Attached files

file filename
EX-32 - EX-32 - Federal Home Loan Bank of Cincinnatil37990exv32.htm
EX-3.2 - EX-3.2 - Federal Home Loan Bank of Cincinnatil37990exv3w2.htm
EX-31.1 - EX-31.1 - Federal Home Loan Bank of Cincinnatil37990exv31w1.htm
EX-31.2 - EX-31.2 - Federal Home Loan Bank of Cincinnatil37990exv31w2.htm
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2009
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 No. 000-51399
FEDERAL HOME LOAN BANK OF CINCINNATI
(Exact name of registrant as specified in its charter)
     
Federally chartered corporation   31-6000228
(State or other jurisdiction of   (I.R.S. Employer 
incorporation or organization)   Identification No.)
     
1000 Atrium Two, P.O. Box 598,    
Cincinnati, Ohio   45201-0598
(Address of principal executive offices)       (Zip Code)
Registrant’s telephone number, including area code
(513) 852-7500
     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.
þ Yes o No
     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
o Yes o No
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer þ   Smaller reporting company o
        (Do not check if a smaller reporting company)
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
o Yes þ No
     As of October 31, 2009, the registrant had 36,578,770 shares of capital stock outstanding. The capital stock of the Federal Home Loan Bank of Cincinnati is not listed on any securities exchange or quoted on any automated quotation system, only may be owned by members and former members and is transferable only at its par value of $100 per share.
Page 1 of 100
 
 


 

Table of Contents
             
           
   
 
       
Item 1.          
   
 
       
        3  
   
 
       
        4  
   
 
       
        5  
   
 
       
        6  
   
 
       
        8  
   
 
       
Item 2.       45  
   
 
       
Item 3.       97  
   
 
       
Item 4.       98  
   
 
       
           
   
 
       
Item 1A.       98  
   
 
       
Item 2.       98  
   
 
       
Item 5.       98  
   
 
       
Item 6.       98  
   
 
       
Signatures     99  
 EX-3.2
 EX-31.1
 EX-31.2
 EX-32

2


Table of Contents

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements.
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CONDITION
(In thousands, except par value)
(Unaudited)
    September 30,     December 31,  
    2009     2008  
ASSETS
               
Cash and due from banks
  $ 2,733,228     $ 2,867  
Interest-bearing deposits
    166       19,906,234  
Federal funds sold
    5,775,000       -  
Trading securities
    2,252,568       2,985  
Available-for-sale securities
    5,725,076       2,511,630  
Held-to-maturity securities (includes $0 and $0 pledged as collateral at September 30, 2009 and December 31, 2008, respectively, that may be repledged) (a)
    12,471,895       12,904,200  
Advances
    38,082,056       53,915,972  
Mortgage loans held for portfolio, net
    9,736,249       8,631,873  
Accrued interest receivable
    161,166       275,560  
Premises, software, and equipment
    10,154       9,611  
Derivative assets
    8,864       17,310  
Other assets
    27,140       27,827  
 
           
 
               
TOTAL ASSETS
  $ 76,983,562     $ 98,206,069  
 
           
 
               
LIABILITIES
               
Deposits:
               
Interest bearing
  $ 1,665,253     $ 1,192,593  
Non-interest bearing
    4,195       868  
 
           
Total deposits
    1,669,448       1,193,461  
 
           
 
               
Consolidated Obligations, net:
               
Discount Notes
    29,169,806       49,335,739  
Bonds
    41,202,616       42,392,785  
 
           
Total Consolidated Obligations, net
    70,372,422       91,728,524  
 
           
 
               
Mandatorily redeemable capital stock
    87,415       110,909  
Accrued interest payable
    290,706       394,346  
Affordable Housing Program
    105,144       102,615  
Payable to REFCORP
    15,372       14,054  
Derivative liabilities
    269,842       286,476  
Other liabilities
    113,587       93,815  
 
           
 
               
Total liabilities
    72,923,936       93,924,200  
 
           
 
               
Commitments and contingencies
               
 
               
CAPITAL
               
Capital stock Class B putable ($100 par value); 36,578 and 39,617 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively
    3,657,848       3,961,698  
Retained earnings
    406,895       326,446  
Accumulated other comprehensive income:
               
Net unrealized gain (loss) on available-for-sale securities
    76       (458 )
Pension and postretirement plans
    (5,193 )     (5,817 )
 
           
Total capital
    4,059,626       4,281,869  
 
           
 
               
TOTAL LIABILITIES AND CAPITAL
  $ 76,983,562     $ 98,206,069  
 
           
(a)   Fair values: $12,947,773 and $13,163,337 at September 30, 2009 and December 31, 2008, respectively.
The accompanying notes are an integral part of these financial statements.

3


Table of Contents

FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF INCOME
(In thousands)
(Unaudited)
                                       
    Three Months Ended September 30,   Nine Months Ended September 30,
    2009     2008     2009     2008  
INTEREST INCOME:
                               
Advances
  $ 108,429     $ 438,097     $ 488,048     $ 1,450,982  
Prepayment fees on Advances, net
    1,716       913       6,569       1,627  
Interest-bearing deposits
    207       1,222       8,597       5,713  
Securities purchased under agreements to resell
    514       2,395       979       13,794  
Federal funds sold
    2,906       33,325       9,130       136,406  
Trading securities
    1,341       43       1,440       138  
Available-for-sale securities
    3,944       32       14,187       32  
Held-to-maturity:
                               
Securities
    147,242       183,293       437,840       507,187  
Securities of other FHLBanks
    -       -       22       -  
Mortgage loans held for portfolio
    115,546       112,122       367,455       344,900  
Loans to other FHLBanks
    11       43       15       280  
 
                       
Total interest income
    381,856       771,485       1,334,282       2,461,059  
 
                       
 
                               
INTEREST EXPENSE:
                               
Consolidated Obligations – Discount Notes
    15,478       228,431       104,405       773,750  
Consolidated Obligations – Bonds
    271,561       443,016       910,220       1,388,784  
Deposits
    424       6,280       1,521       23,990  
Loans from other FHLBanks
    -       -       1       -  
Mandatorily redeemable capital stock
    3,287       1,788       5,485       6,643  
Other borrowings
    -       2       -       26  
 
                       
Total interest expense
    290,750       679,517       1,021,632       2,193,193  
 
                       
 
                               
NET INTEREST INCOME
    91,106       91,968       312,650       267,866  
 
                       
 
                               
OTHER INCOME:
                               
Service fees
    406       294       1,297       919  
Net gains (losses) on trading securities
    179       (22 )     401       (35 )
Net gains on held-to-maturity securities
    -       -       5,943       -  
Net gains on derivatives and hedging activities
    4,846       9,893       12,797       9,391  
Other, net
    1,701       1,855       4,719       4,814  
 
                       
Total other income
    7,132       12,020       25,157       15,089  
 
                       
 
                               
OTHER EXPENSE:
                               
Compensation and benefits
    7,646       6,081       21,623       18,777  
Other operating
    3,926       3,398       10,844       9,800  
Finance Agency
    700       780       2,174       2,338  
Office of Finance
    596       476       2,258       1,791  
Other
    1,311       3,096       1,857       4,345  
 
                       
Total other expense
    14,179       13,831       38,756       37,051  
 
                       
 
                               
INCOME BEFORE ASSESSMENTS
    84,059       90,157       299,051       245,904  
 
                       
 
                               
Affordable Housing Program
    7,197       7,543       24,972       20,752  
REFCORP
    15,373       16,522       54,816       45,030  
 
                       
Total assessments
    22,570       24,065       79,788       65,782  
 
                       
 
                               
NET INCOME
  $ 61,489     $ 66,092     $ 219,263     $ 180,122  
 
                       
The accompanying notes are an integral part of these financial statements.

4


Table of Contents

FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CAPITAL
Nine Months Ended September 30, 2009 and 2008
(In thousands)
(Unaudited)
                                         
                          Accumulated      
    Capital Stock           Other      
    Class B*     Retained   Comprehensive   Total  
    Shares       Par Value       Earnings     Income   Capital  
       
 
                                       
BALANCE, DECEMBER 31, 2007
    34,734     $   3,473,361     $ 286,428     $ (5,203 )   $  3,754,586  
Proceeds from sale of capital stock
    3,558       355,817                       355,817  
Net reclassified to mandatorily redeemable capital stock
    (82 )     (8,222 )                     (8,222 )
 
                                       
Comprehensive income:
                                       
Net income
                    180,122               180,122  
Other comprehensive income:
                                       
Net unrealized loss on available-for-sale securities
                            (1,438 )     (1,438 )
Pension and postretirement benefits
                            479       479  
 
                                   
 
                                       
Total other comprehensive income
                            (959 )     (959 )
 
                                       
Total comprehensive income
                                    179,163  
 
                                     
 
                                       
Dividends on capital stock:
                                       
Cash
                    (108 )             (108 )
Stock
    1,474       147,490       (147,631 )             (141 )
       
 
                                       
BALANCE, SEPTEMBER 30, 2008
    39,684     $ 3,968,446     $ 318,811     $ (6,162 )   $ 4,281,095  
       
 
                                       
   
 
                                       
BALANCE, DECEMBER 31, 2008
    39,617     $ 3,961,698     $ 326,446     $ (6,275 )   $ 4,281,869  
Proceeds from sale of capital stock
    869       86,948                       86,948  
Net reclassified to mandatorily redeemable capital stock
    (3,908 )     (390,798 )                     (390,798 )
 
                                       
Comprehensive income:
                                       
Net income
                    219,263               219,263  
Other comprehensive income:
                                       
Net unrealized gain (loss) on available-for-sale securities
                            534       534  
Pension and postretirement benefits
                            624       624  
 
                                   
Total other comprehensive income
                            1,158       1,158  
 
                                       
Total comprehensive income
                                    220,421  
 
                                     
 
                                       
Dividends on capital stock:
                                       
Cash
                    (138,814 )             (138,814 )
       
 
                                       
BALANCE, SEPTEMBER 30, 2009
    36,578     $ 3,657,848     $ 406,895     $ (5,117 )   $ 4,059,626  
       
* Putable
The accompanying notes are an integral part of these financial statements.

5


Table of Contents

FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
                 
    Nine Months Ended September 30,  
    2009     2008  
OPERATING ACTIVITIES:
               
 
               
Net income
  $ 219,263     $ 180,122  
 
           
 
               
Adjustments to reconcile net income to net cash provided by operating activities:
               
 
               
Depreciation and amortization
    (54,632 )     (5,034 )
Change in net fair value adjustment on derivative and hedging activities
    119,981       (158,744 )
Net fair value adjustment on trading securities
    (401 )     35  
Other adjustments
    (5,913 )     4,854  
Net change in:
               
Accrued interest receivable
    114,417       42,184  
Other assets
    3,334       2,929  
Accrued interest payable
    (103,643 )     (11,524 )
Other liabilities
    24,480       1,883  
 
           
 
               
Total adjustments
    97,623       (123,417 )
 
           
 
               
Net cash provided by operating activities
    316,886       56,705  
 
           
 
               
INVESTING ACTIVITIES:
               
 
               
Net change in:
               
Interest-bearing deposits
    20,145,191       (106,301 )
Federal funds sold
    (5,775,000 )     (370,000 )
Premises, software and equipment
    (2,539 )     (2,430 )
 
               
Trading securities:
               
Net increase in short-term
    (2,248,088 )     -  
Proceeds from long-term
    246       474  
 
               
Available-for-sale securities:
               
Net increase in short-term
    (3,213,220 )     -  
Purchases of long-term
    -       (28,755 )
 
               
Held-to-maturity securities:
               
Net (increase) decrease in short-term
    (661 )     754,893  
Net decrease in other FHLBanks
    6       -  
Proceeds from long-term
    3,145,943       1,666,727  
Purchases of long-term
    (2,706,091 )     (2,843,871 )
 
               
Advances:
               
Proceeds
    316,153,047       1,328,105,277  
Made
    (300,605,516 )     (1,337,731,164 )
 
               
Mortgage loans held for portfolio:
               
Principal collected
    2,287,146       1,081,155  
Purchases
    (3,390,764 )     (689,489 )
 
           
 
               
Net cash provided by (used in) investing activities
    23,789,700       (10,163,484 )
 
           
The accompanying notes are an integral part of these financial statements.

6


Table of Contents

(continued from previous page)
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
                 
    Nine Months Ended September 30,  
    2009     2008  
 
               
FINANCING ACTIVITIES:
               
 
               
Net increase in deposits and pass-through reserves
  $ 468,187     $ 320,855  
Net (payments) proceeds on derivative contracts with financing elements
    (112,730 )     228,879  
 
               
Net proceeds from issuance of Consolidated Obligations:
               
Discount Notes
    493,773,421       719,677,329  
Bonds
    26,541,073       29,537,672  
Bonds transferred from other FHLBanks
    -       271,988  
 
               
Payments for maturing and retiring Consolidated Obligations:
               
Discount Notes
    (513,868,108 )     (712,084,138 )
Bonds
    (27,711,910 )     (28,239,184 )
 
               
Proceeds from issuance of capital stock
    86,948       355,817  
Payments for redemption of mandatorily redeemable capital stock
    (414,292 )     (3 )
Cash dividends paid
    (138,814 )     (108 )
 
           
 
               
Net cash (used in) provided by financing activities
    (21,376,225 )     10,069,107  
 
           
 
               
Net increase (decrease) in cash and cash equivalents
    2,730,361       (37,672 )
Cash and cash equivalents at beginning of the period
    2,867       52,606  
 
           
 
               
Cash and cash equivalents at end of the period
  $ 2,733,228     $ 14,934  
 
           
 
               
Supplemental Disclosures:
               
Interest paid
  $ 1,189,466     $ 2,214,574  
 
           
AHP payments, net
  $ 22,443     $ 20,806  
 
           
REFCORP assessments paid
  $ 53,498     $ 45,046  
 
           
The accompanying notes are an integral part of these financial statements.

7


Table of Contents

FEDERAL HOME LOAN BANK OF CINCINNATI
NOTES TO UNAUDITED FINANCIAL STATEMENTS
Background Information
The Federal Home Loan Bank of Cincinnati (the FHLBank), a federally chartered corporation, is one of 12 District Federal Home Loan Banks (FHLBanks). The FHLBanks serve the public by enhancing the availability of credit for residential mortgages and targeted community development. The FHLBank is regulated by the Federal Housing Finance Agency (Finance Agency).
Note 1— Basis of Presentation
The accompanying interim financial statements of the FHLBank have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of financial statements in accordance with GAAP requires management to make assumptions and estimates. These assumptions and estimates affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. Actual results could differ from these estimates. The interim financial statements presented are unaudited, but they include all adjustments (consisting of only normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the financial condition, results of operations, and cash flows for such periods. These financial statements do not include all disclosures associated with annual financial statements and accordingly should be read in conjunction with the audited financial statements and notes included in the FHLBank’s annual report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission (SEC). Results for the three and nine months ended September 30, 2009 are not necessarily indicative of operating results for the full year.
The FHLBank has evaluated subsequent events for potential recognition or disclosure through the issuance of these financial statements, which occurred on November 12, 2009, and believes there have been no material subsequent events requiring additional disclosure or recognition in these financial statements.
Note 2—Recently Issued Accounting Standards and Interpretations
Fair Value Measurements and Disclosures — Measuring Liabilities at Fair Value. On August 28, 2009, the Financial Accounting Standards Board (FASB) issued amended guidance for the fair value measurement of liabilities. The update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following techniques: (1) a valuation technique that uses: (a) the quoted price of the identical liability when traded as an asset or (b) quoted prices for similar liabilities or for similar liabilities when traded as assets; or (2) another valuation technique that is consistent with the principles of fair value measurements. This guidance is effective for the first reporting period (including interim periods) beginning after issuance (October 1, 2009 for the FHLBank). The FHLBank does not believe that the adoption of this guidance will have a material effect on its financial condition, results of operations or cash flows.
Codification of Accounting Standards. On June 30, 2009, the FASB established the FASB Accounting Standards Codification (ASC) as the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. The ASC does not change current GAAP; rather, its intent is to organize all accounting literature by topic in one place in order to enable users to quickly identify appropriate GAAP. The ASC is effective for interim and annual periods ending after September 15, 2009. The FHLBank adopted the ASC for the period ending September 30, 2009. The FHLBank’s adoption of the ASC did not have a material effect on its financial condition, results of operations or cash flows.
Accounting for Transfers of Financial Assets. On June 12, 2009, the FASB issued guidance which is intended to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. The guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009 (January 1, 2010 for the FHLBank), for interim periods within that first annual reporting period and for interim and annual reporting periods

8


Table of Contents

thereafter. Earlier application is prohibited. The FHLBank does not believe that the adoption of this guidance will have a material effect on its financial condition, results of operations or cash flows.
Recognition and Presentation of Other-Than-Temporary Impairments. On April 9, 2009, the FASB issued guidance amending the other-than-temporary impairment guidance in U.S. GAAP for debt securities. This “other-than-temporary impairment” guidance clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired and changes the presentation and calculation of the other-than-temporary impairment on debt securities recognized in earnings in the financial statements. The guidance does not amend existing recognition and measurement guidance related to other-than-temporary impairment of equity securities. However, it expands and increases the frequency of existing disclosures about other-than-temporary impairment for both debt and equity securities and requires new disclosures to help users of financial statements understand the significant inputs used in determining a credit loss, as well as a rollforward of that amount each period.
If the fair value of a debt security is less than its amortized cost basis at the measurement date, an entity is required to assess whether (a) it has the intent to sell the debt security, or (b) it is more likely than not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an other-than-temporary impairment on the security must be recognized.
In instances in which a determination is made that a credit loss (the difference between the present value of the cash flows expected to be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis, this guidance changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. In these instances, the impairment is separated into (a) the amount of the total impairment related to the credit loss, and (b) the amount of the total impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total impairment related to all other factors is recognized in other comprehensive income. Subsequent non-other-than-temporary impairment related increases and decreases in the fair value of available-for-sale securities are included in other comprehensive income. The other-than-temporary impairment recognized in other comprehensive income for debt securities classified as held-to-maturity is amortized over the remaining life of the debt security as an increase in the carrying value of the security (with no effect on earnings unless the security is subsequently sold or there is additional other-than-temporary impairment related to credit loss recognized).
This “other-than-temporary impairment” guidance is effective for interim and annual reporting periods ending after June 15, 2009 with early adoption permitted. When adopting this guidance, an entity is required to record a cumulative-effect adjustment as of the beginning of the period of adoption to reclassify the non-credit component of any previously recognized other-than-temporary impairment from retained earnings to accumulated other comprehensive income if the entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis.
The FHLBank elected to adopt this “other-than-temporary impairment” guidance as of January 1, 2009. Adoption did not affect the FHLBank’s financial condition, results of operations or cash flows, nor did it require the FHLBank to record a cumulative effect adjustment, since the FHLBank did not consider any investments to be other-than-temporarily impaired.

9


Table of Contents

Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. On April 9, 2009, the FASB issued guidance which clarifies the approach to and provides additional factors to consider in estimating fair value when the volume and level of activity for an asset or liability have significantly decreased. It also includes guidance on identifying circumstances that indicate a transaction is not orderly. This guidance is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted. As required, the FHLBank adopted this guidance as of January 1, 2009 when it adopted the “other-than-temporary impairment” guidance. The adoption of this guidance did not affect the FHLBank’s financial condition, results of operations or cash flows.
Interim Disclosures about Fair Value of Financial Instruments. On April 9, 2009, the FASB issued guidance to require disclosures about the fair value of financial instruments, including disclosure of the method(s) and significant assumptions used to estimate the fair value of financial instruments, in interim financial statements as well as in annual financial statements. Previously, these disclosures were required only in annual financial statements. This guidance is effective for interim and annual reporting periods ending after June 15, 2009. Early adoption of this guidance was permitted in conjunction with the early adoption of the “other-than-temporary impairment” guidance and “fair value measurement” guidance. In periods after initial adoption, this guidance requires comparative disclosures only for periods ending subsequent to initial adoption and does not require earlier periods to be disclosed for comparative purposes at initial adoption. The FHLBank elected to adopt this guidance as of January 1, 2009, which resulted in increased interim financial statement disclosures.

10


Table of Contents

Note 3—Trading Securities
Major Security Types. Trading securities as of September 30, 2009 and December 31, 2008 were as follows (in thousands):
                 
    September 30,   December 31,
    2009     2008  
    Estimated     Estimated  
      Fair Value         Fair Value    
 
               
Government-sponsored enterprises*
  $ 2,249,755     $ -  
Mortgage-backed securities:
               
Other U.S. obligation residential
mortgage-backed securities **
    2,813       2,985  
 
           
 
               
Total
  $ 2,252,568     $ 2,985  
 
           
*   Consists of debt securities issued or guaranteed by Federal Home Loan Mortgage Corporation (Freddie Mac), which are not obligations of the U.S. government.
 
**   Consists of Government National Mortgage Association (Ginnie Mae) securities.
Net gain (loss) on trading securities for the three months ended September 30, 2009 and 2008 included changes in net unrealized gain (loss) (in thousands) of $179 and $(22), respectively, for securities held on September 30, 2009 and 2008. Net gain (loss) on trading securities for the nine months ended September 30, 2009 and 2008 included changes in net unrealized gain (loss) (in thousands) of $401 and $(35), respectively, for securities held on September 30, 2009 and 2008.
Note 4—Available-for-Sale Securities
Major Security Types. Available-for-sale securities as of September 30, 2009 and December 31, 2008 were as follows (in thousands):
                                 
    September 30, 2009  
            Gross     Gross     Estimated  
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     (Losses)     Value  
       
 
                               
Certificates of deposit
  $  5,725,000     $ 146     $ (70 )   $  5,725,076  
 
                       
                                 
    December 31, 2008  
            Gross     Gross     Estimated  
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     (Losses)     Value  
       
 
                               
Certificates of deposit and bank notes
  $  2,512,088     $ 93     $ (551 )   $  2,511,630  
 
                       
All securities outstanding with gross unrealized losses at September 30, 2009 have been in a continuous unrealized loss position for less than 12 months.

11


Table of Contents

Redemption Terms. The amortized cost and estimated fair value of available-for-sale securities by contractual maturity at the dates indicated are shown below (in thousands).
                                 
    September 30, 2009     December 31, 2008  
            Estimated             Estimated  
    Amortized     Fair     Amortized     Fair  
Year of Maturity   Cost     Value     Cost     Value  
         
 
                               
Due in one year or less
  $ 5,725,000     $ 5,725,076     $ 2,512,088     $ 2,511,630  
 
                       
Interest Rate Payment Terms. The following table details additional interest rate payment terms for investment securities classified as available-for-sale as of September 30, 2009 and December 31, 2008 (in thousands):
                   
  September 30, 2009   December 31, 2008
 
                 
Amortized cost of available-for-sale securities:
                 
Fixed-rate
  $ 5,725,000       $ 2,512,088  
 
             
Realized Gains and Losses. There were no sales of available-for-sale securities for the nine months ended September 30, 2009 or 2008.

12


Table of Contents

Note 5—Held-to-Maturity Securities
Major Security Types. Held-to-maturity securities as of September 30, 2009 and December 31, 2008 were as follows (in thousands):
                                 
    September 30, 2009  
            Gross     Gross        
            Unrecognized     Unrecognized        
    Amortized     Holding     Holding     Estimated  
    Cost (1)     Gains     (Losses)     Fair Value  
Government-sponsored enterprises *
  $ 26,668     $ 16     $ -     $ 26,684  
State or local housing agency obligations
    11,185       -       (413 )     10,772  
Mortgage-backed securities:
                               
Other U.S. obligation residential mortgage-backed securities **
    2,617       4       -       2,621  
Government-sponsored enterprise residential mortgage-backed securities ***
    12,220,789       482,595       (4,025 )     12,699,359  
Private-label residential mortgage-backed securities
    210,636       -       (2,299 )     208,337  
 
                       
 
                               
Total mortgage-backed securities
    12,434,042       482,599       (6,324 )     12,910,317  
 
                       
 
                               
Total
  $ 12,471,895     $ 482,615     $ (6,737 )   $ 12,947,773  
 
                       
                                 
    December 31, 2008  
            Gross     Gross        
            Unrecognized     Unrecognized        
    Amortized     Holding     Holding     Estimated  
    Cost (1)     Gains     (Losses)     Fair Value  
Government-sponsored enterprises *
  $ 26,012     $ 38     $ -     $ 26,050  
State or local housing agency obligations
    12,080       -       (536 )     11,544  
Mortgage-backed securities:
                               
Other U.S. obligation residential mortgage-backed securities **
    9,103       -       (3 )     9,100  
Government-sponsored enterprise residential mortgage-backed securities ***
    12,552,810       301,671       (1,138 )     12,853,343  
Private-label residential mortgage-backed securities
    304,195       -       (40,895 )     263,300  
 
                       
 
                               
Total mortgage-backed securities
    12,866,108       301,671       (42,036 )     13,125,743  
 
                       
 
                               
Total
  $ 12,904,200     $ 301,709     $ (42,572 )   $ 13,163,337  
 
                       
(1)   Carrying value equals amortized cost.
 
*   Consists of debt securities issued or guaranteed by Freddie Mac and/or Federal National Mortgage Association (Fannie Mae), which are not obligations of the U.S. government.
 
**   Consists of Ginnie Mae securities.
 
***   Consists of securities issued or guaranteed by Freddie Mac and/or Fannie Mae, which are not obligations of the U.S. government.
The FHLBank’s mortgage-backed security investments consist of senior classes of agency guaranteed securities, government-sponsored enterprise securities, and private-label prime residential mortgage-backed securities. The FHLBank’s investments in mortgage-backed securities must be triple-A rated at the time of purchase.
Investments in government-sponsored enterprise securities, specifically debentures issued by Fannie Mae and Freddie Mac, have been affected by investor concerns regarding the adequacy of those entities’ capital levels to offset expected credit losses from declining home prices and increasing delinquencies. The Housing and Economic Recovery Act (HERA) contains provisions allowing the U.S. Treasury Department to provide support to Fannie Mae and Freddie Mac. Additionally, in

13


Table of Contents

September 2008, the U.S. Treasury and the Finance Agency announced that Fannie Mae and Freddie Mac had been placed into conservatorship, with the Finance Agency named as conservator. The Finance Agency is acting as the conservator of Fannie Mae and Freddie Mac in an attempt to stabilize their financial condition and their ability to support the secondary mortgage market.
The FHLBank has increased exposure to the risk of loss on its investments in mortgage-backed securities when the loans backing the mortgage-backed securities exhibit high rates of delinquency and foreclosure, and when there are losses on the sale of foreclosed properties. Credit safeguards for the FHLBank’s mortgage-backed securities consist of either payment guarantees of principal and interest in the case of U.S. government-guaranteed mortgage-backed securities and government-sponsored enterprise mortgage-backed securities, or credit enhancements for residential mortgage-backed securities issued by entities other than government-sponsored enterprises (private-label mortgage-backed securities) in the form of subordinate tranches in a security structure that absorb the losses before the security purchased by the FHLBank takes a loss. Since the surety of the FHLBank’s private-label mortgage-backed securities holdings relies on credit enhancements and the quality of the underlying loan collateral, the FHLBank analyzes these investments on an ongoing basis in an effort to determine whether the credit enhancement associated with each security is sufficient to protect against potential losses of principal and/or interest on the underlying mortgage loans. The FHLBank has not historically used monoline insurance as a form of credit enhancement for mortgage-backed securities.
The following table summarizes the par value of our six private-label mortgage-backed securities by year of issuance, as well as the weighted-average credit enhancement on the applicable securities as of September 30, 2009 (in thousands, except percentages). The weighted-average credit enhancement is the percent of protection in place to absorb losses of principal that could occur within the specified senior tranches.
                                         
    As of September 30, 2009
                            Percent   Serious
Private-Label           Unrealized     Investment     Average Credit   Delinquency
Mortgage-Backed Securities   Par     (Losses)     Rating     Enhancement   Rate (2)
Prime(1) – Year of Securitization
                                       
2003
  $ 210,405     $ (2,299 )   AAA     7.5%       0.54%  
 
                                   
 
                                       
Total
  $ 210,405     $ (2,299 )                        
 
                                   
(1)   As defined by the originator at the time of origination.
 
(2)   Seriously delinquent is defined as loans 60 days or more past due that underlie the securities, all bankruptcies, foreclosures, and real estate owned.

14


Table of Contents

The following tables summarize the held-to-maturity securities with unrealized losses as of September 30, 2009 and December 31, 2008. The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position (in thousands).
                                                 
    September 30, 2009  
    Less than 12 Months     12 Months or more     Total  
    Estimated     Gross     Estimated     Gross     Estimated     Gross  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     (Losses)     Value     (Losses)     Value     (Losses)  
                         
State or local housing agency obligations
  $ -     $ -     $ 10,772     $ (413 )   $ 10,772     $ (413 )
Mortgage-backed securities:
                                               
Government-sponsored enterprise residential mortgage-backed securities *
    746,535       (4,025 )     -       -       746,535       (4,025 )
Private-label residential mortgage- backed securities
    -       -       208,337       (2,299 )     208,337       (2,299 )
                         
 
                                               
Total
  $ 746,535     $ (4,025 )   $ 219,109     $ (2,712 )   $ 965,644     $ (6,737 )
                         
                                                 
    December 31, 2008  
    Less than 12 Months     12 Months or more     Total  
    Estimated     Gross     Estimated     Gross     Estimated     Gross  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     (Losses)     Value     (Losses)     Value     (Losses)  
                         
State or local housing agency obligations
  $ 11,544     $ (536 )   $ -     $ -     $ 11,544     $ (536 )
Mortgage-backed securities:
                                               
Other U.S. obligation residential mortgage-backed securities **
    9,100       (3 )     -       -       9,100       (3 )
Government-sponsored enterprise residential mortgage-backed securities *
    171,811       (1,138 )     -       -       171,811       (1,138 )
Private-label residential mortgage- backed securities
    -       -       263,300       (40,895 )     263,300       (40,895 )
                         
 
                                               
Total
  $ 192,455     $ (1,677 )   $ 263,300     $ (40,895 )   $ 455,755     $ (42,572 )
                         
*   Consists of securities issued or guaranteed by Freddie Mac and/or Fannie Mae, which are not obligations of the U.S. government.
 
**   Consists of Ginnie Mae securities.
Redemption Terms. The amortized cost and estimated fair value of held-to-maturity securities at the dates indicated by year of contractual maturity are shown below (in thousands). Expected maturities of some securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.
                                 
  September 30, 2009     December 31, 2008  
  Amortized     Estimated     Amortized     Estimated  
Year of Maturity Cost (1)     Fair Value     Cost (1)     Fair Value  
Other than mortgage-backed securities:
                               
Due in 1 year or less
  $ 26,668     $ 26,684     $ 26,012     $ 26,050  
Due after 1 year through 5 years
    -       -       -       -  
Due after 5 years through 10 years
    8,020       7,765       5       5  
Due after 10 years
    3,165       3,007       12,075       11,539  
 
                       
 
                               
Total other
    37,853       37,456       38,092       37,594  
 
                       
 
                               
Mortgage-backed securities
    12,434,042       12,910,317       12,866,108       13,125,743  
 
                       
 
                               
Total
  $ 12,471,895     $ 12,947,773     $ 12,904,200     $ 13,163,337  
 
                       
(1)   Carrying value equals amortized cost.

15


Table of Contents

The amortized cost of the FHLBank’s mortgage-backed securities classified as held-to-maturity includes net discounts (in thousands) of $10,913 and $27,521 at September 30, 2009 and December 31, 2008.
Interest Rate Payment Terms. The following table details additional interest rate payment terms for investment securities classified as held-to-maturity at September 30, 2009 and December 31, 2008 (in thousands):
                        
  September 30, 2009   December 31, 2008
Amortized cost of held-to-maturity securities other than mortgage-backed securities:
                 
Fixed-rate
  $ 34,688       $ 34,722  
Variable-rate
    3,165         3,370  
 
             
 
                 
Total other
    37,853         38,092  
 
             
Amortized cost of held-to-maturity mortgage-backed securities:
                 
Pass-through securities:
                 
Fixed-rate
    8,600,052         7,443,417  
Collateralized mortgage obligations:
                 
Fixed-rate
    3,833,990         5,422,691  
 
             
 
                 
Total mortgage-backed securities
    12,434,042         12,866,108  
 
             
 
                 
Total
  $     12,471,895       $     12,904,200  
 
             
The FHLBank did not sell any securities out of its held-to-maturity portfolio during the year ended December 31, 2008.
The FHLBank sold securities out of its held-to-maturity portfolio during the nine months ended September 30, 2009, each of which had less than 15 percent of the acquired principal outstanding at the time of the sale. Such sales are considered as maturities for the purposes of security classification. The FHLBank realized (in thousands) $5,943 in gross gains and no gross losses on these sales during the nine months ended September 30, 2009.
Note 6—Other-Than-Temporary Impairment Analysis
The FHLBank evaluates its individual available-for-sale and held-to-maturity investment securities holdings in an unrealized loss position for other-than-temporary impairment on a quarterly basis. As part of its securities’ evaluation for other-than-temporary impairment, the FHLBank considers its intent to sell each debt security and whether it is more likely than not that the FHLBank will be required to sell the security before its anticipated recovery. If either of these conditions is met, the FHLBank recognizes an other-than-temporary impairment in earnings equal to the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date. For securities in unrealized loss positions that meet neither of these conditions, the FHLBank performs analyses to determine if any of these securities are other-than-temporarily impaired.
For its government-sponsored enterprise residential mortgage-backed securities, the FHLBank determined that the strength of the issuers’ guarantees through direct obligations or support from the U.S. government is sufficient to protect the FHLBank from losses based on current expectations. As a result, the FHLBank has determined that, as of September 30, 2009, all of the gross unrealized losses on its government-sponsored enterprise mortgage-backed securities are temporary as the declines in market value of these securities are not attributable to credit quality. Furthermore, the FHLBank does not intend to sell the investments, and it is not more likely than not that the FHLBank will be required to sell the investments before recovery of their amortized cost bases. As a result, the FHLBank does not consider any of these investments to be other-than-temporarily impaired at September 30, 2009.
Beginning with the third quarter of 2009, the FHLBank assessed whether the entire amortized cost bases of the private-label residential mortgage-backed securities would be recovered by initially selecting all private-label mortgage-backed securities in an unrealized loss position for cash flow analysis. For certain private-label mortgage-backed securities where underlying collateral data are not available, alternative procedures, such as a screening process, are used to assess these securities for other-than-temporary impairment. Prior to the third quarter of 2009, the FHLBank only performed a cash flow analysis if an initial screening process revealed conditions (i.e., a likely credit loss) suggesting that a detailed cash flow analysis was required. The FHLBank used a screening process for two securities for which underlying collateral data was not available.

16


Table of Contents

The FHLBank performs cash flow analyses for securities in which underlying loan collateral data is available by using two third-party models. The first model considers borrower characteristics and the particular attributes of the loans underlying the FHLBank’s securities, in conjunction with assumptions about future changes in home prices and interest rates, to project prepayments, defaults and loss severities. A significant input to the first model is the forecast of future housing price changes for the relevant states and core based statistical areas (CBSAs), which is based upon an assessment of the individual housing markets. CBSA refers collectively to metropolitan and micropolitan statistical areas as defined by the United States Office of Management and Budget. As currently defined, a CBSA must contain at least one urban area with a population of 10,000 or more people. The FHLBank’s housing price forecast assumed CBSA level current-to-trough home price declines ranging from 0 percent to 20 percent over the next 9 to 15 months. Thereafter, home prices are projected to remain flat in the first six months, before increasing 0.5 percent in the next six months, 3 percent in the second year and 4 percent in each subsequent year.
The month-by-month projections of future loan performance derived from the first model, which reflect projected prepayments, defaults and loss severities, are then input into a second model that allocates the projected loan level cash flows and losses to the various security classes in the securitization structure in accordance with its prescribed cash flow and loss allocation rules. In a securitization in which the credit enhancement for the senior securities is derived from the presence of subordinate securities, losses are generally allocated first to the subordinate securities until their principal balance is reduced to zero. The projected cash flows are based on a number of assumptions and expectations, and the results of these models can vary significantly with changes in assumptions and expectations. The scenario of cash flows determined based on the model approach described above reflects a best estimate of the present value of cash flows expected to be collected.
As a result of the evaluation, the FHLBank believes that it will recover the entire amortized cost basis in its private-label residential mortgage-backed securities. Additionally, because the FHLBank does not intend to sell such securities nor is it more likely than not that the FHLBank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis, it did not consider the private-label residential mortgage-backed securities to be other-than-temporarily impaired at September 30, 2009.
The FHLBank also reviewed its available-for-sale securities and the remainder of its held-to-maturity securities that have experienced unrealized losses at September 30, 2009 and determined that the unrealized losses were temporary, based on the creditworthiness of the issuers and the related collateral characteristics and that the FHLBank will recover its entire amortized cost basis. Additionally, because the FHLBank does not intend to sell its securities nor is it more likely than not that the FHLBank will be required to sell the securities before recovery, it did not consider the investments to be other-than-temporarily impaired at September 30, 2009.

17


Table of Contents

Note 7—Advances
Redemption Terms. At September 30, 2009 and December 31, 2008, the FHLBank had Advances outstanding, including Affordable Housing Program (AHP) Advances (see Note 12), at interest rates ranging from 0.00 percent to 9.75 percent, as summarized below (dollars in thousands). Advances with interest rates of 0.00 percent are AHP-subsidized Advances.
                                 
    September 30, 2009   December 31, 2008
            Weighted           Weighted
            Average           Average
            Interest           Interest
Year of Contractual Maturity       Amount         Rate       Amount         Rate
 
                               
Overdrawn demand deposit accounts
  $ 349       0.19 %   $ 82       0.46 %
 
                               
Due in 1 year or less
    10,021,156       1.89       19,453,340       2.66  
Due after 1 year through 2 years
    3,704,579       3.52       7,027,588       3.29  
Due after 2 years through 3 years
    9,550,936       2.38       5,759,670       2.51  
Due after 3 years through 4 years
    3,689,743       1.85       8,022,345       3.36  
Due after 4 years through 5 years
    1,135,118       2.88       2,955,172       2.95  
Thereafter
    9,152,252       2.33       9,580,509       3.50  
 
                           
 
                               
Total par value
    37,254,133       2.31       52,798,706       3.00  
 
                               
Commitment fees
    (1,125 )             (1,160 )        
Discount on AHP Advances
    (30,863 )             (33,316 )        
Premiums
    4,477               4,664          
Discount
    (7,934 )             (6,689 )        
Hedging adjustments
    863,368               1,153,767          
 
                           
 
                               
Total
  $ 38,082,056             $ 53,915,972          
 
                           
The FHLBank offers Advances to members that may be prepaid on specified dates (call dates) without incurring prepayment or termination fees (callable Advances). Other Advances may only be prepaid subject to a fee to the FHLBank (prepayment fee) that makes the FHLBank financially indifferent to the prepayment of the Advance. At September 30, 2009 and December 31, 2008, the FHLBank had callable Advances (in thousands) of $14,304,834 and $21,634,101.
The following table summarizes Advances at the dates indicated by year of contractual maturity or next call date for callable Advances (in thousands):
                                 
Year of Contractual Maturity   September 30,     Percentage   December 31,     Percentage
or Next Call Date   2009     of Total   2008     of Total
 
                               
Overdrawn demand deposit accounts
  $ 349       - %   $ 82       - %
 
                               
Due in 1 year or less
    20,404,103       55       32,026,608       61  
Due after 1 year through 2 years
    3,397,005       9       6,434,692       12  
Due after 2 years through 3 years
    6,072,336       16       2,276,596       4  
Due after 3 years through 4 years
    1,468,998       4       6,019,345       11  
Due after 4 years through 5 years
    955,490       3       968,120       2  
Thereafter
    4,955,852       13       5,073,263       10  
 
                           
 
                               
Total par value
  $ 37,254,133       100 %   $ 52,798,706       100 %
 
                           
The FHLBank also offers putable Advances. With a putable Advance, the FHLBank effectively purchases a put option from the member that allows the FHLBank to terminate the Advance at predetermined dates. The FHLBank normally would exercise its option when interest rates increase relative to contractual rates. At September 30, 2009 and December 31, 2008, the FHLBank had putable Advances outstanding totaling (in thousands) $7,045,350 and $6,981,250.

18


Table of Contents

Through December 2005, the FHLBank offered convertible Advances. At September 30, 2009 and December 31, 2008, the FHLBank had convertible Advances outstanding totaling (in thousands) $3,230,700 and $3,478,700.
The following table summarizes Advances at the dates indicated by year of contractual maturity or next put/convert date for putable/convertible Advances (in thousands):
                                 
Year of Contractual Maturity   September 30,     Percentage   December 31,     Percentage
or Next Put/Convert Date   2009     of Total   2008     of Total
 
                               
Overdrawn demand deposit accounts
  $ 349       - %   $ 82       - %
 
                               
Due in 1 year or less
    18,582,606       49.9       28,142,090       53.3  
Due after 1 year through 2 years
    3,116,779       8.4       6,735,288       12.7  
Due after 2 years through 3 years
    6,008,036       16.1       5,153,270       9.8  
Due after 3 years through 4 years
    3,284,243       8.8       4,341,845       8.2  
Due after 4 years through 5 years
    911,418       2.4       2,788,772       5.3  
Thereafter
    5,350,702       14.4       5,637,359       10.7  
 
                           
 
                               
Total par value
  $ 37,254,133       100.0 %   $ 52,798,706       100.0 %
 
                           
The FHLBank has never experienced a credit loss on an Advance to a member. Based upon the collateral held as security for its Advances and the repayment history of the FHLBank’s Advances, management believes that an allowance for credit losses on Advances is unnecessary.
The following table shows Advance balances at the dates indicated to members holding five percent or more of total Advances and includes any known affiliates of these members that are members of the FHLBank (dollars in millions):
                                         
September 30, 2009   December 31, 2008
    Principal     % of Total           Principal     % of Total
 
                                       
U.S. Bank, N.A.
  $ 10,315       28 %  
U.S. Bank, N.A.
  $ 14,856       28 %
National City Bank
    4,409       12    
National City Bank
    6,435       12  
Fifth Third Bank
    2,038       5    
Fifth Third Bank
    5,639       11  
 
                                   
 
                                       
Total
  $ 16,762       45 %  
Total
  $ 26,930       51 %
 
                                   
Interest Rate Payment Terms. The following table details additional interest rate payment terms for Advances at the dates indicated (in thousands):
                                 
    September 30, 2009   December 31, 2008
    Amount     % of Total   Amount     % of Total
Par amount of Advances:
                               
Fixed-rate
  $ 18,452,950       50 %   $ 24,501,522       46 %
Variable-rate
    18,801,183       50       28,297,184       54  
 
                       
 
                               
Total
  $ 37,254,133       100 %   $ 52,798,706       100 %
 
                       
Prepayment Fees. The FHLBank records prepayment fees received from members on prepaid Advances net of any associated fair-value hedging adjustments on those Advances. The net amount of prepayment fees is reflected as interest income in the Statements of Income. Gross Advance prepayment fees received from members (in thousands) were $4,791 and $293 for the three months ended September 30, 2009 and 2008, respectively, and $10,662 and $2,538 for the nine months ended September 30, 2009 and 2008, respectively.

19


Table of Contents

Note 8—Mortgage Loans Held for Portfolio, Net
The following table presents information at the dates indicated on mortgage loans held for portfolio (in thousands):
                   
  September 30, 2009   December 31, 2008
Real Estate:
                 
Fixed rate medium-term single-family mortgages (1)
  $ 1,428,249       $ 1,177,689  
Fixed rate long-term single-family mortgages
    8,221,896         7,412,329  
 
             
 
                 
Subtotal fixed rate single-family mortgages
    9,650,145         8,590,018  
 
                 
Premiums
    99,946         61,390  
Discounts
    (9,616 )       (9,934 )
Hedging basis adjustments
    (4,226 )       (9,601 )
 
             
 
                 
Total
  $ 9,736,249       $ 8,631,873  
 
             
(1)   Medium-term is defined as a term of 15 years or less.
The following table details the par value of mortgage loans held for portfolio outstanding at the dates indicated (in thousands):
                   
  September 30, 2009   December 31, 2008
 
                 
Government-guaranteed/insured loans
  $ 1,483,166       $ 1,396,411  
Conventional loans
    8,166,979         7,193,607  
 
             
 
                 
Total par value
  $ 9,650,145       $ 8,590,018  
 
             
The conventional mortgage loans are supported by primary and supplemental mortgage insurance and the Lender Risk Account in addition to the associated property as collateral. The following table presents changes in the Lender Risk Account for the nine months ended September 30, 2009 (in thousands):
         
Lender Risk Account at December 31, 2008
  $ 48,782  
Additions
    12,272  
Claims
    (1,094 )
Scheduled distributions
    (2,760 )
 
     
 
       
Lender Risk Account at September 30, 2009
  $ 57,200  
 
     
The FHLBank had no nonaccrual loans at September 30, 2009 and December 31, 2008.
Mortgage loans, other than those included in large groups of smaller-balance homogeneous loans, are considered impaired when, based on current information and events, it is probable that the FHLBank will be unable to collect all principal and interest amounts due according to the contractual terms of the mortgage loan agreement. At September 30, 2009 and December 31, 2008, the FHLBank had no mortgage loans that were considered impaired.
The FHLBank has experienced no credit losses on mortgage loans to date and no event has occurred that would cause the FHLBank to believe it will have to absorb any credit losses on these mortgage loans. Accordingly, the FHLBank has not provided any allowances for losses on these mortgage loans.
The following table shows unpaid principal balances at the dates indicated to members supplying five percent or more of total unpaid principal and includes any known affiliates that are members of the FHLBank (dollars in millions):
                                 
    September 30, 2009   December 31, 2008
    Principal   % of Total   Principal   % of Total
 
                               
National City Bank
  $ 3,763       39 %   $ 4,709       55 %
Union Savings Bank
    3,078       32       1,995       23  
Guardian Savings Bank FSB
    809       8       544       6  
 
                           
 
                               
Total
  $ 7,650       79 %   $ 7,248       84 %
 
                           

20


Table of Contents

Note 9—Derivatives and Hedging Activities
Nature of Business Activity
The FHLBank is exposed to interest rate risk primarily from the effect of interest rate changes on its interest-earning assets and its funding sources which finance these assets.
Consistent with Finance Agency policy, the FHLBank enters into derivatives to manage the interest rate risk exposures inherent in otherwise unhedged assets and funding positions, to achieve the FHLBank’s risk management objectives and to act as an intermediary between its members and counterparties. Finance Agency Regulations and the FHLBank’s financial management policy prohibit trading in or the speculative use of derivative instruments and limit credit risk arising from these instruments. The FHLBank may only use derivatives to reduce funding costs for Consolidated Obligations and to manage its interest rate risk, mortgage prepayment risk and foreign currency risk positions. Derivatives are an integral part of the FHLBank’s financial management strategy.
The most common ways in which the FHLBank uses derivatives are to:
  §   reduce the interest rate sensitivity and repricing gaps of assets, liabilities, and certain other derivative instruments;
 
  §   manage embedded options in assets and liabilities;
 
  §   reduce funding costs by combining a derivative with a Consolidated Obligation, as the cost of a combined funding structure can be lower than the cost of a comparable Consolidated Obligation Bond;
 
  §   preserve a favorable interest rate spread between the yield of an asset (e.g., an Advance) and the cost of the related liability (e.g., the Consolidated Obligation Bond used to fund the Advance); without the use of derivatives, this interest rate spread could be reduced or eliminated when a change in the interest rate on the Advance does not match a change in the interest rate on the Bond; and
 
  §   protect the value of existing asset or liability positions.
Types of Derivatives
The FHLBank’s financial management policy establishes guidelines for its use of derivatives. The FHLBank may enter into interest rate swaps (including callable and putable swaps), swaptions, interest rate cap and floor agreements, calls, puts, futures, and forward contracts to manage its exposure to changes in interest rates.
The FHLBank may use these types of derivatives to adjust the effective maturity, repricing frequency, or option characteristics of financial instruments (such as Advances, and Consolidated Obligations) to achieve risk/return management objectives.
The FHLBank uses either derivative strategies or embedded options in its funding to minimize hedging costs. Interest rate swaps are used to manage interest rate exposures. Swaptions, caps and floors may be used to manage interest rate and volatility exposures.
An interest rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional principal amount at a predetermined fixed rate for a given period of time. In return for this promise, this party receives cash flows equivalent to the interest on the same notional principal amount at a variable-rate index for the same period of time. The variable-rate received by the FHLBank in its interest rate swaps is LIBOR.

21


Table of Contents

Application of Interest Rate Swaps
The FHLBank generally uses derivatives as fair value hedges of underlying financial instruments. However, because the FHLBank uses interest rate swaps when they are considered to be the most cost-effective alternative to achieve the FHLBank’s financial and risk management objectives, it may enter into interest rate swaps that do not necessarily qualify for hedge accounting (economic hedges). The FHLBank re-evaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new strategies.
Types of Assets and Liabilities Hedged
The FHLBank documents at inception all relationships between derivatives designated as hedging instruments and the hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value hedges to assets and liabilities on the Statements of Condition. The FHLBank also formally assesses (both at the hedge’s inception and at least quarterly) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value of the hedged items and whether those derivatives may be expected to remain effective in future periods. The FHLBank currently uses regression analyses to assess the effectiveness of its hedges.
Consolidated Obligations – While Consolidated Obligations are the joint and several obligations of the FHLBanks, each FHLBank has Consolidated Obligations for which it is the primary obligor. To date, no FHLBank has ever had to assume or pay the Consolidated Obligations of another FHLBank. The FHLBank enters into derivatives to hedge the interest rate risk associated with its specific debt issuances.
The FHLBank manages the risk arising from changing market prices and volatility of a Consolidated Obligation by matching the cash inflow on a derivative with the cash outflow on the Consolidated Obligation. In addition, the FHLBank requires collateral on derivatives at specified levels correlated to counterparty credit ratings and contractual terms.
For instance, in a typical transaction, fixed-rate Consolidated Obligations are issued for one or more FHLBanks, and the FHLBank simultaneously enters into a matching interest rate swap in which the counterparty pays fixed cash flows to the FHLBank designed to mirror in timing and amount the cash outflows the FHLBank pays on the Consolidated Obligation. The FHLBank pays a variable cash flow that closely matches the interest payments it receives on short-term or variable-rate Advances, typically 3-month LIBOR. These transactions are treated as fair value hedges.
This strategy of issuing Bonds while simultaneously entering into derivatives enables the FHLBank to offer a wider range of attractively priced Advances to its members and may allow the FHLBank to reduce its funding costs. The continued attractiveness of such debt depends on yield relationships between the Bond and the derivative markets. If conditions in these markets change, the FHLBank may alter the types or terms of the Bonds that it issues. By acting in both the capital and the swap markets, the FHLBank can raise funds at lower costs than through the issuance of simple fixed- or variable-rate Consolidated Obligations in the capital markets alone.
Advances – The FHLBank offers a wide array of Advance structures to meet members’ funding needs. These Advances may have maturities up to 30 years with variable or fixed rates and may include early termination features or options. The FHLBank may use derivatives to adjust the repricing and/or options characteristics of Advances in order to more closely match the characteristics of the FHLBank’s funding liabilities. In general, whenever a member executes a fixed-rate Advance or a variable-rate Advance with embedded options, the FHLBank will simultaneously execute a derivative with terms that offset the terms and embedded options, if any, in the Advance. For example, the FHLBank may hedge a fixed-rate Advance with an interest rate swap where the FHLBank pays a fixed-rate coupon and receives a floating-rate coupon, effectively converting the fixed-rate Advance to a floating-rate Advance. These types of hedges are treated as fair value hedges.
When issuing a putable Advance, the FHLBank effectively purchases a put option from the member that allows the FHLBank to put or extinguish the fixed-rate Advance, which the FHLBank normally would exercise when interest rates increase. The FHLBank may hedge these Advances by entering into a cancelable derivative.

22


Table of Contents

Mortgage Loans – The FHLBank invests in fixed rate mortgage loans. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected repayment of these investments, depending on changes in estimated prepayment speeds. The FHLBank may manage the interest rate and prepayment risks associated with mortgages through a combination of debt issuance and derivatives. The FHLBank issues both callable and noncallable debt and prepayment linked Consolidated Obligations to achieve cash flow patterns and liability durations similar to those expected on the mortgage loans. The FHLBank is permitted to use derivatives to match the expected prepayment characteristics of the mortgages, although to date it has not done so.

Firm Commitment Strategies – Certain mortgage purchase commitments are considered derivatives. The FHLBank normally hedges these commitments by selling to-be-announced (TBA) mortgage-backed securities for forward settlement. A TBA represents a forward contract for the sale of mortgage-backed securities at a future agreed upon date for an established price. The mortgage purchase commitment and the TBA used in the firm commitment hedging strategy (economic hedge) are recorded as a derivative asset or derivative liability at fair value, with changes in fair value recognized in the current period earnings. When the mortgage purchase commitment derivative settles, the current market value of the commitment is included in the basis of the mortgage loan and amortized accordingly.
Investments – The FHLBank invests in certificates of deposit, bank notes, U.S. agency obligations, government-sponsored enterprise debt securities, mortgage-backed securities, and the taxable portion of state or local housing finance agency obligations, which may be classified as held-to-maturity, available-for-sale or trading securities. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and, possibly, derivatives. The FHLBank may manage the prepayment and interest rate risk by funding investment securities with Consolidated Obligations that have call features or by hedging the prepayment risk with caps or floors, callable swaps or swaptions.
Managing Credit Risk on Derivatives
The FHLBank is subject to credit risk due to nonperformance by counterparties to its derivative agreements. The degree of counterparty risk depends on the extent to which master netting arrangements are included in the contracts to mitigate the risk. The FHLBank manages counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in FHLBank policies and Finance Agency Regulations. Based on credit analyses and collateral requirements at September 30, 2009, the management of the FHLBank does not expect any credit losses on its derivative agreements.
The contractual or notional amount of derivatives reflects the involvement of the FHLBank in the various classes of financial instruments. The notional amount of derivatives does not measure the credit risk exposure of the FHLBank, and the maximum credit exposure of the FHLBank is substantially less than the notional amount. The FHLBank requires collateral agreements on all derivatives, which establish collateral delivery thresholds. The maximum credit risk is the estimated cost of replacing interest rate swaps, forward rate agreements, and mandatory delivery contracts for mortgage loans that have a net positive market value, assuming the counterparty defaults and the related collateral, if any, is of no value to the FHLBank. The FHLBank has not sold or repledged the collateral it received.
As of September 30, 2009 and December 31, 2008, the FHLBank’s maximum credit risk, as defined above, was approximately $44,066,000 and $60,317,000, respectively. These totals include $28,189,000 and $16,145,000 of net accrued interest receivable. In determining maximum credit risk, the FHLBank considers accrued interest receivables and payables, and the legal right to offset derivative assets and liabilities, by counterparty. The FHLBank held $35,202,000 and $43,007,000 of cash as collateral as of September 30, 2009 and December 31, 2008, for net uncollateralized balances of $8,864,000 and $17,310,000, respectively. The FHLBank held no securities as collateral as of September 30, 2009 or December 31, 2008. Additionally, collateral related to derivatives with member institutions includes collateral assigned to the FHLBank, as evidenced by a written security agreement, and held by the member institution for the benefit of the FHLBank.

23


Table of Contents

Certain of the FHLBank’s interest rate swap contracts contain provisions that require the FHLBank to post additional collateral with its counterparties if there is deterioration in the FHLBank’s credit rating. If the FHLBank’s credit rating were lowered by a major credit rating agency, the FHLBank could be required to deliver additional collateral. The aggregate fair value of all interest rate swaps with credit-risk-related contingent features that were in a liability position at September 30, 2009 was $802,582,000, for which the FHLBank has posted collateral of $532,753,000 in the normal course of business, resulting in a net balance of $269,829,000. If the FHLBank’s credit ratings had been lowered from its current rating to the next lower rating, the FHLBank would have been required to deliver up to an additional $159,422,000 of collateral (at fair value) to its derivatives counterparties at September 30, 2009. However, the FHLBank’s credit ratings have not changed during the previous 12 months.
The FHLBank transacts most of its derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute Consolidated Obligations. The FHLBank is not a derivative dealer and thus does not trade derivatives for short-term profit.
Financial Statement Effect and Additional Financial Information
The notional amount of derivatives serves as a factor in determining periodic interest payments or cash flows received and paid. As indicated above, the notional amount represents neither the actual amounts exchanged nor the overall exposure of the FHLBank to credit and market risk. Notional values are not meaningful measures of the risks associated with derivatives. The risks of derivatives only can be measured meaningfully on a portfolio basis that takes into account the derivatives, the items being hedged and any offsets between the two.

24


Table of Contents

The following table summarizes the fair value of the FHLBank’s derivative instruments without the effect of netting arrangements or collateral (in thousands). For purposes of this disclosure, the derivative values include accrued interest on the instruments.
                         
    September 30, 2009  
    Notional              
    Amount of     Derivative     Derivative  
    Derivatives     Assets     Liabilities  
Derivatives designated as fair value hedging instruments:
                       
Interest rate swaps
  $ 27,055,050     $ 192,895     $ (951,893 )
 
                       
Derivatives not designated as hedging instruments:
                       
Interest rate swaps
    396,800       9,019       (9,802 )
Forward rate agreements
    -       -       -  
Mortgage delivery commitments
    126,566       1,265       (13 )
 
                 
Total derivatives not designated as hedging instruments
    523,366       10,284       (9,815 )
 
                 
 
                       
Total derivatives before netting and collateral adjustments
  $ 27,578,416       203,179       (961,708 )
 
                 
 
                       
Netting adjustments
            (159,113 )     159,113  
Cash collateral and related accrued interest
            (35,202 )     532,753  
 
                   
Total collateral and netting adjustments (1)
            (194,315 )     691,866  
 
                   
Derivative assets and derivative liabilities as reported on the Statement of Condition
          $ 8,864     $ (269,842 )
 
                   
                         
    December 31, 2008  
    Notional              
    Amount of     Derivative     Derivative  
    Derivatives     Assets     Liabilities  
Derivatives designated as fair value hedging instruments:
                       
Interest rate swaps
  $ 25,830,900     $ 226,043     $ (1,221,004 )
 
                       
Derivatives not designated as hedging instruments:
                       
Interest rate swaps
    1,976,300       7,632       (13,191 )
Forward rate agreements
    386,000       -       (3,670 )
Mortgage delivery commitments
    917,435       6,282       (153 )
 
                 
Total derivatives not designated as hedging instruments
    3,279,735       13,914       (17,014 )
 
                 
 
                       
Total derivatives before netting and collateral adjustments
  $ 29,110,635       239,957       (1,238,018 )
 
                 
 
                       
Netting adjustments
            (179,640 )     179,640  
Cash collateral and related accrued interest
            (43,007 )     771,902  
 
                   
Total collateral and netting adjustments (1)
            (222,647 )     951,542  
 
                   
Derivative assets and derivative liabilities as reported on the Statement of Condition
          $ 17,310     $ (286,476 )
 
                   
  (1)   Amounts represent the effects of legally enforceable master netting agreements that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties.

25


Table of Contents

The following table presents the components of net gains (losses) on derivatives and hedging activities as presented in the Statements of Income for the dates indicated (in thousands):
                 
    Three Months Ended September 30,  
    2009     2008  
Derivatives and hedged items in fair value hedging relationships:
               
Interest rate swaps
  $ 3,291     $ 8,974  
 
               
Derivatives not designated as hedging instruments:
               
Economic Hedges:
               
Interest rate swaps
    (1,863 )     1,204  
Forward rate agreements
    (2,807 )     281  
Net interest settlements
    400       (281 )
 
               
Mortgage delivery commitments
    5,825       (285 )
 
           
 
               
Total net gain related to derivatives not designated as hedging instruments
    1,555       919  
 
           
 
               
Net gains on derivatives and hedging activities
  $ 4,846     $ 9,893  
 
           
                 
    Nine Months Ended September 30,  
    2009     2008  
Derivatives and hedged items in fair value hedging relationships:
               
Interest rate swaps
  $ 10,643     $ 10,756  
 
               
Derivatives not designated as hedging instruments:
               
Economic Hedges:
               
Interest rate swaps
    2,169       445  
Forward rate agreements
    339       2,830  
Net interest settlements
    1,138       (293 )
 
               
Mortgage delivery commitments
    (1,492 )     (4,347 )
 
           
 
               
Total net gain (loss) related to derivatives not designated as hedging instruments
    2,154       (1,365 )
 
           
 
               
Net gains on derivatives and hedging activities
  $ 12,797     $ 9,391  
 
           

26


Table of Contents

The following table presents, by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the FHLBank’s net interest income for the dates indicated (in thousands):
                                                             
    Three Months Ended September 30,  
                            Effect of  
      Gain/(Loss)     Gain/(Loss)   Net Fair   Derivatives on  
      on     on Hedged   Value Hedge   Net Interest  
      Derivative     Item   Ineffectiveness   Income  
2009
                               
Hedged Item Type:
                               
Advances
  $ (53,110 )   $ 56,469     $ 3,359     $ (135,551 )
Consolidated Bonds
    18,881       (18,949 )     (68 )     40,330  
 
                       
 
                               
 
  $ (34,229 )   $ 37,520     $ 3,291     $ (95,221 )
 
                       
 
                               
2008
                               
Hedged Item Type:
                               
Advances
  $ 11,730     $ (17,315 )   $ (5,585 )   $ (63,513 )
Consolidated Bonds
    (8,674 )     23,233       14,559       23,280  
 
                       
 
                               
 
  $ 3,056     $ 5,918     $ 8,974     $ (40,233 )
 
                       
                                                             
    Nine Months Ended September 30,  
                            Effect of  
      Gain/(Loss)     Gain/(Loss)   Net Fair   Derivatives on  
      on     on Hedged   Value Hedge     Net Interest  
      Derivative     Item   Ineffectiveness     Income  
2009
                               
Hedged Item Type:
                               
Advances
  $ 296,853     $ (290,296 )   $ 6,557     $ (376,466 )
Consolidated Bonds
    (36,744 )     40,830       4,086       111,927  
 
                       
 
                               
 
  $ 260,109     $ (249,466 )   $ 10,643     $ (264,539 )
 
                       
 
                               
2008
                               
Hedged Item Type:
                               
Advances
  $ 2,887     $ (8,540 )   $ (5,653 )   $ (136,247 )
Consolidated Bonds
    (6,471 )     22,880       16,409       58,583  
 
                       
 
                               
 
  $ (3,584 )   $ 14,340     $ 10,756     $ (77,664 )
 
                       

27


Table of Contents

Note 10—Deposits
The FHLBank offers demand and overnight deposits to members and qualifying non-members. In addition, the FHLBank offers short-term interest-bearing deposit programs to members. A member that services mortgage loans may deposit in the FHLBank funds collected in connection with the mortgage loans, pending disbursement of such funds to the owners of the mortgage loans; the FHLBank classifies these items as other interest bearing deposits.
The following table details interest bearing and non-interest bearing deposits with the FHLBank at the dates indicated (in thousands):
                     
    September 30, 2009   December 31, 2008
 
                   
Interest bearing:
                   
Demand and overnight
    $ 1,563,508       $ 1,074,138  
Term
      78,050         94,150  
Other
      23,695         24,305  
 
               
 
                   
Total interest bearing
      1,665,253         1,192,593  
 
               
 
                   
Non-interest bearing:
                   
Other
      4,195         868  
 
               
 
                   
Total non-interest bearing
      4,195         868  
 
               
 
                   
Total deposits
    $ 1,669,448       $ 1,193,461  
 
               
The average interest rates paid on interest bearing deposits were 0.10 percent and 1.79 percent in the three months ended September 30, 2009 and 2008, respectively, and 0.12 percent and 2.18 percent in the nine months ended September 30, 2009 and 2008, respectively.
Aggregate time deposits with a denomination of $100 thousand or more were (in thousands) $77,950 and $94,050 as of September 30, 2009 and December 31, 2008.

28


Table of Contents

Note 11—Consolidated Obligations
Redemption Terms. The following is a summary of the FHLBank’s participation in Consolidated Bonds outstanding at the dates indicated by year of contractual maturity (dollars in thousands):
                                                           
    September 30, 2009     December 31, 2008  
            Weighted             Weighted  
            Average             Average  
            Interest             Interest  
Year of Contractual Maturity   Amount     Rate     Amount     Rate  
 
                               
Due in 1 year or less
  $ 14,067,600       2.12 %   $ 17,162,400       3.02 %
Due after 1 year through 2 years
    6,899,750       2.30       5,271,000       3.98  
Due after 2 years through 3 years
    5,767,000       3.22       5,316,750       4.03  
Due after 3 years through 4 years
    4,378,450       3.60       3,805,000       4.57  
Due after 4 years through 5 years
    2,534,000       3.85       3,090,450       4.40  
Thereafter
    7,197,000       4.53       7,317,000       5.15  
Index amortizing notes
    216,747       4.99       251,757       4.99  
 
                           
 
                               
Total par value
    41,060,547       3.01       42,214,357       3.89  
 
                               
Premiums
    35,326               35,868          
Discounts
    (29,712 )             (35,726 )        
Deferred net loss on terminated hedges
    659               1,496          
Hedging adjustments
    135,796               176,790          
 
                           
 
                               
Total
  $ 41,202,616             $ 42,392,785          
 
                           
The FHLBank’s Consolidated Bonds outstanding at the dates indicated included (in thousands):
                     
    September 30, 2009   December 31, 2008
Par amount of Consolidated Bonds:
                   
Non-callable
    $ 28,588,947       $ 30,239,957  
Callable
      12,471,600         11,974,400  
 
               
 
                   
Total par value
    $ 41,060,547       $ 42,214,357  
 
               
The following table summarizes Consolidated Bonds outstanding at the dates indicated by year of contractual maturity or next call date (in thousands):
                                 
            Percent           Percent
Year of Contractual Maturity or Next Call Date September 30, 2009   of Total   December 31, 2008   of Total
 
                               
Due in 1 year or less
  $ 24,493,600       60 %   $ 28,372,400       67 %
Due after 1 year through 2 years
    7,884,750       19       4,786,000       11  
Due after 2 years through 3 years
    3,112,000       8       2,396,750       6  
Due after 3 years through 4 years
    2,513,450       6       2,430,000       6  
Due after 4 years through 5 years
    1,193,000       3       1,815,450       4  
Thereafter
    1,647,000       4       2,162,000       5  
Index amortizing notes
    216,747       -       251,757       1  
 
                       
 
                               
Total par value
  $ 41,060,547       100 %   $ 42,214,357       100 %
 
                       

29


Table of Contents

Interest Rate Payment Terms. The following table details Consolidated Bonds by interest rate payment type (in thousands):
                     
    September 30, 2009   December 31, 2008
Par value of Consolidated Bonds:
                   
Fixed-rate
    $ 39,289,947       $ 35,789,957  
Variable-rate
      1,770,600         6,424,400  
 
               
 
                   
Total par value
    $ 41,060,547       $ 42,214,357  
 
               
Consolidated Discount Notes. Consolidated Discount Notes are issued to raise short-term funds. Discount Notes are Consolidated Obligations with original maturities up to one year. These notes are issued at less than their face amount and redeemed at par value when they mature. The FHLBank’s participation in Consolidated Discount Notes was as follows (dollars in thousands):
                                                 
                    Weighted Average
    Book Value     Par Value     Interest Rate (1)
 
September 30, 2009
  $ 29,169,806     $ 29,173,794       0.16 %
 
                   
December 31, 2008
  $ 49,335,739     $ 49,388,776       0.79 %
 
                   
  (1)   Represents an implied rate.
Note 12—Affordable Housing Program (AHP)
The following table presents changes in the AHP liability for the nine months ended September 30, 2009 (in thousands):
         
Balance at December 31, 2008
  $ 102,615  
Expense (current year additions)
    24,972  
Subsidy uses, net
    (22,443 )
 
     
 
Balance at September 30, 2009
  $ 105,144  
 
     
Note 13—Capital
The following table demonstrates the FHLBank’s compliance with the Finance Agency’s capital requirements at the dates indicated (dollars in thousands):
                                 
    September 30, 2009     December 31, 2008  
    Required     Actual     Required     Actual  
Regulatory capital requirements:
                               
Risk-based capital
  $ 580,517     $ 4,152,158     $ 542,630     $ 4,399,053  
Capital-to-assets ratio
    4.00%     5.39%     4.00%     4.48%
Regulatory capital
  $ 3,079,342     $ 4,152,158     $ 3,928,243     $ 4,399,053  
Leverage capital-to-assets ratio
    5.00%     8.09%     5.00%     6.72%
Leverage capital
  $ 3,849,178     $ 6,228,237     $ 4,910,303     $ 6,598,580  

30


Table of Contents

As of September 30, 2009 and December 31, 2008, the FHLBank had (in thousands) $87,415 and $110,909 in capital stock classified as mandatorily redeemable capital stock on its Statements of Condition. At the dates indicated, these balances were comprised as follows:
                                 
    September 30, 2009     December 31, 2008  
    Number of           Number of    
    Stockholders   Amount     Stockholders   Amount  
Capital stock subject to mandatory redemption due to:
                               
Withdrawals(1)
    17     $ 87,415       15     $ 110,679  
Other redemptions
    -       -       1       230  
 
                           
 
                               
Total
    17     $ 87,415       16     $ 110,909  
 
                           
  (1)   Withdrawals primarily include members that attain non-member status by merger or acquisition, charter termination, or involuntary termination of membership.
The following table provides the dollar amounts for activities recorded in mandatorily redeemable capital stock for the noted period as follows (in thousands):
         
Balance, December 31, 2008
$   110,909  
Capital stock subject to mandatory redemption reclassified from equity:
       
Withdrawals
    15,182  
Other redemptions
    375,616  
Redemption (or other reduction) of mandatorily redeemable capital stock:
       
Withdrawals
    (38,446 )
Other redemptions
    (375,846 )
 
     
 
       
Balance, September 30, 2009
  $ 87,415  
 
     
The following table shows the amount of mandatorily redeemable capital stock by year of redemption at the dates indicated (in thousands):
                               
Contractual Year of Redemption   September 30, 2009   December 31, 2008
Due in 1 year or less
  $ 5,268     $ 335  
Due after 1 year through 2 years
    8,694       7,043  
Due after 2 years through 3 years
    48,896       7,524  
Due after 3 years through 4 years
    9,335       83,057  
Due after 4 years through 5 years
    15,222       12,950  
 
           
Total par value
  $ 87,415     $ 110,909  
 
           
Capital Concentration. The following table presents holdings of five percent or more of the FHLBank’s total Class B stock, including mandatorily redeemable capital stock, outstanding at the dates indicated and includes stock held by any known affiliates that are members of the FHLBank (dollars in millions):

                                   
September 30, 2009
            Percent
Name   Balance   of Total
     
 
               
U.S. Bank, N.A.
  $ 591       16 %
National City Bank
    404       11  
Fifth Third Bank
    401       11  
The Huntington National Bank
    241       6  
 
             
 
               
Total
  $    1,637       44 %
 
             
                                   
December 31, 2008
            Percent
Name   Balance   of Total
     
 
               
U.S. Bank, N.A.
  $ 841       21 %
National City Bank
    404       10  
Fifth Third Bank
    394       10  
The Huntington National Bank
    241       6  
AmTrust Bank
    223       5  
 
             
 
               
Total
  $    2,103       52 %
 
             


31


Table of Contents

Note 14—Comprehensive Income
The following table shows the FHLBank’s comprehensive income for the three and nine months ended September 30, 2009 and 2008 (in thousands):
                                        
  Three Months Ended September 30,   Nine Months Ended September 30,
    2009     2008     2009     2008  
 
                                 
Net income
  $      61,489     $      66,092       $ 219,263     $ 180,122  
 
                                 
Other comprehensive income:
                                 
Net unrealized gain (loss) on available-for-sale securities
    510       (1,438 )       534       (1,438 )
Pension and postretirement benefits
    311       129         624       479  
 
                         
Total other comprehensive income
    821       (1,309 )       1,158       (959 )
 
                         
 
                                 
Total comprehensive income
  $ 62,310     $ 64,783       $ 220,421     $ 179,163  
 
                         
Note 15—Employee Retirement Plans
The FHLBank participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra Defined Benefit Plan), a tax-qualified defined benefit pension plan. The Plan covers substantially all officers and employees of the FHLBank. Funding and administrative costs of the Pentegra Defined Benefit Plan charged to other operating expenses were $844,000 and $697,000 in the three months ended September 30, 2009 and 2008, respectively, and $2,471,000 and $2,308,000 in the nine months ended September 30, 2009 and 2008, respectively.
The FHLBank also participates in the Pentegra Defined Contribution Plan for Financial Institutions, a tax-qualified defined contribution pension plan. The FHLBank contributes a percentage of the participants’ compensation by making a matching contribution equal to a percentage of voluntary employee contributions, subject to certain limitations. The FHLBank contributed $133,000 and $125,000 to this Plan in the three months ended September 30, 2009 and 2008, respectively, and $591,000 and $520,000 in the nine months ended September 30, 2009 and 2008, respectively.
The FHLBank has a Benefit Equalization Plan (BEP). The BEP is a non-qualified supplemental retirement plan which restores those pension benefits that would be available under the qualified plans (both defined benefit and defined contribution features) were it not for legal limitations on such benefits. The FHLBank also sponsors a fully insured postretirement benefits program that includes health care and life insurance benefits for eligible retirees.
The FHLBank’s contributions to the defined contribution feature of the BEP use the same matching rules as the qualified defined contribution plan discussed above as well as the market related earnings. The FHLBank’s contributions for the three and nine months ended September 30 were (in thousands):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
 
                               
Matching contributions
  $ 25     $ 26     $ 92     $ 93  
Market related earnings (losses)
    514       (225 )     667       (488 )
 
                       
Net
  $ 539     $ (199 )   $ 759     $ (395 )
 
                       

32


Table of Contents

Components of the net periodic benefit cost for the defined benefit feature of the BEP and the postretirement benefits plan for the three and nine months ended September 30 were (in thousands):
                                 
    Three Months Ended September 30,  
                    Postretirement  
    BEP     Benefits Plan  
    2009     2008     2009     2008  
Net Periodic Benefit Cost
                               
Service cost
  $ 157     $ 130     $ 14     $ 12  
Interest cost
    337       259       48       46  
Amortization of unrecognized net loss
    311       129       -       -  
 
                       
Net periodic benefit cost
  $ 805     $ 518     $ 62     $ 58  
 
                       
                                 
    Nine Months Ended September 30,  
                    Postretirement  
    BEP     Benefits Plan  
    2009     2008     2009     2008  
Net Periodic Benefit Cost
                               
Service cost
  $ 377     $ 296     $ 43     $ 37  
Interest cost
    884       748       144       136  
Amortization of unrecognized net loss
    624       479       -       -  
 
                       
Net periodic benefit cost
  $ 1,885     $ 1,523     $ 187     $ 173  
 
                       

33


Table of Contents

Note 16—Segment Information
The FHLBank has identified two primary operating segments based on its method of internal reporting: Traditional Member Finance and the Mortgage Purchase Program. These segments reflect the FHLBank’s two primary Mission Asset Activities and the manner in which they are managed from the perspective of development, resource allocation, product delivery, pricing, credit risk and operational administration. The segments identify the primary ways the FHLBank provides services to member stockholders.
The following tables set forth the FHLBank’s financial performance by operating segment for the three and nine months ended September 30, 2009 and 2008 (in thousands):
                                 
    Three Months Ended September 30,  
    Traditional Member     Mortgage Purchase        
      Finance         Program       Total  
2009
                               
Net interest income
    $ 65,073         $ 26,033            $     91,106  
Other income
      4,112           3,020         7,132  
Other expenses
      12,007           2,172         14,179  
 
                         
 
                               
Income before assessments
      57,178           26,881         84,059  
 
                         
 
                               
Affordable Housing Program
      5,003           2,194         7,197  
REFCORP
      10,435           4,938         15,373  
 
                         
 
                               
Total assessments
      15,438           7,132         22,570  
 
                         
 
                               
Net income
    $ 41,740         $ 19,749       $ 61,489  
 
                         
 
                               
Average assets
    $ 71,248,065         $ 9,807,156       $ 81,055,221  
 
                         
 
                               
Total assets
    $ 67,204,184         $ 9,779,378       $ 76,983,562  
 
                         
 
                               
2008
                               
Net interest income
    $ 73,758         $ 18,210       $ 91,968  
Other income
      12,017           3         12,020  
Other expenses
      12,016           1,815         13,831  
 
                         
 
                               
Income before assessments
      73,759           16,398         90,157  
 
                         
 
                               
Affordable Housing Program
      6,205           1,338         7,543  
REFCORP
      13,510           3,012         16,522  
 
                         
 
                               
Total assessments
      19,715           4,350         24,065  
 
                         
 
                               
Net income
    $ 54,044         $ 12,048       $ 66,092  
 
                         
 
                               
Average assets
    $ 86,100,391         $ 8,610,778       $ 94,711,169  
 
                         
 
                               
Total assets
    $ 88,714,455         $ 8,568,614       $ 97,283,069  
 
                         

34


Table of Contents

                                       
      Nine Months Ended September 30,  
      Traditional Member     Mortgage Purchase        
        Finance         Program       Total  
2009
                                           
Net interest income
      $      218,257         $      94,393       $      312,650  
Other income (loss)
        26,299           (1,142 )       25,157  
Other expenses
        33,033           5,723         38,756  
 
                           
 
                                 
Income before assessments
        211,523           87,528         299,051  
 
                           
 
                                 
Affordable Housing Program
        17,827           7,145         24,972  
REFCORP
        38,739           16,077         54,816  
 
                           
 
                                 
Total assessments
        56,566           23,222         79,788  
 
                           
 
                                 
Net income
      $ 154,957         $ 64,306       $ 219,263  
 
                           
 
                                 
Average assets
      $ 77,593,865         $ 9,602,215       $ 87,196,080  
 
                           
 
                                 
Total assets
      $ 67,204,184         $ 9,779,378       $ 76,983,562  
 
                           
 
                                 
2008
                                 
Net interest income
      $ 203,871         $ 63,995       $ 267,866  
Other income (loss)
        16,588           (1,499 )       15,089  
Other expenses
        31,693           5,358         37,051  
 
                           
 
                                 
Income before assessments
        188,766           57,138         245,904  
 
                           
 
                                 
Affordable Housing Program
        16,088           4,664         20,752  
REFCORP
        34,535           10,495         45,030  
 
                           
 
                                 
Total assessments
        50,623           15,159         65,782  
 
                           
 
                                 
Net income
      $ 138,143         $ 41,979       $ 180,122  
 
                           
 
                                 
Average assets
      $ 84,503,576         $ 8,767,183       $ 93,270,759  
 
                           
 
                                 
Total assets
      $ 88,714,455         $ 8,568,614       $ 97,283,069  
 
                           

35


Table of Contents

Note 17—Fair Value Disclosures
The FHLBank records derivatives, trading securities and available-for-sale securities at fair value on the Statements of Condition. Fair value is a market-based measurement and is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date (an exit price). The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. In order to determine whether a transaction price represents the fair value (or exit price) of an asset or liability, the FHLBank must determine the unit of account, highest and best use, principal or most advantageous market for the asset or liability, and the market participants with whom the transaction would take place. These determinations allow the FHLBank to define the inputs for fair value. In general, the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition.
Fair Value Option. The fair value option provides an irrevocable option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not otherwise carried at fair value. It requires a company to display the fair value of those assets and liabilities for which it has chosen to use fair value on the face of the Statements of Condition. If the fair value option is elected, fair value is used for both the initial and subsequent measurement of the designated assets, liabilities and commitments, with the changes in fair value recognized in net income. The FHLBank did not elect to record any financial assets or financial liabilities at fair value during the nine months ended September 30, 2009.
Fair Value Hierarchy. The fair value hierarchy is used to prioritize the inputs of valuation techniques used to measure fair value. The inputs are evaluated and an overall level for the measurement is determined. This overall level is an indication of how market observable the fair value measurement is and defines the level of disclosure. Outlined below is the application of the fair value hierarchy to the FHLBank’s financial assets and financial liabilities that were carried at fair value at September 30, 2009.
Level 1 – defined as those instruments for which inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. An active market is a market in which the transactions for the instrument occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 – defined as those instruments for which inputs to the valuation methodology include quoted prices for similar instruments in active markets, and for which inputs are observable, either directly or indirectly, for substantially the full term of the financial instrument. The FHLBank’s trading securities, available-for-sale securities and derivative instruments are considered Level 2 instruments based on the inputs utilized to derive fair value.
Level 3 – defined as those instruments for which inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are those supported by little or no market activity or by the entity’s own assumptions.

36


Table of Contents

The FHLBank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The valuation techniques, inputs, and validation processes (as applicable) utilized by the FHLBank for the assets and liabilities carried at fair value at September 30, 2009 and December 31, 2008 on the Statements of Condition were as follows:
Trading securities: The FHLBank’s trading portfolio consists of discount notes issued by Freddie Mac and mortgage-backed securities issued by Ginnie Mae. Quoted market prices in active markets are not available for these securities. Therefore, the fair value of each discount note is determined using indicative fair values derived from a discounted cash flow methodology using market-observed inputs for the interest rate environment. For mortgage-backed securities, the FHLBank requests prices from four specific third-party vendors, and, depending on the number of prices received for each security, selects a median price as defined by the FHLBank’s methodology. The methodology also incorporates variance thresholds to assist in identifying prices that may require further review. In certain limited instances (i.e., prices remain outside of variance thresholds or there is no price available from the third-party services), the FHLBank could obtain a price from securities dealers or internally model a price that is deemed most appropriate after consideration of all relevant facts and circumstances that would be considered by market participants. The third-party vendors use price indications, which generally utilize processes that could include, but are not limited to, the following market observable components: trader inputs, calculated inputs, matrix development, and evaluation models. The third-party vendors derive the fair value from an option-adjusted spread or discounted cash flow methodology.
Available-for-sale securities: The FHLBank’s available-for-sale portfolio consists of certificates of deposit and bank notes. Quoted market prices in active markets are not available for these securities. Therefore, the fair value of each security is determined using indicative fair values derived from an option-adjusted discounted cash flow methodology using market-observed inputs for the interest rate environment and similar instruments.
The FHLBank performs several validation steps in order to verify the accuracy and reasonableness of these fair values. These steps may include, but are not limited to, a detailed review of instruments with significant periodic price changes and a comparison of the fair values received from multiple third-party sources.
Derivative assets/liabilities: The FHLBank’s derivative assets/liabilities consist of interest rate swaps, to-be-announced mortgage-backed securities and mortgage delivery commitments. The FHLBank’s interest rate swaps are not listed on an exchange. Therefore, the FHLBank determines the fair value of each individual interest rate swap using market value models that use readily observable market inputs as their basis (inputs that are actively quoted and can be validated to external sources). The FHLBank uses a mid-market pricing convention as a practical expedient for fair value measurements within a bid-ask spread. These models reflect the contractual terms of the interest rate swaps, including the period to maturity, and estimate fair value based on the LIBOR swap curve and forward rates at period end and, for agreements containing options, on market-based expectations of future interest rate volatility implied from current market prices for similar options. The estimated fair value uses the standard valuation technique of discounted cash flow analysis.
The FHLBank performs several validation steps to verify the reasonableness of the fair value output generated by the primary market value model. In addition to an annual model validation, the FHLBank prepares a monthly reconciliation of the model’s fair values to estimates of fair values provided by the derivative counterparties and to another third party model. The FHLBank believes these processes have provided a reasonable basis for it to place continued reliance on the derivative fair values generated by the primary model.
The fair value of to-be-announced mortgage-backed securities is based on independent indicative and/or quoted prices generated by market transactions involving comparable instruments. The FHLBank determines the fair value of mortgage delivery commitments using market prices from the TBA/mortgage-backed security market or TBA/Ginnie Mae market and adjusts them to reflect the contractual terms of the mortgage delivery commitments, similar to the mortgage loans held for portfolio process. The adjustments to the market prices are market observable, or can be corroborated with observable market data.
The FHLBank is subject to credit risk in derivatives transactions due to potential nonperformance by the derivatives counterparties. To mitigate this risk, the FHLBank enters into derivatives with highly-rated institutions and executes master netting agreements with its derivative counterparties. In addition, to limit the FHLBank’s net unsecured credit exposure to these counterparties, the FHLBank has entered into bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels tied to counterparty credit ratings. The FHLBank has

37


Table of Contents

evaluated the potential for the fair value of the instruments to be impacted by counterparty credit risk and has determined that no adjustments were significant or necessary to the overall fair value measurements at September 30, 2009.
Fair Value on a Recurring Basis. The following table presents for each hierarchy level, the FHLBank’s assets and liabilities that were measured at fair value on its Statements of Condition at the dates indicated (in thousands):
Fair Value Measurements at September 30, 2009 Using:
                            Netting        
                            Adjustment        
                            and Cash        
    Level 1     Level 2     Level 3     Collateral (1)     Total  
Assets
                                       
Trading securities:
                                       
Non mortgage-backed securities government-sponsored
enterprise debt
  $     -     $     2,249,755     $     -     $     -     $     2,249,755  
Other U.S. obligation residential mortgage-backed securities
    -       2,813       -       -       2,813  
Available-for-sale securities:
                                       
Certificates of deposit
    -       5,725,076       -       -       5,725,076  
Derivative assets
    -       203,179       -       (194,315 )     8,864  
 
                             
 
                                       
Total assets at fair value
  $     -     $     8,180,823     $     -     $     (194,315 )   $     7,986,508  
 
                             
 
                                       
Liabilities
                                       
Derivative liabilities
  $     -     $     (961,708 )   $     -     $     691,866     $     (269,842 )
 
                             
 
                                       
Total liabilities at fair value
  $     -     $     (961,708 )   $     -     $     691,866     $     (269,842 )
 
                             
Fair Value Measurements at December 31, 2008 Using:
                            Netting        
                            Adjustment        
                            and Cash        
    Level 1     Level 2     Level 3     Collateral (1)     Total  
Assets
                                       
Trading securities:
                                       
Other U.S. obligation residential mortgage-backed securities
  $     -     $     2,985     $     -     $     -     $     2,985  
Available-for-sale securities:
                                       
Certificates of deposit and bank notes
    -       2,511,630       -       -       2,511,630  
Derivative assets
    -       239,957       -       (222,647 )     17,310  
 
                             
 
                                       
Total assets at fair value
  $     -     $     2,754,572     $     -     $     (222,647 )   $     2,531,925  
 
                             
 
                                       
Liabilities
                                       
Derivative liabilities
  $     -     $     (1,238,018 )   $     -     $     951,542     $     (286,476 )
 
                             
 
                                       
Total liabilities at fair value
  $     -     $     (1,238,018 )   $     -     $     951,542     $     (286,476 )
 
                             
  (1)   Amounts represent the effects of legally enforceable master netting agreements that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties.
For instruments carried at fair value, the FHLBank reviews the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in/out of a level at fair value in the quarter in which the changes occur.

38


Table of Contents

Estimated Fair Values. The estimated fair value amounts shown on the following Fair Value Summary Table have been determined by the FHLBank using available market information and the FHLBank’s best judgment of appropriate valuation methods. These estimates are based on pertinent information available to the FHLBank as of September 30, 2009 and December 31, 2008. The estimated fair values reflect the FHLBank’s judgment of how a market participant would estimate the fair values. The Fair Value Summary Table does not represent an estimate of the overall market value of the FHLBank as a going concern, which would take into account future business opportunities and the net profitability of assets versus liabilities. The valuation techniques, inputs, and validation processes (as applicable) utilized by the FHLBank for the assets and liabilities at September 30, 2009 and December 31, 2008 on the Fair Value Summary Table were as follows:
Cash and due from banks: The estimated fair value approximates the recorded book balance.
Interest-bearing deposits and investment securities: The estimated fair value is determined based on each security’s quoted prices, excluding accrued interest, as of the last business day of the period.
Federal funds sold: The estimated fair value of overnight Federal funds approximates the recorded book balance. The estimated fair value of term Federal funds is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for Federal funds with similar terms, as approximated by adding an estimated current spread to the LIBOR swap curve for Federal funds with similar terms. The estimated fair value excludes accrued interest.
Held-to-maturity securities: The estimated fair value for each individual mortgage-backed security and collateralized mortgage obligation is obtained by requesting prices from four specific third-party vendors, and, depending on the number of prices received for each security, selecting a median price as defined by the FHLBank’s methodology. The methodology also incorporates variance thresholds to assist in identifying prices that may require further review. In certain limited instances (i.e., prices remain outside of variance thresholds or there is no price available from the third-party services), the FHLBank could obtain a price from securities dealers or internally model a price that is deemed most appropriate after consideration of all relevant facts and circumstances that would be considered by market participants. The third-party vendors use price indications, which generally utilize processes that could include, but are not limited to, the following market observable components: trader inputs, calculated inputs, matrix development, and evaluation models. The third-party vendors derive the fair value from an option-adjusted spread or discounted cash flow methodology. The estimated fair value excludes accrued interest. The estimated fair value for taxable municipal bonds is determined based on each security’s indicative market price obtained from a third-party vendor excluding accrued interest. The FHLBank uses various techniques to validate the fair values received from third-party vendors for accuracy and reasonableness.
Advances: The FHLBank determines the estimated fair value of Advances by calculating the present value of expected future cash flows from the Advances excluding accrued interest. The discount rates used in these calculations are the replacement rates for Advances with similar terms, as approximated either by adding an estimated current spread to the LIBOR swap curve or by using current indicative market yields, as indicated by the FHLBank’s Advance pricing methodologies for Advances with similar current terms. Advance pricing is determined based on the FHLBank’s rates on Consolidated Obligations. In accordance with Finance Agency Regulations, Advances with a maturity and repricing period greater than six months require a prepayment fee sufficient to make the FHLBank financially indifferent to the borrower’s decision to prepay the Advances. Therefore, the estimated fair value of Advances does not assume prepayment risk.
For swapped option-based Advances, the estimated fair value is determined (independently of the related derivative) by the discounted cash flow methodology based on the LIBOR swap curve and forward rates at the end of the period adjusted for the estimated current spread on new swapped Advances to the swap curve. For swapped Advances with a conversion option, the conversion option is valued by taking into account the LIBOR swap curve and forward rates at the end of the period and the market’s expectations of future interest rate volatility implied from current market prices of similar options.

39


Table of Contents

Mortgage loans held for portfolio, net: The estimated fair values of mortgage loans are determined based on quoted market prices offered to approved members as indicated by the FHLBank’s Mortgage Purchase Program pricing methodologies for mortgage loans with similar current terms excluding accrued interest. The quoted prices offered to members are based on Fannie Mae price indications on to-be-announced mortgage-backed securities and FHA price indications on government-guaranteed loans; the FHLBank then adjusts these indicative prices to account for particular features of the FHLBank’s Mortgage Purchase Program that differ from the Fannie Mae and FHA securities. These features include, but may not be limited to:
  §   the Mortgage Purchase Program’s credit enhancements;
 
  §   marketing adjustments that reflect the FHLBank’s cooperative business model, and preferences for particular kinds of loans and mortgage note rates.
These prices, however, can change rapidly based upon market conditions and are highly dependent upon the underlying prepayment assumptions.
Accrued interest receivable and payable: The estimated fair value approximates the recorded book value.
Deposits: The FHLBank determines the estimated fair value of FHLBank deposits with fixed rates by calculating the present value of expected future cash flows from the deposits and reducing this amount for accrued interest payable. The discount rates used in these calculations are the cost of deposits with similar terms.
Consolidated Obligations: The FHLBank determines the estimated fair value of Discount Notes by calculating the present value of expected future cash flows from the Discount Notes excluding accrued interest. The discount rates used in these calculations are current replacement rates for Discount Notes with similar current terms, as approximated by adding an estimated current spread to the LIBOR swap curve. Each month’s cash flow is discounted at that month’s replacement rate.
The FHLBank determines the estimated fair value of non-callable Consolidated Obligation Bonds (both unswapped and swapped) by calculating the present value of scheduled future cash flows from the bonds excluding accrued interest. The discount rates used in these calculations are estimated current market yields, as indicated by the Office of Finance, for bonds with similar current terms.
The FHLBank determines the estimated fair value of callable Consolidated Obligation Bonds (both unswapped and swapped) by calculating the present value of expected future cash flows from the bonds excluding accrued interest. The estimated fair value is determined by the discounted cash flow methodology based on the LIBOR swap curve and forward rates adjusted for the estimated spread on new callable bonds to the swap curve and based on the market’s expectations of future interest rate volatility implied from current market prices of similar options.
Adjustments may be necessary to reflect the 12 FHLBanks’ credit quality when valuing Consolidated Obligation Bonds measured at fair value. Due to the joint and several liability of Consolidated Obligations, the FHLBank monitors its own creditworthiness and the creditworthiness of the other FHLBanks to determine whether any credit adjustments are necessary in its fair value measurement of Consolidated Obligation Bonds. The credit ratings of the FHLBanks and any changes to these credit ratings are the basis for the FHLBanks to determine whether the fair values of Consolidated Obligation Bonds have been significantly affected during the reporting period by changes in the instrument-specific credit risk. The FHLBank had no adjustment during the nine months ended September 30, 2009.
Mandatorily redeemable capital stock: The fair value of capital subject to mandatory redemption is par value for the dates indicated as indicated by member contemporaneous purchases and sales at par value. FHLBank stock can only be acquired by members at par value and redeemed at par value. FHLBank stock is not traded and no market mechanism exists for the exchange of stock outside the cooperative structure. 
Commitments: The estimated fair value of the FHLBank’s commitments to extend credit is determined using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The estimated fair value of Standby Letters of Credit is based on the present value of fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. The estimated fair value of standby bond purchase agreements is based on the present value of the estimated fees taking into account the remaining terms of the agreements.

40


Table of Contents

Subjectivity of estimates. Estimates of the fair value of Advances with options, mortgage instruments, derivatives with embedded options and bonds with options using the methods described above and other methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows, prepayment speeds, interest rate volatility, distributions of future interest rates used to value options, and discount rates that appropriately reflect market and credit risks. The judgments also include the parameters, methods, and assumptions used in models to value the options. Changes in these judgments often have a material effect on the fair value estimates. Since these estimates are made as of a specific point in time, they are susceptible to material near term changes.
The carrying values and estimated fair values of the FHLBank’s financial instruments at September 30, 2009 and December 31, 2008 were as follows (in thousands):
FAIR VALUE SUMMARY TABLE
                                 
    September 30, 2009     December 31, 2008  
    Carrying     Estimated     Carrying     Estimated  
Financial Instruments   Value     Fair Value     Value     Fair Value  
 
                               
Assets:
                               
Cash and due from banks
  $ 2,733,228     $ 2,733,228     $ 2,867     $ 2,867  
Interest-bearing deposits
    166       166       19,906,234       19,906,234  
Federal funds sold
    5,775,000       5,775,000       -       -  
Trading securities
    2,252,568       2,252,568       2,985       2,985  
Available-for-sale securities
    5,725,076       5,725,076       2,511,630       2,511,630  
Held-to-maturity securities
    12,471,895       12,947,773       12,904,200       13,163,337  
Advances
    38,082,056       38,298,971       53,915,972       54,150,919  
Mortgage loans held for portfolio, net
    9,736,249       10,062,477       8,631,873       8,888,577  
Accrued interest receivable
    161,166       161,166       275,560       275,560  
Derivative assets
    8,864       8,864       17,310       17,310  
 
                               
Liabilities:
                               
Deposits
    (1,669,448 )     (1,669,669 )     (1,193,461 )     (1,193,818 )
Consolidated Obligations:
                               
Discount Notes
    (29,169,806 )     (29,171,619 )     (49,335,739 )     (49,383,752 )
Bonds
    (41,202,616 )     (42,042,752 )     (42,392,785 )     (43,298,966 )
Mandatorily redeemable capital stock
    (87,415 )     (87,415 )     (110,909 )     (110,909 )
Accrued interest payable
    (290,706 )     (290,706 )     (394,346 )     (394,346 )
Derivative liabilities
    (269,842 )     (269,842 )     (286,476 )     (286,476 )
 
                               
Other:
                               
Commitments to extend credit for Advances
    -       -       -       284  
Standby bond purchase agreements
    -       2,174       -       2,155  

41


Table of Contents

Note 18—Commitments and Contingencies
During the third quarter of 2008, the FHLBank entered into a Lending Agreement with the U.S. Treasury in connection with the U.S. Treasury’s establishment of the Government Sponsored Enterprise Credit Facility (GSECF), as authorized by HERA. As of September 30, 2009, the FHLBank had provided the U.S. Treasury with listings of Advance collateral amounting to $19.0 billion, which provides for maximum borrowings of $16.8 billion. The 12 FHLBanks have joint and several liability for any liquidity accessed by an FHLBank under the GSECF. Neither the FHLBank nor any of the other FHLBanks had drawn on this available source of liquidity as of September 30, 2009.
The following table sets forth the FHLBank’s commitments at the dates indicated (in thousands):
                 
    September 30, 2009   December 31, 2008
Commitments to fund additional Advances
  $ -     $ 4,541  
Mandatory Delivery Contracts for mortgage loans
    126,566       917,435  
Forward rate agreements
    -       386,000  
Outstanding Standby Letters of Credit
    5,564,203       7,916,613  
Consolidated Obligations – committed to, not settled (par value) (1)
    385,300       225,000  
Standby bond purchase agreements (principal)
    411,965       413,125  
(1) At September 30, 2009, $165 million of these commitments were hedged with associated interest rate swaps.
In addition, the 12 FHLBanks have joint and several liability for the par amount of all of the Consolidated Obligations issued on their behalves. The par amounts of the outstanding Consolidated Obligations of all 12 FHLBanks were $973.6 billion and $1,251.5 billion at September 30, 2009 and December 31, 2008, respectively.
Note 19—Transactions with Other FHLBanks
The FHLBank notes all transactions with other FHLBanks on the face of its financial statements. Occasionally, the FHLBank loans short-term funds to and borrows short-term funds from other FHLBanks. These loans and borrowings are transacted at then current market rates when traded. There were no such loans or borrowings outstanding at September 30, 2009 or December 31, 2008. Additionally, the FHLBank occasionally invests in Consolidated Discount Notes issued on behalf of another FHLBank. These investments are purchased in the open market from third parties and are accounted for in the same manner as other similarly classified investments. There were no such investments outstanding at September 30, 2009 or December 31, 2008. The following table details the average daily balance of lending, borrowing and investing between the FHLBank and other FHLBanks for the nine months ended September 30 (in thousands):
                 
    Average Daily Balances  
    2009     2008  
Loans to other FHLBanks
  $ 14,037     $ 14,792  
 
               
Borrowings from other FHLBanks
    1,832       -  
 
               
Investments in other FHLBanks
    9,092       -  
The FHLBank may, from time to time, assume the outstanding primary liability for Consolidated Obligations of another FHLBank (at then current market rates on the day when the transfer is traded) rather than issue new debt for which the FHLBank is the primary obligor. The FHLBank then becomes the primary obligor on the transferred debt. There were no Consolidated Obligations transferred to the FHLBank during the nine months ended September 30, 2009. During the nine months ended September 30, 2008, the par amounts of the liability on Consolidated Obligations transferred to the FHLBank totaled (in thousands) $265,000, being (in thousands) $150,000 transferred by the FHLBank of Dallas and $115,000 transferred by the FHLBank of Chicago. The net premiums associated with these transactions were (in thousands) $6,988 during the nine months ended September 30, 2008. The FHLBank did not transfer any Consolidated Obligations to other FHLBanks during these periods.

42


Table of Contents

Note 20—Transactions with Stockholders
Transactions with Directors’ Financial Institutions. In the ordinary course of its business, the FHLBank may provide products and services to members whose officers or directors serve as directors of the FHLBank (Directors’ Financial Institutions). Finance Agency regulations require that transactions with Directors’ Financial Institutions be made on the same terms as those with any other member. The following table reflects balances with Directors’ Financial Institutions for the items indicated below at the dates indicated (dollars in millions):
                                 
    September 30, 2009   December 31, 2008
    Balance     % of Total (1)   Balance     % of Total (1)
Advances
  $ 1,210       3.2 %   $ 734       1.4 %
Mortgage Purchase Program
    110       1.1       29       0.3  
Mortgage-backed securities
    -       -       -       -  
Regulatory capital stock
    179       4.8       61       1.5  
Derivatives
    -       -       -       -  
  (1)   Percentage of total principal (Advances), unpaid principal balance (Mortgage Purchase Program), principal balance (mortgage-backed securities), regulatory capital stock, and notional balances (derivatives).
Concentrations. The following tables show regulatory capital stock balances, outstanding Advance principal balances, and unpaid principal balances of Mortgage Loans Held for Portfolio at the dates indicated to members and former members holding five percent or more of regulatory capital stock and include any known affiliates that are members of the FHLBank (dollars in millions):
                                       
    Regulatory         Mortgage Purchase
    Capital Stock   Advance   Program Unpaid
September 30, 2009
  Balance   % of Total   Principal   Principal Balance
 
U. S. Bank, N.A.
  $ 591       16 %   $ 10,315     $ 99  
National City Bank
    404       11       4,409       3,763  
Fifth Third Bank
    401       11       2,038       12  
The Huntington National Bank
    241       6       921       289  
 
                         
 
                               
Total
  $ 1,637       44 %   $ 17,683     $ 4,163  
 
                         
                                 
    Regulatory         Mortgage Purchase
    Capital Stock   Advance   Program Unpaid
December 31, 2008
  Balance   % of Total   Principal   Principal Balance
 
U. S. Bank, N.A.
  $ 841       21 %   $ 14,856     $ 116  
National City Bank
    404       10       6,435       4,709  
Fifth Third Bank
    394       10       5,639       15  
The Huntington National Bank
    241       6       2,590       310  
AmTrust Bank
    223       5       2,338       -  
 
                         
 
                               
Total
  $ 2,103       52 %   $ 31,858     $ 5,150  
 
                         

43


Table of Contents

Non-member Affiliates. The FHLBank has relationships with two non-member affiliates, the Kentucky Housing Corporation and the Ohio Housing Finance Agency. The nature of these relationships is twofold: one as an approved borrower from the FHLBank and one in which the FHLBank invests in the purchase of these non-members’ bonds. The Kentucky Housing Corporation and the Ohio Housing Finance Agency had no borrowings during the nine months ended September 30, 2009 or 2008. The FHLBank had principal investments in the bonds of the Kentucky Housing Corporation of $11,185,000 and $12,075,000 as of September 30, 2009 and December 31, 2008, respectively. The FHLBank did not have any investments in the bonds of the Ohio Housing Finance Agency as of September 30, 2009 and December 31, 2008. Charles J. Ruma, a Director of the FHLBank, serves on the board of the Ohio Housing Finance Agency. The FHLBank did not have any investments in or borrowings extended to any other non-member affiliates during the nine months ended September 30, 2009 or 2008.

44


Table of Contents

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This document contains forward-looking statements that describe the objectives, expectations, estimates, and assessments of the FHLBank. These statements use words such as “anticipates,” “expects,” “believes,” “could,” “estimates,” “may,” and “should.” By their nature, forward-looking statements relate to matters involving risks or uncertainties, some of which we may not be able to know, control, or completely manage. Actual future results could differ materially from those expressed or implied in forward-looking statements or could affect the extent to which we are able to realize an objective, expectation, estimate, or assessment. Some of the risks and uncertainties that could affect our forward-looking statements include the following:
     
  § the effects of economic, financial, credit, market, and member conditions on our financial condition and results of operations, including changes in economic growth, general liquidity conditions, interest rates, interest rate spreads, interest rate volatility, mortgage originations, prepayment activity, housing prices, asset delinquencies, and members’ mergers and consolidations, deposit flows, liquidity needs, and loan demand;
 
  § political events, including legislative, regulatory, federal government, judicial or other developments that could affect us, our members, our counterparties, other FHLBanks and other government-sponsored enterprises, and/or investors in the FHLBank System’s Consolidated Obligations;
 
  § competitive forces, including those related to other sources of funding available to members, to purchases of mortgage loans, and to our issuance of Consolidated Obligations;
 
  § the financial results and actions of other FHLBanks that could affect our ability, in relation to the System’s joint and several liability for Consolidated Obligations, to access the capital markets on favorable terms or preserve our profitability, or could alter the regulations and legislation to which we are subject;
 
  § changes in investor demand for Consolidated Obligations;
 
  § the volatility of market prices, interest rates, credit quality, and other indices that could affect the value of investments and collateral we hold as security for member obligations and/or for counterparty obligations;
 
  § the ability to attract and retain skilled individuals;
 
  § the ability to sufficiently develop and support technology and information systems to effectively manage the risks we face;
 
  § the ability to successfully manage new products and services;
 
  § the risk of loss arising from litigation filed against us or one or more of the other FHLBanks; and
 
  § inflation and deflation.
The FHLBank does not undertake any obligation to update any forward-looking statements made in this document.
In this filing, the interrelated disruptions in 2008’s and 2009’s financial, credit, housing, capital, and mortgage markets are referred to generally as the “financial crisis.”

45


Table of Contents

EXECUTIVE OVERVIEW
Organizational Structure and Business Activities
The Federal Home Loan Bank of Cincinnati (FHLBank) is a regional wholesale bank that provides financial products and services to our member financial institutions. We are one of 12 District Banks in the Federal Home Loan Bank System (FHLBank System); our region, known as the Fifth District, comprises Kentucky, Ohio and Tennessee. Each District Bank is a government-sponsored enterprise (GSE) of the United States of America and operates as a separate entity with its own stockholders, employees, and Board of Directors. A GSE combines private sector ownership with public sector sponsorship. The FHLBanks are not government agencies but are exempt from federal, state, and local taxation (except real property taxes). The U.S. government does not guarantee the debt securities or other obligations of the FHLBank System. In addition to being GSEs, the FHLBanks are cooperative institutions. This means that private-sector financial institutions voluntarily become members of our FHLBank and purchase our capital stock in order to gain access to products and services. Only members can purchase our capital stock.
Our FHLBank’s mission is to provide financial intermediation between our member stockholders and the capital markets in order to facilitate and expand the availability of financing for housing and community lending throughout the Fifth District. We achieve our mission through a cooperative business model. We raise private-sector capital from our member stockholders and issue high-quality debt in the worldwide capital markets in conjunction with other FHLBanks to provide members with competitive services—primarily a reliable, readily available, low-cost source of funds called Advances—and a competitive return on their FHLBank capital investment through quarterly dividend payments. An important component of our mission is supporting members in their efforts to assist lower-income housing markets.
The FHLBank System also includes the Federal Housing Finance Agency (Finance Agency) and the Office of Finance. The Finance Agency is an independent agency in the executive branch of the U.S. government that regulates the FHLBanks, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The Finance Agency also oversees the conservatorships of Fannie Mae and Freddie Mac. The Office of Finance is a joint office of the District Banks established by the Finance Agency to facilitate the issuing and servicing of the FHLBank System’s debt securities (called Consolidated Obligations or Obligations).

46


Table of Contents

Financial Condition
Mission Asset Activity
The following table summarizes our financial condition.
                                                 
    Ending Balances     Average Balances  
                            Nine Months Ended     Year Ended  
    September 30,     December 31,     September 30,     December 31,  
(Dollars in millions)   2009     2008     2008     2009     2008     2008  
 
                                               
Advances (principal)
  $ 37,254     $ 62,580     $ 52,799     $ 46,058     $ 60,441     $ 59,973  
 
                                               
Mortgage Purchase Program:
                                               
 
                                               
Mortgage loans held for
portfolio (principal)
    9,650       8,462       8,590       9,489       8,661       8,621  
 
                                               
Mandatory Delivery
Contracts (notional)
    126       178       917       705       141       182  
             
 
                                               
Total Mortgage Purchase Program
    9,776       8,640       9,507       10,194       8,802       8,803  
 
                                               
Letters of Credit (notional)
    5,564       8,023       7,917       6,057       7,824       7,894  
             
 
                                               
Total Mission Asset Activity
  $ 52,594     $ 79,243     $ 70,223     $ 62,309     $ 77,067     $ 76,670  
             
 
                                               
Retained earnings
  $ 407     $ 319     $ 326     $ 398     $ 327     $ 335  
 
                                               
Capital-to-assets ratio
    5.27 %     4.40 %     4.36 %     4.98 %     4.36 %     4.37 %
 
                                               
Regulatory capital-to-assets ratio (1)
    5.39       4.54       4.48       5.16       4.50       4.51  
     (1) See the “Capital Resources” section for further description of regulatory capital.
The trends in our financial condition that began in the fourth quarter of 2008 continued in the first nine months of 2009. The ending and average balances of Mission Asset Activity—comprised of Advances, Letters of Credit, and the Mortgage Purchase Program—decreased in each of the first three quarters of 2009. Overall, Advances and Letters of Credit fell, while balances in the Mortgage Purchase Program increased.
Comparing September 30, 2009 to December 31, 2008, the total principal balance of Mission Asset Activity decreased $17,629 million (25 percent). The principal balance of Advances fell $15,545 million (29 percent), the notional principal of Letters of Credit fell $2,353 million (30 percent), and aggregate balances and commitments in the Mortgage Purchase Program grew $269 million (3 percent). The decrease in Advances was even larger (a 40 percent reduction) from September 30, 2008 to September 30, 2009 because Advance balances began to decrease in the fourth quarter of 2008 after they had reached record highs in October 2008. The decrease in Advances occurred broadly throughout our membership but was disproportionately represented by our larger members.

47


Table of Contents

We believe that Advance balances have decreased from their high point in 2008 for three reasons.
  §   The economic recession resulted in members’ slower loan growth in the second half of 2008 and a decrease in their loans outstanding in the first three quarters of 2009.
 
  §   There was a substantial increase in members’ retail deposits.
 
  §   The availability to members of new funding and liquidity options increased dramatically due to the various fiscal and monetary stimuli and financial guarantees initiated by the federal government, including most importantly the Federal Reserve System and Treasury Department, to combat the financial crisis and recession. In particular, new sources of government-induced liquidity through the Troubled Asset Relief Program (TARP) and the exponential increase in bank reserves initiated by the Federal Reserve have decreased demand for our Advances.
We expect Advance demand to remain weak until monetary policy tightens and an economic recovery begins with expansion of financial institutions’ lending.
Despite the decrease in Advance balances, we continued to fulfill our business role as an important provider of reliable and attractively priced wholesale funding to our members. Although various measures of market penetration have decreased this year, members overall continue to fund over five percent of their assets with our Advances. Our Advance business is cyclical, and we expect slower growth, if not a decrease, in an economic contraction, especially when combined with the extraordinary liquidity that the federal government has provided.
The total principal balance of the Mortgage Purchase Program grew in the first nine months of 2009 due to accelerated refinancing activity in response to lower mortgage rates, especially in the first quarter. The Program currently has strong member participation and interest. This was evidenced this year by the 23 members approved for the Program, with a similar number of additional applications currently being processed for approval, and an over 50 percent increase in regular sellers.
Based on the strong earnings in the first nine months of 2009, we accrued an additional $25 million for future use in the Affordable Housing Program, a $4 million increase over the same period in 2008. By regulation, we annually set aside 10 percent of net income before assessments for this Program. In addition, in April 2009, our Board authorized $5 million in commitments for two voluntary housing programs. We have disbursed more than $15 million of voluntary housing-related funds since 2003, which are over and above the statutory Affordable Housing requirements.
Capital
Our capital adequacy continued to be strong in the first nine months of 2009 and we maintained compliance with all of our regulatory and internal capital limits. Regulatory capital (which includes capital stock accounted for as a liability under mandatorily redeemable stock) at September 30, 2009 totaled $4,152 million, a $247 million (6 percent) decrease from year-end 2008. The decrease in capital resulted from our repurchase of $415 million of stock, most of which had been the subject of two members’ excess stock redemption requests. These repurchases were partially offset by required stock purchases from other members and increases in retained earnings. The regulatory capital-to-assets ratio at September 30 was 5.39 percent, well above the regulatory minimum of 4.00 percent and at a sufficient level to enable us to effectively manage our financial performance and risk exposures. Retained earnings, which totaled $407 million on September 30, grew $81 million (25 percent) in the first nine months. The business and market environment generated sufficient earnings for us to pay stockholders a competitive dividend return in each of the first three quarters as well as to retain a substantial portion of earnings to bolster our capitalization.

48


Table of Contents

Results of Operations
The table below summarizes our results for operations.
                                         
    Three Months     Nine Months     Year Ended  
    Ended September 30,   Ended September 30,   December 31,
(Dollars in millions)   2009     2008     2009     2008       2008  
 
                                       
Net income
  $ 61     $         66         $ 219     $         180         $         236      
 
                                       
Affordable Housing Program accrual
    7       8           25       21           27      
 
                                       
Return on average equity (ROE)
    5.70 %     6.26%     6.75 %     5.92%     5.73%
 
                                       
Return on average assets
    0.30       0.28           0.34       0.26           0.25      
 
                                       
Weighted average dividend rate
    5.00       5.50           4.67       5.42           5.31      
 
                                       
Average 3-month LIBOR
    0.41       2.91           0.83       2.98           2.92      
 
                                       
Average overnight Federal Funds effective rate
    0.15       1.94           0.17       2.40           1.92      
 
                                       
ROE spread to 3-month LIBOR
    5.29       3.35           5.92       2.94           2.81      
 
                                       
Dividend rate spread to 3-month LIBOR
    4.59       2.59           3.84       2.44           2.39      
 
                                       
ROE spread to Federal Funds effective rate
    5.55       4.32           6.58       3.52           3.81      
 
                                       
Dividend rate spread to Federal Funds effective rate
    4.85       3.56           4.50       3.02           3.39      
When short-term interest rates decline dramatically, as occurred in 2009, net income normally decreases. However, earnings in the nine months ended September 30, 2009 improved substantially over the same period of 2008, as net income grew $39 million (22 percent) and ROE increased 0.83 percentage points. By contrast, in the third quarter of 2009 compared to the same period of 2008, net income fell $5 million (7 percent) and ROE decreased 0.56 percentage points.
The ROE spreads to 3-month LIBOR and overnight Federal funds are two market benchmarks we believe our stockholders use to assess the competitiveness of return on their capital investment in the FHLBank, which, along with access to our products and services, is a key source of membership value. These spreads in 2009 were significantly above those in the same periods of 2008.
There were four major reasons for the changes in earnings and profitability:
     
  § Beginning in late 2008 and continuing in the first nine months of 2009, in response to the decline in intermediate- and long-term interest rates, we retired before their final maturities approximately $14 billion of high-cost long-term debt (i.e., Consolidated Bonds), which we had issued mostly to fund mortgage assets, and replaced them with new Bonds at substantially lower costs.
 
  § Average portfolio spreads between short-term and adjustable-rate assets indexed to short-term LIBOR and their related funding costs were wider in the first nine months of 2009 than the same period in 2008 and wider than historical norms. The financial crisis raised the cost of inter-bank lending (represented by LIBOR) relative to other short-term interest costs such as our Discount Notes. We believe this cost differential indicated that, during the financial crisis, market participants viewed the System’s short-term debt as a lower risk investment than other short-term investments. Because we use Discount Notes to fund a large amount (normally between $10 billion and $20 billion) of our LIBOR-indexed Advances, earnings benefited from our relatively more favorable funding costs.
 
    In the third quarter of 2009, short-term LIBOR decreased, causing the spread between LIBOR and Discount Notes to revert back to, and even go below, historical average levels. We believe this was due to market participants’ view that the financial disruptions had eased and to the effects of the massive amounts of liquidity injected into the financial system. As a result, the higher profits from the wider LIBOR to Discount Note spreads dissipated during the third quarter.

49


Table of Contents

     
  § Market yield curves became significantly steeper as short-term interest rates fell to historical lows of close to zero. This benefited earnings due to our modest utilization of short-term debt to fund long-term assets. In addition, due to mismatches of principal paydowns of long-term assets versus liabilities, including muted acceleration of mortgage prepayments, the amount of short funding increased in the first three quarters of 2009.
 
  § There were other gains totaling approximately $14 million, most of which occurred in the first quarter of 2009, including: $6 million from the sale of $216 million of mortgage-backed securities; a $4 million increase in Advance prepayment fees; and a $4 million increase in net market value (primarily unrealized) relating to accounting for derivatives and hedging activities.
Several factors partially offset the favorable earnings drivers. Most significant was the extremely low short-term interest rate environment, which substantially decreased the amount of earnings generated from funding assets with our interest-free capital. For example, the benchmark 3-month LIBOR rate averaged 0.83 percent in the first nine months of 2009, compared to 2.98 percent for the same period in 2008. The positive earnings factors also were partially offset by a reduction in assets, especially Advances.
The lower earnings for the third quarter of 2009 compared to the third quarter of 2008 were primarily the result of the narrowing of the LIBOR to Discount Note Spread discussed above, the decrease in short-term interest rates, the reduction in Advances, and a $5 million reduction in fair value gains from accounting for derivatives and hedging activity. We recognized substantial fair value gains in the third quarter of 2008 due principally to the sharp increase in short-term LIBOR as a result of the accelerating financial crisis.
Our Board authorized paying stockholders a cash dividend in each of the first two quarters of 2009 at a 4.50 percent annualized rate and in the third quarter at an annualized rate of 5.00 percent. These dividend payouts represented historically wide spreads to the average 3-month LIBOR. The difference between the 6.75 percent ROE in the first nine months of 2009 and the 4.67 percent average dividend rate enabled us to increase retained earnings by $81 million. The $239 million increase in retained earnings since year-end 2004 represents more than a doubling of retained earnings as a percent of regulatory capital stock. We believe the increase in retained earnings as a percent of capital stock has enhanced our ability to protect future dividends against earnings volatility and members’ capital stock against impairment risk.
Risk Exposure
Funding and Liquidity Risk
We believe that in the first nine months of 2009, our liquidity position remained strong and our overall ability to fund our operations through debt issuance at acceptable interest costs remained sufficient. Although we can make no assurances, we expect this to continue to be the case and we believe the possibility of a liquidity or funding crisis in the FHLBank System that would impair our FHLBank’s ability to issue new debt, service our outstanding debt or pay competitive dividends is remote. The financial crisis significantly elevated our long-term funding costs, compared to U.S. Treasury securities and LIBOR, in the first half of 2009 as in most of 2008. As the financial crisis appeared to have eased, especially in the third quarter, our long-term funding costs improved relative to these market benchmarks. As a result, late in the second quarter and continuing in the third quarter, we determined it was acceptable from a risk perspective to partially reduce the amount of asset liquidity held, which can be at a cost to earnings, from funding short-term (mostly overnight) investments with longer-term Consolidated Obligation Discount Notes.
Market Risk
Our residual exposures to market risk continued to be moderate, at levels consistent with historical averages and with our cooperative business model. The current level of market risk exposure should ensure that profitability would be competitive across a wide range of stressed interest rate and business environments. We have historically emphasized strategies and tactics aimed at providing a competitive earnings stream over a multitude of market and business environments and a relative lack of earnings volatility. These strategies and tactics include (among others): 1) conservative management of market risk exposure, 2) controlled growth in mortgage assets, 3) holding a nominal amount of riskier types of mortgage-backed securities, 4) accounting and hedging practices that attempt to minimize earnings volatility from use of derivatives, and 5) limiting growth in operating expenses.

50


Table of Contents

Credit Risk
We continued to have limited credit risk exposure from offering Advances, purchasing mortgage loans, making investments, and executing derivative transactions. We have robust policies, strategies and processes designed to identify, manage and mitigate credit risk. Our Advances are overcollateralized and we have a perfected first lien position on all pledged loan collateral. The Mortgage Purchase Program is comprised only of conforming fixed-rate conventional loans and loans fully insured by the Federal Housing Administration. Multiple layers of credit enhancements on the Program’s loans protect us against credit losses down to approximately a 50 percent loan-to-value level (based on value at origination). Actual program delinquencies on conventional loans are well below national averages on similar loans and any losses have been well below the amount of our credit enhancements.
At September 30, 2009, 98 percent of our mortgage-backed securities were issued and guaranteed by Fannie Mae or Freddie Mac, which we believe have the backing of the United States government. Only 2 percent ($211 million) of the holdings were in private-label mortgage-backed securities; these securities are comprised of high-quality residential mortgage loans issued and purchased in 2003 and were rated triple-A at September 30, 2009. The underlying collateral has a de minimis level of delinquencies and foreclosures as reflected in the average serious delinquency rate (loans at least 60 days past due) of 0.54 percent of total principal, while their average credit enhancement stood at 7.5 percent.
Although most of our money market investments are unsecured, we invest in the debt securities of highly rated, investment-grade institutions, have conservative limits on dollar and maturity exposure to each institution, and believe we have strong credit underwriting practices. Finally, we collateralize most of the credit risk exposure resulting from interest rate swap transactions; only the uncollateralized portion of our derivative asset position ($8 million at September 30, 2009) represents unsecured exposure. We continue to expect no credit losses on this source of unsecured credit exposure.
Overall, we have never experienced a credit-related loss on, nor have we ever established a loss reserve for any asset. In addition, we have not taken an impairment charge on any investment. Based on our analysis of exposures and application of GAAP we continue to believe no loss reserves are required for our Advances or mortgage assets, nor do we consider any of our investments to be other-than-temporarily impaired. We expect that this will continue to be the case.
Business Related Developments and Update on Risk Factors
Many of the issues related to our financial condition, results of operations, and liquidity discussed throughout this document relate directly to the financial crisis and economic recession, and to the federal government’s actions to attempt to mitigate their unfavorable effects. During 2009, these factors have resulted in sharply improved profitability relative to short-term interest rates, substantially lower Advance balances, and a modest increase in Mortgage Purchase Program balances. This section provides relevant updates on several risk factors identified in our annual report on Form 10-K.
We continue to monitor several scenarios that could result in further reductions in Mission Asset Activity and lower profitability. Although cyclicality of our Mission Asset Activity and profitability relative to the state of the economy is expected, the effects from the recession and the financial crisis could result in a longer and more severe reduction in our Mission Asset Activity. The scenarios that could unfavorably affect Mission Asset Activity include:
     
  § a continuation of the economic recession, which could further reduce Advance demand;
 
  § a continuation of the financial crisis, which could result in additional measures to add even more liquidity to the financial markets;
 
  § unfavorable effects on the competitiveness of our business model from current or future federal government actions to mitigate the recession and financial crisis;
 
  § potentially unfavorable actions regarding the ultimate financial, legislative and regulatory disposition of issues involving the GSEs, especially actions related to Fannie Mae and Freddie Mac with whom the FHLBanks share a common regulator; and
 
  § issues with earnings pressures and capital adequacy at other FHLBanks.

51


Table of Contents

As discussed above, our profitability relative to short-term interest rates began to decrease in the third quarter of 2009. We expect our profitability will further decrease in the fourth quarter of 2009 and beyond. The profitability in the first nine months of 2009 is inconsistent with the sustained fundamental earnings generated by our business model. The following are the major factors affecting earnings that we are experiencing or expect to experience in the near-to intermediate-term future:
     
  § extremely low short-term interest rates;
 
  § the effects of the collapsing LIBOR to Discount Note spread back to, and even below, historically normal levels;
 
  § replacing expected paydowns of mortgages earning wide net spreads with new mortgages assumed to earn lower net spreads;
 
  § continued reductions in Advance balances; and
 
  § because of the stressed mortgage markets and government purchases that are reducing acceptable mortgages to purchase, the possibility of not being able to fully utilize our mortgage-backed security regulatory authority at acceptable risk-adjusted returns.
Notwithstanding these concerns, we expect our profitability and capacity to pay dividends to remain competitive across a wide range of economic, business, and market rate environments—even many stressful ones. We believe that credit and operational risk will not affect our earnings materially. Based on our earnings simulations, we believe that short-term interest rates would have to increase dramatically, quickly, and last for a sustained period of time before ROE would not exceed 3-month LIBOR. We also believe that a decrease in mortgage rates by 100 basis points that lasted for three years, which would place the 30-year fixed mortgage note rate in a range of 4.00 to 4.50 percent, would not cause ROE to fall below 3-month LIBOR.
Our business model is able to absorb sharp changes in our Mission Asset Activity because we can undertake commensurate reductions in our liability balances and capital and because of our low operating expenses. However, if several large members were to withdraw from membership or otherwise reduce activity with us, the decrease in Mission Asset Activity and/or capital could materially reduce dividend rates available to our remaining members. On November 6, 2009, National City Bank, which was acquired in January 2009 by PNC Financial Services Group, Inc., notified us of its decision to withdraw from membership in our FHLBank. PNC Bank is not a member of our FHLBank because it is chartered outside our District.
Although in the last several years, National City has been one of our largest stockholders and Advance borrowers and our largest historical seller of loans in the Mortgage Purchase Program, we believe that losing this member will have no material affect on our business model. We also believe the membership loss will not materially affect the adequacy of our liquidity, our ability to make timely principal and interest payments on our participations in Consolidated Obligations and other liabilities, our ability to continue providing sufficient membership value to our members, or our profitability. This assessment is similar to one made, and subsequently experienced, when we lost one of our largest members (RBS Citizens, N.A.) in 2007 due to a consolidation of its charter outside of the Fifth District.
The Mortgage Purchase Program has expanded this year due to lower mortgage rates, increased refinancing activity and increased interest from our members. We continue to emphasize both recruiting community financial institution members to the Program and increasing the number of regular sellers. However, issues with our two Supplemental Mortgage Insurance providers could harm the Program’s sustainability. Due to the deterioration in the mortgage markets over the last two years, the providers currently have ratings below the double-A rating required by a Finance Agency Regulation, which means we are in technical violation of this Regulation. On August 11, 2009, the Finance Agency, with certain stipulations, granted a one-year waiver of the double-A rating requirement for existing loans and commitments and a six month waiver for new commitments. We have submitted a proposal to the Finance Agency that, if approved, would replace the current reliance on the credit enhancement provided by these insurers with increased use of the credit enhancement provided by members. We believe this change in credit enhancement structure would maintain compliance with the Program’s legal, accounting, and other regulatory requirements, preserve the Program’s minimal credit risk profile, and enable the Program to continue as a beneficial business activity for our member stockholders. We cannot provide at this time any assurance as to whether the Finance Agency will approve the proposal.

52


Table of Contents

We cannot estimate the ultimate impact on the earnings and capital of other FHLBanks from the market value and credit losses on their private-label securities. Therefore, we can provide no assurance about the potential effects on us from System-wide earnings and capital issues identified in this risk factor in our 2008 annual report on Form 10-K. These potential effects could include 1) requiring us to provide financial assistance to one or more other FHLBanks, 2) higher and more volatile debt costs, 3) more difficulty in issuing debt, especially longer-term debt, at maturity points we would prefer for our asset/liability management needs, and 4) decreases in our Mission Asset Activity and profitability, which are the two key sources of membership value.
CONDITIONS IN THE ECONOMY AND FINANCIAL MARKETS
Economy
The primary external factors that affect our Mission Asset Activity and earnings are the general state and trends of the economy and financial institutions, especially in the states of our District; conditions in the financial, credit, and mortgage markets; and interest rates. The economy entered a sharp recession in December 2007, which continued through 2008 and into 2009. As measured by real Gross Domestic Product (GDP), the national economy contracted by 5.4 percent in the fourth quarter of 2008, 6.4 percent in the first quarter of 2009, and 0.7 percent in the second quarter, and expanded by an advance estimate of 3.5 percent in the third quarter (all rates are annualized).
Although there are indications—including the growth in third quarter GDP, reduction in credit spreads, and unfreezing of some credit markets—that the recession and financial crisis may have subsided, or even ended, in the second and third quarters, it is premature to know if the positive indications will be sustained. Contraindications against a robust pickup in economic activity are that lending by financial institutions appears not to have accelerated in the third quarter, unemployment appears to still be increasing (although unemployment is generally a lagging indicator of economic growth), financial institutions continue having credit difficulties, interest rates remain low, and most stock market indices remain well below the highs from earlier in the decade.
The residual effects on our members of the financial crisis and recession may continue to be serious for some time. These continued effects may include diminished lending activity, credit risk difficulties, strong deposit growth, and existence of substantial liquidity and funding alternatives from the federal government. To the extent these effects continue to be realized, we expect a continuation of subdued demand for our Advances.

53


Table of Contents

Interest Rates
Trends in market interest rates affect members’ demand for Mission Asset Activity, earnings, spreads on assets, funding costs and decisions in managing the tradeoffs in our market risk/return profile. The following table presents key market interest rates (obtained from Bloomberg L.P.).
                                                                                 
                                    Nine Months Ended Sept 30,
    Quarter 3 2009     Quarter 2 2009     Quarter 1 2009     2009   2008   Year 2008  
    Average   Ending   Average   Ending   Average   Ending   Average   Average   Average   Ending
 
                                                                               
Federal Funds Target
    0.25 %     0.25 %     0.25 %     0.25 %     0.25 %     0.25 %     0.25 %     2.43 %     2.09 %     0.25 %
Federal Funds Effective
    0.15       0.07       0.18       0.22       0.18       0.16       0.17       2.40       1.92       0.14  
 
                                                                               
3-month LIBOR
    0.41       0.29       0.85       0.60       1.24       1.19       0.83       2.98       2.92       1.43  
2-year LIBOR
    1.40       1.28       1.50       1.53       1.54       1.38       1.48       3.16       2.95       1.48  
5-year LIBOR
    2.86       2.65       2.74       2.97       2.38       2.21       2.66       3.88       3.70       2.13  
10-year LIBOR
    3.72       3.46       3.50       3.78       2.94       2.86       3.39       4.46       4.25       2.56  
 
                                                                               
2-year U.S. Treasury
    1.01       0.95       1.01       1.11       0.89       0.80       0.97       2.26       2.00       0.77  
5-year U.S. Treasury
    2.45       2.31       2.23       2.56       1.75       1.66       2.15       3.00       2.79       1.55  
10-year U.S. Treasury
    3.50       3.31       3.31       3.54       2.71       2.67       3.18       3.79       3.64       2.21  
 
                                                                               
15-year mortgage current coupon (1)
    3.82       3.57       3.84       4.01       3.75       3.59       3.80       5.03       4.97       3.64  
30-year mortgage current coupon (1)
    4.50       4.26       4.31       4.63       4.13       3.89       4.31       5.58       5.47       3.93  
 
                                                                               
15-year mortgage note rate (2)
    4.61       4.46       4.63       4.87       4.72       4.58       4.65       5.64       5.63       4.91  
30-year mortgage note rate (2)
    5.16       5.04       5.01       5.42       5.06       4.85       5.08       6.09       6.05       5.14  
  (1)   Simple average of current coupon rates of Fannie Mae and Freddie Mac mortgage-backed securities.
 
  (2)   Simple weekly average of 125 national lender’s mortgage rates surveyed and published by Freddie Mac.
After decreasing sharply in 2008, the overnight Federal funds target and effective rates were relatively stable in the first nine months of 2009. The Federal Reserve maintained the overnight Federal funds target rate at a range of zero to 0.25 percent, which it had established by the end of 2008. Short-term LIBOR decreased at a slower pace. By the third quarter of 2009, short-term LIBOR had decreased to a level consistent with its historical relationship to Federal funds. The slower pace of reduction in short-term LIBOR significantly improved our earnings in the first half of 2009.
In the first three quarters of 2009, longer-term LIBOR and U.S. Treasury rates tended to rise. However, spreads of our Consolidated Obligation Bonds to these indices narrowed, with the result being relatively stable and even lower Bond rates. The combination of falling short-term rates and more stable longer-term Bond rates resulted in a steeper funding yield curve, which improved earnings. In addition, earnings benefited from the reduction in Bond spreads relative to market indices. Likewise, mortgage note rates were more stable in 2009 than longer-term LIBOR and U.S. Treasuries, which, along with falling home prices, the recession, and difficult mortgage refinancing conditions, resulted in relatively small increases in mortgage prepayments.
More discussion of the effects on our earnings and market risk exposure from interest rate trends are discussed above in “Executive Overview” and below in “Results of Operations,” as well as in the “Market Risk” section of “Quantitative and Qualitative Disclosures About Risk Management.”

54


Table of Contents

ANALYSIS OF FINANCIAL CONDITION
Asset Composition Data
Mission Asset Activity includes the following components:
  §   the principal balance of Advances;
 
  §   the notional principal amount of available lines in the Letters of Credit program;
 
  §   the principal balance in the Mortgage Purchase Program (Mortgage Loans Held for Portfolio); and
 
  §   the notional principal amount of Mandatory Delivery Contracts.
The following two tables show the composition of our total assets, which support the discussions in this section and in the “Executive Overview.”
Asset Composition - Ending Balances (Dollars in millions)
                                                                                   
    September 30, 2009   December 31, 2008   September 30, 2008     September 30, 2009  
            % of           % of           % of     Change From   Change From
            Total           Total           Total     December 31, 2008   September 30, 2008
    Balance     Assets   Balance     Assets   Balance     Assets     Amount     Pct   Amount     Pct
Advances
                                                                                 
Principal
  $ 37,254       48 %   $ 52,799       54 %   $ 62,580       65 %     $ (15,545 )     (29 )%   $ (25,326 )     (40 )%
Other items (1)
    828       1       1,117       1       348       -         (289 )     (26 )     480       138  
                                                       
 
                                                                                 
Total book value
    38,082       49       53,916       55       62,928       65         (15,834 )     (29 )     (24,846 )     (39 )
 
                                                                                 
Mortgage Loans Held for Portfolio
                                                                                 
Principal
    9,650       13       8,590       9       8,462       9         1,060       12       1,188       14  
Other items
    86       -       42       -       60       -         44       105       26       43  
                                                       
 
                                                                                 
Total book value
    9,736       13       8,632       9       8,522       9         1,104       13       1,214       14  
 
                                                                                 
Investments
                                                                                 
 
                                                                                 
Mortgage-backed securities
                                                                                 
Principal
    12,448       16       12,897       13       13,357       14         (449 )     (3 )     (909 )     (7 )
Other items
    (11 )     -       (28 )     -       (37 )     -         17       61       26       70  
                                                       
 
                                                                                 
Total book value
    12,437       16       12,869       13       13,320       14         (432 )     (3 )     (883 )     (7 )
 
                                                                                 
Short-term money market
    13,777       18       22,444       23       12,142       12         (8,667 )     (39 )     1,635       13  
 
                                                                                 
Other long-term investments
    11       -       12       -       40       -         (1 )     (8 )     (29 )     (73 )
                                                       
 
                                                                                 
Total investments
    26,225       34       35,325       36       25,502       26         (9,100 )     (26 )     723       3  
 
                                                                                 
Loans to other FHLBanks
    -       -       -       -       -       -         -       -       -       -  
                                                       
 
                                                                                 
Total earning assets
    74,043       96       97,873       100       96,952       100         (23,830 )     (24 )     (22,909 )     (24 )
 
                                                                                 
Other assets
    2,941       4       333       -       331       -         2,608       783       2,610       789  
                                                       
 
                                                                                 
Total assets
  $ 76,984       100 %   $ 98,206       100 %   $ 97,283       100 %     $ (21,222 )     (22 )   $ (20,299 )     (21 )
                                                       
 
                                                                                 
Other Business Activity (Notional)
                                                                                 
 
                                                                                 
Letters of Credit
  $ 5,564             $ 7,917             $ 8,023               $ (2,353 )     (30 )   $ (2,459 )     (31 )
 
                                                                       
Mandatory Delivery Contracts
  $ 126             $ 917             $ 178               $ (791 )     (86 )   $ (52 )     (29 )
 
                                                                       
 
                                                                                 
Total Mission Asset Activity (Principal and Notional)
  $ 52,594       68 %   $ 70,223       72 %   $ 79,243       81 %     $ (17,629 )     (25 )   $ (26,649 )     (34 )
                                                       
  (1)   The majority of these balances are hedging related adjustments.

55


Table of Contents

Asset Composition - Average Balances (Dollars in millions)
                                                                                   
    Nine Months Ended   Year Ended   Nine Months Ended      
    September 30, 2009   December 31, 2008   September 30, 2008     September 30, 2009  
                                                      Change From   Change From
            % of           % of           % of     Year Ended   Nine Months Ended
            Total           Total           Total     December 31, 2008   September 30, 2008
    Balance     Assets   Balance     Assets   Balance     Assets     Amount     Pct   Amount     Pct
Advances
                                                                                 
Principal
  $ 46,058       53 %   $ 59,973       64 %   $ 60,441       65 %     $ (13,915 )     (23 )%   $ (14,383 )     (24 )%
Other items (1)
    895       1       526       -       503       -         369       70       392       78  
                                                       
 
                                                                                 
Total book value
    46,953       54       60,499       64       60,944       65         (13,546 )     (22 )     (13,991 )     (23 )
 
                                                                                 
Mortgage Loans Held for Portfolio
                                                                                 
Principal
    9,489       11       8,621       9       8,661       10         868       10       828       10  
Other items
    68       -       62       -       63       -         6       10       5       8  
                                                       
 
                                                                                 
Total book value
    9,557       11       8,683       9       8,724       10         874       10       833       10  
 
                                                                                 
Investments
                                                                                 
 
                                                                                 
Mortgage-backed securities
                                                                                 
Principal
    12,166       14       12,623       14       12,448       13         (457 )     (4 )     (282 )     (2 )
Other items
    (20 )     -       (30 )     -       (28 )     -         10       33       8       29  
                                                       
 
                                                                                 
Total book value
    12,146       14       12,593       14       12,420       13         (447 )     (4 )     (274 )     (2 )
 
                                                                                 
Short-term money market
    18,221       21       12,206       13       10,814       12         6,015       49       7,407       68  
 
                                                                                 
Other long-term investments
    11       -       16       -       16       -         (5 )     (31 )     (5 )     (31 )
                                                       
 
                                                                                 
Total investments
    30,378       35       24,815       27       23,250       25         5,563       22       7,128       31  
 
                                                                                 
Loans to other FHLBanks
    14       -       18       -       15       -         (4 )     (22 )     (1 )     (7 )
                                                       
 
                                                                                 
Total earning assets
    86,902       100       94,015       100       92,933       100         (7,113 )     (8 )     (6,031 )     (6 )
 
                                                                                 
Other assets
    294       -       342       -       338       -         (48 )     (14 )     (44 )     (13 )
                                                       
 
                                                                                 
Total assets
  $ 87,196       100 %   $ 94,357       100 %   $ 93,271       100 %     $ (7,161 )     (8 )   $ (6,075 )     (7 )
                                                       
 
                                                                                 
Other Business Activity (Notional)
                                                                                 
 
                                                                                 
Letters of Credit
  $ 6,057             $ 7,894             $ 7,824               $ (1,837 )     (23 )   $ (1,767 )     (23 )
 
                                                                       
Mandatory Delivery Contracts
  $ 705             $ 182             $ 141               $ 523       287     $ 564       400  
 
                                                                       
 
                                                                                 
Total Mission Asset Activity (Principal and Notional)
  $ 62,309       71 %   $ 76,670       81 %   $ 77,067       83 %     $ (14,361 )     (19 )   $ (14,758 )     (19 )
 
                                                                 
  (1)   The majority of these balances are hedging related adjustments.
To measure the extent of our success in achieving growth in Mission Asset Activity, we consider changes in both period-end balances and period-average balances. There can be large differences in the results of these two computations. Average data can provide more meaningful information about the ongoing condition of and trends in Mission Asset Activity and earnings than period-end data because day-to-day volatility can impact the latter.
On September 30, 2009, Advances represented just under half (49 percent) of our total assets, a decrease of six percentage points from year-end 2008. The Mortgage Portfolio Program increased to 13 percent of total assets, due to growth in the Program and the decrease in total assets, led by Advances. The large balance in other assets on September 30, 2009 was due to our decision to keep funds at the Federal Reserve on that day instead of investing with traditional unsecured counterparties because of the zero or negative interest rate available on overnight investments at the end of the quarter.

56


Table of Contents

Credit Services
The principal balance of Advances decreased significantly in the first nine months of 2009. The decrease began in the fourth quarter of 2008, after Advances had reached record highs in October 2008. Available lines and member usage of the Letters of Credit program also fell substantially. Most of our Letters of Credit support members’ public unit deposits. We earn fees on the actual amount of the available lines members use, which can be substantially less than the lines outstanding.
The following table presents Advance balances by major program.
                                                 
(Dollars in millions)   September 30, 2009   December 31, 2008   September 30, 2008
    Balance       Percent(1)   Balance       Percent(1)   Balance       Percent(1)
     
 
                                               
Short-Term and Adjustable-Rate
                                               
REPO/Cash Management
  $ 1,770       5 %   $ 5,886       11 %   $ 11,161       18 %
LIBOR
    15,354       41       24,225       46       29,619       47  
       
Total
    17,124       46       30,111       57       40,780       65  
 
                                               
Long-Term
                                               
Regular Fixed Rate
    7,830       21       9,722       18       9,332       15  
Convertible (2)
    3,231       9       3,479       7       3,506       6  
Putable (2)
    7,046       19       6,981       13       6,894       11  
Mortgage Related
    1,740       4       1,815       4       1,860       3  
       
Total
    19,847       53       21,997       42       21,592       35  
 
                                               
Other Advances
    283       1       691       1       208       -  
       
 
                                               
Total Advances Principal
    37,254       100 %     52,799       100 %     62,580       100 %
 
                                               
 
                                               
Other Items
    828               1,117               348          
 
                                         
 
                                               
Total Advances Book Value
  $ 38,082             $ 53,916             $ 62,928          
 
                                         
  (1)   As a percentage of total Advances principal.
 
  (2)   Related interest rate swaps executed to hedge these Advances convert them to an adjustable-rate tied to LIBOR.
Most of the reduction in balances occurred in the REPO, LIBOR, and Regular Fixed Rate Advance programs. REPO and LIBOR programs normally have the most fluctuation in balances because larger members tend to use them disproportionately more than smaller members do, they tend to have shorter-term maturities than other programs and, in the case of LIBOR Advances, they can be prepaid without a fee on repricing dates subject to pre-established prepayment “lock out” periods. Other Advance programs experienced smaller changes.

57


Table of Contents

The following tables present the principal balances and related weighted average interest rates for our top five Advance borrowers.
     (Dollars in millions)
                                         
September 30, 2009   December 31, 2008
    Ending     Weighted Average           Ending     Weighted Average
Name   Balance     Interest Rate   Name   Balance     Interest Rate
 
U.S. Bank, N.A.
  $ 10,315       1.57 %   U.S. Bank, N.A.   $ 14,856       3.02 %
National City Bank
    4,409       1.00     National City Bank     6,435       2.83  
Fifth Third Bank
    2,038       2.40     Fifth Third Bank     5,639       3.18  
AmTrust Bank
    1,786       3.91     The Huntington National Bank     2,590       1.22  
RBS Citizens, N.A.
    1,287       0.33     AmTrust Bank     2,338       3.75  
 
                                   
 
                                       
Total of Top 5
  $ 19,835       1.66    
Total of Top 5
  $ 31,858       2.92  
 
                                   
 
                                       
Total Advances (Principal)
  $ 37,254       2.31     Total Advances (Principal)   $ 52,799       3.00  
 
                                   
 
                                       
Top 5 Percent of Total
    53 %           Top 5 Percent of Total     60 %        
 
                                   
RBS Citizens, N.A. and National City Bank are former members. The decrease in total weighted average interest rates from the end of 2008 to September 30, 2009 was due to the reductions in short-term interest rates during 2009, especially LIBOR.
As indicated above, our Advances are concentrated among a small number of members. Concentration ratios have been relatively stable in the last several years. We believe that having large members who actively use our Mission Asset Activity augments the value of membership to all members because it enables us to improve operating efficiency, increase financial leverage, possibly enhance dividend returns, obtain more favorable funding costs, and provide competitively priced Mission Asset Activity.
Although Advance usage fell broadly across the membership, usage decreased disproportionately among our largest borrowers. The top five borrowers accounted for 77 percent of the total decrease in Advance balances, but they represented a smaller proportion (53 percent) of total Advances. In addition, as shown in the following table, the unweighted average ratio of each member’s Advance balance to its most-recently available total assets decreased more for larger members than smaller members. Despite their decrease, we believe the level of these ratios and the fact that the number of borrowing members has held steady at approximately 77 percent of total membership continue to demonstrate that our members view Advances as important sources of funding and liquidity, even in business conditions in which retail deposit growth exceeds loan growth and in which there are abundant sources of liquidity.
                        
    September 30, 2009   December 31, 2008
 
               
Average Advances-to-Assets for Members
               
 
               
Smaller members: assets less than $1.0 billion (681 members)
    5.29 %     6.11 %
 
               
Larger members: assets over $1.0 billion (58 members)
    4.45 %     5.47 %
 
               
All members
    5.22 %     6.06 %
Mortgage Purchase Program (Mortgage Loans Held for Portfolio)
The expansion of the Mortgage Purchase Program in the first nine months of 2009 came after several years in which the Program’s balance was relatively stable. Significantly lower mortgage interest rates in the fourth quarter of 2008 and the first quarter of 2009 increased refinancing activity, which resulted in Program balances increasing. In addition, because of falling home prices, the recession, and difficult mortgage refinancing conditions, mortgage prepayments did not accelerate as much as would normally have been the case given the lower mortgage rates. The growth in the Program helped offset a portion of the earnings lost from the lower balances in the Advance portfolio. The Program’s growth slowed in the second and third quarters, primarily due to diminishing refinancing activity.

58


Table of Contents

Our focus continues to be on recruiting community-based members to participate in the Program and on increasing the number of regular sellers. We approved 23 members to the Program in the first nine months of 2009 and there is a similar number of members in the pipeline either interested in joining the Program or in the process of joining. The number of regular sellers has doubled in the last year. Through September 30, members transacted approximately 3,300 separate commitments to sell us loans, 50 percent more than the amount in any prior full year. Because the recent increases in the number of sellers and new approvals to the Program have come from our smaller community-based members and because we have self-imposed constraints on growth, we expect that the Program will not grow significantly.
The following table reconciles changes in the Program’s principal balance (excluding Mandatory Delivery Contracts) for the nine months ended September 30, 2009.
         
    Mortgage Purchase
(In millions)   Program Principal
 
       
Balance at December 31, 2008
  $ 8,590  
Principal purchases
    3,347  
Principal paydowns
    (2,287 )
 
     
 
       
Balance at September 30, 2009
  $ 9,650  
 
     
We closely track the refinancing incentives of all of our mortgage assets because the mortgage prepayment option represents almost all of our market risk exposure. The principal paydowns in the first three quarters equated to an annual constant prepayment rate of 29 percent, compared to 12 percent in all of 2008. The acceleration in prepayment rates reflected the significant drop in mortgage rates in late 2008 and early 2009. However, as noted above, the refinancing response was muted. The Program’s composition of balances by loan type and original final maturity did not change materially in the first nine months of 2009. However, the weighted average mortgage note rate fell from 5.80 percent at year-end 2008 to 5.56 percent at September 30, 2009, reflecting the prepayments of higher rate notes and the purchase of lower rate notes in the declining mortgage rate environment.
As shown in the following table, the percentage of principal balances from members supplying five percent or more of total principal decreased five percentage points from year-end 2008 to September 30, 2009.
                                      
    September 30, 2009   December 31, 2008
(Dollars in millions)   Unpaid Principal   % of Total   Unpaid Principal   % of Total
 
                               
National City Bank
  $     3,763       39 %   $     4,709       55 %
Union Savings Bank
    3,078       32       1,995       23  
Guardian Savings Bank FSB
    809       8       544       6  
 
                               
 
                               
Total
  $     7,650       79 %   $     7,248       84 %
 
                               
The decrease in the percentage of loans outstanding from National City Bank reflected its lack of new activity with us since mid-2007, while the increase from Union Savings Bank and Guardian Saving Bank FSB reflected refinancing activity in their portfolio that resulted in new loans sold to us.
As in prior years, in the first nine months of 2009, yields we earned on new mortgage loans in the Program relative to funding costs continued to provide profitable risk-adjusted returns. The federal government’s actions to purchase mortgage-backed securities put upward pressure on mortgage prices, which normally lowers yields, but the impact was not large enough to cause profitability on new mortgages to decrease substantially. We cannot predict whether the effects on net spreads from the government’s purchase activities will continue to be modest.

59


Table of Contents

Investments
Money Market Investments
Short-term unsecured money market instruments consist of the following accounts on the Statements of Condition: interest-bearing deposits; Federal funds sold; GSE discount notes, most of which are in our trading portfolio; and certificates of deposit and bank notes in our available-for-sale portfolio. In the first nine months of 2009, our investment portfolio continued to provide liquidity and helped us manage market risk and capital adequacy.
The composition of our money market investment portfolio varies over time based on relative value considerations. Daily balances can fluctuate significantly, usually within a range of $8,000 million to $20,000 million, due to numerous factors, including changes in the actual and anticipated amount of Mission Asset Activity, liquidity requirements, net spreads, opportunities to warehouse debt at attractive rates for future use, and management of financial leverage. Money market investments normally have one of the lowest net spreads of any of our assets, typically ranging from 5 to 15 basis points.
In the nine months ended September 30, 2009, we maintained average money market balances at higher than historical levels, with the portfolio having an average balance of $18,221 million. The increase in balances, which mostly had overnight maturities, began in the fourth quarter of 2008 and occurred primarily because the financial crisis and the Finance Agency’s guidance to target as many as 15 days of liquidity required us to increase asset liquidity. We funded the increased asset liquidity with longer-term Discount Notes. Because of the upward sloping yield curve, these actions tended to negatively affect our earnings.
In the third quarter of 2009, we began to invest in the short-term Discount Note obligations of Freddie Mac. These investments provide us a vehicle to diversify our short-term investments at attractive yields, and we believe that there is less credit risk of delayed or nonrepayment of the principal and interest on these obligations than of other unsecured short-term investments. On September 30, 2009 our investment in Freddie Mac Discount Notes totaled $2,250 million.
Mortgage-Backed Securities
We invest in mortgage-backed securities in order to enhance profitability and to help support the housing market. Mortgage-backed securities currently comprise almost 100 percent of the held-to-maturity securities and $3 million of the trading securities on the Statements of Condition. Our current philosophy is to invest in the mortgage-backed securities of GSEs and government agencies. We have not purchased any mortgage-backed securities issued by other entities since 2003.
We historically have been permitted by Finance Agency Regulation to hold mortgage-backed securities up to a multiple of three times our regulatory capital. In May 2008, the Finance Agency approved our request, pursuant to a Finance Agency authorization permitting a higher multiple, to temporarily expand our mortgage-backed security percentage by up to an additional 1.5 times regulatory capital. In July 2008, we utilized a small portion of this authority. However, because of the financial crisis and recession, in the last twelve months there has been a limited availability of securities that fit our investment parameters, including offering an acceptable risk/return tradeoff. On September 30, 2009, the principal balance of our mortgage-backed securities was $12,448 million and regulatory capital was $4,152 million, for a multiple of 3.00. We cannot predict if we will find attractive securities to again utilize the temporary expanded authority before it expires on March 31, 2010.
As shown in the following table, throughout 2009 principal paydowns exceeded principal purchases of mortgage-backed securities. The principal paydowns equated to an annual constant prepayment rate of 28 percent, compared to 16 percent in all of 2008.
         
    Mortgage-backed
(In millions)   Securities Principal
 
       
Balance at December 31, 2008
  $ 12,897  
Principal purchases
    2,690  
Principal paydowns
    (2,923 )
Principal sales
    (216 )
 
     
 
       
Balance at September 30, 2009
  $ 12,448  
 
     

60


Table of Contents

The following table presents the composition of the principal balances of the mortgage-backed securities portfolio by security type, collateral type, and issuer. Most purchases in the first nine months of 2009 were 15-year pass-through collateral.
                 
(In millions) September 30, 2009 December 31, 2008
 
               
Security Type
               
Collateralized mortgage obligations
  $ 3,843     $ 5,433  
Pass-throughs (1)
    8,605       7,464  
 
           
 
               
Total
  $ 12,448     $ 12,897  
 
           
 
               
Collateral Type (2)
               
15-year collateral
  $ 5,959     $ 5,169  
20-year collateral
    3,404       3,365  
30-year collateral
    3,085       4,363  
 
           
 
               
Total
  $ 12,448     $ 12,897  
 
           
Issuer
               
GSE residential mortgage-backed securities
  $ 12,232     $ 12,581  
Agency residential mortgage-backed securities
    6       12  
Private-label residential mortgage-backed securities
    210       304  
 
           
 
               
Total
  $ 12,448     $ 12,897  
 
           
(1)   On each date, only $3 million of the pass-throughs were 30-year adjustable-rate mortgages. All others were 15-year or 20-year fixed-rate pass-throughs.
(2)   On each date, all but $3 million of principal were comprised of fixed-rate mortgages.
Consolidated Obligations
Changes in Balances and Composition
Our primary source of funding and liquidity is through participating in the issuance of the System’s debt securities—Consolidated Obligations—in the capital markets. The table below presents the ending and average balances of our participations in Consolidated Obligations. All of our Obligations issued and outstanding in 2009, as in the last several years, had “plain-vanilla” interest terms. None had step-up, inverse floating rate, convertible, range, or zero-coupon structures.
                                                 
    Nine Months Ended     Year Ended     Nine Months Ended  
      (In millions)   September 30, 2009     December 31, 2008     September 30, 2008  
    Ending     Average     Ending     Average     Ending     Average  
    Balance     Balance     Balance     Balance     Balance     Balance  
                   
 
                                               
Consolidated Discount Notes:
                                               
Par
  $ 29,174     $ 37,725     $ 49,389     $ 40,450     $ 43,134     $ 39,283  
Discount
    (4 )     (17 )     (53 )     (94 )     (127 )     (94 )
                   
 
                                               
Total Consolidated Discount Notes
    29,170       37,708       49,336       40,356       43,007       39,189  
                   
 
                                               
Consolidated Bonds:
                                               
Unswapped fixed-rate
    25,822       25,383       25,650       25,468       27,737       24,788  
Unswapped adjustable-rate
    1,771       4,380       6,424       9,638       7,525       10,486  
Swapped fixed-rate
    13,467       11,979       10,140       11,969       12,485       11,966  
                   
 
                                               
Total Par Consolidated Bonds
    41,060       41,742       42,214       47,075       47,747       47,240  
                   
 
                                               
Other items (1)
    142       137       179       62       -       59  
                   
Total Consolidated Bonds
    41,202       41,879       42,393       47,137       47,747       47,299  
                   
 
                                               
Total Consolidated Obligations (2)
  $ 70,372     $ 79,587     $ 91,729     $ 87,493     $ 90,754     $ 86,488  
                   
(1)   Includes unamortized premiums/discounts, hedging and other basis adjustments.
(2)   The 12 FHLBanks have joint and several liability for the par amount of all of the Consolidated Obligations issued on their behalves. See Note 11 of the Notes to Unaudited Financial Statements for additional detail and discussion related to Consolidated Obligations. The par amount of the outstanding Consolidated Obligations of all 12 FHLBanks was (in millions) $973,579 and $1,251,542 at September 30, 2009 and December 31, 2008, respectively.

61


Table of Contents

Balances of the various Obligation types can fluctuate significantly based on Advance demand, money market investment balances, comparative changes in their cost levels relative to swapped Consolidated Bonds, supply and demand conditions, and our balance sheet management strategies. In the first nine months of 2009, the average balance of Discount Notes was similar to the average balances for all of 2008 and the first nine months of 2008. Beginning in the second quarter of 2009 and continuing in the third quarter, we decreased our issuance of Discount Notes compared to the first quarter of 2009 and all of 2008. The reduced reliance on Discount Notes reflected the reduction in Advance balances in 2009 and our lower holdings of asset liquidity using money market investments, which we normally fund with Discount Notes. By September 30, Discount Note balances were down substantially from levels earlier in 2009 and in 2008.
The relatively stable balance of unswapped fixed-rate Bonds in the first nine months of 2009 compared to the 2008 periods reflected primarily the relatively modest growth in our mortgage assets.
The following table shows the allocation on September 30, 2009 of unswapped fixed-rate Bonds according to their final remaining maturity and next call date (for callable Bonds).
                                         
     (In millions)   Year of Maturity   Year of Next Call
      Callable   Noncallable   Amortizing   Total   Callable
         
Due in 1 year or less
  $ -     $ 4,429     $ 4     $ 4,433     $ 8,791  
Due after 1 year through 2 years
    445       3,005       4       3,454       1,695  
Due after 2 years through 3 years
    1,580       2,672       54       4,306       125  
Due after 3 years through 4 years
    1,695       2,339       14       4,048       -  
Due after 4 years through 5 years
    1,366       1,168       3       2,537       25  
Thereafter
    5,550       1,357       137       7,044       -  
             
             
Total
  $ 10,636     $ 14,970     $ 216     $ 25,822     $ 10,636  
             
The allocations were consistent with those in the last several years. The Bonds were distributed relatively smoothly throughout the maturity spectrum. Twenty-seven percent had final remaining maturities greater than five years. These longer-term Bonds help us hedge the extension risk of long-term mortgage assets. Forty-one percent provide us with call options, which help manage the prepayment volatility of mortgage assets. Over 80 percent of the callable Bonds have next call dates within the next 12 months and most of them are callable daily after an initial lockout period. Daily call options provide considerable flexibility in managing market risk exposure to lower mortgage rates.
Relative Cost of Funding
Consolidated Obligation Bonds normally have an interest cost at a spread above U.S. Treasury securities and below LIBOR. These spreads can be volatile, and in 2008 and the first quarter of 2009, they were significantly wider and more volatile than in prior years. The financial crisis caused investors to demand significantly more relative compensation for debt securities, especially longer-term securities, issued by non-government entities. We responded to the higher spreads on noncallable Bonds by issuing a greater percentage of callable Bonds and Discount Notes because callable Bond spreads did not widen as much as noncallable Bond spreads. Throughout 2009, both noncallable and callable Bonds spreads and volatility improved back towards historical norms compared to the previous distressed conditions. This reversion of spreads benefited our earnings to the extent we replaced called and matured Bonds.
Deposits
Members’ deposits with us are a relatively minor source of low-cost funding. As shown on the “Average Balance Sheet and Yield/Rates” table in the “Results of Operations,” the average balance of interest-bearing deposits increased $206 million (14 percent) in the first nine months of 2009 compared to the same period of 2008. We believe the growth reflected members’ excess liquidity available for investment. As shown on the Statements of Condition, comparing September 30, 2009 to year-end 2008, interest-bearing deposit balances increased more substantially (by $473 million).

62


Table of Contents

Derivatives Hedging Activity and Liquidity
We discuss our use of and accounting for derivatives in the “Use of Derivatives in Market Risk Management” section of “Quantitative and Qualitative Disclosures About Risk Management.” We discuss our liquidity in “Executive Overview” and in the “Liquidity Risk and Contractual Obligations” section of “Quantitative and Qualitative Disclosures About Risk Management.” Further information on our use of derivatives is contained in our annual report on Form 10-K for year end 2008.
Capital Resources
Capital Leverage
The Gramm-Leach-Bliley Act of 1999 (GLB Act) and Finance Agency Regulations specify limits on how much we can leverage capital by requiring us to maintain at all times at least a 4.00 percent regulatory capital-to-assets ratio. A lower ratio indicates more leverage. We have adopted a more restrictive additional limit in our Financial Management Policy, which targets a floor on the regulatory quarterly average capital-to-assets ratio of 4.20 percent. If our financial leverage increases too much, or becomes too close to the regulatory limit, we have discretionary ability within our Capital Plan to enact changes to ensure our capitalization remains strong and in compliance with all regulatory limits. The following tables present our capital and capital-to-assets ratios, on both a GAAP and regulatory basis.
GAAP and Regulatory Capital
                                                 
    Nine Months Ended   Year Ended   Nine Months Ended
    September 30, 2009   December 31, 2008   September 30, 2008
(In millions)   Period End   Average   Period End   Average   Period End   Average
GAAP Capital Stock
  $ 3,658     $ 3,949     $ 3,962     $ 3,798     $ 3,968     $ 3,745  
Mandatorily Redeemable Capital Stock
    87       155       111       127       131       124  
 
                                   
Regulatory Capital Stock
    3,745       4,104       4,073       3,925       4,099       3,869  
Retained Earnings
    407       398       326       335       319       327  
 
                                   
 
                                               
Regulatory Capital
  $ 4,152     $ 4,502     $ 4,399     $ 4,260     $ 4,418     $ 4,196  
 
                                   
GAAP and Regulatory Capital-to-Assets Ratios
                                                 
    Nine Months Ended   Year Ended   Nine Months Ended
    September 30, 2009   December 31, 2008   September 30, 2008
    Period End   Average   Period End   Average   Period End   Average
GAAP
    5.27 %     4.98 %     4.36 %     4.37 %     4.40 %     4.36 %
Regulatory
    5.39       5.16       4.48       4.51       4.54       4.50  
The decrease in financial leverage in the first nine months of 2009 was due principally to the decrease in Advance balances. Retained earnings increased from year-end 2008 to September 30, 2009 by $81 million because we paid shareholders an average annualized dividend rate of 4.67 percent dividend in the first three quarters of 2009 while the ROE averaged 6.75 percent.

63


Table of Contents

Changes in Capital Stock Balances
The following table presents changes in our regulatory capital stock balances.
         
(In millions)        
 
       
Regulatory stock balance at December 31, 2008
  $ 4,073  
 
       
Stock purchases:
       
Membership stock
    47  
Activity stock
    40  
Stock repurchases:
       
Excess stock redemption
    (376 )
Other stock repurchases
    (39 )
 
     
 
       
Regulatory stock balance at September 30, 2009
  $ 3,745  
 
     
Regulatory capital stock balances decreased $328 million. The decrease resulted primarily from our repurchase of $376 million of excess stock, most of it the subject of two members’ redemption requests. Although total Advance balances decreased, Advance usage from several members increased, resulting in the $40 million increase in activity stock purchases. The membership stock purchases reflected the annual recalculation of the member capital investment requirement.
Excess Stock
The table below shows that, as our Advances fell in 2009, the amount of our excess capital stock outstanding increased and the amount of capital stock members cooperatively utilized within our Capital Plan decreased. A key component of our Capital Plan is cooperative utilization of capital stock, which, within constraints, permits members who have no excess stock of their own to capitalize additional Mission Asset Activity using excess stock owned by other members. Excess capital stock outstanding per our Capital Plan is reduced by the amount of cooperative utilization. If our Capital Plan did not have a cooperative capital feature, members would have been required to purchase up to $281 million of additional stock to capitalize the same total amount of Mission Asset Activity outstanding.
                 
(In millions) September 30, 2009 December 31, 2008
 
               
Excess capital stock (Capital Plan definition)
  $ 907     $ 649  
 
           
 
               
Cooperative utilization of capital stock
  $ 281     $ 406  
 
           
 
               
Mission Asset Activity capitalized with cooperative capital stock
  $ 7,025     $ 10,150  
 
           
A Finance Agency Regulation prohibits us from paying stock dividends if the amount of our regulatory excess stock (defined by the Finance Agency to include stock cooperatively used) exceeds one percent of our total assets. Because of the recent reductions in Advance balances, at year-end 2008 and in each of the first three quarters of 2009, we were above the regulatory threshold and, therefore, were required to pay cash dividends. Until Advances grow substantially again, we expect to continue to be required to pay cash dividends.
Retained Earnings
On September 30, 2009, stockholders’ investment in our FHLBank was supported by $407 million of retained earnings. This represented 11 percent of total regulatory capital stock and 0.53 percent of total assets. When allocating earnings between dividends and retained earnings our Board of Directors considers the goals of paying stockholders a competitive dividend and having an adequate amount of retained earnings to mitigate impairment risk and potentially augment future dividend stability.
Membership and Stockholders
On September 30, 2009, we had 738 member stockholders. In the first nine months of 2009, 17 institutions became new member stockholders while seven were lost, producing a net gain of ten member stockholders. Of the seven members lost, three merged with other Fifth District members, two merged outside of the Fifth District, one was subject to an FDIC seizure and subsequent purchase and assumption agreement with another Fifth District member, and one relocated its charter outside the Fifth District. The impact on Mission Asset Activity and earnings from these membership changes was negligible. Modest fluctuations in Mission Asset Activity and earnings from membership changes are a normal part of our business operations. More pronounced effects could result from the loss of one or more of our largest users.

64


Table of Contents

The following tables list institutions holding five percent or more of outstanding Class B capital stock. The amounts include stock held by any known affiliates that are members of our FHLBank.

(Dollars in millions)
                 
September 30, 2009  
            Percent  
Name      Balance     of Total  
 
               
U.S. Bank, N.A.
  $ 591       16 %
National City Bank
    404       11  
Fifth Third Bank
    401       11  
The Huntington National Bank
    241       6  
 
               
Total
  $ 1,637       44 %
 
             
 
                 
December 31, 2008  
            Percent  
Name      Balance     of Total  
 
               
U.S. Bank, N.A.
  $ 841       21 %
National City Bank
    404       10  
Fifth Third Bank
    394       10  
The Huntington National Bank
    241       6  
AmTrust Bank
    223       5  
 
               
Total
  $ 2,103       52 %
 
             


The decrease in stock held by U.S. Bank, N.A. was due to its request for redemption of a portion of its excess stock in order to reduce its total holdings of FHLBank System stock; we repurchased this excess stock in September 2009. On November 6, 2009, National City Bank, which had been acquired in January 2009 by PNC Financial Services Group, Inc., notified us of its membership withdrawal. See the discussion in the “Business Related Developments and Update on Risk Factors” in the “Executive Overview” for more information on this membership termination.
In the first nine months of 2009, there were no material changes in the percentage of members we have from total eligible companies, in the composition of membership by state, or in the allocation of member stockholders by their asset size. Because most existing eligible commercial banks and thrift/savings and loan associations are already members, our recruitment of new members focuses on credit unions, insurance companies, and de novo banks.
RESULTS OF OPERATIONS
Components of Earnings and Return on Equity
The following table is a summary income statement for the three and nine months ended September 30, 2009 and 2008. Each ROE percentage is computed as the annualized income or expense for the category divided by the average amount of stockholders’ equity for the period.
                                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
(Dollars in millions)   2009   2008   2009   2008
    Amount   ROE (a)   Amount   ROE (a)   Amount   ROE (a)   Amount   ROE (a)
 
                                                               
Net interest income
  $ 91       6.18 %   $ 92       6.38 %   $ 313       7.06 %   $ 268       6.44 %
 
                                                               
Net gains on derivatives and hedging activities
    5       0.33       10       0.69       13       0.29       9       0.23  
Other non-interest income
    2       0.16       2       0.15       12       0.28       6       0.14  
 
                                               
 
                                                               
Total non-interest income
    7       0.49       12       0.84       25       0.57       15       0.37  
 
                                               
 
                                                               
Total revenue
    98       6.67       104       7.22       338       7.63       283       6.81  
 
                                                               
Total other expense
    (14 )     (0.97 )     (14 )     (0.96 )     (39 )     (0.88 )     (37 )     (0.89 )
Assessments
    (23 )     (b )     (24 )     (b )     (80 )     (b )     (66 )     (b )
 
                                               
 
                                                               
Net income
  $ 61       5.70 %   $ 66       6.26 %   $ 219       6.75 %   $ 180       5.92 %
 
                                               
(a)   The ROE amounts have been computed using dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) in this table may produce nominally different results.
 
(b)   The effect on ROE of the REFCORP and Affordable Housing Program assessments is pro-rated within the other categories.

65


Table of Contents

As is normally the case for our FHLBank, in both the three- and nine-months comparison, the largest component of net income was net interest income, which is detailed in the next section.
Most of the income changes for derivatives and hedging activities in both periods represented unrealized market value adjustments. The adjustments resulted primarily from interest rate changes that affected the market values of derivatives differently from the market values of the hedged risks. For the three-months comparison, the smaller gain in the derivatives’ market value adjustment resulted from relatively large gains in the third quarter of 2008 due primarily to the sharp increase in short-term LIBOR from the accelerating financial crisis in that quarter. Overall, we consider the amount of volatility in these two periods to be moderate and consistent with the close hedging relationships of our derivative transactions.
The $6 million increase in other non-interest income for the nine-months comparison period resulted from a gain on the sales, in January 2009, of $216 million of mortgage-backed securities.
Net Interest Income
We manage net interest income within the context of managing the tradeoff between market risk and return. Effective risk/return management requires us to focus principally on the relationships among assets and liabilities that affect net interest income, rather than individual balance sheet and income statement accounts in isolation. Our ROE normally tends to be low compared to many other financial institutions because of our cooperative wholesale business model, our members’ desire to have dividends correlate with short-term interest rates, and our modest overall risk profile.
Components of Net Interest Income
We generate net interest income from two components: 1) the net interest rate spread and 2) funding interest-earning assets with interest-free capital (“earnings from capital”). The sum of these, when expressed as a percentage of the average book balance of interest-earning assets, equals the net interest margin. Because of our relatively low net interest rate spread compared to other financial institutions, we normally derive a substantial proportion of net interest income from deploying our capital to fund assets.
The following table shows the two major components of net interest income, as well as the three major subcomponents of the net interest spread.
                                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
(Dollars in millions)   2009     2008     2009     2008  
            Pct of             Pct of             Pct of             Pct of  
            Earning             Earning             Earning             Earning  
    Amount     Assets     Amount     Assets     Amount     Assets     Amount     Assets  
Components of net interest rate spread:
                                                               
Other components of net interest rate spread
  $ 77       0.38 %   $ 60       0.25 %   $ 263       0.41 %   $ 171       0.25 %
Net (amortization)/accretion (1) (2)
    (9 )     (0.04 )     (6 )     (0.02 )     (25 )     (0.04 )     (26 )     (0.04 )
Prepayment fees on Advances, net (2)
    2       0.01       1       -       6       0.01       2       -  
 
                                               
Total net interest rate spread (3)
    70       0.35       55       0.23       244       0.38       147       0.21  
 
                                                               
Earnings from funding assets with
interest-free capital
    21       0.10       37       0.16       69       0.10       121       0.18  
 
                                               
 
                                                               
Total net interest income/net
interest margin
  $ 91       0.45 %   $ 92       0.39 %   $ 313       0.48 %   $ 268       0.39 %
 
                                               
(1)   Includes (amortization)/accretion of premiums/discounts on mortgage assets and Consolidated Obligations and deferred transaction costs (concession fees) for Consolidated Obligations.
(2)   These components of net interest rate spread have been segregated here to display their relative impact.
(3)   Total earning assets multiplied by the difference in the book yield on interest-earning assets and book cost of interest-bearing liabilities.
Earnings From Capital. Earnings from capital decreased in both comparison periods because of the significant reductions in short-term interest rates. We deploy much of our capital in short-term and adjustable-rate assets in order to help ensure that our ROE moves with short-term interest rates and to help control market risk exposure.

66


Table of Contents

Net Amortization/Accretion. Although volatility in net amortization of mortgage assets and callable Bonds can be substantial, the total change in such amortization was relatively small between the two comparison periods. The amortization of callable Bond concession expense was higher in the first nine months of 2009 than in the same period of 2008 primarily because we called a greater amount of Bonds in 2009.
Although changes in net amortization of purchase premiums and discounts on mortgage assets can be, and in the past have been, significant, they were not significant in the two comparison periods. Net amortization depends on actual and projected principal prepayments. Our mortgage assets normally have a net premium balance, which results in higher net amortization when mortgage rates fall and lower net amortization when mortgage rates rise. Although mortgage rates were generally lower in 2009 than in 2008, changes in actual and projected prepayment speeds were smaller than normally expected due to falling home prices, the recession, and difficult mortgage refinancing conditions. This resulted in smaller than expected changes in net amortization.
Prepayment Fees on Advances. Although Advance prepayment fees can be, and in the past have been, significant, they were relatively moderate in the 2009 and 2008. Prepayment fees depend mostly on the actions and preferences of members to continue holding our Advances. Fees in one period do not necessarily indicate a trend that will continue in future periods.
Other Components of Net Interest Spread. Excluding net amortization and Advance prepayment fees, the other components of the net interest rate spread increased $92 million in the nine-months comparison and $17 million in the three-months comparison. When short-term interest rates decline dramatically, as occurred in 2009, net interest income normally decreases due to a reduction in the earnings from capital. However, several material factors resulted in an overall increase in net interest income for the nine-months comparison and a small $1 million decrease in the three-months comparison. These factors are discussed below in estimated order of impact from largest to smallest.
Nine-Months Comparison
  §   Re-issuing called Consolidated Bonds at lower debt costs—Favorable: During the fourth quarter of 2008 and the first three quarters of 2009, the reductions in intermediate- and long-term interest rates enabled us to retire (call) approximately $14 billion of unswapped Bonds before their final maturities and replace them with new debt (both Bonds and Discount Notes) at significantly lower interest rates. By contrast, the amount of mortgage paydowns, which we reinvested in assets with lower rates, was substantially less than the amount of Bonds called. In addition, the large amount of Bonds called enabled us to favorably alter the distribution of liability maturities, which raised earnings given the sharply upward sloping yield curve, without materially impacting market risk exposure.
 
  §   Wider portfolio spreads on short-term assets compared to funding costs—Favorable: We use Discount Notes to fund a large amount (normally between $10 billion and $20 billion) of our LIBOR-indexed Advances. For 2008 and the first six months of 2009, average portfolio spreads on short-term and adjustable-rate assets indexed to short-term LIBOR relative to their funding costs were substantially wider than the 18 to 20 basis points historical average. Spreads were wider in the first nine months of 2009 than the same period in 2008 because the financial crisis raised the cost of inter-bank lending (represented by LIBOR) relative to other short-term interest costs such as our Discount Notes. In some months, LIBOR rose as other short-term market rates fell. The wider spreads were particularly acute in the fourth quarter of 2008 (which benefited 2009’s earnings) and the first quarter of 2009.
 
  §   Increase in benefit from short funding—Favorable: Market yield curves became significantly steeper in late 2008 and 2009 as short-term interest rates fell to historical lows of close to zero. This benefited earnings due to our modest utilization of short-term debt to fund long-term assets (short funding). In addition, differences in principal paydowns of long-term assets versus liabilities, including muted acceleration of mortgage prepayments, caused the amount of short funding to increase in the first three quarters of 2009.
 
  §   Decrease in financial leverage due to lower Advance balance—Unfavorable: The average principal balance of Advances was $14.4 billion lower in the first nine months of 2009 compared to the same period of 2008, which reduced our financial leverage. Much of the reduction in leverage occurred from repayment and maturities of LIBOR Advances. Because, as explained above, we had funded many of these LIBOR Advances with Discount Notes at elevated spreads until the third quarter, the loss of these Advances decreased net interest income. We did not replace the lower Advance balances with sufficient increases in other asset balances to fully offset the lost income.

67


Table of Contents

Three-Months Comparison
For the three-months comparison, the same factors affected the other components of net interest rate spread as in the nine-months comparison and in approximately the same relative magnitude, except as noted below.
In the third quarter of 2009, short-term LIBOR decreased, causing the spread between LIBOR and Discount Notes to revert back to, and even go below, the levels in the third quarter of 2008 and historical average levels. We believe this was due to market participants’ view that the financial disruptions had eased and to the effects of the massive amounts of liquidity injected into the financial system. As a result, the higher profits from the wider LIBOR to Discount Note spreads dissipated during the third quarter, resulting in a slight decrease in net interest income for the three-months comparison. Partially offsetting this trend was a favorable earnings impact from the continuing calls of high-cost Consolidated Bonds; the impact of the Bond calls increased as 2009 progressed.

68


Table of Contents

Average Balance Sheet and Yield/Rates
The following tables provide yields/rates and average balances for major balance sheet accounts. These tables provide details on the increases in the net interest rate spread. The average rate of each asset and liability category was lower in the 2009 periods than in the 2008 periods. The accounts with the largest reductions in average rates have short-term maturities or are adjustable rate, which means they repriced to lower rates in the first nine months of 2009, corresponding to the significant reductions in short-term market rates. All data include the impact of interest rate swaps, which we allocate to each asset and liability category according to their designated hedging relationship.
                                                 
(Dollars in millions)   Three Months Ended   Three Months Ended
    September 30, 2009   September 30, 2008
    Average             Average     Average             Average  
    Balance     Interest     Rate (1)     Balance     Interest     Rate (1)  
         
Assets
                                               
Advances
  $   41,530     $   110       1.05 %   $   62,185     $   439       2.81 %
Mortgage loans held for portfolio (2)
    9,761       116       4.70       8,569       112       5.21  
Federal funds sold and securities purchased
under resale agreements
    9,070       4       0.15       7,329       36       1.94  
Other short-term investments
    2,275       1       0.23       26       -       2.81  
Interest-bearing deposits in banks (3) (4)
    5,847       4       0.28       2,898       19       2.60  
Mortgage-backed securities
    12,260       147       4.76       13,337       166       4.93  
Other long-term investments
    11       -       4.15       16       -       4.84  
Loans to other FHLBanks
    29       -       0.15       10       -       1.62  
 
                                       
 
                                               
Total earning assets
    80,783       382       1.88       94,370       772       3.25  
 
                                               
Allowance for credit losses on mortgage loans
            -                       -          
Other assets
    272                       341                  
 
                                           
 
                                               
Total assets
  $   81,055                     $   94,711                  
 
                                           
 
                                               
Liabilities and Capital
                                               
Term deposits
  $   176       -       0.61     $   121       1       2.46  
Other interest bearing deposits (4)
    1,584       -       0.04       1,277       5       1.72  
Short-term borrowings
    32,216       16       0.19       39,578       229       2.30  
Unswapped fixed-rate Consolidated Bonds
    25,413       256       3.99       26,639       303       4.53  
Unswapped adjustable-rate Consolidated Bonds
    2,853       4       0.54       9,239       60       2.59  
Swapped Consolidated Bonds
    12,969       12       0.37       12,471       80       2.54  
Mandatorily redeemable capital stock
    251       3       5.19       129       2       5.50  
Other borrowings
    -       -       -       2       -       0.49  
 
                                       
Total interest-bearing liabilities
    75,462       291       1.53       89,456       680       3.02  
 
                                           
 
                                               
Non-interest bearing deposits
    6                       2                  
Other liabilities
    1,307                       1,050                  
Total capital
    4,280                       4,203                  
 
                                           
 
                                               
Total liabilities and capital
  $   81,055                     $   94,711                  
 
                                           
 
                                               
Net interest rate spread
                    0.35 %                     0.23 %
 
                                           
 
                                               
Net interest income and net interest margin
          $   91       0.45 %           $   92       0.39 %
 
                                       
 
                                               
Average interest-earning assets to
interest-bearing liabilities
                    107.05 %                     105.49 %
 
                                           
(1)   Amounts used to calculate average rates are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
(2)   Nonperforming loans are included in average balances used to determine average rate. There were none for the periods displayed.
(3)   Includes securities classified as available-for-sale, based on their amortized costs. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders’ equity for available-for-sale securities.
(4)   Amounts include certificates of deposits and bank notes that are classified as available-for-sale or held-to-maturity securities in the Statements of Condition. Additionally, the average balance amounts include the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end.

69


Table of Contents

                                                 
(Dollars in millions)   Nine Months Ended     Nine Months Ended  
    September 30, 2009     September 30, 2008  
    Average             Average     Average             Average  
    Balance     Interest     Rate (1)     Balance     Interest     Rate (1)  
         
Assets
                                               
Advances
  $ 46,953     $ 495       1.41 %   $ 60,944     $ 1,453       3.18 %
Mortgage loans held for portfolio (2)
    9,557       367       5.14       8,724       345       5.28  
Federal funds sold and securities purchased
under resale agreements
    8,396       10       0.16       8,451       150       2.37  
Other short-term investments
    801       1       0.24       25       1       2.97  
Interest-bearing deposits in banks (3) (4)
    9,024       23       0.34       2,338       55       3.17  
Mortgage-backed securities
    12,146       438       4.82       12,420       456       4.91  
Other long-term investments
    11       -       4.24       16       1       5.10  
Loans to other FHLBanks
    14       -       0.14       15       -       2.53  
 
                                       
 
                                               
Total earning assets
    86,902       1,334       2.06       92,933       2,461       3.54  
 
                                               
Allowance for credit losses on mortgage loans
            -                       -          
Other assets
    294                       338                  
 
                                           
 
                                               
Total assets
  $ 87,196                     $ 93,271                  
 
                                           
 
                                               
Liabilities and Capital
                                               
Term deposits
  $ 140       1       0.93     $ 102       2       3.07  
Other interest bearing deposits (4)
    1,536       1       0.05       1,368       22       2.11  
Short-term borrowings
    37,708       104       0.37       39,189       774       2.64  
Unswapped fixed-rate Consolidated Bonds
    25,388       802       4.23       24,789       863       4.64  
Unswapped adjustable-rate Consolidated Bonds
    4,380       32       0.98       10,486       247       3.15  
Swapped Consolidated Bonds
    12,111       76       0.84       12,024       279       3.11  
Mandatorily redeemable capital stock
    155       5       4.73       124       6       7.15  
Other borrowings
    2       -       0.07       2       -       1.64  
 
                                       
Total interest-bearing liabilities
    81,420       1,021       1.68       88,084       2,193       3.33  
 
                                           
 
                                               
Non-interest bearing deposits
    5                       4                  
Other liabilities
    1,429                       1,115                  
Total capital
    4,342                       4,068                  
 
                                           
 
                                               
Total liabilities and capital
  $ 87,196                     $ 93,271                  
 
                                           
 
                                               
Net interest rate spread
                    0.38 %                     0.21 %
 
                                               
 
                                               
Net interest income and net interest margin
          $ 313       0.48 %           $ 268       0.39 %
 
                                           
 
                                               
Average interest-earning assets to
interest-bearing liabilities
                    106.73 %                     105.50 %
 
                                               
(1)   Amounts used to calculate average rates are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
(2)   Nonperforming loans are included in average balances used to determine average rate. There were none for the periods displayed.
(3)   Includes securities classified as available-for-sale, based on their amortized costs. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders’ equity for available-for-sale securities.
(4)   Amounts include certificates of deposits and bank notes that are classified as available-for-sale or held-to-maturity securities in the Statements of Condition. Additionally, the average balance amounts include the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end.

70


Table of Contents

Volume/Rate Analysis
Another way to consider the change in net interest income is through a standard volume/rate analysis, as presented in the following table. For purposes of this table, we have allocated changes due to the combined volume/rate variance to the rate category.
                                                 
    Three Months Ended   Nine Months Ended  
(In millions)
  September 30, 2009 over 2008   September 30, 2009 over 2008  
    Volume     Rate     Total     Volume     Rate     Total  
         
Increase (decrease) in interest income
                                               
Advances
  $ (146 )   $ (183 )   $ (329 )   $ (333 )   $ (625 )   $ (958 )
Mortgage loans held for portfolio
    16       (12 )     4       33       (11 )     22  
Federal funds sold and securities
purchased under resale agreements
    9       (41 )     (32 )     (1 )     (139 )     (140 )
Other short-term investments
    16       (15 )     1       17       (17 )     -  
Interest-bearing deposits in banks
    19       (34 )     (15 )     159       (191 )     (32 )
Mortgage-backed securities
    (14 )     (5 )     (19 )     (10 )     (8 )     (18 )
Other long-term investments
    -       -       -       (1 )     -       (1 )
Loans to other FHLBanks
    -       -       -       -       -       -  
         
 
                                               
Total
    (100 )     (290 )     (390 )     (136 )     (991 )     (1,127 )
         
Increase (decrease) in interest expense
                                               
Term deposits
    -       (1 )     (1 )     1       (2 )     (1 )
Other interest-bearing deposits
    2       (7 )     (5 )     3       (24 )     (21 )
Short-term borrowings
    (43 )     (170 )     (213 )     (30 )     (640 )     (670 )
Unswapped fixed-rate Consolidated Bonds
    (13 )     (34 )     (47 )     20       (81 )     (61 )
Unswapped adjustable-rate Consolidated Bonds
    (41 )     (15 )     (56 )     (144 )     (71 )     (215 )
Swapped Consolidated Bonds
    3       (71 )     (68 )     2       (205 )     (203 )
Mandatorily redeemable capital stock
    1       -       1       2       (3 )     (1 )
Other borrowings
    -       -       -       -       -       -  
         
 
                                               
Total
    (91 )     (298 )     (389 )     (146 )     (1,026 )     (1,172 )
         
 
                                               
Increase (decrease) in net interest income
  $ (9 )   $ 8     $ (1 )   $ 10     $ 35     $ 45  
         
Because of the large reductions in interest rates from 2008 to 2009, changes in individual asset and liability categories in the volume/rate table cannot be aggregated or netted to reflect the changes in balances or spreads between various interest rates. For example, the earnings benefits we have realized from the spread between LIBOR and Discount Notes (short-term borrowings) and from calling high-cost Bonds cannot be distinguished in the table above.
Effect of the Use of Derivatives on Net Interest Income
As explained elsewhere, the primary reason we use derivatives, most of which are interest rate swaps, is to hedge the fixed interest rates of certain Advances and Consolidated Obligations as well as to manage certain embedded options in assets and liabilities. The following table shows the effect of derivatives on our net interest income.
                                 
(In millions)   Three Months Ended September 30,   Nine Months Ended September 30,
    2009     2008     2009     2008  
Advances (1)
  $ (135 )   $ (63 )   $ (377 )   $ (136 )
Mortgage purchase commitments (2)
    -       -       3       1  
Consolidated Obligations (1)
    40       23       112       59  
 
                       
Decrease to net interest income
  $ (95 )   $ (40 )   $ (262 )   $ (76 )
 
                       
(1)   Represents interest rate swap interest.
(2)   Represents the amortization of derivative fair value adjustments.
Although our overall use of derivatives decreased net interest income more in the 2009 periods than in the 2008 periods, the derivatives made our earnings and market risk profile significantly more stable because they effectively created synthetic adjustable-rate LIBOR-based coupon rates for both fixed-rate Advances and fixed-rate Obligations. We funded the synthetic adjustable-rate Advances with short-term Discount Notes and the synthetic adjustable-rate swapped Obligations. Thus, the derivatives provided a much closer match of interest rate cash flows between assets and liabilities than would have occurred without their use.

71


Table of Contents

The effect on net interest income from derivatives activity primarily represents the net effects of:
  §   the economic cost of hedging purchased options embedded in Advances;
 
  §   converting fixed-rate Regular Advances and Advances with below-market coupons and purchased options to at-market coupons tied to adjustable-rate LIBOR; and
 
  §   converting fixed-rate coupons to an adjustable-rate LIBOR coupon on swapped Consolidated Obligations.
In general, the relative magnitude of each factor depends on changes in both short-term LIBOR and in the notional principal amounts of swapped Advances versus swapped Obligations. The larger reduction in net interest income in the 2009 periods from our use of derivatives was primarily due to the lower short-term LIBOR in 2009 versus 2008, combined with a greater use of derivatives to transform fixed-rate Advances to adjustable-rate LIBOR than of derivatives to transform fixed-rate Obligations to adjustable-rate LIBOR. See the section “Use of Derivatives in Market Risk Management” in “Quantitative and Qualitative Disclosures About Risk Management” for further information.
Non-Interest Income and Non-Interest Expense
The following table presents non-interest income and non-interest expense for the three and nine months ended September 30, 2009 and 2008.
                                         
  Three Months Ended September 30,         Nine Months Ended September 30,
    (Dollars in millions)   2009     2008             2009     2008  
 
                                       
Other Income
                                       
Net gains on held-to-maturity securities
  $ -     $ -             $ 6     $ -  
Net gains on derivatives and hedging
activities
    5       10               13       9  
Other non-interest income, net
    2       2               6       6  
 
                             
 
                                       
Total other income
  $ 7     $ 12             $ 25     $ 15  
 
                             
 
                                       
Other Expense
                                       
Compensation and benefits
  $ 8     $ 6             $ 22     $ 19  
Other operating expense
    4       3               11       10  
Finance Agency
    1       1               2       2  
Office of Finance
    -       1               2       2  
Other expenses
    1       3               2       4  
 
                             
 
                                       
Total other expense
  $ 14     $ 14             $ 39     $ 37  
 
                             
 
                                       
Average total assets
  $ 81,055     $ 94,711             $ 87,196     $ 93,271  
Average regulatory capital
    4,537       4,337               4,502       4,196  
 
                                       
Total other expense to average total assets (1)
    0.07%       0.06%               0.06%       0.05%
Total other expense to average
regulatory capital (1)
    1.24%     1.27%             1.15%     1.18%
(1)   Amounts used to calculate percentages are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
The net gain on held-to-maturity securities and the net gains on derivatives and hedging activities are discussed above under “Components of Earnings and Return on Equity.” Total other expenses grew less than $2 million, or 5 percent, in the nine-months comparison. Total other expense as a percentage of average total assets and average regulatory capital continued to be one of the lowest of the FHLBanks. We continue to maintain a sharp focus on controlling our operating costs.

72


Table of Contents

REFCORP and Affordable Housing Program Assessments
Currently, the combined assessments for REFCORP and the Affordable Housing Program equate to an approximately 27 percent effective annualized net assessment rate. Depending on the level of the FHLBank System’s earnings, the REFCORP assessment is currently expected to be statutorily retired within the next several years. Lower FHLBank System earnings would extend the retirement date and higher earnings would accelerate the date.
In the first three quarters of 2009, assessments totaled $80 million, which reduced ROE by 2.46 percentage points, compared to $66 million in the first three quarters of 2008, which reduced ROE by 2.16 percentage points. The relative burden of assessments was higher in 2009 than in 2008 because net income before assessments rose by 22 percent while average capital rose by only 7 percent; this means a larger assessment was applied to a modestly larger capital base.
Segment Information
Note 16 of the Notes to Unaudited Financial Statements presents information on our two operating business segments. It is important to note that we manage our financial operations and market risk exposure primarily at the level, and within the context, of the entire balance sheet, rather than exclusively at the level of individual operating business segments. Under this approach, the market risk/return profile of each operating business segment may not match, or possibly even have the same trends as, what would occur if we managed each segment on a stand-alone basis.
The table below summarizes each segment’s operating results for the three and nine months ended September 30, 2009 and 2008.
                         
   
Traditional
   
Mortgage
       
(Dollars in millions)  
Member
   
Purchase
       
   
Finance
   
Program
    Total  
Three Months Ended September 30, 2009
                       
 
                       
Net interest income
  $ 65     $ 26     $ 91  
 
                 
Net income
  $ 41     $ 20     $ 61  
 
                 
 
                       
Average assets
  $ 71,248     $ 9,807     $ 81,055  
 
                 
Assumed average capital allocation
  $ 3,765     $ 515     $ 4,280  
 
                 
 
                       
Return on Average Assets (1)
    0.23%     0.80%     0.30%
 
 
 
   
 
   
 
 
Return on Average Equity (1)
    4.40%     15.23%     5.70%
 
 
 
   
 
   
 
 
 
                       
Three Months Ended September 30, 2008
                       
 
                       
Net interest income
  $ 74     $ 18     $ 92  
 
                 
Net income
  $ 54     $ 12     $ 66  
 
                 
 
                       
Average assets
  $ 86,100     $ 8,611     $ 94,711  
 
                 
Assumed average capital allocation
  $ 3,820     $ 383     $ 4,203  
 
                 
 
                       
Return on Average Assets (1)
    0.25%     0.56%       0.28%  
 
 
 
   
 
   
 
 
Return on Average Equity (1)
    5.63%     12.53%       6.26%  
 
 
 
   
 
   
 
 
(1)   Amounts used to calculate returns are based on numbers in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.

73


Table of Contents

                         
   
Traditional
   
Mortgage
       
(Dollars in millions)  
Member
   
Purchase
       
   
Finance
   
Program
    Total  
Nine Months Ended September 30, 2009
                       
 
                       
Net interest income
  $ 218     $ 95     $ 313  
 
                 
Net income
  $ 155     $ 64     $ 219  
 
                 
 
                       
Average assets
  $ 77,594     $ 9,602     $ 87,196  
 
                 
Assumed average capital allocation
  $ 3,864     $ 478     $ 4,342  
 
                 
 
                       
Return on Average Assets (1)
    0.27%     0.90%     0.34%
 
 
 
   
 
   
 
 
Return on Average Equity (1)
    5.36%     17.98%       6.75%  
 
 
 
   
 
   
 
 
 
                       
Nine Months Ended September 30, 2008
                       
 
                       
Net interest income
  $ 204     $ 64     $ 268  
 
                 
Net income
  $ 138     $ 42     $ 180  
 
                 
 
                       
Average assets
  $ 84,504     $ 8,767     $ 93,271  
 
                 
Assumed average capital allocation
  $ 3,685     $ 383     $ 4,068  
 
                 
 
                       
Return on Average Assets (1)
    0.22%       0.64%       0.26%  
 
 
 
   
 
   
 
 
Return on Average Equity (1)
    5.01%     14.67%       5.92%  
 
 
 
   
 
   
 
 
(1)   Amounts used to calculate returns are based on numbers in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
Traditional Member Finance Segment
For the three-month comparison, the lower net income and lower ROE reflected the unfavorable effects of the reduction in the earnings from capital, the decrease in Advance balances, the decrease in the gain from market value adjustments on derivatives, and the narrower LIBOR-Discount Note spread. These were offset only partially by our calls of Consolidated Bonds identified to fund mortgage-backed securities and the higher gain from short funding. For the nine-months comparison, the increase in net income and ROE reflected the wider portfolio spreads on short-term assets, the Bond calls, the higher gain from short funding, a $4 million increase in Advance prepayment fees, the gains from selling mortgage-backed securities, and the increase in the gain from market value adjustments on derivatives. The last three factors were particularly prevalent in the first quarter of 2009.
Mortgage Purchase Program Segment
The net income and ROE increased in 2009 for both comparison periods. The unfavorable effects from lower earnings from capital were more than offset by replacing a large amount of called Bonds with lower cost debt. We believe the Mortgage Purchase Program will continue to provide competitive risk-adjusted returns and augment earnings available to pay member stockholders, although this segment can exhibit more volatility in profitability over time relative to short-term interest rates than the Traditional Member Finance segment. As discussed elsewhere, mortgage assets are the largest source of our market risk exposure. The effect of market risk exposure from the mortgage-backed securities in the Traditional Member Finance segment is diluted by that segment’s Advances and money market investments, which each have a small amount of residual market risk.

74


Table of Contents

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK MANAGEMENT
Overview
Residual risk is defined as the risk exposure to our mission and corporate objectives remaining after applying our policies, controls, decisions, and procedures to manage and mitigate risk. Normally, our most significant residual risks are business/strategic risk and market risk. Currently, we believe the most significant risk is business/strategic risk, which we define as the potential adverse impact on corporate objectives from external factors and events over which we have limited control or influence. Our current business/strategic risks arise primarily from:
  §   residual effects from the economic recession, especially in our Fifth District;
 
  §   residual effects from the financial crisis;
 
  §   the various other actual and potential actions of the Federal government, including the Federal Reserve, Treasury Department and FDIC, to attempt to mitigate the financial crisis and economic recession;
 
  §   potentially unfavorable actions regarding the ultimate financial, legislative and regulatory disposition of issues involving the GSEs, especially actions related to Fannie Mae and Freddie Mac with whom the FHLBanks share a common regulator; and
 
  §   the evolving concerns about some other FHLBanks’ capital adequacy and profitability.
We believe that the residual exposures for our other risks—collectively market risk, capital adequacy, credit risk, and operational risk—continued to be modest in the first nine months of 2009. Market risk exposure continued to be moderate and at a level consistent with our cooperative business model. We have always maintained compliance with our capital requirements and we believe we hold a sufficient amount of retained earnings to protect our capital stock against earnings losses and impairment risk. We continue to conclude that we do not need a loss reserve for any asset class and that no assets are impaired. We did not experience any material operating risk event.
We also believe the funding/liquidity risk eased as 2009 progressed. Although we can make no assurances, we believe the possibility of a liquidity or funding crisis in the FHLBank System that would impair our FHLBank’s ability to service our debt or pay competitive dividends is remote. The impact of the financial crisis on our debt issuance capabilities and funding costs lessened, as our long-term funding costs relative to LIBOR and U.S. Treasuries showed a relative improvement and less volatility.
Market Risk
Measurement and Management of Market Risk Exposure
Market risk exposure is the risk of fluctuations in both the economic value of our stockholders’ capital investment in the FHLBank and the level of future earnings from unexpected changes and volatility in the market environment (most importantly interest rates) and our business operating conditions. There is normally a tradeoff between our long-term market risk exposure and short-term earnings. We attempt to minimize long-term market risk exposure while earning a competitive return on members’ capital stock investment. Effective management of both components is important in order to attract and retain members and capital and to support growth in Mission Asset Activity.
The primary challenges in managing the level and volatility of long-term earnings exposure—i.e., market risk exposure—arise from 1) the tradeoff between earning a competitive return and correlating profitability with short-term interest rates and 2) the market risk exposure of owning mortgage assets on which we have sold prepayment options. We mitigate the market risk of mortgage assets mostly with long-term unswapped fixed-rate callable and noncallable Consolidated Bonds. We have not used derivatives to manage the market risk of mortgage assets, except for hedging a portion of commitments in the Mortgage Purchase Program. Because it is normally cost-prohibitive to completely mitigate mortgage prepayment risk, a residual amount of market risk typically remains after funding and hedging activities.
Our Financial Management Policy established by our Board of Directors specifies five sets of limits regarding market risk exposure, which primarily address long-term market risk exposure. The policy limits address: 1) the sensitivity of the market value of equity to interest rate shocks; 2) the sensitivity of the duration of equity to interest rate shocks; 3) the market capitalization ratio (defined as the ratio of the market value of equity to the par value of regulatory stock) under two interest rate shocks; 4) the market value sensitivity of the mortgage assets portfolio; and 5) the amount of mortgage assets as a

75


Table of Contents

multiple of capital (this limit was implemented in October 2009). We determine compliance with these policy limits at every month-end or more frequently if market or business conditions change significantly. We complied with each of these policy limits in each of the first nine months of 2009, except one for which we had a minor temporary violation in March.
In addition, Finance Agency Regulations and our Financial Management Policy provide controls on market risk exposure by restricting the types of mortgage loans, mortgage-backed securities and other investments we can hold. We have a minimal amount of mortgage-backed securities of private-label issuers, which can have more volatility in prepayment speeds and credit risk than GSE mortgage-backed securities. We have tended to purchase the senior tranches of collateralized mortgage obligations, which can have less prepayment volatility than other tranches. We also manage market risk exposure by charging members prepayment fees on many Advance programs where an early termination of an Advance would result in an economic loss to us.
Market Value of Equity and Duration of Equity – Entire Balance Sheet
Two key measures of long-term market risk exposure are the sensitivities of the market value of equity and the duration of equity to changes in interest rates and other variables. The following table presents the sensitivity profiles for the market value of equity and the duration of equity for the entire balance sheet and interest rate shocks (in basis points). Average results are compiled using data for each month end.
Market Value of Equity
                                                         
     (Dollars in millions)   Down 200   Down 100   Down 50   Flat Rates   Up 50   Up 100   Up 200
     
 
                                                       
Average Results
                                                       
 
                                                       
2009 Year-to-Date
                                                       
Market Value of Equity
  4,139     4,245     4,330     4,424     4,477     4,480     4,374  
 
                                                       
% Change from Flat Case
    (6.4 )%     (4.0 )%     (2.1 )%     -       1.2 %     1.3 %     (1.1 )%
 
                                                       
2008 Full Year
                                                       
Market Value of Equity
  3,698     3,907     3,979     4,010     3,998     3,956     3,840  
 
                                                       
% Change from Flat Case
    (7.8 )%     (2.6 )%     (0.8 )%     -       (0.3 )%     (1.3 )%     (4.2 )%
 
                                                       
 
 
                                                       
Month-End Results
                                                       
 
                                                       
September 30, 2009
                                                       
Market Value of Equity
  4,016     4,110     4,188     4,294     4,322     4,290     4,137  
 
                                                       
% Change from Flat Case
    (6.5 )%     (4.3 )%     (2.5 )%     -       0.7 %     (0.1 )%     (3.7 )%
 
                                                       
December 31, 2008
                                                       
Market Value of Equity
  3,831     3,965     4,060     4,153     4,180     4,136     3,924  
 
                                                       
% Change from Flat Case
    (7.8 )%     (4.5 )%     (2.2 )%     -       0.7 %     (0.4 )%     (5.5 )%
 
                                                       
Duration of Equity
                                                       
 
                                                       
(In years)
  Down 200   Down 100   Down 50   Flat Rates   Up 50   Up 100   Up 200
                 
 
                                                       
Average Results
                                                       
 
                                                       
2009 Year-to-Date
    (2.6 )     (3.8 )     (4.4 )     (3.4 )     (1.2 )     1.1       3.5  
 
                                                       
2008 Full Year
    (5.7 )     (4.3 )     (2.4 )     (0.2 )     1.6       2.6       3.1  
 
                                                       
 
 
                                                       
Month-End Results
                                                       
 
                                                       
September 30, 2009
    (1.6 )     (3.4 )     (4.3 )     (3.9 )     0.5       2.3       4.8  
 
                                                       
December 31, 2008
    (4.2 )     (4.5 )     (4.6 )     (3.1 )     0.6       3.6       6.4  
Our residual exposures to market risk continued to be moderate, at levels consistent with historical averages and with our cooperative business model. As of September 30, 2009, for an up 200 basis points instantaneous and permanent interest rate shock, we estimated that the market value of equity would decrease 3.7 percent, or $157 million. Likewise, market risk exposure to lower long-term interest rates was also moderate on September 30, with an estimated loss in the market value of equity of 4.3 percent, or $184 million, for a down 100 basis points interest rate shock. Based on these long-term market risk metrics, which indicate the potential reduction in future earnings over the whole life of asset cash flows, as well as based on

76


Table of Contents

analysis of cash flows and earnings simulations, we do not expect that profitability would decrease to uncompetitive levels if interest rates were to change by a substantial amount.
Regarding lower mortgage rates, we called approximately $14 billion of unswapped Bonds in the fourth quarter of 2008 and the first three quarters of 2009 and replaced them with new debt at significantly lower interest costs. Mortgage prepayments did not increase proportionately to the amount of the Bonds called, in part due to the credit conditions—especially falling home prices—that have made refinancing difficult for many homeowners. The amount of Bonds we called will substantially mitigate—but not completely offset—the lower earnings resulting from a possible large acceleration in mortgage prepayment speeds if mortgage rates decrease again substantially.
On September 30, 2009, the mortgage asset portfolio had a net premium balance of $79 million, which was composed of a $90 million net premium balance on the Mortgage Purchase Program and an $11 million net discount balance on mortgage-backed securities. For a 1.00 percentage shock decrease to the currently low mortgage rates, we project there would have been a $16 million immediate increase in net amortization on mortgage asset net premiums (which would lower earnings), while for a 2.00 percentage shock increase to mortgage rates, there would have been a $6 million immediate decrease in net amortization (which would raise earnings). This amount of volatility would not materially affect our ongoing profitability.
Market Capitalization Ratios
The ratio of the market value of equity to the book value of regulatory capital indicates the theoretical net market value of portfolio assets after subtracting the theoretical net market cost of liabilities, as a percent of regulatory capital. To the extent the ratio is lower than 100 percent, it reflects a potential reduction in future earnings from the current balance sheet. The market values used in the ratio can represent potential real economic losses, unrealized opportunity losses, or temporary fluctuations. However, the ratio does not measure the market value of equity from the perspective of an ongoing business. We also track the ratio of the market value of equity to the par value of regulatory capital stock. This ratio excludes retained earnings in the denominator and therefore shows the ability of the market value of equity to protect the value of stockholders’ stock investment in our company.
The following table presents both of these ratios for the current (flat rate) interest rate environment. Because both ratios are close to, or above, 100 percent, they support the assessment that we have a moderate amount of market risk exposure.
                 
    September 30, 2009   December 31, 2008
 
               
Market Value of Equity to
Book Value of Regulatory Capital
    103 %     94 %
 
               
Market Value of Equity to
Par Value of Regulatory Capital Stock
    115 %     102 %
Both ratios have increased in 2009, due to a combination of generally lower mortgage rates, narrower market spreads on new mortgage assets, the Bond calls discussed above and throughout this filing, and our repurchase of a material amount of excess capital stock in September 2009.
Market Risk Exposure of the Mortgage Assets Portfolio
The mortgage assets portfolio accounts for almost all of our market risk exposure because of prepayment volatility that we cannot completely hedge while maintaining positive net spreads to funding costs for these assets. We closely analyze the mortgage assets portfolio both together with and separately from the entire balance sheet. The portfolio includes mortgage-backed securities; loans and commitments under the Mortgage Purchase Program; Consolidated Obligations we have issued to finance and hedge these assets; to-be-announced mortgage-backed securities we have sold short to hedge the market risk of Mandatory Delivery Contracts; overnight assets or funding for balancing the portfolio; and allocated capital.

77


Table of Contents

The following table presents the sensitivities of the market value of equity of the mortgage assets portfolio and interest rate shocks (in basis points). Average results are compiled using data for each month end. We allocate equity to this portfolio using the entire balance sheet’s regulatory capital-to-assets ratio. This allocation is not necessarily what would result from an economic allocation of equity to the mortgage assets portfolio but, because it uses the same regulatory capital-to-assets ratio as the entire balance sheet, the results are comparable to the sensitivity results for the entire balance sheet.
% Change in Market Value of Equity—Mortgage Assets Portfolio
                                                         
    Down 200   Down 100   Down 50   Flat Rates   Up 50   Up 100   Up 200
     
 
                                                       
Average Results
                                                       
2009 Year-to-Date
    (29.4 )%     (17.9 )%     (9.3 )%     -       5.4 %     6.2 %     (2.5 )%
2008 Full Year
    (47.4 )%     (16.5 )%     (5.4 )%     -       (0.4 )%     (4.6 )%     (17.7 )%
 
                                                       
 
 
                                                       
Month-End Results
                                                       
September 30, 2009
    (24.7 )%     (15.9 )%     (8.9 )%     -       3.1 %     1.6 %     (8.3 )%
December 31, 2008
    (49.4 )%     (27.4 )%     (13.4 )%     -       5.2 %     0.8 %     (25.0 )%
The table shows that as of September 30, 2009 the market risk exposure of the mortgage assets portfolio had similar directional trends across interest rate shocks as those of the entire balance sheet, although the mortgage assets portfolio had substantially greater risk volatility than the entire balance sheet.
Use of Derivatives in Market Risk Management
As with our participation in debt issuances, derivatives help us hedge market risk created by Advances and mortgage commitments. Derivatives related to Advances most commonly hedge:
  §   the market risk exposure on Putable and Convertible Advances for which members have sold us options embedded within the Advances;
 
  §   the market risk exposure of options we have sold that are embedded with Advances; or
 
  §   Regular Fixed-Rate Advances when it may not be as advantageous to issue Obligations or when it may improve our market risk management.
We also use derivatives to hedge the market risk created by commitment periods of Mandatory Delivery Contracts in the Mortgage Purchase Program.
Derivatives help us intermediate between the normal preferences of capital market investors for intermediate-and- long-term fixed-rate debt securities and the normal preferences of our members for shorter-term or adjustable-rate Advances. We can satisfy the preferences of both groups by issuing long-term fixed-rate Bonds and entering into an interest rate swap that synthetically converts the Bonds to an adjustable-rate LIBOR funding basis that matches up with the short-term and adjustable-rate Advances, thereby preserving a favorable interest rate spread.

78


Table of Contents

The following table presents the notional principal amounts of the derivatives used to hedge other financial instruments. The allocation of our derivatives showed no significant trend or change in the last year outside of normal variations. This is as expected given the lack of growth of the types of Advances that we normally hedge with derivatives.
                                 
            September 30,     December 31,     September 30,  
     (In millions)           2009     2008     2008  
 
Hedged Item
  Hedging Instrument                        
 
                               
Consolidated Obligations
  Interest rate swap   $ 13,632     $ 10,140     $ 12,640  
Convertible Advances
  Interest rate swap     3,231       3,478       3,506  
Putable Advances
  Interest rate swap     7,046       6,981       6,894  
Advances with purchased
caps and/or floors
 
Interest rate swap
    -       1,400       2,400  
Regular Fixed-Rate Advances
  Interest rate swap     3,543       5,808       5,573  
Mandatory Delivery
  Commitments to sell to-be-announced                        
Contracts
  mortgage-backed securities     -       386       35  
 
                         
 
                               
Total based on Hedged Item (1)
          $ 27,452     $ 28,193     $ 31,048  
 
                         
(1)   We enter into Mandatory Delivery Contracts (commitments to purchase loans) in the normal course of business and economically hedge them with interest rate forward agreements (commitments to sell to-be-announced mortgage-backed securities). Therefore, the Mandatory Delivery Contracts (which are derivatives) are the objects of the hedge (the Hedged Item) and are not listed as a Hedging Instrument in this table.
The following table presents the notional principal amounts of derivatives according to their accounting treatment and hedge relationship. This table differs from the one above in that it displays all derivatives, including Mandatory Delivery Contracts (the hedged item) and to-be-announced mortgage-backed securities (their hedging instrument).
                         
    September 30,     December 31,     September 30,  
     (In millions)   2009     2008     2008  
 
                       
Shortcut (Fair Value) Treatment
                       
Advances
  $ 5,918     $ 8,246     $ 7,914  
Consolidated Obligations
    449       860       1,020  
 
                 
 
                       
Total
    6,367       9,106       8,934  
 
                       
Long-haul (Fair Value) Treatment
                       
Advances
    7,705       7,790       10,228  
Consolidated Obligations
    12,983       8,935       11,620  
 
                 
 
                       
Total
    20,688       16,725       21,848  
 
                       
Economic Hedges
                       
Advances
    197       1,631       231  
Consolidated Obligations
    200       345       -  
Mandatory Delivery Contracts
    126       918       178  
To-be-announced mortgage-backed securities hedges
    -       386       35  
 
                 
 
                       
Total
    523       3,280       444  
 
                 
 
                       
Total Derivatives
  $ 27,578     $ 29,111     $ 31,226  
 
                 
Changes in the allocation of derivatives according to their accounting treatment reflected normal variations. In particular, the increase in long-haul treatment of Consolidated Obligations reflected greater use of these types of derivatives as a substitute for Discount Note funding. The overall changes shown did not represent a new hedging or risk management strategy or a change in accounting treatment of existing hedges. An economic hedge is defined as the use of a derivative that economically hedges a financial instrument but that is deemed to not qualify for hedge accounting treatment. The decrease in economic hedges from year-end 2008 to September 30, 2009 was primarily due to the maturity of a large Advance hedged with an interest rate swap.
Effective July 1, 2009, in light of the continued evolution of more rigid accounting interpretations surrounding shortcut accounting treatment and to minimize the related accounting risk, we decided to account for all new derivatives hedging Advances using the long-haul treatment. We expect this to result in some additional minor earnings volatility.

79


Table of Contents

Capital Adequacy
Capital Leverage
Prudent risk management dictates that we maintain effective financial leverage to minimize risk to our capital stock while preserving profitability and that we hold an adequate amount of retained earnings. Pursuant to these objectives, Finance Agency Regulations stipulate that we must comply with three limits on capital leverage and risk-based capital requirements.
  § We must maintain at least a 4.00 percent minimum regulatory capital-to-assets ratio.
  § We must maintain at least a 5.00 percent minimum leverage ratio of capital divided by total assets, which includes a 1.5 weighting factor applicable to permanent capital. Because all of our Class B stock is considered permanent capital, this requirement is met automatically if we satisfy the 4.00 percent unweighted capital requirement.
  § We are subject to a risk-based capital rule, as discussed below.
We have always complied with each capital requirement. See the “Capital Resources” section of the “Analysis of Financial Condition” for information on the most important requirement, the minimum regulatory capital-to-assets ratio.
Retained Earnings
Our Retained Earnings Policy sets forth a range for the amount of retained earnings that we believe is needed to mitigate impairment risk and augment dividend stability in light of all the material risks we face. The current Retained Earnings Policy establishes a range of adequate retained earnings from $140 million to $285 million, with a target level of $170 million. We believe that our retained earnings assessment is conservative. Our methodology biases it towards calculation of a higher amount of retained earnings than we believe actually is needed to protect against impairment risk. In particular, we assume that all unfavorable scenarios and conditions occur simultaneously, implying that each dollar of retained earnings can serve as protection against only one risk event. This scenario is extremely unlikely to occur. On September 30, 2009, we had $407 million of retained earnings, which we believe is sufficient to protect our capital stock against impairment risk and to enhance our ability to protect dividends against earnings volatility.
Risk-Based Capital Regulatory Requirement
We must hold sufficient capital to protect against exposure to market risk, credit risk, and operational risk. The GLB Act and Finance Agency Regulations require total permanent capital, which includes retained earnings and the regulatory amount of Class B capital stock, to at least equal the amount of risk-based capital. Risk-based capital is the sum of market risk, credit risk, and operational risk as specified by the Regulations. The following table shows the amount of risk-based capital required based on the measurements, the amount of permanent capital, and the amount of excess permanent capital.
                         
(Dollars in millions)                
            Monthly Average    
    Quarter End   Nine Months Ended   Year End
    September 30, 2009   September 30, 2009   2008
 
Total risk-based capital requirement
  $                580     $                618     $                543  
Total permanent capital
    4,152       4,502       4,399  
 
                       
 
                       
Excess permanent capital
  $             3,572     $             3,884     $             3,856  
 
                       
 
                       
Risk-based capital as a
percent of permanent capital
    14%     14%     12%
The risk-based capital calculation has historically not been a constraint on our operations. It has ranged from 12 to 20 percent, which is significantly less than the amount of our permanent capital, and has not changed materially during the financial crisis. We expect this to continue to be the case. We do not use the requirement to actively manage our market risk exposure.

80


Table of Contents

Credit Risk
Overview
We assume a substantial amount of inherent credit risk exposure in our dealings with members, purchases of investments, and transactions of derivatives. Credit risk is the risk of monetary loss due to failure of any obligor to meet the terms of any contract with us. Most importantly, credit risk arises from delayed receipt, or no receipt, of principal and interest on assets lent to or purchased from members or investment counterparties, or due to counterparties’ nonpayment of interest due on derivative transactions. We focus on credit risk arising from Advances, loans in the Mortgage Purchase Program, investments, and derivative transactions. For the reasons detailed below, we believe we are exposed to a minimal amount of residual credit risk. Therefore, we have not established a loss reserve or taken an impairment charge on any financial instrument.
Credit Services
Overview. We have numerous policies and practices to manage credit risk exposure from our secured lending activities, which include Advances and Letters of Credit. The objective of our credit risk management is to equalize risk exposure across members and counterparties to a zero level of expected losses. Despite deterioration in the credit conditions of many of our members and in the value of some pledged collateral, we believe that we have a minimal residual amount of credit risk exposure in our secured lending activities. We base this assessment on the following factors:
     
  § a conservative approach to collateralizing credit that results in significant over-collateralization. This includes 1) systematically raising collateral margins and collateral status as the financial condition of a member or of the collateral pledged deteriorates, and 2) adjusting collateral margins for subprime and nontraditional mortgage loans that we have identified and determined are not properly underwritten;
 
  § close monitoring of members’ financial conditions and repayment capacities;
 
  § a risk focused process for reviewing and verifying the quality, documentation, and administration of pledged loan collateral;
 
  § our belief that we have a moderate level of exposure to poorly performing subprime and nontraditional mortgages pledged as collateral; and
 
  § a history of never experiencing a credit loss or delinquency on any Advance.
Because of these factors, we have never established a loan loss reserve for Credit Services.
Collateral. We require each member to provide us a security interest in eligible collateral before it can undertake any secured borrowing. One of our most important policy parameters is that we require each member’s borrowings to be over-collateralized. This means that each member must maintain borrowing capacity in excess of its credit outstanding and that its borrowing capacity is less than estimated market value of the collateral pledged. As of September 30, 2009, the over-collateralization resulted in total collateral pledged of $160.6 billion against a total borrowing capacity of $101.6 billion. Over-collateralization by one member is not applied to another member.
We assign each member one of four levels of collateral status—Blanket, Securities, Listing, and Physical Delivery—based on our credit rating (described below) that reflects our view of the member’s current financial condition, capitalization, level of problem assets, and other credit risk factors.
Blanket collateral status is the least restrictive and is available for lower risk institutions. We assign it to approximately 85 percent of members. Under a Blanket status, the borrowing member is not required to provide loan level detail on pledged loans. We monitor eligible collateral pledged under Blanket status using quarterly regulatory financial reports or periodic collateral “Certification” documents submitted by all significant borrowers. Lower risk members that choose not to pledge loan collateral are assigned Securities status. Under Listing collateral status, a member must pledge, and provide us information on, specifically identified individual loans that meet certain minimum qualifications. Physical Delivery is the most restrictive collateral status, which we assign to members experiencing significant financial difficulties, most insurance companies pledging loans, and newly chartered institutions.

81


Table of Contents

In addition to requiring physical delivery of collateral, we apply more conservative collateral requirements for insurance company members and for newly chartered institutions. The latter are required to deliver collateral until they have developed a solid financial history that trends strongly towards being profitable.
The table below shows the allocation of pledged collateral by collateral type as of September 30, 2009.
                 
    Percent of Total   Collateral Amount
    Pledged Collateral   ($ Billions)
1-4 Family Residential
    62 %   $   99.8  
Home Equity Loans
    20       32.6  
Commercial Real Estate
    9       14.3  
Bond Securities
    7       11.4  
Multi-Family
    1       2.0  
Farm Real Estate
    (a )     0.5  
 
               
Total
    100 %   $  160.6  
 
               
(a)   Less than one percent of total pledged collateral.
Collateral is primarily 1-4 family whole first mortgages on residential property or securities representing a whole interest in such mortgages. Compared to December 31, 2008, the percentage of 1-4 family residential collateral rose four percentage points while the percentage of home equity collateral fell five percentage points. We value listed and physically delivered loan collateral at the lesser of par or our internally estimated market value. Securities collateral is valued using two third-party providers. The market value of loan collateral pledged under a Blanket status is assumed to equal the outstanding unpaid principal balance.
We determine borrowing capacity against pledged collateral by applying Collateral Maintenance Requirements (CMRs), which are informally referred to as over-collateralization rates or “haircuts.” CMRs are percentage adjustments (i.e., discounts) applied to the estimated market value of pledged collateral. The discounts are determined by dividing one by the CMR; for example, a CMR of 150 percent translates into a discount of 66.7 percent, which means that 66.7 percent of the market value is eligible for borrowing. CMRs, which are intended to capture market, credit, liquidity, and prepayment risks that may affect the realizable value of each pledged asset in the event we must liquidate collateral, result in borrowing capacity that is less than the amount of pledged collateral. The table below shows the range of discounts resulting from the CMR process for each major collateral type segregated by collateral status.
         
    Discount Range
1-4 Family Residential
    57-80 %
Home Equity Loans
    25-67 %
Commercial Real Estate
    20-67 %
Bond Securities
    0-49 %
Multi-Family
    40-80 %
Farm Real Estate
    29-57 %
We believe our CMR process results in conservative adjustments of borrowing capacity for all collateral types. Members and collateral with a higher risk profile, more risky credit quality, and/or less favorable performance are generally subjected to higher CMRs. Loans pledged under a Blanket status generally are haircut more aggressively than loans on which we have detailed loan structure and underwriting information, due to unknown factors which may result in the market value being significantly below the book value of the Blanket loans. In most cases, higher quality assets such as 1-4 family residential mortgage loans must be pledged before we will accept lower quality collateral such as commercial real estate loans.
At September 30, 2009, we had $1,478 million of Advances outstanding to nonmembers that had been acquired by financial institutions who are members of other FHLBanks. The merger on November 6, 2009 of National City Bank into PNC Bank, which is chartered in a different FHLBank district, increased the amount of nonmember Advances and outstanding Letters of Credit, as of that date, by $4,433 million. Our Advances to nonmembers are secured either by marketable securities held in our custody (which totaled $269 million on September 30, 2009) or supported by subordination or other inter-FHLBank

82


Table of Contents

security agreements. In accordance with the terms of these agreements, each counterparty FHLBank is required to maintain sufficient collateral to cover our extensions of credit in accordance with its collateral policies and practices, all of which require overcollateralization and periodic verification of collateral levels. Subordination agreements mitigate our risk in the event of default by giving our claim to the value of collateral priority over the interests of the subordinating FHLBank, thus providing an incentive to ensure pledged collateral values are sufficient to cover all parties.
We also have an internal policy that, with certain exceptions granted on a case-by-case basis, we will not extend additional credit to any member (except under the Affordable Housing or the Community Investment and Economic Development Programs) that would result in total borrowings exceeding 50 percent of its total assets.
Perfection. With certain unlikely statutory exceptions, the FHLBank Act affords any security interest granted to us by a member, or by an affiliate of a member, priority over the claims and rights of any party, including any receiver, conservator, trustee, or similar party having rights of a lien creditor. As additional security for members’ indebtedness, we have a statutory lien on their FHLBank capital stock. We perfect our security interest in collateral by 1) filing financing statements on each member pledging loan collateral, 2) taking possession or control of all pledged securities and cash collateral, and 3) taking physical possession of pledged loan collateral when we deem it appropriate based on a member’s financial condition. In addition, at our discretion and consistent with our Credit Policy, we are permitted to call on members to pledge additional collateral at any time during the life of a borrowing.
Subprime and Nontraditional Mortgage Loan Collateral. We have policies and processes to identify subprime loans pledged by members to which we have high credit risk exposure or have extended significant credit. We perform on-site collateral reviews, sometimes engaging third parties, of members we deem to have high credit risk exposure. The reviews include identification of loans that meet our definitions of subprime and nontraditional. Our definitions of a subprime and a nontraditional mortgage loan (NTM) are expansive and conservative. During the review process, we estimate overall subprime and nontraditional mortgage exposure levels by performing random statistical sampling of residential loans in the member’s pledged portfolio.
We have instituted a multi-year program to review all members for exposure to subprime and nontraditional collateral. The members on which we have performed on-site credit reviews to date have encompassed approximately half of the residential mortgage collateral pledged. Based on these reviews, we estimate that approximately 20 to 25 percent of pledged residential loan collateral has one or more subprime characteristics. Although we have estimated NTM exposure for some members, due to the fact this is a relatively new process, we have not reviewed a sufficient number of members to offer a statistically valid estimate of exposure.
We raise CMRs by up to 50 additional percentage points for the identified subprime and/or NTM segment of each pledged loan portfolio. We also apply separate adjustments to CMRs for pledged private-label residential mortgage-backed securities for which there is available information on subprime loan collateral. No security known to have more than one-third subprime collateral is eligible for pledge to support additional credit borrowings.

83


Table of Contents

Internal Credit Ratings of Members. We assign each borrower an internal credit rating, based on a combination of internal credit analysis and consideration of available credit ratings from independent credit rating organizations. Analysis focuses on asset quality, financial performance and earnings quality, liquidity, and capital adequacy. In addition to the credit ratings process, ongoing analyses are performed of institutions that pose elevated credit risk including problem institutions, insurance companies, and large borrowers. The following tables show the distribution of internal credit ratings we assigned to member and non-member borrowers.
September 30, 2009
     (Dollars in billions)
                                         
    All Members and Borrowing        
    Nonmembers   All Borrowers
            Collateral-Based           Credit   Collateral-Based
  Credit           Borrowing           Services   Borrowing
  Rating   Number   Capacity   Number   Outstanding   Capacity
           
1
    73     $           2.0       43     $           0.3     $           1.2  
2
    125       40.2       76       16.8       39.5  
3
    169       11.5       136       5.8       11.0  
4
    201       27.8       174       7.7       27.4  
5
    73       12.7       65       7.1       12.6  
6
    66       2.8       59       2.0       2.5  
7
    45       4.6       42       3.1       4.6  
           
Total
    752     $        101.6       595     $        42.8     $        98.8  
           
December 31, 2008
     (Dollars in billions)
                                         
    All Members and Borrowing        
    Nonmembers   All Borrowers
            Collateral-Based           Credit   Collateral-Based
Credit           Borrowing           Services   Borrowing  
Rating   Number   Capacity   Number   Outstanding   Capacity
           
1
    103     $         32.7       69     $         22.1     $         31.8  
2
    149       5.8       107       2.4       5.2  
3
    223       23.9       196       15.3       23.4  
4
    165       23.5       142       9.0       23.2  
5
    35       10.1       26       7.2       10.0  
6
    49       2.6       46       1.8       2.5  
7
    16       4.5       14       2.9       4.5  
               
Total
    740     $        103.1       600     $         60.7     $        100.6  
               
The left table shows the borrowing capacity (Advances and Letters of Credit) of both members and non-member borrowers. The right side includes only institutions with outstanding credit activity, which includes Advances and Letter of Credit obligations, along with their total borrowing capacity. The lower the numerical rating, the higher our assessment of the member’s credit quality. A “4” rating is our assessment of the lowest level of satisfactory performance.
Although our members overall have satisfactory credit risk profiles, many of them have been unfavorably affected by the financial crisis, which has resulted in a continuing significant downward trend in our member credit ratings. This trend began in the second half of 2007 and accelerated throughout 2008 and the first three quarters of 2009. As of September 30, 2009, 184 members and borrowing nonmembers (24 percent of the total) had credit ratings of 5 or below, with $20.1 billion of borrowing capacity. Between the end of 2007, when the recession and financial crisis began, and September 30, 2009, we moved a net of 141 institutions and $13.3 billion of borrowing capacity into one of the three lowest credit rating categories, and there has been a substantial movement (a net of 86) of members from the first three highest rating categories into the fourth highest rating category. The small amount of borrowing capacity on September 30 for the 73 members and borrowing nonmembers with the highest credit rating reflects the fact that these are all small financial institutions.
A lower internal credit rating can cause us to 1) decrease the institution’s borrowing capacity via a higher collateral maintenance requirement, 2) require it to provide an increased level of detail on pledged collateral, 3) require it to deliver

84


Table of Contents

collateral to us in custody, and/or 4) prompt us to more closely and/or frequently monitor the institution using several established processes. The underwriting is largely performed in advance of individual extensions of credit and is reflected in an institution’s maximum borrowing capacity and, in some cases, maturity limits.
Mortgage Purchase Program
Overview. We believe that the residual amount of credit risk exposure to loans in the Mortgage Purchase Program is de minimis and that it is probable we will be able to collect all principal and interest amounts due according to contractual terms. We base this assessment on the following factors:
     
  § the strong credit enhancements for conventional loans;
 
  § the U.S. government insurance on FHA mortgage loans;
 
  § no credit losses experienced on any purchased loan since inception of the Program;
 
  § minimal delinquencies and defaults experienced in the Program’s loan portfolio;
 
  § underwriting and loan characteristics consistent with favorable expected credit performance; and
 
  § no supplemental mortgage insurance provider having experienced a loss on any loan sold to us, other than one loss for only $16,000 on a partial claim.
Because of these factors, we have not established a loan loss reserve for the Program and have determined that none of our mortgage loans are impaired.
Credit Enhancements. We use similar credit underwriting standards and processes for approving members to participate in the Mortgage Purchase Program as for members who borrow Advances. Our primary management of credit risk for conventional loans involves the collateral supporting the mortgage loans (i.e., homeowners’ equity) and several layers of credit enhancement. The credit enhancements, listed in order of priority, include:
     
  § primary mortgage insurance (when applicable);
 
  § the Lender Risk Account; and
 
  § supplemental mortgage insurance coverage on a loan-by-loan basis that the participating financial institution (PFI) purchases from one of our approved third party providers, naming us the beneficiary.
The combination of homeowners’ equity and credit enhancements protect us down to approximately a 50 percent loan-to-value level (based on values at loan origination), subject, in certain cases, to an aggregate stop-loss feature in the supplemental mortgage insurance policy. This means that the loan’s value (observed from a sale price or appraisal) can fall to half of its value at the time the loan was originated before we would be exposed to a potential loss.
Finance Agency Regulations require that the combination of mortgage loan collateral and credit enhancements be sufficient to raise the implied credit ratings on pools of conventional mortgage loans to at least an investment-grade rating of BBB, although our program internally requires an implied credit rating of AA when each pool is closed. We analyze all pools using a credit assessment model licensed from Standard & Poor’s.
If the implied rating falls below AA, risk-based capital Regulations require us to hold additional risk-based capital to help mitigate the perceived additional credit risk. On September 30, 2009, we had six pools totaling $1.3 billion that fell short of a AA rating, which resulted in an increase of $7 million in our risk-based capital.
Lender Risk Account. The Lender Risk Account is a key feature that helps protect us against credit losses on conventional mortgage loans. It is a purchase price holdback from the PFI on each conventional loan the PFI sells to the FHLBank. Therefore, it provides members an incentive to sell us high quality loans. These funds are available to cover credit losses in excess of the borrower’s equity and primary mortgage insurance on loans in the pool we have purchased. The Lender Risk Account percentage ranges from 30 basis points to 50 basis points of the loans’ purchased principal balance, based on our determination of expected loan losses. We use the Standard & Poor’s credit model to determine the Lender Risk Account percentage to apply to each PFI and to manage the credit risk of committed and purchased conventional loans.
If conventional loan losses, on a loan-by-loan basis, exceed homeowner’s equity and applicable primary mortgage insurance, the Lender Risk Account is drawn on to cover our exposure to these residual losses until the Account is exhausted. Any

85


Table of Contents

portion of the Account not needed to help cover actual loan losses in excess of homeowner’s equity and any applicable primary mortgage insurance is distributed to the PFI over a pre-determined schedule.
The following table presents changes in the Lender Risk Account. The amount of loss claims was approximately $1 million for the nine months ended September 30, 2009. Since inception of the Program, loss claims have only used approximately $2 million, or 3 percent, of the Lender Risk Account.
         
(In millions)   Nine Months Ended
  September 30, 2009
Lender Risk Account at December 31, 2008
  $       49  
Additions
    12  
Claims
    (1 )
Scheduled distributions
    (3 )
 
       
 
       
Lender Risk Account at September 30, 2009
  $       57  
 
       
Loan Characteristics and Credit Performance. Two indications of credit quality are loan-to-value ratios and credit scores provided by Fair Isaac and Company (FICO®). FICO® provides a commonly used measure to assess a borrower’s credit quality, with scores ranging from a low of 300 to a high of 850. Our policy currently stipulates that we will not purchase conventional loans with a FICO® score of less than 660. In current market conditions, the mortgage industry generally considers a FICO® score of over 660, and a loan-to-value ratio of 80 percent or lower, as benchmarks indicating a good credit risk. For conventional loans with FICO® scores between 620 to 660, we also have risk-based pricing adjustments and additional underwriting limitations to further mitigate risks. In addition, we require higher FICOs for loans with loan-to-values that exceed 90 percent.
The following table shows FICO® scores at origination for the conventional loan portfolio. The distributions were similar on September 30, 2009 as in the prior several years.
                 
    September 30,   December 31,
FICO® Score   2009   2008
 
               
< 620
    0 %     0 %
620 to < 660
    4       5  
660 to < 700
    11       12  
700 to < 740
    19       21  
>= 740
    66       62  
 
               
Weighted Average
    751       745  
High loan-to-value ratios, especially those above 90 percent in which homeowners have little or no equity at stake, are key drivers in potential mortgage delinquencies and defaults. The following table shows loan-to-value ratios for conventional loans based on values at origination dates and also values estimated as of September 30, 2009 based on original loan-to-values, principal paydowns that have occurred since origination, and one estimated method of changes in historical home prices for the metropolitan statistical area in which each loan resides. Both measures are weighted by current unpaid principal.
                                         
    Based on Origination Dates           Based On Estimated Current Value
    September 30,   December 31,           September 30,   December 31,
Loan-to-Value         2009               2008         Loan-to-Value         2009               2008      
 
                                       
<= 60%
    21 %     21 %   <= 60%     34 %     34 %
> 60% to 70%
    19       18     > 60% to 70%     22       19  
> 70% to 80%
    52       53     > 70% to 80%     28       21  
> 80% to 90%
    5       5     > 80% to 90%     9       16  
> 90%
    3       3     > 90% to 100%     4       6  
 
                  > 100%     3       4  
 
                                       
Weighted Average
    70 %     70 %  
Weighted Average
    65 %     67 %

86


Table of Contents

The relatively favorable original and estimated current loan-to-value ratios provide further support for our conclusion that the Mortgage Purchase Program has a strong credit quality. Only 7 percent of loans are estimated to have current ratios above 90 percent. The reduction in home prices since origination dates has been more than offset by regular principal amortization as well as partial prepayments. In large part, this reflects the heavy concentration of our mortgage loans from Ohio (discussed below), which several data sources indicate has had relatively modest decrease in home prices. Although the estimated current loan-to-values have a range of uncertainty based on sampling methods to determine current loan values, our research leads us to believe that the range is not large enough to alter the conclusion that the current loan-to-value ratios are favorable, despite the housing market’s difficulties in the last three years. To help derive this assessment, we evaluated two sources for estimates of current loan values.
The following tables provide additional detailed data on conventional loans with FICO® scores at origination below 660 and, separately, current estimated loan-to-value ratios above 90 percent. Some loans are in both categories.
Conventional Loans with FICO® Scores Below 660
                 
    September 30,   December 31,
Loan-to-Value   2009   2008
<= 60%
    25 %     23 %
> 60% to 70%
    25       23  
> 70% to 80%
    27       25  
> 80% to 90%
    12       16  
> 90% to 100%
    5       7  
> 100%
    6       6  
Conventional Loans with Loan-to-Values Above 90%
                 
    September 30,   December 31,
FICO® Score   2009   2008
 
               
< 620
    3 %     3 %
620 to < 660
    3       3  
660 to < 700
    7       7  
700 to < 740
    13       12  
>= 740
    74       75  
For loans with FICO® scores below 660, only 11 percent are estimated to have loan-to-values above 90 percent and their combined 60-day or more delinquency and foreclosure rate, although above the averages for the entire conventional portfolio, is below six percent, which we believe is less than national statistics for loans with FICO® scores below 660. For loans with loan-to-value ratios above 90 percent, only six percent have FICO® scores below 660 and their combined 60-day delinquency or more and foreclosure rate is below six percent.
Based on the available data, we believe we have little exposure to loans in the Program considered to have individual characteristics of “subprime” or “alternative/nontraditional” loans. Further, we do not knowingly purchase any loan that violates the terms of our Anti-Predatory Lending Policy.

87


Table of Contents

The geographical allocation of loans in the Program is concentrated in the Midwest, as shown on the following table based on unpaid principal balance.
                        
    September 30,   December 31,
    2009   2008
 
               
Midwest
    61 %     52 %
Southeast
    21       24  
Southwest
    9       11  
West
    5       7  
Northeast
    4       6  
 
               
Total
    100 %     100 %
 
               
Midwest includes the states of IA, IL, IN, MI, MN, ND, NE, OH, SD, and WI
Southeast includes the states of AL, DC, FL, GA, KY, MD, MS, NC, SC, TN, VA, and WV
Southwest includes the states of AR, AZ, CO, KS, LA, MO, NM, OK, TX, and UT
West includes the states of AK, CA, GU, HI, ID, MT, NV, OR, WA, and WY
Northeast includes the states of CT, DE, MA, ME, NH, NJ, NY, PA, PR, RI, VI, and VT
After being relatively stable in recent years, loans became more concentrated in the Midwest in the first nine months of 2009 due to an increase in loan purchase activity from our second largest seller, which operates much of its business in Ohio. Our loan concentration in the Midwest may further increase due to the loss of one of our historically largest sellers of loans outside of the Midwest. Loans are less concentrated in the Northeast and West, regions that historically have had the most exposure to credit problems including foreclosures and housing price declines. In addition, less than two percent of total loans were originated in the depressed real-estate market of Florida.
Conventional loans in Ohio represented 50 percent of unpaid principal as of September 30, 2009, an increase from year-end 2008’s 40 percent. No other state had more than ten percent of unpaid principal. Our two largest current sellers operate much of their businesses in Ohio, which has had one of the highest state foreclosure rates in the past few years. To mitigate this concentration risk, we emphasize purchases of mortgage-backed securities in our investment portfolio whose underlying loans are not heavily originated in Ohio. However, delinquency rates (loans past due 90 days or more or in foreclosure) on our Ohio loans (0.3 percent) continue to be significantly lower than the overall delinquency rates (4.1 percent) for Ohio’s prime, fixed-rate mortgages.
The relatively low amount of delinquencies and foreclosures is another indication of the Program’s strong credit quality. An analysis of loans past due 90 days or more or in foreclosure is presented below. For comparison, the table shows the same data nationally, based on a nationally recognized delinquency survey. The 0.8 percent ratio translates into $62 million of principal balance.
                                       
    Mortgage Purchase Program   National Averages
    September 30,   December 31,   September 30, (1)   December 31,
    2009   2008   2009   2008
Delinquencies past due 90 days
or more, or in foreclosure:
                               
 
                               
Conventional mortgage loans
    0.8 %     0.5 %     3.5 %     2.3 %
 
                               
FHA mortgage loans
    3.7       2.9       7.4       6.6  
 
(1)   September 30, 2009 national averages for conventional and FHA mortgage loans are based on the most recent national delinquency data, or June 30, 2009.
During the financial crisis, our delinquency/foreclosure rates on both conventional and FHA loans have continued to be well below the national averages. Because of the Program’s credit enhancements, we do not expect to have to pay claims on any loans that become foreclosed. For government-insured (FHA) mortgages, the delinquency rate is generally higher than for the conventional mortgages held in the Program. We rely on government insurance, which generally provides a 100 percent guarantee, as well as quality control processes, to maintain the credit quality of the FHA portfolio.

88


Table of Contents

We perform a credit risk analysis for conventional loans, on a loan-by-loan basis, to determine if projected claims on loans 60 days or more delinquent would be significant enough to exhaust all the credit enhancements. The analysis uses a third party prepayment and housing credit model, which employs conservative assumptions on future home price trends. We also stress this model for an extremely pessimistic assumptions of future home prices. As a result of the analysis, we continue to expect no probable losses on these loans that would exceed the combined credit enhancements, and few losses that would exceed the Lender Risk Account.
Credit Risk Exposure to Supplemental Insurance Providers. The following table presents information on the concentration of supplemental mortgage insurance providers for our conventional loans and their related credit ratings as of September 30, 2009.
                                 
    Percent of   Credit Rating
    Portfolio   S&P   Moody’s   Fitch
Mortgage Guaranty Insurance
Corporation (MGIC)
    55 %   BB   Ba2   BBB-
Genworth Residential Mortgage
Insurance Corporation (Genworth)
    45 %   BBB+   Baa2     N/A  
 
                               
 
                               
Total
    100 %                        
 
                               
Genworth is our current sole provider of supplemental mortgage insurance for new business. We discontinued committing new business with MGIC in 2008, although 55 percent of our loans outstanding have supplemental mortgage insurance underwritten by MGIC. We subject both supplemental mortgage insurance providers to standard credit underwriting analysis. As of September 30, 2009, a stress test of potential exposure resulted in an estimated $13 million total gross credit exposure from both providers and net exposure after consideration of the protection afforded by the Lender Risk Account of $1 million. We believe this constitutes an acceptable amount of exposure under the very extreme scenario of our entire conventional portfolio defaulting and the insurance providers being financially unable to pay any of the resulting claims. Over its life, we have had only 78 claims paid in the Mortgage Purchase Program, all of which we funded from the Lender Risk Account except for one partial claim paid by a supplemental mortgage insurance provider. Therefore, we believe we have a very small amount of expected credit exposure to both providers. See the related discussion in “Business Related Developments and Update on Risk Factors” of the “Executive Overview.”
Investments
Money Market Investments. Most money market investments are unsecured and therefore present credit risk exposure. A credit event for an investment security could be triggered by its default, by delayed payments of principal or interest, or by a rating downgrade that results in a realized market value loss. We believe our conservative investment policies and practices result in a nominal amount of credit risk exposure in our investment portfolio. Our Financial Management Policy permits us to invest only in highly rated counterparties and stipulates restrictions on the amount of exposure we are permitted to have to an individual counterparty and affiliated counterparties.
We supplement the formulaic limits on credit exposure with internal credit underwriting analysis and aggressive trading room management of counterparties’ credit conditions, which could include: 1) suspending new activity, 2) putting them on a trading room “watch list,” 3) applying tighter maturity or dollar limits, 4) liquidating securities holdings, and/or 5) steering investment priorities away from particular counterparties or market segments. In the last year, because of the financial crisis, we suspended activity with or applied tighter maturity or dollar limits on a substantial number of our unsecured credit counterparties.

89


Table of Contents

The following table presents the par amount of deposits held at the Federal Reserve and unsecured money market investments outstanding in relation to the counterparties’ long-term credit ratings provided by Moody’s, Standard & Poor’s, and/or Fitch Advisory Services.
                 
(In millions)   September 30, 2009   December 31, 2008
 
               
Federal Reserve deposits (1)
  $       2,733     $      19,906  
Aaa/AAA
    2,250       -  
Aa/AA
    8,055       2,512  
A
    3,445       -  
Baa/BBB
    -       -  
 
               
 
               
Total
  $      16,483     $      22,418  
 
               
 
(1)   The September 30, 2009 Federal Reserve deposit balance is included in Cash and due from banks on the Statement of Condition.
On September 30, 2009, the unsecured investments held with the Aaa/AAA counterparty were short-term Discount Notes issued by Freddie Mac. In the fourth quarter of 2008 and the first three months of 2009, contrary to our historical practice of investing with private companies, we held on average a majority of our short-term investments as overnight deposits at the Federal Reserve Bank. We believed this was prudent during the height of the financial and credit crisis because these deposits presented no credit risk exposure. Due to our perception that the credit crisis had eased beginning at the end of the first quarter, we decreased our holding of Federal Reserve deposits to smaller amounts. The balance on September 30 in this account resulted from our decision to keep funds at the Federal Reserve instead of investing with traditional unsecured counterparties due to the zero or negative interest rates available on overnight investments with those counterparties at the end of the quarter.
Mortgage-Backed Securities. We have never held any asset-backed securities other than mortgage-backed securities. Historically, almost all of our mortgage-backed securities have been GSE securities issued by Fannie Mae and Freddie Mac, which provide credit safeguards by guaranteeing either timely or ultimate payments of principal and interest, and agency securities issued by Ginnie Mae, which the federal government guarantees. On September 30, 2009, we held six private-label mortgage-backed securities with an outstanding principal balance of $210 million. We have policies to limit, monitor and mitigate exposure to investments having collateral that could be considered “subprime” or “alternative/nontraditional.”
As indicated in Note 5 of the Notes to Unaudited Financial Statements, on September 30, 2009, our mortgage-backed securities issued by GSEs in the held-to-maturity securities portfolio had an estimated net unrealized gain totaling $479 million, which was four percent of their amortized cost. The gain reflects the lower overall level of mortgage rates on September 30 compared to when the securities were originated. Most of these securities were issued by Fannie Mae or Freddie Mac.
In September 2008, the U.S. Treasury and the Finance Agency placed Fannie Mae and Freddie Mac into conservatorship, with the Finance Agency named as conservator. These GSEs continue to receive the highest senior debt ratings available from the NRSROs, which are based in part on their perceived backing by the U.S. government, although the U.S. government does not guarantee Fannie Mae or Freddie Mac securities, either directly or indirectly. Nonetheless, we believe the conservatorships lower the chance that Fannie Mae and Freddie Mac would not be able to fulfill their credit guarantees. In addition, based on the data available to us and our purchase practices, we believe that most of the mortgage loans backing our GSE mortgage-backed securities are of high quality with strong credit performance.

90


Table of Contents

Private-label mortgage-backed securities have more credit risk than GSE and agency mortgage-backed securities because the issuers do not guarantee principal and interest payments. However, we believe the private-label securities that we own are comprised of high quality mortgages and have, and will continue to have, a minimal amount of credit risk. We base this assessment on the following factors.
  §   Each carries increased credit subordination involving additional tranches that absorb the first credit losses beyond that required to receive the triple-A rating. See the table immediately below for information on credit subordination compared to delinquencies.
 
  §   Each is collateralized primarily by prime, fixed-rate, first lien mortgages originated in 2003 or earlier, not in more recent years when the largest numbers of the mortgages with current and expected credit issues were issued.
 
  §   Each has loan characteristics consistent with favorable expected credit performance. Only 2.5 percent of original principal balances had original FICO® scores below 650, the average original FICO® score was 740, and the average current estimated loan-to-value ratio at September 30, 2009 was 50 percent.
 
  §   Each has a strong and seasoned credit performance experience. At September 30, 2009, the 60-day or more delinquency rate was only 0.20 percent and a de minimis amount (0.34 percent) of the loans backing the securities were in foreclosure or real-estate owned.
 
  §   Each continues to receive a triple-A rating.
The following table summarizes the credit support of our private-label mortgage-backed securities:
                                 
    Original   Current           Weighted
    Weighted-   Weighted   Minimum   Average
    Average   Average   Current   Collateral
    Credit Support   Credit Support   Credit Support   Delinquency (1)
 
Private-label mortgage-backed securities
                               
 
                               
September 30, 2009
    4.7 %     7.5 %     5.4 %     0.54 %
 
                               
December 31, 2008
    4.7       6.7       5.1       0.33  
 
(1)   Collateral delinquency includes loans 60 days or more past due that underlie the securities, all bankruptcies, foreclosures, and real estate owned.
In addition, we perform a projected cash flow analysis that considers various factors that affect credit risk exposure, including under stressful conditions for defaults. At September 30, 2009, the analysis indicated that each security will continue to provide all contractual amounts of principal and interest on a timely basis.
The following table presents the fair value of our private-label mortgage-backed securities as a percent of unpaid principal balance:
                         
(Dollars in millions)                   Fair Value as
                    a Percent of
            Unpaid Principal   Unpaid Principal
    Fair Value   Balance   Balance
 
                       
September 30, 2009
  $     208     $     210       99.0 %
 
                       
December 31, 2008
        263           304       86.6  
As of September 30, 2009, our private-label mortgage-backed securities had an estimated net unrealized loss totaling $2 million, which was one percent of their amortized cost. On December 31, 2008, the same portfolio had an estimated unrealized loss totaling $41 million. The decrease in unrealized loss was due to overall reductions in mortgage rates in 2009 and to recovery of a portion of the illiquidity in the mortgage markets for these types of securities. As of September 30, 2009, our six private-label mortgage-backed securities had an average of 72 percent of their original principal balances paid down. Based on the analysis presented above, we have determined that the small amount of gross unrealized losses on our private-label mortgage-backed securities as of September 30, 2009, as for all previous periods, were temporary. We believe these losses were the result of interest rate changes and/or illiquidity in the credit and mortgage markets, which has increased

91


Table of Contents

market yields for these securities, rather than an indication of a material deterioration in the creditworthiness of the underlying collateral. We do not intend to sell these securities, and our analysis of available evidence indicates that it is more likely than not that we will recover their entire amortized cost basis. Therefore, we continue to believe that our private-label securities are not other-than-temporarily impaired. See Note 6 of the Notes to Unaudited Financial Statements for more detailed information supporting our assessment.
Derivatives
The credit exposure on an interest rate swap derivative transaction is the risk that the counterparty does not make timely interest payments, that it defaults, or that swaps are terminated before their maturity date, which could occur because of a failure of the counterparty or us. Any one of these events could result in us having to replace the derivative transaction with that from another counterparty on less favorable terms or could expose us to market risk during the time it takes to replace the transaction.
The gross amount of our credit risk exposure to a counterparty equals the positive net market value of all derivatives outstanding with the counterparty. Each counterparty’s total unsecured limit is based on criteria similar to those we use for money market investments. Each counterparty is required to deliver to us high quality collateral in a market value amount equal to our net market value exposure to the counterparty that exceeds contractual threshold limits. Threshold amounts, which are uncollateralized, vary by the perceived riskiness of the counterparty based on its credit ratings. The residual amount of credit risk exposure is the estimated cost of replacing the derivatives if the counterparty defaults on payments due, net of the value of collateral we hold.
The table below presents, as of September 30, 2009, the gross credit risk exposure (i.e., the market value) of interest rate swap derivatives outstanding, as well as the net unsecured exposure.
                                         
(Dollars in millions)                                  
                    Gross     Fair Value     Net  
Credit Rating   Number of     Notional     Credit     of Collateral     Unsecured  
  Category (1)   Counterparties     Principal     Exposure     Held     Exposure  
 
 
                                       
Aaa/AAA
    -     $ -     $ -     $ -     $ -  
Aa/AA
    7       10,211       2       -       2  
A
    8       17,241       41       (35 )     6  
             
 
                                       
Total
    15     $ 27,452     $ 43     $ (35 )   $ 8  
             
 
(1)   Each category includes the related plus (+) and minus (-) ratings (i.e., “A” includes “A+” and “A-” ratings).
After collateral exchanges, we had net unsecured credit exposure of $8 million. Because of the terms of our swap contracts, use of highly-rated institutions, and the collateralization process, which limit our credit risk exposure to threshold amounts, we continue to expect no credit losses from our derivative transactions.
The following table presents, as of September 30, 2009, counterparties that provided 10 percent or more of the total notional amount of interest rate swap derivatives outstanding.
(In millions)
                         
    Credit             Net  
    Rating     Notional     Unsecured  
Counterparty   Category     Principal     Exposure  
       
Barclays Bank PLC
  Aa/AA   $ 5,074     $ -  
Bank of America, N.A.
    A       4,401       -  
Credit Suisse International
    A       3,111       3  
All others (12 counterparties)
  A to Aa/AA     14,866       5  
                 
 
                       
Total
          $ 27,452     $ 8  
             
Although we cannot predict if we will realize credit or market risk losses from any of our counterparties, we have no reason to believe any of them will be unable to continue making timely interest payments or to more generally continue to satisfy the terms and conditions of their derivative contracts.

92


Table of Contents

Liquidity Risk and Contractual Obligations
Liquidity Overview
Our operations require a continual and substantial amount of liquidity to provide members access to Advance funding and mortgage loan sales in all financial environments and to meet financial obligations as they come due in a timely and cost-efficient manner. Liquidity risk is the risk that we will be unable to satisfy these obligations or meet the Advance and Mortgage Purchase Program funding needs of members in a timely and cost-efficient manner. Our primary source of ongoing permanent liquidity is through our ability to participate in the issuance of FHLBank System Consolidated Obligations. As shown on the Statements of Cash Flows, in the first nine months of 2009, our share of participations in debt issuance totaled $493.8 billion of Discount Notes and $26.5 billion of Consolidated Bonds.
We are exposed to two types of liquidity risk, for which Finance Agency Regulations and our Financial Management Policy require us to hold ample liquidity:
  §   Operational liquidity risk is the potential inability to meet anticipated or unanticipated day-to-day liquidity needs through our normal sources of funding.
 
  §   Contingency liquidity risk is the potential inability to meet liquidity needs because our access to the capital markets to issue Consolidated Obligations is restricted or suspended for a period of time due to a market disruption, operational failure, or real or perceived credit quality problems.
We actively monitor our liquidity measures. Our operational liquidity must equal or exceed our contingency liquidity. To meet the operational liquidity requirement, we are permitted to include the sources of liquidity under the contingency liquidity requirement as well as our access to the capital markets to issue Consolidated Obligations, purchase Federal funds, and borrow deposits. In the first nine months of 2009, as in all of 2008, we satisfied the operational liquidity requirement both as a function of meeting the contingency liquidity requirement and because we were able to adequately access the capital markets to issue Obligations.
We believe that in the first nine months of 2009, our liquidity position remained strong and our overall ability to fund our operations through debt issuance at acceptable interest costs remained sufficient. We expect this to continue to be the case. The System’s triple-A debt ratings, the implicit U.S. government backing of our debt, and our effective funding management were, and continue to be, instrumental in ensuring satisfactory access to the capital markets.
Contingency Liquidity Requirement
To meet the contingency liquidity requirement, we must hold sources of liquidity to meet obligations in the event our access to the capital markets is impeded for seven business days. The liquidity obligations include maturing net liabilities in the next seven business days, assets traded not yet settled, Advance commitments outstanding, Advances maturing in the next seven business days, and a three percent hypothetical increase in Advances. Sources of liquidity for this requirement include, among others, cash, overnight Federal funds, overnight deposits, self-liquidating term Federal funds, 95 percent of the market value of available-for-sale negotiable securities, and 75 percent of the market value of held-to-maturity obligations of the United States, U.S. government agencies and mortgage-backed securities.
The following table presents the components of our contingency liquidity reserves. We continued to hold an adequate amount of liquidity reserves to protect against impaired access to the debt markets for at least seven business days.
                   
(In millions) September 30,   December 31,
    2009     2008  
Total Contingency Liquidity Reserves
  $ 25,181       $ 34,566  
Total Requirement
    (11,248 )       (15,125 )
 
             
 
             
Excess Contingency Liquidity Available
  $ 13,933       $ 19,441  
 
             

93


Table of Contents

Deposit Reserve Requirement
To support our member deposits, we are required to meet a statutory deposit reserve requirement. The sum of our investments in obligations of the United States, deposits in eligible banks or trust companies, and Advances with a final maturity not exceeding five years must equal or exceed the current amount of member deposits. The following table presents the components of this liquidity requirement.
                   
(In millions) September 30,   December 31,
    2009     2008  
Total Eligible Deposit Reserves
  $ 39,967       $ 66,733  
Total Member Deposits
    (1,665 )       (1,193 )
 
             
 
             
Excess Deposit Reserves
  $ 38,302       $ 65,540  
 
             
Contractual Obligations
The following table summarizes our contractual obligations and off-balance sheet commitments as of September 30, 2009. The allocations according to the expiration terms and payment due dates of these obligations were not materially different from those at year-end 2008, and changes reflected normal business variations. As discussed elsewhere in this filing, we believe that, as in the past, we will continue to have sufficient liquidity, including from access to the debt markets to issue Consolidated Obligations, to satisfy these obligations timely.
                                         
(In millions)   < 1 year     1<3 years     3<5 years   > 5 years   Total  
     
 
                                       
Contractual Obligations
                                       
Long-term debt (Consolidated Bonds) – par
  $ 14,067     $ 12,719     $ 6,924     $ 7,350     $ 41,060  
Mandatorily redeemable capital stock
    5       58       24       -       87  
Other long-term obligations (term deposits) – par
    64       14       -       -       78  
Pension and other postretirement benefit obligations
    1       3       4       13       21  
Capital lease obligations
    -       -       -       -       -  
Operating leases (include premises and equipment)
    1       2       2       -       5  
     
 
                                       
Total Contractual Obligations before off-balance sheet items
    14,138       12,796       6,954       7,363       41,251  
     
Off-balance sheet items (1)
                                       
Commitments to fund additional Advances
    -       -       -       -       -  
Standby Letters of Credit
    5,409       60       17       78       5,564  
Standby bond purchase agreements
    144       68       200       -       412  
Commitments to fund mortgage loans
    126       -       -       -       126  
Consolidated Obligations traded, not yet settled
    15       370       -       -       385  
Other purchase obligations
    -       -       -       -       -  
Unused line of credits and other commitments (2)
    -       -       -       -       -  
     
 
                                       
Total off-balance sheet items
    5,694       498       217       78       6,487  
     
 
                                       
Total Contractual Obligations and off-balance sheet items
  $ 19,832     $ 13,294     $ 7,171     $ 7,441     $ 47,738  
     
 
(1)   Represents notional amount of off-balance sheet obligations.
 
(2)   In September 2008, all 12 FHLBank’s entered into an agreement with the United States Department of Treasury to establish a GSE secured lending credit facility. The facility is designed to serve as a contingent source of liquidity for the housing GSEs. The agreement terminates on December 31, 2009. The FHLBank does not currently expect to access funding under the facility.
Operational Risk
Operational risk is defined as the risk of an unexpected loss resulting from human error, fraud, unenforceability of legal contracts, or deficiencies in internal controls or information systems. We mitigate operational risk through adherence to internal department procedures and controls, use of tested information systems, disaster recovery provisions for those systems, acquisition of insurance coverage to help protect us from financial exposure relating to errors or fraud by our personnel, and comprehensive policies and procedures related to Human Resources. In addition, our Internal Audit Department, which reports directly to the Audit Committee of our Board of Directors, regularly monitors and tests compliance from a best practices perspective with all policies, procedures, and applicable regulatory requirements.
We believe there were no material developments regarding our operational risk in the first nine months of 2009.

94


Table of Contents

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Introduction
The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities (if applicable), and the reported amounts of income and expenses during the reported periods. Although management believes its judgments, estimates, and assumptions are reasonably accurate, actual results may differ.
Our critical accounting policies and estimates are described in detail in our 2008 annual report on Form 10-K. Below is a description of our fair value processes as a result of applying new fair value measurement guidance. We have also provided an explanation of our other-than-temporary impairment analysis for investment securities as a result of recent adoption of new other-than-temporary impairment guidance. There have been no material changes during the period to our other policies and estimates described in the 2008 annual report on Form 10-K.
Other-Than-Temporary Impairment Analysis for Investment Securities
Due to the decline in value of residential U.S. real estate and difficult conditions in the credit and mortgage markets, we closely monitor the performance of our private-label mortgage-backed securities portfolio to evaluate our exposure to the risk of loss of principal or interest on these investments and to determine on a quarterly basis whether this risk of loss represents an other-than-temporary impairment. The other-than-temporary impairment analysis considers all available evidence and requires management to make a number of significant judgments, estimates, and assumptions.
An investment security is deemed impaired if the fair value of the security is less than its amortized cost. To determine whether an impairment is other-than-temporary, we assess whether the amortized cost basis of the security will be recovered by considering numerous factors as described in Note 6 of the Notes to Unaudited Financial Statements. We recognize impairment losses if we intend to sell the security, or when available evidence indicates it is more likely than not we will be required to sell the security before the recovery of its amortized cost basis. We also recognize impairment losses when any credit losses are expected for the security. This requires consideration of market conditions and projections of future results.
We use a detailed cash flow analysis to determine if likely credit losses exist for a security. The cash flow analysis requires estimating the present value of cash flows expected to be collected based on the structure of a security and certain assumptions, such as delinquency, default rates, loss severity, and voluntary prepayment rates. These estimates of projected cash flows require significant judgments, estimates and assumptions, especially considering the unprecedented deterioration in the national housing market, the inability to readily determine the fair value of all underlying properties and the uncertainty in other macroeconomic factors that make estimating defaults and severity imprecise. Other parties could arrive at different conclusions as to the likelihood of various default and severity outcomes throughout the life of a security.
In addition to the base case cash flow analysis described in Note 6 of the Notes to Unaudited Financial Statements, we also performed a sensitivity test based on a different scenario that reflects a plausible but more adverse than the base case current-to-trough housing price decline with a more shallow and slower rate of housing price recovery. Specifically, the current-to-trough forecast showed a decline of 5 percentage points more than the base case current-to-trough housing price decline, and the housing price recovery path projected housing prices to remain unchanged from trough levels in the first year, to increase 1 percent in the second year, to increase 2 percent in the third year and to increase 3 percent per year thereafter. Under each of these scenarios, no shortfall of principal or interest is expected.
If we were to determine that an other-than-temporary impairment existed, the security would initially be written down to current market value, with the loss recognized in non-interest income if we intend to sell the security or it is more likely than not we will be required to sell the security before recovery of the amortized cost basis. If we do not intend to sell the security and it is not more likely than not we will be required to sell the security before recovery, the security would be written down to current market value with a separate display of losses related to credit deterioration and losses related to all other factors on the income statement. Any non-credit loss related amounts would then be reclassified and recorded in other comprehensive income, resulting in only net credit-related losses recorded on the income statement. As of September 30, 2009, we did not consider any of our investment securities to be other-than-temporarily impaired.

95


Table of Contents

Fair Values
Fair values play an important role in the valuation of certain assets, liabilities and derivative transactions, which may be reflected in the Statements of Condition or related Notes to Unaudited Financial Statements at fair value. We carry investments classified as available-for-sale and trading, and all derivatives, on the Statements of Condition at fair value.
Fair value measurement guidance establishes a framework for measuring fair value, establishes a fair value hierarchy based on the inputs used to measure fair value and requires additional disclosures for instruments carried at fair value on the Statements of Condition. Fair value is defined as the price – the “exit price” – that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date.
In April 2009, the FASB issued guidance addressing the determination of when a market for a financial asset or a financial liability is not active and when a transaction is not distressed for fair value measurements. We elected to adopt this guidance in the first quarter of 2009 and applied it when determining the fair value of assets and liabilities.
We base our fair value amounts on actual quoted market prices in active markets for identical assets or liabilities, if available, or indicative market-based prices. Our investments currently do not have available quoted market prices. Therefore, we determine fair values based on 1) our valuation models or 2) dealer indications, which may be based on the dealers’ own valuation models and/or prices of similar instruments.
Valuation models and their underlying assumptions are based on the best estimates of management with respect to discount rates, prepayments, market volatility, and other factors. These assumptions may have a significant effect on the reported fair values of assets and liabilities, including derivatives, and the income and expense related thereto. The use of different assumptions or changes in the models and assumptions, as well as changes in market conditions, could result in materially different net income and retained earnings.
We have control processes designed to ensure that fair value measurements are appropriate and reliable, that they are based on observable inputs for orderly transactions wherever possible and that our valuation approaches and assumptions are reasonable and consistently applied. Where applicable, valuations are also compared to alternative external market data (e.g., quoted market prices, broker or dealer indications, pricing services and comparative analyses to similar instruments). For further discussion regarding how we measure financial assets and financial liabilities at fair value, see Note 17 of the Notes to Unaudited Financial Statements.

96


Table of Contents

We categorize each of our financial instruments carried at fair value into one of three levels in accordance with the fair value hierarchy. The hierarchy is based upon the transparency (observable or unobservable) of inputs to the valuation of an asset or liability as of the measurement date. Observable inputs reflect market data obtained from independent sources (Levels 1 and 2), while unobservable inputs reflect our assumptions of market variables (Level 3). Management utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Because items classified as Level 3 are valued using significant unobservable inputs, the process for determining the fair value of these items is generally more subjective and involves a high degree of management judgment and use of assumptions. The following table summarizes our assets and liabilities measured at fair value on a recurring basis by level of valuation hierarchy.
(Dollars in millions)
                                           
    At September 30, 2009  
    Assets   Liabilities  
            Available-                        
    Trading     for-sale     Derivative               Derivative  
      Securities   Securities     Assets (1)     Total     Liabilities (1)  
 Level 1
    - %     - %       - %   - %       - %
 Level 2
    100       100         100     100         100  
 Level 3
    -       -         -     -         -  
 
                             
 Total
    100 %     100 %       100 %   100 %       100 %
 
                             
 
                                         
 Total GAAP Fair Value
  $ 2,253     $ 5,725     $   9   $ 7,987       $ 270  
 
                             
                                           
    At December 31, 2008  
    Assets   Liabilities  
            Available-                        
    Trading     for-sale     Derivative               Derivative  
      Securities   Securities     Assets (1)     Total     Liabilities (1)  
Level 1
    - %     - %       - %   - %       - %
Level 2
    100       100         100     100         100  
Level 3
    -       -         -     -         -  
 
                             
Total
    100 %     100 %       100 %   100 %       100 %
 
                             
 
                                         
Total GAAP Fair Value
  $ 3     $ 2,512     $   17   $ 2,532       $ 286  
 
                             
 
(1)   Based on total fair value of derivative assets and liabilities after effect of counterparty netting and cash collateral netting.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information required by this Item is set forth under the caption “Quantitative and Qualitative Disclosures About Risk Management” in Part I, Item 2, of this filing.

97


Table of Contents

Item 4. Controls and Procedures.
DISCLOSURE CONTROLS AND PROCEDURES
As of September 30, 2009, the FHLBank’s management, including its principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, these two officers each concluded that as of September 30, 2009, the FHLBank maintained effective disclosure controls and procedures to ensure that information required to be disclosed in the reports that it files under the Exchange Act is (1) accumulated and communicated to management as appropriate to allow timely decisions regarding disclosure and (2) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
As of September 30, 2009, the FHLBank’s management, including its principal executive officer and principal financial officer, evaluated the FHLBank’s internal control over financial reporting. Based upon that evaluation, these two officers each concluded that there were no changes in the FHLBank’s internal control over financial reporting that occurred during the quarter ended September 30, 2009 that materially affected, or are reasonably likely to materially affect, the FHLBank’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1A. Risk Factors.
Information relating to this Item is set forth under the caption “Business Related Developments and Update on Risk Factors” in Part I, Item 2, of this filing.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
From time-to-time the FHLBank provides Letters of Credit in the ordinary course of business to support members’ obligations issued in support of unaffiliated, third-party offerings of notes, bonds or other securities. The FHLBank provided $190.1 million of such credit support during the three months ended September 30, 2009. To the extent that these Letters of Credit are securities for purposes of the Securities Act of 1933, their issuance is exempt from registration pursuant to section 3(a)(2) thereof.
Item 5. Other Information.
(a)   On September 17, 2009, the Board of Directors of the FHLBank approved several amendments to the FHLBank’s Bylaws. Article IV of the Bylaws was amended to reflect changes made by the Housing the Economic Recovery Act of 2008 (HERA) in the composition of the Board, the qualifications of its directors and the nomination and election of independent directors. Additionally, a new section on vacancies on the Board was added. Certain other technical and clarifying amendments also were made.
 
 
    The foregoing description of the amendments to the Bylaws is qualified in its entirety by reference to the amended Bylaws, a copy of which is attached as Exhibit 3.2.
Item 6. Exhibits.
(a)   Exhibits.
 
    See Index of Exhibits

98


Table of Contents

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of the 12th day of November 2009.
         
FEDERAL HOME LOAN BANK OF CINCINNATI
(Registrant)
 
       
By:
    /s/ David H. Hehman
 
David H. Hehman
   
    President and Chief Executive Officer (principal executive officer)
 
       
By:
    /s/ Donald R. Able
 
Donald R. Able
   
    Senior Vice President, Controller (principal financial officer)

99


Table of Contents

INDEX OF EXHIBITS
         
        Document incorporated
Exhibit       by reference, filed or
Number (1)   Description of exhibit   furnished, as indicated below
 
3.2
  Bylaws, as amended through September 17, 2009   Filed Herewith
 
       
31.1
  Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer   Filed Herewith
 
       
31.2
  Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer   Filed Herewith
 
       
32
  Section 1350 Certifications   Furnished Herewith
 
(1)   Numbers coincide with Item 601 of Regulation S-K.

100