10-K 1 ind10-k123114.htm 10-K IND 10-K 12/31/14


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, 2014
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, 2014, the aggregate par value of the stock held by members and former members of the registrant was approximately $1.683 billion. At February 28, 2015, 15,753,060 shares of stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: None.



Table of Contents
 
Page
 
 
Number
ITEM 1.
BUSINESS
4 
 
Operating Segments
5 
 
Funding Sources
 
Community Investment and Affordable Housing Programs
 
Use of Derivatives
 
Supervision and Regulation
 
Membership Trends
 
Competition
 
Employees
 
Available Information
ITEM 1A.
RISK FACTORS
ITEM 2.
PROPERTIES
ITEM 3.
LEGAL PROCEEDINGS
ITEM 4.
MINE SAFETY DISCLOSURES
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6.
SELECTED FINANCIAL DATA
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Special Note Regarding Forward-Looking Statements
 
Executive Summary
 
Results of Operations and Changes in Financial Condition
 
Operating Segments
 
Analysis of Financial Condition
 
Liquidity and Capital Resources
 
Off-Balance Sheet Arrangements
 
Contractual Obligations
 
Critical Accounting Policies and Estimates
 
Recent Accounting and Regulatory Developments
 
Risk Management
 ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 ITEM 9A.
CONTROLS AND PROCEDURES
 ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 ITEM 11.
EXECUTIVE COMPENSATION
 ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
 ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
 ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 



Special Note Regarding Forward-Looking Statements

Statements contained in this Form 10-K, including statements describing the 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; 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, dollar amounts of less than one million may not be reflected or, due to rounding, may not appear to agree to the amounts presented in thousands in the Financial Statements and related 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 regional wholesale bank that provides loans, grants, and business services to member financial institutions. We are one of 12 such FHLBanks established in 1932. FHLBanks are privately capitalized and funded, and receive no Congressional appropriations. The FHLBanks, along with the Office of Finance, comprise the FHLBank System.

Our mission is to help families afford housing by working with our member financial institutions to meet our members' funding needs for residential mortgage loans and other types of loans to support the economic growth and job creation of their communities. Our programs provide funding to assist members with liquidity and asset/liability management, interest rate risk management, profitability enhancement, and mortgage pipelines. 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 are eligible to become members of our Bank if they are chartered in or have a principal place of business located in our district states of Indiana or Michigan. 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 are generally limited to making advances to members; however, by regulation, we are also permitted to make advances to Housing Associates, but they may not purchase our stock and have no voting rights.
 
Each FHLBank 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 law to register a class of their equity securities under the Exchange Act);
the requirement that at least 40% of our directors be non-member "independent" directors; that two of these "independent" directors must have more than four years of experience in representing consumer or community interests in banking services, credit needs, housing, or consumer financial protections; and that the remaining "independent" directors must have demonstrated knowledge or experience in auditing or accounting, derivatives, financial management, organizational management, project development or risk management practices, or other expertise established by Finance Agency regulations;
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 United States government does not guarantee, directly or indirectly, our consolidated obligations, which are the joint and several obligations of all FHLBanks.




On July 30, 2008, the United States Congress enacted HERA primarily to address the housing finance crisis, expand the FHA's financing authority and address GSE reform issues, among other matters. A significant provision of HERA created a new federal agency, the Federal Housing Finance Agency, that became the new federal regulator of the FHLBanks, Fannie Mae and Freddie Mac effective on HERA's enactment date. Our former regulator, the Federal Housing Finance Board, was abolished, and Finance Board regulations, policies, and directives were transferred to the Finance Agency. 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.

Operating Segments

We manage our operations by grouping products and services within two operating segments. These segments reflect our two primary mission asset activities and the manner in which they are managed from the perspective of development, resource allocation, product delivery, pricing, credit risk and operational administration. The segments identify the principal ways we provide services to member shareholders.

These operating segments are (i) traditional, which includes credit products (including advances, letters of credit, and lines of credit), investments (including federal funds sold, securities purchased under agreement to resell, AFS securities, and HTM securities), and correspondent services and deposits; and (ii) mortgage loans, which consist of mortgage loans purchased from our members through our MPP and participation interests purchased from the FHLBank of Topeka in mortgage loans originated by its 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, 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 (authorized by the GLB Act amendment to the Bank Act).

Our primary credit product is advances. We offer a wide array of fixed-rate and adjustable-rate advances and interest is generally due monthly. 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;
a competitively priced alternative source of funds, especially with respect to smaller members with less diverse funding sources; and
low-cost funding to help support affordable housing and economic development initiatives.

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. Letters 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 fund request.




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 may be subject to prepayment fees. These advances can include a feature that allows for delayed settlement.
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 any member 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.

Advances Concentration. Credit risk can be magnified if a lender's portfolio is concentrated in a few borrowers. At December 31, 2014, our top five borrowers accounted for 40% 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, 2014
 
Advances Outstanding
 
% of Total
Lincoln National Life Insurance Company
 
$
2,175

 
11
%
Jackson National Life Insurance Company
 
2,123

 
10
%
Tuebor Captive Insurance Company LLC
 
1,611

 
8
%
IAS Services LLC
 
1,250

 
6
%
Blue Cross Blue Shield of Michigan
 
1,171

 
5
%
Subtotal
 
8,330

 
40
%
Others
 
12,300

 
60
%
Total advances, par value
 
$
20,630

 
100
%
 
 
 
 
 
December 31, 2013
 
Advances Outstanding
 
% of Total
Lincoln National Life Insurance Company
 
$
2,100

 
12
%
Jackson National Life Insurance Company
 
1,978

 
11
%
Blue Cross Blue Shield of Michigan
 
1,172

 
7
%
Tuebor Captive Insurance Company LLC
 
990

 
6
%
Flagstar Bank, FSB
 
988

 
6
%
Subtotal
 
7,228

 
42
%
Others
 
9,904

 
58
%
Total advances, par value
 
$
17,132

 
100
%

As of December 31, 2014, 63 of our 395 members each had total assets in excess of $1 billion, and together they comprised approximately 91% of the total member asset base, i.e., the total cumulative assets of our member institutions.

For the year ended December 31, 2014, we did not have gross interest income on advances, excluding the effects of interest-rate exchange agreements, that exceeded 10% of our total interest income from any one customer. For the years ended December 31, 2013 and 2012, we had advances outstanding to and gross interest income from Flagstar Bank, FSB as follows ($ amounts in millions):
 
 
As of and for the Years Ended December 31,
 
 
2013
 
2012
Advances, at par
 
$
988

 
$
3,180

% of total advances, outstanding
 
6
%
 
18
%
 
 
 
 
 
Gross interest income
 
$
95

 
$
107

% of total interest income
 
17
%
 
17
%

See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Analysis of Financial Condition - Total Assets - Advances.



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 preempted 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 financing statements, taking possession or control of such collateral, or by 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, the type of institution and our review of 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, such as commercial MBS, commercial real estate loans and home equity loans, and small business loans or farm real estate loans from CFIs, which were defined for 2015 as FDIC-insured depository institutions with average total assets not exceeding $1.123 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.

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 those policies do not qualify as acceptable collateral and are required to be removed from any collateral value calculation. With respect to the new home mortgage lending rules adopted by the CFPB for residential loans originated on or after January 10, 2014, we accept loans that comply with or are exempt from the ability-to-pay requirements as collateral.

In order to help mitigate the market, credit, liquidity, operational and business risk associated with collateral, we apply an over-collateralization requirement to the book value or market value of pledged collateral to establish its lending value. Collateral that we have determined to contain a low level of risk, such as United States government obligations, is over-collateralized at a lower rate than collateral that carries a higher level of risk, such as small business loans. 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 over-collateralization ratios up to 300%.

The over-collateralization requirement applied to asset classes may also vary depending on collateral status, since lower requirements are applied as our levels of information and control over the assets increase. Over-collateralization requirements are applied using market values for collateral in listing and possession status and book value for collateral pledged through blanket status. In no event, however, would market values applied to whole loan collateral exceed par value. 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 our borrowers, which allows 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. Our short-term investment portfolio typically includes securities purchased under agreements to resell, which are secured by United States Treasuries and mature overnight, and federal funds sold, which can be overnight or term placements of our funds with unsecured counterparties. 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.

The longer term investment portfolio typically generates higher returns and may only include investments deemed investment quality at the time of purchase. They may consist of (i) securities issued by the United States government, its agencies, and certain GSEs, (ii) MBS and ABS issued by Fannie Mae, Freddie Mac and Ginnie Mae that derive credit enhancement from their relationship with the United States government, and (iii) other MBS, ABS, CMOs and REMICs rated AAA or equivalent by at least two NRSROs.

All unsecured investments, including those with our members or their affiliates, are subject to certain selection criteria. Each unsecured counterparty must be approved and 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 maximum 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 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; and
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 regulation 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 the outstanding balances of our 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 balances were within the capital limitation. Generally, our goal is to maintain these investments near the 300% limit. Although these investments, as a percentage of total regulatory capital, were 302% at December 31, 2014, this percentage has decreased below 300% in 2015; therefore, we are currently permitted to purchase additional investments in MBS or ABS.




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.

To support deposits, the Bank Act requires us to have at all times a liquidity deposit reserve in an amount equal to the current deposits received from our members 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. The following table presents our excess liquidity deposit reserves ($ amounts in millions):
 
 
December 31, 2014
 
December 31, 2013
Liquidity deposit reserves
 
$
22,656

 
$
20,669

Less: total deposits
 
1,084

 
1,066

Excess liquidity deposit reserves
 
$
21,572

 
$
19,603


Mortgage Loans. Mortgage loans consist of residential mortgage loans purchased from our members through our MPP and, beginning in 2012, participation interests purchased from the FHLBank of Topeka in residential mortgage loans that were originated by its members under the MPF Program. These programs help fulfill the FHLBank System's housing mission and provide 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. For additional information, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Analysis of Financial Condition - Mortgage Loans Held for Portfolio.

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 or Housing Associate of the FHLBank System, and we may not use a trust or other entity to purchase the loans. 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.

Our mortgage loan purchases are governed by the AMA regulation adopted by the Finance Board in 2000, as amended. Further, while the regulation does not expressly limit us to purchasing fixed-rate loans, before purchasing adjustable-rate loans we would need to analyze whether such purchases would require Finance Agency approval under its new business activity regulation. The new business activity regulation provides that any material change to an FHLBank's business activity that results in new risks or operations needs to be approved by the Finance Agency.

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

Mortgage Standards. All loans we purchase must meet the 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 conventional 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. All loans purchased through our MPP with applications dated on or after January 10, 2014 must qualify as "Safe-Harbor Qualified Mortgages" under CFPB rules.




Under our guidelines, 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 the current outstanding balance (as determined at the last reported month end balance) of MPP loans previously purchased from any one PFI to 50% of the MPP portfolio.

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 any one PFI contributed interest income that exceeded 10% of our total interest income for the years ended December 31, 2014, 2013, or 2012. See Item 1A. Risk Factors - Loss of Significant Borrowers, PFIs or Acceptable Loan Servicers 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 minimum credit rating is determined by using an NRSRO credit risk model.

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 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 established in an amount sufficient to cover expected losses in excess of the borrower's equity and PMI, if any, and used to pay losses for a particular pool of loans.

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 used for all acquisitions of conventional mortgage loans under MPP Advantage.

Original MPP. 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. The LRA for each pool of loans is funded monthly at an annual rate ranging from 7 to 10 bps, depending on the terms of the MCC, 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 PFI(s) that sold us the loans in that pool, generally subject to a minimum 5-year lock-out period and 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.




MPP Advantage. The LRA for MPP Advantage differs from our original MPP in that the funding of the fixed LRA occurs at the time we acquire the loan 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 when purchased. There is no SMI credit enhancement for MPP Advantage. LRA funds not used to pay loan losses may be returned to the PFI subject to a release schedule detailed in each MCC based on the original LRA amount. No LRA funds are returned to the PFI 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. Our current SMI providers are MGIC and Genworth. 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 NRSRO 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 PFIs. PFIs 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 combination of small and mid-size PFIs' loans into one pool also assists in the evaluation of the amount of LRA needed for the overall credit enhancement.

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 typically receive a 0.25% fee on cash-out refinancing transactions, but the fee could vary 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. We do not pay a PFI any fees other than the servicing fee when the PFI retains the servicing rights.

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. As of December 31, 2014 based on the total UPB of MPP loans, 16% were serviced by CitiMortgage, 16% were serviced by JPMorgan Chase &Co., and 11% were serviced by Northpointe Bank, with the remaining 57% serviced by PFIs or other servicers with no one organization servicing over 10%.
Those PFIs that retain servicing rights receive a monthly servicing fee, must be approved by us and may be required to undergo a review 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 rights 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. In December 2014, Washington Mutual Mortgage Securities Corporation (our master servicer) provided notice of termination of our contract effective December 31, 2015 (unless a transition and termination acceptable to both parties is completed earlier). We are in the process of evaluating potential replacements.

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. Our MPP was designed to require loan servicers to foreclose and liquidate in the servicer's name rather than in our name. As the servicers progress through the liquidation process, we are paid in full for all unpaid principal and accrued interest on the loan through the normal remittance process.



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 us if LRA funds are available. 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, based on our contractual arrangement, we or 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 - Mortgage Loans Held for Portfolio - MPP for additional information.

Reactivation and Suspension 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 2012, we entered into an MPF Participation Agreement with the FHLBank of Topeka. In January 2014, the FHLBank of Topeka notified us that it would no longer offer us the option to participate in new MPF MCCs. All participation interests in MPF loans under the existing MPF MCCs were fulfilled in April 2014.

Housing Goals. The Finance Agency is required by its regulations to establish low-income housing goals for mortgage purchases. The low-income housing goals are only in effect for FHLBanks that acquire more than $2.5 billion of mortgages in any calendar year. To our knowledge, the Finance Agency has not yet established any low-income housing goals; we purchased $1.6 billion of mortgages in 2014.

Funding Sources

The primary source of funds for each of the FHLBanks is the sale of consolidated obligations, which consist of CO bonds and discount notes. The Finance Agency and the United States Secretary of the Treasury oversee the issuance of this debt in the capital markets. 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 without the approval of the Finance Agency.

While consolidated obligations are the joint and several obligations of all of the FHLBanks under Section 11(a), 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 all 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 $847.2 billion at December 31, 2014, and $766.8 billion at December 31, 2013. The par amount of the consolidated obligations for which we are the primary obligor was $38.1 billion at December 31, 2014, and $34.1 billion at December 31, 2013.

We must maintain assets that are free from any lien or pledge in 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 trustee 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.

We were in compliance with this regulatory requirement throughout 2014 and 2013.




The following table presents a comparison of the aggregate amount of the qualifying assets to the total amount of outstanding consolidated obligations outstanding on our behalf ($ amounts in millions).
 
 
December 31, 2014
 
December 31, 2013
Aggregate qualifying assets
 
$
41,759

 
$
37,666

Less: total consolidated obligations outstanding
 
38,071

 
34,019

Aggregate qualifying assets in excess of consolidated obligations
 
$
3,688

 
$
3,647

 
 
 
 
 
Ratio of aggregate qualifying assets to consolidated obligations
 
1.10

 
1.11


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 may range from 6 months to 30 years, but the maturities are not subject to any statutory or regulatory limit. CO bonds can be fixed or adjustable rate and callable or non-callable. Those issued with adjustable-rate payment terms use a variety of indices for interest rate resets, including LIBOR, Federal funds, United States Treasury Bill, Constant Maturity Swap, Prime Rate, and others. CO bonds are issued and distributed through negotiated or competitively bid transactions with approved underwriters or selling group members.

Consolidated Obligation Discount Notes. We also issue discount notes to provide short-term funds for advances to members, liquidity, and 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 generally sold below their face values and are redeemed at par when they mature.

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 to the FHLBanks, 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.

Community Investment and Affordable Housing 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 incomes 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, are 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.
Accessibility Modifications Program, which provides funding for accessibility modifications and minor home rehabilitation for eligible senior homeowners or owner-occupied households with a person(s) with a permanent disability.
Disaster Relief Program, which may be activated at 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. In 2014, the disaster relief program was activated and approved by the board of directors to assist victims of the federally declared disaster that resulted from the August 11, 2014 flooding in three southeastern Michigan counties. The deadline to apply for assistance under this program is March 31, 2015.




In addition, 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 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. These advances have maturities ranging from 30 days to 20 years and are priced at our cost of funds plus reasonable administrative expenses. Advances made under our Community Investment Program comprised 3.3% and 3.5% of our total advances outstanding, at par, at December 31, 2014, and 2013, respectively.

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.

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 11 - 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.

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 Chair 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 outstanding 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 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. The GLB Act requires that each FHLBank maintain a capital structure comprised of Class A stock, Class B stock, or both. A member can redeem Class A stock upon six months' prior written notice to its FHLBank. A member can redeem Class B stock upon five years' prior written notice to its FHLBank. Class B stock has a higher weighting than Class A stock for purposes of calculating the minimum leverage requirement applicable to each FHLBank.

The GLB Act requires 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.

HERA Amendments to the Bank Act. HERA eliminated the Finance Agency's authority to appoint directors to our board. HERA also eliminated the Finance Agency's authority to cap director fees (subject to the Finance Agency's review of reasonableness of such compensation) but placed additional controls over executive compensation.

Dodd-Frank Act. 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, including more stringent capital and liquidity requirements; and (vii) created the CFPB. 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.

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 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 registration provisions of the Securities Act of 1933 as amended. We have been, and continue to be, subject to all relevant liability provisions of the Securities Act of 1933 as amended and the Exchange Act.



Federal and State Banking Laws. We are generally not subject to the state and federal banking laws affecting United States retail depository financial institutions. However, 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. In addition, we are required to establish an anti-money laundering program, under which we are required to report suspicious transactions to the Financial Crimes Enforcement Network pursuant to the Bank Secrecy Act and the USA Patriot Act.

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 purchased from the FHLBank of Topeka under the MPF Program, the FHLBank of Chicago (as the MPF Provider) issued the appropriate notice to the affected borrowers and 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 are not aware of any current Finance Agency actions with respect to other FHLBanks that will have a material adverse effect on our financial results.

Membership Trends

Our membership territory is comprised of the states of Indiana and Michigan. In 2014, we gained nine new members and lost eighteen members due to mergers and consolidations, for a net loss of nine members.

The following table presents the composition of our members by type of financial institution:
Type of Institution
 
December 31, 2014
 
% of Total
 
December 31, 2013
 
% of Total
Commercial banks
 
197

 
50
%
 
208

 
52
%
Thrifts
 
37

 
9
%
 
38

 
9
%
Credit unions
 
108

 
27
%
 
108

 
27
%
Insurance companies
 
51

 
13
%
 
49

 
12
%
CDFIs
 
2

 
1
%
 
1

 
%
Total member institutions
 
395

 
100
%
 
404

 
100
%

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. Other suppliers may include the United States government, deposit insurers, the Federal Reserve Banks, investment banks, 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 is 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 debt instruments. Increases in the supply of competing debt products, in the absence of increases in demand, typically 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, 2015, we had 211 full-time employees and 4 part-time employees. Employees are not represented by a collective bargaining unit.

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 2015 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 information. Except where expressly stated, information appearing on the SEC's website is not incorporated into this Annual Report on Form 10-K.

Anyone may also request a copy of any of our public financial reports, our Code of Conduct or our 2015 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 Bank.

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 CFPB, the Financial Stability Oversight Council ("FSOC"), the Comptroller General, the FASB or other federal or state regulatory bodies; and judicial decisions that modify the present regulatory environment. 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.

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. Changes to the regulatory environment that affect our debt underwriters, particularly revised capital and liquidity requirements, could also adversely affect our cost of issuing debt in the capital markets. Similarly, regulatory actions or public policy changes that give preference to certain sectors, business models, regulated entities, or activities could negatively impact us.

On September 12, 2014, the Finance Agency published a proposed rule regarding members of FHLBanks ("Proposed Membership Rule"). For information regarding the Proposed Membership Rule, 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.

If the Proposed Membership Rule is adopted in its current form, we currently expect that the impact on our financial condition and results of operations would be materially adverse, but it would not be immediate. Three of our captive insurance company members, which collectively held $2.9 billion or 14% of outstanding advances as of December 31, 2014, would have their membership terminated five years after issuance of a final rule. Other insurance company members, which collectively held in excess of $586 million or 3% of outstanding advances as of December 31, 2014, could also have their membership terminated after five years if the Finance Agency deems them not to be "insurance companies" under a final rule. In addition, during February 2015, we admitted three captive insurance companies as members of the Bank. Under the Proposed Membership Rule, those companies would have their membership and any outstanding advances terminated upon issuance of a final rule, which may also require our immediate redemption of those members' capital stock in our Bank.

Five members, one of which held outstanding advances as of December 31, 2014 totaling $9.5 million, would not qualify under the proposed ongoing asset tests as of June 30, 2014. If those members that would not comply with the new asset tests (and would not return to compliance within one year) have their membership in our Bank terminated, we expect that the immediate impact on our financial condition and results of operation would be immaterial. Over time, however, we expect that the imposition of ongoing asset tests on our members would adversely impact our results of operations and may adversely affect the value of membership in our Bank.We are continuing to evaluate whether other institutions may not qualify for membership under the proposed new asset tests or as a result of the proposed narrower regulatory definition of "insurance company."




The CFPB issued final rules with an effective date of January 10, 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 loan. 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 a 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 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.

In 2010, the United States Congress enacted the Dodd-Frank Act, which 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 federal regulators decide to implement this law through the issuance of regulations and their enforcement activities. For example, in 2014 the CFTC, along with other regulators, proposed a rule that would subject non-cleared swaps to a mandatory two-way margin requirement, among other things. Any additional margin and capital requirements could adversely affect the liquidity and pricing of our derivative transactions, making derivative trades more costly and less attractive as risk management tools. Under the Dodd-Frank Act and a final rule issued in 2012, if the FSOC were to decide that we are a non-bank financial company, then we would be subject to the supervision of the FRB, which would add a significant layer of regulation to our business.

Other provisions of the Dodd-Frank Act 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.

Regulatory changes affecting our members could negatively affect our business as well. For example, the federal banking regulators are undertaking rulemaking from the Basel Committee on Bank Supervision. The FDIC, OCC, and FRB have established new minimum capital standards for financial institutions to incorporate (and in some cases may further strengthen) the Basel III regulatory capital reforms. The new capital framework could require some of our members to divest assets in order to comply with the more stringent capital requirements, thereby tending to decrease their need for advances. The capital requirements may also adversely impact investor demand for consolidated obligations to the extent that impacted institutions divest or limit their investments in CO bonds or discount notes.

The FRB, OCC, and FDIC have jointly adopted a rule, effective January 1, 2015, that incorporates (and in some cases increases) Basel III liquidity requirements. The liquidity coverage ratio ("LCR") rule requires certain non-banking financial organizations ("Covered Organizations") to maintain sufficient amounts of high quality liquid assets ("HQLA") to withstand a 30-day run on the Covered Organization following severe economic stress, based on certain assumptions about outflow rates for HQLAs. If the Covered Organization qualifies as an "advanced approaches" banking organization, the HQLA requirements are also applied on a consolidated basis to each United States-based banking subsidiary of such Covered Organization that has more than $10 billion in assets.

In addition, HQLAs must be unencumbered, although they may be pledged as part of a blanket lien to a U.S. central bank or government-sponsored enterprise, as long as they do not currently support credit or access to payment services extended to the Covered Organization by such central bank or GSE. HQLAs are divided into three classes or levels. Level 1 assets can be used to meet the liquidity test without limit. Level 2A assets can be counted for liquidity purposes, but are subject to a 15% haircut. Level 2B assets are subject to a 50% haircut. FHLBank consolidated obligations are considered Level 2A liquidity assets, and so are subject to a 15% haircut and capped (with all other Level 2A and Level 2B assets) at 40% of the liquidity requirement. This haircut could make it more costly for any Covered Organization to hold consolidated obligations, which could reduce demand for them. Compliance with the LCR rule is subject to a phase-in period of up to two years. At this time, the effects of the LCR rule on demand for our advances is not expected to be significant.



The Finance Agency has continued its discussions with the FHLBanks to emphasize the importance of mission-related assets (consisting of advances and AMA). If any changes are required in our asset mix, we may have to reduce non mission-related activities, which we expect would adversely impact our level of investments and profitability.

Economic Conditions and Policy 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 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 FRB through its regulation of the supply of money and credit in the United States. The FRB's policies either directly or indirectly influence the yield on interest-earning assets, the cost of interest-bearing liabilities and the demand for our debt. 

On October 29, 2014, the FOMC announced that it decided to conclude its asset purchase program due to substantial improvement in the outlook for the labor market and sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. On January 28, 2015, the FOMC reaffirmed its view that the current 0.00% to 0.25% target range for the federal funds rate remains appropriate and that it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and of rolling over maturing United States Treasury securities at auction. Although these policies should help maintain accommodative financial conditions, the FRB's continuing substantial involvement in both short-term and MBS markets could adversely affect us through lower yields on our investments, higher costs of debt, or both.

Additionally, we are affected by the global economy through member ownership and investment patterns. The slow recovery from the European debt crisis and the resulting recessions in many European countries could have an adverse effect on our financial condition and results of operations. Changes in global investors' perceptions in the strength of the United States economy or the availability of more attractive investment opportunities elsewhere could lead to changes in investors' demand for our consolidated obligations. If global economic conditions deteriorate, our business could experience unfavorable consequences, including reductions in our mission assets and lower profitability.

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.

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

We rely heavily on our information systems and other technology to conduct and manage our business. Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. These computer systems, software and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses or other malicious code and other events that could potentially jeopardize the confidentiality of such information or otherwise cause interruptions or malfunctions in our operations. Although we devote significant resources to protecting our various systems and processes, there is no assurance that our security measures will provide fully effective security. If we experience a significant failure or interruption in certain information systems or a significant cybersecurity event, we may be unable to conduct and manage our business effectively.

In 2014, we completed the initial implementation of an enterprise-wide initiative to substantially replace our core banking system with purchased customizable external software. Future releases, which are expected to take several years, along with several other key initiatives simultaneously undertaken, could subject us to a higher risk of system failure or interruption while we are in the process of conversion. Any failure or interruption could adversely affect our advances and MPP business, member relations, risk management, and profitability, which could negatively affect our financial condition and results of operations.




Despite our policies, procedures, and controls, some operational risks are beyond our control, and the failure of other parties to adequately address their operational risks could adversely affect us. 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. Compromised security at those vendors and third parties could expose us to cyber attacks or other breaches. 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 funding 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 and results of operations.

We have purchased participation interests in MPF mortgage loans that the FHLBank of Topeka acquired from its 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 that are engaged in the operation of the MPF Program were to experience operational or technical difficulties.

The 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 inventory and support our debt. Severe financial and economic disruptions in the past, and the United States government's measures to mitigate their effects, have changed 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 our debt. Any significant disruption of the debt market could have a serious impact on our Bank and the FHLBank System.

A Loss of Significant Borrowers, PFIs or Acceptable Loan Servicers Could Adversely Impact Our Profitability, Our Ability to Achieve Business Objectives, and Our Risk Concentration
 
The loss of any large borrower could adversely impact our profitability and our ability to achieve business objectives. The loss of a large borrower could result from a variety of factors, including acquisition, consolidation of charters within a bank holding company, resolution of a financially distressed member, or regulatory changes. As of December 31, 2014, our top two borrowers, Lincoln National Life Insurance Company and Jackson National Life Insurance Company, held $2.2 billion and $2.1 billion, respectively, or a total of 21% of total advances outstanding, at par.

At December 31, 2014, 22% of our outstanding par value of MPP loans had been purchased from our top two PFIs. One of these two entities originated mortgages on properties in several states, but they are no longer our member because they no longer have their charter within our district. Although the other top PFI originates mortgages on properties in several states, we also purchase mortgage loans from many smaller PFIs that predominantly originate mortgage loans on properties in Indiana and Michigan. Therefore, our concentration of MPP loans on properties in Indiana and Michigan could increase over time.

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 federal banking regulation and Dodd-Frank Act capital requirements are causing mortgage servicing rights to be transitioned to non-depository institutions which may reduce the availability of buyers of mortgage servicing rights. In December 2014, Washington Mutual Mortgage Securities Corporation (our master servicer) provided notice of termination of our contract effective December 31, 2015 (unless a transition and termination acceptable to both parties is completed earlier). We are in the process of evaluating potential replacements.




Downgrades of Our Credit Rating, the Credit Rating of One or More of the Other FHLBanks, or the Credit Rating of the Consolidated Obligations 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

The FHLBanks consolidated obligations are rated Aaa/P-1 with a stable outlook by Moody's and AA+/A-1+ with a stable outlook by S&P. Rating agencies may from time to time change a rating or issue negative reports. Because all of the FHLBanks have joint and several liability for all FHLBank consolidated obligations, negative developments at any FHLBank may affect these credit ratings or result in the issuance of a negative report regardless of an individual FHLBank's financial condition and results of operations. In addition, because of the FHLBanks' GSE status, the credit ratings of the FHLBanks are generally influenced by the sovereign credit rating of the United States.

Based on the credit rating agencies' criteria, downgrades to the United States sovereign credit rating and outlook may occur. As a result, similar downgrades in the credit ratings and outlook on the FHLBanks and the FHLBanks' consolidated obligations may also occur even though they are not obligations of the United States.

Although previous negative rating actions have not impacted our funding costs, uncertainty remains regarding possible longer-term effects resulting from rating actions. Any future downgrades in our credit ratings and outlook, especially a downgrade to an S&P AA rating 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 transactions, and 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.

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

We are exposed to credit losses from member products, investment securities and unsecured counterparties.

Member Products.

Advances. 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 preempted 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, 2014 and 2013, advances to our insurance company members represented 61% of our total advances, at par.

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. If delinquencies in fixed-rate mortgages increase and residential property values decline, we could experience reduced yields or losses exceeding the protection provided by the LRA and SMI credit enhancement and CE obligations, if applicable, on mortgage loans purchased through our MPP or the participation interests in MPF loans acquired from the FHLBank of Topeka or another MPF FHLBank.




We are the beneficiary of third-party PMI and SMI (where applicable) 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, one of our PMI providers is paying 75% of the claim amounts and another one is paying 67% of the claim amounts. The remaining amounts are deferred until the funds are available or the PMI provider is liquidated. 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 or 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 higher losses on mortgage loans.

We are also exposed to credit losses 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 changes in Federal Reserve holdings of MBS, the effect of existing, new or proposed governmental actions (including mortgage loan modification programs), and ongoing private-label RMBS litigation. Future 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 OTTI charges or unrealized losses on private-label RMBS, which could adversely affect our financial condition and operating results.

We are also exposed to credit losses 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. 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 Interest Rates Could Have an Adverse Effect on Earnings

Our ability to prepare for changes in interest rates, or to hedge related exposures such as basis risk, significantly affects the success of our asset and liability management activities and our level of net interest income.

The effect of interest rate changes can be exacerbated by prepayment and extension risk, which is the risk that mortgage-based investments will be refinanced by the borrower in low interest-rate environments or will remain outstanding longer than expected at below-market yields when interest rates increase. Decreases in interest rates typically cause mortgage prepayments to increase and may result in increased premium amortization expense and substandard performance in our mortgage portfolio as we experience a return of principal that we must re-invest in a lower rate environment. While these prepayments would reduce the asset balance, the associated debt may remain outstanding. Increases in interest rates typically cause mortgage prepayments to decrease or mortgage cash flows to slow, possibly resulting in the debt funding the portfolio to mature and the replacement debt to be issued at a higher cost, thus reducing our interest spread.

In prior years, adverse conditions in the housing and mortgage markets, along with a large drop in market interest rates, allowed us to exercise calls of our debt and reissue it at a lower cost, resulting in mortgage spreads that were wider than historic norms and, therefore, resulted in higher earnings. In addition, the outstanding balance of the investment securities that were purchased at higher spreads, as well as the earnings from those investments, have been decreasing. Going forward, these trends are expected to continue to have an adverse effect on our earnings.




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 interest rates could negatively impact our earnings.

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

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 is 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 a smaller 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 and discount notes. 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.

A Failure of the Business and Financial Models and Related Processes Used to Evaluate Various Financial Risks and Derive Certain Estimates in Our Financial Statements Could Produce Unreliable Projections or Valuations, which Could Adversely Affect Our Business, Financial Condition, Results of Operations and Risk Management

We are exposed to operational risk, in part due to the significant use of sophisticated business and financial models when evaluating various financial risks and deriving certain estimates in our financial statements. Our business could be adversely affected if those models fail to produce reliable projections or valuations. These models, which rely on various inputs including, but not limited to, loan volumes and pricing, market conditions for our consolidated obligations, interest rate spreads and prepayment speeds, implied volatility of options contracts, and cash flows on mortgage-related assets, require management to make critical judgments about the appropriate assumptions that are used in the determinations of such risks and estimates and may overstate or understate the value of certain financial instruments, future performance expectations, or 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 Operations - 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 5 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 terms, required those mortgage servicers to implement certain new servicing and foreclosure practices.




In 2013 and 2014, the OCC, along with the FRB, announced that it had reached an agreement in principle with multiple mortgage servicing companies, including those that currently service loans that we hold and continue to purchase, 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 involves case-by-case reviews, and replace it with a broader framework that is intended to significantly reduce the time it takes eligible borrowers to receive compensation from servicers for deficient servicing practices and foreclosure processing. Although many of these servicers have exited the supervision periods imposed on them as a result of consent orders entered into as part of this process, they continue to provide necessary pre-foreclosure notices to delinquent borrowers as a continuing obligation under such consent orders.

As of January 10, 2014, the CFPB made effective a new servicing standard policy that provides the required framework to servicers and codifies several previously-existing industry practices, including formal acknowledgment of loss mitigation requests made by borrowers and temporary suspension of pending foreclosures for borrowers actively pursuing loss mitigation, subject to certain restrictions relating to the borrower’s diligence in seeking mitigation. See Item 1. Business - Operating Segments - Mortgage Loans - Mortgage Purchase Program - Servicing for more information on our servicers.

Although servicers have generally ended their suspension of foreclosures, the processing of foreclosures continues to be slow in certain states due to ongoing 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. In addition, inadequate court budgets in certain states could further delay the processing of foreclosures. While the number of states still experiencing extended delays in foreclosure processing has decreased significantly from prior periods, as of the end of 2014, the foregoing factors continue to have a noticeable effect on the scheduling and enforcement of court-ordered foreclosure sales.

A significant or prolonged delay of mortgage foreclosure proceedings may have adverse effects on our mortgage investments' revenue and expenses and the market value of the underlying collateral, 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 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 depend 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, the Finance Agency could initiate restrictions consistent with those associated with failure of a minimum capital requirement.

The Dodd-Frank Act requires certain financial companies with total consolidated assets of more than $10 billion and that are regulated by a primary federal financial regulatory agency to conduct annual stress tests to determine whether the companies have the capital necessary to absorb losses under adverse economic conditions. In September 2013, the Finance Agency implemented annual stress testing for the FHLBanks. We must report the results of our stress tests to the Finance Agency and the FRB on or before April 30 of each year, and we must publicly disclose a summary of stress test results for the "severely adverse" scenario not earlier than July 15 and not later than July 30 of each year.

Stress testing has evolved as an important analytical tool for evaluating capital adequacy under adverse economic conditions. We regularly use such stress tests, including those annual stress tests required by the Dodd-Frank Act, in our capital planning to measure our exposure to material risks and evaluate the adequacy of capital resources available to absorb potential losses arising from those risks. We consider the stress test results when making changes to our capital structure and assessing our exposures, concentrations, and risk positions.




The severity of the hypothetical scenarios devised by the Finance Agency and the FRB and employed in these stress tests is undefined by law or regulation, and is thus subject to the regulators' discretion. While we believe that both the quality and magnitude of our capital base is sufficient to support our current operations given our risk profile, the results of the stress testing process may affect our approach to managing and deploying capital. The stress testing and capital planning processes may, among other things, require us to increase our capital levels, modify our business strategies, or decrease our exposure to various asset classes.

The stability of our capital is also important in maintaining the value of membership in our Bank. Failure to pay dividends or repurchase stock at par, or a call upon our members to purchase additional stock to restore capital, could make it more difficult for us to attract new members or retain existing members.

Providing Financial Support to Other FHLBanks Could Negatively Impact the Bank's Liquidity, Earnings and Capital and 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. If another FHLBank were to default on its obligation to pay principal and 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 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 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. Such assistance could negatively affect our financial condition, our results of operation and the value of membership in our Bank.

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 - Operational 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

In the ordinary course of business, we may from time to time become a party to lawsuits involving various business matters. We are unaware of any lawsuits presently pending which, individually or in the aggregate, could have a material effect on our financial condition or results of operations.

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 residential mortgage-backed securities ("RMBS") we purchased in the aggregate original principal amount of approximately $2.9 billion. The complaint, which was amended, was an action for rescission and damages and asserted claims for negligent misrepresentation and violations of state and federal securities law occurring in connection with the sale of these private-label RMBS to us. During 2013 and 2014, we executed confidential settlement agreements with certain defendants in this litigation, pursuant to which we have dismissed pending claims against, and provided legal releases to, certain entities with respect to applicable securities at issue in the litigation, in consideration of our receipt of cash payments from or on behalf of those defendants. Following such settlements, our remaining claim consists of allegations of negligent misrepresentation and violations of state securities law against one defendant with respect to one private-label RMBS with an original principal amount of $82.0 million.





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 capital 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, as amended, and Federal Housing Finance Agency ("Finance Agency") regulations. Our Class B stock may be redeemed, at a 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 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 in accordance with our capital plan.
 
None of our capital stock is registered under the Securities Act of 1933 since our shares of capital stock are "exempt securities" under the Act, and therefore 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, 2015, we had 405 shareholders and $1.6 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 capital 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. Under these regulations, stock dividends cannot be paid if our excess stock is greater than 1% of our total assets. 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 capital stock: Class B-1 and Class B-2. Class B-1 is stock held by our members that is not subject to a redemption request, while 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 (applicable quarter). For more information, see Notes to Financial Statements - Note 15 - Capital and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Capital Resources.

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 statement 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 Paid
 
Dividend on Capital Stock
 
Interest Expense on MRCS
 
Total
 
Annualized Dividend Rate (1)
 
Dividend on Capital Stock
 
Interest Expense on MRCS
 
Total
 
Annualized Dividend Rate (1)
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 1
 
$
17,003

 
$
10

 
$
17,013

 
4.00
%
 
$
2

 
$
124

 
$
126

 
3.20
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 4
 
$
16,190

 
$
10

 
$
16,200

 
3.75
%
 
$
28

 
$
118

 
$
146

 
3.00
%
Quarter 3
 
15,411

 
6

 
15,417

 
3.75
%
 
30

 
121

 
151

 
3.00
%
Quarter 2
 
14,891

 
4

 
14,895

 
3.75
%
 
26

 
121

 
147

 
3.00
%
Quarter 1 (2)
 
8,045

 
425

 
8,470

 
2.00
%
 
15

 
68

 
83

 
1.60
%
Quarter 1 
 
14,079

 
745

 
14,824

 
3.50
%
 
27

 
118

 
145

 
2.80
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 4
 
$
14,776

 
$
2,101

 
$
16,877

 
3.50
%
 
$
27

 
$
123

 
$
150

 
2.80
%
Quarter 3
 
14,315

 
1,889

 
16,204

 
3.50
%
 
26

 
165

 
191

 
2.80
%
Quarter 2
 
14,212

 
2,220

 
16,432

 
3.50
%
 
16

 
188

 
204

 
2.80
%
Quarter 1
 
14,305

 
3,720

 
18,025

 
3.50
%
 
19

 
196

 
215

 
2.80
%

(1) 
Reflects the annualized dividend 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.
(2) 
As a result of our unusually high earnings for the fourth quarter of 2013, our board of directors also declared a supplemental cash dividend of 2.00% (annualized) on our capital stock putable-Class B-1 and 1.60% (annualized) on our capital stock putable-Class B-2. These dividends were paid on February 21, 2014.
     





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 years indicated ($ amounts in millions). Our change to the contractual method for amortizing premiums and accreting discounts on our mortgage loans has been reported through retroactive application of the change in accounting principle to all periods presented.
 
 
As of and for the Years Ended December 31,
 
 
2014
 
2013
 
2012
 
2011
 
2010
Statement of Condition:
 
 
 
 
 
 
 
 
 
 
Advances
 
$
20,789

 
$
17,337

 
$
18,130

 
$
18,568

 
$
18,275

Investments (1)
 
10,539

 
10,780

 
16,845

 
15,203

 
19,785

Mortgage loans held for portfolio, net
 
6,820

 
6,168

 
5,994

 
5,950

 
6,695

Total assets
 
41,853

 
37,764

 
41,220

 
40,370

 
44,923

Discount notes
 
12,568

 
7,435

 
8,924

 
6,536

 
8,925

CO bonds
 
25,503

 
26,584

 
27,408

 
30,358

 
31,875

Total consolidated obligations
 
38,071

 
34,019

 
36,332

 
36,894

 
40,800

MRCS
 
16

 
17

 
451

 
454

 
658

Capital stock, Class B putable
 
1,551

 
1,610

 
1,634

 
1,563

 
1,610

Retained earnings (2)
 
777

 
730

 
584

 
493

 
420

AOCI
 
47

 
22

 
(10
)
 
(114
)
 
(90
)
Total capital
 
2,375

 
2,362

 
2,208

 
1,942

 
1,940

 
 
 
 
 
 
 
 
 
 
 
Statement of Income:
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
184

 
$
223

 
$
239

 
$
233

 
$
260

Provision for (reversal of) credit losses
 
(1
)
 
(4
)
 
8

 
5

 
1

Net OTTI credit losses
 

 
(2
)
 
(4
)
 
(27
)
 
(70
)
Other income (loss), excluding net OTTI credit losses
 
13

 
71

 
(9
)
 
(6
)
 
11

Other expenses
 
68

 
68

 
60

 
58

 
55

Total assessments (9)
 
13

 
25

 
18

 
25

 
41

Net income
 
$
117

 
$
203

 
$
140

 
$
112

 
$
104

 
 
 
 
 
 
 
 
 
 
 
Selected Financial Ratios:
 
 
 
 
 
 
 
 

 
 

Return on average equity (3)
 
4.72
%
 
8.82
%
 
6.77
%
 
5.76
%
 
5.77
%
Return on average assets
 
0.30
%
 
0.51
%
 
0.34
%
 
0.26
%
 
0.22
%
Dividend payout ratio (4)
 
58.96
%
 
28.37
%
 
35.15
%
 
35.56
%
 
31.11
%
Net interest margin (5)
 
0.47
%
 
0.56
%
 
0.58
%
 
0.55
%
 
0.56
%
Total capital ratio (6)
 
5.68
%
 
6.25
%
 
5.36
%
 
4.83
%
 
4.32
%
Total regulatory capital ratio (7)
 
5.60
%
 
6.24
%
 
6.48
%
 
6.22
%
 
5.99
%
Average equity to average assets
 
6.29
%
 
5.75
%
 
5.04
%
 
4.59
%
 
3.89
%
Weighted average dividend rate (8)
 
4.18
%
 
3.50
%
 
3.13
%
 
2.50
%
 
1.87
%

(1) 
Consists of interest-bearing deposits, securities purchased under agreements to resell, federal funds sold, AFS securities, and HTM securities.
(2) 
Includes restricted and unrestricted retained earnings.
(3) 
Net income expressed as a percentage of average total capital.
(4) 
Dividends paid in cash during the year divided by net income for the year. The ratio for the year ended December 31, 2014 includes a supplemental dividend of 2.0% related to 2013 results.
(5) 
Net interest income expressed as a percentage of average interest-earning assets.
(6) 
Capital stock plus retained earnings and AOCI expressed as a percentage of total assets.
(7) 
Capital stock plus retained earnings and MRCS expressed as a percentage of total assets.
(8) 
Dividends paid in cash during the year divided by the average amount of Class B capital stock eligible for dividends (i.e., excludes MRCS).
(9) 
Resolution Funding Corporation assessments included through June 30, 2011.



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

Presentation 

This discussion and analysis by management of the Bank's financial condition and results of operations should be read in conjunction with the Financial Statements and related Notes to Financial Statements contained in this Form 10-K.

As used in this Item 7, 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 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 and, due to rounding, may not appear to agree to the amounts presented in thousands in the Financial Statements and related 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.

Our change to the contractual method for amortizing premiums and accreting discounts on our mortgage loans has been reported through retroactive application of the change in accounting principle to all periods presented. See Notes to Financial Statements - Note 2 - Changes in Accounting Principles and Recently Adopted and Issued Accounting Guidance for related disclosures.

Special Note Regarding Forward-Looking Statements
 
Statements in this Form 10-K, including statements describing our objectives, projections, estimates or future predictions, may be considered to 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 FRB 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 resulting from:
changes in our members' deposit flows and credit demands;
regulatory developments impacting suitability or eligibility of membership classes;
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 or improper or inadequate mortgage originations and mortgage servicing;
ability to introduce and successfully manage new 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 (or certain classes of members), prospective members, counterparties, one or more of the FHLBanks and/or investors in the consolidated obligations of the FHLBanks;
ability to raise capital market funding at acceptable terms;
changes in our credit ratings or the credit ratings of the other FHLBanks and the FHLBank System;
changes in the level of government guarantees provided to other United States and international financial institutions;
competition from other entities borrowing funds in the capital markets;
dealer commitment to supporting the issuance of our consolidated obligations;




ability of one or more of the FHLBanks to repay its participation in the consolidated obligations, or otherwise meet its financial obligations;
ability to attract and retain skilled personnel;
ability to develop, implement and support technology and information systems sufficient to manage our business effectively;
nonperformance of counterparties to bilateral and cleared derivative transactions;
changes in terms of derivative agreements and similar agreements;
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, additional disclosures may be made 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 secured loans in the form of advances; purchases whole mortgage loans 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 reasonable, risk-adjusted return on their capital investment. See Item 1. Business - Background Information for more information.
 
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 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, mortgage loans, and long- and short-term investments.
 
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.

We group our products and services within two operating 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 consist of (i) mortgage loans purchased from our members through our MPP and (ii) participation interests purchased from the FHLBank of Topeka in mortgage loans originated by its members under the MPF Program.

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 World Economic Outlook published in October 2014 by the International Monetary Fund revised its global economy growth forecast downward, based on lower-than-expected activity during the first half of 2014. The International Monetary Fund projects 3.8% growth for 2015 to be distributed unevenly among all nations. Risks cited in support of this projection include geopolitical tensions and slow potential growth in advanced economies.





Moody's November 10, 2014 Global Macro Outlook projects continued slow growth for the G20 economies in aggregate during 2015 and 2016. The projected GDP growth of 3% is slightly better than the 2.8% growth expected for 2014. Moody’s cites a slowing of growth in China and structural problems stifling certain European countries as impediments to higher growth rates. It also lists the United States, United Kingdom, and India as candidates for stronger growth during the next two years. On February 3, 2015, Standard and Poor’s reported taking various adverse rating actions on holding companies of certain banking groups in Europe based on the view that the prospect for ongoing extraordinary government support benefiting senior creditors has become less likely.

The United States economy continued to grow following the economic downturn. The Bureau of Economic Analysis issued its "second" estimate of the gross domestic product annual growth rate for the fourth quarter of 2014 of 2.2%, which is down from the 5.0% growth rate during the third quarter of 2014. For the year 2014, real gross domestic product rose 2.4% after rising 2.2% in 2013. Increases in consumer spending, business investment and exports contributed to the increase, offset by increased imports and decreased federal government spending. The ongoing economic recovery remains challenged due to uncertainty about the United States' fiscal situation and a lackluster housing market, as lack of real wage growth and tight credit standards deter potential homebuyers from taking advantage of low interest rates. However, Freddie Mac’s January U.S. Economic and Housing Market Outlook provides an optimistic view of the housing market, particularly in early 2015. It cites an improving national employment picture and downward trending mortgage rates as keys to a better market. The Finance Agency and FHA have adjusted their guidelines to encourage homeownership.

On January 28, 2015, the FOMC reported that economic activity has expanded at a solid rate and cites improvements in the job market as a source for this growth. Additionally, household spending is increasing along with purchasing power, spurred by lower energy prices. However, recovery in the housing market continues at a slow pace. The FOMC anticipates a moderate rate of economic expansion going forward, provided policy remains appropriately accommodative.

The FOMC maintained the target range of the federal funds rate at 0.00-0.25% throughout 2014, leading to short-term interest rates remaining anchored for 2014. In January 2015, the FOMC indicated that it will continue to maintain the target range for the federal funds rate at 0.00-0.25%, as it continues to anticipate that a highly accommodative stance of monetary policy will remain appropriate until progress toward attaining its longer-run goals of maximum employment and 2% inflation occurs. The FOMC will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the FOMC decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals. The FOMC continues to anticipate, based on its assessment of these factors, that it may be appropriate to maintain the target fed funds rate below levels considered normal for the long run beyond the time that the unemployment rate objective is attained. Although not possible to predict, we believe that the continued abnormally low rates in the near-term could cause more interest rate volatility in the future than would normally be anticipated.

The Bureau of Labor Statistics reported that Michigan's preliminary unemployment rate was 6.3% for December 2014, while Indiana's preliminary rate was 5.8%, compared to the national rate of 5.6%. According to information provided by Black Knight Data and Analytics for December, Indiana had a non-current mortgage rate (loans past due 30 days or more) of 9.1%, and Michigan had a non-current mortgage rate of 6.4%, compared to the national rate of 5.6%.

In its December 2014 forecast, the Center for Econometric Model Research at Indiana University predicts an improvement in Indiana employment and personal income growth in 2015 through 2017 after experiencing sluggish employment and personal income growth for 2014. The November 2014 forecast published by the Research Seminar in Quantitative Economics at the University of Michigan predicts continued solid job growth in Michigan through 2016.

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 the issuance of debt, which is affected by events in the capital markets. 

During 2014, the United States Treasury rate curve generally flattened with long-term rates declining and short-term rates gradually increasing. Debt issuance was stable as investor demand for FHLBank consolidated obligations remained elevated.

Although the FOMC decided to conclude its asset purchase program, it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and of rolling over maturing United States Treasury securities at auction. This policy, by keeping the FOMC's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.





Impact on Operating Results. Economic conditions significantly impact 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 and other funding sources, such as retail deposits, as a source of liquidity. Longer-term advances may be used to support residential mortgage loan portfolios by offsetting a portion of the interest rate risk associated with fixed-rate mortgage lending. Periods of economic growth have led our depository members to significantly use wholesale funds because they often fund expansion with wholesale borrowings. 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 for other business purposes.

The steepness of the yield curve, as well as the availability and cost of other sources of wholesale or government funding, influence member demand for advances and the level of sales of mortgage loans under the MPP. Advances to insurance company members, an increasing part of our membership, increased during 2014. Likewise, advances to depository members increased in response to demand driven by various economic factors such as loan growth. The UPB of our MPP loans increased in 2014 as purchases of new MPP Advantage mortgage loans exceeded repayments of outstanding MPP mortgage loans.

The level of market interest rates influences the yield on our earning assets, our cost of funds, and mortgage prepayment speeds. Changes in short-term interest rates particularly 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. 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 operating expenses and valuation of investment securities and derivatives. 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
 
Results of Operations for the Years Ended December 31, 2014 and 2013. The following table presents the comparative highlights of our results of operations ($ amounts in millions):
 
 
Years Ended December 31,
 
 
 
 
Comparative Highlights
 
2014
 
2013
 
$ Change
 
% Change
Net interest income
 
$
184

 
$
223

 
$
(39
)
 
(17
%)
Provision for (reversal of) credit losses
 
(1
)
 
(4
)
 
3

 
71
%
Net interest income after provision for credit losses
 
185

 
227

 
(42
)
 
(18
%)
Other income
 
13

 
69

 
(56
)
 
(82
%)
Other expenses
 
68

 
68

 

 
%
Income before assessments
 
130

 
228

 
(98
)
 
(43
%)
AHP assessments
 
13

 
25

 
(12
)
 
(48
%)
Net income
 
117

 
203

 
(86
)
 
(43
%)
Total OCI
 
25

 
32

 
(7
)
 
(22
%)
Total comprehensive income
 
$
142

 
$
235

 
$
(93
)
 
(40
%)

The decrease in net income for the year ended December 31, 2014 compared to 2013 was primarily due to a decrease in net interest income, resulting from narrower net interest spreads and lower prepayment fees on advances, and a decrease in other income resulting from lower net proceeds from litigation settlements related to certain of our private label RMBS, unrealized gains in 2013 related to our derivative and hedging activities, and realized gains in 2013 from the sale of private-label RMBS.

The decrease in total other comprehensive income for the year ended December 31, 2014 compared to 2013 was primarily due to lower increases in the fair value of our OTTI AFS securities and the accelerated amortization of pension benefits in 2013 combined with an increase in the SERP liability at December 31, 2014, offset by increases in unrealized gains on AFS securities during 2014.





Results of Operations for the Years Ended December 31, 2013 and 2012. The following table presents the comparative highlights of our results of operations ($ amounts in millions):
 
 
Years Ended December 31,
 
 
 
 
Comparative Highlights
 
2013
 
2012
 
$ Change
 
% Change
Net interest income
 
$
223

 
$
239

 
$
(16
)
 
(7
%)
Provision for (reversal of) credit losses
 
(4
)
 
8

 
(12
)
 
(151
%)
Net interest income after provision for credit losses
 
227

 
231

 
(4
)
 
(2
%)
Other income
 
69

 
(13
)
 
82

 
631
%
Other expenses
 
68

 
60

 
8

 
14
%
Income before assessments
 
228

 
158

 
70

 
45
%
AHP assessments
 
25

 
18

 
7

 
42
%
Net income
 
203

 
140

 
63

 
45
%
Total OCI
 
32

 
104

 
(72
)
 
(69
%)
Total comprehensive income
 
$
235

 
$
244

 
$
(9
)
 
(4
%)

The increase in net income for the year ended December 31, 2013 compared to 2012 was primarily due to higher other income that mainly resulted from litigation settlements related to certain of our private-label RMBS, unrealized gains on derivatives and hedging activities and net realized gains on the sale of private-label RMBS.

The decrease in total other comprehensive income for the year ended December 31, 2013 compared to 2012 was primarily due to lower increases in the fair value of our OTTI AFS securities.

Changes in Financial Condition for the Year Ended December 31, 2014. The following table presents the changes in financial condition ($ amounts in millions):
Condensed Statements of Condition
 
December 31, 2014
 
December 31, 2013
 
$ Change
 
% Change
Advances
 
$
20,789

 
$
17,337

 
$
3,452

 
20
%
Mortgage loans held for portfolio, net
 
6,820

 
6,168

 
652

 
11
%
Investments (1)
 
10,539

 
10,780

 
(241
)
 
(2
%)
Other assets (2)
 
3,705

 
3,479

 
226

 
6
%
Total assets
 
$
41,853

 
$
37,764

 
$
4,089

 
11
%
 
 
 
 
 
 
 
 
 
Consolidated obligations
 
$
38,071

 
$
34,019

 
$
4,052

 
12
%
MRCS
 
16

 
17

 
(1
)
 
(7
%)
Other liabilities
 
1,391

 
1,366

 
25

 
2
%
Total liabilities
 
39,478

 
35,402

 
4,076

 
12
%
Capital stock, Class B putable
 
1,551

 
1,610

 
(59
)
 
(4
%)
Retained earnings
 
777

 
730

 
47

 
7
%
AOCI
 
47

 
22

 
25

 
115
%
Total capital
 
2,375

 
2,362

 
13

 
1
%
Total liabilities and capital
 
$
41,853

 
$
37,764

 
$
4,089

 
11
%
 
 
 
 
 
 
 
 
 
Total regulatory capital (3)
 
$
2,344

 
$
2,357

 
$
(13
)
 
(1
%)

(1) 
Includes HTM securities, AFS securities, interest-bearing deposits, securities purchased under agreements to resell, and federal funds sold.
(2) 
Includes cash and due from banks of $3,551 million and $3,319 million at December 31, 2014 and 2013, respectively.
(3) 
Total capital less AOCI plus MRCS.

The increase in total assets at December 31, 2014 compared to December 31, 2013 was primarily due to an increase in advances resulting from our members' higher funding needs.

The increase in total liabilities was substantially due to an increase in consolidated obligations attributable to our higher funding needs.

The increase in total capital consisted largely of a net increase in retained earnings as well as a favorable change in AOCI, partially offset by a net decrease in capital stock resulting from redemptions of excess stock.





Outlook. Although there was a marked decrease in earnings for 2014 due to unusually high levels of other income in 2013 that are not expected to recur, we currently believe that our financial performance for the near term will show more consistency and continue to generate reasonable, risk-adjusted 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 for us to generate spreads well above historical levels on certain types of transactions. The frequency and level of higher-spread investment opportunities diminished during the last few years, despite low costs for our consolidated obligations. Going forward, we expect the spreads on our assets to continue to revert to historical levels.

For the past several years, high deposit balances and low loan demand at our depository members, competitive pressures from alternative sources of wholesale funds available to our membership, industry capital allocations, and consolidation in the financial services industry have affected our advances. As economic conditions continued to slowly improve during 2014, advances to both our insurance company and depository members increased. Although we believe that advances outstanding to our member institutions, particularly insurance companies, could continue to increase, we do not expect a significant change in our total balance of advances during 2015.

Mortgage loans held for portfolio increased over 10% during 2014 as some PFIs increased their activity level and other members began selling mortgages to us under our MPP Advantage. We expect our PFIs' future mortgage loan originations to follow the course of the industry. In general, several factors, including interest rates, competition, the general level of housing activity in the United States, the level of refinancing activity and consumer product preferences affect the volume of mortgage loans purchased. In addition, the small number of large PFIs in our district and the uncertainty surrounding the potential imposition of low-income housing goals by the Finance Agency if our annual purchase volume reaches $2.5 billion could limit future growth in the mortgage loans held for portfolio balance and earnings.

Our investment portfolio declined slightly during 2014 as our private-label RMBS portfolio continued to run off and there were limited opportunities to invest in MBS and ABS because the total book value of these investments exceeded the 300% regulatory capital stock limitation on new purchases due to the excess stock redemptions. We do not expect a significant change in the overall level of our investment portfolio during 2015.

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 on mortgage assets could also cause volatility in our earnings.

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. Although derivatives are used to mitigate market risk, derivatives introduce the potential for short-term earnings volatility. On December 31, 2012, as a result of market participants moving to the OIS curve for collateralized interest rate swaps, we began using the OIS curve in place of the LIBOR rate curve to estimate the fair values of collateralized interest-rate related derivatives. This change has resulted in increased earnings volatility since the hedged items are still valued using the LIBOR rate curve, and we are still using LIBOR-based derivatives. As a result, we expect the increased earnings volatility to continue.

We expect operating expenses to increase in 2015 due to initiatives to enhance our member service capabilities, operating systems and risk management, as well as higher compliance-related expenses.





On September 25, 2014, the FHLBank of Des Moines and the FHLBank of Seattle announced that they had entered into a definitive agreement to merge their two FHLBanks. The Finance Agency granted approval, subject to certain conditions, on December 22, 2014, and the members of the FHLBanks of Des Moines and Seattle ratified the merger on February 27, 2015. The two FHLBanks expect the merger to close in mid-2015. We expect a small increase in other expenses due to the merger, as a result of higher cost allocations from the Office of Finance and the Finance Agency, but we do not expect the merger to have a material impact on our financial position or results of operations.

We will determine future dividends based on net income earned each quarter, our capital policy, the JCE Agreement and regulatory and capital management considerations. The benefit a cooperative enterprise enjoys is having an integrated customer/shareholder base; however, there are certain tensions inherent in our circumstances that are unusual and unique to the FHLBanks. Because only member institutions (and certain former members) can own shares of our capital stock and, by statute and regulation, stock can be issued and repurchased only at par, there is no opportunity for stock price appreciation and no open market for our stock. As a result, return on equity can be received only in the form of dividends. Because membership is entirely voluntary, it is possible for an institution to withdraw its membership from our Bank. However, because redemption of stock can occur only at par, the inability of individual members to capture directly a share of our retained earnings only further supports our desire to maintain a higher dividend payout ratio. Generally, the board has discretion to declare or not declare dividends and to determine the rate of any dividend declared.

Analysis of Results of Operations for the Years Ended December 31, 2014, 2013 and 2012.

Net Interest Income. Net interest income, which is primarily the interest income on advances, mortgage loans held for portfolio, short-term investments, and investment securities less the interest expense on consolidated obligations and interest-bearing deposits, is our primary source of earnings. 
 




The following tables present average balances (calculated daily), 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,
 
2014
 
2013
 
2012
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Federal funds sold and securities purchased under agreements to resell
$
3,090

 
$
2

 
0.07
%
 
$
3,603

 
$
3

 
0.09
%
 
$
4,059

 
$
6

 
0.16
%
Investment securities (1)
10,543

 
154

 
1.46
%
 
11,041

 
170

 
1.54
%
 
11,584

 
203

 
1.75
%
Advances (2)
18,693

 
107

 
0.58
%
 
18,557

 
146

 
0.78
%
 
18,644

 
175

 
0.94
%
Mortgage loans held for
portfolio (2)
6,333

 
231

 
3.65
%
 
6,130

 
231

 
3.78
%
 
5,862

 
255

 
4.36
%
Other assets (interest-earning) (3) 
271

 
1

 
0.26
%
 
513

 
2

 
0.41
%
 
741

 
3

 
0.33
%
Total interest-earning assets
38,930

 
495

 
1.27
%
 
39,844

 
552

 
1.39
%
 
40,890

 
642

 
1.57
%
Other assets (4)
299

 
 
 
 
 
246

 
 
 
 
 
293

 
 
 
 
Total assets
$
39,229

 
 
 
 
 
$
40,090

 
 
 
 
 
$
41,183

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Capital:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
765

 
$

 
0.01
%
 
$
880

 
$

 
0.01
%
 
$
922

 
$

 
0.01
%
Discount notes
8,513

 
7

 
0.08
%
 
8,041

 
8

 
0.10
%
 
7,670

 
8

 
0.10
%
CO bonds (2)
26,456

 
303

 
1.15
%
 
27,083

 
314

 
1.16
%
 
28,837

 
380

 
1.32
%
MRCS (5)
17

 
1

 
6.01
%
 
219

 
7

 
3.45
%
 
452

 
15

 
3.33
%
Other borrowings

 

 
%
 
1

 

 
0.08
%
 

 

 
%
Total interest-bearing liabilities
35,751

 
311

 
0.87
%
 
36,224

 
329

 
0.91
%
 
37,881

 
403

 
1.06
%
Other liabilities
1,009

 
 
 
 
 
1,559

 
 
 
 
 
1,228

 
 
 
 
Total capital
2,469

 
 
 
 
 
2,307

 
 
 
 
 
2,074

 
 
 
 
Total liabilities and capital
$
39,229

 
 
 
 
 
$
40,090

 
 
 
 
 
$
41,183

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
184

 
 
 
 
 
$
223

 
 
 
 
 
$
239

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net spread on interest-earning assets less interest-bearing liabilities
 
 
 
 
0.40
%
 
 
 
 
 
0.48
%
 
 
 
 
 
0.51
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin (6)
 
 
 
 
0.47
%
 
 
 
 
 
0.56
%
 
 
 
 
 
0.58
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average interest-earning assets to interest-bearing liabilities
1.09

 
 
 
 
 
1.10

 
 
 
 
 
1.08

 
 
 
 

(1) 
Consists of AFS securities and HTM securities. The average balances of investment securities are reflected at amortized cost; therefore, the resulting yields do not reflect changes in the estimated fair value of AFS securities that are reflected as a component of OCI, nor do they include the effect of OTTI-related non-credit losses. Interest income/expense includes the effect of associated derivative transactions.
(2) 
Interest income/expense and average yield include all other components of interest, including the impact of net interest payments or receipts on derivatives in qualifying hedge relationships, amortization of hedge accounting adjustments, and prepayment fees on advances.
(3) 
Consists of interest-bearing deposits, loans to other FHLBanks (if applicable), and grantor trust assets that are carried at estimated fair value. The amounts include the rights or obligations to cash collateral, which are included in the estimated fair value of derivative assets or derivative liabilities.
(4) 
Includes changes in the estimated fair value of AFS securities and the effect of OTTI-related non-credit losses on AFS and HTM securities.
(5) 
Includes impact of fourth quarter 2013 supplemental dividend paid in February 2014.
(6) 
Net interest income expressed as a percentage of the average balance of interest-earning assets. 





Changes in both volume and interest rates determine changes in net interest income and net interest margin. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but are attributable to both volume and rate changes, have been allocated to the volume and rate categories based upon the proportion of the volume and rate changes. The following table presents changes in interest income and interest expense by volume and rate ($ amounts in millions):
 
 
Years Ended December 31,
 
 
2014 vs. 2013
 
2013 vs. 2012
Components
 
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
Increase (decrease) in interest income:
 
 

 
 

 
 

 
 
 
 
 
 
Federal funds sold and securities purchased under agreements to resell
 
$

 
$
(1
)
 
$
(1
)
 
$
(1
)
 
$
(2
)
 
$
(3
)
Investment securities
 
(8
)
 
(8
)
 
(16
)
 
(4
)
 
(29
)
 
(33
)
Advances
 

 
(39
)
 
(39
)
 
(1
)
 
(28
)
 
(29
)
Mortgage loans held for portfolio
 
8

 
(8
)
 

 
11

 
(35
)
 
(24
)
Other assets (interest earning)
 
(1
)
 

 
(1
)
 
(1)

 

 
(1
)
Total
 
(1
)
 
(56
)
 
(57
)
 
4

 
(94
)
 
(90
)
Increase (decrease) in interest expense:
 
 

 
 

 
 

 
 
 
 
 
 
Interest-bearing deposits
 

 

 

 

 

 

Discount notes
 

 
(1
)
 
(1
)
 

 

 

CO bonds
 
(7
)
 
(4
)
 
(11
)
 
(22
)
 
(44
)
 
(66
)
MRCS
 
(9
)
 
3

 
(6
)
 
(8
)
 

 
(8
)
Total
 
(16
)
 
(2
)
 
(18
)
 
(30
)
 
(44
)
 
(74
)
Increase (decrease) in net interest income
 
$
15

 
$
(54
)
 
$
(39
)
 
$
34

 
$
(50
)
 
$
(16
)
 
Yields. The lower yield on interest-earning assets was the primary factor driving lower net interest income for the year ended December 31, 2014 compared to 2013. The yield on total interest-earning assets for the year ended December 31, 2014 was 1.27%, a decrease of 12 bps compared to 2013, resulting from lower yields on advances, mortgage loans, and investments, as well as lower prepayment fees on advances. These lower yields were partially offset by a lower cost of funds for consolidated obligations. The yield on total interest-bearing liabilities was 0.87%, a decrease of 4 bps from the prior year. The net effect of the lower yields on interest-earning assets was a reduction in the net interest spread to 0.40% for the year ended December 31, 2014 from 0.48% for the year ended December 31, 2013.

The lower yield on interest-earning assets also drove the decrease in net interest income for the year ended December 31, 2013, compared to 2012. The yield on total interest-earning assets was 1.39%, a decrease of 18 bps for the year ended December 31, 2013, resulting from lower yields on mortgage loans, investments and advances. The cost of funds for total interest-bearing liabilities was 0.91%, a decrease of 15 bps, primarily attributable to the cumulative effect of redemptions and refinancing of higher-cost consolidated obligations in prior periods. The net effect of the lower yields on interest-earning assets was a decrease in the net interest spread to 0.48% for the year ended December 31, 2013 from 0.51% for the year ended December 31, 2012.

Average Balances. Lower average balances of total interest-bearing liabilities, resulting from a slight change in the funding mix from CO bonds to discount notes as well as repurchases and redemptions of MRCS, were a significant factor offsetting lower yields on interest-earning assets for the year ended December 31, 2014 compared to 2013, as well as the year ended December 31, 2013 compared to 2012.





Prepayment Fees. When a borrower prepays an advance, future income will be lower if the principal portion of the prepaid advance is reinvested in lower-yielding assets that continue to be funded by higher-costing debt. At December 31, 2014 and 2013, we had $5.6 billion or 27% of advances outstanding, at par, and $4.1 billion or 24% of advances outstanding, at par, respectively, that can be prepaid without incurring prepayment or termination fees. All other advances may only be prepaid by paying a fee that is sufficient to make us financially indifferent to the prepayment of the advance. The following table presents advance prepayment fees and the associated swap termination fees recognized in interest income at the time of the prepayments ($ amounts in millions):
 
 
Years Ended December 31,
Recognized prepayment/termination fees
 
2014
 
2013
 
2012
Prepayment fees on advances
 
$
3

 
$
113

 
$
12

Associated swap termination fees
 
(1
)
 
(91
)
 
(6
)
Prepayment fees on advances, net
 
$
2

 
$
22

 
$
6


The following table presents deferred advance prepayment fees and deferred swap termination fees associated with those advance prepayments ($ amounts in millions):
 
 
Years Ended December 31,
Deferred prepayment/termination fees
 
2014
 
2013
 
2012
Deferred prepayment fees on advances - adjustment to interest coupon on modified advance
 
$
24