10-K 1 ind12311810-k.htm 10-K Document


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, 2018
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 offices)
 
(Zip code)
Registrant's 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:
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405) 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 (§ 229.405) 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 this Form 10-K or any amendment to this Form 10-K.   x  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a 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
 
 
o Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
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 Class B 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, 2018, the aggregate par value of the Class B stock held by members and former members of the registrant was approximately $2.1 billion. At February 28, 2019, 21,265,312 shares of Class B stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: None.



Table of Contents
 
Page
 
 
Number
 
Glossary of Terms
 
Special Note Regarding Forward-Looking Statements
ITEM 1.
BUSINESS
 
Operating Segments
7 
 
Funding Sources
 
Affordable Housing Programs, Community Investment and Small Business Grants
 
Use of Derivatives
 
Supervision and Regulation
 
Membership
 
Competition
 
Employees
 
Available Information
ITEM 1A.
RISK FACTORS
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None
ITEM 2.
PROPERTIES
ITEM 3.
LEGAL PROCEEDINGS
ITEM 4.
MINE SAFETY DISCLOSURES
N/A
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
 
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
None
 ITEM 9A.
CONTROLS AND PROCEDURES
 ITEM 9B.
OTHER INFORMATION
None
 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, FINANCIAL STATEMENT SCHEDULES
 ITEM 16.
FORM 10-K SUMMARY
None
 





GLOSSARY OF TERMS

ABS: Asset-Backed Securities
Advance: Secured loan to members, former members or Housing Associates
AFS: Available-for-Sale
Agency: GSE and Ginnie Mae
AHP: Affordable Housing Program
AMA: Acquired Member Assets
AOCI: Accumulated Other Comprehensive Income (Loss)
Bank Act: Federal Home Loan Bank Act of 1932, as amended
bps: basis points
CDFI: Community Development Financial Institution
CE: Credit Enhancement
CFI: Community Financial Institution, an FDIC-insured depository institution with average total assets below an annually-adjusted limit established by the Director based on the Consumer Price Index
CFPB: Bureau of Consumer Financial Protection
CFTC: United States Commodity Futures Trading Commission
Clearinghouse: A United States Commodity Futures Trading Commission-registered derivatives clearing organization
CME: CME Clearing
CMO: Collateralized Mortgage Obligation
CO bond: Consolidated Obligation bond
DB Plan: Pentegra Defined Benefit Pension Plan for Financial Institutions, as amended
DC Plan: Pentegra Defined Contribution Retirement Savings Plan for Financial Institutions, as amended
DDCP: Directors' Deferred Compensation Plan
Director: Director of the Federal Housing Finance Agency
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act, as amended
Exchange Act: Securities Exchange Act of 1934, as amended
Fannie Mae: Federal National Mortgage Association
FASB: Financial Accounting Standards Board
FDIC: Federal Deposit Insurance Corporation
FHA: Federal Housing Administration
FHLBank: A Federal Home Loan Bank
FHLBanks: The 11 Federal Home Loan Banks or a subset thereof
FHLBank System: The 11 Federal Home Loan Banks and the Office of Finance
FICO®: Fair Isaac Corporation, the creators of the FICO credit score
Final Membership Rule: Final Rule on FHLBank Membership issued by the Federal Housing Finance Agency effective February 19, 2016
Finance Agency: Federal Housing Finance Agency, successor to Finance Board
Finance Board: Federal Housing Finance Board, predecessor to Finance Agency
FLA: First Loss Account
FOMC: Federal Open Market Committee
Form 8-K: Current Report on Form 8-K as filed with the SEC under the Exchange Act
Form 10-K: Annual Report on Form 10-K as filed with the SEC under the Exchange Act
Form 10-Q: Quarterly Report on Form 10-Q as filed with the SEC under the Exchange Act
FRB: Federal Reserve Board
Freddie Mac: Federal Home Loan Mortgage Corporation
GAAP: Generally Accepted Accounting Principles in the United States of America
Ginnie Mae: Government National Mortgage Association
GLB Act: Gramm-Leach-Bliley Act of 1999, as amended
GSE: United States Government-Sponsored Enterprise
HERA: Housing and Economic Recovery Act of 2008, as amended
Housing Associate: Approved lender under Title II of the National Housing Act of 1934 that is either a government agency or is chartered under federal or state law with rights and powers similar to those of a corporation
HTM: Held-to-Maturity
HUD: United States Department of Housing and Urban Development
JCE Agreement: Joint Capital Enhancement Agreement, as amended, among the 11 FHLBanks
LCH: LCH.Clearnet LLC
LIBOR: London Interbank Offered Rate
LRA: Lender Risk Account



LTV: Loan-to-Value
MAP-21: Moving Ahead for Progress in the 21st Century Act, enacted on July 6, 2012
MBS: Mortgage-Backed Securities
MCC: Master Commitment Contract
MDC: Mandatory Delivery Commitment
Moody's: Moody's Investor Services
MPF: Mortgage Partnership Finance®
MPP: Mortgage Purchase Program, including Original and Advantage unless indicated otherwise
MRCS: Mandatorily Redeemable Capital Stock
MVE: Market Value of Equity
NRSRO: Nationally Recognized Statistical Rating Organization
OCC: Office of the Comptroller of the Currency
OCI: Other Comprehensive Income (Loss)
OIS: Overnight-Indexed Swap
ORERC: Other Real Estate-Related Collateral
OTTI: Other-Than-Temporary Impairment or -Temporarily Impaired (as the context indicates)
PFI: Participating Financial Institution
PMI: Primary Mortgage Insurance
REMIC: Real Estate Mortgage Investment Conduit
REO: Real Estate Owned
RMBS: Residential Mortgage-Backed Securities
S&P: Standard & Poor's Rating Service
Safety and Soundness Act: Federal Housing Enterprises Financial Safety and Soundness Act of 1992, as amended
SEC: Securities and Exchange Commission
Securities Act: Securities Act of 1933, as amended
SERP: Federal Home Loan Bank of Indianapolis 2005 Supplemental Executive Retirement Plan and/or a similar frozen plan
SETP: Federal Home Loan Bank of Indianapolis 2016 Supplemental Executive Thrift Plan, as amended
SMI: Supplemental Mortgage Insurance
SOFR: Secured Overnight Financing Rate
TBA: To Be Announced, a forward contract for the purchase or sale of MBS at a future agreed-upon date for an established price
TDR: Troubled Debt Restructuring
TVA: Tennessee Valley Authority
UPB: Unpaid Principal Balance
VaR: Value at Risk
VIE: Variable Interest Entity
WAIR: Weighted-Average Interest Rate





Special Note Regarding Forward-Looking Statements
 
Statements in this Form 10-K, including statements describing our objectives, projections, estimates or 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, or collateral we hold as security for the obligations of our members and counterparties;
changes in demand for our advances and purchases of mortgage loans resulting from:
changes in our members' deposit flows and credit demands;
federal or state 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 and particularly our district states of Michigan and Indiana, 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 federal government shutdowns, administrative, 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, GSE's generally, one or more of the FHLBanks and/or investors in the consolidated obligations of the FHLBanks;
ability to access the capital markets and raise capital market funding on 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;
dealer commitment to supporting the issuance of our consolidated obligations;
ability of one or more of the FHLBanks to repay its portion of 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 uncleared 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;
changes in or differing interpretations of accounting guidance; and
other risk factors identified in our filings with the SEC. 

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. This Form 10-K, including Business, Risk Factors 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 are included in Item 8.



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 acronyms and terms throughout this Item that are defined herein or in the Glossary of Terms.

Unless otherwise stated, amounts disclosed in this Item 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, calculations 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 serves its member financial institutions in Michigan and Indiana. We are one of 11 regional FHLBanks across the United States, which, along with the Office of Finance, compose the FHLBank System established in 1932. Each FHLBank is a federal instrumentality of the United States of America that is privately capitalized and funded, receives no Congressional appropriations and operates as an independent entity with its own board of directors, management, and employees.

Our mission is to provide reliable and readily available liquidity to our member institutions in support of housing finance and community investment. Our advance and mortgage purchase programs provide funding to assist members with asset/liability management, interest-rate risk management, mortgage pipelines, and other liquidity needs. 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.

We are wholly owned by our member institutions. All federally-insured depository institutions (including commercial banks, savings associations and credit unions), CDFIs certified by the CDFI Fund of the United States Treasury, certain non-federally insured credit unions and non-captive insurance companies are eligible to become members of our Bank if they have a principal place of business, or are domiciled, in our district states of Michigan or Indiana. Applicants for membership must meet certain requirements that demonstrate that they are engaged in residential housing finance. All member institutions are required to purchase a minimum amount 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. Our capital stock is not publicly-traded; it is purchased by members from us and redeemed or repurchased by us at the stated par value. With written approval from us, a member may transfer any of its excess capital stock in our Bank to another member at par value.

As a financial cooperative, our members are also our primary customers. We are generally limited to making advances to and purchasing mortgage loans from members; however, by regulation, we are also permitted to make advances to and purchase loans from Housing Associates, but they may not purchase our stock and have no voting rights. We do not lend directly to, or purchase mortgage loans directly from, the general public.
 
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.




Each FHLBank was organized under the authority of the Bank Act as a GSE, i.e., an entity that combines elements of private capital, public sponsorship, and public policy. The public sponsorship and public policy attributes of the FHLBanks include:

an exemption from federal, state, and local taxation, except employment and real estate taxes;
an exemption from registration under the Securities Act (although 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 have more than four years of experience representing consumer or community interests in banking services, credit needs, housing, or consumer financial protections; and that the remaining "independent" directors 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 $4.0 billion of FHLBank consolidated obligations; and
the required allocation of 10% of annual net earnings before interest expense on MRCS to fund the AHP.

As an FHLBank, we seek to maintain a balance between our public policy mission and our goal of providing adequate returns on our members' capital.

The Finance Agency is the federal regulator of the FHLBanks, Fannie Mae and Freddie Mac. The Finance Agency's stated mission is to ensure that the housing GSEs operate in a safe and sound manner so that they serve as a reliable source of liquidity and funding for housing finance and community investment. 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. The segments identify the principal ways we provide services to our members. 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.

These operating segments are (i) traditional, which consists of credit products, investments, and correspondent services and deposits; and (ii) mortgage loans, which consist substantially of mortgage loans purchased from our members through our MPP. The revenues, profit or loss, and total assets for each segment are disclosed in Notes to Financial Statements - Note 16 - 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.

Our primary credit product is advances. Members utilize advances for a wide variety of purposes including, but not limited to:

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 real estate loans and, especially with respect to CFIs, funding for small business, small farm, and small agri-business portfolio loans;
acquiring or holding MBS;
short-term liquidity;
asset/liability and interest-rate risk management;
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, typically 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 public deposits.

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

Advances. We offer a wide array of fixed-rate and adjustable-rate advances, on which 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. 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, annually, or based on a specified amortization schedule and may have 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. 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 extending 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. The following tables present the par value of advances outstanding to our largest borrowers ($ amounts in millions).
December 31, 2018
 
Advances Outstanding
 
% of Total
The Lincoln National Life Insurance Company
 
$
3,930

 
12
%
Flagstar Bank, FSB
 
3,143

 
10
%
Chemical Bank
 
2,445

 
7
%
Jackson National Life Insurance Company
 
2,016

 
6
%
American United Life Insurance Company
 
1,675

 
5
%
Subtotal - largest borrowers
 
13,209

 
40
%
Next five largest borrowers
 
6,854

 
21
%
Others
 
12,766

 
39
%
Total advances, par value
 
$
32,829

 
100
%
 
 
 
 
 
December 31, 2017
 
Advances Outstanding
 
% of Total
Flagstar Bank, FSB
 
$
5,665

 
17
%
The Lincoln National Life Insurance Company
 
2,900

 
8
%
Jackson National Life Insurance Company
 
2,621

 
8
%
Chemical Bank
 
2,337

 
7
%
American United Life Insurance Company
 
1,671

 
5
%
Subtotal - largest borrowers
 
15,194

 
45
%
Next five largest borrowers
 
6,802

 
19
%
Others
 
12,173

 
36
%
Total advances, par value
 
$
34,169

 
100
%

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 borrowers.

At our discretion, and provided the borrower meets our contractual requirements, advances to borrowers that are no longer members may remain outstanding until maturity, subject to certain regulatory requirements.

For the years ended December 31, 2018, 2017, and 2016, we did not have gross interest income on advances, excluding the effects of interest-rate swaps, from any one borrower that exceeded 10% of our total interest income.

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 status 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, our security interests in collateral posted by insurance company members have express statutory protections in the jurisdictions where our members are domiciled. In addition, we monitor applicable states' laws, and take all necessary action to obtain and maintain a prior perfected security interest in the collateral, including by taking possession or control of the collateral when appropriate.

    



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 lien position on assets owned by the member (i.e., blanket, specific, or partially subordinated). 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, municipal securities, commercial real estate loans and home equity loans, and small business loans or farm real estate loans from CFIs. 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. In addition, under the Bank Act, we have a lien on the borrower's stock in our Bank as security for all of the borrower's indebtedness.

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. Consistent with the CFPB home mortgage lending rules, 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 140% - 155% for residential mortgages pledged through blanket status. Over-collateralization requirements for eligible securities range from 103% to 190%; less traditional types of collateral have standard over-collateralization ratios up to 360%.

The over-collateralization requirement applied to asset classes may also vary depending on collateral status, because 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 assigned to whole loan collateral exceed par value. For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Advances and Other Credit Products.    
    
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 supplement our earnings. Higher earnings bolster our ability to support affordable housing and community investment. Our investment portfolio may only include investments deemed investment quality at the time of purchase.

Our short-term investment portfolio is placed with highly-rated entities, and 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 or Agency MBS passthroughs, unsecured federal funds sold and interest-bearing demand deposit accounts. Each may be purchased with either overnight or term maturities, or in the case of demand deposit accounts, redeemed at any time during business hours. 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 consists of (i) securities issued by the United States government, its agencies, and certain GSEs, and (ii) Agency MBS and ABS.




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. For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Investments.

Under Finance Agency 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.

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.

Mortgage Loans. Mortgage loans consist of residential mortgage loans purchased from our members through our MPP and participating interests purchased in 2012-2014 from the FHLBank of Topeka in residential mortgage loans that were originated by certain of 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.




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 Finance Agency's AMA regulation. 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. Such regulation provides that any material change to an FHLBank's business activity that results in new risks or operations needs to be pre-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 by us as at least investment grade, and we operate our credit enhancement model and methodology accordingly to estimate the amount of necessary credit enhancement for those pools.

As a result of the credit enhancements, the PFI shares the credit risk with us on conventional mortgage loans. We manage the interest-rate risk, prepayment option risk, and liquidity risk.

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 terms of our Anti-Predatory Lending Policy or our Subprime and Nontraditional Residential Mortgage Policy. Furthermore, we require our members to warrant to us that all of the loans pledged or sold to us are in compliance with all applicable laws, including prohibitions on anti-predatory lending. All loans purchased through our MPP 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. During 2018, our top-selling PFI sold us mortgage loans totaling $730 million, or 33% of the total mortgage loans purchased by the Bank in 2018. Our five top-selling PFIs sold us 61%. Because of this concentration, we regularly analyze the implications to our financial management and profitability if we were to lose the business of one or more of these sellers.

At December 31, 2018, 26% of the par value of MPP loans outstanding had been purchased from one PFI. Based on a limit established by our board of directors, the outstanding balance (as determined at the last reported month end) of MPP loans previously purchased from any one PFI cannot exceed 50% of the total MPP portfolio balance.

For the years ended December 31, 2018, 2017, and 2016, no aggregate mortgage loans outstanding previously purchased from any one PFI contributed interest income that exceeded 10% of our total interest income.

The properties underlying the mortgage loans in our MPP portfolio are dispersed across 50 states, the District of Columbia and the Virgin Islands, with concentrations in Michigan and Indiana, the two states in our district.

The median original size of each mortgage loan outstanding was approximately $166 thousand at December 31, 2018




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. The model is used to evaluate each MCC or pool of MCCs to ensure the LRA percentage as credit enhancement is sufficient. The model evaluates the characteristics of the loans the PFIs actually delivered for the likelihood of timely payment of principal and interest. The model's results are based on numerous standard borrower and loan attributes, such as the LTV ratio, loan purpose (such as purchase of home, refinance, or cash-out refinance), type of documentation, income and debt expense ratios and credit scores. Based on the credit assessment, we are required to hold risk-based capital to help mitigate the potential credit risk in accordance with the Finance Agency regulations.

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. In November 2010, we began offering Advantage MPP for new conventional MPP loans, which utilizes an enhanced fixed LRA for additional credit enhancement, resulting in an implied credit rating of at least investment grade, 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 Advantage MPP, 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 on a pool basis.

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 Advantage MPP.

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 6 to 20 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 20 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 five-year lock-out period after the pool is closed to acquisitions.

Advantage MPP. The LRA for Advantage MPP differs from our original MPP in that the funding of the fixed LRA occurs at the time we acquire the loan and is based on the principal amount purchased. Depending on the terms of the MCC, the LRA funding amount varies between 110 bps and 120 bps of the principal amount. 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 five years after the pool is closed to acquisitions. We absorb any losses in excess of available LRA funds.
    
    



SMI. For pools of loans acquired under our original MPP, we have credit protection from loss on each loan, where eligible, through SMI, which provides insurance to cover credit losses to approximately 50% of the property's original value, depending on the SMI contract terms, and subject, in certain cases, to an aggregate stop-loss provision in the SMI policy. Some MCCs that equal or exceed $35 million of total initial principal to be sold on a "best-efforts" basis include an aggregate loss/benefit limit or "stop-loss" that is equal to the total initial principal balance of loans under the MCC multiplied by the stop-loss percentage (ranges from 200 - 400 bps), 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 releasable LRA funds available. We absorb any non-credit losses greater than the available LRA. We do not have SMI coverage on loans purchased under Advantage MPP.

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 with LTVs between 75% and 80%. Our current guidelines do not allow cash-out refinance loans above 80% LTV. 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.

Those PFIs that retain servicing rights receive a monthly servicing fee 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, BNY Mellon. 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.

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 servicer progresses through the process from foreclosure to liquidation, 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 released to the PFI over a period of time in accordance with each MCC) or SMI are made prior to the claims process. For loans that are credit-enhanced with SMI, if it is determined that a loss is covered, the SMI provider pays the claim in full and seeks reimbursement from the LRA funds. 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 has been depleted but is still being funded, based on our contractual arrangement, we and/or the SMI provider are entitled to reimbursement from those funds as they are received, up to the full reimbursable amount of the claim. These claim payments would be reflected as additional deductions from the LRA as they were paid. For more information, 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.




Housing Goals. The Bank Act requires the Finance Agency to establish low-income housing goals for mortgage purchases. Under its current housing goals regulation, the Finance Agency may establish low-income housing goals for FHLBanks that acquire, in any calendar year, more than $2.5 billion of conventional mortgages through an AMA program. If we exceed this volume threshold and fail to meet any affordable housing goals established by the Finance Agency that were determined by the Director to have been feasible, we may be required to submit a housing plan to the Finance Agency.

For information concerning the Finance Agency’s proposed changes to the housing goals regulation, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Accounting and Regulatory Developments - Legislative and Regulatory Developments.

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. Finance Agency 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 the primary liability for consolidated obligations issued to provide funds for a particular FHLBank rests with that FHLBank, consolidated obligations are the joint and several obligations of all of the FHLBanks under Section 11(a). Although each FHLBank is a GSE, consolidated obligations are not obligations of, and are not guaranteed by, the United States government. Consolidated obligations are backed only by the financial resources of all of the FHLBanks and are rated Aaa by Moody's and AA+ by S&P.

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 4 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, SOFR, 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. 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 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 FHLBanks' combined quarterly and annual financial reports.

As the FHLBanks' fiscal agent for debt issuance, the Office of Finance can control the timing and amount of each issuance. Through its oversight of the United States financial markets, the United States Treasury can also affect debt issuance for the FHLBanks. For more information, see Item 1. Business - Supervision and Regulation - Government Corporations Control Act.

Affordable Housing Programs, Community Investment and Small Business Grants

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 may 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. AHP-related advances, of which none were outstanding at December 31, 2018 or 2017, are also part of 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 one or more individuals having a permanent disability; and
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. The disaster relief program was most recently approved by the board of directors and activated to assist victims of the 2018 flooding disaster/emergency declaration in certain Michigan and Indiana counties.

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 typically have maturities ranging from overnight to 20 years and are priced at our cost of funds plus reasonable administrative expenses. At December 31, 2018 and 2017, we had $1.1 billion and $908 million, respectively, of outstanding principal on CIP-related advances.

In 2018, the Bank began offering small business grants under its new Elevate program, which are designed to support the growth and development of small businesses in Michigan and Indiana by providing funding for capital expenditures, workforce training, or other business-related needs. The total amount awarded in 2018 was $255,595.

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 Enterprise Risk Management Policy 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 only permitted to execute derivative transactions to 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 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. For more information, see Notes to Financial Statements - Note 9 - Derivatives and Hedging Activities and Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Use of Derivative Hedges.

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 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 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 Amendments to the Bank Act. The GLB Act amended the Bank Act to require 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 Bank Act requires that each FHLBank maintain permanent capital and total capital in sufficient amounts to comply with specified, minimum risk-based capital and leverage capital requirements. 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. In addition to establishing the Finance Agency, HERA eliminated regulatory authority to appoint directors to our board. HERA also eliminated regulatory authority to cap director fees (subject to the Finance Agency's review of reasonableness of such compensation), but placed additional controls over executive compensation.

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

Furthermore, this Act provides that the United States Comptroller General may review any audit of the financial statements of an FHLBank conducted by an independent registered public accounting firm. If the Comptroller General undertakes such a review, the results and any recommendations must be reported to 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 generally subject to the information, disclosure, insider trading restrictions, and other requirements under the Exchange Act, with certain exceptions. We are not subject to the registration provisions of the Securities Act. We have been, and continue to be, subject to all relevant liability provisions of the Securities Act 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 requires the FHLBanks to submit reports to the Finance Agency concerning transactions involving loans and other financial instruments that involve fraud or possible fraud. In addition, we are required to maintain 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.




We contract with third-party compliance firms to perform certain services on our behalf to assist us with our compliance with these regulations as they are applicable to us. Finance Agency regulations require that we monitor and assess our third-party firms' performance of the services. As we identify deficiencies in our third-party firms' performance, we seek to remediate the deficiencies. Under certain circumstances, we are required to notify the Finance Agency about the deficiencies and our response to assure our compliance with these regulations.

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. Federal law 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 contact 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 participating 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

Our membership territory is comprised of the states of Michigan and Indiana. In 2018, we gained 9 new members and lost 12 members, as a result of mergers and consolidations, for a net loss of 3 members.

The following table presents the composition of our members by type of financial institution.
Type of Institution
 
December 31, 2018
 
% of Total
 
December 31, 2017
 
% of Total
Commercial banks and savings associations
 
192

 
51
%
 
201

 
53
%
Credit unions
 
129

 
34
%
 
123

 
32
%
Insurance companies
 
53

 
14
%
 
55

 
14
%
CDFIs
 
5

 
1
%
 
3

 
1
%
Total member institutions
 
379

 
100
%
 
382

 
100
%

There was no material impact on our business as a result of the change in membership composition.

Competition

We operate in a highly competitive environment. Member demand 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, the Federal Reserve Banks, corporate credit unions, the Central Liquidity Facility, investment banks, commercial banks, and in certain circumstances other FHLBanks. An example of this 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, member creditworthiness, regulatory restrictions, and collateral availability and 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.

Employees

As of December 31, 2018, we had 246 full-time employees and 3 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 "News" and then "Investor Relations."

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 by scrolling to the bottom of any web page on www.fhlbi.com and then selecting "Corporate Governance" in the navigation menu.

Our 2019 Community Lending Plan describes our plan to address the credit needs and market opportunities in our district states of Michigan and Indiana. It is available on our website at www.fhlbi.com/materials under "Bulletins, Publications and Presentations."

Our Audit Committee operates under a written charter adopted by the board of directors that was most recently amended on March 23, 2018. The Audit Committee charter is available on our website by scrolling to the bottom of any web page on www.fhlbi.com and then selecting "Corporate Governance" in the navigation menu.

We provide our website address and the SEC's website address solely for information. Except where expressly stated, information appearing on our website and 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 2019 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
 
We use acronyms and terms throughout this Item that are defined herein or in the Glossary of Terms.

We have identified the following risk factors that could have a material adverse effect on our Bank.

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 domestic and international 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, volatility of interest rates, prepayment speeds, the cost of interest-bearing liabilities and the demand for our debt. In addition, the FHLBanks currently play a predominant role as lenders in the federal funds market; therefore, any disruption in the federal funds market or any related regulatory or policy change may adversely affect our cash management activities, results of operations, and reputation.

The FOMC continues to maintain its 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. These policies are intended to help maintain accommodative financial conditions. However, the FRB's continuing substantial participation in both short-term and MBS markets could adversely affect us through lower yields on our investments, higher costs of debt, and disruption of member demand for our products.

Additionally, we are affected by the global economy through member ownership and investments, and through capital markets exposures. Global political, economic, and business uncertainty has led to increased volatility in capital markets and has the potential to drive volatility in the future. Continued economic uncertainties could lead to further global capital market volatility, lower credit availability, and weaker economic growth. As a result, our business could be exposed to unfavorable market conditions, lower demand for mission-related assets, lower earnings, or reduced ability to pay dividends or redeem or repurchase capital stock. 

Our business and results of operations are sensitive to the condition of the housing and mortgage markets, as well as general business and economic conditions. Adverse trends in the mortgage lending sector, including declines in home prices or loan performance, could reduce the value of collateral securing our advances and the fair value of our MBS. Such reductions in value would increase the possibility of under-collateralization, thereby increasing the risk of loss in case of a member's failure. Also, deterioration in the residential mortgage markets could negatively affect the value of our MPP portfolio, resulting in an increase in the allowance for credit losses on mortgage loans and possible additional realized losses if we were forced to liquidate our MPP portfolio.

Our district is comprised of the states of Michigan and Indiana. In the last several years, both states have experienced improving economic conditions. However, increases in unemployment and foreclosure rates or decreases in job or income growth rates in either state could result in less demand for mission-related assets and therefore lower earnings. For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Summary - Economic Environment.




A Cybersecurity Event; Interruption in Our Information Systems; Unavailability of, or an Interruption of Service at, Our Main Office or Our Backup Facilities; or Failure of or an Interruption in Information Systems of Third-Party Vendors or Service Providers Could Adversely Affect Our Business, Risk Management, Financial Condition, Results of Operations, and Reputation

Cybersecurity.

We rely heavily on our information systems and other technology to conduct and manage our business, which inherently involves large financial transactions with our members and other counterparties. 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, damage, 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. As malicious threat tactics continue to mature, we are required to implement more advanced mitigating controls, which increases our mitigation costs. Moreover, if we experience a significant cybersecurity event, we may be unable to conduct and manage our business functions effectively, we may incur significant expenses in remediating such incidents, and we may suffer reputational harm. Any such occurrence could result in increased regulatory scrutiny of our operations. Although we carry cybersecurity insurance, its coverage may not be adequate to cover losses we may incur if a significant cybersecurity event occurs.

Information Systems; Facilities; Unavailability or Interruption of Service.

In addition, our operations rely on the availability and functioning of our main office, our business resumption center and other facilities. If we experience a significant failure or interruption in our business continuity, disaster recovery or certain information systems, we may be unable to conduct and manage our business functions effectively, we may incur significant expenses in remediating such incidents, and we may suffer reputational harm. Moreover, any of these occurrences could result in increased regulatory scrutiny of our operations.

Office of Finance.

The Office of Finance is a joint office of the FHLBanks established to facilitate the issuance and servicing of consolidated obligations, among other things. A failure or interruption of the Office of Finance's services as a result of breaches, cyber attacks, or technological outages could disrupt each FHLBank's access to these funds and constrain or otherwise negatively affect our business operations. Moreover, any operational failure of the Office of Finance could expose us to the risk of loss of data or confidential information, or other harm, including reputational damage.
 
Other Third Parties.

Despite our policies, procedures, controls and initiatives, some operational risks are beyond our control, and the failure of other parties to adequately address their performance standards and operational risks could adversely affect us. In addition to internal computer systems, we outsource certain communication and information systems and other services critical to our business and regulatory compliance to third-party vendors and service providers, including derivatives clearing organizations and loan servicers. Compromised security at any third party with whom we conduct business could expose us to cyber attacks or other breaches. If one or more of these key external parties were not able to perform their functions for a period of time, at an acceptable service level, or with increased volumes, our business operations could be constrained, disrupted, or otherwise negatively affected. In addition, any failure, interruption or breach in security of these systems, any disruption of service, or any key external party's failure to perform its contractual obligations could result in failures or interruptions in our ability to conduct and manage our business effectively, including, without limitation, our advances, MPP, funding, hedging activities and regulatory compliance. There is no assurance that such failures or interruptions will not occur or, if they do occur, that they will be timely detected or 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, results of operations, or ability to pay dividends or redeem or repurchase capital stock.




MPF Program - FHLBank of Chicago.

We have purchased participating interests in MPF Program 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 Program 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, including increased capital requirements on dealers' inventory and other regulatory changes affecting dealers, 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 further disruption in the debt market could have an adverse impact on our interest spreads, opportunities to call and reissue existing debt or roll over maturing debt, or our ability to meet the Finance Agency's mandates on FHLBank liquidity.

A Loss of Significant Borrowers, PFIs, Acceptable Loan Servicers or Other Financial Counterparties Could Adversely Impact Our Profitability, Our Ability to Achieve Business Objectives, Our Ability to Pay Dividends or Redeem or Repurchase Capital Stock, and Our Risk Concentration
 
The loss of any large borrower or PFI could adversely impact our profitability and our ability to achieve business objectives. The loss of a large borrower or PFI could result from a variety of factors, including acquisition, consolidation of charters within a bank holding company, loss of market share to non-depository institutions, resolution of a financially distressed member, or regulatory changes.

Our top borrower had advances outstanding at December 31, 2018 totaling $3.9 billion, or 12% of the Bank's total advances outstanding, at par. Our top-selling PFI sold us mortgage loans during 2018 totaling $730 million, or 33% of the total mortgage loans purchased by the Bank in 2018.

Our larger PFIs originate mortgages on properties in several states. We also purchase mortgage loans from many smaller PFIs that predominantly originate mortgage loans on properties in Michigan and Indiana. Therefore, our concentration of MPP loans on properties in Michigan and Indiana could continue to increase over time, as we do not currently limit such concentration.

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. Federal banking regulations 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. A scarcity of mortgage servicers could adversely affect our results of operations.

The number of counterparties that meet our internal and regulatory standards for derivative, repurchase, federal funds sold, TBA, and other financial transactions, such as broker-dealers and their affiliates, has decreased over time. In addition, since the Dodd-Frank Act, the requirements for posting margin or other collateral to financial counterparties has tended to increase, both in terms of the amount of collateral to be posted and the types of transactions for which margin is now required. These factors tend to increase the risk exposure that we have to any one counterparty, and as such may tend to increase our reliance upon each of our counterparties. A failure of any one of our major financial counterparties, or continuing market consolidation, could affect our profitability, results of operations, and ability to enter into additional transactions with existing counterparties without exceeding internal or regulatory risk limits.




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 lower a rating or issue negative reports. Because each FHLBank has 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 respective 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.

Uncertainty remains regarding possible longer-term effects resulting from rating actions. Any future downgrades in the credit ratings and outlook, especially a downgrade to an S&P AA rating or equivalent, could result in higher funding costs, additional collateral posting requirements for certain derivative instrument transactions, or disruptions in our access to capital markets. 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 counterparty obligations.

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 if market price and interest-rate volatility 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 scenario. In some cases, we may not be able to liquidate the collateral in a timely manner.

A deterioration of residential or commercial 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 we deem it necessary. If members are unable to fully collateralize their obligations with us, our advances could decrease further, negatively affecting our results of operations or ability to pay dividends or redeem or repurchase capital stock.

Mortgage Loans. If delinquencies in our 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, as applicable, on mortgage loans purchased through our MPP or the participating interests in MPF Program 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, however, certain of our PMI providers are paying less than 100% 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 of mortgage loans purchased under our MPP or through participating 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 potential changes in the Federal Reserve's holdings of MBS and the effect of any new or proposed actions. Additionally, future declines in housing prices, as well as other factors, such as increased loan default rates and loss severities and decreased prepayment speeds, may result in unrealized losses, which could adversely affect our financial condition.

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.

Counterparty Obligations. We assume unsecured credit risk when entering into money market transactions and financial derivatives transactions with domestic and foreign counterparties or through derivatives clearing organizations. A counterparty default could result in losses if our credit exposure to that counterparty is not fully collateralized or if our credit obligations associated with derivative positions are over-collateralized. The insolvency or other inability of a significant counterparty, including a clearing organization, 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.

Moreover, our ability to engage in routine derivatives, funding and other transactions could be adversely affected by the actions and commercial 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 suitable counterparties for routine business transactions.

Changes in the Legal and Regulatory Environment for FHLBanks, Other Housing GSEs or Our Members May Adversely Affect Our Business, Demand for Products, 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, the SEC, the CFTC, the CFPB, the Financial Stability Oversight Council, the Comptroller General, the FASB or other federal or state financial regulatory bodies; or judicial decisions that alter the present regulatory environment. Likewise, whenever federal elections result in changes in the executive branch or in the balance of political parties’ representation in Congress, there is increased uncertainty as to potential administrative, regulatory and legislative actions that may materially adversely affect our business.

Changes that restrict the growth or alter the risk profile of our current business or prohibit the creation of new products or services could negatively impact our earnings. For example, our earnings could be negatively impacted by regulatory changes that (i) further restrict the types, characteristics or volume of mortgages that we may purchase through our MPP or otherwise reduce the economic value of MPP to our members, or (ii) require us to change the composition of our assets and liabilities. In addition, the regulatory environment in which our members provide financial products and services could be changed in a manner that negatively impacts 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, including those that give preference to certain sectors, business models, regulated entities, assets, or activities, could negatively impact us. For example, changes in the status of Fannie Mae and Freddie Mac during the next phases of their conservatorship or as a result of legislative or regulatory changes, may impact funding costs for the FHLBanks, which could negatively affect our business and results of operations. In addition, negative news articles, industry reports, and other announcements pertaining to GSEs, including Fannie Mae, Freddie Mac or the FHLBanks, could cause an increase in interest rates on all GSE debt, as investors may perceive these issuers or their debt instruments as bearing increased risk.




The Finance Agency requires the FHLBanks to maintain sufficient liquidity through short-term investments in an amount at least equal to an FHLBank's cash outflows under hypothetical scenarios for the treatment of maturing advances. This regulatory guidance is designed to assure there is sufficient liquidity in the event of temporary disruptions in the capital markets that affect the FHLBanks' access to funding. To satisfy these scenarios, we maintain balances in shorter-term investments, which may earn lower interest rates than alternate investment options. In certain circumstances we may also need to fund shorter-term advances with short-term discount notes that have maturities beyond those of the related advances, thus increasing our short-term advance pricing or reducing net income through lower net interest spreads. To the extent these increased prices make our advances less competitive, advance levels and net interest income may be negatively affected.

In August 2018, the Finance Agency issued Advisory Bulletin 2018-07 on liquidity ("Liquidity Guidance AB"), which took effect, in part, on December 31, 2018. The Liquidity Guidance AB, among other things, provides guidance related to asset and liability maturity funding gap limits. Specifically, with respect to funding gaps and possible asset and liability mismatches, the Liquidity Guidance AB provides guidance on maintaining appropriate funding gaps for three-month and one-year maturity horizons. Specific initial percentages within prescribed ranges are identified in a Finance Agency supervisory letter. The Liquidity Guidance AB provides for these limits to reduce the liquidity risks associated with a mismatch in asset and liability maturities, including an undue reliance on short-term debt funding, which may increase refinancing risk. As a result of the Liquidity Guidance AB, our cost of funding may increase if we are required to achieve appropriate funding gaps with longer-term funding.

The CFPB rules include 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 CFPB rules. A mortgage borrower 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 if we were to purchase a loan under our AMA programs or if we were to direct a servicer to foreclose on mortgage loan collateral. In addition, if we were to make advances secured by non-safe harbor qualified mortgages retained by a mortgage lender and were to subsequently liquidate such collateral, we could be subject to these defenses to foreclosure or causes of action for damages. This risk, in turn, could reduce the value of our advances collateral, potentially reducing our likelihood of full repayment on our advances if we were required to sell such collateral.

Regulatory reform since the most recent financial crisis has tended to increase the amount of margin collateral that we must provide to collateralize certain kinds of financial transactions, and has broadened the categories of transactions for which we are required to post margin. For example, the Dodd-Frank Act and related regulatory changes have increased the margin we must provide for cleared and uncleared derivative transactions, and, effective in March 2020, Financial Industry Regulatory Authority ("FINRA") Rule 4210 will require us to exchange margin on certain MBS transactions. Materially greater margin requirements - due to Dodd-Frank Act derivatives regulatory requirements, FINRA Rule 4210, or otherwise - could adversely affect the availability and pricing of our derivative transactions, making such trades more costly and less attractive as risk management tools. New and expanded margin requirements on derivatives and MBS could also change our risk exposure to our counterparties and may require us to enhance further our systems and processes.
 
Dodd-Frank Act provisions may also indirectly affect us due to its effects on 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 or financial counterparties. Because the Dodd-Frank Act requires several regulatory bodies to carry out its provisions, its full effect remains uncertain until after the required reports to Congress are issued and implementing regulations are adopted.

Solvency frameworks comparable to the Dodd-Frank Act have been enacted by several members of the European Union pursuant to the European Bank Recovery and Resolution Directive ("BRRD") developed by the Financial Stability Board. We engage in financial transactions with counterparties which are domiciled in countries that have adopted the BRRD. The failure of any such counterparty could subject our transactions with such party to the BRRD solvency framework, the results of which may not be wholly predictable.

New and amended rules promulgated by our members' primary regulators may create unanticipated risks as well. For example, the largest members of the FHLBank System may have increased their advances levels in order to meet Basel III regulatory requirements. At the same time, changes to SEC guidance pertaining to prime money market funds have resulted in a significant increase in demand for government funds and Agency debt, as well as FHLBank discount notes. These developments could influence regulatory guidance, particularly with respect to liquidity. We cannot predict what effects, if any, these developments will have on the FHLBank System as a whole or upon our Bank, nor can we predict what additional regulatory actions may be taken as a result.




For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Accounting and Regulatory Developments - Legislative and Regulatory Developments.

Changes in Interest Rates or Changes in the Differences Between Short-Term Rates and Long-Term Rates Could Have an Adverse Effect on Our 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 risks, which are the risks that mortgage-based investments will be refinanced by borrowers 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, which may result in increased premium amortization expense and a decrease in the yield of our mortgage assets 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, our balance of consolidated obligations may remain outstanding. Conversely, 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.

A flattening yield curve, in which the difference between short-term interest rates and long-term interest rates is lower relative to prior market conditions, will tend to reduce, and has reduced, the net interest margin on new loans added to the MPP portfolio. Until such time as the yield curve becomes steeper, we may continue to earn lower spread income from that portfolio.

Although derivatives are used to mitigate market risk, they also introduce the potential for short-term earnings volatility, principally due to basis risk because we use the OIS curve in place of the LIBOR rate curve as the discount rate to estimate the fair values of collateralized LIBOR-based interest-rate related derivatives while the hedged items currently on the balance sheet are still valued using the LIBOR rate curve. Such volatility may be greater in 2019 as we began purchasing short-term fixed-rate Treasury securities swapped to OIS as a part of our liquidity portfolio.

Changes to or Replacement of the LIBOR Benchmark Interest Rate Could Adversely Affect Our Business, Financial Condition and Results of Operations

Many of our assets and liabilities are indexed to LIBOR. On July 27, 2017, the Financial Conduct Authority ("FCA"), a regulator of financial services firms and financial markets in the United Kingdom, announced that it will plan for a phase-out of regulatory oversight of LIBOR interest rate indices. The FCA indicated that it will cease persuading or compelling banks to submit rates for the calculation of LIBOR after 2021, and that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. The FCA further indicated, however, that it will support the LIBOR indices through 2021 to allow for an orderly transition to an alternative reference rate.

In the United States, efforts to identify a set of alternative U.S. dollar reference interest rates include proposals by the Alternative Reference Rates Committee ("ARRC") of the FRB and the Federal Reserve Bank of New York. The ARRC has proposed the SOFR as its recommended alternative to U.S. dollar LIBOR. SOFR is based on a broad segment of the overnight Treasury repurchase market and is intended to be a measure of the cost of borrowing cash overnight collateralized by Treasury securities. The Federal Reserve Bank of New York began publishing a SOFR in the second quarter of 2018. In January 2019, we participated in the issuance of a SOFR-indexed CO bond, the fourth SOFR issuance for the FHLBank System. The Bank expects to continue to participate in SOFR-indexed CO bonds.




The market transition away from LIBOR to SOFR also is expected to be complicated, including the development of terms and credit adjustments to accommodate differences between LIBOR and SOFR. The introduction of an alternative rate also may introduce additional basis risk for market participants, as an alternative index is utilized along with LIBOR during a transition period. There can be no guarantee that SOFR will become widely used or that alternatives may or may not develop with additional complications. The infrastructure necessary to manage hedging utilizing SOFR still needs to be built, and the transition in the markets and adjustments in our systems could be disruptive, with disruptions potentially beginning before the currently-planned phase-out of FCA support of LIBOR. A mechanism is not yet well-established to convert the credit and tenor features of LIBOR into any proposed replacement rate because markets which could facilitate such conversion are new and currently lack depth or liquidity. Moreover, there is no guarantee that, if the market is fully functioning at the time of the transition, the transition will be successful. Similarly, the transition from one reference rate to another could have accounting effects. For example, such transition could have an effect on our hedge effectiveness, which could affect our results of operations. Additionally, our risk management measuring, monitoring and valuation tools utilize LIBOR as a reference rate. Disruptions in the market for LIBOR and its regulatory framework, therefore, could have unanticipated effects on our risk management activities as well.

Given the large volume of LIBOR-based mortgages and financial instruments, the basis adjustment to the replacement floating rate will receive extraordinary scrutiny, but whether the net impact is positive or negative cannot yet be ascertained. We believe that other market participants, including our member institutions, derivatives clearing organizations, and other financial counterparties are also monitoring the LIBOR transition, but we cannot predict how such institutions will react to the transition, or what effects such reactions will have on us. We are not able to predict at this time whether LIBOR will cease to be available after 2021, whether SOFR or another alternative rate will become the sole market benchmark in place of LIBOR, whether the transitions to new reference rates will be successful, or what the impact of such a transition will be on the Bank's business, financial condition or results of operations.

Competition Could Negatively Impact Advances, the Supply of Mortgage Loans for our MPP, 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, the Federal Reserve Banks, corporate credit unions, the Central Liquidity Facility, investment banks, 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 several 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. In addition, PFIs face increased origination competition from originators that are not members of our Bank. Increased competition can result in a smaller share of the mortgages available for purchase through our MPP 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. There can be no assurance that our supply of funds through issuance of consolidated obligations will be sufficient to meet 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 market, business and operational risk, in part due to the significant use of business and financial models when evaluating various financial risks and deriving certain estimates in our financial statements. Our business could be adversely affected if these 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.

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. 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 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, even if the statutory redemption period had expired for some or all of such stock. Violations of our capital requirements could also restrict our ability to pay dividends, lend, invest, or purchase mortgage loans or participating interests in mortgage loans, or other business activities. Additionally, the Finance Agency could direct us to 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 ability to continue doing business with us.

The formula for calculating risk-based capital includes factors that depend on interest rates and other market metrics outside our control and could cause our 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 a failure of a minimum capital requirement.

The Dodd-Frank Act requires certain financial companies with total consolidated assets of more than $10.0 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. The Finance Agency has implemented annual stress testing for the FHLBanks. We must report the results of our stress tests to the Finance Agency and the FRB on an annual basis, and we must also publicly disclose a summary of stress test results for the "severely adverse" scenario on an annual basis.

The severity of the hypothetical scenarios devised by the Finance Agency and the FRB and employed in these stress tests is not defined by law or regulation, and is thus subject to the regulators' discretion. Nonetheless, 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 redeem 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.




Restrictions on the Redemption, Repurchase, or Transfer of the Bank's Capital Stock Could Result in an Illiquid Investment for the Holder

Under the GLB Act, Finance Agency regulations, and our capital plan, our capital stock may be redeemed upon the expiration of a five-year redemption period, subject to certain conditions. Capital stock may become subject to redemption following the redemption period after a member (i) provides a written redemption notice to the Bank; (ii) gives notice of intention to withdraw from membership; (iii) attains nonmember status by merger or acquisition, charter termination, or other involuntary membership termination; or (iv) has its Bank capital stock transferred by a receiver or other liquidating agent for that member to a nonmember entity. In addition, we may elect to repurchase some or all of the excess capital stock of a shareholder at any time at our sole discretion.

There is no guarantee, however, that we will be able to redeem shareholders' capital stock, even at the end of the prescribed redemption period, or to repurchase their excess capital stock. If a redemption or repurchase of capital stock would cause us to fail to meet our minimum regulatory capital requirements, Finance Agency regulations and our capital plan would prohibit the redemption or repurchase. Moreover, only capital stock that is not required to meet a member's membership capital stock requirement or to support a member or nonmember shareholder's outstanding activity with the Bank (excess capital stock) may be redeemed at the end of the redemption period. Restrictions on the redemption or repurchase of our capital stock could result in an illiquid investment for holders of our stock. In addition, because our capital stock may only be owned by our members (or, under certain circumstances, former members and certain successor institutions), and our capital plan requires our approval before a member or nonmember shareholder may transfer any of its capital stock to another member or nonmember shareholder, we cannot provide assurance that we would allow a member or nonmember shareholder to transfer any excess capital stock to another member or nonmember shareholder at any time.

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. In addition to possibly making payments due on consolidated obligations 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. Moreover, a Finance Agency regulation provides for an FHLBank System-wide annual minimum contribution to AHP of $100 million, and we could be liable for a pro rata share of that amount (based on the FHLBanks' combined net earnings for the previous year), up to 100% of our net earnings for the previous year. Thus, our ability to pay dividends to our members or to redeem or repurchase capital stock could be affected by the financial condition of one or more of the other FHLBanks.

The Inability to Attract and Retain Key Personnel Could Adversely Affect the Bank's Operations

We rely on key personnel for many of our functions and have a relatively small workforce, given the size and complexity of our business. Our ability to attract and retain personnel with the required technical expertise and specialized skills is important for us to manage our business and conduct our operations. Such ability could be challenged as employment in the United States improves, particularly in the Indianapolis area.



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 105,600 square feet. We lease or hold for lease to various tenants the remaining 11,400 square feet. We also maintain two leased off-site backup facilities of approximately 11,900 square feet and 200 square feet, respectively, which are on electrical distribution grids that are separate from each other and from our office building. For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Operational Risk Management.

In the opinion of management, our physical properties are suitable and adequate. All of our properties are insured to approximately 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.

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

We use acronyms and terms throughout this Item that are defined herein or in the Glossary of Terms.

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. 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.
 
Our Class B common stock is registered under the Exchange Act. Because our shares of capital stock are "exempt securities" under the Securities Act, purchases and sales of stock by our members are not subject to registration under the Securities Act.

Number of Shareholders

As of February 28, 2019, we had 390 shareholders and $2.1 billion par value of regulatory capital stock, which includes Class B common stock and MRCS issued and outstanding.

Dividends

A cooperative enterprise enjoys the benefits of an integrated customer/shareholder base; however, there are certain tensions inherent in our membership structure 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 open market for our stock and no opportunity for stock price appreciation. As a result, return on equity can be received only in the form of 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. At December 31, 2018, our excess stock was 0.7% of our total assets.





Our board of directors seeks to reward our members with a competitive, risk-adjusted return on their investment, particularly those who actively utilize our products. 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, regulatory requirements, 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 a member during the dividend payment period (applicable quarter). For more information, see Notes to Financial Statements - Note 13 - 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 employment and 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 of 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)
2019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 1 
 
$
26,480

 
$
2,153

 
$
28,633

 
5.50
%
 
$
4

 
$
150

 
$
154

 
4.40
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 4
 
$
21,470

 
$
1,723

 
$
23,193

 
4.50
%
 
$
6

 
$
125

 
$
131

 
3.60
%
Quarter 3
 
21,115

 
1,842

 
22,957

 
4.50
%
 
4

 
159

 
163

 
3.60
%
Quarter 2
 
19,368

 
1,927

 
21,295

 
4.25
%
 
5

 
24

 
29

 
3.40
%
Quarter 1 (2)
 
11,481

 
1,014

 
12,495

 
2.50
%
 
6

 
20

 
26

 
2.00
%
Quarter 1
 
19,518

 
1,723

 
21,241

 
4.25
%
 
10

 
34

 
44

 
3.40
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter 4
 
$
18,564

 
$
1,724

 
$
20,288

 
4.25
%
 
$
11

 
$
44

 
$
55

 
3.40
%
Quarter 3
 
17,373

 
1,703

 
19,076

 
4.25
%
 
14

 
52

 
66

 
3.40
%
Quarter 2
 
15,803

 
1,701

 
17,504

 
4.25
%
 
15

 
52

 
67

 
3.40
%
Quarter 1
 
15,545

 
1,824

 
17,369

 
4.25
%
 
19

 
54

 
73

 
3.40
%

(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) 
Reflects a supplemental cash dividend.






ITEM 6. SELECTED FINANCIAL DATA
 
We use acronyms and terms throughout this Item that are defined herein or in the Glossary of Terms. 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 selected financial information derived from audited financial statements as of and for the years ended as indicated ($ amounts in millions).
 
 
As of and for the Years Ended December 31,
 
 
2018
 
2017
 
2016
 
2015
 
2014
Statement of Condition:
 
 
 
 
 
 
 
 
 
 
Advances
 
$
32,728

 
$
34,055

 
$
28,096

 
$
26,909

 
$
20,789

Mortgage loans held for portfolio, net
 
11,385

 
10,356

 
9,501

 
8,146

 
6,820

Cash and short term investments 
 
7,610

 
4,601

 
4,128

 
4,932

 
3,552

Investment securities
 
13,378

 
13,027

 
11,880

 
10,415

 
10,538

Total assets
 
65,412

 
62,349

 
53,907

 
50,608

 
41,853

 
 
 
 
 
 
 
 
 
 
 
Discount notes
 
20,895

 
20,358

 
16,802

 
19,251

 
12,568

CO bonds
 
40,266

 
37,896

 
33,467

 
27,862

 
25,503

Total consolidated obligations
 
61,161

 
58,254

 
50,269

 
47,113

 
38,071

 
 
 
 
 
 
 
 
 
 
 
MRCS
 
169

 
164

 
170

 
14

 
16

 
 
 
 
 
 
 
 
 
 
 
Capital stock
 
1,931

 
1,858

 
1,493

 
1,528

 
1,551

Retained earnings
 
1,078

 
976

 
887

 
835

 
777

AOCI
 
42

 
112

 
56

 
23

 
47

Total capital
 
3,051

 
2,946

 
2,436

 
2,386

 
2,375

 
 
 
 
 
 
 
 
 
 
 
Statement of Income:
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
288

 
$
262

 
$
198

 
$
196

 
$
184

Provision for (reversal of) credit losses
 

 

 

 

 
(1
)
Other income (loss)
 
21

 
(6
)
 
6

 
10

 
13

Other expenses
 
92

 
82

 
78

 
72

 
68

AHP assessments
 
22

 
18

 
13

 
13

 
13

Net income
 
$
195

 
$
156

 
$
113


$
121


$
117

 
 
 
 
 
 
 
 


 
 
Selected Financial Ratios:
 
 
 
 
 
 
 
 
 
 

Net interest margin (1)
 
0.45
%
 
0.45
%
 
0.39
%
 
0.44
%
 
0.47
%
Return on average equity
 
6.43
%
 
5.88
%
 
4.92
%
 
5.13
%
 
4.72
%
Return on average assets
 
0.30
%
 
0.26
%
 
0.22
%
 
0.27
%
 
0.30
%
 
 
 
 
 
 
 
 
 
 
 
Weighted average dividend rate (2)
 
5.00
%
 
4.25
%
 
4.25
%
 
4.12
%
 
4.18
%
Dividend payout ratio (3)
 
47.87
%
 
43.05
%
 
53.87
%
 
52.48
%
 
58.96
%
 
 
 
 
 
 
 
 
 
 
 
Total capital ratio (4)
 
4.66
%
 
4.72
%
 
4.52
%
 
4.71
%
 
5.68
%
Total regulatory capital ratio (5)
 
4.86
%
 
4.81
%
 
4.73
%
 
4.70
%
 
5.60
%
Average equity to average assets
 
4.72
%
 
4.47
%
 
4.46
%
 
5.23
%
 
6.29
%

(1) 
Net interest income expressed as a percentage of average interest-earning assets.
(2)  
Dividends paid in cash during the year divided by the average amount of Class B capital stock eligible for dividends under our capital plan, excluding MRCS.
(3) 
Dividends paid in cash during the year divided by net income for the year. The ratios for the years ended December 31, 2018 and 2014 include a supplemental dividend of 2.5% and 2.0% related to 2017 and 2013 results, respectively.
(4) 
Capital stock plus retained earnings and AOCI expressed as a percentage of total assets.
(5) 
Capital stock plus retained earnings and MRCS expressed as a percentage of total assets.




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, 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 acronyms and terms throughout this Item that are defined herein or in the Glossary of Terms.

Unless otherwise stated, amounts disclosed in this Item 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, calculations based upon the disclosed amounts (millions) may not produce the same results.

Executive Summary
 
Overview. We are a regional wholesale bank that serves as a financial intermediary between the capital markets and our members. We primarily make secured loans in the form of advances to our members and purchase whole mortgage loans from our members. Additionally, we purchase other investments and provide other financial services to our members. As an FHLBank, we are generally designed to expand and contract in asset size as the needs of our members and their communities change over time.

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 issuance 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 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.

Due to our cooperative structure and wholesale nature, we typically earn a narrow net interest spread. Accordingly, our net income is relatively low compared to our total assets and capital.

We group our products and services within two operating segments: traditional and mortgage loans.

Economic Environment. The Bank’s financial performance is influenced by a number of regional and national economic and market factors, including the level and volatility of market interest rates, inflation or deflation, monetary policies, and the strength of housing markets.





The FOMC raised the target range for the federal funds rate by 25 bps at its December 2018 meeting. This marked the 8th rate hike of this tightening cycle, reaching a cumulative full 2 percentage point increase in the federal funds target since the cycle began in December 2015. Subsequent to year-end, the FOMC met and left the target rate unchanged, noting that recent data indicates a continuing strong labor market and strong household spending growth, but business fixed investment and near-term price level increases have moderated from last year’s levels. Additionally, inflation indicators remain firmly below long-term averages and just under the FOMC target inflation level of 2% annually, as measured by the Personal Consumption Expenditure deflator. Although it maintained the current federal funds target, the FOMC indicated that it will remain patient in making additional rate changes and that its overall strategy going forward will be data-dependent. The Federal Reserve has continued to unwind the trillions of dollars of quantitative easing ("QE"), also known as quantitative tightening. By early December, the Federal Reserve had reduced its balance sheet holdings by $347 billion, resulting in the lowest level of total remaining QE assets held since January 2014. In the fourth quarter of 2018, yields on U.S. Treasuries increased at the short-end of the yield curve and decreased for Treasuries with maturities of 6-months and greater relative to the prevailing yields at the end of the third quarter. As nominal interest rates remain historically relatively low and interest rates have increased, total returns in many bond market sectors remained low in 2018. Market sectors with negative returns in 2018 include Treasury Inflation-Protection Securities, convertible bonds, high yield bonds, and corporate bonds.

During the fourth quarter 2018, the U.S. Gross Domestic Product ("GDP") for the third quarter was revised downward a second time to an annualized growth rate of 3.4%. This marks the 36th consecutive quarter with positive economic growth, starting with the end of the last recession. The growth rate compares to an increase of 4.2% in the second quarter. According to the Department of Commerce, GDP rose in the third quarter as a result of increases in personal consumption expenditures, private industry investment, non-residential fixed investment, federal government spending, and state and local government spending. According to the Bureau of Economic Analysis ("BEA"), both household debt service ratios and net worth levels remain strong and have been improving along with the labor market. However, the BEA also reported moderating or deteriorating performance in the fourth quarter in the following cyclical economic indicators as a percentage of GDP: residential investment, business fixed investment, motor vehicle and parts consumption, and changes in private inventories.

According to the Bureau of Labor Statistics, labor market activity continues to improve. As of December 2018, the U.S. unemployment rate was 3.9%, compared to the 50-year average of 6.2%. The unemployment rate has dropped steadily since peaking at 10% in October 2009. Wage growth, after steadily declining from 2007 to 2012, has been stagnant, but has recently increased. In December 2018, the annualized wage growth in the U.S. was 3.3%.

Economic activity in the district, represented by Michigan and Indiana, has been similar to national averages. The unemployment rates in Michigan and Indiana in December 2018 were 4.0% and 3.6%, respectively, similar to the national average of 3.9%. Total employment and personal income have continued to grow, though personal income growth has been below national levels in both states. Housing market growth across the U.S. began to slow in late 2018 despite the strength in the overall economy. A shortage of existing home inventory, increased builder costs, and higher mortgage rates are beginning to impact the overall housing market. Consensus projections from the National Association of Realtors, Mortgage Bankers Association and Freddie Mac anticipate continued growth, albeit at a slower pace than recent years, in housing starts and total home sales in 2019, with increases of 4.7% and 2.8% respectively. The housing market in Indiana has remained strong, with home price appreciation setting a record in 2018, and existing home sales have continued a high rate of growth. Both have exceeded the national rates according to the Indiana Association of Realtors. The Indiana Business Research Center at Indiana University states that more construction in low-to-moderately priced homes is needed to satisfy housing demand and maintain housing prices at a level where would-be homeowners can purchase a home. According to Neighborhood-Scout Real Estate data, home prices in Michigan have increased at an average annual rate of 7.7% and 6.7% over the past two and five years, respectively, with both comparing favorably to national averages. According to the Home Builders Association of Michigan ("HBAM"), rising materials costs and regulations, combined with shortages in land and labor, have led to increased expenses in building new homes. This high demand has led to significant increases in existing home prices. According to HBAM, these price increases, combined with slowing construction, has left Michigan in a “near-crisis shortage of affordable homes.”
Indiana University’s Business Research Center projects the average economic growth rate for Indiana to outpace that of the U.S. through 2019, and virtually match the rate of national growth over the next 20 years. Job growth is expected to peak in 2019 and decelerate over the next few years. The University of Michigan Research Seminar in Quantitative Economics has reported continued growth in personal income and real disposable income for Michigan in the past three years and projects continuing improvement over the next three years. Michigan is expected to set a new record for continuous quarters of job growth through the end of 2019, though the pace of job creation slowed in 2018.




Impact on Operating Results. Market interest rates and trends affect yields and margins on earning assets, including advances, purchased mortgage loans, and our investment portfolio, which contribute to our overall profitability. Additionally, market interest rates drive mortgage origination and prepayment activity, which can lead to both favorable and unfavorable net interest margin volatility in our MPP and MBS portfolios. A flat or inverted yield curve, in which the difference between short-term interest rates and long-term interest rates is low, or negative, respectively, can have an unfavorable impact on our net interest margins.

Lending and investing activity by our member institutions is a key driver for our balance sheet and income growth. Such activity is a function of both prevailing interest rates and economic activity, including local economic factors, particularly relating to the housing and mortgage markets. Positive economic trends could drive interest rates higher, which could impair growth of the mortgage market. A less active mortgage market could affect demand for advances and activity levels in our Advantage MPP. However, borrowing patterns between our insurance company and depository members tend to differ during various economic and market conditions, thereby easing the potential magnitude of core business fluctuations during business cycles. Member demand for liquidity during stressed market conditions can lead to advances growth.

Results of Operations and Changes in Financial Condition
 
Results of Operations for the Years Ended December 31, 2018 and 2017. The following table presents the comparative highlights of our results of operations ($ amounts in millions).
 
 
Years Ended December 31,
 
 
 
 
Comparative Highlights
 
2018
 
2017
 
$ Change
 
% Change
Net interest income
 
$
288

 
$
262

 
$
26

 
10
%
Provision for (reversal of) credit losses
 

 

 

 
 
Net interest income after provision for credit losses
 
288

 
262

 
26

 
10
%
Other income (loss)
 
21

 
(6
)
 
27

 
 
Other expenses
 
92

 
82

 
10

 
 
Income before assessments
 
217

 
174

 
43

 
24
%
AHP assessments
 
22

 
18

 
4

 
 
Net income
 
195

 
156

 
39

 
24
%
Total other comprehensive income (loss)
 
(70
)
 
55

 
(125
)
 
 
Total comprehensive income
 
$
125

 
$
211

 
$
(86
)
 
(41
%)

The increase in net income for the year ended December 31, 2018 compared to 2017 was primarily due to a net realized gain on the sale of all of the Bank's private-label RMBS and higher net interest income, partially offset by higher operating expenses.

The decrease in total other comprehensive income for the year ended December 31, 2018 compared to 2017 was primarily due to net unrealized losses on our AFS securities and the recognition of the gain on the sale of the private-label RMBS in other income.

Results of Operations for the Years Ended December 31, 2017 and 2016. The following table presents the comparative highlights of our results of operations ($ amounts in millions).
 
 
Years Ended December 31,
 
 
 
 
Comparative Highlights
 
2017
 
2016
 
$ Change
 
% Change
Net interest income
 
$
262

 
$
198

 
$
64

 
33
%
Provision for (reversal of) credit losses
 

 

 

 
 
Net interest income after provision for credit losses
 
262

 
198

 
64

 
33
%
Other income (loss)
 
(6
)
 
6

 
(12
)
 
 
Other expenses
 
82

 
78

 
4

 
 
Income before assessments
 
174

 
126

 
48

 
38
%
AHP assessments
 
18

 
13

 
5

 
 
Net income
 
156

 
113

 
43

 
38
%
Total other comprehensive income (loss)
 
55

 
33

 
22

 
 
Total comprehensive income
 
$
211

 
$
146

 
$
65

 
44
%

The increase in net income for the year ended December 31, 2017 compared to 2016 was primarily due to higher net interest income as a result of asset growth and higher spreads, partially offset by net losses on derivatives and hedging activities.





The increase in total other comprehensive income for the year ended December 31, 2017 compared to 2016 was primarily due to larger unrealized gains on non-OTTI AFS securities.

Changes in Financial Condition for the Year Ended December 31, 2018. The following table presents the comparative highlights of our changes in financial condition ($ amounts in millions).
Condensed Statements of Condition
 
December 31, 2018
 
December 31, 2017
 
$ Change
 
% Change
Advances
 
$
32,728

 
$
34,055

 
$
(1,327
)
 
(4
%)
Mortgage loans held for portfolio, net
 
11,385

 
10,356

 
1,029

 
10
%
Cash and short-term investments (1)
 
7,610

 
4,601

 
3,009

 
65
%
Other assets (2)
 
13,689

 
13,337

 
352

 
3
%
Total assets
 
$
65,412

 
$
62,349

 
$
3,063

 
5
%
 
 
 
 
 
 
 
 
 
Consolidated obligations
 
$
61,161

 
$
58,254

 
$
2,907

 
5
%
MRCS
 
169

 
164

 
5

 
3
%
Other liabilities
 
1,031

 
985

 
46

 
5
%
Total liabilities
 
62,361

 
59,403

 
2,958

 
5
%
 
 
 
 
 
 
 
 
 
Capital stock
 
1,931

 
1,858

 
73

 
4
%
Retained earnings (3)
 
1,078

 
976

 
102

 
10
%
AOCI
 
42

 
112

 
(70
)
 
(63
%)
Total capital
 
3,051

 
2,946

 
105

 
4
%
 
 
 
 
 
 
 
 
 
Total liabilities and capital
 
$
65,412

 
$
62,349

 
$
3,063

 
5
%
 
 
 
 
 
 
 
 
 
Total regulatory capital (4)
 
$
3,178

 
$
2,998

 
$
180

 
6
%

(1) 
Includes cash, interest-bearing deposits, securities purchased under agreements to resell, and federal funds sold.
(2) 
Includes AFS and HTM securities.
(3) 
Includes restricted retained earnings at December 31, 2018 and 2017 of $222 million and $183 million, respectively.
(4) 
Total capital less AOCI plus MRCS.

The increase in total assets at December 31, 2018 compared to December 31, 2017 was primarily driven by an increase in short-term investments. The Bank enhanced its liquidity position in light of new regulatory guidance from the Finance Agency. For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Accounting and Regulatory Developments.

The increase in total liabilities was attributable to an increase in consolidated obligations to support the Bank's growth in assets.

The increase in total capital was due to the growth of retained earnings and additional capital stock issued to members. These increases were partially offset by the reduction in AOCI, primarily a result of unrealized losses on AFS securities and the recognition of the gain on the sale of the private-label RMBS in other income.

Outlook. We believe that our financial performance will continue to provide reasonable, risk-adjusted returns for our members across a wide range of business, financial, and economic environments. 

We continue to face competition from many sources in both the advances and mortgage purchase businesses. Competing wholesale funding opportunities for our members include brokered deposits, repurchase agreements, capital market debt issuance and other alternative sources. Additionally, the mortgage purchase market offers alternative providers for our members including Fannie Mae, Freddie Mac, and private mortgage aggregators.

During recent years, the advances line of business has experienced solid growth in both depository and insurance sectors. However, alternative sources of wholesale funds available to our members, continued consolidation in the financial services industry, and run-off from captive insurance company advances has continued to pressure overall advances levels. We expect advances to grow at a moderate pace.





Mortgage loans held for portfolio have increased at an average annual rate of nearly 12% since 2015, reflecting increased selling into our Advantage MPP. Factors that impact the volume of mortgage loans purchased include interest rates, competition, the general level of housing activity in the United States, the level of mortgage refinancing activity, consumer product preferences, and the Bank’s capital capacity. As interest rates have continued to trend upward, housing market growth has slowed and refinancing activity has declined, which may lead to a decline in our mortgage purchase volume.

Our investment securities portfolio has increased throughout 2018, with particular growth in the short-term investment portfolio, as a result of increased liquidity requirements issued to the Federal Home Loan Banks by the Finance Agency. In 2019, we began purchasing short-term fixed-rate Treasury securities swapped to OIS as part of our liquidity portfolio. Despite selling all remaining private-label RMBS in 2018, the total MBS portfolio continued to grow. We expect to continue to increase our MBS holdings, though long-term Agency debentures are likely to remain flat to slightly lower.

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 cause volatility in our earnings. Additionally, as market mortgage rates have increased and are likely to flatten or continue increasing, prepayment activity is expected to continue to decline, barring a large decline in market interest rates.

Access to debt markets has been reliable, but the cost of our consolidated obligations has increased. Going forward, the cost will continue to 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. As LIBOR phases out, some of our adjustable-rate funding is expected to move to debt tied to the SOFR index. In January 2019, we participated in the issuance of a SOFR-indexed CO bond, the fourth SOFR issuance for the FHLBank System.

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; however, spreads across asset categories on the balance sheet have moderated in the past year. Although debt costs remain low relative to historic norms, a flattening yield curve began to have an adverse effect on the Bank’s spreads in 2018. We anticipate spreads to continue to compress further before leveling out.

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, they also introduce the potential for short-term earnings volatility, principally due to basis risk because we use the OIS curve in place of the LIBOR rate curve as the discount rate to estimate the fair values of collateralized LIBOR-based interest-rate related derivatives while the hedged items currently on the balance sheet are still valued using the LIBOR rate curve. Such volatility may be greater in 2019 with the purchases of Treasury securities swapped to OIS.

We strive to keep our operating expense ratios relatively low while maintaining adequate systems, support, and staffing. We expect operating expenses to continue to increase beyond the rate of inflation as we continue to invest in operating and risk management systems and member service capabilities.

As a result of all of the foregoing factors, we expect net income in 2019 to be generally consistent with net income in 2018.

Our board of directors seeks to reward our members with a competitive, risk-adjusted return on their investment, particularly those who actively utilize our products. 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, regulatory requirements, our relationship with our members, and the stability of our current capital stock position and membership.





Analysis of Results of Operations for the Years Ended December 31, 2018, 2017 and 2016.

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 table presents average daily balances, interest income/expense, and average yields of our major categories of interest-earning assets and their funding sources ($ amounts in millions).
 
Years Ended December 31,
 
2018
 
2017
 
2016
 
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
$
5,938

 
$
114

 
1.91
%
 
$
4,919

 
$
50

 
1.02
%
 
$
4,215

 
$
17

 
0.40
%
Investment securities (1)
13,038

 
350

 
2.69
%
 
12,621

 
240

 
1.90
%
 
11,872

 
182

 
1.53
%
Advances (2)
32,683

 
726

 
2.22
%
 
31,209

 
406

 
1.30
%
 
25,974

 
220

 
0.85
%
Mortgage loans held for
portfolio (2)
10,902

 
354

 
3.25
%
 
9,922

 
315

 
3.17
%
 
8,792

 
274

 
3.12
%
Other assets (interest-earning) (3) 
1,151

 
21

 
1.83
%
 
364

 
5

 
1.47
%
 
313

 
2

 
0.63
%
Total interest-earning assets
63,712

 
1,565

 
2.46
%
 
59,035

 
1,016

 
1.72
%
 
51,166

 
695

 
1.36
%
Other assets (4)
440

 
 
 
 
 
444

 
 
 
 
 
326

 
 
 
 
Total assets
$
64,152

 
 
 
 
 
$
59,479

 
 
 
 
 
$
51,492

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Capital:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
641

 
11

 
1.72
%
 
$
555

 
5

 
0.86
%
 
$
597

 
1

 
0.12
%
Discount notes
21,265

 
392

 
1.84
%
 
20,116

 
182

 
0.91
%
 
16,129

 
64

 
0.40
%
CO bonds (2)
38,518

 
866

 
2.25
%
 
35,302

 
560

 
1.59
%
 
31,662

 
425

 
1.34
%
MRCS
168

 
8

 
4.99
%
 
167

 
7

 
4.22
%
 
152

 
7

 
4.35
%
Total interest-bearing liabilities
60,592

 
1,277

 
2.11
%
 
56,140

 
754

 
1.34
%
 
48,540

 
497

 
1.02
%
Other liabilities
531

 
 
 
 
 
679

 
 
 
 
 
653

 
 
 
 
Total capital
3,029

 
 
 
 
 
2,660

 
 
 
 
 
2,299

 
 
 
 
Total liabilities and capital
$
64,152

 
 
 
 
 
$
59,479

 
 
 
 
 
$
51,492

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
288

 
 
 
 
 
$
262

 
 
 
 
 
$
198

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net spread on interest-earning assets less interest-bearing liabilities
 
 
 
 
0.35
%
 
 
 
 
 
0.38
%
 
 
 
 
 
0.34
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest margin (5)
 
 
 
 
0.45
%
 
 
 
 
 
0.45
%
 
 
 
 
 
0.39
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average interest-earning assets to interest-bearing liabilities
1.05

 
 
 
 
 
1.05

 
 
 
 
 
1.05

 
 
 
 

(1) 
Consists of AFS and HTM securities. The average balances of investment securities are based on amortized cost; therefore, the resulting yields do not reflect changes in the estimated fair value of AFS securities that are a component of OCI, nor do they reflect OTTI-related non-credit losses. Interest income/expense includes the effects 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 and loans to other FHLBanks (if applicable). Includes the rights or obligations to cash collateral, except for variation margin payments characterized as daily settled contracts. The 2017 and 2016 amounts also include grantor trust assets that are included in other assets in 2018, as a result of adopting ASU 2016-01.
(4) 
Includes changes in the estimated fair value of AFS securities, the effect of OTTI-related non-credit losses on AFS and HTM securities, and in 2018 grantor trust assets.
(5) 
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 the changes in interest income and interest expense by volume and rate ($ amounts in millions).
 
 
Years Ended December 31,
 
 
2018 vs. 2017
 
2017 vs. 2016
Components
 
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
Increase (decrease) in interest income:
 
 

 
 

 
 

 
 
 
 
 
 
Federal funds sold and securities purchased under agreements to resell
 
$
12

 
$
52

 
$
64

 
$
3

 
$
30

 
$
33

Investment securities
 
13

 
97

 
110

 
16

 
42

 
58

Advances
 
20

 
300

 
320

 
51

 
135

 
186

Mortgage loans held for portfolio
 
31

 
8

 
39

 
36

 
5

 
41

Other assets (interest earning)
 
14

 
2

 
16

 

 
3

 
3

Total
 
90

 
459

 
549

 
106

 
215

 
321

Increase (decrease) in interest expense:
 
 

 
 

 
 

 
 
 
 
 
 
Interest-bearing deposits
 
1

 
5

 
6

 

 
4

 
4

Discount notes
 
11

 
199

 
210

 
19

 
99

 
118

CO bonds
 
55

 
251

 
306

 
53

 
82

 
135

MRCS
 

 
1

 
1

 

 

 

Total
 
67

 
456

 
523

 
72

 
185

 
257

Increase (decrease) in net interest income
 
$
23

 
$
3

 
$
26

 
$
34

 
$
30

 
$
64


The increase in net interest income for the year ended December 31, 2018 compared to 2017 and for the year ended December 31, 2017 compared to 2016 was primarily due to an increase in the average balances of interest-earning assets and interest-bearing liabilities.

Yields. The average yield on total interest-earning assets for the year ended December 31, 2018 was 2.46%, an increase of 74 bps compared to 2017, resulting primarily from increases in market interest rates that led to higher yields on advances and investment securities. The cost of total interest-bearing liabilities for the year ended December 31, 2018 was 2.11%, an increase of 77 bps from the prior year due to higher funding costs on consolidated obligations. The net effect was a decrease in the net interest spread to 0.35% for the year ended December 31, 2018 from 0.38% for the year ended December 31, 2017.

The average yield on total interest-earning assets for the year ended December 31, 2017 was 1.72%, an increase of 36 bps compared to 2016, resulting primarily from increases in market interest rates that led to higher yields on advances and investment securities. The cost of total interest-bearing liabilities for the year ended December 31, 2017 was 1.34%, an increase of 32 bps from the prior year due to higher funding costs on consolidated obligations. The net effect was an increase in the net interest spread to 0.38% for the year ended December 31, 2017 from 0.34% for the year ended December 31, 2016.

Average Balances. The average balances of interest-earning assets for the year ended December 31, 2018 increased by 8% compared to 2017. The average balance of short-term investments outstanding for the year ended December 31, 2018 increased by 21% in light of new regulatory guidance from the Finance Agency. The average amount of advances outstanding increased by 5%, generally due to members' higher funding needs. The average amount of mortgage loans held for portfolio outstanding increased by 10% due to higher purchases from members under Advantage MPP than paydowns of original and Advantage MPP. Additionally, the increase in the average balances of investment securities was due primarily to higher purchases of Agency MBS, partially offset by the sale of the private-label RMBS portfolio. The increase in average interest-bearing liabilities for the year ended December 31, 2018, compared to 2017, was due to an increase in consolidated obligations to fund the increases in the average balances of all interest-earning assets.

The average balances of interest-earning assets for the year ended December 31, 2017 increased compared to 2016, largely due to advances and, to a lesser extent, mortgage loans and investment securities. The average amount of advances outstanding increased by 20%, generally due to members' higher funding needs. The average amount of mortgage loans held for portfolio outstanding increased by 13% due to higher purchases from members under Advantage MPP than paydowns of original and Advantage MPP. Additionally, the increase in the average balances of investment securities was due primarily to purchases of Agency MBS. The increase in average interest-bearing liabilities for the year ended December 31, 2017, compared to 2016, was due to an increase in consolidated obligations to fund the increases in the average balances of all interest-earning assets.
 
 
 
 
 
 
 




Provision for (Reversal of) Credit Losses. The changes in the provision for (reversal of) credit losses for the year ended December 31, 2018 compared to 2017 and the year ended December 31, 2017 compared to 2016 were insignificant.
 
 
 
 
 
 
 
Other Income. The following table presents a comparison of the components of other income ($ amounts in millions). 
 
 
Years Ended December 31,
Components
 
2018
 
2017
 
2016
Net OTTI credit losses
 
$

 
$

 
$

Net realized gains from sale of available-for-sale securities
 
32

 

 

Net realized losses from sale of held-to-maturity securities
 

 

 

Net gains (losses) on derivatives and hedging activities
 
(13
)
 
(9
)
 
2

Other
 
2

 
3

 
4

Total other income (loss)