10-K 1 l35085ae10vk.htm 10-K 10-K
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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, 2008
or
[  ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from                      to                     .
Commission File No. 000-51399
FEDERAL HOME LOAN BANK OF CINCINNATI
(Exact name of registrant as specified in its charter)
     
Federally chartered corporation
  31-6000228
 
(State or other jurisdiction of
  (I.R.S. Employer
incorporation or organization)
  Identification No.)
 
   
1000 Atrium Two, P.O. Box 598, Cincinnati, Ohio
 
(Address of principal executive offices)
  45201-0598
 
(Zip Code)
Registrant’s telephone number, including area code (513) 852-7500
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 per share
(Title of class)
     
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
  [  ] Yes  [X] No
     
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d).
 
  [  ] 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  [  ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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 to 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 [  ]
      Accelerated filer [  ]
Non-accelerated filer [X] (Do not check if a smaller reporting company)
    Smaller reporting company [  ]
     
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
 
  [  ] Yes  [X] No
As of February 28, 2009, the registrant had 39,808,929 shares of capital stock outstanding. The capital stock of the Federal Home Loan Bank of Cincinnati is not listed on any securities exchange or quoted on any automated quotation system, only may be owned by members and former members and is transferable only at its par value of $100 per share.
Documents Incorporated by Reference: None
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Table of Contents
             
 
  PART I        
  Business     3  
  Risk Factors     20  
  Unresolved Staff Comments     25  
  Properties     25  
  Legal Proceedings     25  
  Submission of Matters to a Vote of Security Holders     25  
             
 
  PART II        
Item 5.  
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    27  
  Selected Financial Data     28  
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
    29  
  Quantitative and Qualitative Disclosures About Market Risk     100  
  Financial Statements and Supplemental Data     102  
 
 
Financial Statements for the Years Ended 2008, 2007 and 2006
       
 
 
Notes to Financial Statements
    108  
 
 
Supplemental Financial Data
    157  
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
    157  
  Controls and Procedures     157  
  Other Information     158  
             
 
  PART III        
  Directors, Executive Officers and Corporate Governance     158  
  Executive Compensation     162  
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    178  
  Certain Relationships and Related Transactions, and Director Independence     179  
  Principal Accountant Fees and Services     180  
             
 
  PART IV        
  Exhibits, Financial Statement Schedules     181  
        182  
 EX-3.2
 EX-4
 EX-10.5
 EX-10.6
 EX-12
 EX-24
 EX-31.1
 EX-31.2
 EX-32
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PART I
Item 1.   Business.
COMPANY INFORMATION
Organizational Structure
The Federal Home Loan Bank of Cincinnati (FHLBank) is a regional wholesale bank that provides financial products and services to our member financial institutions. We are one of 12 District Banks in the Federal Home Loan Bank System (FHLBank System); our region, known as the Fifth District, comprises Kentucky, Ohio and Tennessee. The U.S. Congress created the FHLBank System in the Federal Home Loan Bank Act of 1932 (the FHLBank Act) to improve liquidity in the U.S. housing market. Each District Bank is a government-sponsored enterprise (GSE) of the United States of America and operates as a separate entity with its own stockholders, employees, and Board of Directors. A GSE combines private sector ownership with public sector sponsorship. The FHLBanks are not government agencies and are exempt from federal, state, and local taxation (except real property taxes). The U.S. government does not guarantee, directly or indirectly, the debt securities or other obligations of the FHLBank System.
The FHLBank System also includes the Federal Housing Finance Agency (Finance Agency) and the Office of Finance. The Finance Agency is an independent agency in the executive branch of the U.S. government. The Housing and Economic Recovery Act of 2008 (HERA) placed the FHLBanks, as well as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), under the regulatory authority of the Finance Agency effective July 30, 2008. Prior to July 30, 2008, the FHLBanks had been regulated by the Federal Housing Finance Board. In this filing, we collectively refer to both regulators as the “Finance Agency” and we refer to prior actions of the predecessor regulator as actions of the Finance Agency.
The Office of Finance is a joint office of the District Banks established by the Finance Agency to facilitate the issuing and servicing of the FHLBank System’s debt securities (called Consolidated Obligations or Obligations).
In addition to being a GSE, the FHLBank is a cooperative institution. Our stockholders are also our primary customers. Private-sector financial institutions voluntarily become members of our FHLBank and purchase our capital stock in order to gain access to our products and services. Only our members can purchase capital stock. All Fifth District federally insured depository institutions and insurance companies that engage in residential housing finance and that meet standard eligibility requirements are permitted to apply for membership. By law, an institution is permitted to be a member of only one Federal Home Loan Bank, although a holding company through its subsidiaries may have memberships in more than one District Bank.
We require each member to purchase our capital stock as a condition of membership and, under certain circumstances, we require a member to purchase stock above the membership stock amount when utilizing our products or services. We issue, redeem, repurchase, and exchange capital stock only at its stated par value of $100 per share. By law, our stock is not publicly traded. Our Capital Plan enables us to efficiently expand and contract capital needed to capitalize our assets in response to changes in our membership base and their credit needs.
The combination of public sponsorship and private ownership that drives our business model is reflected in the composition of our 17-member Board of Directors. Under HERA, all of our directors are elected by our members. Ten directors are executives and/or directors of our member institutions, while the remaining directors are independent directors who represent the public interest.
The number and composition of members have been relatively stable in the last 10 years, between 720 and 760, with the number of new members generally offset by a similar number of exiting members due to mergers and acquisitions. At the end of 2008, we had 728 members.
As of December 31, 2008, we had 189 full-time employees and 6 part-time employees. Our employees are not represented by a collective bargaining unit.

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In this filing, the interrelated and severe disruptions in 2008’s financial, credit, housing, capital, and mortgage markets, which have continued in 2009, are referred to generally as the “financial crisis.”
Mission and Corporate Objectives
Our FHLBank’s mission is to provide financial intermediation between our member stockholders and the capital markets in order to facilitate and expand the availability of financing and flow of credit for housing and community lending throughout the Fifth District. We achieve our mission through a cooperative business model. We raise private-sector capital from our member stockholders and issue high-quality debt in the capital markets with other FHLBanks to provide members with competitive services—primarily a reliable, readily available, low-cost source of funds called Advances—and a competitive return on their FHLBank capital investment through quarterly dividend payments. An important component of our mission related to our public sector sponsorship is providing affordable housing programs and activities to support members in their efforts to assist lower-income housing markets.
Our corporate objectives are to:
  §   operate safely and soundly, remain able to raise funds in the capital markets, and optimize our counterparty and deposit ratings;
 
  §   expand business activity with members;
 
  §   earn and pay a stable long-term competitive return on members’ capital stock;
 
  §   maximize effectiveness of contributions to Housing and Community Investment programs; and
 
  §   maintain effective corporate governance processes.
We manage these objectives collectively. Because an overarching requirement is to ensure our company’s safety and soundness at all times, we strive to maintain modest exposure to business, market, credit, and operational risks and to operate with ample liquidity and capitalization. We believe our business is financially sound, conservatively managed, and well capitalized on a risk-adjusted basis.
Our company’s cooperative ownership structure and the constant par value of stockholders’ capital investment mean that member stockholders derive value from two sources:
  §   the competitive prices, terms, and characteristics of our products; and
 
  §   a competitive dividend return on their capital investment.
In order to maximize the two combined sources of membership value, we must strike a balance between offering more attractively priced products, which tend to decrease our dividends, and increasing dividends, which tends to result from higher priced products. We believe members’ investment in our capital stock is comparable to investing in high-grade short-term, or adjustable-rate, money market instruments or in adjustable-rate preferred equity instruments. We structure our risk exposure so that earnings tend to move in the same direction as changes in short-term market rates. Having relatively stable earnings measured against short-term market rates furnishes member stockholders a degree of predictability on their future dividend returns. There is normally a tradeoff between the level and stability of our stock returns, both in the near term and long term. One measure of our successful resolution of this tradeoff is that few member stockholders have historically chosen, absent mergers and consolidations, to withdraw from membership or to request redemption of their stock held in excess of minimum requirements.
Business Activities
Our principal activity is making readily available, competitively priced and fully collateralized Advances to our members. Together with the issuance of collateralized Letters of Credit, Advances constitute our “Credit Services” business. As a secondary business line, we purchase qualifying residential mortgages through the Mortgage Purchase Program and hold them as portfolio investments. This program offers members a competitive alternative to the traditional secondary mortgage market. Together, these product offerings constitute our “Mission Asset Activity.”

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In addition, through various Housing and Community Investment programs, we assist members in serving very-low-, low-, and moderate-income housing markets and community economic development. These programs provide Advances at below-market rates of interest, direct grants and subsidies, and can help members satisfy their regulatory requirements under the Community Reinvestment Act. In contrast to our Mission Asset Activity, these programs normally generate no profits.
To a more limited extent, we also offer members various correspondent services that assist them in their administration of operations.
To help us achieve our mission, we are permitted to invest in highly rated debt securities of financial institutions and the U.S. government and in mortgage-related securities. In practice, we invest in money market investments and mortgage-backed securities. These investments furnish additional liquidity, help us manage market risk exposure, enhance earnings, and (through the purchase of mortgage-related securities) support the housing market.
Our primary source of funding and liquidity is through participating in the issuance of the FHLBank System’s unsecured debt securities—Consolidated Obligations—in the capital markets. Obligations are the joint and several obligations of all 12 District Banks, backed only by the financial resources of the 12 FHLBanks. A secondary source of funding is our capital. A critical component to the success of our operations is the ability to issue debt securities regularly and frequently in the capital markets under a wide range of maturities, structures, and amounts, and at relatively favorable spreads to benchmark market interest rates, represented by U.S. Treasury securities and the London InterBank Offered Rate (LIBOR), compared to many other financial institutions. We also execute cost-effective derivative transactions to help hedge market risk exposure. These abilities enable us to offer members a wide range of Mission Asset Activity and enable our members to access the capital markets, through their activities with the FHLBank, in ways that they may be unable to do without our services.
The System’s comparative advantage in funding is due largely to its GSE status, which is reflected in its excellent credit ratings from nationally recognized statistical rating organizations (NRSROs). Moody’s Investors Service (Moody’s) and Standard & Poor’s currently assign, and historically have assigned, the System’s Obligations the highest ratings available: long-term debt is rated Aaa by Moody’s and AAA by Standard & Poor’s; and short-term debt is rated P-1 by Moody’s and A-1+ by Standard & Poor’s. These two rating agencies also assign the highest counterparty and deposit ratings available (triple-A) to our FHLBank. These ratings indicate that the FHLBanks have an extremely strong capacity to meet their commitments to pay timely principal and interest on their debt and that the debt is considered to be of the highest quality with minimal credit risk. Maintaining these ratings is vital to fulfilling our mission. No FHLBank has ever defaulted on repayment of, or delayed return of principal or interest on, any Obligation.
The agencies’ rationales for the System’s and our ratings historically have included:
  §   the FHLBank System’s status as a GSE;
 
  §   the joint and several liability for Obligations;
 
  §   excellent asset quality;
 
  §   strong liquidity;
 
  §   conservative use of derivatives;
 
  §   adequate capitalization relative to our risk profile; and
 
  §   a permanent capital structure.
A security rating is not a recommendation to buy, sell or hold securities. A rating organization may revise or withdraw its ratings at any time, and each rating should be evaluated independently of any other rating. We cannot predict what future actions, if any, a rating organization may take regarding the System’s and our ratings.

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Sources of Earnings
Our major source of revenue is interest income earned on Advances, Mortgage Purchase Program notes, and investments. Our major items of expense are:
  §   interest expense paid on Consolidated Obligations and deposits;
 
  §   the requirement to pay 20 percent of annual net earnings to the Resolution Funding Corporation (REFCORP) fund;
 
  §   costs of providing below-market-cost Advances and direct grants and subsidies under the Affordable Housing Program; and
 
  §   non-interest expenses (i.e., other expenses on the Statements of Income).
The largest component of earnings is net interest income, which equals interest income minus interest expense. We derive net interest income from three elements, each of which can vary over time with changes in market conditions, including most importantly interest rates, business conditions and our risk management activities:
  §   interest rate spread, being the difference between the interest we earn on assets and the interest we pay on liabilities;
 
  §   funding a portion of our interest-earning assets with our capital on which we do not pay interest; and
 
  §   leverage of capital with interest-earning assets.
Regulatory Oversight
Our regulator, the Finance Agency, is headed by a director (the Director) who has sole authority to promulgate Agency regulations and to make other Agency decisions. The Finance Agency is charged with ensuring that each FHLBank:
  §   carries out its housing and community development finance mission;
 
  §   remains adequately capitalized;
 
  §   operates in a safe and sound manner; and
 
  §   complies with Finance Agency Regulations.
To carry out these responsibilities, the Finance Agency conducts on-site examinations at least annually of each FHLBank, as well as periodic on- and off-site reviews. Regulations prohibit the public disclosure of examination results. Each FHLBank must submit monthly information to the Agency on its financial condition and operating results. The financial statements of the FHLBank are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Penalties for non-compliance with Finance Agency Regulations are at the discretion of the Agency. While each FHLBank has substantial discretion in governance and operational structure, the Finance Agency maintains broad supervisory and regulatory authority over the FHLBanks. In addition, the Comptroller General has authority to audit or examine the Finance Agency and the FHLBanks, to decide the extent to which the FHLBanks fairly and effectively fulfill the purposes of the FHLBank Act, and to review any audit, or conduct its own audit, of the financial statements of an FHLBank.
BUSINESS SEGMENTS
We manage the development, resource allocation, product delivery, pricing, credit risk management, and operational administration of our Mission Asset Activity in two business segments: Traditional Member Finance and the Mortgage Purchase Program. Traditional Member Finance includes Credit Services, Housing and Community Investment, Investments, some correspondent and deposit services, and other financial products of the FHLBank. See the “Segment Information” section of “Results of Operations” in Item 7 and Note 17 of the Notes to Financial Statements for more information on our business segments including their results of operations.

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Traditional Member Finance
Credit Services
Features. Advances provide members competitively priced sources of funding and can help them manage their asset/liability and liquidity needs. They can both complement and be alternatives to, retail deposits, other wholesale funding sources, and corporate debt issuance. We strive to facilitate efficient, fast, and continual access to funds for our members, which we believe is a major benefit of Advances. Because of our normally ample liquidity and because a member must have in place approved applications and processes—including adequate collateral—before it can borrow from us, in most cases members can access funds on a same-day basis.
Each member must supply us with a security interest in eligible collateral with total estimated market value of more than 100 percent of its Advances outstanding. Collateral is composed primarily of high quality loans—primarily one- to four-family residential mortgages—in accordance with our regulations and procedures. We believe that the combination of our conservative collateral policies and risk-based credit underwriting activities effectively mitigates credit risk associated with Advances. We have never experienced a credit loss on Advances, nor have we ever determined it necessary to establish a loss reserve.
Letters of Credit are collateralized contractual commitments we issue on our members’ behalves to guarantee their performance to third parties. A Letter of Credit obligates us, if required under the terms of the contract, to make direct payments to a third party. In this case, it is treated as an Advance to the member. The most popular use of Letters of Credit is as collateral supporting public unit deposits. Public unit deposits are deposits held by governmental units at financial institutions. Our Letters of Credit have a triple-A rating because of our triple-A long-term credit ratings. We earn fees on Letters of Credit based on the actual notional amount of the Letters utilized.
We price 13 standard Advance programs every business day and several other standard programs on demand. We also offer customized, non-standard Advances that fall under one of the standard programs. Having diverse programs gives members the flexibility to choose and customize their borrowings according to the features listed below (among others).
  §   size: from $1 to a maximum amount limited by a member’s collateral requirements and borrowing capacity, by our capital leverage requirements, and by our available liquidity;
 
  §   final maturity: from overnight to 30 years;
 
  §   interest rate: fixed-rate or adjustable-rate coupons;
 
  §   coupon payment frequency;
 
  §   interest rate index on adjustable-rate coupons;
 
  §   rate reset for adjustable-rate Advances: monthly, quarterly, or other;
 
  §   prepayment ability: no, partial, or full prepayment options, some of which involve a fee;
 
  §   principal paydown: with no, partial, or full amortization of principal; and
 
  §   interest rate options, or other options, embedded in Advances.
Advance Programs. Our primary current Advance programs are Repurchase Based Advances (REPO Advances), LIBOR Advances, Regular Fixed-Rate Advances, Putable Advances, and Mortgage-Related Advances. Besides these, we offer several other smaller Advance programs. There are generally no minimum size requirements for Advances except for REPO Advances, which have a minimum size of $15 million.
REPO Advances are structured like repurchase agreements from investment banks, with one principal difference. Members collateralize their REPO Advances through our normal collateralization process, instead of being required to pledge specific securities as they do in a repurchase agreement. REPO Advances have fixed rates of interest and short-term maturities from one day up to one year, with principal and interest paid at maturity. A majority of REPO Advances outstanding tend to have overnight maturities.

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LIBOR Advances have adjustable interest rates typically priced off 1- or 3-month LIBOR indices. Generally, any prepayment is permitted without a fee if it is made on a repricing date.
Regular fixed-rate Advances have terms of three months to 30 years, with interest normally paid monthly and principal repayment normally at maturity. They have no call or put options.
Putable Advances are fixed or adjustable-rate Advances that provide us an option to terminate the Advance, usually after an initial “lockout” period. Selling us these options enables members to secure lower rates on Putable Advances compared to Regular Fixed-Rate Advances with the same final maturity. Similar to Putable Advances are Convertible Advances. Although we stopped offering new Convertible Advances at the beginning of 2006, we still have a substantial amount outstanding. The difference between a Convertible Advance and a Putable Advance is that the former provides us an option to convert the Advance to a LIBOR Advance, while the latter provides us an option to terminate the Advance. The Putable and Convertible Advance programs allow members to choose, at the Advance’s trade date, the frequency of the dates on which we may terminate the Advance.
Mortgage-Related Advances are fixed rate, amortizing Advances with final maturities of 5 to 30 years. Members structure amortization and prepayment schedules that may be similar to those of residential mortgage loans. We offer two basic prepayment structures for which we do not charge prepayment fees. The first structure is an annual constant prepayment rate, which establishes a fixed and required principal paydown schedule. The second structure permits the member, at its option, to repay principal, once annually, above the scheduled amortization based on actual annualized prepayment speeds experienced on specified 15-year or 30-year current-coupon mortgage-backed securities from Fannie Mae and Freddie Mac. The reference securities are established on the Advance’s trade date. For each structure, members can prepay additional principal subject to our standard applicable prepayment fees.
Advance Prepayment Fees. For many Advance programs, Finance Agency Regulations require us to charge members prepayment fees for early termination of principal when the early termination results in an economic loss to us. We do not charge prepayment fees for certain short-term Advance programs or under the prepayment structures described above for Mortgage-Related Advances. Certain Advance programs are structured as non-prepayable, such as REPO Advances.
We determine prepayment fees using standard present-value calculations that make us economically indifferent to the prepayment. The prepayment fee equals the present value of the estimated profit that we would have earned over the remaining life of the prepaid Advance. If a member prepays principal on an Advance that we have hedged with an interest rate swap, we may also assess the member a fee to compensate us for the cost we may incur for terminating the swap before its stated final maturity.
Housing and Community Investment
Our Housing and Community Investment Programs include the Affordable Housing Program and various housing and community economic development-related Advance programs. We fund the Affordable Housing Program with an accrual equal to 10 percent of our previous year’s regulatory income. See Note 13 of the Notes to Financial Statements for a complete description of the Affordable Housing calculation. This assessment is mandated by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). The actual disbursement of monies related to these programs has no impact on earnings over and above the initial recording of the expense.
The Affordable Housing Program consists of the Competitive Program and a homeownership set-aside program called the Welcome Home Program. Under the Competitive Program, we distribute funds in the form of either grants or below-market rate Advances to members that apply and successfully compete in semiannual offerings. Under the Welcome Home Program, funds are available beginning in March until they have been committed. Members use Welcome Home to assist very low-, low-, and moderate-income families with the down payment and closing costs associated with home purchases. Under both programs, the income of qualifying individuals or households must be 80 percent or less of the area median income. For 2009, up to 35 percent of the Affordable Housing accrual will be set aside for the Welcome Home Program and the remainder allocated to the Competitive Program.
Two other housing programs that fall outside the auspices of the Affordable Housing Program are the Community Investment Program and the smaller Economic Development Advance Program. Advances under the former program have rates equal to our cost of funds, while Advances under the latter program have rates equal to our cost of funds

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plus three basis points. Members use the Community Investment Program primarily to fund housing and, under certain conditions, community economic development projects, while they use Economic Development Advances exclusively for economic development projects.
Finally, over the last several years, the Board has allocated funds to the American Dream Homeownership Challenge program. These voluntary contributions are over and above any regulatory mandated programs. This grant program was established in 2003 to provide funds through our members to increase homeownership by minorities and those with special needs. It was expanded in 2007 to include assistance to families displaced by natural disasters. The Board reviews this program annually to determine the amount to fund, if any.
Investments
We invest in short-term unsecured money market instruments and longer-term unsecured mortgage-related securities. There are five ways the investment portfolio helps us achieve our corporate objectives:
  §   Liquidity management. Investments, especially money market investments, help us manage liquidity. We can structure our short-term debt issuance such that money market investments mature sooner than this debt, providing a source of contingent liquidity when Advance demand spikes or in periods of market stresses when it may not be advantageous or possible to participate in new debt issuance. We also may be able to transform investments to cash without a significant loss of value. Money market investments also support our ability to issue most Advances on the same day members request them.
 
  §   Earnings enhancement. The investments portfolio assists with earning a competitive capital return, which enhances the value of membership, members’ preferences to hold excess capital stock to support Mission Asset Activity, and our commitment to Housing and Community Investment.
 
  §   Market risk management. Short-term money market investments help stabilize earnings because they typically earn a “locked in” match-funded spread with little market risk.
 
  §   Debt issuance management. Maintaining a money market investment portfolio can help us participate in attractively priced debt, on an opportunistic basis. We can temporarily invest proceeds from debt issuances in short-term liquid assets and quickly access them to fund demand for Mission Asset Activity, rather than having debt issuances dictated solely by the timing of member demand.
 
  §   Support of housing market. Investment in mortgage-backed securities and state housing finance agency bonds directly supports the residential mortgage market by providing capital and financing for, and management of, the liquidity, interest rate and options risks inherent in mortgages.
We strive to ensure our investment purchases have a moderate degree of market risk and credit risk, which tends to limit the returns we expect on these securities. We believe that a philosophy of purchasing investments with a high degree of market or credit risk would be inconsistent with our public sponsorship and GSE status. Finance Agency Regulations and our Financial Management Policy specify general guidelines for, and relatively tight constraints on, the types, amounts, and risk profile of investments we are permitted to hold and the maximum amount of credit risk exposure we are permitted to face with eligible counterparties. We are permitted to invest only in the securities of counterparties with high credit ratings, and because of our prudent investment policies and practices, we believe all of our investments have high credit quality.
For short-term money market instruments, we are permitted to purchase overnight and term Federal funds, certificates of deposit, bank notes, bankers’ acceptances, and commercial paper. We may also place deposits at the Federal Reserve Bank. For longer-term investments, we are permitted to purchase:
  §   debt securities issued by the U.S. government or its agencies;
 
  §   mortgage-backed securities and collateralized mortgage obligations supported by mortgage securities (together, mortgage-backed securities) and issued by government-sponsored enterprises or private issuers;
 
  §   asset-backed securities collateralized by manufactured housing loans or home equity loans and issued by government-sponsored enterprises or private issuers; and

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  §   marketable direct obligations of certain government units or agencies (such as state housing finance agencies) that supply needed funding for housing or community lending and that do not exceed 25 percent of our regulatory capital.
Each security in the last three categories must, on its purchase date, be rated triple-A by Moody’s and Standard & Poor’s. We are not permitted to purchase most common stocks, instruments issued by non-U.S. entities, debt instruments that are non-investment grade on their trade dates, and interest-only and principal-only stripped securities, among other securities.
We have never purchased any asset-backed security, have not purchased any adjustable-rate mortgage-backed security in the last ten years, and historically have limited our purchases of private-issued mortgage-backed securities to a small percentage of our total investments. We believe these types of securities historically have tended to provide a less favorable risk/return tradeoff, including credit risk, than fixed-rate and GSE mortgage-backed securities.
Our total investment in mortgage-backed securities and asset-backed securities normally may not exceed, on a book value basis, 300 percent of our previous month-end regulatory capital on the day we purchase the securities. (See the “Capital Resources” section below for the definition of regulatory capital.) In March 2008, in order to help relieve the liquidity pressures in the housing finance markets, the Finance Agency authorized the FHLBanks to temporarily increase their holdings of certain GSE mortgage-backed securities up to a limit of 600 percent of regulatory capital. The expanded leverage is permitted until March 31, 2010, at which time it must return to the prior limit as principal paydowns occur. On May 30, 2008, the Finance Agency approved our request to expand this leverage to 450 percent of regulatory capital. Subsequently, in July we began to move the multiple slightly above 300 percent. However, we did not purchase any mortgage-backed securities in August through December 2008 because of the worsening conditions in the mortgage and agency debt markets. This lack of purchase activity, coupled with principal paydowns, resulted in mortgage-backed securities equaling 287 percent of regulatory capital at year end. Because of the continuing financial market disruptions, we do not know if we will again increase this leverage above 300 percent pursuant to the expanded leverage authority, and if we do, by how much or how soon.
Deposits
We provide a variety of deposit programs, including demand, overnight, term and Federal funds, which enable depositors to invest idle funds in short-term liquid assets. We accept deposits from members, other FHLBanks, any institution to which we offer correspondent services, and other government instrumentalities. The rates of interest we pay on deposits are subject to change daily based on comparable money market interest rates. The balances in deposit programs tend to vary positively with the amount of idle funds members have available to invest as well as the level of short-term interest rates. Deposits have represented a small component of our funding in recent years, typically between one and two percent of our funding sources.
Mortgage Purchase Program (Mortgage Loans Held for Portfolio)
Features and Benefits of the Mortgage Purchase Program
Finance Agency Regulations permit the FHLBanks to purchase and hold specified mortgage loans from their members. Our FHLBank offers the Mortgage Purchase Program, with two products: qualifying conforming fixed-rate conventional 1-4 family residential loans and residential mortgages fully guaranteed by the Federal Housing Administration (FHA). We refer to members approved to sell us loans as Participating Financial Institutions (PFIs). We are permitted to purchase qualifying mortgage loans originated within any state or territory of the United States, although we currently do not purchase loans originated in New York, Massachusetts, Maine, Rhode Island or New Jersey due to features of those states’ Anti-Predatory Lending laws that are less restrictive than we prefer. We do not use any trust or intermediary to purchase mortgage loans from members.
A “conforming” mortgage refers to the maximum amount permissible to be lent as a regular prime (i.e., non-jumbo, non-subprime) mortgage. For 2009, the Finance Agency established that limit as $417,000, the same as for 2007-2008, for most of the United States, with loans originated in a limited number of high-cost cities and counties receiving higher conforming limits. A “conventional” mortgage refers to a non-government-guaranteed mortgage.
We hold purchased mortgage loans on our balance sheet and account for them as Mortgage Loans Held for Portfolio. Finance Agency Regulations do not currently authorize us to sell these loans, either directly or by securitization. If we

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wanted to do so, we would need to obtain Finance Agency approval as a new business activity. Although we have considered the feasibility and economic benefits of selling Program loans to help manage market risk, we currently have no plans to request the authority to do so.
The Mortgage Purchase Program directly supports our public policy mission of supporting housing finance. By selling mortgage loans to us, members can increase their balance sheet liquidity and reduce their interest rate and mortgage prepayment risk. Our Program, along with similar programs at other FHLBanks, promotes a greater degree of competition among mortgage investors. It also enables small- and medium-sized community-based financial institutions to use their existing relationship with us to participate more effectively in the secondary mortgage market. Finally, the Program enhances our long-term profitability on a risk-adjusted basis, which augments the return on member stockholders’ capital investment.
Loan Purchase Process
We negotiate a Master Commitment Contract with each PFI, in which the PFI agrees to make a best effort attempt to sell us a specific dollar amount of loans over a nine-month period. We purchase loans pursuant to a Mandatory Delivery Contract, which is a legal commitment we make to purchase, and a PFI makes to deliver, a specified dollar amount of mortgage loans, with a forward settlement date, at a specified range of mortgage note rates and prices. Shortly before delivering the loans that will fill the Mandatory Delivery Contract, the PFI must submit loan level detail to us including underwriting information. We apply procedures designed to screen out loans that do not comply with our policies. If the loan information satisfies the Master Commitment Contract, the Mandatory Delivery Contract and our underwriting guidelines, we will purchase the loans on the settlement date by placing funds into the PFI’s demand deposit account at our FHLBank.
Sharing of Activities and Risks Between Members and the FHLBank
Because of the FHA guarantee, we bear no credit risk on FHA loans.
A unique feature of conventional loans in the Mortgage Purchase Program is that it separates the various activities and risks associated with residential mortgage lending. We manage interest rate risk (including prepayment risk), liquidity risk, and financing of the loans. PFIs manage marketing, originating and, in most cases, servicing. PFIs may either retain servicing or sell it to a qualified and approved third-party servicer (also referred to as a PFI). PFIs do not pay us a guarantee fee to transfer credit risk on conventional loans, because they retain most of the responsibility for managing and bearing that risk. The Program has a feature for conventional loans, called the Lender Risk Account, which is a purchase-price holdback, under which PFIs are eligible to receive payments from us for managing credit risk. The Lender Risk Account helps protect us against credit risk because actual loan losses are deducted against the amount we ultimately pay the PFI.
Our primary mitigation of credit risk exposure for conventional loans involves the collateral supporting the mortgage loan assets (i.e., homeowners’ equity) and several layers of credit enhancements including (in order of priority) primary mortgage insurance (when applicable), the Lender Risk Account, and Supplemental Mortgage Insurance that the PFI purchases from one of our approved third-party providers naming us as the beneficiary.
The totality of these credit enhancements protects us against credit risk exposure on each conventional loan down to approximately a 50 percent “loan-to-value” level (subject, in certain cases, to an aggregate stop-loss feature in the Supplemental Mortgage Insurance policy). Because of these credit enhancements, we believe our exposure to credit risk on conventional loans purchased in the Mortgage Purchase Program is de minimis. We have never experienced credit losses on any of our acquired mortgage loans, nor have our Supplemental Insurance providers.

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Earnings from the Mortgage Purchase Program
We generate earnings in the Program from monthly interest payments minus the cost of funding and the cost of hedging the Program’s interest rate risk. Interest income on each loan is computed as the mortgage note rate multiplied by the loan’s principal balance:
  §   minus servicing costs (which equal 0.25 percent for conventional loans and 0.44 percent for FHA loans and which are retained by the servicer of the loan);
 
  §   minus the cost of Supplemental Mortgage Insurance (required for conventional loans only);
 
  §   adjusted for the amortization of purchase premiums or the accretion of purchase discounts; and
 
  §   adjusted for the amortization or the accretion of fair value adjustments of commitments.
We consider the cost of the Lender Risk Account and Supplemental Mortgage Insurance when we set conventional loan prices and when we evaluate the Program’s expected return. The pricing of each structure depends on a number of factors and is PFI specific. We do not receive fees for retaining the risk of losses in excess of the credit enhancements.
CONSOLIDATED OBLIGATIONS
Features
Our primary source of funding is through participation in the sale of FHLBank System debt securities, called Consolidated Obligations. There are two types of Obligations: Consolidated Bonds (Bonds) and Consolidated Discount Notes (Discount Notes). We participate in the issuance of Bonds for three purposes:
  §   to finance and hedge intermediate- and long-term fixed-rate Advances and mortgage assets;
 
  §   to finance and hedge short-term, LIBOR-indexed adjustable-rate Advances, and swapped Advances, typically by synthetically transforming fixed-rate Bonds to adjustable-rate LIBOR funding through the execution of interest rate swaps; and
 
  §   to acquire liquidity.
Bonds may have fixed or adjustable (i.e., variable) rates of interest. Fixed-rate Bonds are either noncallable or callable. Generally, our adjustable-rate Bonds use LIBOR for interest rate resets. In the last three years, we have not issued step-up Bonds, range Bonds, zero coupon Bonds or other similarly complex instruments.
The maturity of Bonds typically ranges from one year to 20 years, although there is no statutory or regulatory limit. Bonds can be issued and distributed through negotiated or competitively bid transactions with approved underwriters or selling group members. The FHLBanks also have a TAP Program for fixed-rate, noncallable (bullet) Bonds using specific maturities that may be reopened daily during a 3-month period through competitive auctions. The goal of the TAP Issue Program is to aggregate frequent smaller issues into a larger bond issue that may have greater market liquidity.
We participate in the issuance of Discount Notes to fund short-term Advances, adjustable-rate Advances, swapped Advances, short-term money market investments, and a portion of longer-term fixed-rate assets, as well as to acquire liquidity. Discount Notes have maturities from one day to one year. They are sold at a discount and mature at par. Historically, most of ours have had maturities of three months or less. Discount Notes are offered daily through a selling group or regularly scheduled competitive auctions. After issuance, Discount Notes are often traded in a liquid secondary market through securities dealers and banks.
Many Obligations are issued with the participating FHLBank(s) concurrently entering into interest rate exchange agreements with approved counterparties. No underwriter has a large concentration of issuance volume.

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Pricing of Consolidated Obligations
The interest rates and prices at which the FHLBank System is able to issue Obligations, and their interest cost relationship to other products such as U.S. Treasury securities and LIBOR, change frequently. Interest costs are affected by a multitude of factors including (but not limited to) the following:
  §   overall economic and credit conditions;
 
  §   credit ratings of the FHLBank System;
 
  §   investor demand and preferences for our debt securities;
 
  §   the level of interest rates and the shape of the U.S. Treasury curve and the LIBOR swap curve;
 
  §   the supply, volume, timing, and characteristics of debt issuances by the FHLBanks, other GSEs, and other highly rated issuers;
 
  §   actions by the federal government, including the Federal Reserve Board, U.S. Treasury Department, Federal Deposit Insurance Corporation (FDIC), and legislative and executive branches to affect the economy, financial system, and/or debt or mortgage markets;
 
  §   political events, including legislation and regulatory actions;
 
  §   the volatility of market prices and interest rates;
 
  §   interpretations of market events and issuer news;
 
  §   the presence of inflation or deflation; and
 
  §   currency exchange rates.
Regulatory Aspects
Finance Agency Regulations govern the issuance of Consolidated Obligations. The Office of Finance services Obligations, prepares the FHLBank System’s quarterly and annual combined financial statements, serves as one source of information for the FHLBanks on capital market developments, and administers REFCORP and the Financing Corporation. REFCORP and the Financing Corporation are separate corporations established by Congress to provide funding for the resolution and disposition of insolvent savings institutions.
We have the primary liability for our portion of Obligations, i.e., those issued on our behalf for which we receive the proceeds. However, we also are jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all Obligations. If we do not pay the principal or interest in full when due on any Obligation issued on our FHLBank’s behalf, we are prohibited from paying dividends or redeeming or repurchasing shares of capital stock. If an FHLBank were unable to repay its participation in an Obligation for which it is the primary obligor, the Finance Agency could call on each of the other FHLBanks to repay all or part of the Obligation.
The Finance Agency has never required an FHLBank to make a payment on an Obligation on behalf of another FHLBank. However, if it did, the paying FHLBank(s) would be entitled to reimbursement from the non-complying FHLBank. If the Finance Agency were to determine that the non-complying FHLBank was unable to satisfy its reimbursement obligations, the Finance Agency could allocate the outstanding liability among the remaining FHLBanks on any basis it might determine.
An FHLBank may not issue individual debt securities without Finance Agency approval. We have never sought authority to do so.
LIQUIDITY
Our liquidity requirements are significant because our Advance balances are highly volatile and many Advances have short-term maturities. We regularly monitor liquidity risks and determine the sources of investments and cash available to meet liquidity needs, as well as statutory and regulatory liquidity requirements.

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Our primary long-term source of cost-efficient liquidity under most operating environments is our participation in the issuance of Consolidated Obligations. Because Obligations are triple-A rated and because the FHLBank System is one of the largest sellers of debt in the worldwide capital markets, the System historically has been able to satisfy its liquidity needs through flexible debt issuance across a wide range of structures at relatively favorable spreads to benchmark market interest rates such as LIBOR and U.S. Treasuries. During 2008’s ongoing financial crisis, the System had a reduced ability to issue long-term debt Obligations, especially noncallable Bonds. However, the System continued to be able to issue shorter-term Discount Notes and callable Bonds in adequate amounts and at cost effective rates to maintain sufficient liquidity and funding for our operations. This is discussed further in Item 1A’s “Risk Factors.”
Besides proceeds from debt issuances, our sources of liquidity include cash, maturing Advances and investments, principal paydowns of mortgage assets, the ability to sell certain investments, and interest payments received. Additionally, under certain circumstances, the U.S. Treasury historically has had the ability to acquire up to $4 billion of the FHLBank System’s Obligations. Although this has never happened, if it did, the terms, conditions, and interest rates would be determined by the Secretary of the Treasury. As noted above in the “Investments” section, money market investments, and to a lesser extent, mortgage-backed securities, are potential sources of liquidity for ongoing operations. Compared to debt issuance, investments are more temporary, yet very flexible and important, sources of our daily liquidity management.
Two additional sources of liquidity were provided by HERA. First, the U.S. Treasury is authorized to purchase Obligations until December 31, 2009 in an amount it deems appropriate, supplementing the existing $4 billion limit. Second, in the third quarter of 2008, the U.S. Treasury established a GSE liquidity facility effective through December 31, 2009. Its purpose is to reduce potential disruptions from a GSE liquidity crisis by enabling the U.S. Treasury to provide the GSEs, on an as needed basis, collateralized short-term funds as a source of contingent liquidity. As of the date of this filing, no GSE has requested access to funds from the facility. We currently have no expectation to utilize this facility.
Uses of liquidity include maturities and calls of Obligations, issuances of new Advances, purchases of loans under the Mortgage Purchase Program, purchases of investments, and payments of interest.
CAPITAL RESOURCES
Capital Plan
Basic Characteristics
We are authorized by law (the Gramm-Leach-Bliley Act of 1999 (GLB Act)) to have either one or two classes of stock. Class A stock is conditionally redeemable with a member’s six-month written notice, and Class B stock is conditionally redeemable with a member’s five-year written notice. We offer only Class B stock. In accordance with the GLB Act, our Capital Plan permits us to issue shares of capital stock only under the following circumstances:
  §   as required for an institution to become a member or maintain membership;
 
  §   as required for a member to capitalize certain Mission Asset Activity;
 
  §   to pay stock dividends; and
 
  §   to pay interest on mandatorily redeemable capital stock.
Under Finance Agency Regulations, regulatory capital is composed of all capital stock (including stock classified as mandatorily redeemable), retained earnings, general loss allowances, and other amounts from sources the Finance Agency determines are available to absorb losses. Currently, our regulatory capital consists of only capital stock and retained earnings. Under the GLB Act, permanent capital equals Class B stock plus retained earnings and is available to absorb financial losses.
In accordance with SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS 150), GAAP capital excludes mandatorily redeemable capital stock (i.e., SFAS 150

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capital stock), while regulatory capital includes it. We account for SFAS 150 capital stock as a liability on our Statements of Condition and account for related dividend payments as interest expense. The classification of some capital stock as a liability has no effect on our safety and soundness, liquidity position, market risk exposure, or ability to meet interest payments on our participation in Obligations. SFAS 150 capital stock is fully available to absorb losses until the stock is redeemed or repurchased. See Note 15 of the Notes to Financial Statements for more discussion of SFAS 150.
The GLB Act also requires us to satisfy three capital requirements. The most important of these is that we must maintain at least a 4.00 percent regulatory capital-to-assets ratio. Our capital requirements are further discussed in the “Capital Adequacy” section of Item 7’s “Quantitative and Qualitative Disclosures About Risk Management.”
Membership Stock, Activity Stock, Excess Stock, and Cooperative Capital
Our Capital Plan ties the amount of each member’s required capital stock to both the amount of the member’s assets (membership stock) and the amount and type of its Mission Asset Activity with us (activity stock). To maintain compliance with our capital regulations, we may adjust the percentage range of the membership stock requirement and/or activity stock requirements. Any change to the activity stock requirement applies only prospectively to new Mission Asset Activity.
Membership stock is required to become a member and maintain membership. The amount required currently ranges from 0.15 percent to 0.03 percent of each member’s total assets, with a current minimum of $1 thousand and a current maximum of $100 million for each member. The minimum and maximum dollar amounts became effective in January 2009; previously there had been no minimum or maximum amounts. Two members were modestly affected by this change in our Capital Plan.
In addition to its membership stock, a member may be required to purchase and hold activity stock to capitalize its Mission Asset Activity. For purposes of the Capital Plan, Mission Asset Activity includes the principal balance of Advances, guaranteed funds and rate Advance commitments (GFR), and the principal balance of loans and commitments in the Mortgage Purchase Program that occurred after implementation of the Capital Plan.
The FHLBank must capitalize all Mission Asset Activity with capital stock at a rate of at least four percent. Each member must maintain an amount of Class B activity stock within the range of minimum and maximum percentages for each type of Mission Asset Activity. The current percentages, which have been in effect since the implementation of the Capital Plan, are as follows:
                 
Mission Asset Activity   Minimum Activity Percentage   Maximum Activity Percentage
 
               
Advances
    2 %     4 %
 
               
Advance Commitments
    2       4  
 
               
Mortgage Purchase Program
    0       4  
If a member’s Mission Asset Activity falls to the minimum percentage, it must purchase additional stock to capitalize further Mission Asset Activity. If a member owns more stock than is needed to satisfy the membership stock requirement and the maximum activity stock percentage for each Mission Asset Activity type, we designate the remaining stock as the member’s excess capital stock. We are permitted to repurchase excess capital stock at any time, subject to the terms and conditions of the Capital Plan. The Capital Plan permits each member, within constraints, to use its own excess capital stock to capitalize its additional Mission Asset Activity. In this case, the excess stock is re-allocated to activity stock for that member, at the maximum percentage rate (defined in the table above) in effect at the time.

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After a member capitalizes its Mission Asset Activity with all of its own excess stock, the Capital Plan normally permits the member to capitalize additional Mission Asset Activity with excess stock owned by other members, instead of having to purchase new stock. This essential feature, called “cooperative capital,” enables us to more efficiently utilize our capital stock. A member’s use of cooperative capital reduces the ratio of its activity stock to its Mission Asset Activity by the maximum percentage for each type of Mission Asset Activity. The Capital Plan currently has two limits on each member’s maximum use of cooperative capital.
  §   The member must maintain a ratio of activity stock to Mission Asset Activity at least equal to the minimum allocation percentage identified in the table above.
 
  §   It cannot use more than $100 million of cooperative capital. This limit was changed prospectively from $200 million effective March 10, 2008.
When a member reaches one of these limits through either growth in its Mission Asset Activity or reduction in its capital stock balance, it must capitalize additional Mission Asset Activity with a purchase of new capital stock.
Benefits of the Capital Plan
The Capital Plan enables us to efficiently obtain new stock to capitalize asset growth, thus maintaining an adequate capital-to-assets ratio. It also enables us to deploy excess capital into Mission Assets. When Mission Asset Activity contracts, it permits us, at our option, to repurchase capital stock in a timely and prudent manner, thus maintaining an adequate level of profitability. Additionally, the concept of “cooperative capital” better aligns the interests of heavy users of our products with light users by enhancing the dividend return.
Prior to 2007, the “cooperative capital” feature of our Capital Plan enabled us to continue our long historical practice of paying dividends with additional shares of stock rather than in cash. We believe that paying stock dividends enables members to have more flexibility in managing the amount of their capital investment in our FHLBank in the context of their business needs and that it also is the most efficient and cost effective tool available to raise capital. However, under a Finance Agency capital rule effective on January 29, 2007, if the sum of each member’s excess capital stock exceeds one percent of our total assets, we are not permitted to pay dividends in the form of additional shares of stock. In accordance with this rule, we were permitted to pay stock dividends in the first three quarters, but not the fourth quarter, of 2008.
Retained Earnings
Retained earnings are important to protect members’ capital stock investment against the risk of impairment and to enhance our ability to pay stable and competitive dividends when current earnings are volatile. Impairment risk is the risk that members would have to write down the par value of their capital stock investment in our FHLBank as a result of their analysis of ultimate recoverability. An extreme situation of earnings instability in which losses exceeded the amount of our retained earnings for a period of time determined to be other-than-temporary could result in a determination that the value of our capital stock was impaired.
We have a Retained Earnings Policy adopted by our Board of Directors. The Policy establishes a range for the amount of retained earnings needed to mitigate impairment risk and augment dividend stability in light of all the material risks we face. The current Retained Earnings Policy establishes a range of adequate retained earnings of $140 million to $285 million, with a target level of $170 million. At the end of 2008, our retained earnings were $326 million. We believe the current amount of retained earnings is sufficient to protect our capital stock against impairment risk and to provide the opportunity for dividend stability.
RISK MANAGEMENT
Our FHLBank faces various risks that could affect the ability to achieve our mission and corporate objectives. These risks include 1) business/strategic (including regulatory/legislative), 2) market (also referred to as interest rate risk), 3) capital adequacy, 4) credit 5) funding/liquidity, 6) accounting, and 7) operational (including fraud). Our Board of Directors is required to monitor, oversee, and control all risks and to establish corporate objectives regarding risk philosophy, risk tolerances, and financial performance expectations. We have numerous Board-adopted policies and

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processes that address how we manage our various risks. These policies establish risk tolerances and limits, must comply with all Finance Agency Regulations, and are designed to achieve continual safe and sound operations. The Board delegates day-to-day responsibility for managing and controlling most of these risks to senior management.
Our cooperative business model, corporate objectives, and the strong presence of regulatory oversight provide us clear incentives to minimize risk exposures. Therefore, our risk management practices are infused throughout all of our business activities. Our policies and operating practices are designed to limit risk exposures from ongoing operations in the following broad ways:
  §   by anticipating potential business risks and appropriate responses;
 
  §   by defining permissible lines of business;
 
  §   by limiting the kinds of assets we are permitted to hold and the kinds of hedging and financing arrangements we are permitted to use;
 
  §   by limiting the amount of market risk to which we are permitted to be exposed; and
 
  §   by requiring strict adherence to internal controls, adequate insurance coverage, and comprehensive Human Resources policies, procedures, and strategies.
We have an active process of managing our risk exposures on an enterprise-wide basis through regular formal meetings of several groups and committees. These include, among others, the Asset/Liability Management Committee, the Credit Risk Committee, the Disclosure Committee, the Financial and Correspondent Services Committee, the Business Resumption and Contingency Planning Committee, and the Information Technology Steering Committee. We also manage risk via regular reporting to and discussion with the Board of Directors, as well as by continuous discussion and decision-making among key personnel across the FHLBank.
After applying our risk management strategies, policies, and practices, we believe that the highest residual risks currently are business/strategic (including regulatory and legislative) and funding/liquidity. These risks currently have high residual exposures primarily because of the financial crisis and economic recession. We have limited ability to control the external reasons for the high residual risk exposures in these areas, but we have been aggressive in responding to these factors to limit, to the extent possible, their effects on our business. We further discuss these two current risk areas throughout this filing, in particular in Item 1A’s “Risk Factors” and in Item 7’s “Executive Summary.”
We recognize that we cannot eliminate the other risks for which we believe we have lower residual exposure. For example, although we believe the probability of experiencing a significant credit or operational risk event is very low, if one were to occur, it could materially harm our financial condition, results of operations, and reputation. Therefore, as for all of our risk exposures, we spend substantial resources to mitigate credit risk and operational risk.
USE OF DERIVATIVES
Finance Agency Regulations and our Financial Management Policy establish guidelines for our execution and use of derivative transactions. Permissible derivatives include interest rate swaps, swaptions, interest rate cap and floor agreements, calls, puts, and futures and forward contracts executed as part of our market risk management and financing. We are prohibited from trading in or the speculative use of these instruments and have limits on the amount of credit risk to which we may be exposed from derivatives. Most of our derivatives activity involves interest rate swaps. We account for all derivatives at their fair values in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (SFAS 133).

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As with our participation in debt issuances, derivatives help us hedge market risk created by Advances and mortgage commitments. Derivatives related to Advances most commonly hedge either:
  §   below-market rates and/or the market risk exposure on Putable and Convertible Advances for which members have sold us options embedded within the Advances;
 
  §   the market risk exposure of options we have sold that are embedded with Advances; or
 
  §   Regular Fixed-Rate Advances when it may not be as advantageous to issue Obligations or when it may improve our market risk management.
We also use derivatives to hedge the market risk created by commitment periods of Mandatory Delivery Contracts in the Mortgage Purchase Program.
Derivatives help us intermediate between the normal preferences of capital market investors for intermediate-and- long-term fixed-rate debt securities and the normal preferences of our members for shorter-term or adjustable-rate Advances. We can satisfy the preferences of both groups by issuing long-term fixed-rate Bonds and entering into an interest rate swap that synthetically converts the Bonds to an adjustable-rate LIBOR funding basis that matches up with the short-term and adjustable-rate Advances, thereby preserving a favorable interest rate spread.
Because we have a cooperative business model, our Board of Directors has emphasized the importance of minimizing earnings volatility, including volatility from the use of derivatives. Accordingly, our strategy is to execute derivatives that we expect both to be highly effective hedges of market risk exposure and to receive fair value hedge accounting treatment under SFAS 133. Therefore, the volatility in the market value of equity and earnings from our use of derivatives and application of SFAS 133 has historically tended to be moderate.
In this context, we have not executed derivatives, nor do we currently plan to do so, to hedge market risk exposure outside of specifically identified assets or liabilities or to hedge the market risk of mortgage assets, except for the commitment period of loans in the Mortgage Purchase Program. We believe that the economic benefits of using derivatives to hedge at the level of the entire balance sheet instead of individual instruments, or to hedge mortgage assets (except commitment periods), would generally be less than the increased hedging costs and risks, which include potentially higher earnings volatility.
COMPETITION
Numerous economic and financial factors influence the competition for Advance lending to members. The most important factor that affects Advance demand is the general availability of competitively-priced local retail deposits, which most members view as their primary funding source, in amounts and maturity structures that satisfy members’ funding needs. In addition, both small and large members typically have access to brokered deposits, repurchase agreements and public unit deposits, each of which presents competitive alternatives to Advances. Larger members typically have greater access to other competitive sources of funding and asset/liability management facilitated via the national and global credit markets. These sources include subordinated debt, interbank loans, covered bonds, interest rate swaps, options, bank notes, and commercial paper.
The holding companies of some of our large asset members have membership(s) in other FHLBanks through affiliates chartered in other FHLBank Districts. Others could initiate memberships in other FHLBank Districts. The competition among FHLBanks for the business of multiple-membership institutions is similar to the competition the FHLBanks have with other wholesale lenders and other mortgage investors. We compete with other FHLBanks on the offerings and pricing of Mission Asset Activity, earnings and dividend performance, collateral policies, capital plans, and members’ perceptions of our relative safety and soundness. Some members may also evaluate the actual or perceived benefits of diversifying business relationships among FHLBank memberships. We regularly monitor, to the extent possible, these competitive forces among the FHLBanks.
In 2008, a new source of competition for Advances arose from the U.S. government’s actions designed to provide expanded sources of liquidity and capital to financial institutions in light of the financial crisis and recession. These recent government actions are discussed further in Item 1A’s “Risk Factors” and in Item 7’s “Executive Overview.”

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The primary competitors for loans we purchase in the Mortgage Purchase Program are other housing GSEs, government agencies (Ginnie Mae), other FHLBanks, and private issuers. We compete primarily based on price, products, and services. Fannie Mae and Freddie Mac in particular have long-established and efficient programs and are the dominant purchasers of residential conforming fixed-rate conventional mortgages. In addition, a number of private financial institutions have well-established securitization programs. The Program also may compete indirectly with the U.S. government to the extent it purchases mortgage-backed securities.
For debt issuance, the FHLBank System competes with issuers in the national and global debt markets, including most importantly the U.S. government and other GSEs. Competitive factors include, but are not limited to, the following:
  §   interest rates offered;
 
  §   the amount of debt offered by the System and its competitors;
 
  §   the market’s perception of the credit quality of the issuing institutions and the liquidity of the debt;
 
  §   the types of debt structures offered; and
 
  §   the effectiveness of marketing.
As with Advances, in the second half of 2008, a new source of competition for System debt arose from the actions of the U.S. government (primarily the Treasury and FDIC) to support the financial and credit markets through new, or changes in, various supports, guarantees, and/or insurance coverage of retail deposits and debt issued by financial and other institutions. These actions and their effects on our business are discussed further in Item 1A’s “Risk Factors” and Item 7’s “Executive Overview.”
TAXATION
We are exempt from all federal, state, and local taxation other than real property taxes. However, we are obligated to make payments to REFCORP equal to 20 percent of net earnings after operating expenses and the Affordable Housing Program expense, but before charges for REFCORP. Currently, the combined assessments for REFCORP and the Affordable Housing Program are the equivalent of a 26.7 percent annualized net tax rate. Despite our tax exempt status, any cash dividends we issue are taxable to members and do not benefit from the corporate dividends received exclusion. See Notes 1, 13, and 14 of the Notes to Financial Statements for additional details regarding the assessments for the Affordable Housing Program and REFCORP.

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Item 1A.   Risk Factors.
The following discussion summarizes the important risks we believe we face in order of our perception of the potential severity. The realization of one or more of the risks could negatively affect our business operations, financial condition, and/or results of operations, with various potential results including:
  §   debt investors could face an increased risk of not receiving their principal and/or interest payments on a timely basis;
 
  §   our ability to continue to raise liquidity through participation in debt issuance could be impaired;
 
  §   stockholders could request redemption of a portion of their capital or request withdrawal from membership (both referenced herein as “request withdrawal of capital”);
 
  §   stockholders could have their capital stock investment designated as an impaired asset on their financial statements;
 
  §   dividend rates could become uncompetitive;
 
  §   the amount of Mission Asset Activity could decrease;
 
  §   credit losses could occur; and
 
  §   members could have reduced access to competitively priced Mission Asset Activity.
Most of the factors in this section are directly related to the continuing severe disruptions in the financial, credit, and mortgage markets, the economic recession, and the federal government’s actions to attempt to mitigate the financial crisis and recession. We believe that the totality of the impact of these events has to date been favorable for the value of membership in our FHLBank. However, some individual events harmed our business in 2008, and we cannot predict the ultimate effects of any of these events on our business.
The following risk factors are discussed in order of current importance.
Impaired access to the capital markets for debt issuance could deteriorate our liquidity, decrease the amount and attractiveness of Mission Asset Activity, and lower earnings.
Our principal long-term source of funding and liquidity is through access to the capital markets for participation in the issuance of debt securities, and our principal tools to manage market risk are the issuance of debt securities and execution of derivative transactions. An impaired ability to access these markets, due to events internal or external to our FHLBank, could significantly harm our financial condition and results of operations. We believe we have limited ability to control our access to the capital markets because of the joint and several liability for Consolidated Obligations and our exposure to external events.
In 2008, the financial crisis and economic recession, and the federal government’s significant measures enacted to mitigate their effects, changed the traditional bases on which market participants valued GSE debt securities and consequently affected our funding costs and practices. Our funding costs associated with issuing long-term Consolidated Obligations became more volatile and rose sharply compared to LIBOR and U.S. Treasury securities. We believe this reflects dealers’ reluctance to sponsor, and investors’ current reluctance to buy, as much long-term GSE debt as they previously did, coupled with strong investor demand for short-term, high-quality assets. In addition, at various times in 2008 the System had a reduced ability to issue long-term noncallable debt Obligations at acceptable rates.
As a result, in 2008 we, along with other FHLBanks, reduced our issuance of long-term debt compared to recent years while also taking prudent actions to boost our liquidity, including incorporating Finance Agency guidance to target as many as 15 days of liquidity under certain scenarios. This strategy has included decreasing term money market investments, maintaining the majority of our liquidity in overnight maturities, and lengthening the maturities of our Discount Notes.

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The FHLBanks became more reliant on Discount Notes for funding in 2008. A larger portion of this funding was provided by money market funds. Our relative or absolute funding costs could increase if any further significant change occurs in market conditions or if the health of the money market funds causes a decline in fund assets or in preferences of the funds to reduce their holding of GSE Discount Notes.
In the third quarter of 2008, the U.S. Treasury Department, as authorized by HERA, established a GSE liquidity facility. The purpose of the facility is to provide collateralized short-term funds on an as needed basis to the GSEs, including the FHLBanks, in order to reduce potential disruptions to the GSEs from liquidity issues in the market. We are currently pledging a portion of our Advances as collateral for this facility. As of the date of this filing, no GSE has requested access to funds from the facility and we currently have no expectation to utilize this facility. Any borrowings by one or more of the FHLBanks under the facility would be considered Consolidated Obligations with the same joint and several liability as all other Consolidated Obligations. We cannot predict at this time if this facility will result in a change in our debt costs or their volatility.
Following the announced conservatorship of Fannie Mae and Freddie Mac, security prices indicate market participants may believe that debt of these two GSEs offers lower credit risk than Obligations of the FHLBanks. A stable spread relationship between the debt instruments of Fannie Mae and Freddie Mac, on the one hand, and the FHLBanks, on the other, has not yet emerged, resulting in ongoing spread volatility.
Investors continue to face concern and uncertainty about the futures of Fannie Mae and Freddie Mac including the length of their conservatorship and future business model, the explicit December 31, 2009 expiration date for the GSE liquidity facility, and the level of government support for Fannie Mae and Freddie Mac relative to the FHLBanks. These sources of concern and uncertainty have raised our debt costs.
We expect to continue to have sufficient liquidity and access to debt markets, although we can make no assurances that this will be the case. We believe the chance for a liquidity or funding crisis in the FHLBank System that would impair our ability to service our debt or pay competitive dividends is remote. However, if this were to occur, it could threaten the System’s existence.
The joint and several liability for Consolidated Obligations could 1) require us to provide financial assistance to other FHLBanks and/or 2) increase our debt costs thereby decreasing earnings and the ability to extend Mission Asset Activity to members on favorable terms.
Although no FHLBank has ever defaulted on its principal or interest share of an Obligation and the Finance Agency has never required an FHLBank to make principal or interest payments based on another FHLBank’s Consolidated Obligation liability, the individual debt ratings and outlooks for a few FHLBanks have been downgraded in the last several years. To date, these actions have not directly affected our joint and several liability. We cannot predict what events could occur in the future that could negatively affect this liability.
Several FHLBanks have reported, and may continue reporting, issues with capital adequacy and profitability. This, along with the earnings pressures discussed below, could require us to provide financial assistance to one or more other FHLBanks, for example, by making a payment on an Obligation on behalf of an other FHLBank. We expect that any such assistance would, temporarily or permanently, harm our profitability and could adversely affect our financial condition.
In 2008, several other FHLBanks reported, and may continue to report, earnings pressures due, primarily, to impairment charges taken on private-label mortgage-backed securities, certain one-time events, and possibly earnings exposure to the sharp decreases in interest rates. The earnings pressures from impairment issues with private-label mortgage-backed securities could jeopardize several FHLBanks’ compliance with their capital requirements. These factors could raise investors’ concern regarding the credit risk of FHLBank System debt securities, which we would expect to result in higher and more volatile debt costs and, possibly, more difficulty issuing debt, especially longer-term debt, at maturity points we would prefer for our asset/liability management needs. As a result, our Mission Asset Activity and profitability could decrease, both of which would harm our members.

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New or changes in legislation, other government actions, or Finance Agency Regulations could increase our operating costs, lower profitability, raise uncertainty among our member stockholders, and reduce Mission Asset Activity and capitalization.
HERA created a new federal regulator, the Finance Agency, for the FHLBanks, Fannie Mae, and Freddie Mac. Among other things, HERA is designed to help resolve the current housing finance crisis, expand the Federal Housing Administration’s financing authority and address GSE reform issues. At this time, we cannot predict its near-term or long-term effects, or those of the Finance Agency’s interpretations, regulations and other actions, on our business model, financial condition, results of operation, liquidity, or capital adequacy.
As a financial regulator, the paramount concern of the Finance Agency is to ensure the FHLBanks’ safety and soundness. Legislative mandates and regulations directed to this end could negatively impact our members’ ability and preference to hold our capital stock and engage in Mission Asset Activity with us.
To attempt to mitigate the financial crisis and recession, the federal government has enacted a number of measures, and is considering more, that involve various financial guarantees, equity investments in financial institutions, direct lending, a large amount of budget spending, and other extraordinary actions.
In addition, the FDIC made changes in several of its business activities that affect the FHLBanks. First, in October the FDIC raised deposit insurance coverage levels for many accounts to $250,000, extended deposit insurance coverage to all non-interest bearing transaction deposit accounts, and provided FDIC guarantees to unsecured debt issuances of insured depository institutions. Second, effective April 1, 2009, the FDIC will require depository institutions to include their Advance borrowings when calculating their assessments of deposit insurance premiums with assessments increased for such institutions having total secured liabilities (which includes Advances) exceeding 25 percent of its deposits. As of year-end 2008, 57 of our members would have been affected by the rule. However, the FDIC also raised deposit insurance premiums on eligible deposits and enacted a one-time special assessment of 20 basis points, with the authority to impose additional special assessments of up to ten basis points. We expect these changes to offset a portion of the unfavorable effects from including Advances in the assessments.
Although we understand and support the government’s objectives, we believe these measures, considered together, have increased our funding costs and lowered our Advance demand. We cannot predict whether these negative effects will continue, how severe the effects may become if they continue, or whether the measures ultimately will help our mission, funding costs, and Advance demand by helping to stem the financial crisis and recession.
The current economic recession could decrease our Mission Asset Activity and lower our profitability.
Member demand for Mission Asset Activity depends in part on the general health of the economy and business conditions. A recessionary economy, or an economy characterized by stagflation in which growth is weak but inflation is high, could lower the amount of Mission Asset Activity, decrease profitability and cause stockholders to request withdrawal of capital. These unfavorable effects are more likely to occur if a weak economy is accompanied by significant changes in interest rates or in the legislative and regulatory environment relative to the FHLBank System. Although the financial crisis in 2008 contributed to an increase in average Mission Assets and profitability relative to short-term interest rates, we are concerned that a prolonged economic recession could ultimately erode these two principal sources of membership value.
A change in investors’ or rating agencies’ perception of GSEs may raise our debt costs and/or lower our credit ratings.
In previous years including 2008, errors in accounting, weak risk management practices, and other business issues at GSEs, including other FHLBanks, may have caused investors and rating agencies to view the FHLBank System’s debt securities as riskier investments, which may have resulted in higher debt costs. In addition, the triple-A ratings of the System’s Consolidated Obligations are based in part on the GSE status of the System’s FHLBanks. This status causes some to believe that the U.S. government would support, directly or indirectly, the System’s debt in a credit crisis, although it has no legal obligation to do this. If these assessments or perceptions change, the System’s debt ratings, debt costs, and ability to access debt markets on favorable funding terms could

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suffer. Any action or combination of actions that result in a downgrade of the System’s triple-A debt ratings could materially harm our business and membership value.
Increased competition could decrease the amount of Mission Asset Activity and lower earnings and capitalization.
We operate in a highly competitive environment for our Mission Asset Activity and debt issuance. Unfavorable changes in our competitive position could decrease the amount of Mission Asset Activity and narrow net spreads on that activity. Besides coming from activities of other wholesale lenders and debt issuers, including other GSEs, unfavorable changes in our competitive position could result from consolidations among FHLBanks. Increased competition could reduce our earnings and cause stockholders to request withdrawal of capital.
The concentration of Mission Asset Activity and capital among a small number of members puts us at risk if several large members were to withdraw or sharply reduce their activity with us.
A relatively small number of members provide the bulk of our Mission Asset Activity and capitalization. These members could decrease their Mission Asset Activity and the amount of their FHLBank capital stock as a result of merger and acquisition activity or their reduced demand for our products. Our business model is structured to be able to absorb sharp changes in our Mission Asset Activity because we can undertake commensurate reductions in our liability balances and capital, and because of our low operating expenses. If, however, several large members were to withdraw from membership or otherwise reduce activity with us, the decrease in Mission Asset Activity and/or capital could materially reduce dividend rates available to our remaining members, affect the pricing of Mission Asset Activity, materially decrease earnings and profitability, and cause other stockholders to request withdrawal of capital.
Changes in interest rates and mortgage prepayment speeds could significantly reduce our ability to pay members a competitive dividend from current earnings.
Sharp increases in interest rates, especially short-term rates, or sharp decreases in long-term interest rates could threaten the competitiveness of our profitability compared to our member stockholders’ alternative investment choices. One major way that interest rate movements can lower profitability is through unhedged increases or decreases in mortgage prepayment speeds. Exposure to unhedged changes in mortgage prepayment speeds is one of our largest ongoing risks. In some extremely stressful scenarios, these kinds of changes in interest rates and prepayment speeds could result in our profitability being below stockholders’ expectations for an extended period of time. In such a situation, members could engage in less Mission Asset Activity and could request withdrawal of capital.
Our spreads on assets to funding costs may narrow because of changes in market conditions and competitive factors, resulting in lower profitability.
Our asset spreads tend to be narrow compared to those of many other financial institutions due to our cooperative business model, making our profitability relatively lower. Market conditions could substantially cause asset spreads, and therefore our profitability, to decrease, resulting in members’ requests to withdraw their capital.
We are exposed to credit risk that, if realized, could materially and adversely affect our financial condition and results of operations.
We believe that our residual credit risk exposure to Advance collateral, loans in the Mortgage Purchase Program, investments, and derivatives, including exposure to loans that may have “subprime” and “alternative/nontraditional” characteristics, continued to be minimal in 2008 and that all gross unrealized losses on our assets were temporary, rather than an indication of a material deterioration of the creditworthiness of the issuers or the underlying collateral.
However, given 2008’s financial crisis and recession, we cannot make any assurances that our credit risk losses will continue to be zero. Most of our members are on a blanket lien status which, because it does not require specific loan collateral to be delivered, imparts a degree of uncertainty as to what types of loans members have pledged to collateralize their Advances. Also, in 2008, there was a significant downward trend in the internal

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credit ratings we assign our members. During the year, for certain members, it became necessary for us to reduce borrowing capacity, increase collateral requirements and/or require them to deliver collateral to us or provide us with greater detail on pledged assets. Additionally, money market investments and the uncollateralized portion of interest rate swaps are unsecured; we collateralize most credit risk exposure of swaps by exchanging cash or high-grade securities daily, if necessary, with the counterparties based on net market value positions of the swaps. Finally, although we make investments in the securities of, and execute derivatives with, highly rated institutions, a credit risk event could occur with a large unsecured position.
The amount of our retained earnings could become insufficient to preserve a competitive dividend return or protect stockholders’ capital investment against impairment.
If dividend rates paid to stockholders become uncompetitive because of an insufficient amount of retained earnings, or because of an inability to distribute retained earnings for regulatory reasons, members may request withdrawal of their capital. At the extreme, if the amount of retained earnings were insufficient to protect stockholders’ capital investment against losses, the value of our capital stock on members’ books could be written down below its par value and be designated as an impaired asset.
Changes in relevant accounting standards, especially SFAS 133 and SFAS 91, could materially increase earnings volatility and consequently reduce the quality of members’ capital investment, the amount of Mission Asset Activity and the amount of capital.
We believe there have been no material effects on our Mission Asset Activity, capitalization, or earnings because of our application of SFAS 133 and SFAS 91. Although unlikely to occur, changes in SFAS 133, SFAS 91, or any other accounting standards could increase our earnings volatility, causing less demand for Mission Asset Activity and stockholders to request withdrawal of capital. Earnings volatility could also increase if we began to execute more derivatives involving economic or macro hedges under SFAS 133 or if we significantly increased the amount of our mortgage assets with premiums or discounts, leading to greater volatility from applying SFAS 91.
Our financial condition and results of operations could suffer if we are unable to hire and retain skilled key personnel.
Our business success depends, in large part, on our ability to attract and retain key personnel. Competition for qualified people can be intense. Should we be unable to hire or retain effective key personnel, our profitability and financial condition could deteriorate.
Failures or interruptions in our internal controls, information systems and other operating technologies could harm our financial condition, results of operations, reputation, and relations with member stockholders.
Control failures, including those over financial reporting, or business interruptions with our members and counterparties could occur from human error, fraud, breakdowns in computer systems and operating processes, and natural or man-made disasters. We rely heavily on internal and third party computer systems. Although we believe we have substantial control processes in place, if a significant credit or operational risk event were to occur, it could materially damage our financial condition and results of operations. We can provide no assurances that we would be able to foresee, prevent, mitigate, reverse or repair the negative effects of such failures or interruptions.

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Item 1B.   Unresolved Staff Comments.
None.
Item 2.   Properties.
Our offices are located in 70,879 square feet of leased space in downtown Cincinnati, Ohio. We also maintain a leased, fully functioning, back-up facility in suburban Cincinnati. Additionally, we lease a small office in Nashville, Tennessee for the area marketing representative. We believe that our facilities are in good condition, well maintained, and adequate for our current needs.
Item 3.   Legal Proceedings.
We are subject to various pending legal proceedings arising in the normal course of business. Management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material adverse effect on our financial condition or results of operations.
Item 4.   Submission of Matters to a Vote of Security Holders.
In 2008, the FHLBank conducted its regular election of directors to fill member directorships in Ohio. There were no directorships up for election in Kentucky or Tennessee. The FHLBank also conducted an election to fill independent directorships.
MEMBER DIRECTORSHIP ELECTION
In Ohio, eight individuals were nominated for the four open seats that were held by Richard C. Baylor, Robert E. Brosky, Stephen D. Hailer, and Michael R. Melvin whose terms expired on December 31, 2008. All eight of the nominees accepted the nomination to run for the four open seats. One hundred and seventy eight members participated in the Ohio election. The election results are provided below:
         
Name   Votes Received
Robert E. Brosky
    1,731,652  
Stephen D. Hailer
    1,450,297  
Mark N. DuHamel
    1,255,267  
Richard C. Baylor
    1,102,365  
Michael R. Melvin
    1,077,724  
Robert M. Smith
    593,762  
J. William Stapleton
    379,579  
A. Barry Parmiter
    362,295  
The Ohio election results were ratified by the Board of Directors at its November 20, 2008 meeting. Subsequently, in December 2008, Mr. Baylor resigned as Chairman, President and CEO of Advantage Bank of Cambridge, Ohio. According to Finance Agency regulation, all member directors must be an officer or director of a member institution at all times during their terms of office. Therefore, on January 15, 2009, the Board of Directors elected Mr. Melvin to fill the vacant position on the Board. As a result, the following individuals will serve four-year terms that began January 1, 2009 and expire December 31, 2012.
     
Robert E. Brosky
  Stephen D. Hailer
Chairman of the Board
  President and Chief Executive Officer
First Federal Savings and Loan Association of Lorain
  North Akron Savings Bank
Lorain, Ohio
  Akron, Ohio

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The following individuals will serve three-year terms that began January 1, 2009 and expire December 31, 2011.
     
Michael R. Melvin
  Mark N. DuHamel
President and Chief Executive Officer
  Executive Vice President
Perpetual Federal Savings Bank
  FirstMerit Bank, NA
Urbana, Ohio
  Akron, Ohio
The terms of the following member directors continue in 2009:
     
William Y. Carroll
   
B. Proctor Caudill, Jr.
   
James R. DeRoberts
   
R. Stan Puckett
   
William J. Small
   
Billie W. Wade
   
INDEPENDENT DIRECTORSHIP ELECTION
In the Fifth District, three individuals were nominated for the three open seats. Two of these seats were held by Leslie Dolin Dunn and Charles J. Ruma whose terms expired on December 31, 2008. The third seat is a newly established seat as directed by the Finance Agency. All three of the nominees accepted the nomination to run for the three open seats. Three hundred and fifty six members participated in the independent director election. The election results are provided below:
         
Name   Votes Received
Leslie Dolin Dunn
    3,441,340  
Alvin J. Nance
    3,205,585  
Charles J. Ruma
    3,144,052  
The independent director election results were ratified by the Board of Directors on December 30, 2008. Ms. Dunn and Mr. Nance will serve four-year terms that began January 1, 2009 and expire December 31, 2012. Mr. Ruma will serve a three-year term that began January 1, 2009 and expires December 31, 2011.
The terms of the following independent directors continue in 2009:
 
Grady P. Appleton
Donald R. Ball
Charles J. Koch
Carl F. Wick

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PART II
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
By law, only our members (and former members that have outstanding Mission Asset Activity) may own our stock. As a result, there is no public market for our stock. The par value of our capital stock is $100 per share. As of December 31, 2008, we had 728 stockholders and 40 million shares of capital stock outstanding, all of which were Class B Stock.
We paid quarterly dividends in 2008 and 2007 as outlined in the table below.
                                                 
(Dollars in millions)   2008   2007
            Percent Per                   Percent Per    
Quarter
  Amount   Annum   Form (1)   Amount   Annum   Form
First
  $ 47       5.250     Capital Stock   $ 57       6.375     Cash
Second
    49       5.500     Capital Stock     60       6.500     Cash
Third
    51       5.500     Capital Stock     60       6.500     Cash
Fourth
    49       5.000     Cash     61       7.000     Cash
 
                                               
(1) Fractional share amounts were paid in cash.
                               
Generally, our Board of Directors has discretion to declare or not declare dividends and to determine the rate of any dividend declared. Our dividend declaration policy states that dividends for a quarter are declared and paid from retained earnings after the close of a calendar quarter and are based on average stock balances for the then closed quarter. Thus, any dividend declared during a quarter does not include any actual or projected earnings for the current quarter.
On January 29, 2007, a final Finance Agency Capital Rule became effective that prohibits an FHLBank from issuing new excess capital stock to members, either by paying stock dividends or otherwise, if before or after the issuance the amount of member excess capital stock exceeds or would exceed one percent of the FHLBank’s assets. Excess capital stock for this regulatory purpose is calculated as the aggregate of capital stock owned by all members that is in excess of each member’s membership and mission asset activity requirements (as defined in our Capital Plan). In accordance with this Rule, we paid stock dividends in each of the first three quarters of 2008 and a cash dividend in the fourth of 2008 and in each quarter of 2007. Our Board, and we believe our members, continue to have a stated preference for paying dividends in the form of stock.
We may not declare a dividend if, at the time, we are not in compliance with all of our capital requirements. We also may not declare or pay a dividend if, after distributing the dividend, we would fail to meet any of our capital requirements or if we determine that the dividend would create a safety and soundness issue for the FHLBank. We currently expect to continue to pay dividends at a spread above comparable short-term interest rates. See Note 15 of the Notes to the Financial Statements for additional information regarding our capital stock.
RECENT SALES OF UNREGISTERED SECURITIES
From time-to-time the FHLBank provides Letters of Credit in the ordinary course of business to support members’ obligations issued in support of unaffiliated, third-party offerings of notes, bonds or other securities. The FHLBank provided $200 million, $10 million and $33 million of such credit support during 2008, 2007 and 2006, respectively. To the extent that these Letters of Credit are securities for purposes of the Securities Act of 1933, their issuance is exempt from registration pursuant to section 3(a)(2) thereof.

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Item 6.   Selected Financial Data.
The following table presents selected balance sheet information (based on book balances), income statement data and financial ratios for the five years ended December 31, 2008.
                                         
    Year Ended December 31,  
(Dollars in millions)   2008     2007     2006     2005     2004  
     
BALANCE SHEET DATA:
                                       
 
                                       
Total assets
  $ 98,206     $ 87,335     $ 81,381     $ 77,074     $ 76,402  
Advances
    53,916       53,310       41,956       40,262       41,301  
Mortgage loans held for portfolio, net
    8,632       8,928       8,461       8,418       8,371  
Investments (1)
    35,325       24,678       30,614       28,114       26,497  
Deposits
    1,193       1,054       927       911       1,041  
Consolidated Obligations (2)
    91,729       81,616       75,186       71,098       70,451  
Mandatorily redeemable capital stock
    111       118       137       418       34  
Affordable Housing Program
    103       103       96       91       89  
Payable to REFCORP
    14       17       17       16       15  
Capital stock – putable
    3,962       3,473       3,658       3,504       3,800  
Retained earnings
    326       286       255       208       168  
Total capital
    4,282       3,755       3,907       3,709       3,963  
 
                                       
INCOME STATEMENT DATA:
                                       
 
                                       
Net interest income (3)
  $ 364     $ 421     $ 386     $ 340     $ 302  
Provision for credit losses on mortgage loans
                             
     
Net interest income after provision for credit losses on mortgage loans
    364       421       386       340       302  
 
                                       
Other income (loss)
    9       (6 )     6       3       44  
Other expenses
    51       48       46       42       37  
     
Income before assessments
    322       367       346       301       309  
Assessments
    86       98       93       81       82  
     
 
                                       
Net income
  $ 236     $ 269     $ 253     $ 220     $ 227  
     
 
                                       
Dividends paid in stock
  $ 147     $     $ 205     $ 179     $ 152  
Dividends paid in cash
    49       238                    
     
 
                                       
Total dividends paid
  $ 196     $ 238     $ 205     $ 179     $ 152  
     
 
                                       
Weighted average dividend rate (4)
    5.31 %     6.59 %     5.81 %     5.00 %     4.13 %
Return on average equity
    5.73       6.87       6.70       5.79       5.97  
Return on average assets
    0.25       0.32       0.32       0.28       0.28  
Average net interest margin (3) (5)
    0.39       0.50       0.49       0.43       0.38  
Capital-to-assets ratio at period end
    4.36       4.30       4.80       4.81       5.19  
Operating expense to average assets
    0.041       0.046       0.046       0.042       0.035  
(1)   Investments include interest bearing deposits in banks, securities purchased under agreements to resell, Federal funds sold, trading securities, available-for-sale securities, and held-to-maturity securities.
 
(2)   The 12 FHLBanks have joint and several liability for the par amount of all of the Consolidated Obligations issued on their behalves. See Note 12 of the Notes to Financial Statements for additional detail and discussion related to Consolidated Obligations. The par amount of the outstanding Consolidated Obligations of all 12 FHLBanks was as follows (in millions):
                                         
 
  $ 1,251,542     $ 1,189,706     $ 951,990     $ 937,460     $ 869,242  
     
(3)       Includes (in millions):
                                       
Prepayment fees on Advances, net
  $ 2     $ 3     $ 6     $     $ 69  
     
(4)   Weighted average dividend rates are dividends paid in stock and cash divided by the average number of shares of capital stock eligible for dividends.
 
(5)   Net interest margin is net interest income as a percentage of average earning assets.

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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Contents
         
    30  
 
       
    31  
 
       
    35  
 
       
    38  
 
       
    52  
 
       
    62  
 
       
    89  
 
       
    95  
 
       
    96  

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FORWARD-LOOKING INFORMATION
This document contains forward-looking statements that describe the objectives, expectations, estimates, and assessments of the FHLBank. These statements use words such as “anticipates,” “expects,” “believes,” “could,” “estimates,” “may,” and “should.” By their nature, forward-looking statements relate to matters involving risks or uncertainties, some of which we may not be able to know, control, or completely manage. Actual future results could differ materially from those expressed or implied in forward-looking statements or could affect the extent to which we are able to realize an objective, expectation, estimate, or assessment. Some of the risks and uncertainties that could affect our forward-looking statements include the following:
  §   the effects of economic, financial, market, and member conditions on our financial condition, results of operations, and demand for Mission Asset Activity, including changes in economic growth, general credit and liquidity conditions, interest rates, interest rate spreads, interest rate volatility, mortgage originations, prepayment activity, and members’ activity with mergers and consolidations, deposit flows, liquidity needs, and loan demand;
 
  §   political events, including legislative, regulatory, federal government, judicial or other developments that could affect the FHLBank, our members, counterparties, other FHLBanks and other government sponsored enterprises, and/or investors in the FHLBank System’s Consolidated Obligations;
 
  §   competitive forces, including those related to other sources of funding available to members, to purchases of mortgage loans, and to our issuance of Consolidated Obligations;
 
  §   the results and actions of other FHLBanks that could affect our ability, through the System, to access the capital markets or affect the nature and extent of new regulations and legislation to which we are subjected;
 
  §   changes in investor demand for Consolidated Obligations;
 
  §   the volatility of market prices, interest rates, credit quality, and other indices that could affect the value of investments and collateral we hold as security for member obligations and/or for counterparty obligations;
 
  §   the ability to attract and retain skilled individuals;
 
  §   the ability to sufficiently develop and support technology and information systems to effectively manage the risks we face;
 
  §   the ability to successfully manage new products and services;
 
  §   the risk of loss arising from litigation filed against us or one or more of the other FHLBanks; and
 
  §   inflation and deflation.
The FHLBank does not undertake any obligation to update any forward-looking statements made in this document.
In this filing, the interrelated and severe disruptions in 2008’s financial, credit, housing, capital, and mortgage markets, which have continued in 2009, are referred to generally as the “financial crisis.”

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EXECUTIVE OVERVIEW
Financial Condition
Although, like most financial institutions, our business in 2008 was affected by the financial crisis and economic recession, we believe our financial condition continued to be strong in 2008. We continued to serve and reinforce our role as an important provider of reliable and attractively priced wholesale funding to our members. The following table summarizes our financial condition for the periods indicated.
                                 
    Year Ended December 31,
    Ending Balances   Average Balances
(Dollars in millions)   2008   2007   2008   2007
 
                               
Advances (principal)
  $ 52,799     $ 52,953     $ 59,973     $ 49,302  
Mortgage loans held for portfolio (principal)
    8,590       8,862       8,621       8,742  
Letters of Credit (notional)
    7,917       6,923       7,894       5,551  
Mandatory Delivery Contracts
    917       48       182       88  
 
                               
 
                               
Total Mission Asset Activity
  $ 70,223     $ 68,786     $ 76,670     $ 63,683  
 
                               
 
                               
Retained earnings
  $ 326     $ 286     $ 335     $ 302  
 
                               
Capital-to-assets ratio
    4.36 %     4.30 %     4.37 %     4.63 %
 
                               
Regulatory capital-to-assets ratio (1)
    4.48       4.44       4.51       4.80  
(1) See the “Capital Resources” section for further description of regulatory capital.
As shown above, our average principal balances of Mission Asset Activity increased $12,987 million (20 percent) over 2007. Most of the growth in average Asset Activity occurred from an expansion of Advances and the notional principal amount of available lines outstanding for Letters of Credit. For example, Advances’ average principal balance increased $10,671 million (22 percent), even after former member RBS Citizens decreased its Advances starting in the second half of 2007 by approximately $10,000 million. The substantial growth in average Advance balances occurred because of the increased funding demand from many of our members for liquidity and risk management activities in response to the financial crisis.
The lower 2008 ending Advance balance compared to the average balance was due primarily to significant reductions in the fourth quarter from several members. In the fourth quarter, Advance balances decreased $9,781 million (16 percent), which we believe was for the following reasons:
  §   lower Advance demand as a result of the continuing financial crisis and economic recession; and
 
  §   availability of new funding and liquidity options to members.
Although a handful of members were responsible for most of the dollar growth in average Advances, various market penetration measures show there was a broad-based increased reliance on Advances across the membership. The average ratio of each member’s Advance balances to its total assets increased substantially. The ratio for all members was 6.1 percent on December 31, 2008, compared to 5.1 percent on December 31, 2007. The number of members with outstanding Advances also rose. At year-end 2008, 79 percent of members had Advances, compared to 74 percent at year-end 2007, a change that represented 41 additional borrowers. During 2008, 70 percent of our members executed an Advance transaction, an increase from 59 percent in 2007.
From year-end 2007 to year-end 2008, available lines in the Letters of Credit program grew $994 million (14 percent), mostly to support members’ public unit deposits. Average lines outstanding increased $2,343 million (42 percent),

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which was three times as much as the growth in end-of-period lines outstanding because the growth trend of the lines was large during 2007. We earn fees on the actual amount of the available lines members use, which can be substantially less than the lines outstanding.
The principal balances in the Mortgage Purchase Program decreased slightly in 2008 compared to 2007, on both an ending-balance and average-balance basis. The modest reductions in balances were because our then largest seller ceased new mortgage activity with us in mid-2007 and because of the difficult market for loan originations and refinancings during the financial crisis. In 2008, we approved 21 new members to participate in the Program and 13 additional members sold us loans for the first time.
We believe our capital adequacy continued to be strong in 2008. We maintained compliance with all of our regulatory capital limits. Regulatory capital was $4,399 million on December 31, 2008, which was an increase from year-end 2007 of $522 million (13 percent). The increase reflected: 1) members’ stock purchases to fund Advance growth, and 2) dividends in the first three quarters of 2008 totaling $152 million, which we paid in the form of additional shares of capital stock. Retained earnings grew $40 million (14 percent) year over year to close December 31, 2008 at $326 million.
Our financial leverage, on a book-value basis, was more elevated in 2008 than in 2007. The regulatory capital-to-assets ratio averaged 4.51 percent in 2008, compared to 4.80 percent in 2007. This ratio continued to be sufficiently above the 4.00 percent regulatory minimum for us to effectively manage our financial performance, market risk exposure, and capitalization. If our financial leverage increases too much, or becomes too close to the regulatory limit, we would anticipate making changes in discretionary features of our Capital Plan to ensure our capitalization remains strong and in compliance with all regulatory limits.
We believe that in 2008 and into 2009 our liquidity position remained strong and our overall ability to fund our operations through debt issuance remained sufficient. We expect this to continue to be the case, although we can make no assurances. During the financial crisis, the FHLBank System continued to have satisfactory overall access to the capital markets for debt issuance and derivatives transactions to accommodate and fund our significant Advance activity in 2008 and to manage our market risk exposure. The System’s triple-A debt ratings and the implicit U.S. government backing of our debt were, and continue to be, instrumental in ensuring satisfactory access to the capital markets.
However, in 2008, funding costs associated with issuing long-term Consolidated Obligations became more volatile and rose sharply compared to LIBOR and U.S. Treasury securities. In addition, at various times in 2008, the System had a reduced ability to issue long-term noncallable debt Obligations at acceptable rates. As a result, we reduced our issuance of long-term debt compared to recent years while also taking prudent actions to boost our liquidity. This strategy has included decreasing term money market investments, maintaining the majority of our liquidity in overnight maturities, and lengthening the maturities of our Discount Notes. We believe the possibility for a liquidity or funding crisis in the FHLBank System that would impair our FHLBank’s ability to service our debt or pay competitive dividends is remote.
We believe that the residual exposures to market risk, capital adequacy, credit risk, and operational risk were modest in 2008 and that this will continue to be the case. We have always maintained compliance with our capital requirements, and we hold a sufficient amount of retained earnings to protect our capital stock against impairment risk and all but the most significant earnings losses. Our market risk exposure continued to be moderate and at a level consistent with our cooperative business model. We have never experienced a material operating risk event.
We believe that in 2008 we continued to have limited credit risk exposure from offering Advances, purchasing mortgage loans, making investments, and executing derivative transactions. Since our founding in 1932, we have never experienced a credit loss on any instrument and we have not established a loss reserve or taken an impairment charge for any asset. We have robust policies, strategies and processes designed to identify, manage and mitigate Advances’ credit risk, including overcollateralization requirements and a perfected first lien position for all pledged loan collateral.
Various credit enhancements on loans in the Mortgage Purchase Program protect us down to approximately a 50 percent loan-to-value level. This portfolio is comprised of conforming fixed-rate conventional loans and mortgages

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fully insured by the Federal Housing Administration. We do not hold any higher risk mortgages such as adjustable rate (ARM), interest-only, hybrid ARM, or teaser rate ARM. Although most of our money market investments are unsecured, we invest in the debt securities of highly rated, investment-grade institutions, have conservative limits on exposure to any one institution and to any one affiliated counterparty, and believe we have strong credit underwriting practices.
At December 31, 2008, 98 percent ($12,581 million) of principal balances of our mortgage-backed securities were issued by Fannie Mae or Freddie Mac, and these are now effectively guaranteed by the United States government, while only 2 percent ($304 million) of the holdings were in private-label mortgage-backed securities. Our private-label securities were all issued and purchased in 2003 and are comprised of high quality residential mortgage loans that have had a de minimis level of delinquencies and foreclosures.
Results of Operations
We believe our earnings in 2008 continued to represent a competitive return to member shareholders. The following table summarizes our results of operations and dividend rates paid for each of the last three years.
                         
    Year Ended December 31,
(Dollars in millions)   2008   2007   2006
 
                       
Net income
  $ 236     $ 269     $ 253  
 
                       
Affordable Housing Program assessments
    27       31       30  
 
                       
Return on average equity (ROE)
    5.73 %     6.87 %     6.70 %
 
                       
Return on average assets
    0.25       0.32       0.32  
 
                       
Weighted average dividend rate
    5.31       6.59       5.81  
 
                       
Average 3-month LIBOR
    2.92       5.29       5.20  
 
                       
Average overnight Federal Funds effective rate
    1.92       5.02       4.97  
 
                       
ROE versus 3-month LIBOR
    2.81       1.58       1.50  
 
                       
Dividend rate versus 3-month LIBOR
    2.39       1.30       0.61  
 
                       
ROE versus Federal Funds effective rate
    3.81       1.85       1.73  
 
                       
Dividend rate versus Federal Funds effective rate
    3.39       1.57       0.84  
Although net income and ROE decreased in 2008 versus 2007, our operations continued to generate a competitive level of profitability compared to short-term interest rates. The spreads of ROE to 3-month LIBOR and overnight Federal funds are two market benchmarks we believe our stockholders use to assess the competitiveness of the return on their capital investment in the FHLBank. The ROE spread to both of these benchmarks widened substantially in 2008 versus 2007 and 2006. Although quarterly 2008 earnings were more volatile than in the last several years, each quarter’s ROE spread to 3-month LIBOR was competitive, ranging from 1.78 percentage points to 3.63 percentage points.
The principal reason for the decrease in net income and ROE in 2008 compared to 2007 was the significantly lower interest rate environment, especially for short-term rates, that began in the third quarter of 2007 and continued throughout 2008. For example, average 3-month LIBOR decreased by 2.37 percentage points in 2008. The average overnight Federal funds effective fell even more in 2008 by 3.10 percentage points.

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The most important impact of the lower short-term interest rate environment was that it significantly decreased the amount of earnings generated from funding assets with our interest-free capital. Other material factors that lowered earnings included:
  §   the maturity of a large amount of low-cost long-term noncallable debt;
 
  §   actions we took to increase investment liquidity by raising the amount of overnight assets and extending the maturity of Discount Notes used to fund many overnight assets;
 
  §   higher net amortization of mortgage purchase premiums; and
 
  §   actions we took to reduce market risk exposure to higher long-term interest rates.
Three favorable factors partially offset the unfavorable factors, in descending order of importance.
  §   Average spreads on many assets, especially short-term and adjustable-rate assets indexed to short-term LIBOR, widened substantially in 2008 relative to their funding costs. This was primarily because the interest costs of short-term funding sources, mostly Discount Notes, improved significantly relative to short-term LIBOR. The financial crisis raised the cost of inter-bank lending, represented by LIBOR, compared to other short-term interest costs such as Discount Notes. Market participants’ perception that the System’s short-term debt was a lower risk investment, compared to other short-term investment vehicles, increased the spread between Discount Notes and LIBOR. We funded $15 billion to $20 billion of LIBOR-indexed assets with Discount Notes in 2008.
 
  §   We retired $7.0 billion of callable Bonds in early 2008 and replaced them with new Consolidated Obligations at lower interest costs.
 
  §   Average assets and capital balances expanded.
In 2008, we accrued an additional $27 million for future use in the Affordable Housing Program, a $4 million (12 percent) decrease versus 2007. The amount provided is generally set as 10 percent of earnings before the accrual and reflected our lower earnings in 2008. In addition, in 2008, our Board authorized two voluntary commitments for which a total of $4.6 million was disbursed to support other housing programs.
We paid our stockholders a 5.31 percent average annualized dividend rate in 2008. Although this was a reduction from 2007, the 2.39 percentage points spread in the 2008 average dividend rate paid relative to the average 3-month LIBOR (almost double that of 2007) continued to provide our stockholders a competitive return on capital. In the first quarter of 2009, we declared an annualized dividend rate of 4.50 percent.
In the first three quarters of 2008, we paid stock dividends and in the fourth quarter we paid a cash dividend. Our Board continues to support a preference for paying stock dividends, and we expect to do so whenever the amount of our excess stock is less than one percent of total assets (as required by a Finance Agency Regulation). We believe many members view stock dividends as providing greater value to the return on their capital investment than cash dividends. Stock dividends give members more flexibility in their financial management because, among other things, they may not be immediately taxable to members. Stock dividends enhance our financial performance more than cash dividends because they provide us with a continual source of new capital, which can support additional Mission Asset Activity, preserve our Capital Plan and capital adequacy, and help us manage financial leverage, market risk exposure and liquidity risk.
Business Outlook
Many of the specific items related to our financial condition, results of operations, and liquidity discussed throughout this document, including in Item 1A’s “Risk Factors,” directly relate to the financial crisis and economic recession, and to the federal government’s actions to attempt to mitigate these events. We believe that the net effect of these has to date been favorable for the value of membership in our FHLBank. However, we cannot predict the ultimate effects on our business. We are concerned that if the financial crisis becomes more severe and/or the recession is sharp or long lasting, or if the current or future federal government actions to mitigate these events unfavorably affect the competitiveness of our business model, there could be unfavorable consequences for our business including reductions

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in Mission Asset Activity and profitability. Our historical experience is that a recession causes our Mission Asset Activity and profitability to decrease.
Our business model is structured to be able to absorb sharp changes in our Mission Asset Activity because we can undertake commensurate reductions in our liability balances and capital, and because of our low operating expenses. If, however, several large members were to withdraw from membership or otherwise reduce activity with us, the decrease in Mission Asset Activity and/or capital could materially reduce dividend rates available to our remaining members. Notwithstanding this potential effect on profitability, we believe that a large decrease in Mission Asset Activity would not materially affect our liquidity, capital adequacy, or ability to make timely principal and interest payments on our participation in Consolidated Obligations.
In October 2008, PNC Financial Services Group, Inc. (“PNC”) announced its intention to purchase National City Bank. On December 31, 2008, National City was our second largest stockholder, second largest Advance borrower, and then largest seller of loans in the Mortgage Purchase Program. PNC Bank currently is not a member of our FHLBank and is chartered outside our Fifth District. If we ultimately lose National City as a member, we believe that event would not materially affect the adequacy of our liquidity, profitability, ability to make timely principal and interest payments on our participations in Consolidated Obligation debt and other liabilities, or ability to continue providing sufficient membership value to our members.
In the last two months of 2008 and continuing into the first quarter of 2009, commitments in the Mortgage Purchase Program increased substantially due to the significant decline in mortgage rates. We do not know if the recently elevated activity will continue. We believe that the benefits to all members from prudent growth in the Program are greater than the resulting modest increase in market risk exposure.
Potential issues with our two Supplemental Mortgage Insurance providers, especially the fact that they now have ratings below the double-A required by a Finance Agency Regulation, could decrease growth in outstanding Mortgage Purchase Program balances. However, we are continuing to emphasize both recruiting community financial institution members to the Program and increasing the number of regular sellers. We are exploring alternatives with the Finance Agency that could potentially supplement or replace the current credit enhancement structure, either temporarily or permanently, without threatening the credit risk exposure we face from the Program.
Notwithstanding these concerns, we expect our profitability and capacity to pay competitive dividends to remain competitive across a wide range of economic, business, and market rate environments. We believe that we have a modest amount of earnings exposure to lower mortgage rates because we have hedged faster mortgage prepayment speeds with a substantial amount of callable debt. However, we expect our profitability could decrease in 2009 compared to 2008 due to, among other things: 1) the extremely low level of interest rates; 2) the potential for reductions in the LIBOR-Discount Note spread, 3) Advance balances, and 4) mortgage rates (which could cause increases in net amortization of mortgage purchase premiums); and 5) the possibility of not being able to purchase mortgage-backed securities at our historical leverage levels due to the stressed mortgage markets. Except in the most extreme scenario of all these events occurring simultaneously to the most unfavorable degrees, we believe our profitability will remain competitive in 2009.
CONDITIONS IN THE ECONOMY AND FINANCIAL MARKETS
Economy
The primary external factors that affect our Mission Asset Activity and earnings are the general state and trends of the economy and financial institutions, especially in the states of our District; conditions in the financial, credit, and mortgage markets; and interest rates. As measured by Gross Domestic Product (GDP), the national economy expanded moderately in 2007 (2.0 percent); and it grew by seasonally-adjusted annual rates of 0.9 percent and 2.8 percent in the first and second quarters of 2008, respectively, before contracting by 0.5 percent in the third quarter and by 6.2 percent in the fourth quarter. Official measures indicate that the economy entered a recession in December 2007. Many believe the recession will be severe and long lasting, and exacerbated by the financial crisis.

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The financial crisis primarily resulted from:
  §   deterioration in the residential housing finance market, especially because of reductions in home prices and higher rates of delinquency and foreclosure;
 
  §   poor risk management practices at some financial institutions;
 
  §   realized and/or unrealized losses and sharp decreases in the stock values at some financial institutions, which have seriously pressured their capital adequacy, liquidity, ability to raise funds, and willingness to lend funds.
These disruptions have also resulted in, among other things, illiquidity in the credit markets and higher borrowing costs for many financial institutions as represented by short-term LIBOR widening compared with rates on short-term Federal funds and our Discount Notes.
Interest Rates
Trends in market interest rates strongly affect our earnings and strategic decisions involved in managing the tradeoffs in our market risk/return profile. Interest rates particularly affect us because 1) a large portion of our assets have short-term maturities or short-term adjustable-rate repricing terms, or are swapped to create synthetic short-term adjustable-
rate repricing terms, and 2) earnings generated from funding interest-earning assets with interest-free capital are a significant portion of our net interest income. Interest rate trends can also affect demand for our Mission Asset Activity, spreads on assets and our funding costs. The following table presents key market interest rates for the periods indicated (obtained from Bloomberg L.P.).
                                         
    Year 2008     Year 2007     Year 2006
    Average   Ending   Average   Ending   Ending
 
                                       
Federal Funds Target
    2.09 %     0.25 %     5.05 %     4.25 %     5.25 %
Federal Funds Effective
    1.92       0.14       5.02       3.06       5.17  
 
                                       
3-month LIBOR
    2.92       1.43       5.29       4.70       5.36  
2-year LIBOR
    2.95       1.48       4.91       3.81       5.17  
5-year LIBOR
    3.70       2.13       5.01       4.18       5.09  
10-year LIBOR
    4.25       2.56       5.24       4.67       5.18  
 
                                       
2-year U.S. Treasury
    2.00       0.77       4.35       3.05       4.81  
5-year U.S. Treasury
    2.79       1.55       4.42       3.44       4.69  
10-year U.S. Treasury
    3.64       2.21       4.63       4.03       4.70  
 
                                       
15-year mortgage current coupon (1)
    4.97       3.64       5.54       4.95       5.50  
30-year mortgage current coupon (1)
    5.47       3.93       5.92       5.54       5.81  
                                         
    Year 2008 by Quarter - Average
    Quarter 1   Quarter 2   Quarter 3   Quarter 4
Federal Funds Target
    3.22 %     2.08 %     2.00 %     1.06 %
Federal Funds Effective
    3.18       2.08       1.94       0.51  
 
                               
3-month LIBOR
    3.28       2.75       2.91       2.74  
2-year LIBOR
    2.82       3.26       3.39       2.32  
5-year LIBOR
    3.56       3.99       4.10       3.14  
10-year LIBOR
    4.31       4.52       4.56       3.61  
 
                               
2-year U.S. Treasury
    2.01       2.40       2.37       1.21  
5-year U.S. Treasury
    2.73       3.15       3.12       2.17  
10-year U.S. Treasury
    3.64       3.86       3.86       3.22  
 
                               
15-year mortgage current coupon (1)
    4.69       5.07       5.32       4.81  
30-year mortgage current coupon (1)
    5.36       5.58       5.80       5.14  
 
(1)   Simple average of current coupon rates of Fannie Mae and Freddie Mac mortgage-backed securities.

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Short-term interest rates began to decrease in the second half of 2007, and the reductions accelerated in 2008. By year end the Federal Reserve lowered the overnight Federal funds target rate to a range of zero to 0.25 percent. During 2008, market yield curves steepened significantly, which can benefit our earnings over time since we normally fund a portion of our long-term assets with shorter-term debt. Short-term LIBOR fell less than overnight Federal funds. Overall, considering several offsetting factors, the lower short-term interest rate environment caused our earnings to decrease but resulted in a wider spread between our ROE and short-term interest rates.
After decreasing in the last two quarters of 2007, average intermediate- and long-term rates, including mortgage rates, decreased even more in the early part of the first quarter of 2008 and then again in the fourth quarter of 2008. These rates decreased particularly by a large amount in December, as indicated in the ending rates column for 2008. The rate reductions significantly increased the amount of debt that was economically beneficial for us to call and replace at lower rates, which should continue to benefit future earnings. The December rate reductions also resulted in faster net amortization of mortgage purchase premiums as well as accelerated projections of mortgage prepayment speeds.
The effects on our earnings and market risk exposure from these interest rate trends are discussed below in the “Results of Operations” and in the “Market Risk” section of “Quantitative and Qualitative Disclosures About Risk Management.”

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ANALYSIS OF FINANCIAL CONDITION
Asset Composition Data
Mission Asset Activity includes the following components:
  §   the principal balance of Advances;
 
  §   the notional principal amount of available lines in the Letters of Credit program;
 
  §   the principal balance in the Mortgage Purchase Program; and
 
  §   the notional principal amount of Mandatory Delivery Contracts.
The following two tables show the composition of our total assets on selected dates and periods, which support the discussions in the “Executive Overview,” “Credit Services” and “Mortgage Purchase Program” sections.
Asset Composition - Ending Balances (Dollars in millions)
                                                                                                 
    2008   2007   2006
        % of   Change From           % of   Change From           % of   Change From
          Total   Prior Year           Total   Prior Year           Total   Prior Year
    Balance   Assets   Amount   Pct   Balance   Assets   Amount   Pct   Balance   Assets   Amount   Pct
             
 
                                                                                               
Advances
                                                                                               
Principal
  $ 52,799       54 %   $ (154 )     –%     $ 52,953       61 %   $ 11,011       26 %   $ 41,942       52 %   $ 1,785       4 %
Other items (1)
    1,117       1       760       213       357             343       2,450       14             (91 )     (87 )
                                           
Total book value
    53,916       55       606       1       53,310       61       11,354       27       41,956       52       1,694       4  
Mortgage loans held for portfolio                                                                        
Principal
    8,590       9       (272 )     (3 )     8,862       10       483       6       8,379       10       55       1  
Other items
    42             (24 )     (36 )     66             (16 )     (20 )     82             (12 )     (13 )
                                           
Total book value
    8,632       9       (296 )     (3 )     8,928       10       467       6       8,461       10       43       1  
 
                                                                                               
Investments
                                                                                               
 
                                                                                               
Mortgage-backed securities                                                                        
Principal
    12,897       13       740       6       12,157       14       93       1       12,064       15       (176 )     (1 )
Other items
    (28 )           (5 )     (22 )     (23 )           (14 )     (156 )     (9 )           (16 )     (229 )
                                           
 
                                                                                               
Total book value
    12,869       13       735       6       12,134       14       79       1       12,055       15       (192 )     (2 )
 
                                                                                               
Short-term money market
    22,444       23       9,917       (79 )     12,527       15       (6,009 )     (32 )     18,536       23       2,700       17  
Other long-term investments
    12             (5 )     (29 )     17             (7 )     (29 )     24             (7 )     (23 )
                                           
 
                                                                                               
Total investments
    35,325       36       10,647       43       24,678       29       (5,937 )     (19 )     30,615       38       2,501       9  
Loans to other FHLBanks
                                                                       
                                           
 
                                                                                               
Total earning assets
    97,873       100       10,957       13       86,916       100       5,884       7       81,032       100       4,238       6  
Other assets
    333             (86 )     (21 )     419             70       20       349             69       25  
                                           
 
                                                                                               
Total assets
  $ 98,206       100 %   $ 10,871       12     $ 87,335       100 %   $ 5,954       7     $ 81,381       100 %   $ 4,307       6  
                                           
 
                                                                                               
 
Other Business Activity (Notional)                                                                        
 
                                                                                               
Letters of Credit
  $ 7,917             $ 994       14     $ 6,923             $ 425       7     $ 6,498             $ 5,092       362  
 
                                                                                     
Mandatory Delivery Contracts
  $ 917             $ 869       1,810     $ 48             $ (59 )     (55 )   $ 107             $ 68       174  
 
                                                                                     
 
                                                                                               
Total Mission Asset Activity
(Principal and Notional)
$ 70,223       72 %   $ 1,437       2     $ 68,786       79 %   $ 11,860       21     $ 56,926       70 %   $ 7,000       14  
                                           
(1)   The majority of these balances are SFAS 133-related basis adjustments.

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Asset Composition – Average Balances (Dollars in millions)
                                                                                                 
    2008   2007   2006
            % of   Change From           % of   Change From           % of   Change From
            Total   Prior Year           Total   Prior Year           Total   Prior Year
    Balance   Assets   Amount   Pct   Balance   Assets   Amount   Pct   Balance   Assets   Amount   Pct
             
 
Advances
                                                                                               
Principal
  $ 59,973       64 %   $ 10,671       22 %   $ 49,302       59 %   $ 3,528       8 %   $ 45,774       58 %   $ 934       2 %
Other items (1)
    526             466       777       60             33       122       27             (207 )     (88 )
                                           
 
Total book value
    60,499       64       11,137       23       49,362       59       3,561       8       45,801       58       727       2  
Mortgage loans held for portfolio
                                                                                         
Principal
    8,621       9       (121 )     (1 )     8,742       10       417       5       8,325       11       (22 )      
Other items
    62             (13 )     (17 )     75             (13 )     (15 )     88             (7 )     (7 )
                                           
 
Total book value
    8,683       9       (134 )     (2 )     8,817       10       404       5       8,413       11       (29 )      
 
                                                                                               
 
Investments
                                                                                               
 
                                                                                               
Mortgage-backed securities                                                                        
Principal
    12,623       14       507       4       12,116       15       289       2       11,827       15       (79 )     (1 )
Other items
    (30 )           (14 )     (88 )     (16 )           (18 )     (900 )     2             (15 )     (88 )
                                           
 
Total book value
    12,593       14       493       4       12,100       15       271       2       11,829       15       (94 )     (1 )
 
Short-term money market
    12,206       13       (1,381 )     (10 )     13,587       16       545       4       13,042       16       (624 )     5  
 
Other long-term investments
    16             (3 )     (16 )     19             (7 )     (27 )     26             (7 )     (21 )
                                           
 
Total investments
    24,815       27       (891 )     (3 )     25,706       31       809       3       24,897       31       (725 )     (3 )
 
                                                                                               
Loans to other FHLBanks
    18             11       157       7             (3 )     (30 )     10             (4 )     (29 )
                                           
 
Total earning assets
    94,015       100       10,123       12       83,892       100       4,771       6       79,121       100       (31 )      
 
                                                                                               
Other assets
    342             (59 )     (15 )     401             121       43       280             42       18  
                                           
 
Total assets
  $ 94,357       100 %   $ 10,064       12     $ 84,293       100 %   $ 4,892       6     $ 79,401       100 %   $ 11        
                                           
 
Other Business Activity (Notional)
                                                                                         
 
Letters of Credit
  $ 7,894             $ 2,343       42     $ 5,551             $ 3,666       194     $ 1,885             $ 471       33  
 
                                                                                   
Mandatory Delivery Contracts
  $ 182             $ 94       107     $ 88             $ 12       16     $ 76             $ (58 )     (43 )
 
                                                                                   
 
Total Mission Asset Activity
(Principal and Notional)
  $ 76,670       81 %   $ 12,987       20     $ 63,683       76 %   $ 7,623       14     $ 56,060       71 %   $ 1,325       2  
                                           
(1)   The majority of these balances are SFAS 133-related basis adjustments.
To measure the extent of our success in achieving growth in Mission Asset Activity, we consider changes in both period-end balances and period-average balances. There can be large differences in the results of these two computations. Average data can provide more meaningful information about the ongoing condition of and trends in Mission Asset Activity and earnings than period-end data because the latter can be impacted by day-to-day volatility.
Credit Services
Credit Activity
The strong growth of average Advances balances that began in the second half of 2007 continued in 2008. As shown in the asset composition tables above, the average principal balance of Advances in 2008 increased $10,671 million (22 percent) from 2007. The strong Advance growth on an average-balance basis occurred even after former member RBS Citizens decreased its Advances, starting in the second half of 2007 and continuing in 2008, by approximately $10,000 million.
From year-end 2007 to year-end 2008, Advance principal balances were essentially flat, due primarily to reductions from several large members in the fourth quarter of 2008. The “Financial Condition” section of the “Executive Overview” discusses the reasons for the fast growth in Advances on an average-balance basis and flat change on a year-over-year basis.

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From year-end 2007 to year-end 2008, available lines in the Letters of Credit program grew $994 million (14 percent), mostly to support members’ public unit deposits. Average lines outstanding increased $2,343 million (42 percent), a growth rate three times as much as the end-of-period lines outstanding, again driven by an increased need by the membership to support public unit deposits. We earn fees on the actual amount of the available lines members use, which can be substantially less than the lines outstanding.
Advance Composition
The following tables present Advance balances by major program for each of the last three year ends and the quarter ends of 2008.
                                                 
(Dollars in millions)   2008     2007     2006  
    Balance   Percent(1)   Balance   Percent(1)   Balance   Percent(1)
     
Short-Term and Adjustable-Rate
                                               
REPO/Cash Management
  $ 5,886       11 %   $ 10,483       19 %   $ 7,728       18 %
LIBOR
    24,225       46       24,253       46       22,658       54  
       
Total
    30,111       57       34,736       65       30,386       72  
 
Long-Term
                                               
Regular Fixed-Rate
    9,722       18       6,605       13       4,450       11  
Convertible(2)
    3,479       7       3,892       7       4,485       11  
Putable(2)
    6,981       13       5,779       11       444       1  
Mortgage Related
    1,815       4       1,602       3       1,824       4  
       
Total
    21,997       42       17,878       34       11,203       27  
 
Other Advances
    691       1       339       1       353       1  
       
Total Advances Principal
    52,799       100 %     52,953       100 %     41,942       100 %
                                                 
 
Other Items
    1,117               357               14          
 
                                         
 
Total Advances Book Value
  $ 53,916             $ 53,310             $ 41,956          
 
                                         
(1)   As a percentage of total Advances principal.
(2)   Related interest rate swaps executed to hedge these Advances convert them to an adjustable-rate tied to LIBOR.
                                                                 
    December 31, 2008     September 30, 2008     June 30, 2008     March 31, 2008  
(Dollars in millions)   Balance   Pct(1)   Balance   Pct(1)   Balance   Pct(1)   Balance   Pct(1)
     
 
Short-Term and Adjustable-Rate
                                                         
REPO/Cash Management
  $ 5,886       11 %   $ 11,161       18 %   $ 9,398       17 %   $ 13,502       22 %
LIBOR
    24,225       46       29,619       47       27,673       48       28,079       46  
     
Total
    30,111       57       40,780       65       37,071       65       41,581       68  
 
                                                               
Long-Term
                                                               
Regular Fixed-Rate
    9,722       18       9,332       15       7,646       14       7,039       12  
Convertible(2)
    3,479       7       3,506       6       3,591       6       3,712       6  
Putable(2)
    6,981       13       6,894       11       6,866       12       6,803       11  
Mortgage Related
    1,815       4       1,860       3       1,800       3       1,697       3  
     
Total
    21,997       42       21,592       35       19,903       35       19,251       32  
 
                                                               
Other Advances
    691       1       208             182             142        
     
 
                                                               
Total Advances Principal
    52,799       100 %     62,580       100 %     57,156       100 %     60,974       100 %
 
                                                       
 
                                                               
Other Items
    1,117               348               364               745          
 
                                                       
 
                                                               
Total Advances Book Value
  $ 53,916             $ 62,928             $ 57,520             $ 61,719          
 
                                                       
(1)   As a percentage of total Advances principal.
(2)   Related interest rate swaps executed to hedge these Advances convert them to an adjustable-rate tied to LIBOR.
There was a noticeable shift in the composition of balances. Regular Fixed-Rate and Putable Advances grew, while REPO Advances fell. Other Advance types experienced smaller changes. REPO and LIBOR Advances normally have the most fluctuation in balances and larger members tend to use them disproportionately more than smaller members. Most of 2008’s lower ending Advance balance compared to the average balance was due to significant reductions in these two programs in the fourth quarter. This volatility can be seen in the table above showing the composition of Advances by quarter end.

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Member Advance Usage
Our Advances are concentrated among a small number of members. Concentration ratios have been relatively stable in the last several years. The following tables present the principal balances and related weighted average interest rates for our top five Advance borrowers on the dates indicated. They include affiliates that are members of our FHLBank. The decrease in average interest rates from the end of 2007 to the end of 2008 was due to the reductions in short-term interest rates.
     (Dollars in millions)
                                         
December 31, 2008   December 31, 2007
    Ending     Weighted Average           Ending     Weighted Average
Name   Balance     Interest Rate   Name     Balance     Interest Rate
 
                                       
 
U.S. Bank, N.A.
  $ 14,856       3.02 %   U.S. Bank, N.A.   $ 16,856       4.99 %
National City Bank
    6,435       2.83     Fifth Third Bank     5,539       4.73  
Fifth Third Bank
    5,639       3.18     National City Bank     4,696       5.01  
The Huntington National Bank
    2,590       1.22     The Huntington National Bank     3,085       5.10  
AmTrust Bank
    2,338       3.75     KeyBank, N.A.     2,609       4.05  
 
                                   
 
                                       
Total of Top 5
  $ 31,858       2.92    
Total of Top 5
  $ 32,785       4.89  
 
                                   
 
                                       
Total Advances (Principal)
  $ 52,799       3.00     Total Advances (Principal)   $ 52,953       4.77  
 
                                   
 
                                       
Top 5 Percent of Total
    60 %           Top 5 Percent of Total     62 %        
 
                                   
We believe that having some large members who actively use our Mission Asset Activity augments the value of membership to all members because it enables us to improve operating efficiency, increase financial leverage, enhance dividend returns, obtain favorable funding costs, and provide more competitively priced Mission Asset Activity.
Various market penetration measures suggest there continued to be a broad-based increased reliance on Advances. The number of members with outstanding Advances has fluctuated in the range of 72 to 82 percent in recent years. This percentage rose in 2008, with 79 percent of members having Advance borrowings at year-end 2008, compared to 74 percent at year-end 2007. This change represented 41 additional borrowers.
The ratio of a member’s Advance balances to its total assets is another measure of market penetration as shown in the following table. The ratios exclude nonmembers who may still have Advances outstanding.
                 
    December 31, 2008   December 31, 2007
 
               
Average Advances-to-Assets for Members
               
 
               
Assets less than $1.0 billion (674 members)
    6.11 %     5.09 %
 
               
Assets over $1.0 billion (54 members)
    5.47 %     5.84 %
 
               
All members
    6.06 %     5.14 %
The simple (unweighted) average ratio of each member’s Advances to its total assets increased in 2008. The increase in the ratio reflected members’ increased reliance on our Advances as a key source of funding and liquidity during the financial crisis. The reduction in the ratio for members with assets over $1 billion resulted from the fourth quarter reductions in Advance balances from several of our large members. This large-member ratio increased during much of 2008; for example, on September 30, 2008, the large-member ratio was 6.72 percent.
During 2008, 70 percent of our members executed a new Advance transaction, an increase from 59 percent in 2007. The number of Advances outstanding at year-end 2008 was 16,307, approximately double the largest number of Advances of any other FHLBank. The average-sized Advance was $3.2 million. We have always placed emphasis on serving all of our members by not having a minimum size constraint for most Advance programs.
Advance balances normally exhibit substantial daily and intra-period volatility, in part because of the concentration of Advances among a relatively small number of members. During 2008, the daily principal balances ranged from $51,579 million to $65,272 million. The average daily variance (in absolute value) in 2008’s Advance balances was

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$1,066 million. We believe the ability of members to quickly and cost effectively change how they use Advances is a significant source of membership value, even for those members who do not borrow from us heavily or at all. However, the high volatility can present challenges in efficiently funding Advances, managing capital leverage, and balancing Advance pricing while also generating a competitive return on capital. Advance volatility requires us to maintain a sizable short-term liquidity portfolio.
Mortgage Purchase Program (Mortgage Loans Held for Portfolio)
As shown in the asset composition tables, on both an ending-balance and average-balance basis, the total principal balances in the Mortgage Purchase Program decreased slightly in 2008 compared to 2007. The decrease mostly reflected the fact that, in the third quarter of 2007, our then largest mortgage seller, National City Bank, stopped selling us mortgage loans. Although the amount of mortgage loans held by us from National City Bank has not decreased significantly to date because prepayment speeds have been moderate, we do not expect any significant decrease in mortgage loans outstanding from National City Bank to hinder our ability to continue offering the Program to other members.
The decrease in Mortgage Purchase Program balances also reflected the economic recession and the well-known difficulties in the mortgage market, including reductions in home prices in many markets and tighter credit requirements for new mortgages. Both of these factors lowered the growth rate of mortgage originations and refinancings for most of the year. Depending on prepayment speeds and our ability to replace the expected runoff from National City with purchases from other members, Program balances may change moderately. We expect to maintain the Program at less than 15 percent of total assets. In the past five years, the Program has been approximately 10 percent of total assets.
Our focus continues to be on recruiting community-based members to participate in the Program and on increasing the number of regular sellers. In 2008, we approved 21 new members to participate in the Program and 13 additional members sold us loans for the first time.
In the last two months of 2008 and continuing into the first quarter of 2009, our purchase activity of Mandatory Delivery Contracts (i.e., mortgage commitments) increased substantially due to the significant declines in mortgage rates. As of February 28, 2009, principal plus commitments outstanding totaled $10,522 million. However, because some of the commitments purchased from December 2008 to February 2009 represent refinanced loans held in our Program, we do not expect the principal balance outstanding in the Program to increase sharply.
The following table reconciles changes in the Program’s principal balances (excluding Mandatory Delivery Contracts) in 2008.
                 
(In millions)   2008     2007  
 
               
Balance, beginning of year
  $ 8,862     $ 8,379  
Principal purchases
    1,027       1,510  
Principal paydowns
    (1,299 )     (1,027 )
 
           
 
               
Balance, end of year
  $ 8,590     $ 8,862  
 
           
We closely track the refinancing incentives of all of our mortgage assets because the mortgage prepayment option represents almost all of our market risk exposure. The principal paydowns in 2008 equated to an annual constant prepayment rate of 12 percent, compared to nine percent in 2007. The modest acceleration in 2008 prepayment speeds was due to a substantial decrease in mortgage rates in the fourth quarter of 2007 and the first quarter of 2008. However, we believe the refinancing response was somewhat muted by the difficulties in the mortgage market.

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As shown in the following table, the percentage of principal balances from members supplying 10 percent or more of total balances decreased 5 percentage points from year-end 2007 to year-end 2008. The decrease in the percentage of loans outstanding from National City Bank reflected its lack of new activity with us in the last year.
                                 
    December 31, 2008   December 31, 2007
(Dollars in millions)  
Unpaid Principal
 
% of Total
 
Unpaid Principal
 
% of Total
 
                               
National City Bank
    $   4,709       55 %     $   5,378       61 %
Union Savings Bank
    1,995       23       1,992       22  
 
                               
 
                               
Total
    $   6,704       78 %     $   7,370       83 %
 
                               
The following table presents for year-ends 2008 and 2007 the composition of the Mortgage Purchase Program’s principal balances (including Mandatory Delivery Contracts), mortgage note rates, and loan ages according to loan type.
(Dollars in millions)
                                                 
December 31, 2008            
    Conventional   FHA (Gov’t    
    30 Year   20 Year   15 Year   Total   Guaranteed)   Total
     
 
Total Unpaid Principal
  $    6,485     $ 286     $ 1,265     $ 8,036     $ 1,471     $ 9,507  
 
                                               
Percent of Total
    68%       3%       14%       85%       15%       100%  
 
                                               
Weighted Average
Mortgage Note Rate
    5.89 %     5.61 %     5.22 %     5.77 %     5.97 %     5.80 %
 
Weighted Average
Loan Age (in months)
    34       56       50       37       52       39  
                                                 
December 31, 2007            
    Conventional   FHA (Gov’t    
    30 Year   20 Year   15 Year   Total   Guaranteed)   Total
     
 
                                               
Total Unpaid Principal
  $    6,027     $ 307     $ 1,237     $ 7,571     $ 1,339     $ 8,910  
 
                                               
Percent of Total
    68 %     3 %     14 %     85 %     15 %     100 %
 
                                               
Weighted Average
Mortgage Note Rate
    6.01 %     5.61 %     5.25 %     5.87 %     5.92 %     5.88 %
 
Weighted Average
Loan Age (in months)
    29       47       49       33       52       36  
Because there were not significant amounts of paydowns or new purchases in 2008, the Program’s composition of principal balances by loan type and mortgage note rate did not change materially. The average loan age increased 3 months to 39 months, indicating a moderately, but not yet fully, seasoned portfolio.
After being relatively narrow during most of 2007, initial spreads to funding costs on new mortgage assets widened substantially in the fourth quarter of 2007. The wider spreads continued, on average, in 2008. However, net initial spreads were volatile in 2008, and average expected lifetime spreads have been narrower than initial spreads. Average expected lifetime spreads can be a more useful indication of the effect on earnings from volatility in mortgage prepayment spreads. Both the trends of wider spreads and more volatility are consistent with the difficulties in the mortgage markets and steep market yield curves.
Housing and Community Investment
Since its inception in 1990, our Affordable Housing Program has provided funding for more than 47,000 housing units. In 2008, we provided $27 million of net income for the Affordable Housing Program, which we can award to members in 2009. This represents a $4 million (12 percent) decrease from 2007. The decrease resulted from 2008’s 12 percent lower income before assessments. Including funds recaptured or de-obligated from previous years’ offerings, we set aside $40 million of funds for the Affordable Housing Program. De-obligated funds represent Affordable Housing projects for which we committed funds in prior years but which used fewer subsidies than originally

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anticipated or for projects that did not go forward. Funds are also recaptured from projects in accordance with Finance Agency Regulations. We redeploy Affordable Housing Program funds if they are not used for the purposes intended.
Of the funds available in 2008, $27 million was awarded through the two competitive offerings of the Program and $9 million was disbursed through the Welcome Home Program. The second offering of the competitive Program included $9 million in response to rising mortgage foreclosures and separately targeted vacant foreclosure related properties or areas of high foreclosure. Through Welcome Home, we funded another $9 million for our home ownership down payment assistance program. We approved 81 applications for the competitive offerings and 197 members for Welcome Home funding. In total, almost one-third of our members received approval for funding in one of the two Affordable Housing Programs.
In addition, in 2008, our Board authorized two voluntary commitments for which a total of $4.6 million was disbursed to support other housing programs. We awarded $2.5 million to members utilizing the American Dream Home Ownership Challenge Program to assist minority families and persons with special needs to become homeowners. We also awarded $2.1 million to members and 11 Fifth District non-profit housing counseling agencies to assist customers in avoiding foreclosures.
Average 2008 Advance balances in the Housing and Community Investment Program totaled $178 million for the Affordable Housing Program and $520 million for the Community Investment and Economic Development Program. These programs generally provide Advances at or near zero profit. In total, 39 percent of our members participated in one or more of our housing and community investment programs.
Investments
Money Market Investments
Short-term money market instruments consist of the following accounts on the Statements of Condition: interest-bearing deposits, securities purchased under agreements to resell, Federal funds sold, deposits held at the Federal Reserve, and certificates of deposit and bank notes in our available-for-sale or held-to-maturity portfolio. In 2008, our investment portfolio continued to provide liquidity, enhance earnings overall, and help us manage market risk and capitalization. The composition of our money market investment portfolio varies over time based on relative value considerations. Daily balances can fluctuate significantly, usually within a range of $8,000 million to $20,000 million, due to numerous factors, including changes in the actual and anticipated amount of Mission Asset Activity, liquidity requirements, net spreads, opportunities to warehouse debt at attractive rates for future use, and management of capital leverage.
In 2008, the money market balance averaged $12,206 million, a decrease of $1,381 million from 2007’s average principal balances. The decrease was related directly to the strong growth in average Advance balances and to our desire to manage financial leverage at prudent levels.
In the fourth quarter of 2008, we tended to maintain a money market balance at high levels compared to historical levels. The balance at year-end 2008 was $22,444 million. In the fourth quarter, in order to increase our asset liquidity during the financial crisis, including incorporating Finance Agency guidance to target as many as 15 days of liquidity under certain scenarios, we held larger-than-normal balances of money market investments, maintained them as overnight maturities (which historically has not been the case), and lengthened the maturity of Discount Notes used to fund many of these investments. These actions lowered our earnings. In much of the fourth quarter, most of our money market investments were held as deposits at the Federal Reserve Bank. We continued to hold high levels of liquidity in the first quarter of 2009.
Money market investments normally have one of the lowest net spreads of any of our assets, typically ranging from 5 to 15 basis points. During 2008, match-funded money market spreads tended to widen, materially so in the third and fourth quarters, due mostly to the favorable impact on our funding costs relative to LIBOR during the financial crisis. However, especially in the fourth quarter, most money market investments were not match funded. In order to augment liquidity, we shortened most of our money market investments to overnight maturities and funded them with longer-term Discount Notes. Given the upward sloping yield curve, the maturity mismatching tended to lower spreads and net income.

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Mortgage-Backed Securities
We invest in mortgage-backed securities in order to enhance profitability and to help support the housing market. Mortgage-backed securities currently comprise most of the held-to-maturity securities and all of the trading securities on the Statements of Condition. Our philosophy is to invest mostly in the mortgage-backed securities of GSEs and government agencies. We have not purchased any mortgage-backed securities issued by other entities since 2003.
In May 2008, the Finance Agency approved our request to temporarily expand our mortgage-backed security percentage by up to an additional 1.5 times regulatory capital, to a maximum of 4.5. Subsequently, we began to move the percentage above three, but we were cautious in this strategy during the third and fourth quarters, given the elevated volatility in the mortgage and agency debt markets. We purchased no mortgage-backed securities in August through December 2008. On December 31, 2008, the percentage was 2.87. At this time, because of the financial crisis, we do not know if we will further increase the percentage up to the maximum currently permitted.
The following table reconciles changes in the principal balances of mortgage-backed securities (including outstanding traded-not-settled transactions) in 2008. The principal paydowns in 2008 equated to an annual constant prepayment rate of 16 percent, the same rate for 2007.
                 
(In millions)   2008     2007  
 
               
Balance, beginning of year
  $ 12,157     $ 12,064  
Principal purchases
    2,862       2,176  
Principal paydowns
    (2,122 )     (2,083 )
 
           
Balance, end of year
  $ 12,897     $ 12,157  
 
           
The following table presents the composition of the principal balances of the mortgage-backed securities portfolio by security type, collateral type, and issuer on the dates indicated.
                 
(In millions)
December 31, 2008
December 31, 2007
 
               
Security Type
               
Collateralized mortgage obligations
  $ 5,433     $ 5,170  
Pass-throughs (1)
    7,464       6,987  
 
               
 
               
Total
  $ 12,897     $ 12,157  
 
               
 
               
Collateral Type
               
15-year collateral
  $ 5,169     $ 6,292  
20-year collateral
    3,365       2,088  
30-year collateral
    4,363       3,777  
 
               
 
               
Total
  $ 12,897     $ 12,157  
 
               
 
               
Issuer
               
GSE residential mortgage-backed securities
  $ 12,581     $ 11,782  
Ginnie Mae residential mortgage-backed securities
    12       20  
Private-label residential mortgage-backed securities
    304       355  
 
               
 
               
Total
  $ 12,897     $ 12,157  
 
               
 
(1)   On December 31, 2008 and 2007, $3 million and $4 million, respectively, of the pass-throughs were 30-year adjustable-rate mortgages. All others were 15-year or 20-year fixed-rate pass-throughs.
In 2007 and 2008, we increased the allocation of 20-year and 30-year collateral and decreased the allocation of 15-year collateral. This change was driven by our assessment that the longer term collateral types had a more favorable risk/return tradeoff and our desire to enhance the diversification of collateral types among our mortgage assets.
We continued to own no pass-throughs backed by 30-year fixed rate collateral. Because over 80 percent of Mortgage Purchase Program loans have 30-year original terms, purchasing pass-throughs with shorter than 30-year original terms is one way we diversify mortgage assets to help manage market risk exposure. We also tend to purchase the front-end prepayment tranches of collateralized mortgage obligations, which can have less market value sensitivity than other tranches. As discussed elsewhere, we have historically held a very small amount of private-label securities.

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Consolidated Obligations
Changes in Balances and Composition
Our primary source of funding and liquidity is through participating in the issuance of the System’s debt securities—Consolidated Obligations—in the capital markets. The table below presents, for the periods indicated, the ending and average balances of our participations in Consolidated Obligations.
                                                 
    (In millions)   2008     2007     2006  
    Ending     Average     Ending     Average     Ending     Average  
    Balance     Balance     Balance     Balance     Balance     Balance  
                   
 
               
Consolidated Discount Notes:
                                               
Par
  $ 49,389     $ 40,450     $ 35,576     $ 24,852     $ 22,022     $ 18,914  
Discount
    (53 )     (94 )     (139 )     (89 )     (75 )     (47 )
                   
 
                                               
Total Consolidated Discount Notes
    49,336       40,356       35,437       24,763       21,947       18,867  
                   
Consolidated Bonds:
                                               
Unswapped fixed-rate
    25,650       25,468       25,514       25,890       26,000       26,204  
Unswapped adjustable-rate
    6,424       9,638       8,143       4,670       1,974       2,764  
Swapped fixed-rate
    10,140       11,969       12,507       23,051       25,445       25,972  
                   
 
                                               
Total Par Consolidated Bonds
    42,214       47,075       46,164       53,611       53,419       54,940  
                   
 
                                               
Other items (1)
    179       62       15       (118 )     (180 )     (327 )
                   
Total Consolidated Bonds
    42,393       47,137       46,179       53,493       53,239       54,613  
                   
 
                                               
Total Consolidated Obligations (2)
  $ 91,729     $ 87,493     $ 81,616     $ 78,256     $ 75,186     $ 73,480  
                   
 
(1)   Includes unamortized premiums/discounts, SFAS 133 and other basis adjustments.
 
(2)   The 12 FHLBanks have joint and several liability for the par amount of all of the Consolidated Obligations issued on their behalves. See Note 12 of the Notes to Financial Statements for additional detail and discussion related to Consolidated Obligations. The par amount of the outstanding Consolidated Obligations of all 12 FHLBanks was (in millions) $1,251,542, $1,189,706 and $951,990 at December 31, 2008, 2007 and 2006, respectively.
All of our Obligations issued and outstanding in 2008, as in the last several years, had “plain-vanilla” interest terms. None had step-up, inverse floating rate, convertible, range, or zero-coupon structures.
Balances of the various types of Obligations can fluctuate significantly based on comparative changes in their cost levels, supply and demand conditions, Advance demand, money market investment balances, and our balance sheet management strategies. In 2008, Discount Notes increased substantially on both an average and ending balance basis, for three reasons:
  §   Because of the financial crisis, the interest cost of Discount Notes became significantly lower than the net interest cost of swapped Bonds (which create synthetic adjustable-rate funding that reprices typically monthly or quarterly) and unswapped adjustable-rate Bonds.
 
  §   Discount Notes offer greater flexibility than swapped Bonds in managing volatile Advance levels.
 
  §   As part of the efforts to increase liquidity during the financial crisis, we increased our balances of money market investments, especially those with overnight maturities, which we funded with Discount Notes.
For 2008, on an average balance basis, 46 percent of our Consolidated Obligations were shorter-term Discount Notes. This presents an elevated liquidity risk, compared to relying more on longer-term sources of Obligations. However, as discussed in various other places in this filing, we believe we have managed the incremental liquidity risk appropriately and that the risk the System would be unable to continue issuing Discount Notes is remote.
We increased the average balance of unswapped adjustable-rate Bonds to enhance diversity in funding sources and to help manage liquidity. The ability to have three different sources of short-term and adjustable-rate funding is an important component in managing our financial performance.

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The relatively stable balance of unswapped fixed-rate Bonds reflected primarily the relatively stable balance of our mortgage assets.
The following table shows the allocation on December 31, 2008 of unswapped fixed-rate Bonds according to their final remaining maturity and next call date (for callable Bonds).
                                         
    (In millions)   Year of Maturity     Year of Next Call
    Callable     Noncallable     Amortizing     Total     Callable  
           
 
               
Due in 1 year or less
  $ -     $ 3,553     $ 5     $ 3,558     $ 9,780  
Due after 1 year through 2 years
    365       3,686       5       4,056       215  
Due after 2 years through 3 years
    2,505       2,326       5       4,836       10  
Due after 3 years through 4 years
    1,025       2,315       61       3,401       -  
Due after 4 years through 5 years
    995       1,641       17       2,653       -  
Thereafter
    5,115       1,872       159       7,146       -  
         
      
   
 
                                       
Total
  $    10,005     $ 15,393     $ 252     $ 25,650     $    10,005  
         
      
   
The allocations were consistent with those in the last several years, although the final maturities are currently slightly longer than historically. The Bonds were distributed smoothly throughout the maturity spectrum. Twenty-eight percent had final remaining maturities greater than five years. These longer-term Bonds help us hedge the extension risk of long-term mortgage assets. Thirty-nine percent provide us with call options, which help manage the prepayment volatility of mortgage assets. Almost all of the callable Bonds have next call dates within the next 12 months and most of them are callable daily after an initial lockout period. As of year-end 2008, many had exceeded their final lockout dates. Daily call options provide considerable flexibility in managing market risk exposure.
Relative Cost of Funding
Obligations normally have an interest cost at a spread above that of U.S. Treasury Bills and Notes and below LIBOR. These spreads can be volatile, and in 2008 and 2007, they tended to be significantly wider and more volatile than in prior years. The financial crisis caused investors to demand significantly more relative compensation for debt securities, especially longer-term securities, issued by non-government entities. At some times in 2008, especially the fourth quarter, some Consolidated Bonds had higher interest costs than LIBOR. This is an anomaly given LIBOR’s implied double A-rating and the triple-A ratings of System Bonds.
We responded to the higher spreads on noncallable Bonds by issuing a greater percentage of callable Bonds and Discount Notes to fund new mortgage assets and long-term Advances. These Obligations did not suffer from the widening of spreads to the same extent as noncallable Bonds. At some points in the fourth quarter, rates on callable Bonds were close to, if not below, rates on noncallable Bonds. In addition, in the fourth quarter, when much of the dislocation in our debt spreads occurred, there was only a modest amount of new asset activity requiring long-term debt. Finally, the lower interest rate environment presented an opportunity for us to call many of the existing callable Consolidated Bonds and replace them with lower rate debt. Overall, we believe that neither the level nor the volatility of spreads significantly eroded our operations in 2008. See Item 1A’s “Risk Factors” and the “Executive Overview” for more discussion on the System’s debt issuance in 2008 and current capabilities and trends.
Eligible Asset Requirement
Finance Agency Regulations require us to maintain certain eligible assets free from any lien or pledge in an amount at least equal to the outstanding amount of our participation in Obligations. Eligible assets principally include Advances, loans under the Mortgage Purchase Program, mortgage-backed securities, money market investments, and deposits. The following table shows our compliance with this requirement on the dates indicated.
                   
(In millions)
December 31, 2008
 
December 31, 2007
 
               
Total Book Value Eligible Assets
  $ 98,922       $ 87,462  
Total Book Value Consolidated Obligations
    (91,729 )       (81,616 )
 
                 
 
                 
Excess Eligible Assets
  $ 7,193       $ 5,846  
 
                 

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Deposits
As shown on the Statements of Condition and the “Average Balance Sheet and Yield/Rates” table in the “Results of Operations,” the percentage growth of average and ending deposit balances increased substantially in 2008. However, they continued to be a small amount of our funding.
Derivatives Hedging Activity and Liquidity
We discuss our use of and accounting for derivatives in the “Use of Derivatives in Market Risk Management” section of “Quantitative and Qualitative Disclosures About Risk Management” and in “Critical Accounting Policies and Estimates.” We discuss our liquidity in Item 1A’s “Risk Factors,” the “Executive Overview,” and the “Liquidity Risk and Contractual Obligations” section of “Quantitative and Qualitative Disclosures About Risk Management.”
Capital Resources
Regulatory Limits on Capital Stock
The Gramm-Leach-Bliley Act of 1999 (GLB Act) and Finance Agency Regulations specify limits on how much we can leverage capital by requiring us to maintain at all times at least a 4.00 percent regulatory capital-to-assets ratio. A lower ratio indicates more leverage. We have adopted a more restrictive additional limit in our Financial Management Policy, in which we target a floor on the regulatory quarterly average capital-to-assets ratio of 4.20 percent. The following tables present our capital and capital-to-assets ratios, on both a GAAP and regulatory basis, for the periods indicated.
                                                 
    Year Ended December 31,  
(In millions)   2008     2007     2006  
 
    Year End     Average     Year End     Average     Year End     Average  
GAAP Capital Stock
  $ 3,962     $ 3,798     $ 3,473     $ 3,610     $ 3,658     $ 3,532  
SFAS 150 – Related Stock
    111       127       118       132       137       227  
 
                                   
Regulatory Capital Stock
    4,073       3,925       3,591       3,742       3,795       3,759  
Retained Earnings
    326       335       286       302       255       248  
 
                                   
Regulatory Capital
  $ 4,399     $ 4,260     $ 3,877     $ 4,044     $ 4,050     $ 4,007  
 
                                   
GAAP and Regulatory Capital-to-Assets Ratios:
                                                 
    2008   2007   2006
 
               
    Year End   Average   Year End   Average   Year End   Average
GAAP
    4.36 %     4.37 %     4.30 %     4.63 %     4.80 %     4.76 %
Regulatory
    4.48       4.51       4.44       4.80       4.98       5.05  
In 2008, we continued to comply with the limit on financial leverage. As measured by a lower average regulatory capital-to-assets ratio, our capital was more levered in 2008 compared to 2007. We believe we can continue to effectively manage the moderate additional amount of market risk exposure that has resulted from the greater leverage, which resulted from several factors:
  §   strong Advance growth beginning in the second half of 2007 and continuing for much of 2008;
 
  §   our repurchases throughout 2007 of a substantial amount of mandatorily redeemable capital stock; and
 
  §   an increase in liquidity during the financial crisis and recession, which raised the balances of money market investments.

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Changes in Capital Stock Balances
The following table presents changes in our regulatory capital stock balances in 2008 and 2007.
                 
(In millions)   2008     2007  
Regulatory stock balance at beginning of year
  $ 3,591     $ 3,795  
Stock purchases:
               
Membership stock
    72       49  
Activity stock
    303       308  
Stock dividends
    152       -  
Stock repurchases:
               
Excess stock redemption requests
    (23 )     (98 )
Other stock repurchases
    (22 )     (463 )
 
           
Regulatory stock balance at the end of the year
  $ 4,073     $ 3,591  
 
           
The $482 million increase in regulatory stock resulted principally from the growth in average Advance balances, which required some members to purchase additional activity stock. The activity stock purchases included that from one member affected by a change to our Capital Plan in March 2008, which reduced the maximum amount of our cooperative capital that any member may use to support its Mission Asset Activity. Another primary reason for the increase in regulatory stock was that we paid dividends in the first three quarters of 2008 in the form of additional shares of stock.
Excess Stock
On December 31, 2008, cooperative utilization of stock continued to provide capital for a material portion (15 percent) of Advances and Mortgage Purchase Program activity. As shown in the table below, if our Capital Plan did not have a cooperative capital feature, members would have been required to purchase an additional $368 million of stock to have the same total amount of Mission Asset Activity outstanding.
                 
(In millions)
December 31, 2008
December 31, 2007
Excess capital stock (Capital Plan definition)
  $    649     $    282  
 
               
 
               
Cooperative utilization of capital stock
  $    368     $    525  
 
               
 
               
Mission Asset Activity capitalized with cooperative capital stock
  $    9,200     $    13,129  
 
               
The Finance Agency’s Capital Rule does not permit us to pay stock dividends if the amount of our regulatory excess stock (defined by the Finance Agency to include stock cooperatively utilized in accordance with our Capital Plan) would exceed one percent of our total assets after the dividend. The following table shows for the dates indicated the amount of our regulatory excess stock. At each of the three quarter ends in 2008, we were substantially below the regulatory threshold and, therefore, paid stock dividends. At the end of the fourth quarter, we did not meet the threshold and, therefore, paid a cash dividend. We cannot predict if our excess stock will be above or below the regulatory limit in the future.
                 
(In millions)
December 31, 2008
December 31, 2007
Excess capital stock (Finance Agency definition)
  $    1,019     $    807  
 
               
Total assets
  $    98,206     $    87,335  
 
               
Regulatory limit on excess capital stock (one percent of total assets)
  $    982     $    873  
 
               
Excess capital stock (below) above regulatory limit
  $    37     $    (66 )
 
               
Retained Earnings
On December 31, 2008, stockholders’ investment in our FHLBank was supported by $326 million of retained earnings. This represented eight percent of total regulatory capital stock (including mandatorily redeemable (SFAS 150) stock) and 0.33 percent of total assets. When allocating earnings between dividends and retained earnings our Board of Directors considers the goals of paying stockholders a competitive dividend and having an adequate amount of retained earnings to mitigate impairment risk and augment future dividend stability. Severe losses exceeding the

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amount of our retained earnings could force members to recognize impairment and write down the par value of their capital stock investment. Our current Retained Earnings Policy establishes a range of retained earnings for our FHLBank of between $140 million and $285 million. We believe it is extremely unlikely for other-than-temporary losses to occur that would exceed our retained earnings and force members to recognize impairment of our capital stock.
Membership and Stockholders
On December 31, 2008, we had 728 member stockholders. During 2008, 28 institutions became new member stockholders, while 25 were lost due to mergers, for a net gain of three member stockholders. Of the members lost, 23 merged with other Fifth District members and two merged with institutions outside the Fifth District. The impact on Mission Asset Activity and earnings from these membership changes was negligible. Fluctuations in Mission Asset Activity and earnings from membership changes are a normal part of our business operations. More pronounced effects could result from the loss of one or more of our largest users.
The following tables list institutions holding five percent or more of outstanding Class B capital stock on the dates indicated. The amounts include stock held by any known affiliates that are members of our FHLBank.
(Dollars in millions)
                 
December 31, 2008
            Percent  
Name   Balance     of Total  
     
 
               
U.S. Bank, N.A.
  $ 841       21 %
National City Bank
    404       10  
Fifth Third Bank
    394       10  
The Huntington National Bank
    241       6  
AmTrust Bank
    223       5  
 
             
 
               
Total
  $ 2,103       52 %
 
             
                 
December 31, 2007 
            Percent  
Name
  Balance     of Total  
 
   
 
               
U.S. Bank, N.A.
  $ 675       19 %
Fifth Third Bank
    372       10  
National City Bank
    327       9  
The Huntington National Bank
    231       7  
AmTrust Bank
    214       6  
 
             
 
               
Total
  $ 1,819       51 %
 
             


These members’ stock holdings grew due to their increases in Advance borrowings throughout 2008 and our payment of stock dividends in the first three quarters. In addition, for U.S. Bank, N.A., the growth in stock resulted from the March 2008 change in our Capital Plan that reduced (from $200 million to $100 million) the amount of our excess stock any one member is permitted to use to capitalize its Mission Asset Activity. At the end of 2008, the top five stockholders were also the top five Advance borrowers.
Continuing a trend from prior years, at year-end 2008, the 52 percent concentration of capital stock from our five largest stockholders was somewhat less than the 60 percent concentration of the top five Advance borrowers. This is because the membership stock purchase requirement of our Capital Plan declines as a percentage of members’ assets as those assets increase. It is also due to the historical tendency of our largest members to utilize more fully the Capital Plan’s cooperative capital feature.
In October 2008, PNC Financial Services Group, Inc. (“PNC”) announced its intention to purchase National City Bank. On December 31, 2008, National City was our second largest stockholder with $404 million of our capital stock, our second largest Advance borrower with current principal outstanding of $6,435 million, and our largest historical seller of loans in the Mortgage Purchase Program with current unpaid principal balances of $4,709 million. PNC Bank is currently not a member of our FHLBank and is chartered outside our Fifth District. As of the date of this filing, National City is still a member of our FHLBank and we do not know if National City’s charter or membership in our FHLBank will be terminated because of this purchase. However, if it is, we believe that losing National City’s business would not materially affect the adequacy of our liquidity, profitability, ability to make timely principal and interest payments on our participations in Consolidated Obligation debt and other liabilities, or ability to continue providing sufficient membership value to our members. This assessment is similar to that which we made, and have subsequently experienced, when we lost one of our largest members (RBS Citizens, N.A.) in 2007 due to a consolidation of its charter outside of the Fifth District.

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The following table shows the number of member stockholders according to charter type for the period-ends presented.
                         
      December 31,  
      2008       2007       2006  
Commercial Banks
    474       480       496  
Thrifts and Savings Banks
    130       134       138  
Credit Unions
    104       98       97  
Insurance Companies
    20       13       10  
 
                       
 
                       
Total Member Stockholders
    728       725       741  
 
                       
In 2008 net membership growth came from credit unions and insurance companies. At December 31, 2008, 92 percent of all eligible commercial banks, 98 percent of all eligible thrifts and savings banks, and 50 percent of eligible credit unions with assets above $25 million were member stockholders. Therefore, there are approximately 175 Fifth District financial institutions eligible for membership that are not already members. We will continue to emphasize recruiting those non-member financial institutions that satisfy our eligibility requirements. At the end of 2008 the composition of membership by state was Ohio with 308, Kentucky with 214, and Tennessee with 206.
The table below provides a summary of member stockholders by asset size for the year-ends indicated. Most of our member stockholders are small financial institutions, with approximately 85 percent having assets up to $500 million. As noted elsewhere, having larger members, such as those with assets over $1 billion, is critical to helping achieve our mission objectives, including providing valuable products and services to all members.
                         
    December 31,  
Member Asset Size (1)
    2008       2007       2006  
 
                       
Up to $100 million
    235       242       270  
> $100 up to $500 million
    381       376       371  
> $500 million up to $1 billion
    58       57       54  
> $1 billion
    54       50       46  
 
                       
 
               
Total Member Stockholders
    728       725       741  
 
                       
 
  (1)   The December 31, 2008 membership composition reflects members’ assets as of September 30, 2008.
As shown in the following table, the allocation of our capital stock, including mandatorily redeemable capital stock, among stockholders is consistent with the allocation of the number of stockholders by type of institution. The stock outstanding to commercial banks increased substantially in 2008. The increase occurred primarily from stock purchases required to support additional Advance of those members.
                         
(In millions)   December 31,  
    2008     2007     2006  
 
                       
Commercial Banks
  $    3,053     $    2,681     $    2,946  
Thrifts and Savings Banks
    667       638       677  
Credit Unions
    94       83       83  
Insurance Companies
    149       72       40  
Other (1)
    110       117       49  
 
                 
 
                       
Total
  $    4,073     $    3,591     $    3,795  
 
                 
 
(1)   “Other” includes capital stock of members involved in mergers with non-members where the resulting institution is not a member of the FHLBank. This is considered mandatorily redeemable capital stock and is classified as a liability.

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RESULTS OF OPERATIONS
Components of Earnings and Return on Equity
The following table is a summary income statement for each of the last three years. Each ROE percentage is computed as the annualized income or expense for the category divided by the average amount of stockholders’ equity for the respective period.
                                                 
(Dollars in millions)   2008     2007     2006  
    Amount     ROE  (a)   Amount     ROE (a)    Amount     ROE  (a)
Net interest income
  $ 364       6.46 %   $ 421       7.90 %   $ 386       7.49 %
 
Net gain (loss) on derivatives and hedging activities
    2       0.03       (12 )     (0.22 )     2       0.04  
Other non-interest income
    7       0.13       6       0.11       4       0.07  
 
                                         
Total non-interest income (loss)
    9       0.16       (6 )     (0.11 )     6       0.11  
 
                                         
Total revenue
    373       6.62       415       7.79       392       7.60  
Total other expense
    (51 )     (0.89 )     (48 )     (0.92 )     (46 )     (0.90 )
Assessments
    (86 )     (b)     (98 )     (b)     (93 )     (b)
 
                                         
 
Net income
  $ 236       5.73 %   $ 269       6.87 %   $ 253       6.70 %
 
                                         
  (a)   The ROE amounts have been computed using dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) in this table may produce nominally different results.
 
  (b)   The effect on ROE of the REFCORP and Affordable Housing Program assessments is pro-rated within the other categories.
For 2008 versus 2007, almost all of the decrease in net income and ROE resulted from lower net interest income. We attribute this principally to the decrease in earnings from deployment of interest-free capital given the significantly lower short-term interest rates that began in the third quarter of 2007 and accelerated in 2008. For 2007 versus 2006, almost all of the increase in net income and ROE resulted from higher net interest income, which we attribute, primarily, to wider asset spreads due to more favorable relative funding costs and, secondarily, to growth in the average asset balances.
For 2008 versus 2007, there was a $14 million increase in the unrealized market value from accounting for derivatives under SFAS 133. We consider this amount of volatility to be moderate and consistent with the close economic hedge relationships of our derivatives. The volatility resulted from 1) the substantial movements in interest rates in 2008 and 2007, 2) our replacement of terminated swaps that had been outstanding with Lehman Brothers, and 3) modeling enhancements we made related to interest rate swaps having adjustable-rate legs tied to one-month LIBOR. For 2007 versus 2006, the $14 million decrease in the unrealized market value was due principally to the volatile interest rate environment of the third and fourth quarters of 2007.
Net Interest Income
We manage net interest income within the context of managing the tradeoff between market risk and return. Effective risk/return management requires us to focus principally on the relationships among assets and liabilities that affect net interest income, rather than individual balance sheet and income statement accounts in isolation. Our profitability tends to be low compared to many other financial institutions because of our cooperative wholesale business model, our members’ desire to have dividends correlate with short-term interest rates, and our modest overall risk profile.

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Components of Net Interest Income
We generate net interest income from two components: 1) the net interest rate spread and 2) funding interest-earning assets with interest-free capital. The sum of these, when expressed as a percentage of the average book balance of interest-earning assets, equals the net interest margin. Because of our low net interest rate spread compared to other financial institutions, we normally derive a large proportion of net interest income from deploying our capital to fund assets.
  §   Net interest rate spread. This component equals the balance of total earning assets multiplied by the difference between the book yield on interest-earning assets and the book cost of interest-bearing liabilities. It is composed of net (amortization)/accretion in accordance with SFAS 91, prepayment fees on Advances, and all other sources of earnings from interest-earning assets net of funding costs. The latter is the largest component and represents the coupon yields of interest-earning assets net of the coupon costs of Consolidated Obligations and deposits.
 
  §   Earnings from funding assets with interest-free capital (“earnings from capital”). As yields on assets funded with capital change from movements in market interest rates, earnings from deployed capital funding move in the same direction. Earnings from capital can be computed as the average capital balance multiplied by the average cost of interest-bearing liabilities.
The following table shows, for each of the last three years, the two major components of net interest income, as well as the three major subcomponents of the net interest spread.
                                                 
    2008     2007     2006  
(Dollars in millions)           Pct of             Pct of             Pct of  
            Earning             Earning             Earning  
    Amount     Assets     Amount     Assets     Amount     Assets  
Components of net interest rate spread:
                                               
Other components of net interest rate spread
  $ 253       0.27 %   $ 229       0.27 %   $ 199       0.25 %
Net (amortization)/accretion (1) (2)
    (48 )     (0.05 )     (30 )     (0.03 )     (33 )     (0.04 )
Prepayment fees on Advances, net (2)
    2             3             6       0.01  
                   
 
               
Total net interest rate spread (3)
    207       0.22       202       0.24       172       0.22  
                   
 
               
Earnings from funding assets with interest-free capital
    157       0.17       219       0.26       214       0.27  
                   
 
               
Total net interest income/net interest margin
  $ 364       0.39 %   $ 421       0.50 %   $ 386       0.49 %
                   
(1)   Includes (amortization)/accretion of premiums/discounts on mortgage assets and Consolidated Obligations and deferred transaction costs (concession fees) for Consolidated Obligations.
 
(2)   These components of net interest rate spread have been segregated here to display their relative impact.
 
(3)   Total earning assets multiplied by the difference in the book yield on interest-earning assets and book cost of interest-bearing liabilities.
2008 Versus 2007. An important factor in the $57 million decrease in total net interest income was a $62 million reduction in the earnings from capital. The lower earnings from capital resulted from the significant reductions in short-term interest rates because we tend to deploy much of our capital in short-term and adjustable-rate assets.
Net amortization expense increased $18 million. The two categories normally responsible for most of the volatility in net amortization are mortgages and callable Bonds. The net amortization of purchase premiums and discounts for mortgage assets increased $13 million in 2008, due to reductions in mortgage rates which resulted in accelerated projected mortgage prepayment speeds. (Our recognition of mortgage premiums/discounts depends on both actual and projected prepayment speeds.)
Net amortization of concession (i.e., selling) expenses and premiums/discounts associated with Consolidated Obligations increased $5 million. Most of the net increase was due to a higher balance of short-term Discount Notes, which have concession expense. However, there was a substantial amount of quarterly volatility in concession

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amortization because we called a substantial amount of Bonds in the first and fourth quarters in response to decreases in Bond rates.
Advance prepayment fees decreased $1 million. Advance prepayment fees can be, and in the past have been, significant. Prepayment fees depend mostly on the actions and preferences of members to continue holding our Advances. Fees in one period do not necessarily indicate a trend that will continue in future periods.
Excluding net amortization and Advance prepayment fees, the other components of the net interest rate spread increased $24 million. The total of the other components as a percent of earning assets was constant at 0.27 percent because the average amount of earning assets increased $10.1 billion. Several material factors affected other components, as discussed below, with their estimated impacts (some of which are difficult to determine with precision).
  §   Wider spreads on short-term assets compared to funding costs—Favorable: Beginning in the second half of 2007 and continuing throughout all of 2008, average spreads on many assets, especially short-term and adjustable-rate assets indexed to short-term LIBOR, widened substantially relative to their funding costs. This is because the interest costs of our short-term funding sources, mostly Discount Notes, improved significantly relative to short-term LIBOR. In 2008, we funded $15 billion to $20 billion of LIBOR-indexed assets with Discount Notes. The more favorable relative funding costs resulted from the financial crisis, which raised the cost of inter-bank lending, reflected in higher LIBOR, compared to Discount Notes. The LIBOR-Discount Note spread averaged 70 basis points in 2008, compared to 32 basis points in 2007 and a long-term average of 18 to 20 basis points. It was particularly wide in the fourth quarter, averaging 155 basis points.
 
      We estimate this factor raised 2008’s net interest income by $50 million to $75 million and ROE by 0.90 to 1.30 percentage points. We do not know whether, for how long, or the extent to which this factor will continue to benefit earnings. In December 2008 and continuing in the first two months of 2009, the spread between one-month LIBOR and one-month Discount Notes narrowed to below 20 basis points.
 
  §   Maturity of low cost debt—Unfavorable: One of our key strategies in managing market risk exposure is to fund mortgage assets with a mix of long-term noncallable and callable unswapped Consolidated Bonds having a wide range of final maturities. In 2008, a total of $1.8 billion of such noncallable Bonds, with a weighted average coupon of 3.70 percent, matured. These relatively low cost Bonds generally had average book costs substantially below the book yields of the mortgage assets they funded. For example, the average book yield of mortgage assets on December 31, 2008 was 5.14 percent, 1.44 percentage points above that of the maturing debt. As a result, earnings decreased because we tended to replace the mortgages paying down with new mortgages at lower initial net spreads (which ranged from approximately 0.40 percentage points to 1.00 percentage points in 2008). The impact of this factor will dissipate in 2009 and after because there are relatively fewer lower-cost Bonds maturing. We estimate this factor lowered net interest income by $20 million to $40 million and ROE by 0.35 to 0.70 percentage points.
 
  §   Large overnight asset gap—Unfavorable: In the last several years, we carried a large overnight asset gap of approximately $8 billion to $20 billion. This occurred for two reasons: 1) the preferences of some members for overnight funding and, 2) our restricting the maturities of many money market investments to overnight maturities during the financial crisis in order to increase our liquidity and provide additional mitigation of unsecured credit risk exposure. Because we have limited sources of overnight funding, we tend to fund these overnight assets with non-overnight Discount Notes having maturities of up to one year. Two market trends relative to the overnight asset gap decreased earnings in 2008: 1) overnight interest rates decreased significantly in 2008, and 2) the difference in rates between overnight assets and term Discount Notes widened in the fourth quarter. We estimate these trends lowered net interest income by $15 million to $20 million and ROE by 0.25 to 0.35 percentage points.
 
  §   Re-issuing called Consolidated Bonds at lower rates—Favorable: During the first quarter of 2008, we called $7.0 billion of unswapped Bonds and replaced them with new debt (both Bonds and Discount Notes) at lower interest rates, although we extended the final maturity of this portfolio in order to reduce long-term market risk exposure. We estimate this factor raised net interest income by $15 million to $20 million and ROE by 0.25 to 0.35 percentage points.

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  §   Growth in average asset balances—Favorable: Average total assets expanded by $10.1 billion in 2008. Most of the growth was in Advances principal balances. Based on a range of estimates of the average spreads we earned on the new assets, we estimate this factor raised annual net interest income by $10 million to $15 million and ROE by 0.18 to 0.25 percentage points.
 
  §   Higher average capital balance— Favorable: Average capital expanded by $221 million in 2008. We estimate this factor raised net interest income by $7 million to $10 million and ROE by 0.12 to 0.18 percentage points.
 
  §   Reduction in market risk exposure—Unfavorable: As discussed in the “Market Risk” section of “Quantitative and Qualitative Disclosures About Risk Management,” we lowered average market risk exposure to higher rates in 2008. Given the steep debt curve and decreases in short-term interest rates, we estimate this factor lowered net interest income by $20 million to $30 million and ROE by 0.35 to 0.50 percentage points.
2007 Versus 2006. Of the $35 million increase in 2007’s net interest income, only $5 million occurred from higher earnings from capital, which reflected the small increase in 2007’s average short-term interest rates. Net amortization improved net interest income by $3 million, which was offset by $3 million less in Advance prepayment fees.
The $30 million increase in the other components of the net interest spread, excluding net amortization and prepayment fees, was principally the result of wider spreads on short-term assets compared to funding costs. The spread between short-term LIBOR and Discount Notes widened 15 basis points in 2007 over 2006. Growth in average assets and in average capital also contributed.

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Average Balance Sheet and Yield/Rates
The following table provides yields/rates and average balances for major balance sheet accounts for each of the last three years. All data include the impact of interest rate swaps, which we allocate to each asset and liability category according to their designated hedging relationship.
                                                                         
    2008     2007     2006  
    Average             Average     Average             Average     Average             Average  
     (Dollars in millions)   Balance     Interest     Rate(1)     Balance     Interest     Rate(1)     Balance     Interest     Rate(1)  
Assets
                                                                       
Advances
  $ 60,499     $ 1,895       3.13 %   $ 49,362     $ 2,592       5.25 %   $ 45,801     $ 2,296       5.01 %
Mortgage loans held for portfolio (2)
    8,683       437       5.03       8,817       467       5.30       8,413       430       5.12  
Federal funds sold and securities purchased under resale agreements
    8,181       159       1.95       6,737       346       5.14       7,234       364       5.03  
Other short-term investments (3)
    25       1       2.93       693       37       5.33       1,201       61       5.06  
Interest-bearing deposits in banks(4)
    4,000       69       1.73       6,157       325       5.28       4,607       234       5.07  
Mortgage-backed securities
    12,593       627       4.98       12,100       580       4.79       11,829       546       4.62  
Other long-term investments
    16       1       5.01       19       1       5.72       26       1       5.77  
Loans to other FHLBanks
    18             1.79       7             4.70       10       1       4.81  
 
                                                           
Total earning assets
    94,015       3,189       3.39       83,892       4,348       5.18       79,121       3,933       4.97  
Allowance for credit losses on mortgage loans
                                                                 
Other assets
    342                       401                       280                  
 
                                                                 
Total assets
  $ 94,357                     $ 84,293                     $ 79,401                  
 
                                                                 
Liabilities and Capital
                                                                       
Term deposits
  $ 103       3       2.87     $ 131       7       5.15     $ 88       5       4.88  
Other interest bearing deposits (4)
    1,346       23       1.69       932       44       4.78       814       38       4.70  
Short-term borrowings
    40,356       947       2.35       24,763       1,235       4.99       18,867       925       4.90  
Unswapped fixed-rate Consolidated Bonds
    25,469       1,175       4.62       25,875       1,178       4.55       26,188       1,133       4.33  
Unswapped adjustable-rate Consolidated Bonds
    9,638       301       3.12       4,670       244       5.23       2,764       137       4.95  
Swapped Consolidated Bonds
    12,030       368       3.06       22,948       1,210       5.27       25,661       1,296       5.05  
Mandatorily redeemable capital stock
    127       8       6.45       132       9       6.90       227       13       5.81  
Other borrowings
    1             1.64                         3             5.26  
 
                                                           
Total interest-bearing liabilities
    89,070       2,825       3.17       79,451       3,927       4.94       74,612       3,547       4.75  
 
                                                                 
Non-interest bearing deposits
    4                       14                       1                  
Other liabilities
    1,155                       921                       1,012                  
Total capital
    4,128                       3,907                       3,776                  
 
                                                                 
Total liabilities and capital
  $ 94,357                     $ 84,293                     $ 79,401                  
 
                                                                 
Net interest rate spread
                    0.22 %                     0.24 %                     0.22 %
 
                                                                       
Net interest income and net interest margin
          $ 364       0.39 %           $ 421       0.50 %           $ 386       0.49 %
 
                                                                 
Average interest-earnings assets to interest-bearing liabilities
                    105.55 %                     105.59 %                     106.04 %
 
                                                                       
(1)   Amounts used to calculate average rates are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
 
(2)   Nonperforming loans are included in average balances used to determine average rate. There were none for the periods displayed.
 
(3)   Other short-term investments include securities classified as available-for-sale, based on their amortized costs. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders’ equity for available-for-sale securities.
 
(4)   Amounts include certificates of deposits and bank notes that are classified as held-to-maturity securities in the Statements of Condition. Additionally, the average balance amounts include the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end in accordance with FASB Staff Position No. FIN 39-1, Amendment of FASB Interpretation No. 39. See Note 1 of the Notes to Financial Statements for further information.

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For all but a few accounts, the average rate of each asset and liability category was lower in 2008 than in 2007. Most of the accounts that had lower average rates have short-term maturities or are adjustable rate, which repriced to lower rates during 2008 corresponding to the large reductions in average short-term market rates. Accounts that had higher average rates included the following:
  §   Mortgage-backed securities. Rates on new mortgages rose during the third quarter of 2007 and the second quarter of 2008. The securities we purchased in these quarters increased the account’s average rate in the 2008 periods. In addition, we made no purchases of mortgage-backed securities in the fourth quarter of 2007 or the first and fourth quarters of 2008 when rates on new mortgages were lower. Finally, net accretion increased $11 million in 2008 due to the overall lower rates on new mortgages, which resulted in projections of accelerated prepayment speeds. (We purchased most of our mortgage-backed securities at slight discounts.) This factor increased the average rate nine basis points.
 
  §   Fixed-rate Consolidated Bonds. As discussed above in “Components of Net Interest Income,” in 2008 we retired a large amount of callable Consolidated Bonds and replaced them with Bonds having lower rates. These actions lowered the average rate on this account. However, the continued maturity throughout 2007 and 2008 of a large amount of Bonds with relatively low book costs, and the additional concession expenses related to calling many of the Bonds in this account, more than offset, on a combined basis, the reduction in the book cost from calling Bonds.
Volume/Rate Analysis
Another way to consider the change in net interest income is through a standard volume/rate analysis, as presented in the following table for each of the last three years. For purposes of this table, changes in the composition of the balance sheet that are not due solely to volume or rate changes are allocated proportionately to the volume and rate factors.
                                                 
     (In millions)   2008 over 2007     2007 over 2006  
    Volume     Rate     Total     Volume     Rate     Total  
             
Increase (decrease) in interest income
                                               
Advances
  $ 584     $ (1,281 )   $ (697 )   $ 179     $ 117     $ 296  
Mortgage loans held for portfolio
    (7 )     (23 )     (30 )     21       16       37  
Federal funds sold and securities purchased under resale agreements
    74       (261 )     (187 )     (25 )     7       (18 )
Other short-term investments
    (35 )     (1 )     (36 )     (26 )     2       (24 )
Interest-bearing deposits in banks
    (114 )     (142 )     (256 )     78       13       91  
Mortgage-backed securities
    23       24       47       13       21       34  
Other long-term investments
                                   
Loans to other FHLBanks
    1       (1 )           (1 )           (1 )
             
 
               
Total
    526       (1,685 )     (1,159 )     239       176       415  
             
Increase (decrease) in interest expense
                                               
Term deposits
    (2 )     (2 )     (4 )     2             2  
Other interest bearing deposits
    20       (41 )     (21 )     5       1       6  
Short-term borrowings
    777       (1,065 )     (288 )     289       21       310  
Unswapped fixed-rate Consolidated Bonds
    (19 )     16       (3 )     (13 )     58       45  
Unswapped adjustable-rate Consolidated Bonds
    260       (203 )     57       94       13       107  
Swapped Consolidated Bonds
    (575 )     (267 )     (842 )     (137 )     51       (86 )
Mandatorily redeemable capital stock
          (1 )     (1 )     (5 )     1       (4 )
Other borrowings
                                   
             
 
               
Total
    461       (1,563 )     (1,102 )     235       145       380  
             
 
               
Increase (decrease) in net interest income
  $ 65     $ (122 )   $ (57 )   $ 4     $ 31     $ 35  
             
The rate contribution was responsible for all of the decrease in total net interest income in 2008 versus 2007. This resulted from the unfavorable factors identified above in “Components of Net Interest Income,” as well as the impact of lower short-term interest rates on the earnings from capital. The positive volume contribution was due to the expansion in total assets and capital.

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Effect of the Use of Derivatives on Net Interest Income
As explained elsewhere, the primary reason we use derivatives, most of which are interest rate swaps, is to hedge the fixed interest rates of certain Advances and Consolidated Obligations. The following table shows the effect of derivatives on our net interest income for each of the last three years.
                         
(In millions)   2008     2007     2006  
       
 
               
Advances (1)
  $ (189 )   $ 63     $ 8  
Mortgage purchase commitments (2)
          2       2  
Consolidated Obligations (1)
    69       (103 )     (269 )
       
 
               
Decrease in net interest income
  $ (120 )   $ (38 )   $ (259 )
       
(1)   Relates to interest rate swap interest.
 
(2)   Relates to the amortization of derivative fair value adjustments.
Although our overall use of derivatives lowered net interest income each year, they made our earnings and market risk profile significantly more stable because they effectively created synthetic adjustable-rate LIBOR-based coupon rates for both fixed-rate Advances and fixed-rate Obligations. The synthetic adjustable-rate Advances were funded with short-term Discount Notes and the synthetic adjustable-rate swapped Obligations. Thus, the derivatives provided a closer match of interest rate reset terms than would have occurred without their use.
For each year, the decrease in net interest income resulting from derivatives activity primarily represented the net effect of:
  §   the economic cost of hedging purchased options embedded in Advances;
 
  §   converting fixed-rate Regular Advances and Advances with below-market coupons and purchased options to at-market coupons tied to adjustable-rate LIBOR; and
 
  §   converting fixed-rate coupons to an adjustable-rate LIBOR coupon on swapped Consolidated Obligations.
The relative magnitude of each factor depended on changes in both short-term LIBOR and in the notional principal amounts of swapped Advances versus swapped Obligations. For 2008, the decrease in net interest income from our use of derivatives was primarily due to the reductions in short-term LIBOR, combined with a greater use of derivatives to transform fixed-rate Advances to adjustable-rate LIBOR than of derivatives to transform fixed-rate Obligations to adjustable-rate LIBOR. The “Use of Derivatives in Market Risk Management” section in “Quantitative and Qualitative Disclosures About Risk Management” discloses the notional principal amounts of derivatives used to hedge Advances and Obligations.

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Non-Interest Income and Non-Interest Expense
The following table presents non-interest income and non-interest expense for each of the last three years.
                         
     (Dollars in millions)   2008     2007     2006  
       
 
               
Other Income (Loss)
                       
Net gain (loss) on derivatives and hedging activities
  $ 2     $ (12 )   $ 2  
Other non-interest income, net
    7       6       4  
       
 
               
Total other income (loss)
  $ 9     $ (6 )   $ 6  
       
Other Expense
                       
Compensation and benefits
  $ 26     $ 25     $ 25  
Other operating expense
    13       13       11  
Finance Agency
    3       3       3  
Office of Finance
    3       3       2  
Other expenses
    6       4       5  
       
Total other expense
  $ 51     $ 48     $ 46  
       
 
                       
Average total assets
  $ 94,357     $ 84,293     $ 79,401  
Average regulatory capital
    4,260       4,044       4,007  
 
                       
Total other expense to average total assets(1)
    0.05%     0.06%     0.06%
Total other expense to average regulatory capital(1)
    1.18%     1.20%     1.15%
(1)   Amounts used to calculate percentages are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
The net gain (loss) on derivatives and hedging activities in 2008 is discussed above in the “Components of Earnings and Return on Equity.” Total other expenses increased a moderate $3 million. Total other expense as a percentage of average total assets and average regulatory capital continued to be one of the lowest of the FHLBanks. We continue to maintain a sharp focus on controlling our operating costs.

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Analysis of Quarterly ROE
The following table summarizes the components of 2008’s quarterly ROE and provides quarterly ROE for 2007 and 2006.
                                         
       
    1st Quarter   2nd Quarter   3rd Quarter   4th Quarter   Total  
       
Components of 2008 ROE:
                                       
Net interest income:
                                       
Other net interest income
    7.10 %     7.25 %     6.73 %     7.97 %     7.27 %
Net (amortization)/accretion
    (1.14 )     (0.33 )     (0.41 )     (1.48 )     (0.84 )
Prepayment fees
    0.02       0.03       0.06       0.03       0.03  
       
 
                                       
Total net interest income
    5.98 %     6.95 %     6.38 %     6.52 %     6.46 %
 
                                       
Net gain (loss) on derivatives and hedging activities
    (0.19 )     0.15       0.69       (0.53 )     0.03  
Other non-interest income
    0.14       0.13       0.15       0.10       0.13  
       
 
                                       
Total non-interest income (loss)
    (0.05 )     0.28       0.84       (0.43 )     0.16  
       
 
                                       
Total revenue
    5.93       7.23       7.22       6.09       6.62  
 
                                       
Total other expense
    (0.87 )     (0.85 )     (0.96 )     (0.90 )     (0.89 )
Assessments
    (a)     (a)     (a)     (a)     (a)
       
 
                                       
2008 ROE
    5.06 %     6.38 %     6.26 %     5.19 %     5.73 %
     
 
                                       
2007 ROE
    6.63 %     7.11 %     6.80 %     6.96 %     6.87 %
       
 
                                       
2006 ROE
    6.48 %     6.63 %     6.60 %     7.08 %     6.70 %
       
(a)   The effect on ROE of the REFCORP and Affordable Housing Program assessments is pro-rated within the other categories.
Quarterly ROE in 2008 was volatile, ranging from 5.06 percent to 6.38 percent, with an average of 5.73 percent. Quarterly ROE in 2007 was much less volatile. ROE in 2008 from “other net interest income” decreased substantially in the third quarter. This was due principally to a narrowing of the LIBOR-Discount Note spread to approximately 38 basis points and our actions to increase protection against market risk exposure to higher interest rates. The significant increase in this component of ROE in the fourth quarter was due mostly to the large widening of the LIBOR-Discount Note spread, which averaged 155 basis points in that quarter.
Net amortization expense was high in the first quarter of 2008 because of greater recognition of premiums on the Mortgage Purchase Program resulting from a reduction in mortgage rates and greater recognition of concessions from calling $7 billion of Bonds. Net amortization expense was also high in the fourth quarter of 2008 for the same reasons, with recognition of mortgage premiums being especially high. The net gain (loss) on derivatives and hedging activities also had a noticeable quarterly variance.
The fact that the level of quarterly ROE was significantly higher than short-term interest rates enabled us to pay competitive quarterly dividends that were less volatile than ROE.

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REFCORP and Affordable Housing Program Assessments
Currently, the combined assessments for REFCORP and the Affordable Housing Program equate to a 26.7 percent effective annualized net assessment rate. Depending on the level of the FHLBank System’s earnings, the REFCORP assessment is currently expected to be statutorily retired at some point between 2010 and 2013. Lower FHLBank System earnings would extend the retirement date.
In 2008, assessments totaled $86 million, which reduced ROE by 2.09 percentage points, compared to $98 million in 2007, which reduced ROE by 2.51 percentage points. The burden of assessments fell because net income before assessments decreased 12 percent while average capital increased six percent, which means a smaller assessment was applied over a larger capital base.
Segment Information
Note 17 of the Notes to Financial Statements presents information on our two operating business segments. It is important to note that we manage our financial operations and market risk exposure primarily at the level, and within the context, of the entire balance sheet, rather than at the level of individual operating business segments. Under this approach, the market risk/return profile of each operating business segment would not be expected to match, or possibly even have the same trends as, what would occur if we managed each segment on a stand-alone basis.
The table below summarizes each segment’s operating results for each of the last three years.
                         
(Dollars in millions)                  
    Traditional     Mortgage        
    Member     Purchase        
    Finance     Program     Total  
2008
                       
Net interest income
  $ 305     $ 59     $ 364  
 
                 
Net income
  $ 196     $ 40     $ 236  
 
                 
 
                       
Average assets
  $ 85,593     $ 8,764     $ 94,357  
 
                 
Assumed average capital allocation
  $ 3,745     $ 383     $ 4,128  
 
                 
 
                       
Return on Average Assets (1)
    0.23%     0.46%     0.25%
 
 
 
   
 
   
 
 
Return on Average Equity (1)
    5.24%     10.51%     5.73%
 
 
 
   
 
   
 
 
 
                       
2007
                       
Net interest income
  $ 331     $ 90     $ 421  
 
                 
Net income
  $ 208     $ 61     $ 269  
 
                 
 
                       
Average assets
  $ 74,226     $ 10,067     $ 84,293  
 
                 
Assumed average capital allocation
  $ 3,441     $ 466     $ 3,907  
 
                 
 
                       
Return on Average Assets (1)
    0.28%     0.61%     0.32%
 
 
 
   
 
   
 
 
Return on Average Equity (1)
    6.03%     13.10%     6.87%
 
 
 
   
 
   
 
 
 
                       
2006
                       
Net interest income
  $ 302     $ 84     $ 386  
 
                 
Net income
  $ 197     $ 56     $ 253  
 
                 
 
                       
Average assets
  $ 69,599     $ 9,802     $ 79,401  
 
                 
Assumed average capital allocation
  $ 3,310     $ 466     $ 3,776  
 
                 
 
                       
Return on Average Assets (1)
    0.28%     0.57%     0.32%
 
 
 
   
 
   
 
 
Return on Average Equity (1)
    5.95%     12.03%     6.70%
 
 
 
   
 
   
 
 
  (1)   Amounts used to calculate returns are based on numbers in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.

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Traditional Member Finance Segment
For 2008 versus 2007, the 0.79 percentage points decrease in ROE and the $12 million decrease in net income resulted from the unfavorable factors identified above for the entire balance sheet, which the favorable factors did not fully offset. The most important unfavorable factor was the decrease in earnings from capital as a result of the significantly lower short-term interest rates.
Mortgage Purchase Program Segment
For 2008 versus 2007, the 2.59 percentage points decrease in ROE and the $21 million decrease in net income resulted primarily from $24 million higher net amortization of purchase premiums. Net amortization for loans in this segment increased because rates on new mortgages decreased, which resulted in projections of accelerated prepayment speeds. (We purchased most of the mortgage loans in this segment at premiums.) This factor decreased the segment’s ROE by approximately 4.00 percentage points. Additional unfavorable factors included the maturity of a large amount of low-cost debt and lower earnings from capital, as discussed above in “Components of Net Interest Income.” These factors were offset only partially by an increase in financial leverage (which improves ROE but not net income) and re-issuance of called Consolidated Bonds at lower interest costs.
We believe the Mortgage Purchase Program will continue to provide competitive risk-adjusted returns and augment earnings available to pay member stockholders. We expect that this segment will exhibit more earnings volatility over time than the Traditional Member Finance segment. As discussed elsewhere, mortgage assets are the largest source of our market risk exposure. The effect of market risk exposure from the mortgage-backed securities in the Traditional Member Finance segment is diluted by the segment’s Advances and money market investments.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK MANAGEMENT
Overview
Residual risk is defined as the risk exposure remaining after applying our policies, controls, decisions, and procedures to manage and mitigate risk. Normally, our most significant residual risks are business/strategic risk and market risk. Currently, our most significant risks are business/strategic risk and funding/liquidity risk. We define business/strategic risk as the potential adverse impact on achievement of our mission or corporate objectives resulting from external factors and events, which we may have limited ability to control or influence. Throughout much of this document, and especially in Item 1A’s “Risk Factors” and the “Executive Overview,” we discuss current business/strategic and funding/liquidity risk factors that could be realized as a result of:
  §   the recessionary state of the overall economy and especially of our Fifth District;
 
  §   the ongoing financial crisis;
 
  §   the establishment of a new regulator for the FHLBank System;
 
  §   the placement of Fannie Mae and Freddie Mac into conservatorship;
 
  §   the issues related to the various actual and potential actions of the Federal government, including the Federal Reserve, Treasury Department and FDIC, to attempt to mitigate the financial crisis and economic recession;
 
  §   the evolving concerns about some other FHLBanks’ capital adequacy and profitability; and
 
  §   the merger of one of our largest members (National City Bank) with an institution chartered outside our Fifth District.
Our assessment is that the residual exposures for our other risks—market risk, capital adequacy, credit risk, and operational risk—were modest in 2008. Market risk exposure continued to be moderate and at a level consistent with our cooperative business model. We have always maintained compliance with our capital requirements and we believe we hold a sufficient amount of retained earnings to protect our capital stock against earnings losses and impairment risk. We continue to assess that we need no loan loss reserve for any asset class and that we have no impairment of any asset. We have never experienced a material operating risk event.

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Market Risk
Measurement and Management of Market Risk Exposure
Market risk exposure is the risk of fluctuations in both the economic value of our stockholders’ capital investment in the FHLBank and the level of future earnings from unexpected changes and volatility in the market environment (most importantly interest rates) and our business operating conditions. The economic value of capital is referred to as the market value of equity. Equity includes regulatory capital stock and retained earnings, and may also be called capital.
There is normally a tradeoff between our long-term market risk exposure and the shorter-term earnings component. We attempt to minimize long-term market risk exposure while earning a competitive return on members’ capital stock investment. We refer to this tradeoff as the “market risk/return profile.” Effective management of both components is important in order to attract and retain members and capital and to encourage growth in Mission Asset Activity.
The primary challenges in effectively managing the market risk/return profile arise from two factors:
  §   There is a tradeoff between earning a competitive return on members’ capital investment and correlating this return positively with short-term interest rates. As previously discussed, we believe member stockholders prefer to earn a dividend payable on their capital investment that tracks short-term interest rates.
 
  §   We are subject to unfavorable changes in prepayment speeds on our mortgage assets, referred to as prepayment optionality. In many market environments, prepayment optionality makes our market value of equity decrease for both higher and lower interest rates.
Because of our cooperative ownership structure, members’ competitive alternatives for funding, and our modest overall risk profile, our spreads between asset yields and debt costs tend to be narrow. We tend to hedge non-mortgage assets—Advances and money market investments—with debt having the same or similar maturities. This minimizes the market risk exposure from these assets. In order to help generate a competitive return on capital, we invest our capital in a maturity ladder of assets and normally engage in a limited amount of funding of long-term assets with shorter-term debt, which we refer to as “short funding.” These practices enable earnings to benefit from the fact that, on average over time, the yield curve has been upward sloping. However, they also normally make both the level of ROE and the market value of equity correlate inversely with the level of interest rates. The result is a tradeoff between earning a competitive return on capital and correlating ROE positively with short-term interest rates.
Unhedged changes in mortgage prepayment speeds, which comprise our largest source of residual market risk exposure, make balancing this tradeoff more difficult to achieve. Prepayment speeds change primarily in response to changes in actual and expected future mortgage interest rates. Secondarily, they change in response to changes in other factors such as the type of mortgage assets held, their final maturities, the loan age, home sales, geographical terms, and the historical pattern of the evolution of interest rates. Prepayment speeds tend to accelerate when rates fall (referred to as contraction risk) and tend to slow down when rates rise (referred to as extension risk). Changes in mortgage prepayment speeds, especially faster speeds in lower interest rate environments, generally reduce earnings and make them more volatile.
We hedge the prepayment optionality of mortgage assets mostly with long-term fixed-rate callable and noncallable Consolidated Bonds. We have not used derivatives to manage the market risk of mortgage assets, except for hedging a portion of commitments in the Mortgage Purchase Program. We attempt to hold a portfolio of Bonds that have expected cash flows similar to the aggregate cash flows expected from mortgage assets under a wide range of interest rate and prepayment environments. Because it is normally cost-prohibitive to completely hedge mortgage prepayment speeds, we do not hedge all prepayment risk.
We analyze market risk under a variety of interest rate scenarios, including stressed scenarios, and perform sensitivity analysis of the many variables that can affect market risk. While the typical assumptions in long-term market risk measures—instantaneous, permanent and parallel changes in interest rates—are important in analyzing overall market risk exposure, they are incomplete indicators of that exposure and are less helpful in guiding earnings expectations and sensitivities. They do not indicate the timing of cash flow differences between assets and liabilities, nor do they incorporate active management responses to changes in the market environment or consider the effects of changes in future business activity or the passage of time. To address these limitations, we perform additional analyses of market

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risk exposure including, among others, earnings simulations/sensitivities; key-rate duration analysis; cash flow/repricing gaps; mortgage prepayment analysis; and basis risk exposure.
We use several market risk models from third party software companies. These models enable us to analyze our financial instruments using rigorous valuation techniques of optionality, found in mortgage prepayment speeds, call and put options, and caps/floors. We regularly assess the effects of different assumptions, techniques and methodologies on the measurements of market risk exposure, including comparisons to alternative models and information from brokers/dealers. We may also, after thorough research and consideration, update these models and our assumptions and methods when market conditions and/or our business conditions change significantly. For example, in the fourth quarter of 2008, we updated our assumptions for various mortgage spreads that affect projected prepayment speeds in response to extreme variances in some of these spreads compared to their historical averages, and we revised how we estimate the market value of our callable Consolidated Bonds in response to disconnects in the market’s pricing of these Bonds.
Regulatory and Policy Limits on Market Risk Exposure
Our Financial Management Policy established by our Board of Directors specifies three sets of limits regarding market risk exposure, which primarily address long-term market risk exposure. We determine compliance with our policy limits at every month-end or more frequently if market or business conditions change significantly. We complied with each of our policy limits for market risk exposure in each month of 2008, as we did in 2007.
    Market Value of Equity Sensitivity. The market value of equity for the entire balance sheet in two hypothetical interest rate scenarios (up 200 basis points and down 200 basis points from the current interest rate environment) must be between positive and negative 15 percent of the current balance sheet’s market value of equity. The interest rate movements are “shocks,” defined as instantaneous, permanent, and parallel changes in interest rates in which every point on the yield curve is changed by the same amount.
 
    Duration of Equity. The duration of equity for the entire balance sheet in the current (“flat rate” or “base case”) interest rate environment must be between positive and negative six years. In addition, the duration of equity in up and down 200 basis points interest rate shocks must be within positive and negative eight years.
 
    Mortgage Assets Portfolio. The net market value of the mortgage assets portfolio as a percentage of the book value of portfolio assets must be between positive three percent and negative three percent in each of the up and down 200 basis points interest rate shocks. Net market value is defined here as the market value of assets minus the market value of liabilities, with no assumed capital allocation.
In addition, Finance Agency Regulations and our Financial Management Policy provide controls on market risk exposure by restricting the types of mortgage loans, mortgage-backed securities and other investments we can hold. Historically, we have not purchased a large amount of mortgage-backed securities of private-label issuers, which we believe can have more volatility in prepayment speeds than GSE mortgage-backed securities. We have tended to purchase the front-end prepayment tranches of collateralized mortgage obligations, which can have less prepayment volatility than other tranches. We also manage market risk exposure by charging members prepayment fees on many Advance programs where an early termination of an Advance would result in an economic loss to us.
Market Value of Equity and Duration of Equity – Entire Balance Sheet
Two key measures of long-term market risk exposure are the sensitivities of the market value of equity and the duration of equity to changes in interest rates and other variables.
The market value of equity is the present value of the long-term economic value of current capital, measured as the estimated market value of assets minus the estimated market value of liabilities. The market value of equity does not measure the value of our company as a going concern because it does not consider future new business activity, risk management strategies, or the net profitability of assets after funding costs. We analyze the sensitivity of the market value of equity to changes in interest rates, prepayment speeds, options prices, mortgage and debt spreads, interest rate volatility, and other market variables.
The duration of equity is a second way to measure long-term market risk exposure. Duration is a measure of price volatility. It generally indicates the expected change in an instrument’s market value from a small movement in interest rates. The duration of equity can be computed as the duration of liabilities plus the product of the amount of

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capital leverage and the duration gap (which is the difference between the duration of assets and the duration of liabilities). Capital leverage equals the market value of assets divided by the market value of equity.
For example, a positive five duration of equity indicates that the market value of equity is expected to change inversely with interest rates, such that, for example, a 100 basis points increase in all interest rates is expected to decrease the market value of equity by 5.0 percent. A negative duration, by contrast, indicates that the market value of equity is expected to change in the same direction as interest rates. The duration of equity will change as interest rates move because there will be changes in the expected cash flows of instruments with options, especially for mortgage prepayment speeds.
The following table presents the sensitivity profiles for the market value of equity and the duration of equity for the entire balance sheet for selected periods and interest rate shocks (in basis points). Average results are compiled using data for each month end.
Market Value of Equity
                                                                 
  (Dollars in millions)   Down 200   Down 100   Down 50   Flat Rates   Up 50   Up 100   Up 200
     
 
                                                       
Average Results
                                                       
2008 Full Year
                                                       
Market Value of Equity
  $ 3,698     $ 3,907     $ 3,979     $ 4,010     $ 3,998     $ 3,956     $ 3,840  
%Change from Flat Case
    (7.8 )%     (2.6 )%     (0.8 )%           (0.3 )%     (1.3 )%     (4.2 )%
2007 Full Year
                                                       
Market Value of Equity
  $ 3,781     $ 3,967     $ 3,978     $ 3,935     $ 3,860     $ 3,767     $ 3,571  
%Change from Flat Case
    (3.9 )%     0.8 %     1.1 %           (1.9 )%     (4.3 )%     (9.3 )%
 
                                                       
 
 
 
                                                       
Month-End Results
                                                       
December 31, 2008
                                                       
Market Value of Equity
  $ 3,831     $ 3,965     $ 4,060     $ 4,153     $ 4,180     $ 4,136     $ 3,924  
%Change from Flat Case
    (7.8 )%     (4.5 )%     (2.2 )%           0.7 %     (0.4 )%     (5.5 )%
December 31, 2007
                                                       
Market Value of Equity
  $ 3,477     $ 3,729     $ 3,809     $ 3,814     $ 3,765     $ 3,685     $ 3,497  
%Change from Flat Case
    (8.8 )%     (2.2 )%     (0.1 )%           (1.3 )%     (3.4 )%     (8.3 )%
Duration of Equity
                                                           
(In years)   Down 200   Down 100   Down 50   Flat Rates   Up 50   Up 100   Up 200
     
 
                                                       
Average Results
                                                       
2008 Full Year
    (5.7 )     (4.3 )     (2.4 )     (0.2 )     1.6       2.6       3.1  
2007 Full Year
    (6.3 )     (2.0 )     1.1       3.3       4.7       5.3       5.5  
 
                                                       
 
 
                                                       
Month-End Results
                                                       
December 31, 2008
    (4.2 )     (4.5 )     (4.6 )     (3.1 )     0.6       3.6       6.4  
December 31, 2007
    (7.2 )     (5.6 )     (2.3 )     1.5       3.7       5.0       5.2  
We believe our market risk exposure in 2008 continued to be moderate (not excessive) and at a level consistent with our cooperative business model. During 2008 compared to 2007, we substantially reduced the average long-term market risk exposure to higher long-term interest rates. This was indicated by smaller average losses in the market value of equity and lower average durations of equity in upward interest rate shocks. In some months of 2008, we established this exposure at its lowest level in the last five years.
In 2008, we lowered average market risk exposure to higher rates by extending the maturity of the Consolidated Bond portfolio and by issuing more long-term unswapped Bonds than purchases of mortgage assets. We took these actions to adopt a more defensive posture because of the financial crisis. These actions lowered earnings given an upward sloping yield curve and reductions in short-term interest rates, compared to the earnings that otherwise would have

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occurred. See the discussion in the “Net Interest Income” section of “Results of Operations” relating to the effect on earnings from market risk exposure changes.
Exposure to lower long-term interest rates tended to increase higher in 2008 compared to 2007, as is expected when exposure to higher rates is reduced. However, we believe the level of exposure to lower rates is moderate and does not indicate an undue exposure to lower mortgage rates and faster prepayment speeds. We do not expect our profitability to decrease significantly because of the large decreases in mortgage rates that occurred in the fourth quarter. We also do not expect profitability to decrease to uncompetitive levels if mortgage rates were to decrease by another 50 to 100 basis points for a sustained period.
As of the end of 2008, a 100 basis points decrease in all interest rates—which would put 30-year mortgage rates at historic lows of approximately four percent—would decrease the market value of equity by an estimated 4.5 percent, or $188 million. As of year end, we hedged approximately 48 percent of our mortgage assets with callable debt (or other option-based hedges). We have chosen to issue most of the Bonds with short lockouts. As a result, we can call them quickly and replace them at lower rates to rebalance market risk exposure and mitigate the unfavorable impact of accelerated prepayment speeds. The short lockouts also enable us to timely replace only a portion of the Bonds to match mortgage paydowns, while hedging most new mortgage activity. We called $2.3 billion of Bonds in December 2008, and $6.2 billion in the first two months of 2009. Many of these Bonds were replaced with debt at significantly lower rates than the rates on the Bonds called. Mortgage prepayments have not risen to the amount of the Bonds called as of the date of this filing. The amount of Bonds we have called will mitigate—but not completely offset—the lower earnings resulting from a possible large acceleration in mortgage prepayment speeds.
In December 2008, by some measures (e.g., duration of equity) market risk exposure to higher interest rates increased noticeably, compared to the average exposure for 2008. As of year end, we had replaced a substantial portion of the Consolidated Bonds that we called during December’s long-term interest rate rally with short-term Discount Notes, instead of with new long-term Bonds. One purpose of this strategy was to respond to our concern that during 2008 we had reduced market risk exposure to a level too low to be consistent with long-term competitive profitability. Given a very steep yield curve, as existed in 2008 and early 2009, the replacement of long-term debt with short-term debt is expected to substantially improve near-term earnings. Another reason for the elevated market risk exposure at year-end 2008 was the difficulty of reissuing, at acceptable levels, the same amount of Bonds that we called, because of investors’ lower demand for all types of long-term funding in the financial, credit, and general economic crisis.
The increased risk exposure at year-end 2008 was partially re-adjusted in the first two months of 2009. As we called more Bonds in January and February and as the demand for the System’s callable debt returned more towards normality, we issued more long-term Bonds that provide a greater amount of protection to higher interest rates. The following table shows the exposure as of February 28, 2009.
Market Value and Duration of Equity Sensitivity—February 28, 2009
                                                         
    Down 200   Down 100   Down 50   Flat Rates   Up 50   Up 100   Up 200
     
 
                                                       
Market Value of Equity:
                                                       
% Change from Flat Case
    (9.1 )%     (5.5 )%     (2.8 )%           1.7 %     2.0 %     0.7 %
 
                                                       
Duration of Equity
    (4.7 )     (5.6 )     (5.8 )     (4.4 )     (1.8 )     0.4       2.0  
The movements in our market risk exposure in the last several months is an example of our ability to dynamically manage our market risk exposure in response to actual and expected changes in market and business conditions.
Market Value Ratios
The ratio of the market value of equity to the book value of regulatory capital indicates the theoretical net market value of portfolio assets after subtracting the theoretical net market cost of liabilities, as a percent of regulatory capital. A ratio greater than 100 percent indicates that if we were to liquidate our balance sheet, we would be able to do so at a net gain of cash; while a ratio below 100 percent indicates that liquidation would involve a loss of cash. To the extent the ratio is lower than 100 percent, it reflects a potential reduction in future earnings from the current balance sheet. The market values used in the ratio can represent potential real economic losses, unrealized opportunity losses, or temporary fluctuations. The market value of equity does not include goodwill value or franchise value that we could

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realize in a liquidation, nor does it include the value of future business activity. Therefore, the ratio does not measure the market value of equity from the perspective of an ongoing business.
We also track the ratio of the market value of equity to the par value of regulatory capital stock. This ratio excludes the amount of retained earnings in the denominator and therefore shows the ability of the market value of equity to protect the value of stockholders’ stock investment in our company. It has the same limitations as the ratio of the market value of equity to the book value of equity.
The following table presents both of these ratios for the current (flat rate) interest rate environment for the periods indicated.
                         
            Monthly Average    
            Year Ended   Year End
    December 31, 2008   December 31, 2008   2007
 
                       
Market Value of Equity to Book Value of Equity
    94 %     94 %     93 %
 
                       
Market Value of Equity to Par Value of Capital Stock
    102 %     101 %     101 %
Both ratios support our assertion that we have a moderate amount of market risk exposure. They have been relatively nonvolatile in recent years, including in 2008. For all months of 2008, the ratio of the market value of equity to the par value of stock was close to or above 100 percent. This is consistent with our conservative risk management practices and the amount of retained earnings relative to the amount of capital stock.
Market Risk Exposure of the Mortgage Assets Portfolio
The mortgage assets portfolio accounts for almost all of our market risk exposure because of the prepayment volatility associated with mortgage assets that we cannot completely hedge while maintaining positive net spreads to funding costs for the assets. We closely analyze the mortgage assets portfolio both together with and separately from the entire balance sheet. The portfolio includes mortgage-backed securities; loans under the Mortgage Purchase Program; Consolidated Obligations we have issued to finance and hedge these assets; to-be-announced mortgage-backed securities we have sold short to hedge the market risk of Mandatory Delivery Contracts; overnight assets or funding for balancing the portfolio; and allocated capital.
We allocate equity to this portfolio using the entire balance sheet’s regulatory capital-to-assets ratio. This allocation is not necessarily what would result from an economic allocation of equity to the mortgage assets portfolio but, because it uses the same regulatory capital-to-assets ratio as the entire balance sheet, the results are comparable to the sensitivity results for the entire balance sheet.

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The following table presents the results of the net asset market value sensitivity of the mortgage assets portfolio for selected periods and interest rate shocks (in basis points).
Change in Market Value as % of Asset Book Value—Mortgage Assets Portfolio
                                                         
    Down 200   Down 100   Down 50   Flat Rates   Up 50   Up 100   Up 200
   
 
 
                                                       
Average Results
                                                       
 
                                                       
2008 Full Year
    (1.6 )%     (0.6 )%     (0.2 )%           0.0 %     (0.2 )%     (0.6 )%
 
                                                       
2007 Full Year
    (0.9 )%     0.1 %     0.2 %           (0.3 )%     (0.8 )%     (1.6 )%
 
                                                       
 
 
                                                       
Month-End Results
                                                       
 
                                                       
December 31, 2008
    (1.7 )%     (0.9 )%     (0.5 )%           0.2 %     0.0 %     (0.8 )%
 
                                                       
December 31, 2007
    (1.6 )%     (0.4 )%     0.0 %           (0.3 )%     (0.7 )%     (1.7 )%
The following table presents the sensitivities of the market value of equity of the mortgage assets portfolio for selected periods and interest rate shocks (in basis points). Average results are compiled using data for each month end.
% Change in Market Value of Equity—Mortgage Assets Portfolio
                                                         
    Down 200   Down 100   Down 50   Flat Rates   Up 50   Up 100   Up 200
   
 
 
                                                       
Average Results
                                                       
 
                                                       
2008 Full Year
    (47.4 )%     (16.5 )%     (5.4 )%           (0.4 )%     (4.6 )%     (17.7 )%
 
                                                       
2007 Full Year
    (23.9 )%     2.6 %     4.8 %           (9.3 )%     (20.9 )%     (45.4 )%
 
                                                       
 
 
                                                       
Month-End Results
                                                       
 
                                                       
December 31, 2008
    (49.4 )%     (27.4 )%     (13.4 )%           5.2 %     0.8 %     (25.0 )%
 
                                                       
December 31, 2007
    (49.3 )%     (12.0 )%     (0.7 )%           (7.6 )%     (20.0 )%     (49.9 )%
The table shows that in 2008 the market risk exposure of the mortgage assets portfolio had similar directional trends across interest rate shocks as those of the entire balance sheet, although the mortgage assets portfolio had substantially greater market risk exposure and volatility than the entire balance sheet. The 2008 trends in the entire balance sheet’s market risk exposure were concentrated within the mortgage assets portfolio. We tend to carry a negligible residual amount of long-term market risk exposure in Advances and money market investments.
Earnings Volatility
An important measure of potential earnings volatility is earnings-at-risk simulations over a multi-year horizon under various interest rate scenarios, balance sheet projections, asset spreads, risk management strategies and sensitivities of mortgage prepayment speeds.
We focus on measuring and managing expected and unexpected earnings volatility. Given our relatively low ROE, a small change in a variable that determines earnings can have a disproportionately larger effect on profitability. We expect our business will continue to generate a competitive return on member stockholders’ capital investment across a wide range of business and market economic environments. We believe our history of having manageable earnings volatility reflects our moderate overall market risk exposure. Given that we cannot completely hedge mortgage prepayment optionality at an acceptable cost, we have historically chosen to position our market risk exposure more to severe and less likely movements in interest rates, rather than to smaller and more likely rate changes.
The most significant earnings risk is a large and rapid increase in short-term interest rates or a large and rapid decrease in longer-term interest rates, especially if short-term interest rates decrease less. For some extremely severe interest rate scenarios, our profitability could be uncompetitive for an extended period of time.

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Earnings simulations performed during 2008 using a three to five year time horizon reflected the lower average market risk exposure in 2008 to higher interest rates, with a resulting reduction in earnings exposure to higher rates. We discuss our earnings exposure to lower long-term interest rates in the “Market Value of Equity and Duration of Equity – Entire Balance Sheet” section above.
Use of Derivatives in Market Risk Management
The “Use of Derivatives” section in Item 1 discusses our use of derivatives in relation to managing market risk exposure. The following table presents for the dates indicated the notional principal amounts of the derivatives used to hedge other financial instruments.
                                 
            December 31,  
     (In millions)           2008     2007     2006  
 
                               
Hedged Item
  Hedging Instrument                        
 
                               
Consolidated Obligations
  Interest rate swap   $ 10,140     $ 12,507     $ 26,485  
Convertible Advances
  Interest rate swap     3,478       3,892       4,485  
Putable Advances
  Interest rate swap     6,981       5,779       444  
Advances with purchased caps and/or floors
  Interest rate swap     1,400       2,400       10  
Regular Fixed-Rate Advances
  Interest rate swap     5,808       3,430       365  
Mandatory Delivery Contracts 
  Commitments to sell to-be-announced
mortgage-backed securities
    386       24       86  
 
                         
 
                               
Total based on hedged item (1)
          $ 28,193     $ 28,032     $ 31,875  
 
                         
     
(1)   We enter into Mandatory Delivery Contracts (commitments to purchase loans) in the normal course of business and economically hedge them with interest rate forward agreements (commitments to sell to-be-announced mortgage-backed securities). Therefore, the Mandatory Delivery Contracts (which are derivatives) are the objects of the hedge (the Hedged Item) and are not listed as a Hedging Instrument in this table.
We transact interest rate swaps to hedge the first five items in the table. The large decrease in the notional amount of swaps hedging Consolidated Obligations after 2006 reflected our strategy to decrease our use of these types of swaps and to increase the use of Discount Notes and adjustable-rate Consolidated Obligation Bonds. This strategy was a response to the relative improvements in Discount Note funding costs and a decision to enhance funding flexibility by reducing reliance on longer maturity swapped Obligations. See the “Net Interest Income” section of “Results of Operations” for more discussion.
The increase in 2007 and 2008 in swaps hedging Putable Advances reflected growth in that product line. The increase in swaps hedging regular fixed-rate Advances was the result of our decision to hedge some of these Advances (not having options) with swaps instead of Consolidated Bonds as part of our balance sheet management activities. To hedge Mandatory Delivery Contracts (i.e., commitments to purchase loans under the Mortgage Purchase Program), we use a common strategy in which we short sell, for forward settlement, to-be-announced mortgage-backed securities.

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The following table presents the notional principal amounts of derivatives according to their accounting treatment and hedge relationship. This table differs from the one above in that it displays all derivatives, including Mandatory Delivery Contracts (the hedged item) and to-be-announced mortgage-backed securities (their hedging instrument). Both of these are considered derivatives. See “Critical Accounting Policies and Estimates” for discussion of the types of accounting treatment for derivatives.
                         
(In millions)
  2008     2007     2006  
     
 
                       
Shortcut (Fair Value) Treatment
                       
Advances
  $ 8,246     $ 6,101     $ 809  
Consolidated Obligations
    860       7,942       23,470  
     
 
                       
Total
    9,106       14,043       24,279  
 
                       
Long-haul (Fair Value) Treatment
                       
Advances
    7,790       9,302       4,475  
Consolidated Obligations
    8,935       4,565       3,015  
     
 
                       
Total
    16,725       13,867       7,490  
 
                       
Economic Hedges
                       
Advances
    1,631       98       20  
Consolidated Obligations
    345              
Mandatory Delivery Contracts
    918       48       107  
To-be-announced mortgage-backed securities hedges
    386       24       86  
     
 
                       
Total
    3,280       170       213  
     
 
                       
Total Derivatives
  $ 29,111     $ 28,080     $ 31,982  
     
The 2008 increase in Advance hedges over the last year that apply shortcut accounting treatment reflected an increase in Regular Fixed-Rate Advances and Putable Advances with non-complex options. The 2007 decrease in the amount of Obligation hedges applying shortcut accounting treatment and the increase in those hedges applying long-haul treatment resulted from our decision made in the fourth quarter of 2007 to begin accounting for new Obligation hedges using the long-haul treatment.
An economic hedge is defined as the use of a derivative that economically hedges a financial instrument but that is deemed to not qualify for hedge accounting treatment. The 2008 increase in economic hedges occurred for two reasons. First, several Advance swap relationships failed effectiveness testing, which disqualified them from receiving fair value hedge accounting. These had more complex options than most of our swapped Advances. Second, sharp reductions in mortgage rates in December 2008 stimulated an increase in new mortgage commitments sold to us by members participating in the Mortgage Purchase Program, which increased Mandatory Delivery Contracts and mortgage-backed securities hedges.
Notwithstanding these changes in derivatives’ accounting treatment, the volatility in the market value of equity and earnings from our use of derivatives and application of SFAS 133 was moderate in 2008, as in prior years.
Capital Adequacy
Overview
Prudent risk management dictates that we maintain effective financial leverage to minimize risk to our capital stock while preserving profitability and that we hold an adequate amount of retained earnings. Pursuant to these objectives, Finance Agency Regulations stipulate compliance with limits on capital leverage and risk-based capital requirements.

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Capital Leverage
We must satisfy three regulatory capital requirements.
  §   We must maintain at least a 4.00 percent minimum regulatory capital-to-assets ratio.
 
  §   We must maintain at least a 5.00 percent minimum leverage ratio of capital divided by total assets, which includes a 1.5 weighting factor applicable to permanent capital. Because all of our stock is Class B stock, this requirement is met automatically if we satisfy the 4.00 percent unweighted capital requirement.
 
  §   We are subject to a risk-based capital rule, as discussed below.
We have always complied with each capital requirement. See the “Capital Resources” section of the “Analysis of Financial Condition” for information on our capital leverage compliance for 2008 and 2007.
Retained Earnings
We have a Retained Earnings Policy adopted by our Board of Directors. The Policy sets forth a range for the amount of retained earnings that we believe are needed to mitigate impairment risk and augment dividend stability in light of all the material risks we face. The current Retained Earnings Policy establishes a range of adequate retained earnings from $140 million to $285 million, with a target level of $170 million. At the end of 2008, our retained earnings were $326 million.
We believe the current amount of retained earnings is sufficient to protect our capital stock against impairment risk and to provide the opportunity for dividend stability. We also believe that our retained earnings assessment is conservative. Our methodology biases it towards measuring a higher amount of required retained earnings than we believe are needed to protect against impairment risk. In particular, we assume that all unfavorable scenarios and conditions occur simultaneously, implying that each dollar of retained earnings can serve as protection against only one risk event. This scenario is extremely unlikely to occur.
Components of Capital Plan That Promote Capital Adequacy
The GLB Act and our Capital Plan strongly promote the adequacy of our capital to absorb financial losses in three ways:
  §   the five-year redemption period for Class B stock;
 
  §   the option we have to call on members to purchase additional capital if required to preserve safety and soundness; and
 
  §   the limitations on our ability to honor requested redemptions of capital if we are at risk of not maintaining safe and sound operations.
These combine to give member stockholders a clear incentive to require us to minimize our risk profile.
Risk-Based Capital Regulatory Requirement
We must hold sufficient capital to protect against exposure to market risk, credit risk, and operational risk. One way we measure this requirement is per provisions of the GLB Act and Finance Agency Regulations that require total permanent capital, which includes retained earnings and the regulatory amount of Class B capital stock, to at least equal the amount of risk-based capital. Risk-based capital is the sum of market risk, credit risk, and operational risk as specified by the Regulations. Market risk is measured as the market value of equity at risk, determined from simulations using movements in interest rates and interest rate volatility that could occur during times of market stress, based on value-at-risk analysis. Credit risk is measured for each asset and derivative using formulaic assignments based on histories of corporate defaults for different asset classes. Operational risk is set at 30 percent of the sum of market risk and credit risk.

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The following table shows for the dates and period indicated the amount of risk-based capital required based on the measurements, the amount of permanent capital, and the amount of excess permanent capital.
                         
(Dollars in millions)  
Year End 2008
 
Monthly Average 2008
 
Year End 2007
 
                       
Market risk-based capital
 
$
237    
$
261    
$
263  
Credit risk-based capital
    181       214       207  
Operational risk-based capital
    125       143       141  
 
 
 
   
 
   
 
 
Total risk-based capital requirement
    543       618       611  
Total permanent capital
    4,399       4,260       3,877  
 
 
 
   
 
   
 
 
 
                       
Excess permanent capital
 
$
3,856    
$
3,642    
$
3,266  
 
 
 
   
 
   
 
 
 
                       
Risk-based capital as a
percent of permanent capital
    12 %     15 %     16 %
 
   
 
     
 
     
 
 
The risk-based capital requirement has historically ranged from 12 to 20 percent, which is significantly less than the amount of our permanent capital. The measured requirement has not changed materially during the financial crisis, and we expect this to continue to be the case. We do not use the requirement to actively manage our market risk exposure.
We believe our current Retained Earnings Policy is more consistent than the risk-based capital requirement relative to our overall risk exposure, risk experience, and assessment that our assets require no loan loss reserve or impairment charge. If the risk-based capital requirement were to govern the Retained Earnings Policy range, the amount of retained earnings indicated would be substantially more than what we believe would be needed to adequately protect capital stock from dividend instability and impairment risk. The primary differences between the Retained Earnings Policy and the risk-based capital requirement are the former has a smaller credit risk assessment—$26 million compared to $181 million—and a smaller operational risk assessment—$10 million (excluding our insurance coverage) compared to $125 million. The Retained Earnings Policy assumes that there is no residual credit risk exposure to Advances and the Mortgage Purchase Program, which we believe is consistent with our historical and current exposure. By comparison, at the end of 2008 the risk-based capital requirement had a credit risk assessment of $63 million for Advances and $59 million for the Mortgage Purchase Program. The Retained Earnings Policy also has a smaller credit risk assessment for investments.
Proposed Regulation on Capital Adequacy
In January 2009, the Finance Agency released an interim final rule that addresses the idea of critical capital levels and four categories of capital classification for an FHLBank. The critical capital level is two percent of total assets, below which an FHLBank would be considered critically undercapitalized. The capital classifications are based on the regulatory capital requirements listed above. Based on our analysis of the interim rule and the historical performance of our capitalization, we expect, but can provide no assurance, that the final rule will not affect our business.
Credit Risk
Overview
Credit risk is the risk of loss due to default on assets lent to or purchased from members or investment counterparties, to delayed receipt of interest and principal, or to counterparties’ nonpayment of interest due on derivative transactions. As explained below, we believe we have minimal amount of residual exposure to credit risk. Therefore, we have not established a loss reserve or taken an impairment charge for any assets.

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Credit Services
Overview. We have numerous policies and practices to manage credit risk exposure from our secured lending activities (Advances and Letters of Credit).
Although our credit risk management is risk-based in nature, our goal is to manage to a zero level of loss exposure. Despite the deterioration in the credit conditions of many of our members and of our pledged collateral, we believe that we have a minimal residual amount of credit risk exposure in our secured lending activities. We base this assessment on the following factors:
  §   a conservative approach to collateralizing credit that results in significant over-collateralization. This includes 1) systematically raising collateral margins as the financial condition of a member or of the collateral pledged deteriorates, and 2) adjusting collateral margins for sub-prime and non-traditional mortgage loans that we have identified and determined are not properly underwritten;
 
  §   a process for increasing the level of collateral perfection when the financial condition of a member deteriorates;
 
  §   close monitoring of members’ financial conditions and repayment capacities;
 
  §   a risk focused and expanded process for reviewing the quality, documentation, and administration of pledged loan collateral;
 
  §   an assessment that we have a moderate level of exposure to poorly performing subprime and nontraditional mortgages pledged as collateral; and
 
  §   a history of never experiencing a credit loss or delinquency on any Advance.
Because of these factors, we have never established a loan loss reserve for Credit Services.
Collateral. We require each member to provide us a security interest in eligible collateral before it can undertake any secured borrowing. One of our most important policy parameters is that we require each member’s borrowings to be over-collateralized. This means that each member must maintain collateral value in excess of its credit outstanding.
As of year-end 2008, the over-collaterialization resulted in a total estimated value of collateral pledged of $157.7 billion and a total borrowing capacity of $103.1 billion.
Each borrowing member must execute a Blanket Security Agreement that sets forth the necessary collateral requirements. We assign four levels of collateral status: Blanket, Securities, Listing, and Physical Delivery. We assign each member a status based on its FHLBank assigned credit rating (described below) that reflects our perception of the member’s current financial condition, capitalization, level of problem assets, and other credit risk factors.
Blanket collateral status is the least restrictive and is available for lower risk institutions. We assign it to approximately 85 percent of members. Under a Blanket status, the member borrower is not required to provide loan level detail on pledged loans. We monitor eligible collateral pledged under Blanket status using regulatory financial reports, which most members submit quarterly, or periodic collateral “Certification” documents submitted by all significant borrowers. Lower risk members that choose not to pledge loan collateral are assigned Securities status. A member under Listing collateral status must pledge, and provide us information on, specifically identified individual loans that meet certain minimum qualifications.
Physical Delivery is the most restrictive collateral status, which we assign to members experiencing significant financial difficulties, most insurance companies pledging loans, and newly chartered institutions. We apply more conservative collateral requirements for insurance company members. For example, we generally require them to deliver collateral because they do not have the backing of the FDIC or other deposit insurance funds controlled by a regulator. Newly chartered institutions are required to deliver collateral until they have developed a financial history and are trending strongly toward profitability. We require borrowers assigned to these statuses to deliver into our possession securities and/or original notes, mortgages or deeds of trust. The instruments we accept are highly restrictive and subject to a conservative valuation process.

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Our collateral is primarily 1-4 family whole first mortgages on residential property or securities representing a whole interest in such mortgages. Other eligible collateral includes:
  §   multi-family mortgage loans;
 
  §   securities issued, insured, or guaranteed by the U.S. government or any of its agencies;
 
  §   cash or deposits in the FHLBank;
 
  §   other real estate-related collateral acceptable to us, including commercial real estate loans, home equity loans, farm real estate loans, and commercial mortgage backed securities, provided that the collateral has a readily ascertainable value and we can perfect a security interest in the property; and
 
  §   non-real estate secured small business loans and agribusiness loans if the member is a Community Financial Institution.
We value listed and physically delivered loan collateral at the lesser of par or the internally-estimated market value. Securities collateral is valued using two third party providers. The market value of loan collateral pledged under a Blanket status is assumed to equal the outstanding unpaid principal balance.
We determine borrowing capacity against pledged assets by applying Collateral Maintenance Requirements (CMR), informally referred to as overcollateralization rates or “haircuts.” CMRs are discounts applied to the estimated market value of pledged collateral, primarily to capture market, credit, liquidity, and prepayment risks that may affect the realizable value of each pledged asset type. Members with a higher risk profile and/or collateral with more risky credit quality and/or performance are subjected to higher CMRs. We believe our CMR process results in conservative adjustments for all collateral types.
However, loans pledged under a Blanket status generally are haircut more aggressively than loans on which we have detailed loan structure and underwriting information, due to unknown factors which may result in the market value being significantly below the book value of the Blanket loans. In addition, for assets pledged under a Blanket arrangement, CMRs also reflect conservative restrictions on the amount of credit we will extend against a given collateral type based on the collateral’s delinquency and loss performance and the financial strength of the borrower. We may further adjust the lendable value of collateral if we identify poor credit administration practices and/or significant subprime or nontraditional mortgage loan exposure. Listed or delivered loan collateral is subjected to a regimen of discounts based on its underwriting characteristics, structure, and performance history.
Finally, we have an internal policy that we will not extend additional credit (except under the Affordable Housing or the Community Investment and Economic Development Programs) to any member, except in certain instances evaluated on a case-by-case basis, which would result in total borrowings in excess of 50 percent of its total assets.
The table below indicates the pledged collateral allocated by collateral type as of December 31, 2008, and the range of standard CMRs.
                 
    Percent of Total    
    Pledged Collateral   CMR Range
 
               
 
               
1-4 Family Residential
    58 %     125-175 %
Home Equity Loans
    25       150-400  
Commercial Real Estate
    10       150-500  
Bond Securities
    6       101-205  
Multi-Family
    1       125-150  
Farm Real Estate
    (a )     150-350  
 
               
 
               
Total
    100 %        
 
               
     
(a)   Farm real estate pledged collateral is less than one percent of total pledged collateral.

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Perfection. With certain unlikely statutory exceptions, the FHLBank Act affords any security interest granted to us by a member, or by an affiliate of a member, priority over the claims and rights of any party, including any receiver, conservator, trustee, or similar party having rights of a lien creditor. As additional security for members’ indebtedness, we have a statutory lien on their FHLBank capital stock.
Our security interest in collateral is perfected by 1) filing financing statements on each member pledging loan collateral, 2) taking possession or control of all pledged securities and cash collateral, and 3) taking physical possession of pledged loan collateral when we deem it appropriate based on a member’s financial condition. In addition, at our discretion and consistent with our Credit Policy, we are permitted to call on members to pledge additional collateral at any time during the life of a borrowing.
Credit risk exposure exists in cases of fraud by a failing institution or its employees. In addition, credit losses could occur should a regulatory agency, for an unknown reason, prevent us from liquidating our collateral position.
Subprime and Nontraditional Mortgage Loan Collateral. We have policies and processes to identify subprime loans pledged by members to which we have high credit risk exposure or have extended significant credit.
We perform on-site collateral reviews of members we deem to have high credit risk exposure, and in some cases require third parties be engaged to perform these reviews. The reviews include identification of loans that meet our definitions of subprime and nontraditional. Our definitions of a sub-prime and a non-traditional mortgage loan (NTM) are expansive and conservative. Subprime loans include loans to borrowers with Fair Isaac and Company (FICO®) scores below 640; loans with a recent delinquency history; loans to borrowers with a history of bankruptcy, foreclosure or significant judgments; and loans with high-risk underwriting characteristics in terms of FICO® score, debt-to-income ratio, and loan-to-value ratio. NTMs include interest only loans; certain hybrid, payment option and teaser rate adjustable-rate mortgages not underwritten to the fully indexed rate; negative amortization loans; stated income loans; and loans underwritten with a “piggyback” or “silent second” mortgage as a substitute for borrower equity. During the review process, we estimate overall subprime and nontraditional mortgage exposure levels by performing random statistical sampling of residential loans in the member’s pledged portfolios. We also rate each such loan based on its FICO® score, debt-to-income ratio, and loan-to-value ratio.
We increase our CMRs up to 50 additional percentage points for the identified subprime and/or NTM segment of each pledged loan portfolio. The magnitude of the adjustment depends on the risk characteristics of the subprime and/or NTM portfolios. We increase adjustments for portfolio segments having layered risk elements, for example, subprime NTMs or loans with multiple NTM characteristics. Portfolios that have low FICO® scores, relatively high loan-to-value ratios, and high debt-to income-ratios are subject to the most aggressive adjustments. As previously discussed, our standard CMRs are already risk adjusted based on the financial strength of the member institution and the performance of the portfolio pledged. Adjustments for subprime and NTM portfolios are add-ons to the standard adjustments.
Further, we apply separate adjustments to CMRs for pledged private-label residential mortgage-backed securities for which there is available information on subprime loan collateral. These haircuts increase as subprime collateral levels increase. No security known to have more than one-third subprime collateral is eligible for pledge to support additional borrowings.
For members on which we have performed on-site credit reviews, we estimate that approximately 21 percent of pledged loan collateral has one or more subprime characteristics. This estimate is likely conservative if applied to all of our members, because to date it has been based on our review of high credit risk members only. Although we have estimated NTM exposure for some members, due to the fact this is a relatively new process, we have not reviewed a sufficient number of members to offer a statistically valid estimate of exposure.

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Internal Credit Ratings of Members. We assign each borrower an internal credit rating, based on a combination of internal credit analysis and consideration of available credit ratings from independent credit rating organizations. The following tables show the distribution of internal credit ratings we assigned to member and non-member borrowers as of December 31, 2008.
   (Dollars in millions)
                                         
    All Members and Borrowing      
    Nonmembers   All Borrowers
            Collateral-Based           Credit   Collateral-Based
Credit           Borrowing           Services   Borrowing
Rating   Number   Capacity   Number   Outstanding   Capacity
 
                                     
1
    103     $ 32,690     69     $ 22,121     $ 31,778  
2
    149       5,854     107       2,353       5,236  
3
    223       23,935     196       15,278       23,442  
4
    165       23,462     142       9,001       23,227  
5
    35       10,113     26       7,250       9,957  
6
    49       2,568     46       1,789       2,511  
7
    16       4,498     14       2,924       4,473  
         
 
                                     
Total
    740     $ 103,120     600     $ 60,716     $ 100,624  
         
The left table shows the borrowing capacity (Advances and Letters of Credit) of both members and non-member borrowers. The right side includes only institutions with outstanding credit activity, which includes Advances and Letter of Credit obligations, along with their total borrowing capacity. The lower the numerical rating, the higher is our assessment of the member’s credit quality. A “4” rating is our assessment of the lowest level of satisfactory performance.
Although we believe that, overall, our members have satisfactory credit risk profiles, many of them have been unfavorably affected by the financial crisis as reflected in a significant downward trend in our member credit ratings. This trend began in the second half of 2007 and accelerated throughout 2008. As of year-end 2008, for members and borrowing nonmembers: 100 (14 percent of the total) had credit ratings of 5 or below, with $17,179 million of borrowing capacity (17 percent of total borrowing capacity); 475 (64 percent) had one of the top three credit ratings; and 165 (22 percent) had a “4” credit rating. By contrast, as of year-end 2007, the 43 members and borrowing nonmembers had credit ratings of 5 and below, 580 had one of the top three credit ratings, and 115 had a “4” credit rating. Between the end of 2007 and the end of 2008, through our standard credit rating process, we moved a net of 57 institutions, including a few of our largest members, and $10,353 million of borrowing capacity into one of the three lowest credit rating categories.
The credit ratings are one factor we use to determine collateral borrowing capacity based on the CMR process. A reduction in a member’s credit rating can decrease members’ borrowing capacity, remove its ability to be under a blanket pledge, require the member to deliver collateral to us in custody, and/or require the member to provide an increased level of detail on pledged loan assets. We also more closely monitor members with lower credit ratings. In 2008, based on the deterioration in many members’ credit ratings, we implemented all of these actions to ensure that our collateral continued to effectively mitigate credit risk from Advances.

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Mortgage Purchase Program
Overview. We believe that the residual amount of credit risk exposure to loans in the Mortgage Purchase Program is de minimis and that it is probable we will be able to collect all principal and interest amounts due according to contractual terms. We base this assessment on the following factors:
  §   the strong credit enhancements for conventional loans;
 
  §   the U.S. government insurance on FHA mortgage loans;
 
  §   no credit losses experienced on any purchased loan since inception of the Program;
 
  §   minimal delinquencies and defaults experienced in the Program’s loan portfolio;
 
  §   loan characteristics consistent with favorable expected credit performance; and
 
  §   no member or Supplemental Insurance provider having experienced a loss on any loan sold to us.
Because of these factors, we have not established a loan loss reserve for the Program, and we have determined that we have no mortgage loans that are impaired.
Credit Enhancements. We use similar credit underwriting standards and processes for approving members to participate in the Mortgage Purchase Program as for members who borrow Advances. Our primary management of credit risk for conventional loans involves the collateral supporting the mortgage loans (i.e., homeowners’ equity) and several layers of credit enhancement. The credit enhancements, listed in order of priority, include:
  §   primary mortgage insurance (when applicable);
 
  §   the Lender Risk Account; and
 
  §   Supplemental Mortgage Insurance coverage on a loan-by-loan basis that the participating financial institution (PFI) purchases from one of our approved third party providers naming us the beneficiary.
The combination of homeowners’ equity and the credit enhancements protect us down to approximately a 50 percent loan-to-value level, subject, in certain cases, to an aggregate stop-loss feature in the Supplemental Mortgage Insurance policy. This means that the loan’s current value (observed from a sale price or appraisal) can fall to half of its value at the time the loan was originated.
Finance Agency Regulations require that the combination of mortgage loan collateral and credit enhancements be sufficient to raise the implied credit ratings on pools of conventional mortgage loans to at least an investment-grade rating of AA. We analyze all pools using a credit assessment model licensed from Standard & Poor’s, and each meets this requirement when the pool is closed. If the implied rating falls below AA, Regulations require us to hold additional risk-based capital to help mitigate the perceived additional credit risk. As estimated by the current versions of this model, we have six pools totaling $1.7 billion that fall short of a AA rating, which has resulted in an increase of $9 million in our risk-based capital.
Lender Risk Account. The Lender Risk Account is a key feature that helps protect us against credit losses on conventional mortgage loans. It is a performance-based purchase price holdback from the PFI on each conventional loan the PFI sells to the FHLBank. Therefore, it provides members an incentive to sell us high quality loans. These funds are available to cover credit losses in excess of the borrower’s equity and primary mortgage insurance on loans in the pool we have purchased.
We assign each PFI a separate Lender Risk Account percentage, which we may vary over time for the PFI on separate Master Commitment Contracts. The percentage amount of the Lender Risk Account is based on our determination, made at the time a Master Commitment Contract is established, of the losses we expect on the loans to be delivered under that Contract. The percentages range from 30 basis points to 50 basis points of the loans’ purchased principal balance.
We use the Standard & Poor’s credit model, approved by the Finance Agency, to determine the Lender Risk Account percentage to apply to each PFI and to manage the credit risk of committed and purchased conventional loans. This model evaluates the characteristics of the loans the PFIs commit to deliver and the loans actually delivered to us for

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the likelihood of timely payment of principal and interest. It assigns a credit score based on numerous standard borrower attributes, such as the loan-to-value ratio, loan purpose (purchase of home, refinance, or cash-out refinance), quality and quantity of documentation, income and debt expense ratios, and credit scores.
If conventional loan losses, on a loan-by-loan basis, exceed homeowner’s equity and applicable primary mortgage insurance, the proceeds from the Lender Risk Account are drawn on to cover our exposure to these residual losses until the Account is exhausted. Any portion of the Account not needed to help cover actual loan losses in excess of homeowner’s equity and any applicable primary mortgage insurance is distributed to the PFI over a pre-determined schedule set forth in the Master Commitment Contract. Distribution normally begins five years after the Contract is filled and ends after the eleventh year. Once a Contract has been outstanding for more than 11 years, a Lender Risk Account balance is no longer maintained for that pool. If losses occur after scheduled payments from the Account are made to the PFI, such funds are no longer available to cover the losses.
The following table presents changes in the Lender Risk Account in 2008 and 2007. The amount of loss claims was less than $1 million. Since inception of the Program, loss claims have used 2.1 percent of the Lender Risk Account.
                 
(In millions)   2008     2007  
 
               
Lender Risk Account at beginning of year
  $ 50     $ 46  
Additions
    3       5  
Claims
    (1 )      
Scheduled distributions
    (3 )     (1 )
 
           
 
               
Lender Risk Account at end of year
  $ 49     $ 50  
 
           
Loan Characteristics and Credit Performance. Two indications of credit quality are loan-to-value ratios and credit scores provided by Fair Isaac and Company (FICO®). FICO® provides a commonly used measure to assess a borrower’s credit quality, with scores ranging from a low of 300 to a high of 850. Our policy stipulates that we will not purchase conventional loans with a FICO® score of less than 620. In addition, for a loan with a cash-out refinancing (in which the mortgagee receives a portion of the property’s equity as cash at the closing of the loan), we require higher FICO® scores if the loan-to-value ratio is above certain thresholds. In current market conditions, the mortgage industry generally considers a FICO® score of over 660, and a loan-to-value ratio of 80 percent or lower, as benchmarks indicating a good credit risk
The following table shows two measures of the conventional loan portfolio’s credit quality as of the dates indicated. The percents are of total principal balances. The distributions are based on data from the origination dates of the loans weighted by unpaid principal.
                                     
    December 31,     December 31,
Loan-to-Value
  2008   2007
FICO® Score
  2008   2007
 
                                 
<= 60%
    21 %     21 % < 620     0 %     0 %
> 60% to 70%
    18       18   620 to < 660     4       4  
> 70% to 80%
    53       53   660 to < 700     10       10  
> 80% to 90%
    5       5   700 to < 740     18       19  
> 90%
    3       3   >= 740     68       67  
 
                                 
Weighted Average
    70 %     70 %  
Weighted Average
    752       751  
The distributions and averages for each category were virtually the same at year-end 2008 as in the prior several years. These measures are indications that the Mortgage Purchase Program has a strong credit quality. Only four percent of our mortgage loans had a FICO® score below 660. Based on the available data, we believe we have very little exposure to loans in the Program considered to have individual characteristics of “subprime” or “alternative/nontraditional” loans. Further, we do not knowingly purchase any loan that violates the terms of our Anti-Predatory Lending Policy.

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The geographical allocation of loans in the Program is concentrated in the Midwest, as shown on the following table based on unpaid principal balance.
                 
    December 31,
    2008   2007
Midwest
    52 %     48 %
Southeast
    24       25  
Southwest
    11       12  
West
    7       8  
Northeast
    6       7  
 
               
 
               
Total
    100 %     100 %
 
               
Midwest includes the states of IA, IL, IN, MI, MN, ND, NE, OH, SD, and WI.
Southeast includes the states of AL, DC, FL, GA, KY, MD, MS, NC, SC, TN, VA, and WV
Southwest includes the states of AR, AZ, CO, KS, LA, MO, NM, OK, TX, and UT
West includes the states of AK, CA, GU, HI, ID, MT, NV, OR, WA, and WY
Northeast includes the states of CT, DE, MA, ME, NH, NJ, NY, PA, PR, RI, VI, and VT.
The allocation has been relatively stable in the last several years. Loans are underrepresented in the Northeast and West, regions that historically have had the most exposure to credit problems including foreclosures and housing price declines. In addition, less than two percent of total loans were originated in the depressed real-estate market of Florida.
The Program has loans dispersed across many states. However, loans are heavily concentrated in Ohio, which represented 38 percent of unpaid principal as of December 31, 2008. No other state had more than six percent of unpaid principal. The concentration of loans in Ohio is because our largest historical seller was headquartered in Ohio, which has had one of the highest state foreclosure rates in the few years. One thing we do to mitigate this concentration risk is to emphasize purchases of mortgage-backed securities whose loans are not heavily originated in Ohio. Delinquency rates on our Ohio loans have not increased materially and are significantly lower than the delinquency rates overall for Ohio’s prime, fixed-rate mortgages.
Of our 1-4 family residential loans in the Program at December 31, 2008, single-family detached properties represented 82 percent of unpaid principal, with Planned Unit Development properties having 14 percent and low-rise condos having 4 percent. All other property types were less than one percent of unpaid principal. Single-family detached properties are considered to have the lowest credit risk.
Another indication of the Program’s strong credit quality is the relatively low amount of actual delinquencies and foreclosures. An analysis of loans past due 90 days or more or in foreclosure is presented below. For comparison, the table shows the same data nationally, based on a nationally recognized December 31, 2008 delinquency survey.
                 
    Mortgage Purchase Program

    2008   2007
Delinquencies past due 90 days or more, or in foreclosure:
               
 
               
Conventional mortgage loans
    0.5  %     0.2  %    
 
               
FHA mortgage loan
    2.9       2.6  
 
    National Averages

    2008   2007
Delinquencies past due 90 days or more, or in foreclosure:
               
 
               
Conventional mortgage loans
    2.3  %     1.0  %
 
               
FHA mortgage loan
    6.6       5.5  
During the financial crisis, our delinquency/foreclosure rates on both conventional and FHA loans continued to be well below the national averages. Because of the Program’s credit enhancements, we do not expect to have to pay claims on any loans that become foreclosed. For government-insured (FHA) mortgages, the delinquency rate is

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generally higher than for the conventional mortgages held in the Program. We rely on government insurance, which generally provides a 100 percent guarantee, as well as quality control processes, to maintain the credit quality of the FHA portfolio.
In 2008, we instituted a credit risk analysis for conventional loans, on a loan-by-loan basis, to determine if any projected claims on loans 60 days or more delinquent would be significant enough to exhaust all the credit enhancements. The analysis uses extremely conservative and unlikely assumptions, primarily that 100 percent of loans 60 days or more delinquent will result in a default claim. The results of the analysis for year-end 2008 show that there would be no loss from any of these loans that would exceed the combined credit enhancements.
Other Information on Credit Risk. The following table presents as of December 31, 2008 information on the concentration of Supplemental Mortgage Insurance providers for our conventional loans and their related credit ratings:
                                 
    Percent of   Credit Rating (1)
   
  Portfolio  
 
S&P
 
Moody’s
 
Fitch
Mortgage Guaranty Insurance Corporation (MGIC)
    80 %     A-     Ba2     A-  
Genworth Residential Mortgage Insurance Corporation (Genworth)
    20 %     A+     Baa2     N/A  
 
                               
 
                               
Total
    100 %                        
 
                               
(1) As of February 13, 2009.
In 2008 and 2009, Standard & Poor’s and Moody’s lowered the rating of MGIC and Genworth, and Fitch did the same for MGIC. Before the downgrade of MGIC, we had discontinued committing new business with that provider, but we continue to use Genworth for new business. Because of the downgrades and the lack of alternative Supplemental Mortgage Insurance providers, we are currently in technical violation of a Regulatory requirement that these providers be rated at least double-A. We are exploring alternatives with the Finance Agency that could potentially supplement or replace the current credit enhancement structure, either temporarily or permanently, without threatening the credit risk exposure we face from the Program.
We subject both Supplemental Mortgage Insurance providers to standard credit underwriting analysis and additionally calculate our potential exposure based on historically high industry loss rates that we further stress. This process resulted in an estimated $17 million credit exposure from all providers as of December 31, 2008. We believe this constitutes an acceptable amount of exposure under the very extreme scenario of our entire conventional portfolio defaulting and the Supplemental Mortgage Insurance providers being financially unable to pay the resulting claims. We have had only 54 claims through December 31, 2008 in the Mortgage Purchase Program out of over 100,000 conventional loans purchased since its inception in 2000. We funded all of these claims from the Lender Risk Account and none from Supplemental Mortgage Insurance providers. Because of this, we believe it is extremely unlikely that claims will rise to a significant level. Therefore, we believe we have a very small amount of credit exposure to both providers and that the downgrades will not affect the creditworthiness of the Mortgage Purchase Program.
Investments
Money Market Investments. Most money market investments are unsecured and therefore present credit risk exposure. Our Financial Management Policy permits us to invest in only highly rated counterparties. A credit event for an investment security could be triggered by its default or delayed payments of principal or interest, or from a security’s rating downgrade that results in a realized market value loss. We believe our conservative investment policies and practices result in a nominal amount of credit risk exposure in our investment portfolio.
The Financial Management Policy specifies constrained limits on the amount of unsecured credit exposure we are permitted to extend to individual and affiliated counterparties. Each counterparty’s limit is based on its long-term counterparty credit ratings from nationally recognized statistical rating organizations (NRSRO) and on percentages, which vary by credit rating category, of the lesser of our total capital or t