during the same periods in 2013. These changes in fair value were primarily due to the impact of changes in interest rates and credit spreads on our fixed rate trading securities which are generally offset by the changes in fair value on derivatives and hedging activities, as discussed above. In addition, during the three and nine months ended September 30, 2014, we sold HTM and AFS securities and realized gains of $6.4 million and $9.7 million. We sold AFS securities during the three and nine months ended September 30, 2013, and realized gains of $1.1 million and $3.0 million.

We extinguish higher-costing debt from time to time in an effort to better match our projected asset cash flows and to reduce our future interest costs. During the three and nine months ended September 30, 2014, we extinguished bonds with a total par value of $91.3 million and $115.0 million and recognized losses of $10.0 million and $12.7 million through other (loss) income. We did not extinguish any debt during the three months ended September 30, 2013. During the nine months ended September 30, 2013, we extinguished bonds with a total par value of $162.1 million and recognized losses of $25.7 million.

Hedging Activities

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

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

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

57

The following tables categorize the net effect of hedging activities on net income by product (dollars in millions):
 
 
For the Three Months Ended September 30, 2014
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
(6.9
)
 
$
—

 
$
(0.5
)
 
$
5.1

 
$
(2.3
)
Net interest settlements
 
(41.0
)
 
(30.2
)
 
—

 
18.8

 
(52.4
)
Total impact to net interest income
 
(47.9
)
 
(30.2
)
 
(0.5
)
 
23.9

 
(54.7
)
Other (loss) income:
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
0.4

 
(14.6
)
 
—

 
2.1

 
(12.1
)
Losses on economic hedges
 
—

 
(4.7
)
 
—

 
—

 
(4.7
)
Total net gains (losses) gains on derivatives and hedging activities
 
0.4

 
(19.3
)
 
—

 
2.1

 
(16.8
)
Net gains on trading securities2
 
—

 
0.7

 
—

 
—

 
0.7

Net amortization/accretion3
 
—

 
—

 
—

 
(0.8
)
 
(0.8
)
Total impact to other (loss) income
 
0.4


(18.6
)
 
—

 
1.3

 
(16.9
)
Total net effect of hedging activities4
 
$
(47.5
)
 
$
(48.8
)
 
$
(0.5
)
 
$
25.2

 
$
(71.6
)
 
 
For the Three Months Ended September 30, 2013
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
(4.8
)
 
$
—

 
$
(0.9
)
 
$
10.9

 
$
5.2

Net interest settlements
 
(39.5
)
 
(12.4
)
 
—

 
14.4

 
(37.5
)
Total impact to net interest income
 
(44.3
)
 
(12.4
)
 
(0.9
)
 
25.3

 
(32.3
)
Other (loss) income:
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
Gains on fair value hedges
 
0.5

 
0.3

 
—

 
1.1

 
1.9

(Losses) gains on economic hedges
 
—

 
(1.4
)
 
0.2

 
1.6

 
0.4

Total net gains (losses) on derivatives and hedging activities
 
0.5

 
(1.1
)
 
0.2

 
2.7

 
2.3

Net losses on trading securities2
 
—

 
(7.8
)
 
—

 
—

 
(7.8
)
Net amortization/accretion3
 
—

 
2.8

 
—

 
—

 
2.8

Total impact to other (loss) income
 
0.5

 
(6.1
)
 
0.2

 
2.7

 
(2.7
)
Total net effect of hedging activities4
 
$
(43.8
)
 
$
(18.5
)
 
$
(0.7
)
 
$
28.0

 
$
(35.0
)

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

2
Represents the net gains (losses) on those trading securities in which we have entered into a corresponding economic derivative to hedge the risk of changes in fair value. As a result, this line item may not agree to the Statements of Income.
    
3
Represents the amortization/accretion of fair value hedging adjustments on closed bond hedge relationships included in other (loss) income as a result of debt extinguishments and closed investment hedge relationships included in other (loss) income as a result of investment sales.

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




58

The following tables categorize the net effect of hedging activities on net income by product (dollars in millions):
 
 
For the Nine Months Ended September 30, 2014
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Balance
Sheet
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
(24.6
)
 
$
—

 
$
(1.3
)
 
$
18.9

 
$
—

 
$
(7.0
)
Net interest settlements
 
(121.9
)
 
(83.6
)
 
—

 
45.7

 
—

 
(159.8
)
Total impact to net interest income
 
(146.5
)
 
(83.6
)
 
(1.3
)
 
64.6

 
—

 
(166.8
)
Other (loss) income:
 
 
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
1.3

 
(35.1
)
 
—

 
3.0

 
—

 
(30.8
)
(Losses) gains on economic hedges
 
(0.1
)
 
(60.2
)
 
(0.2
)
 
12.5

 
—

 
(48.0
)
Total net gains (losses) on derivatives and hedging activities
 
1.2

 
(95.3
)
 
(0.2
)
 
15.5

 
—

 
(78.8
)
Net gains on trading securities2
 
—

 
47.2

 
—

 
—

 
—

 
47.2

Net amortization/accretion3
 
—

 
—

 
—

 
(0.4
)
 
—

 
(0.4
)
Total impact to other (loss) income
 
1.2

 
(48.1
)
 
(0.2
)
 
15.1

 
—

 
(32.0
)
Total net effect of hedging activities4
 
$
(145.3
)
 
$
(131.7
)
 
$
(1.5
)
 
$
79.7

 
$
—

 
$
(198.8
)
 
 
For the Nine Months Ended September 30, 2013
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Balance
Sheet 5
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
(26.7
)
 
$
—

 
$
(3.3
)
 
$
37.8

 
$
—

 
$
7.8

Net interest settlements
 
(122.2
)
 
(23.9
)
 
—

 
48.0

 
—

 
(98.1
)
Total impact to net interest income
 
(148.9
)
 
(23.9
)
 
(3.3
)
 
85.8

 
—

 
(90.3
)
Other (loss) income:
 
 
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
 
 
Gains on fair value hedges
 
2.2

 
4.4

 
—

 
1.7

 
—

 
8.3

Gains (losses) on economic hedges
 
—

 
61.2

 
0.3

 
(1.5
)
 
4.0

 
64.0

Total net gains (losses) on derivatives and hedging activities
 
2.2

 
65.6

 
0.3

 
0.2

 
4.0

 
72.3

Net losses on trading securities2
 
—

 
(87.1
)
 
—

 
—

 
—

 
(87.1
)
Net gains on consolidated obligations held at fair value
 
—

 
—

 
—

 
1.0

 
—

 
1.0

Net amortization/accretion3
 
—

 
2.8

 
—

 
(1.2
)
 
—

 
1.6

Total impact to other (loss) income
 
2.2

 
(18.7
)
 
0.3

 
—

 
4.0

 
(12.2
)
Total net effect of hedging activities4
 
$
(146.7
)
 
$
(42.6
)
 
$
(3.0
)
 
$
85.8

 
$
4.0

 
$
(102.5
)

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

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

3
Represents the amortization/accretion of fair value hedging adjustments on closed bond hedge relationships included in other (loss) income as a result of debt extinguishments and closed investment hedge relationships included in other (loss) income as a result of investments sales.

4
The hedging activity tables do not include the interest component on the related hedged items or the gross advance prepayment fee income on terminated advance hedge relationships.

5
Represents net gains on interest rate caps. We did not hold any interest rate caps during 2014.


59

NET AMORTIZATION/ACCRETION

Amortization/accretion varies from period to period depending on our hedge relationship termination activities and the maturity, call, or prepayment of assets or liabilities previously in hedge relationships. Amortization/accretion on advances, mortgage loans, and consolidated obligation bonds during the three and nine months ended September 30, 2014 and 2013 resulted primarily from the normal amortization of existing fair value hedging adjustments.

NET INTEREST SETTLEMENTS

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

GAINS (LOSSES) ON FAIR VALUE HEDGES

Gains (losses) on fair value hedges are driven by hedge ineffectiveness. Hedge ineffectiveness occurs when changes in the fair value of the derivative and the related hedged item do not perfectly offset each other. The primary drivers of hedge ineffectiveness are changes in the benchmark interest rate and volatility.

We use the LIBOR swap curve to discount cash flows on all hedged assets or liabilities in fair value hedging relationships where the hedged risk is changes in fair value attributable to changes in the designated benchmark interest rate, LIBOR. We utilize the Overnight Index Swap (OIS) curve to discount cash flows on derivatives in fair value hedging relationships. During 2014, a divergence between the LIBOR and OIS curves occurred. Due to this divergence and an increase in the volume of  AFS investment hedge relationships, we experienced additional hedge ineffectiveness. As we expect to hold these instruments to maturity, we anticipate that these losses will reverse over the remaining life of the hedge relationship.

GAINS (LOSSES) ON ECONOMIC HEDGES

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

Investments
 
We utilize interest rate swaps to economically hedge a portion of our trading securities against changes in fair value. Gains and losses on these economic derivatives are due primarily to changes in interest rates. Gains and losses on our trading securities are due primarily to changes in interest rates and credit spreads.

The following table summarizes gains and losses on these economic derivatives as well as the related trading securities (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Gains (losses) on interest rate swaps
$
0.9

 
$
4.2

 
$
(43.3
)
 
$
77.8

Interest settlements
(5.6
)
 
(5.6
)
 
(16.9
)
 
(16.6
)
Net (losses) gains on investment derivatives
(4.7
)
 
(1.4
)
 
(60.2
)
 
61.2

Net gains (losses) on related trading securities
0.7

 
(7.8
)
 
47.2

 
(87.1
)
Net losses on investment hedge relationships
$
(4.0
)
 
$
(9.2
)
 
$
(13.0
)
 
$
(25.9
)


60

Consolidated Obligations
 
Derivatives used to hedge consolidated obligations in a fair value hedge relationship that fail retrospective hedge effectiveness testing are considered to be ineffective and are required to be accounted for as economic derivatives. We may also utilize interest rate swaps to economically hedge against changes in fair value on consolidated obligations elected under the fair value option. Gains and losses on these economic derivatives are primarily due to changes in interest rates. At September 30, 2014, we did not hold any interest rate swaps in ineffective fair value hedge relationships. In addition, all bonds previously elected under the fair value option and the related interest rate swaps had matured.

The following table summarizes gains and losses on these economic derivatives as well as the related consolidated obligations elected under the fair value option (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Losses on interest rate swaps
$
—

 
$
—

 
$
—

 
$
(1.4
)
Gains (losses) on interest rate swaps in ineffective fair value hedge relationships
—

 
0.9

 
10.3

 
(5.5
)
Interest settlements
—

 
0.7

 
2.2

 
5.4

Net gains (losses) on consolidated obligation derivatives
—

 
1.6

 
12.5

 
(1.5
)
Net gains on related consolidated obligations elected under the fair value option
—

 
—

 
—

 
1.0

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

 
$
1.6

 
$
12.5

 
$
(0.5
)

Statements of Condition

SEPTEMBER 30, 2014 AND DECEMBER 31, 2013

Financial Highlights

Our total assets increased to $98.4 billion at September 30, 2014 from $73.0 billion at December 31, 2013. Our total liabilities increased to $94.1 billion at September 30, 2014 from $69.5 billion at December 31, 2013. Total capital increased to $4.3 billion at September 30, 2014 from $3.5 billion at December 31, 2013. See further discussion of changes in our financial condition in the appropriate sections that follow.

Cash

At September 30, 2014, our total cash balance was $9.5 billion compared to $0.4 billion at December 31, 2013. The increase was primarily due to limited opportunities to reinvest funds from short-term investments that matured before the end of the third quarter.

Advances

The following table summarizes our advances by type of institution (dollars in millions):
 
September 30,
2014
 
December 31,
2013
Commercial banks
$
44,671

 
$
28,237

Thrifts
1,724

 
1,249

Credit unions
939

 
686

Insurance companies
16,601

 
15,136

Total member advances
63,935

 
45,308

Housing associates
46

 
8

Non-member borrowers
39

 
44

Total par value
$
64,020

 
$
45,360



61

Our total advance par value increased $18.7 billion or 41 percent at September 30, 2014 when compared to December 31, 2013. The increase was due to borrowings from a wide range of members, primarily driven by advances to large depository institution members.

The following table summarizes our advances by product type (dollars in millions):
 
September 30, 2014
 
December 31, 2013
 
Amount
 
% of Total
 
Amount
 
% of Total
Variable rate
$
43,825

 
68.5
 
$
27,906

 
61.5
Fixed rate
19,732

 
30.8
 
17,054

 
37.6
Amortizing
463

 
0.7
 
400

 
0.9
Total par value
64,020

 
100.0
 
45,360

 
100.0
Discounts
(7
)
 
 
 
(8
)
 
 
Fair value hedging adjustments
207

 
 
 
298

 
 
Total advances
$
64,220

 
 
 
$
45,650

 
 

Fair value hedging adjustments decreased $90.6 million or 30 percent at September 30, 2014 when compared to December 31, 2013. The decrease was primarily due to a decrease in cumulative fair value adjustments on advances in hedge relationships resulting from changes in interest rates.

At September 30, 2014 and December 31, 2013, advances outstanding to our five largest member borrowers totaled $41.7 billion and $26.7 billion, representing 65 and 59 percent of our total advances outstanding. The following table summarizes advances outstanding to our five largest member borrowers at September 30, 2014 (dollars in millions):
 
Amount
 
% of Total
Wells Fargo Bank, N.A.
$
34,000

 
53.1
Transamerica Life Insurance Company 1
2,350

 
3.7
HICA Education Loan Corporation
2,125

 
3.3
Principal Life Insurance Company
1,750

 
2.7
TH Insurance Holdings Company LLC
1,500

 
2.3
Total par value
$
41,725

 
65.1

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

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

The FHLBank Act requires that we obtain sufficient collateral on advances to protect against losses. We have never experienced a credit loss on an advance to a member or eligible housing associate. Based upon our collateral and lending policies, the collateral held as security, and the repayment history on advances, management has determined that there were no probable credit losses on our advances as of September 30, 2014 and December 31, 2013. Accordingly, we have not recorded any allowance for credit losses on our advances. See additional discussion regarding our collateral requirements in “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Advances.”


62

Mortgage Loans

The following table summarizes information on our mortgage loans held for portfolio (dollars in millions):
 
September 30,
2014
 
December 31,
2013
Fixed rate conventional loans
$
5,884

 
$
5,945

Fixed rate government-insured loans
567

 
547

Total unpaid principal balance
6,451

 
6,492

Premiums
82

 
81

Discounts
(13
)
 
(16
)
Basis adjustments from mortgage loan commitments
10

 
8

Total mortgage loans held for portfolio
6,530

 
6,565

Allowance for credit losses
(6
)
 
(8
)
Total mortgage loans held for portfolio, net
$
6,524

 
$
6,557

    
Our mortgage loans remained relatively stable at September 30, 2014 when compared to December 31, 2013. The slight decrease was primarily due to principal paydowns exceeding mortgage loan purchases. Throughout the nine months ended September 30, 2014, we purchased mortgage loans with a total unpaid principal balance of $625.9 million from our participating financial institutions (PFIs) and received principal paydowns of $657.8 million. Mortgage purchase activity and paydowns generally increased during 2014 due primarily to a decline in interest rates.

Our allowance for credit losses declined $2.4 million or 30 percent at September 30, 2014 when compared to December 31, 2013 due to a reversal for credit losses on our mortgage loans of $1.7 million and charge-offs of $0.7 million during the year. The reversal was due to a reduction in loan delinquencies and improvements in housing market forecasts. During the three and nine months ended September 30, 2013, we did not record a provision or reversal for credit losses on our mortgage loans. For additional discussion on our mortgage loan credit risk, refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Mortgage Assets.”


63

Investments

The following table summarizes the carrying value of our investments (dollars in millions):
 
September 30, 2014
 
December 31, 2013
 
Amount
 
% of Total
 
Amount
 
% of Total
Short-term investments1
 
 
 
 
 
 
 
Interest-bearing deposits
$
1

 
—
 
$
1

 
—
Securities purchased under agreements to resell
2,060

 
11.5
 
8,200

 
40.7
Federal funds sold
2,635

 
14.7
 
1,200

 
6.0
Total short-term investments
4,696

 
26.2
 
9,401

 
46.7
Long-term investments2
 
 
 
 
 
 
 
Interest-bearing deposits
1

 
—
 
1

 
—
Mortgage-backed securities
 
 
 
 
 
 
 
GSE residential
9,455

 
52.7
 
8,132

 
40.4
Other U.S. obligations residential
1,378

 
7.7
 
5

 
—
Other U.S. obligations commercial
1

 
—
 
2

 
—
Private-label residential
26

 
0.1
 
30

 
0.2
Total mortgage-backed securities
10,860

 
60.5
 
8,169

 
40.6
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations
427

 
2.4
 
448

 
2.2
GSE obligations
1,420

 
7.9
 
1,489

 
7.4
State or local housing agency obligations
89

 
0.5
 
95

 
0.5
Other
455

 
2.5
 
528

 
2.6
Total non-mortgage-backed securities
2,391

 
13.3
 
2,560

 
12.7
Total long-term investments
13,252

 
73.8
 
10,730

 
53.3
Total investments
$
17,948

 
100.0
 
$
20,131

 
100.0

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

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

Our investments decreased $2.2 billion or 11 percent at September 30, 2014 when compared to December 31, 2013. The decrease was primarily due to a reduction in short-term investments as there were limited opportunities to reinvest maturities which occurred before the end of the third quarter. This was partially offset by the purchase of GSE and other U.S. obligation MBS during the year. At September 30, 2014, we had GSE MBS purchases with a total par value of $0.2 billion that had traded but not yet settled. These investments have been recorded as "available-for-sale securities" in our Statements of Condition with a corresponding payable recorded in "other liabilities".

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

Refer to “Item 1. Financial Statements — Note 6 — Other-Than-Temporary Impairment” for additional information on our OTTI analysis performed at September 30, 2014. As a result of our analysis, we determined that all gross unrealized losses on our investment portfolio are temporary. We do not intend to sell these securities, and it is not more likely than not that we will be required to sell these securities before recovery of their amortized cost bases. As a result, we did not consider any of these securities to be other-than-temporarily impaired at September 30, 2014.


64

Consolidated Obligations

Consolidated obligations, which include bonds and discount notes, are the primary source of funds to support our advances, mortgage loans, and investments. At September 30, 2014 and December 31, 2013, the par value of consolidated obligations for which we are primarily liable totaled $93.2 billion and $68.3 billion.

DISCOUNT NOTES

The following table summarizes our discount notes, all of which are due within one year (dollars in millions):
 
September 30,
2014
 
December 31,
2013
Par value
$
62,810

 
$
38,144

Discounts
(7
)
 
(7
)
Total
$
62,803

 
$
38,137

    
Our discount notes increased $24.7 billion or 65 percent at September 30, 2014 when compared to December 31, 2013. The increase was primarily due to our increased utilization of shorter-term discount notes to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

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

BONDS

The following table summarizes information on our bonds (dollars in millions):
 
September 30,
2014
 
December 31,
2013
Total par value
$
30,395

 
$
30,205

Premiums
20

 
22

Discounts
(19
)
 
(18
)
Fair value hedging adjustments
(9
)
 
(14
)
Total bonds
$
30,387

 
$
30,195


Our bonds remained relatively stable at September 30, 2014 when compared to December 31, 2013. During 2014, we utilized consolidated obligation bonds as well as shorter-term discount notes to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Fair value hedging adjustments changed $4.9 million or 35 percent at September 30, 2014 when compared to December 31, 2013. The change was primarily due to an increase in cumulative fair value adjustments on bonds in hedge relationships resulting from changes in interest rates.

Deposits

Deposit levels will vary based on member alternatives for short-term investments. Our deposits decreased $0.2 billion or 33 percent at September 30, 2014 when compared to December 31, 2013 due to a decrease in demand and overnight deposits.


65

Capital

The following table summarizes information on our capital (dollars in millions):
 
September 30,
2014
 
December 31,
2013
Capital stock
$
3,456

 
$
2,692

Retained earnings
712

 
678

Accumulated other comprehensive income
152

 
87

Total capital
$
4,320

 
$
3,457


Our capital increased $0.9 billion or 25 percent at September 30, 2014 when compared to December 31, 2013. The increase was due to increased capital stock, accumulated other comprehensive income (AOCI), and retained earnings. Capital stock increased primarily due to additional activity-based capital stock held driven by the growth in advances. AOCI increased due to an increase in unrealized gains on AFS securities resulting primarily from changes in interest rates and volumes of MBS securities. Retained earnings increased due to net income earned in excess of dividends paid. Refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital — Capital Stock” for additional information on our capital stock activity.

Derivatives

We use derivatives to manage interest rate risk, including mortgage prepayment risk, in our Statements of Condition. The notional amount of derivatives serves as a factor in determining periodic interest payments and cash flows received and paid. However, the notional amount of derivatives represents neither the actual amounts exchanged nor our overall exposure to credit and market risk. The following table categorizes the notional amount of our derivatives by type (dollars in millions):
 
September 30,
2014
 
December 31,
2013
Interest rate swaps
 
 
 
Noncallable
$
24,321

 
$
28,533

Callable by counterparty
12,361

 
5,680

Callable by the Bank
37

 
82

Total interest rate swaps
36,719

 
34,295

Forward settlement agreements (TBAs)
87

 
28

Mortgage delivery commitments
91

 
30

Total notional amount
$
36,897

 
$
34,353

    
The notional amount of our derivative contracts increased $2.5 billion or 7 percent at September 30, 2014 when compared to December 31, 2013. We increased our utilization of swapped consolidated obligation bonds in addition to short-term discount notes, to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Liquidity and Capital Resources

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

LIQUIDITY

Sources of Liquidity

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


66

Our primary source of liquidity is proceeds from the issuance of consolidated obligations (bonds and discount notes) in the capital markets. Although we are primarily liable for the portion of consolidated obligations that are issued on our behalf, we are also jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all consolidated obligations issued by the FHLBank System. At September 30, 2014 and December 31, 2013, the total par value of outstanding consolidated obligations for which we are primarily liable was $93.2 billion and $68.3 billion. At September 30, 2014 and December 31, 2013, the total par value of outstanding consolidated obligations issued on behalf of other FHLBanks for which we are jointly and severally liable was approximately $723.7 billion and $698.5 billion.

During the nine months ended September 30, 2014, proceeds from the issuance of bonds and discount notes were $21.5 billion and $159.1 billion compared to $30.4 billion and $90.9 billion for the same period in 2013. We continued to issue shorter-term discount notes as well as step-up, callable, and term fixed rate consolidated obligation bonds to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

Our ability to raise funds in the capital markets as well as our cost of borrowing may be affected by our credit ratings. As of October 31, 2014, our consolidated obligations were rated AA+/A-1+ by Standard and Poor's and Aaa/P-1 by Moody's and both ratings had a stable outlook. For further discussion of how credit rating changes may impact us in the future, refer to “Item 1A. Risk Factors” in our 2013 Form 10-K.

The Office of Finance and FHLBanks have contingency plans in place that prioritize the allocation of proceeds from the issuance of consolidated obligations during periods of financial distress when consolidated obligations cannot be issued in sufficient amounts to satisfy all FHLBank demand. In the event of significant market disruptions or local disasters, our President or his designee is authorized to establish interim borrowing relationships with other FHLBanks. To provide further access to funding, the FHLBank Act also authorizes the U.S. Treasury to directly purchase new issue consolidated obligations of the GSEs, including FHLBanks, up to an aggregate principal amount of $4.0 billion. As of October 31, 2014, no purchases had been made by the U.S. Treasury under this authorization.

Uses of Liquidity

We use our available liquidity, including proceeds from the issuance of consolidated obligations, primarily to repay consolidated obligations, fund advances, and purchase investments. During the nine months ended September 30, 2014, payments on consolidated obligations totaled $155.8 billion compared to $103.7 billion for the same period in 2013. A portion of these payments were due to the call and extinguishment of certain higher-costing par value bonds in an effort to better match our projected asset cash flows and reduce our future interest costs. During the nine months ended September 30, 2014 and 2013, we called bonds with a total par value of $2.8 billion and $1.4 billion and extinguished bonds with a total par value of $115.0 million and $162.1 billion.

During the nine months ended September 30, 2014, advance disbursements totaled $85.1 billion compared to $65.9 billion for the same period in 2013. The increase primarily was due to borrowings from a wide range of members, primarily driven by advances to large depository institution members during the year.

During the nine months ended September 30, 2014, investment purchases (excluding overnight investments) totaled $132.4 billion compared to $65.4 billion for the same period in 2013. Investment purchases increased primarily due to the purchase of money market investments, including secured resale agreements, in an effort to manage our liquidity position and counterparty credit risk.

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

Liquidity Requirements
Finance Agency regulations mandate three liquidity requirements. First, we are required to maintain contingent liquidity sufficient to meet our liquidity needs, which shall, at a minimum, cover five calendar days of inability to access the consolidated obligation debt markets. Second, we are required to have available at all times an amount greater than or equal to members' current deposits invested in advances with maturities not to exceed five years, deposits in banks or trust companies, and obligations of the U.S. Treasury. Third, we are required to maintain, in the aggregate, unpledged qualifying assets in an amount at least equal to the amount of our participation in total consolidated obligations outstanding. At September 30, 2014 and December 31, 2013 and throughout the nine months ended September 30, 2014, we were in compliance with all three of the Finance Agency liquidity requirements.

67

In addition to the liquidity measures previously discussed, the Finance Agency has provided us with guidance to maintain sufficient liquidity in an amount at least equal to our anticipated cash outflows under two different scenarios. One scenario (roll-off scenario) assumes that we cannot access the capital markets to issue debt for a period of 10 to 20 days with initial guidance set at 15 days and that during that time members do not renew any maturing, prepaid, and called advances. The second scenario (renew scenario) assumes that we cannot access the capital markets to issue debt for a period of three to seven days with initial guidance set at five days and that during that time we will automatically renew maturing and called advances for all members except very large, highly-rated members. This guidance is designed to protect against temporary disruptions in the debt markets that could lead to a reduction in market liquidity and thus the inability for us to provide advances to our members. At September 30, 2014 and December 31, 2013 and throughout the nine months ended September 30, 2014, we were in compliance with this liquidity guidance.

CAPITAL

Capital Requirements

We are subject to three regulatory capital requirements. First, the FHLBank Act requires that we maintain at all times permanent capital greater than or equal to the sum of our credit, market, and operations risk capital requirements, all calculated in accordance with Finance Agency regulations. Only permanent capital, defined as Class B capital stock, which includes mandatorily redeemable capital stock and retained earnings, can satisfy this risk-based capital requirement. Second, the FHLBank Act requires a minimum four percent capital-to-asset ratio, which is defined as total regulatory capital divided by total assets. Total regulatory capital includes all capital stock, including mandatorily redeemable capital stock, and retained earnings. It does not include AOCI. Third, the FHLBank Act imposes a five percent minimum leverage ratio, which is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 times, divided by total assets. At September 30, 2014 and December 31, 2013, we were in compliance with all three of the Finance Agency's regulatory capital requirements. Refer to "Item 1. Financial Statements — Note 12 — Capital" for additional information.

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

The capital stock requirements established in our Capital Plan are designed so that we remain adequately capitalized as member activity changes. Our Board of Directors may make adjustments to the capital stock requirements within ranges established in our Capital Plan.
Capital stock owned by members in excess of their capital stock requirement is deemed excess capital stock. Under our Capital Plan, we, at our discretion and upon 15 days' written notice, may repurchase excess membership capital stock. We, at our discretion, may also repurchase excess activity-based capital stock to the extent that (i) the excess capital stock balance exceeds an operational threshold set forth in the Capital Plan, which is currently set at zero, or (ii) a member submits a notice to redeem all or a portion of the excess activity-based capital stock. At September 30, 2014, we had excess capital stock of $0.1 million. At December 31, 2013, we had no excess capital stock outstanding.
The following table summarizes our regulatory capital stock by type of member (dollars in millions):
 
September 30,
2014
 
December 31,
2013
Commercial banks
$
2,296

 
$
1,619

Thrifts
114

 
96

Credit unions
121

 
106

Insurance companies
925

 
871

Total GAAP capital stock
3,456

 
2,692

Mandatorily redeemable capital stock
8

 
9

Total regulatory capital stock
$
3,464

 
$
2,701



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Retained Earnings
Our Enterprise Risk Management Policy (ERMP) requires a minimum retained earnings level based on the level of market risk, credit risk, and operational risk within the Bank. If realized financial performance results in actual retained earnings below the minimum level, we will establish an action plan as determined by our Board of Directors to enable us to return to our targeted level of retained earnings within twelve months. At September 30, 2014, our actual retained earnings were above the minimum level, and therefore no action plan was necessary.
The Bank entered into a Joint Capital Enhancement Agreement (JCE Agreement) with all of the other FHLBanks in February 2011. The JCE Agreement, as amended, is intended to enhance our capital position over time. It requires us to allocate 20 percent of our quarterly net income to a separate restricted retained earnings account until the balance of that account equals at least one percent of our average balance of outstanding consolidated obligations for the previous quarter. The restricted retained earnings are not available to pay dividends. At September 30, 2014 and December 31, 2013, our restricted retained earnings balance totaled $68.9 million and $50.8 million, representing ten and seven percent of total retained earnings. For more information on our JCE Agreement, refer to "Item 1. Business — Retained Earnings" in our 2013 Form 10-K.

Dividends

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

The following table summarizes dividend-related information (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Aggregate cash dividends paid
$
19.4

 
$
13.1

 
$
56.6

 
$
39.1

Effective combined annualized dividend rate paid on capital stock
2.81
%
 
2.59
%
 
2.80
%
 
2.59
%
Annualized dividend rate paid on membership capital stock
0.50
%
 
0.50
%
 
0.50
%
 
0.50
%
Annualized dividend rate paid on activity-based capital stock
3.50
%
 
3.50
%
 
3.50
%
 
3.50
%
Average three-month LIBOR
0.23
%
 
0.26
%
 
0.23
%
 
0.28
%

Critical Accounting Policies and Estimates

For a discussion of our critical accounting policies and estimates, refer to our 2013 Form 10-K. There have been no material changes to our critical accounting policies and estimates during the nine months ended September 30, 2014.


69

Bank Developments

Potential Merger

On July 31, 2014, our Bank and the Federal Home Loan Bank of Seattle (Seattle Bank) announced that we had entered into an exclusivity arrangement regarding a potential merger of the two banks. A detailed due diligence process was completed by both banks throughout the third quarter of 2014 for the purpose of weighing the long-term benefits and impact of a potential merger.

On September 25, 2014, the boards of both banks unanimously approved, and the banks executed, a definitive merger agreement. Material details of the merger agreement are included in the Bank's Form 8-K filed with the SEC on September 25, 2014. The closing of the merger is subject to certain closing conditions, including approval by the Finance Agency, as well as ratification by the member-owners of our Bank and the Seattle Bank. A merger application was sent to the Finance Agency for approval on October 31, 2014.

The boards of both banks believe that a merger would combine two complementary organizations with similar cultures, membership characteristics, and solid financial positions. The combined bank would remain a member-owned and member-centric cooperative, deeply focused on helping its members strengthen their institutions to better serve their customers and communities. It would provide funding solutions for more than 1,500 member financial institutions in 13 states and the U.S. Pacific territories. The combined bank is currently expected to be headquartered in Des Moines. 

Amended Employment Agreements

On November 10, 2014, the Bank entered into amended employment agreements with the following executive officers: Richard S. Swanson, President and Chief Executive Officer (CEO); Steven T. Schuler, Executive Vice President and Chief Financial Officer (CFO); Dusan Stojanovic, Executive Vice President and Chief Risk Officer; and Daniel D. Clute, Executive Vice President and Chief Business Officer. The primary substantive changes to the agreements were to revise the change in control benefits payable to these executive officers and to revise the agreements’ provisions regarding termination for “Good Reason.” The other changes to the agreements were technical and conforming in nature. The amended employment agreements supersede and replace the employment agreements previously in effect. The foregoing description of the amended employment agreements is qualified in its entirety by reference to the agreements themselves, copies of which are filed as exhibits to this quarterly report and incorporated herein by reference.

Legislative and Regulatory Developments

Joint Final Rule on Credit Risk Retention for Asset-Backed Securities

On October 22, 2014, the Finance Agency and other U.S. federal regulators jointly approved a final rule requiring sponsors of asset-backed securities (ABS) to retain credit risk in those transactions. The final rule largely retains the risk retention framework contained in the proposal issued by the agencies in August 2013 and generally requires sponsors of ABS to retain a minimum 5 percent economic interest in a portion of the credit risk of the assets collateralizing the ABS, unless all securitized assets satisfy specified qualifications. The final rule specifies criteria for qualified residential mortgage (QRM), commercial real estate, auto, and commercial loans that would make them exempt from the risk retention requirement. The definition of QRM is aligned with the definition of "qualified mortgage" (QM) as provided in Section 129C of the Truth in Lending Act, and its implementing regulations, as adopted by the Consumer Financial Protection Bureau. The QM definition requires, among other things, full documentation and verification of consumers' debt and income and a debt-to-income ratio that does not exceed 43 percent; and restricts the use of certain product features, such as negative amortization and interest-only and balloon payments.

Other exemptions from the credit risk requirement include certain mortgage loans secured by three-to-four unit residential properties that meet the criteria for QM and certain types of community-focused residential mortgages (including extensions of credit made by community development financial institutions). The final rule also includes a provision that requires the agencies to periodically review the definition of QRM, the exemption for certain community-focused residential mortgages, and the exemption for certain three-to four unit residential mortgage loans and consider whether they should be modified.

    

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The final rule exempts agency MBS from the risk retention requirements as long as the sponsoring agency is operating under the conservatorship or receivership of the Finance Agency and fully guarantees the timely payment of principal and interest on all assets in the issued security. Further, MBS issued by any limited-life regulated entity succeeding to either Fannie Mae or Freddie Mac operating with capital support from the United States would be exempt from the risk retention requirements. The final rule will be effective one year after publication in the Federal Register for the residential mortgage-backed securitizations and two years after publication for all other securitization types. The Bank is currently assessing the impact of the final rule and has not yet determined the effect, if any, that this rule may have on the Bank's operations.

Federal Home Loan Bank Capital Stock and Capital Plans

The Finance Agency issued on October 8, 2014, a proposed rule that would transfer existing parts 931 and 933 of the Federal Housing Finance Board regulations, which address requirements for FHLBanks’ capital stock and capital plans, to new Part 1277 of the Finance Agency regulations (Capital Proposed Rule). The Capital Proposed Rule would not make any substantive changes to these requirements, but would delete certain provisions that applied only to the one-time conversion of FHLBank stock to the new capital structure required by the Gramm-Leach-Bliley Act. The Capital Proposed Rule would also make certain clarifying changes so that the rules would more precisely reflect long-standing practices and requirements with regard to transactions in FHLBank stock. The Capital Proposed Rule would add appropriate references to ‘‘former members’’ to clarify when former FHLBank members can be required to maintain investment in FHLBank capital stock after withdrawal from the FHLBank. The Bank is currently evaluating the Capital Proposed Rule. Comments on the Capital Proposed Rule are due by December 8, 2014.

Federal Housing Finance Agency Proposed Rule
The Finance Agency issued on September 12, 2014, a proposed rule that would:
•
Impose a new test on all FHLBank members that requires them to maintain at least one percent of their assets in first-lien home mortgage loans, including MBS, on an ongoing basis, with maturities of five years or more to maintain their membership in the FHLBanks. The proposal also suggests the possibility of a two percent or a five percent test as options.

•
Require all insured depository members (other than FDIC-insured depositories with less than $1.1 billion in assets) to maintain, on an ongoing basis, at least 10 percent of their assets in a broader range of residential mortgage loans, including those secured by junior liens and MBS, in order to maintain their membership in the FHLBanks.

•
Eliminate all currently eligible captive insurance companies from FHLBank membership. Current captive insurance company members would have their memberships terminated five years after this rule is finalized; there would be restrictions on the level and maturity of advances that FHLBanks could make to these members during the sunset period; and any new captive insurance members admitted after the date of the proposed rule would have their memberships and advances terminated upon issuance of a final rule.

•
Clarify how an FHLBank should determine the “principal place of business” of an insurance company or community development financial institution for purposes of membership. Current rules define an institution’s “principal place of business” as the state in which it maintains its home office. The proposal would add a second component requiring an institution to conduct business operations from the home office for that state to be considered its principal place of business. The changes would apply prospectively.

Comments on the proposed rule are due by January 12, 2015. The Bank is currently evaluating the proposed rule. Refer to "Item 1A. Risk Factors" for a discussion of the potential impact of the proposed rule on the Bank.


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Basel Committee on Bank Supervision - Liquidity Coverage Ratio

On September 3, 2014, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (Banking Agencies) finalized the liquidity coverage ratio (LCR) rule, applicable to: (i) U.S. banking organizations with $250 billion or more in consolidated total assets or $10 billion or more in total on-balance sheet foreign exposure, and their consolidated subsidiary depository institutions with $10 billion or more in total consolidated assets; and (ii) certain other U.S. bank or savings and loan holding companies having at least $50 billion in total consolidated assets. The LCR rule requires such covered companies to maintain a stock of “high quality liquid assets” (HQLA) that is no less than 100 percent of their total net cash outflows over a prospective 30-day stress period. Among other things, the final rule defines the various categories of HQLA, called Levels 1, 2A, or 2B. The treatment of HQLAs for the LCR is most favorable under the Level 1 category, less favorable under the Level 2A category, and least favorable under the Level 2B category.

Under the final rule, collateral pledged to the FHLBanks but not securing existing borrowings may be considered eligible HQLA to the extent the collateral itself qualifies as eligible HQLA; qualifying FHLBank System consolidated obligations are categorized as Level 2A HQLAs; and the amount of a covered company’s funding that is assumed to run off includes 25 percent of FHLBank advances maturing within 30 days, to the extent such advances are not secured by level 1 or level 2A HQLA, where 0 percent and 15 percent run-off assumptions apply, respectively.  At this time, the impact of the final rule is uncertain. The final rule requires that all covered companies be fully compliant by January 1, 2017.

Margin and Capital Requirements for Covered Swap Entities

On September 3, 2014, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the Finance Agency (collectively, the Agencies), jointly proposed a rule to establish minimum margin collection requirements for registered swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants (collectively, Swap Entities) that are subject to the jurisdiction of one of the Agencies (the Proposed Rule). In addition, the Proposed Rule affords the Agencies discretion to subject other persons to the Proposed Rule’s requirements (such persons, together with Swap Entities, Covered Swap Entities). Comments on the Proposed Rule are due by November 24, 2014.

In addition, on September 17, 2014, the Commodity Futures Trading Commission (CFTC) adopted its version of the Proposed Rule (CFTC Proposed Rule) that generally mirrors the Proposed Rule. The CFTC Proposed Rule will only apply to a limited number of registered swap dealers and major swap participants that are not subject to the jurisdiction of one of the Agencies. Comments on the CFTC Proposed Rule are due by December 2, 2014.
The Proposed Rule would subject non-cleared swaps and non-cleared security-based swaps between Covered Swap Entities, and between Covered Swap Entities and financial end users that have material swaps exposure to a mandatory two-way initial margin requirement. The amount of initial margin required to be posted would be either the amount calculated using a standardized schedule set forth in the Proposed Rule, which provides the gross initial margin (as a percentage of total notional exposure) for certain asset classes, or an internal margin model conforming to the requirements of the Proposed Rule that is approved by the applicable Agency. The Proposed Rule specifies the types of collateral that may be posted as initial margin (generally, cash, government securities, liquid debt, equity securities and gold); and sets forth haircuts for certain collateral asset classes. Initial margin must be segregated with an independent, third-party custodian and may not be rehypothecated.
The Proposed Rule would require variation margin to be exchanged daily for non-cleared swaps and non-cleared security-based swaps between Covered Swap Entities and between Covered Swap Entities and all financial end users (without regard to the swaps exposure of the particular financial end-user). The variation margin amount is the daily mark-to-market change in the value of the swap to the Covered Swap Entity, taking into account variation margin previously paid or collected. Variation margin may only be paid in cash, is not subject to segregation with an independent, third-party custodian, and may, if permitted by contract, be rehypothecated.
Under the Proposed Rule, the variation margin requirement would become effective on December 1, 2015 and the initial margin requirement would be phased in over a four-year period commencing on that date. For entities that have less than a $1 trillion notional amount of non-cleared derivatives, the Proposed Rule’s initial margin requirement would not come into effect until December 1, 2019.
The Bank would not be a Covered Swap Entity under the Proposed Rule, although the Finance Agency has discretion to designate the Bank a Covered Swap Entity. Rather, the Bank would be a financial end-user under the Proposed Rule, and it would likely have material swaps exposure upon the effective date of the Proposed Rule’s initial margin requirement.

72

Since the Bank is currently posting and collecting variation margin on its non-cleared swaps, it is not anticipated that the Proposed Rule’s variation margin requirement, if adopted, would have a material impact on the Bank’s costs. However, if the Proposed Rule’s initial margin requirement is adopted, it is anticipated that the Bank’s cost of engaging in non-cleared swaps would increase.
Money Market Mutual Fund Reform

On June 19, 2013, the SEC proposed two alternatives for amending rules that govern money market mutual funds under the Investment Company Act of 1940. On July 23, 2014, the SEC approved final rule amendments that, among other things, will:

•
Require institutional prime money market funds (including institutional municipal money market funds) to sell and redeem shares based on their floating net asset value, which would result in the daily share prices of the money market funds fluctuating along with changes in the market-based value of the funds’ investments;

•
Allow money market fund boards of directors to directly address a run on a fund by imposing liquidity fees or suspending redemptions temporarily; and

•
Include enhanced diversification, disclosure and stress testing requirements as well as provide updated reporting by money market funds and private funds that operate like money market funds.

The rule amendments do not change the existing regulatory treatment of FHLBanks’ consolidated obligations as liquid assets. FHLBank consolidated discount notes continue to be included in the definition of “daily liquid assets,” and the definition of “weekly liquid assets” continues to include FHLBank consolidated discount notes with a remaining maturity up to 60 days. At this time, the future impact of these regulations on demand for FHLBank consolidated obligations is unknown.

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

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

MARKET RISK

We define market risk as the risk that MVCS or net income will change as a result of changes in market conditions, such as interest rates, spreads, and volatilities. Interest rate risk, including mortgage prepayment risk, was our predominant type of market risk exposure during the nine months ended September 30, 2014 and 2013. Our general approach toward managing interest rate risk is to acquire and maintain a portfolio of assets and liabilities, which, taken together, limit our expected exposure to interest rate risk. Management regularly reviews our sensitivity to interest rate changes by monitoring our market risk measures in parallel and non-parallel interest rate shifts and spread and volatility movements.

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

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


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

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

We monitor and manage to the MVCS policy limits to ensure the stability of the Bank's value. As of September 30, 2014, the policy limits for MVCS are 2.2 percent, 5 percent, and 12 percent declines from the base case in the up and down 50, 100, and 200 basis point parallel interest rate shift scenarios and 2.5 percent, 5.5 percent, and 13 percent declines from the base case in the up and down 50, 100, and 200 basis point non-parallel interest rate shift scenarios. Any breach of policy limits requires an immediate action to bring the exposure back within policy limits, as well as a report to the Board of Directors.

During the first quarter of 2008, due to the low interest rate environment, our Board of Directors suspended indefinitely the policy limit pertaining to the down 200 basis point parallel interest rate shift scenario. In October 2012, our Board of Directors amended the suspension by approving a rule for compliance to the down 200 basis point scenario that reinstates/suspends the associated policy limit when the 10-year swap rate increases above/drops below the 2.50 percent and remains so for five consecutive days. At September 30, 2014 and December 31, 2013, the 10-year swap rate was above 2.50 percent and therefore the associated policy limit was applicable.

The following tables show our base case and change from base case MVCS in dollars per share and percent change respectively, based on outstanding shares, including shares classified as mandatorily redeemable, assuming instantaneous parallel shifts in interest rates at September 30, 2014 and December 31, 2013:
 
Market Value of Capital Stock (dollars per share)
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
September
$
116.0

 
$
120.8

 
$
122.7

 
$
122.7

 
$
122.6

 
$
121.9

 
$
119.2

December
$
114.8

 
$
120.1

 
$
121.5

 
$
121.2

 
$
120.3

 
$
119.1

 
$
115.8

 
% Change from Base Case
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
September
(5.5
)%
 
(1.6
)%
 
—
%
 
—
%
 
—
 %
 
(0.7
)%
 
(2.9
)%
December
(5.3
)%
 
(0.9
)%
 
0.3
%
 
—
%
 
(0.7
)%
 
(1.7
)%
 
(4.4
)%

The following tables show our base case and change from base case MVCS in dollars per share and percent change respectively, based on outstanding shares, including shares classified as mandatorily redeemable, assuming instantaneous non-parallel shifts in interest rates at September 30, 2014 and December 31, 2013:
 
Market Value of Capital Stock (dollars per share)
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
September
$
121.2

 
$
122.6

 
$
122.9

 
$
122.7

 
$
122.8

 
$
121.9

 
$
118.7

December
$
122.0

 
$
122.7

 
$
122.3

 
$
121.2

 
$
120.0

 
$
117.7

 
$
115.8

 
% Change from Base Case
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
September
(1.2
)%
 
(0.1
)%
 
0.2
%
 
—
%
 
0.1
 %
 
(0.6
)%
 
(3.3
)%
December
0.7
 %
 
1.2
 %
 
0.9
%
 
—
%
 
(1.0
)%
 
(2.9
)%
 
(4.4
)%

The increase in our base case MVCS at September 30, 2014 when compared to December 31, 2013 was primarily attributable to the following factors:

•
Option-adjusted spread: The spread between mortgage interest rates and LIBOR, adjusted for the mortgage prepayment option, decreased at September 30, 2014 when compared to December 31, 2013. This had a positive impact on MVCS as it increased the value of mortgage-related assets.



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

The increase in our base case MVCS at September 30, 2014 was partially offset by an increase in activity-based capital stock driven by higher advance growth and decreased funding costs relative to the LIBOR swap curve. During the first nine months of 2014, our advance activity with members increased, and therefore our activity-based capital stock balances increased. As we issued this activity-based capital stock at par, which is below our current MVCS level, our MVCS was negatively impacted. In addition, our funding costs relative to the LIBOR swap curve decreased in the first nine months of 2014, thereby increasing the present value of our liabilities that fund mortgage assets and decreasing MVCS.

Projected Income Sensitivity

We monitor projected 24-month income sensitivity to limit short-term earnings volatility of the Bank. The projected 24-month income simulation policy limit is based on forward interest rates and business assumptions. The income sensitivity policy limit specifies a floor on our projected earned dividend for each shock scenario. Our earned dividend is computed as an annualized ratio of projected net income to average projected capital stock over the projection horizon. We were in compliance with the projected 24-month income simulation policy limit at September 30, 2014 and December 31, 2013.

CAPITAL ADEQUACY

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

Economic Value of Capital Stock

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

The following table shows EVCS in dollars per share based on outstanding shares, including shares classified as mandatorily redeemable, at September 30, 2014 and December 31, 2013:
Economic Value of Capital Stock (dollars per share)
September
$
128.1

December
$
123.5

    
The increase in our EVCS at September 30, 2014 when compared to December 31, 2013 was primarily attributable to the following factors:

•
Decreased funding costs relative to the LIBOR swap curve. Our funding costs relative to the LIBOR swap curve decreased at September 30, 2014 when compared to December 31, 2013. This had a positive impact on EVCS mainly through its impact on the value of mortgage-related assets and their associated funding.

•
Slope of yield curves. The slope of the yield curves used to discount cash flows flattened at September 30, 2014 when compared to December 31, 2013. This had a positive impact on EVCS as the flattening of the yield curves increased the value of long-term mortgage-related assets and reduced the value of short-term funding.

The increase in our base case EVCS at September 30, 2014 was partially offset by an increase in activity-based capital stock driven by higher advance growth. During the first nine months of 2014, our advance activity with members increased, and therefore our activity-based capital stock balances increased. As we issued this activity-based capital stock at par, which is below our current EVCS level, our EVCS was negatively impacted.


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Retained Earnings Minimum Level and Regulatory Capital Requirements

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

LIQUIDITY RISK

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

CREDIT RISK

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

Advances

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

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

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

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


76

Although management has policies and procedures in place to manage credit risk, we may be exposed to this risk if our outstanding advance value exceeds the liquidation value of our collateral. We mitigate this risk by applying collateral discounts or haircuts to the unpaid principal balance or market value, if available, of the collateral to determine the advance equivalent value of the collateral securing each borrower's obligation. The amount of these discounts will vary based on the type of collateral and security agreement. We determine these discounts or haircuts using data based upon historical price changes, discounted cash flow analyses, and loan level modeling.
 
At September 30, 2014 and December 31, 2013, borrowers pledged $168.0 billion and $140.1 billion of collateral (net of applicable discounts) to support activity with us, including advances. At September 30, 2014 and December 31, 2013, our advance balances were $64.2 billion and $45.7 billion. Borrowers pledge collateral in excess of their collateral requirement mainly to demonstrate available liquidity and to borrow additional amounts in the future.

Based upon our collateral and lending policies, the collateral held as security, and the repayment history on credit products, management has determined that there are no probable credit losses on our credit products as of September 30, 2014 and December 31, 2013. Accordingly, we have not recorded any allowance for credit losses on our credit products.

Mortgage Assets

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

MPF LOANS

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

The following table presents the unpaid principal balance of our MPF portfolio by product type (dollars in millions):
Product Type
 
September 30,
2014
 
December 31,
2013
Original MPF
 
$
850

 
$
842

MPF 100
 
30

 
35

MPF 125
 
3,792

 
3,629

MPF Plus
 
1,212

 
1,439

MPF Government
 
567

 
547

Total unpaid principal balance
 
$
6,451

 
$
6,492


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

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

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


77

Allowance for Credit Losses. We utilize an allowance for credit losses to reserve for estimated losses in our conventional mortgage portfolio. During the three and nine months ended September 30, 2014, we recorded reversals for credit losses on our mortgage loans of $1.4 million and $1.7 million due to a reduction in loan delinquencies and improvements in housing market forecasts. For the three and nine months ended September 30, 2013, we did not record a provision or reversal for credit losses on our mortgage loans. Refer to “Item 1. Financial Statements — Note 9 — Allowance for Credit Losses” for additional information on our allowance for credit losses.

The following table presents a rollforward of the allowance for credit losses on our conventional mortgage loans (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Balance, beginning of period
$
7.2

 
$
14.7

 
$
8.0

 
$
15.8

Charge-offs
(0.2
)
 
(0.5
)
 
(0.7
)
 
(1.6
)
Reversal for credit losses on mortgage loans
(1.4
)
 
—

 
(1.7
)
 
—

Balance, end of period
$
5.6

 
$
14.2

 
$
5.6

 
$
14.2


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

Investments

We maintain an investment portfolio primarily to provide investment income and liquidity. Our short-term portfolio may include, but is not limited to, interest-bearing deposits, Federal funds sold, securities purchased under agreements to resell, certificates of deposit, and commercial paper. Our long-term portfolio may include, but is not limited to, other U.S. obligations, GSE obligations, state or local housing agency obligations, taxable municipal bonds, and MBS.

Our primary credit risk on investments is the counterparties' ability to meet repayment terms. We mitigate this credit risk by purchasing investment quality securities. We define investment quality as a security with adequate financial backings so that full and timely payment of principal and interest on such security is expected and there is minimal risk that the timely payment of principal and interest would not occur because of adverse changes in economic and financial conditions during the projected life of the security. We consider a variety of credit quality factors when analyzing potential investments, including collateral performance, marketability, asset class or sector considerations, local and regional economic conditions, nationally recognized statistical rating organization (NRSRO) credit ratings, and/or the financial health of the underlying issuer.

REGULATORY RESTRICTIONS

On November 8, 2013, the Finance Agency issued a final rule implementing Section 939A of the Dodd-Frank Act, which requires Federal agencies to remove provisions from their regulations that require the use of ratings issued by NRSROs. The final rule requires us to make our own determination of credit quality with respect to our investments, but does not prevent us from using NRSRO ratings or other third party analysis in our credit determinations. The final rule became effective on May 7, 2014.
 
To minimize credit risk on investments, the Finance Agency 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;

•
debt instruments that are not investment quality, other than certain investments targeted at low-income persons or communities and instruments that became less than investment quality after acquisition;


78

•
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 that are investment quality; (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.

UNSECURED CREDIT RISK

We face credit risk from unsecured exposures primarily within our short-term portfolio. While unsecured, we do not consider investments issued or guaranteed by the U.S. Government, an agency or instrumentality of the U.S. Government, or the FDIC to be a credit risk exposure.

We are prohibited from investing in financial instruments issued by non-U.S. entities other than those issued by U.S. branches and agency offices of foreign commercial banks. Our unsecured credit exposures to U.S. branches and agency offices of foreign commercial banks include the risk that, as a result of political or economic conditions in a country, the counterparty may be unable to meet their contractual repayment obligations. Our unsecured credit exposures to domestic counterparties and U.S. subsidiaries of foreign commercial banks include the risk that these counterparties have extended credit to foreign counterparties. We were in compliance with the above regulation and did not own any financial instruments issued by non-U.S. entities, other than those issued by U.S. branches and agency offices of foreign commercial banks, as of September 30, 2014.

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

Our unsecured credit exposure may consist of the following overnight investment types:

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

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


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At September 30, 2014, our unsecured investment exposure consisted of overnight Federal funds sold. The following table presents our unsecured investment exposure by counterparty credit rating and domicile at September 30, 2014 (excluding accrued interest receivable) (dollars in millions):
 
 
Credit Rating1
Domicile of Counterparty
 
AA
 
A
 
BBB
 
Total
Domestic
 
$
—

 
$
—

 
$
485

 
$
485

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

 
—

 
—

 
300

Canada
 
—

 
650

 
—

 
650

Finland
 
300

 
—

 
—

 
300

Germany
 
—

 
300

 
—

 
300

Netherlands
 
300

 
—

 
—

 
300

Norway
 
—

 
300

 
—

 
300

Total U.S. branches and agency offices of foreign commercial banks
 
900

 
1,250

 
—

 
2,150

Total unsecured investment exposure
 
$
900

 
$
1,250

 
$
485

 
$
2,635


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

INVESTMENT RATINGS

The following table summarizes the carrying value of our investments by credit rating at September 30, 2014 (dollars in millions):
 
September 30, 2014
 
Credit Rating1
 
AAA
 
AA
 
A
 
BBB
 
BB
 
Unrated
 
Total
Interest-bearing deposits2
$
—

 
$
2

 
$
—

 
$
—

 
$
—

 
$
—

 
$
2

Securities purchased under agreements to resell
—

 
700

 
—

 
—

 
—

 
1,360

 
2,060

Federal funds sold
—

 
900

 
1,250

 
485

 
—

 
—

 
2,635

Investment securities:


 


 


 


 


 


 
 
Mortgage-backed securities


 


 


 


 


 


 
 
GSE residential
—

 
9,455

 
—

 
—

 
—

 
—

 
9,455

Other U.S. obligations residential
—

 
1,378

 
—

 
—

 
—

 
—

 
1,378

Other U.S. obligations commercial
—

 
1

 
—

 
—

 
—

 
—

 
1

Private-label residential
—

 
—

 
9

 
14

 
3

 
—

 
26

Total mortgage-backed securities
—

 
10,834

 
9

 
14

 
3

 
—

 
10,860

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

 
427

 
—

 
—

 
—

 
—

 
427

GSE obligations
—

 
1,420

 
—

 
—

 
—

 
—

 
1,420

State or local housing agency obligations
23

 
66

 
—

 
—

 
—

 
—

 
89

Other
352

 
103

 
—

 
—

 
—

 
—

 
455

Total non-mortgage-backed securities
375

 
2,016

 
—

 
—

 
—

 
—

 
2,391

Total investments3
$
375

 
$
14,452

 
$
1,259

 
$
499

 
$
3

 
$
1,360

 
$
17,948


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

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

3
At September 30, 2014, 15 percent of our total investments were unsecured.

80

The following table summarizes the carrying value of our investments by credit rating at December 31, 2013 (dollars in millions):
 
December 31, 2013
 
Credit Rating1
 
AAA
 
AA
 
A
 
BBB
 
BB
 
Unrated
 
Total
Interest-bearing deposits2
$
—

 
$
2

 
$
—

 
$
—

 
$
—

 
$
—

 
$
2

Securities purchased under agreements to resell
—

 
3,700

 
3,300

 
—

 
—

 
1,200

 
8,200

Federal funds sold
—

 
—

 
900

 
300

 
—

 
—

 
1,200

Investment securities:


 


 


 


 


 


 
 
Mortgage-backed securities


 


 


 


 


 


 
 
GSE residential
—

 
8,132

 
—

 
—

 
—

 
—

 
8,132

Other U.S. obligations residential
—

 
5

 
—

 
—

 
—

 
—

 
5

Other U.S. obligations commercial
—

 
2

 
—

 
—

 
—

 
—

 
2

Private-label residential
—

 
—

 
10

 
17

 
3

 
—

 
30

Total mortgage-backed securities
—

 
8,139

 
10

 
17

 
3

 
—

 
8,169

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

 
448

 
—

 
—

 
—

 
—

 
448

GSE obligations
—

 
1,489

 
—

 
—

 
—

 
—

 
1,489

State or local housing agency obligations
23

 
72

 
—

 
—

 
—

 
—

 
95

Other3
331

 
196

 
—

 
—

 
—

 
1

 
528

Total non-mortgage-backed securities
354

 
2,205

 
—

 
—

 
—

 
1

 
2,560

Total investments4
$
354

 
$
14,046

 
$
4,210

 
$
317

 
$
3

 
$
1,201

 
$
20,131


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

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

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

4
At December 31, 2013, six percent of our total investments were unsecured.
    
Our total investments decreased at September 30, 2014 when compared to December 31, 2013. The decrease was primarily due to a reduction in short-term investments as there were limited opportunities to reinvest maturities which occurred before the end of the third quarter. This was partially offset by the purchase of GSE and other U.S. obligation MBS during the year.

MORTGAGE-BACKED SECURITIES

We limit our investments in MBS to those guaranteed by the U.S. Government, issued by a GSE, or those we deem to be investment quality at the time of purchase. We are exposed to credit risk to the extent these MBS fail to perform adequately. We perform ongoing analysis on these investments to determine potential credit issues. At September 30, 2014 and December 31, 2013, we owned $10.9 billion and $8.2 billion of MBS, of which approximately 99.8 percent and 99.6 percent were guaranteed by the U.S. Government or issued by GSEs and 0.2 percent and 0.4 percent were private-label MBS.


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Our private-label MBS are variable rate securities backed by prime loans that were securitized prior to 2004. We record these investments as HTM. The following table summarizes characteristics of our private-label MBS (dollars in millions):
 
 
September 30, 2014
Credit rating:
 
 
 A
 
$
8

BBB
 
14

BB
 
4

Total unpaid principal balance
 
$
26

 
 
 
Amortized cost
 
$
26

Gross unrealized gains
 
1

Gross unrealized losses
 
(1
)
Fair value
 
$
26

 
 
 
Weighted average percentage of fair value to unpaid principal balance
 
98.9
%
Original weighted average FICO® score
 
725

Original weighted average credit support1
 
3.9
%
Weighted average credit support2
 
12.0
%
Weighted average collateral delinquency rate3
 
7.8
%

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

2
Based on the credit support as of September 30, 2014 and is calculated using the current unpaid principal balance of the individual securities.

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

At September 30, 2014, we did not consider any of our private-label MBS to be other-than-temporarily impaired. For more information on our evaluation of OTTI, refer to “Item 1. Financial Statements — Note 6 — Other-Than-Temporary Impairment.”

Derivatives

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

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

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

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

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

82

The following tables show our derivative counterparty credit exposure (dollars in millions):
 
 
September 30, 2014
Credit Rating1
 
Notional Amount
 
Net Derivatives
Fair Value Before Collateral
 
Cash Collateral Pledged
To (From) Counterparty
 
Net Credit Exposure
 to Counterparties
Non-member counterparties:
 
 
 
 
 
 
 
 
Asset positions with credit exposure
 
 
 
 
 
 
 
 
Bilateral derivatives
 
 
 
 
 
 
 
 
   A
 
$
7,143

 
$
12

 
$
(5
)
 
$
7

   Cleared derivatives2, 3
 
4

 
—

 
—

 
—

Liability positions with credit exposure
 
 
 
 
 
 
 
 
Bilateral derivatives
 
 
 
 
 
 
 
 
   A
 
3,635

 
(57
)
 
58

 
1

BBB
 
4,558

 
(45
)
 
46

 
1

Cleared derivatives2
 
14,996

 
(72
)
 
158

 
86

Total derivative positions with credit exposure to non-member counterparties
 
30,336

 
(162
)
 
257

 
95

Member institutions3,4
 
61

 
—

 
—

 
—

Total
 
30,397

 
$
(162
)
 
$
257

 
$
95

Derivative positions without credit exposure
 
6,500

 
 
 
 
 
 
Total notional
 
$
36,897

 
 
 
 
 
 

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

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

 
$
14

 
$
(13
)
 
$
1

   A
 
3,208

 
51

 
(41
)
 
10

   Cleared derivatives2
 
18,980

 
40

 
39

 
79

Liability positions with credit exposure
 
 
 
 
 
 
 


Bilateral derivatives
 
 
 
 
 
 
 
 
   A
 
3,095

 
(68
)
 
71

 
3

BBB3
 
2,853

 
(69
)
 
69

 
—

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

 
(32
)
 
125

 
93

Member institutions3,4
 
4

 
—

 
—

 
—

Total
 
28,861

 
$
(32
)
 
$
125

 
$
93

Derivative positions without credit exposure
 
5,492

 
 
 
 
 


Total notional
 
$
34,353

 


 


 



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

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

3
Net credit exposure is less than $1.0 million.

4
Represents mortgage delivery commitments with our member institutions.


OPERATIONAL RISK

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

83

BUSINESS RISK

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

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

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

Internal Control Over Financial Reporting

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

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

Finance Agency proposed rule could materially impact the Bank's financial condition and results of operations.

On September 12, 2014, the Finance Agency issued a proposed rule that would change the eligibility requirements for FHLBank members by, among other things, imposing new ongoing membership requirements and eliminating currently eligible captive insurance companies from FHLBank membership. Refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations—Legislative and Regulatory Developments" for additional discussion of the proposed rule.

If the proposed rule is adopted in its current form, it is expected that the Bank's financial condition and results of operations could be materially impacted. Most significantly, our current captive insurance company members would have their memberships terminated five years after the rule is finalized. As of September 30, 2014, we have seven captive insurance company members, with total advances outstanding to these members of $3.8 billion, representing 5.9 percent of our total advances outstanding.

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The proposed merger is subject to certain closing conditions, including regulatory approval and approval of members of the Bank and of the Seattle Bank, which may not be received, may take longer than expected or may impose conditions that are not presently anticipated or that could have an adverse effect on the continuing bank following the merger.

There are significant risks and uncertainties associated with our proposed merger with the Seattle Bank (the Merger) that could delay or prevent the completion of the Merger. Before the Merger may be completed, the banks must obtain Finance Agency regulatory approval on the jointly prepared merger application that was submitted on October 31, 2014. Once the Finance Agency has approved the application, the members of both banks must vote on whether to ratify the Merger. No assurance can be given as to whether or when these approvals will be received. General economic and financial market conditions, and other internal and external factors may also affect the ability to complete the Merger. The Finance Agency may also impose conditions on the completion of the Merger or require changes to the terms of the merger agreement. Such conditions or changes could have the effect of delaying or preventing completion of the Merger or imposing additional costs on or limiting the revenues of the continuing bank, any of which might have an adverse effect on the continuing bank following the Merger.

If the Merger is not completed, we will have incurred substantial expenses without realizing the expected benefits of the Merger.

We have devoted significant internal resources to the pursuit of this Merger and the expected benefit of those resource allocations would be lost if the Merger is not completed. Additionally, the merger agreement provides that we must pay a termination fee in the amount of $57 million in the event that the merger agreement is terminated under certain circumstances. Payment of the termination fee would require us to use available resources that would have otherwise been available for other operating purposes.

Combining the two banks may be more difficult, costly or time consuming than expected and the anticipated benefits and cost savings of the Merger may not be realized.

The Bank and the Seattle Bank have operated and, until the completion of the Merger, will continue to operate, independently. The success of the Merger, including anticipated benefits and cost savings, will depend, in part, on the continuing bank's ability to successfully combine and integrate the businesses of the two banks in a manner that permits growth opportunities and does not materially disrupt the existing member relations nor result in decreased revenues due to loss of members. It is possible that the integration process could result in the loss of key employees, the disruption of either bank's ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the continuing bank's ability to maintain relationships with its members and employees or to achieve the anticipated benefits and cost savings of the Merger. If difficulties with the integration process are encountered, the anticipated benefits of the Merger may not be realized fully or at all, or may take longer to realize than expected. There also may be business disruptions that cause us to lose members or cause members to withdraw their membership. Integration efforts will also divert management attention and resources. These integration matters could have an adverse effect on us during this transition period and for an undetermined period after completion of the Merger.

For additional discussion of our risk factors, refer to our 2013 Form 10-K.

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

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.


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ITEM 6. EXHIBITS

2.1
Agreement and Plan of Merger between the Federal Home Loan Bank of Des Moines and the Federal Home Loan Bank of Seattle dated September 25, 20141
3.1
Organization Certificate of the Federal Home Loan Bank of Des Moines dated October 13, 19322
3.2
Bylaws of the Federal Home Loan Bank of Des Moines, as amended and restated effective February 26, 20093
4.1
Federal Home Loan Bank of Des Moines Capital Plan, as amended, approved by the Federal Housing Finance Agency on August 5, 2011 and effective September 5, 20114
10.1
Integration Performance Incentive Plan, effective as of September 18, 20145
10.2
Amended Severance Policy, effective as of September 18, 20145
10.3
Enhanced Severance Policy Plan, effective as of September 18, 20145
10.4
Employment Agreement with Richard S. Swanson, dated as of November 10, 2014
10.5
Employment Agreement with Steven T. Schuler, dated as of November 10, 2014
10.6
Employment Agreement with Dusan Stojanovic, dated as of November 10, 2014
10.7
Employment Agreement with Daniel D. Clute, dated as of November 10, 2014
31.1
Certification of the President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of the Executive Vice President and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of the President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of the Executive Vice President and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101
The following financial information from the Bank's Third Quarter 2014 Form 10-Q, formatted in XBRL (Extensible Business Reporting Language): (i) Statements of Condition at September 30, 2014 and December 31, 2013, (ii) Statements of Income for the Three and Nine Months Ended September 30, 2014 and 2013, (iii) Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2014 and 2013, (iv) Statements of Capital as of September 30, 2014 and September 30, 2013, (v) Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013, and (vi) Condensed Notes to the Unaudited Financial Statements

1
Incorporated by reference to our Form 8-K filed with the SEC on September 25, 2014 (Commission File No. 000-51999).
    
2
Incorporated by reference to the correspondingly numbered exhibit to our Registration Statement on Form 10 filed with the SEC on May 12, 2006 (Commission File No. 000-51999).

3
Incorporated by reference to the correspondingly numbered exhibit to our Form 8-K filed with the SEC on March 2, 2009 (Commission File No. 000-51999).

4
Incorporated by reference to exhibit 99.2 of our Form 8-K filed with the SEC on July 17, 2013 (Commission File No. 000-51999).

5
Refer to our Form 8-K filed with the SEC on September 24, 2014 for additional information (Commission File No. 000-51999).


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SIGNATURES

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

FEDERAL HOME LOAN BANK OF DES MOINES
 
 
(Registrant)
 
 
 
 
 
 
 
Date:
 
November 12, 2014
 
 
 
 
 
 
 
 
 
 
 
 
By:
 
/s/ Richard S. Swanson
 
 
 
Richard S. Swanson
President and Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
 
 
 
By:
 
/s/ Ardis E. Kelley
 
 
 
 
Ardis E. Kelley
Senior Vice President and Chief Accounting Officer
(Principal Accounting Officer)
 
 
 


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