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Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
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. 000-51401
fhlbc-20201231_g1.jpg Federal Home Loan Bank of Chicago
(Exact name of registrant as specified in its charter)
Federally chartered corporation36-6001019
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
200 East Randolph Drive
Chicago,IL60601
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (312565-5700

Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Securities registered pursuant to Section 12(g) of the Act: Class B Capital Stock, par value $100 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes 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 filings requirements for the past 90 days. Yes No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filerAccelerated filer
Non-accelerated filerSmaller reporting company
Emerging growth company
If emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standard provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No

Registrant's stock is not publicly traded and is only issued to members of the registrant. Such stock is issued and redeemed at par value, $100 per share, subject to applicable regulatory and statutory limits. At June 30, 2020, the aggregate par value of the stock held by current and former members was $2,125,328,880. As of January 31, 2021, registrant had 23,000,345 total outstanding shares of Class B Capital Stock, including mandatorily redeemable capital stock.
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fhlbc-20201231_g1.jpgFederal Home Loan Bank of Chicago
TABLE OF CONTENTS


PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV
Item 15.
Item 16.
F-1
S-1

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fhlbc-20201231_g1.jpgFederal Home Loan Bank of Chicago
(Dollars in tables in millions except per share amounts unless otherwise indicated)


Item 1. Business.

Where to Find More Information

The Federal Home Loan Bank of Chicago a maintains a website located at www.fhlbc.com where we make available our financial statements and other information regarding us and our products free of charge. We are required to file with the Securities and Exchange Commission (SEC) an annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. The SEC maintains a website that contains these reports and other information regarding our electronic filings located at www.sec.gov. Information on these websites, or that can be accessed through these websites, does not constitute a part of this annual report.

A Glossary of Terms can be found on page 128.


Introduction

We are a federally chartered corporation and one of 11 Federal Home Loan Banks (the FHLBs) that, with the Office of Finance, comprise the Federal Home Loan Bank System (the System). The FHLBs are government-sponsored enterprises (GSE) of the United States of America and were organized under the Federal Home Loan Bank Act of 1932, as amended (FHLB Act), in order to improve the availability of funds to support home ownership.

Each FHLB operates as a separate entity with its own management, employees, and board of directors. Each FHLB is a member-owned cooperative with members from a specifically defined geographic district. Our defined geographic district consists of the states of Illinois and Wisconsin. We are supervised and regulated by the Federal Housing Finance Agency (FHFA), an independent federal agency in the executive branch of the United States (U.S.) government.

As a cooperative, we do business with our members and, under limited circumstances, our former members, as well as providing support for the members of other FHLBs through our role operating the Mortgage Partnership Finance® (MPF®) Program. All federally-insured depository institutions, insurance companies engaged in residential housing finance, credit unions, and community development financial institutions located in Illinois and Wisconsin are eligible to apply for membership. All members are required to purchase our capital stock as a condition of membership; our capital stock is not publicly traded.

“Mortgage Partnership Finance”, “MPF”, "eMPF", “MPF Xtra”, “Downpayment Plus”, "DPP", "Downpayment Plus Advantage", "DPP Advantage", and "Community First" are registered trademarks of the Federal Home Loan Bank of Chicago.


Mission Statement

Our mission is to partner with our member shareholders in Illinois and Wisconsin to provide them competitively priced funding, a reasonable return on their investment in the Bank, and support for community investment activities.

a     Unless otherwise specified, references to we, us, our and the Bank are to the Federal Home Loan Bank of Chicago.
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fhlbc-20201231_g1.jpgFederal Home Loan Bank of Chicago
(Dollars in tables in millions except per share amounts unless otherwise indicated)

Membership Trends

The following table presents the geographic locations of our members by type of institution:

December 31, 2020December 31, 2019
Number of InstitutionsNumber of Institutions
IllinoisWisconsinTotalPercentIllinoisWisconsinTotalPercent
Commercial banks306 150 456 66 %309 156 465 67 %
Savings institutions46 21 67 10 %49 21 70 10 %
Credit unions48 52 100 15 %49 51 100 15 %
Insurance companies42 15 57 8 %36 12 48 %
Community Development
Financial Institutions
5 1 6 1 %%
Total447 239 686 100 %448 241 689 100 %


The following table presents our FDIC-insured depository institution members by asset size. Community Financial Institution is defined by our regulator, the FHFA, as FDIC-insured institutions with no more than $1.224 billion (the limit during 2020) in average total assets over three years. This limit is adjusted annually for inflation. See the Glossary of Terms on page 128 for further details.


As of December 31,20202019
FDIC-insured depository institution member asset size:
Community Financial Institutions90.25 %91.22 %
Larger non-CFI institutions9.75 %8.78 %
Total100 %100 %


In 2020, our total membership declined by three institutions.

We lost 23 members due to mergers and acquisitions. Although 20 of these members were acquired by other members in our district, three were acquired by out-of-district institutions.

We gained 20 new members by adding ten commercial banks, one credit union, and nine insurance companies during 2020, as we continue to work toward our goal of building a stronger cooperative by adding new members.

Additionally, pursuant to the FHFA 2016 Final Rule for Membership in the Federal Home Loan Bank System, effective February 19, 2021, we terminated the membership of our three captive insurance company members.

In 2020, 89% of our member institutions used at least one of our core product offerings - advances, letters of credit, or MPF Program products - or participated in our competitive Affordable Housing Program (AHP) or Downpayment Plus® Program (DPP) Programs.


Business Overview

Our mission-focused business is different from that of a typical financial services firm. As a cooperative, we use our resources to support member utilization of the cooperative, and to support the communities in which members operate.

Our mission is to partner with our members in Illinois and Wisconsin to provide them with competitively priced funding, a reasonable return on their investment in the Bank, and support for their community investment activities. Our vision is dedication to efficiently delivering valuable products, solutions, and services to our members through teamwork, innovative thinking, and creating positive change with our commitment to diversity, equity, and inclusion.

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fhlbc-20201231_g1.jpgFederal Home Loan Bank of Chicago
(Dollars in tables in millions except per share amounts unless otherwise indicated)

Our strategy focuses on three primary pillars:

1. Financial Strength and Member Engagement. Leverage our financial strength to ensure we stay true to our mission: we will support our members’ return on investment; provide meaningful support for their community investment activities; and promote member engagement.
2. Technology and Operational Excellence. Achieve operational excellence by: designing processes around technology solutions; providing nimbleness, security and scale; enhancing customer experience; and increasing efficiencies; and positioning us for strategic alternatives.
3. Talent and Culture. Build an inclusive workplace that: promotes diversity and equity and attracts and retains key talent in a rapidly changing environment.

Mission Asset Ratio

The following table represents our view of the mission-focused business we do as a cooperative bank.

20202019
Average par value for the year ended December 31,
Advances$53,639 $54,880 
Mortgage assets (Acquired Member Assets - AMA)10,312 8,256 
Primary mission assets$63,951 $63,136 
Consolidated obligations$94,130 $91,271 
U.S. Treasuries5,487 4,003 
Consolidated obligations less U.S. Treasuries$88,643 $87,268 
Primary mission asset ratio72.1 %72.3 %
Supplemental mission assets and activities as of December 31,
MPF Program Loans held by other third party investors$26,300 $19,198 
Member standby letters of credit16,395 23,851 
Mission related liquidity7,527 7,487 
Small Business Administration investments2,529 1,787 
Housing authority standby bonds purchased and commitments outstanding480 459 
MPF Loan delivery commitments1,527 615 
Advance commitments595 38 
Member derivatives2 
Community First Fund loans and commitments46 46 
Supplemental mission assets and activities$55,401 $53,488 

We provide credit to members principally in the form of secured loans called advances (inclusive of forward starting advances), as well as through standby letters of credit. We provide liquidity for home mortgage loans to members approved as Participating Financial Institutions (PFIs) through the MPF Program. We also serve as a critical source of standby liquidity for our members.

Our primary funding source is proceeds from the sale to the public of FHLB debt instruments (consolidated obligations) which are, under the FHLB Act, the joint and several liability of all the FHLBs. Consolidated obligations are not obligations of the U.S. government, and the U.S. government does not guarantee them. Additional funds are provided by deposits, other borrowings, and the issuance of capital stock. We also provide members and non-members with correspondent services such as safekeeping, wire transfers, and cash management.

The FHFA issued an advisory bulletin which provides guidance relating to how the FHFA will assess each FHLB’s core mission achievement. The FHFA will assess core mission achievement by using a ratio of primary mission assets, which includes advances and mortgage loans acquired from members (also referred to as acquired member assets), to consolidated obligations, less U.S. Treasuries held for liquidity purposes in our trading or available for sale accounts. The primary mission asset ratio will be calculated annually at year-end as part of the FHFA’s examination process, using annual average par values. When the ratio is at least 70% or higher, the FHLB's strategic plan should include an assessment of the FHLB’s prospects for
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maintaining this level and when the ratio is less than 70%, the FHFA expects certain actions with respect to an FHLB's strategic plan to increase the ratio.

Our primary mission asset ratio for the year ended December 31, 2020, was 72.1%.

For a discussion on how the loss of, or change in business activities with, significant members may negatively impact our primary mission asset ratio, see Risk Factors on page 23.

Member-Focused Business

Member credit products, which include advances, standby letters of credit, and other extensions of credit to borrowers, are discussed in detail below.

Advances

We provide credit to members principally in the form of secured loans, called advances. Our advances to members:

serve as a reliable source of funding and liquidity;
provide members with enhanced tools for asset-liability management;
provide interim funding for those members that choose to sell or securitize their mortgages;
support residential mortgages held in member portfolios;
support important housing markets, including those focused on very low-, low-, and moderate-income households; and
provide funds to member community financial institutions (CFI) for secured loans to businesses, farms, agribusinesses, and community development activities.
We make secured, fixed- or floating-rate advances to our members. Advances are secured by mortgages and other collateral that our members pledge. We determine the maximum amount and term of advances we will lend to a member as follows:

we value the types of collateral eligible to be pledged to us and apply a margin to secure our advances to members, based on our assessment of the member's creditworthiness and financial condition; and
we conduct periodic collateral reviews with members to establish the amount we will lend against each collateral type.

We are required to obtain and maintain a security interest in eligible collateral at the time we originate or renew an advance. For further detail on our underwriting and collateral guidelines, see Establishing Credit Limits on page 70.

We offer a variety of fixed- and adjustable-rate advances, with maturities ranging from one day to 30 years. Examples of standard advance structures include the following:

Fixed-Rate Advances: Fixed-rate advances have maturities from one day to 30 years.

Variable-Rate Advances: Variable-rate advances include advances that have interest rates that reset periodically at a fixed spread to an FHLB discount note rate-based index, London Interbank Offer Rate (LIBOR), Federal Funds, or some other index (such as the Secured Overnight Financing Rate (SOFR)). Depending upon the type of advance selected, the member may have an interest-rate cap embedded in the advance to limit the rate of interest the member would have to pay.

Putable Advances: We issue putable, fixed- and floating-rate advances in which we maintain the right to terminate the advance at predetermined exercise dates at par.

Callable Advances: We issue callable, fixed-rate advances in which members have the right to prepay the advance on predetermined dates without incurring prepayment or termination fees.

Other Advances: (1) Open-line advances are designed to provide flexible funding to meet our members' daily liquidity needs and may be drawn for one day. These advances are automatically renewed. Rates are set daily at the close of business. (2) Fixed amortizing advances have maturities that range from one year to 30 years, with the principal
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repaid over the term of the advances monthly, quarterly, or semi-annually. (3) Fixed Rate with Floating Spread advances are designed to meet our members’ liability duration needs at lower cost than regular fixed rate advances.

We also offer features designed to meet our members' business needs such as the following:

Symmetrical prepayment feature where the member would either pay a prepayment fee or prepay the advance below par upon termination, depending on the structure of the advance at the time of termination.

Commitment feature, called “forward-starting advances", to fund an advance on a negotiated funding date at a predetermined interest rate.

Expander feature, which allows a member one or multiple opportunities to increase the principal amount of the advance.

The FHLB Act authorizes us to make advances to non-member housing associates that meet regulatory eligibility requirements including that the housing associate is approved under Title II of the National Housing Act. We currently have approved four non-member housing associates that are eligible to borrow from the Bank. We had $18 million in advances outstanding to non-member housing associates at December 31, 2020, and $18 million at December 31, 2019.

For disclosure relating to our five largest advance borrowers as of December 31, 2020, see page 53.

Competition

Demand for our advances is affected by, among other things, the cost of other sources of funding available to our members, including our members' customer deposits. We compete with suppliers of both secured and unsecured wholesale funding. These competitors may include investment banks, commercial banks, and other FHLBs when our members' affiliated institutions are members of other FHLBs. Under the FHLB Act and FHFA regulations, affiliated institutions in different FHLB districts may be members of different FHLBs.

Some members may have limited access to alternative funding sources while other members may have access to a wider range of funding sources, such as repurchase agreements, brokered deposits, commercial paper, covered bonds collateralized with residential mortgage loans, and other funding sources. Some members, particularly larger members, may have independent access to the national and global credit markets.

The availability of alternative funding sources influences the demand and pricing for our advances and can vary as a result of a number of factors, such as the regulatory environment, market conditions, products, members' creditworthiness, and availability of collateral. We compete for advances on the basis of the total cost of our products to our members (which include the rates we charge, required capital stock purchases, and any dividends we pay), credit and collateral terms, prepayment terms, product features such as embedded options, and the ability to meet members' specific requests on a timely basis. In addition, the transition from LIBOR to SOFR (as further discussed in LIBOR Transition on page 56) may impact the pricing of our advance products relative to competitor rates and may reduce the number of advance products we can offer.

In addition, our competitive environment continues to be impacted by the changes in the interest-rate environment and the extent to which our members use our advances primarily as a back-up source of liquidity as opposed to part of their primary funding strategies. Moreover, the Federal Reserve’s emergency actions to increase liquidity, along with market conditions resulting from the COVID-19 pandemic, have resulted in lower demand for new advances from our depository members and prepayment of their existing advances. For further discussion of the impact of these and other factors on demand for our advances, see Risk Factors starting on page 23.

Standby Letters of Credit

We may provide members and housing associates with standby letters of credit (also referred to herein as letters of credit) to support obligations to third parties to facilitate residential housing finance, community lending, to achieve liquidity, and for asset-liability management purposes. In particular, members often use letters of credit as collateral for deposits from federal and state governmental agencies. Letters of credit are generally available for terms of up to 20 years or for a one year term renewable annually. If we are required to make payment for a beneficiary's draw, these amounts either must be reimbursed by the member immediately or may be converted to an advance. Our underwriting and collateral requirements for letters of credit are the same as the underwriting and collateral requirements for advances. Letters of credit are not currently subject to activity capital stock purchase requirements, but effective May 3, 2021, an activity capital stock requirement will apply to all letters of credit issued on or after that date. If any advances were to be made in connection with these standby letters of credit, they would be made under the same standards and terms as any other advance. For more details on our letters of credit see Note 16 - Commitments and Contingencies to the financial statements.
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Mortgage Partnership Finance® Program

MPF Program Overview

We developed the MPF® Program to provide an additional source of liquidity to our members and to allow us to invest in mortgages to help fulfill our housing mission. The MPF Program is a secondary mortgage market business under which we purchase mortgage loans from our members and housing associates and members and housing associates of other FHLBs (together with us, the MPF Banks) that participate in the MPF Program (collectively, Participating Financial Institutions or PFIs). These mortgage loans are conventional and government mortgage loans secured by one-to-four family residential properties with maturities ranging from 5 to 30 years or participations in such mortgage loans that are acquired under the MPF Program (MPF Loans).

We purchase MPF Loans to retain in our portfolio for investment, to sell to third parties, or to securitize Government Loans into Ginnie MBS. Our regulatory limit for our investment in MPF Loans held in our portfolio is the lesser of eight times retained earnings or 20% of total assets. Our MPF Loan products are outlined in the chart below:
MPF ProductMortgage TypeLoan BalanceHeld in our Portfolio for Investment?
MPF Original a, MPF 35, MPF 100 b; MPF 125 and MPF Plus b
ConventionalConformingYes
MPF Government c
GovernmentDetermined by the applicable government agency eligibility guidelinesYes
MPF XtraConventionalConformingMPF Loans are concurrently sold to the Federal National Mortgage Association (Fannie Mae).
MPF Direct b
ConventionalNon-conforming (jumbo - up to $2,500,000)MPF Loans are concurrently sold to a third party investor.
MPF Government MBSGovernmentDetermined by the applicable government agency eligibility guidelinesGovernment Loans are held in our portfolio for a short period of time until such loans are pooled into Ginnie Mae MBS.
a    PFIs share in the associated credit risk of these MPF Loan products in accordance with the FHFA Acquired Member Assets (AMA) regulation requirements.
b     MPF 100, MPF Plus, and MPF Direct are not currently offered.
c    Government Loans are insured or guaranteed by one of the following government agencies: the Federal Housing Administration (FHA); the Department of Veterans Affairs (VA); Rural Housing Service of the Department of Agriculture (RHS); or Department of Housing and Urban Development (HUD) (collectively, Government Loans).

We provide programmatic and operational support in our role as the administrator of the MPF Program on behalf of the other MPF Banks for a fee. MPF Banks may acquire whole loans from their PFIs to retain on their balance sheet and may purchase or sell participations in MPF Loans with other MPF Banks. Other MPF Banks’ PFIs that participate in off balance sheet products sell MPF Loans directly to us.

Member PFIs

Members and eligible housing associates become PFIs of their respective MPF Bank by executing a PFI Agreement that provides the MPF Loan selling and servicing terms and conditions. The MPF Guides supplement the PFI Agreement and provides additional requirements for PFI eligibility including maintenance of anti-predatory lending policies, errors and omissions insurance and a fidelity bond. All of the PFI's obligations under the PFI Agreement are secured under its advances agreement with the MPF Bank. A PFI is required to deliver collateral for their CE Amount (as further discussed below) and an MPF Bank can request additional collateral to secure the PFI's other obligations under the PFI Agreement, if necessary.

Mortgage Standards

For conventional MPF Loans held in our portfolio, PFIs are required to deliver mortgage loans that meet the underwriting and eligibility requirements in the PFI Agreement and the MPF Guides, unless a PFI is granted a waiver that exempts such PFI from complying with a specific requirement. MPF Loan requirements include:
A maximum loan-to-value (LTV) ratio of 95%;
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Mortgage Loans with LTVs greater than 80% must be insured by primary mortgage insurance (PMI);
Compliance with all applicable laws documented using standard Fannie Mae/Freddie Mac Uniform Instruments; and
Meeting the definition of a Qualified Mortgage under the Truth and Lending Act (TILA).

Mortgage loans that are classified as high cost, high rate, or Home Ownership and Equity Protection Act loans, or loans in similar categories defined under predatory lending or abusive lending laws are not eligible under the MPF Program. We perform a quality assurance review of a selected sample of MPF Loans for each PFI in order to determine that the loans complied with the MPF Program requirements at the time of acquisition.

For our off balance sheet products and Government Loan product, PFIs are required to deliver mortgage loans that meet the applicable investor or government agency eligibility and underwriting requirements outlined in the MPF Guides.

We make customary representations and warranties regarding the eligibility of the off balance sheet MPF Loans to third party investors. If a loan eligibility requirement or other warranty is breached, these third parties could require us to repurchase the MPF Loan or provide an indemnity. PFIs make the same representations and warranties to us with respect to the MPF Loans. When a PFI sells a mortgage loan under any MPF Loan product that fails to comply with the representations and warranties, the PFI may be required to provide an indemnification covering related losses or to repurchase the MPF Loans if the failure cannot be cured. See Mortgage Repurchase Risk on page 74 for further information about MPF Loans repurchases.

Loss Structure for Credit Risk Sharing Products

For conventional MPF Loan products held in our portfolio, PFIs are required to share in the credit risk associated with the mortgage loans. Each MPF Loan delivered by a PFI is linked to a Master Commitment (MC) and losses arising from a mortgage loan are allocated to the appropriate loss layer in that MC. Credit losses not absorbed by the borrower’s equity in the property and any primary mortgage insurance (if available), are allocated between a PFI and their MPF Bank in the following order:

The PFI’s performance based CE Fees. The PFI is paid a monthly credit enhancement fee for sharing the credit risk associated with these mortgage loans (CE Fees) and some of this fee may be performance based. CE Fees vary between 6 to 14 basis points depending on the product. We will withhold a PFI's scheduled performance based CE Fees in order to reimburse ourselves for any losses allocated to the First Loss Account (FLA) and the amount of such withholding is a component of the overall credit enhancement provided by the PFI.

The MPF Bank’s First Loss Account (FLA). The FLA functions as a tracking mechanism for our first layer of credit loss exposure before the PFI's credit enhancement obligation (CE Amount) would cover the next layer of losses. The amount of the FLA is agreed upon when a PFI begins to sell loans into an MC depending on the product. Our FLA exposure varies by MPF Loan product type and it can build over the life of the MC by 3-6 basis points annually or it can be fixed from 35-100 basis points.

The PFI’s CE Amount. The PFI's CE Amount is a direct liability of the PFI to pay credit losses up to a specified amount, which may include proceeds from a provider of supplemental mortgage guaranty insurance (SMI). The CE Amount is determined by the MPF Bank consistent with the FHFA's AMA regulation. For further details, see Setting Credit Enhancement Levels on page 73.

The MPF Bank. After the CE Amount has been exhausted, the MPF Bank will absorb any further losses.

MPF Servicing

PFIs can retain the rights and responsibilities for servicing MPF Loans sold under the MPF Program or choose a servicing released option. If PFIs chose to retain servicing rights for MPF Loans sold under the MPF Xtra and MPF Government MBS products, we are contractually obligated to Fannie Mae and Ginnie Mae, respectively, with respect to servicing those loans. The MPF Direct product is servicing released only and we do not have any responsibilities related to the servicing of MPF Loans delivered under the MPF Direct product.

We monitor servicers that service (1) MPF Loans held in our portfolio and (2) MPF Loans that are sold under MPF Xtra and MPF Government MBS when we are contractually responsible to Fannie Mae or Ginnie Mae, respectively, for the loan servicing. If a servicer fails to comply with the servicing requirements, we can charge fees, require mortgage loan repurchase, request indemnification or terminate the servicer’s right to service the MPF Loans.

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Competition

We face competition in the markets for conventional loans, non-conforming loans, government loans, and loans with credit risk sharing arrangements from secondary market participants. Secondary market participants include, but are not limited to, dealers, banks, hedge funds, money managers, insurance companies, large mortgage aggregators, private investors, and other GSEs such as Fannie Mae and Freddie Mac. Some of these competitors have greater resources, larger volumes of business, and longer operating histories. As a result, our ongoing revenue derived from MPF Loan products may be affected by the volume of business done by our competitors.

Other Activities

Investments

We maintain a portfolio of investments for liquidity purposes and to provide additional earnings. To ensure the availability of funds to meet member credit needs, we maintain a portfolio of short-term liquid assets, principally overnight Federal Funds sold, and securities purchased under agreements to resell, entered into with or issued by highly rated institutions and other eligible counterparties. For further discussion of unsecured credit exposures related to our short-term investment portfolio, see Unsecured Short Term Investments on page 77.

Our longer-term investment debt securities portfolio includes securities issued by the U.S. government, U.S. government agencies, and GSEs, as well as investments in Federal Family Education Loan Program (FFELP) student loan asset-backed securities (ABS), and mortgage-backed securities (MBS) that are issued by GSEs or that were rated “AAA/Aaa” or “AA/Aa” from Moody's Investors Service (Moody's), Standard and Poor's Rating Service (S&P), or Fitch Ratings, Inc. (Fitch) at the time of purchase. For a discussion of how recent market conditions have affected the carrying value and ratings of these securities, see Investment Debt Securities on page 76. For this purpose, GSE includes Fannie Mae, Freddie Mac, and the Federal Farm Credit Banks Funding Corporation. Securities issued by GSEs are not guaranteed by the U.S. government.

Under FHFA regulations, we are prohibited from trading debt securities for speculative purposes or engaging in market-making activities. Additionally, we are prohibited from investing in certain types of securities or loans, including:

instruments, such as common stock, that represent an ownership in an entity, other than common stock in small business investment companies (where one or more members or housing associates of the Bank also make a material investment in the same activity) or certain investments targeted to low-income households or communities;

instruments issued by non-U.S. entities, other than those issued by U.S. branches and agency offices of foreign commercial banks;

non-investment grade debt instruments, other than certain investments targeted to low-income households or communities, or instruments that were downgraded after purchase;

whole mortgages or other whole loans, other than, (1) those acquired under our MPF Program, (2) certain investments targeted to low-income households or communities, (3) certain marketable direct obligations of state, local, or tribal government units or agencies, that are investment quality, (4) certain MBS or asset-backed securities backed by manufactured housing loans or home equity loans; and, (5) certain foreign housing loans authorized under the FHLB Act;

interest-only or principal-only stripped securities;

residual-interest or interest-accrual classes of securities;

fixed-rate MBS or eligible ABS, or floating-rate MBS or eligible ABS, that on the trade date are at rates equal to their contractual cap and that have average lives that vary by more than six years under an assumed instantaneous interest rate change of 300 basis points, unless the instrument qualifies as AMA; and

non-U.S. dollar-denominated securities.

FHFA regulations further limit our investment in MBS and ABS by requiring that these investments may not exceed 300% of our previous month-end regulatory capital on the day we purchase the securities and we may not exceed our holdings of such securities in any one calendar quarter by more than 50% of our total regulatory capital at the beginning of that quarter. For purposes of calculating the limit on our MBS/ABS portfolio, we value our investments in accordance with FHFA regulations based on amortized cost for securities classified as held-to-maturity or available-for-sale and on fair value for trading debt securities.
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Regulatory capital consists of our total capital stock (including the mandatorily redeemable capital stock) plus our retained earnings. This limitation does not apply to instruments qualifying as AMA, like newly issued Ginnie Mae securities that have been created through the MPF Government MBS product that are temporarily owned by the Bank.

Subject to regulatory limitations, we resumed making investments in MBS in June 2018.

Additionally, we are subject to certain investment limitations related to LIBOR, as discussed in LIBOR Transition on page 56.

Derivative Activities

We engage in most of our derivative transactions with major broker-dealers as part of our interest rate risk management and hedging strategies.  Additionally, we also enter into interest rate derivatives with our members in order to provide them with indirect access to the derivatives market.  In instances where we do not use interest rate derivatives for our own hedging purposes, we act as an intermediary for our members by entering into an interest rate derivative directly with the member and then entering into an offsetting interest rate derivative transaction with a non-member counterparty. We do not act as a dealer in derivative transactions involving members.

The FHFA's regulations and our internal derivatives and hedging policies all establish guidelines for our use of interest rate derivatives. These regulations prohibit the speculative use of financial instruments authorized for hedging purposes. They also limit the amount of counterparty credit risk allowed. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk on page 80.

Community Investment Activities

We provide financing and direct funding tools that support the affordable housing and community lending initiatives of our members that benefit very low-, low-, and moderate-income individuals, households, businesses and neighborhoods. Outlined below is a more detailed description of the mission-related programs that we administer and fund:

Affordable Housing Program (AHP) - We offer AHP subsidies in the form of direct grants to members to stimulate affordable rental and homeownership opportunities for households with incomes at or below 80% of the area's median income, adjusted for family size. By regulation, we are required to contribute 10% of our income before assessments to fund AHP. Of that required contribution, we may allocate up to the greater of $4.5 million or 35% to provide funds to members participating in our homeownership set-aside programs.

Direct grants are available under our competitive AHP to members in partnership with community sponsors and may be used to fund the acquisition, rehabilitation, and new construction of affordable rental or owner-occupied housing. We awarded competitive AHP subsidies of $25 million for the year ended December 31, 2020 and $28 million for the year ended December 31, 2019, for projects designed to provide housing to 2,113 and 2,671 households.

In addition, direct grants are available to members under our Downpayment Plus® homeownership set-aside programs and may be provided to eligible homebuyers to assist with down payment, closing, counseling, or rehabilitation costs in conjunction with an acquisition. During the years ended December 31, 2020 and 2019, we funded $17 million and $20 million through our Downpayment Plus programs to assist 2,999 and 3,451 very low- to moderate-income homebuyers.

During 2021, we anticipate having $43 million available in total for our Downpayment Plus programs and grants through our competitive AHP.

Community Advances Programs and related letters of credit - We offer programs where members may apply for advances or letters of credit to support affordable housing or community economic development lending. These programs provide advance funding at interest rates below regular advance rates for terms typically up to 10 years. Our Community Advances programs may be used to finance affordable homeownership housing, multi-family rental projects, industrial and manufacturing facilities, agricultural businesses, healthcare, educational centers, public or private infrastructure projects, or commercial businesses. As of December 31, 2020, and 2019, we had $381 million and $666 million in advances outstanding under the Community Advances programs and related letters of credit outstanding of $77 million and $102 million.

Community First® Fund - Our Board of Directors approved $50 million in 2011 to supplement our current affordable housing and community investment programs, which became the foundation for the Community First Fund (the Fund). The Fund is an innovative revolving credit facility designed to provide low cost, longer term financing to community development financial institutions, community development loan funds, and state housing finance authorities promoting affordable housing and economic development in our district. We approved our first loans under the Fund in 2014 and as of December 31, 2020, and 2019, had $45 million in loans outstanding and $1 million in unfunded loan commitments.
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COVID-19 Relief Programs - In response to the COVID-19 pandemic, the Bank offered the COVID-19 Relief Programs to support communities in Illinois and Wisconsin. For more information on our COVID-19 Relief Programs, see COVID-19 Relief Programs on page 13.

Deposits

We accept deposits from our members, institutions eligible to become members, any institution for which we are providing correspondent services, other FHLBs, and other government instrumentalities. We offer several types of deposits to our deposit customers including demand, overnight, and term deposits. For a description of our liquidity requirements with respect to member deposits see Liquidity on page 54.

Funding

Consolidated Obligations

Our primary source of funds is the sale to the public of FHLB debt instruments, called consolidated obligations, in the capital markets. Additional funds are provided by deposits, other borrowings, and the issuance of capital stock. Consolidated obligations, which consist of bonds and discount notes, are the joint and several liability of the FHLBs, although the primary obligation is with the individual FHLB that receives the proceeds from issuance. Consolidated obligations are issued to the public through the Office of Finance using authorized securities dealers. Consolidated obligations are backed only by the financial resources of the FHLBs and are not guaranteed by the U.S. government. See Funding on page 55 for further discussion.

Competition

We compete with the U.S. government, Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities, including the World Bank, for funds raised through the issuance of unsecured debt in the domestic and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lesser amounts of debt issued at the same cost than otherwise would be the case. For example, a change in the types or an increase in the amounts of U.S. Treasury issuance may affect our ability to raise funds because it provides alternative investment options. Furthermore, to the extent that investors perceive Fannie Mae and Freddie Mac or other issuers as having a higher level of government support, their debt securities may be more attractive to investors than FHLB System debt.

The FHLBs have traditionally had a diversified funding base of domestic and foreign investors, although investor demand for our debt depends in part on prevailing conditions in the financial markets. For further discussion of market conditions and their potential impact on us, see Risk Factors starting on page 23 and Funding on page 55.

Although the available supply of funds from the FHLBs' debt issuances has kept pace with the funding requirements of our members, there can be no assurance that this will continue to be the case.

Business Environment

Our financial condition and results of operations are influenced by the interest rate environment, global and national economies, local economies within our districts of Illinois and Wisconsin, and the conditions in the financial, housing, and credit markets. In particular, our net interest income is affected by several external factors, including market interest rate levels and volatility, credit spreads and the general state of the economy.  We endeavor to manage our interest rate risk by entering into fair value hedge relationships utilizing interest rate derivative agreements to hedge a portion of our advances, available-for-sale debt securities, and debt.  We are exposed to the variability in the total net proceeds received from forecasted zero-coupon discount note issuances, which is attributable to changes in the benchmark interest rate. As a result, we enter into cash flow hedge relationships utilizing derivative agreements to hedge the total net proceeds received from our "rolling" forecasted zero-coupon discount note issuances attributable to changes in the benchmark interest rate. Additionally, we enter into economic hedges using derivative agreements to hedge our mortgage-related assets, which are sensitive to changes in mortgage rates. Many of our balance sheet hedging strategies are subject to change due to the planned phase-out of LIBOR. For further discussion of the potential impact of the LIBOR transition, see Risk Factors starting on page 23 and LIBOR Transition on page 56.

Our profitability is significantly affected by the interest rate environment.  We earn relatively narrow spreads between yields on assets and the rates paid on corresponding liabilities.  A large portion of our advance business is based on our funding costs plus a narrow spread. We also expect our ability to generate significant earnings on capital and short-term investments will be affected by the Federal Reserve’s policy of setting the short-term Federal Funds rate.  Income and spreads can also be affected
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by changes in regulations or accounting rules, which can change the funding, hedging, and the liquidity profile of our balance sheet. Short-term interest rates also directly affect our earnings on invested capital.

Our operating results are affected not only by rising or falling interest rates, but also by the particular path and volatility of changes in market interest rates and the prevailing shape of the yield curve. A flattening of the yield curve tends to compress our net interest margin, while steepening of the curve offers better opportunities to purchase assets with wider net interest spreads. The performance of our MPF Loans held for investment portfolio is particularly affected by shifts in the 10-year maturity range of the yield curve, which heavily influences mortgage rates and potential refinancings. Yield curve shape can also influence the pace at which borrowers refinance or prepay their existing loans, as borrowers may select shorter-duration mortgage products in a refinancing. As higher coupon MPF Loans mature, the return of principal may not be invested in assets with a comparable yield, resulting in a potential decline in the aggregate yield on the remaining MPF Loans held for investment portfolio and investment debt securities and a possible decrease in our net interest margin.

Lastly, the volume related to our MPF Xtra and MPF Direct programs as well as our Ginnie Mae MBS issuances also are influenced by the interest rate environment, global and national economies, local economies within our districts of Illinois and Wisconsin, and the conditions in the financial, housing and credit markets.

Environmental, Social, and Governance

We consider Environmental, Social, and Governance (ESG) criteria to be exceptionally valuable as it relates to the manner in which we conduct business with our member shareholders. We have developed extensive programs impacting the communities we serve in Illinois and Wisconsin, as well as our employees, to offer support in times of crisis such as the current COVID-19 pandemic. We are committed to maintaining a position that enables us to provide the services needed to empower those who rely on our organization.

Environmental

In 2019, we announced our plan to move to the Old Post Office at 433 West Van Buren Street in Chicago, Illinois in 2021. This move affords an enhanced commitment to energy efficiency. Our new building will offer a variety of green and eco-friendly actions we can partake in. Additionally, there will be amenities we can utilize to help create a more sustainable environment. This list includes a recycling program, which will help extend the life of current landfill areas, e-recycling for electronic waste such as light bulbs and ballasts, and a 3.5-acre green space on the rooftop.

Social

We were named a Top Workplace in 2020 by the Chicago Tribune. This honor is based on our employees’ feedback to a survey administered earlier this year by a third-party employee engagement technology partner the Chicago Tribune uses to rank workplaces in the Chicago area. The anonymous survey measures important aspects of an engaged culture, including alignment, execution, and connection.

COVID-19 Relief Programs

In response to the COVID-19 pandemic, on April 20, 2020 the Bank announced the COVID-19 Relief Program to support communities in Illinois and Wisconsin. Under this program, each Bank member and non-member housing associate was eligible to draw up to $4 million in an interest-free advance (up to a total of $2.76 billion in interest-free advances under the program). Additionally, under this program, the Bank offered all members and non-member housing associates the opportunity to request up to $20,000 in grants to benefit small businesses and non-profit organizations of their choosing. While the initial program was highly successful, the Bank reviewed what communities were not impacted by the program. As a result of evaluating the impact of the COVID-19 Relief Program and gaps in its impact, the Bank offered grants to our members under the Targeted Impact Fund to support four categories of beneficiaries - minority and women business enterprises, organizations focused on the advancement of Black and Brown communities, social services agencies working with communities hardest hit by COVID-19 including Black, Latin, Tribal, and rural communities as well as the elderly. These grants were available to be used to promote equity and opportunity for underserved populations. (The COVID-19 Relief Program and the Targeted Impact Fund are collectively, the “COVID-19 Relief Programs”). The Bank committed to invest approximately $30 million in the COVID-19 Relief Programs, of which $28 million was provided to members and recorded as an expense in 2020.

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Please reference the table below for more data on our COVID-19 Relief Programs.

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Community Investment Activities

We provide financing and direct funding tools that support the affordable housing and local community lending initiatives of our members. By using our products individually or in combination, our members and their community partners can create economically competitive solutions that contribute to the quality of life in the communities they serve. Please reference the table below for data on our community lending, grant and voluntary programs since their inception.

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For more information, please see Community Investment Activities on page 11.
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Charitable

We organize, support, and participate in various community outreach events. These events include but are not limited to Step Up for Kids, which raises funds for patients at Lurie Children’s Hospital; Christ the King Corporate Work-Study Program, which provides students the opportunity to work in an office building and earn about 65% of their high school tuition; and Ronald McDonald House Charities.

As part of its commitment to exemplary corporate citizenship, the Bank believes in supporting various legitimate eligible causes that are consistent with the Bank's corporate mission and business objectives, or which enhance the communities in the Bank's district. In addition to direct Bank donations to eligible organizations, the Bank will also currently match employees' contributions of more than $25 to certain organizations up to a maximum of $500 per employee.

In November 2020, the Bank announced it would donate to three charitable organizations, totaling $60,000 in support, to be decided based on employees’ votes in a survey. The three charities selected by Bank employees to each receive $20,000 from the Bank were Chicago Family Health Center, My Block, My Hood, My City, and South Suburban PADS – organizations that directly assist communities disproportionately impacted by the COVID-19 pandemic and support positive change in neighborhoods throughout our district. In addition to the financial support, the Bank is identifying ways for employees to provide ongoing support to the organizations.

Diversity, Equity, and Inclusion

Diversity, equity, and inclusion are strategic business priorities for the Bank. Our Chief Diversity Officer is a member of the senior management team, reports to the President and Chief Executive Officer and serves as a liaison to the Board of Directors. We recognize that diversity increases capacity for innovation and creativity, equity ensures employees get what they need to be successful, and inclusion allows us to leverage the unique perspectives of all employees and strengthens our retention efforts. We operationalize our commitment through the development and execution of a three-year diversity, equity, and inclusion strategic plan that includes quantifiable metrics to measure our success and we report regularly on our performance to management and the Board of Directors. In addition, the FHFA’s Office of Minority and Women Inclusion has adopted regulations and provides ongoing guidance, including through their annual examination, with respect to our promotion of diversity, equity, and inclusion.

We offer a range of opportunities for our employees to connect, and grow personally and professionally through our diversity, equity, and inclusion committee, working groups and employee resource groups. We consider learning an important component of our diversity, equity, and inclusion strategy and regularly offer educational opportunities to our employees and evaluate inclusive behaviors as part of our annual performance management process. The Bank also incorporates diversity, equity, and inclusion as a key component of its incentive plan framework to ensure organizational focus and accountability.

The Bank’s Office of Diversity and Inclusion hosted our 3rd Annual Cultural Exploration in 2020. The five-day event was hosted virtually and focused on the roots and implications of systemic racism. Our Board of Directors, Executive Team, five randomly-selected Bank employees, and thought leaders participated in this immersive experience to discuss race as it relates to housing, employment, and access to capital, and more. At the end of each presentation, the participants discussed their own experiences and proposed solutions that will allow the Bank to actively combat systemic racism and be a leader for positive change in our district.

We are committed to supplier diversity, and strive to partner with businesses owned by minorities, women, veterans, people with disabilities, and members of the LGBTQ community. We believe our diverse suppliers are cost competitive, value strong customer service, and are dedicated to excellence. As part of our commitment to supplier diversity, over 81% of our total project spend through January 31, 2021 related to the Bank’s upcoming move to the Old Post Office was with diverse vendors.

Governance

Board of Directors

Our Board of Directors is responsible for the overall management and oversight of the Bank pursuant to the Federal Home Loan Bank Act. Like each of the other Federal Home Loan Banks, our Board of Directors is composed of two types of directors: member directors and independent directors. As discussed in Item 10. Directors, Executive Officers and Corporate Governance on page 89, our member directors are nominated and elected by the Bank’s member institutions, while our independent directors are nominated by our Board and elected by our member institutions. While we do not have a formal policy regarding Board diversity, our Board values diversity across a number of categories, including diversity of gender, race, and ethnicity, as well as professional backgrounds, when nominating independent director candidates. Of the eight independent directors serving on our Board during 2020, five were in gender and/or racially diverse categories. We believe the diverse nature of our directors enhances the oversight and governance of our Bank. For more details on our Board of Directors, please see Item 10. Directors, Executive Officers and Corporate Governance on page 89.

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Code of Ethics and Reporting

We are committed to the highest possible standards of honesty, integrity, impartiality, and conduct. These standards are essential to our business and foster confidence in our Bank and the FHLB System. To promote these ethical standards with our employees and our vendors, we maintain a Whistleblower Policy and Procedure and the Federal Home Loan Bank of Chicago Code of Ethics.

Human Capital Resources

Our human capital is a significant contributor to the success of our strategic business objectives. In managing our human capital, the Bank focuses on its workforce profile, including the promotion of diversity, equity and inclusion as discussed above, as well as the various programs and philosophies described below.

Workforce Profile

Our workforce is primarily comprised of corporate employees, with our principal operations in one location. As of December 31, 2020, we had 466 full-time and 8 part-time employees. As of December 31, 2020, approximately 48% of our workforce is female, 52% male, 63% White, and 37% People of Color. Our workforce historically has included a number of longer-tenured employees. We strive to both develop talent from within the organization and supplement with external hires. We believe that developing talent internally results in institutional strength and continuity and promotes loyalty and commitment in our employee base, which furthers our success, while adding new employees contributes to new ideas, continuous improvement, and our goals of a diverse and inclusive workforce. As of December 31, 2020, the average tenure of our employees was 7.9 years. There are no collective bargaining agreements with our employees.

Total Rewards

We seek to attract, develop and retain talented employees to achieve our strategic business initiatives, enhance business performance and provide members a reasonable return on their investment in the Bank. We support this objective through a combination of development programs, benefits and employee wellness programs and recognizing and rewarding performance. Specifically, our programs include:

Cash compensation that includes competitive salary and performance based incentives
Benefits, including health insurance, life and AD&D insurance, supplemental life insurance, 401(k) retirement savings plans with employer match, and pension benefits
Wellness program, including employee assistance program, health coaching, interactive education sessions, and sporting events sponsorship
Time away from work, including time off for vacation, illness, personal, holiday, and volunteer opportunities
Culture, including employee resource groups, philanthropic volunteer groups, and various diversity and inclusion initiatives
Work/Life balance, including 100% paid salary continuation for short term disability, family leave, new child leave, military leave, bereavement, jury duty, and court appearances, flexible scheduling, and remote working options
Development programs and training, including leadership development, educational assistance programs, internal educational and development opportunities, fee reimbursement for external educational and development programs, and incentive award goals for developmental activities
Management succession planning, which includes the Bank’s Board of Directors and leadership actively engaging in management succession planning, with a defined plan for key roles

Our performance management framework includes annual goal setting as well as mid-year and year-end performance reviews. Merit and incentive payments are differentiated for the Bank’s highest performers.

We are committed to the health, safety, and wellness of our employees. In response to the COVID-19 pandemic, we have implemented significant operating environment changes, safety protocols and procedures that we determined were in the best interest of our employees and members, and which comply with government regulations. This includes having nearly all of the Bank’s employees work remotely, while implementing additional safety measures for employees continuing critical on-site work.

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Oversight, Audits, and Legislative and Regulatory Developments

Regulatory Oversight

We are supervised and regulated by the FHFA, an independent federal agency in the executive branch of the U.S. government. The FHFA's operating and capital expenditures are funded by assessments on the FHLBs; no tax dollars or other appropriations support the operations of our regulator. To assess our safety and soundness, the FHFA conducts annual, on-site examinations as well as periodic on-site reviews. Additionally, we are required to submit monthly financial information on our condition and results of operations to the FHFA.

The Government Corporations Control Act, to which we are subject, provides that before a government corporation issues and offers obligations to the public, the Secretary of the Treasury (Secretary) shall prescribe the form, denomination, maturity, interest rate, and conditions of the obligations, the method and time issued, and the selling price. The FHLB Act also authorizes the Secretary discretion to purchase consolidated obligations up to an aggregate principal amount of $4.0 billion. No borrowings under this authority have been outstanding since 1977.

We must submit annual management reports to Congress, the President, the Office of Management and Budget, and the Comptroller General. These reports include a statement of financial condition, a statement of operations, a statement of cash flows, a statement of internal accounting and administrative control systems, and the report of the independent public accounting firm on our financial statements.

Our business is subject to extensive regulation and supervision. As discussed throughout this Form 10-K, the laws, regulations, and regulatory guidance to which we are subject cover all key aspects of our business, and directly and indirectly affect our product and service offerings, collateral practices, pricing, competitive position and strategic plan, relationship with members and third parties, capital structure, cash needs and uses, and information security. As a result, such laws and regulations have a significant effect on key drivers of our results of operations, including, for example, our capital and liquidity, product and service offerings, risk management, and costs of compliance. For a discussion of risks relating to the complex body of laws and regulations to which we are subject, see Risk Factors on page 23. For a discussion of recent regulatory and legislative developments impacting us, see Recent Legislative and Regulatory Developments on page 18.

Regulatory Audits

The Comptroller General has authority under the FHLB Act to audit or examine us and to decide the extent to which we are fairly and effectively fulfilling the purposes of the FHLB Act. Furthermore, the Government Corporations Control Act provides that the Comptroller General may review any audit of the financial statements conducted by an independent registered public accounting firm. If the Comptroller General conducts such a review, then the results and any recommendations must be reported to the Congress, the Office of Management and Budget, and the FHLB in question. The Comptroller General may also conduct a separate audit of any of our financial statements.


Recent Legislative and Regulatory Developments

FDIC Brokered Deposits Restrictions

On January 22, 2021, the FDIC published a final rule, effective April 1, 2021, that amends its brokered deposits regulations that apply to less than well-capitalized insured depository institutions. The FDIC stated that the amendments are intended to modernize and clarify the FDIC’s brokered deposit regulations and they establish a new framework for analyzing the deposit broker definition, which determines whether deposits placed through deposit placement arrangements qualify as brokered deposits. These deposit placement arrangements include those between insured depository institutions and third parties, such as financial technology companies, for a variety of business purposes, including access to deposits. The amendments to the FDIC’s brokered deposit regulations, among other things, clarify what it means to be engaged in the business of facilitating the placement of deposits and expand the scope of the primary purpose exception. The rule amendments are expected to have the effect of narrowing the definition of deposit broker and excluding more deposits from treatment as brokered deposits. The amendments also establish an application and reporting process with respect to the primary purpose exception for businesses that do not meet one of several bright-line tests, and they affirm the FDIC’s position that the brokering of certificates of deposit constitutes deposit brokering.

This rule may have an effect on member demand for certain advances, but we cannot predict the extent of the impact. At this time, we do not expect this rule to materially affect our financial condition or results of operations.

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United States Department of Treasury (Treasury) and Federal National Mortgage Association (Fannie Mae) Preferred Stock Purchase Agreement Amendment

On January 14, 2021, Treasury and Fannie Mae entered into a letter agreement amending the terms of their Preferred Stock Purchase Agreement (PSPA) which could impact PFIs that participate in the MPF Program’s MPF Xtra product (where MPF loans acquired are concurrently sold to Fannie Mae). Under the PSPA, Treasury provides liquidity to Fannie Mae in exchange for senior preferred stock. Under the recent PSPA amendment, effective January 1, 2022, the FHFA (acting as conservator for Fannie Mae) and Treasury agreed to limit the dollar volume of loans Fannie Mae could purchase from a single seller through Fannie Mae’s cash window to $1.5 billion per year. As administrator of the MPF Program, the Bank purchases MPF Xtra loans from PFIs and sells them to Fannie Mae via the cash window process. Based on volumes for the MPF Xtra product program-wide in 2020, the PSPA amendment would significantly curtail MPF Xtra cash window sales.

Although we do not currently expect this amendment to have a material impact on our financial condition or results of operations, it may negatively impact the volume of loans that PFIs are able to sell through the MPF Program unless we are successful in our efforts to develop a solution.

Margin and Capital Requirements for Covered Swap Entities

On July 1, 2020, the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), the Farm Credit Administration, and the FHFA (collectively, Prudential Banking Regulators) jointly published a final rule, effective August 31, 2020, amending regulations that established minimum margin and capital requirements for uncleared swaps for covered swap entities under the jurisdiction of the Prudential Banking Regulators (Prudential Margin Rules). In addition to other changes, the final rule: (1) allows swaps entered into by a covered swap entity prior to an applicable compliance date to retain their legacy status and not become subject to the Prudential Margin Rules in the event that the legacy swaps are amended to replace an interbank offered rate (such as LIBOR) or other discontinued rate, or due to other technical amendments, notional reductions or portfolio compression exercises; (2) introduces a new Phase 6 compliance date for initial margin requirements for covered swap entities and their counterparties with an average daily aggregate notional amount (AANA) of uncleared swaps from $8 billion to $50 billion; and (3) clarifies that initial margin (IM) trading documentation does not need to be executed prior to the parties becoming obligated to exchange IM.

On the same date, the Prudential Banking Regulators published an interim final rule, effective September 1, 2020, extending the IM compliance date for Phase 6 counterparties to September 1, 2022.

On November 9, 2020, the CFTC published a final rule extending the IM compliance date for Phase 6 counterparties to September 1, 2022, thereby aligning with the Prudential Banking Regulators. Further, on January 5, 2021, the CFTC published a final rule, effective February 4, 2021, that primarily amends the minimum margin and capital requirements for uncleared swaps under the jurisdiction of the CFTC (CFTC Margin Rules) by requiring covered entities to use a revised AANA calculation starting on September 1, 2022. The amendments, among other things, require entities subject to the CFTC’s jurisdiction to calculate the AANA for uncleared swaps during March, April and May of the current year, based on an average of month-end dates, as opposed to the previous requirement which required the calculation of AANA during June, July and August of the prior year, based on daily calculations. Parties would continue to be expected to exchange IM based on the AANA totals as of September 1 of the current year. These amendments align with the recommendation of the Basel Committee on Banking Supervision and Board of the International Organization of Securities Commissions. Separately, on January 25, 2021, the CFTC published a final rule, effective February 24, 2021, that amends the CFTC Margin Rules to permit, among other changes, covered swap entities to maintain separate minimum transfer amounts (MTA) for IM and variation margin for each swap counterparty, provided the combined MTA does not exceed $500,000.

We do not expect these rules to have a material effect on our financial condition or results of operations.

FHFA Final Rule on FHLB Housing Goals Amendments

On June 25, 2020, the FHFA published a final rule, effective August 24, 2020, amending the FHLB housing goals regulation. Enforcement of the final rule will phase in over three years. The final rule replaces the four existing retrospective housing goals with a single prospective mortgage purchase housing goal target in which 20% of Acquired Member Asset (AMA) mortgages purchased in a year must be comprised of loans to low-income or very low-income families, or to families in low-income areas. The final rule also establishes a separate small member participation housing goal with a target level in which 50% of the members selling AMA loans in a calendar year must be small members. The final rule provides that an FHLB may request FHFA approval of alternative target levels for either or both of the goals. The final rule also establishes that housing goals apply to each FHLB that acquires any AMA mortgages during a year, eliminating the existing $2.5 billion volume threshold that previously triggered the application of housing goals for each FHLB.

We do not believe these changes will have a material effect on our financial condition or results of operations.
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FHFA Final Rule on Stress Testing

On March 24, 2020, the FHFA published a final rule, effective upon issuance, to amend its stress testing rule, consistent with section 401 of the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (EGRRCPA). The final rule (i) raises the minimum threshold for entities regulated by the FHFA to conduct periodic stress tests from $10 billion to $250 billion or more in total consolidated assets; (ii) removes the requirements for FHLBs to conduct stress testing; and (iii) removes the adverse scenario from the list of required scenarios. FHLBs are currently excluded from this regulation because no FHLB has total consolidated assets over $250 billion, but the FHFA reserved its discretion to require an FHLB with total consolidated assets below the $250 billion threshold to conduct stress testing. These amendments align the FHFA stress testing rule with rules adopted by other financial institution regulators that implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) stress testing requirements, as amended by EGRRCPA.

This rule eliminates these stress testing requirements for the Bank, unless the FHFA exercises its discretion to require stress testing in the future. We do not expect this rule to have a material effect on our financial condition or results of operations.

FHLB Membership Request for Input

On February 24, 2020, the FHFA issued a Request for Input on FHLB membership (the Membership RFI). The Membership RFI, as part of a holistic review of FHLB membership, seeks public input on whether the FHFA’s existing regulation on FHLB membership, located at 12 CFR part 1263, remains adequate to ensure: (i) the FHLB System remains safe and sound and able to provide liquidity to members in a variety of conditions; and (ii) the advancement of the FHLBs’ housing finance and community development mission. The FHFA sought input on several broad questions relating to FHLB membership requirements, as well as on certain more specific questions related to the implementation of the current membership regulation. Responses were due on June 23, 2020.

While it is uncertain what actions, if any, the FHFA will take as a result of the responses received from the Membership RFI, any rulemaking actions to update the current FHLB membership regulation may impact FHLB membership eligibility or requirements, and ultimately our business, business opportunities, and results of operation.

FHFA Advisory Bulletin 2020-01 Federal Home Loan Bank Risk Management of AMA Risk Management

On January 31, 2020, the FHFA released guidance on risk management of AMA. The guidance communicates the FHFA’s expectations with respect to an FHLB’s funding of its members through the purchase of eligible mortgage loans and includes expectations that an FHLB will have board-established limits on AMA portfolios and management-established thresholds to serve as monitoring tools to manage AMA-related risk exposure. The guidance provides that the board of an FHLB should ensure that the bank serves as a liquidity source for members, and an FHLB should ensure that its portfolio limits do not result in the FHLB’s acquisition of mortgages from smaller members being “crowded out” by the acquisition of mortgages from larger members. The advisory bulletin contains the expectation that the board of an FHLB should set limits on the size and growth of portfolios and on acquisitions from a single participating financial institution. In addition, the guidance provides that the board of an FHLB should consider concentration risk in the areas of geographic area, high-balance loans, and in third-party loan originations.

We do not expect this guidance to materially affect our financial conditions or results of operations, although it may limit our ability to provide secondary market liquidity to our PFI members under certain market conditions, including in the event of rapid growth of our AMA portfolio and/or a significant reduction in our advances balances.

LIBOR Transition

FHFA Supervisory Letter - Planning for LIBOR Phase-Out

On September 27, 2019, the FHFA issued a Supervisory Letter (LIBOR Supervisory Letter) to the FHLBs that the FHFA stated is designed to ensure the FHLBs will be able to identify and prudently manage the risks associated with the termination of LIBOR in a safe and sound manner. The LIBOR Supervisory Letter provided that the FHLBs should, by March 31, 2020, cease entering into new LIBOR referenced financial assets, liabilities, and derivatives with maturities beyond December 31, 2021 for all product types except investments. With respect to investments, the FHLBs were required, by December 31, 2019, to stop purchasing investments that reference LIBOR and mature after December 31, 2021. These phase-out dates did not apply to collateral accepted by the FHLBs. The LIBOR Supervisory Letter also directed the FHLBs to update their pledged collateral certification reporting requirements by March 31, 2020, in an effort to encourage members to distinguish LIBOR-linked collateral maturing after December 31, 2021. The FHLBs were expected to cease entering into LIBOR-indexed financial instruments maturing after December 31, 2021, by the deadlines specified in the LIBOR Supervisory Letter, subject to limited exceptions granted by the
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FHFA for LIBOR-linked products serving compelling mission, risk mitigating, and/or hedging purposes that do not currently have readily available alternatives. We have already ceased purchasing investments that reference LIBOR and mature after December 31, 2021. In addition, we previously ceased entering into option embedded advance products that reference LIBOR and have suspended transactions in certain structured advances and advances with terms directly linked to LIBOR that mature after December 31, 2021. Also as of July 1, 2020, we no longer enter into consolidated obligation bonds and derivatives with swaps, caps, or floors indexed to LIBOR that terminate after December 31, 2021.

As a result of the market volatility experienced during 2020 due in part by the COVID-19 pandemic, the FHFA extended the FHLBs’ authority to enter into LIBOR-based instruments that mature after December 31, 2021 from March 31, 2020 to June 30, 2020, except for investments and option embedded products. In addition, the FHFA extended the requirement to update pledged collateral certification reporting requirements from March 31, 2020, to September 30, 2020.

We continue to evaluate the potential impact of the LIBOR Supervisory Letter and the related subsequent guidance on our financial condition and results of operations, but we may experience lower overall demand or increased costs for our advances, which in turn may negatively impact the future composition of our balance sheet, capital stock levels, core mission asset ratio, net income and dividend.

LIBOR Transition – ISDA 2020 IBOR Fallbacks Protocol and Supplement to the 2006 ISDA Definitions

On October 23, 2020, the International Swaps and Derivatives Association, Inc. (ISDA), published a Supplement to the 2006 ISDA Definitions (Supplement) and the ISDA 2020 Interbank Offered Rate (IBOR) Fallbacks Protocol (Protocol). Both the Supplement and the Protocol took effect on January 25, 2021. On that date, all legacy bilateral derivative transactions subject to Protocol-covered agreements (including ISDA agreements) that incorporate certain covered ISDA definitional booklets and reference a covered IBOR, including U.S. Dollar LIBOR, were amended to apply the new ISDA-recommended IBOR fallbacks in the event of the relevant IBOR’s cessation. To the extent our counterparties do not adhere to the Protocol, it will be necessary to bilaterally amend legacy covered agreements (including ISDA agreements) to address LIBOR fallbacks. The Protocol will remain open for adherence after the effective date. As of January 25, 2021, all new derivative contracts are subject to the relevant IBOR fallbacks set forth in the Supplement.

On October 21, 2020, the FHFA issued a Supervisory Letter to the FHLBs that required each FHLB to adhere to the Protocol by December 31, 2020, and to the extent necessary, to amend any bilateral agreements regarding the adoption of the Protocol by December 15, 2020.

We adhered to the Protocol on October 23, 2020. For a discussion of the potential impact of the LIBOR transition, refer to LIBOR Transition on page 56 and Risk Factors, starting on page 23.

COVID-19 Developments

FHFA Supervisory Letter – Paycheck Protection Program (PPP) Loans as Collateral for FHLB Advances

On April 23, 2020, the FHFA issued a Supervisory Letter (PPP Supervisory Letter) permitting the FHLBs to accept PPP loans as collateral for advances as “Agency Securities,” given the Small Business Administration’s (SBA) 100 percent guarantee of the unpaid principal balance. On April 20, 2020, the SBA published its third interim final rule related to PPP loans, which explicitly waived certain regulatory requirements that must be satisfied before a member could pledge PPP loans to the FHLBs as collateral. The PPP Supervisory Letter establishes a series of conditions under which the FHLBs may accept PPP loans as collateral, which conditions focus on the financial condition of members, collateral discounts, and pledge dollar limits.

On December 27, 2020, the President signed into law an extension of the PPP until March 31, 2021. On April 23, 2020, following the FHFA’s issuance of the PPP Supervisory Letter, we issued a member communication detailing the terms on which the Bank would accept PPP loans as collateral. The April 23, 2020 Supervisory Letter from the FHFA allowing FHLBs to accept PPP loans as collateral remains in effect.

Federal Reserve Lending Facilities. The Federal Reserve announced on November 30, 2020 that certain of its lending facilities scheduled to expire would be extended through March 31, 2021.

CARES Act

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law on March 27, 2020. The $2.2 trillion package was the largest stimulus bill in U.S. history. The CARES Act is in addition to previous relief legislation passed by Congress in March 2020. The legislation provides the following:
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Assistance to businesses, states and municipalities.
Creates a loan program for small businesses, non-profits and physician practices that can be forgiven through employee retention incentives.
Provides the Secretary of Treasury authority to make loans or loan guarantees to states, municipalities, and eligible business and loosens some regulations imposed through the Dodd-Frank Act.
Direct payments to eligible tax payers and their families.
Expands eligibility for unemployment insurance and payment amounts.
Includes mortgage forbearance provisions and a foreclose moratorium.

Funding for the PPP, which was created by the CARES Act, was increased with the enactment of subsequent laws, most recently by the Consolidated Appropriations Act, 2021, on December 27, 2020. While some provisions of the CARES Act have expired, others have been extended by regulatory and legislative action. Additional phases of the CARES Act or other COVID-19 pandemic relief legislation may be enacted by Congress. We continue to evaluate the potential impact of such legislation on our business, including its continued impact to the U.S. economy; impacts to mortgages held or serviced by our members and that we accept as collateral; and the impacts on our MPF program.

Additional COVD-19 Presidential, Legislative and Regulatory Developments

In light of the COVID-19 pandemic, the former and current Presidents, through executive orders, governmental agencies, including the SEC, OCC, Federal Reserve, FDIC, National Credit Union Administration, CFTC and the FHFA, as well as state governments and agencies, have taken, and may continue to take, actions to provide various forms of relief from, and guidance regarding, the financial, operational, credit, market, and other effects of the pandemic, some of which may have a direct or indirect impact on us or our members. Many of these actions are temporary in nature. We continue to monitor these actions and guidance as they evolve and to evaluate their potential impact on us.

Taxation and AHP Assessments

We are exempt, by statute, from all federal, state, and local taxation except for real estate property taxes, which are a component of our lease payments for office space or on real estate we own as a result of foreclosure on MPF Loans. In lieu of taxes, we set aside funds for our AHP at a calculated rate of 10% of income before assessments. For details on our assessments, see Note 11 - Affordable Housing Program to the financial statements.
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Item 1A.    Risk Factors.

Business Risks

The coronavirus disease 2019 (COVID-19) pandemic, its impact on the economy and markets, and the resulting government measures, could have a material adverse effect on our business, results of operations, and financial condition.

The COVID-19 pandemic has caused, and is likely to continue to cause, significant volatility and disruption in the international and U.S. financial markets and closure of many businesses, leading to increased unemployment. Adverse economic trends as a result of the impact of the COVID-19 pandemic could materially: reduce the value of collateral pledged to secure member credit; increase credit losses, including as a result of increased forbearances granted by Bank members and PFIs to borrowers, or as a result of mortgage servicer failures; reduce the fair value of the Bank’s investments; adversely affect demand for Bank products and FHLB debt; affect our ability to maintain an appropriate liquidity and funding balance between our financial assets and liabilities; and cause our derivative or Federal Fund counterparties, or our counterparties for securities purchased under agreements to resell, to fail to meet their obligations to us. The effects of the COVID-19 pandemic on overall funding costs may continue to cause compression in net interest margin if returns on our liquidity asset portfolio also decline. Economic uncertainty resulting from the COVID-19 pandemic may also increase the risk of loss in our Fannie Mae DUS bond investments if default on the underlying loans results in increased prepayments of these bonds by Fannie Mae. Since any such prepayment can be made without a prepayment premium, the Bank may suffer losses as it unwinds the related hedging swaps in a low rate environment. If economic and market conditions deteriorate, the Bank’s financial condition, results of operation, ability to pay dividends, meet dividend guidance, or redeem or repurchase capital stock could be adversely impacted.

To mitigate the adverse effects of the COVID-19 pandemic, the U.S. federal government and its agencies have instituted various responsive policies and actions. Any such actions and policies, including fiscal stimulus, Federal Reserve rate cuts, the continuation of a low rate environment, and/or any future negative rate environment, may directly and indirectly influence: interest rates on the Bank’s assets and liabilities; the cost or demand for FHLB debt or advances; or prepayment on our MPF Loans and investments with associated reinvestment risks, which could adversely affect our financial condition, results of operations, and ability to pay dividends. Additionally, the Federal Reserve’s emergency actions to increase liquidity, along with market conditions resulting from the COVID-19 pandemic, have resulted in lower demand for new advances from our depository members and prepayment of their existing advances. To the extent this trend continues or escalates, our financial condition and results of operation could be adversely impacted. Moreover, new or modified legislation enacted by Congress or regulations or guidance adopted by the FHFA or other agencies could have a negative effect on our and our members’ ability to conduct business or the costs of doing business.

The extent to which the COVID-19 pandemic will affect or will continue to affect our business, financial condition, and results of operations is unpredictable. There is uncertainty in: the pandemic’s scope and duration, and any resulting economic consequences; the continued effectiveness of our business continuity plan (which currently primarily leverages work-from-home arrangements that are dependent on third party providers of phone and internet services that vary by worker); the direct and indirect impact on our workforce and board of directors, our members, our counterparties and service providers, as well as other market participants; any governmental authorities and other third parties’ actions taken in response to the COVID-19 pandemic; the pace of recovery when the pandemic subsides; and the long-term impact of the pandemic on our and our members’ businesses. Adverse developments with respect to any of these factors could have a material adverse impact on the Bank’s financial condition and results of operation.

Our business and results of operations may be adversely affected by the U.S housing and mortgage markets, as well as other economic conditions, and related U.S. government policies.

Our business and results of operations are sensitive to the U.S. housing and mortgage markets, as well as international, domestic and district-specific markets and other economic conditions. For example, adverse trends in the mortgage lending sector and residential real estate sector, including declines in housing prices or deterioration in loan performance trends, could reduce the value of collateral pledged to secure member credit. These trends could also lead to a reduction in the fair value of the Bank’s investments and MPF Loan portfolio, could adversely affect demand for Bank products, and could cause members to default on their credit obligations to us. Moreover, adverse trends in employment levels, a slowdown in regional or national economic activity, geopolitical instability, trade disruptions, or a sustained capital market correction could adversely affect overall economic conditions, and in turn result in adverse consequences in our or our members’ businesses. If economic and market conditions deteriorate, the Bank’s financial condition, results of operation, ability to pay dividends, meet dividend guidance, or redeem or repurchase capital stock could be adversely impacted.

Our business and results of operations are also affected by the fiscal and monetary policies and actions of the federal government and its agencies in response to adverse economic conditions, including the Federal Reserve, which regulates of the
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supply of money and credit in the United States. Any federal government actions and policies, including rate cuts or stimulus measures/quantitative easing programs, may directly and indirectly influence interest rates on the Bank’s assets and liabilities, the demand for FHLB debt or advances, or prepayment on our MPF Loans and investments with associated reinvestment risks, which could adversely affect our financial condition, results of operations, and ability to pay dividends. Additionally, federal government actions like the recent U.S. Department of Treasury and Fannie Mae letter agreement, as further discussed in Recent Legislative and Regulatory Developments on page 18 may impact our MPF Program.

The Bank and our members are subject to and affected by a complex body of laws and regulations, which could change or be applied in a manner detrimental to our business operations, and adversely affect our financial condition.

We are a GSE organized under the authority of the FHLB Act and are governed by Federal laws and the regulations of the FHFA. From time to time, changes in legislation have significantly affected the FHLBs and their business operations. New or modified legislation enacted by Congress or regulations or guidance adopted by the FHFA or other agencies could have a negative effect on our ability to conduct business (including our ability to adapt to changing conditions) or our costs of doing business.

The FHFA’s extensive regulatory authority over the FHLBs includes the authority to liquidate, merge, consolidate, or redistrict the FHLBs. With respect to an FHLB merger or consolidation, members will be subject to the terms and conditions of any plan of merger and/or terms established or approved by the FHFA. Likewise, members’ rights in a liquidation will be subject to approval of the FHFA and may be inconsistent with our capital plan. The FHFA also has authority over FHLB liquidity and capital requirements, and authority over the scope of permissible FHLB products and activities (including the authority to impose limits on those products and activities). We cannot predict the extent to which future FHFA rule changes or guidance could impact our business or our members.

Changes in our statutory or regulatory requirements or policies or in their application could result in changes in, among other things, our membership base; our cost of funds; liquidity requirements; retained earnings and capital requirements; accounting policies; debt issuance limits; dividend payment limits; the form of dividend payments; capital redemption and repurchase limits; permissible business activities; product pricing and structure; collateral practices; compliance requirements; operational processes; and the size, scope, or nature of our lending, investment and MPF Program activities; or how we manage our balance sheet; all and any of which could be detrimental to our business operations and financial condition.

In addition, as Congress and the Administration continue to consider reforms to the U.S. housing finance system, including the resolution of Fannie Mae and Freddie Mac, any legislative proposals or administrative actions could directly or indirectly impact GSEs that support the U.S. housing market, including the FHLBs. Also, there are additional uncertainties in the legislative and regulatory environment resulting from the change in Administrations and the Congress.

Moreover, new or modified legislation or regulations governing or impacting our members and counterparties may affect our ability to conduct business or cost of doing business. See Recent Legislative and Regulatory Developments on page 18 for more information about recent regulatory developments.

We face competition for advances, which could adversely affect our business.

Our primary business is making advances to members. We compete with other suppliers of wholesale funding, both secured and unsecured, including investment banks, commercial banks, the Federal Reserve, and, in certain circumstances, other FHLBs with which members have a relationship through affiliates. Changes to legislation or regulations affecting our members, changes to our members’ business models, or the availability of alternative funding sources, may negatively affect our advance levels. Moreover, if we are unable to structure our advance products, collateral requirements, and pricing to satisfy the specific funding requirements of all members, our members may turn to other sources of liquidity and our advance levels could decrease.

We may make changes in policies, programs, and agreements affecting members' access to advances and other credit products, the MPF Program, the AHP, and other programs, products, and services. As a result, some members may choose to obtain financing from alternative sources. Further, many competitors are not subject to the same regulations as us, which may enable those competitors to offer products and terms that we are not able to offer. Any change made in pricing our advances to compete with these alternative funding sources may decrease our profitability on advances. Additionally, as we manage our refunding risk and maintain compliance with our liquidity requirements and other regulatory guidance, any resulting increase in advance pricing may decrease demand for our advances. State and federal regulators’ perception of the stability and reliability of our advances can also directly impact the amount of advances used by our members. A decrease in advance demand or a decrease in profitability on advances could adversely impact our financial condition and results of operations.

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Our and our members’ inability to adapt products and services to evolving industry standards and customer preference amid a highly competitive and regulated landscape, while managing expenditures, could harm our business.

Our and our members’ success depend on the ability to adapt products and services to evolving industry standards and to meet customer needs, particularly amid a highly competitive and regulated landscape that may impact our and our members’ ability to effectively respond to changing market conditions. The widespread adoption of new technologies could require substantial expenditures. If we or our members are unable to adopt new technologies or improve our technological capabilities, including retention of key technology personnel and the development of necessary operating and management processes, we and our members may not be able to remain competitive and our businesses, financial conditions, and results of operations may be significantly compromised. We and our members are also faced with increasing operating costs in managing cybersecurity risks. We and our members may not be successful in developing or introducing new products, systems, and services to keep pace with larger competitors, in integrating new products, systems, or services into existing platforms, in responding or adapting to changes in customer behavior or preferences, and in reducing costs, all of which may harm our business and results of operations.

The loss of, or change of business activities with, significant members could result in lower demand for our products and services, and negatively impact our financial condition and results of operation.

Due to the nature of our charter, membership in our Bank is generally limited to federally-insured depository institutions, insurance companies, credit unions and community development financial institutions in Illinois and Wisconsin. Given this limitation in membership eligibility, a loss of members or decreased business activities with large members could negatively impact our financial condition and results of operation.

At December 31, 2020, our five largest advance borrowers held 49.9% of total advances outstanding. Advance balances with our largest members and our other members could change due to factors such as a change in member demand or borrowing capacity, regulatory changes, market conditions, or the competitive factors discussed herein or otherwise. If, for any reason, we were to lose our largest members, or experience sustained decreases in the business they conduct with us, including as a result of prepayments, our financial condition and results of operations could be negatively impacted.

As discussed above, the Federal Reserve’s recent emergency actions to increase liquidity, along with market conditions resulting from the COVID-19 pandemic, has resulted in lower demand for advances from our large depository members and prepayment of their existing advances.

In addition, as result of regulatory changes adopted by the FHFA in 2016, our captive insurance company members had their membership terminated in February 2021. At December 31, 2020, these former captive insurance company members had $11.4 billion of advances outstanding, with a remaining weighted tenor of approximately 3 years, which constituted 25% of our outstanding advances as of December 31, 2020. Once these captive insurance company advances mature, our advance and capital stock levels could decrease if not replaced by business from other members.

Moreover, various factors, including regulatory requirements, have contributed to increased consolidation in the financial services industry, and could reduce current and potential Bank members. For example, depository institutions continue to experience consolidation due to, among other things, increased regulatory burden, greater competition from non-bank “Fintech” companies, lower interest margin, and/or higher technology costs that incentivize scale. If for any reason, we were to lose a member or members whose business and capital stock investments are significant to our business, our business operations, financial condition, and results of operations could be negatively impacted.

To the extent that the reduced demand for our products by depository members, the loss of business with our former captive insurance company members, or reduced demand as a result of further industry consolidation is not replaced by demand from our other members, or to the extent we are unable to sustain our current business with our insurance company members, our results of operations, primary mission asset ratio and supplemental mission asset ratio may be negatively impacted.

Failure to meet minimum regulatory capital requirements and guidance could affect our ability to conduct business and could adversely affect our earnings.

We are subject to certain minimum capital requirements under the FHLB Act, as amended, and the FHFA rules and regulations that include total capital, leverage capital, and risk-based capital requirements. If we are unable to satisfy our minimum capital requirements, we could be subject to certain capital restoration requirements and prohibited from paying dividends and redeeming or repurchasing capital stock without the prior approval of the FHFA, which could adversely affect a member's investment in our capital stock. Furthermore, any suspension of dividends and/or capital stock repurchases and redemptions could decrease member confidence, which in turn could reduce advance demand and net income should members elect to use
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alternative sources of wholesale funding. For further discussion of our minimum regulatory capital requirements, see Note 12 - Capital and Mandatorily Redeemable Capital Stock (MRCS) to the financial statements.

Additionally, recent FHFA guidance around our capital stock levels relative to total assets and retained earnings and dividend policy has impacted how we manage our balance sheet, which could adversely affect our business and a member’s investment in our stock. For a discussion of our retained earnings and dividend policy, see Retained Earnings and Dividend Policy section on page 66.

Changes in the perception, status or regulation of GSEs and the related effect on debt issuance could reduce demand or increase the cost of the FHLBs' debt issuance and adversely affect our earnings.

The FHLBs are GSEs organized under the authority of the FHLB Act. Negative news articles, industry reports, and other announcements relating to any GSE could create pressure on debt pricing for all GSEs, as investors could perceive such instruments as bearing increased risk. Moreover, the scope, timing, and effect of any regulatory reform affecting the GSEs, including the ultimate resolution to the conservatorship of Fannie Mae and Freddie Mac, could have a significant effect on the FHLB system and could negatively change the perception of the risks associated with the GSEs and their debt securities. Any such negative information or other factors could result in the FHLBs having to pay a higher rate of interest on consolidated obligations to make them attractive to investors, which could negatively affect the FHLBs' results of operations or access to funding.

How successfully we are able to manage our balance sheet in the face of factors such as changes in the economic environment, changes in member demand, or increased guidance from our regulator may have a material adverse effect on our results of operations and financial condition.

If the composition of our balance sheet significantly changes in some manner, whether as a result of the economic environment or other factors like member demand, we would be presented with challenges. If we are unable to successfully maintain our balance sheet and cost infrastructure at an appropriate composition and size scaled to member demand, including as a result of the regulatory limitations described below, our results of operations and financial condition may be negatively impacted.

Regulatory guidance from the FHFA, our regulator, may have an effect on how we manage our balance sheet and cost infrastructure, and may limit our ability to effectively adapt to changing conditions. The following are examples of regulatory guidance that constrains our balance sheet management and operations:

We are subject to a mission asset ratio requirement, as further described on page 5, which may impact our ability to make new investments through various advance demand cycles.
We are subject to guidance providing for each FHLB to maintain a ratio of at least two percent of capital stock to total assets, which may impact how we manage our capital and investments.
As further discussed in Liquidity Measures on page 54, we are subject to the Liquidity AB. Under certain market conditions, the Liquidity AB may require us to hold additional liquid assets. Maintaining large balances of liquid assets may reduce our ability to invest in higher-yielding assets, and may in turn negatively impact net interest income. Additionally, to the extent that the Bank adjusts pricing for its short-term advances and letters of credit as a result of the Liquidity AB, these products may become less competitive, which may adversely affect advance and capital stock levels as well as letters of credit levels, and ultimately our net income. Moreover, in certain circumstances, we may need to fund overnight or shorter-term investments and advances with discount notes that have maturities that extend beyond the maturities of the related investments or advances. Net interest income on investments and advances may be reduced as a result of these requirements.
As further discussed in Liquidity Measures on page 54, Liquidity AB provides guidance on maintaining appropriate funding gaps, compliance with which, may increase our cost of funding, and may ultimately result in a reduction in our net interest income on investments and advances.

Limitations on the payment of dividends and repurchase of excess capital stock, any reduction in dividend levels, failure to meet our dividend guidance or the cessation of dividend guidance in the future, or future changes to our capital stock requirements may adversely affect our business.

Our business model is based on the goal of maintaining a balance between our housing mission and our objective to provide a reasonable return on our members' investment in the cooperative. We work to achieve this balance by delivering low-cost credit to help our members meet the credit needs of their communities while striving to pay a reasonable dividend on our Class B2 membership stock and a higher dividend on Class B1 activity stock in order to recognize those members that are using our products. See Dividend Payments on page 66.

Under FHFA regulations, the FHLBs may pay dividends on their stock only out of previously retained earnings or current net income, and our ability to pay dividends is subject to statutory and regulatory restrictions and is dependent upon our ability to continue to generate net income. Further, the level of our dividend payments is restricted by our retained earnings and dividend
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policy as further described under Retained Earnings and Dividend Policy section on page 66. Relatedly, our ability to meet or provide any dividend guidance may be impacted by a change in financial or economic conditions, regulatory and statutory limitations, our retained earnings and dividend policy, and any other relevant factors. As a result of these factors, we may be unable to pay dividends, unable maintain a higher dividend on Class B1 activity stock, unable to meet or provide any dividend guidance, or the level of dividends could be significantly reduced.

To the extent that current and prospective members determine that our dividend and/or dividend guidance are insufficient or our ability to pay future dividends or repurchase excess capital stock becomes limited (as further discussed in the risk factor on limitations on our ability to repurchase excess stock), we may be unable to expand our membership, or lose members, or we may experience decreased member demand for products requiring capital stock purchases, which may in turn adversely affect our results of operations and financial condition.

Changes in our current capital stock requirements, the extent to which we are able to continue to offer the Reduced Capitalization Advance Program (“RCAP”) (which reduces a member’s activity stock requirement for certain advances), or the extent to which we effect future changes to our capital plan (including our capital stock requirements), may impact member utilization of the Bank, which in turn may adversely affect our results of operations and financial condition.

Our MPF Program relies on the participation of other FHLBs and their PFIs, and the loss of any such participants may impact our results and operation and business. Additionally, a decline in national mortgage originations, the competitive and highly regulated landscape, and the loss of certain PFIs in the future may negatively impact our MPF Program and the related business.

The MPF Program is a secondary mortgage market business under which we purchase mortgage loans from our PFIs and PFIs of other FHLBs for on- and off-balance sheet products (together with us, the MPF Banks). We also provide programmatic and operational support in our role as the administrator of the MPF Program on behalf of the other MPF Banks for a fee. Accordingly, the success of the program depends not only on the participation of our PFIs, but also on the participation of other MPF Banks as well as their PFIs. To the extent an insufficient number of FHLBs and their PFIs choose to participate in the MPF Program, the program may suffer losses that impact our results of operation and business.

While national mortgage originations increased in 2020, they were in a downward trend from the end of 2016 through 2018, and are expected to decline in 2021 compared to 2020. To the extent that the decline in national mortgage originations resumes, we may experience a decrease in volume available to purchase from our PFIs. In addition, PFIs may stop selling loans under the MPF Program due to mergers with or into other organizations, or as a result of market competition. To the extent a sufficient number of our PFIs experience a decline in new mortgage originations or discontinue selling under the MPF Program, and we do not gain a sufficient number of new PFIs to offset such decline or departures, we may incur a decrease in volume available to purchase from our PFIs, resulting in a decline in MPF Program volume. Moreover, our MPF Program is subject to FHFA regulation and oversight, including volume caps limiting the dollar value of loans PFIs can sell loans under the program, as well as volume caps on the dollar value of MPF Xtra loans the MPF Program can sell to Fannie Mae. Further, to the extent FHFA regulation or guidance necessitates changes to MPF Traditional loans products, this could have a negative impact on the volume of loans sold into the MPF Program. To the extent we cannot offset these limitations with increased loan purchases from other PFIs, product enhancements, or through development of new channels, our business may be negatively impacted.

During 2020, the top five PFIs, in the aggregate, accounted for 21% of our MPF on balance sheet purchases held in portfolio. To the extent we lose our business with these PFIs and cannot attract comparable replacements, our business may be adversely affected.

Restrictions on the redemption, repurchase, or transfer of our capital stock could result in an illiquid investment for the holder.

Under the GLB Act and FHFA regulations, and our Capital Plan, our capital stock is subject to redemption upon the expiration of a five-year redemption period. Only capital stock in excess of a member's or former member's minimum investment requirement that was subject to a redemption request, capital stock of a member that has submitted a notice to withdraw from membership, or capital stock held by a member whose membership has been terminated may be redeemed at the end of the applicable redemption period. Further, we may elect to repurchase excess stock from time to time at our sole discretion without regard to the five-year redemption period.

There is no guarantee that we will be able to redeem capital stock held by a shareholder even at the end of the redemption period or to repurchase excess capital stock. FHFA regulations and our capital plan restrict us from redeeming or repurchasing capital stock under certain scenarios, including in instances where the redemption or repurchase would cause us to fail to meet our minimum capital requirements. For additional information on limitations on our ability to repurchase or redeem capital stock,
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see Statutory and Regulatory Restrictions on Capital Stock Repurchase and Redemption on page 64.

In addition, since our capital stock may only be owned by our members (or, under certain circumstances, former members and certain successor institutions), and our Capital Plan requires the Bank’s approval before a member or nonmember shareholder may transfer any of its capital stock to another member or nonmember shareholder, we cannot provide assurance that a member or nonmember shareholder would be allowed to transfer any excess capital stock at any time.

For further discussion of our minimum capital requirements, see Note 12 - Capital and Mandatorily Redeemable Capital Stock (MRCS) to the financial statements.

Market Risks

Changes in interest rates or an inability to successfully manage interest-rate risk could have a material adverse effect on our net interest income.

We realize net interest income primarily from the spread between interest earned on our outstanding advances, MPF Loans, and investments less the interest paid on our consolidated obligations and other liabilities. When interest rates increase, we may experience extension risk, which is the risk that our mortgage-based investments will remain outstanding longer than expected at below-market yields. Therefore, any rapid change in interest rates could adversely affect our net interest income. Conversely, very low interest-rate environment could adversely impact us in various ways, including lower market yields on investments and faster prepayments on our MPF Loans and investments with associated premium write-offs and reinvestment risk. These risks are increased to the extent we have concentrations of high interest rates, concentrations of loan vintages or geographic concentrations. Our investment income and, in turn, our financial condition and results of operations, could be adversely impacted as a result. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk on page 80 for additional discussion and analysis regarding our sensitivity to interest rate changes and the use of derivatives to manage our exposure to interest-rate risk.

As previously discussed, our business and results of operations are affected significantly by the fiscal and monetary policies of the U.S. government and its agencies, including the Federal Reserve Board's policies, which are difficult to predict. Therefore, our ability to anticipate changes regarding the direction and speed of interest rate changes, or to hedge the related exposures, significantly affects the success of our asset and liability management activities and our level of net interest income. We use a number of measures in our efforts to monitor and manage interest rate risk, including income simulations and duration, market value, and convexity sensitivity analyses. Given the unpredictability of the financial markets, capturing all potential outcomes in these analyses is difficult. Key assumptions include, but are not limited to, loan volumes and pricing, market conditions for our consolidated obligations, interest rate spreads and prepayment speeds, implied volatility of options contracts, and cash flows on mortgage-related assets. These assumptions are inherently uncertain and they cannot precisely estimate net interest income and the market value of equity. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes and changes in market conditions and management strategies, among other factors. Volatility and disruption in the credit markets may have resulted in a higher level of volatility in our interest-rate risk profile and could negatively affect our ability to management interest-rate risk effectively.

We depend on the FHLBs' ability to access the capital markets in order to fund our business.

Our primary source of funds is the sale of FHLB consolidated obligations in the capital markets, including the short-term capital markets due to our continued reliance on discount note funding. Our ability to obtain funds through the sale of consolidated obligations depends in part on prevailing market conditions, such as investor demand and liquidity in the financial markets, which are beyond the control of the FHLBs. The U.S. government’s financial or economic measures may also affect the FHLBs’ funding costs and practices. Our ability to operate our business, meet our obligations, and generate net interest income depends primarily on the ability of the FHLB System to issue debt frequently to meet member demand and to refinance our existing outstanding consolidated obligations at attractive rates, maturities, and call features, when needed. A significant portion of our advances are issued at interest rates that reset periodically at a fixed spread to an FHLB discount note rate-based index, so member demand for such advances may decrease to the extent that the FHLB System is unable to continue to issue debt at attractive rates.

The sale of FHLB consolidated obligations can also be influenced by factors other than conditions in the capital markets, including legislative and regulatory developments, civil unrest, government actions, and the impact of government shutdowns that affect the relative attractiveness of FHLB consolidated obligations. For example, past money market fund reforms have contributed to increased demand for FHLB consolidated obligations. As policymakers examine measures intended to improve the resilience of money market funds and broader short-term funding markets, including in response to the impact of the COVID-19 pandemic, any resulting regulatory changes could decrease money market demand for FHLB consolidated obligations, and in turn could have a negative effect on our financial condition and results of operations. The FHLB System currently plays a predominant role as lenders in the federal funds market; therefore any disruption in the federal funds market or any related
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regulatory or policy change may have an adverse effect on our cash management activities, results of operation, and reputation. In addition, a decrease in the level of dealer participation and support may also adversely affect liquidity in the agency debt markets and have an adverse effect on our results of operations.

Additionally, we have a significant amount of discount notes outstanding with maturities of one year or less. We are exposed to liquidity risk if there is any significant disruption in the short-term debt markets. If a disruption were prolonged, we may not be able to obtain funding on acceptable terms. Any significant disruption that would prevent us from re-issuing discount notes for an extended period of time as they mature may require us to recognize a loss of up to $65 million of currently open (as of December 31, 2020) deferred hedge costs out of accumulated other comprehensive income. Without access to the short-term debt markets, the alternative longer-term funding, if available, would increase funding costs and could cause us to increase advance rates, potentially adversely affecting demand for advances. If we cannot access funding when needed on acceptable terms, our ability to support and continue operations could be adversely affected. As a result, our inability to manage our liquidity position or our contingency liquidity plan to meet our obligations, as well as the credit and liquidity needs of our members, could adversely affect our financial condition and results of operations, and the value of FHLB membership.

The FHLBs also compete with the U.S. government, Fannie Mae, Freddie Mac, and other government-sponsored enterprises (GSEs), as well as corporate, sovereign, and supranational entities, including the World Bank, for funds raised through the issuance of unsecured debt in the domestic and global debt markets. Increases in the supply of competing debt products, such as an increased in the supply of Treasury securities, could result in higher debt costs and negatively affect demand for consolidated obligations. This could adversely affect our financial condition, results of operations, or ability to pay dividends, meet dividend guidance, or redeem or repurchase capital stock.

Our funding costs and/or access to the capital markets and demand for certain of our products could be adversely impacted by any changes in the credit ratings for FHLB System consolidated obligations or our individual credit ratings.

FHLB System consolidated obligations are rated Aaa/P-1 with a stable outlook by Moody's and AA+/A-1+ with a stable outlook by S&P. Rating agencies may from time to time change a rating or outlook or issue negative reports. Because all of the FHLBs have joint and several liability for all FHLB consolidated obligations, negative developments at any FHLB may affect these credit ratings or result in the issuance of a negative report regardless of the financial condition and results of operations of the other FHLBs. In addition, because of the FHLBs' GSE status, the credit ratings of the FHLB System, the FHLBs, and consolidated obligations are directly influenced by the long-term sovereign credit rating of the U.S. government. As a result, if the U.S. sovereign credit ratings or outlooks are downgraded, similar downgrades in the credit ratings or outlook of the FHLBs and FHLB System consolidated obligations would mostly likely occur even though they are not obligations of, nor guaranteed by, the United States.

Future downgrades in credit ratings or outlook may: result in higher FHLB funding costs and/or disruptions in access to the capital markets; disrupt our ability to maintain adequate liquidity; trigger additional collateral posting requirements; impact our ability to enter into derivative instruments with acceptable terms; or weaken demand for products like letters of credit. Any such events may adversely affect our financial condition and results of operations.

Changes to, and replacement of, the LIBOR benchmark interest rate could adversely affect our business, financial condition and results of operations.

In July 2017, the United Kingdom’s Financial Conduct Authority (FCA), a regulator of financial services firms and financial markets in the U.K., stated that they will plan for a phase out of regulatory oversight of LIBOR interest rate indices. The FCA has indicated they will support the LIBOR indices through 2021 to allow for an orderly transition to an alternative reference rate. On November 18, 2020, the Intercontinental Exchange Benchmark Administration Limited (IBA), LIBOR’s administrator, announced its intent to publish a consultation seeking industry feedback on its proposal to cease 1-week and 2-month USD LIBOR after December 31, 2021, and extending publication of all remaining USD LIBOR tenors through June 30, 2023. On November 30, 2020, the Federal Reserve Board, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency issued a joint statement urging banks to cease entering into new LIBOR transactions after 2021 notwithstanding the IBA’s proposal. The IBA published its consultation on December 4, 2020, with a comment deadline of January 25, 2021. It remains unclear and difficult to predict whether and to what extent panel banks will continue to provide LIBOR submissions to the administrator of LIBOR, whether LIBOR rates will cease to be published or supported before or after 2021, or whether any additional reforms to LIBOR may be enacted in the United Kingdom or otherwise at a federal or state level in the United States with respect to USD LIBOR. As noted throughout this Form 10-K, many of the Bank’s assets and liabilities are indexed to LIBOR, some with maturities or termination dates extending past December 31, 2021.

In the United States, the Federal Reserve Board and the Federal Reserve Bank of New York convened the Alternative Reference Rates Committee (ARRC) to identify a set of alternative reference interest rates for possible use as market benchmarks. ARRC
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has proposed the Secured Overnight Financing Rate (SOFR) as its recommended alternative to LIBOR. SOFR is based on a broad segment of the overnight Treasury repurchase market and is intended to be a measure of the cost of borrowing cash overnight collateralized by Treasury securities. Since 2018, market activity in SOFR-linked financial instruments continues to develop. The FHLBs, including the Bank, have offered SOFR-linked consolidated obligations on an ongoing basis and continue to offer SOFR-linked advances. The overnight Treasury repurchase market underlying SOFR has experienced and may experience disruptions from time to time, which has resulted and may result in unexpected fluctuations in SOFR. Introduction of an alternate reference rate also may create challenges in hedging and asset liability management and introduce additional basis risk and increased volatility for the Bank and other market participants. While market activity in SOFR-linked financial instruments has continued to develop, the progress has been uneven and there can be no guarantee that SOFR will become widely accepted and used across market segments and financial products in a timely and consistent manner and any other alternative reference rate may or may not be developed.

On September 27, 2019, the FHFA issued a Supervisory Letter (the "Supervisory Letter") that the FHFA stated is designed to ensure the FHLBs will be able to identify and prudently manage the risks associated with the termination of LIBOR in a safe and sound manner. Among other things, the Supervisory Letter provides that the FHLBs should cease entering into certain transactions referencing LIBOR that mature after December 31, 2021. We continue to evaluate and plan for the eventual replacement of the LIBOR benchmark interest rate, including the possibility of SOFR as the primary replacement rate.

The market transition away from LIBOR is expected to be gradual and complicated, including the development of term and credit adjustments to accommodate differences between LIBOR and any alternative rate. There can be no assurances that we and other market participants will be appropriately prepared for an actual discontinuation of LIBOR, that existing assets and liabilities based on or linked to LIBOR will transition successfully to alternative reference rates or benchmarks, or of the timing of the cessation of LIBOR, or of the adoption and degree of integration of any alternative reference rates or benchmarks in the markets. Introduction of an alternative rate also may introduce additional basis risk for market participants including the Bank as an alternative index is utilized along with LIBOR. The discontinuation of LIBOR may have an unpredictable impact on the contractual mechanics of outstanding securities, loans, derivatives or other products, require renegotiation of outstanding contracts, impact the return on investments, or cause significant disruption to financial markets that are relevant to our business, among other adverse consequences. Additionally, any transition from current benchmarks may alter the Bank’s risk profiles and models, systems, valuation tools, and effectiveness of hedging strategies, as well as increase the costs and risks related to potential regulatory requirements. Given the uncertainties, the Bank is not able to predict the impact of the transition from LIBOR on the Bank’s business, financial condition, or results of operations.

(See also LIBOR Transition on page 56 for more details on our LIBOR transition, details on our SOFR-linked consolidated obligations and advances, and a presentation of variable rate financial instruments by interest-rate index at December 31, 2021 and additional steps we are taking in the LIBOR transition).

Credit Risks

Our financial condition and results of operations, and the value of Bank membership, could be adversely affected by our exposure to credit risk.

We are exposed to credit risk principally through advances or commitments to our members, MPF Loans and related exposures, derivatives counterparties, unsecured counterparties, repurchase agreement transactions, and issuers of investment securities or the collateral underlying them. We assume secured and unsecured credit risk exposure associated with the risk that a borrower or counterparty could default, and we could suffer a loss if we are unable to fully recover amounts owed on a timely basis. In addition, we have exposure to credit risk because fair value of collateral may decline as a result of deterioration in the creditworthiness of the obligor or the credit quality of a security instrument (whether due to economic conditions or otherwise), or because the value of the collateral may not be what we assigned to it (whether as a result of misrepresentation or inaccurate valuation). We have a high concentration of credit risk exposure to financial institutions and mortgage assets. If we have insufficient collateral before or after an event of default, or we are unable to liquidate the collateral for the value assigned to it in the event of default, we could experience a credit loss, which could adversely affect our financial condition and results of operations.

We follow guidelines established by our Board of Directors and the FHFA on unsecured extensions of credit, which limit the amounts and terms of unsecured credit exposure to highly rated counterparties, the U.S. government, other FHLBs, and partners of our Community First Fund. However, there can be no assurance that these activities will prevent losses due to defaults on these assets.

Advances. To the extent our members are under financial stress, we are exposed to the risk that they may default on their outstanding obligations to us, including the repayment of advances. If a member defaults on its obligations, or the FDIC, or any other applicable receiver, fails either to promptly repay all of that failed institution's obligations or to assume the outstanding advances, then we may be required to liquidate the collateral pledged by the failed institution. The volatility of market prices and
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interest rates could affect the value of the collateral. The proceeds realized from the liquidation of pledged collateral may not be sufficient to fully satisfy the amount of the failed institution's obligations or the operational cost of liquidating the collateral. Default by a member with significant outstanding obligations to us could adversely affect our results of operations and financial condition.

As we continue to work toward building a stronger cooperative and increasing advances by adding new members or expanding borrowings with existing members, we are actively focusing on institutions that have not traditionally been a large part of our borrowing base, such as insurance companies, community development financial institutions, and housing associates. As we increase our membership to include more non-federally insured members and increase credit outstanding to such members, we face uncertainties surrounding the possible resolution of those members, in part due to our lack of experience in dealing with their regulators and any receivers and other liquidators that may be involved in the resolution of these members.

Also, as we update our collateral loan eligibility criteria to accept more complex loan structures and additional commercial loan property types, we face risks relating to valuing and liquidating collateral with these characteristics. Although we will closely monitor our credit and collateral agreement processes, we may experience credit losses and our business may be adversely affected if we are unable to sufficiently collateralize our risk exposures in the event of potential default by or resolution of these members.

Derivatives Counterparties. Our hedging strategies are highly dependent on our ability to enter into cleared and uncleared (over-the-counter) derivative instrument transactions with counterparties on acceptable terms to reduce interest-rate risk and funding costs.

If we experience disruptions in the credit markets, it may increase the likelihood that one of our derivatives counterparties fails to meet their obligations to us. If a counterparty defaults on payments due to us, we may need to enter into a replacement derivative contract with a different counterparty, which may be at a higher cost, or we may be unable to obtain a replacement contract. Additionally, the insolvency of one of our largest derivatives counterparties combined with an adverse change in the market before we are able to transfer or replace the derivative contracts could adversely affect our financial condition and results of operations. We may also be exposed to collateral losses to the extent that we have pledged collateral and its value changes, or could experience losses if the counterparty fails to return the collateral. Additionally, we may be exposed to losses stemming from the replacement of the underlying LIBOR benchmark on LIBOR-linked derivatives to a replacement risk-free rate benchmark, such as SOFR, following cessation or non-representativeness of LIBOR in 2021 or thereafter. Losses from any of the foregoing could negatively affect our financial condition and results of operations and the value of FHLB membership.

Federal Funds. We invest in Federal Funds sold in order to ensure the availability of funds to meet members' credit and liquidity needs. Because these investments are unsecured, our credit policies and FHFA regulations restrict these investments to short-term maturities and certain eligible counterparties. If the credit markets experience disruptions, it may increase the likelihood that one of our Federal Funds counterparties could experience liquidity or financial constraints that may cause them to become insolvent or otherwise default on their obligations to us. For further discussion on our Federal Funds investments, see Unsecured Short Term Investments on page 77.

Securities Purchased Under Agreements to Resell. We also invest in securities purchased under agreements to resell in order to ensure the availability of funds to meet members' liquidity and credit needs. These investments are secured by marketable securities held by a third party custodian. If the credit markets experience disruptions, it may increase the likelihood that one of our counterparties could experience liquidity or financial constraints that may cause them to become insolvent or otherwise default on their obligations to us. If the collateral pledged to secure those obligations has decreased in value, we may suffer a credit loss. See the table in Investment Debt Securities on page 76 for a summary of counterparty credit ratings for these investments.

Our MPF Program products have different risks than those related to our traditional advances products, which could adversely impact our results of operations.

The MPF Program, as compared to our advances products, is more susceptible to credit losses. To the extent that economic conditions weaken and regional or national home prices decline, we could experience higher delinquency levels and loss severities on our MPF Loan portfolio in the future.

We are exposed to losses on our conventional MPF Loans held in our portfolio through our obligation to absorb losses up to the FLA and to the extent those losses are not recoverable from PFIs from withholding performance-based CE Fees (Recoverable CE Fees). Our FLA exposure as of December 31, 2020 is $148 million. The next layer of losses after the FLA is allocated to the PFI, or SMI, as applicable, through the CE Amount. If losses accelerate in the overall mortgage market, we may experience increased losses that are allocated to us through the FLA or that may otherwise exceed the PFI's CE Amount and Recoverable CE Fees. Further, the PFIs may experience credit deterioration and default on their CE Amount, which, to the extent not offset against collateral provided by the PFIs, could cause us to incur additional losses and have an adverse effect on our results of
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operations.

Under the MPF Government product, we absorb any associated credit losses if we are unable to recover from the servicer or the insuring or guarantying government agency. We have the same risk with respect to the MPF Government MBS loans we acquired from our members or PFIs of other MPF Banks.

We also have geographic concentrations of MPF Loans secured by properties in certain states. To the extent that any of these geographic areas experience significant declines in the local housing markets, regional economic conditions, or a natural or man-made disaster, we could experience increased losses. For further information on these concentrations, see Geographic Concentration on page 74.

For a description of the MPF Program, our obligations with respect to credit losses and the PFI's obligation to provide credit enhancement and comply with anti-predatory lending laws, see Mortgage Partnership Finance Program on page 8.

We are jointly and severally liable for the consolidated obligations of other FHLBs.

Under the FHLB Act, we are jointly and severally liable with other FHLBs for consolidated obligations issued through the Office of Finance. If another FHLB defaults on its obligation to pay principal or interest on any consolidated obligation, the FHFA has the ability to allocate the outstanding liability among one or more of the remaining FHLBs on a pro rata basis or on any other basis that the FHFA may determine. The likelihood of triggering our joint and several liability obligation depends on many factors, including the financial condition and financial performance of the other FHLBs. If we were required by the FHFA to make payment on consolidated obligations beyond our primary obligation, our financial condition, and results of operations could be negatively affected.

The occurrence of weather-related events, other natural or environmental disasters, health emergencies, or other disruptive events, especially one affecting our district and/or members in our district, could negatively impact our business and results of operations. Relatedly, climate change could have a material adverse impact on our members and our business operations.

The occurrence of weather-related events, other natural or environmental disasters, terrorist attacks, civil unrest, health emergencies, pandemics, or other disruptive events (any such event, a “major disruptive event”), especially one affecting our district, could negatively impact our business and results of operations. A major disruptive event that damages or destroys real estate securing mortgage loans, or negatively impacts the ability of borrowers to continue to make principal and interest payments on mortgage loans, or negatively impacts our members’ business could increase delinquency rates and default rates, and negatively impact our collateral, MPF Loan portfolio, MBS or other investment portfolios, community investment programs, or cause our members to become delinquent or to default on their advances and other credit obligations to us. A decline in the local economies in which our members operate resulting from a major disruptive event could reduce members’ needs for funding, which could reduce demand for our advances. The nature and level of these major disruptive events and the impact of global climate change upon their frequency and severity cannot be predicted. If major disruptive events occur, they may have a material effect on our financial condition or results of operations.

Relatedly, the Bank’s business, and the activities of its members, could be disrupted by climate change. Potential physical risks from climate change may include adverse weather-related events and environmental disasters as described above. In addition, these physical changes may prompt changes in regulations or consumer preferences, which in turn could have negative consequences for the business models of the Bank and its members. The Bank and its members will need to respond to any new laws and regulations, as well as consumer and business preferences resulting from climate change concerns. The Bank and its members may face cost increases, asset value reductions, operating and modeling process changes, and the like. The Bank could experience a drop in demand for its products and services. In addition, the Bank could face reductions in creditworthiness on the part of some members or counterparties or in the value of Bank investments or loans pledged as collateral or acquired through our MPF Program.

Operational Risks

We rely on quantitative models to manage risk, to make business decisions, and to value our assets and liabilities. Our business could be adversely affected if those models fail to produce reliable results.

We make significant use of both internal and external business and financial models to measure and monitor our risk exposures; including interest rate, prepayment, and other market risks, as well as credit risk. We also use models in determining the fair value of financial instruments when independent price quotations are not available or reliable. The information provided by these models is also used in making business decisions relating to strategies, initiatives, risk management, transactions, and products,
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and for financial reporting and dividend guidance. Models are inherently imperfect predictors of actual results. We use assumptions to predict interest rates, prepayment speeds, default rates, severity rates, and other factors that may overstate or understate future experience. When market conditions change rapidly and dramatically, the assumptions used for our models may not keep pace with changing conditions. Inaccurate data or assumptions in these models are likely to produce unreliable results. For example, uncertainty in the housing and mortgage markets may increase our exposure to the inherent risks associated with the reliance on internal models that use key assumptions to project future trends and performance. Although we regularly adjust our internal models in response to changes in economic conditions and the housing market and rely on our vendors to adjust our external models, the risk remains that our models could produce unreliable results or estimates that vary considerably from actual results.

If these models fail to produce reliable results, we may not make appropriate risk management or business decisions (including decisions relating to our dividend guidance), which could adversely affect our earnings, liquidity, capital position, reputation, and financial condition. Any strategies that we employ to attempt to manage the risks associated with the use of models may not be effective.

Failures or interruptions in our information systems and other technology, our controls, or our operating processes generally, may harm our business, financial condition, results of operations, and reputation.

Our business is dependent upon our ability to interface effectively with other FHLBs, members, PFIs, and other third parties. Our products and services involve a complex and sophisticated operating environment supported by operating systems and technologies, which may be purchased, custom-developed, or hosted by third parties. Maintaining the availability, effectiveness, and efficiency of the technology used in our operations, including our information systems, is dependent on the continued timely implementation of technology solutions and improvements (including software updates and security patches) and systems necessary to effectively manage the Bank and mitigate risks, which may require significant capital expenditures. If we are unable to maintain or improve these technological capabilities, including retention of key technology personnel and the development of necessary operating and management processes, we may not be able to remain competitive and our business, financial condition, and results of operations may be significantly compromised. To date, we have not experienced any material effect or losses related to significant interruptions in our information systems, cyberattacks or other breaches.

Additionally, failures in our controls, including internal controls over financial reporting, could result from human error, fraud, design flaws, breakdowns in information and computer systems, or natural or man-made disasters. Moreover, lapses in, and inadequacies with respect to, our operating processes, including manual processes and data management, could affect our overall operations, including collateral maintenance. We also rely on our employees and third parties in our day-to-day and ongoing operations, who may, as a result of human error, misconduct, malfeasance or a failure or breach of systems or infrastructure, expose us to risk. A significant control failure, or a lapse in certain operating processes, could materially impact our financial condition and results of operations. We may not be able to foresee, prevent, mitigate, reverse, or repair some or all of the negative effects of such failures. If we are unable to correct material weaknesses or deficiencies in internal controls in a timely manner, our ability to record, process, summarize and report financial information accurately and within the time periods specified in the rules and forms of the SEC could be adversely affected. A failure in our internal control over financial reporting or a lapse in our operating processes could cause our members to lose confidence in our reported financial information, in our processes, or in us as a whole, subject us to government enforcement actions, and generally, materially, and adversely impact our business and financial condition.

A significant portion of our business support services are hosted by third party vendors and if our vendors fail to adequately perform the contracted services in the manner necessary to meet our needs or if they become subject to any information or security breach or technological failures, our business, financial condition, and results of operations may be harmed. Additionally any failure in the operating systems related to the Office of Finance could disrupt our ability to conduct and manage our business.

We have engaged various vendors to provide us with data center and hosted services that may include hardware, software support, connectivity, and other technology services, including vendors for which there are few substitutes or would be difficult to replace in a timely manner. Any failure, interruption, or breach in security of these systems or services, including relating to the downstream service providers of our vendors, could result in disruptions in our ability to conduct business. There is no assurance that if or when such incidents do occur, that they will be adequately addressed by us or the third party vendors on whom we rely. Further, any such event may not be disclosed to us in a timely manner. The occurrence of any failures or interruptions could have a material adverse effect on our business, financial condition, and results of operations.

Additionally, we rely on the Office of Finance to facilitate the issuance and servicing of our consolidated obligations. A failure, interruption, or breach in the security of the Office of Finance's or their critical vendors' or third parties’ (including the Federal Reserve Banks) operating systems could disrupt our access to funds, and may harm our business. Moreover, any operational failure of the Office of Finance or their critical vendors or third parties could also expose us to the risk of loss of data or
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confidential information, or other harm, including reputational damage.

The performance of our MPF Loan portfolio depends in part upon third party servicers and defaults by one or more of these third parties on its obligations to us could adversely affect our results of operations or financial condition.

Mortgage Servicing. We rely on PFIs and third party servicers to perform mortgage loan servicing activities for our MPF Loans held in portfolio. With respect to the MPF Xtra and MPF Government MBS products, we are contractually obligated to Fannie Mae and Ginnie Mae, respectively, with respect to servicing of the related MPF Loans under certain servicing options.

Servicing activities include collecting payments from borrowers, paying taxes and insurance on the properties secured by the MPF Loans, advancing principal and interest under scheduled remittance options, maintaining applicable government agency insurance or guaranty, reporting loan delinquencies, loss mitigation, and disposition of real estate acquired through foreclosure or deed-in-lieu of foreclosure. If current housing market trends negatively decline, the number of delinquent mortgage loans serviced by PFIs and third party servicers could increase. Managing a substantially higher volume of non-performing loans could create operational difficulties for our servicers. In the event that any of these entities fails to perform its servicing duties, we could experience a temporary interruption in collecting principal and interest or even credit losses on MPF Loans or incur additional costs associated with obtaining a replacement servicer if the servicer fails to indemnify us for its breaches. Similarly, if any of our servicers become ineligible to continue to perform servicing activities under MPF Program guidelines, we could incur additional costs to obtain a replacement servicer. If a PFI servicer fails to perform its servicing responsibilities, we can potentially recover losses we incur from the collateral pledged to us under our Advances, Collateral Pledge and Security Agreement with the PFI; however, the amount of collateral pledged thereunder is not sized to cover a specific amount related to servicing obligations. If a third party servicer is not one of our members, we would not have this additional remedy.

We offer servicing released alternatives for most of our MPF Loan products but currently we only have one servicing aggregator for particular products. If a servicing aggregator that is established as an approved servicer for the MPF Program exited the business or was not offering attractive servicing released premiums, or if we should decide to terminate our relationship with the servicer, our MPF Loan volume could be negatively impacted until we could engage replacement servicers.

Master Servicing. We act as master servicer for the MPF Program. In this regard, we have engaged a vendor for certain master servicing activities, Wells Fargo Bank N.A., which monitors the servicers' compliance with the MPF Program requirements and issues periodic reports to us. While we manage MPF Program cash flows, if the vendor should refuse or be unable to provide the necessary service, or if we should decide to terminate our relationship with the vendor, we may be required to engage another vendor which could result in delays in reconciling MPF Loan payments to be made to us or increased expenses to retain a new master servicing vendor.

General Risk Factors

A cyberattack, information or security breach, or a technology failure of ours or a third party could adversely affect our ability to conduct our business, result in the disclosure or misuse of confidential or proprietary information, and adversely impact our results of operations and financial condition, as well as cause legal or reputational harm.

Our operations are highly dependent on the security, controls and efficacy of our infrastructure, computer, communications, internet and data management systems, as well as those of our counterparties and other third parties, including their downstream service providers. Our business relies on effective access management and the secure collection, processing, transmission, storage and retrieval of confidential, proprietary, personally identifiable, and other information in our computer and data management systems and networks, and in the computer and data management systems and networks of third parties. The continued occurrence of high-profile data breaches and other cyberattacks at financial and other institutions indicates the continuing existence of an external environment with diverse and sophisticated methods of attack and potential data exfiltration. These breaches or other attacks are pervasive and evolving and include computer viruses, malicious or destructive code (such as ransomware), phishing attacks, denial of service or information or other security breach tactics that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction or theft of confidential, proprietary, personally identifiable, and other information, damages to systems, or otherwise material disruption to our or our members’ or other third parties’ network access or business operations. Additionally, threats of cyber terrorism, external extremist parties, including state-sponsored actors, result in heightened risk exposure. The techniques used in cyberattacks change frequently and have grown increasingly sophisticated, and these attacks or ensuing security breaches could persist for an extended period of time before being detected. It could take considerable additional time for us to determine the scope, extent, amount, and type of information compromised, at which time the impact on the Bank and measures to recover and restore to a business as usual state may be difficult to assess.

The materiality of these risks depends on the nature, extent, and potential magnitude of a potential incident or attack. In this
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environment, we continue to engage in ongoing monitoring of the effectiveness of our security controls, engage in proper testing of our security controls and responses, and implement changes as needed to mitigate security vulnerabilities and bolster operational resilience. Regardless of the measures we have taken, our ability to conduct business may be adversely affected by any significant improper access to, or disclosure of personally identifiable information, or other confidential information, or cyberattacks or other significant disruptions. A failure or breach of our operational or security systems or infrastructure resulting in disruption to our critical business operations could expose us to regulatory, market, privacy and liquidity risk, and adversely impact our results of operations and financial condition, as well as cause legal or reputational harm. Moreover, expanded government scrutiny of practices relating to the safekeeping of personally identifiable information or other confidential information may result in the adoption of stricter laws or regulations that could impede our business or increase compliance costs Our cyber risk and other insurance might not be sufficient to cover us against claims related to security incidents, breaches, cyberattacks and other related events.

The loss of key personnel or difficulties recruiting and retaining qualified personnel could adversely impact our business and financial results.

Much of our future success depends on the continued availability and service of senior management personnel. The loss of any of our executive officers or other key senior management personnel could harm our business. Additionally, we must continue to recruit, retain and motivate a qualified and diverse pool of employees, both to maintain our current business, including succession planning, and to execute our strategic initiatives. If we are unable to recruit, retain and motivate such employees to maintain our current business and support our projected growth, our business and financial performance may be adversely affected.



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Item 1B.    Unresolved Staff Comments.

Not applicable.


Item 2.    Properties.


As of February 28, 2021, we occupy 95,105 square feet of leased office space at 200 East Randolph Drive, Chicago, Illinois 60601 (the “Aon Location”).  We also maintain 5,518 square feet of leased space for an off-site back-up facility 15 miles northwest of our main facility, which is on a separate electrical distribution grid.

The Bank expects to relocate from the Aon Location to a leased new office space of 129,065 square feet at 433 West Van Buren Street, Chicago, Illinois 60607 in 2021.



Item 3. Legal Proceedings.

On October 15, 2010, the Bank instituted litigation relating to 64 PLMBS bonds purchased by the Bank in an aggregate original principal amount of $4.29 billion. Of the three cases that were filed by the Bank, only the action filed in the Circuit Court of Cook County, Illinois remains active. As of February 28, 2021, the remaining litigation covers three PLMBS bonds, which we have since sold as part of our PLMBS sale discussed in Note 2 –Summary of Significant Accounting Policies to the financial statements. As of February 28, 2021, Morgan Stanley & Co., Incorporated, and certain of its affiliates, remain as the sole defendants in the Illinois action.

In this action, the Bank asserts claims for untrue or misleading statements in the sale of securities, signing or circulating securities documents that contained material misrepresentations, and negligent misrepresentation. The Bank seeks the remedies of rescission, recovery of damages, and recovery of reasonable attorneys' fees and costs of suit.

The Bank may also be subject to various other legal proceedings arising in the normal course of business. After consultation with legal counsel, management is not aware of any other proceedings that might have a material effect on the Bank's financial condition or results of operations.


Item 4. Mine Safety Disclosures.
Not applicable.

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PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.

Our members, and under limited circumstances former members, own our capital stock. Former members may continue to hold our capital stock when they have withdrawn from membership or have merged with out-of-district institutions. Our members elect our directors. We conduct our business almost exclusively with our members. Our stock can only be acquired and redeemed or repurchased at a par value of $100 per share. Our stock is not publicly traded and no market mechanism exists for the exchange of stock outside our cooperative structure.

We issue only one class of capital stock, Class B stock, consisting of two sub-classes of stock, Class B1 stock and Class B2 stock which, under our Capital Plan has a par value of $100 per share. As of January 31, 2021, we had 23,000,345 shares of capital stock outstanding, including mandatorily redeemable capital stock recorded as a liability, and we had 699 stockholders of record. For details on our Capital Plan, on member withdrawals and other terminations, and related amounts classified as mandatorily redeemable capital stock, see Note 12 - Capital and Mandatorily Redeemable Capital Stock (MRCS) to the financial statements and Capital Resources on page 62.

Information regarding our cash dividends declared in each quarter in 2019 and 2020, and information regarding regulatory requirements and restrictions on dividends, is set forth in the Retained Earnings & Dividends Policy section on page 66.

The following table presents, by type of institution, the outstanding capital stock holdings of our members and former members. Our capital stock may be redeemed upon five years' notice from the member to the Bank, subject to applicable conditions. For a description of our policies and related restrictions regarding capital stock redemptions and repurchases, see Capital Resources on page 62.


As ofDecember 31, 2020December 31, 2019
Commercial banks$928 $1,057 
Savings institutions89 173 
Credit unions449 285 
Insurance companies543 197 
Community Development Financial Institutions1 
Total GAAP capital stock2,010 1,713 
Stock reclassified as mandatorily redeemable capital stock (liability)279 324 
Total regulatory capital stock outstanding$2,289 $2,037 


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Item 6.    Selected Financial Data.

As of or for the years ended December 31,20202019201820172016
Selected statements of condition data
Investments a
$39,649 $38,882 $32,684 $30,683 $28,060 
Advances46,695 50,508 52,628 48,085 45,067 
MPF Loans held in portfolio, net10,041 10,000 7,103 5,193 4,967 
Total assets100,356 99,827 92,857 84,355 78,692 
Consolidated obligation discount notes48,643 41,675 43,166 41,191 35,949 
Consolidated obligation bonds42,670 50,474 42,250 37,121 36,903 
Capital stock2,010 1,713 1,698 1,443 1,711 
Retained earnings4,072 3,770 3,536 3,297 3,020 
Total capital$6,289 $5,454 $5,289 $4,852 $4,695 
Other selected data at period end
Member standby letters of credit outstanding$16,395 $23,851 $24,306 $19,572 $10,828 
MPF Loans par value outstanding - FHLB System b
70,326 68,759 58,820 51,563 46,293 
MPF Loans par value outstanding - FHLB Chicago PFIs b
18,934 17,364 14,522 12,484 11,624 
Number of members686 689 705 720 728 
Total employees (full and part time)474 488 468 460 440 
Selected statements of income data
Net interest income after provision for (reversal of) credit losses$588 $458 $513 $483 $455 
Noninterest income104 100 16 44 76 
c
Noninterest expense275 223 191 174 167 
Net income$374 $300 $303 $317 $327 
Other selected data during the periods ended
MPF Loans par value amounts funded - FHLB System b
$27,387 $21,005 $13,617 $11,915 $10,872 
Number of PFIs funding MPF products - FHLB System b
877 898 902 909 873 
MPF Loans par value amounts funded - FHLB Chicago PFIs b
$8,852 $5,788 $3,614 $2,521 $3,145 
Number of PFIs funding MPF products - FHLB Chicago b
207 210 208 204 191 
Selected ratios (rates annualized)
Total regulatory capital to assets ratio6.34 %5.82 %5.97 %5.99 %6.40 %
Market value of equity to book value of equity105 %105 %105 %107 %108 %
Primary mission asset ratio d
72.1 %72.3 %71.1 %67.3 %66.2 %
Dividend rate class B1 activity stock-period paid5.00 %5.00 %4.06 %3.19 %2.75 %
Dividend rate class B2 membership stock-period paid2.25 %2.19 %1.65 %1.10 %0.60 %
Return on average assets0.36 %0.30 %0.33 %0.38 %0.42 %
Return on average equity6.10 %5.29 %5.74 %6.84 %7.18 %
Average equity to average assets5.90 %5.67 %5.74 %5.58 %5.87 %
Net yield on average interest earning assets0.59 %0.47 %0.56 %0.59 %0.59 %
Return on average Regulatory Capital spread to 3-month LIBOR index5.42 %2.92 %3.25 %5.25 %5.96 %
Cash dividends$84 $82 $64 $40 $37 
Dividend payout ratio22.46 %27.33 %21.12 %12.62 %11.31 %
a    Investments includes investment debt securities, interest bearing deposits, Federal Funds sold, and securities purchased under agreements to resell.
b    Includes all MPF products, whether on or off our balance sheet. See Mortgage Partnership Finance Program beginning on page 8 for details on our various MPF products.
c    Includes $38 million in litigation settlement awards.
d    The FHFA issued an advisory bulletin that provides guidance relating to a primary mission asset ratio by which the FHFA will assess each FHLB's core mission achievement. See Mission Asset Ratio on page 5 for more information.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Information

Statements contained in this report, including statements describing the plans, objectives, projections, estimates, strategies, or future predictions of management, statements of belief, any projections or guidance on dividends or other financial items, or any statements of assumptions underlying the foregoing, may be “forward-looking statements.” These statements may use forward-looking terminology, such as “anticipates,” “believes,” “expects,” “could,” "plans," “estimates,” “may,” “should,” “will,” their negatives, or other variations of these terms. We caution that, by their nature, forward-looking statements involve risks and uncertainties related to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. These risks and uncertainties could cause actual results to differ materially from those expressed or implied in these forward-looking statements and could affect the extent to which a particular objective, projection, estimate, or prediction is realized. As a result, undue reliance should not be placed on such statements.

These forward-looking statements involve risks and uncertainties including, but not limited to, the following:

the impact of the COVID-19 pandemic on the global and national economies and on our and our members’ businesses;

the loss or changes in business activities with significant members; changes in the demand by our members for advances, including as a result of the Federal Reserve’s emergency actions to increase liquidity along with market conditions resulting from the COVID-19 pandemic, the impact of pricing increases, and the availability of other sources of funding for our members, such as deposits;

regulatory limits on our investments;

the impact of new business strategies, including our ability to develop and implement business strategies focused on maintaining net interest income; our ability to successfully maintain our balance sheet and cost infrastructure at an appropriate composition and size scaled to member demand; our ability to execute our business model, implement business process improvements and scale our size to our members' borrowing needs; the extent to which our members use our advances as part of their core financing rather than just as a back-up source of liquidity; and our ability to implement product enhancements and new products and generate enough volume in new products to cover our costs related to developing such products;

the extent to which changes in our current capital stock requirements and/or our ability to continue to offer the Reduced Capitalization Advance Program for certain future advance borrowings, our ability to continue to pay enhanced dividends on our activity stock or our ability to maintain current levels of dividends, and any amendments to our capital plan, impact Bank product usage and activity with members;

our ability to meet required conditions to repurchase and redeem capital stock from our members (including maintaining compliance with our minimum regulatory capital requirements and determining that our financial condition is sound enough to support such repurchases), the amount and timing of such repurchases or redemptions, any changes in our repurchase processes, and our ability to maintain compliance with regulatory and statutory requirements relating to our dividend payments;

general economic and market conditions, including the timing and volume of market activity, inflation/deflation, unemployment rates, housing prices, the condition of the mortgage and housing markets, increased delinquencies and/or loss rates on mortgages, prolonged or delayed foreclosure processes, and the effects on, among other things, mortgage-backed securities; volatility resulting from the effects of, and changes in, various monetary or fiscal policies and regulations, such as those determined by the Federal Reserve Board and Federal Deposit Insurance Corporation; impacts from various measures to stimulate the economy and help borrowers refinance home mortgages; disruptions in the credit and debt markets and the effect on future funding costs, sources, and availability; the impact of the occurrence of a major natural or other disaster, a pandemic such as COVID-19, or other disruptive event; the impact of climate change;

volatility of market prices, rates, and indices, or other factors, such as natural disasters, that could affect the value of our investments or collateral; changes in the value or liquidity of collateral securing advances to our members;

changes in the value of and risks associated with our investments in mortgage loans, mortgage-backed securities, and the related credit enhancement protections;
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changes in our ability or intent to hold mortgage-backed securities to maturity;

changes in mortgage interest rates and prepayment speeds on mortgage assets;

membership changes, including the loss of members through mergers and consolidations or as a consequence of regulatory requirements; changes in the financial health of our members, including the resolution of some members; risks related to expanding our membership to include more institutions with regulators and resolution processes with which we have less experience;

increased reliance on short-term funding and changes in investor demand and capacity for consolidated obligations and/or the terms of interest rate derivatives and similar agreements, including changes in the relative attractiveness of consolidated obligations as compared to other investment opportunities; changes in our cost of funds due to concerns over U.S. fiscal policy, and any related rating agency actions impacting FHLB consolidated obligations;

uncertainties relating to the scheduled phase-out of the London Interbank Offered Rate (LIBOR);

political events, including legislative, regulatory, judicial, or other developments that affect us, our members, our counterparties and/or investors in consolidated obligations, including, among other things, changes in the proposals and legislation related to housing finance and GSE reform; changes in the Presidential Administration and the Congress; changes in our regulator or changes affecting our regulator and changes in the FHLB Act or applicable regulations as a result of the Housing and Economic Recovery Act of 2008 (Housing Act) or as may otherwise be issued by our regulator; the potential designation of us as a nonbank financial company for supervision by the Federal Reserve;

regulatory changes to FHLB membership requirements, capital requirements, MPF program requirements, and liquidity requirements by the FHFA, and increased guidance from the FHFA impacting our balance sheet management, product structures, and collateral practices;

the ability of each of the other FHLBs to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which we have joint and several liability;

the pace of technological change and our ability to develop and support technology and information systems, including our ability to protect the security of our information systems and manage any failures, interruptions or breaches in our information systems or technology services provided to us through third party vendors;

our ability to attract and retain skilled employees;

the impact of new accounting standards and the application of accounting rules, including the impact of regulatory guidance on our application of such standards and rules;

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

our ability to identify, manage, mitigate, and/or remedy internal control weaknesses and other operational risks; and

the reliability of our projections, assumptions, and models on our future financial performance and condition, including dividend projections.

For a more detailed discussion of the risk factors applicable to us, see Risk Factors starting on page 23.

These forward-looking statements are representative only as of the date they are made, and we undertake no obligation to update any forward-looking statement as a result of new information, future events, changed circumstances, or any other reason.

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Executive Summary

2020 Financial Highlights

We recorded net income of $374 million in 2020 compared to $300 million in 2019.
Net interest income for 2020 was $595 million, compared to $458 million in 2019, primarily due to increased advance prepayment fee income, partially offset by the effects of falling interest rates (which generally declined more quickly on our debt than our longer duration assets).
Noninterest income increased by $4 million to $104 million in 2020 compared to $100 million in 2019, in part due to a gain of $109 million from the sale of our private label mortgage backed securities (PLMBS) portfolio in the fourth quarter of 2020 and a year over year increase of $16 million of MPF fee income driven by the year’s significant MPF Loan prepayment activity. These increases to noninterest income were partially offset by a net loss of $88 million in derivatives, economic hedging, and instruments held under fair value option in 2020, which is a change of $114 million as compared to the net gain of $26 million in 2019.
Noninterest expense increased $52 million to $275 million for 2020, primarily driven by $28 million in COVID-19 relief offered to our members in 2020, and an increase in compensation and benefits expense.
Total assets were $100.4 billion at year-end 2020 compared to $99.8 billion at year-end 2019, as the decline in advances was offset by an increase in our liquidity portfolio and investment securities.
Total investment securities increased 6% in 2020 to $24.5 billion, as we invested in primarily GSE residential MBS during the first half of 2020.
Retained earnings were $4.1 billion at year-end 2020, up from $3.8 billion at year-end 2019, and we remained in compliance with all of our regulatory capital requirements as of year-end 2020.

Summary and Outlook

This past year was a difficult year as communities across Illinois and Wisconsin experienced a rise in COVID-19 cases, causing strains in businesses, communities, and local economies. These challenges will likely persist until vaccines become widely available. This makes the support our members’ communities receive from each of our members even more important, which means the Bank’s role in serving its members is essential.

The Bank’s commitment to provide our members reliable, high value products, services, and solutions in support of their businesses has been uninterrupted by the COVID-19 pandemic, and we remain committed to supporting our members and their communities through these times. In 2020, the Bank implemented a number of programs and accommodations to support our members and their communities. Discussed below are many of the year’s triumphs in which we and our members came together to adapt to new ways of supporting our members’ communities in extraordinary ways.

COVID-19 Relief

In April 2020, the Bank announced its COVID-19 Relief Program consisting of zero-rate advances (Relief Advances) to strengthen our members’ balance sheets and grants (Relief Grants) to provide needed support to our members’ communities. This unique program, available from April 27, 2020 to May 22, 2020, achieved 98% member participation with $1.9 billion in Relief Advances drawn and $13.1 million in Relief Grants disbursed to over 5,000 small business and nonprofit beneficiaries. As the pandemic continued to impact communities across our district, we offered additional support through the Targeted Impact Fund. Through our members’ participation between August 17, 2020 and November 13, 2020, $9.8 million in grant funding was awarded to more than 1,300 organizations supporting Black, Latino, Native American, elderly, rural, and low- and moderate-income populations hardest-hit by the pandemic and advancing equity in these underserved communities.

Member Product and Program Use

In 2020, 89% of our members and non-member housing associates used at least one of our core product offerings—advances, letters of credit, or MPF Program products—or participated in our competitive AHP or DPP Programs. Below is a recap of member product and program use in 2020.
Advances outstanding: At year-end 2020, 505 members had advances of $46.7 billion, down 8% from year-end 2019. Many of our depository members experienced an inflow of deposits on their balance sheets along with reduced loan demand, while also having access to other liquidity sources as a result of certain government actions related to the COVID-19 pandemic. Although these factors continued to reduce our depository members’ need for advances, increased advance borrowing by insurance company members has partially offset the decrease by depository
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members.
Letters of credit outstanding: At year-end 2020, 204 members had letters of credit outstanding of $16.4 billion, down 31% from year-end 2019. This decrease was primarily the result of one of our captive insurance company members reducing its letters of credit usage in anticipation of membership termination on February 19, 2021.
MPF loans outstanding: During 2020, 152 PFIs funded into our MPF on balance sheet products. At year-end 2020, MPF loans outstanding on our balance sheet were $10.0 billion, mostly unchanged from year-end 2019 as new acquisition volume kept pace with paydowns and prepayment activity. During 2020, new acquisition volume was driven primarily by refinancing activity as mortgage rates declined overall.
Competitive AHP: In 2020, $24.8 million was awarded to 23 members through our competitive AHP to help finance 44 affordable housing projects consisting of more than 2,000 housing units located in Illinois and Wisconsin.
DPP: In 2020, 178 members disbursed $17 million in DPP grants on behalf of nearly 3,000 homebuyers in our members’ communities.

Technology Enhancements for a Seamless Borrowing Experience and Expanded Capacity

The Bank is dedicated to providing a seamless borrowing experience for our members. In 2020, we implemented enhancements to our eBanking platform to make borrowing easier for our members. These enhancements included:
The ability to execute certain letters of credit, roll over advances, and pre-pay advances online.
Improved navigation for funding transactions, including a new dashboard for funding details, real time advance status, and a streamlined advance wizard.
Up to seven years of historical data on-demand with the ability to extract past transactional data.

Throughout 2020, we remained dedicated to finding ways for our members to leverage innovative technology and expand their collateral opportunities with us. We helped our members remain competitive by providing additional collateral lendable value through new loan types. These collateral expansion efforts support our members’ activity with us and serve as an additional source of contingent liquidity. Below is a recap of capacity expansions we made in 2020:
Eligibility of SBA 7(a) Paycheck Protection Program (PPP) Loans: On April 23, 2020, as a part of our COVID-19 relief efforts, we began accepting PPP loans as eligible collateral from member institutions that are approved SBA lenders. See also Recent Legislative and Regulatory Developments on page 18 for additional details.
Accepting eNotes as Collateral: On August 3, 2020, we began accepting electronic promissory notes (eNotes) as pledged collateral. Currently, we accept 1-4 Family mortgage loans and closed end term 2nd mortgage loans.
Accepting Construction Loans as Collateral: On October 1, 2020, we began accepting construction, land development, and other land loans as eligible collateral from our depository members.

Virtual Member Engagements

This past year, the COVID-19 pandemic changed the way we connect with each other. Virtual events replaced in-person gatherings, but we were able to successfully convert all in-person conferences and educational workshops to live, virtual events and were delighted to see 85% of our member institutions attend at least one virtual event. The Bank remains committed to providing our members the value they obtain from our member engagements—whether they are conducted virtually or in-person once it is safe to do so again.

Investing in Members’ Communities

Providing our members support for their local communities is central to our mission, and the Bank achieves this through products, programs, and awards that drive economic development, expand lending capital and capacity, and recognize community leaders. Here is a recap of those efforts in 2020.
Community Small Business Advance: The Community Small Business Advance enables our members to support their local economy and community revitalization efforts in income-eligible communities. In 2020, nearly $900,000 in interest-rate subsidy was reserved to support an anticipated $16.4 million in lending to 24 small businesses.
Community First® Capacity-Building Grant Program: In 2020, we increased the allocation for the Community First Capacity-Building Grant Program to accommodate heightened demand due to the COVID-19 pandemic. In response to the extraordinary volume of highly competitive applications received, we awarded $948,562 to 21 nonprofit lenders in partnership with 14 members. These grants provide flexible funding to nonprofit lenders in support of economic development and affordable housing in Illinois and Wisconsin.
Community First Awards: In 2020, we awarded $40,000 in Community First Awards to recognize outstanding
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achievements of our members and their local partners in the communities they serve. Award recipients included an innovative food and beverage manufacturing incubator, leaders in community economic development and sustainable homeownership, and a partnership supporting immigrants, refugees, and asylum seekers.

Fourth Quarter 2020 Dividends and Dividend Guidance

Based on our preliminary financial results for the fourth quarter of 2020, the Board of Directors declared a dividend of 5.00% (annualized) for Class B1 activity stock, unchanged from eight previous quarters. The Bank pays a higher dividend per share on activity stock to recognize members that support the entire cooperative through the use of our products. The higher dividend received on Class B1 activity stock has the effect of lowering members’ borrowing costs, and this benefit has increased on a relative basis as the Federal Reserve cut short-term interest rates twice in 2020. We expect to maintain a 5.00% (annualized) dividend for Class B1 activity stock for the first and second quarters of 2021, based on current projections and assumptions regarding our financial condition. We provide dividend guidance to assist members in planning their advance, letters of credit, and MPF products activity with us.

Additionally, based on our preliminary financial results for the fourth quarter of 2020, the Board of Directors declared a dividend of 2.00% (annualized) for Class B2 membership stock. Given the current interest rate environment, we reduced the B2 dividend to be more aligned with current market rates.

Any future dividend payments remain subject to determination and declaration by our Board of Directors and may be impacted by further changes in financial or economic conditions, regulatory and statutory limitations, and any other relevant factors. For additional discussion of risks that may impact the Bank’s dividend payments, see the Risk Factors section starting on page 23.
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Critical Accounting Policies and Estimates

See Note 2 - Summary of Significant Accounting Policies to the financial statements for further details on our accounting policies.

The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets, liabilities, income and expense. To understand the Bank's financial position and results of operations, it is important to understand the Bank's most significant accounting policies and the extent to which management uses judgment, estimates and assumptions in applying those policies. The Bank's critical accounting policies and estimates include the following:

Derivatives and hedging activities; and
Fair value estimates.

Derivatives and Hedging Activities

We transact most of our derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute consolidated obligations. We are not a derivatives dealer and do not trade derivatives for speculative purposes. We enter into derivative transactions through either of the following:

A bilateral agreement with an individual counterparty for over-the-counter derivative transactions.
Clearinghouses classified as DCOs through FCMs, which are clearing members of the DCOs, for cleared derivative transactions.

Managing Interest Rate Risk

We carry all derivatives at fair value in our statements of condition. We use fair value hedges to manage our exposure to changes in the fair value of (1) a recognized asset or liability or (2) an unrecognized firm commitment, attributable to changes in a benchmark interest rate. Our cash flow hedge strategy is to hedge the variability in the total net proceeds received from rolling forecasted zero-coupon discount note issuance, attributable to changes in the benchmark interest rate, by entering into pay-fixed interest rate swaps.

We may elect the fair value option for financial instruments, such as advances, MPF Loans held for sale, and consolidated obligation discount notes and bonds, in cases where hedge accounting treatment may not be achieved due to the inability to meet the hedge effectiveness testing criteria, or in certain cases where we wish to mitigate the risk associated with selecting the fair value option for other instruments. We may also use economic hedges when hedge accounting is not permitted or hedge effectiveness is not achievable.

Derivative Hedge Accounting - Refer to Note 2 - Summary of Significant Accounting Policies and Note 9 - Derivatives and Hedging Activities for further details. We apply hedge accounting to qualifying hedge relationships. A qualifying hedge relationship exists when a derivative hedging instrument is expected to effectively offset changes in fair values, cash flows, or underlying risk of the hedged item during the term of the hedge relationship. We prepare formal contemporaneous documentation at inception of the hedge relationship to support that the hedge relationship qualifies for hedge accounting treatment and assess hedge effectiveness on an ongoing basis. On a quantitative basis hedge effectiveness is considered to exist when correlation between the hedged item and hedging instrument is between 80% and 125%. On a qualitative basis hedge effectiveness is considered to exist when the correlation is between 90% and 110%. The hedge documentation formally documents the hedge relationship and its risk management objective and strategy for undertaking the hedge, including identification of the hedging instrument, the hedged item, the nature of the risk being hedged, and how the hedging instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value attributable to the hedged risk will be assessed.





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As of December 31, 2020, we held $50.8 billion notional of interest-rate derivatives with a total, net asset (liability) fair market value of $(2.2) billion, excluding posted collateral. These derivatives hedge mostly our fixed rate interest bearing assets and liabilities. The following table shows the estimated changes in the fair market value of our interest-rate derivatives under parallel interest-rate shifts allowing interest rates going negative under current low rate environment (for example the same change to interest rates on short-, intermediate-, and long-term fixed income maturities):

 As of December 31, 2020
Change from base case in bps-200 -100 -50 -25 +25 +50 +100+200
Net change in fair market value$(4,304)$(2,009)$(969)$(475)$457 $897 $1,728 $3,203 

The above table includes total derivatives entered into by the Bank, which includes interest-rate derivatives related to fair value hedges, cash flow hedges, and economic hedges.

In addition to performing the above sensitivity analysis, we also compare our fair value estimates of our outstanding derivatives to the estimates of our counterparties. At December 31, 2020 our total, net estimated fair market value of derivatives was $2 million (0.1%) over the counterparties' estimated values.


Fair Value Estimates

We believe our estimated fair value amounts are reasonable; however, as outlined below, there are inherent limitations in any valuation technique.

• Our estimated fair value amounts are highly subjective in nature. We select assumptions and inputs from a market participant's perspective to use with any of our valuation techniques. Such assumptions and inputs include, but are not limited to, the amount and timing of future cash flows, prepayment speed, expected interest rate volatility, possible distributions of future interest rates used to value options, and the selection of discount rates that appropriately reflect market and credit risks. Significant judgment is required when selecting such assumptions and inputs. Using different assumptions and inputs could have a material effect on our estimated fair value amounts. Further, the estimated fair value amounts presented in our statements of condition and disclosed in our notes to financial statements are not necessarily indicative of the amounts that would be realized in current market transactions.

• Our estimated fair value amounts are made as of the statement of condition date; and accordingly, such estimated fair value amounts are susceptible to material changes thereafter.

Fair value represents the exit price that we would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date.

Valuation Techniques and Significant Inputs

We utilize the fair value hierarchy when selecting valuation techniques and significant inputs to measure the fair value of our assets and liabilities. Our valuation techniques may utilize market, cost, and/or income models to estimate fair values. Under the fair value hierarchy, valuation techniques and significant inputs are prioritized from the most objective, such as quoted market prices in external active markets, to the least objective, such as valuation approaches that utilize unobservable inputs. The fair value hierarchy requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Outlined below is an overview of Level 1, Level 2, and Level 3 of the fair value hierarchy. Refer to Note 15 - Fair Value for further details on our valuation techniques and significant inputs.

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that we can access at the measurement date.

Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (1) quoted prices for similar assets or liabilities in active markets; (2) quoted prices for identical or similar assets or liabilities in markets that are not active or in which little information is released publicly; (3) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals and implied volatilities); and (4) inputs that are derived principally from or corroborated by observable market data (e.g., implied
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spreads).

Level 3 inputs are unobservable inputs used to measure fair value of an asset or liability to the extent that relevant observable inputs are not available; for example, situations in which there is little, if any, market activity for the asset or liability at the measurement date.

Valuation of Derivatives and Hedged Items. For purposes of estimating the fair value of derivatives and items for which we are hedging changes in the benchmark fair value, we employ a valuation model that uses market data from the Eurodollar futures, cash LIBOR, U.S. Treasury obligations, Effective federal funds rates (EFFR), overnight indexed swap rates, Secured Overnight Financing Rate (SOFR), SOFR Futures and the U.S. dollar interest-rate-swap markets to construct discount and forward-yield curves using standard financial market techniques.

For the valuation of derivatives, we use OIS based on the federal funds effective rate as the discount rate for our interest-rate derivatives which are not cleared through a DCO, while SOFR discounting curve is used for valuation of derivative cleared through a DCO. For derivatives, we compare the fair values obtained from our valuation model to clearinghouse valuations (in the case of cleared derivatives) and non-binding dealer estimates (in the case of bilateral derivatives), and may also compare derivative fair values to those of similar instruments, to ensure such fair values are reasonable.

For the valuation of hedged assets or liabilities in fair-value hedging relationships where the hedged risk changes in the benchmark fair value, we use LIBOR, OIS or SOFR as the discount rate, depending on which interest-rate index was designated as the benchmark rate at inception of the hedge relationship. These valuations are calculated using the same valuation model that calculates the fair values of the associated hedging derivatives. This valuation model is subject to a model validation approximately every two years by either an external party or an internal validation group. We periodically review and refine, as appropriate, the assumptions and valuation methodologies to reflect market indications as closely as possible.

Depending upon the spreads between LIBOR, OIS and SOFR rates, the use of the curve to value our interest-rate exchange agreements and the curve (plus or minus a constant spread) to derive the benchmark fair values of our hedged items could be different and result in increased fair-value hedge ineffectiveness. In addition, while not likely, this valuation methodology has the potential to lead to the loss of hedge accounting for some of these hedging relationships. Either of these outcomes could result in increased earnings volatility, which could potentially be material. However, through December 31, 2020, no hedge relationships failed our hedge effectiveness criteria as a result of using LIBOR, OIS or SOFR curves as the discount rate.

Valuation of Investment Securities. To value our holdings of investment securities, we obtain prices from three designated third-party pricing vendors when available. The pricing vendors use various proprietary models to price these securities. The inputs to those models are derived from various sources including, but not limited to, benchmark yields, reported trades, dealer estimates, issuer spreads, benchmark securities, bids, offers and other market-related data. Because many securities do not trade on a daily basis, the pricing vendors use available information as applicable such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing to determine the prices for individual securities. Each pricing vendor has an established challenge process in place for all security valuations, which facilitates resolution of potentially erroneous prices identified by the Bank. Annually, we conducted reviews of the three pricing vendors to reconfirm our understanding of the vendors' pricing processes, methodologies and control procedures and were satisfied that those processes, methodologies and control procedures were adequate and appropriate.

As of December 31, 2020, multiple vendor prices were received for substantially all of our investment securities and the final prices for substantially all of those securities were computed by averaging those prices. Based on our review of the pricing methods and controls employed by the third-party pricing vendors and the relative lack of dispersion among the vendor prices (or, in those instances in which there were outliers or significant yield variances, our additional analyses), we believe the final prices used are reasonably likely to be exit prices and further that the fair-value measurements are classified appropriately in the fair-value hierarchy.
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Results of Operations


Net Interest Income

Net interest income is the difference between the amount we recognize into interest income on our interest earning assets and the amount we recognize into interest expense on our interest bearing liabilities. These amounts were determined in accordance with GAAP and were based on the underlying contractual interest rate terms of our interest earning assets and interest bearing liabilities as well as the following items:
Amortization of premiums;
Accretion of discounts and credit OTTI reversals;
Hedge ineffectiveness, which represents the difference between changes in fair value of the derivative hedging instrument and the related change in fair value of the hedged item is recognized into either interest income or interest expense, whichever is appropriate. For cash flow hedges, recognition occurs only when amounts are reclassified out of accumulated other comprehensive income. Such recognition occurs when earnings are affected by the hedged item;
Net interest paid or received on interest rate swaps that are accounted for as fair value or cash flow hedges;
Amortization of fair value and cash flow closed hedge adjustments;
Advance and investment prepayment fees; and
MPF credit enhancement fees.
The following table presents the increase or decrease in interest income and expense due to volume or rate variances. The calculation of these components includes the following considerations:
 
Average Balance: Average balances are calculated using daily balances. Amortized cost is used to compute the average balances for most of our financial instruments, including MPF Loans held in portfolio (including those that are on nonaccrual status) and available-for-sale debt securities. Fair value is used to compute average balances for our trading debt securities and financial instruments carried at fair value under the fair value option.

Total Interest: Total interest includes the net interest income components, as discussed above, applicable to our interest earning assets and interest bearing liabilities.

Yield/Rate: Effective yields/rates are based on total interest and average balances as defined above. Yields/rates are calculated on an annualized basis. The calculation of the yield on our available-for-sale securities does not give effect to changes in fair value that are reflected as a component of accumulated other comprehensive income (AOCI).

The change in volume is calculated as the change in average balance multiplied by the current year yield. The change in rate is calculated as the change in yield multiplied by the prior year average balance. Any changes due to the combined volume/rate variance have been allocated to volume.


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2020 compared to 2019
For comparisons to 2018 see Net Interest Income on page 40 in our 2019 Form 10-K.
20202019Increase (decrease) due to
Average BalanceInterest Income/ExpenseYield/ RateAverage BalanceInterest Income/ ExpenseYield/ RateVolumeRateNet Change
For the years ended December 31,
Investment debt securities$23,642 $497 2.10 %$20,575 $704 3.42 %$65 $(272)$(207)
Advances54,639 586 1.07 %55,203 1,333 2.41 %(7)(740)(747)
MPF Loans held in portfolio10,382 295 2.84 %8,308 313 3.77 %59 (77)(18)
Federal funds sold and securities purchased under agreements to resell10,215 44 0.43 %11,625 253 2.18 %(6)(203)(209)
Interest earning deposits1,885 8 0.42 %1,262 28 2.22 %3 (23)(20)
Other interest earning assets155 5 3.23 %114 3.51 %1  1 
Interest earning assets100,918 1,435 1.42 %97,087 2,635 2.71 %52 (1,252)(1,200)
Noninterest earning assets2,354 1,797 
Total assets103,272 98,884 
Consolidated obligation discount notes45,604 307 0.67 %45,699 1,038 2.27 % (731)(731)
Consolidated obligation bonds48,749 516 1.06 %45,273 1,109 2.45 %36 (629)(593)
Other interest bearing liabilities1,407 17 1.21 %1,012 30 2.96 %5 (18)(13)
Interest bearing liabilities95,760 840 0.88 %91,984 2,177 2.37 %34 (1,371)(1,337)
Noninterest bearing liabilities1,910 1,231 
Total liabilities97,670 93,215 
Net yield on interest earning assets$100,918 $595 0.59 %$97,087 $458 0.47 %$20 $117 $137 

Interest income from investment debt securities decreased due to lower market interest rates in 2020 compared to the same period in 2019.
Interest income from advances decreased primarily due to lower market interest rates in 2020 compared to the same period in 2019.
Interest income from MPF Loans held in portfolio declined due to the lower mortgage rate environment impacting the yield earned on new loan originations, along with an increased recognition of premium amortization expense of $76 million in 2020 compared to $30 million in 2019, primarily due to an increase in loans prepaid. However, the decline in overall rate yield of the MPF portfolio was mostly offset by higher volumes, on an average basis, as new-acquisition volume continued to outpace paydown and maturity activity due to loan origination activity driven by refinancings as mortgage rates declined overall.
Interest income from overnight Federal Funds sold and securities purchased under agreements to resell decreased due to lower market interest rates in 2020 compared to the same period in 2019.
Interest expense on our shorter termed consolidated obligation discount notes decreased due to lower market interest rates in 2020 compared to the same period in 2019.
Interest expense on our longer termed consolidated obligation bonds decreased due to lower market interest rates in 2020 compared to the same period in 2019.
For details of the effect our fair value and cash flow hedge activities had on our net interest income see Trading Securities, Derivatives and Hedging Activities, and Instruments Held Under Fair Value Option table on page 49.


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fhlbc-20201231_g1.jpgFederal Home Loan Bank of Chicago
(Dollars in tables in millions except per share amounts unless otherwise indicated)
Although the Bank maintained ready access to funding throughout 2020, we have experienced some disruptions in the long-term debt markets. The impact of the COVID-19 pandemic on our overall funding costs may cause compression in net interest margin in the future as returns on our liquidity asset portfolio decline over the same time. The extent to which the COVID-19 pandemic will affect or will continue to affect our business, financial condition, and results of operations will depend on future developments, which are uncertain and cannot be predicted. For a discussion of risks relating to our financial condition and results of operation as a result of the COVID-19 pandemic, including risks relating to our net interest margin and advance levels, see Risk Factors on page 23.

Noninterest income

For comparisons to 2018 see Noninterest Income on page 42 in our 2019 Form 10-K.


For the years ended December 31,20202019
Trading securities$15 $24 
Investment securities gains109 — 
Derivatives and hedging activities(148)(9)
Instruments held under fair value option60 35 
MPF fees,31 and28 from other FHLBs54 38 
Other, net14 12 
Noninterest income$104 $100 

Investment Securities Gains

Gains on our investment securities due to sale of our AFS and HTM private label mortgage backed securities (PLMBS) were the primary driver of our increase in noninterest income for 2020. See Note 2 - Summary of Significant Accounting Policies for further details on our sale of PLMBS during October 2020.

Trading Securities, Derivatives and Hedging Activities, and Instruments Held Under Fair Value Option

Gains on our instruments held under fair value option were more than offset by losses in our derivatives and hedging activities and trading securities. The corresponding gains and losses for instruments held under fair value option, derivatives and hedging activities, and trading securities were primarily attributable to the decline in market interest rates in 2020 compared to 2019.

The following table details the net income effect of all of our hedging related transactions, which were recorded in the following lines in our statements of net income.


AdvancesInvestmentsMPF LoansDiscount NotesBondsOtherTotal  
Year ended December 31, 2020
Recorded in net interest income$(216)$(182)$1 $(20)$122 $ $(295)
Recorded in derivatives & hedging activities(86)(91)(3)20 8 4 (148)
Recorded in trading securities (6)    (6)
Recorded on instruments held under fair value option64  (1) (3) 60 
Total net effect gain (loss) of hedging activities$(238)$(279)$(3)$ $127 $4 $(389)
Year ended December 31, 2019
Recorded in net interest income$29 $(52)$(1)$(25)$(53)$— $(102)
Recorded in derivatives & hedging activities(40)(11)16 10 12 (9)
Recorded in trading securities— 14 — — — — 14 
Recorded on instruments held under fair value option49 — (1)— (14)35 
Total net effect gain (loss) of hedging activities$38 $(49)$14 $(21)$(57)$13 $(62)


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fhlbc-20201231_g1.jpgFederal Home Loan Bank of Chicago
(Dollars in tables in millions except per share amounts unless otherwise indicated)
MPF fees (including from other FHLBs)

A majority of MPF fees are from other FHLBs that pay us a fixed membership fee to participate in the MPF Program and a
volume based fee for us to provide services related to MPF Loans carried on their balance sheets. MPF fees also include
income from other third party off balance sheet MPF Loan products and other related transaction fees. These fees are designed
to compensate us for the expenses we incur to administer the program. Increases in our 2020 MPF fees were primarily driven by refinancing activity as mortgage rates declined overall, accelerating the recognition of fee income from our third party off balance sheet MPF Loan products. MPF fees have also grown as MPF Loan volume has increased as noted in Item 6. Selected Financial Data.

Other, net

Other, net consists primarily of fee income we earn from member standby letters of credit products, as noted in Item 6. Selected Financial Data.

Noninterest Expense

For comparisons to 2018 see Noninterest Expense on page 43 in our 2019 Form 10-K.

 
For the years ended December 31,20202019
Compensation and benefits$132 $115 
Nonpayroll operating expenses94 96 
COVID-19 relief28 — 
Other, net21 12 
Noninterest expense$275 $223 

The following analysis and comparisons apply to the periods presented in the above table.

Compensation and benefits increased due to salary increases and increased pension-related expenses. We had 474 employees as of December 31, 2020, compared to 488 as of December 31, 2019.

Operating expenses were comparable to prior periods as we continue our planned investment in information technology, specifically applications, infrastructure and resiliency.

As further discussed in Environmental, Social, and Governance on page 13, in response to the COVID-19 pandemic, the Bank committed to invest approximate $30 million to the COVID-19 Relief Programs, of which $28 million was provided to members and recorded as an expenses in the second, third, and fourth quarter of 2020.

The extent to which the COVID-19 pandemic will affect or will continue to affect our business, financial condition, and results of operations will depend on future developments, which are uncertain and cannot be predicted. For a discussion of risks relating to our financial condition and results of operation as a result of the COVID-19 pandemic, see