10-Q 1 d10q.htm FORM 10-Q FORM 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-51845

FEDERAL HOME LOAN BANK OF ATLANTA

(Exact name of registrant as specified in its charter)

 

Federally chartered corporation

      

56-6000442

    
(State or other jurisdiction of
incorporation or organization)
     (I.R.S. Employer
Identification No.)
  

1475 Peachtree Street, NE, Atlanta, Ga.

       

30309

    
(Address of principal executive offices)      (Zip Code)   

Registrant’s telephone number, including area code: (404) 888-8000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.

x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:

 

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x    Smaller reporting company  ¨
      (Do not check if a smaller reporting company)   

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

The number of shares outstanding of the registrant’s Class B Stock, par value $100, as of October 31, 2008, was 90,134,877.

 


Table of Contents

Table of Contents

 

PART I.

       FINANCIAL INFORMATION    1

Item 1.

   Financial Statements    1
       Statements of Condition    1
       Statements of Income    2
       Statements of Capital    3
       Statements of Cash Flows    4
       Notes to Financial Statements    6

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    28

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    59

Item 4.

   Controls and Procedures    62

Item 4T.

   Controls and Procedures    62

PART II.

   OTHER INFORMATION    63

Item 1.

   Legal Proceedings    63

Item 1A.

   Risk Factors    63

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    65

Item 3.

   Defaults Upon Senior Securities    65

Item 4.

   Submission of Matters to a Vote of Security Holders    65

Item 5.

   Other Information    67

Item 6.

   Exhibits    68
SIGNATURES    69


Table of Contents
PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

FEDERAL HOME LOAN BANK OF ATLANTA

STATEMENTS OF CONDITION

(Unaudited)

(In thousands, except par value)

 

     As of
     September 30, 2008    December 31, 2007

ASSETS

     

Cash and due from banks

       $ 7,961        $ 18,927

Interest-bearing deposits

     3,059      3,403

Federal funds sold

     16,775,100      14,835,000

Trading securities (includes $439,725 and $592,065 pledged as collateral as of September 30, 2008 and December 31, 2007, respectively, that may be repledged and includes other FHLBanks’ bonds of $280,853 and $284,542 as of September 30, 2008 and December 31, 2007, respectively)

     4,233,093      4,627,545

Held-to-maturity securities, net (fair value of $21,179,270 and $21,577,379 as of September 30, 2008 and December 31, 2007, respectively)

     23,893,355      22,060,517

Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans of $861 and $846 as of September 30, 2008 and December 31, 2007, respectively

     3,337,109      3,526,582

Advances, net

     164,285,082      142,867,373

Accrued interest receivable

     757,799      824,815

Premises and equipment, net

     28,771      30,652

Derivative assets

     248,663      43,039

Other assets

     148,628      99,911
             

TOTAL ASSETS

       $ 213,718,620        $ 188,937,764
             

LIABILITIES

     

Deposits:

     

Interest-bearing

       $ 7,946,985        $ 7,115,183

Noninterest-bearing

          19,844
             

Total deposits

     7,946,985      7,135,027
             

Securities sold under agreements to repurchase

     259,414     

Consolidated obligations, net:

     

Discount notes

     55,512,638      28,347,939

Bonds

     138,634,570      142,237,042
             

Total consolidated obligations, net

     194,147,208      170,584,981
             

Mandatorily redeemable capital stock

     35,454      55,538

Accrued interest payable

     1,171,472      1,460,113

Affordable Housing Program

     138,299      156,184

Payable to REFCORP

          30,681

Derivative liabilities

     828,641      1,305,132

Other liabilities

     133,064      187,872
             

Total liabilities

     204,660,537      180,915,528
             

Commitments and contingencies (Note 11)

     

CAPITAL

     

Capital stock Class B putable ($100 par value) issued and outstanding shares:

     

Subclass B1 issued and outstanding shares: 14,661 and 12,900 as of September 30, 2008 and December 31, 2007, respectively

     1,466,138      1,289,973

Subclass B2 issued and outstanding shares: 72,342 and 62,660 as of September 30, 2008 and December 31, 2007, respectively

     7,234,192      6,266,043
             

Total capital stock Class B putable

     8,700,330      7,556,016

Retained earnings

     360,307      468,779

Accumulated other comprehensive loss

     (2,554)      (2,559)
             

Total capital

     9,058,083      8,022,236
             

TOTAL LIABILITIES AND CAPITAL

       $ 213,718,620        $ 188,937,764
             

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

 

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FEDERAL HOME LOAN BANK OF ATLANTA

STATEMENTS OF INCOME

(Unaudited)

(In thousands)

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2008     2007    2008    2007

INTEREST INCOME

          

Advances

       $ 1,040,858         $ 1,669,241        $ 3,566,369        $ 4,419,063

Prepayment fees on advances, net

     714       169      3,428      1,209

Interest-bearing deposits

     1,846       1,007      24,753      2,808

Federal funds sold

     76,584       222,679      216,959      532,451

Trading securities

     80,073       66,461      226,567      199,269

Held-to-maturity securities

     303,680       248,055      877,774      730,725

Mortgage loans held for portfolio

     45,331       45,514      138,540      128,000

Loans to other FHLBanks

     27       44      77      47
                            

Total interest income

     1,549,113       2,253,170      5,054,467      6,013,572
                            

INTEREST EXPENSE

          

Consolidated obligations:

          

Discount notes

     237,442       202,660      687,187      357,494

Bonds

     1,049,116       1,779,371      3,575,479      4,918,100

Deposits

     23,051       78,043      102,694      208,671

Loans from other FHLBanks

     1       4      13      33

Securities sold under agreements to repurchase

     1,324       2,242      1,324      14,550

Mandatorily redeemable capital stock

     268       3,450      1,391      10,196

Other borrowings

     50       155      179      449
                            

Total interest expense

     1,311,252       2,065,925      4,368,267      5,509,493
                            

NET INTEREST INCOME

     237,861       187,245      686,200      504,079

(Reversal) provision for credit losses on mortgage loans held for portfolio

     (135)       161      15      72
                            

NET INTEREST INCOME AFTER (REVERSAL) PROVISION FOR CREDIT LOSSES

     237,996       187,084      686,185      504,007
                            

OTHER INCOME (LOSS)

          

Service fees

     539       562      1,799      1,892

Net gains (losses) on trading securities

     31,070       92,538      (50,968)      19,723

Realized loss on held-to-maturity securities

     (87,344)            (87,344)     

Net losses on derivatives and hedging activities

     (45,299)       (72,816)      (51,219)      (9,898)

Other

     (129)       (8)      (73)      571
                            

Total other (loss) income

     (101,163)       20,276      (187,805)      12,288
                            

OTHER EXPENSE

          

Compensation and benefits

     15,668       14,525      47,966      44,519

Other operating expenses

     10,751       8,351      27,100      23,407

Finance Agency

     1,480       1,252      4,665      3,755

Office of Finance

     852       814      3,090      2,601

Provision for credit losses on receivable

     170,486            170,486     

Other

     321       814      1,001      2,356
                            

Total other expense

     199,558       25,756      254,308      76,638
                            

(LOSS) INCOME BEFORE ASSESSMENTS

     (62,725 )     181,604      244,072      439,657
                            

Affordable Housing Program

     (5,093 )     15,177      20,066      36,931

REFCORP

     (11,526 )     33,285      44,801      80,545
                            

Total assessments

     (16,619 )     48,462      64,867      117,476
                            

NET (LOSS) INCOME

       $ (46,106 )       $ 133,142        $ 179,205        $ 322,181
                            

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

 

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FEDERAL HOME LOAN BANK OF ATLANTA

STATEMENTS OF CAPITAL

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

(Unaudited)

(In thousands)

 

     Capital Stock Class B Putable    Retained
Earnings
   Accumulated
Other

Comprehensive Loss
   Total Capital
     Shares    Par Value         

BALANCE, DECEMBER 31, 2006

   57,718        $ 5,771,798        $ 406,376        $ (4,537)        $ 6,173,637

Issuance of capital stock

   46,211      4,621,099                4,621,099

Repurchase/redemption of capital stock

   (29,028)      (2,902,824)                (2,902,824)

Net shares reclassified to mandatorily redeemable capital stock

   (774)      (77,356)                (77,356)

Comprehensive income:

              

Net income

             322,181           322,181

Other comprehensive loss:

              

Benefit plans:

              

Amortization of net loss

                  780      780

Amortization of net prior service credit

                  (544)      (544)

Amortization of net transition obligation

                  30      30
                  

Total comprehensive income

                       322,447
                  

Cash dividends on capital stock

             (268,572)           (268,572)
                                

BALANCE, SEPTEMBER 30, 2007

   74,127        $ 7,412,717        $ 459,985        $ (4,271)        $ 7,868,431
                                

BALANCE, DECEMBER 31, 2007

   75,560        $ 7,556,016        $ 468,779        $ (2,559)        $ 8,022,236

Issuance of capital stock

   46,112      4,611,210                4,611,210

Repurchase/redemption of capital stock

   (34,434)      (3,443,391)                (3,443,391)

Net shares reclassified to mandatorily redeemable capital stock

   (235)      (23,505)                (23,505)

Comprehensive income:

              

Net income

             179,205           179,205

Other comprehensive loss:

              

Benefit plans:

              

Amortization of net loss

                  515      515

Amortization of net prior service credit

                  (542)      (542)

Amortization of net transition obligation

                  32      32
                  

Total comprehensive income

                       179,210
                  

Cash dividends on capital stock

             (287,677)           (287,677)
                                

BALANCE, SEPTEMBER 30, 2008

   87,003        $ 8,700,330        $ 360,307        $ (2,554)        $ 9,058,083
                                

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

 

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FEDERAL HOME LOAN BANK OF ATLANTA

STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

     Nine Months Ended September 30,
     2008    2007

OPERATING ACTIVITIES

     

Net income

       $ 179,205        $ 322,181

Adjustments to reconcile net income to net cash provided by operating activities:

     

Depreciation and amortization:

     

Net premiums and discounts on consolidated obligations

     153,977      118,691

Net premiums and discounts on investments

     (9,575)      (3,986)

Net premiums and discounts on mortgage loans

     744      (669)

Concessions on consolidated obligations

     39,388      23,526

Net deferred loss on derivatives

     247      231

Premises and equipment

     2,202      1,847

Capitalized software

     3,522      3,384

Other

     6,457      (8,664)

Provision for credit losses on mortgage loans held for the portfolio

     15      72

Provision for credit losses on receivable

     170,486     

Net realized gains from redemption of held-to-maturity securities

     (401)     

Realized loss on held-to-maturity securities

     87,344     

Gain due to early extinguishment of debt

          (234)

Loss on disposal of capitalized software

     322     

Gain due to change in net fair value adjustment on derivative and hedging activities

     (853,825)      (316,585)

Fair value adjustment on trading securities

     87,161      (19,723)

Settlement of derivative transactions with trading securities

     840,589     

Net change in:

     

Accrued interest receivable (excluding derivative accrued interest)

     69,285      (84,372)

Other assets

     (217,353)      (8,322)

Affordable Housing Program liability

     (18,167)      16,646

Accrued interest payable (excluding derivative accrued interest)

     (288,644)      256,377

Payable to REFCORP*

     (42,207)      9,679

Other liabilities

     184      16,150
             

Total adjustments

     31,751      4,048
             

Net cash provided by operating activities

     210,956      326,229
             

INVESTING ACTIVITIES

     

Net change in:

     

Interest-bearing deposits

     (1,251,151)      (36,878)

Federal funds sold

     (1,940,100)      (10,520,000)

Deposits with other FHLBanks

     344      1,458

Trading Securities:

     

Proceeds from sales

     1,900,000     

Proceeds from maturities

     550,000     

Purchases

     (2,978,941)     

Held-to-maturity securities:

     

Net change in short-term

     800,000      8,000

Proceeds

     2,690,512      2,173,219

Purchases

     (5,405,075)      (3,123,199)

Advances:

     

Proceeds from principal collected

     135,095,543      130,542,484

Made

     (156,253,231)      (167,285,569)

Mortgage loans held for portfolio:

     

Proceeds from principal collected

     354,417      292,794

Purchases

     (165,290)      (794,094)

Capital expenditures:

     

Purchase of premises and equipment

     (372)      (1,177)

Purchase of software

     (3,900)      (2,307)
             

Net cash used in investing activities

     (26,607,244)      (48,745,269)
             

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

 

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     Nine Months Ended September 30,
     2008    2007

FINANCING ACTIVITIES

     

Net change in:

     

Deposits

     811,958      1,092,011

Securities sold under agreement to repurchase

     259,414      (500,000)

Net proceeds on derivative contracts with financing element

     945,338     

Proceeds from issuance of consolidated obligations:

     

Discount notes

     269,256,294      601,880,639

Bonds

     95,512,887      81,327,796

Payments for debt issuance costs

     (29,614)      (20,368)

Payments for maturing and retiring consolidated obligations:

     

Discount notes

     (242,112,421)      (576,251,056)

Bonds

     (99,040,105)      (60,465,616)

Proceeds from issuance of capital stock

     4,611,210      4,621,099

Payments for repurchase/redemption of capital stock

     (3,443,391)      (2,902,824)

Payments for repurchase/redemption of mandatorily redeemable capital stock

     (43,589)      (122,483)

Cash dividends paid

     (342,659)      (256,762)
             

Net cash provided by financing activities

     26,385,322      48,402,436
             

Net decrease in cash and cash equivalents

     (10,966)      (16,604)

Cash and cash equivalents at beginning of the period

     18,927      28,671
             

Cash and cash equivalents at end of the period

       $ 7,961        $ 12,067
             

Supplemental disclosures of cash flow information:

     

Cash paid for:

     

Interest paid

       $ 3,947,579        $ 4,853,316
             

AHP assessments paid, net

       $ 37,951        $ 20,410
             

REFCORP assessments paid

       $ 87,008        $ 70,866
             

Noncash investing and financing activities:

     

Dividends declared but not paid

       $ 58,946        $ 99,019
             

Net shares reclassified to mandatorily redeemable capital stock

       $ 23,505        $ 77,356
             

Held-to-maturity securities acquired with accrued liabilities

       $        $ 149,997
             

 

* Payable to REFCORP includes the net change in the REFCORP receivable/payable.

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

 

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FEDERAL HOME LOAN BANK OF ATLANTA

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

Note 1—Basis of Presentation

The accompanying unaudited interim financial statements of the Federal Home Loan Bank of Atlanta (the “Bank”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). To prepare the financial statements in conformity with GAAP, management must make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period. Actual results could be different from these estimates. The foregoing interim financial statements are unaudited; however, in the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary for a fair statement of the results for the interim periods, have been included. The results of operations for interim periods are not necessarily indicative of results to be expected for the year ending December 31, 2008, or for other interim periods. The unaudited interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2007, which are contained in the Bank’s 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 27, 2008 (“Form 10-K”).

Descriptions of the significant accounting policies of the Bank are included in Note 1 to the 2007 audited financial statements. There have been no material changes to these policies as of September 30, 2008.

Reclassifications. Certain amounts in the prior-year financial statements have been reclassified to conform to the current presentation.

In particular, in accordance with FASB Staff Position (“FSP”) No. FIN 39-1, Amendment of FASB Interpretation No. 39 (“FSP FIN 39-1”), the Bank recognized the effects of applying FSP FIN 39-1 as a change in accounting principle through retrospective application for all financial statement periods presented. For more information related to FSP FIN 39-1, see Note 2 to these financial statements.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115 (“SFAS 159”), which amends SFAS No. 95, Statement of Cash Flows (“SFAS 95”), and SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, (“SFAS 115”), cash flows from trading securities (which include securities for which an entity has elected the fair value option) should be classified in the statement of cash flows based on the nature of and purpose for which the securities were acquired. Prior to this amendment, SFAS 95 and SFAS 115 specified that all cash flows from trading securities must be classified as cash flows from operating activities. On a retroactive basis, beginning in the first quarter of 2008, the Bank classifies purchases, sales and maturities of trading securities held for investment purposes as cash flows from investing activities. Cash flows related to trading securities held for trading purposes continue to be reported as cash flows from operating activities. Previously, all cash flows associated with trading securities were reflected in the statement of cash flows as operating activities. For more information on SFAS 159, see Note 2 to these financial statements.

During the third quarter of 2008, on a retrospective basis, the Bank reclassified its investments in certificates of deposit, previously reported as interest-bearing deposits, to present them appropriately as held-to-maturity securities in its statements of condition and income based on the definition of a security under SFAS 115. These financial instruments have been classified as held-to-maturity securities based on their short-term nature and the Bank’s history of holding them until maturity. This reclassification had no effect on total assets or net interest income and net income and was not material to the previously issued financial statements.

 

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The effects of the above reclassifications on the Bank’s prior year financial statements were as follows (in thousands):

 

     Statement of Condition
As of December 31, 2007
     As
Originally
Reported
   FSP FIN 39-1
Reclassification
   SFAS 159
Reclassification
   Certificates of
Deposit
Reclassification
   As
Currently
Reported

Assets:

              

Interest-bearing deposits (a)

       $ 1,608,573        $ (805,170)        $        $ (800,000)        $ 3,403

Held-to-maturity securities

     21,260,517                800,000      22,060,517

Accrued interest receivable

     828,004      (3,189)                824,815

Derivative assets

     43,048      (9)                43,039

Total assets

     189,746,132      (808,368)                188,937,764

Liabilities:

              

Accrued interest payable

     1,460,122      (9)                1,460,113

Derivative liabilities

     2,113,491      (808,359)                1,305,132

Total liabilities

     181,723,896      (808,368)                180,915,528

Total liabilities and capital

     189,746,132      (808,368)                188,937,764

 

(a)    “As adjusted” amount represents deposits with other FHLBanks.

 

     Statement of Income
Three Months Ended September 30, 2007
     As
Originally
Reported
   FSP FIN 39-1
Reclassification
   SFAS 159
Reclassification
   Certificates of
Deposit
Reclassification
   As
Currently
Reported

Interest Income:

              

Interest-bearing deposits

       $ 13,720        $        $        $ (12,713)        $ 1,007

Held-to-maturity securities

     235,342                12,713      248,055
     Statement of Income
Nine Months Ended September 30, 2007
     As Originally
Reported
   FSP FIN 39-1
Reclassification
   SFAS 159
Reclassification
   Certificates of
Deposit
Reclassification
   As
Currently
Reported

Interest Income:

              

Interest-bearing deposits

       $ 38,129        $        $        $ (35,321)        $ 2,808

Held-to-maturity securities

     695,404                35,321      730,725

 

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     Statement of Cash Flows
Nine Months Ended September 30, 2007
     As
Originally
Reported
   FSP FIN 39-1
Reclassification
   SFAS 159
Reclassification
   Certificates of
Deposit
Reclassification
   As
Currently
Reported

Operating Activities:

              

Net change in trading securities

       $ (19,723)        $        $ 19,723        $        $

Fair value adjustment on trading securities

               (19,723)           (19,723)

Investing Activities:

              

Net change in interest-bearing deposits

     (28,878)                (8,000)      (36,878)

Held-to-maturity securities:

              

Net change in short-term

                    8,000      8,000

Note 2—Recently Adopted and Issued Accounting Standards

SFAS No. 157, Fair Value Measurements (“SFAS 157”) was issued in September 2006. In defining fair value, SFAS 157 retains the exchange price notion in earlier definitions of fair value. However, the definition of fair value under SFAS 157 focuses on the price that would be received to sell an asset or paid to transfer a liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). SFAS 157 applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. Accordingly, SFAS 157 does not expand the use of fair value in any new circumstances. SFAS 157 also establishes a fair value hierarchy that prioritizes the information used to develop assumptions used to determine the exit price. Under this standard, fair value measurements would be disclosed separately by level within the fair value hierarchy. The Bank adopted SFAS 157 effective January 1, 2008. The adoption of SFAS 157 had no effect on the Bank’s financial condition or results of operations. For additional information on the fair value of certain financial assets and liabilities, see Note 10 to the financial statements.

SFAS 159, issued in February 2007, creates a fair value option allowing an entity irrevocably to elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities, with changes in fair value recognized in earnings as they occur. SFAS 159 requires an entity to report those financial assets and financial liabilities measured at fair value in a manner that separates those reported fair values from the carrying amounts of assets and liabilities measured using another measurement attribute on the face of the statement of financial position. SFAS 159 also requires an entity to provide information that would allow users to understand the effect on earnings of changes in the fair value on those instruments selected for the fair value election. The Bank adopted SFAS 159 effective January 1, 2008. There was no initial effect of adoption since the Bank did not elect the fair value option for any existing asset or liability. In addition, the Bank did not elect the fair value option for any financial assets originated or purchased, or for liabilities issued, through September 30, 2008.

FSP FIN 39-1, issued in April 2007, permits an entity to offset fair value amounts recognized for derivative instruments and fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from derivative instruments recognized at fair value executed with the same counterparty under a master netting arrangement. Under FSP FIN 39-1, the receivable or payable related to cash collateral may not be offset if the amount recognized does not represent or approximate fair value or arises from instruments in a master netting arrangement that are not eligible to be offset. The decision whether to offset such fair value amounts

 

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represents an elective accounting policy decision that, once elected, must be applied consistently. An entity should recognize the effects of applying FSP FIN 39-1 as a change in accounting principle through retrospective application for all financial statements presented unless it is impracticable to do so. Upon adoption of FSP FIN 39-1, an entity is permitted to change its accounting policy to offset or not offset fair value amounts recognized for derivative instruments under master netting arrangements. The Bank adopted FSP FIN 39-1 effective January 1, 2008 and retroactively applied its requirements to all prior periods. The Bank has not changed its accounting policy of offsetting fair value amounts recognized for derivative instruments under the same master netting arrangement. As a result of the adoption of FSP FIN 39-1, certain amounts on the Bank’s Statements of Condition as of December 31, 2007, were modified to conform to the 2008 presentation, as summarized in Note 1 to the financial statements.

Statement 133 Implementation Issue No. 23 (“Issue E23”), Issues Involving Application of the Shortcut Method under Paragraph 68, issued in January 2008 amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), explicitly to permit the use of the shortcut method for those hedging relationships in which (a) the interest rate swap has a nonzero fair value at the inception of the hedging relationship, attributable solely to differing prices within the bid-ask spread; and/or (b) the hedged item has a trade date that differs from its settlement date because of generally established conventions in the marketplace in which the transaction to acquire or issue the hedged item is executed. Issue E23 is effective for hedging relationships designated on or after January 1, 2008. At adoption, preexisting hedging relationships utilizing the shortcut method that did not meet the requirements of Issue E23 as of the inception of the hedging relationship must be dedesignated prospectively. The effects of applying hedge accounting prior to the effective date may not be reversed. A hedging relationship that does not qualify for the shortcut method based on Issue E23 could be redesignated without the application of the shortcut method if that hedging relationship meets the applicable requirements of SFAS 133. The Bank adopted Issue E23 effective January 1, 2008. The Bank concluded that no dedesignations were required as a result of the adoption of Issue E23. In addition, since May 31, 2005, the Bank no longer applies the short-cut method to new hedging relationships. Therefore the adoption of Issue E23 had no effect on the Bank’s financial condition or results of operations.

SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133 (“SFAS 161”), issued in March 2008, requires enhanced disclosures about an entity’s derivative and hedging activities. These enhanced disclosures will discuss (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS 133, and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008 with earlier adoption allowed. The Bank does not believe that the adoption of SFAS 161 will have a material effect on its financial condition or results of operations.

SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”), issued in May 2008, identifies the sources of accounting principles and the framework, or hierarchy, for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. SFAS 162 is effective November 15, 2008. The Bank does not believe that the adoption of SFAS 162 will have a material effect on its financial condition or results of operations.

FSP No. 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161 (“FSP 133-1 and FIN 45-4”) was issued in September 2008. FSP 133-1 and FIN 45-4 amended

 

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SFAS 133 and FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others—an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34 (“FIN 45”), to improve disclosures about credit derivatives and guarantees and clarify the effective date of SFAS No. 161. FSP 133-1 and FIN 45-4 amended SFAS 133 to require entities to disclose sufficient information to allow users to assess the potential effect of credit derivatives, including their nature, maximum payment, fair value, and recourse provisions. FSP 133-1 and FIN 45-4 amended FIN 45 to require a disclosure about the current status of the payment/performance risk of a guarantee, which could be indicated by external credit ratings or categories by which the Bank measures risk. The Bank does not currently enter into credit derivatives, but does have guarantees: letters of credit and the joint and several liability on consolidated obligations of the 12 Federal Home Loan Banks (“FHLBanks”). FSP 133-1 and FIN 45-4 is effective for periods ending after November 15, 2008. The Bank does not believe that the adoption of adoption of FSP 133-1 and FIN 45-4 will have a material effect on its financial statements or results of operations.

FSP No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (“FSP FAS 157-3”), issued in October 2008, clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP FAS 157-3 was effective upon issuance, including prior periods for which financial statements have not been issued. Revisions resulting from a change in the valuation technique or its application should be accounted for as a change in accounting estimate following the guidance in SFAS No. 154, Accounting Changes and Error Corrections (“SFAS 154”). However, the disclosure provisions in SFAS 154 for a change in accounting estimate are not required for revisions resulting from a change in valuation technique or its application. As FSP FAS 157-3 clarified but did not change the application of SFAS 157, the adoption of FSP FAS 157-3 had no effect on the Bank’s financial condition or results of operations.

Note 3—Trading Securities

Major Security Types. Trading securities were as follows (in thousands):

 

     As of September 30, 2008    As of December 31, 2007

Government-sponsored enterprises debt obligations

       $ 3,938,084        $ 4,283,519

Other FHLBanks’ bonds

     280,853      284,542

State or local housing agency obligations

     14,156      59,484
             

Total

       $ 4,233,093        $ 4,627,545
             

Net gains (losses) on trading securities during the three- and nine-month periods ended September 30, 2008 included net unrealized holding gains of $11.7 million and net unrealized holding losses of $40.7 million, respectively, compared to net unrealized holding gains of $92.5 million and $19.7 million for the same periods ended September 30, 2007, respectively.

 

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Other FHLBanks’ Consolidated Obligation Bonds. The following table details the Bank’s investment in other FHLBanks’ consolidated obligation bonds by primary obligor (in thousands):

 

     As of September 30, 2008    As of December 31, 2007

Other FHLBanks’ bonds:

     

FHLBank Dallas

       $ 81,947        $ 83,525

FHLBank Chicago

     69,605      70,345
             
     151,552      153,870

FHLBank TAP Program*

     129,301      130,672
             

Total

       $ 280,853        $ 284,542
             

 

* Under this program, the FHLBanks can offer debt obligations representing aggregations of smaller bond issues into larger bond issues that may have greater market liquidity. Because of the aggregation of smaller issues, there is more than one primary obligor.

Note 4—Held-to-maturity Securities

Major Security Types. Held-to-maturity securities were as follows (in thousands):

 

     As of September 30, 2008    As of December 31, 2007
     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value

Certificates of deposit

       $        $        $        $        $ 800,000        $ 70        $ 30        $ 800,040

State or local housing agency obligations

     109,397      1,651      591      110,457      117,988      4,933      65      122,856

Mortgage-backed securities:

                       

U.S. agency obligations-guaranteed

     40,297      349      89      40,557      47,460      779           48,239

Government-sponsored enterprises

     7,203,990      7,712      105,480      7,106,222      2,968,441      8,591      37,260      2,939,772

Private label

     16,539,671           2,617,637      13,922,034      18,126,628      2,068      462,224      17,666,472
                                                       

Total

       $ 23,893,355        $ 9,712        $ 2,723,797        $ 21,179,270        $ 22,060,517        $ 16,441        $ 499,579        $ 21,577,379
                                                       

 

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The following tables summarize the held-to-maturity securities with unrealized losses (in thousands). The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.

 

     As of September 30, 2008
     Less than 12 Months    12 Months or More    Total
     Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses

State or local housing agency obligations

       $ 31,109        $ 591        $        $        $ 31,109        $ 591

Mortgage-backed securities:

                 

U.S. agency obligations-guaranteed

     16,278      89                16,278      89

Government-sponsored enterprises

     5,323,241      71,215      1,011,652      34,265      6,334,893      105,480

Private label

     6,444,807      1,269,940      7,275,213      1,347,697      13,720,020      2,617,637
                                         

Total

       $ 11,815,435        $ 1,341,835        $ 8,286,865        $ 1,381,962        $ 20,102,300        $ 2,723,797
                                         
     As of December 31, 2007
     Less than 12 Months    12 Months or More    Total
     Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses

Certificates of deposit

       $ 499,970        $ 30        $        $        $ 499,970        $ 30

State or local housing agency obligations

               5,125      65      5,125      65

Mortgage-backed securities:

                 

Government-sponsored enterprises

     250,137      707      1,609,791      36,553      1,859,928      37,260

Private label

     6,762,719      126,604      10,392,842      335,620      17,155,561      462,224
                                         

Total

       $ 7,512,826        $ 127,341        $ 12,007,758        $ 372,238        $ 19,520,584        $ 499,579
                                         

Mortgage-Backed Securities. The Bank’s investments in mortgage-backed securities (“MBS”) consist of agency guaranteed securities and senior tranches of private label prime or Alt-A residential MBS. The Bank has increased exposure to the risk of loss on its investments in MBS when the loans backing the MBS exhibit high rates of delinquency and foreclosures, as well as losses on the sale of foreclosed properties. The Bank regularly requires high levels of credit enhancements from the structure of the collateralized mortgage obligation to reduce its risk of loss on such securities. Credit enhancements are defined as the percentage of subordinate tranches, overcollateralization, or excess spread, or the support of monoline insurance, if any, in a security structure that will absorb the losses before the security the Bank purchased will take a loss. The Bank does not purchase credit enhancements for its MBS from monoline insurance companies.

The Bank’s investments in private label MBS were rated “AAA” (or its equivalent) by a nationally recognized statistical rating organization (“NRSRO”), such as Moody’s Investors Service (“Moody’s”) and Standard & Poor’s Rating Services (“S&P”), at purchase date. The “AAA”-rated securities achieve their ratings through credit enhancement, over-collateralization and senior-subordinated shifting interest features; the latter results in subordination of payments to junior classes to ensure cash flows to the senior classes.

 

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Other Than Temporary Impairment. The Bank had a total of 442 securities in an unrealized loss position, with total gross unrealized losses of $2.7 billion as of September 30, 2008. The Bank evaluates its individual held-to-maturity investment securities holdings for other-than-temporary impairment on a quarterly basis, or more frequently if events or changes in circumstances indicate that these investments may be temporarily impaired.

To determine which individual securities are at risk for other-than-temporary impairment, the Bank considers various characteristics of each security including, but not limited to, the following: the credit rating and related outlook or status; the underlying type of collateral; the duration and amount of the unrealized loss; and any credit enhancements or insurance. The relative importance of this information varies based on the facts and circumstances surrounding each security, as well as the economic environment at the time of assessment. As a result of this security-level review, the Bank identifies individual securities believed to be at risk for other-than-temporary impairment, which are evaluated further by analyzing the performance of the security. Securities with weaker performance measures are evaluated by estimating projected cash flows based on the structure of the security and certain assumptions, such as prepayments, default rates and loss severity, to determine whether the Bank expects to receive all of the contractual cash flows as scheduled.

Based on the Bank’s impairment analysis as of September 30, 2008, the Bank recognized an other-than-temporary impairment loss of $87.3 million related to three private label MBS in its held-to-maturity securities portfolio. This other-than-temporary impairment loss is reported in the Statements of Income as “Realized loss on held-to-maturity securities.” These securities had a total amortized cost of $289.2 million and a fair value of $201.9 million at the time of impairment.

The remainder of the Bank’s held-to-maturity portfolio that has not been designated as other-than-temporarily impaired has experienced unrealized losses and decreases in fair value due to interest rate volatility, illiquidity in the marketplace, and credit deterioration in the U.S. mortgage markets. This decline in fair value is considered temporary as the Bank expects to collect all contractual cash flows and the Bank has the ability and intent to hold these investments to maturity and expects to collect all contractual cash flows as scheduled. The ability and intent of the Bank is demonstrated by the fact that the Bank is well capitalized, has sufficient liquidity and has no need to sell these securities, nor has the Bank entered into any contractual constraints that would impact such intent and ability.

 

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Note 5—Advances

Redemption Terms. The Bank had advances outstanding, as summarized below (in thousands):

 

     As of September 30, 2008    As of December 31, 2007

Year of contractual maturity:

     

Overdrawn demand deposit accounts

       $ 56        $ 18,219

Due in one year or less

     42,861,883      34,062,503

Due after one year through two years

     33,120,548      19,356,806

Due after two years through three years

     27,359,984      22,684,160

Due after three years through four years

     15,715,800      18,326,931

Due after four years through five years

     10,418,757      16,430,434

Due after five years

     31,901,023      29,350,652
             

Total par value

     161,378,051      140,229,705

Discount on AHP advances

     (14,023)      (13,461)

Discount on EDGE* advances

     (13,249)      (14,091)

SFAS 133 hedging adjustments

     2,937,901      2,667,120

Deferred commitment fees

     (3,598)      (1,900)
             

Total

       $ 164,285,082        $ 142,867,373
             

 

* The Economic Development and Growth Enhancement Program

The following table summarizes advances by year of contractual maturity or, for convertible advances, next conversion date (in thousands):

 

     As of September 30, 2008

Year of contractual maturity or next convert date:

  

Overdrawn demand deposit accounts

       $ 56

Due or convertible in one year or less

     64,128,659

Due or convertible after one year through two years

     34,873,489

Due or convertible after two years through three years

     27,426,313

Due or convertible after three years through four years

     11,855,955

Due or convertible after four years through five years

     9,072,106

Due or convertible after five years

     14,021,473
      

Total par value

       $ 161,378,051
      

The Bank has never experienced a credit loss on advances. Based on the collateral pledged as security for advances, management’s credit analysis of members’ financial conditions, and prior repayment history, management believes no allowance for credit losses on advances is necessary. No advance was past due as of September 30, 2008 or December 31, 2007.

Interest-rate Payment Terms. The following table details interest-rate payment terms for advances (in thousands):

 

     As of September 30, 2008    As of December 31, 2007

Par value of advances:

     

Fixed-rate

       $ 125,606,676        $ 115,846,392

Variable-rate

     35,771,375      24,383,313
             

Total

       $ 161,378,051        $ 140,229,705
             

 

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Table of Contents

Note 6—Consolidated Obligations

Consolidated obligations, consisting of consolidated obligation bonds and discount notes, are the joint and several obligations of the FHLBanks and are backed only by the financial resources of the FHLBanks. The FHLBanks Office of Finance (“Office of Finance”) tracks the amount of debt issued on behalf of each FHLBank. In addition, the Bank separately tracks and records as a liability its specific portion of consolidated obligations for which it is the primary obligor.

Interest-rate Payment Terms. The following table details consolidated obligation bonds by interest-rate payment type (in thousands):

 

     As of September 30, 2008    As of December 31, 2007

Par value of consolidated bonds:

     

Fixed-rate

       $ 102,829,750        $ 112,134,915

Simple variable-rate

     32,316,900      18,311,900

Step

     2,328,000      8,951,550

Zero-coupon

     434,060      659,060

Variable-rate that converts to fixed-rate

     325,000      670,000

Variable-rate capped floater

     120,000      908,000

Fixed-rate that converts to variable-rate

     15,000      259,950

Inverse floating-rate

          24,500
             

Total

       $ 138,368,710        $ 141,919,875
             

Redemption Terms. The following is a summary of the Bank’s participation in consolidated obligation bonds outstanding, by year of contractual maturity (dollar amounts in thousands):

 

     As of September 30, 2008    As of December 31, 2007
     Amount    Weighted
Average
Interest
Rate
   Amount    Weighted
Average
Interest
Rate

Year of contractual maturity:

           

Due in one year or less

       $ 72,931,765    2.91%        $ 62,826,705    4.56%

Due after one year through two years

     23,309,145    3.53%      29,721,925    4.64%

Due after two years through three years

     9,407,400    3.99%      14,448,245    4.63%

Due after three years through four years

     4,549,850    4.50%      4,665,400    4.93%

Due after four years through five years

     14,315,500    4.34%      7,851,500    5.06%

Due after five years

     13,855,050    4.99%      22,406,100    5.08%
                   

Total par value

     138,368,710    3.49%      141,919,875    4.70%

Premiums

     25,013         19,479   

Discounts

     (259,204)         (375,211)   

SFAS 133 hedging adjustments

     500,870         673,965   

Deferred net losses on terminated hedges

     (819)         (1,066)   
                   

Total

       $ 138,634,570           $ 142,237,042   
                   

 

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Table of Contents

The Bank’s consolidated obligation bonds outstanding included (in thousands):

 

     As of September 30, 2008    As of December 31, 2007

Par value of consolidated bonds:

     

Noncallable

       $ 100,836,660        $ 71,188,475

Callable

     37,532,050      70,731,400
             

Total

       $ 138,368,710        $ 141,919,875
             

The following table summarizes consolidated obligation bonds outstanding, by year of contractual maturity or, for callable consolidated obligation bonds, next call date (in thousands):

 

     As of September 30, 2008

Year of contractual maturity or next call date:

  

Due or callable in one year or less

       $ 93,030,315

Due or callable after one year through two years

     23,036,645

Due or callable after two years through three years

     6,814,400

Due or callable after three years through four years

     854,350

Due or callable after four years through five years

     5,675,500

Due or callable after five years

     8,957,500
      

Total par value

       $ 138,368,710
      

Consolidated Obligation Discount Notes. The Bank’s participation in consolidated obligation discount notes, all of which are due within one year, was as follows (dollar amounts in thousands):

 

     Book Value    Par Value    Average
Interest Rate

As of September 30, 2008

       $ 55,512,638        $ 55,699,802    2.38%
                  

As of December 31, 2007

       $ 28,347,939        $ 28,514,466    4.23%
                  

Note 7—Capital and Mandatorily Redeemable Capital Stock

Capital. The Bank was in compliance with the regulatory capital rules and requirements of the Federal Housing Finance Agency (“Finance Agency”), successor to the Federal Housing Finance Board effective on July 30, 2008 (collectively, the “Regulator”), as shown in the following table (dollar amounts in thousands):

 

     As of September 30, 2008    As of December 31, 2007
     Required    Actual    Required    Actual

Regulatory capital requirements:

           

Risk based capital

       $ 2,733,723        $ 9,096,091        $ 981,647        $ 8,080,333

Total capital-to-assets ratio

     4.00%      4.26%      4.00%      4.28%

Total regulatory capital*

       $ 8,548,745        $ 9,096,091        $ 7,557,511        $ 8,080,333

Leverage ratio

     5.00%      6.38%      5.00%      6.42%

Leverage capital

       $ 10,685,931        $ 13,644,137        $ 9,446,888        $ 12,120,499

 

* The Regulator has determined that mandatorily redeemable capital stock is considered capital for regulatory purposes, and “total regulatory capital” includes the Bank’s $35.5 million and $55.5 million in mandatorily redeemable capital stock at September 30, 2008 and December 31, 2007, respectively.

 

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Mandatorily Redeemable Capital Stock. The following table provides the number of members that attained nonmember status and the number of nonmembers for which the Bank has completed the repurchase/redemption of mandatorily redeemable capital stock:

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2008    2007    2008    2007

Beginning of period

   10    11    11    9

Attainment of nonmember status

   4    12    6    16

Repurchase/redemption during the period

   (3)    (1)    (6)    (3)
                   

End of period

   11    22    11    22
                   

The Bank’s activity for mandatorily redeemable capital stock was as follows (in thousands):

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2008    2007    2008      2007

Balance, beginning of period

       $ 35,382        $ 226,511        $ 55,538          $ 215,705

Capital stock subject to mandatory redemption reclassified from equity during the period due to attainment of nonmember status

     6,720      31,416      24,073        77,356

Capital stock no longer subject to redemption due to a nonmember becoming a member

               (568 )     

Repurchase/redemption of mandatorily redeemable capital stock during the period

     (6,648)      (87,349)      (43,589)        (122,483)
                             

Balance, end of period

       $ 35,454        $ 170,578        $ 35,454          $ 170,578
                             

The following table shows the amount of mandatorily redeemable capital stock by year of redemption (in thousands). The year of redemption in the table is the end of the five-year redemption period, or with respect to activity-based stock, the later of the expiration of the five-year redemption period or the activity’s maturity date:

 

     As of September 30, 2008    As of December 31, 2007

Contractual year of redemption:

     

Due in one year or less

       $ 4,322        $ 28,758

Due after one year through two years

     1,462      786

Due after two years through three years

     1,350      625

Due after three years through four years

     8,499      3,600

Due after four years through five years

     2,250      4,727

Due after five years

     17,571      17,042
             

Total

       $ 35,454        $ 55,538
             

 

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Note 8—Employee Retirement Plans

Components of the net periodic benefit cost for the Bank’s supplemental defined benefit pension plan were as follows (in thousands):

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2008    2007    2008    2007

Service cost

       $ 111        $ 200        $ 346        $ 600

Interest cost

     141      150      421      450

Amortization of prior service credit

     (34)      (32)      (90)      (94)

Amortization of net loss

     93      150      288      450
                           

Net periodic benefit cost

       $ 311        $ 468        $ 965        $ 1,406
                           

Components of the net periodic benefit cost for the Bank’s postretirement health benefit plan were as follows (in thousands):

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2008    2007    2008    2007

Service cost

       $ 70        $ 147        $ 213        $ 441

Interest cost

     96      133      291      399

Amortization of net transition obligation

     9      10      32      30

Amortization of prior service credit

     (151)      (150)      (452)      (450)

Amortization of net loss

     76      110      227      330
                           

Net periodic benefit cost

       $ 100        $ 250        $ 311        $ 750
                           

Note 9—Derivatives and Hedging Activities

For accounting policies and additional information concerning derivatives and hedging activities, see Note 14 to the 2007 audited financial statements included in the Bank’s Form 10-K.

Net losses on derivatives and hedging activities were as follows (in thousands):

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2008    2007    2008    2007

(Losses) gains related to fair-value hedge ineffectiveness

       $ (226,972)        $ 19,180        $ (234,054)        $ 25,528

Gains (losses) on SFAS 133 non-qualifying hedges and other

     181,673      (91,996)      182,835      (35,426)
                           

Net losses on derivatives and hedging activities

       $ (45,299)        $ (72,816)        $ (51,219)        $ (9,898)
                           

 

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The following table provides outstanding notional balances and estimated fair values of the derivatives outstanding used for fair value hedges and stand alone derivatives that are SFAS 133 non-qualifying hedges (in thousands):

 

     As of September 30, 2008    As of December 31, 2007
     Notional    Estimated Fair
Value
   Notional    Estimated Fair
Value

Interest-rate swaps:

           

Fair value hedges

       $ 196,758,098        $ (2,536,256)        $ 207,143,643        $ (2,031,901)

SFAS 133 non-qualifying hedges

     21,117,688      (287,634)      12,338,065      (263,429)

Interest-rate swaptions:

           

SFAS 133 non-qualifying hedges

     500,000      25      115,000      10,823

Interest-rate caps/floors:

           

SFAS 133 non-qualifying hedges

     2,820,000      10,778      3,260,000      25,980

Interest-rate futures/forwards:

           

SFAS 133 non-qualifying hedges

     1,500      102      1,500      109

Mortgage delivery commitments:

           

SFAS 133 non-qualifying hedges

               9,309      41
                           

Total

       $ 221,197,286        $ (2,812,985)        $ 222,867,517        $ (2,258,377)
                           

Total derivatives excluding accrued interest

          $ (2,812,985)           $ (2,258,377)

Accrued interest

        175,773         187,934

Cash collateral held by counterparty - assets

        968,683         808,359

Cash collateral held from counterparty - liabilities

        1,088,551         (9)
                   

Net derivative balances

          $ (579,978)           $ (1,262,093)
                   

Net derivative assets balance

          $ 248,663           $ 43,039

Net derivative liabilities balance

        (828,641)         (1,305,132)
                   

Net derivative balances

          $ (579,978)           $ (1,262,093)
                   

The fair values of bifurcated embedded derivatives presented on a combined basis with the host contract and not included in the above table are as follows (in thousands):

 

     As of September 30, 2008    As of December 31, 2007

Host contract:

     

Advances

       $ 4,366        $ 8,459

Callable bonds

          408
             

Total

       $ 4,366        $ 8,867
             

Based on credit analyses and collateral requirements, Bank management presently does not anticipate any credit losses on its existing derivative agreements with counterparties as of September 30, 2008. The contractual or notional amount of derivatives reflects the involvement of the Bank in the various classes of financial instruments. The notional amount of derivatives does not measure the credit risk exposure of the Bank, and the maximum credit exposure of the Bank is substantially less than the notional amount. The Bank is subject to credit risk due to the risk of nonperformance by counterparties to the derivative agreements. The Bank requires collateral agreements that establish collateral delivery thresholds for all

 

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derivatives and master netting arrangements to mitigate the risk. The Bank manages counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in Bank policy and Regulator regulations. The maximum credit risk is the estimated cost of replacing interest-rate swaps, forward agreements, mandatory delivery contracts for mortgage loans, and purchased caps and floors that have a net positive market value, if the counterparty defaults and the related collateral pledged to the Bank, if any, is of no value to the Bank. As of September 30, 2008, the Bank has not sold or repledged any such collateral.

As of September 30, 2008 and December 31, 2007, the Bank’s maximum credit risk, as defined above, was approximately $56.9 million and $43.0 million, respectively. These totals include $19.2 million and $11.0 million, respectively, of net accrued interest receivable. In determining maximum credit risk, the Bank considers accrued interest receivables and payables, and the legal right to offset derivative assets and liabilities by counterparty. Cash and securities held and pledged to the Bank as collateral for derivatives were $23.6 million and $0 as of September 30, 2008 and December 31, 2007, respectively. Additionally, collateral with respect to derivatives with member institutions included collateral pledged to the Bank, as evidenced by a written security agreement and held by the member institution for the benefit of the Bank.

Lehman Brothers Special Financing Inc. (“LBSF”) was a counterparty to the Bank on multiple derivative transactions documented under an International Swap Dealers Association, Inc. master agreement (the “Master Agreement”). Lehman Brothers Holdings Inc. (“Lehman”), the parent company of LBSF, is a credit support provider for these obligations of LBSF under such transactions. On September 15, 2008, Lehman filed for protection under Chapter 11 of the federal Bankruptcy Code in the United States Bankruptcy Court in the Southern District of New York, which is an event of default under the Master Agreement. On September 18, 2008, the Bank sent LBSF a notice identifying the occurrence of an event of default and designating September 19, 2008 as the early termination date in respect of all outstanding derivative transactions. On October 3, 2008, the Bank sent a settlement statement to LBSF notifying it of all amounts payable if, as permitted under the Master Agreement, the value of the collateral due to be returned to the Bank were netted against all other amounts due between the parties as a result of unwinding the derivative transactions, and demanding payment for that amount. See Note 13 for a discussion of the October 3, 2008 bankruptcy filing by LBSF.

In accordance with the Master Agreement, the net amount due to the Bank as a result of such excess collateral held by LBSF is approximately $189.4 million. Management evaluated this receivable in accordance with the guidance provided by SFAS No. 5, Accounting for Contingencies (“SFAS 5”), and related pronouncements. The Bank recorded a $170.5 million reserve based on management’s estimate of the probable amount that will be realized. The net receivable of $18.9 million is recorded in “Other assets” on the Statements of Condition. Determining the reserve amount requires management to use considerable judgment and is based on the facts currently available. As additional relevant facts become available in future periods, the amount of the reserve may be adjusted accordingly.

Note 10—Estimated Fair Values

As discussed in Note 2 to the financial statements, the Bank adopted SFAS 157 and SFAS 159 on January 1, 2008. SFAS 157 defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. SFAS 157 applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. Accordingly, SFAS 157

 

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does not expand the use of fair value in any new circumstances. SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value. As of September 30, 2008, the Bank had not elected to measure any financial assets or liabilities using the fair value option under SFAS 159; therefore the adoption of SFAS 159 had no effect on the Bank’s financial condition or results of operations.

The Bank records trading securities and derivative assets and liabilities at fair value. Fair value is a market-based measurement and is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the assets or owes the liability. In general, the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition. In determining whether a transaction price represents the fair value of the asset or liability at initial recognition, each reporting entity is required to consider factors specific to the transaction and the asset or liability, the principal or most advantageous market for the asset or liability, and market participants with whom the entity would transact in the market.

SFAS 157 establishes a fair value hierarchy to prioritize the inputs of valuation techniques used to measure fair value. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of how market-observable the fair value measurement is and defines the level of disclosure. SFAS 157 clarifies fair value in terms of the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal (or most advantageous) market for the asset or liability at the measurement date (an exit price). In order to determine the fair value or the exit price, entities must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the reporting entity to define the inputs for fair value and level of hierarchy.

Outlined below is the application of the fair value hierarchy established by SFAS 157 to the Bank’s financial assets and financial liabilities that are carried at fair value.

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. As of September 30, 2008, the Bank did not carry any financial assets and liabilities at fair value hierarchy Level 1.

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. As of September 30, 2008, the types of financial assets and liabilities the Bank carried at fair value hierarchy Level 2 included trading securities and derivatives.

Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are supported by little or no market activity or by the entity’s own assumptions. As of September 30, 2008, while the Bank did not carry any financial assets or liabilities, measured on a recurring basis, at fair value hierarchy Level 3, the Bank did value certain financial assets, measured on a non-recurring basis, at fair value hierarchy Level 3.

 

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The Bank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.

Fair Value on a Recurring Basis. The following table presents for each SFAS 157 hierarchy level, the Bank’s financial assets and financial liabilities that are measured at fair value on a recurring basis on its Statements of Condition (in thousands):

 

     As of September 30, 2008
     Fair Value Measurements Using          
     Level 1    Level 2    Level 3    Netting
Adjustment*
   Total

Assets

              

Trading securities

       $ —          $ 4,233,093        $ —          $        $ 4,233,093

Derivative assets

     —        (839,888)      —        1,088,551      248,663
                                  

Total assets at fair value

       $ —          $ 3,393,205        $ —          $ 1,088,551        $ 4,481,756
                                  

Liabilities

              

Derivative liabilities

       $ —          $ (1,797,324)        $ —          $ 968,683        $ (828,641)
                                  

Total liabilities at fair value

       $ —          $ (1,797,324)        $ —          $ 968,683        $ (828,641)
                                  

 

* Amounts represent the effect of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and also cash collateral held or placed with the same counterparties.

For financial instruments carried at fair value, the Bank reviews the fair value hierarchy classification of financial assets and liabilities on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and/or out of Level 3 at fair value in the quarter in which the changes occur. There were no transfers of financial instruments carried at fair value, on a recurring basis, in or out of the Level 3 category during the nine months ended September 30, 2008.

Fair Value on a Nonrecurring Basis. The Bank measures certain held-to-maturity securities at fair value on a nonrecurring basis. These held-to-maturity securities are not measured at fair value on an ongoing basis, but are subject to fair value adjustments only in certain circumstances (i.e., when there is evidence of other-than-temporary impairment). For the three- and nine-month periods ended September 30, 2008, the Bank recorded an other-than-temporary impairment loss of $87.3 million related to its held-to-maturity securities.

The following table presents these investment securities by level within the SFAS 157 valuation hierarchy, for which a nonrecurring change in fair value has been recorded, and the total change in value of these investment securities for which a fair value adjustment has been included in the Statements of Income (in thousands):

 

     As of September 30, 2008    Total (Loss) for the
Three and Nine
Months Ended
September 30,
2008
 
     Fair Value Measurements
Using
  
     Level 1    Level 2    Level 3   

Held-to-maturity securities

   $    $    $ 201,893    $ (87,344 )

Described below are the Bank’s fair value measurement methodologies for financial assets and liabilities measured or disclosed at fair value.

Cash and due from banks and interest-bearing deposits. The estimated fair value approximates the recorded book balance.

Trading securities. The estimated fair value of trading securities is determined based on independent market-based prices received from a third party pricing service, excluding accrued interest. The Bank’s principal markets for securities portfolios are the secondary institutional markets, with an exit price that is predominantly reflective of bid level pricing in that market.

 

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When prices are not available, the estimated fair value is determined by calculating the present value of the expected future cash flows based on market observable inputs obtained from an outside source that are input into the Bank’s valuation model.

Held-to-maturity securities. Certain held-to-maturity private label MBS whose fair values previously were determined by reference to prices obtained from third-party broker/dealers or pricing services were changed from a Level 2 classification to a Level 3 classification in the third quarter of 2008. Previously, these valuations relied on observed trades, as evidenced by both activity observed in the market, and similar prices obtained from multiple sources. Beginning in late 2007 and continuing into 2008, the divergence among prices obtained from these sources increased, and became significant in the third quarter of 2008. The significant reduction in transaction volumes and widening credit spreads led the Bank to conclude that the prices received from pricing services, which were derived from the third party’s proprietary models, were reflective of significant unobservable inputs. Because of the significant unobservable inputs used by the pricing services, the Bank considered these to be Level 3 inputs.

Due to the reduced market activity for certain of the Bank’s held-to-maturity private label MBS, during the third quarter of 2008 the Bank also determined prices for these securities using a discounted cash flow approach. This discounted cash flow model used cash flows adjusted for credit factors calculated by a third party model and discounted at a rate incorporating interest-rate and market liquidity factors. Other significant inputs include loan default rates, prepayment speeds, and loss severity rates. Due to the unobservable nature of the inputs, the discounted cash flow model is classified as Level 3.

The Bank evaluated the reasonableness of the two above Level 3 indicators of prices for certain of its held-to-maturity MBS and determined that multiple inputs from different pricing sources would collectively provide the best evidence of fair value as of September 30, 2008. Therefore, the Bank determined fair value based on a weighted average of a third party pricing service and the internal discounted cash flow model. The Bank’s determination of fair value was primarily weighted towards the independent pricing service inputs due to the Bank’s historical use of such pricing service.

The estimated fair value of agency MBS and other held-to-maturity securities is determined based on market-based prices received from a third party pricing service, excluding accrued interest. The prices received from the third-party pricing service are generally non-binding. The Bank’s principal markets for securities portfolios are the secondary institutional markets, with an exit price that is predominantly reflective of bid level pricing in that market. In obtaining such valuation information from third parties, the Bank generally evaluates the prices for reasonableness in order to determine whether such valuations are representative of an exit price in the Bank’s principal markets.

Federal funds sold. The estimated fair value is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for federal funds with similar terms and represent market observable rates.

Advances. The Bank determines the estimated fair values of advances by calculating the present value of expected future cash flows from the advances and excluding the amount of the accrued interest receivable. The discount rates used in these calculations are the replacement advance rates based on the market observable LIBOR curve for advances with similar terms as of September 30, 2008 and December 31, 2007. In accordance with the Regulator’s advances regulations, advances with a maturity or repricing period greater than six months require a prepayment fee sufficient to make the Bank financially indifferent to the borrower’s decision to prepay the advances, thereby removing prepayment risk from the fair value calculation.

Mortgage loans held for portfolio. The estimated fair values for mortgage loans are determined based on quoted market prices of similar mortgage loans available in the pass-through securities market.

 

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These prices, however, can change rapidly based upon market conditions and are highly dependent upon the underlying prepayment assumptions.

Accrued interest receivable and payable. The estimated fair value approximates the recorded book value.

Derivative assets and liabilities. The Bank calculates the fair value of derivatives using a present value of future cash flows discounted by a market observable rate, predominately LIBOR. The fair values are based on a AA credit rating, which is maintained through the use of collateral agreements.

Derivative instruments are primarily transacted in the institutional dealer market and priced with observable market assumptions at a mid-market valuation point. The Bank does not provide a credit valuation adjustment based on aggregate exposure by derivative counterparty when measuring the fair value of its derivatives. This is because the collateral provisions pertaining to the Bank’s derivatives obviate the need to provide such a credit valuation adjustment. The fair values of the Bank’s derivatives take into consideration the effects of legally enforceable master netting agreements that allow the Bank to settle positive and negative positions and offset cash collateral with the same counterparty on a net basis. The Bank, and each derivative counterparty, have bilateral collateral thresholds that take into account both the Bank’s and the Bank’s counterparty’s credit ratings. As a result of these practices and agreements, the Bank has concluded that the impact of the credit differential between it and its derivative counterparties was sufficiently mitigated to an immaterial level and no further adjustments were deemed necessary to the recorded fair values of derivative assets and liabilities in the Statements of Condition at September 30, 2008 and December 31, 2007.

Deposits. The Bank determines estimated fair values of Bank deposits by calculating the present value of expected future cash flows from the deposits and reducing this amount for accrued interest payable. The discount rates used in these calculations are based on LIBOR.

Borrowings. The Bank determines the estimated fair value of borrowings by calculating the present value of expected future cash flows from the borrowings and reducing this amount for accrued interest payable. The discount rates used in these calculations are based on market observable rates, predominantly LIBOR.

Consolidated obligations. The Bank calculates the fair value of consolidated obligation bonds and discount notes by using the present value of future cash flows using a cost of funds as the discount rate. The cost of funds discount curves are based primarily on the market observable LIBOR rate and to some extent on the Office of Finance cost of funds curve that also is market observable.

Mandatorily redeemable capital stock. The fair value of mandatorily redeemable capital stock is par value, including estimated dividends earned at the time of reclassification from equity to liabilities, until such amount is paid. Capital stock can be acquired by members only at par value and redeemed by the Bank at par value. Capital stock is not traded and no market mechanism exists for the exchange of capital stock outside the cooperative structure.

Commitments to extend credit for mortgage loans. Mortgage loan purchase commitments are recorded as derivatives at their fair values.

The following estimated fair value amounts have been determined by the Bank using available market information and the Bank’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the Bank at September 30, 2008 and December 31, 2007. Although the Bank uses its best judgment in estimating the fair values of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology.

 

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For example, because an active secondary market does not exist for a portion of the Bank’s financial instruments, in certain cases, fair values are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, these estimated fair values are not necessarily indicative of the amounts that would be realized in current market transactions. The Fair Value Summary Tables do not represent an estimate of the overall market value of the Bank as a going concern, which would take into account future business opportunities and the net profitability of assets versus liabilities.

The carrying values and estimated fair values of the Bank’s financial instruments as of September 30, 2008 were as follows (in thousands):

2008 FAIR VALUE SUMMARY TABLE

 

Financial Instruments

   Carrying
Value
   Net
Unrealized
Gains (Losses)
   Estimated
Fair Value

Assets:

        

Cash and due from banks

       $ 7,961        $        $ 7,961

Interest-bearing deposits

     3,059           3,059

Federal funds sold

     16,775,100      43      16,775,143

Trading securities

     4,233,093           4,233,093

Held-to-maturity securities

     23,893,355      (2,714,085)      21,179,270

Mortgage loans held for portfolio, net

     3,337,109      (15,905)      3,321,204

Advances, net

     164,285,082      (614,424)      163,670,658

Accrued interest receivable

     757,799           757,799

Derivative assets

     248,663           248,663

Liabilities:

        

Deposits

     (7,946,985)      371      (7,946,614)

Securities sold under agreements to repurchase

     (259,414)      180      (259,234)

Consolidated obligations, net:

        

Discount notes

     (55,512,638)      (4,250)      (55,516,888)

Bonds

     (138,634,570)      1,129,321      (137,505,249)

Mandatorily redeemable capital stock

     (35,454)           (35,454)

Accrued interest payable

     (1,171,472)           (1,171,472)

Derivative liabilities

     (828,641)           (828,641)

 

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The carrying values and estimated fair values of the Bank’s financial instruments as of December 31, 2007 were as follows (in thousands):

2007 FAIR VALUE SUMMARY TABLE

 

Financial Instruments

   Carrying
Value
   Net
Unrealized
Gains (Losses)
   Estimated
Fair Value

Assets:

        

Cash and due from banks

       $ 18,927        $        $ 18,927

Interest-bearing deposits

     3,403           3,403

Federal funds sold

     14,835,000      955      14,835,955

Trading securities

     4,627,545           4,627,545

Held-to-maturity securities

     22,060,517      (483,138)      21,577,379

Mortgage loans held for portfolio, net

     3,526,582      (11,961)      3,514,621

Advances, net

     142,867,373      14,669      142,882,042

Accrued interest receivable

     824,815           824,815

Derivative assets

     43,039           43,039

Liabilities:

        

Deposits

     (7,135,027)      80      (7,134,947)

Consolidated obligations, net:

        

Discount notes

     (28,347,939)      14,989      (28,332,950)

Bonds

     (142,237,042)      (194,267)      (142,431,309)

Mandatorily redeemable capital stock

     (55,538)           (55,538)

Accrued interest payable

     (1,460,113)           (1,460,113)

Derivative liabilities

     (1,305,132)           (1,305,132)

Note 11—Commitments and Contingencies

As described in Note 6, consolidated obligations are backed only by the financial resources of the 12 FHLBanks. The Regulator, under 12 CFR Section 966.9(d), may at any time require any FHLBank to make principal or interest payments due on any consolidated obligations, whether or not the primary obligor FHLBank has defaulted on the payment of that obligation. No FHLBank has had to assume or pay the consolidated obligation of another FHLBank.

The par value of the FHLBanks’ outstanding consolidated obligations for which the Bank is jointly and severally liable was approximately $1.1 trillion and $1.0 trillion as of September 30, 2008 and December 31, 2007, respectively, exclusive of the Bank’s own outstanding consolidated obligations.

During the third quarter of 2008, each FHLBank entered into a Lending Agreement with the U.S. Treasury in connection with the U.S. Treasury’s establishment of the Government Sponsored Enterprise Credit Facility (“GSECF”), as authorized by the Housing and Economic Recovery Act of 2008 (“Housing Act”). The GSECF is designed to serve as a contingent source of liquidity for the housing government-sponsored enterprises, including each of the 12 FHLBanks. Any borrowings by one or more of the FHLBanks under the GSECF are considered consolidated obligations with the same joint and several liability as all other consolidated obligations. The terms of any borrowings are agreed to at the time of issuance. Loans under the Lending Agreement are to be secured by collateral acceptable to the U.S. Treasury, which consists of FHLBank advances to members that have been collateralized in accordance with regulatory standards and MBS issued by Fannie Mae or Freddie Mac. Each FHLBank is required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the U.S. Treasury, a list of eligible collateral, updated on a weekly basis. As of September 30, 2008, the Bank has provided the U.S. Treasury with a listing of collateral amounting to $24.8 billion, which provides for maximum borrowings of $21.5 billion.

 

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The amount of collateral available can be increased or decreased (subject to the approval of the U.S. Treasury) at any time through the delivery of an updated listing of collateral. As of September 30, 2008, the Bank has not drawn on this available source of liquidity.

The Bank’s outstanding standby letters of credit were as follows:

 

     As of September 30, 2008    As of December 31, 2007

Outstanding notional (in thousands)

   $    7,441,307    $    6,443,273

Original terms

   Less than three months to 15 years    Less than three months to 15 years

Final expiration year

   2023    2022

The value of the guarantees related to standby letters of credit is recorded in other liabilities and amounted to $23.2 million and $23.1 million as of September 30, 2008 and December 31, 2007, respectively. Based on management’s credit analyses and collateral requirements, the Bank does not deem it necessary to record any additional liability on these commitments.

Commitments that unconditionally obligate the Bank to purchase closed mortgage loans totaled $0 and $9.3 million as of September 30, 2008 and December 31, 2007, respectively. Commitments are generally for periods not to exceed 45 days. Such commitments are recorded as derivatives at their fair values under SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (“SFAS 149”).

The Bank executes derivatives with major banks and broker-dealers and generally enters into bilateral collateral agreements. As of September 30, 2008 and December 31, 2007, the Bank had pledged, as collateral to broker-dealers who have market risk exposure from the Bank related to derivatives, securities with a carrying value of $439.7 million and $592.1 million, respectively, which can be sold or repledged by those counterparties.

At September 30, 2008, the Bank had committed to the issuance of $3.7 billion (par value) in consolidated obligation bonds, of which $3.7 billion were hedged with associated interest rate swaps, and $136.0 million (par value) in consolidated obligation discount notes. At December 31, 2007, the Bank had committed to the issuance of $50.0 million (par value) in consolidated obligation bonds and $1.7 billion (par value) in consolidated obligation discount notes. There were no related interest rate swaps associated with the issuance of these consolidated obligations.

The Bank is subject to legal proceedings arising in the normal course of business. After consultation with legal counsel, management does not anticipate, as of the date of the financial statements, that the ultimate liability, if any, arising out of these matters will have a material effect on the Bank’s financial condition or results of operations.

For a discussion of the loan loss reserve taken by the Bank related to the LBSF receivable, see Note 9.

 

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Note 12—Transactions with Members and their Affiliates and with Housing Associates

The Bank is a cooperative whose member institutions own almost all of the capital stock of the Bank. Former members own the remaining capital stock to support business transactions still carried on the Bank’s Statements of Condition. All holders of the Bank’s capital stock are able to receive dividends on their investments, to the extent declared by the Bank’s board of directors. All advances are issued to members and eligible “housing associates” under the Federal Home Loan Bank Act of 1932, as amended (“FHLBank Act”), and mortgage loans held for portfolio are purchased from members. The Bank also maintains demand deposit accounts primarily to facilitate settlement activities that are related directly to advances and mortgage loan purchases. All transactions with members are entered into in the ordinary course of the Bank’s business. Transactions with any member that has an officer or director who also is a director of the Bank are subject to the same Bank policies as transactions with other members.

The Bank defines related parties as each of the other FHLBanks and those members with regulatory capital stock outstanding in excess of 10 percent of total regulatory capital stock. Based on this definition, one member institution, Countrywide Bank, FSB (“Countrywide”), which held 22.7 percent of the Bank’s total regulatory capital stock as of September 30, 2008, was considered a related party. Total advances outstanding to Countrywide were $43.5 billion and $47.7 billion as of September 30, 2008 and December 31, 2007, respectively. Total deposits held in the name of Countrywide were $24.2 million and $2.5 billion as of September 30, 2008 and December 31, 2007, respectively. No mortgage loans were acquired from Countrywide during the nine-month periods ended September 30, 2008 and 2007. No mortgage-backed securities were acquired from Countrywide during the nine-month period ended September 30, 2008, compared to $860.2 million and $1.3 billion, respectively, during the three- and nine-month periods ended September 30, 2007.

Note 13—Subsequent Events

On October 3, 2008, the Bank filed suit in New York State Court against LBSF with respect to certain terminated derivative transactions. Later that same day, LBSF filed for bankruptcy protection, and the Bank’s action has now been stayed pursuant to applicable bankruptcy law.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

Some of the statements made in this quarterly report on Form 10-Q may be “forward-looking statements,” which include statements with respect to the plans, objectives, expectations, estimates and future performance of the Bank and involve known and unknown risks, uncertainties, and other factors, many of which may be beyond the Bank’s control and which may cause the Bank’s actual results, performance, or achievements to be materially different from future results, performance, or achievements expressed or implied by the forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. The reader can identify these forward-looking statements through the Bank’s use of words such as “may,” “will,” “anticipate,” “hope,” “project,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “could,” “intend,” “seek,” “target,” and other similar words and expressions of the future. Such forward-looking statements include statements regarding any one or more of the following topics:

 

 

The Bank’s business strategy and changes in operations, including, without limitation, product growth and change in product mix

 

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Future performance, including profitability, developments, or market forecasts

 

Forward-looking accounting and financial statement effects.

The forward-looking statements may not be realized due to a variety of factors, including, without limitation, those risk factors provided under Item 1A of the Bank’s Form 10-K and those risk factors presented under Item 1A in Part II of this quarterly report on Form 10-Q.

All written or oral statements that are made by or are attributable to the Bank are expressly qualified in their entirety by this cautionary notice. The reader should not place undue reliance on forward-looking statements, since the statements speak only as of the date that they are made. The Bank has no obligation and does not undertake publicly to update, revise, or correct any of the forward-looking statements after the date of this quarterly report, or after the respective dates on which these statements otherwise are made, whether as a result of new information, future events, or otherwise.

The discussion presented below provides an analysis of the Bank’s results of operations and financial condition for the third quarter and first nine months of 2008 and 2007. Management’s discussion and analysis should be read in conjunction with the financial statements and accompanying notes presented elsewhere in the report, as well as the Bank’s audited financial statements for the year ended December 31, 2007.

Executive Summary

General Overview

The Bank is a cooperative whose primary business activity is providing loans, which the Bank refers to as “advances,” to its members and eligible housing associates. The Bank also purchases one-to-four family residential mortgage loans from members, makes grants and subsidized advances under the Affordable Housing Program (“AHP”), and provides certain cash management services to members and eligible nonmembers. The consolidated obligations (“COs”) issued by the Office of Finance on behalf of the FHLBanks are the principal funding source for Bank assets. The Bank is primarily liable for repayment of COs issued on its behalf and is jointly and severally liable for the COs issued on behalf of the other FHLBanks. Deposits, other borrowings, and the issuance of capital stock provide additional funding to the Bank. The Bank delivers competitively-priced credit to help its members meet the credit needs of their communities while historically paying members a competitive dividend.

Financial Condition

As of September 30, 2008, total assets were $213.7 billion, an increase of $24.8 billion, or 13.1 percent, from December 31, 2007. This increase was due primarily to an increase in advances, federal funds sold, and held-to-maturity securities. Advances, the largest asset on the Bank’s balance sheet, increased $21.4 billion, or 15.0 percent, during this same period due to increased demand for advances during the last month of the third quarter of 2008. Also during this period, federal funds sold increased by $1.9 billion, or 13.1 percent, in an effort by the Bank to increase its liquidity position and held-to-maturity securities increased by $1.8 billion, or 8.31 percent, due to the Bank’s purchase of agency MBS.

 

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As of September 30, 2008, total liabilities were $204.7 billion, an increase of $23.7 billion, or 13.1 percent, from December 31, 2007. This increase was due primarily to a $23.6 billion, or 13.8 percent, increase in consolidated obligations. Consolidated obligation discount notes increased by $27.2 billion, or 95.8 percent, and consolidated obligation bonds decreased by $3.6 billion, or 2.53 percent, during this same period. Due to investors’ reluctance to buy longer-term debt obligations during the third quarter of 2008, the Bank issued large quantities of discount notes.

As of September 30, 2008, total capital was $9.1 billion, an increase of $1.0 billion, or 12.9 percent, from December 31, 2007, primarily as a result of an increase in the Bank’s capital stock. The Bank’s retained earnings were $360.3 million, a decrease of $108.5 million, or 23.1 percent, from December 31, 2007. The reduction in retained earning was due to the establishment of a $170.5 million reserve for a credit loss on a receivable due from Lehman Brothers Special Financing Inc. (“LBSF”), which declared bankruptcy on October 3, 2008, a $87.3 million other-than-temporary impairment loss on the Bank’s private label MBS, and a dividend of $58.9 million for the third quarter of 2008. The Bank continues to meet regulatory capital-to-assets ratios and liquidity requirements.

Results of Operations

The Bank recorded a net loss of $46.1 million for the third quarter of 2008, a decrease of $179.2 million from net income of $133.1 million for the third quarter of 2007. The Bank’s net income for the first nine months of 2008 was $179.2 million, a decrease of $143.0 million from net income of $322.2 million for the same period in 2007. The decrease in net income during the periods was due primarily to the establishment of a $170.5 million reserve for a credit loss on a receivable due from LBSF, with a corresponding charge to other expense, and the recording of an other-than-temporary impairment loss of $87.3 million on the Bank’s private label MBS. The reserve for credit loss on the receivable represents 90.0 percent of the outstanding receivable, which is management’s best estimate of collectability. These amounts were offset partially by a $50.6 million and $182.1 million increase in net interest income during the third quarter and first nine months of 2008, respectively, resulting from higher average advances and MBS balances, and an increase in interest rate spread, during the periods.

The Bank attempts to provide a return on investment which, when combined with providing members access to competitively-priced funding, will be competitive with comparable investments. The Bank assesses the effectiveness of its dividend goal by comparing the dividend rate on its capital stock to three-month average LIBOR. This benchmark is consistent with the Bank’s interest rate risk and capital management goals.

The Bank’s annualized return on equity (“ROE”) was (2.13) percent for the third quarter of 2008, compared to 7.52 percent for the third quarter of 2007. ROE spread to three-month average LIBOR decreased between the periods, equaling (5.04) percent for the third quarter of 2008 as compared to 2.08 percent for the third quarter of 2007. The decrease in this spread was due primarily to a $179.2 million decrease in net income during the period, resulting in a decrease in ROE and ROE spread to three-month average LIBOR.

The Bank’s annualized ROE was 2.84 percent for the first nine months of 2008, compared to 6.65 percent for the first nine months of 2007. ROE spread to three-month average LIBOR decreased between the periods, equaling (0.14) percent for the first nine months of 2008 as compared to 1.26 percent for the first nine months of 2007. The decrease in this spread was due primarily to a $143.0 million decrease in net income during the period, resulting in a decrease in ROE and ROE spread to three-month average LIBOR.

 

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The Bank’s interest rate spread increased by 12 basis points and eight basis points for the third quarter and first nine months of 2008, respectively, compared to the same periods in 2007. The increase in interest rate spread during the periods was due to an increase in the use of short-term, lower rate funding. Short-term funding rates decreased by more than long-term funding rates during the period. In addition, there was a slight increase in the amount of interest expense reclassified to other income for interest on stand-alone derivatives relating to trading securities as required under GAAP.

Business Outlook

During the quarter ended September 30, 2008, unprecedented instability in the financial markets affecting financial institutions, including government-sponsored enterprises (“GSEs”), significantly increased the volatility in GSE debt pricing, funding and demand. On September 7, 2008, the Federal Housing Finance Agency (the “Finance Agency”), successor to the Federal Housing Finance Board effective on July 30, 2008 (collectively, the “Regulator”), announced that it had placed both Fannie Mae and Freddie Mac into conservatorship. Over the course of the third quarter, FHLBank funding costs associated with issuing long-maturity senior debt, as compared to three-month LIBOR on a swapped cash flow basis, rose sharply relative to short-term debt. This change in the slope of the funding curve reflected general investor reluctance to buy longer-term obligations of the GSEs, coupled with strong investor demand for short-term, high-quality assets. As long-term investors struggled with price declines of longer-term GSE debt, money market funds provided a strong bid for short-term GSE debt. As such, during the quarter, the FHLBanks issued large quantities of discount notes, floating-rate notes, short-term callable bonds and short-term bullet bonds in order to meet this demand. As of September 30, 2008, discount notes comprised 28.6 percent of the Bank’s consolidated obligations, as compared to 16.6 percent as of December 31, 2007.

As a result of the instability in the financial markets:

 

   

On September 9, 2008, the U.S. Department of Treasury (the “Treasury”) entered into a Lending Agreement (the “Lending Agreement”) with the Bank and with each of the other 11 FHLBanks that is identical to the Lending Agreement entered into by the Bank. The FHLBanks entered into these Lending Agreements in connection with the Treasury’s establishment of a Government Sponsored Enterprise Credit Facility that is designed to serve as a contingent source of liquidity for the housing GSEs, including the FHLBanks.

   

On September 19, 2008, the Federal Reserve Board announced that to further support market functioning, the Federal Reserve plans to purchase from primary dealers federal agency discount notes, which are short-term debt obligations issued by Fannie Mae, Freddie Mac, and the FHLBanks.

   

On October 4, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”).

   

On October 7, 2008, federal bank and thrift regulatory agencies announced they would request public comment on proposed regulatory action to lower the risk weight for select obligations of Fannie Mae and Freddie Mac from 20 percent to 10 percent (the “Risk Weighting Proposal”). The agencies also requested comment on whether to reduce the risk weight for FHLBank debt in the same manner.

   

On October 14, 2008, the Treasury announced that from the $700 billion EESA, Treasury will make $250 billion in capital available to U.S. financial institutions in the form of preferred stock.

 

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On October 14, 2008, the Federal Deposit Insurance Corporation (the “FDIC”) announced its commitment to guarantee new senior unsecured debt issued prior to June 30, 2009 by domestic banks and thrift institutions.

Commencing with the initiation of the rescue of Fannie Mae and Freddie Mac, followed by the conservatorship and subsequent U.S. government actions to address the general credit crisis, investors and dealers became cautious about buying or trading longer-term GSE debt, which increased funding costs and reduced demand. In addition, investors and dealers have exercised caution with respect to longer-term debt of the FHLBanks due to confusion about the level of government support for Fannie Mae and Freddie Mac relative to the FHLBanks. According to the press release announcing the Risk Weighting Proposal, the proposed change in regulation is reflective of the level of financial support the Treasury announced in September 2008 to Fannie Mae and Freddie Mac. This regulation, if adopted without a corresponding change in the risk weight for FHLBank debt, could result in higher investor demand for Fannie Mae and Freddie Mac debt securities relative to similar FHLBank debt securities. Further, in response to the FDIC announcement discussed above, the spreads on agency debt widened significantly as investors anticipate the development and sale of a new debt security that features an explicit guarantee of the FDIC.

These developments have continued into the fourth quarter of 2008. To the extent that the FHLBanks’ cost of funds increase, member institutions may, in turn, experience higher costs for advance borrowings. The continued inability of the Bank to issue long-term debt at attractive pricing could have a material adverse effect on the Bank’s results of operations. To the extent that the Bank’s cost of funds or liquidity is affected negatively for an extended period of time, the Bank’s business and ability to offer advances could be materially adversely affected.

On October 7, 2008, the FDIC issued a proposed rule to raise an insured institution’s base assessment rate based upon its ratio of secured liabilities to domestic deposits. Under the proposed rule, an institution’s ratio of secured liabilities to domestic deposits (if greater than 15 percent) would increase its assessment rate, but the resulting base assessment rate after any such increase could be no more than 50 percent greater than it was before the adjustment. Because all of the Bank’s advances are secured liabilities, the proposed rule, if adopted, could affect negatively member demand for advances. In addition, the FDIC guarantee of certain debt of domestic banks and thrift institutions discussed above may provide members with alternative sources of funding, which could affect negatively member demand for advances. While advance demand increased significantly during the last month of the third quarter of 2008 as a result of the general illiquidity of markets, the Bank does not expect that new advance activity will increase at this rate during the fourth quarter.

On October 9, 2008, the Bank filed a current report on Form 8-K related to certain actions it has taken related to the multiple interest rate swap transactions it had with LBSF, in light of the bankruptcy filings of LBSF and its parent, Lehman Brothers Holdings Inc. (“Lehman”), which is a credit support provider for these obligations of LBSF under such transactions. Due to extreme market volatility at the time the Bank terminated these swap transactions with LBSF, LBSF held collateral of the Bank in excess of the termination payments that may be owed under certain circumstances by the Bank to LBSF under the swap transactions in an amount currently estimated to be approximately $189.4 million. The Bank intends to file proofs of claim, and otherwise pursue its claims, as permitted by law, against LBSF and Lehman in the relevant bankruptcy proceedings. Management evaluated this receivable in accordance with the guidance provided by SFAS 5 and related pronouncements. The Bank recorded a $170.5 million reserve based on management’s estimate of the probable amount that will be realized. The net receivable of $18.9 million is recorded in “Other assets” on the Statements of Condition. Determining the reserve amount requires management to use considerable judgment and is based on the facts currently available. As additional relevant facts become available in future periods, the amount of the reserve may be adjusted accordingly.

 

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As a result of the recent market conditions, delinquency and foreclosure rates have increased significantly nationwide. Additionally, home prices have fallen in many areas, increasing the likelihood and magnitude of potential losses to lenders of foreclosed real estate. These trends may continue through the end of the year and into the foreseeable future. The uncertainty as to the depth and duration of these trends has led to a significant reduction in the market values of MBS. During the third quarter and first nine months of 2008, the Bank recorded an other-than-temporary impairment charge of $87.3 million related to three private label MBS in its held-to-maturity securities portfolio. Given the current market conditions and the significant judgments involved, there is a continuing risk that further declines in fair value may occur and that the Bank may record additional material other-than-temporary impairments in future periods, which could affect the Bank’s earnings and retained earnings. See “Risk Management—Credit Risk—Investments” and “Critical Accounting Policies—Fair Values” below for a full discussion of the other-than-temporary impairment.

According to the FDIC, during the third quarter of 2008 eight banks were closed and the FDIC was named receiver, compared to three banks during 2007. Two of the banks that were closed during the third quarter of 2008 were members of the Bank. All outstanding advances to these two banks were paid in full and there was no material effect to the Bank’s financial condition or results of operations. At the time of their closure, these two banks were assigned a credit risk rating of 10 by the Bank (10 being the greatest amount of credit risk). As of September 30, 2008, 29 Bank members were assigned a credit risk rating of 10 by the Bank, compared to 30 at June 30, 2008.

On October 3, 2008, Wells Fargo & Company (“Wells Fargo”) and Wachovia Corporation (“Wachovia”), the parent of Wachovia Bank, National Association, one of the Bank’s 10 largest borrowers as of September 30, 2008, announced they had signed an agreement and plan of merger dated October 3, 2008. The announcement stated that the merger agreement has been approved by the board of directors of Wells Fargo and Wachovia and is subject to customary closing conditions, including regulatory and Wachovia shareholder approval. Wells Fargo is not a member of the Bank. The effects of this merger on the Bank’s financial condition or results of operation cannot be determined at this time.

For the third quarter of 2008, the Bank’s board of directors approved an annualized dividend rate of 2.89 percent. This rate equaled the average three-month LIBOR (London Interbank Offered Rate) for the first nine months of 2008. The annualized dividend rate for the first and second quarter of 2008 was 6.00 percent and 5.75 percent, respectively. The third quarter 2008 annualized dividend rate is lower than previous quarters because of recent volatility in the financial markets and a more conservative financial management approach in light of these conditions. In addition, the Bank will change its dividend declaration and payment schedule beginning in the fourth quarter of 2008 so a dividend can be declared and paid to members after net income is calculated for the preceding quarter. To accommodate this change, the Bank will declare and pay to members any fourth quarter dividend at the end of January 2009.

Management expects to continue to use interest-rate derivatives to hedge the Bank’s MBS and mortgage portfolios. These derivatives assist in mitigating interest-rate and prepayment risk. However, to the extent that they do not qualify for hedge accounting treatment under GAAP, their use could result in earnings volatility. Management also uses derivative instruments to hedge other macro-level risks that do not qualify for hedge accounting treatment under GAAP. However, management seeks to contain the magnitude of mark-to-market adjustments by limiting the use of derivative instruments to hedge macro-level risks.

 

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Financial Condition

The Bank’s principal assets consist of advances, short- and long-term investments, and mortgage loans held for portfolio. The Bank obtains funding to support its business primarily through the issuance by the Office of Finance on the Bank’s behalf of debt securities in the form of consolidated obligations.

The following table presents the distribution of the Bank’s total assets, liabilities, and capital by major class as of the dates indicated (dollar amounts in thousands). These items are discussed in more detail below:

 

     As of September 30, 2008    As of December 31, 2007    Increase/(Decrease)
     Amount    Percent of
Total
   Amount    Percent of
Total
   Amount    Percent

Interest-bearing deposits

       $ 3,059           $ 3,403           $ (344)    (10.11)

Federal funds sold

     16,775,100    7.85      14,835,000    7.85      1,940,100    13.08

Certificates of deposit

             800,000    0.42      (800,000)    (100.00)

Long-term investments

     28,126,448    13.16      25,888,062    13.70      2,238,386    8.65

Mortgage loans, net

     3,337,109    1.56      3,526,582    1.87      (189,473)    (5.37)

Advances, net

     164,285,082    76.87      142,867,373    75.62      21,417,709    14.99

Other assets

     1,191,822    0.56      1,017,344    0.54      174,478    17.15
                                   

Total assets

       $ 213,718,620    100.00        $ 188,937,764    100.00        $ 24,780,856    13.12
                                   

Deposits

       $ 7,946,985    3.88        $ 7,135,027    3.94        $ 811,958    11.38

Securities sold under agreements to repurchase

     259,414    0.13              259,414    100.00

Consolidated obligations, net:

                 

Discount notes

     55,512,638    27.12      28,347,939    15.67      27,164,699    95.83

Bonds

     138,634,570    67.74      142,237,042    78.62      (3,602,472)    (2.53)

Other liabilities

     2,306,930    1.13      3,195,520    1.77      (888,590)    (27.81)
                                   

Total liabilities

       $ 204,660,537    100.00        $ 180,915,528    100.00        $ 23,745,009    13.12
                                   

Capital stock

       $ 8,700,330    96.05        $ 7,556,016    94.19        $ 1,144,314    15.14

Retained earnings

     360,307    3.98      468,779    5.84      (108,472)    (23.14)

Accumulated other comprehensive loss

     (2,554)    (0.03)      (2,559)    (0.03)      5    0.20
                                   

Total capital

       $ 9,058,083    100.00        $ 8,022,236    100.00        $ 1,035,847    12.91
                                   

Advances

Advances were $164.3 billion at September 30, 2008, an increase of $21.4 billion, or 15.0 percent, from December 31, 2007. This increase was due to a significant increase in member demand for advances during the last month of the third quarter of 2008 as a result of the general illiquidity of markets. During the third quarter of 2008, advances made totaled $60.9 billion and advances repaid totaled $42.1 billion, resulting in a net increase of $18.8 billion during the period. At September 30, 2008, 77.8 percent of the Bank’s advances were fixed-rate and the majority of the Bank’s variable-rate advances were indexed primarily to LIBOR. The Bank also offers variable-rate advances tied to the federal funds rate, prime rate and CMS (constant maturity swap) rates.

 

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The concentration of the Bank’s advances to its 10 largest borrowing member institutions was as follows:

 

     Advances to 10 largest
borrowing member
institutions
   Percent of total advances
outstanding

September 30, 2008

       $ 104.7 billion    64.9%

December 31, 2007

     97.6 billion    69.6%

Investments

The Bank maintains a portfolio of investments for liquidity purposes, to provide for the availability of funds to meet member credit needs and to provide additional earnings. Investment income also enhances the Bank’s capacity to meet its commitment to affordable housing and community investment, to cover operating expenses, and to satisfy the Bank’s annual Resolution Funding Corporation (“REFCORP”) assessment.

The Bank’s short-term investments generally consist of interest-bearing deposits, certificates of deposit, and overnight and term federal funds. The Bank’s long-term investments consist of MBS issued by GSEs or private securities that carry the highest rating from Moody’s or S&P when purchased, securities issued by the U.S. government or U.S. government agencies, and consolidated obligations issued by other FHLBanks. The long-term investment portfolio generally provides the Bank with higher returns than those available in the short-term money markets. The following table sets forth more detailed information regarding short- and long-term investments held by the Bank (dollar amounts in thousands):

 

               Increase/ (Decrease)
     As of September 30, 2008    As of December 31, 2007    Amount    Percent

Short-term investments:

           

Interest-bearing deposits

       $ 3,059        $ 3,403        $ (344)    (10.11)

Held-to-maturity-Certificates of deposit

          800,000      (800,000)    (100.00)

Federal funds sold

     16,775,100      14,835,000      1,940,100    13.08
                         

Total short-term investments

       $ 16,778,159        $ 15,638,403        $ 1,139,756    7.29
                         

Long-term investments:

           

Trading securities:

           

Government-sponsored enterprises debt obligations

       $ 3,938,084        $ 4,283,519        $ (345,435)    (8.06)

Other FHLBanks’ bonds

     280,853      284,542      (3,689)    (1.30)

State or local housing agency obligations

     14,156      59,484      (45,328)    (76.20)

Held-to-maturity securities:

           

State or local housing agency obligations

     109,397      117,988      (8,591)    (7.28)

Mortgage-backed securities:

           

U.S. agency obligations-guaranteed

     40,297      47,460      (7,163)    (15.09)

Government-sponsored enterprises

     7,203,990      2,968,441      4,235,549    142.69

Private label

     16,539,671      18,126,628      (1,586,957)    (8.75)
                         

Total long-term investments

       $ 28,126,448        $ 25,888,062        $ 2,238,386    8.65
                         

 

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Short-term investments were $16.8 billion at September 30, 2008, an increase of $1.1 billion, or 7.29 percent, from December 31, 2007. During this period, the Bank’s investment in overnight federal funds increased $4.9 billion and its investment in term federal funds decreased by $3.0 billion, resulting in a net increase in federal funds of $1.9 billion. The Bank’s focus on overnight federal funds, and less on term federal funds, was primarily to increase its liquidity position in light of increased advance demand. The increase in federal funds was offset by $800.0 million in maturing certificates of deposit during this same period.

Long-term investments were $28.1 billion at September 30, 2008, an increase of $2.2 billion, or 8.65 percent, from December 31, 2007. The increase in long-term investments during the period was due primarily to activity in the Bank’s MBS portfolio. The Bank purchased $3.3 billion, $1.5 billion and $147.8 million in agency MBS during the first, second and third quarter of 2008, respectively. These purchases of agency MBS were offset partially by a $1.6 billion decrease in the Bank’s private label MBS portfolio during the first nine months of 2008 due primarily to principal repayments and maturities. The Bank’s continuing decline in its purchase of MBS was due primarily to its inability to issue long-term debt at attractive pricing and increased customer demand for advances.

The Regulator limits an FHLBank’s investment in MBS and asset-backed securities by requiring that the total book value of MBS owned by the FHLBank generally may not exceed 300 percent or, in certain circumstances 600 percent, of the FHLBank’s previous month-end capital plus its mandatorily redeemable capital stock on the day it purchases the securities. The Bank attempts to maintain MBS investments at 295 percent to 300 percent of total capital. Management believes that these investment amounts help to maximize and stabilize earnings. These investments amounted to 262 percent of total capital plus mandatorily redeemable capital stock at both September 30, 2008 and December 31, 2007. The amount of MBS investments has been lower than management’s target due to the lack of attractive MBS securities available for purchase as well as the Bank’s efforts to increase its liquidity position in light of increased advance demand.

The Bank’s held-to-maturity portfolio had a total of 442 securities in an unrealized loss position, with total gross unrealized losses of $2.7 billion as of September 30, 2008. The Bank evaluates its individual held-to-maturity investment securities holdings for other-than-temporary impairment on a quarterly basis, or more frequently if events or changes in circumstances indicate that these investments may be other-than-temporarily impaired. As part of its impairment analysis, the Bank considers its ability and intent to hold each security for a sufficient time to allow for any anticipated recovery of unrealized losses.

To determine which individual securities are at risk for other-than-temporary impairment, the Bank considers various characteristics of each security including, but not limited to, the following: the credit rating and related outlook or status; the underlying type of collateral; the duration and amount of the unrealized loss; and any credit enhancements or insurance. The relative importance of this information varies based on the facts and circumstances surrounding each security, as well as the economic environment at the time of assessment. As a result of this security-level review, the Bank identifies individual securities believed to be at risk for other-than-temporary impairment, which are evaluated further by analyzing the performance of the security. Securities with weaker performance measures are evaluated by estimating projected cash flows based on the structure of the security and certain assumptions, such as prepayments, default rates and loss severity, to determine whether the Bank expects to receive all of the contractual cash flows as scheduled.

 

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Based on the Bank’s impairment analysis at September 30, 2008, the Bank recognized an other-than-temporary impairment loss of $87.3 million related to three private label MBS in its held-to-maturity securities portfolio (the “OTTI Charge”). The Bank recognizes an other-than-temporary impairment when it is probable that the Bank will not collect all scheduled contractual cash flows. The amount of other-than-temporary impairment is calculated as the difference between the current carrying value and the securities’ fair value.

The following table presents the indicated loss of contractual cash flows, the estimated date of first loss of contractual cash flows, and the impairment charge recognized for each of the securities for which an other-than-temporary impairment charge was recognized (in thousands):

 

Security

   Indicated
Loss of
Contractual
Cash Flows
   Date of First
Indicated Loss
   OTTI Charge
Recognized
#1    $ 28    2025    $ 40,992
#2      12    2032      32,995
#3      4    2027      13,357
                
Total    $ 44       $ 87,344
                

The losses noted above were based upon expected losses from prime based collateral, which is consistent with the originator’s original classification, adjusted for actual performance to date. However, each of these bonds has at least one NRSRO that considers the collateral to be Alt-A. In the event these bonds have performance more closely aligned with Alt-A collateral expectations, the indicated losses noted above could be different.

The remainder of the Bank’s held-to-maturity securities portfolio that has not been designated as other-than-temporarily impaired has experienced unrealized losses and decreases in fair value due to interest rate volatility, illiquidity in the marketplace, and credit deterioration in the U.S. mortgage markets. This decline in fair value is considered temporary as the Bank expects to collect all contractual cash flows and the Bank has the ability and intent to hold these investments to maturity. The ability and intent of the Bank is demonstrated by the fact that the Bank is well capitalized, has sufficient liquidity and has no need to sell these securities, nor has the Bank entered into any contractual constraints that would impact such intent and ability.

Mortgage Loans Held for Portfolio

Mortgage loans held for portfolio were $3.3 billion, a decrease of $189.5 million, or 5.37 percent, from December 31, 2007. Mortgage loans comprised 1.56 percent of the Bank’s total assets as of September 30, 2008 compared to 1.87 percent as of December 31, 2007. Mortgage loans purchased under the Mortgage Purchase Program (“MPP”) increased by $49.7 million from December 31, 2007 to September 30, 2008. Mortgage loans purchased under the Mortgage Partnership Finance® Program (“MPF® Program”) and the Affordable Multifamily Participation Program (“AMPP”) decreased by $238.7 million and $459.0 thousand, respectively, during this same period due to the maturity of assets purchased. In 2006, the Bank ceased purchasing assets under AMPP, and in 2008 the Bank ceased purchasing assets under the MPF Program. Early in the third quarter of 2008, the Bank suspended acquisitions of mortgage loans under MPP and the increase in the MPP balance for the period is attributable primarily to purchases during the first quarter of 2008.

As of September 30, 2008 and December 31, 2007, the Bank’s mortgage loan portfolio was concentrated in the Southeast because those members selling loans to the Bank were located primarily in the Southeast.

Consolidated Obligations

The Bank funds its assets primarily through the issuance of consolidated obligation bonds and, to a lesser extent, consolidated obligation discount notes.

 

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Consolidated obligation issuances financed 90.8 percent of the $213.8 billion in total assets at September 30, 2008, remaining relatively stable from the financing ratio of 90.3 percent as of December 31, 2007.

Consolidated obligation bonds were $138.6 billion at September 30, 2008, a decrease of $3.6 billion, or 2.53 percent, from December 31, 2007. Consolidated obligation bonds outstanding at September 30, 2008 and December 31, 2007 were primarily fixed-rate debt. However, the Bank often enters into derivatives simultaneously with the issuance of consolidated obligation bonds to convert the rates on them, in effect, into a short-term interest rate, usually based on LIBOR. Of the par value of $138.4 billion of consolidated obligation bonds outstanding as of September 30, 2008, $92.8 billion, or 67.1 percent, had their terms reconfigured through the use of interest rate exchange agreements. The comparable notional amount of such outstanding derivatives at December 31, 2007 was $102.7 billion, or 72.4 percent, of the par value of consolidated obligation bonds.

Consolidated obligation discount notes were $55.5 billion at September 30, 2008, an increase of $27.2 billion, or 95.8 percent, from December 31, 2007. The increase in consolidated obligation discount notes during the period was due to increased demand in the marketplace for short-term debt and a corresponding decrease in demand for longer-term debt in light of market conditions. As such, during the third quarter of 2008, the Bank issued large quantities of discount notes.

Deposits

The Bank offers demand and overnight deposit programs to members primarily as a liquidity management service. In addition, a member that services mortgage loans may deposit in the Bank funds collected in connection with the mortgage loans, pending disbursement of those funds to the owners of the mortgage loan. For demand deposits, the Bank pays interest at the overnight rate.

Most of these deposits represent member liquidity investments, which members may withdraw on demand. Therefore, the total account balance of the Bank’s deposits may be quite volatile. As a matter of prudence, the Bank typically invests deposit funds in liquid short-term assets. Member loan demand, deposit flows, and liquidity management strategies influence the amount and volatility of deposit balances carried at the Bank. Deposits totaled $7.9 billion as of September 30, 2008, compared to $7.1 billion as of December 31, 2007.

To support its member deposits, the FHLBank Act requires the Bank to have as a reserve an amount equal to or greater than the current deposits received from members. These reserves are required to be invested in obligations of the United States, deposits in eligible banks or trust companies, or advances with maturities not exceeding five years. The Bank was in compliance with this depository liquidity requirement as of September 30, 2008.

Other Liabilities

Other liabilities were $2.3 billion at September 30, 2008, a decrease of $888.6 million, or 27.8 percent, from December 31, 2007. This decrease was due primarily to a $476.5 million decrease in derivative liabilities due to the interaction of interest rates on associated derivatives and the early termination of derivative agreements with LBSF, and a $288.6 million decrease in accrued interest payable related to the decrease in consolidated obligation bonds.

Capital and Retained Earnings

Total capital was $9.1 billion at September 30, 2008, an increase of $1.0 billion, or 12.9 percent, from December 31, 2007. An increase in the Bank’s membership and advance balances that resulted in an increase in the Bank’s membership stock and activity-based stock was the primary factor causing the increase in the Bank’s total capital.

 

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The Bank’s retained earnings were $360.3 million, a decrease of $108.5 million, or 23.1 percent, from December 31, 2007. The reduction in retained earnings was due to the establishment of a $170.5 million reserve for a credit loss on the LBSF receivable, the $87.3 million other-than-temporary impairment charge, and a dividend of $58.9 million for the third quarter of 2008.

The FHLBank Act and Regulator regulations specify that each FHLBank must meet certain minimum regulatory capital standards. The Bank was in compliance with the Regulator’s regulatory capital rules and requirements as shown in the following table (dollar amounts in thousands):

 

     As of September 30, 2008    As of December 31, 2007
     Required    Actual    Required    Actual

Regulatory capital requirements:

           

Risk based capital

       $ 2,733,723        $ 9,096,091        $ 981,647        $ 8,080,333

Total capital-to-assets ratio

     4.00%      4.26%      4.00%      4.28%

Total regulatory capital*

       $ 8,548,745        $ 9,096,091        $ 7,557,511        $ 8,080,333

Leverage ratio

     5.00%      6.38%      5.00%      6.42%

Leverage capital

       $ 10,685,931        $ 13,644,137        $ 9,446,888        $ 12,120,499

 

* The Regulator has determined that mandatorily redeemable capital stock is considered capital for regulatory purposes, and “total regulatory capital” includes the Bank’s $35.5 million and $55.5 million in mandatorily redeemable capital stock at September 30, 2008 and December 31, 2007, respectively.

As of September 30, 2008, the Bank had capital stock subject to mandatory redemption from 11 former members, consisting of B2 activity-based stock. The Bank is not required to redeem or repurchase such activity-based stock until the later of the expiration of the five-year redemption period or the activity’s maturity date. In accordance with the Bank’s current practice, if activity-based stock becomes excess stock as a result of an activity no longer remaining outstanding, the Bank will repurchase the excess activity-based stock if the dollar amount of excess stock exceeds the threshold specified by the Bank, which is currently $100 thousand. As of September 30, 2008 and December 31, 2007, the Bank’s activity-based stock included $13.0 million and $12.4 million, respectively, of excess shares subject to repurchase by the Bank at its discretion. The Bank’s excess stock threshold and standard repurchase practice may be changed at the Bank’s discretion with proper notice to members.

Results of Operations

Net Income

The following table sets forth the Bank’s significant income items for the third quarter and first nine months of 2008 and 2007, and provides information regarding the changes during the periods (dollar amounts in thousands):

 

     Three Months Ended
September 30,
   Increase/
(Decrease)
   Increase/
(Decrease) %
   Nine Months Ended
September 30,
   Increase/
(Decrease)
   Increase/
(Decrease) %
     2008    2007          2008    2007      

Net interest income

       $ 237,861        $ 187,245        $ 50,616    27.03        $ 686,200        $ 504,079        $ 182,121    36.13

Other (loss) income

     (101,163)      20,276      (121,439)    (598.93)      (187,805)      12,288      (200,093)    (1,628.36)

Other expense

     199,558      25,756      173,802    674.80      254,308      76,638      177,670    231.83

Total assessments

     (16,619)      48,462      (65,081)    (134.29)      64,867      117,476      (52,609)    (44.78)

Net (loss) income

     (46,106)      133,142      (179,248)    (134.63)      179,205      322,181      (142,976)    (44.38)

The Bank recorded a net loss of $46.1 million for the third quarter of 2008, a decrease of $179.2 million from net income of $133.1 million for the third quarter of 2007. The Bank’s net income for the first nine months of 2008 was $179.2 million, a decrease of $143.0 million from net income of $322.2 million for the same period in 2007.

 

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The decrease in net income during the periods was due primarily to the establishment of a $170.5 million reserve for a credit loss on a receivable due from LBSF, which declared bankruptcy on October 3, 2008, with a corresponding charge to other expense, and the $87.3 million other-than-temporary impairment charge.

Net Interest Income

The primary source of the Bank’s earnings is net interest income. Net interest income equals interest earned on assets (including member advances, mortgage loans, MBS held in portfolio, and other investments), less the interest expense incurred on consolidated obligations, deposits, and other borrowings. Also included in net interest income are miscellaneous related items such as prepayment fees earned and the amortization of debt issuance discounts, concession fees and SFAS 133-related adjustments.

The following table presents spreads between the average yield on total interest-earning assets and the average cost of interest-bearing liabilities for the third quarter and first nine months of 2008 and 2007 (dollar amounts in thousands). The interest rate spread is affected by the inclusion or exclusion of net interest income/expense associated with the Bank’s derivatives. For example, if the derivatives qualify for fair-value hedge accounting under SFAS 133, the net interest income/expense associated with the derivative is included in the calculation of interest rate spread. If the derivatives do not qualify for fair-value hedge accounting under SFAS 133 (“SFAS 133 non-qualifying hedges”), the net interest income/expense associated with the derivatives is excluded from the calculation of the interest rate spread. There are also numerous amortizations associated with SFAS 133 basis adjustments that are reflected in net interest income, which affect interest rate spread. As noted in the tables below, during the third quarter and first nine months of 2008, compared to the same periods in 2007, the interest rate spread increased by 12 basis points and eight basis points, respectively. This increase was due to:

 

   

an increase in the use of short-term, lower rate funding. Short-term funding rates also decreased by more than long-term funding rates during the period

   

a slight increase in the amount of interest expense reclassified to other income for interest on stand-alone derivatives relating to trading securities as required under GAAP.

 

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Spread and Yield Analysis

 

     Three Months Ended September 30,
     2008    2007
     Average
Balance
   Interest    Yield/
Rate
   Average
Balance
   Interest    Yield/
Rate

Assets

                 

Federal funds sold

       $ 13,493,273        $ 76,584    2.26%        $ 16,714,860        $ 222,679    5.29%

Interest-bearing deposits (1)

     355,859      1,846    2.06%      73,512      1,007    5.43%

Certificates of deposit

     959,783      6,738    2.79%      926,420      12,713    5.44%

Long-term investments (2)

     30,075,105      377,015    4.99%      23,476,592      301,803    5.10%

Advances

     151,194,235      1,041,572    2.74%      120,384,709      1,669,410    5.50%

Mortgage loans held for portfolio (3)

     3,382,666      45,331    5.33%      3,402,034      45,514    5.31%

Loans to other FHLBanks

     6,565      27    1.64%      3,261      44    5.35%
                                 

Total interest-earning assets

     199,467,486      1,549,113    3.09%      164,981,388      2,253,170    5.42%
                         

Allowance for credit losses on mortgage loans

     (892)            (687)      

Other assets

     2,567,581            2,928,316      
                         

Total assets

       $ 202,034,175              $ 167,909,017      
                         

Liabilities and Capital

                 

Demand and overnight deposits

       $ 4,903,822      23,029    1.87%        $ 5,934,648      76,736    5.13%

Term deposits

                  4,811      65    5.36%

Other interest-bearing deposits (4)

     4,125      22    2.12%      92,844      1,242    5.31%

Short-term borrowings

     38,894,650      237,493    2.43%      15,833,877      202,819    5.08%

Long-term debt

     144,158,159      1,049,116    2.90%      134,736,227      1,779,371    5.24%

Other borrowings

     248,299      1,592    2.55%      407,465      5,692    5.54%
                                 

Total interest-bearing liabilities

     188,209,055      1,311,252    2.77%      157,009,872      2,065,925    5.22%
                         

Noninterest-bearing deposits

                28,353      

Other liabilities

     5,225,413            3,844,012      

Total capital

     8,599,707            7,026,780      
                         

Total liabilities and capital

       $ 202,034,175              $ 167,909,017      
                         

Net interest income and net yield on interest-earning assets

          $ 237,861    0.47%           $ 187,245    0.45%
                             

Interest rate spread

         0.32%          0.20%
                     

Average interest-earning assets to interest-bearing liabilities

         105.98%          105.08%
                     

 

Notes

(1) Interest-bearing deposits includes amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties.
(2) Trading securities are included in the Long-term investments line at fair value.
(3) Nonperforming loans are included in average balances used to determine average rate.
(4) Other interest-bearing deposits includes amounts recognized for the right to return cash collateral received under master netting agreements with derivative counterparties.

 

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Spread and Yield Analysis

 

     Nine Months Ended September 30,
     2008    2007
     Average
Balance
   Interest    Yield/
Rate
   Average
Balance
   Interest    Yield/
Rate

Assets

                 

Federal funds sold

       $ 11,080,022        $ 216,959    2.62%        $ 13,377,382        $ 532,451    5.32%

Interest-bearing deposits (1)

     1,180,710      24,753    2.80%      66,746      2,808    5.62%

Certificates of deposit

     738,960      17,383    3.14%      874,295      35,321    5.40%

Long-term investments (2)

     28,702,241      1,086,958    5.06%      23,372,356      894,673    5.12%

Advances

     149,412,973      3,569,797    3.19%      108,310,633      4,420,272    5.46%

Mortgage loans held for portfolio (3)

     3,463,163      138,540    5.34%      3,224,818      128,000    5.31%

Loans to other FHLBanks

     4,814      77    2.14%      1,172      47    5.36%
                                 

Total interest-earning assets

     194,582,883      5,054,467    3.47%      149,227,402      6,013,572    5.39%
                         

Allowance for credit losses on mortgage loans

     (947)            (701)      

Other assets

     2,684,963            2,725,939      
                         

Total assets

       $ 197,266,899              $ 151,952,640      
                         

Liabilities and Capital

                 

Demand and overnight deposits

       $ 5,811,046      102,310    2.35%        $ 5,216,957      202,777    5.20%

Term deposits

                  8,161      322    5.28%

Other interest-bearing deposits (4)

     19,599      384    2.62%      139,979      5,572    5.32%

Short-term borrowings

     32,964,362      687,379    2.79%      9,315,066      357,976    5.14%

Long-term debt

     143,953,644      3,575,479    3.32%      126,623,067      4,918,100    5.19%

Other borrowings

     108,902      2,715    3.33%      620,331      24,746    5.33%
                                 

Total interest-bearing liabilities

     182,857,553      4,368,267    3.19%      141,923,561      5,509,493    5.19%
                         

Noninterest-bearing deposits

     7,968            27,905      

Other liabilities

     5,959,934            3,521,240      

Total capital

     8,441,444            6,479,934      
                         

Total liabilities and capital

       $ 197,266,899              $ 151,952,640      
                         

Net interest income and net yield on interest-earning assets

          $ 686,200    0.47%           $ 504,079    0.45%
                             

Interest rate spread

         0.28%          0.20%
                     

Average interest-earning assets to interest-bearing liabilities

         106.41%          105.15%
                     

 

Notes

(1) Interest-bearing deposits includes amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties.
(2) Trading securities are included in the Long-term investments line at fair value.
(3) Nonperforming loans are included in average balances used to determine average rate.
(4) Other interest-bearing deposits includes amounts recognized for the right to return cash collateral received under master netting agreements with derivative counterparties.

Net interest income for the periods presented was affected by changes in average balances (volume change) and changes in average rates (rate change) of interest-earning assets and interest-bearing liabilities. The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities affected the Bank’s interest income and interest expense (in thousands). As noted in the table, the overall change in net interest income during the third quarter and first nine months of 2008, compared to the same periods in 2007, was primarily volume related.

 

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Volume and Rate Table*

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2008 vs. 2007    2008 vs. 2007
     Volume    Rate    Increase
(Decrease)
   Volume    Rate    Increase
(Decrease)

Increase (decrease) in interest income:

                 

Federal funds sold

       $ (36,726)        $ (109,369)        $ (146,095)        $ (79,704)        $ (235,788)        $ (315,492)

Interest-bearing deposits

     1,799      (960)      839      24,040      (2,095)      21,945

Certificates of deposit

     442      (6,417)      (5,975)      (4,850)      (13,088)      (17,938)

Long-term investments

     82,890      (7,678)      75,212      201,941      (9,656)      192,285

Advances

     354,764      (982,602)      (627,838)      1,345,088      (2,195,563)      (850,475)

Mortgage loans held for portfolio

     (260)      77      (183)      9,528      1,012      10,540

Loans to other FHLBanks

     26      (43)      (17)      72      (42)      30
                                         

Total

     402,935      (1,106,992)      (704,057)      1,496,115      (2,455,220)      (959,105)
                                         

Increase (decrease) in interest expense:

                 

Demand and overnight deposits

     (11,510)      (42,197)      (53,707)      20,915      (121,382)      (100,467)

Term deposits

     (32)      (33)      (65)      (161)      (161)      (322)

Other interest-bearing deposits

     (749)      (471)      (1,220)      (3,262)      (1,926)      (5,188)

Short-term borrowings

     181,671      (146,997)      34,674      556,599      (227,196)      329,403

Long-term debt

     116,901      (847,156)      (730,255)      606,350      (1,948,971)      (1,342,621)

Other borrowings

     (1,719)      (2,381)      (4,100)      (15,143)      (6,888)      (22,031)
                                         

Total

     284,562      (1,039,235)      (754,673)      1,165,298      (2,306,524)      (1,141,226)
                                         

Increase (decrease) in net interest income

       $ 118,373        $ (67,757)        $ 50,616        $ 330,817        $ (148,696)        $ 182,121
                                         

 

* Volume change is calculated as the change in volume multiplied by the previous rate, while rate change is the change in rate multiplied by the previous volume. The rate/volume change, change in rate multiplied by change in volume, is allocated between volume change and rate change at the ratio each component bears to the absolute value of its total.

The table below outlines the overall effect of hedging activities on net interest income and other income (loss) related results (in thousands). For a description regarding the individual interest components discussed below, see the Bank’s Form 10-K.

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2008    2007    2008    2007

Net interest income

       $ 237,861        $ 187,245        $ 686,200        $ 504,079
                           

Interest components of hedging activities included in net interest income:

           

Hedging advances

       $ (470,166)        $ 176,930        $ (1,005,827)        $ 491,647

Hedging consolidated obligations

     241,721      (106,076)      650,793      (324,401)

Hedging related amortization

     (16,016)      (320)      (2,919)      (15,093)
                           

Net (decrease) increase in net interest income

       $ (244,461)        $ 70,534        $ (357,953)        $ 152,153
                           

Interest components of derivative activity included in other income (loss):

           

Purchased options

       $ 6,990        $ 327        $ 16,578        $ 981

Synthetic macro funding

     (11,297)      (2,794)      (25,117)      (7,360)

Trading securities

     (36,514)      (2,998)      (88,528)      (12,033)

Other

     —        25      41      77
                           

Net decrease in other (loss) income

       $ (40,821)        $ (5,440)        $ (97,026)        $ (18,335)
                           

 

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Other Income (Loss)

The Bank’s other income (loss) is composed primarily of net gains (losses) on trading securities and net losses on derivatives and hedging activities. The following table presents the components of other income (loss) (in thousands):

 

     Three Months Ended
September 30,
   Increase
(Decrease)
   Nine Months Ended
September 30,
   Increase
(Decrease)
     2008    2007       2008    2007   

Other Income (Loss):

                 

Service fees

       $ 539        $ 562        $ (23)        $ 1,799        $ 1,892        $ (93)

Net gains (losses) on trading securities

     31,070      92,538      (61,468)      (50,968)      19,723      (70,691)

Realized loss on held-to-maturity securities

     (87,344)           (87,344)      (87,344)           (87,344)

Net losses on derivatives and hedging activities

     (45,299)      (72,816)      27,517      (51,219)      (9,898)      (41,321)

Other

     (129)      (8)      (121)      (73)      571      (644)
                                         

Total other (loss) income

       $ (101,163)        $ 20,276        $ (121,439)        $ (187,805)        $ 12,288        $ (200,093)
                                         

The Bank hedges trading securities with derivative transactions, and the income effect of the market-value change for these securities under SFAS 115 during the third quarter and the first nine months of 2008 and 2007 was offset by market-value changes in the related derivatives. The overall changes in other income (loss) for the third quarter and first nine months of 2008, compared to the same periods in 2007, were caused primarily by the OTTI Charge and by adjustments required to report trading securities at fair value, as required by GAAP, and hedging-related adjustments, which are reported in the overall hedging activities (including those related to trading securities).

 

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The Bank also records all gains or losses, comprising changes in fair value and interest paid or received, of SFAS 133 non-qualifying hedges in the net losses on derivatives and hedging activities classification. The following table details each of the components of net losses on derivatives and hedging activities (in thousands):

 

Net Losses on Derivatives and Hedging Activities
     Advances    Purchased
Options,
Macro
Hedging
and
Synthetic
Macro
Funding
   Investments    MPF/MPP
Loans
   Consolidated
Obligations
Bonds
   Consolidated
Obligations
Discount
Notes
   Intermediary
Positions

and Other
   Total

Three Months Ended September 30, 2008

                       

Interest-related

       $        $ (4,307)        $ (36,514)        $        $        $        $        $ (40,821)

SFAS 133 qualifying fair value hedges

     (283,440)                     56,683      (215)           (226,972)

SFAS 133 non-qualifying hedges and other

          (25,943)      (76,318)      (59)                324,814      222,494
                                                       

Total (losses) gains

       $ (283,440)        $ (30,250)        $ (112,832)        $ (59)        $ 56,683        $ (215)        $ 324,814        $ (45,299)
                                                       

Three Months Ended September 30, 2007

                       

Interest-related

       $        $ (2,467)        $ (2,998)        $        $        $        $ 25        $ (5,440)

SFAS 133 qualifying fair value hedges

     9,740           5           9,204      231           19,180

SFAS 133 non-qualifying hedges and other

          2,217      (89,493)      739                (19)      (86,556)
                                                       

Total gains (losses)

       $ 9,740        $ (250)        $ (92,486)        $ 739        $ 9,204        $ 231        $ 6        $ (72,816)
                                                       

Nine Months Ended September 30, 2008

                       

Interest-related

       $        $ (8,539)        $ (88,528)        $        $        $        $ 41        $ (97,026)

SFAS 133 qualifying fair value hedges

     (293,603)                     60,994      (1,445)           (234,054)

SFAS 133 non-qualifying hedges and other

          (31,001)      (13,760)      (205)                324,827      279,861
                                                       

Total (losses) gains

       $ (293,603)        $ (39,540)        $ (102,288)        $ (205)        $ 60,994        $ (1,445)        $ 324,868        $ (51,219)
                                                       

Nine Months Ended September 30, 2007

                       

Interest-related

       $        $ (6,379)        $ (12,033)        $        $        $        $ 77        $ (18,335)

SFAS 133 qualifying fair value hedges

     19,664           5           5,628      231           25,528

SFAS 133 non-qualifying hedges and other

          3,213      (20,669)      446                (81)      (17,091)
                                                       

Total gains (losses)

       $ 19,664        $ (3,166)        $ (32,697)        $ 446        $ 5,628        $ 231        $ (4)        $ (9,898)
                                                       

The amounts reported for SFAS 133 non-qualifying hedges and other, included in the column titled “Intermediary Positions and Other,” increased during the third quarter and first nine months of 2008, compared to the same periods in 2007. These increases are due to an adjustment to a payable amount due to LBSF, which the Bank declared in default. The adjustment represents the difference between the payable amount due as of the event of default date and the payable amount due as of the settlement date. In this instance, there were considerable market swings that account for the change in value between the two dates. The adjustment amount was offset partially by amounts reported in the SFAS 133 qualifying fair value hedges component of Advances and Consolidated Obligation Bonds in the table above; which represent ineffectiveness in SFAS 133 fair value hedges.

 

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Management generally uses derivative instruments to hedge net interest income, with a primary goal of stabilizing the interest-rate spread over time and mitigating interest-rate risk and cash-flow variability.

Non-interest Expense

Non-interest expense during the third quarter and first nine months of 2008 increased 178.6 percent and 76.7 percent, respectively, compared to the same periods in 2007. The increase during the periods was due to the $170.5 million provision for credit losses on the LBSF receivable recorded in other expense during the third quarter of 2008.

Liquidity and Capital Resources

Liquidity is necessary to satisfy members’ borrowing needs on a timely basis, repay maturing and called consolidated obligations, and meet other obligations and operating requirements. Many members rely on the Bank as a source of standby liquidity, and the Bank attempts to be in a position to meet member funding needs on a timely basis.

The Regulator’s regulations and Bank policy require the Bank to maintain contingent liquidity in an amount sufficient to meet its liquidity needs for five business days if it is unable to access the capital markets. In addition, the Bank attempts to maintain sufficient liquidity to service debt obligations for at least 90 days, assuming restricted debt market access. At times, the Bank did not meet its 90-day debt service goal during the quarter ended September 30, 2008 due to an increased reliance on discount notes and other short-term debt because of their attractive pricing.

The Bank’s principal source of liquidity is consolidated obligation debt instruments, which carry GSE status and are rated Aaa/P-1 by Moody’s and AAA/A-1+ by S&P. To provide liquidity, the Bank also may use other short-term borrowings, such as federal funds purchased, securities sold under agreements to repurchase, and loans from other FHLBanks. These funding sources depend on the Bank’s ability to access the capital markets at competitive market rates. Although the Bank maintains secured and unsecured lines of credit with money market counterparties, the Bank’s income and liquidity would be affected adversely if it were not able to access the capital markets at competitive rates for an extended period. Historically, the FHLBanks have had excellent capital market access, although the FHLBanks have experienced a decrease in investor demand for consolidated obligation bonds since mid- July 2008, and this decrease in demand has intensified, particularly with respect to long-term COs, since September 2008. However, during this time, the Bank has increased its issuance of short-term discount notes as an alternative source of funding.

During the third quarter of 2008, each FHLBank entered into a Lending Agreement with the U.S. Treasury in connection with the U.S. Treasury’s establishment of the Government Sponsored Enterprise Credit Facility (“GSECF”), as authorized by the Housing Act. The GSECF is designed to serve as a contingent source of liquidity for the housing government-sponsored enterprises, including each of the 12 FHLBanks. Any borrowings by one or more of the FHLBanks under the GSECF are considered consolidated obligations with the same joint and several liability as all other consolidated obligations. The terms of any borrowings are agreed to at the time of issuance. Loans under the Lending Agreement are to be secured by collateral acceptable to the U.S. Treasury, which consists of FHLBank advances to members that have been collateralized in accordance with regulatory standards and MBS issued by Fannie Mae or Freddie Mac. The maximum borrowings under the Lending Agreement are subject to the federal debt ceiling limits and are based upon eligible collateral. Each FHLBank is required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the U.S. Treasury, a list of eligible collateral, updated on a weekly basis. As of September 30, 2008, the Bank has provided the U.S. Treasury with a listing of advance collateral amounting to $24.8 billion, which provides for maximum borrowings of $21.5 billion.

 

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The amount of collateral can be increased or decreased (subject to the approval of the U.S. Treasury) at any time through the delivery of an updated listing of collateral. As of September 30, 2008, the Bank has not drawn on this available source of liquidity.

Contingency plans are in place that prioritize the allocation of liquidity resources in the event of operational disruptions at the Bank or the Office of Finance, as well as systemic Federal Reserve wire transfer system disruptions. Under the Housing Act, the Secretary of Treasury has the authority, at his or her discretion, to purchase consolidated obligations, subject to the general federal debt ceiling limits. Previously, the FHLBank Act had authorized the Secretary of Treasury, at his or her discretion, to purchase consolidated obligations up to an aggregate principal amount of $4 billion. No borrowings under this latter authority have been outstanding since 1977 and the Bank has no immediate plans to request the Treasury to exercise the authority under the Housing Act.

Off-balance Sheet Commitments

The Bank’s primary off-balance sheet commitments are as follows:

 

 

The Bank has joint and several liability for all FHLBank consolidated obligations

 

The Bank has outstanding commitments arising from standby letters of credit.

Should an FHLBank be unable to satisfy its payment obligation under a consolidated obligation for which it is the primary obligor, any of the other FHLBanks, including the Bank, could be called upon to repay all or any part of such payment obligation, as determined or approved by the Regulator. The Bank considers the joint and several liability as a related party guarantee. These related party guarantees meet the scope exceptions in FIN 45. Accordingly, the Bank has not recognized a liability for its joint and several obligations related to other FHLBanks’ consolidated obligations at September 30, 2008 or December 31, 2007. As of September 30, 2008, the FHLBanks had $1.3 trillion in aggregate par value of consolidated obligations issued and outstanding, $194.1 billion of which was attributable to the Bank.

As of September 30, 2008, the Bank had outstanding standby letters of credit of approximately $7.4 billion with original terms of less than three months to 15 years, with the longest final expiration in 2023. Commitments to extend credit, including standby letters of credit, are agreements to lend. The Bank issues a standby letter of credit for the account of a member in exchange for a fee. A member may use these standby letters of credit to facilitate a financing arrangement. The Bank requires its borrowers, upon the effective date of the letter of credit through its expiration, to collateralize fully the face amount of any letter of credit issued by the Bank, as if such face amount were an advance to the borrower. If the Bank is required to make payment for a beneficiary’s draw, the Bank converts such paid amount to an advance to the member. The Bank’s underwriting and collateral requirements for standby letters of credit are the same as those requirements for advances. Based on management’s credit analyses and collateral requirements, the Bank does not deem it necessary to have an allowance for credit losses for these unfunded letters of credit as of September 30, 2008.

Contractual Obligations

As of September 30, 2008, there has not been a material change in the Bank’s contractual obligations reported in the Bank’s Form 10-K.

 

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Risk Management

The Bank’s lending, investment, and funding activities and the use of derivative hedge instruments expose the Bank to a number of risks, including any one or more of the following:

 

 

Market risk, which is the risk that the market value, or estimated fair value, of the Bank’s portfolio will decline as a result of changes in interest rates

 

Liquidity risk, which is the risk that the Bank will be unable to meet its obligations as they come due or meet the credit needs of its members and associates in a timely and cost-efficient manner

 

Credit risk, which is the risk that the market value of an obligation will decline as a result of deterioration in creditworthiness, or that the amount will not be realized

 

Operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people or systems, or from external events, as well as reputation and legal risks associated with business practices or market conduct that the Bank may undertake

 

Business risk, which is the risk of an adverse effect on the Bank’s profitability resulting from external factors that may occur in both the short term and long term.

A detailed discussion of the Bank’s management of these risks is contained in the Bank’s Form 10-K and under “Item 3. Quantitative and Qualitative Disclosure About Market Risk” below.

Credit Risk

Credit risk is defined as the risk of loss due to defaults on principal and interest payments on advances, mortgage-backed securities and other investments, derivatives, mortgage loans and unsecured extensions of credit.

Advances

Secured advances to member financial institutions account for the largest category of Bank assets; thus, advances are the Bank’s principal source of credit risk exposure. The Bank uses a risk-focused approach to credit and collateral underwriting. The Bank attempts to reduce credit risk on advances by monitoring the financial condition of borrowers and the quality and value of the assets members pledge as eligible collateral.

The Bank utilizes a credit risk rating system for its members, which focuses primarily on an institution’s overall financial health and takes into account quality of assets, earnings, and capital position. The Bank assigns each borrower that is an insured depository institution a credit risk rating from one to 10 according to the relative amount of credit risk such borrower poses to the Bank (one being the least amount of credit risk and 10 the greatest amount of credit risk). In general, borrowers in categories eight through 10 may have more restrictions on the types of collateral they may use to secure advances, may be required to maintain higher collateral maintenance levels and deliver loan collateral, may be restricted from obtaining convertible advances and may face more stringent collateral reporting requirements. At times, the Bank may place more restrictive requirements on a borrower than those generally applicable to borrowers with the same rating based upon management’s assessment of the borrower and its collateral.

 

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The following table sets forth the number of borrowers and the par amount of advances outstanding to borrowers with the specified ratings as of the specified dates (dollar amounts in thousands). The Bank began utilizing this credit risk rating system during the quarter ended June 30, 2008:

 

     As of September 30, 2008    As of June 30, 2008

Rating

   Number of
Borrowers
   Outstanding
Advances
   Number of
Borrowers
   Outstanding
Advances

   1-4

   215        $ 9,305,740    203        $ 8,699,040

   5-7

   444      81,212,322    427      62,919,884

   8

   140      15,477,349    139      16,369,958

   9

   89      51,406,751    90      51,379,489

   10

   29      1,275,276    30      1,152,768

The Bank establishes a credit limit for each borrower. The credit limit is not a committed line of credit, but rather an indication of the borrower’s general borrowing capacity with the Bank. The Bank determines the credit limit in its sole and absolute discretion, by evaluating a wide variety of factors indicating the borrower’s overall creditworthiness. The credit limit is expressed as a percentage equal to the ratio of the borrower’s total liabilities to the Bank, including the face amount of outstanding letters of credit, the principal amount of outstanding advances and the total exposure of the Bank to the borrower under any derivative contract, to the borrower’s total assets. Generally, borrowers are held to a credit limit of no more than 30.0 percent. Credit limits in excess of 30.0 percent must be approved by the Bank’s Credit and Collateral Committee. The Bank’s maximum allowable credit limit is 50.0 percent. However, the Bank’s board of directors, or a relevant committee thereof, may approve a higher limit at its discretion.

Each borrower must maintain a collateral maintenance level of qualifying collateral that, when discounted to the lendable collateral value (“LCV”), is equal to at least 100 percent of the outstanding principal amount of all advances and other liabilities of the borrower to the Bank. Borrowers with a credit risk rating of nine or 10 currently must maintain higher collateral maintenance levels. The LCV is the value that the Bank assigns to each type of qualifying collateral for purposes of determining the amount of credit that such qualifying collateral will support. For each type of qualifying collateral, the Bank discounts the unpaid principal balance, market value, or other value of the qualifying collateral, to calculate the LCV. The following table provides information about the types of collateral held for the Bank’s advances (dollar amounts in thousands):

 

     Total Par
Value of
Outstanding
Advances
   Discounted
Value of
Collateral
Pledged by
Members
   First
Mortgage
Collateral (%)
   Securities
Collateral (%)
   Other Real
Estate
Related
Collateral (%)

As of September 30, 2008

       $ 161,378,051        $ 271,816,256    57.5    12.5    30.0

As of December 31, 2007

     140,229,705      227,230,433    67.4    11.8    20.8

In its history, the Bank has never experienced a credit loss on an advance. In consideration of this, and the Bank’s policies and practices detailed above, the Bank has not established an allowance for credit losses on advances as of September 30, 2008.

 

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Investments

While the Bank faces what it believes to be minimal credit risk on advances to members, it is subject to credit risk on certain unsecured investments, including federal funds sold and MBS.

The Bank follows guidelines approved by its board of directors regarding unsecured extensions of credit, in addition to Regulator regulations with respect to term limits and eligible counterparties. The Bank’s Risk Management Policy (“RMP”) permits the Bank to invest in agency (Fannie Mae, Freddie Mac and Ginnie Mae) and private label MBS, including collateralized mortgage obligations and real estate mortgage-investment conduits, rated AAA by S&P or Aaa by Moody’s at the time of purchase. The table below provides the credit ratings for the Bank’s investment portfolio (in thousands).

 

     As of September 30, 2008
     AAA    AA    A-
     Book Value    Estimated
Fair Value
   Book
Value
   Estimated
Fair Value
   Book
Value
   Estimated
Fair Value

Trading securities:

                 

Government-sponsored enterprises debt obligations

       $ 3,938,084        $ 3,938,084    $    $    $    $

Other FHLBanks’ bonds

     280,853      280,853                    

State or local housing agency obligations

     14,156      14,156                    
                                         

Total trading securities

     4,233,093      4,233,093                    
                                         

Held-to-maturity securities:

                 

State or local housing agency obligations

     93,362      93,971      16,035      16,486          

Mortgage-backed securities:

                 

U.S. agency obligations-guaranteed

     40,297      40,557                    

Government-sponsored enterprises

     7,203,990      7,106,222                    

Private label

     16,266,788      13,694,514      169,381      124,018      103,502      103,502
                                         

Total held-to-maturity

     23,604,437      20,935,264      185,416      140,504      103,502      103,502
                                         

Total investment securities

       $ 27,837,530        $ 25,168,357        $ 185,416        $ 140,504        $ 103,502        $ 103,502
                                         

As of September 30, 2008, a substantial portion of the Bank’s MBS portfolio consisted of private label MBS. The MBS purchased by the Bank attain triple-A ratings through credit enhancements, which primarily consist of the subordination of the claims of the other tranches of these securities.

Consistent with its practice with respect to members, the Bank monitors the financial condition of investment counterparties to ensure that they are in compliance with the Bank’s RMP and the Regulator’s regulations. Unsecured credit exposure to any counterparty is limited by the credit quality and capital of the counterparty and by the capital of the Bank. On a monthly basis, management produces financial monitoring reports regarding the financial condition of the Bank’s counterparties. These reports are reviewed by the Bank’s board of directors.

The Bank experienced an increase in the market value of unsecured credit exposure in its investment portfolio related to counterparties other than the U.S. government or U.S. government agencies and instrumentalities from $10.6 billion at December 31, 2007 to $13.5 billion as of September 30, 2008. As of September 30, 2008, the Bank had unsecured credit exposure to four non-U.S. government counterparties that was greater than 10 percent of total unsecured credit exposure. The Bank did not have any unsecured credit exposure to counterparties in excess of five percent but less than 10 percent of total unsecured credit exposure.

 

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The following table summarizes, by investment rating, the unpaid principal balance of the Bank’s private label MBS by year of issuance, as well as the gross unrealized losses and the weighted-average credit enhancement on the applicable securities (dollar amounts in thousands). The weighted-average credit enhancement is the percent of protection in place to absorb losses of principal that could occur on the securities’ combined outstanding principal balances of the relevant senior and subordinate tranches.

 

     As of September 30, 2008
     AAA    AA    A-          
     Outstanding
Principal
Balance
   Gross
Unrealized
Losses
   Outstanding
Principal
Balance
   Gross
Unrealized
Losses
   Outstanding
Principal
Balance
   Gross
Unrealized
Losses
   Subtotal Gross
Unrealized
Losses
   Weighted Average
Credit Support
Percentage

Prime - Year of Issuance

                       

2003 and prior

       $ 3,520,569        $ 367,266        $ —          $ —          $ —          $ —          $ 367,266    4.6

2004

     3,482,842      464,077      —        —        —        —        464,077    6.5

2005

     3,521,417      572,368      —        —        —        —        572,368    8.5

2006

     1,523,649      291,784      —        —              291,784    10.3

2007

     2,257,278      464,841      141,215      45,363      —        —        510,204    12.1

2008

     382,285      52,669      —        —        —        —        52,669    16.5
                                                     

Total Prime

     14,688,040      2,213,005      141,215      45,363      —        —        2,258,368    8.1
                                                     

Alt-A- Year of Issuance

                       

2003 and prior

     974,138      198,004      —        —        —        —        198,004    9.9

2004

     160,209      22,210      —        —        —        —        22,210    12.3

2005

     443,478      139,055      —        —        —        —        139,055    27.8

2006

     —        —        —        —        —        —        —      —  

2007

     —        —        —        —        —        —        —      12.3

2008

     —        —        —        —        —        —        —      —  
                                                     

Total Alt-A

     1,577,825      359,269      —        —        —        —        359,269    15.0
                                                     

Total

       $ 16,265,865        $ 2,572,274        $ 141,215        $ 45,363        $ —          $ —          $ 2,617,637    8.8
                                                     

The Bank’s held-to-maturity portfolio as of September 30, 2008 included $16.5 billion of private label MBS. Approximately 89 percent of the underlying mortgages collateralizing the private label MBS are considered prime and the remaining underlying mortgages collateralizing these securities are considered Alt-A, as determ