10-K 1 ind12311210k.htm 10-K IND 12/31/12 10K


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 FORM 10-K
 
 (Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
Or
 
o
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 000-51404
 
 FEDERAL HOME LOAN BANK OF INDIANAPOLIS
(Exact name of registrant as specified in its charter)
  
 
Federally Chartered Corporation
 
35-6001443
(State or other jurisdiction of incorporation)
 
(IRS employer identification number)
 
 
 8250 Woodfield Crossing Blvd. Indianapolis, IN
 
46240
(Address of principal executive office)
 
(Zip code)
Telephone number, including area code:
(317) 465-0200
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
The Bank's Class B capital stock, par value $100 per share
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o  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.
o  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    o  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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   x  Yes     o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.   o  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
o Large accelerated filer
 
o  Accelerated filer
x  Non-accelerated filer (Do not check if a smaller reporting company)
 
o Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
o  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, 2012, the aggregate par value of the stock held by members and former members of the registrant was approximately $2.059 billion. At February 28, 2013, 18,083,231 shares of stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: None.



 
Page
 
 
Number
Item 1.
4 
 
5 
 
 
Community Investment and Affordable Housing Programs
 
 
 
 
 
 
Item 1A.
Item 2.
Item 3.
Item 4.
MINE SAFETY DISCLOSURES
Item 5.
Item 6.
Item 7.
 
 
 
 
 
 
 
 
Contractual Obligations
 
 
 
 Item 7A.
 Item 8.
 Item 9.
 Item 9A.
 Item 10.
 Item 11.
 Item 12.
 Item 13.
 Item 14.
 Item 15.
 



Special Note Regarding Forward-Looking Statements

Statements contained in this Form 10-K, including statements describing the objectives, projections, estimates, or predictions for our future, may be "forward-looking statements." These statements may use forward-looking terms, such as "anticipates," "believes," "could," "estimates," "may," "should," "will," or their negatives or other variations on these terms. We caution that, by their nature, forward-looking statements involve risk or uncertainty, and that actual results could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized.

These forward-looking statements involve risks and uncertainties including, but not limited to, the following: economic and market conditions; volatility of market prices, rates, and indices; political, legislative, regulatory, or judicial events; war, terrorism or natural disasters; membership changes; competitive forces; changes in investor demand for Consolidated Obligations and/or the terms of interest rate exchange agreements and similar agreements; and timing and volume of market activity. This Form 10-K, including the Business section and Management’s Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with our financial statements and notes, which begin on page F-1.




ITEM 1. BUSINESS

As used in this Form 10-K, unless the context otherwise requires, the terms "we," "us," "our," and the "Bank" refer to the Federal Home Loan Bank of Indianapolis or its management. We use certain acronyms and terms throughout this Item 1 that are defined in the Glossary of Terms located in Item 15. Exhibits and Financial Statement Schedules.

Unless otherwise stated, dollar amounts disclosed in this Item 1 are rounded to the nearest million; therefore, amounts of less than one million may not be reflected in Item 1 and, due to rounding, may not appear to agree to the amounts presented in thousands in the Financial Statements and Notes to Financial Statements. Amounts used to calculate dollar and percentage changes are based on numbers in the thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.

Background Information
The Federal Home Loan Bank of Indianapolis is a wholesale bank that provides loans, grants, and business services to member financial institutions in Indiana and Michigan. We are one of twelve such banks (collectively, the "FHLBanks" or individually an "FHLBank") in the FHLBank System, established in 1932. FHLBanks are privately capitalized and funded, and receive no Congressional appropriations.
Our mission is to help families afford housing by working with member financial institutions located in Indiana and Michigan to meet our members' funding needs for both residential mortgage loans and other types of loans to support the economic growth of their communities. We also provide grants for building and rehabilitating low-income housing.
Our programs provide funding to help members with liquidity and asset/liability management, interest rate risk, profitability enhancement, and mortgage pipeline funding. In addition to funding, we provide various correspondent services, such as securities safekeeping and wire transfers. We also help to meet the economic and housing needs of communities and families through grants and low-cost advances that help support affordable housing and economic development initiatives.
Our Bank was organized under the authority of the Bank Act. We are wholly-owned by our member financial institutions, which are also our primary customers. We do not lend directly to, or purchase mortgage loans directly from, the general public. All federally-insured depository institutions (including commercial banks, thrifts and credit unions), CDFIs certified by the CDFI Fund of the United States Treasury, and insurance companies that have a principal place of business located in Indiana or Michigan are eligible to become members of our Bank. Applicants for membership must meet certain requirements that demonstrate that they are engaged in residential housing finance. All member financial institutions are required to purchase shares of our Class B Capital Stock as a condition of membership. Only members may own our capital stock, except for stock held by former members or their legal successors during their stock redemption period. We expect to deliver a market return, within a framework of conservative risk management, on the equity investment by our member/owner institutions.
 
Each of the FHLBanks is a GSE and a federal instrumentality of the United States of America that operates as an independent entity with its own board of directors, management, and employees. A GSE is an entity that combines elements of private capital, public sponsorship, and public policy. The public sponsorship and public policy attributes of the FHLBanks include:

exemption from federal, state, and local taxation, except real estate taxes;
exemption from registration under the Securities Act of 1933, as amended (the FHLBanks are required by federal regulation to register a class of their equity securities under the Exchange Act);
the requirement that at least two-fifths of our directors be non-member "independent" directors, that two of these "independent" directors must have experience in consumer or community interests, and that the remaining "independent" directors must have demonstrated financial experience;
the United States Treasury's authority to purchase up to $4 billion of Consolidated Obligations of the FHLBanks; and
the requirement to use 10% of annual net earnings before Interest Expense on MRCS to fund the AHP.

The principal source of our funding is the proceeds from the sale to the public of FHLBank debt instruments, known as Consolidated Obligations, which consist of CO Bonds and Discount Notes. The Office of Finance was established as a joint office of the FHLBanks to facilitate the issuance and servicing of Consolidated Obligations. The 12 FHLBanks, along with the Office of Finance, comprise the FHLBank System. The United States government does not guarantee, directly or indirectly, our Consolidated Obligations, which are the joint and several obligations of all 12 FHLBanks.




On July 30, 2008, the United States Congress enacted HERA primarily to address the housing finance crisis, expand the FHA financing authority and address GSE reform issues, among other matters. A significant provision of HERA created a new federal agency, the Finance Agency, that became the new federal regulator of the FHLBanks, Fannie Mae and the Freddie Mac effective on the date of enactment of HERA. Our former regulator, the Finance Board, has been abolished, and Finance Board regulations, policies, and directives have been transferred to the Finance Agency. Consequently, unless the context requires otherwise, we will use the term "Finance Agency" herein to refer either to the Finance Agency established by HERA, or to its predecessor, the Finance Board. The Finance Agency's operating expenses with respect to the FHLBanks are funded by assessments on the FHLBanks. No tax dollars are used to support the operations of the Finance Agency relating to the FHLBanks.

On July 21, 2010, the United States Congress enacted the Dodd-Frank Act which, among other provisions: (i) created an interagency Oversight Council that is charged with identifying and regulating systemically important financial institutions; (ii) regulates the over-the-counter derivatives market; (iii) imposed new executive compensation proxy and disclosure requirements; (iv) established new requirements for MBS, including a risk-retention requirement; (v) reformed the credit rating agencies; (vi) made a number of changes to the federal deposit insurance system; and (vii) created the Consumer Financial Protection Bureau. Although the FHLBanks were exempted from several notable provisions of the Dodd-Frank Act, our business operations, funding costs, rights, obligations, and the environment in which we carry out our housing-finance mission have been and are likely to continue to be impacted by the Dodd-Frank Act. For additional information concerning this legislation, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Accounting and Regulatory Developments - Legislative and Regulatory Developments.

Business Segments

We manage our operations by grouping products and services within two business segments. These business segments are (i) Traditional, which includes credit products (such as Advances, letters of credit, and lines of credit), investments (including Federal Funds Sold, Securities Purchased Under Agreement to Resell, AFS securities, and HTM securities), correspondent services, and deposits; and (ii) Mortgage Loans, which includes mortgage loans purchased from our members through our MPP and participation interests purchased from the FHLBank of Topeka in mortgage loans that were purchased by the FHLBank of Topeka from its PFI members under the MPF Program. The revenues, profit or loss, and total assets for each segment are disclosed in Notes to Financial Statements - Note 18 - Segment Information.

Traditional.

Credit Products. We offer our members a wide variety of credit products, including Advances, letters of credit, and lines of credit. We approve member credit requests based on our assessment of the member's creditworthiness and financial condition, as well as its collateral position. All credit products must be fully collateralized by a member's pledge of eligible assets, primarily one-to-four family residential mortgage loans, various types of securities, deposits in our Bank, and certain ORERC, such as commercial MBS, commercial real estate loans and home equity loans, supplemented by a statutory lien provided under the Bank Act on each member's stock in our Bank. We also accept small business loans and farm real-estate loans as collateral from CFIs, which were defined for 2012 as FDIC-insured depository institutions with average total assets not exceeding $1.076 billion over the three years preceding the transaction date. This limit is subject to annual adjustment by the Finance Agency Director based on the consumer price index and is rounded to the nearest million.

We offer a wide array of fixed-rate and adjustable-rate Advances, our primary credit product. Interest is generally due on a monthly basis. The maturities of Advances currently offered typically range from 1 day to 10 years, although the maximum maturity may be longer in some instances. Members utilize Advances for a wide variety of purposes including:

funding for single-family mortgages and multi-family mortgages held in portfolio, including both conforming and non-conforming mortgages (as determined in accordance with secondary market criteria);
temporary funding during the origination, packaging, and sale of mortgages into the secondary market;
funding for commercial loans and, especially with respect to CFIs, funding for small business, small farm, and small agri-business portfolio loans;
asset/liability management;
acquiring or holding MBS;
a cost-effective alternative to holding short-term investments to meet contingent liquidity needs; and
a competitively priced alternative source of funds, especially with respect to smaller members with less diverse funding sources.




We offer standby letters of credit, generally for up to 10 years in term, which are rated Aaa by Moody's and AA+ by S&P. Letters of credit are performance contracts that guarantee the performance of a member to a third party and are subject to the same collateralization and borrowing limits that are applicable to Advances. A letter of credit may be offered to assist members in facilitating residential housing finance, community lending, asset/liability management, or liquidity. We also offer a standby letter of credit product to collateralize Indiana public deposits.

We also offer lines of credit, which allow members to fund short-term cash needs without submitting a new application for each request for funds.

Advances. Our primary Advance products include:

Fixed-rate Bullet Advances, which have fixed rates throughout the term of the Advances. These Advances are typically referred to as "bullet" Advances because no principal payment is due until maturity. Prepayments prior to maturity are subject to prepayment fees.
Putable Advances, which are fixed-rate Advances that give us an option to terminate the Advance prior to maturity. We would normally exercise the option to terminate the Advance when interest rates increase. Upon our exercise of the option, the member must repay the putable Advance or convert it to a floating rate instrument under the terms established at the time of the original issuance.
Fixed-rate Amortizing Advances, which are fixed-rate Advances that require principal payments either monthly or annually, based on a specified amortization schedule with a balloon payment of remaining principal at maturity.
Adjustable-rate Advances, which are sometimes called "floaters," reprice periodically based on a variety of indices, including LIBOR. Quarterly LIBOR floaters are the most common type of adjustable-rate Advance we extend to our members. Prepayment terms are agreed to before the Advance is extended. Most frequently, no prepayment fees are required if a member prepays an adjustable rate Advance on a reset date, after a pre-determined lock-out period, with the required notification. No principal payment is due prior to maturity.
Variable-rate Advances, which reprice daily. These Advances may be extended on terms from one day to six months and may be prepaid on any given business day during that term without fee or penalty. No principal payment is due until maturity.
Callable Advances, which are fixed-rate Advances that give the member an option to prepay the Advance before maturity on call dates with no prepayment fee, which members normally would exercise when interest rates decrease.

We also offer customized Advances to meet the particular needs of our members. Our entire menu of Advance products is generally available to each creditworthy member, regardless of the member's asset size. Finance Agency regulations require us to price our credit products consistently and without discrimination to all members applying for Advances. We are also prohibited from pricing our Advances below our marginal cost of matching term and maturity funds in the marketplace, including embedded options, and the administrative cost associated with making such Advances to members. Therefore, Advances are typically priced at standard spreads above our cost of funds. Our board-approved credit policy allows us to offer lower rates on certain types of Advances transactions. Determinations of such rates are based on factors such as volume, maturity, product type, funding availability and costs, and competitive factors in regard to other sources of funds.

We are generally limited to making Advances to members; however, by regulation, we are also permitted to make Advances to Housing Associates. A Housing Associate is an approved lender under Title II of the National Housing Act of 1934 that is either a government agency or is chartered under federal or state law with rights and powers similar to those of a corporation. A Housing Associate must lend its own funds as its principal activity in the mortgage lending field and, although it must meet the same lending requirements under Finance Agency regulations as members, it may not purchase our stock and has no voting rights. We do not presently have Advances outstanding to any Housing Associates.

Advances Concentration. Credit risk can be magnified if a lender's portfolio is concentrated in a few borrowers. At December 31, 2012, our top five borrowers accounted for 48% of total Advances outstanding, at par. Because of this concentration in Advances, we perform frequent credit and collateral reviews on our largest borrowers. In addition, we regularly analyze the implications to our financial management and profitability if we were to lose the business of one or more of these customers.




The following tables present the par value of Advances outstanding for our five largest borrowers ($ amounts in millions). At our discretion, and provided the borrower meets our contractual requirements, Advances to borrowers that are no longer members may remain outstanding until maturity.
December 31, 2012
 
Advances Outstanding
 
% of Total
Flagstar Bank, FSB
 
$
3,180

 
18
%
Jackson National Life Insurance Company
 
1,810

 
10
%
Lincoln National Life Insurance Company
 
1,350

 
8
%
Blue Cross Blue Shield of Michigan
 
1,038

 
6
%
Guggenheim Life and Annuity Company
 
1,038

 
6
%
Subtotal
 
8,416

 
48
%
Others
 
8,966

 
52
%
Total Advances, par value
 
$
17,382

 
100
%
 
 
 
 
 
December 31, 2011
 
Advances Outstanding
 
% of Total
Flagstar Bank, FSB
 
$
3,953

 
22
%
Jackson National Life Insurance Company
 
1,915

 
11
%
Blue Cross Blue Shield of Michigan
 
1,053

 
6
%
Guggenheim Life and Annuity Company
 
1,038

 
6
%
American United Life Insurance Company
 
832

 
5
%
Subtotal
 
8,791

 
50
%
Others
 
8,977

 
50
%
Total Advances, par value
 
$
17,768

 
100
%

As of December 31, 2012, 56 of our 411 members had assets in excess of $1 billion, and together they comprised approximately 84% of the total member asset base, i.e., the total cumulative assets of our member institutions. Our current largest non-member borrower, Bank of America, N.A., had outstanding Advances of $0.3 billion at December 31, 2012, all of which will mature in 2013.

For the years ended December 31, 2012, and 2011, we had gross interest earned on Advances, excluding the effects of interest-rate exchange agreements with non-member counterparties, from one customer, Flagstar Bank, FSB, that exceeded 10% of our Total Interest Income. We had Advances outstanding to and imputed interest income earned from Flagstar Bank, FSB as follows ($ amounts in millions):
 
 
As of and for the Years
Ended December 31,
 
 
2012
 
2011
Advances, at par
 
$
3,180

 
$
3,953

% of Total Advances, outstanding
 
18
%
 
22
%
 
 
 
 
 
Gross interest income earned
 
$
107

 
$
118

% of Total Interest Income
 
17
%
 
17
%




Collateral. All credit products extended to a member must be fully collateralized by the member's pledge of eligible assets. Each borrowing member and its affiliates that hold pledged collateral are required to grant us a security interest in such collateral. All such security interests held by us are afforded a priority by the Competitive Equality Banking Act of 1987 over the claims of any party, including any receiver, conservator, trustee, or similar party having rights as a lien creditor, except for claims held by bona fide purchasers for value or by parties that are secured by prior perfected security interests, provided that such claims would otherwise be entitled to priority under applicable law. Moreover, with respect to federally-insured depository institution members, our claims are given certain preferences pursuant to the receivership provisions of the Federal Deposit Insurance Act. With respect to insurance company members, however, Congress provided in the McCarran-Ferguson Act of 1945 that state law generally governs the regulation of insurance and shall not be invalidated by federal law unless the federal law expressly regulates the business of insurance. Thus, if a court were to determine that the priority provision afforded the FHLBanks under Section 10(e) of the Bank Act conflicts with state insurance law applicable to our insurance company members, the court might then determine that the priority of our security interest would be governed by state law, not Section 10(e). Under these circumstances, the "super lien" priority protection afforded to our security interest under Section 10(e) may not fully apply when we lend to insurance company members. However, we further protect our security interests in the collateral pledged by our members by filing UCC-1 financing statements, taking possession or control of such collateral, or taking other appropriate steps.

Collateral Status Categories. We take collateral under a blanket, specific listings or possession status depending on the credit quality of the borrower, type of institution and our review of conflicting liens. The blanket status is the least restrictive and allows the member to retain possession of the pledged collateral, provided that the member executes a written security agreement and agrees to hold the collateral for our benefit. Under the specific listings status, the member maintains possession of the specific collateral pledged, but the member generally provides listings of loans pledged with detailed loan information such as loan amount, payments, maturity date, interest rate, LTV, collateral type, FICO® scores, etc. Members under possession status are required to place the collateral in possession with our Bank or a third-party custodian in amounts sufficient to secure all outstanding obligations.

Eligible Collateral. Eligible collateral types include certain investment securities, one-to-four family first mortgage loans, multi-family first mortgage loans, deposits in our Bank, certain ORERC assets, and small business loans or farm real estate loans from CFIs (authorized by the GLB Act amendment to the Bank Act). While we only extend credit based on the borrowing capacity for such approved collateral, our contractual arrangements typically allow us to take other assets as collateral to provide additional protection, including (in the case of members and former members) the borrower's stock in our Bank. We have an Anti-Predatory Lending Policy and a Subprime and Nontraditional Residential Mortgage Policy that establish guidelines for any subprime or nontraditional loans included in the collateral pledged to us. Loans that are delinquent or violate our Anti-Predatory Lending Policy or our Subprime and Nontraditional Residential Mortgage Policy do not qualify as acceptable collateral and are required to be removed from any collateral value calculation.

Advances must be fully collateralized. Our over-collateralization requirements vary based upon the type of asset being pledged. Standard requirements range from 100% for deposits (cash) to 145% - 175% for residential mortgages pledged through blanket status. Over-collateralization requirements for eligible securities range from 105% to 195%; less traditional types of collateral have standard coverage ratios up to 300%. Over-collateralization requirements are applied using market values for collateral in listing and possession status and using book value for collateral pledged through blanket status. In no event, however, would market values applied to whole loan collateral exceed par. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Advances for more information.
    
Collateral Review and Monitoring. We verify collateral balances by performing periodic, on-site collateral audits on each of our borrowing members, which allow us to verify loan pledge eligibility, credit strength and documentation quality, as well as adherence to our Anti-Predatory Lending Policy, our Subprime and Nontraditional Residential Mortgage Policy, and other collateral policies. In addition, on-site collateral audit findings are used to adjust over-collateralization amounts to mitigate credit risk and collateral liquidity concerns.




Investments. We maintain a portfolio of investments, purchased from approved counterparties, members and their affiliates, or other FHLBanks, to provide liquidity, utilize balance sheet capacity and enhance our earnings. Our portfolio of short-term investments in highly-rated entities ensures the availability of funds to meet our members' credit needs. The longer term investment portfolio typically provides higher returns and may consist of (i) securities issued by the United States government, its agencies, and certain GSEs, (ii) MBS and ABS that are issued by government-sponsored mortgage agencies, and (iii) certain securities that carry ratings from two or more of the following NRSROs: Moody's, S&P or Fitch. We have significant investments in Fannie Mae and Freddie Mac securities that derive credit enhancement from their relationship with the United States government.

All unsecured investments, such as federal funds, including those with our members or their affiliates, are subject to certain selection criteria. Each approved unsecured counterparty has an exposure limit, which is computed in the same manner regardless of the counterparty's status as a member, affiliate of a member or unrelated party. These criteria determine the permissible amount and term of the investment. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Investments - Short-Term Investments for more information.

Under the Finance Agency's regulations, except for certain investments authorized under state trust law for our retirement plans, we are prohibited from investing in the following types of securities:

instruments, such as common stock, that represent an equity ownership in an entity, other than stock in small business investment companies, or certain investments targeted to low-income persons or communities;
instruments issued by non-United States entities, other than those issued by United States branches and agency offices of foreign commercial banks;
non-investment grade debt instruments, other than certain investments targeted to low-income persons or communities and instruments that were downgraded after their purchase;
whole mortgages or other whole loans, except for

those acquired under the MPP or the MPF Program;
certain investments targeted to low-income persons or communities; and
certain foreign housing loans authorized under Section 12(b) of the Bank Act; or

non-United States dollar denominated securities.

In addition, we are prohibited by a Finance Agency regulation and Advisory Bulletin, as well as internal policy, from purchasing certain types of investments, such as interest-only or principal-only stripped MBS, CMOs, REMICs or ABS; residual-interest or interest-accrual classes of CMOs, REMICs, ABS and MBS; and CMOs or REMICs with underlying collateral containing pay option/negative amortization mortgage loans, unless those loans or securities are guaranteed by the United States government, Fannie Mae, Freddie Mac or Ginnie Mae.

Finance Agency policy further provides that the total book value of our investments in MBS and ABS must not exceed 300% of our total regulatory capital, consisting of Class B stock, Retained Earnings, and MRCS, as of the day we purchase the investments, based on the capital amount most recently reported to the Finance Agency. If our outstanding investments in MBS and ABS exceed the limitation at any time, but were in compliance at the time we purchased the investments, we would not be considered out of compliance with the regulation, but we would not be permitted to purchase additional investments in MBS or ABS until these outstanding investments were within the capital limitation. These investments, as a percentage of total regulatory capital, were 295% at December 31, 2012. Generally, our goal is to maintain these investments near the 300% limit.

Further, we will not knowingly purchase any MBS or ABS that violate the provisions of our Anti-Predatory Lending Policy or our Subprime and Nontraditional Residential Mortgage Policy.




Deposit Products. Deposit products provide a small portion of our funding resources, while also giving members a high-quality asset that satisfies their regulatory liquidity requirements. We offer several types of deposit products to our members and other institutions including overnight and demand deposits. We may accept uninsured deposits from:

our members;
institutions eligible to become members;
any institution for which we are providing correspondent services;
interest-rate swap counterparties;
other FHLBanks; or
other federal government instrumentalities.

The following table presents the composition of our deposits ($ amounts in millions):
 
 
December 31, 2012
 
December 31, 2011
Types of Deposits
 
Amount
 
% of Total
 
Amount
 
% of Total
Interest-Bearing:
 
 
 
 
 
 
 
 
Demand and overnight
 
$
704

 
39
%
 
$
620

 
99
%
Time
 
2

 
%
 

 
%
Other Interest Bearing
 

 
%
 

 
%
Non-Interest-Bearing:
 
 
 
 
 
 
 
 
Demand Non-Interest Bearing
 
1,066

 
60
%
 

 
%
Other Non-Interest Bearing
 
15

 
1
%
 
9

 
1
%
Total Deposits
 
$
1,787

 
100
%
 
$
629

 
100
%

To support deposits, the Bank Act requires us to have an amount equal to the current deposits invested in (i) obligations of the United States, (ii) deposits in eligible banks or trust companies, or (iii) Advances with a maturity not exceeding five years. We were in compliance with the Bank Act liquidity requirements for deposits. The following table presents our excess liquidity deposit reserves ($ amounts in millions):
 
 
December 31, 2012
 
December 31, 2011
Liquidity deposit reserves
 
$
16,205

 
$
17,500

Less: Total Deposits
 
1,787

 
629

Excess liquidity deposit reserves
 
$
14,418

 
$
16,871


Mortgage Loans. Mortgage Loans includes mortgage loans purchased from our members through our MPP and participation interests purchased from the FHLBank of Topeka in mortgage loans that were purchased by the FHLBank of Topeka from its PFI members under the MPF Program. Our participation in these programs helps fulfill the FHLBank System's housing mission and provides an additional source of liquidity to FHLBank members that choose to sell mortgage loans into the secondary market rather than holding them in their own portfolios. These programs are considered AMA, a core mission activity of the FHLBanks, as defined by Finance Agency regulations.

Housing Goals. Finance Agency regulations require that low-income housing goals be established if total mortgage purchases exceed $2.5 billion annually. No low-income housing goals are currently in place because we did not purchase at least $2.5 billion of mortgages in 2012.

Mortgage Purchase Program.

Overview. We purchase mortgage loans directly from our members through our MPP. Members that participate in the MPP are known as PFIs. By regulation, we are not permitted to purchase loans directly from any institution that is not a member of the FHLBank System, and we may not use a trust or other entity to purchase the loans for us. We purchase conforming, medium- or long-term, fixed-rate, fully amortizing, level payment loans predominantly for primary, owner-occupied, detached residences, including single-family properties, and two-, three-, and four-unit properties. Additionally, to a lesser degree, we purchase loans for primary, owner-occupied, attached residences (including condominiums and planned unit developments), second/vacation homes, and investment properties.




All of our mortgage loan purchases are governed by a Finance Board regulation adopted in 2000, as amended. Prior to that time, the FHLBanks could only purchase mortgage loans based upon individual approvals from the Finance Board. Further, while the regulation does not specifically limit us to purchasing fixed-rate loans, we would need to comply with the Finance Agency's regulation on new business activities to purchase adjustable-rate loans. The Finance Agency regulations provide that any material changes to mortgage purchase programs that result in a different risk profile need to be approved by the Finance Agency as a new business activity.

Under current regulations, all pools of mortgage loans purchased by us, other than government-insured mortgage loans, must have sufficient credit enhancement so that the pools of loans are at least investment grade. In accordance with Finance Agency regulations, we limit the pools of mortgage loans that we will purchase to those with an implied NRSRO credit rating of at least BBB.

Loan Purchase Guidelines. All loans we purchase must meet guidelines for our MPP or be specifically approved as an exception based on compensating factors. Our guidelines generally meet or exceed the underwriting standards of Fannie Mae and Freddie Mac. For example, the maximum LTV ratio for any mortgage loan at the time of purchase is 95%, and borrowers must meet certain minimum credit scores depending upon the type of property or loan. In addition, we will not knowingly purchase any loan that violates the provisions of our Anti-Predatory Lending Policy or our Subprime and Nontraditional Residential Mortgage Policy.

PFIs must complete all application documents, which are reviewed by our Credit Department. In addition, a PFI must:

be an active originator of conventional mortgages and have servicing capabilities, if applicable, or use a servicer that we approve;
advise us if it has been the subject of any adverse action by either Fannie Mae or Freddie Mac; and
along with its parent company, if applicable, meet the capital requirements of each state and federal regulatory agency with jurisdiction over the member's or parent company's activities.

Mortgage Loan Concentration. Our board of directors has established a limit that restricts MPP loans outstanding purchased from any one PFI to 50% of MPP loans outstanding.

Based upon the average balances of MPP loans outstanding, at par, and imputing the amount of interest income, no mortgage loans outstanding previously purchased from a single member contributed interest income that exceeded 10% of our Total Interest Income for the year ended December 31, 2012. For the year ended December 31, 2011, we had mortgage loans outstanding of $1.6 billion previously purchased from a former member (a predecessor-in-interest to Bank of America) that contributed interest income totaling $89 million that exceeded 10% of our Total Interest Income. See Item 1A. Risk Factors - Loss of One or More Large Customers Could Adversely Impact Our Profitability, Our Ability to Achieve Business Objectives, and Our Risk Concentration for additional information.

Credit Enhancement. FHA mortgage loans are backed by insurance provided by the United States government and, therefore, no additional credit enhancements (such as an LRA or SMI) are required.

For conventional mortgage loans, the credit enhancement required to reach the expected credit rating is determined by using an NRSRO credit risk model. As part of the credit enhancement, an LRA is then established in an amount sufficient to cover expected losses in excess of the borrower's equity and PMI, if any.

MPP Advantage. Our original MPP, which we ceased offering for conventional loans in November 2010, relied on credit enhancement from LRA and SMI to achieve an implied credit rating of at least AA based on an NRSRO model in compliance with Finance Agency regulations. On November 29, 2010, we began offering MPP Advantage for new conventional MPP loans, which utilizes an enhanced fixed LRA account for additional credit enhancement, resulting in an implied credit rating of at least BBB, consistent with Finance Agency regulations, instead of utilizing coverage from an SMI provider. The only substantive difference between the two programs is the credit enhancement structure. For both the original MPP and MPP Advantage, the funds in the LRA are used to pay losses for a particular pool of loans.




MPP Credit Waterfall. Credit losses on defaulted mortgage loans in a pool are paid from these sources, until they are exhausted, in the following order:

borrower's equity;
PMI, if applicable;
LRA;
SMI, if applicable; and
our Bank.
    
LRA. We use either a "spread LRA" or a "fixed LRA" for credit enhancement. The spread LRA is used in combination with SMI for credit enhancement of conventional mortgage loans purchased under our original MPP, and the fixed LRA is being used for all acquisitions of new conventional mortgage loans purchased under MPP Advantage. The spread LRA is funded through a reduction to the net yield earned on the loans, and the corresponding purchase price paid to the PFI reflects our reduced net yield. Under our original MPP, the LRA for each pool of loans is funded monthly, at an annual rate ranging from seven to ten bps depending on the terms of the MCC, from the interest spread received on outstanding loans and is used to pay loan loss claims or is held until the LRA accumulates to a required "release point." The release point is 30 to 85 bps of the then outstanding principal balances of the loans in that pool, depending on the terms of the original contract. If the LRA exceeds the required release point, the excess amount is eligible for return to the member(s) that sold us the loans in that pool, subject to a minimum 5-year lock-out period and, in some instances, completion of the releases by the 11th year after loan acquisition. SMI provides an additional layer of credit enhancement beyond the LRA. Losses that exceed LRA funds are covered by SMI up to a severity of approximately 50% of the original property value of the loan, depending on the SMI contract terms. We absorb any losses in excess of LRA funds and SMI.

The LRA for MPP Advantage differs from our original program in that the funding of the LRA occurs at the time the loan is acquired and consists of a portion of the principal balance purchased. The LRA funding amount is currently 120 bps of the principal balance of the loans in the pool. There is no SMI credit enhancement for MPP Advantage. Funds in the LRA not used to pay loan losses may be returned to the seller subject to a release schedule detailed in each pool's contract based on the original LRA amount. No LRA funds are returned to the member for the first 5 years after acquisition, but such returns are available to be completed by the 26th year after loan acquisition. We absorb any losses in excess of LRA funds.

SMI. For pools of loans acquired under the original MPP, we entered into the insurance contracts directly with the SMI providers, including a contract for each pool or aggregate pool. Pursuant to Finance Agency regulation, the PFI must be responsible for all expected credit losses on the mortgages sold to us. Therefore, the PFI was the purchaser of the SMI policy, and we are designated as the beneficiary. Although we remit the premium payments to the SMI provider, the premiums are the PFI's obligation. We collect the SMI premiums from the monthly mortgage remittances received from the PFIs or their designated servicer and remit them to the SMI provider as an administrative convenience.

In order to limit the cost of SMI coverage, certain of our insurance contracts with MGIC, and subsequently with Genworth, contain an aggregate loss/benefit limit or "stop-loss" on any MCCs that equal or exceed $35 million. The stop-loss is equal to the total initial principal balance of loans under the MCC multiplied by the stop-loss percentage, as is then in effect, and represents the maximum aggregate amount payable by the SMI provider under the SMI policy for that pool. Even with the stop-loss provision, the aggregate of the LRA and the amount payable by the SMI provider under an SMI stop-loss contract will be equal to or greater than the amount of credit enhancement required for the pool to have an implied S&P credit rating of at least AA at the time of purchase. Non-credit losses, such as uninsured property damage losses that are not covered by the SMI, can be recovered from the LRA to the extent that there are LRA funds available.

Pool Aggregation. We offer pool aggregation under our MPP. Our pool aggregation program is designed to reduce the credit enhancement costs to small and mid-size members participating in the program. Members that participate in the MPP are allowed to pool their loans with similar pools of loans originated by other PFIs to create aggregate pools of approximately $100 million original UPB or greater. The cost of obtaining SMI for a pool of $100 million is less than the cost of obtaining SMI for smaller separate pools of loans. The combination of small and mid-size members' loans into one pool also assists in the evaluation of the amount of LRA needed for the overall credit enhancement. Pool aggregation has continued with MPP Advantage.




Conventional Loan Pricing. We consider the cost of the credit enhancement (LRA and SMI, if applicable) when we formulate conventional loan pricing. Each of these credit enhancement structures is accounted for not only in our expected return on acquired mortgage loans, but also in the risk review performed during the accumulation/pooling process. The pricing of each structure is dependent on a number of factors and is specific to the PFI or group of PFIs.

We receive a 0.25% to 0.75% fee on cash-out refinancing transactions depending on the initial LTV ratio. We also adjust the market price we pay for loans depending upon market conditions. We continue to evaluate the scope and rate of such fees as they evolve in the industry, and we may change our fee structure to be similar to those of the other GSEs. We do not pay a PFI any fees other than the servicing fee when the PFI retains the servicing rights.

Earnings from the MPP. Our earnings from the MPP are comprised of the monthly interest payments we receive, which are computed on each loan at the mortgage note rate multiplied by the principal balance outstanding, adjusted for the following:

servicing costs;
the cost of funding the LRA;
the cost of the SMI, if applicable;
the net amortization of purchased loan premiums or discounts;
the net amortization of terminated hedge basis adjustments; and
uninsured credit losses.

Servicing. We do not service the mortgage loans we purchase. PFIs may elect to retain servicing rights for the loans sold to us, or they may elect to sell servicing rights to an MPP-approved servicer. The servicers are responsible for all aspects of servicing, including, among other responsibilities, the administration of any foreclosure and claims processes from the date we purchase the loan until the loan has been fully satisfied. The MPP is designed and structured in a manner that requires loan servicers, when necessary, to foreclose and liquidate any acquired real estate in the servicer's name. Therefore, our practice is not to take or hold title to any underlying property.

Currently, JPMorgan Chase & Co. is the only approved servicer to which servicing rights may be sold when we originally purchase the mortgage loans. Those PFIs that retain servicing rights receive a monthly servicing fee, must be approved by us and must undergo an audit by a third-party quality control contractor that advises the PFIs of any deficiencies in servicing procedures or processes and then notifies us so that we can monitor the PFIs' performance. The PFIs that retain servicing rights can sell those at a later date with our approval. Servicing activities, whether retained or released, are subject to review by our master servicer, Washington Mutual Mortgage Securities Corporation. If we deem servicing to be inadequate, we can require that the servicing of those loans be transferred to a servicer that is acceptable to us.

It is the servicer's responsibility to initiate loss claims on the loans. No payments from the LRA (other than excess amounts returned to the PFI over a period of time in accordance with each MCC) or SMI are made prior to the claims process. For loans that are credit-enhanced with SMI, if it is determined that a loss is covered, the SMI provider pays the claim in full and seeks reimbursement from the LRA. The SMI provider is entitled to reimbursement for credit losses from funds available in the LRA that are equal to the aggregate amounts contributed to the LRA less any amounts paid for previous claims and any amounts that have been released to the PFI from the LRA or paid to us to cover prior claims. If the LRA is still being funded, the SMI provider could make claims against those payments as they are received up to the full reimbursable amount of the claim, and these amounts would be reflected as additional deductions from the LRA as they were paid. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - MPP for additional information.

Reactivation of our Participation in the MPF Program. We participated in the MPF Program from its inception through 2002, when we discontinued active participation in favor of our MPP. In June of 2012, we entered into an MPF Participation Agreement with the FHLBank of Topeka. Under the MPF Participation Agreement, we purchase participation interests in government-guaranteed or -insured mortgages originated by certain of the FHLBank of Topeka's member institutions through their participation in the MPF Program offered by the FHLBank of Chicago. We amended the MPF Participation Agreement in July 2012 to enable us to also purchase participation interests in conventional MPF mortgages. To date, all of our purchases have been 75% participation interests. We expect our purchases of MPF participation interests to supplement our MPP purchases and to partially reduce the concentration of mortgage loans in Indiana and Michigan. We do not intend to offer the MPF Program to our members, but instead intend to continue to offer only the MPP.




The MPF Participation Agreement provides that we share all mortgages and commitments in which we have a participation interest with the FHLBank of Topeka and all of their income, revenue, losses, expenses, pair-off fees, and cash flow proportionate to our respective participation interests in the mortgages or commitments. We treat the acquisition of such participation interests as true sales by the FHLB of Topeka for accounting purposes, based on a legal opinion obtained from outside counsel.

Under the MPF Program, participating members of MPF FHLBanks (currently the FHLBanks of Boston, Chicago, Des Moines, New York, Pittsburgh, and Topeka) can sell fixed rate, size-conforming, single-family mortgage loans to MPF FHLBanks (closed loans) and originate loans on behalf of their respective MPF FHLBank (table-funded loans). The MPF FHLBank invests in qualifying 5- to 30-year conventional conforming and government-guaranteed or insured (by FHA, VA, RHA and/or HUD) fixed rate mortgage loans on 1-4 family residential properties. We, in turn, may purchase participation interests in such mortgages from the FHLBank of Topeka.

Primary factors that may influence future growth in participations in MPF mortgage loans held for portfolio include: (i) the volume of loans purchased under our MPP; (ii) the availability of MPF loans for sale from the FHLBank of Topeka and any FHLBanks with which we may enter into MPF Participation Agreements in the future; (iii) the willingness of MPF FHLBanks to enter into MPF Participation Agreements with us; (iv) the willingness of other FHLBanks to sell such participation interests to us; (v) refinancing activity; (vi) the level of interest rates and the shape of the yield curve; (vii) the relative competitiveness of MPF pricing to the prices offered by other buyers of mortgage loans; and (viii) risk management considerations.
    
A majority of the states and some municipalities have enacted laws against mortgage loans considered predatory or abusive. Some of these laws impose liability for violations not only on the originator, but also upon purchasers and assignees of mortgage loans. We rely upon the FHLBank of Topeka to take measures to reduce our exposure to potential liability under these laws and are not aware of any claim, action or proceeding asserting that we are liable under these laws. However, there can be no assurance that we will never have any liability under predatory or abusive lending laws.

MPF Provider. The MPF Program is managed by the MPF Provider, a division of the FHLBank of Chicago. The MPF Provider maintains the structure of MPF loan products and the eligibility rules for MPF loans. In addition, it manages the pricing and delivery mechanism for MPF loans and the back-office processing of MPF loans (and participation interests in MPF loans) in its role as master servicer and master custodian. The MPF Provider has engaged Wells Fargo Bank N.A. as the vendor for master servicing and as the primary custodian for the MPF Program.

The MPF Provider publishes and maintains the MPF Origination, Underwriting and Servicing Guides, all of which detail the requirements that the MPF PFIs must follow in originating, underwriting or selling and servicing MPF loans. The MPF Provider maintains the infrastructure through which MPF FHLBanks can fund or purchase MPF loans through their respective PFIs, and through which we can acquire participation interests in certain new MPF loans. In exchange for providing these services, each MPF FHLBank pays the MPF Provider a fee, which is based upon the unpaid balances of MPF loans funded. We pay a proportion of the MPF Provider's fee that is based on the proportion of the unpaid balance of MPF loans in which we have acquired participation interests.
 
MPF PFIs. MPF FHLBanks permit their respective members and eligible Housing Associates to apply to become MPF PFIs. The MPF FHLBank reviews the general eligibility of the member, its servicing qualifications and its ability to supply documents, data and reports required to be delivered by such PFIs under the MPF Program. A PFI Agreement with the FHLBank provides the terms and conditions for the sale or funding of MPF loans, including required CE Obligations, and establishes the terms and conditions for servicing MPF loans. All of the MPF PFI's CE Obligations under this agreement are secured in the same manner as the other obligations of the PFI under its Advances agreement with its FHLBank. The participating MPF FHLBank has the right under its respective Advances agreement to request additional collateral to secure the PFI's MPF CE Obligations. The FHLBank of Topeka is the lead bank under our MPF Participation Agreement. It has the authority under the individual bank pricing option to change the pricing offered to its MPF PFIs, but a change would affect all delivery commitment terms and loan note rates in the same manner for all of its MPF PFIs.




Mortgage Standards. PFIs are required to deliver mortgage loans that meet the eligibility requirements in the MPF Origination, Underwriting and Servicing Guides applicable to MPF loans, which are broadly summarized as follows:

Mortgage characteristics:
must be qualifying 5- to 30-year conforming conventions, fixed rate, fully amortizing mortgage loans; and
secured by first liens on owner-occupied 1- to 4-unit single-family residential properties and single-unit second homes.
LTV ratio and PMI:
the maximum LTV for conventional MPF loans is 95%; and
conventional MPF loans with LTV greater than 80% are insured by PMI from a mortgage guaranty insurance company that has successfully passed an internal credit review and is approved under the MPF Program.
Documentation and compliance:
mortgage documents and transactions are required to comply with all applicable laws;
mortgage loans are documented using standard Fannie Mae/Freddie Mac uniform instruments.
Government loans:
have substantially the same parameters as conventional MPF loans except that their LTV may not exceed the LTV limits set by the applicable government agency; and
they must meet all requirements to be insured or guaranteed by the applicable government agency.
Ineligible mortgage loans include:
loans unable to be rated by S&P;
loans not meeting eligibility requirements;
loans classified as high cost, high rate or high risk; and
Home Ownership and Equity Protection Act loans or loans in similar categories defined under predatory or abusive lending laws, or subprime, non-traditional, or higher-priced mortgage loans.

MPF Servicing. PFIs selling MPF loans may either retain the servicing function or transfer it. If a PFI chooses to retain the servicing function, it receives a servicing fee. Servicing-retained PFIs may utilize approved subservicers to perform the servicing duties. If the PFI chooses to transfer servicing rights to an approved third-party provider, the servicing is transferred concurrently with the sale of the MPF loan with the PFI receiving a servicing-released premium. The servicing fee is paid to the third-party servicer. All servicing-retained and servicing-released PFIs are subject to the rules and requirements set forth in the MPF Servicing Guide. Throughout the servicing process, the master servicer monitors PFI compliance with MPF Program requirements and makes periodic reports to the MPF Provider.  

Allocation of Risk. The MPF Program is designed to allocate risks associated with MPF loans between the investors and the PFIs. PFIs have direct knowledge of their mortgage markets and have developed expertise in underwriting and servicing residential mortgage loans. By allowing PFIs to originate MPF loans, whether through retail or wholesale operations, and to retain or acquire servicing of MPF loans, the MPF Program gives control of those functions that most impact credit quality to PFIs. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - MPF Program for more information.
 
Under the Finance Agency's AMA regulation, the PFI "must bear the direct economic consequences" of certain losses with respect to a master commitment based upon the MPF product and other criteria. To comply with these regulations, MPF purchases and fundings (like purchases and fundings under MPP) are structured so that the credit risk associated with MPF loans is shared with PFIs. The master commitment defines the pool of MPF loans for which the CE Obligation is set so that the risk associated with investing in such a pool of MPF loans is equivalent to investing in a AA-rated asset.
 
For conventional MPF loan products in which we purchase participation interests, PFIs assume or retain a portion of the credit risk. Subsequent to any PMI, we and the FHLBank of Topeka share in the credit risk of the loans with the PFI. Along with the FHLBank of Topeka, in proportion to our respective participation interests in MPF loans, we assume the first layer of loss coverage as defined by the FLA. If losses beyond the FLA layer are incurred for a pool, the PFI assumes the loan losses up to the amount of the CE Obligation as specified in a master commitment agreement for each pool of mortgage loans purchased from the PFI. The CE Obligation provided by the PFI ensures that it retains a credit stake in the loans it sells. PFIs are paid a CE fee for managing this credit risk. In some instances, all or a portion of the CE fee may be based on performance. Any losses in excess of the FLA and the member's CE Obligation for a pool of MPF loans are then shared between us and the FHLBank of Topeka in proportion to our participation interests in such MPF loans. The PFIs' CE Obligations must be fully collateralized with assets considered eligible under the FHLBank of Topeka's collateral policy. However, each MPF PFI's CE Obligations are secured by the collateral that also secures the rest of the PFI's obligations to the FHLBank of Topeka generally, and, therefore, are not collateralized for our specific benefit.




Funding Sources

The primary source of funds for each of the FHLBanks is the sale of Consolidated Obligations in the capital markets. The Finance Agency and the United States Secretary of the Treasury have oversight over the issuance of our debt through our agent, the Office of Finance. The Finance Agency's regulations govern the issuance of debt on our behalf and authorize us to issue Consolidated Obligations through the Office of Finance, under Section 11(a) of the Bank Act. No FHLBank is permitted to issue individual debt under Section 11(a) without the approval of the Finance Agency. All of the FHLBanks are jointly and severally liable for the Consolidated Obligations issued under Section 11(a).

While Consolidated Obligations, which consist of CO Bonds and Discount Notes, are, by regulation, the joint and several obligations of the FHLBanks, the primary liability for Consolidated Obligations issued to provide funds for a particular FHLBank rests with that FHLBank. Consolidated Obligations are backed only by the financial resources of the FHLBanks. Although each FHLBank is a GSE, Consolidated Obligations are not obligations of, and are not guaranteed by, the United States government. Our Consolidated Obligations are rated Aaa by Moody's and AA+ by S&P. The aggregate par amount of the FHLBank System's outstanding Consolidated Obligations was approximately $687.9 billion at December 31, 2012, and $691.9 billion at December 31, 2011. The par amount of the Consolidated Obligations for which we are the primary obligor was $36.3 billion at December 31, 2012, and $36.9 billion at December 31, 2011.

We must maintain, free from any lien or pledge, an amount at least equal to the amount of Consolidated Obligations outstanding on our behalf from among the following types of qualifying assets:

cash;
obligations of, or fully guaranteed by, the United States;
Advances;
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 Bank Act, which include, among others, 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 are assigned a rating or assessment by an NRSRO that is equivalent to or higher than the rating or assessment assigned by that NRSRO to the Consolidated Obligations. Rating modifiers are ignored when determining the applicable rating level.

The following table ($ amounts in millions) presents a comparison of the aggregate amount of the qualifying asset types to the total amount of outstanding Consolidated Obligations issued on our behalf. We were in compliance with this requirement at both December 31, 2012 and 2011.
 
 
December 31, 2012
 
December 31, 2011
Aggregate qualifying assets
 
$
41,154

 
$
40,318

Total Consolidated Obligations
 
36,332

 
36,894

Aggregate qualifying assets in excess of Consolidated Obligations
 
$
4,822

 
$
3,424

 
 
 
 
 
Ratio of aggregate qualifying assets to Consolidated Obligations
 
1.13

 
1.09


Consolidated Obligation Bonds. CO Bonds satisfy term funding requirements and are issued with a variety of maturities and terms under various programs. The maturities of these securities typically range from six months to 30 years, but the maturities are not subject to any statutory or regulatory limit. The CO Bonds can be fixed- or adjustable-rate and callable or non-callable. They are issued and distributed through negotiated or competitively bid transactions with approved underwriters or selling group members.

CO Bonds are generally issued with either fixed rate payment terms or adjustable rate payment terms, which use a variety of indices for interest rate resets, including LIBOR, Federal funds, United States Treasury Bill, Constant Maturity Swap, Prime Rate, and others. In the aggregate, the FHLBanks may represent a significant percentage of the Federal Funds Sold market at any one time, although each FHLBank manages its investment portfolio separately.

Consolidated Obligation Discount Notes. We also issue Discount Notes to provide short-term funds for Advances to members, liquidity, and for other investments. These securities can have maturities that range from one day to one year and are offered daily through a Discount Note selling group and other authorized securities dealers. Discount Notes are sold at a discount and mature at par.




Office of Finance. The issuance of the Consolidated Obligations is facilitated and executed by the Office of Finance, which also services all outstanding debt, provides information on capital market developments, and manages our relationship with the NRSROs with respect to Consolidated Obligations. The Office of Finance also prepares and publishes the Combined Financial Report of the FHLBanks.

As the FHLBanks' fiscal agent for debt issuance, the Office of Finance can control the timing and amount of each issuance. The United States Treasury can affect debt issuance for the FHLBanks through its oversight of the United States financial markets. See Supervision and Regulation - Government Corporations Control Act herein for additional information.

Financing Corporation. The Financing Corporation is a corporation established by Congress in the Competitive Equality Banking Act of 1987 and was originally intended to finance a rebuilding of the Federal Savings and Loan Insurance Corporation (“FSLIC”). All of the FHLBanks provided initial funding for the Financing Corporation, which served as a financing vehicle for the FSLIC Resolution Fund, the entity that assumed the assets and liabilities of FSLIC following its insolvency. Since the early 1990s, the Financing Corporation's sole purpose has been to manage the outstanding debt obligations that it issued. Two FHLBank Presidents serve on a rotating basis, along with the President of the Office of Finance, as the directors of the Financing Corporation. The FHLBanks have no continuing responsibilities to the Financing Corporation other than to direct the Office of Finance to manage its activities.

Community Investment and Affordable Housing Programs

We offer a variety of specialized Advance programs to support housing and community development needs. Through our Community Investment Program, we offer Advances to our members involved in community economic development activities benefiting low- or moderate-income families or neighborhoods. These Advances have maturities ranging from 30 days to 20 years and are priced at our cost of funds plus reasonable administrative expenses. These funds can be used for the development of housing, infrastructure improvements, or assistance to small businesses or businesses that are creating or retaining jobs in the member's community for low- and moderate-income families. Advances made under our Community Investment Programs comprised 3.3% and 3.2% of our total Advances outstanding, at par, at December 31, 2012, and 2011, respectively.

In addition to our Community Investment Programs, each FHLBank is required to set aside 10% of its annual net earnings before Interest Expense on MRCS to fund its AHP, subject to an annual FHLBank System-wide minimum of $100 million. Through our AHP, we provide cash grants or interest subsidies on Advances to our members, which are, in turn, provided to awarded projects or qualified individuals to finance the purchase, construction, or rehabilitation of very low- to moderate-income owner-occupied or rental housing. Our AHP includes the following:

Competitive Program, which is the primary grant program to finance the purchase, construction or rehabilitation of housing for individuals with income at or below 80% of the median income for the area, and to finance the purchase, construction, or rehabilitation of rental housing, with at least 20% of the units occupied by, and affordable for, very low-income households. Each year, 65% of our annual available AHP funds are granted through this program.

Set-Aside Programs, which include 35% of our annual available AHP funds administered through the following:

Homeownership Opportunities Program, which provides assistance with down payments and closing costs to first-time homebuyers.
Neighborhood Impact Program, which provides rehabilitation assistance to homeowners to help improve neighborhoods.
Disaster Relief Program, which may be reactivated in our discretion, in cases of federal or state disaster declarations for rehabilitation or down payment assistance targeted to low- or moderate-income homeowner disaster victims.



Use of Derivatives

Derivatives are an integral part of our financial management strategies to manage identified risks inherent in our lending, investing and funding activities and to achieve our risk management objectives. Finance Agency regulations and our RMP establish guidelines for the use of derivatives. Permissible derivatives include interest-rate swaps, swaptions, interest-rate cap and floor agreements, calls, puts, futures, and forward contracts. We are permitted to execute derivative transactions to only manage interest-rate risk exposure inherent in otherwise unhedged asset or liability positions, hedge embedded options in assets and liabilities including mortgage prepayment risk positions, hedge any foreign currency positions, and act as an intermediary between our members and interest-rate swap counterparties. We are prohibited from trading in or the speculative use of these instruments, and we have limits for counterparty credit risk arising from these instruments.

Our use of derivatives is the primary way we align the preferences of investors for the types of debt securities that they want to purchase and the preferences of member institutions for the types of Advances they want to hold and the types of mortgage loans they want to sell. See Notes to Financial Statements - Note 10 - Derivatives and Hedging Activities and Item 7A. Quantitative and Qualitative Disclosures About Market Risk for more information.

Supervision and Regulation

The Bank Act. We are supervised and regulated by the Finance Agency, an independent agency in the executive branch of the United States government, established by HERA. Our former regulator, the Finance Board, was abolished on July 30, 2009. Finance Board regulations, policies and directives have been transferred to the Finance Agency.

Under the Bank Act, the Finance Agency's responsibility is to ensure that, pursuant to regulations promulgated by the Finance Agency, each FHLBank:

carries out its housing finance mission;
remains adequately capitalized and able to raise funds in the capital markets; and
operates in a safe and sound manner.

The Finance Agency is headed by a Director, who is appointed to a five-year term by the President of the United States, with the advice and consent of the Senate. The Director appoints a Deputy Director for the Division of Enterprise Regulation, a Deputy Director for the Division of FHLBank Regulation, and a Deputy Director for Housing Mission and Goals, who oversees the housing mission and goals of Fannie Mae and Freddie Mac, as well as the housing finance and community and economic development mission of the FHLBanks. HERA also established the Federal Housing Finance Oversight Board, comprised of the Secretaries of the Treasury and HUD, the Chairman of the SEC, and the Director. The Federal Housing Finance Oversight Board functions as an advisory body to the Director. The Finance Agency's operating expenses are funded by assessments on the FHLBanks, Fannie Mae and Freddie Mac. As such, no tax dollars or other appropriations support the operations of the Finance Agency or the FHLBanks. In addition to reviewing our submissions of monthly and quarterly financial information on our financial condition and results of operations, the Finance Agency conducts annual on-site examinations and performs periodic on- and off-site reviews in order to assess our safety and soundness.

The Bank Act gives the Secretary of the Treasury the discretion to purchase Consolidated Obligations up to an aggregate principal amount of $4 billion. No borrowings under this authority have been outstanding since 1977.

The United States Treasury receives a copy of the Finance Agency's annual report to the Congress, monthly reports reflecting the FHLBank System's securities transactions, and other reports reflecting the FHLBank System's operations. Our annual financial statements are audited by an independent registered public accounting firm in accordance with standards issued by the Public Company Accounting Oversight Board as well as the government auditing standards issued by the United States Comptroller General. The Comptroller General has authority under the Bank Act to audit or examine the Finance Agency and the FHLBank System and to decide the extent to which they fairly and effectively fulfill the purposes of the Bank Act. The Finance Agency's Office of Inspector General also has investigation authority over the Finance Agency and the FHLBank System.




GLB Act Amendments to the Bank Act. Prior to the enactment of the GLB Act in 1999, the Bank Act provided for a "subscription" capital structure for the FHLBanks. Under that structure, a single class of capital stock was issued to members by their respective FHLBank pursuant to a statutory formula that required each member to purchase stock in an aggregate amount equal to the greatest of the following (i) $500; (ii) 1% of the member's total mortgage assets; or (iii) 5% of the Advances outstanding to the member. The stock was redeemable by a member that sought to withdraw from its FHLBank membership upon six months' prior written notice to that FHLBank. Upon redemption, a member would receive the par value of its stock.

The GLB Act amended the Bank Act to provide a more flexible and permanent capital structure for the FHLBanks by requiring that each FHLBank develop and implement a capital plan that, among other things, would replace the previous single-class FHLBank capital stock with a new capital structure comprised of Class A Stock, Class B Stock, or both. Class A Stock is redeemable by a member upon six months' prior written notice to its FHLBank. Class B Stock is redeemable by a member upon five years' prior written notice to its FHLBank. Class B Stock also has a higher weighting than Class A Stock for purposes of calculating the minimum leverage requirement applicable to each FHLBank.

The GLB Act amendments require that each FHLBank maintain permanent capital and total capital, as defined below, in sufficient amounts to comply with specified, minimum risk-based capital and leverage capital requirements.

Permanent capital is defined as the amount of our Class B Stock (including MRCS) plus our Retained Earnings. We are required to maintain permanent capital at all times in an amount equal to our risk-based capital requirement, which includes the following components:

Credit risk, which represents the sum of our credit risk charges for all assets, off-balance sheet items and derivative contracts, calculated using the methodologies and risk weights assigned to each classification in the regulations;
Market risk, which represents the sum of the market value of our portfolio at risk from movements in interest rates, foreign exchange rates, commodity prices, and equity prices that could occur during periods of market stress, and the amount by which the market value of total capital is less than 85% of the book value of total capital; and
Operations risk, which represents 30% of the sum of our credit risk and market risk capital requirements.

Total capital is defined as permanent capital plus a general allowance for losses plus any other amounts determined by the Finance Agency to be available to absorb losses. Total capital must equal at least 4% of Total Assets.
Leverage capital is defined as 150% of permanent capital. Leverage capital must equal at least 5% of Total Assets.

From time to time, for reasons of safety and soundness, the Finance Agency may require one or more individual FHLBanks to maintain more permanent capital or total capital than is required by the regulations. Failure to comply with these requirements or the minimum capital requirements could result in the imposition of operating agreements, cease and desist orders, civil money penalties, and other regulatory action, including involuntary merger, liquidation, or reorganization as authorized by the Bank Act.

In addition to changes in capital structure, the GLB Act also transferred more of the governance and management of each FHLBank to its board of directors and officers and away from the Finance Agency. This included the right of the directors to elect the chair and vice chair of the board of directors. The Finance Agency has issued guidance to the FHLBanks on various matters that are now governed by their boards but are of concern to the Finance Agency.

HERA Amendments to the Bank Act. HERA eliminated the Finance Agency's authority to appoint directors to our board. The appointed directors are now independent directors who are elected by the entire membership to four-year terms, subject to transitional staggered terms, which may be shorter. The member directors are also elected by each state's membership to four-year terms (subject to staggering). HERA also eliminated the Finance Agency's authority to cap director fees but placed additional controls over executive compensation.

Government Corporations Control Act. We are subject to the Government Corporations Control Act, which provides that, before we can issue and offer Consolidated Obligations to the public, the Secretary of the United States Treasury must prescribe the form, denomination, maturity, interest rate, and conditions of the obligations; the way and time issued; and the selling price.

Furthermore, this Act provides that the United States Comptroller General may review any audit of the financial statements of an FHLBank conducted by an independent registered public accounting firm. If the Comptroller General undertakes such a review, the results and any recommendations must be reported to the Congress, the Office of Management and Budget, and the FHLBank in question. The Comptroller General may also conduct a separate audit of any of our financial statements.




Federal Securities Laws. Our shares of Class B Stock are registered with the SEC under the Exchange Act, and we are subject to the information, disclosure, insider trading restrictions, and other requirements under the Exchange Act. We are not subject to the provisions of the Securities Act of 1933 as amended. We have been, and continue to be, subject to all relevant liability provisions of the Exchange Act.

Federal and State Banking Laws. We are not generally subject to the state and federal banking laws affecting United States retail depository financial institutions. However, as we do provide our members with certain correspondent services, such as wire transfer services, our activities are subject to certain requirements of the Bank Secrecy Act, as amended by the USA Patriot Act, that are applicable to these services. We are, therefore, required to report suspicious activities in limited circumstances, such as those involving the movement of large amounts of cash or the attempted wire transfer of funds to persons or countries that are on the United States government's restricted list. The Bank Act, as amended by HERA, requires the FHLBanks to submit reports to the Finance Agency concerning transactions involving financial instruments and loans that involve fraud or possible fraud. The Financial Crimes Enforcement Network has also issued a proposed rule that would require the FHLBanks to establish anti-money laundering programs and report suspicious activities to them pursuant to the Bank Secrecy Act and the USA Patriot Act, and otherwise to comply with such acts.

As a wholesale secured lender and a secondary market purchaser of mortgage loans, we are not, in general, directly subject to the various federal and state laws regarding consumer credit protection, such as anti-predatory lending laws. However, as non-compliance with these laws could affect the value of these loans as collateral or acquired assets, we require our members to warrant that all of the loans pledged or sold to us are in compliance with all applicable laws. The Helping Families Save Their Homes Act of 2009 requires that, when a mortgage loan (defined to include any consumer credit transaction secured by the principal dwelling of the consumer) is sold or transferred, the new creditor shall, within 30 days of the sale or transfer, notify the borrower of the following: the identity, address and telephone number of the new creditor; the date of transfer; how to reach an agent or party with the authority to act on behalf of the new creditor; the location of the place where the transfer is recorded; and any other relevant information regarding the new creditor. In accordance with this statute, we provide the appropriate notice to borrowers whose mortgage loans we purchase under our MPP and have established procedures to ensure compliance with this notice requirement. In the case of the participation interests in mortgage loans we purchase from the FHLBank of Topeka under the MPF Program, the FHLBank of Chicago (as the MPF Provider) issues the appropriate notice to the affected borrowers and has established its own procedures to ensure compliance with the notice requirement.

Regulatory Enforcement Actions. While examination reports are confidential between the Finance Agency and an FHLBank, the Finance Agency may publicly disclose supervisory actions or agreements that the Finance Agency has entered into with an FHLBank. We are not subject to any such Finance Agency actions, and we do not believe any current Finance Agency actions with respect to other FHLBanks will have a material adverse effect on our cost of funds.

Membership Trends

Our membership territory is comprised of the states of Indiana and Michigan. In 2012, we gained four new members and lost nine members, for a net loss of five members. Historically, few of our members have chosen to withdraw from membership other than in connection with mergers and consolidations. During 2012, we lost two members as a result of regulatory resolution actions due to their distressed financial condition.

The following table presents the composition of our members by type of financial institution:
Type of Institution
 
December 31, 2012
 
December 31, 2011
Commercial banks
 
216

 
218

Thrifts
 
39

 
46

Credit unions
 
108

 
105

Insurance companies
 
48

 
47

Total member institutions
 
411

 
416





Competition

We operate in a highly competitive environment. Demand by members for Advances is affected by, among other factors, the cost and availability of other sources of funds, including deposits. We compete with other suppliers of wholesale funding, both secured and unsecured. Such other suppliers may include the United States government, deposit insurers, the Federal Reserve Banks, investment banking concerns, commercial banks, and in certain circumstances, other FHLBanks. An example of these circumstances occurs when a financial holding company has subsidiary banks that are members of different FHLBanks, and can, therefore, choose to take Advances from the FHLBank with the best terms. Larger institutions may have access to all of these alternatives as well as independent access to the national and global credit markets. The availability of alternative funding sources can be affected by a variety of factors, including market conditions, members' creditworthiness and regulatory restrictions, and availability of collateral and its valuation.

Likewise, our MPP and the MPF Program are subject to significant competition. The most direct competition for mortgage purchases comes from other buyers or guarantors of government-guaranteed or conventional, conforming fixed-rate mortgage loans such as Ginnie Mae, Fannie Mae and Freddie Mac.

We also compete with Fannie Mae, Freddie Mac and other GSEs as well as corporate, sovereign, and supranational entities for funds raised through the issuance of CO Bonds, Discount Notes, and other debt instruments. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs to us or lesser amounts of debt issued on our behalf at the same cost than otherwise would be the case. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - The Capital Markets for additional information.

Employees

As of February 28, 2013, we had 195 full-time employees and 4 part-time employees. A collective bargaining unit does not represent the employees. We had 45 contractors at February 28, 2013, primarily due to our enterprise-wide initiative to replace our core banking system.

Available Information

Our Annual and Quarterly Reports on Forms 10-K and 10-Q, together with our Current Reports on Form 8-K, are filed with the SEC through the EDGAR filing system. A link to EDGAR is available through our public website at www.fhlbi.com by selecting "Investor Relations/Financial Publications."

We have a Code of Conduct that is applicable to all directors, officers, and employees and the members of our Affordable Housing Advisory Council. The Code of Conduct is available on our website at www.fhlbi.com by selecting "About" and then selecting "Code of Conduct" from the drop-down menu.

Our 2013 Community Lending Plan describes our plan to address the credit needs and market opportunities in our district states of Indiana and Michigan. It is available on our website at www.fhlbi.com by selecting "Community Investment" and then selecting "Publications, Bulletins and Presentations" from the drop-down menu.

We provide our website address and the SEC's website address solely for the reader's information. Except where expressly stated, information appearing on the SEC's website is not incorporated into this Annual Report on Form 10-K.

The reader may also request a copy of any of our public financial reports, our Code of Conduct or our 2013 Community Lending Plan through our Corporate Secretary at FHLBank of Indianapolis, 8250 Woodfield Crossing Boulevard, Indianapolis, IN 46240, (317) 465-0200.




ITEM 1A. RISK FACTORS
 
As used in this Form 10-K, unless the context otherwise requires, the terms "we," "us," "our," and the "Bank" refer to the Federal Home Loan Bank of Indianapolis or its management. We use certain acronyms and terms throughout this section of the Form 10-K which are defined in the Glossary of Terms located in Item 15. Exhibits and Financial Statement Schedules.

We have identified the following risk factors that could have a material adverse effect on our business, financial condition or results of operations.

Economic Conditions Could Have an Adverse Effect on Our Business, Liquidity, Financial Condition, and Results of Operations.

Our business, liquidity, financial condition, and results of operations are sensitive to general international and domestic business and economic conditions, such as changes in short-term and long-term interest rates and the money supply, inflation, volatility in both debt and equity capital markets, and the strength of the local economies in which we conduct business.

Our business and results of operations are significantly affected by the fiscal and monetary policies of the United States government and its agencies, including the Federal Reserve Board through its regulation of the supply of money and credit in the United States. The Federal Reserve Board's policies either directly or indirectly influence the yield on our interest-earning assets, the cost of our interest-bearing liabilities and the demand for our Consolidated Obligations. The Federal Reserve Board has taken several measures intended to depress short-term and longer-term interest rates. These measures, as well as other systemic events, such as the recession in certain European countries, could adversely affect our results of operations in many ways, such as through lower market yields on our new investments and faster prepayment speeds on our existing investments with associated reinvestment risk. Also, changes in investors' perceptions in either the strength of the United States economy or availability of investment in overseas capital markets could lead to changes in foreign investors' interest in our Consolidated Obligations.

Our district is comprised of the states of Indiana and Michigan. Economic data for our district have generally been unfavorable compared to national data, with unemployment and foreclosure rates higher than national rates. The slow recovery from the financial crisis, unfavorable economic conditions and effects on the competitiveness of our business model from current or future federal government actions to improve economic conditions could result in additional unfavorable consequences for our business, including further reductions in our statutory mission activities and lower profitability.

Inability to Access Capital Markets on Acceptable Terms Could Adversely Affect Our Liquidity, Operations, Financial Condition and Results of Operations and the Value of Membership in Our Bank.

Our primary source of funds is the sale of Consolidated Obligations in the capital markets. Our ability to obtain funds through the sale of Consolidated Obligations depends in part on prevailing conditions in the capital markets, such as investor demand and liquidity, and on dealer commitment to support our debt. Severe financial and economic disruptions, and the United States government's measures to mitigate their effects, could change the traditional bases on which market participants value GSE debt securities and consequently could affect our funding costs and practices, which could make it more difficult and more expensive to issue longer-term debt. This could result in focusing our efforts on short-term debt funding with maturities of six months or less. Any significant disruption of the short-term debt market could have a serious impact on our Bank and the FHLBank System.

If we are unable to access funding when needed on acceptable terms, our ability to support and continue our operations could be adversely affected, which could negatively affect our financial condition and results of operations and the value of membership in our Bank.




Our Credit Rating, the Credit Rating of One or More of the Other FHLBanks, or the Credit Rating of the Consolidated Obligations Could be Lowered, Which Could Adversely Impact Our Cost of Funds, Our Ability to Access the Capital Markets, and/or Our Ability to Enter Into Derivative Instrument Transactions on Acceptable Terms.

In August 2011, S&P and Moody's each took various negative actions regarding credit ratings on the FHLBanks and the FHLBank System's Consolidated Obligations, based on the implied linkage between the FHLBanks and the FHLBank System's Consolidated Obligations, and the United States government. The FHLBank of Seattle is rated AA with a rating outlook of negative and each of the other 11 FHLBanks is rated AA+ with a rating outlook of negative by S&P. The FHLBank System's Consolidated Obligations are rated AA+ by S&P with a rating outlook of negative. Each of the 12 FHLBanks is currently rated Aaa with a rating outlook of negative by Moody's. S&P's and Moody's ratings outlooks assess the potential direction of a long-term credit rating over the medium term (usually six months to two years) depending on their assessment of the general economic and/or business conditions.

Although these rating actions have not had an impact on our funding costs, uncertainty still remains regarding possible longer-term effects resulting from rating actions. Our cost of issuing debt could be adversely affected if our credit rating or the credit ratings of one or more other FHLBanks are lowered. Any future downgrades in our credit ratings and outlook, especially a downgrade to AA or equivalent, could result in higher funding costs or disruptions in our access to capital markets, including additional collateral posting requirements under certain derivative instrument agreements. Furthermore, member demand for certain of our products could possibly weaken. To the extent that we cannot access funding when needed on acceptable terms to effectively manage our cost of funds, our financial condition and results of operations and the value of membership in our Bank may be negatively affected.

Changes in Interest Rates Could Have an Adverse Effect on Earnings.

A change in interest rates or a change in the level or shape of the yield curve could have an adverse impact on earnings. We purchase mortgage loans, MBS, and ABS at both premiums and discounts. We make certain key assumptions on mortgage-related assets, including prepayment speeds, cash flows, loan volumes, and pricing. These assumptions are inherently uncertain and, as a result, may not result in accurate predictions of the impact of higher or lower interest rates on our earnings.

In addition, adverse conditions in the housing and mortgage markets resulted in an environment that made it more difficult to refinance mortgages or sell homes. These conditions occurred concurrently with a large drop in market interest rates which allowed us to exercise calls of our debt and reissue it at a lower cost. As a result, mortgage spreads have been wider than historic norms. As the existing portfolio is paid down, the overall portfolio spread could continue to decline.

A number of measures are used to monitor and manage interest rate risk. Although we have analyzed the impact of changes in the level of interest rates and the shape of the yield curve over a broad range of scenarios, extreme and/or protracted movements in these factors could result in reduced earnings or even losses.

Our Exposure to Credit Risk Could Adversely Affect Our Financial Condition and Results of Operations.

We are exposed to credit risk from member products, investment securities and unsecured counterparties. The continuing weak credit conditions in the United States could have an adverse effect on our credit performance, financial condition and results of operations. In addition, the European debt crisis and the resulting recessions in many European countries, as well as the ratings agencies' downgrades of the sovereign debt ratings of several European countries, have increased foreign credit risk. Continued European economic difficulties could indirectly have an adverse effect on our credit performance, financial condition and results of operations to the extent those difficulties negatively affect the United States economy.

Member Products.

Advances. During 2012, the financial services industry continued to experience both financial institution failures and acquisitions to resolve distressed institutions. If a member fails and the appointed receiver or rehabilitator (or another applicable entity) does not either (i) promptly repay all of the failed institution's obligations to our Bank or (ii) properly assign or assume the outstanding Advances, we may be required to liquidate the collateral pledged by the failed institution. The proceeds realized from the liquidation may not be sufficient to fully satisfy the amount of the failed institution's obligations plus the operational cost of liquidation, particularly when the volatility of market prices and interest rates adversely affect the value of the collateral. Price volatility could also adversely impact our determination of over-collateralization requirements, which could ultimately cause a collateral deficiency in a liquidation action. In some cases, we may not be able to liquidate the collateral in a timely manner.




Our claims with respect to federally-insured depository institution members are given certain preferences pursuant to the receivership provisions of the Federal Deposit Insurance Act. However, with respect to our insurance company members, Congress provided in the McCarran-Ferguson Act of 1945 that state law generally governs the regulation of insurance and shall not be invalidated by federal law unless the federal law expressly regulates the business of insurance. Thus, if a court were to determine that the priority provision of Section 10(e) of the Bank Act conflicts with state insurance law applicable to our insurance company members, the court might then determine that the priority of our security interest would be governed by state law, not Section 10(e). Under these circumstances, the "super lien" priority protection afforded to our security interest under Section 10(e) may not fully apply when we lend to insurance company members, which could result in increased credit risk. As of December 31, 2012, Advances to our insurance company members represented 49% of our total Advances, at par, compared to 41% at December 31, 2011.

The deterioration of real estate property values could further affect the mortgages pledged as collateral for Advances. In order to remain fully collateralized, we may require members to pledge additional collateral, when deemed necessary. This requirement may adversely affect members that lack additional assets to pledge as collateral. If members are unable to collateralize their obligations with us, our Advances could decrease further, negatively affecting our results of operations.

Mortgage Loans. Since the inception of the MPP, we have acquired only traditional fixed-rate loans with fixed terms of up to 30 years. Delinquencies in fixed-rate mortgages have increased, and residential property values in many states have declined. If delinquency rates and loss severity on mortgage loans continue to increase, we could experience further reduced yields or losses on mortgage loans purchased through our MPP or the participation interests in MPF loans acquired from the FHLBank of Topeka or another MPF FHLBank, exceeding the protection provided by the LRA and SMI credit enhancement and CE obligations, if applicable.

We are the beneficiary of third-party PMI and SMI coverage on conventional mortgage loans we acquire through our MPP, upon which we rely in part to reduce the risk of losses on those loans. As a result of actions by their respective state insurance regulators, three of our PMI providers are now permitted to pay only a portion of the claim amounts. One of the three PMI providers is now paying only 60% of the claim amounts and the other two PMI providers are now paying only 50% of the claim amounts. The remaining amounts are deferred until the funds are available or the PMI provider is liquidated. Our other PMI/SMI providers have been downgraded by one or more of the NRSROs, and at least one PMI/SMI provider reported that it did not meet some of its capital requirements. It is possible that insurance regulators may impose restrictions on the ability of our other PMI/SMI providers to pay claims. If our PMI/SMI providers further reduce the portion of mortgage insurance claims they will pay to us, further delay or condition the payment of mortgage insurance claims, or if additional adverse actions are taken by their state insurance regulators, we could experience significant increased losses on mortgage loans.

In June 2012, we entered into an MPF Participation Agreement with the FHLBank of Topeka. Under the MPF Participation Agreement, we can purchase participation interests in government-guaranteed or insured mortgages originated by certain of the FHLBank of Topeka's member institutions through their participation in the MPF Program offered by the FHLBank of Chicago. We amended the MPF Participation Agreement in July of 2012 to enable us to acquire conventional MPF mortgages originated by certain of the FHLBank of Topeka's member institutions through their participation in the MPF Program as well. Credit risk arising from our participation in mortgage loans originated under the MPF Program falls into three categories: (i) the risk of credit losses on the mortgage loans represented in our FLA and last loss positions; (ii) the risk that a PFI will not perform as promised with respect to its loss position provided through its CE Obligations on mortgage pools; and (iii) the risk that a third-party insurer (obligated under PMI arrangements) will fail to perform as obligated. Should a PMI third-party insurer fail to perform, our credit risk exposure would increase because our FLA is the next layer to absorb credit losses on mortgage loan pools.

We are also exposed to credit risk from servicers for mortgage loans purchased under our MPP or through participation interests in mortgage loans purchased from other FHLBanks under the MPF Program if they fail to perform their contractual obligations.



Investment Securities. The MBS market continues to face uncertainty over the effect of home price deterioration and of existing, new or proposed governmental actions (including mortgage loan modification programs), as well as ongoing private-label RMBS litigation and the changes in Federal Reserve holdings of MBS. The NRSROs have downgraded a significant number of private-label MBS, including many in our portfolio. These and other factors led to the deterioration of the fair value of our private-label RMBS, as well as OTTI charges for many of our private-label RMBS. Further declines in the housing price forecast, as well as other factors, such as increased loan default rates and loss severities and decreased prepayment speeds, may result in additional material OTTI charges or unrealized losses on private-label RMBS in future periods, which could materially adversely affect our financial condition and operating results.

We are also exposed to credit risk from third-party providers of credit enhancements on the MBS investments that we hold in our investment portfolios, including mortgage insurers, bond insurers and financial guarantors. Our results of operations could be adversely impacted if one or more of these providers fails to fulfill its contractual obligations to us.

Unsecured Counterparties. We assume unsecured credit risk when entering into money market transactions and financial derivatives transactions with domestic and foreign counterparties. Many of our active derivative counterparties or guarantors were downgraded by Moody's during 2012. A counterparty default could result in losses if our credit exposure to that counterparty is not collateralized or if our credit obligations associated with derivative positions are over-collateralized. The insolvency or other inability of a significant counterparty to perform its obligations under such transactions or other agreements could have an adverse effect on our financial condition and results of operations, as well as our ability to engage in routine derivative transactions. If we are unable to transact additional business with those counterparties, our ability to effectively use derivatives could be adversely affected, which could impair our ability to manage some aspects of our interest rate risk.

Our ability to engage in routine derivatives, funding and other transactions could be adversely affected by the soundness of financial institutions that transact business with our counterparties. Financial services institutions are interrelated as a result of trading, clearing, counterparty and/or other relationships. Consequently, financial difficulties experienced by one or more financial services institutions could lead to market-wide disruptions that may impair our ability to find counterparties for routine business transactions.

Changes in the Legal and Regulatory Environment May Adversely Affect Our Business, Demand for Advances, the Cost of Debt Issuance, and the Value of FHLBank Membership.

We could be materially adversely affected by the adoption of new or revised laws, policies, regulations or accounting guidance; new or revised interpretations or applications of laws, policies, or regulations by the Finance Agency, its Office of Inspector General, the SEC, the CFTC, the Consumer Financial Protection Bureau, the Financial Stability Oversight Council, the Comptroller General, the FASB or other federal or state regulatory bodies; judicial decisions that modify the present regulatory environment; and the failure of certain regulatory rules or policies to change in the manner we anticipated at the time we established our own rules and policies.

Changes that restrict the growth of our current business or prohibit the creation of new products or services could negatively impact our earnings. Further, the regulatory environment affecting members could be changed in a manner that would negatively impact their ability to take full advantage of our products and services, our ability to rely on their pledged collateral, or their desire to maintain membership in our Bank.



On October 5, 2012, the Finance Agency published a notice requesting comments on a proposed Advisory Bulletin that would set forth standards to guide the Finance Agency in its supervision of the FHLBanks' secured lending to their insurance company members. The Finance Agency's notice indicates that lending to insurance company members exposes FHLBanks to risks that are not associated with advances to the insured depository institution members, arising from the different states' statutory and regulatory regimes and the statutory accounting principles and reporting practices applicable to insurance companies. The proposed standards include consideration of, among other factors, the level of an FHLBank's exposure to insurance companies in relation to its capital structure and retained earnings. A number of insurance companies are members of our Bank, and nearly half of the outstanding principal balance of our Advances as of December 31, 2012 was comprised of Advances to insurance company members. Our results of operations may be adversely affected due to the reduced business opportunities that would result if the Finance Agency issues guidance or regulations that effectively reduce the availability of FHLBank membership to insurers (by, for example, purporting to limit the kinds of insurance companies that may join an FHLBank) or limit insurance company members' access to FHLBank Advances (by, for example, purporting to impose materially greater limitations or restrictions on or related to Advances to insurance company members than those relating to depository members). On the other hand, we already utilize some of the proposed standards; others, if implemented by the Finance Agency, could provide further guidance to the FHLBanks in their credit underwriting and collateral management practices relating to insurance companies. Such guidance could potentially increase FHLBank business with insurance companies. 

The Consumer Financial Protection Bureau issued final rules with an effective date of January 14, 2014 establishing new standards for mortgage lenders to follow during the loan approval process to determine whether a borrower has the ability to repay the mortgage. The Dodd-Frank Act provides defenses to foreclosure and causes of action for damages if the mortgage lender does not meet the standards in the final rules. Mortgage borrowers can assert these defenses and causes of action against the original mortgage lender, and against purchasers and other assignees of the mortgage loan, which would include us as loan purchaser under our AMA programs or if we were to foreclose on mortgage loan collateral. The final rules provide for limited safe harbor from certain liability for qualified mortgage loans (“QMs”), which could incentivize lenders, including our members, to limit their mortgage lending to safe harbor QMs or otherwise reduce their origination of mortgage loans that are not safe harbor QMs. This could reduce the overall level of members' mortgage lending and, in turn, reduce demand for FHLBank Advances. In addition, mortgage lenders unable to sell mortgage loans (whether because they are not QMs or otherwise) would be expected to retain such loans as assets. If we were to make Advances secured, in part, by such mortgage loans and subsequently to liquidate the collateral, we could be subject to these defenses to foreclosure or causes of action for damages by the mortgage borrower. This in turn could reduce the value of our Advances collateral, potentially reducing our likelihood of repayment on our Advances if we were required to sell such collateral. Moreover, the QM safe harbor is complex, and lenders and assignees may draw erroneous conclusions about its scope.

In September 2008, the Finance Agency placed Fannie Mae and Freddie Mac into conservatorship, and the United States Treasury put in place a set of financing agreements to help those GSEs continue to meet their debt service obligations. The future role of the housing GSEs has been a national topic of discussion since Fannie Mae and Freddie Mac were placed into conservatorship. While these discussions have focused on Fannie Mae and Freddie Mac, the FHLBank System's role in the United States housing market and the FHLBank System's status as a GSE are also part of the discussions. On February 11, 2011, the United States Department of the Treasury and HUD issued a joint report mandated by the Dodd-Frank Act, outlining a plan to wind down Fannie Mae and Freddie Mac as well as significantly reduce the United States government’s role in housing finance.




Although the FHLBanks are not the primary focus, the report identifies possible reforms for the FHLBank System, which would:

focus the FHLBanks on small- and medium-sized financial institutions;
limit a holding company and its subsidiaries to membership in a single FHLBank when the subsidiaries are located in different FHLBank districts and would otherwise be eligible to join different FHLBanks;
limit the level of outstanding advances to individual members, thereby affecting the large financial institutions; and
reduce the FHLBanks’ investment portfolios and their composition, focusing the FHLBanks on providing liquidity for insured depository institutions.

The report also supports exploring additional means to provide funding to housing lenders, including potentially the development of a covered bond market. A developed covered bond market could compete with our Advances. If housing GSE reform legislation is enacted incorporating these requirements, we could be significantly limited in our ability to make Advances to our members and subject to additional limitations on our investment authority.

Given the continuing uncertainty surrounding the timing and pace of the above reforms, our funding costs and access to funds may be adversely affected by changes in investors’ perceptions of the risks associated with the housing GSEs. Additionally, investor concerns about United States agency debt and the United States agency debt market may also adversely affect our competitive position and result in higher funding costs, which could negatively affect our earnings. A reduction in our investment portfolio or a change in its composition could adversely impact our earnings and dividends. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Accounting and Regulatory Developments - Legislative and Regulatory Developments for more information regarding other recent and pending legislative and regulatory developments.

On July 21, 2010, the United States government enacted the Dodd-Frank Act. The Dodd-Frank Act made significant changes to the overall regulatory framework of the United States financial system. Several provisions in the Dodd-Frank Act could affect us and our members, depending on how the various regulators decide to implement this federal law through the issuance of regulations and their enforcement activities. For example, if the Financial Stability Oversight Council established by the Dodd-Frank Act were to decide that we are a non-bank financial company, then we would be subject to the supervision of the Federal Reserve Board. Other provisions may not directly affect us but could affect our members. For example, this law establishes a solvency framework to address the failure of a financial institution, which could include one or more of our members. Because the Dodd-Frank Act requires several regulatory bodies to carry out its provisions, the full effect of this law remains uncertain until after the required regulations and reports to Congress are issued and implemented. For additional information concerning this legislation, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Accounting and Regulatory Developments - Legislative and Regulatory Developments.

A Failure or Interruption in Our Information Systems, Information Systems of Third Party Vendors or Service Providers or the FHLBank of Chicago's Information Systems, or a Cybersecurity Event, Could Adversely Affect Our Business, Risk Management, Financial Condition, Results of Operations, and Reputation.

We have not experienced a failure or disruption in our information systems or a cybersecurity event that has had a material adverse impact on our business. However, we rely heavily on our information systems and other technology to conduct and manage our business. If we experience a failure or interruption in any of these systems or a cybersecurity event, we may be unable to conduct and manage our business effectively, including, without limitation, our Advances and hedging activities.

Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Our computer systems, software and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses or other malicious code and other events that could jeopardize the confidentiality or integrity of such information, or otherwise cause interruptions or malfunctions in our operations, which could result in significant losses, damage to our reputation, litigation, regulatory fines or penalties, or other adverse effects on our business, financial condition or results of operations. In addition, we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures arising from operational and security risks.




During 2011, we began an enterprise-wide initiative to replace our core banking system. This implementation, which is expected to take several years, along with several other key initiatives simultaneously undertaken, could subject us to a higher risk of failure or interruption while we are in the process of conversion. Any failure or interruption could adversely affect our Advances business, member relations, risk management, and profitability, which could negatively affect our financial condition and results of operations.

In addition to internal computer systems, we rely on third party vendors and service providers, including the Office of Finance, for many of our communications and information systems needs. Any failure, interruption or breach in security of these systems, or any disruption of service, could result in failures or interruptions in our ability to conduct and manage our business effectively, including, and without limitation, our hedging and advances activities. There is no assurance that such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. Any failure, interruption, or breach could significantly harm our customer relations and business operations, which could negatively affect our financial condition, profitability and cash flows.

During the second quarter of 2012, we reactivated our participation in the MPF Program. We purchase participation interests in MPF mortgage loans that the FHLBank of Topeka acquired from its respective PFIs. In its role as MPF Provider, the FHLBank of Chicago provides the infrastructure and operational support for the MPF Program and is responsible for publishing and maintaining the MPF Origination, Underwriting and Servicing Guides, which detail the requirements PFIs must follow in originating or selling and servicing MPF mortgage loans. If the FHLBank of Chicago changes or ceases to operate the MPF Program or experiences a failure or interruption in its information systems and other technology in its operation of the MPF Program, our MPF business could be adversely impacted, which could negatively affect our financial condition, profitability and cash flows. In the same way, we could be adversely affected if any of the FHLBank of Chicago's third-party vendors engaged in the operation of the MPF Program were to experience operational or technical difficulties.

The Business and Financial Models and Related Processes Used to Derive Certain Estimates in Our Financial Statements and Evaluate Various Financial Risks Could Fail to Produce Reliable Projections or Valuations, Which Could Adversely Affect Our Business, Financial Condition, Results of Operations and Risk Management.

We are exposed to operations risk due to the significant use of sophisticated business and financial models when deriving certain estimates in our financial statements and evaluating various financial risks. Our business could be adversely affected if those models fail to produce reliable projections or valuations. These models, which rely on various inputs and require management to make critical judgments about the appropriate assumptions that are used in the calculations, may overstate or understate the value of certain financial instruments, future performance expectations, and our level of risk exposure. Our models could produce unreliable results for a number of reasons, including, but not limited to, invalid or incorrect assumptions underlying the models, the need for manual adjustments in response to rapid changes in economic conditions, incorrect coding of the models, incorrect data being used by the models or inappropriate application of a model to products or events outside the model's intended use. In particular, models are less dependable when the economic environment is outside of historical experience, as has been the case in recent years. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Critical Accounting Policies and Estimates for more information.

A Significant or Prolonged Delay in the Initiation or Completion of Foreclosure Proceedings on Mortgage Loans May Have an Adverse Effect on Our Business, Financial Condition and Results of Operations.

In October 2010, a number of single-family mortgage servicers temporarily halted some or all of the foreclosures they were processing after discovering deficiencies in their own and their service providers’ foreclosure processes. The servicer foreclosure process deficiencies generated significant concern and were reviewed by various government agencies and the various state attorneys general.

On February 9, 2012, a settlement was announced among five of the nation’s largest mortgage servicers (Bank of America Corporation, JPMorgan Chase & Co., Wells Fargo & Company, Citigroup Inc., and Ally Financial Inc. (formerly General Motors Acceptance Corporation) and the federal government and 49 state attorneys general. The announced settlement, among other things, required implementation by those mortgage servicers of certain new servicing and foreclosure practices.




In January 2013, the Office of the Comptroller of the Currency announced that it had reached an agreement in principle, along with the Federal Reserve Board, with ten mortgage servicing companies (Aurora, Bank Of America, Citibank, JPMorgan Chase, MetLife Bank, PNC, Sovereign, SunTrust, U.S. Bank and Wells Fargo) subject to enforcement actions for deficient practices in mortgage loan servicing and foreclosure processing. Under this agreement, the participating servicers would cease the independent foreclosure review process, which involved case-by-case reviews, and replace it with a broader framework allowing eligible borrowers to receive compensation significantly more quickly. The Office of the Comptroller of the Currency and the Federal Reserve Board continue to work to reach similar agreements with other servicers that are not parties to this agreement, but that are also subject to enforcement actions involving claims of deficient practices in mortgage loan servicing and foreclosure processing.

Although servicers have generally ended their suspension of foreclosures, the processing of foreclosures continues to be slow in many states due to continuing issues in the servicer foreclosure process, including efforts by servicers to comply with regulatory consent orders and requirements, recent changes in state foreclosure laws, court rules and proceedings, and the pipeline of foreclosures resulting from these delays as well as the elevated level of foreclosures caused by the housing market downturn. In addition, inadequate court budgets in certain states could further delay the processing of foreclosures.

A significant or prolonged delay of mortgage foreclosure proceedings may have an adverse effect on the market value of the underlying collateral in our mortgage investments, which could adversely affect our business, financial condition and results of operations.

A Failure to Meet Minimum Regulatory Capital Requirements Could Affect Our Ability to Pay Dividends, Redeem or Repurchase Capital Stock, and Attract New Members.

We are required to maintain sufficient capital to meet specific minimum requirements established by the Finance Agency. Historically, our capital has exceeded all capital requirements, and we have maintained adequate capital and leverage ratios. However, if we violate any of these requirements or if our board or the Finance Agency determines that we have incurred, or are likely to incur, losses resulting, or losses that are expected to result, in a charge against capital, we would not be able to redeem or repurchase any capital stock while such charges are continuing or expected to continue. Violations could also result in restrictions pertaining to dividend payments, lending, investment, purchases of mortgage loans or participation interests in mortgage loans, or other business activities. Additionally, the Finance Agency could require that we call upon our members to purchase additional capital stock to meet our minimum regulatory capital requirements. Members may be unable or unwilling to satisfy such calls for additional capital, thereby adversely affecting their desire to continue doing business with our Bank.

The formula for calculating risk-based capital includes factors that are dependent on interest rates and other market metrics outside our control and could cause the minimum requirement to increase to a point exceeding our capital level. Further, if our Retained Earnings were to become inadequate or negative, the Finance Agency could initiate restrictions consistent with those associated with failure of a minimum capital requirement.

The stability of our capital is also important in maintaining the value of membership in our Bank. Failure to meet minimum capital requirements, the inability to pay dividends or repurchase stock at par, or a request for capital contributions to restore capital could make it more difficult for us to attract new members or retain existing members.




Competition Could Negatively Impact Our Access to Funding, Our Earnings, Advances and Investments, and the Supply of Mortgage Loans for our MPP and the MPF Program.

We operate in a highly competitive environment. Demand for Advances is affected by, among other factors, the cost and availability of other sources of liquidity for our members, including deposits. We compete with other suppliers of wholesale funding, both secured and unsecured. Such other suppliers may include the United States government, deposit insurers, the Federal Reserve Banks, investment banking concerns, commercial banks and, in certain circumstances, other FHLBanks. Large institutions may also have independent access to the national and global credit markets. The availability of alternative funding sources to members can significantly influence the demand for Advances and can vary as a result of a variety of factors, including market conditions, members' creditworthiness, and availability of collateral. Lower demand for Advances could negatively impact our earnings.

Likewise, our MPP and the MPF Program are subject to significant competition. The most direct competition for purchases of mortgages comes from other buyers of conventional, conforming, fixed-rate mortgage loans, such as Fannie Mae and Freddie Mac. Increased competition can result in smaller market share of the mortgages available for purchase and, therefore, lower earnings.

We also compete with Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities for funds raised through the issuance of CO Bonds, Discount Notes, and other debt instruments. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs to us or lesser amounts of debt issued at the same cost than otherwise would be the case. Although our supply of funds through issuance of Consolidated Obligations has kept pace with our funding needs, there can be no assurance that this will continue at the level required for our future operational needs.

Loss of One or More Large Customers Could Adversely Impact Our Profitability, Our Ability to Achieve Business Objectives, and Our Risk Concentration.
 
The loss of any large customer could adversely impact our profitability and our ability to achieve business objectives. The loss of a large customer could result from a variety of factors, including acquisition, consolidation of charters within a bank holding company, or resolution of a financially distressed member. As of December 31, 2012, our top two borrowers, Flagstar Bank, FSB and Jackson National Life Insurance Company, held $3.2 billion and $1.8 billion, respectively, or a total of 28% of total Advances outstanding, at par.

At December 31, 2012, our top two MPP customers accounted for 35% of outstanding MPP assets, at par. These two entities are no longer our members because they no longer have charters within our district. Although the mortgage loans purchased through our MPP remain outstanding until prepayment or maturity, we are no longer able to purchase mortgage loans from these two entities. We currently purchase mortgage loans from smaller PFIs that predominantly originate mortgage loans in Indiana and Michigan. Over time, we expect our concentration of MPP loans originating in Indiana and Michigan to increase. We also purchase participation interests in MPF loans only from the FHLBank of Topeka. If the FHLBank of Topeka (or its PFIs) were to discontinue its participation in MPF, we would not be able to acquire participation interests in any other MPF loans unless another MPF FHLBank were to elect to sell such loans to us.

Providing Financial Support to Other FHLBanks Could Negatively Impact Our Members.

We are jointly and severally liable with the other FHLBanks for the Consolidated Obligations issued on behalf of the FHLBanks through the Office of Finance. We may not pay any dividends to members or redeem or repurchase any shares of our capital stock if the principal and interest due on all Consolidated Obligations have not been paid in full when due. If another FHLBank were to default on its obligation to pay principal or interest on any Consolidated Obligations, the Finance Agency may allocate the outstanding liability among one or more of the remaining FHLBanks on a pro-rata basis or on any other basis the Finance Agency may determine. As a result, our ability to pay dividends to our members or to redeem or repurchase shares of our capital stock could be affected not only by our own financial condition, but also by the financial condition of one or more of the other FHLBanks. Although no FHLBank has ever defaulted on its debt obligations since the FHLBank System was established in 1932, the recent economic crisis adversely impacted the capital adequacy and financial results of some FHLBanks. In addition to servicing debt under our joint and several liability, we may voluntarily or involuntarily provide financial assistance to another FHLBank in order to resolve a condition of financial distress.
 





Notes to Financial Statements, continued
($ amounts in thousands unless otherwise indicated)


ITEM 2. PROPERTIES

We own an office building containing approximately 117,000 square feet of office and storage space at 8250 Woodfield Crossing Boulevard, Indianapolis, IN, of which we use approximately 65,000 square feet. We lease or hold for lease to various tenants the remaining 52,000 square feet. We also maintain a leased off-site backup facility of approximately 6,800 square feet, which is on a separate electrical distribution grid. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Operations Risk Management for additional information.

In the opinion of management, our physical properties are suitable and adequate. All of our properties are insured to nearly replacement cost. In the event we were to need more space, our lease terms with tenants generally provide the ability to move tenants to comparable space at other locations at our cost for moving and outfitting any replacement space to meet our tenants' needs.





ITEM 3. LEGAL PROCEEDINGS

We are unaware of any potential claims against us that could be material.

Private-Label Mortgage-Backed Securities Litigation

On October 15, 2010, we filed a complaint in the Superior Court of Marion County, Indiana, relating to private-label mortgage-backed securities we purchased in the aggregate original principal amount of approximately $2.9 billion. The complaint, which has been amended, is an action for rescission and damages and asserts claims for negligent misrepresentation and violations of state and federal securities law occurring in connection with the sale of these private-label mortgage-backed securities ("MBS"). On July 3, 2012, the Court entered an order granting in part and denying in part the defendants' motion to dismiss the amended complaint, which had the effect of removing certain federal securities law claims as to ten of the securities. Additionally, on January 11, 2013, the Court granted our uncontested motion for voluntary dismissal of all claims with regard to four other securities originally included in the complaint.

On May 14, 2012, one defendant named along with other parties in connection with three of the securities, Residential Funding Mortgage Securities I, Inc., filed for protection under Chapter 11 of the United States bankruptcy code in the United States Bankruptcy Court for the Southern District of New York. Consequently, we voluntarily dismissed (without prejudice against refiling) our amended complaint as to that defendant. In November 2012, we filed a proof of claim in that entity's bankruptcy proceeding.

The table below provides additional information concerning the 26 private-label residential MBS remaining at issue in the amended complaint, including the original principal amount of each security, the named defendants and their alleged capacities with respect to each security.
Number
Original Face Amount
Defendants
Capacities
1
$70,000,000
Banc of America Mortgage Securities, Inc.
Depositor
 
 
Bank of America Securities LLC
Underwriter / Seller
 
 
Bank of America Corporation
Controlling Person
2
96,221,210
Banc of America Securities LLC
Seller
 
 
Bank of America Corporation
Controlling Person
 
 
Structured Asset Mortgage Investments II Inc.
Depositor
 
 
Bear, Stearns & Co. Inc.
Underwriter
3
100,306,000
CWMBS, Inc.
Depositor
 
 
Credit Suisse (USA), Inc.
Controlling Person
 
 
Credit Suisse First Boston LLC
Underwriter / Seller
 
 
Credit Suisse Holdings (USA), Inc.
Controlling Person
4
100,000,000
CWMBS, Inc.
Depositor
 
 
Goldman, Sachs & Co.
Underwriter / Seller
 
 
The Goldman Sachs Group Inc.
Controlling Person
5
42,330,700
Chase Mortgage Finance Corporation
Depositor
 
 
J.P. Morgan Securities Inc.
Underwriter / Seller
 
 
JPMorgan Chase & Co.
Controlling Person
 
 
JPMorgan Securities Holdings LLC
Controlling Person
6
54,755,000
Bear, Stearns & Co. Inc.
Underwriter / Seller
 
 
CWMBS, Inc.
Depositor
7
64,454,000
Credit Suisse (USA), Inc.
Controlling Person
 
 
Credit Suisse First Boston LLC
Underwriter / Seller
 
 
Credit Suisse First Boston Mortgage Securities Corp.
Depositor
 
 
Credit Suisse Holdings (USA), Inc.
Controlling Person
9
86,000,000
The Goldman Sachs Group Inc.
Controlling Person
 
 
GS Mortgage Securities Corp.
Depositor
 
 
Goldman, Sachs & Co.
Underwriter / Seller




Number
Original Face Amount
Defendants
Capacities
10
56,658,000
The Goldman Sachs Group Inc.
Controlling Person
 
 
GS Mortgage Securities Corp.
Depositor
 
 
Goldman, Sachs & Co.
Underwriter / Seller
11
100,000,000
The Goldman Sachs Group Inc.
Controlling Person
 
 
GS Mortgage Securities Corp.
Depositor
 
 
Goldman, Sachs & Co.
Underwriter / Seller
13
53,899,000
The Goldman Sachs Group Inc.
Controlling Person
 
 
GS Mortgage Securities Corp.
Depositor
 
 
Goldman, Sachs & Co.
Underwriter / Seller
14
143,000,000
The Goldman Sachs Group Inc.
Controlling Person
 
 
GS Mortgage Securities Corp.
Depositor
 
 
Goldman, Sachs & Co.
Underwriter / Seller
15
105,000,000
The Goldman Sachs Group Inc.
Controlling Person
 
 
GS Mortgage Securities Corp.
Depositor
 
 
Goldman, Sachs & Co.
Underwriter / Seller
17
82,019,000
IndyMac MBS, Inc.
Depositor
 
 
UBS Securities LLC
Underwriter / Seller
18
54,125,700
J.P. Morgan Acceptance Corporation I
Depositor
 
 
J.P. Morgan Securities Inc.
Underwriter / Seller
 
 
JPMorgan Chase & Co.
Controlling Person
 
 
JPMorgan Securities Holdings LLC
Controlling Person
19
90,360,000
Greenwich Capital Markets, Inc.
Underwriter / Seller
20
99,160,206
Credit Suisse (USA), Inc.
Controlling Person
 
 
Credit Suisse First Boston LLC
Seller
 
 
Credit Suisse Holdings (USA), Inc.
Controlling Person
 
 
Residential Funding Securities, LLC
Underwriter
21
94,464,000
Greenwich Capital Markets, Inc.
Underwriter / Seller
22
95,418,000
GS Mortgage Securities Corp.
Depositor
 
 
Goldman, Sachs & Co.
Underwriter / Seller
 
 
The Goldman Sachs Group Inc.
Controlling Person
23
143,860,000
WaMu Asset Acceptance Corp.
Depositor
 
 
WaMu Capital Corp.
Underwriter
24
93,831,000
J.P. Morgan Securities Inc.
Underwriter / Seller
 
 
JPMorgan Chase & Co.
Controlling Person
 
 
JPMorgan Securities Holdings LLC
Controlling Person
 
 
WaMu Asset Acceptance Corp.
Depositor
 
 
WaMu Capital Corp.
Underwriter
25
106,000,000
Goldman, Sachs & Co.
Underwriter / Seller
 
 
The Goldman Sachs Group Inc.
Controlling Person
 
 
WaMu Asset Acceptance Corp.
Depositor
 
 
WaMu Capital Corp.
Underwriter
26
59,874,246
Credit Suisse (USA), Inc.
Controlling Person
 
 
Credit Suisse Holdings (USA), Inc.
Controlling Person
 
 
Credit Suisse First Boston LLC
Seller
 
 
WaMu Asset Acceptance Corp.
Depositor
 
 
WaMu Capital Corp.
Underwriter
 
 
 
 
 
 
 
 




Number
Original Face Amount
Defendants
Capacities
27
112,889,185
Banc of America Securities LLC
Seller
 
 
Bank of America Corporation
Controlling Person
 
 
WaMu Asset Acceptance Corp.
Depositor
 
 
WaMu Capital Corp.
Underwriter
28
100,000,000
UBS Securities LLC
Underwriter / Seller
 
 
Wells Fargo Asset Securities Corporation
Depositor
31
59,618,990
Wells Fargo Asset Securities Corporation
Depositor
 
 
Greenwich Capital Markets, Inc.
Underwriter / Seller
Total
$2,264,244,237
 
 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

No Trading Market

Our Class B Stock is not publicly traded, and there is no established market for such stock. Members may be required to purchase additional shares of Class B Stock from time to time in order to meet minimum stock purchase requirements under our Capital Plan, which was implemented on January 2, 2003, in accordance with the provisions of the Gramm-Leach-Bliley Act of 1999 amendments to the Federal Home Loan Bank Act of 1932, as amended and Federal Housing Finance Agency ("Finance Agency") regulations. Our Class B Stock may be redeemed, at par value of $100 per share, up to five years after we receive a written redemption request by a member, subject to regulatory limits and to the satisfaction of any ongoing stock purchase requirements applicable to the member. We may repurchase shares held by members in excess of their required holdings at our discretion at any time.
 
None of our capital stock is registered under the Securities Act of 1933, and purchases and sales of stock by our members are not subject to registration under the Securities Act of 1933.

Number of Shareholders

As of February 28, 2013 we had 416 shareholders and $1.8 billion par value of regulatory capital stock, which includes Capital Stock and Mandatorily Redeemable Capital Stock ("MRCS") issued and outstanding.

Dividends

Dividends may, but are not required to, be paid on our Class B Stock. Our board of directors may declare and pay dividends in either cash or capital stock or a combination thereof, subject to Finance Agency regulations. Our board of directors' decision to declare dividends is influenced by our financial condition, overall financial performance and Retained Earnings, as well as actual and anticipated developments in the overall economic and financial environment including the level of interest rates and conditions in the mortgage and credit markets. In addition, our board of directors considers several other factors, including our risk profile, the impact on our relationship with our members and the stability of our current capital stock position and membership.

Our Capital Plan provides for two sub-series of Class B Stock: Class B-1 and Class B-2. Class B-2 is required stock that is subject to a redemption request. Class B-1 shareholders receive a higher dividend than Class B-2 shareholders. The Class B-2 dividend is presently equal to 80% of the amount of the Class B-1 dividend and can only be changed by an amendment to our Capital Plan with approval of the Finance Agency. The amount of the dividend to be paid is based on the average number of shares of each sub-series held by the member during the dividend payment period. For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Capital Resources and Notes to Financial Statements - Note 15 - Capital.





We are exempt from federal, state, and local taxation, except for real estate taxes. Despite our tax-exempt status, any cash dividends paid by us to our members are taxable dividends to the members, and our members do not benefit from the exclusion for corporate dividends received. The preceding information is for general information only. It is not tax advice. Members should consult their own tax advisors regarding particular federal, state, and local tax consequences for purchasing, holding, and disposing of our Class B Stock, including the consequences of any proposed change in applicable law.

We paid quarterly cash dividends as set forth in the following table ($ amounts in thousands).
 
 
Class B-1
 
Class B-2
By Quarter
 
Annualized Rate (2)
 
Dividend on Capital Stock
 
Interest Expense on MRCS
 
Total
 
Annualized Rate (2)
 
Dividend on Capital Stock
 
Interest Expense on MRCS
 
Total
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 1 (1)
 
3.5
%
 
$
14,305

 
$
3,720

 
$
18,025

 
2.8
%
 
$
19

 
$
196

 
$
215

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 4
 
3.5
%
 
$
14,145

 
$
3,707

 
$
17,852

 
2.8
%
 
$
25

 
$
208

 
$
233

Quarter 3
 
3.0
%
 
11,750

 
3,126

 
14,876

 
2.4
%
 
45

 
208

 
253

Quarter 2
 
3.0
%
 
11,588

 
3,143

 
14,731

 
2.4
%
 
58

 
215

 
273

Quarter 1
 
3.0
%
 
11,698

 
3,203

 
14,901

 
2.4
%
 
62

 
221

 
283

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 4
 
2.5
%
 
$
9,599

 
$
2,839

 
$
12,438

 
2.0
%
 
$
16

 
$
229

 
$
245

Quarter 3
 
2.5
%
 
9,838

 
3,350

 
13,188

 
2.0
%
 
12

 
388

 
400

Quarter 2
 
2.5
%
 
9,917

 
3,450

 
13,367

 
2.0
%
 
12

 
487

 
499

Quarter 1
 
2.5
%
 
10,546

 
3,930

 
14,476

 
2.0
%
 
12

 
508

 
520


(1) 
This dividend was paid on February 22, 2013.
(2) 
Reflects the annualized rate on all of our average capital stock outstanding in Class B-1 and Class B-2, respectively, regardless of its classification for financial reporting purposes as either Capital Stock or MRCS. The Class B-2 dividend is paid at 80% of the amount of the Class B-1 dividend.





ITEM 6. SELECTED FINANCIAL DATA
 
We use certain acronyms and terms in this Item 6 that are defined in the Glossary of Terms located in Item 15. Exhibits and Financial Statement Schedules. The following table should be read in conjunction with the financial statements and related notes and the discussion set forth in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The table presents a summary of certain financial information derived from audited financial statements as of and for the periods indicated ($ amounts in millions):
 
 
As of and for the Years Ended December 31,
 
 
2012
 
2011
 
2010
 
2009
 
2008
Statement of Condition:
 
 
 
 
 
 
 
 
 
 
Advances
 
$
18,130

 
$
18,568

 
$
18,275

 
$
22,443

 
$
31,249

Investments (1)
 
16,845

 
15,203

 
19,785

 
14,994

 
15,758

Mortgage Loans Held for Portfolio, net
 
6,001

 
5,955

 
6,702

 
7,272

 
8,780

Total Assets
 
41,228

 
40,375

 
44,930

 
46,599

 
56,860

Discount Notes
 
8,924

 
6,536

 
8,925

 
6,250

 
23,466

CO Bonds
 
27,408

 
30,358

 
31,875

 
35,908

 
28,697

Total Consolidated Obligations
 
36,332

 
36,894

 
40,800

 
42,158

 
52,163

MRCS
 
451

 
454

 
658

 
756

 
539

Capital Stock, Class B Putable
 
1,634

 
1,563

 
1,610

 
1,726

 
1,879

Retained Earnings
 
592

 
498

 
427

 
349

 
283

AOCI
 
(10
)
 
(114
)
 
(90
)
 
(329
)
 
(71
)
Total Capital
 
2,216

 
1,947

 
1,947

 
1,746

 
2,091

 
 
 
 
 
 
 
 
 
 
 
Statement of Income:
 
 
 
 
 
 
 
 
 
 
Net Interest Income
 
242

 
231

 
267

 
272

 
278

Provision for Credit Losses
 
8

 
5

 
1

 

 

Net OTTI credit losses
 
(4
)
 
(27
)
 
(70
)
 
(60
)
 

Other Income (Loss), excluding net OTTI credit losses
 
(9
)
 
(6
)
 
11

 
2

 
15

Other Expenses
 
60

 
58

 
55

 
49

 
41

Total Assessments
 
18

 
25

 
41

 
45

 
68

Net Income
 
143

 
110

 
111

 
120

 
184

 
 
 
 
 
 
 
 
 
 
 
Selected Financial Ratios:
 
 
 
 
 
 
 
 

 
 

Return on average equity (2)
 
6.89
%
 
5.63
%
 
6.13
%
 
5.94
%
 
8.14
%
Return on average assets
 
0.35
%
 
0.26
%
 
0.24
%
 
0.23
%
 
0.32
%
Dividend payout ratio (3)
 
34.45
%
 
36.29
%
 
29.18
%
 
44.72
%
 
53.63
%
Net interest margin (4)
 
0.59
%
 
0.55
%
 
0.57
%
 
0.52
%
 
0.48
%
Total capital ratio (5)
 
5.37
%
 
4.82
%
 
4.33
%
 
3.75
%
 
3.68
%
Total regulatory capital ratio (6)
 
6.49
%
 
6.23
%
 
6.00
%
 
6.07
%
 
4.75
%
Average equity to average assets
 
5.05
%
 
4.60
%
 
3.90
%
 
3.87
%
 
3.88
%
Weighted average dividend rate, Class B stock (7)
 
3.13
%
 
2.50
%
 
1.87
%
 
2.83
%
 
5.01
%

(1) 
Investments consist of Interest-Bearing Deposits, Securities Purchased Under Agreements to Resell, Federal Funds Sold, AFS securities, and HTM securities.
(2) 
Return on average equity is Net Income expressed as a percentage of average total capital.
(3) 
The dividend payout ratio is calculated by dividing dividends paid in cash during the period by Net Income for the period.
(4) 
Net interest margin is Net Interest Income expressed as a percentage of average interest-earning assets.
(5) 
Total capital ratio is Capital Stock plus Retained Earnings and AOCI expressed as a percentage of Total Assets.
(6) 
Total regulatory capital ratio is Capital Stock plus Retained Earnings and MRCS expressed as a percentage of Total Assets.
(7) 
The weighted average dividend rate is calculated by dividing dividends paid in cash during the period by the average of Class B Capital Stock eligible for dividends (i.e., excludes MRCS).



ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Presentation 

This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and related notes contained in this Form 10-K.

As used in this Item 7, unless the context otherwise requires, the terms "we," "us," and "our," and the "Bank" refer to the Federal Home Loan Bank of Indianapolis or its management. We use certain acronyms and terms throughout this Item 7 that are defined in the Glossary of Terms located in Item 15. Exhibits and Financial Statement Schedules.

Unless otherwise stated, amounts disclosed in this Item 7 are rounded to the nearest million; therefore, dollar amounts of less than one million may not be reflected in this Item 7 and, due to rounding, may not appear to agree to the amounts presented in thousands in the Financial Statements and Notes to Financial Statements. Amounts used to calculate dollar and percentage changes are based on numbers in the thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.

Special Note Regarding Forward-Looking Statements
 
Statements in this Form 10-K, including statements describing our objectives, projections, estimates or future predictions, may be "forward-looking statements." These statements may use forward-looking terminology, such as "anticipates," "believes," "could," "estimates," "may," "should," "expects," "will," or their negatives or other variations on these terms. We caution that, by their nature, forward-looking statements involve risk or uncertainty and that actual results either could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, the following:

economic and market conditions, including the timing and volume of market activity, inflation or deflation, changes in the value of global currencies, and changes in the financial condition of market participants;
volatility of market prices, interest rates, and indices or other factors, resulting from the effects of, and changes in, various monetary or fiscal policies and regulations, including those determined by the Federal Reserve Board and the FDIC, or a decline in liquidity in the financial markets that could affect the value of investments, including OTTI of private-label RMBS, or collateral we hold as security for the obligations of our members and counterparties;
demand for our Advances and purchases of mortgage loans under our MPP or participation interests in mortgage loans purchased from other FHLBanks under the MPF Program resulting from:
changes in our members' deposit flows and credit demands;
membership changes, including, but not limited to, mergers, acquisitions and consolidations of charters;
changes in the general level of housing activity in the United States, the level of refinancing activity and consumer product preferences; and
competitive forces, including, without limitation, other sources of funding available to our members;
changes in mortgage asset prepayment patterns, delinquency rates and housing values;
our ability to introduce new products and services and successfully manage the risks associated with our products and services, including new types of collateral securing Advances;
political events, including legislative, regulatory, or other developments, and judicial rulings that affect us, our status as a secured creditor, our members, counterparties, one or more of the FHLBanks and/or investors in the Consolidated Obligations of the FHLBanks;
changes in our ability to raise capital market funding, including changes in our credit ratings or the credit ratings of the other FHLBanks and the FHLBank System and the level of government guarantees provided to other United States and international financial institutions; competition from other entities borrowing funds in the capital markets; and dealer commitment to supporting the issuance of our Consolidated Obligations.
negative adjustments in the FHLBanks' or the FHLBank System's credit ratings that could adversely impact the pricing and marketability of our Consolidated Obligations, products, or services;
risk of loss should one or more of the FHLBanks be unable to repay its participation in the Consolidated Obligations, or otherwise be unable to meet its financial obligations;
ability to attract and retain skilled personnel;
ability to develop and support technology and information systems sufficient to effectively manage the risks of our business;




changes in terms of interest-rate exchange agreements and similar agreements;
risk of loss arising from natural disasters, acts of war or acts of terrorism; and
changes in or differing interpretations of accounting guidance. 

Although we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make through reports filed with the SEC in the future, including our Forms 10-K, 10-Q and 8-K.

Executive Summary
 
Overview. We are a regional wholesale bank that makes Advances; purchases whole mortgages from our member financial institutions; purchases participation interests in mortgage loans from other FHLBanks; purchases other investments; and provides other financial services to our member financial institutions. Our member financial institutions may consist of federally-insured depository institutions (including commercial banks, thrifts, and credit unions), insurance companies and CDFIs. All member financial institutions are required to purchase shares of our Class B Capital Stock as a condition of membership. 

Our public policy mission is to facilitate and expand the availability of financing for housing and community development. We seek to achieve our mission by providing products and services to our members in a safe, sound, and profitable manner, and by generating a competitive return on their capital investment. See Item 1. Business - Background Information for more information.
 
We group our products and services within two business segments:

Traditional, which consists of (i) credit products (including Advances, letters of credit, and lines of credit), (ii) investments (including Federal Funds Sold, Securities Purchased Under Agreements to Resell, AFS securities and HTM securities) and (iii) correspondent services and deposits; and
Mortgage Loans, which consists of (i) mortgage loans purchased from our members through our MPP and (ii) participation interests purchased from the FHLBank of Topeka in mortgage loans that were purchased from its PFI members under the MPF Program.

Our principal source of funding is the proceeds from the sale to the public of FHLBank debt instruments, called Consolidated Obligations, which are the joint and several obligation of all 12 FHLBanks. We obtain additional funds from deposits, other borrowings, and the sale of capital stock to our members.

Our primary source of revenue is interest earned on Advances, long- and short-term investments, and mortgage loans.
 
Our Net Interest Income is primarily determined by the interest-rate spread between the interest rate earned on our assets and the interest rate paid on our share of the Consolidated Obligations. We use funding and hedging strategies to manage the related interest-rate risk.

Economic Conditions. Our financial condition and results of operations are influenced by the general state of the global and national economies; the conditions in the financial, credit and mortgage markets; the prevailing level of interest rates; and the economies in our district states of Indiana and Michigan and their impact on our member financial institutions.

The United States economy entered a recession in December 2007, which ended in June 2009. Although the United States economy has begun to show signs of improvement, many of the effects of the recession and the world-wide financial crisis continued in the United States during 2012, including serious pressures on earnings and capital at many financial institutions, high unemployment rates, and high levels of mortgage delinquencies and foreclosures. Although the housing market remains depressed, recent market indicators including new housing starts and existing home sales are trending slightly higher.

On January 1, 2013, the Senate and the House passed tax legislation, which avoided imposing tax increases on most taxpayers. However, the tax bill did not deal with the debt ceiling limit, sequester, and potential government shutdown due to an expiring continuing resolution that could have significant impacts on the United States economy and financial markets. Continued political debates around tax increases, spending cuts and deficit reduction and renewed negotiations around the debt ceiling could adversely affect the financial markets and ultimately FHLBank funding levels beginning late in the first quarter of 2013.





The world-wide financial crisis continued to have an impact on the global economy during 2012. During the first quarter of 2012, all three of the major NRSROs announced ratings downgrades on some of the Eurozone countries, or placed them on review for possible downgrade. According to a report issued by Fitch on June 27, 2012, the severity of the economic crisis in Europe intensified in the second quarter of 2012. During the third quarter of 2012, the European Central Bank announced plans to stop paying interest on overnight deposits in order to encourage investment and lending in Europe and then, later in the quarter, announced plans to support peripheral countries through outright bond purchases. According to a report issued by Moody's on February 12, 2013, although Europe's financial markets have experienced a relative period of calm, private sector deleveraging and public sector austerity are still the dominant impediments to growth. Europe's financial markets and economy remain under significant stress, which is likely to continue to negatively affect the global economy.

During the year ended December 31, 2012, short-term interest rates remained at historic lows while intermediate- and long-term rates showed a generally modest upward trend during the first quarter of 2012 and a downward trend during the remainder of 2012. The FOMC indicated that it will maintain the target range for the federal funds rate at 0.00-0.25%, as it continues to anticipate that economic conditions, including low rates of resource utilization and subdued inflation trends, are likely to warrant exceptionally low levels of the federal funds rate at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a half percentage point above the FOMC's longer run goal of 2%, and longer-term inflation expectations continue to be well anchored. Although not possible to predict, the continued abnormally low rates in the near-term could cause more interest rate volatility and ultimately higher rates in the future than would normally be anticipated.

The Bureau of Labor Statistics reported that Michigan's preliminary unemployment rate equaled 8.9% for December 2012, while Indiana's preliminary rate was 8.5%, compared to the United States rate of 7.6%. According to information provided by LPS Applied Analytics for December, Indiana had a non-current mortgage rate (loans past due 30 days or more) of 12.2%, and Michigan had a non-current mortgage rate of 8.9%, compared to the national rate of 10.6%.

In its most recent forecast, the Center for Econometric Research at Indiana University predicts that the Indiana economy will achieve slow and steady economic growth, with a gradually declining unemployment rate. The most recent forecast published by the Research Seminar in Quantitative Economics at the University of Michigan forecasts a moderately paced but sustained recovery from now through 2014, with some strengthening in 2013 and 2014 compared to 2012. University of Michigan economists expect a moderate rate of job growth in Michigan for 2013.

The Capital Markets. The Office of Finance, our fiscal agent, issues debt in the global capital markets on behalf of the FHLBanks in the form of Consolidated Obligations, which include CO Bonds and Discount Notes. Our funding operations are dependent on debt issued by the Office of Finance, and the issuance of our debt is affected by events in the capital markets. 

Overall, the capital markets continued to experience volatility in 2012, mainly driven by concerns about European sovereigns and the impact of the European recession on other national economies. Other concerns included continued high unemployment and depressed, but increasing, housing prices in the United States.

Due to our status as a GSE and the application of S&P's government-related entity criteria, our issuer rating is constrained by the long-term sovereign credit rating of the United States government. During 2011, S&P announced rating downgrades that affected the long-term sovereign rating of the United States government, resulting in similar rating downgrades affecting the rating of each of the FHLBanks and the rating of the FHLBank System's Consolidated Obligations. These changes did not have a material impact on our funding costs during 2012.





To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the FOMC agreed in December to continue purchasing additional agency MBS at a pace of $40 billion per month and longer-term United States Treasury securities at a pace of $45 billion per month. The FOMC will maintain its existing policy of reinvesting principal payments from its holdings of agency MBS and debt in agency MBS and of rolling over maturing United States Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help make broader financial conditions more accommodative. The FOMC will closely monitor incoming information on economic and financial developments in coming months. If the outlook for the labor market does not improve substantially, the FOMC will continue its purchases of United States Treasury and agency MBS and employ its other policy tools as appropriate, until such improvement is achieved in a context of price stability.

During 2012, investments in taxable money market funds, which purchase a significant portion of the Discount Notes and short maturity CO Bonds issued by the FHLBanks, were generally flat. As a subset of those assets, taxable money market fund investments allocated to the "U.S. Other Agency" category were also unchanged. In the first quarter of 2013, taxable money fund assets have increased with the year-end expiration of the FDIC's Transaction Account Guarantee program, which provides unlimited FDIC insurance, as money managers consider moving cash from banks into money market funds. Potential changes to money market funds, one of the FHLBank System's most important investor bases, could adversely affect our debt. However, implementation of any proposals is likely to be phased in over time, and is not anticipated to begin until late 2013 or early 2014. The market remains cautiously optimistic for a compromise on mutual fund reform between the regulators and the industry, which could avert negative consequences for FHLBank debt demand.

Impact on Operating Results. Our overall results are dependent on the market environment and, in particular, our members' demand for wholesale funding and their sales of mortgage loans to us. As part of their overall business strategy, our depository members typically use wholesale funding, in the form of Advances, along with other sources of funding, such as retail deposits, as a source of liquidity and to fund residential mortgage loans in their portfolio. Periods of economic growth have led to significant use of wholesale funds by our depository members because they often fund expansion by using wholesale borrowing. Conversely, slow economic growth has tended to decrease our depository members' wholesale borrowing activity. 

Our insurance company members have different business models and are subject to different regulations; therefore, their demand for Advances is not always correlated with that of our depository members. Our insurance company members tend to use Advances as a source of liquidity, for asset/liability management or other business purposes.

Member demand for Advances and sales of mortgage loans under the MPP and MPF Program is also influenced by the steepness of the yield curve, as well as the availability and cost of other sources of wholesale or government funding. Advances to insurance company members, an increasing part of our membership and focus of our business, increased during 2012. However, Advances to depository members were lower due to repayments and decreased demand related to various economic factors such as growth in our members' deposits and low loan demand at our members' institutions.The UPB of our MPP loans decreased slightly in 2012 as repayments of outstanding MPP mortgage loans exceeded the purchases of new MPP Advantage mortgage loans. However, the UPB of Mortgage Loans Held for Portfolio increased slightly due to purchases of participation interests from the FHLBank of Topeka under the MPF Program.

Changes in short-term interest rates affect our interest income and interest expense because a considerable portion of our assets and liabilities are either directly or indirectly tied to short-term interest rates such as the federal funds or three-month LIBOR rates. Short-term interest rates also directly affect our earnings on invested capital. The level of market interest rates influences the yield on our earning assets, our cost of funds, and mortgage prepayment speeds. These factors drive our spreads, interest margins, and earnings. Since our assets and liabilities do not reprice immediately, there tends to be a lag between changes in market rates and changes to our spreads and margins. Other factors that may influence our margins or earnings include demand for our products, fee income, operating expenses and valuation of investment securities. See Results of Operations and Changes in Financial Condition herein for a detailed discussion of these factors.





Results of Operations and Changes in Financial Condition
 
Net Income for the Years Ended December 31, 2012 and 2011. The following table presents the comparative highlights of our results of operations ($ amounts in millions):
 
 
Years Ended December 31,
Comparative Highlights
 
2012
 
2011
 
$ Change
 
% Change
Net Interest Income After Provision for Credit Losses
 
$
234

 
$
226

 
$
8

 
3
%
Other Income (Loss)
 
(13
)
 
(33
)
 
20

 
60
%
Other Expenses
 
60

 
58

 
2

 
2
%
Income Before Assessments
 
161

 
135

 
26

 
19
%
Total Assessments
 
18

 
25

 
(7
)
 
(29
%)
Net Income
 
$
143

 
$
110

 
$
33

 
30
%

Net Income for the year ended December 31, 2012 was $143.3 million. The increase of $33.3 million compared to 2011 was primarily due to lower OTTI credit losses on our private-label RMBS, higher Net Interest Income and a decrease in Total Assessments as a result of satisfying our obligation to REFCORP as of June 30, 2011. Net Interest Income After Provision for Credit Losses increased by $7.2 million or 3% in the year ended December 31, 2012, compared to 2011.

Net Income for the Years Ended December 31, 2011 and 2010. The following table presents the comparative highlights of our results of operations ($ amounts in millions):
 
 
Years Ended December 31,
Comparative Highlights
 
2011
 
2010
 
$ Change
 
% Change
Net Interest Income After Provision for Credit Losses
 
$
226

 
$
266

 
$
(40
)
 
(15
%)
Other Income (Loss)
 
(33
)
 
(59
)
 
26

 
44
%
Other Expenses
 
58

 
55

 
3

 
7
%
Income Before Assessments
 
135

 
152

 
(17
)
 
(12
%)
Total Assessments
 
25

 
41

 
(16
)
 
(41
%)
Net Income
 
$
110

 
$
111

 
$
(1
)
 
(1
%)

Net Income for the year ended December 31, 2011 was $110.1 million. The decrease of $0.9 million or 1% compared to 2010 was primarily due to lower net interest income and net losses on derivatives and hedging activities, substantially offset by lower OTTI credit losses on our private-label RMBS and a decrease in Total Assessments resulting from the satisfaction of our obligation to REFCORP as of June 30, 2011. Net Interest Income After Provision for Credit Losses decreased by $39.9 million or 15% in 2011, compared to 2010, primarily due to contracting spreads on mortgage-related assets and a reduction in prepayment fees on Advances.





Changes in Financial Condition for the Year Ended December 31, 2012. The following table presents the changes in financial condition ($ amounts in millions):
Condensed Statements of Condition
 
December 31, 2012
 
December 31, 2011
 
$ Change
 
% Change
Advances
 
$
18,130

 
$
18,568

 
$
(438
)
 
(2
%)
Mortgage Loans Held for Portfolio, net
 
6,001

 
5,955

 
46

 
1
%
Investments (1)
 
16,845

 
15,203

 
1,642

 
11
%
Other Assets (2)
 
252

 
649

 
(397
)
 
(61
%)
Total Assets
 
$
41,228

 
$
40,375

 
$
853

 
2
%
 
 
 
 
 
 
 
 
 
Consolidated Obligations
 
$
36,332

 
$
36,894

 
$
(562
)
 
(2
%)
Mandatorily Redeemable Capital Stock
 
451

 
454

 
(3
)
 
(1
%)
Other Liabilities
 
2,229

 
1,080

 
1,149

 
106
%
Total Liabilities
 
39,012

 
38,428

 
584

 
2
%
Capital Stock, Class B Putable
 
1,634

 
1,563

 
71

 
5
%
Retained Earnings
 
592

 
498

 
94

 
19
%
Accumulated Other Comprehensive Income (Loss)
 
(10
)
 
(114
)
 
104

 
91
%
Total Capital
 
2,216

 
1,947

 
269

 
14
%
Total Liabilities and Capital
 
$
41,228

 
$
40,375

 
$
853

 
2
%
 
 
 
 
 
 
 
 
 
Total Regulatory Capital (3)
 
$
2,677

 
$
2,515

 
$
162

 
6
%

(1) 
Includes HTM Securities, AFS Securities, Interest-Bearing Deposits, Securities Purchased Under Agreements to Resell, and Federal Funds Sold.
(2) 
Other Assets includes Cash and Due From Banks of $105.5 million and $512.7 million at December 31, 2012 and 2011, respectively.
(3) 
Total Regulatory Capital is Total Capital plus MRCS less AOCI.

Total Assets at December 31, 2012 were $41.2 billion, a net increase of $852.1 million or 2% compared to December 31, 2011. Advances outstanding totaled $18.1 billion. The net decrease of 2% compared to December 31, 2011 was attributable to lower Advances to our depository members, partially offset by higher Advances to our insurance company members. Mortgage Loans Held for Portfolio totaled $6.0 billion. The net increase of 1% compared to December 31, 2011 included participation interests purchased from the FHLBank of Topeka under our MPF Program, which was reactivated during 2012. Investments totaled $16.8 billion at December 31, 2012. The net increase of 11% compared to December 31, 2011 was primarily attributable to an increase in short-term investments.

Consolidated Obligations totaled $36.3 billion at December 31, 2012. The net decrease of $562.7 million or 1.5% compared to December 31, 2011 was attributable to additional funding provided by Deposits.

Total Capital was $2.2 billion at December 31, 2012. The increase of $268.7 million or 14% for the year ended December 31, 2012 consisted of a net increase in Capital Stock of $71.2 million, a net increase in Retained Earnings of $93.9 million, and a favorable change in Accumulated Other Comprehensive Loss of $103.5 million, primarily due to an increase in the fair value of OTTI AFS securities.

Outlook

We currently expect our financial performance for the near term to continue to generate attractive returns for member shareholders across a wide range of business, financial, and economic environments. Events in the capital and housing markets in the last several years have created opportunities to generate spreads well above historical levels on certain types of transactions. Although we expected the frequency and level of higher-spread investment opportunities to diminish in 2012, the Eurozone crisis and the FOMC program to purchase additional mortgage-backed securities have led to very low costs for our Consolidated Obligations. The FOMC's decision to continue to increase policy accommodation by purchasing additional agency MBS has affected the credit spreads on agency MBS. Going forward, this could lead to fewer favorable opportunities to invest in these securities. We expect Net Interest Income to decline if the cost of our debt increases to pre-crisis levels and the spreads on our assets revert to historical levels.





Our Advances have been affected by increased deposits and low loan demand at our depository members, competitive pressures from alternative sources of wholesale funds available to our membership, and consolidation in the financial services industry. Although total Advances decreased during 2012, Advances to our insurance company members increased. We believe that Advances outstanding to our insurance company members, and the relative percentage of their Advances to the total, could continue to increase. The FOMC announced that it will maintain the target range for the federal funds rate at 0.00-0.25% at least as long as (i) the unemployment rate remains above 6.5%, (ii) inflation between one and two years ahead is projected to be no more than a half percentage point above the longer run goal of 2% and (iii) longer-term inflation expectations continue to be well anchored. We do not expect a significant change in our total Advance balance during 2013.

The UPB of Mortgage Loans Held for Portfolio increased slightly due to acquisitions of MPP Advantage loans and participation interests from the FHLBank of Topeka under the MPF Program in 2012. We expect our future Mortgage Loans Held for Portfolio balance and earnings to remain at their current levels or grow modestly as we continue to build member interest in MPP Advantage and purchase participation interests from the FHLBank of Topeka. However, future growth in the Mortgage Loans Held for Portfolio balance and earnings could be adversely impacted by the FOMC's decision to purchase additional agency MBS, the continuing low interest-rate environment, the limited number of large sellers in our district, and possible Finance Agency limits on mortgage loan assets as a component of core mission assets.

We actively monitor the credit quality of our investments; however, elevated credit risk related to our private-label RMBS and ABS resulted in OTTI charges for 2010, 2011 and 2012. If delinquency or loss rates on mortgages increase, or there is a decline in residential real estate values, we could experience additional OTTI charges. Because of the uncertainty regarding regulatory changes and legal challenges in the housing market, as well as economic, financial market, and housing market conditions and the actual and projected performance of the loan collateral underlying our MBS, it is not possible to predict to what extent we will have additional OTTI charges in the future. See Risk Management - Credit Risk Management - Investments - OTTI Evaluation Process herein for more information.

The cost of our Consolidated Obligations in the future will depend on several factors, including the direction and level of market interest rates, competition from other issuers of agency debt, changes in the investment preferences of potential buyers of agency debt securities, global demand, pricing in the interest-rate swap market, and other technical market factors.

We do not currently anticipate any major changes in the composition of our Statement of Condition that would significantly increase earnings sensitivity to changes in the market environment. In addition to having embedded prepayment options and basis risk exposure, which increase both our market risk and earnings volatility, the amortization of purchased premiums and discounts on mortgage assets could also result in greater volatility.

In the future, we will continue to engage in various hedging strategies and use derivatives to assist in mitigating the volatility of earnings and the market value of equity that arises from the maturity structure of our financial assets and liabilities. While we expect hedging with derivatives to reduce market risk and earnings volatility, estimated fair value adjustments could cause earnings volatility. On December 31, 2012, we began using the OIS rate curve instead of the LIBOR rate curve to estimate the fair values of interest-rate related derivatives as a result of market participants moving to the OIS curve for collateralized interest rate swaps. This change may result in increased earnings volatility since the hedged items are still valued using the LIBOR rate curve.

We strive to keep our operating expense ratios relatively low while maintaining adequate systems, support, and staffing. Operating expenses are expected to increase in 2013 due to further operating systems enhancement, risk management and compliance-related expenses.





Analysis of Results of Operations for the Years Ended December 31, 2012, 2011 and 2010

Net Interest Income After Provision for Credit Losses. Net Interest Income, which is primarily the interest earned on Advances, short-term investments, investment securities and Mortgage Loans Held for Portfolio less the interest expense on Consolidated Obligations and Interest-Bearing Deposits, is our primary source of earnings. 

Factors that increased Net Interest Income After Provision for Credit Losses for the year ended December 31, 2012, compared to the same period in 2011, included:
 
wider spreads on Advances, primarily due to lower funding costs;
lower average balances of Consolidated Obligations; and
higher average balances of Advances and AFS securities.

These increases were partially offset by:
 
lower average balances of short-term investments, Mortgage Loans Held for Portfolio and HTM securities;
narrower spreads on Mortgage Loans Held for Portfolio, AFS securities and HTM securities; and
an increase in the Provision for Credit Losses on Mortgage Loans Held for Portfolio.

Factors that decreased Net Interest Income After Provision for Credit Losses for the year ended December 31, 2011, compared to the same period in 2010, included:
 
narrower spreads on Investment securities, Federal Funds Sold and Securities Purchased Under Agreements to Resell;
lower prepayment fee income on Advances; and
lower average balances of Federal Funds Sold and Securities Purchased Under Agreements to Resell, Advances and Mortgage Loans Held for Portfolio.

These decreases were partially offset by:

higher average balances of Investment securities;
lower average balances of Consolidated Obligations; and
wider spreads on Advances and Mortgage Loans Held for Portfolio, due to the replacement of higher-costing debt with lower-costing debt.

See Net Gains (Losses) on Derivatives and Hedging Activities herein for information on the net effect of derivatives on our Net Interest Income.





The following tables present average balances, interest income and expense, and average yields of our major categories of interest-earning assets and the sources funding those interest-earning assets ($ amounts in millions): 
 
Years Ended December 31,
 
2012
 
2011
 
2010
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield (5)
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield (5)
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield (5)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Federal Funds Sold and Securities Purchased Under Agreements to Resell
$
4,059

 
$
6

 
0.16
%
 
$
5,710

 
$
7

 
0.13
%
 
$
8,198

 
$
17

 
0.21
%
Investment securities (1)
11,584

 
203

 
1.75
%
 
11,828

 
227

 
1.92
%
 
10,815

 
259

 
2.39
%
Advances (2)
18,644

 
175

 
0.94
%
 
18,069

 
169

 
0.93
%
 
20,432

 
214

 
1.05
%
Mortgage Loans Held for Portfolio (2)
5,867

 
258

 
4.40
%
 
6,304

 
300

 
4.75
%
 
6,821

 
349

 
5.11
%
Other Assets (interest-earning) (3)
741

 
3

 
0.33
%
 
343

 

 
0.11
%
 
149

 
1

 
0.89
%
Total interest-earning assets
40,895

 
645

 
1.58
%
 
42,254

 
703

 
1.66
%
 
46,415

 
840

 
1.81
%
Other Assets (4)
293

 
 
 
 
 
313

 
 
 
 
 
(13
)
 
 
 
 
Total Assets
$
41,188

 
 
 
 
 
$
42,567

 
 
 
 
 
$
46,402

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Capital:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-Bearing Deposits
$
922

 
$

 
0.01
%
 
$
1,032

 
$

 
0.02
%
 
$
735

 
$

 
0.04
%
Discount Notes
7,670

 
8

 
0.10
%
 
7,980

 
8

 
0.10
%
 
9,296

 
15

 
0.16
%
CO Bonds (2)
28,837

 
380

 
1.32
%
 
29,917

 
449

 
1.50
%
 
32,263

 
544

 
1.68
%
MRCS
452

 
15

 
3.33
%
 
556

 
15

 
2.60
%
 
758

 
14

 
1.81
%
Other borrowings

 

 
%
 

 

 
%
 

 

 
%
Total interest-bearing liabilities
37,881

 
403

 
1.06
%
 
39,485

 
472

 
1.19
%
 
43,052

 
573

 
1.33
%
Other Liabilities
1,228

 
 
 
 
 
1,126

 
 
 
 
 
1,539

 
 
 
 
Total Capital
2,079

 
 
 
 
 
1,956

 
 
 
 
 
1,811

 
 
 
 
Total Liabilities and Capital
$
41,188

 
 
 
 
 
$
42,567

 
 
 
 
 
$
46,402

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Interest Income
 
 
$
242

 
 
 
 
 
$
231

 
 
 
 
 
$
267