Allowance for Credit Losses

The Bank has established an allowance methodology for each of the Bank's portfolio segments: credit products, government-guaranteed or insured mortgage loans held for portfolio, conventional MPF loans held for portfolio, and BOB loans.

Credit Products. The Bank manages its total credit exposure (TCE) (which includes advances, letters of credit, advance commitments, and other credit product exposure) through an integrated approach. This generally provides for a credit limit to be established for each borrower, includes an ongoing review of each borrower's financial condition and is coupled with collateral/lending policies to limit risk of loss while balancing the borrowers' needs for a reliable source of funding. In addition, the Bank lends to its members in accordance with the Act and Finance Agency regulations. Specifically, the Act requires the Bank to obtain collateral to fully secure credit products. The estimated value of the collateral required to secure each member's credit products is calculated by applying collateral weightings, or haircuts, to the value of the collateral. The Bank accepts cash, certain investment securities, residential mortgage loans, deposits, and other real estate related assets as collateral. In addition, Community Financial Institutions (CFIs) are eligible to utilize expanded statutory collateral provisions for small business, agriculture, and community development loans. The Bank's capital stock owned by the borrowing member is pledged as secondary collateral. Collateral arrangements may vary depending upon borrower credit quality, financial condition and performance, borrowing capacity, and overall credit exposure to the borrower. The Bank can require additional or substitute collateral to protect its security interest. Management of the Bank believes that these policies effectively manage the Bank's respective credit risk from credit products.

Based upon the financial condition of the member, the Bank either allows a member to retain physical possession of the collateral assigned to the Bank or requires the member to specifically place physical possession or control of the collateral with the Bank or its custodians. However, notwithstanding financial condition, the Bank always takes possession or control of securities used as collateral if it is used for maximum borrowing capacity (MBC) or to secure advances. The Bank perfects its security interest in all pledged collateral. The Act affords any security interest granted to the Bank by a member priority over the claims or rights of any other party except for claims or rights of a third party that would be entitled to priority under otherwise applicable law and are held by a bona fide purchaser for value or by a secured party holding a prior perfected security interest.

Using a risk-based approach, the Bank considers the payment status, collateral types and concentration levels, and borrower's financial condition to be indicators of credit quality on its credit products. At September 30, 2012 and December 31, 2011, the Bank had rights to collateral on a member-by-member basis with an estimated value in excess of its outstanding extensions of credit.

The Bank continues to evaluate and make changes to its collateral guidelines, as necessary, based on current market conditions. At September 30, 2012 and December 31, 2011, the Bank did not have any credit products that were past due, on nonaccrual status, or considered impaired. In addition, there were no credit products considered to be troubled debt restructurings (TDRs).

Based upon the collateral held as security, its credit extension policies, collateral policies, management's credit analysis and the repayment history on credit products, the Bank did not incur any credit losses on credit products during 2012 or 2011, or since inception. Accordingly, the Bank has not recorded any allowance for credit losses. Additionally, at September 30, 2012 and December 31, 2011, the Bank has not recorded any allowance for credit losses for off-balance sheet credit products.

Mortgage Loans - Government-Guaranteed or Insured. The Bank invests in government-guaranteed or insured fixed-rate mortgage loans secured by one-to-four family residential properties. Government-guaranteed mortgage loans are those insured or guaranteed by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Rural Housing Service of the Department of Agriculture and/or by Housing and Urban Development (HUD). Any losses from such loans are expected to be recovered from those entities. If not, losses from such loans must be contractually absorbed by the servicers. Therefore, there is no allowance for credit losses on government-guaranteed or insured mortgage loans.

Mortgage Loans - Conventional MPF. The allowances for conventional loans are determined by analyses that include consideration of various data observations such as past performance, current performance, loan portfolio characteristics, collateral-related characteristics, industry data, and prevailing economic conditions. The measurement of the allowance for credit losses includes: (1) reviewing all residential mortgage loans at the individual master commitment level; (2) reviewing specifically identified collateral-dependent loans for impairment; and/or (3) reviewing homogeneous pools of residential mortgage loans.

The Bank's allowance for credit losses takes into consideration the CE associated with conventional mortgage loans under the MPF Program. Specifically, the determination of the allowance generally considers expected primary mortgage insurance (PMI), supplemental mortgage insurance (SMI), and other CE amounts. Any incurred losses that are expected to be recovered from the CE reduce the Bank's allowance for credit losses.

For conventional MPF loans, credit losses that are not fully covered by PMI are allocated to the Bank up to an agreed upon amount, referred to as the first loss account (FLA). The FLA functions as a tracking mechanism for determining the point after which the participating financial institution (PFI) is required to cover losses. The Bank pays the PFI a fee, a portion of which may be based on the credit performance of the mortgage loans, in exchange for absorbing the second layer of losses up to an agreed-upon CE amount. The CE amount may be a direct obligation of the PFI and/or an SMI policy paid for by the PFI, and may include performance-based fees which can be withheld to cover losses allocated to the Bank (referred to as recaptured CE fees). Estimated losses exceeding the CE and SMI, if any, are incurred by the Bank. The PFI is required to pledge collateral to secure any portion of its CE amount that is a direct obligation. A receivable which is assessed for collectability is generally established for losses expected to be recovered by withholding CE fees. At September 30, 2012 and December 31, 2011, the MPF exposure under the FLA was $30.7 million and $34.3 million respectively. This exposure includes both accrual and nonaccrual loans. The Bank records CE fees paid to PFIs as a reduction to mortgage loan interest income. The Bank incurred CE fees of $1.0 million and $1.1 million for the third quarter of 2012 and 2011, respectively, and $3.0 million and $3.5 million during the nine months ended September 30, 2012 and 2011, respectively.

Collectively Evaluated Mortgage Loans. The Bank collectively evaluates the homogeneous mortgage loan portfolio for impairment. The allowance for credit loss methodology for mortgage loans considers loan pool specific attribute data, applies loss severities and incorporates the CEs of the MPF Program and PMI. The probability of default and loss given default are based on the actual 12-month historical performance of the Bank's mortgage loans. Actual probability of default was determined by applying migration analysis to categories of mortgage loans (current, 30 days past due, 60 days past due, and 90 days past due). Actual loss given default was determined based on realized losses incurred on the sale of mortgage loan collateral over the previous 12 months. Given the credit deterioration experience by PMI companies, estimated future claim payments from these companies have been reduced and factored into estimated loan losses in determining the allowance for credit losses. The resulting estimated losses after PMI are then reduced by the CEs the Bank expects to be eligible to receive. The CEs are contractually set and calculated by Master Commitment. Losses in excess of the CEs are incurred by the Bank.

Individually Evaluated Mortgage Loans. The Bank evaluates certain mortgage loans for impairment individually. These loans are considered TDRs as discussed in the TDR section of this Note 9.

BOB Loans. Both the probability of default and loss given default are determined and used to estimate the allowance for credit losses on BOB loans. Loss given default is considered to be 100% due to the fact that the BOB program has no collateral or credit enhancement requirements. The probability of default is based on the actual performance of the BOB program. The Bank considers BOB loans that are delinquent to be nonperforming assets.

Rollforward of Allowance for Credit Losses. Mortgage Loans - Conventional MPF.



	2012
(in thousands)	Three months ended September 30,			Nine months ended September 30,
Balance, beginning of period	$	14,066		$	14,344
Charge-offs	(27		)	(382		)
Provision for credit losses	19			96
Balance, September 30	$	14,058		$	14,058
Ending balance, individually evaluated for impairment	$	253
Ending balance, collectively evaluated for impairment	13,805
Total allowance for credit losses	$	14,058
Recorded investment balance, end of period:
Individually evaluated for impairment, with or without a related allowance	$	5,956
Collectively evaluated for impairment	3,238,985
Total recorded investment	$	3,244,941



	2011
(in thousands)	Three months ended September 30,			Nine months ended September 30,
Balance, beginning of period	$	9,150		$	3,150
Charge-offs	(41		)	(202		)
Provision for credit losses	2,418			8,579
Balance, September 30	$	11,527		$	11,527
Ending balance, individually evaluated for impairment	$	102
Ending balance, collectively evaluated for impairment	11,425
Total allowance for credit losses	$	11,527
Recorded investment balance, end of period:
Individually evaluated for impairment, with or without a related allowance	$	2,859
Collectively evaluated for impairment	3,706,369
Total recorded investment	$	3,709,228

Rollforward of Allowance for Credit Losses. BOB Loans.



	2012
(in thousands)	Three months ended September 30,			Nine months ended September 30,
Balance, beginning of period	$	2,773		$	3,223
Charge-offs	(94		)	(673		)
Provision (benefit) for credit losses	(175		)	(46		)
Balance, September 30	$	2,504		$	2,504
Ending balance, individually evaluated for impairment	$	94
Ending balance, collectively evaluated for impairment	2,410
Total allowance for credit losses	$	2,504
Recorded investment balance, end of period:
Individually evaluated for impairment, with or without a related allowance	$	264
Collectively evaluated for impairment	15,550
Total recorded investment	$	15,814



	2011
(in thousands)	Three months ended September 30,			Nine months ended September 30,
Balance, beginning of period	$	2,998		$	5,753
Charge-offs	(353		)	(916		)
Provision (benefit) for credit losses	60			(2,132		)
Balance, September 30	$	2,705		$	2,705
Ending balance, individually evaluated for impairment	$	87
Ending balance, collectively evaluated for impairment	2,618
Total allowance for credit losses	$	2,705
Recorded investment balance, end of period:
Individually evaluated for impairment, with or without a related allowance	$	305
Collectively evaluated for impairment	17,143
Total recorded investment	$	17,448

Credit Quality Indicators. Key credit quality indicators for mortgage and BOB loans include the migration of past due loans, nonaccrual loans, loans in process of foreclosure, and impaired loans.



(in thousands)	September 30, 2012
Recorded investment:⁽¹⁾	Conventional MPF Loans			Government-Guaranteed or Insured Loans			BOB Loans			Total
Past due 30-59 days	$	48,970		$	16,745		$	—		$	65,715
Past due 60-89 days	11,169			4,623			145			15,937
Past due 90-179 days	15,948			4,104			102			20,154
Past due 180 days or more	56,571			2,467			115			59,153
Total past due loans	$	132,658		$	27,939		$	362		$	160,959
Total current loans	3,112,283			339,557			15,452			3,467,292
Total loans	$	3,244,941		$	367,496		$	15,814		$	3,628,251
Other delinquency statistics:
In process of foreclosures, included above ⁽²⁾	$	58,797		$	1,130		$	—		$	59,927
Serious delinquency rate ⁽³⁾	2.2		%	1.8		%	1.4		%	2.2		%
Past due 90 days or more still accruing interest	$	—		$	6,571		$	—		$	6,571
Loans on nonaccrual status ⁽⁴⁾	$	78,278		$	—		$	626		$	78,904



(in thousands)	December 31, 2011
Recorded investment:⁽¹⁾	Conventional MPF Loans			Government-Guaranteed or Insured Loans			BOB Loans			Total
Past due 30-59 days	$	60,998		$	25,077		$	332		$	86,407
Past due 60-89 days	16,810			9,290			40			26,140
Past due 90-179 days	22,749			5,740			380			28,869
Past due 180 days or more	60,887			2,947			296			64,130
Total past due loans	$	161,444		$	43,054		$	1,048		$	205,546
Total current loans	3,402,834			311,648			16,341			3,730,823
Total loans	$	3,564,278		$	354,702		$	17,389		$	3,936,369
Other delinquency statistics:
In process of foreclosures, included above ⁽²⁾	$	60,533		$	2,015		$	—		$	62,548
Serious delinquency rate ⁽³⁾	2.4		%	2.5		%	2.2		%	2.4		%
Past due 90 days or more still accruing interest	$	—		$	8,687		$	—		$	8,687
Loans on nonaccrual status ⁽⁴⁾	$	87,488		$	—		$	1,148		$	88,636

Notes:

⁽¹⁾The recorded investment in a loan is the unpaid principal balance of the loan, adjusted for accrued interest, net deferred loan fees or costs, unamortized premiums or discounts, adjustments for fair value hedges and direct write-downs. The recorded investment is not net of any valuation allowance.

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

⁽³⁾Loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the total loan portfolio class.

⁽⁴⁾Generally represents mortgage loans with contractual principal or interest payments 90 days or more past due and not accruing interest.

Real Estate Owned (REO). The Bank had $9.9 million and $9.8 million of REO in other assets at September 30, 2012 and December 31, 2011, respectively.

TDRs. TDRs are considered to have occurred when a concession is granted to the debtor that otherwise would not have been considered had it not been for economic or legal reasons related to the debtor's financial difficulties.

Mortgage Loans - Conventional MPF. The Bank offers a loan modification program for its MPF Program. The loans modified under this program are considered TDRs. The loan modification program modifies borrower's monthly payment for a period of up to 36 months to no more than a housing expense ratio of 31% of their monthly income. The outstanding principal balance is re-amortized to reflect a principal and interest payment for a term not to exceed 40 years and a housing expense ratio not to exceed 31%. This will result in a balloon payment at the original maturity date of the loan as the maturity date and number of remaining monthly payments is unchanged in the modified loan. If the 31% ratio is still not met, the interest rate is reduced for up to 36 months in 0.125% increments below the original note rate, to a floor rate of 3%, resulting in reduced monthly principal and interest payments during the 36 month period, until the target 31% housing expense ratio is met or the 3% interest rate floor is hit.

A TDR is individually evaluated for impairment when determining its related allowance for credit losses. Credit loss is measured by factoring in expected cash shortfalls incurred as of the reporting date as well as the economic loss attributable to delaying or decreasing the original contractual principal and interest, if applicable. All mortgage loans individually evaluated for impairment were considered TDRs at September 30, 2012, totaling $6.0 million.

BOB Loans. The Bank offers a BOB loan deferral which the Bank considers a TDR. A deferred BOB loan is not required to pay principal or accrue interest for up to a one-year period. The credit loss is measured by factoring expected shortfalls incurred as of reporting date.

TDR Modifications. The following table presents the recorded investment balance, as of the modification date.



	Three months ended September 30, 2012
(in thousands)	Pre-Modification		Post-Modification
Conventional MPF loans	$	1,866	$	1,745
BOB loans	264		264
Total	$	2,130	$	2,009



	Nine months ended September 30, 2012
(in thousands)	Pre-Modification		Post-Modification
Conventional MPF loans	$	2,827	$	2,671
BOB loans	264		264
Total	$	3,091	$	2,935



	Three months ended September 30, 2011
(in thousands)	Pre-Modification		Post-Modification
Conventional MPF loans	$	340	$	329
BOB loans	305		305
Total	$	645	$	634



	Nine months ended September 30, 2011
(in thousands)	Pre-Modification		Post-Modification
Conventional MPF loans	$	2,063	$	2,017
BOB loans	305		305
Total	$	2,368	$	2,322

Certain TDRs may experience a payment default, which the Bank considers to be a loan 60 days or more delinquent. Conventional MPF loans modified during the previous 12 months which experienced a payment default during the third quarter and first nine months of 2012 and 2011 were immaterial.

Individually Evaluated Impaired Loans.



	September 30, 2012
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance for Credit Losses
With no related allowance:
Conventional MPF loans	$	508	$	505	$	—

With a related allowance:
Conventional MPF loans	$	5,448	$	5,416	$	253
BOB loans	264		264		94

Total:
Conventional MPF loans	$	5,956	$	5,921	$	253
BOB loans	264		264		94



	December 31, 2011
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance for Credit Losses
With no related allowance:
Conventional MPF loans	$	645	$	640	$	—

With a related allowance:
Conventional MPF loans	$	3,421	$	3,410	$	128
BOB loans	100		100		36

Total:
Conventional MPF loans	$	4,066	$	4,050	$	128
BOB loans	100		100		36

The table below presents the average recorded investment of individually impaired loans and related interest income recognized. The Bank included the individually impaired loans as of the date on which they became a TDR. However, prior to third quarter 2011 conventional MPF loans were not accounted for as TDRs because they were deemed to be immaterial. Deferred BOB loans were deemed to be TDRs effective July 1, 2011.



	Three months ended September 30, 2012				Nine months ended September 30, 2012
(in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Conventional MPF loans	$	5,841	$	87	$	5,094	$	228
BOB loans	176		—		81		—
Total	$	6,017	$	87	$	5,175	$	228



	Three months ended September 30, 2011				Nine months ended September 30, 2011
(in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Conventional MPF loans	$	2,749	$	41	$	2,398	$	107
BOB loans	305		—		102		—
Total	$	3,054	$	41	$	2,500	$	107

Purchases, Sales and Reclassifications. During the nine months ended September 30, 2012 and 2011, there were no significant purchases or sales of financing receivables. Furthermore, none of the financing receivables were reclassified to held-for-sale.