10-Q 1 fhlb09301610q.htm FORM 10-Q - FHLB DES MOINES Q3 2016 Document
 
 
 
 
 
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, 2016
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, 2016
 
Class B Stock, par value $100
 
62,272,305
 
 
 
 
 
 
 
 
 



Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Note 15 - Activities with Stockholders
 
 
 
 
 
 
Note 16 - Activities with Other FHLBanks
 
 
 
 
 
 
Note 17 - Subsequent Events
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CONDITION
(dollars and shares in millions, except capital stock par value)
(Unaudited)
 
 
September 30,
2016
 
December 31,
2015
ASSETS
 
 
 
 
Cash and due from banks
 
$
245

 
$
982

Interest-bearing deposits
 
2

 
2

Securities purchased under agreements to resell
 
6,250

 
6,775

Federal funds sold
 
4,635

 
2,270

Investment securities
 
 
 
 
Trading securities (Note 3)
 
4,077

 
4,047

Available-for-sale securities (Note 4)
 
22,931

 
20,988

Held-to-maturity securities (fair value of $5,051 and $6,142) (Note 5)
 
4,956

 
6,085

Total investment securities
 
31,964

 
31,120

Advances (includes $2 and $8 at fair value under the fair value option) (Note 7)
 
125,828

 
89,173

Mortgage loans held for portfolio, net of allowance for credit losses of $2 and $1 (Notes 8 and 9)
 
6,792

 
6,755

Accrued interest receivable
 
187

 
143

Premises, software, and equipment, net
 
27

 
25

Derivative assets, net (Note 10)
 
109

 
94

Other assets
 
35

 
35

TOTAL ASSETS
 
$
176,074

 
$
137,374

LIABILITIES
 
 
 
 
Deposits
 
 
 
 
Interest-bearing
 
$
916

 
$
924

Non-interest-bearing
 
117

 
186

Total deposits
 
1,033

 
1,110

Consolidated obligations (Note 11)
 
 
 
 
Discount notes
 
84,481

 
98,990

Bonds (includes $0 and $15 at fair value under the fair value option)
 
82,454

 
31,208

Total consolidated obligations
 
166,935

 
130,198

Mandatorily redeemable capital stock (Note 12)
 
675

 
103

Accrued interest payable
 
181

 
119

Affordable Housing Program payable
 
104

 
62

Derivative liabilities, net (Note 10)
 
85

 
102

Other liabilities
 
56

 
55

TOTAL LIABILITIES
 
169,069

 
131,749

Commitments and contingencies (Note 14)
 

 

CAPITAL (Note 12)
 
 
 
 
Capital stock - Class B putable ($100 par value); 57 and 47 issued and outstanding shares
 
5,658

 
4,714

Additional capital from merger
 
92

 
194

Retained earnings
 
 
 
 
Unrestricted
 
1,094

 
700

Restricted
 
200

 
101

Total retained earnings
 
1,294

 
801

Accumulated other comprehensive income (loss)
 
(39
)
 
(84
)
TOTAL CAPITAL
 
7,005

 
5,625

TOTAL LIABILITIES AND CAPITAL
 
$
176,074

 
$
137,374

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

3

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF INCOME
(dollars in millions)
(Unaudited)
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
INTEREST INCOME
 
 
 
 
 
 
 
 
Advances
 
$
237

 
$
81

 
$
594

 
$
210

Prepayment fees on advances, net
 
1

 
—

 
6

 
9

Interest-bearing deposits
 
1

 
—

 
2

 
—

Securities purchased under agreements to resell
 
4

 
1

 
13

 
4

Federal funds sold
 
5

 
2

 
13

 
4

Trading securities
 
13

 
9

 
39

 
27

Available-for-sale securities
 
63

 
49

 
176

 
116

Held-to-maturity securities
 
19

 
19

 
59

 
40

Mortgage loans held for portfolio
 
56

 
62

 
176

 
182

Total interest income
 
399

 
223

 
1,078

 
592

INTEREST EXPENSE
 
 
 
 
 
 
 
 
Consolidated obligations - Discount notes
 
98

 
22

 
320

 
52

Consolidated obligations - Bonds
 
177

 
112

 
428

 
302

Deposits
 
1

 
—

 
1

 
—

Mandatorily redeemable capital stock
 
6

 
1

 
15

 
2

Total interest expense
 
282

 
135

 
764

 
356

NET INTEREST INCOME
 
117

 
88

 
314

 
236

Provision (reversal) for credit losses on mortgage loans
 
1

 
1

 
2

 
2

NET INTEREST INCOME AFTER PROVISION (REVERSAL) FOR CREDIT LOSSES
 
116

 
87

 
312

 
234

OTHER INCOME (LOSS)
 
 
 
 
 
 
 
 
Net gains (losses) on trading securities
 
(2
)
 
17

 
51

 
9

Net gains (losses) on derivatives and hedging activities
 
(3
)
 
(43
)
 
(76
)
 
(39
)
Gains on litigation settlements, net
 
—

 
12

 
337

 
12

Other, net
 
—

 
2

 
7

 
3

Total other income (loss)
 
(5
)
 
(12
)
 
319

 
(15
)
OTHER EXPENSE
 
 
 
 
 
 
 
 
Compensation and benefits
 
13

 
12

 
39

 
34

Contractual services
 
1

 
4

 
7

 
9

Professional fees
 
4

 
4

 
8

 
6

Merger related expenses
 
—

 
3

 
—

 
38

Other operating expenses
 
5

 
4

 
14

 
10

Federal Housing Finance Agency
 
2

 
2

 
6

 
5

Office of Finance
 
2

 
2

 
5

 
4

Other, net
 
1

 
1

 
3

 
2

Total other expense
 
28

 
32

 
82

 
108

NET INCOME BEFORE ASSESSMENTS
 
83

 
43

 
549

 
111

Affordable Housing Program assessments
 
9

 
4

 
56

 
11

NET INCOME
 
$
74

 
$
39

 
$
493

 
$
100

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

4


FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF COMPREHENSIVE INCOME
(dollars in millions)
(Unaudited)
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2016
 
2015
 
2016
 
2015
Net income
 
$
74

 
$
39

 
$
493

 
$
100

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
Net unrealized gains (losses) on available-for-sale securities
 
46

 
(120
)
 
45

 
(122
)
Pension and postretirement benefits
 
—

 
(1
)
 
—

 
—

Total other comprehensive income (loss)
 
46

 
(121
)
 
45

 
(122
)
TOTAL COMPREHENSIVE INCOME (LOSS)
 
$
120

 
$
(82
)
 
$
538

 
$
(22
)
The accompanying notes are an integral part of these financial statements.




5

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

 
 
Capital Stock Class A (putable)
Capital Stock Class B (putable)
 
Total Capital Stock
 
 
Shares
 
Par Value
 
Shares
 
Par Value
 
Shares
 
Par Value
BALANCE, DECEMBER 31, 2014
 
—

 
$
—

 
35

 
$
3,469

 
35

 
$
3,469

Proceeds from issuance of capital stock
 
—

 
—

 
22

 
2,234

 
22

 
2,234

Capital stock issued from merger
 
—

 
31

 
9

 
863

 
9

 
894

Repurchases/redemptions of capital stock
 
—

 
(31
)
 
(25
)
 
(2,515
)
 
(25
)
 
(2,546
)
Net shares reclassified (to) from mandatorily redeemable capital stock
 
—

 
—

 
1

 
75

 
1

 
75

Additional capital from merger
 
—

 
—

 
—

 
—

 
—

 
—

Comprehensive income (loss)
 
—

 
—

 
—

 
—

 
—

 
—

Cash dividends on capital stock
 
—

 
—

 
—

 
—

 
—

 
—

BALANCE, SEPTEMBER 30, 2015
 
—

 
$
—

 
42

 
$
4,126

 
42

 
$
4,126

 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2015
 
—

 
$
—

 
47

 
$
4,714

 
47

 
$
4,714

Proceeds from issuance of capital stock
 
—

 
—

 
48

 
4,792

 
48

 
4,792

Repurchases/redemptions of capital stock
 
—

 
—

 
(31
)
 
(3,116
)
 
(31
)
 
(3,116
)
Net shares reclassified (to) from mandatorily redeemable capital stock
 
—

 
—

 
(7
)
 
(732
)
 
(7
)
 
(732
)
Comprehensive income (loss)
 
—

 
—

 
—

 
—

 
—

 
—

Cash dividends on capital stock
 
—

 
—

 
—

 
—

 
—

 
—

BALANCE, SEPTEMBER 30, 2016
 
—

 
$
—

 
57

 
$
5,658

 
57

 
$
5,658

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





























6



FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CAPITAL (continued from previous page)
(dollars and shares in millions)
(Unaudited)
 
 
Additional Capital from Merger
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Total
Capital
 
 
 
Unrestricted
 
Restricted
 
Total
 
 
BALANCE, DECEMBER 31, 2014
 
$
—

 
$
645

 
$
75

 
$
720

 
$
123

 
$
4,312

Proceeds from issuance of capital stock
 
—

 
—

 
—

 
—

 
—

 
2,234

Capital stock issued from merger
 
—

 
—

 
—

 
—

 
—

 
894

Repurchases/redemptions of capital stock
 
—

 
—

 
—

 
—

 
—

 
(2,546
)
Net shares reclassified (to) from mandatorily redeemable capital stock
 
—

 
—

 
—

 
—

 
—

 
75

Additional capital from merger
 
246

 
—

 
—

 
—

 
—

 
246

Comprehensive income (loss)
 
—

 
80

 
20

 
100

 
(122
)
 
(22
)
Cash dividends on capital stock
 
(25
)
 
(50
)
 
—

 
(50
)
 
—

 
(75
)
BALANCE, SEPTEMBER 30, 2015
 
$
221

 
$
675

 
$
95

 
$
770

 
$
1

 
$
5,118

 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2015
 
$
194

 
$
700

 
$
101

 
$
801

 
$
(84
)
 
$
5,625

Proceeds from issuance of capital stock
 
—

 
—

 
—

 
—

 
—

 
4,792

Repurchases/redemptions of capital stock
 
—

 
—

 
—

 
—

 
—

 
(3,116
)
Net shares reclassified (to) from mandatorily redeemable capital stock
 
—

 
—

 
—

 
—

 
—

 
(732
)
Comprehensive income (loss)
 
—

 
394

 
99

 
493

 
45

 
538

Cash dividends on capital stock
 
(102
)
 
—

 
—

 
—

 
—

 
(102
)
BALANCE, SEPTEMBER 30, 2016
 
$
92

 
$
1,094

 
$
200

 
$
1,294

 
$
(39
)
 
$
7,005

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


7

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS
(dollars in millions)
(Unaudited)
 
 
For the Nine Months Ended
 
 
September 30,
 
 
2016
 
2015
OPERATING ACTIVITIES
 
 
 
 
Net income
 
$
493

 
$
100

Adjustments to reconcile net income to net cash provided by (used in) operating activities
 
 
 
 
Depreciation and amortization
 
37

 
25

Net (gains) losses on trading securities
 
(51
)
 
(9
)
Net change in derivatives and hedging activities
 
5

 
—

Other adjustments
 
(5
)
 
1

Net change in:
 
 
 
 
Accrued interest receivable
 
(64
)
 
(10
)
Other assets
 
(1
)
 
(4
)
Accrued interest payable
 
62

 
21

Other liabilities
 
42

 
(9
)
Total adjustments
 
25

 
15

Net cash provided by (used in) operating activities
 
518

 
115

INVESTING ACTIVITIES
 
 
 
 
Net change in:
 
 
 
 
Interest-bearing deposits
 
(366
)
 
(155
)
Securities purchased under agreements to resell
 
525

 
91

Federal funds sold
 
(2,365
)
 
(320
)
Premises, software, and equipment
 
(7
)
 
(5
)
Cash transferred for merger
 
—

 
2,341

Trading securities
 
 
 
 
Proceeds from maturities of long-term
 
1,617

 
519

Purchases of long-term
 
(1,597
)
 
—

Available-for-sale securities
 
 
 
 
Proceeds from maturities of long-term
 
1,902

 
1,316

Purchases of long-term
 
(3,465
)
 
(1,108
)
Held-to-maturity securities
 
 
 
 
Proceeds from sales and maturities of long-term
 
1,178

 
724

Purchases of long-term
 
(64
)
 
(89
)
Advances
 
 
 
 
Principal collected
 
134,568

 
88,354

Originated
 
(171,179
)
 
(88,455
)
Mortgage loans held for portfolio
 
 
 
 
Principal collected
 
931

 
931

Originated or purchased
 
(988
)
 
(652
)
Proceeds from sales of foreclosed assets
 
10

 
10

Net cash provided by (used in) investing activities
 
(39,300
)
 
3,502

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

8

FEDERAL HOME LOAN BANK OF DES MOINES
STATEMENTS OF CASH FLOWS (continued from previous page)
(dollars in millions)
(Unaudited)
 
 
For the Nine Months Ended
 
 
September 30,
 
 
2016
 
2015
FINANCING ACTIVITIES
 
 
 
 
Net change in deposits
 
(77
)
 
123

Net payments on derivative contracts with financing elements
 
(4
)
 
(6
)
Net proceeds from issuance of consolidated obligations
 
 
 
 
Discount notes
 
209,409

 
198,088

Bonds
 
77,918

 
15,564

Payments for maturing and retiring consolidated obligations
 
 
 
 
Discount notes
 
(223,948
)
 
(191,074
)
Bonds
 
(26,667
)
 
(25,087
)
Proceeds from issuance of capital stock
 
4,792

 
2,234

Payments for repurchases/redemptions of capital stock
 
(3,116
)
 
(2,546
)
Net payments for repurchases/redemptions of mandatorily redeemable capital stock
 
(160
)
 
(568
)
Cash dividends paid
 
(102
)
 
(75
)
Net cash provided by (used in) financing activities
 
38,045

 
(3,347
)
Net increase (decrease) in cash and due from banks
 
(737
)
 
270

Cash and due from banks at beginning of the period
 
982

 
495

Cash and due from banks at end of the period
 
$
245

 
$
765

 
 
 
 
 
SUPPLEMENTAL DISCLOSURES
 
 
 
 
Cash Transactions:
 
 
 
 
Interest paid
 
$
1,200

 
$
798

Affordable Housing Program payments
 
14

 
9

Non-Cash Transactions:
 
 
 
 
Capitalized interest on reverse mortgage investment securities
 
20

 
11

Mortgage loan charge-offs
 
2

 
5

Transfers of mortgage loans to real estate owned
 
6

 
6

Capital stock reclassified to (from) mandatorily redeemable capital stock, net
 
732

 
(75
)
Capital stock issued from merger
 
—

 
894

Assets acquired (liabilities assumed) from merger:
 
 
 
 
Trading securities
 
—

 
551

Available-for-sale securities
 
—

 
9,825

Held-to-maturity securities
 
—

 
5,829

Advances
 
—

 
9,191

Mortgage loans held for portfolio
 
—

 
615

Accrued interest receivable
 
—

 
47

Premises, software, and equipment
 
—

 
3

Derivative assets
 
—

 
40

Other assets
 
—

 
22

Deposits
 
—

 
(371
)
Consolidated obligation discount notes
 
—

 
(12,449
)
Consolidated obligation bonds
 
—

 
(13,613
)
Mandatorily redeemable capital stock
 
—

 
(725
)
Accrued interest payable
 
—

 
(38
)
Affordable Housing Program payable
 
—

 
(17
)
Derivative liabilities
 
—

 
(74
)
Other liabilities
 
—

 
(37
)
The accompanying notes are an integral part of these financial statements.

9

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 11 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 source of funding to its member institutions and eligible housing associates in Alaska, Hawaii, Idaho, Iowa, Minnesota, Missouri, Montana, North Dakota, Oregon, South Dakota, Utah, Washington, Wyoming, and the U.S. Pacific territories of American Samoa, Guam, and the Commonwealth of the Northern Mariana Islands. 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, subject to a minimum and maximum amount, 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 and former members own all of the outstanding capital stock (including mandatorily redeemable capital stock) of the Bank. Former members own 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.




10

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, 2015, which are contained in the Bank's 2015 Annual Report on Form 10-K filed with the SEC on March 21, 2016 (2015 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, 2016.

On May 31, 2015, the Bank completed the merger (the Merger) with the Federal Home Loan Bank of Seattle (Seattle Bank). The Merger had a significant impact on all aspects of the Bank's financial condition, results of operations, and cash flows. As a result, income statement results for the current period are not directly comparable to results prior to the Merger.

The following unaudited pro forma information has been prepared by adjusting the Bank's historical data to give effect to the Merger as if it had occurred on January 1, 2014 (dollars in millions):
 
Nine Months Ended
 
September 30, 2015
Interest income
$
707

Net income
$
110


The unaudited pro forma financial information was prepared in accordance with the acquisition method of accounting for mutual entities under existing standards and is not necessarily indicative of the results of operations that would have occurred if the Merger had been completed on the date indicated, nor is it indicative of the future operating results of the Bank.

CHANGE IN ACCOUNTING PRINCIPLE

On January 1, 2016, the Bank retrospectively adopted Accounting Standards Codification Update 2015-03, Simplifying the Presentation of Debt Issuance Costs issued by the Financial Accounting Standards Board (FASB) on April 7, 2015. As a result, $7 million of unamortized concessions included in “Other assets” at December 31, 2015 were reclassified as a reduction in the balance of the corresponding consolidated obligations. The reclassification resulted in a decrease of $4 million in “Consolidated obligation discount notes” and of $3 million in “Consolidated obligation bonds” at December 31, 2015. Accordingly, the Bank’s total assets and total liabilities each decreased by $7 million at December 31, 2015. The adoption of this guidance did not have any effect on the Bank’s results of operations or cash flows. See “Note 2 - Recently Adopted and Issued Accounting Guidance” for discussion on this guidance.

RECLASSIFICATIONS

Certain amounts in the Bank's 2015 financial statements and footnotes have been reclassified to conform to the presentation for the three and nine months ended September 30, 2016. These amounts were not deemed to be material.

SIGNIFICANT ACCOUNTING POLICIES

There have been no material changes to the Bank's significant accounting policies during the nine months ended September 30, 2016, with the exception of one policy noted below. Descriptions of all significant accounting policies are included in "Note 1 - Summary of Significant Accounting Policies" in the 2015 Form 10-K.








11

Concessions. The Bank pays concessions to dealers in connection with the issuance of certain consolidated obligations. The Office of Finance prorates the amount of the concession to each FHLBank based upon the percentage of the debt issued that is attributed to that FHLBank. Concessions paid on consolidated obligations designated under the fair value option are expensed as incurred and recorded in other expense. Concessions paid on consolidated obligations not designated under the fair value option are deferred and amortized over the contractual life of the consolidated obligations using the level-yield method. Unamortized concessions are included as a direct deduction from the carrying amount of “Consolidated obligation discount notes” or “Consolidated obligation bonds” in the Statements of Condition and the amortization of those concessions is included in consolidated obligation interest expense.

Note 2 — Recently Adopted and Issued Accounting Guidance

ADOPTED ACCOUNTING GUIDANCE

Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships

On March 10, 2016, the FASB issued amendments to clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under GAAP does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The amendments provide entities with the option to apply the guidance using either a prospective approach or a modified retrospective approach. The guidance would have become effective for the Bank in 2017 but the guidance allowed early adoption. The Bank elected to early adopt this guidance prospectively on January 1, 2016. The adoption of this guidance did not have an effect on the Bank’s financial condition, results of operations, or cash flows.

Simplifying the Accounting for Measurement-Period Adjustments

On September 25, 2015, the FASB issued guidance to simplify the accounting for measurement-period adjustments recognized in a business combination. This guidance requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. It also requires that the acquirer present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. This guidance became effective for the Bank beginning on January 1, 2016 and was adopted prospectively. The adoption of this guidance did not have an effect on the Bank’s financial condition, results of operations, or cash flows.

Cloud Computing Arrangements

On April 15, 2015, the FASB issued amendments to clarify a customer's accounting for fees paid in a cloud computing arrangement. The amendments provide guidance to customers on determining whether a cloud computing arrangement includes a software license that should be accounted for as internal-use software. If the arrangement does not contain a software license, it would be accounted for as a service contract. This guidance became effective for the Bank beginning on January 1, 2016 and was adopted prospectively. The adoption of this guidance did not effect the Bank’s financial condition, results of operations, or cash flows.

Simplifying the Presentation of Debt Issuance Costs

On April 7, 2015, the FASB issued guidance to simplify the presentation of debt issuance costs. This guidance requires that debt issuance costs related to a recognized debt liability be presented on the statement of condition as a direct deduction from the carrying amount of that debt liability, consistent with the presentation of debt discounts. This guidance became effective for the Bank beginning on January 1, 2016 and was adopted on a retrospective basis. The adoption of this guidance resulted in a reclassification of unamortized debt issuance costs from other assets to consolidated obligations on the Bank's Statement of Condition. The adoption of this guidance did not have a material effect on the Bank's financial condition, results of operations, or cash flows. Refer to "Note 1 — Basis of Presentation — Change in Accounting Principle" for additional details on this reclassification.







12

Amendments to the Consolidation Analysis

On February 18, 2015, the FASB issued amended guidance intended to enhance consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The new guidance primarily focuses on the following:

•
Placing more emphasis on risk of loss when determining a controlling financial interest. A reporting organization may no longer have to consolidate a legal entity in certain circumstances based solely on its fee arrangement, when certain criteria are met. 

•
Reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a variable interest entity (VIE).

•
Changing consolidation conclusions for entities in several industries that typically make use of limited partnerships or VIEs.

This guidance became effective for the Bank beginning on January 1, 2016. The adoption of this guidance did not have an effect on the Bank’s financial condition, results of operations, or cash flows.

ISSUED ACCOUNTING GUIDANCE

Classification of Certain Cash Receipts and Cash Payments

On August 26, 2016, the FASB issued amendments to clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. This guidance is intended to reduce existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This guidance is effective for the Bank for interim and annual periods beginning on January 1, 2018, and early adoption is permitted. This guidance should be applied using a retrospective transition method to each period presented. The Bank is in the process of evaluating this guidance, but its effect on the Bank's cash flows is not expected to be material.
Measurement of Credit Losses on Financial Instruments

On June 16, 2016, the FASB issued amended guidance for the accounting of credit losses on financial instruments. The amendments require entities to measure expected credit losses based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The new guidance requires a financial asset, or a group of financial assets, measured at amortized cost to be presented at the net amount expected to be collected. The guidance also requires, among other things, the following:
•
The statement of income to reflect the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period.

•
Entities to determine the allowance for credit losses for purchased financial assets with a more-than-insignificant amount of credit deterioration since origination (PCD assets) that are measured at amortized cost in a similar manner to other financial assets measured at amortized cost. The initial allowance for credit losses is required to be added to the purchase price of the assets acquired.

•
Entities to record credit losses relating to AFS debt securities through an allowance for credit losses. The amendments limit the allowance for credit losses to the amount by which fair value is below amortized cost.

•
Public entities to further disaggregate the current disclosure of credit quality indicators in relation to the amortized cost of financing receivables by the year of origination (i.e., vintage).


13

This guidance is effective for the Bank for interim and annual periods beginning on January 1, 2020. Early application is permitted as of the interim and annual reporting periods beginning after December 15, 2018. This guidance should be applied using a modified-retrospective approach, through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. In addition, entities are required to use a prospective transition approach for PCD assets upon adoption and for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The Bank is in the process of evaluating this guidance, and its effect on the Bank's financial condition, results of operations, and cash flows has not yet been determined.
Contingent Put and Call Options in Debt Instruments

On March 14, 2016, the FASB issued amendments to clarify the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. The guidance requires entities to apply only the four-step decision sequence when assessing whether the economic characteristics and risks of call (put) options are clearly and closely related to the economic characteristics and risks of their debt hosts. Consequently, when a call (put) option is contingently exercisable, an entity does not have to assess whether the event that triggers the ability to exercise a call (put) option is related to interest rates or credit risks. This guidance becomes effective for the Bank for the interim and annual periods beginning on January 1, 2017, and early adoption is permitted. The guidance should be applied on a modified retrospective basis to existing debt instruments as of the beginning of the period for which the amendments are effective. The Bank is in the process of evaluating this guidance, but its effect on the Bank's financial condition, results of operations, or cash flows is not expected to be material.
Leases

On February 25, 2016, the FASB issued guidance which requires recognition of lease assets and lease liabilities on the statement of condition and disclosure of key information about leasing arrangements. Specifically, this guidance requires a lessee, of operating or finance leases, to recognize on the statement of condition a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities. Under previous GAAP, a lessee was not required to recognize lease assets and lease liabilities arising from operating leases on the statement of condition. While this guidance does not fundamentally change lessor accounting, some changes have been made to align that guidance with the lessee guidance and other areas within GAAP.

The guidance becomes effective for the Bank for the interim and annual periods beginning on January 1, 2019, and early application is permitted. The guidance requires lessors and lessees to recognize and measure leases at the beginning of the earliest period presented in the financial statements using a modified retrospective approach. The Bank is in the process of evaluating this guidance, and its anticipated effect on the Bank's financial condition, results of operations, or cash flows has not yet been determined.

Recognition and Measurement of Financial Assets and Financial Liabilities

On January 5, 2016, FASB issued amended guidance on certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This guidance includes, but is not limited to, the following:

•
Requires equity investments (with certain exceptions) to be measured at fair value with changes in fair value recognized in net income.

•
Requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments.

•
Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.

•
Eliminates the requirement for public entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet.


14

The guidance becomes effective for the Bank for the interim and annual periods beginning on January 1, 2018, and early adoption is only permitted for certain provisions. The amendments, in general, should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the period of adoption. 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.

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 Bank for the annual period ending December 31, 2016 and for the annual and interim periods thereafter, and early application is permitted. This guidance is not expected to have an effect on the Bank's financial condition, results of operations, cash flows, or financial statement disclosures.

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 recognizing 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, and lease contracts. The guidance provides entities with the option of using either of the following adoption methods: a full retrospective method, retrospectively to each prior reporting period presented; or a modified retrospective method, retrospectively with the cumulative effect of initially applying this guidance recognized at the date of initial application.

On August 12, 2015, the FASB issued an amendment to defer the effective date of this guidance issued in May 2014 by one year. In 2016, the FASB has issued additional amendments to clarify certain aspects of the new revenue guidance. However, these amendments do not change the core principle in the new revenue standard.

This guidance is effective for the Bank for interim and annual periods beginning on January 1, 2018. Early application is permitted only as of the interim and annual reporting periods beginning after December 15, 2016. The Bank is in the process of evaluating this guidance, but its effect on the Bank's financial condition, results of operations, and cash flows is not expected to be material.

Note 3 — Trading Securities

MAJOR SECURITY TYPES

Trading securities were as follows (dollars in millions):
 
September 30,
2016
 
December 31,
2015
Non-mortgage-backed securities
 
 
 
Other U.S. obligations1
$
229

 
$
237

GSE and Tennessee Valley Authority obligations
3,086

 
3,077

Other2
288

 
276

     Total non-mortgage-backed securities
3,603

 
3,590

Mortgage-backed securities
 
 
 
GSE multifamily
474

 
457

Total fair value
$
4,077

 
$
4,047


1
Represents investment securities backed by the full faith and credit of the U.S. Government.

2
Consists of taxable municipal bonds.






15

NET GAINS (LOSSES) ON TRADING SECURITIES

During the three and nine months ended September 30, 2016, the Bank recorded net holding losses of $2 million and net holding gains of $51 million on its trading securities compared to net holding gains of $17 million and $9 million for the same periods in 2015. The Bank did not sell any trading securities during the three and nine months ended September 30, 2016 and 2015.

Note 4 — Available-for-Sale Securities

MAJOR SECURITY TYPES

AFS securities were as follows (dollars in millions):
 
September 30, 2016
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 

Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations2
$
3,720

 
$
4

 
$
(21
)
 
$
3,703

GSE and Tennessee Valley Authority obligations
1,494

 
10

 
(12
)
 
1,492

State or local housing agency obligations
1,023

 
—

 
(1
)
 
1,022

Other3
291

 
5

 
—

 
296

Total non-mortgage-backed securities
6,528

 
19

 
(34
)
 
6,513

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations single-family2
3,509

 
3

 
(11
)
 
3,501

GSE single-family
1,345

 
11

 
—

 
1,356

GSE multifamily
11,586

 
36

 
(61
)
 
11,561

Total mortgage-backed securities
16,440

 
50

 
(72
)
 
16,418

Total
$
22,968

 
$
69

 
$
(106
)
 
$
22,931


 
December 31, 2015
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 

Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations2
$
4,010

 
$
4

 
$
(29
)
 
$
3,985

GSE and Tennessee Valley Authority obligations
2,124

 
14

 
(23
)
 
2,115

State or local housing agency obligations
1,048

 
—

 
(1
)
 
1,047

Other3
276

 
4

 
(2
)
 
278

Total non-mortgage-backed securities
7,458

 
22

 
(55
)
 
7,425

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations single-family2
2,284

 
—

 
(14
)
 
2,270

GSE single-family
1,593

 
13

 
(1
)
 
1,605

GSE multifamily
9,735

 
36

 
(83
)
 
9,688

Total mortgage-backed securities
13,612

 
49

 
(98
)
 
13,563

Total
$
21,070

 
$
71

 
$
(153
)
 
$
20,988


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

2
Represents investment securities backed by the full faith and credit of the U.S. Government.

3
Consists of taxable municipal bonds and/or Private Export Funding Corporation (PEFCO) bonds.



16

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 millions). In cases where the gross unrealized losses for an investment category are less than $1 million, the losses are not reported.
 
September 30, 2016
 
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. obligations1
$
20

 
$
—

 
$
3,174

 
$
(21
)
 
$
3,194

 
$
(21
)
GSE and Tennessee Valley Authority obligations
—

 
—

 
942

 
(12
)
 
942

 
(12
)
State or local housing agency obligations
684

 
(1
)
 
14

 
—

 
698

 
(1
)
Total non-mortgage-backed securities
704

 
(1
)
 
4,130

 
(33
)
 
4,834

 
(34
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations single-family1
1,242

 
(4
)
 
1,122

 
(7
)
 
2,364

 
(11
)
GSE single-family
152

 
—

 
26

 
—

 
178

 
—

GSE multifamily
2,207

 
(5
)
 
6,776

 
(56
)
 
8,983

 
(61
)
Total mortgage-backed securities
3,601

 
(9
)
 
7,924

 
(63
)
 
11,525

 
(72
)
Total
$
4,305

 
$
(10
)
 
$
12,054

 
$
(96
)
 
$
16,359

 
$
(106
)

 
December 31, 2015
 
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. obligations1
$
3,645

 
$
(29
)
 
$
—

 
$
—

 
$
3,645

 
$
(29
)
GSE and Tennessee Valley Authority obligations
1,701

 
(23
)
 
—

 
—

 
1,701

 
(23
)
State or local housing agency obligations
555

 
(1
)
 
6

 
—

 
561

 
(1
)
Other2
97

 
(2
)
 
—

 
—

 
97

 
(2
)
Total non-mortgage-backed securities
5,998

 
(55
)
 
6

 
—

 
6,004

 
(55
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations single-family1
2,270

 
(14
)
 
—

 
—

 
2,270

 
(14
)
GSE single-family
277

 
(1
)
 
33

 
—

 
310

 
(1
)
GSE multifamily
8,166

 
(66
)
 
926

 
(17
)
 
9,092

 
(83
)
Total mortgage-backed securities
10,713

 
(81
)
 
959

 
(17
)
 
11,672

 
(98
)
Total
$
16,711

 
$
(136
)
 
$
965

 
$
(17
)
 
$
17,676

 
$
(153
)

1
Represents investment securities backed by the full faith and credit of the U.S. Government.

2
Consists of taxable municipal bonds and/or PEFCO bonds.



17

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 millions):
 
 
September 30, 2016
 
December 31, 2015
Year of Contractual Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
Due in one year or less
 
$
177

 
$
178

 
$
430

 
$
431

Due after one year through five years
 
522

 
529

 
968

 
978

Due after five years through ten years
 
4,641

 
4,625

 
4,664

 
4,637

Due after ten years
 
1,188

 
1,181

 
1,396

 
1,379

Total non-mortgage-backed securities
 
6,528

 
6,513

 
7,458

 
7,425

Mortgage-backed securities
 
16,440

 
16,418

 
13,612

 
13,563

Total
 
$
22,968

 
$
22,931

 
$
21,070

 
$
20,988


NET GAINS (LOSSES) FROM SALE OF AFS SECURITIES

During the nine months ended September 30, 2016, the Bank received $287 million in proceeds from the sale of AFS securities and recognized gains of less than $1 million. During the three months ended September 30, 2016 and the three and nine months ended September 30, 2015, the Bank did not sell any AFS securities.

PREPAYMENT FEES

Prepayment fees on AFS securities are recorded as interest income in the Statements of Income. During the three and nine months ended September 30, 2016, AFS MBS were prepaid and the Bank received $2 million and $5 million in prepayment fees, which were offset in part by fair value hedging adjustments and discount amortization combined of $1 million and $2 million. During both the three and nine months ended September 30, 2015, an AFS MBS was prepaid and the Bank received a $3 million prepayment fee, which was offset in part by fair value hedging adjustments and premium amortization combined of $1 million.


18

Note 5 — Held-to-Maturity Securities

MAJOR SECURITY TYPES

Held-to-maturity (HTM) securities were as follows (dollars in millions):
 
September 30, 2016
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
GSE and Tennessee Valley Authority obligations
$
398

 
$
92

 
$
—

 
$
490

State or local housing agency obligations
691

 
5

 
(4
)
 
692

Total non-mortgage-backed securities
1,089

 
97

 
(4
)
 
1,182

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations single-family2
30

 
—

 
—

 
30

Other U.S. obligations commercial2
4

 
—

 
—

 
4

GSE single-family
3,816

 
11

 
(8
)
 
3,819

Private-label residential
17

 
—

 
(1
)
 
16

Total mortgage-backed securities
3,867

 
11

 
(9
)
 
3,869

Total
$
4,956

 
$
108

 
$
(13
)
 
$
5,051


 
December 31, 2015
 
Amortized
Cost1
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
GSE and Tennessee Valley Authority obligations
$
401

 
$
57

 
$
(2
)
 
$
456

State or local housing agency obligations
956

 
9

 
—

 
965

Total non-mortgage-backed securities
1,357

 
66

 
(2
)
 
1,421

Mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations single-family2
47

 
—

 
—

 
47

Other U.S. obligations commercial2
6

 
—

 
—

 
6

GSE single-family
4,655

 
9

 
(15
)
 
4,649

Private-label residential
20

 
—

 
(1
)
 
19

Total mortgage-backed securities
4,728

 
9

 
(16
)
 
4,721

Total
$
6,085

 
$
75

 
$
(18
)
 
$
6,142


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

2
Represents investment securities backed by the full faith and credit of the U.S. Government.



19

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 millions). In cases where the gross unrealized losses for an investment category are less than $1 million, the losses are not reported.
 
September 30, 2016
 
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
 
 
 
 
 
 
 
 
 
 
 
State or local housing agency obligations
$
279

 
$
(4
)
 
$
5

 
$
—

 
$
284

 
$
(4
)
Total non-mortgage-backed securities
279

 
(4
)
 
5

 
—

 
284

 
(4
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations single-family1
29

 
—

 
—

 
—

 
29

 
—

Other U.S. obligations commercial1
1

 
—

 
2

 
—

 
3

 
—

GSE single-family
2,105

 
(6
)
 
493

 
(2
)
 
2,598

 
(8
)
Private-label residential
—

 
—

 
11

 
(1
)
 
11

 
(1
)
Total mortgage-backed securities
2,135

 
(6
)
 
506

 
(3
)
 
2,641

 
(9
)
Total
$
2,414

 
$
(10
)
 
$
511

 
$
(3
)
 
$
2,925

 
$
(13
)

 
December 31, 2015
 
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 and Tennessee Valley Authority obligations
$
96

 
$
(2
)
 
$
—

 
$
—

 
$
96

 
$
(2
)
State or local housing agency obligations
93

 
—

 
—

 
—

 
93

 
—

Total non-mortgage-backed securities
189

 
(2
)
 
—

 
—

 
189

 
(2
)
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations single-family1
40

 
—

 
—

 
—

 
40

 
—

Other U.S. obligations commercial1
5

 
—

 
—

 
—

 
5

 
—

GSE single-family
3,052

 
(15
)
 
20

 
—

 
3,072

 
(15
)
Private-label residential
—

 
—

 
13

 
(1
)
 
13

 
(1
)
Total mortgage-backed securities
3,097

 
(15
)
 
33

 
(1
)
 
3,130

 
(16
)
Total
$
3,286

 
$
(17
)
 
$
33

 
$
(1
)
 
$
3,319

 
$
(18
)

1
Represents investment securities backed by the full faith and credit of the U.S. Government.


20

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 millions):
 
 
September 30, 2016
 
December 31, 2015
Year of Contractual Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Non-mortgage-backed securities
 
 
 
 
 
 
 
 
Due in one year or less
 
$
11

 
$
11

 
$
18

 
$
18

Due after one year through five years
 
62

 
62

 
131

 
131

Due after five years through ten years
 
368

 
418

 
409

 
440

Due after ten years
 
648

 
691

 
799

 
832

Total non-mortgage-backed securities
 
1,089

 
1,182

 
1,357

 
1,421

Mortgage-backed securities
 
3,867

 
3,869

 
4,728

 
4,721

Total
 
$
4,956

 
$
5,051

 
$
6,085

 
$
6,142


Note 6 — Other-Than-Temporary Impairment

The Bank evaluates its individual AFS and HTM securities in an unrealized loss position for other-than-temporary impairment (OTTI) on a quarterly basis. 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.

PRIVATE-LABEL MORTGAGE-BACKED SECURITIES

On a quarterly basis, the Bank engages other designated FHLBanks to perform cash flow analyses on its private-label MBS using two third-party models in order to assess whether the entire amortized cost bases of these securities will be recovered. To ensure consistency in the determination of OTTI, an OTTI Governance Committee, comprised of representation from all FHLBanks, is responsible for reviewing and approving the key modeling assumptions, inputs, and methodologies used by the designated FHLBanks when generating the cash flow projections. For a description of these models, refer to "Item 8. Financial Statements and Supplementary Data - Note 8 - Other-than-Temporary Impairment" in the Bank's 2015 Form 10-K.

The FHLBanks' OTTI Governance Committee developed a short-term housing price forecast with projected changes ranging from a decrease of one percent to an increase of ten percent over the twelve month period beginning July 1, 2016. For the vast majority of markets, the projected short-term housing price changes range from an increase of three 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.

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, 2016, 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, 2016.


21

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, 2016:

•
Other U.S. obligations and GSE and Tennessee Valley Authority obligations. The unrealized losses were due primarily to changes in interest rates and credit spreads, and not to a significant deterioration in the fundamental credit quality of the obligations. 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, 2016.

•
State or local 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 were 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, 2016.

Note 7 — Advances

CONTRACTUAL MATURITY

The following table summarizes the Bank's advances outstanding by contractual maturity (dollars in millions):
 
 
September 30, 2016
 
December 31, 2015
Year of Contractual Maturity
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Overdrawn demand deposit accounts
 
$
5

 
3.45
%
 
$
1

 
3.34
%
Due in one year or less
 
20,759

 
0.86

 
18,967

 
0.77

Due after one year through two years
 
30,944

 
1.02

 
8,608

 
1.48

Due after two years through three years
 
23,587

 
0.88

 
18,517

 
0.93

Due after three years through four years
 
6,862

 
1.10

 
17,439

 
0.60

Due after four years through five years
 
28,837

 
0.82

 
16,521

 
0.74

Thereafter
 
14,528

 
0.96

 
8,858

 
1.36

Total par value
 
125,522

 
0.92
%
 
88,911

 
0.89
%
Premiums
 
94

 
 
 
128

 
 
Discounts
 
(7
)
 
 
 
(9
)
 
 
Fair value hedging adjustments
 
219

 
 
 
143

 
 
Total
 
$
125,828

 
 
 
$
89,173

 
 


22

The following table summarizes all advances at September 30, 2016 and December 31, 2015, by year of contractual maturity or next call date for callable advances, and by year of contractual maturity or next put date for putable advances (dollars in millions):
 
 
Year of Contractual Maturity
or Next Call Date
 
Year of Contractual Maturity
or Next Put Date
 
 
September 30, 2016
 
December 31, 2015
 
September 30, 2016
 
December 31, 2015
Overdrawn demand deposit accounts
 
$
5

 
$
1

 
$
5

 
$
1

Due in one year or less
 
95,329

 
73,242

 
22,179

 
21,156

Due after one year through two years
 
10,922

 
4,513

 
29,756

 
7,549

Due after two years through three years
 
9,437

 
4,377

 
23,547

 
17,576

Due after three years through four years
 
2,446

 
2,337

 
6,862

 
17,439

Due after four years through five years
 
5,329

 
1,818

 
28,673

 
16,521

Thereafter
 
2,054

 
2,623

 
14,500

 
8,669

Total par value
 
$
125,522

 
$
88,911

 
$
125,522

 
$
88,911

 
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). At September 30, 2016 and December 31, 2015, the Bank had callable advances outstanding totaling $78.6 billion and $54.8 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 replacement funding at the prevailing market rate. Generally, put options are exercised when interest rates increase. At September 30, 2016 and December 31, 2015, the Bank had putable advances outstanding totaling $2.1 billion and $2.6 billion.

PREPAYMENT FEES

The Bank generally 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. For certain advances with symmetrical prepayment features, the Bank may charge the borrower a prepayment fee or pay the borrower a prepayment credit, depending on certain circumstances, such as movements in interest rates, when the advance is prepaid. Prepayment fees and credits 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 millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Prepayment fee income
$
2

 
$
—

 
$
11

 
$
14

Fair value hedging adjustments1
(1
)
 
—

 
(5
)
 
(5
)
Prepayment fees on advances, net
$
1

 
$
—

 
$
6

 
$
9


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."

Note 8 — Mortgage Loans Held for Portfolio

The Bank participates in the Mortgage Partnership Finance (MPF) program (Mortgage Partnership Finance and MPF are registered trademarks of the FHLBank of Chicago). This program 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 MPF PFIs generally originate, service, and credit enhance mortgage loans that are sold to the Bank. MPF 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 MPF PFI to a designated mortgage service provider.


23

Effective May 31, 2015, as a part of the Merger, the Bank acquired mortgage loans previously purchased by the Seattle Bank under the Mortgage Purchase Program (MPP). This program involved investment by the Seattle Bank in single-family mortgage loans that were purchased directly from MPP PFIs. Similar to the MPF program, MPP PFIs generally originated, serviced, and credit enhanced the mortgage loans sold to the Seattle Bank. In 2005, the Seattle Bank ceased entering into new MPP master commitment contracts and therefore all MPP loans acquired by the Bank were originated prior to 2006. The Bank does not currently purchase mortgage loans under this program.

The following tables present information on the Bank's mortgage loans held for portfolio (dollars in millions):
 
September 30, 2016
 
MPF
 
MPP
 
Total
Fixed rate, long-term single-family mortgage loans
$
5,097

 
$
420

 
$
5,517

Fixed rate, medium-term1 single-family mortgage loans
1,172

 
8

 
1,180

Total unpaid principal balance
6,269

 
428

 
6,697

Premiums
81

 
14

 
95

Discounts
(8
)
 
(1
)
 
(9
)
Basis adjustments from mortgage loan commitments
11

 
—

 
11

Total mortgage loans held for portfolio
6,353

 
441

 
6,794

Allowance for credit losses
(2
)
 
—

 
(2
)
Total mortgage loans held for portfolio, net
$
6,351

 
$
441

 
$
6,792


 
December 31, 2015
 
MPF
 
MPP
 
Total
Fixed rate, long-term single-family mortgage loans
$
4,884

 
$
500

 
$
5,384

Fixed rate, medium-term1 single-family mortgage loans
1,265

 
14

 
1,279

Total unpaid principal balance
6,149

 
514

 
6,663

Premiums
76

 
18

 
94

Discounts
(9
)
 
(1
)
 
(10
)
Basis adjustments from mortgage loan commitments
9

 
—

 
9

Total mortgage loans held for portfolio
6,225

 
531

 
6,756

Allowance for credit losses
(1
)
 
—

 
(1
)
Total mortgage loans held for portfolio, net
$
6,224

 
$
531

 
$
6,755


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

The following tables present the Bank's mortgage loans held for portfolio by collateral or guarantee type (dollars in millions):
 
September 30, 2016
 
MPF
 
MPP
 
Total
Conventional mortgage loans
$
5,747

 
$
384

 
$
6,131

Government-insured mortgage loans
522

 
44

 
566

Total unpaid principal balance
$
6,269

 
$
428

 
$
6,697

 
December 31, 2015
 
MPF
 
MPP
 
Total
Conventional mortgage loans
$
5,602

 
$
464

 
$
6,066

Government-insured mortgage loans
547

 
50

 
597

Total unpaid principal balance
$
6,149

 
$
514

 
$
6,663


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

24

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, MPF conventional mortgage loans held for portfolio, MPP 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.

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 mortgage-backed securities (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, 2016 and December 31, 2015, 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, 2016 and December 31, 2015, 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, 2016 and 2015.

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, 2016 and December 31, 2015. Accordingly, the Bank has not recorded any allowance for credit losses for its credit products.

25

GOVERNMENT-INSURED MORTGAGE LOANS

The Bank invests in government-insured fixed rate mortgage loans in both the MPF and MPP portfolios 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 and has never experienced a credit loss on its government-insured mortgage loans. As a result, the Bank did not establish an allowance for credit losses for its government-insured mortgage loans at September 30, 2016 and December 31, 2015. 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.

MPF 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 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, whichever is less and as applicable to the specific loan.

•
First Loss Account (FLA). The FLA is a memorandum account used to track the Bank's potential loss exposure under each master commitment prior to the PFI's credit enhancement obligation.

•
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. For absorbing losses in excess of the FLA, PFIs are paid a credit enhancement fee, a portion of which may be performance-based.

MPP CONVENTIONAL MORTGAGE LOANS

For conventional MPP loans, the loss protection consists of the following loss layers, in order of priority:

•
Homeowner Equity.

•
Primary Mortgage Insurance. 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, whichever is less and as applicable to the specific loan.

•
Lender Risk Account (LRA). The LRA is a lender-specific account originally funded by the Seattle Bank in an amount approximately sufficient to cover expected losses on the pool of mortgages either up front as a portion of the purchase proceeds or through a portion of the net interest remitted monthly by the member. To the extent available, LRA funds are used to offset any losses that occur. Typically, after five years, excess funds over required balances are distributed to the member in accordance with a step-down schedule that is established upon execution of a master commitment contract.  


26

ALLOWANCE METHODOLOGY

The Bank utilizes an allowance for credit losses to reserve for estimated losses in its conventional MPF and MPP mortgage loan portfolios at the balance sheet date. The measurement of the Bank's MPF and MPP 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, and (iii) estimating additional credit losses in the conventional mortgage loan portfolio.

Collectively Evaluated Conventional Mortgage Loans. The Bank collectively evaluates the majority of its conventional MPF and MPP mortgage loan portfolios for impairment and estimates an allowance for credit losses based primarily on the following factors: (i) current loan delinquencies, (ii) loans migrating to collateral-dependent status, and (iii) actual historical loss severities. 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 MPF and MPP conventional mortgage loans, including TDRs and collateral-dependent loans, for impairment. The Bank's TDRs include loans granted under its loan modification plans 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.

A charge-off is recorded if it is estimated that the recorded investment in a loan will not be recovered. The Bank evaluates whether to record a charge-off based upon the occurrence of a confirming event, including but not limited to, the occurrence of foreclosure or when a loan is deemed collateral-dependent. The Bank charges-off the portion of the outstanding conventional mortgage loan balance in excess of the fair value of the underlying collateral, which is determined using property values, less selling costs and expected proceeds from PMI.

Estimating Additional Credit Loss in the MPF and MPP Conventional Mortgage Loan Portfolios. The Bank may make adjustments for certain limitations in its estimation of credit losses. These adjustments recognize 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. These additional factors include, but are not limited to certain quantifiable economic factors, such as unemployment rates and home prices impacting housing markets.






27

The following table summarizes the recorded investment and allowance for credit losses of the Bank's conventional mortgage loan portfolio by impairment methodology (dollars in millions):
 
MPF
 
MPP1
 
Total
Recorded investment, September 30, 20162
 
 
 
 
 
Collectively evaluated for impairment
$
5,818

 
$
372

 
$
6,190

Individually evaluated for impairment, without a related allowance
30

 
25

 
55

Total recorded investment
$
5,848

 
$
397

 
$
6,245

 
 
 
 
 
 
Recorded investment, December 31, 20152
 
 
 
 
 
Collectively evaluated for impairment
$
5,659

 
$
449

 
$
6,108

Individually evaluated for impairment, without a related allowance
37

 
31

 
68

Total recorded investment
$
5,696

 
$
480

 
$
6,176

 
 
 
 
 
 
Allowance for credit losses, September 30, 2016
 
 
 
 
 
Collectively evaluated for impairment
$
2

 
$
—

 
$
2

 
 
 
 
 
 
Allowance for credit losses, December 31, 2015
 
 
 
 
 
Collectively evaluated for impairment
$
1

 
$
—

 
$
1


1    The allowance for credit losses on MPP loans was less than $1 million at September 30, 2016 and December 31, 2015.

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



















28

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 millions):
 
September 30, 2016
 
MPF
 
MPP
 
 
 
Conventional
 
Government
 
Conventional
 
Government
 
Total
Past due 30 - 59 days
$
52

 
$
19

 
$
12

 
$
4

 
$
87

Past due 60 - 89 days
13

 
8

 
4

 
2

 
27

Past due 90 - 179 days
10

 
5

 
3

 
1

 
19

Past due 180 days or more
23

 
4

 
12

 
2

 
41

Total past due mortgage loans
98

 
36

 
31

 
9

 
174

Total current mortgage loans
5,750

 
500

 
366

 
38

 
6,654

Total recorded investment of mortgage loans1
$
5,848

 
$
536

 
$
397

 
$
47

 
$
6,828

 
 
 
 
 
 
 
 
 
 
In process of foreclosure (included above)2
$
16

 
$
2

 
$
7

 
$
—

 
$
25

Serious delinquency rate3
1
%
 
2
%
 
4
%
 
7
%
 
1
%
Past due 90 days or more and still accruing interest4
$
—

 
$
9

 
$
—

 
$
3

 
$
12

Non-accrual mortgage loans5
$
37

 
$
—

 
$
26

 
$
—

 
$
63


 
December 31, 2015
 
MPF
 
MPP
 
 
 
Conventional
 
Government
 
Conventional
 
Government
 
Total
Past due 30 - 59 days
$
57

 
$
21

 
$
13

 
$
5

 
$
96

Past due 60 - 89 days
16

 
7

 
4

 
2

 
29

Past due 90 - 179 days
12

 
5

 
3

 
1

 
21

Past due 180 days or more
30

 
5

 
16

 
3

 
54

Total past due mortgage loans
115

 
38

 
36

 
11

 
200

Total current mortgage loans
5,581

 
524

 
444

 
42

 
6,591

Total recorded investment of mortgage loans1
$
5,696

 
$
562

 
$
480

 
$
53

 
$
6,791

 
 
 
 
 
 
 
 
 
 
In process of foreclosure (included above)2
$
19

 
$
4

 
$
9

 
$
—

 
$
32

Serious delinquency rate3
1
%
 
2
%
 
4
%
 
8
%
 
1
%
Past due 90 days or more and still accruing interest4
$
—

 
$
10

 
$
—

 
$
4

 
$
14

Non-accrual mortgage loans5
$
46

 
$
—

 
$
32

 
$
—

 
$
78


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.


29

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 Bank did not recognize any interest income on impaired loans during the three and nine months ended September 30, 2016 and 2015.

The following table summarizes the average recorded investment of the Bank's individually evaluated impaired loans (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Impaired loans without an allowance
 
 
 
 
 
 
 
Conventional MPF Loans
$
32

 
$
41

 
$
34

 
$
45

Conventional MPP Loans
25

 
33

 
27

 
15

Total
$
57

 
$
74

 
$
61

 
$
60


REAL ESTATE OWNED

At September 30, 2016 and December 31, 2015, the Bank had $5 million and $7 million of real estate owned (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, 2016 and December 31, 2015.

OFF-BALANCE SHEET CREDIT EXPOSURES

At September 30, 2016 and December 31, 2015, 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."


30

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 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 asset does not match a change in the interest rate on the liability;

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

•
manage embedded options in assets and liabilities; and

•
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.

APPLICATION OF DERIVATIVES
 
Derivative instruments are accounted for by the Bank in two ways:
 
•
as a fair value hedge of an associated financial instrument or firm commitment for those items qualifying under applicable accounting guidance (fair value hedge); or

•
as an economic hedge to manage certain defined risks in its Statements of Condition. These hedges are primarily used to (i) manage mismatches between the coupon features of the Bank's assets and liabilities and offset prepayment risk in certain assets, or (ii) mitigate the income statement volatility that occurs when financial instruments are recorded at fair value and hedge accounting is not permitted by accounting guidance (economic hedge).

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 (uncleared 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.


31

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 fair value hedging 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 monthly) whether the derivatives it uses in hedging transactions have been effective in offsetting changes in the fair value of hedged items attributable to the hedged risk 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.

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.


32

The following table summarizes the Bank's notional amount and the 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 millions):
 
 
September 30, 2016
 
December 31, 2015
 
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
Derivatives designated as hedging instruments (fair value hedges)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
49,271

 
$
206

 
$
993

 
$
37,526

 
$
134

 
$
635

Derivatives not designated as hedging instruments (economic hedges)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
1,411

 
22

 
119

 
1,456

 
21

 
70

Interest rate swaptions
 
—

 
—

 
—

 
200

 
—

 
—

Forward settlement agreements (TBAs)
 
204

 
—

 
1

 
45

 
—

 
—

Mortgage delivery commitments
 
211

 
1

 
—

 
51

 
—

 
—

Total derivatives not designated as hedging instruments
 
1,826

 
23

 
120

 
1,752

 
21

 
70

Total derivatives before netting and collateral adjustments
 
$
51,097

 
229

 
1,113

 
$
39,278

 
155

 
705

Netting adjustments and cash collateral1
 
 
 
(120
)
 
(1,028
)
 
 
 
(61
)
 
(603
)
Total derivative assets and derivative liabilities
 
 
 
$
109

 
$
85

 
 
 
$
94

 
$
102


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. Cash collateral posted by the Bank (including accrued interest) was $0.9 billion and $0.5 billion at September 30, 2016 and December 31, 2015. At September 30, 2016 and December 31, 2015, the Bank had not received any cash collateral from clearing agents and/or counterparties.

The following table summarizes the components of “Net gains (losses) on derivatives and hedging activities” as presented in the Statements of Income (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015

 
2016
 
2015
Derivatives designated as hedging instruments (fair value hedges)
 
 
 
 
 
 
 
Interest rate swaps
$
(7
)
 
$
(6
)
 
$
(16
)
 
$
1

Derivatives not designated as hedging instruments (economic hedges)
 
 
 
 
 
 
 
Interest rate swaps
10

 
(32
)
 
(45
)
 
(24
)
Forward settlement agreements (TBAs)
(2
)
 
(1
)
 
(5
)
 
(1
)
Mortgage delivery commitments
1

 
1

 
4

 
1

Net interest settlements
(5
)
 
(5
)
 
(14
)
 
(16
)
Total net gains (losses) related to derivatives not designated as hedging instruments
4

 
(37
)
 
(60
)
 
(40
)
Net gains (losses) on derivatives and hedging activities
$
(3
)
 
$
(43
)
 
$
(76
)
 
$
(39
)




33

The following tables summarize, by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair value hedging relationships, the net fair value hedge ineffectiveness, and the effect of those derivatives on the Bank's net interest income (dollars in millions):
 
 
For the Three Months Ended September 30, 2016
Hedged Item Type
 
Gains (Losses) on
Derivatives
 
Gains (Losses) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
69

 
$
(82
)
 
$
(13
)
 
$
(36
)
Advances2
 
95

 
(95
)
 
—

 
(34
)
Consolidated obligation bonds
 
(103
)
 
109

 
6

 
23

Total
 
$
61

 
$
(68
)
 
$
(7
)
 
$
(47
)
 
 
For the Three Months Ended September 30, 2015
Hedged Item Type
 
Gains (Losses) on
Derivatives
 
Gains (Losses) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
(241
)
 
$
238

 
$
(3
)
 
$
(44
)
Advances2
 
(91
)
 
90

 
(1
)
 
(48
)
Consolidated obligation bonds
 
71

 
(73
)
 
(2
)
 
32

Total
 
$
(261
)
 
$
255

 
$
(6
)
 
$
(60
)
 
 
For the Nine Months Ended September 30, 2016
Hedged Item Type
 
Gains (Losses) on
Derivatives
 
Gains (Losses) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
(335
)
 
$
319

 
$
(16
)
 
$
(110
)
Advances2
 
(83
)
 
84

 
1

 
(111
)
Consolidated obligation bonds
 
49

 
(50
)
 
(1
)
 
56

Total
 
$
(369
)
 
$
353

 
$
(16
)
 
$
(165
)
 
 
For the Nine Months Ended September 30, 2015
Hedged Item Type
 
Gains (Losses) on
Derivatives
 
Gains (Losses) on
Hedged Items
 
Net Fair Value
Hedge
Ineffectiveness
 
Effect on
Net Interest
Income1
Available-for-sale investments
 
$
(161
)
 
$
161

 
$
—

 
$
(111
)
Advances2
 
(58
)
 
59

 
1

 
(130
)
Consolidated obligation bonds
 
68

 
(68
)
 
—

 
87

Total
 
$
(151
)
 
$
152

 
$
1

 
$
(154
)

1
Represents the net interest settlements on derivatives in fair value hedge relationships and the amortization of the financing element of off-market derivatives, both of which are included in the interest income or interest expense line item of the respective hedged item type. This amortization for off-market derivatives totaled $7 million and $23 million for the three and nine months ended September 30, 2016. The amortization totaled $10 million and $13 million for the three and nine months ended September 30, 2015.

2
Includes net gains (losses) on fair value hedge firm commitments of forward starting advances.

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 uncleared 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 uncleared derivatives.


34

For cleared derivatives, the Clearinghouse is the Bank's counterparty. The Clearinghouse notifies the clearing agent of the required initial and variation margin and the clearing agent in turn notifies the Bank. 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 for changes in the fair value of cleared derivatives is posted daily through a clearing agent.

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 uncleared 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 uncleared derivative instruments in net liability positions. The aggregate fair value of all uncleared 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, 2016 was $431 million, for which the Bank posted collateral of $352 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 $71 million of collateral to its uncleared derivative counterparties at September 30, 2016.

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, based on credit considerations, at September 30, 2016.

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 millions):
 
September 30, 2016
 
December 31, 2015
 
Derivative Assets
 
Derivative Liabilities
 
Derivative Assets
 
Derivative Liabilities
Derivative instruments meeting netting requirements
 
 
 
 
 
 
 
Gross recognized amount
 
 
 
 
 
 
 
Uncleared derivatives
$
112

 
$
543

 
$
110

 
$
406

Cleared derivatives
116

 
570

 
45

 
299

Total gross recognized amount
228

 
1,113

 
155

 
705

Gross amounts of netting adjustments and cash collateral
 
 
 
 
 
 
 
Uncleared derivatives
(106
)
 
(458
)
 
(109
)
 
(304
)
Cleared derivatives
(14
)
 
(570
)
 
48

 
(299
)
Total gross amounts of netting adjustments and cash collateral
(120
)
 
(1,028
)
 
(61
)
 
(603
)
Net amounts after netting adjustments and cash collateral
 
 
 
 
 
 
 
Uncleared derivatives
6

 
85

 
1

 
102

Cleared derivatives
102

 
—

 
93

 
—

Total net amounts after netting adjustments and cash collateral
108

 
85

 
94

 
102

Uncleared derivatives instruments not meeting netting requirements1
1

 
—

 
—

 
—

Total derivative assets and derivative liabilities
 
 
 
 
 
 
 
Uncleared derivatives
7

 
85

 
1

 
102

Cleared derivatives
102

 
—

 
93

 
—

Total derivative assets and derivative liabilities
$
109

 
$
85

 
$
94

 
$
102


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

35

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, 2016 and December 31, 2015, the total par value of outstanding consolidated obligations of the FHLBanks was $967.7 billion and $905.2 billion.

DISCOUNT NOTES

The following table summarizes the Bank's discount notes (dollars in millions):
 
September 30, 2016
 
December 31, 2015
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Par value
$
84,550

 
0.41
%
 
$
99,074

 
0.31
%
Discounts and concessions1
(69
)
 
 
 
(84
)
 
 
Total
$
84,481

 
 
 
$
98,990

 
 

1
Concessions represent fees paid to dealers in connections with the issuance of certain consolidated obligation discount notes.

BONDS

The following table summarizes the Bank's bonds outstanding by contractual maturity (dollars in millions):
 
 
September 30, 2016
 
December 31, 2015
Year of Contractual Maturity
 
Amount
 
Weighted
Average
Interest
Rate
 
Amount
 
Weighted
Average
Interest
Rate
Due in one year or less
 
$
42,966

 
0.74
%
 
$
15,676

 
0.78
%
Due after one year through two years
 
19,344

 
0.97

 
3,808

 
2.91

Due after two years through three years
 
7,849

 
1.61

 
1,604

 
2.13

Due after three years through four years
 
2,833

 
2.39

 
2,780

 
2.93

Due after four years through five years
 
4,783

 
1.81

 
2,243

 
3.35

Thereafter
 
4,404

 
3.02

 
4,788

 
3.08

Total par value
 
82,179

 
1.12
%
 
30,899

 
1.85
%
Premiums
 
271

 
 
 
312

 
 
Discounts and concessions1
 
(67
)
 
 
 
(35
)
 
 
Fair value hedging adjustments
 
71

 
 
 
32

 
 
Total
 
$
82,454

 
 
 
$
31,208

 
 

1
Concessions represent fees paid to dealers in connections with the issuance of certain consolidated obligation bonds.

The following table summarizes the Bank's bonds outstanding by call features (dollars in millions):
 
September 30,
2016
 
December 31,
2015
Noncallable or nonputable
$
79,870

 
$
28,050

Callable
2,309

 
2,849

Total par value
$
82,179

 
$
30,899

 

36

Note 12 — Capital

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 generally issues a single class of capital stock (Class B stock). 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 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, 2016 and December 31, 2015, the Bank had no excess capital stock outstanding.

MANDATORILY REDEEMABLE CAPITAL STOCK

The Bank reclassifies capital stock subject to redemption from equity to a liability (mandatorily redeemable capital stock) at the time shares meet the definition of a mandatorily redeemable financial instrument. This occurs after a member provides written notice of intention to withdraw from membership, becomes ineligible for continuing membership, or attains non-member status by merger or consolidation, charter termination, or other involuntary termination from membership. Dividends on mandatorily redeemable capital stock are classified as interest expense in the Statements of Income.

As a result of the final rule on membership issued by the Finance Agency effective February 19, 2016, the eligibility requirements for FHLBank members were changed rendering captive insurance companies ineligible for FHLBank membership. Captive insurance company members that were admitted as members prior to September 12, 2014 (the date the Finance Agency proposed this rule) will have their memberships terminated no later than February 19, 2021. Captive insurance company members that were admitted as members after September 12, 2014 will have their memberships terminated no later than February 19, 2017. On the effective date of the final rule, the Bank reclassified $723 million of capital stock, the total outstanding capital stock held by all of the Bank's captive insurance companies, to mandatorily redeemable capital stock. At September 30, 2016 and December 31, 2015, the Bank's mandatorily redeemable capital stock totaled $675 million and $103 million. During the three and nine months ended September 30, 2016, interest expense on mandatorily redeemable capital stock was $6 million and $15 million. During the three and nine months ended September 30, 2015, interest expense on mandatorily redeemable capital stock was $1 million and $2 million.


37

The following tables summarize changes in mandatorily redeemable capital stock (dollars in millions):
 
For the Three Months Ended September 30,
 
2016
 
2015
Balance, beginning of period
$
698

 
$
119

Capital stock reclassified to (from) mandatorily redeemable capital stock, net
1

 
14

Repurchases/redemptions of mandatorily redeemable capital stock
(24
)
 
(27
)
Balance, end of period
$
675

 
$
106


 
 For the Nine Months Ended September 30,
 
2016
 
2015
Balance, beginning of period
$
103

 
$
24

Mandatorily redeemable capital stock assumed from merger
—

 
725

Capital stock reclassified to (from) mandatorily redeemable capital stock, net
732

 
(75
)
Repurchases/redemptions of mandatorily redeemable capital stock
(160
)
 
(568
)
Balance, end of period
$
675

 
$
106


The following table summarizes the Bank's mandatorily redeemable capital stock by year of contractual redemption (dollars in millions):
Year of Contractual Redemption1
 
September 30,
2016
 
December 31, 2015
Due in one year or less
 
$
4

 
$
7

Due after one year through two years
 
5

 
4

Due after two years through three years
 
—

 
65

Due after three years through four years
 
4

 
4

Due after four years through five years
 
2

 
—

Thereafter2
 
639

 
—

Past contractual redemption date due to outstanding activity with the Bank
 
21

 
23

Total
 
$
675

 
$
103


1
At the Bank's election, the mandatorily redeemable capital stock may be redeemed prior to the expiration of the five year redemption period that commences on the date of the notice of redemption, or in the case of captive insurance company members, on the date of the membership termination.

2
Represents mandatorily redeemable capital stock resulting from the Finance Agency rule previously discussed that makes captive insurance companies ineligible for FHLBank membership. The related mandatorily redeemable capital stock is not required to be redeemed until five years after the member's termination.

ADDITIONAL CAPITAL FROM MERGER

The Bank recognized the net assets acquired from the Seattle Bank by recording the par value of capital stock issued in the transaction as capital stock, with the remaining portion of net assets acquired reflected in a new capital account captioned as “Additional capital from merger.” The Bank treats this additional capital from merger as a component of total capital for regulatory capital purposes. Dividends on capital stock have been paid from this account since the merger date and the Bank intends to pay future dividends, when and if declared, from this account until the additional capital from merger balance is depleted. At September 30, 2016 and December 31, 2015 the Bank's additional capital from merger balance totaled $92 million and $194 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, 2016 and December 31, 2015, the Bank's restricted retained earnings account totaled $200 million and $101 million.


38

ACCUMULATED OTHER COMPREHENSIVE INCOME

The following table summarizes changes in accumulated other comprehensive income (AOCI) (dollars in millions):
 
Net unrealized gains (losses) on AFS securities (Note 4)
 
Pension and postretirement benefits
 
Total AOCI
Balance, June 30, 2015
$
124

 
$
(2
)
 
$
122

Other comprehensive income (loss) before reclassifications
 
 
 
 
 
Net unrealized gains (losses) on AFS securities
(120
)
 
—

 
(120
)
Reclassifications from other comprehensive income (loss) to net income
 
 
 
 
 
Amortization - pension and postretirement
—

 
(1
)
 
(1
)
Net current period other comprehensive income (loss)
(120
)
 
(1
)
 
(121
)
Balance, September 30, 2015
$
4

 
$
(3
)
 
$
1

 
 
 
 
 
 
Balance, June 30, 2016
$
(83
)
 
$
(2
)
 
$
(85
)
Other comprehensive income (loss) before reclassifications
 
 
 
 
 
Net unrealized gains (losses) on AFS securities
46

 
—

 
46

Net current period other comprehensive income (loss)
46

 
—

 
46

Balance, September 30, 2016
$
(37
)
 
$
(2
)
 
$
(39
)
 
 
 
 
 
 
Balance, December 31, 2014
$
126

 
$
(3
)
 
$
123

Other comprehensive income (loss) before reclassifications
 
 
 
 
 
Net unrealized gains (losses) on AFS securities
(122
)
 
—

 
(122
)
Net current period other comprehensive income (loss)
(122
)
 
—

 
(122
)
Balance, September 30, 2015
$
4

 
$
(3
)
 
$
1

 
 
 
 
 
 
Balance, December 31, 2015
$
(82
)
 
$
(2
)
 
$
(84
)
Other comprehensive income (loss) before reclassifications
 
 
 
 
 
Net unrealized gains (losses) on AFS securities
45

 
—

 
45

Net current period other comprehensive income (loss)
45

 
—

 
45

Balance, September 30, 2016
$
(37
)
 
$
(2
)
 
$
(39
)


REGULATORY CAPITAL REQUIREMENTS

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 stock (including 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 Class B stock (including mandatorily redeemable capital stock), additional capital from merger, and retained earnings. It does not include 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, 2016 and December 31, 2015, nonpermanent capital included additional capital from merger.

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.


39

The following table shows the Bank's compliance with the Finance Agency's regulatory capital requirements (dollars in millions):
 
September 30, 2016
 
December 31, 2015
 
Required
 
Actual
 
Required
 
Actual
Regulatory capital requirements
 
 
 
 
 
 
 
Risk-based capital
$
939

 
$
7,627

 
$
951

 
$
5,618

Regulatory capital
$
7,043

 
$
7,719

 
$
5,495

 
$
5,812

Leverage capital
$
8,804

 
$
11,533

 
$
6,869

 
$
8,621

Capital-to-assets ratio
4.00
%
 
4.38
%
 
4.00
%
 
4.23
%
Leverage ratio
5.00
%
 
6.55
%
 
5.00
%
 
6.28
%

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 three and nine months ended September 30, 2016 and 2015.


40

The following table summarizes the carrying value, fair value, and fair value hierarchy of the Bank's financial instruments at September 30, 2016 (dollars in millions). 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
 
$
245

 
$
245

 
$
—

 
$
—

 
$
—

 
$
245

Interest-bearing deposits
 
2

 
—

 
2

 
—

 
—

 
2

Securities purchased under agreements to resell
 
6,250

 
—

 
6,250

 
—

 
—

 
6,250

Federal funds sold
 
4,635

 
—

 
4,635

 
—

 
—

 
4,635

Trading securities
 
4,077

 
—

 
4,077

 
—

 
—

 
4,077

Available-for-sale securities
 
22,931

 
—

 
22,931

 
—

 
—

 
22,931

Held-to-maturity securities
 
4,956

 
—

 
5,035

 
16

 
—

 
5,051

Advances
 
125,828

 
—

 
125,973

 
—

 
—

 
125,973

Mortgage loans held for portfolio, net
 
6,792

 
—

 
6,932

 
121

 
—

 
7,053

Accrued interest receivable
 
187

 
—

 
187

 
—

 
—

 
187

Derivative assets, net
 
109

 
—

 
229

 
—

 
(120
)
 
109

Other assets
 
23

 
23

 
—

 
—

 
—

 
23

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
(1,033
)
 
—

 
(1,033
)
 
—

 
—

 
(1,033
)
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
 
Discount notes
 
(84,481
)
 
—

 
(84,500
)
 
—

 
—

 
(84,500
)
Bonds
 
(82,454
)
 
—

 
(83,123
)
 
—

 
—

 
(83,123
)
Total consolidated obligations
 
(166,935
)
 
—

 
(167,623
)
 
—

 
—

 
(167,623
)
Mandatorily redeemable capital stock
 
(675
)
 
(675
)
 
—

 
—

 
—

 
(675
)
Accrued interest payable
 
(181
)
 
—

 
(181
)
 
—

 
—

 
(181
)
Derivative liabilities, net
 
(85
)
 
—

 
(1,113
)
 
—

 
1,028

 
(85
)
Other
 
 
 
 
 
 
 
 
 
 
 
 
Commitments to fund advances
 
—

 
—

 
4

 
—

 
—

 
4

Standby letters of credit
 
(3
)
 
—

 
—

 
(3
)
 
—

 
(3
)
Standby bond purchase agreements
 
—

 
—

 
2

 
—

 
—

 
2


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.


41

The following table summarizes the carrying value, fair value, and fair value hierarchy of the Bank's financial instruments at December 31, 2015 (dollars in millions):
 
 
 
 
Fair Value
Financial Instruments
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
 
$
982

 
$
982

 
$
—

 
$
—

 
$
—

 
$
982

Interest-bearing deposits
 
2

 
—

 
2

 
—

 
—

 
2

Securities purchased under agreements to resell
 
6,775

 
—

 
6,775

 
—

 
—

 
6,775

Federal funds sold
 
2,270

 
—

 
2,270

 
—

 
—

 
2,270

Trading securities
 
4,047

 
—

 
4,047

 
—

 
—

 
4,047

Available-for-sale securities
 
20,988

 
—

 
20,988

 
—

 
—

 
20,988

Held-to-maturity securities
 
6,085

 
—

 
6,123

 
19

 
—

 
6,142

Advances
 
89,173

 
—

 
89,212

 
—

 
—

 
89,212

Mortgage loans held for portfolio, net
 
6,755

 
—

 
6,792

 
112

 
—

 
6,904

Accrued interest receivable
 
143

 
—

 
143

 
—

 
—

 
143

Derivative assets, net
 
94

 
—

 
155

 
—

 
(61
)
 
94

Other assets
 
19

 
19

 
—

 
—

 
—

 
19

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
(1,110
)
 
—

 
(1,110
)
 
—

 
—

 
(1,110
)
Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
 
Discount notes
 
(98,990
)
 
—

 
(98,984
)
 
—

 
—

 
(98,984
)
Bonds
 
(31,208
)
 
—

 
(31,610
)
 
—

 
—

 
(31,610
)
Total consolidated obligations
 
(130,198
)
 
—

 
(130,594
)
 
—

 
—

 
(130,594
)
Mandatorily redeemable capital stock
 
(103
)
 
(103
)
 
—

 
—

 
—

 
(103
)
Accrued interest payable
 
(119
)
 
—

 
(119
)
 
—

 
—

 
(119
)
Derivative liabilities, net
 
(102
)
 
—

 
(705
)
 
—

 
603

 
(102
)
Other
 
 
 
 
 
 
 
 
 
 
 
 
Commitments to fund advances
 
—

 
—

 
(1
)
 
—

 
—

 
(1
)
Standby letters of credit
 
(2
)
 
—

 
—

 
(2
)
 
—

 
(2
)
Standby bond purchase agreements
 
—

 
—

 
2

 
—

 
—

 
2


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.

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


42

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, 2016 and December 31, 2015, four prices were received for the majority of the Bank's investment securities and the final prices for those securities were computed by averaging the prices received. Based on the Bank's review of the pricing methods and controls employed by the third-party pricing vendors and the relative lack of dispersion among the vendor prices, the Bank believes its final prices are representative of the prices that would have been received if the assets had been sold at the measurement date (i.e., exit prices) and further, that the fair value measurements are classified appropriately in the fair value hierarchy.

Advances. The fair value of advances is determined by calculating the present value of the expected future cash flows and reducing the amount for accrued interest receivable. For advances elected under the fair value option, fair value includes 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 assumes no prepayment risk.

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

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

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

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

Mortgage Loans Held for Portfolio. The fair value of mortgage loans held for portfolio is 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, liquidity, 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.

43

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. 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 broker price opinion, which considers actual property characteristics and conditions, or a property value 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. 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.

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 uncleared 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 grantor trust assets, which are carried at estimated fair value based on quoted market prices as of the last business day of the reporting period.

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

Consolidated Obligations. The fair value of consolidated obligations is 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.

44

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.


45

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, 2016 (dollars in millions):
Recurring Fair Value Measurements
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
 
$
—

 
$
229

 
$
—

 
$
—

 
$
229

GSE and Tennessee Valley Authority obligations
 
—

 
3,086

 
—

 
—

 
3,086

Other non-MBS
 
—

 
288

 
—

 
—

 
288

GSE multifamily MBS
 
—

 
474

 
—

 
—

 
474

Total trading securities
 
—

 
4,077

 
—

 
—

 
4,077

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

 
3,703

 
—

 
—

 
3,703

GSE and Tennessee Valley Authority obligations
 
—

 
1,492

 
—

 
—

 
1,492

State or local housing agency obligations
 
—

 
1,022

 
—

 
—

 
1,022

Other non-MBS
 
—

 
296

 
—

 
—

 
296

Other U.S. obligations single-family MBS
 
—

 
3,501

 
—

 
—

 
3,501

GSE single-family MBS
 
—

 
1,356

 
—

 
—

 
1,356

GSE multifamily MBS
 
—

 
11,561

 
—

 
—

 
11,561

Total available-for-sale securities
 
—

 
22,931

 
—

 
—

 
22,931

Advances2
 
—

 
2

 
—

 
—

 
2

Derivative assets, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 
—

 
228

 
—

 
(120
)
 
108

Mortgage delivery commitments
 
—

 
1

 
—

 
—

 
1

Total derivative assets, net
 
—

 
229

 
—

 
(120
)
 
109

Other assets
 
23

 
—

 
—

 
—

 
23

Total recurring assets at fair value
 
$
23

 
$
27,239

 
$
—

 
$
(120
)
 
$
27,142

Liabilities
 
 
 
 
 
 
 
 
 
 
Derivative liabilities, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 
$
—

 
$
(1,112
)
 
$
—

 
$
1,028

 
$
(84
)
Forward settlement agreements (TBAs)
 
—

 
(1
)
 
—

 
—

 
(1
)
Total derivative liabilities, net
 
—

 
(1,113
)
 
—

 
1,028

 
(85
)
Total recurring liabilities at fair value
 
$
—

 
$
(1,113
)
 
$
—

 
$
1,028

 
$
(85
)

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 financial instruments recorded under the fair value option.


46

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, 2015 (dollars in millions):
Recurring Fair Value Measurements
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment1
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations
 
$
—

 
$
237

 
$
—

 
$
—

 
$
237

GSE and Tennessee Valley Authority obligations
 
—

 
3,077

 
—

 
—

 
3,077

Other non-MBS
 
—

 
276

 
—

 
—

 
276

GSE multifamily MBS
 
—

 
457

 
—

 
—

 
457

Total trading securities
 
—

 
4,047

 
—

 
—

 
4,047

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

 
3,985

 
—

 
—

 
3,985

GSE and Tennessee Valley Authority obligations
 
—

 
2,115

 
—

 
—

 
2,115

State or local housing agency obligations
 
—

 
1,047

 
—

 
—

 
1,047

Other non-MBS
 
—

 
278

 
—

 
—

 
278

Other U.S. obligations single-family MBS
 
—

 
2,270

 
—

 
—

 
2,270

GSE single-family MBS
 
—

 
1,605

 
—

 
—

 
1,605

GSE multifamily MBS
 
—

 
9,688

 
—

 
—

 
9,688

Total available-for-sale securities
 
—

 
20,988

 
—

 
—

 
20,988

Advances2
 
—

 
8

 
—

 
—

 
8

Derivative assets, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 
—

 
155

 
—

 
(61
)
 
94

Other assets
 
19

 
—

 
—

 
—

 
19

Total recurring assets at fair value
 
$
19

 
$
25,198

 
$
—

 
$
(61
)
 
$
25,156

Liabilities
 
 
 
 
 
 
 
 
 
 
Bonds2
 
$
—

 
$
(15
)
 
$
—

 
$
—

 
$
(15
)
Derivative liabilities, net
 
 
 
 
 
 
 
 
 
 
Interest-rate related
 
—

 
(705
)
 
—

 
603

 
(102
)
Total recurring liabilities at fair value
 
$
—

 
$
(720
)
 
$
—

 
$
603

 
$
(117
)

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 financial instruments 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. The Bank estimates the fair value of these assets based primarily on a broker price opinion or property values from an external pricing vendor. The Bank applies a haircut on these values, which can range between 10 and 20 percent, to capture certain limitations in the estimation process and takes into consideration estimated selling costs of 10 percent and expected PMI proceeds. The following table summarizes outstanding 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 period then ended (dollars in millions):
 
September 30,
2016
 
December 31,
2015
Impaired mortgage loans held for portfolio1
$
10

 
$
25

Real estate owned1
1

 
1

Total non-recurring assets1
$
11

 
$
26


1
The fair value information presented for September 30, 2016 is as of the date the fair value adjustment was recorded during the nine months ended September 30, 2016. The fair value information presented for December 31, 2015 is as of the date the fair value adjustment was recorded during the year ended December 31, 2015.




47

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 elects the fair value option for certain financial instruments when a hedge relationship does not qualify for hedge accounting. These fair value elections are made primarily in an effort to mitigate the potential income statement volatility that can arise when an economic derivative is adjusted for changes in fair value but the related hedged item is not.

For financial instruments recorded under the fair value option, the related contractual interest income and interest expense are recorded as part of net interest income in the Statements of Income. The remaining changes are recorded as “Net gains (losses) on financial instruments held at fair value” in the Statements of Income.

For the three and nine months ended September 30, 2016 and 2015, net gains on financial instruments held at fair value (i.e. advances and/or consolidated obligation bonds) were less than $1 million. At September 30, 2016 and December 31, 2015, the Bank determined no credit risk adjustments for nonperformance were necessary to the instruments recorded under the fair value option.

The following tables summarize the difference between the unpaid principal balance and fair value of outstanding instruments for which the fair value option has been elected (dollars in millions):
 
September 30, 2016
 
Unpaid Principal Balance
 
Fair Value
 
Fair Value Over (Under) Unpaid Principal
Advances1
$
2

 
$
2

 
$
—


 
December 31, 2015
 
Unpaid Principal Balance
 
Fair Value
 
Fair Value Over (Under) Unpaid Principal
Advances1
$
8

 
$
8

 
$
—

Bonds
15

 
15

 
—


1
At September 30, 2016 and December 31, 2015, none of the advances were 90 days or more past due or had been placed on non-accrual status.


48

Note 14 — Commitments and Contingencies

Joint and Several Liability. The 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, 2016 and December 31, 2015, 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 $801.0 billion and $775.2 billion.

The following table summarizes additional off-balance sheet commitments for the Bank (dollars in millions):
 
September 30, 2016
 
December 31, 2015
 
Expire
within one year
 
Expire
after one year
 
Total
 
Total
Standby letters of credit
$
5,880

 
$
131

 
$
6,011

 
$
5,482

Standby bond purchase agreements
98

 
333

 
431

 
560

Commitments to purchase mortgage loans
211

 
—

 
211

 
51

Commitments to issue bonds
54

 
—

 
54

 
—

Commitments to issue discount notes
—

 
—

 
—

 
2,500

Commitments to fund advances
204

 
90

 
294

 
145

Other commitments
—

 
—

 
—

 
87


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 2025. Unearned fees for standby letters of credit are recorded in “Other liabilities” in the Statements of Condition and amounted to $3 million and $2 million at September 30, 2016 and December 31, 2015.

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, 2016 and December 31, 2015 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. At September 30, 2016, the Bank had standby bond purchase agreements with five housing associates. The standby bond purchase commitments entered into by the Bank have original expiration periods of up to seven years, currently no later than 2020. During both the nine months ended September 30, 2016 and 2015, the Bank was not required to purchase any bonds under these agreements. For both the three months ended September 30, 2016 and 2015, the Bank received fees for the guarantees that amounted to less than $1 million. For both the nine months ended September 30, 2016 and 2015, the Bank received fees for the guarantees that amounted to $1 million. The estimated fair value of standby bond purchase agreements at September 30, 2016 and December 31, 2015 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, 2016 and December 31, 2015 is reported in “Note 10 — Derivatives and Hedging Activities” as mortgage delivery commitments.

Commitments to Issue Bonds and Discount Notes. At September 30, 2016, the Bank had commitments to issue $54 million of consolidated obligation bonds and no commitments to issue consolidated obligation discount notes. At December 31, 2015, the Bank had commitments to issue $2.5 billion of consolidated obligation discount notes and no commitments to issue consolidated obligation bonds.

49

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, 2016 and December 31, 2015, the Bank had commitments to fund advances of $294 million and $145 million.

Other Commitments. On December 30, 2013, the Bank entered into an agreement with the Iowa Finance Authority (IFA) to purchase up to $100 million of taxable multi-family mortgage revenue bonds. As of December 31, 2015, the Bank had a commitment to purchase $87 million of bonds under the IFA agreement. As of September 30, 2016, the Bank did not have a commitment to purchase bonds as the IFA agreement expired on June 30, 2016.

The Bank has an FLA memorandum account which is used to track the Bank's potential loss exposure under each MPF master commitment prior to the PFI's credit enhancement obligation. For absorbing certain losses in excess of the FLA, PFIs are paid a credit enhancement fee, a portion of which may be performance-based. To the extent the Bank experiences losses under the FLA, it may be able to recapture performance-based credit enhancement fees paid to the PFI to offset these losses. The FLA balance for all MPF master commitments with a PFI credit enhancement obligation was $96 million and $93 million at September 30, 2016 and December 31, 2015. For additional information related to the FLA commitment, refer to "Note 9 — Allowance for Credit Losses."
Legal Proceedings. As a result of the Merger, the Bank is currently involved in a number of legal proceedings initiated by the Seattle Bank against various entities relating to its purchases and subsequent impairment of certain private-label MBS. Although the Seattle Bank sold all private-label MBS during the first quarter of 2015, the Bank continues to pursue these proceedings. Other than the private-label MBS litigation, the Bank does not believe any legal proceedings to which it is a party could have a material impact on its financial condition, results of operations, or cash flows.
Litigation settlement gains are considered realized and recorded when the Bank receives cash or assets that are readily convertible to known amounts of cash or claims to cash. In addition, litigation settlement gains are considered realizable and recorded when the Bank enters into a signed agreement that is not subject to appeal, where the counterparty has the ability to pay, and the amount to be received can be reasonably estimated. Prior to being realized or realizable, the Bank considers potential litigation settlement gains to be gain contingencies, and therefore they are not recorded in the Statements of Income.
The Bank records legal expenses related to litigation settlements as incurred in other expenses in the Statements of Income with the exception of certain legal expenses related to litigation settlement awards that are contingent based fees for the attorneys representing the Bank. The Bank incurs and recognizes these contingent based legal fees only when litigation settlement awards are realized, at which time these fees are netted against the gains recognized on the litigation settlement.  During the nine months ended September 30, 2016, the Bank recognized and received $337 million in net gains on litigation settlements through other income (loss), due to the settlement of certain private-label MBS claims. The Bank did not recognize any net gains on litigation settlements during the three months ended September 30, 2016. During both the three and nine months ended September 30, 2015, the Bank recognized $12 million in net gains on litigation settlements.

Note 15 — Activities with Stockholders

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

TRANSACTIONS WITH DIRECTORS' FINANCIAL INSTITUTIONS

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









50

The following table summarizes the Bank's outstanding transactions with Directors' Financial Institutions (dollars in millions):
 
 
September 30, 2016
 
December 31, 2015
 
 
Amount
 
% of Total
 
Amount
 
% of Total
Advances
 
$
2,649

 
2
 
$
1,606

 
2
Mortgage loans
 
170

 
3
 
151

 
2
Deposits
 
25

 
2
 
17

 
2
Capital stock
 
163

 
3
 
120

 
2

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, 2016, the Bank had the following business concentrations with stockholders (dollars in millions):
 
 
Capital Stock
 
 
 
Mortgage
 
Interest
Stockholder
 
Amount
 
% of Total1
 
Advances
 
Loans
 
Income2
Wells Fargo Bank, N.A.
 
$
2,755

 
43
 
$
68,625

 
$
—

 
$
278

Superior Guaranty Insurance Company3
 
30

 
1
 
—

 
737

 
—

Wells Fargo Bank Northwest, N.A.3
 
2

 
—
 
—

 
39

 
—

Total
 
$
2,787

 
44
 
$
68,625

 
$
776

 
$
278


1
Pursuant to applicable Finance Agency regulations, the Bank's voting structure limits the voting rights of these stockholders and other members holding a significant amount of the Bank's capital stock.

2
Represents interest income earned on advances during the nine months ended September 30, 2016. Interest income on mortgage loans is excluded from this table as this interest relates to the borrower, not to the stockholder.

3
Superior Guaranty Insurance Company and Wells Fargo Bank Northwest, N.A. are affiliates of Wells Fargo Bank, N.A.


At December 31, 2015, the Bank had the following business concentrations with stockholders (dollars in millions):
 
 
Capital Stock
 
 
 
Mortgage
 
Interest
Stockholder
 
Amount
 
% of Total1
 
Advances
 
Loans
 
Income2
Wells Fargo Bank, N.A.
 
$
1,490

 
31
 
$
37,000

 
$
—

 
$
99

Superior Guaranty Insurance Company3
 
37

 
1
 
—

 
899

 
—

Wells Fargo Bank Northwest N.A.3
 
2

 
—
 
—

 
48

 
—

Total
 
$
1,529

 
32
 
$
37,000

 
$
947

 
$
99


1
Pursuant to applicable Finance Agency regulations, the Bank's voting structure limits the voting rights of these stockholders and other members holding a significant amount of the Bank's capital stock.
 
2
Represents interest income earned on advances during the year ended December 31, 2015. Interest income on mortgage loans is excluded from this table as this interest relates to the borrower, not to the stockholder.

3
Superior Guaranty Insurance Company and Wells Fargo Bank Northwest, N.A. are affiliates of Wells Fargo Bank, N.A.

Note 16 — Activities with Other FHLBanks

MPF Mortgage Loans. The Bank pays a service fee to the FHLBank of Chicago (Chicago Bank) for its participation in the MPF program. This service fee expense is recorded in other expense. For both the three months ended September 30, 2016 and 2015, the Bank recorded less than $1 million in service fee expense to the Chicago Bank. For both the nine months ended September 30, 2016 and 2015, the Bank recorded $2 million in service fee expense to the Chicago Bank.

Overnight Funds. The Bank may lend or borrow unsecured overnight funds to or from other FHLBanks. All such transactions are at current market rates. During the nine months ended September 30, 2016, the Bank did not lend funds to other FHLBanks. The following table summarizes loan activity to other FHLBanks during the nine months ended September 30, 2015 (dollars in millions):
Other FHLBank
 
Beginning
Balance
 
Advance
 
Principal
Repayment
 
Ending
Balance
2015
 
 
 
 
 
 
 
 
Topeka
 
$
—

 
$
100

 
$
(100
)
 
$
—


51


The following table summarizes borrowing activity from other FHLBanks during the nine months ended September 30, 2016 and 2015 (dollars in millions):
Other FHLBank
 
Beginning
Balance
 
Borrowing
 
Principal
Payment
 
Ending
Balance
2016
 
 
 
 
 
 
 
 
San Francisco
 
$
—

 
$
200

 
$
(200
)
 
$
—

 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
Dallas
 
$
—

 
$
200

 
$
(200
)
 
$
—

San Francisco
 
—

 
100

 
(100
)
 
—

 
 
$
—

 
$
300

 
$
(300
)
 
$
—


At September 30, 2016 and 2015, none of the previous transactions were outstanding on the Bank's Statements of Condition. The interest income and expense related to these transactions was immaterial.

Note 17 — Subsequent Events

Subsequent events have been evaluated from October 1, 2016, through the time of the Form 10-Q filing with the Securities and Exchange Commission. No material subsequent events were identified.

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, 2015, filed with the Securities and Exchange Commission (SEC) on March 21, 2016 (2015 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:

52


53

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 11 Federal Home Loan Banks (FHLBanks);

•
changes in regulatory requirements regarding the eligibility criteria for membership with our Bank;

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

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

•
changes in our capital structure and capital requirements;

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

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

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

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

•
increases in delinquency or loss estimates 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;

•
member consolidations and failures; and

•
reliance on the FHLBank of Chicago as Mortgage Partnership Finance (MPF) provider (Mortgage Partnership Finance and MPF are registered trademarks of the FHLBank of Chicago), and Fannie Mae, Redwood Trust Inc., and Ginnie Mae as the ultimate investors of certain MPF products.



54

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 2015 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 our district. Our mission is to be a reliable provider of funding, liquidity, and services for our members so that they can meet the housing, business, and economic development needs of the communities they serve. We strive to achieve our mission within an operating principle that balances the trade-off between attractively priced products, reasonable returns on capital stock, and maintaining adequate capital to support safe and sound business operations. Our members include commercial banks, thrifts, credit unions, insurance companies, and community development financial institutions (CDFIs).

Financial Results
On May 31, 2015, we completed the merger (the Merger) with the Federal Home Loan Bank of Seattle (Seattle Bank). The Merger had a significant impact on all aspects of our financial condition, results of operations, and cash flows. As a result, the financial results for the current period are not directly comparable to the financial results prior to the Merger.

For the three and nine months ended September 30, 2016, we reported net income of $74 million and $493 million compared to $39 million and $100 million for the same periods in 2015. Our net income for the nine months ended September 30, 2016, calculated in accordance with accounting principles generally accepted in the United States of America (GAAP), was boosted by $337 million of net gains on litigation settlements. We did not record any litigation settlement gains in the quarter ending September 30, 2016.

The litigation settlements are the result of settlements with certain defendants in the our private-label MBS litigation. As a result of the Merger, we are currently involved in a number of legal proceedings initiated by the Seattle Bank against various entities relating to its purchases and subsequent impairments of certain private-label MBS. Although the Seattle Bank sold all private-label MBS during the first quarter of 2015, we continue to pursue these proceedings. We did not record any gains on litigation settlements during the three months ended September 30, 2016. For both the three and nine months ended September 30, 2015, we recorded net gains on litigation settlements of $12 million.

Net interest income totaled $117 million and $314 million for the three and nine months ended September 30, 2016 compared to $88 million and $236 million for the same periods last year. The increases were primarily due to an increase in interest income resulting from the higher interest rate environment and higher average advance and investment volumes, a portion of which for the year-to-date period was attributable to the assets acquired in the Merger. Our net interest margin was 0.27 percent and 0.26 percent during the three and nine months ended September 30, 2016 compared to 0.29 percent for both the three and nine months ended September 30, 2015. The decline was primarily due to increased costs on our interest-bearing liabilities driven by the higher interest rate environment and higher average volumes of advances which generate lower margins when compared to our other interest-earning assets.

We recorded a loss of $5 million and income of $319 million in other income (loss) for the three and nine months ended September 30, 2016 compared to losses of $12 million and $15 million for the same periods last year. Other income (loss) included litigation settlements which were the primary driver of the increase for the nine months ended September 30, 2016 as discussed above. Other factors impacting other income (loss) include net gains (losses) on derivatives and hedging activities and net gains (losses) on trading securities, as described below.

During the three and nine months ended September 30, 2016, we recorded net losses of $3 million and $76 million on our derivatives and hedging activities through other income (loss) compared to net losses of $43 million and $39 million during the same periods last year. These fair value changes were primarily attributable to the impact of changes in interest rates on interest rate swaps that we utilize to hedge our investment securities portfolio. 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. 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.


55

During the three and nine months ended September 30, 2016, we recorded net losses on trading securities of $2 million and net gains of $51 million compared to net gains of $17 million and $9 million during the same periods in 2015. 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 generally offset by changes in fair value on derivatives that we utilize to economically hedge these securities. Trading securities are recorded at fair value with changes in fair value reflected through other income (loss).

Other expense totaled $28 million and $82 million for the three and nine months ended September 30, 2016 compared to $32 million and $108 million for the same periods last year. The decrease was primarily due to one time merger related expenses incurred during the three and nine months ended September 30, 2015. Merger related expenses primarily included compensation and benefit expenses and merger transaction and integration expenses.
    
Our total assets increased to $176.1 billion at September 30, 2016, from $137.4 billion at December 31, 2015, due primarily to a $36.7 billion increase in advances. Advances increased due to borrowings from a wide range of members with the most significant increase from a large depository institution member.

Our total liabilities increased to $169.1 billion at September 30, 2016, from $131.8 billion at December 31, 2015, due primarily to an increase in consolidated obligations issued to fund the growth in our assets.

Total capital increased to $7.0 billion at September 30, 2016, from $5.6 billion at December 31, 2015. Total capital was impacted by an increase in retained earnings and an increase in capital stock. Retained earnings increased to $1.3 billion due to net income earned. Capital stock increased due to increased member activity which was partially offset by the reclassification of $0.7 billion of capital stock, including all capital stock outstanding to captive insurance companies, to mandatorily redeemable capital stock. This capital stock reclassification was in response to the Finance Agency final rule affecting captive insurance company membership that became effective on February 19, 2016.

Total regulatory capital increased to $7.7 billion at September 30, 2016, from $5.8 billion at December 31, 2015, both of which were above the required regulatory minimum. Regulatory capital includes all capital stock, mandatorily redeemable capital stock, additional capital from merger, and retained earnings.

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 interest income and GAAP net income before assessments 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 non-routine and unpredictable items, including net asset prepayment fee income, debt extinguishment losses, merger related expenses, mandatorily redeemable capital stock interest expense, and net gains on litigation settlements. The resulting non-GAAP measure, referred to as our adjusted earnings, reflects both adjusted net interest income and adjusted net income before assessments.

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 or not routine. 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 these non-GAAP measures can be used to assist in understanding the components of our earnings, they should not be considered a substitute for results reported under GAAP.

As indicated in the tables that follow, our adjusted net interest income and adjusted net income before assessments increased during the three and nine months ended September 30, 2016 when compared to the same periods in 2015. The increase in our adjusted net interest income and adjusted net income before assessments was primarily due to an increase in interest income due to the higher interest rate environment and higher advance and investment volumes, a portion of which were acquired through the Merger.


56

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,
 
2016
 
2015
 
2016
 
2015
GAAP net interest income before provision (reversal) for credit losses on mortgage loans
$
117

 
$
88

 
$
314

 
$
236

Exclude:
 
 
 
 
 
 
 
Prepayment fees on advances, net1
1

 
—

 
6

 
9

Prepayment fees on investments, net2
—

 
2

 
2

 
2

Mandatorily redeemable capital stock interest expense3
(6
)
 
—

 
(15
)
 
—

Total adjustments
(5
)
 
2

 
(7
)
 
11

Include items reclassified from other income (loss):
 
 
 
 
 
 
 
Net interest expense on economic hedges
(4
)
 
(5
)
 
(13
)
 
(15
)
Adjusted net interest income
$
118

 
$
81


$
308

 
$
210

Adjusted net interest margin
0.27
%
 
0.27
%
 
0.25
%
 
0.26
%

1
Prepayment fees on advances, net includes basis adjustment amortization.

2
Prepayment fees on investments, net includes basis adjustment amortization and premium and/or discount amortization.

3
Effective January 1, 2016, the adjusted earnings methodology was approved to exclude mandatorily redeemable capital stock interest expense from adjusted net interest income.

The following table summarizes the reconciliation between GAAP net income before assessments and adjusted net income before assessments (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015 Revised
GAAP net income before assessments
$
83

 
$
43

 
$
549

 
$
111

Exclude:
 
 
 
 
 
 
 
Prepayment fees on advances, net1
1

 
—

 
6

 
9

Prepayment fees on investments, net2
—

 
2

 
2

 
2

Mandatorily redeemable capital stock interest expense3
(6
)
 
—

 
(15
)
 
—

Net gains (losses) on trading securities
(2
)
 
17

 
51

 
9

Net gains (losses) on derivatives and hedging activities
(3
)
 
(43
)
 
(76
)
 
(39
)
Gains on litigation settlements, net
—

 
12

 
337

 
12

Merger related expenses
—

 
(3
)
 
—

 
(38
)
Include:
 
 
 
 
 
 
 
Net interest expense on economic hedges
(4
)
 
(5
)
 
(13
)
 
(15
)
Adjusted net income before assessments
$
89

 
$
53

 
$
231

 
$
141


1
Prepayment fees on advances, net includes basis adjustment amortization.

2
Prepayment fees on investments, net includes basis adjustment amortization and premium and/or discount amortization.

3
Effective January 1, 2016, the adjusted earnings methodology was approved to exclude mandatorily redeemable capital stock interest expense from adjusted net income.

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.”


57

CONDITIONS IN THE FINANCIAL MARKETS

Economy and Financial Markets

Economic and market data received since the Federal Open Market Committee (FOMC or Committee) meeting in July of 2016 indicates that economic activity has picked up from the moderate pace witnessed in the first half of the year. The labor market has continued to strengthen and job gains have been solid, however the unemployment rate has seen little change in recent months. Growth in household spending and the housing sector strengthened, however business fixed investments remain soft. Inflation has continued to run below the Committee's longer-run objective of two percent, partly reflecting declines in energy prices and non-energy import prices. Market-based measurements of inflation adjusted compensation remained low and long-term inflation expectations have remained stable.

In its September 21, 2016 statement, the FOMC stated it expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further toward levels the FOMC judges consistent with its dual mandate to foster maximum employment and price stability. In addition, the FOMC stated it anticipates that inflation will remain low in the near term, but it anticipates inflation will rise gradually towards its two percent objective over the medium term as the labor market improves further and the effects of lower energy prices and other factors dissipate. The FOMC will continue to monitor inflation and global economic and financial developments closely.

Mortgage Markets

The housing market continued to improve throughout the third quarter of 2016, although slower than during the first half of the year, as indicated by rising home prices, lower inventories of properties for sale, increased housing construction activity, and increased sales of existing homes. The improvement in the housing market has been partly attributable to the continued strengthening of the economy and partly due to the seasonality of home sales. The outlook for a sustainable recovery in residential sales and home prices remains promising over the long term, as consumer sentiment continues to improve and first time home buyer activity improves. Many market participants, however, expect this recovery to occur at a slower pace than in previous years.

Mortgage rates remained low throughout the third quarter, which has resulted in an increase in refinancing volume and has stimulated additional demand for home purchases as the cost of debt has made homes more affordable.

Interest Rates

The following table shows information on key market interest rates1:
 
Third Quarter 2016
3-Month
Average
 
Third Quarter 2015
3-Month
Average
 
Third Quarter 2016
9-Month
Average
 
Third Quarter 2015
9-Month
Average
 
September 30, 2016
Ending Rate
 
December 31, 2015
Ending Rate
Federal funds
0.40
%
 
0.14
%
 
0.38
%
 
0.13
%
 
0.29
%
 
0.20
%
Three-month LIBOR
0.79

 
0.31

 
0.69

 
0.28

 
0.85

 
0.61

2-year U.S. Treasury
0.72

 
0.68

 
0.77

 
0.63

 
0.76

 
1.05

10-year U.S. Treasury
1.56

 
2.22

 
1.74

 
2.11

 
1.60

 
2.27

30-year residential mortgage note
3.45

 
3.96

 
3.60

 
3.83

 
3.42

 
4.01


1
Source is Bloomberg.


58

In its December 2015 meeting, the FOMC increased the Federal Reserve's key target interest rate, the Federal funds rate, to a range of 0.25 to 0.50 percent and maintained this range throughout the third quarter of 2016 compared to a range of 0.00 to 0.25 percent for the same period in 2015. In its September 21, 2016 statement, the FOMC reaffirmed that the current exceptionally low target range for the Federal funds rate remains appropriate. The FOMC stated that it will assess progress towards its longer-run goals of maximum employment and a two percent inflation rate. The assessment will take into account measures of labor market conditions, indicators of inflation pressures, inflation expectations, and financial and international developments. The Committee anticipates it will be appropriate to increase the target range for the Federal funds rate when information indicates continued improvement in the labor market and the Committee is reasonably confident inflation will move back to its two percent objective.

Following the United Kingdom's vote to leave the European Union at the end of the second quarter, interest rates remained lower throughout the third quarter.

The 10-year U.S. Treasury yields and mortgage rates were lower on average in the third quarter of 2016 when compared to prior year. Interest rates declined as concerns of growth and declines in commodity prices have impacted markets globally. While the FOMC considers removing monetary policy accommodation as data warrants, foreign central banks have continued to ease monetary policy further in 2016.
 
In its September 21, 2016 statement, the FOMC stated that it is maintaining its existing policy of reinvesting principal payments from the Federal Reserve's holdings of agency debt and agency MBS into agency MBS and of rolling over maturing U.S. Treasury securities at auction, and it anticipates doing so until normalization of the level of the Federal funds rate is well under way. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Funding Spreads

The following table reflects our funding spreads to LIBOR (basis points)1:
 
Third Quarter 2016
3-Month
Average
 
Third Quarter 2015
3-Month
Average
 
Third Quarter 2016
9-Month
Average
 
Third Quarter 2015
9-Month
Average
 
 September 30, 2016
Ending Spread
 
December 31, 2015
Ending Spread
3-month
(43.1
)
 
(13.5
)
 
(30.3
)
 
(15.1
)
 
(54.3
)
 
(20.2
)
2-year
(8.2
)
 
(6.5
)
 
(2.3
)
 
(10.5
)
 
(10.3
)
 
(0.2
)
5-year
15.3

 
9.1

 
18.7

 
3.2

 
13.9

 
16.2

10-year
51.7

 
54.7

 
59.0

 
45.1

 
48.0

 
59.5


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 2016, our short-term funding spreads relative to London Interbank Offered Rate (LIBOR) improved when compared to spreads at December 31, 2015 as investor demand increased with market volatility and in response to money market reform. During the first nine months of 2016, we utilized consolidated obligation discount notes in addition to step-up, callable, and term fixed and floating rate consolidated obligation bonds to capture attractive funding, match the repricing structures on advances, and meet liquidity requirements. Spreads relative to LIBOR deteriorated on long-term debt as investor demand remained focused on short-term maturities.

59

SELECTED FINANCIAL DATA

The following tables present selected financial data for the periods indicated (dollars in millions):
Statements of Condition
September 30, 2016
 
June 30,
2016
 
March 31,
2016
 
December 31,
2015
 
September 30,
2015
Cash
$
245

 
$
460

 
$
242

 
$
982

 
$
765

Investments1
42,851

 
44,143

 
45,666

 
40,167

 
37,911

Advances
125,828

 
116,294

 
101,157

 
89,173

 
74,484

Mortgage loans held for portfolio, net2
6,792

 
6,640

 
6,667

 
6,755

 
6,878

Total assets
176,074

 
167,860

 
154,056

 
137,374

 
120,360

Consolidated obligations
 
 
 
 
 
 
 
 
 
Discount notes
84,481

 
92,521

 
103,699

 
98,990

 
77,247

Bonds
82,454

 
66,599

 
42,459

 
31,208

 
36,488

Total consolidated obligations3
166,935

 
159,120

 
146,158

 
130,198

 
113,735

Mandatorily redeemable capital stock
675

 
698

 
732

 
103

 
106

Total liabilities
169,069

 
161,356

 
148,420

 
131,749

 
115,242

Capital stock — Class B putable
5,658

 
5,241

 
4,607

 
4,714

 
4,126

Additional capital from merger
92

 
128

 
163

 
194

 
221

Retained earnings
1,294

 
1,220

 
988

 
801

 
770

Accumulated other comprehensive income (loss)
(39
)
 
(85
)
 
(122
)
 
(84
)
 
1

Total capital
7,005

 
6,504

 
5,636

 
5,625

 
5,118

 
For the Three Months Ended
Statements of Income
September 30,
2016
 
June 30,
2016
 
March 31,
2016
 
December 31,
2015
 
September 30,
2015
Net interest income
$
117

 
$
94

 
$
103

 
$
81

 
$
88

Provision (reversal) for credit losses on mortgage loans
1

 
1

 
—

 
—

 
1

Other income (loss)4
(5
)
 
192

 
132

 
(15
)
 
(12
)
Other expense5
28

 
27

 
27

 
29

 
32

AHP assessments
9

 
26

 
21

 
4

 
4

AHP voluntary contributions
—

 
—

 
—

 
2

 
—

Net income
74

 
232

 
187

 
31

 
39

Selected Financial Ratios6
 
 
 
 
 
 
 
 
 
Net interest spread7
0.24
%
 
0.21
%
 
0.25
%
 
0.23
%
 
0.27
%
Net interest margin8
0.27

 
0.24

 
0.28

 
0.26

 
0.29

Return on average equity
4.35

 
15.34

 
12.92

 
2.31

 
3.08

Return on average capital stock
5.40

 
19.11

 
15.39

 
2.82

 
3.92

Return on average assets
0.17

 
0.59

 
0.50

 
0.09

 
0.13

Average equity to average assets
3.92

 
3.86

 
3.87

 
4.09

 
4.22

Regulatory capital ratio9
4.38

 
4.34

 
4.21

 
4.23

 
4.34

Dividend payout ratio10
47.85

 
15.24

 
16.23

 
88.56

 
66.48


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

2
Includes an allowance for credit losses of $2 million at September 30, 2016, and $1 million at June 30, 2016, March 31, 2016, December 31, 2015, and September 30, 2015.

3
The total par value of outstanding consolidated obligations of the FHLBanks was $967.7 billion, $963.8 billion, $896.8 billion, $905.2 billion, and $856.5 billion at September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015, and September 30, 2015, respectively.

4
Other income (loss) includes, among other things, net gains (losses) on investment securities, net gains (losses) on derivatives and hedging activities, net gains (losses) on the disposal of fixed assets, and gains on litigation settlements, net.

5
Other expense includes, among other things, compensation and benefits, professional fees, contractual services, merger related expenses, and gains and losses on real estate owned (REO).

6
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.

7
Represents yield on total interest-earning assets minus cost of total interest-bearing liabilities.

8
Represents net interest income expressed as a percentage of average interest-earning assets.

9
Represents period-end regulatory capital expressed as a percentage of period-end total assets. Regulatory capital includes Class B capital stock (including mandatorily redeemable capital stock), additional capital from merger, and retained earnings.

10
Represents dividends declared and paid in the stated period expressed as a percentage of net income in the stated period.

60

RESULTS OF OPERATIONS

Net Income

The following table presents comparative highlights of our net income for the three and nine months ended September 30, 2016 and 2015 (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,
 
2016
 
2015
 
$ Change
 
% Change
 
2016
 
2015
 
$ Change
 
% Change
Net interest income
$
117

 
$
88

 
$
29

 
33
 %
 
$
314

 
$
236

 
$
78

 
33
 %
Provision (reversal) for credit losses on mortgage loans
1

 
1

 
—

 
—

 
2

 
2

 
—

 
—

Other income (loss)
(5
)
 
(12
)
 
7

 
58

 
319

 
(15
)
 
334

 
2,227

Other expense
28

 
32

 
(4
)
 
(13
)
 
82

 
108

 
(26
)
 
(24
)
AHP assessments
9

 
4

 
5

 
125

 
56

 
11

 
45

 
409

Net income
$
74

 
$
39

 
$
35

 
90
 %
 
$
493

 
$
100

 
$
393

 
393
 %

61

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. The following table presents average balances and rates of major asset and liability categories (dollars in millions):    
 
For the Three Months Ended September 30,
 
2016
 
2015
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
945

 
0.38
%
 
$
1

 
$
541

 
0.12
%
 
$
—

Securities purchased under agreements to resell
5,076

 
0.36

 
4

 
5,497

 
0.12

 
1

Federal funds sold
5,492

 
0.40

 
5

 
4,221

 
0.13

 
2

Mortgage-backed securities2,3,4
20,295

 
1.13

 
58

 
19,784

 
0.92

 
46

    Other investments2,3,5
11,998

 
1.23

 
37

 
11,510

 
1.04

 
31

Advances3,6
121,016

 
0.78

 
238

 
69,693

 
0.46

 
81

Mortgage loans7
6,704

 
3.33

 
56

 
6,960

 
3.58

 
62

Loans to other FHLBanks
—

 
—

 
—

 
1

 
0.12

 
—

Total interest-earning assets
171,526

 
0.93

 
399

 
118,207

 
0.75

 
223

Non-interest-earning assets
545

 
—

 
—

 
653

 
—

 
—

Total assets
$
172,071

 
0.92
%
 
$
399

 
$
118,860

 
0.74
%
 
$
223

Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
979

 
0.09
%
 
$
1

 
$
960

 
0.04
%
 
$
—

Consolidated obligations
 
 
 
 
 
 
 

 
 

 
 

Discount notes3
86,422

 
0.45

 
98

 
68,443

 
0.13

 
22

Bonds3
75,549

 
0.93

 
177

 
43,322

 
1.02

 
112

Other interest-bearing liabilities8
689

 
3.40

 
6

 
117

 
3.34

 
1

Total interest-bearing liabilities
163,639

 
0.69

 
282

 
112,842

 
0.48

 
135

Non-interest-bearing liabilities
1,681

 
—

 
—

 
1,003

 
—

 
—

Total liabilities
165,320

 
0.68

 
282

 
113,845

 
0.47

 
135

Capital
6,751

 
—

 
—

 
5,015

 
—

 
—

Total liabilities and capital
$
172,071

 
0.65
%
 
$
282

 
$
118,860

 
0.45
%
 
$
135

Net interest income and spread9
 
 
0.24
%
 
$
117

 
 
 
0.27
%
 
$
88

Net interest margin10
 
 
0.27
%
 
 
 
 
 
0.29
%
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
104.82
%
 
 
 
 
 
104.75
%
 
 

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
MBS interest income includes net prepayment fee income of less than $1 million during the three months ended September 30, 2016 as a result of an AFS MBS prepayment. For the three months ended September 30, 2015, MBS interest income includes net prepayment fee income of $2 million.

5
Other investments primarily include U.S. Treasury obligations, other U.S. obligations, government-sponsored enterprise (GSE) obligations, Tennessee Valley Authority obligations, state or local housing agency obligations, and taxable municipal bonds.

6
Advance interest income includes prepayment fee income of $1 million for the three months ended September 30, 2016. Advance prepayment fees were less than $1 million for the three months ended September 30, 2015.

7
Non-accrual loans are included in the average balance used to determine the average yield.

8
Other interest-bearing liabilities consists primarily of mandatorily redeemable capital stock.

9
Represents yield on total interest-earning assets minus yield on total interest-bearing liabilities.

10
Represents net interest income expressed as a percentage of average interest-earning assets.

62

The following table presents average balances and rates of major asset and liability categories (dollars in millions):    
 
For the Nine Months Ended September 30,
 
2016
 
2015
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
 
Average
Balance1
 
Yield/Cost
 
Interest
Income/
Expense
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
894

 
0.36
%
 
$
2

 
$
516

 
0.11
%
 
$
—

Securities purchased under agreements to resell
5,018

 
0.35

 
13

 
6,550

 
0.09

 
4

Federal funds sold
4,730

 
0.38

 
13

 
4,282

 
0.11

 
4

Mortgage-backed securities2,3,4
19,423

 
1.13

 
165

 
15,774

 
0.98

 
116

    Other investments2,3,5
12,737

 
1.14

 
109

 
7,306

 
1.21

 
67

Advances3,6
110,003

 
0.73

 
600

 
66,675

 
0.44

 
219

Mortgage loans7
6,684

 
3.51

 
176

 
6,738

 
3.62

 
182

Total interest-earning assets
159,489

 
0.90

 
1,078

 
107,841

 
0.73

 
592

Non-interest-earning assets
521

 
—

 
—

 
654

 
—

 
—

Total assets
$
160,010

 
0.90
%
 
$
1,078

 
$
108,495

 
0.73
%
 
$
592

Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
955

 
0.07
%
 
$
1

 
$
745

 
0.03
%
 
$
—

Consolidated obligations
 
 
 
 
 
 
 

 
 

 
 

Discount notes3
96,560

 
0.44

 
320

 
64,869

 
0.11

 
52

Bonds3
54,163

 
1.06

 
428

 
37,146

 
1.09

 
302

Other interest-bearing liabilities8
605

 
3.38

 
15

 
67

 
3.24

 
2

Total interest-bearing liabilities
152,283

 
0.67

 
764

 
102,827

 
0.46

 
356

Non-interest-bearing liabilities
1,509

 
—

 
—

 
1,052

 
—

 
—

Total liabilities
153,792

 
0.66

 
764

 
103,879

 
0.46

 
356

Capital
6,218

 
—

 
—

 
4,616

 
—

 
—

Total liabilities and capital
$
160,010

 
0.64
%
 
$
764

 
$
108,495

 
0.44
%
 
$
356

Net interest income and spread9
 
 
0.23
%
 
$
314

 
 
 
0.27
%
 
$
236

Net interest margin10
 
 
0.26
%
 
 
 
 
 
0.29
%
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
104.73
%
 
 
 
 
 
104.88
%
 
 

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
MBS interest income includes net prepayment fee income of $2 million during both the nine months ended September 30, 2016 and 2015 as a result of AFS MBS prepayments.

5
Other investments primarily include U.S Treasury obligations, other U.S. obligations, GSE obligations, Tennessee Valley Authority obligations, state or local housing agency obligations, and taxable municipal bonds.
    
6
Advance interest income includes prepayment fee income of $6 million and $9 million for the nine months ended September 30, 2016 and 2015.

7
Non-accrual loans are included in the average balance used to determine the average yield.

8
Other interest-bearing liabilities consists primarily of mandatorily redeemable capital stock.

9
Represents yield on total interest-earning assets minus yield on total interest-bearing liabilities.

10
Represents net interest income expressed as a percentage of average interest-earning assets.


63

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, 2016 vs. September 30, 2015
 
September 30, 2016 vs. September 30, 2015
 
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
$
—

 
$
1

 
$
1

 
$
—

 
$
2

 
$
2

Securities purchased under agreements to resell
—

 
3

 
3

 
(1
)
 
10

 
9

Federal funds sold
—

 
3

 
3

 
—

 
9

 
9

Mortgage-backed securities
1

 
11

 
12

 
30

 
19

 
49

Other investments
1

 
5

 
6

 
46

 
(4
)
 
42

Advances
81

 
76

 
157

 
189

 
192

 
381

Mortgage loans
(2
)
 
(4
)
 
(6
)
 
(1
)
 
(5
)
 
(6
)
Total interest income
81

 
95

 
176

 
263

 
223

 
486

Interest expense
 
 
 
 
 
 
 
 
 
 
 
Deposits
—

 
1

 
1

 
—

 
1

 
1

Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes
7

 
69

 
76

 
38

 
230

 
268

Bonds
76

 
(11
)
 
65

 
135

 
(9
)
 
126

Other interest-bearing liabilities
5

 
—

 
5

 
13

 
—

 
13

Total interest expense
88

 
59

 
147

 
186

 
222

 
408

Net interest income
$
(7
)
 
$
36

 
$
29

 
$
77

 
$
1

 
$
78

    
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, 2016, our net interest spread was 0.24 percent and 0.23 percent compared to 0.27 percent for both the three and nine months ended September 30, 2015. Our net interest spread was primarily impacted by a higher cost on total interest-bearing liabilities, which was partially offset by a higher yield on total interest-earning assets. 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 during the three and nine months ended September 30, 2016 when compared to the same periods in 2015 due primarily to higher average volumes and the higher interest rate environment. Average advance volumes for the three months ended September 30, 2016 increased primarily due to borrowings from a large depository institution member. Average advance volumes for the nine months ended September 30, 2016 increased due to an increase in borrowings from a wide range of members with the most significant increase from a large depository institution. Average advance volumes for the nine months ended September 30, 2016 also increased due to advances acquired as a result of the Merger.

Investments

Interest income on investments increased during the three and nine months ended September 30, 2016 when compared to the same periods in 2015. Interest income on investments increased during the three months ended September 30, 2016 primarily due to the higher interest rate environment. Interest income on investments increased during the nine months ended September 30, 2016 primarily to higher average investment volumes due in part to the acquisition of MBS and non-MBS investments as a result of the Merger.


64

Mortgage Loans

Interest income on mortgage loans decreased during the three and nine months ended September 30, 2016 when compared to the same periods in 2015 due to a decline in mortgage interest rates which resulted in an increase in mortgage loan refinancing activity. Interest income on mortgage loans also decreased due to lower average mortgage loan volumes due to principal payments exceeding mortgage loan purchases.

Discount Notes

Interest expense on discount notes increased during the three and nine months ended September 30, 2016 when compared to the same periods in 2015 due to the higher interest rate environment and higher average volumes. Discount notes were utilized to capture attractive funding, match repricing structures on advances, and provide additional liquidity.

Bonds

Interest expense on bonds increased during the three and nine months ended September 30, 2016 when compared to the same periods in 2015 due primarily to higher average bond volumes. The increase in average volumes was primarily due to our increased utilization of bonds to capture attractive funding, match repricing structures on short-term and variable rate callable advances, and provide additional liquidity.

Other Interest-Bearing Liabilities

Interest expense on other interest-bearing liabilities increased for the three and nine months ended September 30, 2016 when compared to the same periods in 2015 due to higher interest expense on mandatorily redeemable capital stock. The average mandatorily redeemable capital stock balance increased as a result of the reclassification of $0.7 billion of capital stock, including all capital stock outstanding to captive insurance companies, to mandatorily redeemable capital stock during the year. This capital stock reclassification was in response to the Finance Agency final rule affecting captive insurance company membership effective February 19, 2016.

Other Income (Loss)

The following table summarizes the components of other income (loss) (dollars in millions):
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2016
 
2015
 
2016
 
2015
Net gains (losses) on trading securities
$
(2
)
 
$
17

 
$
51

 
$
9

Net gains (losses) on derivatives and hedging activities
(3
)
 
(43
)
 
(76
)
 
(39
)
Gains on litigation settlements, net
—

 
12

 
337

 
12

Other, net
—

 
2

 
7

 
3

Total other income (loss)
$
(5
)
 
$
(12
)
 
$
319

 
$
(15
)
    
Other income (loss) can be volatile from period to period depending on the type of activity recorded. During the nine months ended September 30, 2016, other income (loss) was primarily impacted by net gains on litigation settlements of $337 million as a result of settlements with certain defendants in our private-label MBS litigation. In addition, during the three and nine months ended September 30, 2016, other income (loss) was impacted by net gains (losses) on derivatives and hedging activities and net gains (losses) on trading securities.

During the three and nine months ended September 30, 2016, we recorded net losses of $3 million and $76 million on our derivatives and hedging activities through other income (loss) compared to net losses of $43 million and $39 million during the same periods in 2015. These fair value changes were primarily attributable to the impact of changes in interest rates on interest rate swaps that we utilize to hedge our investment securities portfolio. We use derivatives to manage interest rate risk, including mortgage prepayment risk. 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.



65

During the three and nine months ended September 30, 2016, we recorded net losses on trading securities of $2 million and net gains of $51 million compared to net gains of $17 million and $9 million during the same periods in 2015. These changes in fair value were primarily due to the impact of interest rates and credit spreads on our fixed rate trading securities which are generally offset by the changes in fair value on derivatives that we utilize to economically hedge these securities. Trading securities are recorded at fair value with changes in fair value reflected through other income (loss).

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 and the amortization of the financing element of our off market derivatives in interest income or expense or other income (loss). Changes in the fair value of both the derivative and the hedged item are recorded as a component of other income (loss) in “Net gains (losses) 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 income (loss) in “Net gains (losses) 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).


66

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, 2016
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
6

 
$
—

 
$
—

 
$
1

 
$
7

Net interest settlements
 
(42
)
 
(38
)
 
—

 
26

 
(54
)
Total impact to net interest income
 
(36
)
 
(38
)
 
—

 
27

 
(47
)
Other income (loss):
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
—

 
(13
)
 
—

 
6

 
(7
)
Gains (losses) on economic hedges
 
—

 
5

 
(1
)
 
—

 
4

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

 
(8
)
 
(1
)
 
6

 
(3
)
Net gains (losses) on trading securities2
 
—

 
(4
)
 
—

 
—

 
(4
)
Total impact to other income (loss)
 
—

 
(12
)
 
(1
)
 
6

 
(7
)
Total net effect of hedging activities3
 
$
(36
)
 
$
(50
)
 
$
(1
)
 
$
33

 
$
(54
)
 
 
For the Three Months Ended September 30, 2015
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
9

 
$
2

 
$
(1
)
 
$
—

 
$
10

Net interest settlements
 
(59
)
 
(46
)
 
—

 
35

 
(70
)
Total impact to net interest income
 
(50
)
 
(44
)
 
(1
)
 
35

 
(60
)
Other income (loss):
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
(1
)
 
(3
)
 
—

 
(2
)
 
(6
)
Gains (losses) on economic hedges
 
—

 
(37
)
 
—

 
—

 
(37
)
Total net gains (losses) on derivatives and hedging activities
 
(1
)
 
(40
)
 
—

 
(2
)
 
(43
)
Net gains (losses) on trading securities2
 
—

 
19

 
—

 
—

 
19

Total impact to other income (loss)
 
(1
)
 
(21
)
 
—

 
(2
)
 
(24
)
Total net effect of hedging activities3
 
$
(51
)
 
$
(65
)
 
$
(1
)

$
33

 
$
(84
)

1
Represents the amortization/accretion of fair value hedging adjustments on closed hedge relationships and the amortization of the financing element of off-market derivatives.

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

67

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, 2016
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
19

 
$
1

 
$
(1
)
 
$
1

 
$
20

Net interest settlements
 
(138
)
 
(115
)
 
—

 
65

 
(188
)
Total impact to net interest income
 
(119
)
 
(114
)
 
(1
)
 
66

 
(168
)
Other income (loss):
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
1

 
(16
)
 
—

 
(1
)
 
(16
)
Gains (losses) on economic hedges
 
—

 
(59
)
 
(1
)
 
—

 
(60
)
Total net gains (losses) on derivatives and hedging activities
 
1


(75
)

(1
)

(1
)

(76
)
Net gains (losses) on trading securities2
 
—

 
47

 
—

 
—

 
47

Total impact to other income (loss)
 
1

 
(28
)
 
(1
)
 
(1
)
 
(29
)
Total net effect of hedging activities3
 
$
(118
)
 
$
(142
)
 
$
(2
)
 
$
65

 
$
(197
)
 
 
For the Nine Months Ended September 30, 2015
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
4

 
$
3

 
$
(2
)
 
$
5

 
$
10

Net interest settlements
 
(145
)
 
(114
)
 
—

 
92

 
(167
)
Total impact to net interest income
 
(141
)
 
(111
)
 
(2
)
 
97

 
(157
)
Other income (loss):
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
1

 
—

 
—

 
—

 
1

Gains (losses) on economic hedges
 
—

 
(40
)
 
—

 
—

 
(40
)
Total net gains (losses) on derivatives and hedging activities
 
1

 
(40
)
 
—

 
—

 
(39
)
Net gains (losses) on trading securities2
 
—

 
10

 
—

 
—

 
10

Total impact to other income (loss)
 
1

 
(30
)
 
—

 
—

 
(29
)
Total net effect of hedging activities3
 
$
(140
)
 
$
(141
)
 
$
(2
)
 
$
97

 
$
(186
)

1
Represents the amortization/accretion of fair value hedging adjustments on closed hedge relationships and the amortization of the financing element of off market derivatives.

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


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. In addition, amortization is impacted by the financing element of our off market derivatives.

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.


68

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 factors that affect hedge ineffectiveness include changes in the benchmark interest rate, volatility, and the divergence in the valuation curves used to value our assets, liabilities, and derivatives.

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 investment 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 also 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,
 
2016
 
2015
 
2016
 
2015
Gains (losses) on interest rate swaps economically hedging our investments
$
10

 
$
(32
)
 
$
(45
)
 
$
(24
)
Interest settlements
(5
)
 
(5
)
 
(14
)
 
(16
)
Net gains (losses) on investment derivatives
5

 
(37
)
 
(59
)
 
(40
)
Net gains (losses) on related trading securities
(4
)
 
19

 
47

 
10

Net gains (losses) on economic investment hedge relationships
$
1

 
$
(18
)
 
$
(12
)
 
$
(30
)

Other Expense
The following table shows the components of other expense (dollars in millions):
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Compensation and benefits
$
13

 
$
12

 
$
39

 
$
34

Contractual services
1

 
4

 
7

 
9

Professional fees
4

 
4

 
8

 
6

Merger related expenses
—

 
3

 
—

 
38

Other operating expenses
5

 
4

 
14

 
10

Total operating expenses
23

 
27

 
68

 
97

Federal Housing Finance Agency
2

 
2

 
6

 
5

Office of Finance
2

 
2

 
5

 
4

Other, net
1

 
1

 
3

 
2

Total other expense
$
28

 
$
32

 
$
82

 
$
108


Other expense totaled $28 million and $82 million for the three and nine months ended September 30, 2016 compared to $32 million and $108 million for the same periods last year. The decrease was primarily due to one time merger related expenses incurred during the three and nine months ended September 30, 2015 as a result of the Merger. Merger related expenses primarily included compensation and benefits expenses and Merger transaction and integration expenses.


69

STATEMENTS OF CONDITION

Financial Highlights

Our total assets increased to $176.1 billion at September 30, 2016 from $137.4 billion at December 31, 2015. Our total liabilities increased to $169.1 billion at September 30, 2016 from $131.8 billion at December 31, 2015. Total capital increased to $7.0 billion at September 30, 2016 from $5.6 billion at December 31, 2015. See further discussion of changes in our financial condition in the appropriate sections that follow.

Cash and Due from Banks

At September 30, 2016, our total cash balance was $0.2 billion compared to $1.0 billion at December 31, 2015. Our cash balance was high at the end of 2015 due to limited investment opportunities.

Advances

The following table summarizes our advances by type of institution (dollars in millions):
 
September 30,
2016
 
December 31,
2015
Commercial banks
$
87,853

 
$
52,643

Thrifts
2,668

 
2,771

Credit unions
2,900

 
2,647

Non-captive insurance companies
16,973

 
13,601

Captive insurance companies
14,675

 
15,219

Community development financial institution
3

 
3

Total member advances
125,072

 
86,884

Housing associates
117

 
123

Non-member borrowers
333

 
1,904

Total par value
$
125,522

 
$
88,911


Our total advance par value increased $36.6 billion or 41 percent at September 30, 2016 when compared to December 31, 2015. The increase in total par value was due to an increase in borrowings from a wide range of members with the most significant increase from a large depository institution member.

The following table summarizes our advances by product type (dollars in millions):
 
September 30, 2016
 
December 31, 2015
 
Amount
 
% of Total
 
Amount
 
% of Total
Variable rate
$
96,384

 
77
 
$
57,942

 
65
Fixed rate
27,714

 
22
 
29,788

 
34
Amortizing
1,424

 
1
 
1,181

 
1
Total par value
125,522

 
100
 
88,911

 
100
Premiums
94

 
 
 
128

 
 
Discounts
(7
)
 
 
 
(9
)
 
 
Fair value hedging adjustments
219

 
 
 
143

 
 
Total advances
$
125,828

 
 
 
$
89,173

 
 

Fair value hedging adjustments changed $76 million or 53 percent at September 30, 2016 when compared to December 31, 2015 due primarily to an increase in cumulative fair value adjustments on advances in hedge relationships resulting from changes in interest rates.


70

At September 30, 2016 and December 31, 2015, 62 and 61 percent of our advances were variable rate callable advances. Callable advances may be prepaid by borrowers on pertinent dates (call dates) and therefore provide borrowers a source of long-term financing with prepayment flexibility. Interest rates on our variable rate callable advances reset at each call date to be consistent with either the underlying LIBOR index or our current offering rate in line with our underlying cost of funds. In addition, we retain the flexibility to adjust the spread relative to our cost of funds for the majority of these variable rate advances on each reset date. We generally fund our variable rate callable advances with either discount notes, LIBOR indexed debt, or debt swapped to a LIBOR index. For additional discussion on our funding strategies, refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Sources of Liquidity.”

At September 30, 2016 and December 31, 2015, advances outstanding to our five largest member borrowers totaled $83.9 billion and $50.5 billion, representing 67 and 57 percent of our total advances outstanding. The following table summarizes advances outstanding to our five largest member borrowers at September 30, 2016 (dollars in millions):
 
Amount
 
% of Total
Wells Fargo Bank, N.A.
$
68,625

 
55

Transamerica Life Insurance Company1
4,170

 
3

TH Insurance Holdings Company LLC2
4,000

 
3

Truman Insurance Company2
3,588

 
3

HICA Education Loan Corporation2
3,511

 
3

Total par value
$
83,894

 
67


1
Excludes $1.6 billion of advances with Transamerica Premier Life Insurance Company, an affiliate of Transamerica Life Insurance Company.

2
Represents a captive insurance company member whose membership will terminate within five years of the Finance Agency's final rule on membership that became effective February 19, 2016.


On January 20, 2016, the Finance Agency issued a final rule effective February 19, 2016 that changes the eligibility requirements for FHLBank members by rendering captive insurance companies ineligible for FHLBank membership. Captive insurance company members that were admitted as members prior to September 12, 2014 (the date the Finance Agency proposed this rule) will have their memberships terminated no later than February 19, 2021. Captive insurance company members that were admitted as members after September 12, 2014 will have their memberships terminated no later than February 19, 2017. As of September 30, 2016, we had 12 captive insurance company members with advances outstanding of $14.7 billion, which represented 12 percent of our total advances outstanding. Of our captive insurance company members, six members with advance balances outstanding of $11.1 billion will have their membership terminated within five years of the effective date of the final rule and six members with advance balances outstanding of $3.6 billion will have their membership terminated within one year of the effective date, according to the final rule. As indicated in the table above, three of our top five largest member borrowers are captive insurance company members. The magnitude of the impact of the final rule will depend, in part, on our size and profitability at the time of membership termination or maturity of the related 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 Federal Home Loan Bank Act of 1932 (FHLBank Act), Federal Housing Finance Agency (Finance Agency) regulations, and other applicable laws and regulations.

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, 2016 and December 31, 2015. 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.”


71

Mortgage Loans

The following tables summarize information on our mortgage loans held for portfolio (dollars in millions):
 
September 30, 2016
 
MPF
 
MPP
 
Total
Fixed rate conventional loans
$
5,747

 
$
384

 
$
6,131

Fixed rate government-insured loans
522

 
44

 
566

Total unpaid principal balance
6,269

 
428

 
6,697

Premiums
81

 
14

 
95

Discounts
(8
)
 
(1
)
 
(9
)
Basis adjustments from mortgage loan commitments
11

 
—

 
11

Total mortgage loans held for portfolio
6,353

 
441

 
6,794

Allowance for credit losses
(2
)
 
—

 
(2
)
Total mortgage loans held for portfolio, net
$
6,351

 
$
441

 
$
6,792

 
December 31, 2015
 
MPF
 
MPP
 
Total
Fixed rate conventional loans
$
5,602

 
$
464

 
$
6,066

Fixed rate government-insured loans
547

 
50

 
597

Total unpaid principal balance
6,149

 
514

 
6,663

Premiums
76

 
18

 
94

Discounts
(9
)
 
(1
)
 
(10
)
Basis adjustments from mortgage loan commitments
9

 
—

 
9

Total mortgage loans held for portfolio
6,225

 
531

 
6,756

Allowance for credit losses
(1
)
 
—

 
(1
)
Total mortgage loans held for portfolio, net
$
6,224

 
$
531

 
$
6,755


Our total mortgage loans remained relatively stable at September 30, 2016 when compared to December 31, 2015. 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."


72

Investments

The following table summarizes the carrying value of our investments (dollars in millions):
 
September 30, 2016
 
December 31, 2015
 
Amount
 
% of Total
 
Amount
 
% of Total
Short-term investments1
 
 
 
 
 
 
 
Interest-bearing deposits
$
1

 
—
 
$
1

 
—
Securities purchased under agreements to resell
6,250

 
15
 
6,775

 
17
Federal funds sold
4,635

 
11
 
2,270

 
6
State or local housing agency obligations
—

 
—
 
8

 
—
Total short-term investments
10,886

 
26
 
9,054

 
23
Long-term investments2
 
 
 
 
 
 
 
Interest-bearing deposits
1

 
—
 
1

 
—
Mortgage-backed securities
 
 
 
 
 
 
 
GSE single-family
5,172

 
12
 
6,260

 
16
GSE multifamily
12,035

 
28
 
10,145

 
25
Other U.S. obligations single-family3
3,531

 
8
 
2,317

 
6
Other U.S. obligations commercial3
4

 
—
 
6

 
—
Private-label residential
17

 
—
 
20

 
—
Total mortgage-backed securities
20,759

 
48
 
18,748

 
47
Non-mortgage-backed securities
 
 
 
 
 
 
 
Other U.S. obligations3
3,932

 
9
 
4,222

 
11
GSE and Tennessee Valley Authority obligations
4,976

 
12
 
5,593

 
14
State or local housing agency obligations
1,714

 
4
 
1,995

 
4
Other
583

 
1
 
554

 
1
Total non-mortgage-backed securities
11,205

 
26
 
12,364

 
30
Total long-term investments
31,965

 
74
 
31,113

 
77
Total investments
$
42,851

 
100
 
$
40,167

 
100

1
Short-term investments have original maturities equal to or less than one year.

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

3
Represents investment securities backed by the full faith and credit of the U.S. Government.

Our investments increased $2.7 billion or 7 percent at September 30, 2016 when compared to December 31, 2015. The increase was due in part to the purchase of money market investments and agency MBS securities during the year.

The Finance Agency 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. At September 30, 2016, our ratio of MBS to regulatory capital was 2.69. At December 31, 2015, our ratio of MBS to regulatory capital was 3.23 due to the Merger, and as a result, we were precluded from purchasing any additional MBS until this ratio fell below 3.00.

We evaluate AFS and HTM securities in an unrealized loss position for other-than-temporary-impairment (OTTI) on at least a quarterly basis. As part of our OTTI evaluation, we consider our intent to sell each debt security and whether it is more likely than not that we will be required to sell the security before its anticipated recovery. If either of these conditions is met, we will recognize an OTTI charge to earnings equal to the entire difference between the security's amortized cost basis and its fair value at the reporting date. For securities in an unrealized loss position that meet neither of these conditions, we perform 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, 2016. As a result of our analysis, we determined that all gross unrealized losses on our investment portfolio were 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, 2016.


73

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, 2016 and December 31, 2015, the carrying value of consolidated obligations for which we are primarily liable totaled $166.9 billion and $130.2 billion.

DISCOUNT NOTES

The following table summarizes our discount notes, all of which are due within one year (dollars in millions):
 
September 30,
2016
 
December 31,
2015
Par value
$
84,550

 
$
99,074

Discounts and concession fees1
(69
)
 
(84
)
Total
$
84,481

 
$
98,990


1
Concessions represent fees paid to dealers in connection with the issuance of certain consolidated obligation discount notes.
    
Our discount notes decreased $14.5 billion or 15 percent at September 30, 2016 when compared to December 31, 2015. The decrease was primarily due to our use of bonds in place of discount notes to manage our funding needs throughout the third quarter. 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,
2016
 
December 31,
2015
Total par value
$
82,179

 
$
30,899

Premiums
271

 
312

Discounts and concession fees1
(67
)
 
(35
)
Fair value hedging adjustments
71

 
32

Total bonds
$
82,454

 
$
31,208


1
Concessions represent fees paid to dealers in connection with the issuance of certain consolidated obligation bonds.

Our bonds increased $51.2 billion or 164 percent at September 30, 2016 when compared to December 31, 2015. The increase was primarily due to our utilization of bonds to capture attractive funding, match repricing structures on short-term and variable rate advances, and to provide additional liquidity. Fair value hedging adjustments changed $39 million or 122 percent at September 30, 2016 when compared to December 31, 2015 due primarily to an increase in cumulative fair value adjustments on bonds in hedge relationships resulting from changes in interest rates.
 
For additional information on our bonds, refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Sources of Liquidity.”

Deposits

Deposit levels will vary based on member alternatives for short-term investments. Our deposits decreased $77 million or 7 percent at September 30, 2016 when compared to December 31, 2015 due primarily to a decrease in non-interest-bearing deposits.


74

Mandatorily Redeemable Capital Stock

We reclassify capital stock subject to redemption from equity to a liability (mandatorily redeemable capital stock) at the time shares meet the definition of a mandatorily redeemable financial instrument. This occurs after a member provides written notice of redemption, gives notice of intention to withdraw from membership, becomes ineligible for continuing membership, or attains non-member status by merger or consolidation, charter termination, or other involuntary termination from membership.

Our total mandatorily redeemable capital stock balance increased $572 million at September 30, 2016 when compared to December 31, 2015 due primarily to the reclassification of $723 million in captive insurance company capital stock to mandatorily redeemable capital stock in the first quarter of 2016 in response to the Finance Agency final rule affecting membership eligibility that became effective February 19, 2016. The final rule changed the eligibility requirements for FHLBank members by rendering captive insurance companies ineligible for FHLBank membership. According to the final rule, captive insurance company members that were admitted as members prior to September 12, 2014 (the date the Finance Agency proposed this rule) will have their memberships terminated no later than February 19, 2021. Captive insurance company members that were admitted as members after September 12, 2014 will have their memberships terminated no later than February 19, 2017. At September 30, 2016 and December 31, 2015, our mandatorily redeemable capital stock totaled $675 million and $103 million.

Capital

The following table summarizes information on our capital (dollars in millions):
 
September 30,
2016
 
December 31,
2015
Capital stock
$
5,658

 
$
4,714

Additional capital from merger
92

 
194

Retained earnings
1,294

 
801

Accumulated other comprehensive income (loss)
(39
)
 
(84
)
Total capital
$
7,005

 
$
5,625


Our capital increased $1.4 billion or 25 percent at September 30, 2016 when compared to December 31, 2015. The increase was due to an increase in capital stock and retained earnings. Capital stock increased $944 million due to an increase in member activity, partially offset by the reclassification of $732 million of capital stock, including all capital stock outstanding to captive insurance company members, to mandatorily redeemable capital stock. Retained earnings increased $493 million due to net income earned. 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.


75

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,
2016
 
December 31,
2015
Interest rate swaps
 
 
 
Noncallable
$
46,907

 
$
33,927

Callable by counterparty
3,639

 
4,976

Callable by the Bank
136

 
79

Total interest rate swaps
50,682

 
38,982

Interest rate swaptions
—

 
200

Forward settlement agreements (TBAs)
204

 
45

Mortgage delivery commitments
211

 
51

Total notional amount
$
51,097

 
$
39,278

    
The notional amount of our derivative contracts increased $11.8 billion or 30 percent at September 30, 2016 when compared to December 31, 2015. During the nine months ended September 30, 2016, we increased our utilization of swapped consolidated obligation bonds in addition to discount notes to capture attractive funding, match repricing structures on advances, 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.

Our primary source of liquidity is proceeds from the issuance of consolidated obligations (bonds and discount notes) in the capital markets. During the nine months ended September 30, 2016, proceeds from the issuance of bonds and discount notes were $77.9 billion and $209.4 billion compared to $15.6 billion and $198.1 billion for the same period in 2015. We continued to issue shorter-term discount notes as well as step-up, callable, and term fixed and floating rate consolidated obligation bonds to capture attractive funding, match repricing structures on advances and investments, and provide additional liquidity.

We maintained continual access to funding and adapted our debt issuance to meet the needs of our members, including demand for variable rate callable advance products that generally favored the issuance of shorter-term debt. Access to short-term debt markets has been reliable as investors have sought the FHLBanks' short-term debt as an asset of choice, which has led to advantageous funding opportunities and increased utilization of consolidated obligation short-term bonds as well as discount notes. However, due to the short-term maturity of the debt, we may be exposed to additional risks associated with refinancing and our ability to access the capital markets.

76

We monitor our debt refinancing risk and continue to enhance our liquidity and funding management. In measuring the level of assets requiring refinancing, we consider the maturity characteristics of our assets and liabilities. The following table presents the composition of our assets and liabilities by maturity (dollars in millions):
 
 
September 30, 2016
 
 
1 year or less
 
> 1 year
 
Total
Assets
 
 
 
 
 
 
Investments1
 
$
15,332

 
$
26,788

 
$
42,120

Advances2
 
20,764

 
104,758

 
125,522

Mortgage loans held for portfolio3
 
1,326

 
5,371

 
6,697

   Subtotal
 
$
37,422

 
$
136,917

 
174,339

Other4
 
 
 
 
 
1,735

Total assets
 

 

 
$
176,074

 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
Consolidated obligation bonds5
 
$
42,966

 
$
39,213

 
$
82,179

Consolidated obligation discount notes5
 
84,550

 
—

 
84,550

   Subtotal
 
$
127,516

 
$
39,213

 
166,729

Other4
 
 
 
 
 
2,340

Total liabilities
 

 

 
$
169,069

Maturity gap
 
$
90,094

 
 
 

Maturity gap percentage6
 
51
%
 
 
 


1
Represents the principal balance of interest-bearing deposits, securities purchased under agreements to resell, Federal funds sold, trading securities, AFS securities, and HTM securities. MBS and asset-backed investments are based on expected maturity, which factors in projected prepayments; all other investments are based on contractual maturity. Certain assumptions are factored into the greater than one year bucket as they are not monitored as part of the maturity gap.

2
Represents the principal balance of advances based on contractual maturity. At September 30, 2016, 63 percent of our advances are callable, many of which have call dates in the next year. For further detail of our advance call dates, refer to "Item 1. Financial Statements — Note 7 — Advances".

3
Represents the principal balance of MPF and MPP mortgage loans based on expected maturity, which factors in projected prepayments. Certain assumptions are factored into the greater than one year bucket as they are not monitored as part of the maturity gap.

4
Represents all other assets or liabilities reflected in the Bank's Statement of Condition that are not monitored as part of the maturity gap.

5
Represents the principal balance of consolidated obligations based on contractual maturity.

6
The maturity gap percentage is calculated as the maturity gap divided by total assets.

We monitor the maturity gap between assets and liabilities and are currently striving to reduce our maturity gap percentage to reduce the level of refinancing risk that could potentially occur if we could not obtain funding in the capital markets due to an unforeseen event. This can be accomplished by shortening the maturity of our assets and/or lengthening the maturity of our liabilities. Our maturity gap objective and the time period for achieving this may vary based on a number of factors including our member borrowing needs, supply and demand in the debt markets, and other factors.

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, 2016, 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 and our ability to access the capital markets may impact us in the future, refer to “Item 1A. Risk Factors” in our 2015 Form 10-K.

Although we are primarily liable for the portion of consolidated obligations which are issued on our behalf, we are also jointly and severally liable with the other FHLBanks for the payment of principal and interest on all consolidated obligations issued by the FHLBank System. At September 30, 2016 and December 31, 2015, the total par value of outstanding consolidated obligations for which we are primarily liable was $166.7 billion and $130.0 billion. At September 30, 2016 and December 31, 2015, the total par value of outstanding consolidated obligations issued on behalf of other FHLBanks for which we are jointly and severally liable was approximately $801.0 billion and $775.2 billion.

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 if 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, 2016, no purchases had been made by the U.S. Treasury under this authorization.

77

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, 2016, repayments of consolidated obligations totaled $250.6 billion compared to $216.2 billion for the same period in 2015. A portion of these payments were due to the call of certain bonds in an effort to better match our projected asset cash flows. During the nine months ended September 30, 2016 and 2015, we called bonds with a total par value of $1.6 billion and $13.9 billion.

During the nine months ended September 30, 2016, advance disbursements totaled $171.2 billion compared to $88.5 billion for the same period in 2015. The increase was due to borrowings from a wide range of members with the most significant increase from a large depository institution member. During the nine months ended September 30, 2016, investment purchases (excluding overnight investments) totaled $88.7 billion compared to $112.1 billion for the same period in 2015. Investment purchases during each period were primarily driven by the purchase of money market investments, including secured resale agreements in an effort to manage our liquidity position.

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, 2016 and December 31, 2015, we were in compliance with all three of the Finance Agency liquidity requirements.
In addition to the liquidity measures previously discussed, the Finance Agency has provided us with guidance to maintain sufficient liquidity in an amount at least equal to our anticipated cash outflows under two different scenarios. One scenario (roll-off scenario) assumes that we cannot access the capital markets to issue debt for a period of 10 to 20 days with initial guidance set at 15 days and that during that time members do not renew any maturing, prepaid, and called advances. The second scenario (renew scenario) assumes that we cannot access the capital markets to issue debt for a period of three to seven days with initial guidance set at five days and that during that time we will automatically renew maturing and called advances for all members except very large, highly-rated members. This guidance is designed to protect against temporary disruptions in the debt markets that could lead to a reduction in market liquidity and thus the inability for us to provide advances to our members. At September 30, 2016 and December 31, 2015, 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, (including 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 Class B capital stock (including mandatorily redeemable capital stock), additional capital from merger, and retained earnings. It does not include accumulated other comprehensive income (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. Nonpermanent capital includes additional capital from merger. At September 30, 2016 and December 31, 2015, 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.


78

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 generally issue a single class of capital stock (Class B stock). We have two subclasses of Class B 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 Class B capital issued is subject to a five year notice of redemption period.

We reclassify capital stock subject to redemption from equity to a liability (mandatorily redeemable capital stock) when a member provides written notice of redemption, gives notice of intention to withdraw from membership, becomes ineligible for continuing membership, or attains non-member status by merger or consolidation, charter termination, or other involuntary termination from membership.

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, 2016 and December 31, 2015, we had no excess capital stock outstanding.
    
    
The following table summarizes our regulatory capital stock by type of member (dollars in millions):
 
September 30,
2016
 
December 31,
2015
Commercial banks
$
4,262

 
$
2,823

Thrifts
171

 
176

Credit unions
317

 
293

Non-captive insurance companies
268

 
768

Captive insurance companies
640

 
654

Total GAAP capital stock
5,658

 
4,714

Mandatorily redeemable capital stock
675

 
103

Total regulatory capital stock
$
6,333

 
$
4,817


The increase in GAAP and regulatory capital stock held at September 30, 2016 when compared to December 31, 2015 was primarily due to an increase in member activity. In addition, mandatorily redeemable capital stock increased due primarily to the reclassification of captive insurance company capital stock to mandatorily redeemable capital stock in the first quarter of 2016 in response to the Finance Agency final rule affecting membership eligibility that became effective February 19, 2016.

Additional Capital from Merger

We recognized net assets acquired from the Seattle Bank by recording the par value of capital stock issued in the transaction as capital stock, with the remaining portion of net assets acquired reflected in a new capital account captioned “Additional capital from merger.” We treat this additional capital from merger as a component of total capital for regulatory capital purposes. Dividends on capital stock have been paid from this account since the merger date and we intend to pay future dividends, when and if declared, from this account until the additional capital from merger balance is depleted.


79

Retained Earnings
Our Enterprise Risk Management Policy (ERMP) includes a target level, not a required level, of retained earnings and additional capital from merger based on the amount deemed necessary to protect the redemption value of capital stock, facilitate safe and sound operations, maintain regulatory capital ratios, and support our ability to pay a relatively stable dividend. We monitor our achievement of this target and may utilize tools such as restructuring our balance sheet, generating additional income, reducing our risk exposures, increasing capital stock requirements, or reducing our dividends to enable us to return to our targeted level of retained earnings. At September 30, 2016, our actual retained earnings were 106 percent of target.
We 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, 2016 and December 31, 2015, our restricted retained earnings balance totaled $200 million and $101 million. One percent of our average balance of outstanding consolidated obligations for the three months ended September 30, 2016 was $1.5 billion. For more information on our JCE Agreement, refer to "Item 1. Business — Retained Earnings" in our 2015 Form 10-K.

Dividends

Our Board of Directors believes any 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 over time, and an activity-based capital stock dividend, when possible, at a level above the membership capital stock dividend. Our actual dividend is determined quarterly by our Board of Directors, based on policies, regulatory requirements, 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,
 
2016
 
2015
 
2016
 
2015
Aggregate cash dividends paid1
$
36

 
$
25

 
$
102

 
$
75

Effective combined annualized dividend rate paid on capital stock
2.98
%
 
2.87
%
 
2.91
%
 
2.92
%
Annualized dividend rate paid on membership capital stock
0.75
%
 
0.50
%
 
0.58
%
 
0.50
%
Annualized dividend rate paid on activity-based capital stock
3.50
%
 
3.50
%
 
3.50
%
 
3.50
%
Average three-month LIBOR
0.79
%
 
0.31
%
 
0.69
%
 
0.28
%

1
Amounts for the three and nine months ended September 30, 2016 exclude $6 million and $15 million paid on mandatorily redeemable capital stock, which is recorded as interest expense on the Statements of Income. Amounts for the three and nine months ended September 30, 2015 exclude $1 million and $2 million paid on mandatorily redeemable capital stock.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

For a discussion of our critical accounting policies and estimates, refer to our 2015 Form 10-K. There have been no material changes to our critical accounting policies and estimates during the nine months ended September 30, 2016.

LEGISLATIVE AND REGULATORY DEVELOPMENTS

Minority and Women Inclusion

On October 27, 2016, the Finance Agency proposed amendments to its Minority and Women Inclusion regulations that, if adopted, would clarify the scope of our obligation to promote diversity and ensure inclusion. These proposed amendments update existing Finance Agency regulations aimed at promoting diversity and the inclusion and utilization of minorities, women, and individuals with disabilities in all Bank business and activities, including management, employment and contracting.



80


The proposed amendments would:

•
require us to develop standalone diversity and inclusion strategic plans or incorporate diversity and inclusion into their existing strategic planning processes and adopt strategies for promoting diversity and ensuring inclusion;

•
encourage us to expand contracting opportunities for minorities, women, and individuals with disabilities through subcontracting arrangements;

•
require us to amend our policies on equal opportunity in employment and contracting by adding sexual orientation, gender identity, and status as a parent to the list of protected classifications; and

•
require us to provide information in our annual reports to the Finance Agency about our efforts to advance diversity and inclusion through capital market transactions, affordable housing and community investment programs, initiatives to improve access to mortgage credit, and strategies for promoting the diversity of supervisors and managers.

Comments on the proposed amendments are due by December 27. We are currently assessing the effect of the proposed amendments.

FHLBank Membership for Non-Federally-Insured Credit Unions

On September 28, 2016, the Finance Agency proposed amendments to regulations governing FHLBank membership that would implement statutory amendments to the FHLBank Act authorizing us to accept applications for membership from state-chartered credit unions without Federal share insurance, provided that certain prerequisites have been met. The new rule, if adopted, would generally treat these credit unions the same as other depository institutions.

Comments are due on the proposed rule by November 28, 2016. We are currently assessing the effect of the proposed rule but do not anticipate that, if adopted, it would have a material impact.

Indemnification Payments

On September 20, 2016, the Finance Agency issued a re-proposed rule that, if adopted, would establish standards for identifying whether an indemnification payment by an FHLBank or the OF to an officer, director, employee, or other entity-affiliated party in connection with an administrative proceeding or civil action instituted by the Finance Agency is prohibited or permissible. Under the proposed rule, those payments with respect to an administrative proceeding or civil action and that been initiated by the Finance Agency are only permitted if they relate to:

•
premiums for professional liability insurance or fidelity bonds for directors and officers, to the extent that the insurance or fidelity bond covers expenses and restitution, but not a judgment in favor of the Finance Agency or a civil money penalty;

•
expenses of defending an action, subject to an agreement to repay those expenses in certain instances; and

•
amounts due under an indemnification agreement entered into on or prior to September 20, 2016.

The proposed rule also outlines the process a board of directors must undertake prior to making any permitted indemnification payment for expenses of defending an action initiated by the Finance Agency.

Comments are due on the proposed rule by December 21, 2016. We are currently assessing the effect of the proposed rule but do not anticipate that, if adopted, it would have a material impact.





81

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 strategic 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.

Market Risk

We define market risk as the risk that Market Value of Capital Stock (MVCS) or net income will change as a result of changes in market conditions, such as interest rates, spreads, and volatilities. Interest rate risk, including mortgage prepayment risk, was our predominant type of market risk exposure during the nine months ended September 30, 2016 and 2015. Our general approach toward managing interest rate risk is to acquire and maintain a portfolio of assets, liabilities, and derivatives, which, taken together, limit our expected exposure to interest rate risk. Management regularly reviews our sensitivity to interest rate changes by monitoring our market risk measures in parallel and non-parallel interest rate shifts and spread and volatility movements.

Our key risk measures are MVCS Sensitivity and Projected Income Sensitivity.

MARKET VALUE OF CAPITAL STOCK SENSITIVITY
  
We define MVCS as an estimate of the market value of assets minus the market value of liabilities (excluding mandatorily redeemable capital stock) divided by the total shares of capital stock (including mandatorily redeemable 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 run-off balance sheet. The timing and variability of balance sheet cash flows are calculated by an internal model. To ensure the accuracy of the MVCS calculation, we reconcile the computed market prices of complex instruments, such as derivatives and mortgage assets, to market observed prices or dealers' quotes.

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

To protect the MVCS from large interest rate swings, we manage the interest rate risk of our balance sheet by using hedging transactions, such as entering into or canceling interest rate swaps, caps, floors, and swaptions and issuing consolidated obligation bonds, including those with step-up, callable, or other structured features.

We monitor and manage to the MVCS policy limits to ensure the stability of the Bank's value. As of September 30, 2016, 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 policy limit breach requires a prompt action to address the measure outside of the policy limit and the breach must be reported to the Enterprise Risk Committee of the Bank and the Risk Committee of the Board of Directors.

During the first quarter of 2008, due to the low interest rate environment, our Board of Directors suspended indefinitely the policy limit pertaining to the down 200 basis point parallel interest rate shift scenario. In October 2012, our Board of Directors amended the suspension by approving a rule for compliance to the down 200 basis point scenario that reinstates/suspends the associated policy limit when the 10-year swap rate increases above/drops below 2.50 percent and remains so for five consecutive days. At September 30, 2016 and December 31, 2015, the 10-year swap rate was below 2.50 percent and therefore the associated policy limit was suspended.


82

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 of capital stock, including shares classified as mandatorily redeemable, assuming instantaneous parallel shifts in interest rates at September 30, 2016 and December 31, 2015:
 
Market Value of Capital Stock (dollars per share)
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
September 30, 2016
$
119.5

 
$
117.9

 
$
117.6

 
$
118.4

 
$
118.8

 
$
118.5

 
$
117.1

December 31, 2015
$
110.4

 
$
113.8

 
$
115.4

 
$
116.9

 
$
117.5

 
$
117.5

 
$
116.3

 
% Change from Base Case
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
September 30, 2016
0.9
 %
 
(0.4
)%
 
(0.7
)%
 
—
%
 
0.3
%
 
0.2
%
 
(1.1
)%
December 31, 2015
(5.5
)%
 
(2.6
)%
 
(1.2
)%
 
—
%
 
0.5
%
 
0.5
%
 
(0.5
)%

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 of capital stock, including shares classified as mandatorily redeemable, assuming instantaneous non-parallel shifts in interest rates at September 30, 2016 and December 31, 2015:
 
Market Value of Capital Stock (dollars per share)
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
September 30, 2016
$
118.7

 
$
118.2

 
$
118.3

 
$
118.4

 
$
118.2

 
$
118.2

 
$
117.2

December 31, 2015
$
118.1

 
$
118.2

 
$
117.8

 
$
116.9

 
$
115.4

 
$
114.0

 
$
110.3

 
% Change from Base Case
 
Down 200
 
Down 100
 
Down 50
 
Base Case
 
Up 50
 
Up 100
 
Up 200
September 30, 2016
0.3
%
 
(0.1
)%
 
—
%
 
—
%
 
(0.1
)%
 
(0.1
)%
 
(1.0
)%
December 31, 2015
1.0
%
 
1.1
 %
 
0.8
%
 
—
%
 
(1.3
)%
 
(2.5
)%
 
(5.6
)%

The change in our base case MVCS at September 30, 2016 when compared to December 31, 2015 was primarily attributable to the following factors:

•
Increase in retained earnings: We recorded net income of $493 million, which included net gains on litigation settlements in the amount of $337 million, during the nine months ended September 30, 2016. This has a positive impact on our market value of equity, thereby increasing MVCS.

•
Increased shares of capital stock: Our capital stock balance increased at September 30, 2016 when compared to December 31, 2015 due to capital stock issued as a result of increased member advance activity. As we issued this capital stock at par, which is below our current MVCS value, our MVCS was negatively impacted.

PROJECTED INCOME SENSITIVITY

We monitor projected 24-month income sensitivity to limit short-term earnings volatility of the Bank. The projected 24-month income sensitivity policy limit is based on forward interest rates, and business and risk management assumptions. The risk management assumptions may result in a forecast differing from business expectations. The income sensitivity policy limit specifies a floor on our projected return on capital stock for each shock scenario. Our projected return on capital stock 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, 2016 and December 31, 2015. For more information on our Projected Income Sensitivity, refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management" in our 2015 Form 10-K.


83

Capital Adequacy

An adequate capital position is necessary for providing safe and sound operations of the Bank. To manage our capital adequacy we maintain capital levels in accordance with Finance Agency regulations and monitor retained earnings and additional capital from merger. In addition, a capital adequacy measure from a risk management perspective is Economic Value of Capital Stock (EVCS).

RETAINED EARNINGS AND ADDITIONAL CAPITAL FROM MERGER TARGET LEVEL AND REGULATORY CAPITAL REQUIREMENTS

Our ERMP includes a target level of retained earnings and additional capital from merger based on the amount deemed necessary to protect the redemption value of capital stock, facilitate safe and sound operations, maintain regulatory capital ratios, and support our ability to pay a relatively stable dividend. We are also subject to three regulatory capital requirements. For additional information on our compliance with these requirements, refer to “Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources".

ECONOMIC VALUE OF CAPITAL STOCK

We define EVCS as the net present value of expected future cash flows of our assets and liabilities (excluding mandatorily redeemable capital stock), discounted at our cost of funds, and divided by the total shares of capital stock (including mandatorily redeemable capital stock) outstanding. This measurement 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 of capital stock, including shares classified as mandatorily redeemable, at September 30, 2016 and December 31, 2015:
Economic Value of Capital Stock (dollars per share)
September 30, 2016
$
126.3

December 31, 2015
$
123.1

    
The change in our EVCS at September 30, 2016 when compared to December 31, 2015 was primarily attributable to the following factors:

•
Increase in retained earnings. We recorded net income of $493 million, which included net gains on litigation settlements in the amount of $337 million, during the nine months ended September 30, 2016. This has a positive impact on our market value of equity, thereby increasing EVCS.

•
Increased shares of capital stock. Our capital stock balance increased at September 30, 2016 when compared to December 31, 2015 due to capital stock issued as a result of increased member activity. As we issued this capital stock at par, which is below our current EVCS value, our EVCS was negatively impacted.

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 our 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.


84

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 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.

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, 2016 and December 31, 2015, borrowers pledged $328.1 billion and $268.8 billion of collateral (net of applicable discounts) to support activity with us, including advances. At September 30, 2016 and December 31, 2015, our advance balances were $125.8 billion and $89.2 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, 2016 and December 31, 2015. Accordingly, we have not recorded any allowance for credit losses on our credit products.

MORTGAGE LOANS

We are exposed to credit risk through our participation in the MPF program and MPP. Mortgage loan 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 loans 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.


85

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 participating financial institution (PFI). We have offered eight MPF loan products under the MPF program: Original MPF, MPF 100, MPF 125, MPF Plus, MPF Government, MPF Government MBS, MPF Xtra, and MPF Direct. While still held in our Statements of Condition, we currently do not offer the MPF 100 or MPF Plus loan products. MPF Xtra, MPF Direct, and MPF Government MBS loans products are passed through to a third-party investor and are not maintained in our Statements of Condition.

Effective May 31, 2015, as part of the Merger, we acquired mortgage loans previously purchased by the Seattle Bank under the MPP. This program involved investment by the Seattle Bank in single-family mortgage loans that were purchased directly from MPP PFIs. Similar to the MPF program, MPP PFIs generally originated, serviced, and credit enhanced the mortgage loans sold to the Seattle Bank. In 2005, the Seattle Bank ceased entering into new MPP master commitment contracts and therefore all MPP loans acquired were originated prior to 2006. We currently do not purchase mortgage loans under this program.

The following table presents the unpaid principal balance of our MPF and MPP portfolios by product type (dollars in millions):
Product Type
 
September 30,
2016
 
December 31,
2015
MPF Conventional:
 
 
 
 
Original MPF
 
$
858

 
$
849

MPF 100
 
18

 
22

MPF 125
 
4,159

 
3,860

MPF Plus
 
712

 
871

MPF Government
 
522

 
547

Total MPF
 
6,269

 
6,149

 
 
 
 
 
MPP Conventional
 
384

 
464

MPP Government
 
44

 
50

Total MPP
 
428

 
514

Total mortgage loan unpaid principal balance
 
$
6,697

 
$
6,663


We manage the credit risk on mortgage loans acquired in the MPF program and MPP 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 an allowance for credit losses 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, the ability of the loan servicer to repurchase any government-insured loan once it reaches 90 days delinquent, and the contractual obligation of the loan servicer to liquidate a government-insured loan in full upon sale of the REO property if not repurchased previously. 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. For our MPF loans, these loss layers may vary depending on the MPF product alternatives selected and consist of (i) homeowner equity, (ii) primary mortgage insurance (PMI), (iii) a first loss account (FLA), and (iv) a credit enhancement obligation of the PFI. For our MPP loans, these loss layers consist of (i) homeowner equity, (ii) primary mortgage insurance (PMI), and (iii) a lender risk account (LRA). For a detailed discussion of these loss layers, refer to “Item 1. Financial Statements — Note 9 — Allowance for Credit Losses.”


86

Allowance for Credit Losses. We utilize an allowance for credit losses to reserve for estimated losses in our conventional MPF and MPP mortgage loan portfolios at the balance sheet date. The measurement of our MPF and MPP 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, and (iii) estimating additional credit losses in the conventional mortgage loan portfolio. The allowance for credit losses on our conventional MPF mortgage loans was $2 million and $1 million at September 30, 2016 and December 31, 2015. The allowance for credit losses on our conventional MPP mortgage loans was less than $1 million at both September 30, 2016 and December 31, 2015.

A charge-off is recorded if it is estimated that the recorded investment in a loan will not be recovered. We evaluate whether to record a charge-off based upon the occurrence of a confirming event, including but not limited to, the occurrence of foreclosure or when a loan is deemed collateral-dependent. We charge-off the portion of the outstanding conventional mortgage loan balance in excess of the fair value of the underlying collateral, which is determined using property values, less selling costs and expected proceeds from PMI.

Refer to “Item 1. Financial Statements — Note 9 — Allowance for Credit Losses” for additional information on our allowance for credit losses.

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 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.

Finance Agency regulations limit the type of investments we may purchase. We are prohibited from investing in financial instruments issued by non-U.S. entities other than those issued by U.S. branches and agency offices of foreign commercial banks, unless otherwise approved by the Finance Agency. 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. At September 30, 2016, 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, and those approved by the Finance Agency.

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, 2016, we were in compliance with the regulatory limits established for unsecured credit.


87

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, commercial paper, and U.S. Treasury obligations. Our long-term portfolio may include, but is not limited to, other U.S. obligations, GSE and Tennessee Valley Authority obligations, state or local housing agency obligations, taxable municipal bonds, and MBS. We face credit risk from unsecured exposures primarily within our short-term portfolio. We consider investments issued or guaranteed by the U.S. Government, an agency or instrumentality of the U.S. Government, or the FDIC to be of the highest credit quality and therefore those exposures are not monitored with other unsecured investments.

We generally limit unsecured credit exposure to the following overnight investment types:

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

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

At September 30, 2016, 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, 2016 (excluding accrued interest receivable) (dollars in millions):
 
 
Credit Rating1,2
Domicile of Counterparty
 
AA
 
A
 
BBB
 
Total
Domestic
 
$
—

 
$
—

 
$
440

 
$
440

U.S subsidiaries of foreign commercial banks
 
—

 
125

 
—

 
125

Total domestic and U.S. subsidiaries of foreign commercial banks
 
—

 
125

 
440

 
565

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

Australia
 
500

 
—

 
—

 
500

Canada
 
—

 
1,200

 
—

 
1,200

Finland
 
600

 
—

 
—

 
600

France
 
—

 
100

 
—

 
100

Netherlands
 
—

 
70

 
—

 
70

Norway
 
—

 
400

 
—

 
400

Sweden
 
600

 
600

 
—

 
1,200

Total U.S. branches and agency offices of foreign commercial banks
 
1,700

 
2,370

 
—

 
4,070

Total unsecured investment exposure
 
$
1,700

 
$
2,495

 
$
440

 
$
4,635


1
Represents the lowest credit rating available for each investment based on an NRSRO. In instances where an NRSRO rating is not available for the investment, the issuer rating is applied.

2
Table excludes investments issued or guaranteed by the U.S. Government, an agency or instrumentality of the U.S. Government, or the FDIC.


88

Investment Ratings

The following tables summarize the carrying value of our investments by credit rating (dollars in millions):
 
September 30, 2016
 
Credit Rating1
 
AAA
 
AA
 
A
 
BBB
 
BB or Lower
 
Total
Interest-bearing deposits2
$
—

 
$
2

 
$
—

 
$
—

 
$
—

 
$
2

Securities purchased under agreements to resell
1,500

 
—

 
500

 
4,250

 
—

 
6,250

Federal funds sold
—

 
1,700

 
2,495

 
440

 
—

 
4,635

Investment securities:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE single-family
—

 
5,172

 
—

 
—

 
—

 
5,172

GSE multifamily
—

 
12,035

 
—

 
—

 
—

 
12,035

Other U.S. obligations single-family3
—

 
3,531

 
—

 
—

 
—

 
3,531

Other U.S. obligations commercial3
—

 
4

 
—

 
—

 
—

 
4

Private-label residential
—

 
—

 
6

 
9

 
2

 
17

Total mortgage-backed securities
—

 
20,742

 
6

 
9

 
2

 
20,759

Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations3
—

 
3,932

 
—

 
—

 
—

 
3,932

GSE and Tennessee Valley Authority obligations
—

 
4,976

 
—

 
—

 
—

 
4,976

State or local housing agency obligations
1,257

 
456

 
—

 
—

 
—

 
1,713

Other
477

 
107

 
—

 
—

 
—

 
584

Total non-mortgage-backed securities
1,734

 
9,471

 
—

 
—

 
—

 
11,205

Total investments4
$
3,234

 
$
31,915

 
$
3,001

 
$
4,699

 
$
2

 
$
42,851


 
December 31, 2015
 
Credit Rating1
 
AAA
 
AA
 
A
 
BBB
 
BB or Lower
 
Total
Interest-bearing deposits2
$
—

 
$
2

 
$
—

 
$
—

 
$
—

 
$
2

Securities purchased under agreements to resell
1,625

 
150

 
—

 
5,000

 
—

 
6,775

Federal funds sold
—

 
450

 
1,820

 
—

 
—

 
2,270

Investment securities:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
GSE single-family
—

 
6,260

 
—

 
—

 
—

 
6,260

GSE multifamily
—

 
10,145

 
—

 
—

 
—

 
10,145

Other U.S. obligations single-family3
—

 
2,317

 
—

 
—

 
—

 
2,317

Other U.S. obligations commercial3
—

 
6

 
—

 
—

 
—

 
6

Private-label residential
—

 
—

 
7

 
11

 
2

 
20

Total mortgage-backed securities
—

 
18,728

 
7

 
11

 
2

 
18,748

Non-mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Other U.S. obligations3
—

 
4,222

 
—

 
—

 
—

 
4,222

GSE and Tennessee Valley Authority obligations
—

 
5,593

 
—

 
—

 
—

 
5,593

State or local housing agency obligations
1,465

 
538

 
—

 
—

 
—

 
2,003

Other
451

 
103

 
—

 
—

 
—

 
554

Total non-mortgage-backed securities
1,916

 
10,456

 
—

 
—

 
—

 
12,372

Total investments4
$
3,541

 
$
29,786

 
$
1,827

 
$
5,011

 
$
2

 
$
40,167


1
Represents the lowest credit rating available for each investment based on an NRSRO. In instances where an NRSRO rating is not available for the investment, the issuer rating is applied.

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

3
Represents investment securities backed by the full faith and credit of the U.S. Government.

4
At September 30, 2016, eleven percent of our total investments were unsecured. At December 31, 2015, six percent of our total investments were unsecured.

89

Our total investments increased at September 30, 2016 when compared to December 31, 2015. The increase was due in part to the purchase of money market investments and agency MBS securities during the year.

At September 30, 2016 and December 31, 2015, we did not consider any of our investments 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.”

Mortgage-Backed Securities

We are exposed to mortgage asset credit risk through our 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 the strength and ability to guarantee the payments from the agency that created the structure, underlying loan performance, and other economic factors in the local market or nationwide.

We limit our investments in MBS to those guaranteed by the U.S. Government, issued by a GSE, or those we determine to be investment quality at the time of purchase. We perform ongoing analysis on these investments to determine potential credit issues. At September 30, 2016 and December 31, 2015, we owned $20.8 billion and $18.7 billion of MBS, of which approximately 99.9 percent were guaranteed by the U.S. Government or issued by GSEs and 0.1 percent were private-label MBS during both periods.

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, 2016
Credit rating:
 
 
 A
 
$
6

BBB
 
9

BB or Lower
 
2

Total unpaid principal balance
 
$
17

 
 
 
Amortized cost
 
$
17

Gross unrealized gains
 
—

Gross unrealized losses
 
(1
)
Fair value
 
$
16

 
 
 
Weighted average percentage of fair value to unpaid principal balance
 
97.2
%
Original weighted average FICO® score
 
725

Original weighted average credit support1
 
3.9
%
Weighted average credit support2
 
13.0
%
Weighted average collateral delinquency rate3
 
6.7
%

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, 2016 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.

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 (uncleared 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.


90

Uncleared Derivatives. Due to risk of nonperformance by the counterparties to our derivative agreements, we generally require collateral on uncleared 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 uncleared 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.


91

The following tables show our derivative counterparty credit exposure (dollars in millions):
 
 
September 30, 2016
Credit Rating1
 
Notional Amount
 
Net Derivatives
Fair Value Before Collateral
 
Cash Collateral Pledged
To (From) Counterparty
 
Net Credit Exposure
 to Counterparties
Non-member counterparties:
 
 
 
 
 
 
 
 
Liability positions with credit exposure
 
 
 
 
 
 
 
 
Uncleared derivatives
 
 
 
 
 
 
 
 
AA
 
$
579

 
$
(56
)
 
$
57

 
$
1

A
 
5,117


(81
)
 
85

 
4

BBB4
 
816

 
(12
)
 
12

 
—

Cleared derivatives2
 
37,539

 
(454
)
 
557

 
103

Total derivative positions with credit exposure to non-member counterparties
 
44,051

 
(603
)
 
711

 
108

Member institutions3
 
170

 
1

 
—

 
1

Total
 
44,221

 
$
(602
)
 
$
711

 
$
109

Derivative positions without credit exposure
 
6,876

 
 
 
 
 
 
Total notional
 
$
51,097

 
 
 
 
 
 

 
 
December 31, 2015
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
 
 
 
 
 
 
 
 
Uncleared derivatives
 
 
 
 
 
 
 
 
   A4
 
$
15

 
$
—

 
$
—

 
$
—

Liability positions with credit exposure
 
 
 
 
 
 
 


Uncleared derivatives
 
 
 
 
 
 
 
 
   A4
 
370

 
(11
)
 
11

 
—

BBB4
 
1,268

 
(23
)
 
23

 
—

Cleared derivatives2
 
22,851

 
(254
)
 
348

 
94

Total derivative positions with credit exposure to non-member counterparties
 
24,504

 
(288
)
 
382

 
94

Member institutions3,4
 
34

 
—

 
—

 
—

Total
 
24,538

 
$
(288
)
 
$
382

 
$
94

Derivative positions without credit exposure
 
14,740

 
 
 
 
 


Total notional
 
$
39,278

 


 


 



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

2
Represents derivative transactions cleared with CME Clearing, our clearinghouse, who is not rated. CME Clearing's parent, CME Group Inc. was rated Aa3 by Moody's and AA- by Standard and Poor's at both September 30, 2016 and December 31, 2015.

3
Represents mortgage delivery commitments with our member institutions.

4
Net credit exposure is less than $1 million.


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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. Due to the manual nature of many of our processes, our operational risk exposure is elevated. To mitigate this risk, we continue to focus on process and control improvements, system upgrades, and assessments of staffing adequacy. During the first nine months of 2016, we have added staff to lead and support critical business functions, designed a new control structure surrounding spreadsheets and other applications used in the financial reporting and close process, and implemented enhancements to access controls over key IT applications.

Strategic Risk

We define strategic risk as the risk of an adverse impact on our mission, financial condition, or current and future profitability resulting from external factors that may occur in both the short- and long-term. Strategic risk includes political, 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 mitigate strategic risk through strategic 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 2015 Form 10-K.


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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 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, as amended (the Exchange Act) is (i) recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms; and (ii) accumulated and communicated to our management, including our President and chief executive officer (CEO), and chief financial officer (CFO), as appropriate, to allow timely decisions regarding required disclosure.

Management, with the participation of our President and CEO, and CFO, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the quarterly period covered by this report. Based on that evaluation, and management's previous identification of material weaknesses in our internal control over financial reporting at December 31, 2015, our President and CEO, and CFO have concluded that our disclosure controls and procedures were not effective as of September 30, 2016.

As previously disclosed in our 2015 Form 10-K, management identified three material weaknesses in our internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The three weaknesses previously identified were:

1.
We did not maintain effective control over multiple changes within our business environment during 2015, including certain implications of the Merger, based on the criteria established in the COSO framework. COSO Principle 9 states that an organization should identify and assess changes that could significantly impact the system of internal controls. As these significant changes occur, the scope and nature of the organization’s leadership, priorities, business model, and business processes and activities need to adapt and evolve because a control infrastructure effective in one set of conditions might not be effective when those conditions change significantly. Our internal control infrastructure failed to effectively adapt to and evolve around multiple business environment changes that occurred during 2015.

2.
We did not maintain effective controls over spreadsheets used in our financial close and reporting process. Specifically, we identified multiple issues with the design and operating effectiveness of controls over key spreadsheets used in our financial close and reporting process.

3.
We did not consistently conform to existing internal control procedures established to ensure appropriate logical access to the Bank’s information technology systems. Specifically, the manual processes used to remove unnecessary employee and contractor access and execute the required management testing of the removal process were not performed timely as designed as a result of multiple changes within our business environment, including the Merger.
    
Remediation of Material Weaknesses in Internal Control over Financial Reporting

Management is committed to improving our overall system of internal control over financial reporting and is taking steps to fully remediate the identified material weaknesses. The following briefly describes certain remediation actions we have taken or plan to take to address these material weaknesses:
1.
Management has made changes to the governance of our internal control infrastructure and processes that are expected to facilitate timely, recurring evaluations of internal controls over financial reporting for known and/or expected changes in our business environment during each calendar year. This process included a complete review and assessment of our system of internal control over financial reporting conducted by an independent third party working closely with Bank staff. As a result of this assessment, certain internal controls over financial reporting were enhanced and put in place. These controls are currently being tested by internal audit. The Bank also added staff to lead and support this business function.

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2.
Management has designed a new control structure surrounding spreadsheets and other applications used in the financial reporting and close process as part of a comprehensive project to address the related material weakness, which is in the process of implementation. Once completed, this project is expected to increase the number and effectiveness of controls surrounding spreadsheets utilized in the financial reporting process. Longer term, management intends to reduce the number of financial reporting spreadsheets through automation. As of September 30, 2016, the new control structure has been implemented for the most significant spreadsheets. These controls are currently being tested by internal audit.

3.
Management has designed and implemented enhancements to access controls over key IT applications used in the financial reporting and close process. This included strengthening existing controls, adding additional controls, and adding staff to the information technology department to support the effective execution of these controls. These controls are currently being tested by internal audit.
Management believes that the measures described above should strengthen our internal control over financial reporting. We cannot provide assurance, however, that these steps will remediate such weaknesses or the timing of when such steps will be completed, nor can we be certain of whether additional actions will be required or the costs of any such actions. The material weaknesses cannot be considered remediated until the applicable remedial actions and associated internal controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.
Changes in Internal Control Over Financial Reporting
During the quarter ended September 30, 2016, management continued to take steps to remediate the material weaknesses and other control deficiencies identified at December 31, 2015. Other than these remediation steps, which included certain changes in controls as outlined above, there have been no changes in our internal control over financial reporting during the third quarter of 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting at September 30, 2016.



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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS
    
As a result of the Merger, we are currently involved in a number of legal proceedings initiated by the Seattle Bank against various entities relating to its purchases and subsequent impairments of certain private-label MBS, as described below. Although the Seattle Bank sold all private-label MBS during the first quarter of 2015, we continue to be involved in these proceedings. The private-label MBS litigation is described in “Part I. Item 3. Legal Proceedings” in our 2015 Form 10-K and below. After consultation with legal counsel, other than the private-label MBS litigation, we do not believe any legal proceedings to which we are a party could have a material impact on our financial condition, results of operations, or cash flows.

Private-Label MBS Litigation

As the Seattle Bank previously reported, in December of 2009, it filed 11 complaints in the Superior Court of Washington for King County relating to private-label MBS that it purchased from various dealers and financial institutions in an aggregate original principal amount of approximately $4 billion. The Seattle Bank's complaints under Washington State law requested rescission of its purchases of the securities and repurchases of the securities by the defendants for the original purchase prices plus eight percent per annum (plus related costs), minus distributions on the securities received by the Seattle Bank. The Seattle Bank asserted that the defendants made untrue statements and omitted important information in connection with their sales of the securities to the Seattle Bank.

In October 2010, each defendant group filed a motion to dismiss the proceedings against it. The issues raised by those motions were fully briefed and were the subject of oral arguments that occurred in March and April 2011. In a series of decisions handed down in June, July, and August 2011, the judge handling the pre-trial motions ruled in favor of the Seattle Bank on all issues, except that the judge granted the defendants' motions to dismiss certain of the Seattle Bank's allegations of misrepresentation as to owner occupancy of properties securing loans in the securitized loan pools. In addition, the judge granted motions to dismiss a group of related entities as defendants in one of the 11 cases for lack of personal jurisdiction. The resolution of the pre-trial motions allowed the cases to proceed to the discovery phase, which is complete. In a series of rulings in November 2015, the judge denied the defendants' motions for summary judgment on common issues and granted Seattle Bank's motion to strike the seller defendants' due diligence defenses. With a few exceptions, the judge has also denied, in whole or in part, each defendant's individual motion or motions for summary judgment. The judge granted partial summary judgment to three defendants on a total of five certificates.

Of the 11 cases initially filed, eight have been settled, two remain active, and one has been appealed. The aggregate consideration paid for the private-label MBS that continue to be actively litigated or are currently on appeal is $1.0 billion. The first trial against one of the remaining defendant groups is scheduled for early 2017.  

Litigation Settlement Gains

Litigation settlement gains are considered realized and recorded when we receive cash or assets that are readily convertible to known amounts of cash or claims to cash. In addition, litigation settlement gains are considered realizable and recorded when we enter into a signed agreement that is not subject to appeal, where the counterparty has the ability to pay, and the amount to be received can be reasonably estimated. Prior to being realized or realizable, we consider potential litigation settlement gains to be gain contingencies, and therefore they are not recorded in the Statements of Income.
We record legal expenses related to litigation settlements as incurred in other expenses in the Statements of Income with the exception of certain legal expenses related to litigation settlement awards that are contingent based fees for the attorneys representing the Bank. We incur and recognize these contingent based legal fees only when litigation settlement awards are realized, at which time these fees are netted against the gains recognized on the litigation settlement. 
During the three months ended September 30, 2016 we did not settle any private-label MBS claims. During the nine months ended September 30, 2016, we settled multiple private-label MBS claims and recognized $337 million in net gains on litigation settlements. During the three and nine months ended September 30, 2015, we recognized $12 million in net gains on litigation settlements. We continue to pursue litigation with the other defendants.


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ITEM 1A. RISK FACTORS

For a discussion of our risk factors, refer to our 2015 Form 10-K. There have been no material change to our risk factors during the nine months ended September 30, 2016.

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

PricewaterhouseCoopers LLP (PwC) serves as the independent registered public accounting firm for our Bank. Rule 201(c)(1)(ii)(A) of Regulation S-X (the Loan Rule) prohibits an accounting firm, such as PwC, from having certain financial relationships with its audit clients and affiliated entities. Specifically, the Loan Rule provides, in relevant part, that an accounting firm generally would not be independent if it receives a loan from a lender that is a “record or beneficial owner of more than ten percent of the audit client’s equity securities.”
PwC has advised our Bank as of December 31, 2015 and September 30, 2016 that it has a borrowing relationship with a Bank member (referred below as the “lender”) who owns more than 10 percent of the Bank’s capital stock, which under the Loan Rule, would call into question PwC’s independence with respect to the Bank. We are providing this disclosure to explain the facts and circumstances, as well as PwC’s and the Audit Committee’s conclusions, concerning PwC’s objectivity and impartiality with respect to the audit of our Bank.
PwC advised our Audit Committee that it believes that, in light of the facts of this borrowing relationship, its ability to exercise objective and impartial judgment on all matters encompassed within PwC’s audit engagement have not been impaired and that a reasonable investor with knowledge of all relevant facts and circumstances would reach the same conclusion. PwC has advised the Audit Committee that this conclusion is based in part on the following considerations:
•
the borrowings are in good standing and the lender does not have the right to take action against PwC, as borrower, in connection with the financings;

•
the debt balances outstanding are immaterial to PwC and to the lender;

•
PwC has borrowing relationships with a diverse group of lenders, therefore PwC is not dependent on any single lender or group of lenders; and

•
the PwC audit engagement team has no involvement in PwC’s treasury function and PwC’s treasury function has no oversight or ability to influence the PwC audit engagement team.


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Additionally, our Audit Committee assessed PwC’s ability to perform an objective and impartial audit, and continue to conclude that PwC has maintained objectivity and impartiality in connection with its audit of our financial statements. The conclusion is based on the unique nature and status of our Bank, and due to our ownership structure and limited voting rights of our members. In addition to the above listed considerations, the Audit Committee considered the following:
•
as of December 31, 2015 and September 30, 2016, no officer or director of the lender served on the board of directors of the Bank; and

•
the lender is subject to the same terms and conditions for conducting business with the Bank as any other member.

Based on the Audit Committee’s evaluation, the Audit Committee has concluded that PwC’s ability to exercise objective and impartial judgment on all issues encompassed within PwC’s audit engagement has not been impaired.
 


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ITEM 6. EXHIBITS
3.1
Organization Certificate of the Federal Home Loan Bank of Des Moines, as amended and restated effective May 31, 20151 
3.2
Bylaws of the Federal Home Loan Bank of Des Moines, as amended and restated effective February 10, 20162
4.1
Federal Home Loan Bank of Des Moines Capital Plan, as amended and approved by the Federal Housing Finance Agency on May 31, 20151
10.1
Employment Agreement with Joseph E. Amato, effective May 2, 20163
10.2
General Release with Richard S. Swanson, effective June 30, 20164
10.3
MPF Consolidated Interbank Agreement, effective July 22, 2016
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.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document

1
Incorporated by reference to our Form 8-K filed with the SEC on June 1, 2015 (Commission File No. 000-51999).

2
Incorporated by reference to our Form 8-K filed with the SEC on February 17, 2016 (Commission File No. 000-51999).

3
Incorporated by reference to our Form 8-K/A (Amendment No. 1) filed with the SEC on August 5, 2016 (Commission File No. 000-51999).

4
Incorporated by reference to our Form 8-K/A (Amendment No. 1) filed with the SEC on July 13, 2016 (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 10, 2016
 
 
 
 
 
 
 
 
 
 
 
 
By:
 
/s/ Michael L. Wilson
 
 
 
 
Michael L. Wilson
President and Chief Executive Officer
 
 
 
 
 
 
 
By:
 
/s/ Ardis E. Kelley
 
 
 
 
Ardis E. Kelley
Senior Vice President and Chief Accounting Officer
(Principal Accounting Officer)
 
 
 


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