10-K 1 fhlb12311610k.htm FORM 10-K - DECEMBER 31, 2016 Document
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
 
 
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 

For the fiscal year ended December 31, 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
 

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Class B Stock, par value $100
Name of Each Exchange on Which Registered: None

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer x
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Registrant's stock is not publicly traded and is only issued to members of the registrant. Such stock is issued and redeemed at par value, $100 per share, subject to certain regulatory and statutory limits. At June 30, 2016, the aggregate par value of the stock held by current and former members of the registrant was $5,938,837,000. At February 28, 2017, 65,214,243 shares of stock were outstanding.




Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

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. As a result, you are cautioned not to place undue reliance on such statements. 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);

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;

disruptions in the credit and debt markets and the effect on future funding costs, sources, and availability;

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

the ability to meet capital and liquidity 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 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 in certain MPF products.


3


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

PART I

ITEM 1. BUSINESS
OVERVIEW
The Federal Home Loan Bank of Des Moines (the Bank, we, us, or our) is a federally chartered corporation organized on October 31, 1932, that is exempt from all federal, state, and local taxation (except real property taxes) and is one of 11 district FHLBanks. The FHLBanks were created under the authority of the Federal Home Loan Bank Act of 1932 (FHLBank Act). With the passage of the Housing and Economic Recovery Act of 2008 (Housing Act), the Federal Housing Finance Agency (Finance Agency) was established and became the new independent federal regulator of Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, Enterprises), as well as the FHLBanks and FHLBanks' Office of Finance (Office of Finance), effective July 30, 2008. The Finance Agency's mission is to 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.
We are a cooperative. This means we are owned by our customers, whom we call members. Our members include commercial banks, thrifts, credit unions, insurance companies, and community development financial institutions (CDFIs) in our district of 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. While not considered members, we also conduct certain business activities with state and local housing associates meeting certain statutory criteria.

MERGER

We completed the merger with the Federal Home Loan Bank of Seattle (Seattle Bank) (the Merger) on May 31, 2015 (merger date). The Merger had a significant impact on all aspects of our financial condition, results of operations, and cash flows. As a result, financial results for the periods after the Merger may not be directly comparable to financial results for periods prior to the Merger.
BUSINESS MODEL
Our mission is to provide funding and liquidity for our members and housing associates so they can meet the housing, economic development, and business needs of the communities they serve. We strive to achieve our mission within an operating principle that balances the trade-off between attractively priced products, reasonable returns on capital stock, and maintaining an adequate level of retained earnings to preserve par value of member-owned capital stock.
We are capitalized primarily through the purchase of capital stock by our members. As a condition of membership, all of our members must purchase and maintain membership capital stock based on a percentage of their total assets as of the preceding December 31st subject to a cap of $10 million and a floor of $10,000. Each member is also required to purchase and maintain activity-based capital stock to support certain business activities with us. Member demand for our products expands and contracts with economic and market conditions. Our self-capitalizing capital structure, which allows us to repurchase or require additional capital stock based on member activity, provides us with the flexibility to effectively and efficiently meet the changing needs of our membership. While eligible to borrow, housing associates are not members and, as such, are not permitted to purchase capital stock.

4


Our capital stock is not publicly traded. It is purchased and redeemed by members or repurchased by us at a par value of $100 per share. Our current and former members own all of our outstanding capital stock. Former members own capital stock (included in mandatorily redeemable capital stock) to support business transactions still carried in our Statements of Condition. All stockholders, including current and former members, may receive dividends on their capital stock investment to the extent declared by our Board of Directors.
Our primary business activities are providing collateralized loans, known as advances, to members and housing associates and acquiring residential mortgage loans from or through our members. In addition, we invest in investment quality securities. Our primary source of funding and liquidity is the issuance of debt securities, referred to as consolidated obligations, in the capital markets. Consolidated obligations are the joint and several obligations of all FHLBanks and are backed only by the financial resources of the FHLBanks. A critical component to the success of our operations is the ability to issue consolidated obligations regularly in the capital markets under a wide range of maturities, structures, and amounts, and at relatively favorable spreads to market interest rates.
Our net income is primarily attributable to the difference between the interest income we earn on our advances, mortgage loans, and investments, and the interest expense we pay on our consolidated obligations and member deposits, as well as components of other income (loss) (e.g., gains and losses on derivatives and hedging activities and gains and losses on trading securities). A portion of our annual net income is used to fund our Affordable Housing Program (AHP), which provides grants and subsidized advances to members to support housing for very low to moderate income households. By regulation, we are required to contribute 10 percent of our net earnings each year to the AHP. In addition to the required AHP assessment, our Board may elect to make voluntary contributions to the AHP. For purposes of the required AHP assessment, net earnings is defined as net income before assessments, plus interest expense related to mandatorily redeemable capital stock. For additional details on our AHP, refer to the "Affordable Housing Program Assessments" section of Item 1.
We have risk management policies that govern our exposure to market, liquidity, credit, operational, and strategic risk, as well as capital adequacy. Our primary objective is to manage assets, liabilities, and derivative exposures in ways that protect the par redemption value of our capital stock while earning a reasonable return. For additional information on our risk management practices, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management.”

MEMBERSHIP
Our membership includes commercial banks, thrifts, credit unions, insurance companies, and CDFIs. The majority of depository institutions in our district that are eligible for membership are currently members.
The following table summarizes our membership by type of institution:
 
 
December 31,
Institutional Entity
 
2016
 
2015
 
2014
Commercial banks
 
1,061

 
1,088

 
942

Thrifts
 
57

 
65

 
48

Credit unions
 
231

 
221

 
110

Non-captive insurance companies
 
56

 
54

 
48

Captive insurance companies
 
12

 
13

 
7

Community development financial institutions
 
5

 
4

 
1

Total
 
1,422


1,445


1,156



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The following table summarizes our membership by asset size:
 
 
December 31,
Membership Asset Size1
 
2016
 
2015
 
2014
Depository institutions2
 
 
 
 
 
 
Less than $100 million
 
30
%
 
31
%
 
35
%
$100 million to $500 million
 
46

 
46

 
47

Greater than $500 million
 
19

 
18

 
13

Insurance companies
 
 
 
 
 
 
Less than $100 million
 
1

 
1

 
1

$100 million to $500 million
 
1

 
1

 
1

Greater than $500 million
 
3

 
3

 
3

Total
 
100
%
 
100
%
 
100
%

1
Membership asset size is based on September 30, 2016 financial information received from members.

2
Depository institutions consist of commercial banks, thrifts, credit unions, and community development financial institutions.

Our membership level decreased during 2016 primarily due to 40 member consolidations and eight dissolved charters, partially offset by the addition of 27 new members. At December 31, 2016, approximately 73 percent of our members were Community Financial Institutions (CFIs). For 2016, CFIs were defined under the FHLBank Act to include all Federal Deposit Insurance Corporation (FDIC) insured institutions with average total assets over the previous three-year period of less than $1.128 billion. CFIs are eligible to pledge certain collateral types that non-CFIs cannot pledge, including secured business loans and lines of credit and secured agri-business loans and lines of credit.

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

Overnight Advance. This product has a maturity of one business day and is renewed automatically until the borrower pays off the advance. Interest rates are set daily.

Fixed Rate Advances. These advances are available over a variety of terms in amortizing and non-amortizing structures. Using an amortizing advance, a borrower makes predetermined principal payments at scheduled intervals throughout the term of the advance. Forward starting advances are a type of fixed rate non-amortizing advance with settlement dates up to two years in the future, allowing members to lock in an interest rate at the outset, while delaying the receipt of funding. Delayed amortizing advances are a type of fixed rate advance with a feature that delays commencement of the repayment of the principal up to five years, allowing members control over the principal cash flows and the repayment of the advance. Certain long-term fixed rate, amortizing, and forward starting advances contain a symmetrical prepayment feature. This feature allows borrowers to prepay an advance and potentially realize a gain if interest rates rise to a level greater than those existing when the advance was originated.

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Variable Rate Advances. These advances have interest rates that reset periodically to a specified interest rate index such as London Interbank Offered Rate (LIBOR). Capped LIBOR advances are a type of variable rate advance in which the interest rate cannot exceed a specified maximum interest rate. Certain variable rate advances provide for the borrower's ability to prepay at reset dates and our ability to adjust interest rates (including spread) at reset dates.

Callable Advances. These advances may be prepaid by borrowers on pertinent dates (call dates) and therefore provide borrowers a source of long-term financing with prepayment flexibility. Callable advances can be either fixed or floating in nature. Floating rate callable advances may reset at different frequencies ranging from one to six months and are callable at each reset. These advances are often referred to as either Member Option Variable Rate Advances (MOVR) or Member Option LIBOR Advances (MOLA) and are a significant portion of our floating rate advances. Interest rates on MOVR advances reset at each call date to be consistent with the Bank's current offering rate, in line with our underlying cost of funds. Interest rates on MOLA reset at each call date consistent with the underlying LIBOR index. Fixed rate callable advances may have different call schedules based on member specifications, and principal balances may be amortizing in nature. In addition, we retain the right to adjust the price of these advances at each reset date. We generally fund advances indexed to a discount note rate with discount notes, and advances indexed to LIBOR with LIBOR indexed debt or debt swapped to a LIBOR index.

Putable Advances. These advances may, at our discretion, be terminated on predetermined dates prior to the stated maturity of the advances, requiring the borrower to repay the advance. Should an advance be terminated, replacement funding at the prevailing market rates and terms will be offered, based on our available advance products and subject to our normal credit and collateral requirements.

Community Investment Advances. These advances are below-market rate funds used by borrowers in both affordable housing projects and community development. Interest rates on these advances represent our cost of funds plus a mark-up to cover our administrative expenses. This mark-up is determined by our Asset-Liability Committee. On an annual basis, our Board of Directors establishes limits on the total amount of funds available for community investment advances.
For the years ended December 31, 2016, 2015, and 2014, advances represented 69, 61, and 63 percent of our total average assets and generated 57, 39, and 36 percent of our total interest income. For additional information on our advances, including our top five borrowers, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Advances.” In addition, refer to “Item 1A. Risk Factors” for a discussion on our exposure to customer concentration risk.
COLLATERAL
We are required by regulation to obtain and maintain a security interest in eligible collateral at the time we originate or renew an advance and throughout the life of the advance to ensure a fully collateralized position. Eligible collateral includes (i) whole first mortgages on improved residential real property or securities representing a whole interest in such mortgages, (ii) loans and securities issued, insured, or guaranteed by the U.S. Government or any agency thereof, including mortgage-backed securities (MBS) issued or guaranteed by Fannie Mae, Freddie Mac, or Government National Mortgage Association (Ginnie Mae) and Federal Family Education Loan Program (FFELP) guaranteed student loans, (iii) cash deposited with us, and (iv) other real estate-related collateral acceptable to us provided such collateral has a readily ascertainable value and we can perfect a security interest in such property. CFIs may also pledge collateral consisting of secured small business, small agri-business, or small farm loans. As additional security, the FHLBank Act provides that we have a lien on each member's capital stock investment; however, capital stock cannot be pledged as collateral to secure credit exposures.
Borrowers may pledge collateral to us by executing a blanket lien, specifically assigning collateral, or placing physical possession of collateral with us or our custodians. We perfect our security interest in all pledged collateral by filing Uniform Commercial Code financing statements or taking possession or control of the collateral. Under the FHLBank Act, any security interest granted to us by our members, or any affiliates of our members, has priority over the claims and rights of any party (including any receiver, conservator, trustee, or similar party having rights of a lien creditor), unless those claims and rights would be entitled to priority under otherwise applicable law and are held by actual purchasers or by parties that have perfected security interests.

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Under a blanket lien, we are granted a security interest in all financial assets of the borrower to fully secure the borrower's obligation. Other than securities and cash deposits, we do not initially take delivery of collateral pledged by blanket lien borrowers. In the event of deterioration in the financial condition of a blanket lien borrower, we have the ability to require delivery of pledged collateral sufficient to secure the borrower's obligation. With respect to non-blanket lien borrowers that are federally insured, we generally require collateral to be specifically assigned. With respect to non-blanket lien borrowers that are not federally insured (typically insurance companies, CDFIs, and housing associates), we generally take control of collateral through the delivery of cash, securities, or loans to us or our custodians.
For additional information on our collateral requirements, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Advances.”
HOUSING ASSOCIATES
The FHLBank Act permits us to provide advances to eligible housing associates. Housing associates are approved mortgagees under Title II of the National Housing Act that meet certain criteria, including: (i) chartered under law and have succession, (ii) subject to inspection and supervision by some governmental agency, and (iii) lend their own funds as their principal activity in the mortgage field. The same regulatory lending requirements that apply to our members generally apply to housing associates. Because housing associates are not members, they are not subject to certain provisions of the FHLBank Act applicable to members and cannot own our capital stock. In addition, they may only pledge certain types of collateral including: (i) Federal Housing Administration (FHA) mortgages, (ii) Ginnie Mae securities backed by FHA mortgages, (iii) certain residential mortgage loans, and (iv) cash deposited with us.
PREPAYMENT FEES
We charge a borrower a prepayment fee when the borrower prepays certain advances before the original maturity. For advances with symmetrical prepayment features, we 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.
Standby Letters of Credit
We may issue standby letters of credit on behalf of our members, certain other FHLBank members (through a master participation agreement), and housing associates to facilitate business transactions with third parties. These letters of credit are generally used to facilitate residential housing finance and community lending, assist with asset-liability management, or provide liquidity or other funding. Standby letters of credit must be fully collateralized with eligible collateral at the time of issuance.
Mortgage Loans
We invest in mortgage loans through the MPF program, a secondary mortgage market structure developed by the FHLBank of Chicago to help fulfill the housing mission of the FHLBanks. As a result of the Merger, we also acquired mortgage loans previously purchased by the Seattle Bank under the Mortgage Purchase Program (MPP). These programs are considered core mission activities of the FHLBanks, as defined by Finance Agency regulations.
MPF
Under the MPF program, we purchase or fund eligible mortgage loans (MPF loans) from or through, members or housing associates called participating financial institutions (PFIs). We may also acquire MPF loans through participations with other FHLBanks. MPF loans are conforming conventional or government-insured fixed rate mortgage loans secured by one-to-four family residential properties with maturities ranging from five to 30 years. For the years ended December 31, 2016, 2015, and 2014, MPF loans represented 4, 6, and 8 percent of our total average assets and generated 14, 27, and 36 percent of our total interest income.
MPF Provider
The FHLBank of Chicago serves as the MPF Provider for the MPF program. In its role as MPF Provider, the FHLBank of Chicago provides the infrastructure and operational support for the MPF program and is responsible for publishing and maintaining the MPF Guides, which detail the requirements PFIs must follow in originating, selling, and servicing MPF loans. The MPF Provider provides a service for FHLBanks, if needed, that establishes the base price of MPF loan products utilizing the agreed upon methodologies determined by the participating MPF FHLBanks. In exchange for providing these services, the MPF Provider receives a fee from each of the FHLBanks participating in the MPF program. The MPF Provider has engaged Wells Fargo Bank N.A. (Wells Fargo) as the master servicer for the MPF program.

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MPF Governance Committee
The MPF Governance Committee, which consists of representatives from each of the FHLBanks participating in the MPF program, is responsible for recommending and implementing strategic MPF program decisions, including, but not limited to, pricing methodology changes. Participating MPF FHLBanks are allowed to determine their own price or adjust the base price of MPF loan products established by the FHLBank of Chicago. Accordingly, we monitor daily market conditions and make price adjustments to our MPF loan products when deemed necessary. This allows us to impact the level of member demand in our MPF program as well as profitability, risk management, and regulatory requirements.
Participating Financial Institutions
Our members and eligible housing associates must apply to become a PFI. In order to do MPF business with us, each member or eligible housing associate must meet certain eligibility standards and sign a PFI Agreement. The PFI Agreement provides the terms and conditions for the sale or funding of MPF loans, including the servicing of MPF loans.
PFIs may either retain the servicing of MPF loans or sell the servicing to an approved third-party provider. If a PFI chooses to retain the servicing, it receives a servicing fee to manage the servicing activities. If a PFI chooses to sell the servicing rights to an approved third-party provider, the servicing is transferred concurrently with the sale of the MPF loans and a servicing fee is paid to the third-party provider. Throughout the servicing process, the master servicer monitors the PFI's compliance with MPF program requirements and makes periodic reports to the MPF Provider.
MPF Loan Types
We currently offer MPF closed loan products in which we purchase loans acquired or closed by the PFI. In addition, we offer certain off-balance sheet loan products. MPF Xtra is an off-balance sheet loan product in which we assign 100 percent of our interest in PFI master commitments to the FHLBank of Chicago. The FHLBank of Chicago then purchases mortgage loans from our PFIs and sells MPF Xtra loans to Fannie Mae. MPF Direct is an off-balance sheet jumbo loan product in which mortgage loans are sold from our PFIs to a real estate investment trust. MPF Government MBS is an off-balance sheet loan product where our PFIs sell government loans directly to the FHLBank of Chicago where they are pooled and securitized into Ginnie Mae MBS securities. We receive a small fee for our continued management of the PFI relationship under MPF Xtra, MPF Direct, and MPF Government MBS.
The PFI performs all traditional retail loan origination functions on our MPF loan products. We are responsible for managing the interest rate risk and liquidity risk associated with the MPF loans we purchase and carry in our Statements of Condition. In order to limit our credit risk exposure to approximately that of an investor in an investment grade MBS, we require a credit risk sharing arrangement with the PFI on all MPF loans at the time of purchase.
For additional discussion on our mortgage loans and their related credit risk, refer to “Item 8. Financial Statements and Supplementary Data — Note 10 — Allowance for Credit Losses” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Mortgage Loans.”
MPF Loan Volume
Over the years, our member base for MPF loans has evolved from large-volume loan purchases from a small number of large PFIs to purchasing the majority of our MPF loans from a diverse base of banks and credit unions. Our ability to price MPF loans, coupled with the low interest rate environment, has allowed us to serve the liquidity needs of a broad range of members and maintain relatively stable mortgage loan volumes. During the years ended December 31, 2016, 2015, and 2014, we purchased $1.5 billion, $0.8 billion, and $0.9 billion of MPF loan products (excluding MPF Xtra, MPF Direct, and MPF Government MBS). In addition, our members delivered $1.4 billion, $1.0 billion, and $0.7 billion of MPF Xtra, MPF Direct, and MPF Government MBS loans during the years ended December 31, 2016, 2015, and 2014. We began offering MPF Direct in 2015 and MPF Government MBS in 2016.
If we exceed $2.5 billion in MPF loan purchases in a calendar year (excluding MPF Xtra, MPF Direct, and MPF Government MBS), we may become subject to housing goals as specified by the Finance Agency.

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MPP
Effective May 31, 2015, as a part of the Merger, we acquired mortgage loans previously purchased by the Seattle Bank under the MPP. Similar to the MPF program, the MPP includes a risk sharing arrangement under which we manage the interest rate risk and liquidity risk of MPP loans, while the members retain the primary credit risk.
Through the MPP, the Seattle Bank purchased mortgage loans directly from PFIs. MPP loans were conforming conventional or government-insured fixed rate mortgage loans secured by one-to-four family residential properties with maturities ranging from five to 30 years. MPP PFIs were responsible for all traditional retail loan origination functions related to MPP loans. MPP PFIs who sold MPP loans to the Seattle Bank could either continue to service the mortgage loans or sell the servicing rights to a third party service provider.
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 and we expect that the $416 million outstanding at December 31, 2016 will continue to decrease as the remaining MPP loans are paid off. We do not service the acquired MPP loans nor do we own any servicing rights. We have engaged Bank of New York Mellon as the MPP master servicer. For the year ended December 31, 2016, MPP loans represented less than 1 percent of our total average assets and generated one percent of our total interest income.
For additional information on our mortgage loans, see “Item 7. Management's Discussion and Analysis of Financial Condition and Risk Management — Credit Risk — Mortgage Loans” and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Mortgage Loans.”
TEMPORARY LOAN MODIFICATION PLANS

We offer loan modification plans for our MPF and MPP PFIs. Under these plans, we generally permit the recapitalization of past due amounts up to the original loan amount and/or reduce the interest rate for a specified period of time. No other terms of the original loan, including contractual maturity, are generally modified. At December 31, 2016, 68 modified loans totaling $18 million were outstanding in our Statements of Condition.
Investments
We maintain an investment portfolio primarily to provide investment income and liquidity. Our investment portfolio consists of both short- and long-term investments. Our short-term investments may include, but are not limited to, interest-bearing deposits, Federal funds sold, securities purchased under agreements to resell, certificates of deposit, commercial paper, and U.S. treasury obligations. Our long-term investments may include, but are not limited to, other U.S. obligations, government-sponsored enterprise (GSE) and Tennessee Valley Authority obligations, state or local housing agency obligations, taxable municipal bonds, and MBS. Our long-term investments generally provide higher spreads than our short-term investments. For the years ended December 31, 2016, 2015, and 2014, investments represented 26, 32, and 28 percent of our total average assets and generated 27, 32, and 28 percent of our total interest income.
We do not have any subsidiaries. We also have no equity positions in any partnerships, corporations, or off-balance sheet special purpose entities. In an effort to reduce credit risk, our Enterprise Risk Management Policy (ERMP) prohibits new purchases of private-label MBS. In addition, Finance Agency regulations limit the type of investments we may purchase.
The Finance Agency further limits our investments in MBS by requiring that the total book value of our MBS not exceed three times regulatory capital at the time of purchase. For details on our compliance with this regulatory requirement, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Investments.” For additional discussion on our investments and their related credit risk, refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management — Credit Risk — Investments."

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Standby Bond Purchase Agreements
We currently hold standby bond purchase agreements with housing associates within our district whereby, for a fee, we agree to serve as a standby liquidity provider if required, to purchase and hold the housing associate's bonds until the designated marketing agent can find a suitable investor or the housing associate repurchases the bonds according to a schedule established by the agreement. Each standby bond purchase agreement includes the provisions under which we would be required to purchase the bonds. If purchased, the bonds would be classified as available-for-sale (AFS) securities in our Statements of Condition. For additional details on our standby bond purchase agreements, refer to “Item 8. Financial Statements and Supplementary Data — Note 18 — Commitments and Contingencies.”
Deposits
We accept deposits from our members and eligible housing associates. We offer several types of deposit programs, including demand, overnight, and term deposits. Deposit programs provide us funding while providing members a low-risk interest-earning asset.
Consolidated Obligations
Our primary source of funding and liquidity is the issuance of debt securities, referred to as consolidated obligations, in the capital markets. Consolidated obligations (bonds and discount notes) are the joint and several obligations of all FHLBanks and are backed only by the financial resources of the FHLBanks. They are not obligations of the U.S. Government, and the U.S. Government does not guarantee them. At February 28, 2017, Standard & Poor's Ratings Services (S&P) and Moody's Investors Service, Inc. (Moody's) rated the consolidated obligations AA+/A-1+ and Aaa/P-1, both with a stable outlook.
The Office of Finance issues all consolidated obligations on behalf of the FHLBanks. It is also responsible for servicing all outstanding debt, coordinating transfers of debt between the FHLBanks, serving as a source of information for the FHLBanks on capital market developments, managing the FHLBank System's relationship with the rating agencies with respect to consolidated obligations, and preparing and making available the FHLBank System's Combined Financial Reports.
Although we are primarily responsible for the portion of consolidated obligations issued on our behalf, we are also jointly and severally liable with the other FHLBanks for the payment of principal and interest on all consolidated obligations. The Finance Agency, at its discretion, may require any FHLBank to make principal and/or interest payments due on any consolidated obligation, whether or not the primary obligor FHLBank has defaulted on the payment of that consolidated obligation. The Finance Agency has never exercised this discretionary authority.
To the extent that an FHLBank makes any payment on a consolidated obligation on behalf of another FHLBank, the paying FHLBank is entitled to reimbursement from the FHLBank otherwise responsible for the payment. However, if the Finance Agency determines that an FHLBank is unable to satisfy its obligations, then it may allocate the outstanding liability among the remaining FHLBanks on a pro-rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding, or on any other basis that it may determine.

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

BONDS
Bonds are generally issued to satisfy our intermediate- and long-term funding needs. Typically, they have maturities ranging up to 30 years, although there is no statutory or regulatory limitation as to their maturity. Bonds are issued with either fixed or variable rate payment terms that use a variety of indices for interest rate resets such as LIBOR. To meet the specific needs of certain investors, both fixed and variable rate bonds may also contain certain embedded features, which result in complex coupon payment terms and call features. When bonds are issued on our behalf, we may concurrently enter into a derivative agreement to effectively convert the fixed rate payment stream to variable or to offset the embedded features in the bond.
Depending on the amount and type of funding needed, bonds may be issued through negotiated or competitively bid transactions with approved underwriters or selling group members (i.e., TAP Issue Program, auction, and Global Debt Program), or through debt transfers between FHLBanks.

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The TAP Issue Program is used to issue fixed rate, noncallable bonds with standard maturities of two, three, five, seven, or ten years. The goal of the TAP Issue Program is to aggregate frequent smaller bond issues into a larger bond issue that may have greater market liquidity.
An auction process is used to issue fixed rate, callable bonds. Auction structures are determined by the FHLBanks in consultation with the Office of Finance and the securities dealer community. We may receive zero to 100 percent of the proceeds of the bonds issued via the callable auction depending on (i) the amounts and costs for the bonds bid by underwriters, (ii) the maximum costs we or other FHLBanks participating in the same issue, if any, are willing to pay for the obligations, and (iii) the guidelines for allocation of bond proceeds among multiple participating FHLBanks administered by the Office of Finance.
The Global Debt Program allows the FHLBanks to diversify their funding sources to include overseas investors. Global Debt Program bonds may be issued in maturities ranging up to 30 years and can be customized with different terms and currencies. The FHLBanks approve the terms of the individual issues under the Global Debt Program.
For additional information on our bonds, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Consolidated Obligations” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Sources of Liquidity.”
DISCOUNT NOTES
Discount notes are generally issued to satisfy our short-term funding needs. They have maturities of up to 365/366 days and are offered daily through a discount note selling group and other authorized underwriters. Discount notes are generally sold at a discount and mature at par.
On a daily basis, we may request that specific amounts of discount notes with specific maturity dates be offered by the Office of Finance for sale through certain securities dealers. We may receive zero to 100 percent of the proceeds of the discount notes issued via this sales process depending on (i) the time of the request, (ii) the maximum costs we or other FHLBanks participating in the same issue, if any, are willing to pay for the discount notes, and (iii) the amount of orders for the discount notes submitted by dealers.
Twice weekly, we may request that specific amounts of discount notes with fixed maturities of four to 26 weeks be offered by the Office of Finance through competitive auctions conducted with securities dealers in the discount note selling group. One or more of the FHLBanks may also request that amounts of those same discount notes be offered for sale for their benefit through the same auction. The discount notes offered for sale through competitive auction are not subject to a limit on the maximum costs the FHLBanks are willing to pay. We may receive zero to 100 percent of the proceeds of the discount notes issued through a competitive auction depending on the amounts of the discount notes bid by underwriters and the guidelines for allocation of discount note proceeds among multiple participating FHLBanks administered by the Office of Finance.
For additional information on our discount notes, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Consolidated Obligations” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Liquidity — Sources of Liquidity.”
Derivatives
We use derivatives to manage interest rate risk in our Statements of Condition. Finance Agency regulations and our ERMP establish guidelines for derivatives, prohibit trading in or the speculative use of derivatives, and limit credit risk arising from derivatives.
The goal of our interest rate risk management strategy is not to eliminate interest rate risk, but to manage it within appropriate limits. One key way we manage interest rate risk is to acquire and maintain a portfolio of assets and liabilities which, together with their associated derivatives, are conservatively matched with respect to the expected repricings.

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We can use interest rate swaps, swaptions, interest rate caps and floors, options, and future/forward contracts as part of our interest rate risk management strategies. These derivatives can be used as either a fair value hedge of a financial instrument or firm commitment or an economic hedge to manage certain defined risks in our Statements of Condition. We use economic hedges primarily to (i) manage mismatches between the coupon features of our assets and liabilities, (ii) offset prepayment risk in certain assets, (iii) mitigate the income statement volatility that occurs when financial instruments are recorded at fair value and hedge accounting is not permitted by accounting guidance, or (iv) to reduce exposure reset risk.
Additional information on our derivatives can be found in "Item 8. Financial Statements and Supplementary Data — Note 11 — Derivatives and Hedging Activities” and “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Derivatives.”
CAPITAL AND DIVIDENDS
Capital 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 capital stock). We have two subclasses of capital stock: membership and activity-based. Each member must purchase and hold membership capital stock in an amount equal to 0.12 percent of its total assets as of the preceding December 31st subject to a cap of $10.0 million and a floor of $10,000. Each member is also required to purchase activity-based capital stock equal to 4.00 percent of its advances and mortgage loans outstanding in our Statements of Condition. All capital stock issued is subject to a five year notice of redemption period.

The capital stock requirements established in our Capital Plan are designed so that we remain adequately capitalized as member activity changes. Our Board of Directors may make adjustments to the capital stock requirements within ranges established in our Capital Plan.
 
Capital stock owned by members in excess of their capital stock requirement is deemed excess capital stock. Under our Capital Plan, we, at our discretion and upon 15 days' written notice, may repurchase excess membership capital stock. We, at our discretion, may also repurchase excess activity-based capital stock to the extent that (i) the excess capital stock balance exceeds an operational threshold set forth in the Capital Plan, which is currently set at zero, or (ii) a member submits a notice to redeem all or a portion of the excess activity-based capital stock.

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 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.
For additional information on our capital, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital.”
Additional Capital from Merger
We 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 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 to our members have been paid from this account since the merger date and we intend to pay future dividends to members, when and if declared, from this account until the additional capital from merger balance is depleted.
Retained Earnings
Our ERMP includes a target level of retained earnings and additional capital from merger based on the amount deemed necessary to help 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 attain our targeted level of retained earnings over time. At December 31, 2016, our actual retained earnings were 95 percent of target. Based on our projected earnings and assuming no material increase in our risk profile, we expect to be above target by the end of 2017.

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We entered into a Joint Capital Enhancement Agreement (JCE Agreement) with all of the other FHLBanks in 2011. The JCE Agreement, as amended, is intended to enhance the capital position of each FHLBank by allocating the earnings historically paid to satisfy the Resolution Funding Corporation obligation to a separate restricted retained earnings account. Under the JCE Agreement, each FHLBank allocates 20 percent of its quarterly net income to a restricted retained earnings account until the balance of that account equals at least one percent of its average balance of outstanding consolidated obligations for the previous quarter. The restricted retained earnings are not available to pay dividends and are presented separately in our Statements of Condition. At December 31, 2016 and 2015, our restricted retained earnings account totaled $231 million and $101 million. One percent of our average balance of outstanding consolidated obligations for the three months ended September 30, 2016 was $1.6 billion. To review the JCE Agreement, as amended, see Exhibit 99.1 of our Form 8-K filed with the Securities and Exchange Commission (SEC) on August 5, 2011.
Dividends
Our Board of Directors may declare and pay different dividends for each subclass of capital stock. Dividend payments may be made in the form of cash and/or additional shares of capital stock. Historically, we have only paid cash dividends. By regulation, we may pay dividends from current earnings, unrestricted retained earnings, or additional capital from merger, but we may not declare a dividend based on projected or anticipated earnings. We are prohibited from paying a dividend in the form of additional shares of capital stock if, after the issuance, the outstanding excess capital stock would be greater than one percent of our total assets. Our Board of Directors may not declare or pay dividends if it would result in our non-compliance with regulatory capital requirements.
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 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.
For additional information on our dividends, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital — Dividends.”
COMPETITION
Advances
One of our primary businesses is to make advances to our members and eligible housing associates. Demand for our advances is affected by, among other things, the cost of other available sources of funding for our borrowers. We compete with other suppliers of secured and unsecured wholesale funding including, but not limited to, investment banks, commercial banks, other GSEs, and U.S. Government agencies. We may also compete with other FHLBanks to the extent that member institutions have affiliated institutions located outside of our district. Furthermore, our members may have access to brokered deposits and resale agreements, each of which represent competitive alternatives to our advances. Many of our competitors are not subject to the same body of regulation that we are, which enables those competitors to offer products and terms that we may not be able to offer. Efforts to effectively compete with other suppliers of wholesale funding by changing the pricing of our advances may result in a decrease in the profitability of our advance business.
Mortgage Loans
The purchase of mortgage loans through the MPF program is subject to competition on the basis of prices paid for mortgage loans, customer service, and ancillary services, such as automated underwriting and loan servicing options. We compete primarily with other GSEs, such as Fannie Mae, Freddie Mac, and other financial institutions and private investors for acquisition of conventional fixed rate mortgage loans.
Consolidated Obligations
Our primary source of funding is through the issuance of consolidated obligations. We compete with the U.S. Government, Fannie Mae, Freddie Mac, and other GSEs as well as corporate, sovereign, and supranational entities for funds raised through the issuance of debt in the national and global debt markets. In the absence of increased demand, increased supply of competing debt products may result in higher debt costs or lesser amounts of debt issued at the same cost. Although our debt issuances have kept pace with the funding needs of our members, there can be no assurance that this will continue.

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TAXATION
We are exempt from all federal, state, and local taxation except real property taxes.
AFFORDABLE HOUSING PROGRAM ASSESSMENTS
The FHLBank Act requires each FHLBank to establish and fund an AHP, which provides subsidies in the form of direct grants and below-market interest rate advances to members who use the funds to assist in the purchase, construction, or rehabilitation of housing for very low to moderate income households. Annually, the FHLBanks must set aside for the AHP the greater of ten percent of their current year net earnings or their pro-rata share of an aggregate $100 million to be contributed in total by the FHLBanks. In addition to the required AHP assessment, our Board may elect to make voluntary contributions to the AHP. For purposes of the required AHP assessment, net earnings is defined as net income before assessments, plus interest expense related to mandatorily redeemable capital stock. The exclusion of interest expense related to mandatorily redeemable capital stock is a regulatory interpretation of the Finance Agency. We accrue the AHP assessment on a monthly basis and reduce our AHP liability as program funds are distributed. For additional information on our AHP, refer to “Item 8. Financial Statements and Supplementary Data — Note 14 — Affordable Housing Program.”
OVERSIGHT, AUDITS, AND EXAMINATIONS
The Finance Agency supervises and regulates the FHLBanks and the Office of Finance. The Finance Agency has a statutory responsibility and corresponding authority to ensure that the FHLBanks operate in a safe and sound manner. Consistent with that duty, the Finance Agency has an additional responsibility to ensure the FHLBanks carry out their housing and community development finance mission. In order to carry out those responsibilities, the Finance Agency establishes regulations governing the entire range of operations of the FHLBanks, conducts ongoing off-site monitoring and supervisory reviews, performs annual on-site examinations and periodic interim on-site reviews, and requires the FHLBanks to submit monthly and quarterly information regarding their financial condition, results of operations, and risk metrics.

The Comptroller General of the United States (the “Comptroller General”) has authority under the FHLBank Act to audit or examine the Finance Agency and the Bank and to decide the extent to which they fairly and effectively fulfill the purposes of the FHLBank Act. Furthermore, the Government Corporation Control Act provides that the Comptroller General may review any audit of a FHLBank’s financial statements conducted by an independent registered public accounting firm. If the Comptroller General conducts such a review, then he or she must report the results and provide his or her recommendations to Congress, the Office of Management and Budget, and the FHLBank in question. The Comptroller General may also conduct his or her own audit of the financial statements of any FHLBank.

As required by federal regulation, we have an internal audit department and an audit committee of our Board. An independent public accounting firm registered with the Public Company Accounting Oversight Board (PCAOB) audits our annual financial statements. Our independent registered public accounting firm, PricewaterhouseCoopers LLP, must adhere to PCAOB and Government Auditing Standards, as issued by the Comptroller General, when conducting our audits. Our Board, our senior management, and the Finance Agency receive these audit reports. We also submit annual management reports to Congress, the President of the United States, the Office of Management and Budget, and the Comptroller General. These reports include audited financial statements, a statement of internal accounting and administrative control systems, and the report of the independent registered public accounting firm on the financial statements.
AVAILABLE INFORMATION
We are required to file with the SEC an annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. The SEC maintains a website containing these reports and other information regarding our electronic filings located at www.sec.gov. These reports may also be read and copied at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. Further information about the operation of the SEC's Public Reference Room may be obtained by calling 1-800-SEC-0330.

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We also make our annual reports, quarterly reports, current reports, and amendments to all such reports filed with or furnished to the SEC available, free of charge, on our internet website at www.fhlbdm.com as soon as reasonably practicable after such reports are available. Annual and quarterly reports for the FHLBanks on a combined basis are also available, free of charge, at the website of the Office of Finance as soon as reasonably practicable after such reports are available. The internet website address to obtain these reports is www.fhlb-of.com.
Information contained in the previously mentioned websites, or that can be accessed through those websites, is not incorporated by reference into this annual report on Form 10-K and does not constitute a part of this or any report filed with the SEC.
PERSONNEL
As of February 28, 2017, we employed 300 full-time and seven part-time employees. Our employees are not covered by a collective bargaining agreement.


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ITEM 1A. RISK FACTORS

The following discussion summarizes some of the more important risks we face. This discussion is not exhaustive, and there may be other risks we face, which are not described below. The risks described below, if realized, could negatively affect our business operations, financial condition, and future results of operations and, among other things, could result in our inability to pay dividends on our capital stock or repurchase capital stock.
WE ARE SUBJECT TO A COMPLEX BODY OF LAWS AND REGULATIONS THAT COULD CHANGE IN A MANNER DETRIMENTAL TO OUR BUSINESS OPERATIONS
The FHLBanks are GSEs, organized under the authority of the FHLBank Act, and as such, are governed by federal laws and regulations adopted and applied by the Finance Agency. From time to time, Congress may amend the FHLBank Act or other statutes in ways that affect the rights and obligations of the FHLBanks and the manner in which the FHLBanks carry out their housing finance mission and business operations. Due to the recent change in the U.S. Government, there are additional uncertainties in the legislative and regulatory environment. New or modified legislation enacted by Congress or regulations adopted by the Finance Agency or other financial services regulators could adversely impact our ability to conduct business or the cost of doing business.

For a discussion of recent legislative and regulatory activity that could affect us, refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Legislative and Regulatory Developments.”
WE ARE JOINTLY AND SEVERALLY LIABLE FOR THE CONSOLIDATED OBLIGATIONS OF OTHER FHLBANKS AND MAY BE REQUIRED TO PROVIDE FINANCIAL ASSISTANCE TO OTHER FHLBANKS
Each of the FHLBanks relies upon the issuance of consolidated obligations as a primary source of funds. Consolidated obligations are the joint and several obligations of the 11 FHLBanks and are backed only by the financial resources of the FHLBanks. They are not obligations of the U.S. Government, and the U.S. Government does not guarantee them. The Finance Agency, at its discretion, may require any FHLBank to make principal and/or interest payments due on any consolidated obligation, whether or not the primary obligor FHLBank has defaulted on the payment of that consolidated obligation. Furthermore, if the Finance Agency determines that an FHLBank is unable to satisfy its obligations, it may allocate the outstanding liability among the remaining FHLBanks on a pro-rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding, or on any other basis that it may determine. Accordingly, we could incur liability beyond our primary obligation under consolidated obligations, which could negatively affect our financial condition and results of operations. Moreover, we may not pay dividends to, or redeem or repurchase capital stock from, any of our members if timely payment of principal and interest on all FHLBank consolidated obligations has not been made. Accordingly, our ability to pay dividends or to redeem or repurchase capital stock may be affected not only by our financial condition, but by the financial condition of the other FHLBanks.
Due to our relationship with other FHLBanks, we could also be impacted by events other than the default on a consolidated obligation. Events that impact other FHLBanks include, but are not limited to, member failures, capital deficiencies, and other-than-temporary impairment (OTTI) charges. These events may cause the Finance Agency, at its discretion, to require any FHLBank to either provide capital to or buy assets of any other FHLBank. If we are called upon by the Finance Agency to do either of these items, it may negatively impact our financial condition.
ACTUAL OR PERCEIVED CHANGES IN THE FHLBANK'S CREDIT RATINGS AS WELL AS THE U.S. GOVERNMENT'S CREDIT RATING COULD ADVERSELY AFFECT OUR BUSINESS
Our consolidated obligations are currently rated AA+/A-1+ by S&P and Aaa/P-1 by Moody's, both with a stable outlook. These ratings are subject to reduction or withdrawal at any time by an NRSRO, and the FHLBank System may not be able to maintain these credit ratings. Adverse rating agency actions on the FHLBank System or U.S. Government may reduce investor confidence and negatively affect our cost of funds and ability to issue consolidated obligations on acceptable terms, which could adversely impact our financial condition and results of operations.

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A reduction in our credit rating could also trigger additional collateral posting requirements under our derivative agreements. For cleared derivatives, the Derivative Clearing Organization (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. We were not required to post additional initial margin by our clearing agents, based on credit considerations at December 31, 2016. For the majority of uncleared derivative contracts, we are required to deliver additional collateral on derivatives in net liability positions to counterparties if there is deterioration in our credit rating. Further, demand for certain Bank products, including, but not limited to, standby letters of credit and standby bond purchase agreements, is influenced by our credit rating. A reduction in our credit rating could weaken or eliminate demand for such products, and our financial condition and results of operations could be adversely affected.

WE COULD BE ADVERSELY AFFECTED BY OUR INABILITY TO ACCESS THE CAPITAL MARKETS

Our primary source of funds is through the issuance of consolidated obligations in the capital markets. Our ability to obtain funds through the issuance of consolidated obligations depends in part on our real and perceived relationship to the U.S. Government, prevailing market conditions in the capital markets, and rating agency actions, all of which are beyond our control. In addition, changes to the regulatory environment that affect bank counterparties and debt underwriters could adversely affect our ability to access the capital markets and the cost of that funding. We cannot make any assurance that we will be able to obtain funding on terms acceptable to us, if at all. If we cannot access funding when needed, our ability to support and continue business operations, including our ability to refund maturing debt and compliance with regulatory liquidity requirements, could be adversely impacted, which would thereby adversely impact our financial condition and results of operations. Although our debt issuances have historically kept pace with the funding needs of our members and eligible housing associates, there can be no assurance that this will continue.
FAILURE TO MEET MINIMUM REGULATORY CAPITAL REQUIREMENTS COULD ADVERSELY AFFECT OUR ABILITY TO REDEEM OR REPURCHASE CAPITAL STOCK, PAY DIVIDENDS, AND ATTRACT NEW MEMBERS
We are required to maintain capital to meet specific minimum requirements, as defined by the Finance Agency. Historically, our capital has exceeded all capital requirements and we have maintained adequate capital and leverage ratios. If we fail to meet any of these requirements or if our Board of Directors or the Finance Agency determines that we have incurred, or are likely to incur, losses resulting in, or losses that are expected to result in, a charge against capital, we would not be able to redeem or repurchase any capital stock while such charges are continuing or expected to continue. In addition, failure to meet our capital requirements could result in the Finance Agency's imposition of restrictions pertaining to dividend payments, lending, investing, or other business activities. Additionally, the Finance Agency could require that we call upon our members to purchase additional capital stock to meet our minimum regulatory capital requirements. Members may be unable or unwilling to satisfy such calls for additional capital, which could lead to a member's involuntary termination of membership as a result of noncompliance with the Bank's Capital Plan, which could adversely impact our financial condition and results of operations.
WE COULD BE ADVERSELY AFFECTED BY OUR EXPOSURE TO CUSTOMER CONCENTRATION RISK
We are subject to customer concentration risk as a result of our reliance on a relatively small number of member institutions for a large portion of our total advances and resulting interest income. At December 31, 2016 and 2015, advances outstanding to our top five borrowers totaled $92.2 billion and $50.5 billion, representing 70 and 57 percent of our total advances outstanding. At December 31, 2016 and 2015, our single largest borrower accounted for 59 and 42 percent of total advances outstanding. Advance balances with these and our other members could change due to factors such as a change in member demand or borrowing capacity, relocation of members out of our district, or members with affiliated institutions located outside of our district choosing to do business with another FHLBank. In addition, advance balances could change as a result of new or modified legislation enacted by Congress or regulations or other directives adopted by the Finance Agency or other financial services regulators. If, for any reason, we were to lose, or experience a decrease in the amount of business with our top five borrowers, our financial condition and results of operations could be negatively affected.  Refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Statements of Condition - Advances” for additional information on our top five borrowers.


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WE FACE COMPETITION FOR ADVANCES, MORTGAGE LOANS, AND FUNDING
Our primary business activities are providing advances to members and housing associates and acquiring residential mortgage loans from or through our members. Demand for our advances is affected by, among other things, the cost of other available sources of funding for our borrowers. We may from time to time compete with other suppliers of secured and unsecured wholesale funding including, but not limited to, investment banks, commercial banks, other GSEs, and U.S. Government agencies. We may also compete with other FHLBanks to the extent that member institutions have affiliated institutions located outside of our district. Furthermore, our members may have access to brokered deposits and resale agreements, each of which represent competitive alternatives to our advances. Many of our competitors are not subject to the same body of regulation that we are, which enables those competitors to offer products and terms that we may not be able to offer. Efforts to effectively compete with other suppliers of wholesale funding by changing the pricing of our advances may result in a decrease in the profitability of our advance business. A decrease in the demand for advances or a decrease in the profitability on advances would negatively affect our financial condition and results of operations.
The purchase of mortgage loans through the MPF program is subject to competition on the basis of prices paid for mortgage loans, customer service, and ancillary services, such as automated underwriting and loan servicing options. We compete primarily with other GSEs, such as Fannie Mae, Freddie Mac, and other financial institutions, the Federal Reserve, and private investors for acquisition of conventional fixed rate mortgage loans. Increased competition could result in a reduction in the amount of mortgage loans we are able to purchase, which could negatively affect our financial condition and results of operations.
We also compete with the U.S. Government, Fannie Mae, Freddie Mac, and other GSEs as well as corporate, sovereign, and supranational entities for raising funds through the issuance of debt in the national and global markets. In the absence of increased demand, increased supply of competing debt products may result in higher debt costs or lesser amounts of debt issued at the same cost. An increase in funding costs would negatively affect our financial condition and results of operations.
WE COULD BE ADVERSELY AFFECTED BY OUR EXPOSURE TO CREDIT RISK
We are exposed to credit risk if the market value of an obligation declines as a result of deterioration in the creditworthiness of the obligor or the credit quality of a security instrument. We assume unsecured and secured credit risk exposure in that a borrower or counterparty could default and we may suffer a loss if we are not able to fully recover amounts owed to us in a timely manner.
We attempt to mitigate unsecured credit risk by limiting the terms of unsecured investments and the borrowing capacity of our counterparties. We attempt to mitigate secured credit risk through collateral requirements and credit analysis of our borrowers and counterparties. We require collateral on advances, standby letters of credit, certain mortgage loan credit enhancements provided by PFIs, certain investments, and derivatives. All advances, standby letters of credit, and applicable mortgage loan credit enhancements are required to be fully collateralized. We evaluate the types of collateral pledged by our borrowers and counterparties and assign a borrowing capacity to the collateral, generally based on a percentage of its unpaid principal balance or estimated market value, if available. We generally have the ability to call for additional or substitute collateral during the life of an obligation to ensure we are fully collateralized. Notwithstanding these mitigating factors, we may suffer losses that could adversely impact our financial condition and results of operations.
If a borrower or counterparty fails, we have the right to take ownership of the collateral covering the obligation. However, if the liquidation value of the collateral is less than the value of the outstanding obligation, we may incur losses that could adversely affect our financial condition and results of operations. If we are unable to secure the obligations of borrowers and counterparties, our lending, investing, and hedging activities could decrease, which would negatively impact our financial condition and results of operations.

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CHANGES IN ECONOMIC CONDITIONS OR FEDERAL FISCAL AND MONETARY POLICY COULD ADVERSELY IMPACT OUR BUSINESS
We operate with narrow margins and our net income is sensitive to changes in market conditions that can impact the interest we earn and pay and introduce volatility in other income (loss). These conditions include, but are not limited to, the following:
changes in interest rates;
fluctuations in both debt and equity capital markets;
conditions in the financial, credit, mortgage, and housing markets;
regulatory initiatives;
the willingness and ability of financial institutions to expand lending;
and the strength of the U.S. economy and the local economies in which we conduct business.
Our financial condition, results of operations, and ability to pay dividends could be negatively affected by changes in one or more of these conditions.
Additionally, our business and results of operations may be affected by the fiscal and monetary policies of the federal government and its agencies, including the Federal Reserve, which regulates the supply of money and credit in the U.S. The Federal Reserve's policies directly and indirectly influence the yield on interest-earning assets and the cost of interest-bearing liabilities, which could adversely affect our financial condition, results of operations, and ability to pay dividends.
WE COULD BE ADVERSELY AFFECTED BY OUR INABILITY TO ENTER INTO DERIVATIVE INSTRUMENTS ON ACCEPTABLE TERMS
We use derivatives to manage interest rate risk in our Statements of Condition. Our effective use of derivative instruments depends upon management's ability to determine the appropriate hedging strategies and positions in light of our assets and liabilities as well as prevailing and anticipated market conditions. In addition, the effectiveness of our hedging strategies depends upon our ability to enter into derivatives with acceptable counterparties, on terms desirable to us, and in quantities necessary to hedge our corresponding assets and liabilities. If we are unable to manage our hedging positions properly, or are unable to enter into derivative instruments on desirable terms, we may incur higher funding costs and be unable to effectively manage our interest rate risk and other risks, which could negatively affect our financial condition and results of operations.
EXPOSURE TO OPTION RISK IN OUR FINANCIAL ASSETS AND LIABILITIES COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS
Our mortgage assets provide homeowners the option to prepay their mortgages prior to maturity. The effect of changes in interest rates can exacerbate prepayment or extension risk, which is the risk that mortgage assets will be refinanced by the mortgagor in low interest rate environments or will remain outstanding longer than expected at below-market yields when interest rates increase. Our advances, consolidated obligations, and derivatives may provide us, the borrower, the issuer, or the counterparty with the option to call or put the asset or liability. These options leave us susceptible to unpredictable cash flows associated with our financial assets and liabilities. The exercise of the option and the prepayment or extension risk is dependent upon general market conditions and could have an adverse effect on our financial condition and results of operations.
INCREASES IN DELINQUENCY OR LOSS ESTIMATES ON OUR MPF AND MPP LOANS MAY HAVE AN ADVERSE IMPACT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The condition of the U.S. housing market can have a significant impact on the Bank. If economic conditions weaken and result in increased unemployment and a decline in home prices, we could see an increase in loan delinquencies or loss estimates and decide to increase our allowance for credit losses on mortgage loans. In addition, to the extent that mortgage insurance providers fail to fulfill their obligations to pay us for claims, we could bear additional losses on certain mortgage loans with outstanding mortgage insurance coverage. As a result, our financial condition and results of operations could be adversely impacted.

20


THE IMPACT OF FINANCIAL MODELS AND THE UNDERLYING ASSUMPTIONS USED TO VALUE FINANCIAL INSTRUMENTS AND COLLATERAL MAY HAVE AN ADVERSE IMPACT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The degree of management judgment involved in determining the fair value of financial instruments or collateral is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments and collateral that are actively traded and have quoted market prices or parameters readily available, there is little to no subjectivity in determining fair value. If market quotes are not available, fair values are based on discounted cash flows using market estimates of interest rates and volatility or on dealer prices or prices of similar instruments. We utilize external and internal pricing models to determine the fair value of certain financial instruments and collateral. For external pricing models, we review the vendors' pricing processes, methodologies, and control procedures for reasonableness. For internal pricing models, the underlying assumptions are based on management's best estimates for discount rates, prepayments, market volatility, and other factors. The assumptions used in both external and internal pricing models could have a significant effect on the reported fair values of assets and liabilities or collateral, the related income and expense, and the expected future behavior of assets and liabilities or collateral. While models we use to value financial instruments and collateral are subject to periodic validation by independent parties, rapid changes in market conditions could impact the value of our financial instruments and collateral. The use of different models and assumptions, as well as changes in market conditions, could impact our financial condition and results of operations as well as the amount of collateral we require from borrowers and counterparties.
The information provided by our internal financial models is also used in making business decisions relating to strategies, initiatives, transactions, and products. We have adopted controls, procedures, and policies to monitor and manage assumptions used in our internal models. However, models are inherently imperfect predictors of actual results because they are based on assumptions about future performance or activities. Changes in any models or in any of the assumptions, judgments, or estimates used in the models may cause the results generated by the model to be materially different. If the results are not reliable due to inaccurate assumptions, we could make poor business decisions, including asset and liability management, or other decisions, which could result in an adverse financial impact.
FAILURES OR INTERRUPTIONS IN INTERNAL CONTROLS, INFORMATION SYSTEMS, AND OTHER OPERATING TECHNOLOGIES COULD HARM OUR FINANCIAL CONDITION, RESULTS OF OPERATIONS, REPUTATION, AND RELATIONS WITH MEMBERS
Control failures, including failures in our controls over financial reporting, or business interruptions with members, vendors, or counterparties, could result from human error, fraud, breakdowns in information and computer systems, lapses in operating processes, or natural or man-made disasters. If a significant control failure or business interruption were to occur, it could materially damage our financial condition and results of operations. We may not be able to foresee, prevent, mitigate, reverse, or repair the negative effects of such failures or interruptions.
Moreover, we rely heavily upon information systems and other operating technologies to conduct and manage our business. To the extent that we, our members, vendors, or counterparties experience a technical failure or interruption in any of these systems or other operating technologies, including any "cyberattacks" or other breaches of technical security, we may be unable to conduct and manage our business effectively. Although we have implemented a disaster recovery and business continuity plan, we can make no assurance that it will be able to prevent, timely and adequately address, or mitigate the negative effects of any technical failure or interruption. Any technical failure or interruption could harm our customer relations, risk management, and profitability, and could adversely impact our financial condition and results of operations.
During 2016, we identified certain control deficiencies in our internal control over financial reporting. These control deficiencies were evaluated, individually and in the aggregate, and as a result, we determined one material weakness in our internal control over financial reporting remained from the previous year which related to our failure to maintain effective controls over spreadsheets used in our financial close and reporting process. This material weakness is described more fully in “Item 9A. Controls and Procedures”. These control deficiencies could result in a misstatement of any of our financial statement accounts and disclosures that could in turn result in a material misstatement of the annual or interim financial statements that would not be prevented or detected. Accordingly, management has concluded that these control deficiencies constitute a material weakness. In addition, other material weaknesses or deficiencies may be identified in the future.
If we are unable to correct the material weakness or deficiencies in internal control over financial reporting in a timely manner, our ability to record, process, summarize, and report financial information accurately and within the time periods specified in the rules and forms of the SEC could be adversely affected. This failure could cause our members to lose confidence in our reported financial information, subject us to government enforcement actions, and generally, materially, and adversely impact our business and financial condition.

21


THE INABILITY TO ATTRACT AND RETAIN KEY PERSONNEL COULD ADVERSELY IMPACT OUR BUSINESS
We rely heavily upon our employees in order to successfully execute our business and strategies. The success of our business mission depends, in large part, on our ability to attract and retain certain key personnel with required talents and skills. Should we be unable to hire or retain key personnel with the needed talents or skills, our business operations could be adversely impacted.
MEMBER CONSOLIDATIONS AND FAILURES COULD ADVERSELY AFFECT OUR BUSINESS
Member consolidations and failures could reduce the number of current and potential members in our district. During 2016, our membership level declined slightly, due primarily to 40 member consolidations. If the number of member consolidations and/or failures were to accelerate, we could experience a reduction in the level of our members' advance and other business activities. This loss of business could negatively impact our business operations, financial condition, and results of operations.
RELIANCE ON THE FHLBANK OF CHICAGO, AS MPF PROVIDER, AND FANNIE MAE, RED WOOD TRUST, INC., AND GINNIE MAE AS THE ULTIMATE INVESTORS IN THE MPF XTRA, MPF DIRECT, AND MPF GOVERNMENT MBS PRODUCTS, COULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS
As part of our business, we participate in the MPF program with the FHLBank of Chicago. In its role as MPF Provider, the FHLBank of Chicago provides the infrastructure and operational support for the MPF program and is responsible for publishing and maintaining the MPF Guides, which detail the requirements PFIs must follow in originating, selling, and servicing MPF loans. If the FHLBank of Chicago changes its MPF Provider role, ceases to operate the MPF program, or experiences a failure or interruption in its information systems and other technology, our mortgage purchase business could be adversely affected, and we could experience a related decrease in our net interest margin and profitability. In the same way, we could be adversely affected if any of the FHLBank of Chicago's third-party vendors supporting the operation of the MPF program were to experience operational or technical difficulties.
Additionally, under the MPF Xtra loan product, we assign 100 percent of our interest in PFI master commitments to the FHLBank of Chicago, who then purchases mortgage loans from our PFIs and sells those loans to Fannie Mae. Under the MPF Direct product, mortgage loans are sold directly from our PFIs to Redwood Trust, Inc., a real estate investment trust. Through the MPF Government MBS product our PFIs sell government loans directly to the FHLBank of Chicago where they are pooled and securitized into Ginnie Mae MBS securities. Should the FHLBank of Chicago, Fannie Mae, Redwood Trust, Inc., or Ginnie Mae experience any operational difficulties or inability to continue to do business, those difficulties could have a negative impact on the value of the Bank to our membership.


22


ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES
We lease approximately 43,000 square feet of office space located at 801 Walnut Street, Des Moines, Iowa from an affiliate of our member, Wells Fargo. We also maintain 12,500 square feet of leased office space at 666 Walnut Street, Des Moines, Iowa, and 8,200 square feet of office space at 901 5th Avenue, Seattle, Washington. These additional locations are used principally for information technology staff and employees serving our members in the western states within the Bank’s district. We also maintain a leased, off-site back-up facility with approximately 3,500 square feet in Urbandale, Iowa, and approximately 3,000 square feet of office space in Washington, D.C., which is shared with two other FHLBanks.

ITEM 3. 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 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.

Of the 11 cases initially filed, ten have been settled in whole or in part and one has been dismissed. We have appealed the dismissal of claims related to five certificates across three different cases. The aggregate consideration paid for the private-label MBS currently on appeal is $767 million.

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 2016, we settled multiple private-label MBS claims and recognized $376 million in net gains on litigation settlements. During 2015, we recognized $14 million in net gains on litigation settlements.
ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.


23


PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
We are a cooperative. This means we are owned by our customers, whom we call members. Our current and former members own all of our outstanding capital stock. Our capital stock is not publicly traded and has a par value of $100 per share. All shares are issued, redeemed, or repurchased by us at the stated par value. Our capital stock may be redeemed with a five year notice from the member or voluntarily repurchased by us at par value, subject to certain limitations set forth in our Capital Plan. At February 28, 2017, we had 1,416 current members that held 64.9 million shares of capital stock and 20 former members that held 0.3 million shares of mandatorily redeemable capital stock.
We paid the following quarterly cash dividends during 2016 and 2015 (dollars in millions):
 
 
2016
 
2015
Quarter Declared and Paid
 
Amount1
 
Annualized Rate2
 
Amount1
 
Annualized Rate2
First Quarter
 
$
31

 
2.82
%
 
$
26

 
2.94
%
Second Quarter
 
35

 
2.94

 
24

 
2.94

Third Quarter
 
36

 
2.98

 
25

 
2.87

Fourth Quarter
 
41

 
3.03

 
27

 
2.75


1
Amounts exclude cash dividends paid on mandatorily redeemable capital stock for each quarter of 2016 and 2015. The total dividends paid on mandatorily redeemable capital stock during 2016 were $21 million. Total dividends paid on mandatorily redeemable capital stock during 2015 were $3 million. For financial reporting purposes, these dividends were classified as interest expense.

2
Reflects the annualized rate paid on our average capital stock outstanding during the prior quarter regardless of its classification for financial reporting purposes as either capital stock or mandatorily redeemable capital stock.
For the first quarter during 2016, we paid an annualized rate of 3.50 percent on activity-based capital stock and an annualized rate of 0.50 percent on membership capital stock. For the remainder of 2016, we paid an annualized rate of 3.50 percent on activity-based capital stock and an annualized rate of 0.75 percent on membership capital stock. For each quarter during 2015, we paid an annualized rate of 3.50 percent on activity-based capital stock and an annualized rate of 0.50 percent on membership capital stock.
For additional information on our dividends, see “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital — Dividends.”


24


ITEM 6. SELECTED FINANCIAL DATA

The following tables present selected financial data for the periods indicated (dollars in millions):
 
December 31,
Statements of Condition1
2016
 
2015
 
2014
 
2013
 
2012
Cash
$
223

 
$
982

 
$
495

 
$
448

 
$
252

Investments2
41,218

 
40,167

 
23,079

 
20,131

 
13,433

Advances
131,601

 
89,173

 
65,168

 
45,650

 
26,614

Mortgage loans held for portfolio, net
6,913

 
6,755

 
6,562

 
6,557

 
6,952

Total assets
180,605

 
137,374

 
95,524

 
73,004

 
47,367

Consolidated obligations
 
 
 
 
 
 
 
 
 
Discount notes
80,947

 
98,990

 
57,773

 
38,137

 
8,675

Bonds
89,898

 
31,208

 
32,362

 
30,195

 
34,345

Total consolidated obligations3
170,845

 
130,198

 
90,135

 
68,332

 
43,020

Mandatorily redeemable capital stock
664

 
103

 
24

 
9

 
9

Total liabilities
173,204

 
131,749

 
91,212

 
69,547

 
44,533

Capital stock — Class B putable
5,917

 
4,714

 
3,469

 
2,692

 
2,063

Additional capital from merger
52

 
194

 

 

 

Retained earnings
1,450

 
801

 
720

 
678

 
622

Accumulated other comprehensive income (loss)
(18
)
 
(84
)
 
123

 
87

 
149

Total capital
7,401

 
5,625

 
4,312

 
3,457

 
2,834

 
For the Years Ended December 31,
Statements of Income1
2016
 
2015
 
2014
 
2013
 
2012
Net interest income
$
449

 
$
317

 
$
251

 
$
213

 
$
241

Provision (reversal) for credit losses on mortgage loans
3

 
2

 
(2
)
 
(6
)
 

Other income (loss)4
396

 
(30
)
 
(51
)
 
(35
)
 
(49
)
Other expense5
118

 
137

 
67

 
62

 
68

AHP assessments
75

 
15

 
14

 
12

 
13

AHP voluntary contributions

 
2

 

 

 

Net income
649

 
131

 
121

 
110

 
111

Selected Financial Ratios6,1
 
 
 
 
 
 
 
 
 
Net interest spread7
0.24
%
 
0.25
%
 
0.28
%
 
0.34
%
 
0.42
%
Net interest margin8
0.28

 
0.28

 
0.30

 
0.39

 
0.49

Return on average equity
10.09

 
2.74

 
3.17

 
3.68

 
3.98

Return on average capital stock
12.43

 
3.42

 
4.04

 
4.94

 
5.44

Return on average assets
0.40

 
0.12

 
0.14

 
0.20

 
0.23

Average equity to average assets
3.92

 
4.21

 
4.56

 
5.40

 
5.69

Regulatory capital ratio9
4.48

 
4.23

 
4.41

 
4.63

 
5.69

Dividend payout ratio10
21.83

 
78.99

 
65.16

 
48.72

 
52.46


1
Financial results for the periods after the Merger are not directly comparable to results for periods prior to the Merger.

2
Investments include interest-bearing deposits, securities purchased under agreements to resell, Federal funds sold, trading securities, AFS securities, and held-to-maturity (HTM) securities.

3
The total par value of outstanding consolidated obligations of the 11 FHLBanks was $989.3 billion, $905.2 billion, $847.2 billion, $766.8 billion, and $687.9 billion at December 31, 2016, 2015, 2014, 2013, and 2012.

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 extinguishment of debt, 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.

25


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

Our Management's Discussion and Analysis (MD&A) is designed to provide information that will help the reader develop a better understanding of our financial statements, changes in our financial statements from year to year, and the primary factors driving those changes. Our MD&A is organized as follows:
CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Income (Loss)
 
 
 
 
 
 
 
 
 
 
 
 
Affordable Housing Program Assessments and Voluntary Contributions
 
 
 
 
 
 
 
 
 
 
 
 
Cash and Due from Banks
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mandatorily Redeemable Capital Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

26


FORWARD-LOOKING INFORMATION

Statements contained in this annual report on Form 10-K, including statements describing the objectives, projections, estimates, or future predictions in our operations, may be forward-looking statements. These statements may be identified by the use of forward-looking terminology, such as believes, projects, expects, anticipates, estimates, intends, strategy, plan, could, should, may, and will or their negatives or other variations on these terms. By their nature, forward-looking statements involve risk or uncertainty, and actual results could differ materially from those expressed or implied or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. As a result, you are cautioned not to place undue reliance on such statements. A detailed discussion of risks and uncertainties is included under “Item 1A. Risk Factors.”

EXECUTIVE OVERVIEW

Our Bank is a member-owned cooperative serving shareholder members in our district. Our mission is to provide funding and liquidity for our members and housing associates so they can meet the housing, economic development, and business needs of the communities they serve. We strive to achieve our mission within an operating principle that balances the trade-off between attractively priced products, reasonable returns on capital stock, and maintaining an adequate level of retained earnings to preserve par value of member-owned capital stock. Our members include commercial banks, thrifts, credit unions, insurance companies, and CDFIs.

Financial Results

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

In 2016, we reported net income of $649 million compared to $131 million in 2015. Our net income, calculated in accordance with accounting principles generally accepted in the United States of America (GAAP), was significantly impacted by net gains on litigation settlements of $376 million. We recorded $14 million of net gains on litigation settlements in 2015.

The litigation settlements are the result of settlements with certain defendants in our private-label MBS litigation. As a result of the Merger, we are currently involved in 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.

Net interest income totaled $449 million in 2016 compared to $317 million in 2015. The increase was primarily due to an increase in interest income resulting from the higher interest rate environment and higher advance and investment volumes, a portion of which was attributable to assets acquired in the Merger. Our net interest margin was 0.28 percent during 2016 and 2015.

We recorded a net gain of $396 million in 2016 in other income (loss) compared to a net loss of $30 million in 2015. Other income (loss) included net gains on litigation settlements which were the primary driver as discussed above. Other factors impacting other income (loss) in 2016 were net gains (losses) on derivatives and hedging activities and net gains (losses) on trading securities as described below.

In 2016, we recorded net gains of $7 million on our derivatives and hedging activities through other income (loss) compared to net losses of $38 million in 2015. The net gains were primarily driven by changes in interest rates. These changes impacted ineffectiveness on our AFS fair value hedge relationships and fair value changes on interest rate swaps we utilized to economically hedge our investment securities portfolio. We utilize derivative instruments to manage interest rate 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 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Hedging Activities" for additional discussion on our derivatives and hedging activities, including the net impact of economic hedge relationships.

In 2016, we recorded net gains on trading securities of $3 million compared to net losses of $12 million in 2015. These changes in fair value were primarily due to the impact of changes in interest rates and credit spreads on our fixed rate trading securities. Trading securities are recorded at fair value with changes in fair value reflected through other income (loss).

    

27


Other expense totaled $118 million for 2016 compared to $137 million for 2015. The decrease was primarily due to one-time merger related expenses of $39 million incurred during 2015. The decrease in other expenses was partially offset by an increase in compensation and benefits, professional fees, and other operating expenses during 2016 when compared to 2015 due primarily to additional costs associated with operating a larger institution and improving our internal control environment.

Our total assets increased to $180.6 billion at December 31, 2016 from $137.4 billion at December 31, 2015 due primarily to an increase in advances. Advances increased $42.4 billion, driven primarily by growth from a large depository institution member.

Our total liabilities increased to $173.2 billion at December 31, 2016 from $131.8 billion at December 31, 2015 due primarily to an increase in consolidated obligations issued to fund the increase in assets.

Total capital increased to $7.4 billion at December 31, 2016 from $5.6 billion at December 31, 2015. Total capital was primarily impacted by an increase in retained earnings and an increase in capital stock. Retained earnings increased to $1.5 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 company members, to mandatorily redeemable capital stock. The capital stock reclassification was in response to the Finance Agency final rule affecting captive insurance company membership that became effective on February 19, 2016. Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Statements of Condition — Advances" for additional discussion on the Finance Agency final rule.

Total regulatory capital increased to $8.1 billion at December 31, 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.

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, it 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 2016 when compared to 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.


28


The following table summarizes the reconciliation between GAAP and adjusted net interest income (dollars in millions):
 
 
For the Years Ended December 31,
 
 
2016
 
2015
 
2014
GAAP net interest income before provision (reversal) for credit losses on mortgage loans
 
$
449

 
$
317

 
$
251

Exclude:
 
 
 
 
 
 
Prepayment fees on advances, net1
 
8

 
11

 
6

Advance premium amortization
 
(1
)
 
(10
)
 

Prepayment fees on investments, net2
 
2

 
3

 

Mandatorily redeemable capital stock interest expense3
 
(21
)
 

 

Total adjustments
 
(12
)
 
4

 
6

Include items reclassified from other income (loss):
 
 
 
 
 
 
Net interest expense on economic hedges
 
(18
)
 
(21
)
 
(20
)
Adjusted net interest income
 
$
443

 
$
292

 
$
225

Adjusted net interest margin
 
0.27
%
 
0.26
%
 
0.27
%

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 Years Ended December 31,
 
 
2016
 
2015
 
2014
GAAP net income before assessments
 
$
724

 
$
148

 
$
135

Exclude:
 
 
 
 
 
 
Prepayment fees on advances, net1
 
8

 
11

 
6

 Advance premium amortization
 
(1
)
 
(10
)
 

Prepayment fees on investments, net2
 
2

 
3

 

Mandatorily redeemable capital stock interest expense3
 
(21
)
 

 

Net gains (losses) on trading securities
 
3

 
(12
)
 
68

Net gains (losses) from sale of available-for-sale securities
 

 

 
1

Net gains (losses) from sale of held-to-maturity securities
 

 

 
9

Net gains (losses) on derivatives and hedging activities
 
7

 
(38
)
 
(123
)
Net gains (losses) on extinguishment of debt
 

 

 
(13
)
Gains on litigation settlements, net
 
376

 
14

 

Merger related expenses
 

 
(39
)
 
(2
)
Include:
 
 
 
 
 
 
Net interest expense on economic hedges
 
(18
)
 
(21
)
 
(20
)
Adjusted net income before assessments
 
$
332

 
$
198

 
$
169


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.

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


29


CONDITIONS IN THE FINANCIAL MARKETS

Economy and Financial Markets

Economic and market data received prior to the Federal Open Market Committee (FOMC or Committee) meeting in December of 2016 indicated economic activity had been expanding moderately since mid-year. Conditions in the labor market have been solid in recent months and the unemployment rate has declined. Growth in household spending has been rising moderately, however business fixed investments have remained soft. Inflation increased since earlier in the year, but is still below the Committee's longer-run objective of two percent, partly reflecting earlier declines in energy prices and non-energy import prices. Market-based measurements of inflation adjusted compensation have moved up considerably, but still remain low.

In its December 14, 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. The FOMC sees risks to the outlook for the economy and the labor market as nearly balanced in the near-term, but continues to monitor global economic and financial developments. In addition, the FOMC stated it anticipates that inflation will remain near recent low levels in the near term, but it anticipates inflation will rise towards its two percent objective over the medium term as the labor market improves further and the effects of lower energy prices and import prices dissipate. The FOMC will continue to monitor inflation closely.

Mortgage Markets

The housing market has continued to improve over the past year, as indicated by rising home prices, lower inventories of properties for sale, and increased housing construction activity along with increased sales of existing homes. More recently, improvements slowed due to seasonality and increases in interest rates. The improvement in the housing market has been partly attributable to the continued strengthening of the economy.

Market volatility and interest rate increases during the fourth quarter resulted in higher mortgage rates and a decrease in refinancing volume when compared to the first nine months of 2016. The increase in mortgage rates may have a negative impact on the demand for home purchases as the cost of debt has made homes less affordable.

Interest Rates

The following table shows information on key market interest rates1:
 
Fourth Quarter 2016
3-Month
Average
 
Fourth Quarter 2015
3-Month
Average
 
2016
12-Month
Average
 
2015
12-Month
Average
 
2016
Ending Rate
 
2015
Ending Rate
Federal funds
0.45
%
 
0.16
%
 
0.40
%
 
0.13
%
 
0.55
%
 
0.20
%
Three-month LIBOR
0.92

 
0.41

 
0.75

 
0.32

 
1.00

 
0.61

2-year U.S. Treasury
1.00

 
0.82

 
0.83

 
0.67

 
1.19

 
1.05

10-year U.S. Treasury
2.14

 
2.18

 
1.84

 
2.13

 
2.45

 
2.27

30-year residential mortgage note
3.80

 
3.89

 
3.65

 
3.85

 
4.32

 
4.01


1
Source is Bloomberg.


30


The Federal Reserve's key target interest rate, the Federal funds rate, maintained a range of 0.25 to 0.50 percent during most of 2016. In its December 14, 2016 statement, the FOMC decided to raise the target range for the Federal funds rate to 0.50 to 0.75 percent. The Committee's stance on monetary policy remains accommodative even after this increase, supporting further strengthening in labor market conditions and a return to two percent inflation. In determining the timing and size of future adjustments to the target range for the Federal funds rate, the FOMC will assess realized and expected economic 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 for only gradual increases to the target range for the Federal funds rate based on expectations of economic conditions. It is expected the Federal funds rate will remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the Federal funds rate will depend on the economic outlook as informed by incoming data.

During 2016, short-term interest rates increased, while the 10-year U.S. Treasury yields and mortgage rates decreased on average when compared to 2015. Interest rates were volatile as concerns about global growth and political uncertainties impacted markets globally. While the FOMC considers removing monetary policy accommodation as data warrants, foreign central banks eased monetary policy further in 2016.

In its December 14, 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 rolling over maturing U.S. Treasury securities at auction. The FOMC also stated that the policy of keeping the Federal Reserve'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:
 
Fourth Quarter 2016
3-Month
Average
 
Fourth Quarter 2015
3-Month
Average
 
2016
12-Month
Average
 
2015
12-Month
Average
 
 2016
Ending Spread
 
 2015
Ending Spread
3-month
(44.6
)
 
(13.2
)
 
(33.8
)
 
(14.7
)
 
(42.7
)
 
(20.2
)
2-year
(12.4
)
 
0.7

 
(4.7
)
 
(7.8
)
 
(16.5
)
 
(0.2
)
5-year
12.8

 
17.5

 
17.3

 
6.8

 
9.0

 
16.2

10-year
51.6

 
61.4

 
57.2

 
49.1

 
57.7

 
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 2016, our funding spreads relative to LIBOR improved when compared to spreads at December 31, 2015 as investor demand increased with market volatility and higher interest rates, and in response to money market reform. During 2016, we utilized consolidated obligation discount notes in addition to fixed term and floating rate, callable, and step-up consolidated obligation bonds to capture attractive funding, to match the repricing structures on advances and meet liquidity requirements. Spreads relative to LIBOR experienced minor changes on long-term debt year-over-year.


31


RESULTS OF OPERATIONS

Net Income

The following table presents comparative highlights of our net income for the years ended December 31, 2016, 2015, and 2014 (dollars in millions). See further discussion of these items in the sections that follow.
 
 
 
 
 
2016 vs. 2015
 
 
 
2015 vs. 2014
 
2016
 
2015
 
$ Change
 
% Change
 
2014
 
$ Change
 
% Change
Net interest income
$
449

 
$
317

 
$
132

 
42
 %
 
$
251

 
$
66

 
26
%
Provision (reversal) for credit losses on mortgage loans
3

 
2

 
1

 
50

 
(2
)
 
4

 
200

Other income (loss)
396

 
(30
)
 
426

 
1,420

 
(51
)
 
21

 
41

Other expense
118

 
137

 
(19
)
 
(14
)
 
67

 
70

 
104

AHP assessments
75

 
15

 
60

 
400

 
14

 
1

 
7

AHP voluntary contributions

 
2

 
(2
)
 
100

 

 
2

 
100

Net income
$
649

 
$
131

 
$
518

 
395
 %
 
$
121

 
$
10

 
8
%

32


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 Years Ended December 31,
 
2016
 
2015
 
2014
 
Average
Balance1
 
Yield
 
Interest
Income/
Expense
 
Average
Balance1
 
Yield
 
Interest
Income/
Expense
 
Average
Balance1
 
Yield
 
Interest
Income/
Expense
Interest-earning assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
852

 
0.37
%
 
$
3

 
$
554

 
0.12
%
 
$
1

 
$
358

 
0.07
%
 
$

Securities purchased under agreements to resell
5,257

 
0.36

 
19

 
6,450

 
0.10

 
7

 
7,640

 
0.05

 
4

Federal funds sold
5,089

 
0.40

 
21

 
4,276

 
0.12

 
5

 
3,160

 
0.08

 
2

Mortgage-backed securities2,3,4
19,772

 
1.15

 
226

 
16,644

 
0.97

 
162

 
9,919

 
1.19

 
118

    Other investments2,3,5
12,031

 
1.21

 
146

 
8,425

 
1.14

 
96

 
2,576

 
2.43

 
63

Advances3,6
114,047

 
0.77

 
876

 
69,784

 
0.46

 
324

 
52,983

 
0.45

 
239

Mortgage loans7
6,729

 
3.46

 
233

 
6,758

 
3.63

 
245

 
6,514

 
3.75

 
245

Loans to other FHLBanks
1

 
0.51

 

 
1

 
0.17

 

 

 

 

Total interest-earning assets
163,778

 
0.93

 
1,524

 
112,892

 
0.74

 
840

 
83,150

 
0.81

 
671

Non-interest-earning assets
544

 

 

 
646

 

 

 
657

 

 

Total assets
$
164,322

 
0.93
%
 
$
1,524

 
$
113,538

 
0.74
%
 
$
840

 
$
83,807

 
0.80
%
 
$
671

Interest-bearing liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
$
970

 
0.08
%
 
$
1

 
$
822

 
0.03
%
 
$

 
$
533

 
0.01
%
 
$

Consolidated obligations
 
 
 
 
 
 
 

 
 

 
 

 
 
 
 
 
 
Discount notes
93,282

 
0.44

 
414

 
70,818

 
0.15

 
106

 
53,136

 
0.08

 
43

Bonds3
61,476

 
1.04

 
639

 
35,962

 
1.15

 
414

 
25,401

 
1.48

 
377

Other interest-bearing liabilities8
636

 
3.32

 
21

 
77

 
3.26

 
3

 
12

 
2.11

 

Total interest-bearing liabilities
156,364

 
0.69

 
1,075

 
107,679

 
0.49

 
523

 
79,082

 
0.53

 
420

Non-interest-bearing liabilities
1,522

 

 

 
1,081

 

 

 
906

 

 

Total liabilities
157,886

 
0.68

 
1,075

 
108,760

 
0.48

 
523

 
79,988

 
0.53

 
420

Capital
6,436

 

 

 
4,778

 

 

 
3,819

 

 

Total liabilities and capital
$
164,322

 
0.65
%
 
$
1,075

 
$
113,538

 
0.46
%
 
$
523

 
$
83,807

 
0.50
%
 
$
420

Net interest income and spread9
 
 
0.24
%
 
$
449

 
 
 
0.25
%
 
$
317

 
 
 
0.28
%
 
$
251

Net interest margin10
 
 
0.28
%
 
 
 
 
 
0.28
%
 
 
 
 
 
0.30
%
 
 
Average interest-earning assets to interest-bearing liabilities
 
 
104.74
%
 
 
 
 
 
104.84
%
 
 
 
 
 
105.14
%
 
 

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 and $3 million for the years ended December 31, 2016. and 2015. There were no MBS prepayments in 2014.

5
Other investments primarily include other U.S. obligations, GSE and Tennessee Valley Authority obligations, state or local housing agency obligations, taxable municipal bonds, and Private Export Funding Corporation (PEFCO) bonds.

6
Advance interest income includes prepayment fee income of $8 million, $11 million, and $6 million for the years ended December 31, 2016, 2015, and 2014.

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

8
Other interest-bearing liabilities consists of mandatorily redeemable capital stock and borrowings from other FHLBanks.

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

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



33


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).
 
2016 vs. 2015
 
2015 vs. 2014
 
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
$

 
$
2

 
$
2

 
$

 
$
1

 
1

Securities purchased under agreements to resell
(2
)
 
14

 
12

 
(1
)
 
4

 
3

Federal funds sold
1

 
15

 
16

 
1

 
2

 
3

Mortgage-backed securities
32

 
32

 
64

 
69

 
(25
)
 
44

Other investments
44

 
6

 
50

 
81

 
(48
)
 
33

Advances
268

 
284

 
552

 
79

 
5

 
84

Mortgage loans
(1
)
 
(11
)
 
(12
)
 
9

 
(8
)
 
1

Total interest income
342

 
342

 
684

 
238

 
(69
)
 
169

Interest expense
 
 
 
 
 
 
 
 
 
 
 
Deposits

 
1

 
1

 

 

 

Consolidated obligations
 
 
 
 
 
 
 
 
 
 
 
Discount notes
43

 
265

 
308

 
17

 
46

 
63

Bonds
268

 
(43
)
 
225

 
133

 
(96
)
 
37

Other interest-bearing liabilities
18

 

 
18

 
3

 

 
3

Total interest expense
329

 
223

 
552

 
153

 
(50
)
 
103

Net interest income
$
13

 
$
119

 
$
132

 
$
85

 
$
(19
)
 
$
66

    
NET INTEREST SPREAD

Net interest spread equals the yield on total interest-earning assets minus the cost of total interest-bearing liabilities. During 2016, our net interest spread was 0.24 percent compared to 0.25 percent and 0.28 percent for the same periods in 2015 and 2014. Our net interest spread during 2016 was primarily impacted by a higher cost on total interest-bearing liabilities and a higher proportion of advances that generate lower yields when compared to the majority of our other interest-earnings 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 2016 when compared to 2015 and during 2015 when compared to 2014 due to the higher short-term interest rate environment and higher average balances. Average advance balances increased in 2016, driven primarily by growth from a large depository institution member. Average advance balances increased in 2015, driven by growth from insurance company members and a large depository institution member. Average advance balances also increased during both 2016 and 2015 when compared to the prior year due to advances acquired as a result of the Merger.

Investments

Interest income on investments increased during 2016 when compared to 2015 and during 2015 when compared to 2014. The increase in 2016 was due primarily to higher average balances of MBS and other investments and the higher short-term interest rate environment. The increase in 2015 when compared to 2014 was due mainly to the higher average balances of MBS and other investments, partially offset by the low interest rate environment. Average investment balances increased during both 2016 and 2015 when compared to the prior year due to the acquisition of certain MBS and non-MBS investments as a result of the Merger. In addition, we purchased MBS in 2016.


34


Mortgage Loans

Interest income on mortgage loans decreased in 2016 when compared to 2015 and remained relatively stable during 2015 when compared to 2014. The decrease during 2016 was due to a decline in mortgage rates which resulted in an increase in mortgage loan refinancing activity.

Discount Notes

Interest expense on discount notes increased during 2016 when compared to 2015 and during 2015 when compared to 2014 due to the higher short-term interest rate environment and higher average balances. Discount notes were utilized to capture attractive funding, match repricing structures on advances, and provide additional liquidity. Average balances also increased during both 2016 and 2015 when compared to the prior year due to the assumption of discount notes as a result of the Merger.

Bonds

Interest expense on bonds increased during 2016 when compared to 2015 and during 2015 when compared to 2014 primarily due to higher average bond balances, offset in part by lower bond rates. The increase in average bond balances was due to our increased utilization of bonds to capture attractive funding, better match repricing structures on short-term and variable rate callable advances, and provide additional liquidity. Average bond balances also increased during both 2016 and 2015 when compared to the prior year due to bonds assumed as a result of the Merger.

Other Interest-Bearing Liabilities

Interest expense on other interest-bearing liabilities increased during 2016 when compared to 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 Years Ended December 31,
 
2016
 
2015
 
2014
Net gains (losses) on trading securities
$
3

 
$
(12
)
 
$
68

Net gains (losses) from sale of available-for-sale securities

 

 
1

Net gains (losses) from sale of held-to-maturity securities

 

 
9

Net gains (losses) on derivatives and hedging activities
7

 
(38
)
 
(123
)
Net gains (losses) on extinguishment of debt

 

 
(13
)
Gains on litigation settlements, net
376

 
14

 

Other, net
10

 
6

 
7

Total other income (loss)
$
396

 
$
(30
)
 
$
(51
)
    
Other income (loss) can be volatile from period to period depending on the type of activity recorded. We recorded a net gain of $396 million in 2016 in other income (loss) compared to a net loss of $30 million in 2015 and a net loss of $51 million in 2014. During 2016, other income (loss) was primarily impacted by net gains on litigation settlements of $376 million as a result of settlements with certain defendants in our private-label MBS litigation. We also had net gains on litigation settlements of $14 million during 2015. 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.


35


During 2016, we recorded net gains of $7 million on our derivatives and hedging activities compared to net losses of $38 million in 2015. The net gains were primarily driven by changes in interest rates. These changes impacted ineffectiveness on our AFS fair value hedge relationships and fair value changes on interest rate swaps that we utilized to economically hedge our investment securities portfolio. During 2014, we recorded losses of $123 million on our derivative and hedging activities primarily due to the changes in interest rates on interest rate swaps that we utilized to economically hedge our investment securities portfolio and a divergence between the curves used to value our assets, liabilities, and derivatives. Due to this divergence and an increase in the volume of AFS investment hedge relationships that had longer terms to maturity, we experienced additional hedge ineffectiveness.

During 2016, we recorded net gains on trading securities of $3 million compared to net losses of $12 million in 2015 and net gains of $68 million in 2014. These changes in fair value were primarily due to the impact of changes in interest rates and credit spreads on our fixed rate trading securities. During 2015, credit spreads widened and, as a result, we incurred losses on both our trading securities and on the interest rate swaps hedging these securities. Trading securities are recorded at fair value with changes in fair value reflected through other income (loss).

During 2014, other income (loss) also included losses on the extinguishment of debt of $13 million and realized gains on the sale of AFS and HTM securities of $10 million. We did not sell any AFS or HTM securities or extinguish any debts during 2016 or 2015.

Hedging Activities

We use derivatives to manage interest rate 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).


36


The following tables categorize the net effect of hedging activities on net income by product (dollars in millions):
 
 
For the Year Ended December 31, 2016
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
21

 
$
3

 
$
(2
)
 
$
1

 
$
23

Net interest settlements
 
(173
)
 
(149
)
 

 
87

 
(235
)
Total impact to net interest income
 
(152
)
 
(146
)
 
(2
)
 
88

 
(212
)
Other income (loss):
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 
5

 
19

 

 
(11
)
 
13

Gains (losses) on economic hedges
 

 
(6
)
 

 

 
(6
)
Total net gains (losses) on derivatives and hedging activities
 
5

 
13

 

 
(11
)
 
7

Net gains (losses) on trading securities2
 

 
(1
)
 

 

 
(1
)
Total impact to other income (loss)
 
5

 
12

 

 
(11
)
 
6

Total net effect of hedging activities3
 
$
(147
)
 
$
(134
)
 
$
(2
)
 
$
77

 
$
(206
)

 
 
For the Year Ended December 31, 2015
Net Effect of
Hedging Activities
 
Advances
 
Investments
 
Mortgage
Loans
 
Bonds
 
Discount Notes
 
Total
Net interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Net amortization/accretion1
 
$
7

 
$
2

 
$
(2
)
 
$
5

 
$

 
$
12

Net interest settlements
 
(203
)
 
(158
)
 

 
117

 

 
(244
)
Total impact to net interest income
 
(196
)
 
(156
)
 
(2
)
 
122

 

 
(232
)
Other income (loss):
 
 
 
 
 
 
 
 
 
 
 
 
Net gains (losses) on derivatives and hedging activities:
 
 
 
 
 
 
 
 
 
 
 
 
Gains (losses) on fair value hedges
 

 
(10
)
 

 
3

 

 
(7
)
Gains (losses) on economic hedges
 

 
(32
)
 
(1
)
 
1

 
1

 
(31
)
Total net gains (losses) on derivatives and hedging activities
 

 
(42
)
 
(1
)
 
4