10-K 1 d263632d10k.htm 10-K 10-K
Table of Contents
Index to Financial Statements

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

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

For the fiscal year ended December 31, 2011

OR

 

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

For the transition period from                      to                     

Commission file 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

 

 

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Class B Stock, par value $100

(Title of class)

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes  ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     x  Yes    ¨  No

Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

 

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

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

Registrant’s stock is not publicly traded and is only issued to members of the registrant. Such stock is issued and redeemed at par value, $100 per share, subject to certain regulatory and statutory limits. At June 30, 2011, the aggregate par value of the stock held by current and former members of the registrant was $6,717,491,500, and 67,174,915 total shares were outstanding as of that date. At February 29, 2012, 61,971,001 total shares were outstanding.


Table of Contents
Index to Financial Statements

Table of Contents

 

     PART I       

Item 1.

  

Business

     4   

Item 1A.

  

Risk Factors

     21   

Item 1B.

  

Unresolved Staff Comments

     26   

Item 2.

  

Properties

     26   

Item 3.

  

Legal Proceedings

     26   

Item 4.

  

Mine Safety Disclosure

     27   
   PART II   

Item 5.

  

Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     28   

Item 6.

  

Selected Financial Data

     30   

Item 7.

  

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

     32   

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

     82   

Item 8.

  

Financial Statements and Supplementary Data

     83   

Item 9.

  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     147   

Item 9A.

  

Controls and Procedures

     147   

Item 9B.

  

Other Information

     147   
   PART III   

Item 10.

  

Directors, Executive Officers and Corporate Governance

     148   

Item 11.

  

Executive Compensation

     155   

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     172   

Item 13.

  

Certain Relationships, Related Transactions and Director Independence

     173   

Item 14.

  

Principal Accountant Fees and Services

     174   
   PART IV   

Item 15.

  

Exhibits and Financial Statement Schedules

     176   

SIGNATURES

  


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Important Notice About Information in this Annual Report

In this annual report on Form 10-K (Report), unless the context suggests otherwise, references to the “Bank” mean the Federal Home Loan Bank of Atlanta. “FHLBanks” means the 12 district Federal Home Loan Banks, including the Bank, and “FHLBank System” means the FHLBanks and the Federal Home Loan Banks Office of Finance (Office of Finance), as regulated by the Federal Housing Finance Agency (Finance Agency). “FHLBank Act” means the Federal Home Loan Bank Act of 1932, as amended.

The information contained in this Report is accurate only as of the date of this Report and as of the dates specified herein.

The product and service names used in this Report are the property of the Bank and, in some cases, the other FHLBanks. Where the context suggests otherwise, the products, services, and company names mentioned in this Report are the property of their respective owners.

Special Cautionary Notice Regarding Forward-looking Statements

Some of the statements made in this Report may be “forward-looking statements” within the meaning of section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended, and are intended to be covered by the safe harbor provided by the same. Forward-looking statements include statements with respect to the Bank’s beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, 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. 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;

 

 

future performance, including profitability, dividends, developments, or market forecasts;

 

 

forward-looking accounting and financial statement effects; and

 

 

those other factors identified and discussed in the Bank’s public filings with the Securities and Exchange Commission (SEC).

It is important to note that the description of the Bank’s business is a statement about the Bank’s operations as of a specific date. It is not meant to be construed as a policy, and the Bank’s operations, including the portfolio of assets held by the Bank, are subject to reevaluation and change without notice.

The forward-looking statements may not be realized due to a variety of factors, including, without limitation, any one or more of the following factors:

 

 

future economic and market conditions, including, for example, inflation and deflation, the timing and volume of market activity, general consumer confidence and spending habits, the strength of local economies in which the Bank conducts its business, and interest-rate changes that affect the housing markets;

 

 

demand for Bank advances resulting from changes in members’ deposit flows and credit demands, as well as from changes in other sources of funding and liquidity available to members;

 

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Index to Financial Statements
 

volatility of market prices, rates, and indices that could affect the value of collateral held by the Bank as security for the obligations of Bank members and counterparties to derivatives and similar agreements;

 

 

the risk of changes in interest rates on the Bank’s interest-rate sensitive assets and liabilities;

 

 

changes in various governmental monetary or fiscal policies, as well as legislative and regulatory changes, including changes in accounting principles generally accepted in the United States of America (GAAP) and related industry practices and standards, or the application thereof;

 

 

changes in the credit ratings of the U.S. government and/or the FHLBanks;

 

 

political, national, and world events, including acts of war, terrorism, natural disasters or other catastrophic events, and legislative, regulatory, judicial, or other developments that affect the economy, the Bank’s market area, the Bank, its members, counterparties, its federal regulator, and/or investors in the consolidated obligations of the FHLBanks;

 

 

competitive forces, including other sources of funding available to Bank members, other entities borrowing funds in the capital markets, and the ability to attract and retain skilled individuals;

 

 

the Bank’s ability to develop, implement, promote the efficient performance of, and support technology and information systems, including the internet, sufficient to measure and effectively manage the risks of the Bank’s business;

 

 

changes in investor demand for consolidated obligations of the FHLBanks and/or the terms of derivatives and similar agreements, including changes in investor preference and demand for certain terms of these instruments, which may be less attractive to the Bank, or which the Bank may be unable to offer;

 

 

the Bank’s ability to introduce, support, and manage the growth of new products and services and to successfully manage the risks associated with those products and services;

 

 

the Bank’s ability to successfully manage the risks associated with any new types of collateral securing advances;

 

 

the availability from acceptable counterparties, upon acceptable terms, of options, interest-rate and currency swaps, and other derivative financial instruments of the types and in the quantities needed for investment funding and risk-management purposes;

 

 

the uncertainty and costs of litigation, including litigation filed against one or more of the FHLBanks;

 

 

changes in the FHLBank Act or Finance Agency regulations that affect FHLBank operations and regulatory oversight;

 

 

adverse developments or events, including financial restatements, affecting or involving one or more other FHLBanks or the FHLBank System in general; and

 

 

other factors and other information discussed herein under the caption “Risk Factors” and elsewhere in this Report, as well as information included in the Bank’s future filings with the SEC.

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 this Report and in future reports and other filings made by the Bank with the SEC. The Bank operates in a changing economic environment, and new risk factors emerge from time to time. Management cannot accurately predict any new factors, nor can it assess the effect, if any, of any new factors on the business of the Bank or the extent to which any factor, or combination of factors, may cause actual results to differ from those implied by any forward-looking statements.

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 Report, or after the respective dates on which these statements otherwise are made, whether as a result of new information, future events, or otherwise, except as may be required by law.

 

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Index to Financial Statements

PART I.

 

Item 1. Business.

Overview

The Bank is a federally chartered corporation organized in 1932 and one of 12 district FHLBanks. The FHLBanks, along with the Finance Agency and the Office of Finance, comprise the FHLBank System. The FHLBanks are U.S. government-sponsored enterprises (GSEs) organized under the authority of the FHLBank Act. Each FHLBank operates as a separate entity within a defined geographic district and has its own management, employees, and board of directors. The Bank’s defined geographic district includes Alabama, Florida, Georgia, Maryland, North Carolina, South Carolina, Virginia, and the District of Columbia.

The Bank is a cooperative owned by member institutions that are required to purchase capital stock in the Bank as a condition of membership. All federally insured depository institutions, insurance companies, and certified community development financial institutions (CDFIs) chartered in the Bank’s defined geographic district and engaged in residential housing finance are eligible to apply for membership. The Bank’s stock is owned entirely by current or former members and is not publicly traded. As of December 31, 2011, the Bank’s membership totaled 1,062 financial institutions, comprising 757 commercial banks, 96 savings banks, 39 thrifts, 154 credit unions, 15 insurance companies, and one certified CDFI.

The primary function of the Bank is to provide readily available, competitively priced funding to these member institutions. The Bank serves the public by providing its member institutions with a source of liquidity, thereby enhancing the availability of credit for residential mortgages and targeted community development.

The primary source of funds for the Bank is proceeds from the sale to the public of FHLBank debt instruments, known as “consolidated obligations,” or “COs,” which are the joint and several obligations of all of the FHLBanks. Deposits, other borrowings, and the issuance of capital stock provide additional funds to the Bank. The Bank accepts deposits from both member and eligible nonmember financial institutions and federal instrumentalities. The Bank also provides members and nonmembers with correspondent banking services such as safekeeping, wire transfer, and cash management.

The Bank is exempt from ordinary federal, state, and local taxation, except real property taxes, and it does not have any subsidiaries nor does it sponsor any off-balance sheet special purpose entities.

As of December 31, 2011, the Bank had total assets of $125.3 billion, total advances of $87.0 billion, total deposits of $2.7 billion, total COs of $115.0 billion, and a retained earnings balance of $1.3 billion. The Bank’s net income for the year ended December 31, 2011 was $184 million. The Bank manages its operations as one business segment. Management and the Bank’s board of directors review enterprise-wide financial information in order to make operating decisions and assess performance.

The Finance Agency was established and became the independent regulator of the FHLBanks effective July 30, 2008 with the passage of the Housing and Economic Recovery Act of 2008 (Housing Act). Pursuant to the Housing Act, all regulations, orders, determinations, and resolutions that were issued, made, prescribed, or allowed to become effective by the former Federal Housing Finance Board (Finance Board) will remain in effect until modified, terminated, set aside, or superseded by the Finance Agency Director, any court of competent jurisdiction, or operation of law. The Finance Agency’s stated mission with respect to the FHLBanks is to provide effective supervision, regulation and housing mission oversight of the FHLBanks to promote their safety and soundness, support housing finance and affordable housing, and support a stable and liquid mortgage market. The Office of Finance, a joint office of the FHLBanks, facilitates the issuance and servicing of the FHLBanks’ debt instruments and prepares the combined quarterly and annual financial reports of the FHLBanks.

 

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Index to Financial Statements

Products and Services

The Bank’s products and services include the following:

 

 

Credit Products;

 

 

Community Investment Services; and

 

 

Cash Management and Other Services.

Credit Products

The credit products that the Bank offers to its members include both advances and standby letters of credit.

Advances

Advances are the Bank’s primary product. Advances are fully secured loans made to members and eligible housing finance agencies, called “housing associates” (nonmembers that are approved mortgagees under Title II of the National Housing Act). The carrying value of the Bank’s outstanding advances was $87.0 billion and $89.3 billion as of December 31, 2011 and 2010, respectively, and advances represented 69.4 percent and 67.7 percent of total assets as of December 31, 2011 and 2010, respectively. Advances generated 23.2 percent, 22.8 percent, and 38.9 percent of total interest income for the years ended December 31, 2011, 2010, and 2009, respectively.

Advances serve as a funding source to the Bank’s members for a variety of conforming and nonconforming mortgages. Thus, advances support important housing markets, including those focused on low- and moderate-income households. For those members that choose to sell or securitize their mortgages, advances can supply interim funding.

Generally, member institutions use the Bank’s advances for one or more of the following purposes:

 

 

providing funding for single-family mortgages and multifamily mortgages held in the member’s portfolio, including both conforming and nonconforming mortgages;

 

 

providing temporary funding during the origination, packaging, and sale of mortgages into the secondary market;

 

 

providing funding for commercial real estate loans;

 

 

assisting with asset-liability management by matching the maturity and prepayment characteristics of mortgage loans or adjusting the sensitivity of the member’s balance sheet to interest-rate changes; and

 

 

providing a cost-effective alternative to meet contingent liquidity needs.

Pursuant to statutory and regulatory requirements, the Bank may make long-term advances only for the purpose of enabling a member to purchase or fund new or existing residential housing finance assets, which may include, for community financial institutions, defined small business loans, small farm loans, small agri-business loans, and community development loans. The Bank indirectly monitors the purpose for which members use advances through limitations on eligible collateral and as described below.

The Bank obtains a security interest in eligible collateral to secure a member’s advance prior to the time it originates or renews an advance. Eligible collateral is defined by the FHLBank Act, Finance Agency regulations, and the Bank’s credit and collateral policy. The Bank requires its borrowers to execute an advances and security agreement that establishes the Bank’s security interest in all collateral pledged by the borrower. The Bank perfects its security interest in collateral prior to making an advance to the borrower. As additional security for a member’s indebtedness, the Bank has a statutory and contractual lien on the member’s capital stock in the Bank. The Bank also may require additional or substitute collateral from a borrower, as provided in the FHLBank Act and the financing documents between the Bank and its borrowers.

 

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Index to Financial Statements

The Bank assesses member creditworthiness and financial condition typically on a quarterly basis to determine the term and maximum dollar amount of the advances the Bank will lend to a particular member. In addition, the Bank discounts eligible collateral and periodically revalues the collateral pledged by each member to secure its outstanding advances. The Bank has never experienced a credit loss on an advance.

The FHLBank Act affords any security interest granted to the Bank by any member of the Bank, or any affiliate of any such member, priority over the claims and rights of any party (including any receiver, conservator, trustee, or similar party having rights of a lien creditor), other than claims and rights of a party that (1) would be entitled to priority under otherwise applicable law; and (2) is an actual bona fide purchaser for value or is an actual secured party whose security interest is perfected in accordance with applicable state law.

Pursuant to its regulations, the Federal Deposit Insurance Corporation (FDIC) has recognized the priority of an FHLBank’s security interest under the FHLBank Act, and the right of an FHLBank to require delivery of collateral held by the FDIC as receiver for a failed depository institution.

The Bank offers standard and customized advances to fit a variety of member needs. Generally, the Bank offers maturities as described below, but longer maturities are available subject to a member’s financial condition and available funding. The Bank’s advances include, among other products, the following:

Adjustable or variable rate indexed advances. Adjustable or variable rate indexed advances include:

 

 

Daily Rate Credit Advance (DRC Advance). The DRC Advance provides short-term funding with rate resets on a daily basis, similar to federal funds lines. The DRC Advance is available generally from one day to 24 months.

 

 

Adjustable Rate Credit Advance (ARC Advance). The ARC Advance is a long-term advance available for a term generally of up to 10 years with rate resets at specified intervals.

 

 

Capped and Floored Advances. The capped advance includes an interest-rate cap, while the floored advance includes an interest-rate floor. The interest rate on the advance adjusts according to the difference between the interest-rate cap/floor and the established index. The Bank offers this product with a maturity generally of one year to 10 years.

 

 

Float-to-Fixed Advance. This advance is an advance that floats to London Interbank Offered Rate (LIBOR) and changes to a predetermined fixed rate on a predetermined date prior to maturity. The Bank offers this product with a maturity generally of up to 20 years. The float-to-fixed advance is a new product that became available to members beginning in the third quarter of 2011.

Fixed rate advances. Fixed rate advances include:

 

 

Fixed Rate Credit Advance (FRC Advance). The FRC Advance offers fixed-rate funds with principal due at maturity generally from one month to 10 years.

 

 

Callable Advance. The callable advance is a fixed-rate advance with a fixed maturity and the option for the member to prepay the advance on an option exercise date(s) before maturity without a fee. The options can be Bermudan (periodically during the life of the advance) or European (one-time). The Bank offers this product with a maturity generally of up to 10 years with options from three months to 10 years.

 

 

Expander Advance. The expander advance is a fixed-rate advance with a fixed maturity and an option by the borrower to increase the amount of the advance in the future at a predetermined interest rate. The option may be Bermudan or European. The Bank has established internal limits on the amount of such options that may be sold to mature in any given quarter. The Bank offers this product with a maturity generally of two years to 20 years with an option exercise date that can be set from one month to 10 years.

Hybrid advances. The hybrid advance is a fixed- or variable-rate advance that allows the inclusion of interest-rate caps and/or floors. The Bank offers this product with a maturity generally of up to 10 years with options from three months to 10 years.

 

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Index to Financial Statements

Convertible advances. In a convertible advance, the Bank purchases an option from the member that allows the Bank to modify the interest rate on the advance from fixed to variable on certain specified dates. The Bank’s option can be Bermudan or European. The Bank offers this product with a maturity generally of up to 15 years with options from three months to 15 years.

In 2012, the Bank expects to offer members additional flexibility to customize advances by allowing members to combine one or more of the above advance features in a single advance.

The following table sets forth the par value of outstanding advances by product characteristics (dollars in millions). See Note 9–Advances to the audited financial statements for further information on the distinction between par value and carrying value of outstanding advances.

 

     As of December 31,  
     2011     2010  
     Amount     Percent
of Total
    Amount     Percent
of Total
 

Adjustable or variable rate indexed

   $ 10,977        13.29      $ 8,852        10.41   

Fixed rate(1)

     37,038        44.86        23,073        27.13   

Hybrid

     25,082        30.38        39,415        46.34   

Convertible

     8,276        10.02        12,592        14.80   

Amortizing(2)

     1,196        1.45        1,119        1.32   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total par value

     $         82,569                100.00        $         85,051                100.00   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Includes convertible advances whose conversion options have expired.

(2) 

The Bank offers a fixed-rate advance that may be structured with principal amortization in either equal increments or similar to a mortgage.

The Bank establishes interest rates on advances using the Bank’s cost of funds on COs and the interest-rate swap market. The Bank establishes an interest rate applicable to each type of advance each day and then adjusts those rates during the day to reflect changes in the cost of funds and interest rates.

The Bank includes prepayment fee provisions in most advance transactions. With respect to callable advances, prepayment fees apply to prepayments on a date other than an option exercise date(s). As required by Finance Agency regulations, the prepayment fee is intended to make the Bank economically indifferent to a borrower’s decision to prepay an advance before maturity or, with respect to a callable advance, on a date other than an option exercise date.

 

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Index to Financial Statements

The following table presents information on the Bank’s 10 largest borrowers of advances (dollars in millions):

 

           As of December 31, 2011  

Institution

   City, State    Advances
Par Value
     Percent of
Total
Advances
     Weighted-
average
Interest
Rate

(%) (1)
 

Bank of America, National Association

   Charlotte, NC        $     16,039         19.43         3.47   

Branch Banking and Trust Company

   Winston Salem, NC      9,098         11.02         3.29   

Navy Federal Credit Union

   Vienna, VA      7,605         9.21         3.27   

SunTrust Bank

   Atlanta, GA      7,027         8.51         0.16   

Capital One, National Association

   McLean, VA      6,373         7.72         0.28   

Compass Bank

   Birmingham, AL      2,944         3.57         1.44   

E*TRADE Bank

   Arlington, VA      2,274         2.75         3.18   

BankUnited

   Miami Lakes, FL      2,215         2.68         3.07   

Regions Bank

   Birmingham, AL      1,910         2.31         0.95   

Pentagon Federal Credit Union

   Alexandria, VA      1,506         1.82         4.07   
     

 

 

    

 

 

    

Subtotal (10 largest borrowers)

        56,991         69.02         2.45   

Subtotal (all other borrowers)

              25,578         30.98         2.78   
     

 

 

    

 

 

    

Total par value

          $ 82,569                 100.00                       2.55   
     

 

 

    

 

 

    

 

(1) The average interest rate of the member’s advance portfolio weighted by each advance’s outstanding balance.

A description of the Bank’s credit risk management and collateral valuation methodology as it relates to its advance activity is contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Prudent Risk Management and Appetite—Credit Risk.

Standby Letters of Credit

The Bank provides members with irrevocable standby letters of credit to support certain obligations of the members to third parties. Members may use standby letters of credit for residential housing finance and community lending or for liquidity and asset-liability management. In particular, members often use standby letters of credit as collateral for deposits from public sector entities. Standby letters of credit are generally available for terms of two months up to 20 years or for a one year term renewable annually. The Bank requires members to fully collateralize the face amount of any letter of credit issued by the Bank during the term of the letter of credit, and the Bank charges the member an annual fee based on the face amount of the letter of credit. If the Bank is required to make payment for a beneficiary’s draw, these amounts must be reimbursed by the member immediately or, subject to the Bank’s discretion, may be converted into an advance to the member. The Bank’s underwriting and collateral requirements for standby letters of credit are the same as the underwriting and collateral requirements for advances. Letters of credit are not subject to activity-based capital stock purchase requirements. The Bank has never experienced a credit loss related to a standby letter of credit reimbursement obligation. Unlike advances, standby letters of credit are accounted for as contingent liabilities because a standby letter of credit may expire in accordance with its terms without ever being drawn upon by the beneficiary. The Bank had $21.5 billion and $22.3 billion of outstanding standby letters of credit as of December 31, 2011 and 2010, respectively.

 

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Index to Financial Statements

Advances and Standby Letters of Credit Combined

The following table presents information on the Bank’s 10 largest borrowers of advances and standby letters of credit combined (dollars in millions):

 

          As of December 31, 2011  

Institution

               City, State                 Advances Par
Value and
Standby Letters of
Credit Balance
     Percent of Total
Advances Par

Value and Standby
Letters of Credit
 

Bank of America, National Association

     Charlotte, NC    $ 23,174         22.27   

Branch Banking and Trust Company

     Winton Salem, NC          14,492         13.92   

SunTrust Bank

     Atlanta, GA      8,787         8.44   

Navy Federal Credit Union

     Vienna, VA      7,605         7.31   

Capital One, National Association

     McLean, VA      6,621         6.36   

Compass Bank

     Birmingham, AL      6,297         6.05   

E*TRADE Bank

     Arlington, VA      2,274         2.18   

BankUnited

     Miami Lakes, FL      2,216         2.13   

RBC Bank (USA) (1)

     Raleigh, NC      2,204         2.12   

Regions Bank

     Birmingham, AL      2,051         1.97   
     

 

 

    

 

 

 

Subtotal (10 largest borrowers)

        75,721         72.75   

Subtotal (all other borrowers)

                        28,358         27.25   
     

 

 

    

 

 

 

Total advances par value and standby letters of credit

     $ 104,079                             100.00   
     

 

 

    

 

 

 

 

(1)

After close of business on March 9, 2012, RBC Bank (USA) merged with and into PNC Bank, National Association, a nonmember.

Community Investment Services

Each FHLBank contributes 10 percent of its annual regulatory income to its Affordable Housing Program (AHP), or such additional prorated sums as may be required to assure that the aggregate annual contribution of the FHLBanks is not less than $100 million. Regulatory income is defined as GAAP income before interest expense related to mandatorily redeemable capital stock and the assessment for AHP, but after the assessment for the Resolution Funding Corporation (REFCORP), discussed under the heading Taxation/Assessments below.

AHP provides direct subsidy funds or subsidized advances to members to support the financing of rental and for-sale housing for very low-, low-, and moderate-income individuals and families. The Bank offers a competitive AHP, a set-aside AHP, and a discounted advance program that supports projects that provide affordable housing to those individuals and families. A description of each program is as follows:

 

 

the competitive AHP is offered annually through a competitive application process and provides funds for either rental or ownership projects submitted through member financial institutions;

 

 

the set-aside AHP currently consists of five distinct products: First-time Homebuyer, Community Stability, Foreclosure Recovery, Energy Efficiency/Weatherization, and Accessibility Rehabilitation. Except for the First-time Homebuyer product, each of the set-aside AHP products are new products offered by the Bank in 2011. The set-aside AHP products are available on a first-come, first-served basis and provide funds through member financial institutions to be used for down payment, closing costs, and other costs associated with the purchase, purchase/rehabilitation, or rehabilitation of a home for families at or below 80 percent of the area median income; and

 

 

the discounted advance program consists of the Community Investment Program and the Economic Development Program, each of which provides the Bank’s members with access to low-cost funding to create affordable rental and homeownership opportunities and to engage in commercial and economic development activities that benefit low- and moderate-income individuals and neighborhoods.

 

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During the first quarter of 2011, the Bank discontinued its Economic Development and Growth Enhancement Program (EDGE). The EDGE was a selective program that provided subsidized advances to member financial institutions for specific community economic development projects; however, EDGE experienced low utilization by members.

For the years ended December 31, 2011 and 2010, AHP assessments were $21 million and $31 million, respectively.

Cash Management and Other Services

The Bank provides a variety of services to help members meet day-to-day cash management needs. These services include cash management services that support member advance activity, such as daily investment accounts, automated clearing house transactions, and custodial mortgage accounts. In addition to cash management services, the Bank provides other noncredit services, including wire transfer services and safekeeping services. These cash management, wire transfer, and safekeeping services do not generate material amounts of income and are performed primarily as ancillary services for the Bank’s members.

The Bank also acts as an intermediary for its members that have limited or no access to the capital markets but need to enter into derivatives. This service assists members with asset-liability management by giving them indirect access to the capital markets. These intermediary transactions involve the Bank entering into a derivative with a member and then entering into a mirror-image derivative with one of the Bank’s approved counterparties. The derivatives entered into by the Bank as a result of its intermediary activities do not qualify for hedge accounting treatment and are separately marked to fair value through earnings. The Bank attempts to earn income from this service sufficient to cover its operating expenses through the minor difference in rates on these mirror-image derivatives. The net result of the accounting for these derivatives is not material to the operating results of the Bank. The Bank may require both the member and the counterparty to post collateral for any market value exposure that may exist during the life of the transaction. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Legislative and Regulatory Updates for a discussion of new and pending regulations that may affect the Bank’s ability to continue to act as an intermediary for its members in derivatives transactions.

Mortgage Loan Purchase Programs

Historically, the Bank offered mortgage loan purchase programs to members to provide them an alternative to holding mortgage loans in portfolio or selling them into the secondary market. These programs, the Mortgage Partnership Finance® Program1 (MPF® Program or MPF) and the Mortgage Purchase Program (MPP), are authorized under applicable regulations. Under both the MPF Program and MPP, the Bank purchased loans directly from member participating financial institutions (PFIs). The loans consisted of one-to-four family residential properties with original maturities ranging from five years to 30 years. Depending upon the program, the acquired loans may have included qualifying conventional conforming, Federal Housing Administration (FHA) insured, and Veterans Administration (VA) guaranteed fixed-rate mortgage loans. The Bank also purchased participation interests in loans on affordable multifamily rental properties through its Affordable Multifamily Participation Program (AMPP).

The Bank ceased purchasing new mortgage assets under MPF and MPP in 2008, and stopped purchasing participation interests under AMPP in 2006. The Bank purchased loans with contractual maturity dates extending out to 2038. The Bank plans to continue to support its existing MPP, MPF, and AMPP portfolios, which eventually will be reduced to zero in the ordinary course of the maturities of the assets.

Regulatory interpretive guidance provides that an FHLBank may sell loans acquired through its mortgage loan purchase programs, so long as it also sells the related credit enhancement obligation. The Bank currently is not selling loans it has acquired through its mortgage loan purchase programs.

 

1 “Mortgage Partnership Finance” and “MPF” are registered trademarks of FHLBank Chicago.

 

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Descriptions of the MPF Program and MPP underwriting and eligibility standards and credit enhancement structures are contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Prudent Risk Management and Appetite—Credit Risk.

MPF Program

The unpaid principal balance of MPF loans held by the Bank was $1.4 billion and $1.8 billion at December 31, 2011 and 2010, respectively. FHLBank Chicago developed the MPF Program and, as the MPF provider, is responsible for providing transaction processing services, as well as developing and maintaining the underwriting criteria and program servicing guide. The Bank pays FHLBank Chicago a fee for providing these services. Conventional loans purchased from PFIs under the MPF Program are subject to varying levels of loss allocation and credit enhancement structures. FHA-insured and VA-guaranteed loans are not subject to the credit enhancement obligations applicable to conventional loans under the MPF Program. The Bank held $123 million and $160 million in FHA/VA loans under the MPF Program as of December 31, 2011 and 2010, respectively.

As of December 31, 2011, three of the Bank’s MPF PFIs, Branch Banking and Trust Company, SunTrust Bank and Capital One, National Association, which like all PFIs are currently inactive, were among the Bank’s top 10 borrowers.

MPP

The unpaid principal balance of MPP loans held by the Bank was $193 million and $241 million as of December 31, 2011 and 2010, respectively. As the Bank operates its MPP independently of other FHLBanks, it has greater control over the prices offered to its customers, quality of customer service, relationship with any third-party service provider, and program changes. Certain benefits of greater Bank control include the Bank’s ability to control operating costs and to manage its regulatory relationship directly with the Finance Agency. As of December 31, 2011, there were no MPP PFIs that were among the Bank’s top 10 borrowers.

AMPP

The Bank held participation interests in AMPP loans with an unpaid principal balance of $21 million as of December 31, 2011 and 2010.

Investments

The Bank maintains a portfolio of short- and long-term investments for liquidity purposes, to provide for the availability of funds to meet member credit needs and to provide additional earnings for the Bank. Investment income also enhances the Bank’s capacity to meet its commitments to affordable housing and community investment, cover operating expenses, and satisfy the Bank’s annual REFCORP assessment, discussed below. The long-term investment portfolio generally provides the Bank with higher returns than those available in short-term investments.

The Bank’s short-term investments were $14.5 billion and $16.9 billion as of December 31, 2011 and 2010, respectively. The Bank’s long-term investments were $21.7 billion and $23.0 billion as of December 31, 2011 and 2010, respectively. Short- and long-term investments represented 28.9 percent and 30.3 percent of the Bank’s total assets as of December 31, 2011 and 2010, respectively. These investments generated 68.0 percent, 68.5 percent and 54.4 percent of total interest income for the years ended December 31, 2011, 2010, and 2009, respectively.

The Bank’s short-term investments consist of overnight and term federal funds sold, certificates of deposit, and interest-bearing deposits. The Bank’s long-term investments consist of mortgage-backed securities (MBS) issued by government-sponsored mortgage agencies or private securities that, at purchase, carried the highest rating

 

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from Moody’s Investors Service (Moody’s) or Standard and Poor’s Ratings Services (S&P), securities issued by the U.S. government or U.S. government agencies, state and local housing agency obligations, and COs issued by other FHLBanks.

The Bank’s MBS investment practice is to purchase MBS from a group of Bank-approved dealers, which may include “primary dealers.” Primary dealers are banks and securities brokerages that trade in U.S. government securities with the Federal Reserve System. The Bank does not purchase MBS from its members, except in the case in which a member or its affiliate is on the Bank’s list of approved dealers. The Bank bases its investment decisions in all cases on the relative rates of return of competing investments and does not consider whether an MBS is being purchased from or issued by a member or an affiliate of a member. The MBS balance at December 31, 2011 and 2010 included MBS with a carrying value of $3.0 billion and $3.9 billion, respectively, issued by one of the Bank’s members and its affiliates with dealer relationships. See Note 6—Available-for-sale Securities and Note 7—Held-to-maturity Securities to the audited financial statements for a tabular presentation of the available-for-sale and held-to-maturity securities issued by members or affiliates of members.

Finance Agency regulations prohibit the Bank from investing in certain types of securities. These restrictions are set out in more detail in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Prudent Risk Management and Appetite—Credit Risk.

Prior to June 20, 2011, Finance Agency regulations further limited the Bank’s investment in MBS and asset-backed securities by requiring that the total carrying value of MBS owned by the Bank not exceed 300 percent of the Bank’s previous month-end total capital, as defined by regulation, plus mandatorily redeemable capital stock on the day it purchases the securities. Effective June 20, 2011, the value of securities used in the 300 percent of capital limit calculation was changed from carrying value to amortized historical cost for securities classified as held-to-maturity or available-for-sale, and fair value for securities classified as trading. For discussion regarding the Bank’s compliance with this regulatory requirement, refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Investments.

The Bank periodically invests in the outstanding COs issued by other FHLBanks as a part of its investment strategy. A description of the FHLBanks’ COs appears below under the heading Funding Sources—Consolidated Obligations. The terms of these investment COs generally are similar to the terms of COs issued by the Bank. At the time of such investment decision, however, indebtedness of the Bank may not be available for repurchase. The purchase of these investments is funded by a pool of liabilities and capital of the Bank and is not funded by specific or “matched” COs issued by the Bank.

The Bank purchases COs issued by other FHLBanks through third-party dealers as long-term investments, consistent with Finance Agency regulations and guidance. These investments provide a relatively predictable source of liquidity while at the same time maximizing earnings and the Bank’s leveraged capital ratio (as these longer-term investments typically earn a higher yield than short-term investments such as term federal funds sold). The Bank purchases long-term debt issued by other GSEs for the same reason, and generally the rates of return on such other long-term debt are similar to those on COs of the same maturity.

Normally, at the time of purchase of these investments, the Bank also enters into derivatives with mirror-image terms to the investments to offset price movements in the investment. This hedging helps maintain an appropriate repricing balance between assets and liabilities. At December 31, 2011 and 2010, the Bank held only one other FHLBank’s CO bond, in the amounts indicated in the table below.

 

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The following table sets forth the Bank’s investments in U.S. agency securities (dollars in millions):

 

     As of December 31,  
     2011     2010  
     Amount     Percent of
Total
Investments
    Weighted
-average
Yield
(%)
    Amount     Percent of
Total
Investments
    Weighted
-average
Yield
(%)
 

Government-sponsored enterprises debt obligations

      $ 4,146        11.47        3.16      $ 4,179        10.48        3.61   

Other FHLBank’s bond(1)

    82        0.23                18.75        74        0.19                17.63   

Mortgage-backed securities:

           

U.S. agency obligations-guaranteed

    803        2.22        1.08        960        2.41        1.07   

Government-sponsored enterprises

        9,886        27.36        1.89            8,716        21.86        2.57   
 

 

 

   

 

 

     

 

 

   

 

 

   

Total

      $ 14,917                41.28        $ 13,929            34.94     
 

 

 

   

 

 

     

 

 

   

 

 

   

 

(1) 

Consists of one inverse variable-rate consolidated obligation bond, on which Federal Home Loan Bank of Chicago is the primary obligor.

The Bank is subject to credit and market risk on its investments. For discussion as to how the Bank manages these risks, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Management.

Funding Sources

Consolidated Obligations

COs consisting of bonds and discount notes are the joint and several obligations of the FHLBanks, backed only by the financial resources of the FHLBanks. COs are not obligations of the U.S. government, and the United States does not guarantee the COs. The Bank, working through the Office of Finance, is able to customize COs to meet investor demands. Customized features can include different indices and embedded derivatives. These customized features are offset predominately by derivatives to reduce the market risk associated with the COs.

Although the Bank is primarily liable for its portion of COs (i.e., those issued on its behalf), the Bank also is jointly and severally liable with the other FHLBanks for the payment of principal and interest on COs of all the FHLBanks. If the principal or interest on any CO issued on behalf of the Bank is not paid in full when due, the Bank may not pay any extraordinary expenses or pay dividends to, or redeem or repurchase shares of stock from, any member of the Bank. The Finance Agency may at any time require any FHLBank to make principal or interest payments due on any COs, whether or not the primary obligor FHLBank has defaulted on the payment of that obligation.

To the extent that an FHLBank makes any payment on a CO on behalf of another FHLBank, the paying FHLBank is entitled to reimbursement from the noncomplying FHLBank. However, if the Finance Agency determines that the noncomplying FHLBank is unable to satisfy its obligations, the Finance Agency may allocate the outstanding liability among the remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all COs outstanding or on any other basis the Finance Agency may determine.

Finance Agency regulations also state that the Bank must maintain the following types of assets free from any lien or pledge in an aggregate amount at least equal to the amount of the Bank’s portion of the COs outstanding, provided that any assets that are subject to a lien or pledge for the benefit of the holders of any issue of COs shall be treated as if they were assets free from any lien or pledge for purposes of this negative pledge requirement:

 

 

cash;

 

 

obligations of, or fully guaranteed by, the United States;

 

 

secured advances;

 

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mortgages that have any guaranty, insurance, or commitment from the United States or any agency of the United States;

 

 

investments described in Section 16(a) of the FHLBank Act which, among other items, includes securities that a fiduciary or trust fund may purchase under the laws of the state in which the FHLBank is located; and

 

 

other securities that have been assigned a rating or assessment by a nationally recognized statistical rating organization (NRSRO) that is equivalent to or higher than the rating or assessment assigned by that NRSRO to the COs.

The following table presents the Bank’s compliance with this requirement (in millions):

 

          Outstanding Debt              Aggregate Unencumbered Assets      

As of December 31, 2011

     $ 114,992                   $ 125,061   

As of December 31, 2010

                 119,113         131,532   

The Office of Finance has responsibility for facilitating and executing the issuance of the COs. It also services all outstanding debt.

Consolidated Obligation Bonds. Consolidated obligation bonds satisfy longer-term funding requirements. Typically, the maturity of these securities ranges from one year to 10 years, but the maturity is not subject to any statutory or regulatory limit. Consolidated obligation bonds can be issued and distributed through negotiated or competitively bid transactions with approved underwriters or selling group members. The FHLBanks also use the TAP issue program for fixed-rate, noncallable bonds. Under this program, the FHLBanks offer debt obligations at specific maturities that may be reopened daily, generally during a three-month period through competitive auctions. The goal of the TAP program is to aggregate frequent smaller issues into a larger bond issue that may have greater market liquidity.

Consolidated Obligation Discount Notes. Through the Office of Finance, the FHLBanks also issue consolidated obligation discount notes to provide short-term funds for advances to members, for the Bank’s short-term investments, and for the Bank’s variable-rate and convertible advance programs. These securities have maturities up to 366 days and are offered daily through a consolidated obligation discount-note selling group. Discount notes are issued at a discount and mature at par.

The following table shows the net amount of the Bank’s outstanding consolidated obligation bonds and discount notes (in millions).

 

     As of December 31,  
     2011      2010  

Consolidated obligations, net:

     

Bonds

     $ 90,662         $ 95,198   

Discount notes

     24,330         23,915   
  

 

 

    

 

 

 

Total

     $                     114,992         $                     119,113   
  

 

 

    

 

 

 

Certification and Reporting Obligations. Under Finance Agency regulations, before the end of each calendar quarter and before paying any dividends for that quarter, the president of the Bank must certify to the Finance Agency that, based upon known current facts and financial information, the Bank will remain in compliance with applicable liquidity requirements and will remain capable of making full and timely payment of all current obligations (which includes the Bank’s obligation to pay principal and interest on COs issued on its behalf through the Office of Finance) coming due during the next quarter. The Bank is required to provide notice to the Finance Agency upon the occurrence of any of the following:

 

 

the Bank is unable to provide the required certification;

 

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the Bank projects at any time that it will fail to comply with its liquidity requirements or will be unable to meet all of its current obligations due during the quarter;

 

 

the Bank actually fails to comply with its liquidity requirements or to meet all of its current obligations due during the quarter; or

 

 

the Bank negotiates to enter or enters into an agreement with one or more other FHLBanks to obtain financial assistance to meet its current obligations due during the quarter.

The Bank must file a CO payment plan for Finance Agency approval upon the occurrence of any of the following:

 

 

the Bank becomes a noncomplying FHLBank as a result of failing to provide a required certification related to liquidity requirements and ability to meet all current obligations;

 

 

the Bank becomes a noncomplying FHLBank as a result of being required to provide notice to the Finance Agency of certain matters related to liquidity requirements or inability to meet current obligations; or

 

 

the Finance Agency determines that the Bank will cease to be in compliance with its liquidity requirements or will lack the capacity to meet all of its current obligations due during the quarter.

Regulations permit a noncompliant FHLBank to continue to incur and pay normal operating expenses in the regular course of business. However, a noncompliant FHLBank may not incur or pay any extraordinary expenses, declare or pay dividends, or redeem any capital stock until such time as the Finance Agency has approved the FHLBank’s CO payment plan or inter-FHLBank assistance agreement or has ordered another remedy, and the noncompliant FHLBank has paid all its direct obligations.

Deposits

The FHLBank Act allows the Bank to accept deposits from its members, any institution for which it is providing correspondent services, other FHLBanks, or other governmental instrumentalities. Deposits provide some of the Bank’s funding resources while also giving members a low-risk earning asset that satisfies their regulatory liquidity requirements. As of December 31, 2011 and 2010, the Bank had demand and overnight deposits of $2.7 billion and $3.1 billion, respectively.

To support its member deposits, the FHLBank Act requires the Bank to have as a reserve an amount equal to or greater than its current deposits from members. These reserves are required to be invested in obligations of the United States, deposits in eligible banks or trust companies, or certain advances with maturities not exceeding five years. As of December 31, 2011 and 2010, the Bank had excess deposit reserves of $76.1 billion and $77.6 billion, respectively.

Capital, Capital Rules, Retained Earnings, and Dividends

Capital and Capital Rules

The Bank is required to comply with regulatory requirements for total capital, leverage capital, and risk-based capital. Under these requirements, the Bank must maintain total capital in an amount equal to at least four percent of total assets and weighted leverage capital in an amount equal to at least five percent of total assets. “Weighted leverage capital” is defined as the sum of permanent capital weighted 1.5 times and nonpermanent capital weighted 1.0 times. Under the risk-based capital requirement, the Bank must maintain permanent capital, defined by the FHLBank Act and applicable regulations as the sum of paid-in capital for Class B stock and retained earnings, in an amount equal to or greater than the sum of the Bank’s credit, market, and operating risk capital requirements. The regulatory definition of permanent capital results in a calculation of permanent capital different from that determined in accordance with GAAP because the regulatory definition treats mandatorily redeemable capital stock as capital.

 

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Credit risk capital is the sum of the capital charges for the Bank’s assets, off-balance sheet items, and derivatives contracts. The Bank calculates these charges using the methodology and risk weights assigned to each classification by the Finance Agency. Market risk capital is the sum of the market value of the Bank’s portfolio at risk from movement in interest rates, foreign exchange rates, commodity prices, and equity prices that could occur during times of market stress and the amount, if any, by which the market value of total capital is less than 85 percent of the carrying value of total capital. Operational risk capital is equal to 30 percent of the sum of the credit risk capital component and the market risk capital component. Regulations define “total capital” as the sum of:

 

 

permanent capital;

 

 

the amount of paid-in Class A stock, if any (the Bank does not issue Class A stock);

 

 

the amount of the Bank’s general allowance for losses (if any); and

 

 

the amount of any other instruments identified in the Bank’s capital plan that the Finance Agency has determined to be available to absorb losses.

To satisfy these capital requirements, the Bank maintains a capital plan, as last amended by the board of directors on May 13, 2011. Each member’s minimum stock requirement is an amount equal to the sum of a “membership” stock component and an “activity-based” stock component under the plan. The FHLBank Act and applicable regulations require that the minimum stock requirement for members must be sufficient to enable the Bank to meet its minimum leverage and risk-based capital requirements. If necessary, the Bank may adjust the minimum stock requirement from time to time within the ranges established in the capital plan. Each member is required to comply promptly with any adjustment to the minimum stock requirement.

The capital plan permits the Bank’s board of directors to set the membership and activity-based stock requirements within a range as set forth in the capital plan. As of December 31, 2011, the membership stock requirement was 0.15 percent (15 basis points) of the member’s total assets, subject to a cap of $26 million.

As of December 31, 2011, the activity-based stock requirement was the sum of the following:

 

 

4.50 percent of the member’s outstanding par value of advances; and

 

 

8.00 percent of any outstanding targeted debt/equity investment (investments similar to AMPP assets) sold by the member to the Bank on or after December 17, 2004.

In addition, the activity-based stock requirement may include a percentage of any outstanding balance of acquired member assets (such as MPF and MPP assets), although this percentage was set at zero as of December 31, 2011. As of December 31, 2011, all of the Bank’s AMPP assets had been acquired from a nonmember; therefore, the 8.00 percent activity-based stock requirement did not apply with respect to those AMPP assets.

Although applicable regulations allow the Bank to issue Class A stock or Class B stock, or both, to its members, the Bank’s capital plan allows it to issue only Class B stock. For additional information regarding the Bank’s stock, refer to Item 5, Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Retained Earnings and Dividends

The Bank has established a capital management policy to help preserve the value of the members’ investment in the Bank and reasonably mitigate the effect on capital of unanticipated operating and accounting events. At least quarterly, the Bank assesses the adequacy of its retained earnings under a highly stressed scenario and an extremely stressed scenario, each over a three year horizon and assuming quarterly excess stock repurchases. This assessment considers pessimistic assumptions about forecasted income, mark-to-market adjustments on

 

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derivatives and trading securities, credit risk, market risk, and operational risk. Quarterly, the board of directors sets the targeted amount of retained earnings the Bank is required to hold after the payment of dividends based on this assessment. Based upon this quantitative analysis, the board of directors established the target amount of retained earnings at $468 million as of December 31, 2011. The Bank’s retained earnings at December 31, 2011 were higher than this target by $786 million, as discussed in more detail in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Bank may pay dividends on its capital stock only out of its unrestricted retained earnings or current net earnings. The Bank’s board of directors has discretion to declare or not declare dividends and to determine the rate of any dividends declared. The board of directors may neither declare nor require the Bank to pay dividends when it is not in compliance with all of its capital requirements or if, after giving effect to the dividend, the Bank would fail to meet any of its capital requirements. The Bank also may not declare a dividend if the dividend would create a financial safety and soundness issue for the Bank.

The Finance Agency prohibits any FHLBank from issuing dividends in the form of stock or otherwise issuing new “excess stock” if that FHLBank has excess stock greater than one percent of that FHLBank’s total assets or if issuing such dividends or new excess stock would cause that FHLBank to exceed the one percent excess stock limitation. Excess stock is FHLBank capital stock not required to be held by the member to meet its minimum stock requirement under an FHLBank’s capital plan. At December 31, 2011, the Bank’s excess capital stock outstanding was 0.92 percent of the Bank’s total assets. Historically, the Bank has not issued dividends in the form of stock or issued new “excess stock,” and a member’s existing excess activity-based stock is applied to any activity-based stock requirements related to new advances.

Derivatives

Finance Agency regulations and the Bank’s Risk Management Policy (RMP) establish guidelines for derivatives. These policies and regulations prohibit trading in or the speculative use of these instruments and limit permissible credit risk arising from these instruments. The Bank enters into derivatives only to manage the interest-rate risk exposures inherent in otherwise unhedged assets and funding positions, and to achieve the Bank’s risk management objectives. These derivatives consist of interest-rate swaps (including callable swaps and putable swaps), swaptions, interest-rate cap and floor agreements, and futures and forward contracts. Generally, the Bank uses derivatives in its overall interest-rate risk management to accomplish one or more of the following objectives:

 

 

reduce the interest-rate net sensitivity of COs, advances, investments, and mortgage loans by, in effect, converting them to a short-term interest rate, usually based on LIBOR;

 

 

manage embedded options in assets and liabilities;

 

 

hedge the market value of existing assets or liabilities; and

 

 

hedge the duration risk of pre-payable instruments.

The total notional amount of the Bank’s outstanding derivatives was $139.7 billion and $142.2 billion as of December 31, 2011 and 2010, respectively. The contractual or notional amount of a derivative is not a measure of the amount of credit risk from that transaction. Rather, the notional amount serves as a basis for calculating periodic interest payments or cash flows.

The Bank may enter into derivatives concurrently with the issuance of COs with embedded options. Issuing bonds while simultaneously entering into derivatives converts, in effect, fixed-rate liabilities into variable-rate liabilities. The continued attractiveness of such debt depends on price relationships in both the bond market and derivatives markets. If conditions in these markets change, the Bank may alter the types or terms of the bonds issued. Similarly, the Bank may enter into derivatives in conjunction with the origination of advances with embedded options. Issuing fixed-rate advances while simultaneously entering into derivatives converts, in effect, fixed-rate advances into variable-rate earning assets.

 

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The Bank is subject to credit risk in all derivatives due to potential nonperformance by the derivative counterparty. The Bank reduces this risk by executing derivatives only with highly-rated financial institutions. In addition, the legal agreements governing the Bank’s derivatives require the credit exposure of all derivatives with each counterparty to be netted. As of December 31, 2011, the Bank had credit risk exposure to four counterparties, before considering collateral, in an aggregate amount of $40 million. None of these counterparties was a top ten borrower of the Bank. As of December 31, 2010, the Bank had credit risk exposure to one counterparty, before considering collateral, in an aggregate amount of $66 million. This counterparty was Bank of America, National Association, which was one of the Bank’s ten largest advances borrowing institutions as of December 31, 2010.

The market risk of derivatives can be measured meaningfully only on a portfolio basis, taking into account the entire balance sheet and all derivatives. The market risk of the derivatives and the hedged items is included in the measurement of the Bank’s effective duration gap (the difference between the expected weighted average maturities of the Bank’s assets and liabilities). As of December 31, 2011, the Bank’s duration calculations suggested an effective duration gap of negative 0.06 years. While duration calculations are inherently approximate rather than absolute, a positive duration gap generally indicates an overall exposure to rising interest rates; conversely, a negative duration gap normally indicates an overall exposure to falling interest rates. The larger the duration gap, whether positive or negative, indicates a larger exposure risk.

For further discussion as to how the Bank manages its credit risk and market risk on its derivatives, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation—Prudent Risk Management and Risk Appetite. For further discussion as to the possible impact of new and pending regulations regarding derivatives, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Legislative and Regulatory Update.

Competition

Advances. A number of factors affect demand for the Bank’s advances, including, but not limited to, the availability and cost of other sources of liquidity for the Bank’s members, such as demand deposits, brokered deposits and the repurchase market. The Bank individually competes with other suppliers of secured and unsecured wholesale funding. Such other suppliers may include investment banks, commercial banks, and in certain circumstances, other FHLBanks. Smaller members may have access to alternative funding sources through sales of securities under agreements to repurchase, while larger members may have access to all the alternatives listed. Large members also may have independent access to the national and global credit markets. The availability of alternative funding sources to members can significantly influence the demand for the Bank’s advances and can vary as a result of a number of factors including, among others, market conditions, members’ creditworthiness, and availability of collateral. As the banking industry generally has stabilized, the competition to fund large members affiliated with members of other FHLBanks has increased. Aggressive pricing strategies by other FHLBanks or other alternative funding sources could impact the Bank’s membership and overall business.

Members continue to experience significant levels of liquidity in part due to higher FDIC deposit insurance limits which in 2010 were permanently increased to $250,000 per depositor, and the extension of the FDIC Transaction Account Guaranty Program, which provided depositors with unlimited coverage for qualifying noninterest-bearing accounts through December 31, 2012. Further, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) repealed the statutory prohibition against the payment of interest on commercial demand deposits, effective July 21, 2011. Members’ ability to pay interest on their commercial demand deposit accounts may increase their ability to attract or retain customer deposits, which could further increase their liquidity and reduce their demand for advances. In addition, the FDIC issued a final rule on February 25, 2011 to revise the assessment system applicable to FDIC insured financial institutions. Among other things, the rule now includes FHLBank advances in members’ assessment base, and eliminates an adjustment to the base assessment rate paid for secured liabilities, including FHLBank advances. To the extent that these changes result in increased assessments and thus indirectly increase the cost of advances for some

 

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members, it may negatively impact their demand for our advances. Recent legislative proposals to develop a U.S. covered bond market could enhance the attractiveness of covered bonds as an alternative funding source for members, although it is unclear the extent to which these proposals will progress during 2012.

Debt Issuance. The Bank competes with Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities for funds raised through the issuance of unsecured debt in the national and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lesser amounts of debt issued at the same cost than otherwise would be the case. In addition, the availability and cost of funds raised through the issuance of certain types of unsecured debt may be affected adversely by regulatory initiatives that tend to reduce investments by certain depository institutions in unsecured debt with greater price volatility or interest-rate sensitivity than fixed-rate, fixed-maturity instruments of the same maturity. Further, a perceived or actual higher level of government support for other GSEs may increase demand for their debt securities relative to similar FHLBank securities.

Interest-rate Exchange Agreements. The sale of callable debt and the simultaneous execution of callable interest-rate swaps that mirror the debt have been important sources of competitive funding for the Bank. As such, the availability of markets for callable debt and interest-rate swaps may be an important determinant of the Bank’s relative cost of funds. There is considerable competition among high credit quality issuers in the markets for these instruments.

Regulatory Oversight, Audits, and Examinations

The Finance Agency supervises and regulates the FHLBanks. The Finance Agency is responsible for ensuring that (1) the FHLBanks operate in a safe and sound manner, including maintenance of adequate capital and internal controls; (2) the operations and activities of the FHLBanks foster liquid, efficient, competitive and resilient national housing finance markets; (3) the FHLBanks comply with applicable laws and regulations; and (4) the FHLBanks carry out their housing finance mission through authorized activities that are consistent with the public interest. In this capacity, the Finance Agency issues regulations and policies that govern, among other things, the permissible activities, powers, investments, risk-management practices, and capital requirements of the FHLBanks, and the authorities and duties of FHLBank directors. The Finance Agency conducts annual, on-site examinations of the Bank as well as periodic off-site reviews. In addition, the Bank must submit to the Finance Agency monthly financial information on the condition and results of operations of the Bank.

In 2006, in accordance with the Finance Board’s regulation, the Bank registered its Class B stock with the SEC under Section 12(g)(1) of the Securities Exchange Act of 1934, as amended (Exchange Act). The Housing Act codified the regulatory requirement that each FHLBank register a class of its common stock under Section 12(g) of the Exchange Act. As a result of this registration, the Bank is required to comply with the disclosure and reporting requirements of the Exchange Act and to file with the SEC annual, quarterly and current reports, as well as meet other SEC requirements, subject to certain exemptive relief obtained from the SEC and under the Housing Act.

The Government Corporation Control Act provides that, before a government corporation (which includes each of the FHLBanks) issues and offers obligations to the public, the Secretary of the Treasury shall prescribe (1) the form, denomination, maturity, interest rate, and conditions of the obligations; (2) the time and manner in which issued; and (3) the selling price. Under the FHLBank Act, the Secretary of the Treasury has the authority, at his or her discretion, to purchase COs up to an aggregate principal amount of $4.0 billion. No borrowings under this authority have been outstanding since 1977. The U.S. Department of the Treasury (Treasury) receives the Finance Agency’s annual report to Congress, weekly reports reflecting securities transactions of the FHLBanks, and other reports reflecting the operations of the FHLBanks.

The Comptroller General has authority under the FHLBank Act to audit or examine the Finance Agency and the Bank and to decide the extent to which they fairly and effectively fulfill the purposes of the FHLBank Act.

 

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Furthermore, the Government Corporation Control Act provides that the Comptroller General may review any audit of the financial statements conducted by an independent registered public accounting firm. If the Comptroller General conducts such a review, he or she must report the results and provide his or her recommendations to Congress, the Office of Management and Budget, and the FHLBank in question. The Comptroller General also may conduct his or her own audit of any financial statements of the Bank.

The Bank has an internal audit department, the Bank’s board of directors has an audit committee, and an independent registered public accounting firm audits the annual financial statements of the Bank. The independent registered public accounting firm conducts these audits following the standards of the Public Company Accounting Oversight Board (United States) and Government Auditing Standards issued by the Comptroller General. The Finance Agency receives the Bank’s Report and audited financial statements. The Bank must submit annual management reports to Congress, the President of the United States, the Office of Management and Budget, and the Comptroller General. These reports include a statement of financial condition, a statement of operations, a statement of cash flows, a statement of internal accounting and administrative control systems, and the report of the independent registered public accounting firm on the financial statements.

Personnel

As of December 31, 2011, the Bank employed 357 full-time and nine part-time employees. The number of full-time employees decreased 11.6 percent and part-time employees decreased 30.8 percent from December 31, 2010. Over the last several years, staffing levels at the Bank increased in response to growing shareholder demand for products and services. During 2011, management began to strategically reduce overall staffing levels and restructure the Bank in response to changing business and economic conditions.

Taxation/Assessments

Although the Bank is exempt from ordinary federal, state, and local taxation except for real property tax, the Bank was obligated to make quarterly payments to REFCORP through the second quarter of 2011. On August 5, 2011, the Finance Agency certified that the FHLBanks had fully satisfied their REFCORP obligation with their payment on July 15, 2011. Prior to the satisfaction of the FHLBanks’ REFCORP obligation, each FHLBank was required to make payments to REFCORP (20 percent of annual GAAP net income before REFCORP assessments and after payment of AHP assessments) until the total amount of payments actually made was equivalent to a $300 million annual annuity whose final maturity date was April 15, 2030 (the expiration date of the REFCORP obligation). The Finance Agency shortened or lengthened the period during which the FHLBanks made payments to REFCORP based on actual payments made relative to the referenced annuity. The Finance Agency, in consultation with the U.S. Secretary of the Treasury, selected the appropriate discounting factors used in calculating the annuity.

The FHLBanks entered into a Joint Capital Enhancement Agreement (as amended, the Joint Capital Agreement), which requires each FHLBank to allocate 20 percent of its net income to a separate restricted retained earnings account, beginning in the third quarter of 2011. Because the REFCORP assessment reduced the amount of regulatory income used to calculate the AHP assessment, it had the effect of reducing the total amount of funds allocated to the AHP. The amounts allocated to the new restricted retained earnings account, however, will not be treated as an assessment and will not reduce each FHLBank’s net income. As a result, each FHLBank’s AHP contributions as a percentage of pre-assessment earnings will increase because the REFCORP obligation has been fully satisfied. Refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Capital, for further discussion of the Joint Capital Agreement.

Each year the Bank must set aside for its AHP 10 percent of its annual regulatory income, or such prorated sums as may be required to assure that the aggregate contribution of the FHLBanks is not less than $100 million. If an FHLBank experienced a regulatory loss for a full year, the FHLBank would have no obligation to the AHP for that year, since each FHLBank’s required annual AHP contribution is limited to its annual regulatory income.

 

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REFCORP has been designated as the calculation agent for AHP and REFCORP assessments. The combined REFCORP and AHP assessments for the Bank were $43 million, $100 million and $103 million for the years ended December 31, 2011, 2010, and 2009, respectively.

 

Item 1A. Risk Factors.

The following discussion summarizes some of the more important risks that the Bank faces. This discussion is not exhaustive, and there may be other risks that the Bank faces, which are not described below. These risks should be read in conjunction with the other information included in this Report, including, without limitation, in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, the financial statements and notes and “Special Cautionary Notice Regarding Forward-looking Statements.” The risks described below, if realized, could negatively affect the Bank’s business operations, financial condition, and future results of operations and, among other things, could result in the Bank’s inability to pay dividends on its capital stock.

The Bank is jointly and severally liable for payment of principal and interest on the COs issued by the other FHLBanks.

Each of the FHLBanks relies upon the issuance of COs as a primary source of funds. COs are the joint and several obligations of all of the FHLBanks, backed only by the financial resources of the FHLBanks. Accordingly, the Bank is jointly and severally liable with the other FHLBanks for the COs issued by the FHLBanks through the Office of Finance, regardless of whether the Bank receives all or any portion of the proceeds from any particular issuance of COs.

The Finance Agency by regulation may require any FHLBank to make principal or interest payments due on any CO at any time, whether or not the FHLBank that was the primary obligor has defaulted on the payment of that obligation. The Finance Agency may allocate the liability among one or more FHLBanks on a pro rata basis or on any other basis the Finance Agency may determine. Accordingly, the Bank could incur significant liability beyond its primary obligation under COs due to the failure of other FHLBanks to meet their obligations, which could negatively affect the Bank’s financial condition and results of operations.

During 2011, at least one of the other FHLBanks was classified by the Finance Agency as undercapitalized. In addition, during the recent financial crisis several FHLBanks announced matters related to net losses, suspension of dividends, suspension of stock repurchases and risk-based capital deficiencies, primarily in light of losses related to private-label MBS. If the economy experiences additional significant stress, it is possible that these FHLBanks may experience further MBS-related losses that in turn affect the FHLBanks’ financial condition and ability to pay principal and interest when due on the COs for which they are primarily liable.

The Bank’s funding depends upon its ability to regularly access the capital markets.

The Bank seeks to be in a position to meet its members’ credit and liquidity needs and pay its obligations without maintaining excessive holdings of low-yielding liquid investments or being forced to incur unnecessarily high borrowing costs. The Bank’s primary source of funds is the sale of COs in the capital markets, including the short-term discount note market. The Bank’s ability to obtain funds through the sale of COs depends in part on prevailing conditions in the capital markets (including investor demand), such as the effects of any reduced liquidity in financial markets, which are beyond the Bank’s control.

Changes in the Bank’s credit ratings may adversely affect the Bank’s ability to issue COs on acceptable terms, and such changes may be outside the Bank’s control due to changes in the U.S. sovereign ratings.

The Bank is rated Aaa with a negative outlook by Moody’s and AA+ with a negative outlook by S&P. In addition, the COs of the FHLBanks are rated Aaa with a negative outlook/P-1 by Moody’s and AA+/A-1+ by

 

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S&P. Historically, the Bank and the FHLBanks’ COs enjoyed the highest ratings from Moody’s and S&P; however, the credit rating agencies view these ratings as constrained by the sovereign credit of the U.S., which is beyond the Bank’s control, and in the third quarter of 2011, the credit rating agencies revised their ratings for the individual FHLBanks and the COs concurrently with their downgrades of the U.S. credit rating. These ratings are subject to further revision or withdrawal at any time by the rating agencies; therefore, the Bank may not be able to maintain these credit ratings. Further negative ratings actions or negative guidance may adversely affect the Bank’s cost of funds and ability to issue COs on acceptable terms, trigger additional collateral requirements under the Bank’s derivative contracts, and reduce the attractiveness of the Bank’s standby of credit, which could have a negative effect on the Bank’s financial condition and results of operations.

The Bank faces competition for advances, which could have an adverse effect on earnings.

Advances represent the Bank’s primary product offering. For the year ended December 31, 2011, advances represented 69.4 percent of the Bank’s total assets. The Bank competes with other suppliers of wholesale funding, including investment banks, commercial banks, and in certain circumstances, other FHLBanks, which provide secured and unsecured loans to the Bank’s members. These alternative funding sources may offer more favorable terms on their loans than the Bank does on its advances, including more flexible credit or collateral standards. During 2011, the Bank’s members experienced high deposit levels partly as a result of the FDIC’s increased deposit insurance coverage, and decreasing member demand for advances. In addition, many of the Bank’s competitors are not subject to the same body of regulations applicable to the Bank, which enables those competitors to offer products more quickly and on terms that the Bank may not be able to offer. Any change made by the Bank in the pricing of its advances in an effort to effectively compete with these competitive funding sources may decrease the Bank’s profitability on advances, which could result in lower dividend yields to members. A decrease in the demand for the Bank’s advances or a decrease in the Bank’s profitability on advances could have a material adverse effect on the Bank’s financial condition and results of operations.

The Bank is exposed to risks because of customer concentration.

The Bank is subject to customer concentration risk as a result of the Bank’s reliance on a relatively small number of member institutions for a large portion of the Bank’s total advances and resulting interest income. As of December 31, 2011 and 2010, the Bank’s largest borrower, Bank of America, National Association, accounted for $16.0 billion and $25.0 billion, respectively, of the Bank’s total advances then outstanding, which represented 19.4 percent and 29.4 percent, respectively, of the Bank’s total advances then outstanding. In addition, as of December 31, 2011 and 2010, 10 of the Bank’s member institutions (including Bank of America, National Association) collectively accounted for $57.0 billion and $58.0 billion, respectively, of the Bank’s total advances then outstanding, which represented 69.0 percent and 68.3 percent, respectively, of the Bank’s total advances then outstanding. If, for any reason, the Bank were to lose, or experience a decrease in the amount of, its business relationships with its largest borrower or a combination of several of its large borrowers—whether as the result of any such member becoming a party to a merger or other transaction, or as a result of market conditions, competition or otherwise—the Bank’s financial condition and results of operations could be negatively affected.

The financial services industry has seen a significant number of failed financial institutions, many of which were Bank members, during 2011, and the Bank expects more financial institution failures during 2012. All or a portion of the assets and liabilities of a failed financial institution may be acquired by another financial institution. In addition, stronger financial institutions may see more opportunities during 2012 to acquire other financial institutions under attractive terms and conditions. This consolidation of the industry may reduce the number of potential members in the Bank’s district and result in a loss of overall business for the Bank.

Changes in interest rates could significantly affect the Bank’s earnings.

Like many financial institutions, the Bank realizes income primarily from the spread between interest earned on the Bank’s outstanding loans and investments and interest paid on the Bank’s borrowings and other liabilities. Although the Bank uses a number of measures to monitor and manage changes in interest rates, the Bank may

 

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experience “gaps” in the interest-rate sensitivities of its assets and liabilities resulting from both duration and convexity mismatches. The existence of gaps in interest-rate sensitivities means that either the Bank’s interest-bearing liabilities will be more sensitive to changes in interest rates than its interest-earning assets, or vice versa. In either case, if interest rates move contrary to the Bank’s position, any such gap could adversely affect the net present value of the Bank’s interest-sensitive assets and liabilities, which could negatively affect the Bank’s financial condition and results of operations.

Prepayment of mortgage assets could affect earnings.

The Bank invests in both MBS and whole mortgage loans. Changes in interest rates can significantly affect the prepayment patterns of these assets, and such prepayment patterns could affect the Bank’s earnings. In management’s experience, it is difficult to hedge prepayment risk in mortgage loans. Therefore, prepayments of mortgage assets could have an adverse effect on the income of the Bank.

The Bank’s exposure to credit risk could have an adverse effect on the Bank’s financial condition and results of operations.

The Bank assumes secured and unsecured credit risk exposure associated with the risk of default by, or insolvency of, a borrower or counterparty. Any substantial devaluation of collateral, failure to properly perfect the Bank’s security interest in collateral, an inability to liquidate collateral, or any disruptions in the servicing of collateral in the event of a default could create credit losses for the Bank.

The Bank invests in U.S. agency (Fannie Mae, Freddie Mac, and Ginnie Mae) MBS and has historically invested in private-label MBS rated AAA by S&P or Fitch Ratings or Aaa by Moody’s at the time of purchase. As of December 31, 2011, a substantial portion of the Bank’s MBS portfolio consisted of private-label MBS. Market prices for many of these private-label MBS have deteriorated since 2007. Given continued uncertainty in market conditions and the significant judgments involved in determining market value, there is a risk that further declines in fair value in the Bank’s MBS portfolio may occur and that the Bank may record additional other-than-temporary impairment losses in future periods, which could materially adversely affect the Bank’s earnings and retained earnings and the value of Bank membership.

Rising delinquency rates on the Bank’s mortgage loans held for portfolio could adversely impact the Bank’s financial condition.

As discussed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates—Allowance for Credit Losses, delinquency rates on the Bank’s conventional single-family residential mortgages increased from 4.37 percent as of December 31, 2010 to 5.87 percent as of December 31, 2011, and the estimated loss severity rate used in the loan loss reserve methodology for MPF loans increased from 14.0 percent at December 31, 2010 to 37.6 percent at December 31, 2011. Accordingly, the Bank recorded an allowance for credit losses on conventional single-family residential mortgage loans of $5 million at December 31, 2011, an increase from $0 at December 31, 2010. While the Bank has not changed its base methodology for calculating the allowance for loan losses since December 31, 2010, the Bank increased the loss severity estimates that it applies to projected defaulted loans. This revision in loss assumptions reflects the prolonged deterioration in U.S. housing markets and resulting expectations as to the length and depth of depressed housing prices and impact on realized losses. To the extent that economic conditions further weaken and regional or national home prices continue to decline, the Bank may determine to further increase its allowance for credit losses on mortgage loans.

The insolvency or other inability of a significant counterparty to perform its obligations could adversely affect the Bank.

The Bank assumes credit risk when entering into securities transactions, money market transactions, supplemental mortgage insurance agreements, and derivative contracts with counterparties. The Bank routinely

 

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executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. The insolvency or other inability of a significant counterparty to perform its obligations under a derivative contract or other agreement could have an adverse effect on the Bank’s financial condition and results of operations. In addition, the Bank’s credit risk may be exacerbated based on market movements or when the collateral pledged to the Bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Bank.

The Bank uses master derivative contracts that contain provisions that require the Bank to net the exposure under all transactions with the counterparty to one amount to calculate collateral requirements. At times, the Bank enters into derivative contracts with U.S. branches or agency offices of foreign commercial banks in jurisdictions in which it is uncertain whether the netting provisions would be enforceable in the event of insolvency of the foreign commercial bank. Although the Bank attempts to monitor the creditworthiness of all counterparties, it is possible that the Bank may not be able to terminate the agreement with a foreign commercial bank before the counterparty would become subject to an insolvency proceeding.

The Bank relies upon derivative instruments to reduce its interest-rate risk, and the Bank may not be able to enter into effective derivative instruments on acceptable terms.

The Bank uses derivative instruments to attempt to reduce its interest-rate risk and mortgage prepayment risk. The Bank’s management determines the nature and quantity of hedging transactions based on various factors, including market conditions and the expected volume and terms of advances. As a result, the Bank’s effective use of these instruments depends on the ability of Bank management to determine the appropriate hedging positions in light of the Bank’s assets, liabilities, and prevailing and anticipated market conditions. In addition, the effectiveness of the Bank’s hedging strategy depends upon the Bank’s ability to enter into these instruments with acceptable parties, upon terms satisfactory to the Bank, and in the quantities necessary to hedge the Bank’s corresponding obligations. If the Bank is unable to manage its hedging positions properly or is unable to enter into hedging instruments upon acceptable terms, the Bank may be unable to manage its interest-rate and other risks, or may be required to decrease its MBS holdings, which could affect the Bank’s financial condition and results of operations.

Refer to the information set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Derivatives and Hedging Activities, for a discussion of the effect of the Bank’s use of derivative instruments on the Bank’s net income, and Management’s Discussion and Analysis of Financial Condition and Results of Operations—Legislative and Regulatory Developments for a discussion of the new statutory and regulatory requirements for derivative transactions under the Dodd-Frank Act.

The financial models and the underlying assumptions used to value financial instruments may differ materially from actual results.

The degree of management judgment in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market parameters. If market quotes are not available, fair values are based on discounted cash flows using market estimates of interest rates and volatility or on dealer prices or prices of similar instruments. Pricing models and their underlying assumptions are based on management’s best estimates for discount rates, prepayments market volatility, and other factors. These assumptions may have a significant effect on the reported fair values of assets and liabilities, including derivatives, the related income and expense, and the expected future behavior of assets and liabilities. While models used by the Bank to value instruments and measure risk exposures are subject to periodic validation by independent parties, rapid changes in market conditions could impact the value of the Bank’s instruments, as well as the Bank’s financial condition and results of operations. Models are inherently imperfect predictors of actual results because they are based on assumptions about future performance. Changes in any models or in any of the assumptions, judgments or estimates used in the models may cause the results generated by the model to be materially different from actual results.

 

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An increase in the percentage of AHP contributions that the Bank is required to make could decrease the Bank’s dividends payable to its members.

If the aggregate AHP contributions of the FHLBanks were to fall below $100 million, the Finance Agency would prorate the remaining sums among the FHLBanks, subject to certain conditions, as may be required to meet the minimum $100 million annual contribution. Increasing the Bank’s AHP contribution in such a scenario would reduce the Bank’s earnings and potentially reduce the dividend paid to members.

The Bank may not be able to pay dividends at rates consistent with historical practices.

The Bank’s board of directors may declare dividends on the Bank’s capital stock, payable to members, from the Bank’s unrestricted retained earnings and current net earnings. The Bank’s ability to pay dividends also is subject to statutory and regulatory liquidity requirements. For example, the Bank has adopted a capital management policy to address regulatory guidance issued to all FHLBanks regarding retained earnings. The Bank’s capital management policy requires the Bank to establish a target amount of retained earnings by considering factors such as forecasted income, mark-to-market adjustments on derivatives and trading securities, market risk, operational risk, and credit risk, all of which may be influenced by events beyond the Bank’s control. Events such as changes in interest rates, collateral value, credit quality of members, and any future other-than-temporary impairment losses may affect the adequacy of the Bank’s retained earnings and may require the Bank to reduce its dividends from historical ratios to achieve and maintain the targeted amount of retained earnings. During the recent financial crisis, the Bank did not declare any dividends for the fourth quarter of 2008 or the first two quarters of 2009. Although the Bank has declared quarterly dividends since the third quarter of 2009, the dividend rate has been lower than before the financial crisis and it is unclear whether, or when, the Bank will be able to return to pre-crisis dividend rates.

An economic downturn or natural disaster in the Bank’s region could adversely affect the Bank’s profitability and financial condition.

Economic recession over a prolonged period or other unfavorable economic conditions in the Bank’s region could have an adverse effect on the Bank’s business, including the demand for Bank products and services, and the value of the Bank’s collateral securing advances, investments, and mortgage loans held in portfolio. Portions of the Bank’s region also are subject to risks from hurricanes, tornadoes, floods or other natural disasters. These natural disasters, including those resulting from significant climate changes, could damage or dislocate the facilities of the Bank’s members, may damage or destroy collateral that members have pledged to secure advances, may adversely affect the viability of the Bank’s mortgage purchase programs or the livelihood of borrowers of the Bank’s members, or otherwise could cause significant economic dislocation in the affected areas of the Bank’s region.

The Bank relies heavily upon information systems and other technology.

The Bank relies heavily upon information systems and other technology to conduct and manage its business. The Bank owns some of these systems and technology, and third parties own and provide to the Bank some of the systems and technology. To the extent that the Bank experiences a failure or interruption in any of these systems or other technology, including as the result of any “cyberattacks” or other breaches of technology security, the Bank may be unable to conduct and manage its business effectively, including, without limitation, its hedging and advances activities. The Bank can make no assurance that it will be able to prevent, timely and adequately address, or mitigate the negative effects of, any such failure or interruption. Any failure or interruption could significantly harm the Bank’s customer relations, risk management, and profitability, which could have a negative effect on the Bank’s financial condition and results of operations.

 

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The Bank is subject to a complex body of laws and regulations, which could change in a manner detrimental to the Bank’s operations.

The FHLBanks are GSEs, organized under the authority of the FHLBank Act, and governed by federal laws and regulations as adopted and applied by the Finance Agency. From time to time, Congress has amended the FHLBank Act in ways that have affected the rights and obligations of the FHLBanks and the manner in which the FHLBanks carry out their housing finance mission and business operations. New or modified legislation enacted by Congress or regulations adopted by the Finance Agency could have a negative effect on the Bank’s ability to conduct business or on the cost of doing business.

Changes in regulatory requirements could result in, among other things, an increase in the FHLBanks’ cost of funding and regulatory compliance, a change in permissible business activities, or a decrease in the size, scope, or nature of the FHLBanks’ lending activities, which could affect the Bank’s financial condition and results of operations.

The statutory and regulatory framework under which most financial institutions, including the Bank, operate will change substantially over the next several years as a result of the enactment of the Dodd-Frank Act and subsequent implementing regulations. Refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Legislative and Regulatory Developments for a discussion of recent legislative and regulatory activity that could affect the Bank.

 

Item 1B. Unresolved Staff Comments.

None.

 

Item 2. Properties.

The Bank owns approximately 235,514 square feet of office space at 1475 Peachtree Street, NE, Atlanta, Georgia 30309. The Bank occupies approximately 208,776 square feet of this space, and approximately 26,738 square feet of this space is leased to a single tenant. This lease expires December 31, 2012. The annual rental income from this lease is not material to the Bank’s results of operations. The Bank leases 17,900 square feet of office space in an off-site backup facility located in Norcross, Georgia. The Bank also leases 3,337 square feet of office space located in Washington, D.C. for its government relations personnel. The Bank believes these facilities are well maintained and are adequate for the purposes for which they currently are used.

 

Item 3. Legal Proceedings.

MBS Litigation

On January 18, 2011, the Bank filed a complaint in the State Court of Fulton County, Georgia against Countrywide Financial Corporation (n/k/a/ Bank of America Home Loans), Countywide Securities Corporation, Countrywide Home Loans, Inc., Bank of America Corporation (as successor to the Countrywide defendants), J.P. Morgan Securities, LLC (f/k/a J.P. Morgan Securities, Inc. and Bear Stearns & Co., Inc.) and UBS Securities, LLC, et al. The Bank’s claims arise from material misrepresentations in the offering documents of thirty private-label MBS sold to the Bank. The Bank’s complaint alleges that the Countrywide Defendants (Countrywide Financial Corporation, Countrywide Securities Corporation, and Countrywide Home Loans, Inc.) and J.P. Morgan Securities, LLC violated the Georgia RICO (Racketeer Influenced and Corrupt Organizations) Act. The complaint further alleges that those defendants, as well as UBS Securities, LLC committed fraud and negligent misrepresentation in violation of Georgia law, and that Bank of America Corporation is liable to the Bank as a successor to the Countrywide Defendants. The Bank is seeking monetary damages and other relief as compensation for losses it has incurred in connection with the purchase of these private-label MBS.

On May 19, 2011, the defendants filed a joint motion to dismiss; the Bank filed its opposition on July 8, 2011. No order has been issued by the court in response to this motion. On January 5, 2012, the State Court of Fulton

 

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County, Georgia entered into a scheduling order that requires the parties to complete fact discovery by December 15, 2012 and expert discovery by March 1, 2013, requires the parties to file pretrial dispositive motions by May 1, 2013 and responses by June 1, 2013, establishes September 15, 2013 as the date for the consolidated pretrial order, and sets trial for October 2013.

MBS Proposed Settlement

In a separate matter, on January 21, 2011, the Bank (together with certain other private-label MBS holders collectively comprising greater than 25 percent of the voting rights with respect to certain private-label MBS) instructed Bank of New York, in its capacity as indenture trustee, to pursue enforcement of seller representations and warranties concerning the eligibility of mortgages for securitization in certain Countrywide-issued private-label MBS. On June 29, 2011, a proposed settlement was announced between the trustee and certain Countrywide affiliates with respect to nearly all trust-related claims arising out of these private-label MBS, and the Bank and other investors (Institutional Investors) filed a Notice of Petition to intervene with the Supreme Court of the State of New York, County of New York in support of final court approval of this settlement. On August 26, 2011, certain other interested investors (Objectors) removed the action to the United States District Court, Southern District of New York; Bank of New York subsequently moved to remand the action back to state court. On October 19, 2011, the district court denied the motion to remand. On October 31, 2011, the Institutional Investors filed a petition with the United States Court of Appeals for the Second Circuit seeking to appeal the denial. On February 27, 2012, the United States Court of Appeals for the Second Circuit reversed the district court decision and remanded the action back to state court. It is not certain at this time whether the settlement will ultimately be approved, the timing of any final settlement or the amount of any distribution the Bank may receive as part of a final settlement.

Other

The Bank is subject to other various legal proceedings and actions from time to time in the ordinary course of its business. After consultation with legal counsel, management does not anticipate that the ultimate liability, if any, arising out of those matters presently known to the Bank will have a material adverse effect on the Bank’s financial condition or results of operations.

 

Item 4. Mine Safety Disclosure.

Not applicable.

 

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PART II

 

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

The Bank’s members or former members own all the stock of the Bank. The Bank’s stock is not publicly traded or quoted, and there is no established marketplace for it, nor does the Bank expect a market to develop. The Bank’s capital plan prohibits the trading of its capital stock, except in connection with merger or acquisition activity.

A member may request in writing that the Bank redeem its excess stock at par. Any such redemption request is subject to a five year redemption period after the Bank receives the request, subject to certain regulatory requirements and to the satisfaction of any ongoing stock investment requirements applicable to the member. In addition, any member may withdraw from membership upon five years written notice to the Bank. Subject to the member’s satisfaction of any outstanding indebtedness and other statutory requirements, the Bank shall redeem at par the member’s stock upon withdrawal from membership. The Bank, in its discretion, may repurchase shares held by a member in excess of its required stock holdings, subject to certain limitations and thresholds in the Bank’s capital plan. The Bank repurchased $927 million, $513 million and $612 million of excess activity-based stock during the second, third, and fourth quarters of 2011, respectively. The Bank repurchased $4 million, $503 million, and $247 million of excess activity-based stock during the first, third, and fourth quarters of 2010, respectively. Repurchases of excess activity-based stock during the first quarter of 2010 were limited to an amount equal to each member’s increased membership stock requirement for 2010, if any, pursuant to the annual recalculation of each member’s minimum stock requirement. The par value of all capital stock is $100 per share. As of February 29, 2012, the Bank had 1,095 member and non-member shareholders and 62.0 million shares of its common stock outstanding (including mandatorily redeemable shares); 1.25 million of those outstanding shares represented excess membership stock and 17.1 million of those outstanding shares represented excess activity-based stock. Under the Bank’s capital management plan, the Bank expects to repurchase excess capital stock on a quarterly basis during 2012 at levels consistent with 2011; however, determinations of excess capital stock repurchases are subject to the Bank’s actual financial performance for each quarter.

The Bank declares and pays any dividends only after net income is calculated for the preceding quarter. The Bank declared quarterly cash dividends in 2011 and 2010 as outlined in the table below (dollars in millions).

 

     2011      2010  

  Quarter            

   Amount      Annualized Rate (%)(1)      Amount      Annualized Rate (%)(2)  

  First

     $15         0.79         $5         0.27   

  Second

             14         0.81                 6         0.26   

  Third

     13         0.76         8         0.44   

  Fourth

     12         0.80         8         0.39   

 

(1) 

Dividend rate was equal to the average three-month LIBOR for the preceding quarter plus 50 basis points.

(2) 

Dividend rate was equal to the average three-month LIBOR for the preceding quarter.

The Bank may pay dividends on its capital stock only out of its unrestricted retained earnings account or out of its current net earnings. The Bank’s board of directors has discretion to declare or not declare dividends and to determine the rate of any dividends declared. The Bank’s board of directors may neither declare nor require the Bank to pay dividends if, after giving effect to the dividend, the Bank would fail to meet any of its capital requirements. The Bank also may not declare any dividend when it is not in compliance with all of its capital requirements or if it is determined that the dividend would create a financial safety and soundness issue for the Bank.

The Bank’s board of directors has adopted a capital management policy that includes a targeted amount of retained earnings separate and apart from the restricted retained earnings account. For further discussion of the

 

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Index to Financial Statements

Bank’s dividends and the Joint Capital Agreement pursuant to which the restricted retained earnings account was established, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Because only member and former member institutions, not individuals, may own the Bank’s capital stock, the Bank has no equity compensation plans.

The Bank also issues standby letters of credit in the ordinary course of its business. From time to time, the Bank provides standby letters of credit to support members’ obligations, members’ letters of credit or obligations issued to support unaffiliated, third-party offerings of notes, bonds, or other securities. The Bank issued $13.1 billion, $10.9 billion, and $13.2 billion in letters of credit in 2011, 2010, and 2009, respectively. To the extent that these letters of credit are securities for purposes of the Securities Act of 1933, the issuance of the letter of credit by the Bank is exempt from registration pursuant to section 3(a)(2) thereof.

 

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Item 6. Selected Financial Data.

The following selected historical financial data of the Bank should be read in conjunction with the audited financial statements and related notes thereto, and with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are included elsewhere in this Report. The following data, insofar as it relates to each of the years 2007 to 2011, have been derived from annual financial statements, including the statements of condition at December 31, 2011 and 2010 and the related statements of income and of cash flows for the three years ended December 31, 2011 and notes thereto appearing elsewhere in this Report. The financial information presented in the following table, and in the financial statements included in this Report, is not necessarily indicative of the financial condition, results of operations, or cash flows of any other interim or yearly periods (dollars in millions).

 

    As of and for the Years Ended December 31,  
    2011     2010     2009     2008     2007  

Statements of Condition (at year end)

         

Total assets

  $ 125,270      $ 131,798      $ 151,311      $ 208,564      $ 188,938   

Investments(1)

    36,138        39,879        32,940        38,376        41,527   

Mortgage loans held for portfolio

    1,639        2,040        2,523        3,252        3,527   

Allowance for credit losses on mortgage loans

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

Advances

    86,971        89,258        114,580        165,856        142,867   

REFCORP prepayment

                         14          

Deposits

    2,655        3,093        2,989        3,573        7,135   

Consolidated obligations, net:

         

Discount notes

    24,330        23,915        17,127        55,195        28,348   

Bonds

    90,662        95,198        121,450        138,181        142,237   

Total consolidated obligations, net(2)

        114,992            119,113            138,577            193,376            170,585   

Mandatorily redeemable capital stock

    286        529        188        44        55   

Affordable Housing Program payable

    109        126        125        139        156   

Payable to REFCORP

           20        21               31   

Capital stock - putable

    5,718        7,224        8,124        8,463        7,556   

Retained earnings

    1,254        1,124        873        435        469   

Accumulated other comprehensive loss

    (411)        (402)        (744)        (5)        (3)   

Total capital

    6,561        7,946        8,253        8,893        8,022   

Statements of Income (for the year ended)

         

Net interest income

    459        544        397        841        704   

Provision for credit losses

    5                               

Net impairment losses recognized in earnings

    (118)        (143)        (316)        (186)          

Net gains (losses) on trading securities

    2        31        (135)        200        107   

Net (losses) gains on derivatives and hedging activities

    (9)        8        543        (229)        (97)   

Letters of credit fees

    19        14        7        4          

Other income(3)

    2        3        3        1        3   

Noninterest expense(4)

    123        79        113        286        110   

Income before assessments

    227        378        386        345        607   

Assessments(5)

    43        100        103        91        162   

Net income

    184        278        283        254        445   

Performance Ratios (%)

         

Return on equity(6)

    2.52        3.42        3.58        2.95        6.47   

Return on assets(7)

    0.15        0.19        0.16        0.13        0.28   

Net interest margin(8)

    0.37        0.38        0.22        0.42        0.44   

Regulatory capital ratio (at year end)(9)

    5.79        6.74        6.07        4.29        4.28   

Equity to assets ratio(10)

    5.91        5.63        4.34        4.25        4.27   

Dividend payout ratio(11)

    29.48        9.63        8.51        113.36        85.97   

 

(1) 

Investments consist of interest-bearing deposits, federal funds sold, and securities classified as trading, available-for-sale, and held-to-maturity.

(2) 

The amounts presented are the Bank’s primary obligations on consolidated obligations outstanding. The par value of the FHLBanks’ outstanding consolidated obligations for which the Bank is jointly and severally liable was as follows (in millions):

December 31, 2011

   $     578,118   

December 31, 2010

     678,528   

December 31, 2009

     793,314   

December 31, 2008

     1,060,410   

December 31, 2007

     1,019,272   
(3) 

Other income includes service fees and other.

 

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(4) 

For the year ended December 31, 2010, amount includes $51 million which represents the reversal of a portion of the provision for credit losses established on a receivable due from Lehman Brothers Special Financing Inc. (LBSF). For the year ended December 31, 2008, amount includes $170 million which represents provision for credit losses established on a receivable due from LBSF.

(5) 

On August 5, 2011, the Finance Agency certified that the FHLBanks have satisfied their REFCORP obligation.

(6) 

Calculated as net income divided by average total equity.

(7) 

Calculated as net income divided by average total assets.

(8) 

Net interest margin is net interest income as a percentage of average earning assets.

(9) 

Regulatory capital ratio is regulatory capital stock plus retained earnings as a percentage of total assets at year end.

(10) 

Calculated as average equity divided by average total assets.

(11) 

Calculated as dividends declared during the year divided by net income during the year.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis relates to the Bank’s financial condition as of December 31, 2011 and 2010, and results of operations for the years ended December 31, 2011, 2010, and 2009. This section explains the changes in certain key items in the Bank’s financial statements from year to year, the primary factors driving those changes, the Bank’s risk management processes and results, known trends or uncertainties that the Bank believes may have a material effect on the Bank’s future performance, as well as how certain accounting principles affect the Bank’s financial statements.

This discussion should be read in conjunction with the Bank’s audited financial statements and related notes for the year ended December 31, 2011 included in Item 8 of this Report. Readers also should review carefully “Special Cautionary Notice Regarding Forward-looking Statements” and Item 1A, Risk Factors, for a description of the forward-looking statements in this Report and a discussion of the factors that might cause the Bank’s actual results to differ, perhaps materially, from these forward-looking statements.

Executive Summary

Financial Condition

As of December 31, 2011, total assets were $125.3 billion, a decrease of $6.5 billion, or 4.95 percent, from December 31, 2010. This decrease was primarily due to a $3.7 billion, or 9.38 percent, decrease in total investments and a $2.3 billion, or 2.56 percent, decrease in advances. Advances, the largest asset on the Bank’s balance sheet, decreased as a result of scheduled maturities, strategic prepayments, prepayments as a result of member closures, and members’ significant deposit holdings and slow loan growth. The decrease in total investments was primarily due to a $2.4 billion decrease in short-term investments and a $1.3 billion decrease in MBS as further discussed in Management’s Discussion and Analysis—Financial Condition—Investments below.

As of December 31, 2011, total liabilities were $118.7 billion, a decrease of $5.1 billion, or 4.15 percent, from December 31, 2010. This decrease was primarily due to a $4.1 billion, or 3.46 percent, decrease in COs. The decrease in COs corresponds to the decrease in demand for advances by the Bank’s members during the year.

As of December 31, 2011, total capital was $6.6 billion, a decrease of $1.4 billion, or 17.4 percent, from December 31, 2010. This decrease was primarily due to the repurchase of $2.1 billion of excess capital stock and the payment of $54 million in dividends. These decreases were partially offset by the issuance of $649 million in activity-based capital stock and $23 million in membership capital stock, and the recording of $184 million in net income during the year.

Results of Operations

The Bank recorded net income of $184 million for 2011, a decrease of $94 million, or 33.7 percent, from net income of $278 million for 2010. The decrease in net income was primarily due to an $85 million decrease in net interest income, a $44 million increase in noninterest expense and a $17 million increase in noninterest loss, partially offset by a $57 million decrease in total assessments. These items are discussed in more detail in Management’s Discussion and Analysis—Results of Operations—Net Income below.

One way in which the Bank analyzes its performance is by comparing its annualized return on equity (ROE) to three-month average LIBOR. The Bank’s ROE was 2.52 percent for 2011, compared to 3.42 percent for 2010. ROE decreased in 2011 compared to 2010 primarily as a result of a decrease in net income, as discussed above. ROE spread to three-month average LIBOR decreased in 2011 compared to 2010, equaling 218 basis points for 2011 as compared to 308 basis points for 2010. The decrease in this spread was due to the decrease in ROE as previously discussed.

The Bank’s interest rate spread was 32 basis points for 2011 and 2010. The Bank’s interest rate spread has remained stable during the two periods.

 

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Business Outlook

During a sluggish 2011, the Bank maintained a reasonable level of net income, increased its retained earnings, repurchased excess capital stock, and paid dividends each quarter. Despite some recent signs of marginal economic improvement, the Bank expects the challenges of 2011 to continue during 2012: moderate demand for advances, continued uncertainty with respect to the Bank’s private-label MBS portfolio, limited investment opportunities, and increasing pressure on income. A growing challenge is the increase in regulatory requirements, such as derivatives clearing requirements driven by the Dodd-Frank Act, that may have a material impact on the Bank’s operations. The Bank seeks to maintain a conservative capital and financial management approach that will protect members’ investment in the Bank and provide long term value of membership.

Overall advance demand decreased during 2011 as a result of scheduled maturities, strategic prepayments, prepayments as a result of member closures, and members’ significant deposit holdings and slow loan growth. Advances increased during the fourth quarter of 2011 as members increased their liquidity in response to market volatility from the European sovereign debt crisis and in anticipation of increased Basel III liquidity requirements. The overall decline in advances slowed compared to 2010 as members began to focus on extending their existing low interest-rate advances and saw some increased loan growth. The Bank believes overall advances likely will decline somewhat during 2012, but the Bank anticipates more stabilization. During 2011, the Bank established four new AHP products. Letter of credit activity has remained, and is expected to continue to remain, relatively stable.

Although the credit related portion of other-than-temporary impairment losses recognized in earnings was lower during 2011 compared to 2010, the private-label MBS portfolios of the Bank and the FHLBank System continue to deteriorate. Other-than-temporary impairment losses have been highly volatile and there is little basis for establishing a ceiling on the amount of losses these securities could be expected to experience. Delays in foreclosures with respect to defaulted loans underlying the private-label MBS may increase credit related losses, as delays have the effect of diverting cash streams to subordinate tranches of the private-label MBS and shortening the amount of time until the Bank’s more senior tranches may be required to absorb any losses. The Bank has seen some recovery in fair market values for some of its private-label MBS; this recovery reduces pressure on the Bank’s retained earnings.

Looking forward, the Bank may experience income declines as a result of the decrease in advances. The Bank’s investments, which represented 68.0 percent of the Bank’s total interest income for the year ended December 31, 2011, are also declining, primarily due to reductions in the MBS portfolio. In addition, the Bank’s mortgage loan portfolio will also experience income declines as loans mature. The current interest rate environment and conditions in the mortgage market have made it challenging for the Bank to reinvest maturing and prepaying portfolios with attractive yielding investments, which may adversely affect the Bank’s earnings. To offset declining yields on its MBS portfolio, the Bank has invested in liquidity investments and money market investments.

In 2011, the Bank made several strategic changes to its internal organization in order to optimize business development and realign the Bank’s risk management structure. During the first half of 2011, the Bank separated the chief financial officer and the chief risk officer roles, establishing the chief risk officer (who oversees the Bank’s enterprise risk management department) as a direct report to the president and chief executive officer. The credit and collateral, accounting, and financial reporting functions were consolidated under the chief financial officer, and a new chief business officer position was created to oversee the Bank’s member sales and outreach, community investment services, corporate communications, and government and industry relations. The Bank also began to strategically reduce overall staffing levels during 2011 in response to the changing business and economic conditions.

 

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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 of debt securities in the form of COs by the Office of Finance on the Bank’s behalf.

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

 

     As of December 31,      Increase (Decrease)  
     2011      2010     
     Amount      Percent
of Total
     Amount      Percent
of Total
     Amount      Percent  

Advances

   $ 86,971         69.43       $ 89,258         67.72       $ (2,287)         (2.56)   

Long-term investments

     21,655         17.29         22,986         17.44         (1,331)         (5.79)   

Short-term investments

     14,483         11.56         16,893         12.82         (2,410)         (14.27)   

Mortgage loans, net

     1,633         1.30         2,039         1.55         (406)         (19.94)   

Other assets

     528         0.42         622         0.47         (94)         (14.94)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Total assets

   $     125,270         100.00       $     131,798         100.00       $ (6,528)         (4.95)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Consolidated obligations, net:

                 

Discount notes

   $ 24,330         20.50       $ 23,915         19.31       $ 415         1.73   

Bonds

     90,662         76.37         95,198         76.86         (4,536)         (4.76)   

Deposits

     2,655         2.24         3,093         2.50         (438)         (14.14)   

Other liabilities

     1,062         0.89         1,646         1.33         (584)         (35.47)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Total liabilities

   $ 118,709         100.00       $ 123,852         100.00       $ (5,143)         (4.15)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Capital stock

   $ 5,718         87.15       $ 7,224         90.92       $ (1,506)         (20.86)   

Retained earnings

     1,254         19.11         1,124         14.14         130         11.55   

Accumulated other comprehensive loss

     (411)         (6.26)         (402)         (5.06)         (9)         (2.12)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Total capital

   $ 6,561         100.00       $ 7,946         100.00       $ (1,385)         (17.44)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Advances

The following table sets forth the Bank’s advances outstanding by year of maturity and the related weighted- average interest rate (dollars in millions):

 

     As of December 31,  
     2011      2010  
     Amount      Weighted-
average
Interest
Rate
(%)
     Amount      Weighted-
average
Interest
Rate
(%)
 

Overdrawn demand deposit accounts

           $ 3         5.36               $ 1         5.47   

Due in one year or less

     36,542         1.41         26,628         3.23   

Due after one year through two years

     11,173         3.38         16,186         3.28   

Due after two years through three years

     7,851         2.89         10,938         3.59   

Due after three years through four years

     3,881         3.48         6,369         3.32   

Due after four years through five years

     5,836         2.53         3,678         3.75   

Due after five years

     17,283         4.21         21,251         3.89   
  

 

 

       

 

 

    

Total par value

     82,569         2.58         85,051         3.48   

Discount on AHP advances

     (12)            (13)      

Discount on EDGE advances

     (10)            (11)      

Hedging adjustments

     4,431            4,238      

Deferred commitment fees

     (7)            (7)      
  

 

 

       

 

 

    

Total

           $     86,971                  $     89,258      
  

 

 

       

 

 

    

 

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The decrease in advances from December 31, 2010 to December 31, 2011 was due to maturing advances, prepayments, and decreased demand for new advances. The Bank has not seen a discernible impact on either the volume of advances or the distribution of advances outstanding by year of maturity as a result of the Federal Reserve’s recent announcements that it expects to maintain short-term interest rates near zero through 2014. At December 31, 2011, 86.2 percent of the Bank’s advances were fixed-rate. However, the Bank often simultaneously enters into derivatives with the issuance of advances to convert the rates on them, in effect, into a short-term variable interest rate, usually based on LIBOR. As of December 31, 2011 and 2010, 65.7 percent and 87.4 percent, respectively, of the Bank’s fixed-rate advances were swapped and 9.79 percent and 9.42 percent, respectively, of the Bank’s variable-rate advances were swapped. The majority of the Bank’s variable-rate advances were indexed to LIBOR. The Bank also offers variable-rate advances tied to the federal funds rate, prime rate, and constant maturity swap rates.

The concentration of the Bank’s advances to its 10 largest borrowing member institutions as of December 31, 2011 is contained in Item 1, Business–Credit Products–Advances. Management believes that the Bank holds sufficient collateral, on a member-specific basis, to secure the advances to all borrowers, including these 10 institutions, and the Bank does not expect to incur any credit losses on these advances.

Supplementary financial data on the Bank’s advances is set forth under Item 8, Financial Statements and Supplementary Information.

Investments

The following table sets forth more detailed information regarding short- and long-term investments held by the Bank (dollars in millions):

 

     As of December 31,      Increase (Decrease)  
             2011                      2010                  Amount          Percent  

Short-term investments:

           

Interest-bearing deposits (1)

         $ 1,203             $ 2             $ 1,201         *   

Certificates of deposit

     650         1,190         (540)         (45.38)   

Federal funds sold

     12,630         15,701         (3,071)         (19.56)   
  

 

 

    

 

 

    

 

 

    

Total short-term investments

     14,483         16,893         (2,410)         (14.27)   
  

 

 

    

 

 

    

 

 

    

Long-term investments:

           

State or local housing agency debt obligations

     103         111         (8)         (7.21)   

U.S. government agency debt obligations

     4,228         4,253         (25)         (0.58)   

Mortgage-backed securities:

           

U.S. government agency securities

         10,689             9,676             1,013             10.46   

Private label

     6,635         8,946         (2,311)         (25.83)   
  

 

 

    

 

 

    

 

 

    

Total mortgage-backed securities

     17,324         18,622         (1,298)         (6.97)   
  

 

 

    

 

 

    

 

 

    

Total long-term investments

     21,655         22,986         (1,331)         (5.79)   
  

 

 

    

 

 

    

 

 

    

Total investments

       $     36,138           $     39,879           $     (3,741)         (9.38)   
  

 

 

    

 

 

    

 

 

    

 

(1) 

As of December 31, 2011, interest-bearing deposits includes a $1.2 billion business money market account with Branch Banking and Trust Company, one of the Bank’s ten largest borrowers. One of the Bank’s member directors is a senior executive vice president of Branch Banking and Trust Company. Pursuant to Finance Agency regulation, the Bank’s member directors serve as officers or directors of a Bank member, and the Bank may enter into business transactions with such members from time to time in the ordinary course of business.

* Not meaningful

The decrease in short-term investments from December 31, 2010 to December 31, 2011 was primarily due to a decrease in federal funds sold. The amount held in federal funds sold will vary each day based on the federal funds rates, the Bank’s liquidity requirements, and the availability of high quality counterparties in the federal

 

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funds market. In addition, during 2011, the Federal Reserve paid interest on required and excess reserves held by depository institutions at a rate of 0.25 percent. A significant and sustained increase in bank reserves during 2011 combined with the rate of interest paid on those reserves at the Federal Reserve has contributed to a decline in the volume of transactions taking place in the overnight federal funds market.

The decrease in long-term investments from December 31, 2010 to December 31, 2011 was primarily due to a decrease in private-label MBS during the year due to principal repayments and maturities and no additional purchases by the Bank of private-label MBS.

As of December 31, 2011 and 2010, the total MBS balance included MBS with a carrying value of $3.0 billion and $3.9 billion, respectively, issued by one of the Bank’s members and their affiliates with dealer relationships. This member, Bank of America, National Association, was one of the Bank’s ten largest advances borrowing institutions as of December 31, 2011 and 2010.

Prior to June 20, 2011, the Finance Agency limited an FHLBank’s investment in MBS and asset-backed securities by requiring that the total carrying value of MBS owned by the FHLBank generally may not exceed 300 percent of the FHLBank’s previous month-end total capital, as defined by regulation, plus its mandatorily redeemable capital stock on the day it purchases the securities. Effective June 20, 2011, the value of MBS securities used in the 300 percent of capital limit calculation was changed from carrying value to amortized historical costs for securities classified as held-to-maturity or available-for-sale, and fair value for MBS securities classified as trading. These investments amounted to 244 percent and 210 percent of total capital plus mandatorily redeemable capital stock at December 31, 2011 and 2010, respectively. The Bank was below its target range of 250 percent to 275 percent at December 31, 2011 and 2010 due to a lack of quality MBS at attractive prices during recent market conditions and due to the Bank’s high level of excess capital stock. The Bank suspended new purchases of private-label MBS beginning in the first quarter of 2008, resulting in a greater percentage of U.S. government agency MBS as of December 31, 2011 compared to December 31, 2010. In addition, private-label MBS are experiencing faster prepayments than U.S. government agency MBS, further increasing the proportion of U.S. government agency MBS in the Bank’s MBS portfolio.

As of December 31, 2011, the Bank had a total of 52 securities classified as available-for-sale in an unrealized loss position, with total gross unrealized losses of $410 million and a total of 107 securities classified as held-to-maturity in an unrealized loss position, with total gross unrealized losses of $224 million. As of December 31, 2010, the Bank had a total of 44 securities classified as available-for-sale in an unrealized loss position, with total gross unrealized losses of $397 million and a total of 130 securities classified as held-to-maturity in an unrealized loss position, with total gross unrealized losses of $234 million.

The Bank evaluates its individual investment securities for other-than-temporary impairment on at least a quarterly basis, as described in detail in Note 8—Other-than-temporary Impairment to the Bank’s 2011 audited financial statements. The table below summarizes the total other-than-temporary impairment losses (in millions):

 

     For the Years Ended December 31,  
             2011                      2010                      2009          

Total other-than-temporary impairment losses

             $ (55)                 $ (200)                 $         (1,306)   

Net amount of impairment losses (reclassified from) recorded in other comprehensive loss

     (63)         57         990   
  

 

 

    

 

 

    

 

 

 

Net impairment losses recognized in earnings

             $         (118)                 $         (143)                 $ (316)   
  

 

 

    

 

 

    

 

 

 

Certain other private-label MBS in the Bank’s investment securities portfolio that have not been designated as other-than-temporarily impaired have 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. These declines in fair value are considered temporary as the Bank presently expects to collect all contractual cash flows, the Bank does not intend to sell the securities and it is not more likely than not that the Bank will be required to sell the securities before the anticipated recovery of its remaining amortized cost basis, which may be at

 

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maturity. This assessment is based on the determination that the Bank has sufficient capital and liquidity to operate its business and has no need to sell these securities, nor has the Bank entered into any contractual constraints that would require the Bank to sell these securities.

Supplementary financial data on the Bank’s investment securities is set forth under Item 8, Financial Statements and Supplementary Data.

Mortgage Loans Held for Portfolio

The decrease in mortgage loans held for portfolio from December 31, 2010 to December 31, 2011 was due to the Bank ceasing to purchase these assets and the maturity of these assets during the year.

As of December 31, 2011 and 2010, the Bank’s conventional mortgage loan portfolio was concentrated in the southeastern United States because those members selling loans to the Bank were located primarily in that region. The following table provides the percentage of unpaid principal balance of conventional single-family residential mortgage loans held for portfolio for the five largest state concentrations.

 

     As of December 31,  
     2011      2010  
     Percent of Total      Percent of Total  

South Carolina

     24.61         24.50   

Florida

     23.17         21.07   

Georgia

     14.45         14.42   

North Carolina

     12.99         14.12   

Virginia

     8.90         9.19   

All other

     15.88         16.70   
  

 

 

    

 

 

 

Total

     100.00         100.00   
  

 

 

    

 

 

 

Supplementary financial data on the Bank’s mortgage loans is set forth under Item 8, Financial Statements and Supplementary Data.

Consolidated Obligations

The Bank funds its assets primarily through the issuance of consolidated obligation bonds and, to a lesser extent, consolidated obligation discount notes. CO issuances financed 91.8 percent of the $125.3 billion in total assets at December 31, 2011, remaining relatively stable from the financing ratio of 90.4 percent as of December 31, 2010.

The decrease in COs from December 31, 2010 to December 31, 2011 corresponds to the decrease in demand for advances by the Bank’s members and the increase in liquidity from maturing and prepaid advances during the year. COs outstanding at December 31, 2011 and 2010 were primarily fixed-rate. However, the Bank often simultaneously enters into derivatives with the issuance of CO bonds to convert the interest rates, in effect, into short-term variable interest rates, usually based on LIBOR. As of December 31, 2011 and 2010, 81.9 percent and 77.3 percent, respectively, of the Bank’s fixed-rate CO bonds were swapped and 6.42 percent and 0.24 percent, respectively, of the Bank’s variable-rate CO bonds were swapped. As of December 31, 2011 and 2010, 4.64 percent and 5.41 percent, respectively, of the Bank’s fixed-rate CO discount notes were swapped to a variable rate.

As of December 31, 2011, callable CO bonds constituted 32.0 percent of the total par value of CO bonds outstanding, compared to 26.3 percent at December 31, 2010. This increase was due to market conditions during the third quarter of 2011 that made the issuance of swapped callable fixed maturity debt more attractive to the

 

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Bank. The derivatives that the Bank may employ to hedge against the interest-rate risk associated with the Bank’s callable CO bonds are callable by the counterparty. The Bank generally will call a hedged CO bond if the call feature of the derivative is exercised. These call features could require the Bank to refinance a substantial portion of outstanding liabilities during times of decreasing interest rates. Call options on unhedged callable CO bonds generally are exercised when the bond can be replaced at a lower economic cost.

On July 13, 2011, Moody’s placed the Aaa bond rating of the U.S., and consequently the ratings of GSEs, including the FHLBanks, on review for possible downgrade. The review was prompted due to the risk that the statutory debt limit may not be raised in time to prevent a default on U.S. Treasury debt obligations. On August 2, 2011, Moody’s confirmed the Aaa rating of the U.S., but revised the rating outlook to negative. Consequently, Moody’s confirmed the Aaa ratings of GSEs, including the FHLBanks, but revised the ratings outlook to negative.

On July 15, 2011, S&P placed the long-term AAA credit ratings of 10 of the 12 FHLBanks, including the Bank, on CreditWatch with negative implications. S&P also placed the long-term AAA rating on the senior unsecured debt issues of the FHLBank System on CreditWatch with negative implications, and affirmed the short-term A-1+ ratings of all FHLBanks and the FHLBank System’s debt issues. These rating actions reflected S&P’s concurrent placement of the long-term sovereign credit rating of the U.S. on CreditWatch negative, and S&P’s view that the issuer credit ratings of the FHLBanks are constrained by such U.S. credit rating. On August 8, 2011, S&P downgraded the long-term senior unsecured debt issues of the FHLBank System to AA+ with a negative outlook, following S&P’s downgrade on August 5, 2011 of the U.S. long-term sovereign credit rating to AA+ with a negative outlook. Additionally, S&P placed the long-term credit ratings of all 12 FHLBanks, including the Bank, at AA+ with a negative outlook, and affirmed the short-term A-1+ ratings of all FHLBanks.

During the period immediately prior to August 2, 2011 (the date established by Treasury as the date the U.S. would begin defaulting on its debt obligations if the U.S. debt limit was not increased), capital markets tightened and demand for FHLBank CO bonds decreased. The Bank increased its issuance of CO discount notes during this period; in addition, the Bank previously had increased its short-term liquidity during the month of July in anticipation of possible disruption in the capital markets due to the statutory debt limit debate. Debt issuance and pricing in the capital markets generally stabilized after the debt limit was increased on August 2, 2011, and the Bank did not experience a material impact on its ability to issue COs or on the Bank’s financial condition or results of operations for the third quarter of 2011. However, any additional downgrade of the U.S. sovereign debt and a resultant downgrade of the FHLBanks could result in disruptions in the capital markets and increase the Bank’s cost of funds, which may adversely impact the Bank’s results of operations and financial condition.

The European sovereign debt crisis triggered a rotation to less risky assets during the second half of 2011, resulting in increased demand for FHLBank COs and a lower cost of funds for the Bank.

Supplementary financial data on the Bank’s short-term borrowings is set forth under Item 8, Financial Statements and Supplementary Data.

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 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 with the Bank. Total deposits were relatively stable at December 31, 2011 compared to December 31, 2010.

 

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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 December 31, 2011.

Capital

The FHLBank Act and Finance Agency regulations specify that each FHLBank must meet certain minimum regulatory capital standards. The Bank must maintain (1) total capital in an amount equal to at least four percent of its total assets; (2) leverage capital in an amount equal to at least five percent of its total assets; and (3) permanent capital in an amount equal to at least its regulatory risk-based capital requirement. Permanent capital is defined by the FHLBank Act and applicable regulations as the sum of paid-in capital for Class B stock and retained earnings. Mandatorily redeemable capital stock is considered capital for regulatory purposes. The Bank was in compliance with these regulatory capital rules and requirements as shown in detail in Note 15—Capital and Mandatorily Redeemable Capital Stock to the Bank’s audited financial statements.

Finance Agency regulations establish criteria based on the amount and type of capital held by an FHLBank for four capital classifications as follows:

 

 

Adequately Capitalized—FHLBank meets both risk-based and minimum capital requirements;

 

 

Undercapitalized—FHLBank does not meet one or both of its risk-based or minimum capital requirements;

 

 

Significantly Undercapitalized—FHLBank has less than 75 percent of one or both of its risk-based or minimum capital requirements; and

 

 

Critically Undercapitalized—FHLBank total capital is two percent or less of total assets.

Under the regulations, the Director of the Finance Agency (Director) will make a capital classification for each FHLBank at least quarterly and notify the FHLBank in writing of any proposed action and provide an opportunity for the FHLBank to submit information relevant to such action. The Director is permitted to make discretionary classifications. An FHLBank must provide written notice to the Finance Agency within 10 days of any event or development that has caused or is likely to cause its permanent or total capital to fall below the level required to maintain its most recent capital classification or reclassification. The regulations delineate the types of prompt corrective actions the Director may order in the event an FHLBank is not adequately capitalized, including submission of a capital restoration plan by the FHLBank and restrictions on its dividends, stock redemptions, executive compensation, new business activities, or any other actions the Director determines will ensure safe and sound operations and capital compliance by the FHLBank. On December 22, 2011, the Bank received notification from the Director that, based on September 30, 2011 data, the Bank meets the definition of “adequately capitalized.”

As of December 31, 2011, the Bank had capital stock subject to mandatory redemption from 68 members and former members, consisting of B1 membership stock and B2 activity-based capital stock, compared to 63 members and former members as of December 31, 2010, consisting of B1 membership capital stock and B2 activity-based capital stock. The Bank is not required to redeem or repurchase such capital stock until the expiration of the five-year redemption period or, with respect to activity-based capital stock, until the later of the expiration of the five-year redemption period or the activity no longer remains outstanding. The Bank makes its determination regarding the repurchase of excess capital stock on a quarterly basis.

As of December 31, 2011 and 2010, the Bank’s outstanding stock included $1.1 billion and $2.7 billion, respectively, of excess shares subject to repurchase by the Bank at its discretion.

 

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In 2011, the FHLBanks entered into a Joint Capital Agreement which is intended to enhance the capital position of each FHLBank and the safety and soundness of the FHLBank System. The intent of the Joint Capital Agreement is to allocate that portion of each FHLBank’s earnings historically paid to satisfy its REFCORP obligation to a restricted retained earnings account at that FHLBank. These restricted retained earnings are not available to pay dividends. Each FHLBank subsequently amended its capital plan to implement the provisions of the Joint Capital Agreement. The Finance Agency approved the capital plan amendments and certified satisfaction of the REFCORP obligation on August 5, 2011. In accordance with the Joint Capital Agreement, starting in the third quarter of 2011, each FHLBank contributes 20% of its net income to a restricted retained earnings account.

Results of Operations

The following is a discussion and analysis of the Bank’s results of operations for the years ended December 31, 2011, 2010, and 2009.

Net Income

The following table sets forth the Bank’s significant income items for the years ended December 31, 2011, 2010, and 2009, and provides information regarding the changes during the periods (dollars in millions). These items are discussed in more detail below.

 

     For the Years Ended December 31,      Increase (Decrease)  
        2011 vs. 2010      2010 vs. 2009  
     2011      2010      2009      Amount      Percent      Amount      Percent  

Net interest income

   $             459       $             544       $             397       $             (85)                 (15.64)       $             147         36.83   

Provision for credit losses

     5                         5         *                   (171.70)   

Noninterest (loss) income

     (104)         (87)         102         (17)         (18.80)         (189)         (185.94)   

Noninterest expense

     123         79         113         44         57.40         (34)         (30.36)   

Total assessments

     43         100         103         (57)         (57.37)         (3)         (2.01)   

Net income

     184         278         283         (94)         (33.73)         (5)         (2.03)   

 

* Not meaningful

Net Interest Income

A 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 liabilities (including COs, 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 certain derivative instruments and hedging activities related adjustments.

The decrease in net interest income during 2011 compared to 2010 was primarily due to a decrease in interest earned on the Bank’s long-term investments and advances during 2011 compared to 2010. The decrease in interest earned on long-term investments was primarily due to a decrease in yield on these investments during 2011 compared to 2010. The decrease in interest earned on advances was primarily due to a decrease in the average balance of advances outstanding during 2011 compared to 2010.

The increase in net interest income during 2010 compared to 2009 was primarily due to the write-off of hedging related basis adjustments on advances that were prepaid during 2009. In addition, during 2009, amortization related to discontinued hedging activities and the reclassification of interest from net interest income to “Net (losses) gains on derivatives and hedging activities” on derivatives in non-qualifying hedging relationships lowered net interest income in 2009.

 

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The following table summarizes key components of net interest income for the years presented (in millions):

 

     Years Ended December 31,  
     2011      2010      2009  

Interest income:

        

Advances

     $         258             $         320             $         881   

Investments

     754         960         1,232   

Mortgage loans held for portfolio

     97         121         152   
  

 

 

    

 

 

    

 

 

 

Total interest income

     1,109         1,401         2,265   
  

 

 

    

 

 

    

 

 

 

Interest expense:

        

Consolidated obligations

     645         852         1,862   

Deposits

     1         3         4   

Mandatorily redeemable capital stock

     4         2         2   
  

 

 

    

 

 

    

 

 

 

Total interest expense

     650         857         1,868   
  

 

 

    

 

 

    

 

 

 

Net interest income

     $ 459             $ 544             $ 397   
  

 

 

    

 

 

    

 

 

 

As discussed above, net interest income also includes components of hedging activity. When a hedging relationship is discontinued, the cumulative fair value adjustment on the hedged item will be amortized into interest income or expense over the remaining life of the asset or liability. Also, when hedging relationships qualify for hedge accounting, the interest components of the hedging derivatives will be reflected in interest income or expense. As shown in the table summarizing the net effect of derivatives and hedging activity on the Bank’s results of operations, the impact of hedging on interest income was a decrease of $1.4 billion, $2.1 billion and $2.5 billion during the years ended December 31, 2011, 2010, and 2009, respectively.

 

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The following table presents spreads between the average yield on total interest-earning assets and the average cost of interest-bearing liabilities for the years ended December 31, 2011, 2010, and 2009 (dollars in millions). The interest-rate spread is affected by the inclusion or exclusion of net interest income or expense associated with the Bank’s derivatives. For example, if the derivatives qualify for fair-value hedge accounting under GAAP, the net interest income or expense associated with the derivative is included in net interest income and in the calculation of interest-rate spread. If the derivatives do not qualify for fair-value hedge accounting under GAAP, the net interest income or expense associated with the derivatives is excluded from net interest income and the calculation of the interest-rate spread. Amortization associated with hedging-related basis adjustments is also reflected in net interest income, which affects interest-rate spread.

Spread and Yield Analysis

 

    For the Years Ended December 31,  
    2011     2010     2009  
    Average
Balance
    Interest     Yield/
Rate
(%)
    Average
Balance
    Interest     Yield/
Rate
(%)
    Average
Balance
    Interest     Yield/
Rate
(%)
 

Assets

                 

Federal funds sold

      $    14,483          $    24        0.16          $    13,302          $       31        0.23          $    11,637          $       22        0.19   

Interest-bearing deposits (1)

    3,599        4        0.12        3,655        7        0.18        4,427        7        0.17   

Certificates of deposit

    909        2        0.23        1,146        4        0.33        17               0.19   

Long-term investments (2)

    22,160        724        3.27        21,814        918        4.21        25,096        1,203        4.79   

Advances

    79,848        258        0.32        100,948        320        0.32        136,868        881        0.64   

Mortgage loans held for portfolio (3)

    1,829        97        5.32        2,300        121        5.25        2,861        152        5.30   

Loans to other FHLBanks

    2               0.14        1               0.19        1               0.18   
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest-earning assets

    122,830        1,109        0.90        143,166        1,401        0.98        180,907        2,265        1.25   
   

 

 

       

 

 

       

 

 

   

Allowance for credit losses on mortgage loans

    (1)            (1)            (1)       

Other assets

    844            1,013            1,403       
 

 

 

       

 

 

       

 

 

     

Total assets

      $  123,673              $  144,178              $  182,309       
 

 

 

       

 

 

       

 

 

     

Liabilities and Capital

                 

Deposits (4)

      $      2,851        1        0.04          $      3,142        3        0.09          $      4,067        4        0.09   

Short-term borrowings

    18,960        17        0.09        19,486        29        0.15        38,200        260        0.68   

Long-term debt

    89,896        628        0.70        107,614        823        0.76        124,514        1,602        1.29   

Other borrowings

    421        4        0.92        443        2        0.38        380        2        0.40   
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest-bearing liabilities

    112,128        650        0.58        130,685        857        0.66        167,161        1,868        1.12   
   

 

 

       

 

 

       

 

 

   

Other liabilities

    4,230            5,372            7,236       

Total capital

    7,315            8,121            7,912       
 

 

 

       

 

 

       

 

 

     

Total liabilities and capital

      $  123,673              $  144,178              $  182,309       
 

 

 

       

 

 

       

 

 

     

Net interest income and net yield on interest-earning assets

        $  459        0.37            $     544        0.38            $     397        0.22   
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Interest rate spread

        0.32             0.32            0.13   
     

 

 

       

 

 

       

 

 

 

Average interest-earning assets to interest-bearing liabilities

          109.54           109.55            108.22   
     

 

 

       

 

 

       

 

 

 

 

  (1) 

Includes amounts recognized for the right to reclaim cash collateral paid under master netting agreements with derivative counterparties.

  (2) 

Includes trading securities at fair value and available-for-sale securities at amortized cost.

  (3) 

Nonperforming loans are included in average balances used to determine average rate.

  (4) 

Includes amounts recognized for the right to return cash collateral received under master netting agreements with derivative counterparties.

The interest-rate spread has remained stable in 2011 compared to 2010.

 

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The interest-rate spread increased by 19 basis points in 2010 compared to 2009. Approximately 13 basis points of this increase was the result of derivative and hedging adjustments in 2009 that decreased interest income on advances that were offset by increases in other income that did not reoccur in 2010. The remaining increase resulted from rates on liabilities decreasing faster than yields on assets over categories with comparable balances.

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 volume changes and rate changes affected the Bank’s interest income and interest expense (in millions). As noted in the table below, the overall decrease in net interest income in 2011 compared to 2010 and the increase in net interest income in 2010 compared to 2009 were primarily rate related.

Volume and Rate Table(1)

 

    2011 vs. 2010     2010 vs. 2009  
        Volume         Rate     Increase
    (Decrease)    
        Volume             Rate         Increase
     (Decrease)    
 

Increase (decrease) in interest income:

           

Federal funds sold

    $      3        $      (10)        $      (7)        $        3        $            6        $        9   

Interest-bearing deposits

           (3)        (3)        (1)        1          

Certificates of deposit

    (1)        (1)        (2)        4               4   

Long-term investments

    15        (209)        (194)        (149)        (136)        (285)   

Advances

    (68)        6        (62)        (191)        (370)        (561)   

Mortgage loans held for portfolio

    (25)        1        (24)        (29)        (2)        (31)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    (76)        (216)        (292)        (363)        (501)        (864)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Increase (decrease) in interest expense:

           

Deposits

           (2)        (2)        (1)               (1)   

Short-term borrowings

           (12)        (12)        (89)        (142)        (231)   

Long-term debt

    (128)        (67)        (195)        (195)        (584)        (779)   

Other borrowings

           2        2                        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    (128)        (79)        (207)        (285)        (726)        (1,011)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Increase (decrease) in net interest

income

      $    52          $    (137)          $    (85)          $    (78)        $        225        $        147   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1) 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.

Noninterest Income (Loss)

The following table presents the components of noninterest income (loss) (in millions):

 

    For the Years Ended December 31,     Increase (Decrease)  
    2011     2010     2009     2011 vs. 2010     2010 vs. 2009  

Net impairment losses recognized in earnings

      $            (118)          $            (143)          $            (316)          $              25          $              173   

Net gains (losses) on trading securities

    2        31        (135)        (29)        166   

Net (losses) gains on derivatives and hedging activities

    (9)        8        543        (17)        (535)   

Letters of credit fees

    19        14        7        5        7   

Other

    2        3        3        (1)          
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest (loss) income

      $            (104)          $              (87)          $              102          $            (17)          $            (189)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The increase in total noninterest loss in 2011 compared to 2010 was primarily due to a decrease in net (losses) gains on derivatives and hedging activities due to a decrease in hedging and stand alone related income partially offset by an increase in income associated with derivatives hedging trading securities. Noninterest loss also increased in 2011 compared to 2010 due to a decrease in the fair value of trading securities, partially offset by lower credit related other-than-temporary impairment losses in 2011 compared to 2010.

 

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The Bank recorded total noninterest loss of $87 million in 2010 compared to total noninterest income of $102 million in 2009. The primary reason for the decline was a $244 million decrease in derivatives and hedging adjustments associated with prepaid advances that were offset in net interest income that occurred in 2009 but did not reoccur in 2010. In addition, there was a $125 million decrease in net gains on derivative and hedging activities, net of trading securities. These decreases were partially offset by a $173 million decrease in other-than-temporary impairment losses recognized in earnings in 2010 compared to 2009.

The following tables summarize the net effect of derivatives and hedging activity on the Bank’s results of operations (in millions):

 

    For the Year Ended December 31, 2011  
      Advances         Investments         Consolidated  
Obligation
Bonds
      Consolidated  
Obligation
Discount
Notes
      Balance  
Sheet
    Total  

Net interest income:

           

Amortization or accretion of hedging activities in net interest income(1)

      $ (199)             $ —             $ 37               $ —             $ —         $ (162)    

Net interest settlements included in net interest income(2)

    (2,054)         —         804                —         (1,248)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net interest (expense) income

    (2,253)         —         841                —         (1,410)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net gains (losses) on derivatives and hedging activities:

           

Gains (losses) on fair value hedges

    146         —         (2)         —         —         144    

Gains (losses) on derivatives not receiving hedge accounting

           (129)                —         (38)         (153)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net gains (losses) on derivatives and hedging activities

    154         (129)                —         (38)         (9)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net interest income and net gains (losses) on derivatives and hedging activities

          (2,099)         (129)         845                (38)         (1,419)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net gains on trading securities(3)

    —                —         —         —           
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net effect of derivatives and hedging activities

      $ (2,099)             $     (127)             $ 845               $            $     (38)         $     (1,417)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Represents the amortization or accretion of hedging fair value adjustments for both open and closed hedge positions.

(2) 

Represents interest income or expense on derivatives included in net interest income.

(3) 

Includes only those gains or losses on trading securities or financial instruments held at fair value that have an economic derivative “assigned,” therefore, this line item may not agree to the income statement.

 

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    For the Year Ended December 31, 2010  
      Advances         Investments         Consolidated  
Obligation
Bonds
      Consolidated  
Obligation
Discount
Notes
      Balance  
Sheet
    Total  

Net interest income:

           

Amortization or accretion of hedging activities in net interest income(1)

      $ (254)               $ —               $ 55               $ —           $ —           $ (199)    

Net interest settlements included in net interest income(2)

          (3,068)         —         1,149         10         —         (1,909)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net interest (expense) income

    (3,322)         —         1,204         10         —         (2,108)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net gains (losses) on derivatives and hedging activities:

           

Gains (losses) on fair value hedges

    234         —         (35)         (3)         —         196    

(Losses) gains on derivatives not receiving hedge accounting

    —         (192)         13         —         (9)         (188)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net gains (losses) on derivatives and hedging activities

    234         (192)         (22)         (3)         (9)           
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net interest income and net gains (losses) on derivatives and hedging activities

    (3,088)         (192)         1,182                (9)         (2,100)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net gains on trading securities(3)

    —         31         —         —         —         31    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net effect of derivatives and hedging activities

      $ (3,088)               $ (161)               $ 1,182               $          $ (9)           $     (2,069)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Represents the amortization or accretion of hedging fair value adjustments for both open and closed hedge positions.

(2) 

Represents interest income or expense on derivatives included in net interest income.

(3) 

Includes only those gains or losses on trading securities or financial instruments held at fair value that have an economic derivative “assigned,” therefore, this line item may not agree to the income statement.

 

    For the Year Ended December 31, 2009  
        Advances             Investments             Consolidated    
Obligation
Bonds
        Consolidated    
Obligation
Discount
Notes
        Balance     
Sheet
    Total  

Net interest income:

           

Amortization or accretion of hedging activities in net interest income(1)

      $ (605)               $ —               $ 68               $ (1)           $     —           $ (538)    

Net interest settlements included in net interest income(2)

          (3,527)         —         1,491         103         —         (1933)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net interest (expense) income

    (4,132)         —         1,559         102         —         (2,471)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net gains (losses) on derivatives and hedging activities:

           

Gains (losses) on fair value hedges

    518         —         (39)         (9)         —         470    

Gains on derivatives not receiving hedge accounting

           49                              73    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net gains (losses) on derivatives and hedging activities

    525         49         (31)         (5)                543    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net interest income and net gains (losses) on derivatives and hedging activities

    (3,607)         49         1,528         97                (1,928)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net losses on trading securities(3)

    —         (135)         —         —         —         (135)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net effect of derivatives and hedging activities

      $ (3,607)               $ (86)               $ 1,528               $ 97               $          $     (2,063)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Represents the amortization or accretion of hedging fair value adjustments for both open and closed hedge positions.

(2) 

Represents interest income or expense on derivatives included in net interest income.

(3) 

Includes only those gains or losses on trading securities or financial instruments held at fair value that have an economic derivative “assigned,” therefore, this line item may not agree to the income statement.

 

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Noninterest Expense and Assessments

The following table presents the components of noninterest expense and assessments (in millions).

 

    For the Years Ended December 31,      Increase (Decrease)  
    2011      2010      2009      2011 vs. 2010      2010 vs. 2009  

Noninterest expense:

             

Compensation and benefits

      $ 75           $ 66           $ 55           $ 9           $ 11   

Cost of quarters

    5         4         4         1           

Other operating expenses

    35         45         42         (10)         3   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

    115         115         101                 14   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Finance Agency and Office of Finance

    16         14         11         2         3   

Reversal of provision for credit losses on receivable

            (51)                 51         (51)   

Other

    (8)         1         1         (9)           
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest expense

    123         79         113         44         (34)   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Assessments:

             

Affordable Housing Program

    21         31         32         (10)         (1)   

REFCORP

    22         69         71         (47)         (2)   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assessments

    43         100         103         (57)         (3)   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

      $     166           $         179           $         216           $ (13)           $     (37)   
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses remained stable during 2011 compared to 2010. The increase in noninterest expense during 2011, compared to 2010, and the decrease in noninterest expense during 2010, compared to 2009, was primarily due to the Bank’s reduction in its provision for credit losses on a receivable due from LBSF by $51 million during 2010, which resulted in an increase in income. For more information about the LBSF receivable, see Note 18—Derivatives and Hedging Activities—Managing Credit Risk on Derivatives, to the audited financial statements.

The decrease in total assessments during 2011, compared to 2010, was primarily due to the satisfaction of the Bank’s REFCORP obligation during the second quarter of 2011 as previously discussed. Total assessments remained relatively stable in 2010 compared to 2009, decreasing by $3 million during 2010 compared to 2009.

Liquidity and Capital Resources

Liquidity is necessary to satisfy members’ borrowing needs on a timely basis, repay maturing and called COs, 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 Bank maintains contingent liquidity, 45 day liquidity, and operational liquidity.

Finance Agency regulations 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. The Bank met this regulatory liquidity requirement throughout 2011. During the recent financial crisis, the Finance Agency provided liquidity guidance to the FHLBanks generally to provide ranges of days within which each FHLBank should maintain positive cash balances based upon different assumptions and scenarios. The Bank has operated within these ranges since the Finance Agency issued this guidance.

In addition, the Bank strives to maintain sufficient liquidity to service debt obligations for at least 45 days (30-day moving average), assuming restricted debt market access. The Bank implemented this 45 day debt service goal effective January 28, 2010; prior to that, the Bank’s goal was to maintain sufficient liquidity for 90 days. The Bank determined that changing the Bank’s liquidity goal from 90 days to 45 days would more closely align the Bank’s internal measures with those recommended by the Finance Agency and would more accurately

 

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reflect the Bank’s practice of not committing to CO settlements beyond 30 days. The Bank was in compliance with its 90 day liquidity goal at the time of this determination and through January 28, 2010. The Bank met its 45 day internal liquidity goal throughout 2011. The Bank has established a daily liquidity target to meet its operational liquidity (defined as the ready cash and borrowing capacity available to meet the Bank’s day-to-day needs). The Bank has had significant excess operational liquidity throughout the past two years.

The Bank’s principal source of liquidity is CO debt instruments. 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 experienced a decrease in investor demand for consolidated obligation bonds beginning in mid-July 2008 and continuing through the first half of 2009. During that time, the Bank increased its issuance of short-term discount notes as an alternative source of funding. The Bank’s funding costs and ability to issue longer-term and structured debt generally have returned to pre-2008 levels, but continue to reflect some market volatility.

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 FHLBank Act, the Secretary of Treasury has the authority, at his or her discretion, to purchase COs up to an aggregate amount of $4.0 billion. No borrowings under this authority have been outstanding since 1977.

During July 2011 the Bank increased its issuance of CO discount notes to maintain a high level of short-term liquidity in anticipation of possible disruption in the capital markets as a result of the statutory debt limit debate. Although some temporary tightening occurred in the capital markets immediately prior to the August 2, 2011 debt limit deadline, the Bank was essentially unaffected as a result of its prior increase in liquidity. After the debt ceiling agreement was announced, the debt markets generally stabilized. The Bank maintained higher than historical levels of short-term liquidity during the second half of 2011, and expects to continue to do so for the near future, in order to take advantage of relatively attractive short-term investment rates in a prolonged low-rate environment and protect against continued general market uncertainty.

As discussed above under Financial Condition–Consolidated Obligations, in August, Moody’s revised its rating outlook on the Aaa bond rating of the U.S., and consequently the ratings outlook of the FHLBanks, to negative. On August 5, 2011, S&P downgraded the long-term sovereign credit rating of the U.S. from AAA to AA+, and consequently downgraded all the FHLBanks to AA+ on August 8, 2011. These actions reflect the rating agencies’ view that the ratings of the FHLBank System and the individual FHLBanks are constrained by the sovereign rating of the U.S. However, the Bank did not experience a material impact on its ability to meet its liquidity goals or on the Bank’s financial condition or results of operations during 2011 due to these rating agency actions. It is possible that any further changes to the U.S. sovereign credit rating, and consequently to the FHLBanks’ credit ratings, may cause disruptions in the financial markets, increase the Bank’s cost of funds, or decrease the Bank’s ability to access the capital markets, which may adversely impact the Bank’s ability to maintain sufficient liquidity levels.

Off-Balance Sheet Commitments

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

 

 

the Bank’s joint and several liability for all FHLBank COs; and

 

 

the Bank’s outstanding commitments arising from standby letters of credit.

 

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Should an FHLBank be unable to satisfy its payment obligation under a CO 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 Finance Agency. The Bank considers the joint and several liability to be a related-party guarantee. These related-party guarantees meet the scope exception under GAAP. Accordingly, the Bank has not recognized a liability for its joint and several obligations related to other FHLBanks’ COs at December 31, 2011 and December 31, 2010. As of December 31, 2011, the FHLBanks had $691.9 billion in aggregate par value of COs issued and outstanding, $113.8 billion of which was attributable to the Bank. No FHLBank has ever defaulted on its principal or interest payments under any CO, and the Bank has never been required to make payments under any CO as a result of the failure of another FHLBank to meet its obligations.

As of December 31, 2011, the Bank had outstanding standby letters of credit of $21.5 billion with original terms of less than 12 months to 20 years, with the longest final stated expiration in 2030. As of December 31, 2010, the Bank had outstanding standby letters of credit of $22.3 billion with original terms of less than two months to 20 years, with the longest final stated expiration in 2030, as well as one evergreen letter of credit.

S&P’s downgrade of the U.S. sovereign credit rating and S&P’s related downgrade of the issuer credit ratings of the FHLBanks did not have a material impact on the Bank’s standby letter of credit activity during 2011. However, any further downgrade of the Bank’s credit rating by one or more NRSROs could negatively impact the Bank’s standby letter of credit activity, as beneficiaries may have certain issuer credit rating requirements or other eligibility requirements. See Financial Condition–Consolidated Obligations and Liquidity and Capital Resources above for further discussion of recent actions taken by Moody’s and S&P.

The Bank generally requires standby letters of credit to contain language permitting the Bank, upon annual renewal dates and prior notice to the beneficiary, to choose not to renew the standby letter of credit, which effectively terminates the standby letter of credit prior to its scheduled final expiration date. The Bank may issue standby letters of credit for terms of longer than one year without annual renewals or for open-ended terms with annual renewals (commonly known as evergreen letters of credit) based on the creditworthiness of the member applicant and appropriate additional fees.

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. Standby letters of credit are not subject to activity-based capital stock purchase requirements. If the Bank is required to make a payment for a beneficiary’s draw, the Bank in its discretion may convert such paid amount to an advance to the member and will require a corresponding activity-based capital stock purchase. 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 standby letters of credit as of December 31, 2011. Management regularly reviews its standby letter of credit pricing in light of several factors, including the Bank’s potential liquidity needs related to draws on its standby letters of credit.

 

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Contractual Obligations

The table below presents the payment due dates or expiration terms of the Bank’s contractual obligations and commitments as of December 31, 2011 (in millions):

 

         One year or less              After one year    
through three
years
     After three
years
    through five    
years
           After five      
years
             Total          

Contractual obligations:

              

Long-term debt

     $ 48,163         $ 28,914         $ 6,088         $ 6,254         $ 89,419   

Standby letters of credit

     4,297         8,042         1,411         7,760         21,510   

Mandatorily redeemable capital stock

     4         60         221         1         286   

Pension and post-retirement contributions

     5         4         5         12         26   

Operating leases

             1         1                 2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     $ 52,469         $ 37,021         $ 7,726         $ 14,027         $ 111,243   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Critical Accounting Policies and Estimates

The preparation of the Bank’s financial statements in accordance with GAAP requires management to make a number of judgments and assumptions that affect the Bank’s reported results and disclosures. Several of the Bank’s accounting policies inherently are subject to valuation assumptions and other subjective assessments and are more critical than others to the Bank’s results. The Bank has identified the following policies that, given the assumptions and judgment used, are critical to an understanding of the Bank’s financial condition and results of operations:

 

 

Fair Value Measurements;

 

 

Other-than-temporary Impairment;

 

 

Allowance for Credit Losses; and

 

 

Derivatives and Hedging Activities.

Fair Value Measurements

The Bank carries certain assets and liabilities, including investments classified as trading and available-for-sale, and all derivatives on the balance sheet at fair value. Fair value 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, representing an exit price.

Fair values play an important role in the valuation of certain of the assets, liabilities and hedging transactions of the Bank. Fair values are based on quoted market prices or market-based prices, if such prices are available, even in situations in which trading volume may be low when compared with prior periods as has been the case during the current market disruption. If quoted market prices or market-based prices are not available, the Bank determines fair values based on valuation models that use discounted cash flows, using market estimates of interest rates and volatility.

Valuation models and their underlying assumptions are based on the best estimates of management of the Bank with respect to:

 

 

market indices (primarily LIBOR);

 

 

discount rates;

 

 

prepayments;

 

 

market volatility; and

 

 

other factors, including default and loss rates.

 

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These assumptions, particularly estimates of market indices and discount rates, may have a significant effect on the reported fair values of assets and liabilities, including derivatives, and the income and expense related thereto. The use of different assumptions, as well as changes in market conditions, could result in materially different net income and retained earnings. The assumptions used in the models are corroborated by and independently verified against market observable data where possible.

The Bank categorizes its financial instruments carried at fair value into a three-level classification in accordance with GAAP. The valuation hierarchy is based upon the transparency (observable or unobservable) of inputs to the valuation of an asset or liability as of the measurement date. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Bank’s market assumptions. The Bank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.

As of December 31, 2011 and 2010, the fair value of the Bank’s available-for-sale private-label MBS investment portfolio was determined using unobservable inputs.

For further discussion regarding how the Bank measures financial assets and financial liabilities at fair value, see Note 19—Estimated Fair Values to the Bank’s 2011 audited financial statements.

Other-than-temporary Impairment

The Bank evaluates its individual available-for-sale and held-to-maturity investment securities for other-than-temporary impairment on at least a quarterly basis. The Bank recognizes an other-than-temporary impairment loss when the Bank determines it will not recover the entire amortized cost basis of a security. Securities in the Bank’s private-label MBS portfolio that are in an unrealized loss position are evaluated by estimating the projected cash flows using a model that incorporates projections and assumptions based on the structure of the security and certain economic environment assumptions such as delinquency and default rates, loss severity, home price appreciation, interest rates, and securities prepayment speeds while factoring in the underlying collateral and credit enhancement.

If the present value of the expected cash flows of a particular security is less than the security’s amortized cost basis, the security is considered to be other-than temporarily impaired. The amount of the other-than-temporary impairment is separated into two components: (1) the amount of the total impairment related to credit loss; and (2) the amount of the total impairment related to all other factors. The portion of the other-than-temporary impairment loss that is attributable to the credit loss (that is, the difference between the present value of the cash flows expected to be collected and the amortized cost basis) is recognized in noninterest income (loss). The credit loss on a debt security is limited to the amount of that security’s unrealized loss. If the Bank does not intend to sell the security and it is not more likely than not that the Bank will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis, the portion of the impairment loss that is not attributable to the credit loss is recognized through other comprehensive loss.

If the Bank determines that an other-than-temporary impairment exists, the Bank accounts for the investment security as if it had been purchased on the measurement date of the other-than-temporary impairment loss at an amortized cost basis equal to the previous amortized cost basis less the other-than-temporary impairment recognized in income. For debt securities classified as held-to-maturity, the difference between the new amortized cost basis and the cash flows expected to be collected is accreted into interest income prospectively over the remaining life of the security.

Allowance for Credit Losses

The Bank is required to assess potential credit losses and establish an allowance for credit losses, if required, for each identified portfolio segment of financing receivables. A portfolio segment is the level at which the Bank

 

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develops and documents a systematic method for determining its allowance for credit losses. The Bank has established a reserve methodology for each of the following portfolio segments of financing receivables: advances and letters of credit, conventional single-family residential mortgage loans, government-guaranteed or insured single-family residential mortgage loans, multifamily residential mortgage loans and term federal funds.

The Bank considers the application of these standards to its advance, mortgage loan and federal fund portfolio a critical accounting policy, as determining the appropriate amount of the allowance for credit losses requires the Bank to make a number of assumptions. The Bank’s assumptions are based on information available as of the date of the financial statements. Actual results may differ from these estimates.

Advances

Finance Agency regulations require the Bank to obtain eligible collateral from borrowing members to protect against potential credit losses. Eligible collateral is defined by statute and regulation. The Bank monitors the financial condition of borrowers and regularly verifies the existence and characteristics of a risk-based sample of mortgage collateral pledged to secure advances. Each borrower’s collateral requirements and the scope and frequency of its collateral verification reviews are dependent upon certain risk factors. Since its establishment in 1932, the Bank has never experienced a credit loss on an advance. Based on the collateral held as security, its collateral policies, management’s credit analysis and the repayment history on advances, the Bank’s management did not anticipate any credit losses on advances as of December 31, 2011 or 2010. Accordingly, the Bank has not recorded any allowance for credit losses on advances. Refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Prudent Risk Management and Appetite—Credit Risk for further discussion regarding the Bank’s credit risk policies and practice.

Single-family Residential Mortgage Loans

With the exception of modified loans that are considered a troubled debt restructuring, conventional single-family residential mortgage loans are evaluated collectively for impairment. The overall allowance for credit losses is determined by an analysis (at least quarterly) that includes consideration of various data, such as past performance, current performance, loan portfolio characteristics, collateral valuations, industry data, and prevailing economic conditions. Inherent in the Bank’s evaluation of past performance are the effects of various credit enhancements at the individual master commitment level to determine the credit enhancement available to recover losses on conventional single-family residential mortgage loans under each individual master commitment.

A modified loan that is considered a troubled debt restructuring is individually evaluated for impairment when determining its related allowance for credit losses. Credit loss is measured by factoring in expected cash shortfalls (i.e., loss severity rate) incurred as of the reporting date, as well as the economic loss attributable to delaying the original contractual principal and interest due dates.

Government-guaranteed or Insured Single-family Residential Mortgage Loans

The Bank also invests in government-guaranteed or insured fixed-rate mortgage loans secured by one-to-four family residential properties. Government-guaranteed or insured mortgage loans are mortgage loans guaranteed or insured by the VA or the FHA. Any losses from such loans are expected to be recovered from those entities. Any losses from such loans that are not recovered from those entities are absorbed by the servicers. Therefore, there is no allowance for credit losses on government-guaranteed or insured mortgage loans.

Multifamily Residential Mortgage Loans

Multifamily residential mortgage loans are individually evaluated for impairment. An independent third-party loan review is performed annually on all the Bank’s multifamily residential mortgage loans to identify credit

 

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risks and to assess the overall ability of the Bank to collect on those loans. This assessment may be conducted more frequently if management notes significant changes in the portfolio’s performance in the quarterly review report provided on each loan. The allowance for credit losses related to multifamily residential mortgage loans is comprised of specific reserves and a general reserve.

The Bank establishes a specific reserve for all multifamily residential mortgage loans with a credit rating at or below a predetermined classification. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan. The loans are collateral dependent; that is, the ability to repay the loan is dependent on amounts generated by the collateral. Therefore, should a loan be classified as impaired, the loan will be adjusted to reflect the fair value of the underlying collateral less cost to sell.

To identify the loans that will be subject to review for impairment, the Bank reviews all multifamily residential mortgage loans with a credit rating at or below a predetermined classification. The Bank uses six grade categories when assigning credit ratings to individual loans. These credit ratings involve a high degree of judgment in estimating the amount and timing of future cash flows and collateral values. While the Bank’s allowance for credit losses is sensitive to the credit ratings assigned to a loan, a hypothetical one-level downgrade or upgrade in the Bank’s credit ratings for all multifamily residential mortgage loans would not result in a change in the allowance for credit losses that would be material as a proportion of the unpaid principal balance of the Bank’s mortgage loan portfolio.

A general reserve is maintained on multifamily residential mortgage loans not subject to specific reserve allocations to recognize the economic uncertainty and the imprecision inherent in estimating and measuring losses when evaluating reserves for individual loans. To establish the general reserve, the Bank assigns a risk classification to this population of loans. A specified percentage is allocated to the general reserve for designated risk classification levels. The loans and risk classification designations are reviewed by the Bank on an annual basis.

Federal Funds

Term federal funds are generally short-term and their recorded balance approximates fair value. The Bank invests in federal funds with investment-grade counterparties, which are only evaluated for purposes of an allowance for credit losses if the investment is not paid when due. As of December 31, 2011 and 2010, all investments in federal funds were repaid or expected to repay according to the contracted terms.

See Note 2—Summary of Significant Accounting Policies—Mortgage Loans Held in Portfolio to the Bank’s 2011 audited financial statements and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Prudent Risk Management and Appetite—Credit Risk for a further discussion of management’s estimate of credit losses.

Derivatives and Hedging Activities

General

The Bank records all derivatives on the Statements of Condition at fair value with changes in fair value recognized in current period earnings. The Bank designates derivatives as either fair-value hedging instruments or non-qualifying hedging instruments for which hedge accounting is not applied. The Bank has not entered into any cash-flow hedges as of December 31, 2011 and 2010. The Bank uses derivatives in its risk management program for the following purposes:

 

 

conversion of a fixed rate to a variable rate;

 

 

conversion of a variable rate with a fixed component to another variable rate; and

 

 

macro hedging of balance sheet risks.

 

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To qualify for hedge accounting, the Bank documents the following concurrently with the execution of each hedging relationship:

 

 

the hedging strategy;

 

 

identification of the hedging instrument and the hedged item;

 

 

determination of the appropriate accounting designation;

 

 

the method used for the determination of effectiveness for transactions qualifying for hedge accounting; and

 

 

the method for recording ineffectiveness for hedging relationships.

The Bank also evaluates each debt issuance, advance made, and financial instrument purchased to determine whether the cash item contains embedded derivatives that meet the criteria for bifurcation. If, after evaluation, it is determined that an embedded derivative must be bifurcated, the Bank will measure the fair value of the embedded derivative.

Assessment of Hedge Effectiveness

An assessment must be made to determine the effectiveness of qualifying hedging relationships; the Bank uses two methods to make such an assessment. If the hedging instrument is a swap and meets specific criteria, the hedging relationship may qualify for the short-cut method of assessing effectiveness. The short-cut method allows for an assumption of no ineffectiveness, which means that the change in the fair value of the hedged item is assumed to be equal and offsetting of the change in fair value of the hedging instrument. For periods beginning after May 31, 2005, management determined that it would no longer apply the short-cut method to new hedging relationships.

The long-haul method of effectiveness is used to assess effectiveness for hedging relationships that qualify for hedge accounting, but do not meet the criteria for the use of the short-cut method. The long-haul method requires separate valuations of both the hedged item and the hedging instrument. If the hedging relationship is determined to be highly effective, the change in fair value of the hedged item related to the designated risk is recognized in current period earnings in the same period as the change in fair value of the hedging instrument. If the hedging relationship is determined not to be highly effective, hedge accounting either will not be allowed or will cease at that point. The Bank performs effectiveness testing on a monthly basis and uses statistical regression analysis techniques to determine whether a long-haul hedging relationship is highly effective.

Accounting for Ineffectiveness and Hedge De-designation

The Bank accounts for any ineffectiveness for all long-haul fair-value hedges using the dollar offset method. In the case of non-qualifying hedges that do not qualify for hedge accounting, the Bank reports only the change in fair value of the derivative. The Bank reports all ineffectiveness for qualifying hedges and non-qualifying hedges in the income statement caption “Net (losses) gains on derivatives and hedging activities” which is included in the “Noninterest income (loss)” section of the Statements of Income.

The Bank may discontinue hedge accounting for a hedging transaction (de-designation) if it fails effectiveness testing or for other asset-liability-management reasons. The Bank also treats modifications to hedged items as a discontinuance of a hedging relationship. When a hedge relationship is discontinued, the Bank will cease marking the hedged item to fair value and will amortize the cumulative basis adjustment resulting from hedge accounting. The Bank reports related amortization as interest income or expense over the remaining life of the associated hedged item. The associated derivative will continue to be marked to fair value through earnings until it matures or is terminated.

 

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Recently Issued and Adopted Accounting Guidance

See Note 3—Recently Issued and Adopted Accounting Guidance to the Bank’s 2011 audited financial statements for a discussion of recently issued and adopted accounting guidance.

Legislative and Regulatory Developments

The legislative and regulatory environment for the FHLBanks and the Office of Finance has changed profoundly over the past few years, beginning with the Housing Act in 2008 and continuing, as financial regulators issue proposed and/or final rules to implement the Dodd-Frank Act following its enactment in July 2010 and as Congress considers housing finance and GSE reform. The FHLBanks’ business operations, funding costs, rights, obligations, and/or the environment in which the FHLBanks carry out their housing finance mission are likely to be materially affected by the Dodd-Frank Act; however, the full effect of the Dodd-Frank Act will become known only after the required regulations, studies and reports are issued and finalized. Significant regulatory actions and developments for the period covered by this Report are summarized below.

Dodd-Frank Act

Derivatives Transactions

The Dodd-Frank Act provides for new statutory and regulatory requirements for derivative transactions, including those utilized by the Bank to hedge its interest rate and other risks. As a result of these requirements, certain derivative transactions will be required to be cleared through a third-party central clearinghouse and traded on regulated exchanges or new swap execution facilities.

Mandatory Clearing of Derivatives Transactions. The Commodity Futures Trading Commission (CFTC) has issued a final rule regarding the process for determining which types of swaps will be subject to mandatory clearing, but has not yet made any such determinations under this process. The CFTC has also issued a proposal setting forth an implementation schedule for effectiveness of its mandatory clearing determinations. Pursuant to this proposal, regardless of when the CFTC determines that a type of swap is required to be cleared, such mandatory clearing would not take effect until certain rules being promulgated by the CFTC and the SEC under the Dodd-Frank Act have been finalized. In addition, the proposal provides that each time the CFTC determines that a type of swap is required to be cleared, the CFTC would have the option to implement such requirement in three phases. Under the proposal, the Bank would be a “category 2 entity” and would therefore have to comply with mandatory clearing requirements for a particular swap during phase 2 (within 180 days of the CFTC’s issuance of such requirements). Based on the CFTC’s proposed implementation schedule and the time periods set forth in the rule for CFTC determinations regarding mandatory clearing, it is not expected that any of the Bank’s swaps will be required to be cleared until the end of 2012, at the earliest.

Collateral Requirements for Cleared Swaps. Cleared swaps will be subject to initial and variation margin requirements established by the clearinghouse and its clearing members. While clearing swaps may reduce counterparty credit risk, the margin requirements for cleared swaps have the potential of making derivative transactions more costly. In addition, mandatory swap clearing will require the Bank to enter into new relationships and accompanying documentation with clearing members (which the Bank is currently negotiating) and additional documentation with the Bank’s swap counterparties.

The CFTC has issued a final rule requiring that collateral posted by swap customers to a clearinghouse in connection with cleared swaps be legally segregated on a customer-by-customer basis (the LSOC Model). Pursuant to the LSOC Model, customer collateral must be segregated by customer on the books of a futures commission merchant (FCM) and derivatives clearing organization but may be commingled with the collateral of other customers of the same FCM in one physical account. The LSOC model affords greater protection to collateral posted for cleared swaps than is currently afforded to collateral posted for futures contracts. However, because of operational and investment risks inherent in the LSOC Model and because of certain provisions applicable to FCM insolvencies under the U.S. Bankruptcy Code, the LSOC Model does not afford complete

 

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protection to cleared swaps customer collateral. To the extent the CFTC’s final rule places the Bank’s posted collateral at greater risk of loss in the clearing structure than under the current over-the-counter market structure, the Bank may be adversely impacted.

Definitions of Certain Terms under New Derivatives Requirements. The Dodd-Frank Act will require swap dealers and certain other large users of derivatives to register as “swap dealers” or “major swap participants,” as the case may be, with the CFTC and/or the SEC. Based on the definitions in the proposed rules jointly issued by the CFTC and SEC, it does not appear likely that the Bank will be required to register as a “major swap participant,” although this remains a possibility. Also, based on the definitions in the proposed rules, it does not appear likely that the Bank will be required to register as a “swap dealer” for the derivative transactions that the Bank enters into with dealer counterparties for the purpose of hedging and managing the Bank’s interest rate risk.

It is also unclear how the final rule will treat the call and put optionality in certain advances to members. The CFTC and SEC have issued joint proposed rules further defining the term “swap” under the Dodd-Frank Act. These proposed rules and accompanying interpretive guidance attempt to clarify what products will and will not be regulated as “swaps.” While it is unlikely that advance transactions between the Bank and its member customers will be treated as “swaps,” the proposed rules and accompanying interpretive guidance are not entirely clear on this issue.

Depending on how the terms “swap” and “swap dealer” are defined in the final regulations, the Bank may be faced with the business decision of whether to continue to offer certain types of advance products to member customers if those transactions would require the Bank to register as a swap dealer. Designation as a swap dealer would subject the Bank to significant additional regulation and costs including, without limitation, registration with the CFTC, new internal and external business conduct standards, additional reporting requirements, and additional swap-based capital and margin requirements. Even if the Bank is designated as a swap dealer as a result of its advance activities, the proposed regulations would permit the Bank to apply to the CFTC to limit such designation to those specified activities for which the Bank is acting as a swap dealer. Upon such designation, the Bank’s hedging activities would not be subject to the full requirements that will generally be imposed on traditional swap dealers.

Uncleared Derivatives Transactions. The Dodd-Frank Act will also change the regulatory landscape for derivative transactions that are not subject to mandatory clearing requirements (uncleared trades). While the Bank expects to continue to enter into uncleared trades on a bilateral basis, such trades will be subject to new regulatory requirements, including mandatory reporting, documentation, and minimum margin and capital requirements. Under the proposed margin rules, the Bank will have to post both initial margin and variation margin to the Bank’s swap dealer counterparties, but may be eligible in both instances for modest unsecured thresholds as “low-risk financial end users.” Pursuant to additional Finance Agency provisions, the Bank will be required to collect both initial margin and variation margin from the Bank’s swap dealer counterparties, without any unsecured thresholds. These margin requirements and any related capital requirements could adversely impact the liquidity and pricing of certain uncleared derivative transactions entered into by the Bank, making such trades more costly.

The CFTC has issued a proposal setting forth an implementation schedule for the effectiveness of the new margin and documentation requirements for uncleared swaps. Pursuant to the proposal, regardless of when the final rules regarding these requirements are issued, such rules would not take effect until (1) certain other rules being promulgated under the Dodd-Frank Act take effect; and (2) a certain additional time period has elapsed. The length of this additional time period depends on the type of entity entering into the uncleared swaps. The Bank would be a “category 2 entity” and would therefore have to comply with the new requirements during phase 2 (within 180 days of the effectiveness of the final applicable rulemaking). Accordingly, it is not likely that the Bank would have to comply with such requirements until the end of 2012, at the earliest.

 

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Temporary Exemption from Certain Provisions. While certain provisions of the Dodd-Frank Act took effect on July 16, 2011, the CFTC has issued an order (and an amendment to that order) temporarily exempting persons or entities with respect to provisions of Title VII of the Dodd-Frank Act that reference “swap dealer,” “major swap participant,” “eligible contract participant,” and “swap.” These exemptions will expire upon the earlier of: (1) the effective date of the applicable final rule further defining the relevant terms; or (2) July 16, 2012. In addition, the provisions of the Dodd-Frank Act that will have the most effect on the Bank did not take effect on July 16, 2011, but will take effect no less than 60 days after the CFTC publishes final regulations implementing such provisions. The CFTC is expected to publish such final regulations during the first half of 2012, but it is not expected that such final regulations will become effective until later in 2012, and delays beyond that time are possible. In addition, as discussed above, mandatory clearing requirements and new margin and documentation requirements for uncleared swaps may be subject to additional implementation schedules, further delaying the effectiveness of such requirements.

The Bank, together with the other FHLBanks, is actively participating in the regulatory process regarding the Dodd-Frank Act by formally commenting to the regulators regarding a variety of rulemakings that could impact the FHLBanks. The Bank is also working with the other FHLBanks to implement the processes and documentation necessary to comply with the Dodd-Frank Act’s new requirements for derivatives.

Regulation of Systemically Important Nonbank Financial Companies.

Federal Reserve Board Proposed Definitions. On February 11, 2011, the Federal Reserve Board (FRB) issued a proposed rule with a comment deadline of March 30, 2011 that would define certain key terms relevant to “nonbank financial companies” under the Dodd-Frank Act, including the interagency oversight council’s (Oversight Council) authorities described below. The proposed rule provides that a company is “predominantly engaged in financial activities” and thus a nonbank financial company if:

 

 

the annual gross financial revenue of the company represents 85 percent or more of the company’s gross revenue in either of its two most recent completed fiscal years; or

 

 

the company’s total financial assets represent 85 percent or more of the company’s total assets as of the end of either of its two most recently completed fiscal years.

The Bank would likely be deemed predominantly engaged in financial activities and thus a nonbank financial company under the proposed rule.

Oversight Council Proposed Rule. On October 18, 2011, the Oversight Council issued a second notice of proposed rulemaking to provide guidance regarding the standards and procedures it will consider in designating nonbank financial companies whose financial activities or financial condition may pose a threat to the overall financial stability of the U.S., and to subject those companies to FRB supervision and certain prudential standards. The proposed rule supersedes a prior proposal on these designations. Under the proposed designation process, in non-emergency situations the Oversight Council will first identify those U.S. nonbank financial companies that have $50 billion or more of total consolidated assets and exceed any of five other quantitative threshold indicators of interconnectedness or susceptibility to material financial distress. Significantly for the Bank, in addition to the asset size criterion, one of the other thresholds is whether a nonbank financial company has $20 billion or more of borrowing outstanding, including bonds (in the Bank’s case, COs) issued. As of December 31, 2011, the Bank had $125.3 billion in total assets and $115.0 billion in total outstanding COs. If a nonbank financial company meets both the total consolidated assets threshold and any of the other quantitative thresholds, the Oversight Council will then analyze the potential threat that the nonbank financial company may pose to the U.S. financial stability, based in part on information from the company’s primary financial regulator and nonpublic information collected directly from the company. Comments on the proposed rule were due by December 19, 2011.

 

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FRB Proposed Prudential Standards. On January 5, 2012, the FRB issued a proposed rule that would implement the enhanced prudential standards and early remediation standards required by the Dodd-Frank Act for nonbank financial companies identified by the Oversight Council as posing a threat to the U.S. financial stability. Such proposed prudential standards include: risk-based capital and leverage requirements, liquidity standards, requirements for overall risk management, single-counterparty credit limits, stress test requirements, and a debt-to-equity limit. The capital and liquidity requirements would be implemented in phases and would be based on or exceed the Basel international capital and liquidity framework (as discussed in further detail below under Additional Developments). Comments on the proposed rule are due by April 30, 2012.

The FRB and Oversight Council proposed rules are broad enough to likely capture the Bank as a nonbank financial company and may subject the Bank to FRB oversight and prudential standards, unless the final applicable rules exempt the FHLBanks. If the Bank is designated by the Oversight Council for supervision and oversight by the FRB, then the Bank’s operations and business could be adversely impacted by additional costs and business activities’ restrictions resulting from such oversight.

Significant Finance Agency Regulatory Actions

Proposed Rule on Incentive-based Compensation Arrangements. On April 14, 2011, seven federal financial regulators, including the Finance Agency, published a proposed rule with a comment deadline of May 31, 2011, that would prohibit “covered financial institutions” from entering into incentive-based compensation arrangements with covered persons (including executive officers and other employees that may be in a position to expose the institution to risk of material loss) that encourage inappropriate risks. Among other things, the proposed rule would require mandatory deferrals of a portion of incentive compensation for executive officers and require board identification and oversight of incentive-based compensation for covered persons who are not executive officers. The proposed rule would impact the design of the Bank’s compensation policies and practices, including its incentive compensation policies and practices, if adopted as proposed. Comments on the proposed rule were due by May 31, 2011.

Proposed Rule on Prudential Management and Operations Standards. On June 20, 2011, the Finance Agency issued a proposed rule to establish prudential standards with respect to ten categories of operation and management of the FHLBanks and the other housing finance GSEs, including internal controls, interest rate risk exposure and market risk. The Finance Agency proposes to adopt the standards as guidelines set out in an appendix to the rule, which generally provide principles and leave to the regulated entities the obligation to organize and manage their operations in a way that ensures the standards are met, subject to the oversight of the Finance Agency. The proposed rule also provides potential consequences for failing to meet the standards, such as requirements regarding submission of a corrective action plan and the authority of the Director to impose other sanctions, such as limits on asset growth or increases in capital, that the Director believes appropriate, until the regulated entity returns to compliance with the prudential standards. Comments on this proposed rule were due on or before August 19, 2011.

Conservatorship and Receivership. On June 20, 2011, the Finance Agency issued a final rule to establish a framework for conservatorship and receivership operations for the FHLBanks. The final rule addresses the nature of a conservatorship or receivership and provides greater specificity on the FHLBank’s operations, in line with procedures set forth in similar regulatory frameworks such as the FDIC’s receivership authority. The rule clarifies the relationship among various classes of creditors and equity holders under a conservatorship or receivership and the priorities for contract parties and other claimants in receivership. This rule became effective on July 20, 2011.

Final Rule on Voluntary Mergers. On November 28, 2011, the Finance Agency issued a final rule, effective December 28, 2011, that establishes the conditions and procedures for the consideration and approval of voluntary mergers between FHLBanks. Under the rule, two or more FHLBanks may merge provided:

 

 

the FHLBanks have agreed upon the terms of the proposed merger and the board of directors of each such FHLBank has authorized the execution of the merger agreement;

 

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the FHLBanks have jointly filed a merger application with the Finance Agency to obtain the approval of the Director;

 

 

the Director has granted approval of the merger, subject to any closing conditions as the Director may determine must be met before the merger is consummated;

 

 

the members of each such FHLBank ratify the merger agreement;

 

 

the Director has received evidence that the closing conditions have been met; and

 

 

the Director has accepted the organization certificate of the continuing FHLBank.

Final Rule on Private Transfer Fee Covenants. On March 16, 2012, the Finance Agency issued a final rule, effective 120 days after publication, that would restrict the Bank from purchasing, investing in, taking a security interest in, or otherwise dealing in mortgage loans on properties encumbered by private transfer fee covenants, securities backed by such mortgage loans, and securities backed by the income stream from such covenants, except for certain transfer fee covenants. Excepted transfer fee covenants would include covenants to pay private transfer fees to covered associations (including organizations comprising owners of home, condominiums, cooperatives, manufactured homes and certain other tax-exempt organizations) that use the private transfer fees exclusively for the direct benefit of the property. The foregoing restrictions would apply only to mortgages on properties encumbered by private transfer fee covenants created on or after February 8, 2011, securities backed by such mortgages, and securities issued after February 8, 2011 and backed by revenue from private transfer fees regardless of when the covenants were created.

Other Significant Regulatory Actions

National Credit Union Administration Proposal on Emergency Liquidity. On December 22, 2011, the National Credit Union Administration (NCUA) issued an advance notice of proposed rulemaking that would require federally insured credit unions to have access to backup federal liquidity sources for use in times of financial emergency and distressed economic circumstances. The proposed rule would require federally insured credit unions, as part of their contingency funding plans, to have access to backup federal liquidity sources through one of four ways:

 

 

becoming a member in good standing of the Central Liquidity Facility (CLF) directly;

 

 

becoming a member in good standing of CLF indirectly through a corporate credit union;

 

 

obtaining and maintaining demonstrated access to the Federal Reserve Discount Window; or

 

 

maintaining a certain percentage of assets in highly liquid Treasury securities.

The rule would apply to both federal and state-chartered credit unions. If enacted, the proposed rule may encourage credit unions to favor these federal sources of liquidity over FHLBank membership and advances, which could have a negative impact on the Bank’s results of operations. Comments on the advance notice of proposed rulemaking were due by February 21, 2012.

Additional Developments

Fraud Detection and Reporting. The FHLBanks have seen an increased regulatory focus on preventing, detecting, and reporting fraud or possible fraud. In 2010, the Finance Agency issued a regulation requiring the FHLBanks to report to the Finance Agency upon the discovery of any fraud or possible fraud related to the purchase or sale of financial instruments or loans. On November 3, 2011, the Financial Crimes Enforcement Network (FinCEN) proposed regulations that would require the GSEs to develop anti-money laundering (AML) programs and to file suspicious activity reports (SARs) with FinCen, in addition to any reports provided to the Finance Agency. Any requirement to develop AML and SARs reporting programs would significantly increase the Bank’s fraud reporting and detection operations.

 

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Home Affordable Refinance Program and Other Foreclosure Prevention Efforts. During the third quarter of 2011, the Finance Agency and Fannie Mae and Freddie Mac (the Enterprises) announced a series of changes to the Home Affordable Refinance Program (HARP) that are intended to assist more eligible borrowers who can benefit from refinancing their home mortgage. Other federal agencies have implemented other programs during the past few years to prevent foreclosure (including the Home Affordable Modification Program and the Principal Reduction Alternative). Other proposals such as expansive principal writedowns or principal forgiveness, or converting delinquent borrowers into renters and conveying the properties to investors, have recently gained some popularity as well. On February 9, 2012, state and federal officials announced a settlement with five of the nation’s largest mortgage servicers. The announced settlement, among other things, will require the servicers to implement new servicing and foreclosure practices and includes certain incentives for the servicers to offer loan modifications that may include principal reductions on certain loans. The Bank does not expect the HARP changes or existing foreclosure prevention programs to have a material impact on the Bank’s MBS portfolio. Although it is unclear at this time whether additional foreclosure prevention efforts will be implemented during 2012, new programs that include expansive principal writedowns or forgiveness with respect to securitized loans could have a material negative impact on the Bank’s MBS portfolio.

Housing Finance and GSE Reform. On February 11, 2011, the Department of the Treasury and the U.S. Department of Housing and Urban Development issued a report to Congress entitled Reforming America’s Housing Finance Market. The report provided options for Congressional consideration regarding the long-term structure of housing finance. In response, several bills were introduced in Congress during 2011, and Congress continues to consider various proposals to reform the U.S. housing finance system, including specific reforms to Fannie Mae and Freddie Mac. Although the FHLBanks are not the primary focus of these housing finance reforms, they have been recognized as playing a vital role in helping smaller financial institutions access liquidity and capital to compete in an increasingly competitive marketplace.

Housing finance and GSE reform is not expected to progress significantly prior to the 2012 presidential election, but it is expected that GSE legislative activity will continue. While none of the legislation introduced thus far proposes specific changes to the FHLBanks, the Bank could nonetheless be affected in numerous ways by changes to the U.S. housing finance structure and to Fannie Mae and Freddie Mac. The ultimate effects of housing finance and GSE reform or any other legislation, including legislation to address the debt limit or federal deficit, on the FHLBanks is unknown at this time and will depend on the legislation, if any, that is finally enacted.

Basel Committee on Banking Supervision Capital Framework. In September 2010, the Basel Committee on Banking Supervision (Basel Committee) approved a new capital framework for internationally active banks, commonly known as Basel III. Banks subject to the new framework would be subject to increased capital and liquidity requirements, with core capital being more strictly defined to include only common equity and other capital assets that are able to fully absorb losses. The Basel Committee also proposed a liquidity coverage ratio for short-term liquidity needs that would be phased in by 2015, as well as a net stable funding ratio for longer-term liquidity needs that would be phased in by 2018.

On January 5, 2012, the FRB announced its proposed rule on enhanced prudential standards and early remediation requirements, as required by the Dodd-Frank Act, for nonbank financial companies designated as systemically important by the Oversight Council. The proposed rule proposes risk-based capital and leverage requirements, liquidity standards, requirements for overall risk management, single-counterparty credit limits, stress test requirements, and a debt-to-equity limit. The proposal declines to finalize certain standards such as liquidity requirements until the Basel III framework gains greater international consensus, but the proposal includes a liquidity buffer requirement that would be in addition to the final Basel Committee framework requirements. The size of the buffer would be determined through liquidity stress tests, taking into account a financial institution’s structure and risk factors.

While it is still uncertain how the capital and liquidity standards being developed by the Basel Committee ultimately will be implemented by the U.S. regulatory authorities, the new framework and the FRB’s proposed

 

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plan could require some of the Bank’s members to divest assets in order to comply with the more stringent capital and liquidity requirements, thereby tending to decrease their need for advances; on the other hand, the new framework may incent the Bank’s members to borrow term advances to create balance sheet liquidity. The requirements may also adversely affect investor demand for FHLBank System COs to the extent that impacted institutions divest or limit their investments in FHLBank System COs.

Prudent Risk Management and Appetite

The Bank’s lending, investment, and funding activities and the use of derivative hedge instruments expose the Bank to a number of risks. A robust risk management framework aligns risk-taking activities with the Bank’s strategies and risk appetite. A risk management framework also balances risks and rewards. The Bank’s risk management framework consists of risk governance, risk appetite, and risk management policies.

The Bank’s board of directors and management recognize that risks are inherent to the Bank’s business model and that the process of establishing a risk appetite does not imply that the Bank seeks to mitigate or eliminate all risk. By defining and managing to a specific risk appetite, the board of directors and management ensure that there is a common understanding of the Bank’s desired risk profile which enhances their ability to make improved strategic and tactical decisions. Additionally, the Bank aspires to achieve and exceed best practices in governance, ethics, and compliance, and to sustain a corporate culture that fosters transparency, integrity, and adherence to legal and ethical obligations.

The Bank’s board of directors and management have established this risk appetite statement and risk metrics for controlling and escalating actions based on the nine continuing objectives that represent the foundation of the Bank’s strategic and tactical planning:

 

 

Capital Adequacy—maintain adequate levels of capital components (retained earnings and capital stock) that protect against the risks inherent on the Bank’s balance sheet and provide sufficient resiliency to withstand potential stressed losses.

 

 

Market Risk/Earnings—produce a long-term return on equity spread to 3-month LIBOR of 50 to 100 basis points, while providing attractive funding for advance products, consistent payment of dividends, reliable access to funding, and maintenance of retained earnings in excess of stressed retained earnings targets.

 

 

Liquidity Risk—maintain sufficient liquidity and funding sources to allow the Bank to meet expected and unexpected obligations.

 

 

Credit Risk—avoid credit losses by managing credit and collateral risk exposures within acceptable parameters. Achieve this objective through data-driven analysis (and when appropriate perform shareholder-specific analysis), monitoring and verification.

 

 

Governance/Compliance/Legal—comply with all applicable laws and regulations.

 

 

Mission/Business Model—deliver financial services and consistent access to affordable funds in the size and structure members desire, helping members to manage risk and extend credit in their communities, while achieving its affordable housing mission goals; and provide value through the consistent payment of dividends and the repurchasing of excess stock.

 

 

Operational Risk—manage the key risks associated with operational availability of critical systems, the integrity and security of the Bank’s information, and the alignment of technology investment with key business objectives through enterprise-wide risk management practices and governance based on Committee of Sponsoring Organizations of the Treadway Commission (COSO) and Control Objectives for Information and Related Technology standards; and deliver an employment value proposition that allows the Bank to build, retain, engage, and develop staff capable of meeting the evolving needs of our key stakeholders and the ability to effectively manage enterprise-wide risks.

 

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Reputation—recognize the importance of and advance positive awareness and perception of the Bank and its mission among key external stakeholders impacting the Bank’s ability to achieve its mission.

 

 

Diversification and Concentration—monitor through enhanced reporting any elevated risk concentrations, and when appropriate, manage and mitigate the increased risk.

The board and management recognize risk and risk producing events are dynamic and constantly being presented. Accordingly, reporting, analyzing, and mitigating risks are paramount to successful corporate governance.

The RMP also governs the Bank’s approach to managing the above risks. The Bank’s board of directors reviews the RMP annually and formally re-adopts the RMP at least once every three years. It also reviews and approves amendments to the RMP from time to time as necessary. To ensure compliance with the RMP, the Bank has established internal management committees to provide oversight of these risks. The Bank produces a comprehensive risk assessment report on an annual basis that is reviewed by the board of directors. In addition to the established risk appetite and the RMP, the Bank also is subject to Finance Agency regulations and policies regarding risk management.

Below is a more specific discussion of how the Bank manages its market risk, liquidity risk, credit risk, operational risk, and business risk within this risk management and appetite framework.

Market Risk

General

The Bank is exposed to market risk in that changes in interest rates and spreads can have a direct effect on the value of the Bank’s assets and liabilities. As a result of the volume of its interest-earning assets and interest-bearing liabilities, the component of market risk having the greatest effect on the Bank’s financial condition and results of operations is interest-rate risk.

Interest-rate risk represents the risk that the aggregate market value or estimated fair value of the Bank’s asset, liability, and derivative portfolios will decline as a result of interest-rate volatility or that net earnings will be affected significantly by interest-rate changes. Interest-rate risk can occur in a variety of forms. These include repricing risk, yield-curve risk, basis risk, and option risk. The Bank faces repricing risk whenever an asset and a liability reprice at different times and with different rates, resulting in interest-margin sensitivity to changes in market interest rates. Yield-curve risk reflects the possibility that changes in the shape of the yield curve may affect the market value of the Bank’s assets and liabilities differently because a liability used to fund an asset may be short-term while the asset is long-term, or vice versa. Basis risk occurs when yields on assets and costs on liabilities are based on different bases, such as LIBOR, versus the Bank’s cost of funds. Different bases can move at different rates or in different directions, which can cause erratic changes in revenues and expenses. Option risk is presented by the optionality that is embedded in some assets and liabilities. Mortgage assets represent the primary source of option risk.

The primary goal of the Bank’s interest-rate risk measurement and management efforts is to control the above risks through prudent asset-liability management strategies so that the Bank may provide members with dividends that consistently are competitive with existing market interest rates on alternative short-term and variable-rate investments. The Bank attempts to manage interest-rate risk exposure by using appropriate funding instruments and hedging strategies. Hedging may occur at the micro level, for one or more specifically identified transactions, or at the macro level. Management evaluates the Bank’s macro hedge position and funding strategies on a daily basis and makes adjustments as necessary.

The Bank measures its potential market risk exposure in a number of ways. These include asset, liability, and equity duration analyses; earnings forecast scenario analyses that reflect repricing gaps; and convexity

 

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characteristics under assumed changes in interest rates, the shape of the yield curve, and market basis relationships. The Bank establishes tolerance limits for these financial metrics and uses internal models to measure each of these risk exposures at least monthly.

Use of Derivatives

The Bank enters into derivatives to reduce the interest-rate risk exposure inherent in otherwise unhedged assets and funding positions. The Bank does not engage in speculative trading of these instruments. The Bank’s management attempts to use derivatives to reduce interest-rate exposure in the most cost-efficient manner. The Bank’s derivative position includes interest-rate swaps, options, swaptions, interest-rate cap and floor agreements, and forward contracts. These derivatives are used to adjust the effective maturity, repricing frequency, or option characteristics of financial instruments to achieve risk-management objectives. Within its risk management strategy, the Bank uses derivative financial instruments in two ways:

 

 

As a fair-value hedge of an underlying financial instrument or a firm commitment. For example, the Bank uses derivatives to reduce the interest-rate net sensitivity of COs, advances, investments, and mortgage loans by, in effect, converting them to a short-term interest rate, usually based on LIBOR. The Bank also uses derivatives to manage embedded options in assets and liabilities, and to hedge the market value of existing assets and liabilities. The Bank reevaluates its hedging strategies from time to time and may change the hedging techniques used or adopt new strategies as deemed prudent.

 

 

As an asset-liability management tool, for which hedge accounting is not applied (non-qualifying hedge). The Bank may enter into derivatives that do not qualify for hedge accounting. As a result, the Bank recognizes the change in fair value and interest income or expense of these derivatives in the “Noninterest Income (Loss)” section of the Statements of Income as “Net (losses) gains on derivatives and hedging activities” with no offsetting fair-value adjustments of the hedged asset, liability, or firm commitment. Consequently, these transactions can introduce earnings volatility.

 

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The following table summarizes the notional amounts of derivative financial instruments (in millions).

 

             As of December 31,  
             2011      2010  

Hedged Item / Hedging Instrument

 

Hedging Objective

  Hedge
Accounting
Designation
   Notional Amount      Notional Amount  

Advances

         
Pay fixed, receive variable interest rate swap (without options)   Converts the advance’s fixed rate to a variable rate index.   Fair value
hedges
       $ 13,160           $ 13,632   
    Non-qualifying
hedges
     100         100   
Pay fixed, receive variable interest rate swap (with options)   Converts the advance’s fixed rate to a variable rate index and offsets option risk in the advance.   Fair value
hedges
     32,749         50,519   
    Non-qualifying
hedges
     741         1,241   
Pay variable with embedded features, receive variable interest rate swap (non-callable)   Reduces interest rate sensitivity and repricing gaps by converting the advance’s variable rate to a different variable rate index and/or offsets embedded option risk in the advance.   Fair value
hedges
     864         413   
Pay variable with embedded features, receive variable interest rate swap (callable)   Reduces interest rate sensitivity and repricing gaps by converting the advance’s variable rate to a different variable rate index and/or offsets embedded option risk in the advance.   Fair value
hedges
             323   
Pay variable, receive variable basis swap   Reduces interest rate sensitivity and repricing gaps by converting the advance’s variable rate to a different variable rate index.   Non-qualifying
hedges
     248         216   
      

 

 

    

 

 

 
    Total      47,862         66,444   
      

 

 

    

 

 

 

Investments

         
Pay fixed, receive variable interest rate swap   Converts the investment’s fixed rate to a variable rate index.   Non-qualifying
hedges
     2,678         2,950   
Pay variable, receive variable interest rate swap   Converts the investment’s variable rate to a different variable rate index.   Non-qualifying
hedges
     50         50   
      

 

 

    

 

 

 
    Total      2,728         3,000   
      

 

 

    

 

 

 

Consolidated Obligation Bonds

         
Receive fixed, pay variable interest rate swap (without options)   Converts the bond’s fixed rate to a variable rate index.   Fair value
hedges
     46,674         38,310   
    Non-qualifying
hedges
     1,100         2,850   
Receive fixed, pay variable interest rate swap (with options)   Converts the bond’s fixed rate to a variable rate index and offsets option risk in the bond.   Fair value
hedges
     26,403         21,962   
    Non-qualifying
hedges
     1,000           
Receive variable with embedded features, pay variable interest rate swap (callable)   Reduces interest rate sensitivity and repricing gaps by converting the bond’s variable rate to a different variable rate index and/or offsets embedded option risk in the bond.   Fair value
hedges
     20         30   
Receive variable, pay variable basis swap   Reduces interest rate sensitivity and repricing gaps by converting the bond’s variable rate to a different variable rate index.   Non-qualifying
hedges
     100           
      

 

 

    

 

 

 
    Total      75,297         63,152   
      

 

 

    

 

 

 

 

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<
             As of December 31,