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EX-12 - EXHIBIT 12 - Federal Home Loan Bank of Cincinnatiex12201510-k.htm
EX-32 - EXHIBIT 32 - Federal Home Loan Bank of Cincinnatiex32201510-k.htm
EX-24 - EXHIBIT 24 - Federal Home Loan Bank of Cincinnatiex24201510-k.htm
EX-31.1 - EXHIBIT 31.1 - Federal Home Loan Bank of Cincinnatiex311201510-k.htm
EX-99.1 - EXHIBIT 99.1 - Federal Home Loan Bank of Cincinnatiex991201510-k.htm
EX-3.2 - EXHIBIT 3.2 - Federal Home Loan Bank of Cincinnatiex302201510-k.htm
EX-31.2 - EXHIBIT 31.2 - Federal Home Loan Bank of Cincinnatiex312201510-k.htm
EX-99.2 - EXHIBIT 99.2 - Federal Home Loan Bank of Cincinnatiex992201510-k.htm


 UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
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
incorporation or organization) 
 
(I.R.S. Employer
Identification No.)
600 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
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class B Stock, par value $100 per share
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes   x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d).
o Yes   x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x Yes   o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).        x Yes   o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x
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 Exchange Act).
o Yes   x No
As of February 29, 2016, the registrant had 43,340,502 shares of capital stock outstanding, which included stock classified as mandatorily redeemable. The capital stock of the registrant 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.
Documents Incorporated by Reference: None

Page 1 of


Table of Contents
 
PART I
 
 
 
 
Item 1.
Business
 
 
 
Item 1A.
Risk Factors
 
 
 
Item 1B.
Unresolved Staff Comments
 
 
 
Item 2.
Properties
 
 
 
Item 3.
Legal Proceedings
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
 
PART II
 
 
 
 
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
 
 
Item 6.
Selected Financial Data
 
 
 
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 8.
Financial Statements and Supplementary Data
 
 
 
 
 
Financial Statements for the Years Ended 2015, 2014, and 2013
 
 
 
 
Notes to Financial Statements
 
 
 
 
Supplemental Financial Data
 
 
 
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
 
 
Item 9A.
Controls and Procedures
 
 
 
Item 9B.
Other Information
 
 
 
 
PART III
 
 
 
 
Item 10.
Directors, Executive Officers and Corporate Governance
 
 
 
Item 11.
Executive Compensation
 
 
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
 
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
 
 
 
Item 14.
Principal Accountant Fees and Services
 
 
 
 
PART IV
 
 
 
 
Item 15.
Exhibits and Financial Statement Schedules
 
 
 
Signatures
 

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PART I

Special Cautionary Notice Regarding Forward Looking Information

This document contains forward-looking statements that describe the objectives, expectations, estimates, and assessments of the Federal Home Loan Bank of Cincinnati (the FHLB). 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, inflation and deflation, 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 Federal Home Loan Banks (FHLBanks) and other government-sponsored enterprises (GSEs), and/or investors in the Federal Home Loan Bank System's (FHLBank System) debt securities, which are called Consolidated Obligations or 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 FHLBank 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 management and other key employees;

the ability to develop, secure and support technology and information systems that effectively manage the risks we face;

the ability to successfully manage new products and services; and

the risk of loss arising from litigation filed against us or one or more other FHLBanks.

We do not undertake any obligation to update any forward-looking statements made in this document.


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Item 1.
Business.


COMPANY INFORMATION

Organizational Structure

The FHLB is a regional wholesale bank that provides financial products and services to our members. We are part of the FHLBank System (or System). Each FHLBank operates as a separate entity with its own stockholders, employees, Board of Directors, and business model. Our region, known as the Fifth District, is comprised of Kentucky, Ohio and Tennessee.

The U.S. Congress chartered the FHLBank System in the Federal Home Loan Bank Act of 1932 (the FHLBank Act) to help provide liquidity in the U.S. housing market. FHLBanks are GSEs of the United States of America. A GSE combines private sector ownership with public sector sponsorship. In addition to being GSEs, the FHLBanks are cooperative institutions, privately and wholly owned by their members, who purchase capital stock and who are the primary customers.

The FHLBanks are not government agencies and the U.S. government does not guarantee, directly or indirectly, the debt securities or other obligations of the FHLBank System.

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), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Office of Finance. The Office of Finance is a joint office of the FHLBanks that facilitates the issuance and servicing of the FHLBank System's Consolidated Obligations (or Obligations).

All federally insured depository institutions, certain insurance companies, and community development financial institutions chartered in the Fifth District may voluntarily apply for membership in our FHLB. Applicants must satisfy membership requirements in accordance with statutes and Finance Agency regulations. These requirements deal primarily with home financing activities, satisfactory financial condition such that Advances may be made safely, and matters related to the regulatory, supervisory and management oversight of the applicant. By law, an institution is permitted to be a member of only one FHLBank, although a holding company may have memberships in more than one FHLBank through its subsidiaries.

The combination of public sponsorship and private ownership that drives our business model is reflected in the composition of our 17-member Board of Directors, all of whom members elect. Ten directors are officers and/or directors of our member institutions, while the remaining directors are independent directors who represent the public interest.

At December 31, 2015, we had 699 members, 203 full-time employees, and no part-time employee. Our employees are not represented by a collective bargaining unit.

Mission and Corporate Objectives

The FHLB's mission is to provide financial intermediation between the capital markets and our member stockholders in order to facilitate and expand the availability of financing for housing and community lending and investment.

How We Achieve Our Mission
We achieve our mission through a cooperative business model. We raise private-sector capital from member stockholders and issue high-quality debt securities in the capital markets (along with other FHLBanks) in order to provide products and services (called Mission Asset Activity) to members and generate a competitive return on their capital investment in our company.

The primary products we offer are readily available low-cost loans called Advances, purchases of certain whole mortgage loans sold by qualifying members through the Mortgage Purchase Program (MPP), and Letters of Credit. We also offer affordable housing programs and related activities to support members in their efforts to assist low- and moderate-income households and their local communities. To a more limited extent, we also have several correspondent services that assist members in operational administration.

The primary way we obtain funding is through participation in the issuance of the FHLBank System's unsecured debt securities, called Consolidated Obligations, in the global capital markets. Secondary sources of funding are capital and deposits we accept from our members. A critical component of the success of the FHLBank System is its ability to maintain a comparative

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advantage in funding, which is due largely to its GSE status and low risk operations. We regularly issue Obligations under a wide range of maturities, structures, and amounts, and at relatively favorable spreads to benchmark market interest rates (represented by U.S. Treasury securities and the London InterBank Offered Rate (LIBOR)) compared with many other financial institutions.

Because we are a cooperative organization with some members using our products more heavily than others and members having different percentages of capital stock, we must achieve a balance in generating membership value from product prices and characteristics and paying a competitive dividend rate. We attempt to achieve this balance by pricing Mission Asset Activity at relatively narrow spreads over funding costs, compared with other financial institutions, while still achieving acceptable profitability.
  
Corporate Objectives
Our corporate objectives, listed below, are to promote housing finance among members and ensure our operations and governance are effective and efficient. The first three objectives drive how members derive value from being in the cooperative.

Mission Asset Activity: Implement strategies and tactics to effectively manage ongoing operations and promote members’ usage of our products and services.

Stock Return: Earn adequate profitability so that members receive a competitive long-term dividend rate on their capital stock investment.

Housing and Community Investment Programs: Maintain effective housing and community investment programs that maximize mandatory programs and offer additional voluntary contributions.

Safe and Sound Operations: Optimize the FHLB’s counterparty and deposit ratings, achieve an acceptable rating on annual regulatory examinations, and maintain an adequate amount and composition of capital.

Risk Management: Employ effective risk management practices and maintain risk exposures at low to moderate levels.

Governance: Operate in accordance with effective corporate governance processes.

Business Activities

Mission Asset Activity
The following are our principal business activities with members:

We lend readily-available, competitively-priced, and fully-collateralized Advances.

We issue collateralized Letters of Credit.

We purchase qualifying residential mortgage loans through the MPP and hold them on our balance sheet.

Together, these product offerings constitute “Mission Asset Activity.” We refer to Advances and Letters of Credit as Credit Services.

Affordable Housing and Community Investment
In addition, through various Housing and Community Investment programs, we assist members in serving very low-, low-, and moderate-income households and community economic development. These programs provide Advances at below-market rates of interest, as well as direct grants.

Investments
To help us achieve our mission and corporate objectives, we invest in highly-rated debt instruments of financial institutions and the U.S. government and in mortgage-related securities. In practice, these investments normally include shorter-term liquidity instruments and longer-term mortgage-backed securities, as permitted by Finance Agency regulation. Investments provide liquidity, help us manage market risk exposure, enhance earnings, and through the purchase of mortgage-related securities, support the housing market.


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Sources of Earnings

Our major source of revenue is interest income earned on Advances, MPP loans, and investments.

Major items of expense are:

interest paid on Consolidated Obligations and deposits to fund assets;

costs of providing below-market-cost Advances and direct grants and subsidies under the Affordable Housing Program; and

non-interest expenses.

The largest component of earnings is net interest income, which equals interest income minus interest expense. We derive net interest income from the interest rate spread earned on assets versus funding costs and the use of financial leverage. Each of these can vary over time with changes in market conditions, including most importantly interest rates, business conditions and our risk management activities.

We believe members' capital investment is comparable to investing in adjustable-rate preferred equity instruments. Therefore, we structure our balance sheet risk exposures so that earnings tend to move in the same direction as changes in short-term market rates, which can help provide a degree of predictability for dividend returns.

Capital

Due to our cooperative structure, we obtain capital from members. Each member must own capital stock as a condition of membership and normally must hold additional stock above the membership stock amount in order to gain access to Advances and possibly to sell us MPP loans. We issue, redeem, and repurchase capital stock only at its stated par value of $100 per share. By law, our stock is not publicly traded.

We strive to ensure that assets are self-capitalizing, meaning that we acquire capital primarily in connection with growth in Mission Asset Activity. We also maintain an amount of capital to ensure we meet all of our regulatory and business requirements relating to capital adequacy and protection of creditors against losses. We hold retained earnings to protect members' stock investment against impairment risk.

Tax Status

We are exempt from all federal, state, and local taxation other than real property taxes. Any cash dividends we issue are taxable to members and do not benefit from the corporate dividends received exclusion. Notes 1 and 14 of the Notes to Financial Statements provide additional details regarding the assessment for the Affordable Housing Program.

Ratings of Nationally Recognized Statistical Rating Organizations

The FHLBank System's comparative advantage in funding is acknowledged in its excellent credit ratings from nationally recognized statistical rating organizations (NRSROs). Moody's Investors Service (Moody's) currently assigns, and historically has assigned, the System's Consolidated Obligations the highest ratings available: long-term debt is rated Aaa and short-term debt is rated P-1. It also assigns a Prime-1 short-term bond rating on each FHLBank. It affirmed these ratings in 2015 and maintained a stable outlook. In 2015, Standard & Poor's affirmed its issuer credit ratings on each FHLBank and its AA+ ratings on the System's senior debt and also maintained a stable outlook.

The ratings closely follow the U.S. sovereign ratings from both agencies. The lower-than AAA debt ratings from Standard & Poor's has had no discernible impact on the System's debt issuance capabilities since the rating change occurred in 2011.

The agencies' rationales for their ratings of the System and our FHLB include the System's status as a GSE; the joint and several liability for Obligations; excellent overall asset quality; extremely strong capacity to meet commitments to pay timely principal and interest on debt; strong liquidity; conservative use of derivatives; adequate capitalization relative to our risk profile; a stable capital structure; and the fact that no FHLBank has ever defaulted on repayment of, or delayed return of principal or interest on, any Obligation.

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A credit rating is not a recommendation to buy, sell or hold securities. A rating organization may revise or withdraw its ratings at any time, and each rating should be evaluated independently of any other rating. We cannot predict what future actions, if any, a rating organization may take regarding the System's or our ratings.

Regulatory Oversight

The Finance Agency is headed by a Director who has authority to promulgate regulations and to make other decisions. The Finance Agency is charged with ensuring that each FHLBank carries out its housing and community development finance mission, remains adequately capitalized, operates in a safe and sound manner, and complies with Finance Agency regulations.

To carry out these responsibilities, the Finance Agency conducts on-site examinations at least annually of each FHLBank, as well as periodic on- and off-site reviews, and receives monthly information on each FHLBank's financial condition and operating results. While an individual FHLBank has substantial discretion in governance and operational structure, the Finance Agency maintains broad supervisory and regulatory authority. In addition, the Comptroller General has authority to audit or examine the Finance Agency and the FHLBanks, to decide the extent to which the FHLBanks fairly and effectively fulfill the purposes of the FHLBank Act, and to review any audit, or conduct its own audit, of the financial statements of an FHLBank.


BUSINESS SEGMENTS

We manage the development, resource allocation, product delivery, pricing, credit risk management, and operational administration of our Mission Asset Activity in two business segments: Traditional Member Finance and the MPP. Traditional Member Finance includes Credit Services, Housing and Community Investment, Investments, some correspondent and deposit services, and other financial products of the FHLB. See the “Segment Information” section of “Results of Operations” in Item 7 and Note 18 of the Notes to Financial Statements for more information on our business segments, including their results of operations.

Traditional Member Finance

Credit Services
Advances. Advances are competitively priced sources of funds available for members to help manage their asset/liability and liquidity needs. Advances can both complement and be alternatives to retail deposits, other wholesale funding sources, and corporate debt issuance. We strive to facilitate efficient, fast, and continual member access to funds. In most cases members can access funds on a same-day basis.

We price a variety of standard Advance programs every business day and several other standard programs on demand. We also offer customized, non-standard Advances. Having diverse programs gives members the flexibility to choose and customize their borrowings according to size, maturity, interest rate, interest rate index (for adjustable-rate coupons), interest rate options, and other features.

Repurchase based (REPO) Advances are short-term, fixed-rate instruments structured similarly to repurchase agreements from investment banks, with one principal difference. Members collateralize their REPO Advances through our normal collateralization process, instead of being required to pledge specific securities as would be required in a repurchase agreement. A majority of REPO Advances outstanding have overnight maturities.

LIBOR Advances have adjustable interest rates typically priced off 1- or 3-month LIBOR indices. LIBOR Advances may be structured at the member's option as either prepayable with a fee or prepayable without a fee if the prepayment is made on a repricing date.

Regular Fixed-Rate Advances have terms of 3 months to 30 years, with interest normally paid monthly and principal repayment normally at maturity. Members may choose to purchase call options on these Advances, although in the last five years, balances with call options have been at or close to zero.

Putable Advances are fixed-rate Advances that provide us an option to terminate the Advance, usually after an initial “lockout” period. Most have long-term original maturities. Selling us these options enables members to secure lower rates on Putable Advances compared to Regular Fixed-Rate Advances with the same final maturity.


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Mortgage-Related Advances are fixed-rate, amortizing Advances with final maturities of 5 to 30 years. Some of these Advances, at the choice of the member, provide members with prepayment options without fees.

We also offer various other Advance programs that have smaller outstanding balances.

Letters of Credit. Letters of Credit are collateralized contractual commitments we issue on a member's behalf to guarantee its performance to third parties. A Letter of Credit may obligate us to make direct payments to a third party, in which case it is treated as an Advance to the member. The most popular use of Letters of Credit is as collateral supporting public unit deposits, which are deposits held by governmental units at financial institutions. We earn fees on Letters of Credit based on the actual notional amount of the Letters utilized.

How We Manage Risks of Credit Services. We manage market risk from Advances by funding them with Consolidated Obligations and interest rate swaps that have similar interest rate risk characteristics as the Advances. The net effect is that in practice we mitigate nearly all of Advances' market risk exposures.

In addition, for many, but not all, Advance programs, Finance Agency regulations require us to charge members prepayment fees for early termination of principal when the early termination results in an economic loss to us. We determine prepayment fees using standard present-value calculations that make us economically indifferent to the prepayment. The prepayment fee equals the present value of the estimated profit that we would have earned over the remaining life of the prepaid Advance. If a member prepays principal on an Advance that we have hedged with an interest rate swap, we may also assess the member a fee to compensate us for the cost we incur in terminating the swap before its stated final maturity. Some Advance programs are structured as non-prepayable and may have additional restrictions in order to terminate.

We manage credit risk on Advances by requiring each member to supply us with a security interest in eligible collateral that in the aggregate has estimated value in excess of the total Advances and Letters of Credit. Collateral is comprised mostly of single-family loans, home equity lines, multi-family loans and bond securities. The combination of conservative collateral policies and risk-based credit underwriting activities mitigates virtually all potential credit risk associated with Advances and Letters of Credit. We have never experienced a credit loss on Advances, nor have we ever determined it necessary to establish a loan loss reserve for Advances. Item 7's “Quantitative and Qualitative Disclosures About Risk Management” and Notes 8 and 10 of the Notes to Financial Statements have more detail on our credit risk management of member borrowings.

Housing and Community Investment
Our Housing and Community Investment Programs include the Affordable Housing Program and various housing and community economic development-related Advance programs. We fund the Affordable Housing Program with an accrual equal to 10 percent of our previous year's net earnings, mandated by the Financial Institutions Reform, Recovery and Enforcement Act of 1989. See Note 14 of the Notes to Financial Statements for a complete description of the Affordable Housing Program calculation.

The Affordable Housing Program provides funding for the development of affordable housing. The Program consists of a Competitive Program and a homeownership program called Welcome Home, which assists homebuyers with down payments and closing costs. Under the Competitive Program, we currently distribute funds in the form of grants to members that apply and successfully compete in an annual offering. Under Welcome Home, we make funds available beginning in March until they have been fully committed. For both programs, the income of qualifying individuals or households must be 80 percent or less of the area median income. We set aside up to 35 percent of the Affordable Housing Program accrual for Welcome Home and allocate the remainder to the Competitive Program.

Our Board of Directors also may allocate funds to voluntary housing programs. In 2015, the Board re-authorized an additional $1 million to the Carol M. Peterson Housing Fund for use during the year. These funds are primarily used as grants to pay for accessibility rehabilitation and emergency repairs for special needs and elderly homeowners. In March 2016, the Board re-authorized this fund in the amount of $1.5 million for use in 2016. In 2012, the Board of Directors also established the Disaster Reconstruction Program, a $5 million voluntary housing program that provides grants for purchase or rehabilitation of a home to Fifth District residents that have suffered loss or damage to their primary residence as a result of a state or federally declared disaster. Since the program's inception, we have disbursed nearly $3 million to assist 177 households.

Two other housing programs that fall outside the auspices of the Affordable Housing Program are the Community Investment Program and the Economic Development Program. Advances under the former program have rates equal to our cost of funds, while Advances under the latter program have rates equal to our cost of funds plus three basis points. Members use the Community Investment Program to serve housing needs of low- and moderate-income households and, under certain

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conditions, community economic development projects. The Economic Development Program is a discounted Advance program used to promote economic development and job creation and retention.

Investments
Types of Investments. One reason we hold investments is to carry sufficient asset liquidity. Permissible liquidity investments include Federal funds, certificates of deposit, bank notes, bankers' acceptances, commercial paper, securities purchased under agreements to resell, and debt securities issued by the U.S. government or its agencies. The first five categories represent unsecured lending to private counterparties. We also may place deposits with the Federal Reserve Bank. We are prohibited by Finance Agency regulations from investing (secured or unsecured) in financial investments issued by non-U.S. entities other than those issued by U.S. branches and agency offices of foreign commercial banks. Most liquidity investments have short-term maturities.

We are also permitted by regulation to purchase the following other investments, which have longer original maturities than liquidity investments:

mortgage-backed securities and collateralized mortgage obligations supported by mortgage securities (together, referred to as mortgage-backed securities) and issued by GSEs or private issuers;

asset-backed securities collateralized by manufactured housing loans or home equity loans and issued by GSEs or private issuers; and

marketable direct obligations of certain government units or agencies (such as state housing finance agencies) that supply needed funding for housing or community lending and that do not exceed 20 percent of our regulatory capital.

We have never purchased asset-backed securities and do not own any privately-issued mortgage-backed securities. Per Finance Agency regulations, the total investment in mortgage-backed securities and asset-backed securities may not exceed, on a book value basis, 300 percent of previous month-end regulatory capital on the day we purchase the securities. See the “Capital Resources” section below for the definition of regulatory capital.

Purposes of Having Investments. The investments portfolio helps us achieve corporate objectives in the following ways:

Liquidity management. Liquidity investments help support the ability to fund assets on a timely basis, especially Advances. These investments supply a source of liquidity because we normally ensure they have shorter maturities than the debt we issue to fund them. We also may be able to obtain liquidity by selling certain investments for cash without a significant loss of value.

Earnings enhancement. The investments portfolio assists with earning a competitive return on capital, which also increases funding for Housing and Community Investment programs.

Market risk management. Liquidity investments help stabilize earnings because they typically earn a relatively stable spread to the cost of debt issued to fund them, with less market risk than mortgage assets.

Debt issuance management. Maintaining a short-term liquidity investment portfolio can help us participate in attractively priced debt issuances, on an opportunistic basis. We can temporarily invest proceeds from debt issuances in short-term liquid assets and quickly access them to fund demand for Mission Asset Activity, rather than having debt issuances dictated solely by the timing of member demand.

Support of housing market. Investment in mortgage-backed securities and state housing finance agency bonds directly supports the residential mortgage market by providing capital and financing for mortgages.

How We Manage Risks of Investments. We strive to ensure our investment holdings have a moderate degree of market risk and limited credit risk, which tends to lower the returns we can expect to earn on these securities. We believe that a philosophy of purchasing investments with a high amount of market or credit risk would be inconsistent with our GSE status and corporate objectives.

Market risk associated with short-term investments tends to be minimal because of their short maturities and because we typically fund them with similar duration short-term Consolidated Obligations. We mitigate much of the market risk of mortgage-backed securities, which exists primarily from changes in mortgage prepayment speeds, by limiting their balances to

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300 percent of regulatory capital, by funding them with a portfolio of long-term fixed-rate callable and noncallable Obligations, and by managing the market risk exposure of the entire balance sheet within prudent policy limits.

Finance Agency regulations and internal policies also provide controls on market risk exposure by restricting the types of mortgage loans, mortgage-backed securities and other investments we can hold. These restrictions prohibit, among others, the purchase of interest only or principal only stripped mortgage-backed securities and mortgage-backed securities whose average life varies more than six years under a 300 basis points interest rate shock.

Our internal policies specify guidelines for, and relatively tight constraints on, the types and amounts of short-term investments we are permitted to hold and the maximum amount of credit risk exposure we are permitted to have with eligible counterparties. We are permitted to invest only in the instruments of counterparties with high credit ratings, and because of our conservative investment policies and practices, we believe all of our investments have high credit quality. We have never had a credit loss or credit-related write down of any investment security.
 
Deposits
We provide a variety of deposit programs, including demand, overnight, term and Federal funds, which enable depositors to invest funds in short-term liquid assets. We accept deposits from members, other FHLBanks, any institution to which we offer correspondent services, and other government instrumentalities. The rates of interest we pay on deposits are subject to change daily based on comparable money market interest rates. The balances in deposit programs tend to vary positively with the amount of idle funds members have available to invest, as well as, the level of short-term interest rates. Deposits have represented a small component of our funding in recent years, typically less than one percent of our funding sources.

Mortgage Purchase Program (MPP or Mortgage Loans Held for Portfolio)

Description of the MPP
Types of Loans and Benefits. Finance Agency regulations permit FHLBanks to purchase and hold specified whole mortgage loans from their members, which offers members a competitive alternative to the traditional secondary mortgage market and directly supports housing finance. We account for MPP loans as mortgage loans held for portfolio. By selling mortgage loans to us, members can increase their balance sheet liquidity and lower interest rate and mortgage prepayment risks. The MPP particularly enables small- and medium-sized community-based financial institutions to use their existing relationship with us to participate more effectively in the secondary mortgage market.

Under the MPP, we purchase two types of mortgage loans: qualifying conforming fixed-rate conventional 1-4 family residential mortgages and residential mortgages fully insured by the Federal Housing Administration (FHA). Members approved to sell us these loans are referred to as Participating Financial Institutions (PFIs). Although regulations permit us to purchase qualifying mortgage loans originated within any state or territory of the United States, beginning several years ago we no longer purchase loans originated in New York, Massachusetts, Maine, Rhode Island or New Jersey due to features of those states' Anti-Predatory Lending laws that are less restrictive than we prefer.

A “conventional” mortgage refers to a non-government-guaranteed mortgage. A “conforming” mortgage refers to the maximum amount permissible to be lent as a regular prime (i.e., non-jumbo, non-subprime) mortgage. For 2016, the Finance Agency re-established the conforming limit at $417,000 with loans originated in a limited number of high-cost cities and counties receiving higher conforming limits. We do not purchase mortgages subject to these higher amounts.

Loan Purchase Process. A Master Commitment Contract is negotiated with each PFI, in which the PFI agrees to make a best efforts attempt to sell us a specific dollar amount of mortgage loans generally over a period of up to 12 months. We purchase loans pursuant to a Mandatory Delivery Contract, which is a legal commitment we make to purchase, and a PFI makes to deliver, a specified dollar amount of mortgage loans, with a forward settlement date, at a specified range of note rates and prices.

Shortly before delivering the loans that will fill the Mandatory Delivery Contract, the PFI must submit loan level detail including underwriting information. We apply procedures through the automated Loan Acquisition System designed to screen loans that do not comply with our policies. Our underwriting guidelines generally mirror those of Fannie Mae and Freddie Mac for conforming conventional loans, although our guidelines and pool composition requirements are more conservative in a number of ways in order to further limit credit risk exposure. PFIs are required to make certain representations and warranties against our underwriting guidelines on the loans they sell to us. If a PFI sells us a loan in breach of those representations and warranties, we have the contractual right to require the PFI to repurchase the loan.


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How We Manage Risks of the MPP
Market Risk. We mitigate the MPP's market risk similarly to how we mitigate market risk from mortgage-backed securities.

Credit Risk - Conventional Mortgage Loans. A unique feature of the MPP is that it separates the various activities and risks associated with residential mortgage lending for conventional loans and allows these risks and activities to be taken on by different entities. We manage the funding of the loans, market risk (including interest rate risk and prepayment risk), and liquidity risk. PFIs manage marketing, originating and, in most cases, servicing the loans. PFIs may either retain servicing or sell it to a qualified and approved third-party servicer (also referred to as a PFI). Because PFIs manage and bear most of the credit risk, they do not pay us a guarantee fee to transfer credit risk.

We manage credit risk exposure for conventional loans through underwriting and pool composition requirements and by applying layered credit enhancements. These enhancements, which apply after a homeowner's equity is exhausted, include (in order of priority) primary mortgage insurance (when applicable), the Lender Risk Account (discussed below), and for loans acquired before February 2011, Supplemental Mortgage Insurance that the PFI purchased from one of our approved third-party providers naming us as the beneficiary.

Beginning in February 2011, we discontinued use of Supplemental Mortgage Insurance for new loan purchases and replaced it with expanded use of the Lender Risk Account and aggregation of loan purchases into larger pools to provide diversification in credit risk exposure. These credit enhancements are designed to adequately protect us against credit losses in scenarios of severe downward movements in housing prices and unfavorable changes in other factors that can affect loan delinquencies and defaults.

The Lender Risk Account is a key component of how we manage residual credit risk. It is a holdback of a portion of the initial purchase price. Starting after five years from the loan purchase date, we may return the holdback to PFIs if they manage credit risk to pre-defined acceptable levels of exposure on the loan pools they sell to us. Actual loan losses are deducted from the amount of the purchase-price holdback we return to the PFI. The Lender Risk Account provides PFIs with a strong incentive to sell us high quality performing mortgage loans.

Credit Risk - FHA Mortgage Loans. Because the FHA makes an explicit guarantee on FHA loans, we do not require any credit enhancements on these loans beyond underwriting, homeowner's equity, and primary mortgage insurance.

Item 7's “Quantitative and Qualitative Disclosures About Risk Management” provides more detail on how we manage market and credit risks for the MPP.

Earnings from the MPP
The MPP enhances long-term profitability on a risk-adjusted basis and augments the return on member stockholders' capital investment. We generate earnings in the MPP from monthly interest payments minus the cost of funding and the cost of hedging the MPP's interest rate risk. Interest income on each loan is computed as the mortgage note rate multiplied by the loan's principal balance:

minus servicing costs (0.25 percent for conventional loans and 0.44 percent for FHA loans);
minus the cost of Supplemental Mortgage Insurance (for applicable loans); and
adjusted for the amortization of purchase premiums or the accretion of purchase discounts and for the amortization or accretion of fair value adjustments on loans initially classified as mortgage loan commitments.

For new loan purchases, we consider the cost of the Lender Risk Account when we set conventional loan prices and evaluate the MPP's expected return. The pricing of each structure depends on a number of factors and is specific to the PFI and to the loan pool. We do not receive fees or income for retaining the risk of losses in excess of any credit enhancements.



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FUNDING - CONSOLIDATED OBLIGATIONS

Our primary source of funding and hedging market risk exposure is through participation in the sale of debt securities (Consolidated Obligations) to global investors. Obligations are the joint and several obligations of all the FHLBanks, backed only by the financial resources of these institutions.

There are two types of Consolidated Obligations: Consolidated Bonds (Bonds) and Consolidated Discount Notes (Discount Notes). We participate in the issuance of Bonds for three purposes:

to finance and hedge intermediate- and long-term fixed-rate Advances and mortgage assets;
to finance and hedge short-term, LIBOR-indexed adjustable-rate Advances, and swapped Advances, typically by synthetically transforming fixed-rate Bonds to adjustable-rate LIBOR funding through the execution of interest rate swaps; and
to acquire liquidity.

Bonds may have fixed or adjustable rates of interest. Fixed-rate Bonds are either noncallable or callable. A callable Bond is one that we are able to redeem in whole or in part at our discretion on one or more predetermined call dates according to the Bond's offering notice. The maturity of Bonds typically ranges from one year to 20 years. Our adjustable-rate Bonds use LIBOR for interest rate resets. In the last five years, we have not participated in the issuance of range Bonds, zero coupon Bonds, or indexed principal redemption Bonds.

We use fixed-rate Bonds to fund longer-term fixed-rate Advances and longer-term fixed-rate mortgage assets, and use adjustable-rate Bonds to fund adjustable-rate LIBOR Advances.

We transact in interest rate swaps to synthetically convert some fixed-rate Bonds to adjustable-rate terms indexed to LIBOR. These are used to hedge adjustable-rate LIBOR Advances.

We participate in the issuance of Discount Notes to fund short-term Advances, adjustable-rate LIBOR Advances, putable Advances (which we normally swap to LIBOR), liquidity investments, and a portion of longer-term fixed-rate assets. Discount Notes have maturities from one day to one year, with most of ours normally maturing within three months.

The mix of Obligations fluctuates in response to relative changes in short-term versus long-term assets, relative changes in fixed-rate versus adjustable-rate assets, decisions on market risk management (particularly the amount of funding of longer-term assets with short-term Obligations), and differences in relative costs of various Obligations.
 
Interest rates on Obligations, including their relationship to other products such as U.S. Treasury securities and LIBOR, are affected by a multitude of factors such as: overall economic and credit conditions; credit ratings of the FHLBank System; investor demand and preferences for our debt securities; the level of interest rates and the shape of the U.S. Treasury curve and the LIBOR swap curve; and the supply, volume, timing, and characteristics of debt issuances by the FHLBanks, other GSEs, and other highly rated issuers.

Finance Agency regulations govern the issuance of Obligations. An FHLBank may not issue individual debt securities without Finance Agency approval, and we have never done so. The Office of Finance services Obligations, prepares the FHLBank System's quarterly and annual combined financial statements, and serves as a source of information for the FHLBanks on capital market developments.

We have the primary liability for our portion of Obligations, i.e., those issued on our behalf for which we received the proceeds. However, we also are jointly and severally liable with the other FHLBanks for the payment of principal and interest on all Obligations. If we do not pay the principal or interest in full when due on any Obligation issued on our FHLB's behalf, we are prohibited from paying dividends or redeeming or repurchasing shares of capital stock. If another FHLBank were unable to repay its participation in an Obligation for which it is the primary obligor, the Finance Agency could call on each of the other FHLBanks to repay all or part of the Obligation. The Finance Agency has never invoked this authority.

 


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LIQUIDITY

Our business requires a continual and substantial amount of liquidity to meet financial obligations (primarily maturing Consolidated Obligations) in a timely and cost-efficient manner and to provide members access to timely Advance funding and mortgage loan sales in all financial environments. We obtain liquidity by issuing debt, holding short-term assets that mature before their associated funding, and having the ability to sell certain investments without significant accounting or economic consequences. Sources of asset liquidity include cash, maturing Advances, maturing investments, principal paydowns of mortgage assets, the ability to sell certain investments, and interest payments received. Uses of liquidity include repayments of Obligations, issuances of new Advances, purchases of loans under the MPP, purchases of investments, and payments of interest.

Liquidity requirements are significant because Advance balances can be volatile, many have short-term maturities, and we strive to allow members to borrow Advances on the same day they request them. We regularly monitor liquidity risks and the investment and cash resources available to meet liquidity needs, as well as statutory and regulatory liquidity requirements.

Because Obligations have favorable credit ratings and because the FHLBank System is one of the largest sellers of debt in the worldwide capital markets, the System historically has been able to satisfy its liquidity needs through debt issuance across a wide range of structures at relatively favorable spreads to benchmark market interest rates.
 

CAPITAL RESOURCES

Capital Plan

Basic Characteristics
Under Finance Agency regulations, regulatory capital is composed of all capital stock (including stock classified as mandatorily redeemable), retained earnings, general loss allowances, and other amounts from sources the Finance Agency determines are available to absorb losses. Currently, our regulatory capital consists of capital stock and retained earnings. Under the Gramm-Leach-Bliley Act of 1999 (GLB Act), permanent capital equals Class B stock plus retained earnings and is available to absorb financial losses.

Our Capital Plan has the following basic characteristics:

We offer only one class of capital stock, Class B, which is redeemable upon a member's five-year advance written notice, with certain conditions described below. We may elect, at our discretion, to repurchase stock redemption requests sooner than five years.

We issue shares of capital stock as required for an institution to become a member or maintain membership, as required for members to capitalize Mission Asset Activity, and when we may pay dividends in the form of additional shares of stock.

The Capital Plan enables us to efficiently expand and contract capital stock needed to capitalize assets in response to changes in our membership base and demand for Mission Asset Activity. This enables us to maintain a prudent amount of financial leverage and also consistently generate a competitive dividend return.

We may, subject to the restrictions described below, repurchase certain capital stock (i.e., "excess" capital stock).

The concept of “cooperative capital,” explained below, better aligns the interests of heavy users of our products with light users by enhancing the dividend return.

Prudent risk management requires us to maintain effective financial leverage to minimize risk to capital stock while preserving profitability and to 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. We have always complied with the regulatory capital requirements.

We must maintain at least a four percent minimum regulatory capital-to-assets ratio. This has historically been the regulatory capital requirement that has been closest to affecting our operations.

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We must maintain at least a five 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 permanent capital, this requirement is met automatically if we satisfy the four percent unweighted capital requirement.
We are subject to a risk-based capital rule in which we must hold an amount of "permanent" capital that exceeds the amount of exposure to market risk, credit risk, and operational risk. How we determine the amount of these risk exposures is stipulated by Finance Agency regulation. Permanent capital includes retained earnings and the regulatory amount of Class B capital stock.

In addition to the minimum capital requirements, the GLB Act and our Capital Plan promote the adequacy of our capital to absorb financial losses in three ways, which combine to give member stockholders a clear incentive to require us to minimize our risk profile:

the five-year redemption period for Class B stock;
the option we have to call on members to purchase additional capital if required to preserve safety and soundness; and
the limitations, described below, on our ability to honor requested redemptions of capital if we are at risk of not maintaining safe and sound operations.

GAAP capital excludes mandatorily redeemable capital stock, while regulatory capital includes it. Mandatorily redeemable capital stock, which is stock subject to pending redemption, is accounted for as a liability on our Statements of Condition and related dividend payments are accounted for as interest expense. The classification of some capital stock as a liability has no effect on our safety and soundness, liquidity position, market risk exposure, or ability to meet interest payments on our participation in Obligations. Mandatorily redeemable capital stock is fully available to absorb losses until the stock is redeemed or repurchased. See Note 15 of the Notes to Financial Statements for more discussion of mandatorily redeemable capital stock.

Components of Capital Stock Purchases and Operations of the Capital Plan
Our Capital Plan ties the amount of each member's required capital stock to both the amount of the member's assets (membership stock) and the amount and type of its Mission Asset Activity with us (activity stock). Membership stock is required to become a member and maintain membership. The amount required for each member currently ranges from a minimum of $1 thousand to a maximum of $25 million for each member, with the amount within that range determined as a percentage of member assets.

In addition to its membership stock, a member may be required to purchase and hold activity stock to capitalize its Mission Asset Activity. For purposes of the Capital Plan, Mission Asset Activity includes the principal balance of Advances, guaranteed funds and rate Advance commitments, and the principal balance of loans and commitments in the MPP that occurred after implementation of the Capital Plan.

The FHLB must capitalize all Mission Asset Activity with capital stock at a rate of at least four percent. However, each member is permitted to maintain an amount of activity stock within the range of minimum and maximum percentages for each type of Mission Asset Activity. The current percentages are as follows:
    
Mission Asset Activity
 
Minimum Activity Percentage
 
Maximum Activity Percentage
Advances
 
   2%
 
   4%
Advance Commitments
 
2
 
4
MPP
 
0
 
4
 
If a member owns more stock than is needed to satisfy both its membership stock requirement and the maximum activity stock percentages for its Mission Asset Activity, we designate the remaining stock as the member's excess capital stock. The member may utilize its excess stock to capitalize additional Mission Asset Activity.

If an individual member's excess stock reaches zero, the Capital Plan normally permits us, within certain limits, to capitalize additional Mission Asset Activity of that member with excess stock owned by other members at the maximum percentage rate. This feature, called “cooperative capital,” enables us to more effectively utilize our capital stock. A member's use of cooperative capital reduces the ratio of its activity stock to its Mission Asset Activity for each type of Mission Asset Activity. There is a limit to how much cooperative capital a member may use, which we currently set at $200 million.


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When a member's ratio of activity stock to its Mission Asset Activity reaches the minimum activity stock percentage for all types of Mission Asset Activity, the member must capitalize additional Mission Asset Activity of a given type by purchasing capital stock at that asset type's minimum percentage rate, assuming availability of cooperative capital.

Statutory and Regulatory Restrictions on Capital Stock Redemption and Repurchases
In accordance with the GLB Act, our stock is putable by members. However, for us and the other FHLBanks, there are significant statutory and regulatory restrictions on our obligation or right to redeem or repurchase outstanding stock, including, but not limited to, the following:

We may not redeem any capital stock if, following the redemption, we would fail to satisfy any Regulatory capital requirements. By law, we may not redeem any stock if we become undercapitalized.

We may not redeem any capital stock without approval of the Finance Agency if either our Board of Directors or the Finance Agency determines that we have incurred or are likely to incur losses resulting or expected to result in a charge against capital.

If our FHLB is liquidated and after payment in full to our creditors, stockholders would be entitled to receive the par value of their capital stock. In addition, each stockholder would be entitled to any retained earnings in an amount proportional to the stockholder's share of the total shares of capital stock. In the event of a merger or consolidation of the FHLB, the Board of Directors shall determine the rights and preferences of the FHLB's stockholders, subject to any terms and conditions imposed by the Finance Agency.

Retained Earnings

Purposes and Amount of Retained Earnings
Retained earnings are important to protect members' capital stock investment against the risk of impairment and to enhance our ability to pay stable and competitive dividends when earnings may be volatile in light of the risks we face. Impairment risk is the risk that members would have to write down the par value of their capital stock investment in our FHLB as a result of their analysis of ultimate recoverability. An extreme situation of earnings instability, in which losses exceeded the amount of our retained earnings for a period of time determined to be other-than-temporary, could result in a determination that the value of our capital stock was impaired.
 
We have a policy that sets forth a range for the amount of retained earnings we believe is needed to mitigate impairment risk and facilitate dividend stability in light of the risks we face. The current retained earnings requirement ranges from $375 million to $600 million, based on mitigating quantifiable risks under very stressed business and market scenarios to a 99 percent confidence level. Given the regulatory environment, we carry a greater amount of retained earnings than required by the Policy. At the end of 2015, our retained earnings totaled $765 million. We believe the current amount of retained earnings is sufficient to protect our capital stock against impairment risk and to provide dividend stability if needed.

Joint Capital Agreement to Augment Retained Earnings
The FHLBanks entered into a Joint Capital Enhancement Agreement (the “Capital Agreement”) in February 2011. The Capital Agreement provides that each FHLBank will allocate quarterly at least 20 percent of its net income to a restricted retained earnings account (the “Account”). The 20 percent reserve allocation to the Account is similar to what had been required under the FHLBanks' REFCORP obligation, which was satisfied in 2011. The Account is not available to be distributed as dividends except under certain limited circumstances. The Capital Agreement does not limit our ability to use retained earnings held outside of the Account to pay dividends.

Although we have always maintained compliance with our capital requirements, we believe the Capital Agreement enhances risk mitigation by building a larger capital buffer over time to absorb unexpected losses, if any, that we may experience. Therefore, the Capital Agreement provides additional protection against impairment risk to stockholders' capital investment.



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USE OF DERIVATIVES

Finance Agency regulations and our policies establish guidelines for the execution and use of derivative transactions. We are prohibited from trading in, or the speculative use of, derivatives and have limits on the amount of credit risk to which we may be exposed. Most of our derivatives activity involves interest rate swaps, some of which may include options. We account for all derivatives at their fair values.

Similar to our participation in debt issuances, use of derivatives is integral to hedging market risk created by offering Advances, purchasing mortgage assets, and transacting mortgage commitments. Derivatives related to Advances most commonly hedge either:

below-market rates and/or the market risk exposure on Putable Advances, and certain other Advances, for which members have sold us options embedded within the 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.

Derivatives related to mortgage assets are used to augment debt issuance in the hedging of market risk. We also use derivatives to hedge the market risk associated with fixed-rate mortgage purchase commitments in the MPP.

Derivatives transactions related to Bonds also help us intermediate between the preference of capital market investors for intermediate- and long-term fixed-rate debt securities and the preference 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.

Use of derivatives can result in a substantial amount of volatility of accounting and economic earnings. Because we have a cooperative business model, our Board of Directors has emphasized the importance of controlling earnings volatility. Accordingly, our strategy is to execute derivatives that we expect to be effective hedges of market risk exposure relative to their impacts on profitability. As a result, the volatility in the market value of equity and earnings from our use of derivatives has historically tended to be moderate.


COMPETITION

Numerous economic and financial factors influence members' use of Mission Asset Activity. One of the most important factors that affect Advance demand is the amount of member deposits, which for most members are their primary source of funds. In addition, both small and, in particular, large members typically have access to wholesale funds besides FHLB Advances. Another important source of competition for Advances is the ongoing fiscal and monetary stimuli initiated by the federal government to combat the continued difficulties in the housing market and broader economy. This is discussed in Item 1A's “Risk Factors” and in Item 7's “Executive Overview."
 
The holding companies of some of our large asset members have membership(s) in other FHLBanks through their affiliates. Others could initiate memberships in other Districts. The competition among FHLBanks for the business of multiple-membership institutions is similar to the FHLBanks' competition with other wholesale lenders and mortgage investors. We compete with other FHLBanks on the offerings and pricing of Mission Asset Activity, earnings and dividend performance, collateral policies, capital plans, and members' perceptions of our relative safety and soundness. Some members may also evaluate benefits of diversifying business relationships among FHLB memberships. We regularly monitor these competitive forces among the FHLBanks.

The primary competitors for mortgage loans we purchase in the MPP are Fannie Mae and Freddie Mac, government agencies such as the Government National Mortgage Association (Ginnie Mae), and private issuers. Fannie Mae and Freddie Mac, in particular, have long-established and efficient programs and are the dominant purchasers of fixed-rate conventional mortgages. In addition, a number of private financial institutions have well-established securitization programs, although they may not currently be as active as they were historically. The MPP also competes with the Federal Reserve to the extent it purchases mortgage-backed securities and affects market prices and availability of supply.


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For debt issuance, the FHLBank System competes with issuers in the national and global debt markets, including most importantly the U.S. government and other GSEs.


Item 1A.    Risk Factors.        

The following are the most important risks we currently face. The realization of one or more of the risks could negatively affect our results of operations, financial condition, and, at the extreme, the viability of our business franchise. The effects could include reductions in Mission Asset Activity, lower earnings and dividends, and, at the extreme, impairment of our capital or an inability to participate in issuances of Consolidated Obligations. The risks identified below are not the only risks we face. Other risks not presently known or which we deem to be currently immaterial may also impact our business. Additionally, the risks identified may adversely affect our business in ways we do not expect or anticipate.

Economy. An economic downturn could lower Mission Asset Activity and profitability.

Member demand for Mission Asset Activity depends in large part on the general health of the economy and overall business conditions. Numerous external factors can affect our Mission Asset Activity and earnings including:

the general state and trends of the economy and financial institutions, especially in our Fifth District;
conditions in the financial, credit, mortgage, and housing markets;
interest rates;
competitive alternatives to our products, such as retail deposits and other sources of wholesale funding;
actions of the Federal Reserve to affect liquidity reserves of financial institutions and the money supply;
the willingness and ability of financial institutions to expand lending; and
regulatory initiatives.

Because our business tends to be cyclical, a recessionary economy normally lowers the amount of Mission Asset Activity, can decrease profitability, and can cause stockholders to request redemption of a portion of their capital or request withdrawal from membership (both referred to in this document as “request withdrawal of capital”). These unfavorable effects are more likely to occur and be more severe if a weak economy is accompanied by significant changes in interest rates, stresses in the housing market, elevated competitive forces, or actual or potential changes in the legislative and regulatory environment.

Since the last recession, which officially ended in 2009, the economy has grown at a measured pace, contributing to tempered broad-based member demand for Mission Asset Activity. In addition, overall Advance demand has been and continues to be unfavorably affected by the substantial amount of deposit based liquidity provided to financial institutions through the monetary actions of the Federal Reserve, and a more onerous regulatory environment for our members. Acceleration of these conditions or another recession could decrease Mission Asset Activity, which could reduce profitability.

Competition. The competitive environment for our products could adversely affect business activities, including decreasing the level and utilization rates of Mission Asset Activity, earnings, and capitalization.

We operate in a highly competitive environment for Mission Asset Activity. Increased competition could decrease the amount of Mission Asset Activity and narrow profitability on that activity, both of which could cause stockholders to request withdrawals of capital. Historically, our primary competition has been from other wholesale lenders and debt issuers, including other GSEs. A substantial source of competition in the last eight years has come from the federal government's actions to stimulate the economy, especially the actions of the Federal Reserve System through its policies of quantitative easing and maintaining extremely low interest rates. Among other effects, these actions have significantly expanded liquidity and excess reserves available to many members. We expect overall, broad-based growth in Advance demand will remain modest until the government reduces these initiatives by tightening monetary policy and winding down its holdings of U.S. Treasury and mortgage-backed securities. Even if these events take place, we cannot provide assurance regarding the pace or strength of the renewed Advance demand that we would anticipate.


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In addition, the FHLBank System competes for funds through issuance of debt with the U.S. Treasury, Fannie Mae, Freddie Mac, other GSEs, and corporate, state, and sovereign entities, among others. Increases in the supply and types of competing debt products or other regulatory factors could adversely affect the System's ability to access funding or increase the cost of our debt issuance. Either of these effects could in turn adversely affect our financial conditions and results of operations and the value of FHLB membership.

GSE Reform. Potential GSE reform could unfavorably affect our business model, financial condition, and results of operations.

The FHLBank System's regulator, the Finance Agency, also regulates Fannie Mae and Freddie Mac. While there appears to be consensus that a permanent financial and political solution to the current conservatorship status of Fannie Mae and Freddie Mac should be implemented, which could include maintaining the current structure, no consensus has evolved to date around any of the various legislative proposals. However, some policy proposals have included provisions applicable to the FHLBanks, such as limitations on Advances and portfolio investments, development of a covered bond market, and restrictions on GSE mortgage finance, that could threaten the FHLBank System's long-standing business model.

Because the FHLBanks shares a common regulator with Fannie Mae and Freddie Mac, the ultimate resolution to the conservatorship of Fannie Mae and Freddie Mac could affect the FHLBanks. There are significant differences between the FHLBank System and Fannie Mae and Freddie Mac, including the System's focus on lending as opposed to guaranteeing mortgages and its distinctive cooperative business model. Legislation could inadequately account for these differences, which could imperil the ability of the FHLBank System to continue operating effectively within its current business model or could change the System's business model. We cannot predict the effects on the System if GSE reform were to be enacted.

FHLB Regulatory Environment. We face a heightened regulatory and legislative environment, which could unfavorably affect our business model, financial condition, and results of operations.

In addition to potential GSE reform, the legislative and regulatory environment in which the FHLBank System operates continues to undergo rapid change driven principally by reforms emanating from the Housing and Economic Reform Act of 2008 (HERA) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Recently-promulgated and future legislative and regulatory actions could significantly affect our business model, financial condition, or results of operations.
  
In addition, in January 2016, the Finance Agency published a final rule regarding membership requirements, part of which will negatively affect our business. The rule prohibits captive insurance companies membership eligibility in the FHLBank System. The membership regulation is discussed further in Item 7's "Executive Overview."

We believe that, taken as a whole, legislative and regulatory actions have raised our operating costs and imparted added uncertainty regarding the business model under which the FHLBanks may operate in the future. We are unable at this time to predict the ultimate effects the heightened regulatory environment could have on the FHLBank System's business model or on our financial condition and results of operations.
 
Liquidity and Market Access. Impaired access to the capital markets for debt issuance could increase liquidity risk, decrease the amount of Mission Asset Activity, lower earnings by raising debt costs and, at the extreme, result in realization of liquidity risk preventing the System from meeting its financial obligations.

Our principal long-term source of funding, liquidity, and market risk management is through access to the capital markets for participation in the issuances of debt securities and execution of derivative transactions at prices and yields that are adequate to support our business model. Our ability to obtain funds through the sale of Consolidated Obligations depends in part on prevailing conditions in the capital markets, particularly the short-term capital markets, due to a large reliance on short-term funding. Access to the capital markets on favorable terms and strong investor demand for FHLBank System debt are the fundamental source of the FHLBank System's business franchise. The System's strong debt ratings, the implicit U.S. government backing of our debt, and effective funding management are instrumental in ensuring satisfactory access to the capital markets.

We are exposed to liquidity risk if there are significant disruptions in the capital markets. Although the last several years experienced ongoing issues with the federal government's fiscal condition and changes in the regulatory environment that affected the functioning of capital markets, the FHLBank System has been able to maintain access to the capital markets

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for debt issuances on acceptable terms (including when the FHLBank System's debt was downgraded by Standard & Poor's). However, there is no assurance this will continue to be the case. Future ability to effectively access the capital markets could be adversely affected by external events (such as general economic and financial instabilities, political instability, wars, and natural disasters), continued evolution of capital markets in response to financial regulations, and by the System's joint and several liability for Consolidated Obligations, which exposes us to events at other FHLBanks. If access to capital markets were to be impaired for any extended period, the effect on our financial condition and results of operations could be material. At the extreme, the System's ability to achieve its mission and satisfy its financial obligations could be threatened.

Credit and Counterparty Risk. We are exposed to credit risk that, if realized, could materially affect our ability to pay members a competitive dividend.

We believe we have a de minimis overall amount of residual credit risk exposure related to Credit Services, purchases of investments, and transactions in derivatives, and a minimal amount of credit risk exposure related to the MPP. However, we can make no assurances that credit losses will not materially affect our financial condition or results of operations. An extremely severe and prolonged economic downturn, especially if combined with continued significant disruptions in housing or mortgage markets, could result in credit losses on assets that could impair our financial condition or results of operations.

The FHLB is an asset-based lender for Advances and Letters of Credit. Advances are over-collateralized and we have a perfected first lien position on collateral. However, we do not have full information on the characteristics of nor do we estimate current market values on a large portion of collateral. This results in a degree of uncertainty as to the precise amount of over-collateralization.

Although credit losses in the MPP have historically been small, they could increase under adverse economic scenarios involving significant and sustained reductions in home prices and sustained elevated levels of unemployment and other factors that influence delinquencies and defaults.

Some of our liquidity investments are unsecured, as are uncollateralized portions of interest rate swaps. We make unsecured liquidity investments in and transact derivatives with highly rated, investment-grade institutions, have conservative limits on dollar and maturity exposure to each institution, and have strong credit underwriting practices. Failure of an investment or derivative counterparty with which we have a large unsecured position could have a material adverse effect on our financial conditions and results of operations. To the extent we engage in derivative transactions required to be cleared under provisions of the Dodd-Frank Act, we may be exposed to nonperformance from central clearinghouses and Futures Commission Merchants.

Financial institutions are increasingly inter-related as a result of trading, clearing, counterparty, and other relationships. As a result, actual or potential defaults of one or more financial institutions could lead to market-wide disruptions making it difficult for us to find qualified counterparties for transactions.

Market Risk. Changes in interest rates and mortgage prepayment speeds (together referred to as market risk exposure or interest rate risk exposure) could significantly reduce our ability to pay members a competitive dividend from current earnings.

Exposure of earnings to unhedged changes in interest rates and mortgage prepayment speeds is one of our largest ongoing residual risks. We derive most of our income from the interest earned on assets less the interest paid on Consolidated Obligations and deposits used to fund the assets. We hedge mortgage assets with a combination of Consolidated Obligations, derivatives transactions, and capital. Interest rate movements can lower profitability in two ways: 1) directly due to their impact on earnings from cash flow mismatches between assets and liabilities; and 2) indirectly via their impact on prepayment speeds, which can unfavorably affect the cash flow mismatches. The effects on income can include acceleration in the amortization of purchased premiums on mortgage assets.

Because it is normally cost-prohibitive to completely mitigate market risk exposure, a residual amount of market risk normally remains after incorporating risk management activities. Sharp increases in interest rates, especially short-term rates, or sharp decreases in long-term interest rates could adversely affect us and our stockholders by making dividend rates less competitive relative to the returns available to members on alternative investments.


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In some extremely stressful scenarios, changes in interest rates and prepayment speeds could result in dividends being below stockholders' expectations for an extended period of time. In such a situation, members could engage in less Mission Asset Activity and could request a withdrawal of capital. See Item 7's "Quantitative and Qualitative Disclosures About Risk Management" for additional information about market risk exposure.

Asset Profitability. Spreads on assets to funding costs may narrow because of changes in market conditions and competitive factors, resulting in lower profitability.

Spreads on our assets tend to be narrow compared to those of many other financial institutions due to our cooperative business model. Market conditions, competitive forces, and, as discussed above, market risk exposure could cause these already narrow asset spreads to decline, which could substantially reduce our profitability. A key spread relationship is that we tend to utilize Consolidated Discount Notes to fund a significant amount of assets that have adjustable-rates tied to LIBOR. Because rates on Discount Notes do not perfectly correlate with LIBOR, a narrowing of this spread, for example from investors changing perceptions about the quality of our debt, could lower income and reduce balances of Mission Asset Activity.

Capital Adequacy. Failure to meet capital adequacy requirements mandated by Finance Agency regulations and by our policies, or not being able to pay dividends or repurchase or redeem capital stock, may lower demand for Mission Asset Activity, affect results of operations, and lower membership value.

To ensure safe and sound operations, we must hold a minimum amount of capital relative to our asset levels. We must also hold a minimum amount of retained earnings to, among other things, help protect members' capital stock investment against impairment risk. If we were to violate any capital requirement, we may be unable to pay dividends or redeem and repurchase capital stock. This could adversely affect the value of membership including members' capital investment. Outcomes could be reduced demand for Mission Asset Activity, decreased profitability, requests from members to redeem a portion of their capital or to withdraw from membership, or increased investors' perception of the riskiness of our FHLB.

Business Concentration and Industry Consolidation and Composition. Sharp reductions in Mission Asset Activity resulting from lower usage by large members, consolidation of large members or growth in lending activities by entities not eligible for FHLB membership could adversely impact our net income and dividends.

The amount of Mission Asset Activity and capital is concentrated among a handful of large members. The financial industry continues to consolidate among a smaller number of institutions and the market share of mortgage financing has shown a systemic trend towards financial institutions who are currently ineligible for FHLB membership. Our members could decrease their Mission Asset Activity and the amount of their capital stock as a result of merger and acquisition activity or continued loss of market share to ineligible FHLB members. At December 31, 2015, one member, JPMorgan Chase Bank, N.A., held nearly half of our Advances and one member PFI, Union Savings Bank, accounted for over 25 percent of the outstanding MPP principal balance. Our business model is structured to be able to absorb sharp changes in Mission Asset Activity because we can undertake commensurate reductions in liability balances and capital and because of our relatively modest operating expenses. However, an extremely large and sustained reduction in Mission Asset Activity could affect our profitability and ability to pay competitive dividends, as well as, at the FHLBank System level, raise policy questions about the relevance of the FHLBank System in its traditional mission of supporting housing finance.

Exposure to FHLBank System. Financial difficulties at other FHLBanks could require us to provide financial assistance to another FHLBank, which could adversely affect our results of operations or our financial condition.

Each FHLBank has a joint and several liability for principal and interest payments on Consolidated Obligations, which are backed only by the financial resources of the FHLBanks. Although no FHLBank has ever defaulted on its principal or interest share of an Obligation, there can be no assurance that this will continue to be the case. Financial performance issues could require our FHLB to provide financial assistance to one or more other FHLBanks, for example, by making a payment on an Obligation on behalf of another FHLBank. Such assistance could adversely affect our financial condition, earnings, ability to pay dividends, or ability to redeem or repurchase capital stock.


20


Member Regulatory Environment. Members face increased regulatory scrutiny, which could further decrease Mission Asset Activity and lower profitability.

In the last number of years, regulation and scrutiny of the financial industry has increased significantly. We believe these activities have decreased members' overall usage of Advances.

The Basel Committee on Banking Supervision (the Basel Committee) has developed a proposed new capital regime for internationally active banks. Banks subject to the new regime are required, among other things, to have higher capital ratios. While it is uncertain how the new capital regime and other standards, such as those related to liquidity, developed by the Basel Committee will ultimately be implemented by U.S. regulatory authorities, the new regime could require some of our members to divest assets in order to comply with the regime's more stringent capital and liquidity requirements, thereby possibly lowering Advance demand. Additionally, the liquidity requirements being implemented could adversely impact Advance demand and investor demand for Consolidated Obligations because they would limit the ability of members to fully include Advances and Consolidated Obligations in required liquidity calculations. This could raise our debt costs and, in turn, raise the Advance rates we are able to offer members, thereby harming the ability to fulfill our business model.

Personnel Risk. Our financial condition and results of operations could suffer if we are unable to hire and retain skilled key personnel.

The success of our business mission depends, in large part, on the ability to attract and retain key personnel. Competition for qualified people or ineffective succession planning could affect the ability to hire or retain effective key personnel, thereby harming our financial condition and results of operations.

Operational and Compliance Risks. Failures or interruptions in our internal controls, compliance activities, information systems and other operating technologies could harm our financial condition, results of operations, reputation, and relations with members.

Control failures, including failures in our controls over financial reporting, or business interruptions with members and counterparties could occur from human error, fraud, breakdowns in information and computer systems and financial and business models we use, lapses in operating processes, or natural or man-made disasters. If a significant control failure or business interruption were to occur, it could materially damage our financial condition and results of operations. We may not be able to foresee, prevent, mitigate, reverse or repair the negative effects of such failures or interruptions.

We rely heavily on internal and third-party information systems and other technology to conduct and manage our business. Our operations rely on the secure processing, storage and transmission of confidential and other information in computer systems and networks. Computer systems, software and networks can be vulnerable to failures and interruptions including “cyberattacks,” which are breaches, unauthorized access, misuse, computer viruses or other malicious code and other events against information owned by our company and customers. These failures and interruptions could jeopardize the confidentiality or integrity of information, or otherwise cause interruptions or malfunctions in operations.

We can make no assurance that we will be able to prevent, timely and adequately address, or mitigate the negative effects of failures, interruptions, or "cyberattacks" in information systems and other technology. If we experience a failure, interruption, or "cyberattack" in any of these systems, we may be unable to effectively conduct or manage our business activities, operating processes, and risk management, which could significantly harm customer relations, our reputation, or profitability, potentially resulting in material adverse effects on our financial condition and results of operations.
 

Item 1B.    Unresolved Staff Comments.

None.

Item 2.        Properties.

Our offices are located in approximately 79,000 square feet of leased space in downtown Cincinnati, Ohio. We also maintain a leased, fully functioning, back-up facility in suburban Cincinnati. Additionally, we lease a small office in Nashville, Tennessee

21


for the area marketing representative. We believe that our facilities are in good condition, well maintained, and adequate for our current needs.

Item 3.        Legal Proceedings.

From time to time, we are subject to various legal proceedings arising in the normal course of business. Management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material adverse effect on our financial condition or results of operations.

Item 4.        Mine Safety Disclosures.

Not applicable.


22



PART II

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

By law our stock is not publicly traded, and only our members (and former members with a withdrawal notice pending) may own our stock. The par value of our capital stock is $100 per share. As of December 31, 2015, we had 699 stockholders and 44 million shares of capital stock outstanding, all of which were Class B Stock.

We paid quarterly dividends in 2015 and 2014 as outlined in the table below.
(Dollars in millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
2014
 
 
 
 
Annualized
 
 
 
 
 
 
 
Annualized
 
 
Quarter
 
Amount
 
Rate
 
Form
 
Quarter
 
Amount
 
Rate
 
Form
First
 
$
43

 
4.00
%
 
Cash
 
First
 
$
47

 
4.00
%
 
Cash
Second
 
42

 
4.00

 
Cash
 
Second
 
44

 
4.00

 
Cash
Third
 
43

 
4.00

 
Cash
 
Third
 
42

 
4.00

 
Cash
Fourth
 
44

 
4.00

 
Cash
 
Fourth
 
43

 
4.00

 
Cash
Total
 
$
172

 
4.00

 
 
 
Total
 
$
176

 
4.00

 
 
    

Generally, our Board of Directors has discretion to declare or not declare dividends and to determine the rate of any dividend declared. Our Retained Earnings and Dividend Policy states that dividends for a quarter are declared and paid from retained earnings after the close of a calendar quarter and are based on average stock balances for the then closed quarter. Our Board of Directors' decision to declare dividends is influenced by the financial condition, overall financial performance and retained earnings of the FHLB, and actual and anticipated developments in the overall economic and financial environment including, most importantly, interest rates and the mortgage and credit markets. The dividend rate is generally referenced as a spread to average short-term interest rates experienced during the quarter to help assess a competitive level for our stockholders.

A Finance Agency Capital Rule prohibits us from issuing new excess capital stock to members, either by paying stock dividends or otherwise, if before or after the issuance the amount of member excess capital stock exceeds or would exceed one percent of the FHLB's assets. Excess capital stock for this regulatory purpose is calculated as the aggregate of capital stock owned that is in excess of all membership and Mission Asset Activity requirements (as defined in our Capital Plan).

We may not declare a dividend if, at the time, we are not in compliance with all of our capital requirements. We also may not declare or pay a dividend if, after distributing the dividend, we would fail to meet any of our capital requirements or if we determine that the dividend would create a safety and soundness issue for the FHLB. See Note 15 of the Notes to the Financial Statements for additional information regarding our capital stock.


RECENT SALES OF UNREGISTERED SECURITIES

From time to time, we provide 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. We provided $17 million of such credit support during 2015. We did not provide such credit support during 2014 and 2013. 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.


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Item 6.
Selected Financial Data.

The following table presents selected Statement of Condition data, Statement of Income data and financial ratios for the five years ended December 31, 2015.
 
Year Ended December 31,
(Dollars in millions)
2015
 
2014
 
2013
 
2012
 
2011
STATEMENT OF CONDITION DATA AT PERIOD END:
 
 
 
 
 
 
 
 
 
Total assets
$
118,797

 
$
106,640

 
$
103,181

 
$
81,562

 
$
60,397

Advances
73,292

 
70,406

 
65,270

 
53,944

 
28,424

Mortgage loans held for portfolio
7,982

 
6,989

 
6,826

 
7,548

 
7,871

Allowance for credit losses on mortgage loans
2

 
5

 
7

 
18

 
21

Investments (1)
37,356

 
26,007

 
22,364

 
19,950

 
21,941

Consolidated Obligations, net:
 
 
 
 
 
 
 
 
 
Discount Notes
77,199

 
41,232

 
38,210

 
30,840

 
26,136

Bonds
35,105

 
59,217

 
58,163

 
44,346

 
28,855

Total Consolidated Obligations, net
112,304

 
100,449

 
96,373

 
75,186

 
54,991

Mandatorily redeemable capital stock
38

 
63

 
116

 
211

 
275

Capital:
 
 
 
 
 
 
 
 
 
Capital stock - putable
4,429

 
4,267

 
4,698

 
4,010

 
3,126

Retained earnings
765

 
689

 
621

 
538

 
444

Accumulated other comprehensive loss
(13
)
 
(17
)
 
(9
)
 
(11
)
 
(11
)
Total capital
5,181

 
4,939

 
5,310

 
4,537

 
3,559

STATEMENT OF INCOME DATA:
 
 
 
 
 
 
 
 
 
Net interest income
$
322

 
$
317

 
$
328

 
$
308

 
$
249

(Reversal) provision for credit losses

 

 
(7
)
 
1

 
12

Non-interest income (loss)
30

 
23

 
20

 
13

 
(5
)
Non-interest expense
75

 
68

 
64

 
58

 
57

Assessments
28

 
28

 
30

 
27

 
37

Net income
$
249

 
$
244

 
$
261

 
$
235

 
$
138

FINANCIAL RATIOS:
 
 
 
 
 
 
 
 
 
Dividend payout ratio (2)
69.2
%
 
72.2
%
 
68.1
%
 
60.1
%
 
95.4
%
Weighted average dividend rate (3)
4.00

 
4.00

 
4.18

 
4.44

 
4.25

Return on average equity
4.90

 
4.93

 
5.10

 
6.20

 
3.89

Return on average assets
0.24

 
0.24

 
0.28

 
0.35

 
0.21

Net interest margin (4)
0.31

 
0.31

 
0.35

 
0.46

 
0.37

Average equity to average assets
4.81

 
4.90

 
5.47

 
5.68

 
5.29

Regulatory capital ratio (5)
4.40

 
4.71

 
5.27

 
5.84

 
6.37

Operating expenses to average assets (6)
0.058

 
0.054

 
0.055

 
0.067

 
0.068

(1)
Investments include interest bearing deposits in banks, securities purchased under agreements to resell, Federal funds sold, trading securities, available-for-sale securities, and held-to-maturity securities.
(2)
Dividend payout ratio is dividends declared in the period as a percentage of net income.
(3)
Weighted average dividend rates are dividends paid divided by the average number of shares of capital stock eligible for dividends.
(4)
Net interest margin is net interest income before (reversal)/provision for credit losses as a percentage of average earning assets.
(5)
Regulatory capital ratio is period-end regulatory capital (capital stock, mandatorily redeemable capital stock and retained earnings) as a percentage of period-end total assets.
(6)
Operating expenses comprise compensation and benefits and other operating expenses, which are included in non-interest expense.


24


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


EXECUTIVE OVERVIEW
 
 
 
 
 
 
 
 
 
 
Financial Condition

Mission Asset Activity
The following table summarizes our financial condition.
 
Year Ended December 31,
 
Ending Balances
 
Average Balances
(In millions)
2015
 
2014
 
2015
 
2014
Total Assets
$
118,797

 
$
106,640

 
$
105,569

 
$
101,157

Mission Asset Activity:
 
 
 
 
 
 
 
Advances (principal)
73,242

 
70,299

 
70,355

 
66,492

Mortgage Purchase Program (MPP):
 
 
 
 
 
 
 
Mortgage loans held for portfolio (principal)
7,758

 
6,796

 
7,396

 
6,620

Mandatory Delivery Contracts (notional)
450

 
451

 
471

 
273

Total MPP
8,208

 
7,247

 
7,867

 
6,893

Letters of Credit (notional)
19,555

 
17,780

 
17,694

 
15,154

Total Mission Asset Activity
$
101,005

 
$
95,326

 
$
95,916

 
$
88,539


In 2015, the FHLB fulfilled its mission by providing readily available and competitively priced wholesale funding to its member financial institutions, supporting its commitment to affordable housing, and paying stockholders a competitive dividend return on their capital investment.

The balance of Mission Asset Activity – which we define as Advances, Letters of Credit, and total MPP (including purchase commitments) – was $101.0 billion at December 31, 2015, an increase of $5.7 billion (six percent) from year-end 2014. This growth was primarily driven by an increase in the principal balance of Advances. As of December 31, 2015, members funded on average 3.4 percent of their assets with Advances, and the market penetration rate was relatively stable with approximately 70 percent of members holding Mission Asset Activity. The majority of members continued to have modest demand for new Advance borrowings due to measured economic growth, an abundance of deposits and significant amounts of liquidity made available as a result of the actions of the Federal Reserve System.

The principal balance of mortgage loans held for portfolio at December 31, 2015 rose $1.0 billion (14 percent) from year-end 2014. The growth reflected ongoing improvements in the housing market and low mortgage rates. During 2015, we purchased $2.4 billion of mortgage loans, while principal reductions totaled $1.4 billion. Residual credit risk exposure in the mortgage loan portfolio continued to be minimal.

Based on 2015 earnings, we contributed $28 million to the Affordable Housing Program (AHP) pool of funds to be awarded to members in 2016. In addition, we continued our voluntary sponsorship of two other housing programs, which provide resources to pay for accessibility rehabilitation and emergency repairs for special needs and elderly homeowners and to help members aid their communities following natural disasters.
 
Investments and Other Assets
The balance of investments at December 31, 2015 was $37.4 billion, an increase of $11.3 billion (44 percent) from year-end 2014. Most of the increase was because we held more short-term liquidity investments at the end of 2015. At December 31, 2015, investments included $15.3 billion of mortgage-backed securities and $22.1 billion of other investments, which were mostly short-term instruments held for liquidity.

Investment balances averaged $27.3 billion in 2015, a decrease of $0.2 billion (one percent) from 2014's average. This reflected minimal changes in average liquidity investments and mortgage-backed securities. All of our mortgage-backed securities held at December 31, 2015 were issued and guaranteed by Fannie Mae, Freddie Mac or a U.S. agency.

25



The balance of cash and due from banks at December 31, 2015 was $10 million, compared to $3.1 billion at December 31, 2014. The 2014 balance was larger than normal due to holding $3.1 billion in deposits at the Federal Reserve on that date.

We maintained an adequate amount of asset liquidity throughout the year under a variety of liquidity measures as discussed in the "Liquidity Risk" section of "Quantitative and Qualitative Disclosures About Risk Management."
 
Capital
Capital adequacy remained strong throughout 2015, exceeding all minimum regulatory capital requirements. The GAAP capital-to-assets ratio at December 31, 2015 was 4.36 percent, while the regulatory capital-to-assets ratio was 4.40 percent. Both ratios exceeded the regulatory required minimum of four percent. Regulatory capital includes mandatorily redeemable capital stock accounted for as a liability under GAAP. The average GAAP and regulatory capital ratios in 2015 were 4.81 percent and 4.88 percent, respectively, higher than the year-end ratios. The year-end ratios reflected the higher amount of short-term liquidity balances we carried on that date.

The amounts of GAAP and regulatory capital increased $242 million and $213 million, respectively, in 2015, due primarily to purchases of capital stock by members to support Advance growth.

Total retained earnings were $765 million at December 31, 2015, an increase of $76 million (11 percent) from year-end 2014. We believe the amount of retained earnings is sufficient to protect against members' impairment risk of their capital stock investment in the FHLB and to provide the opportunity to stabilize future dividends. Our Capital Plan also has safeguards to prevent financial leverage ratios from falling below regulatory minimum levels.

Results of Operations

Overall Results
The table below summarizes our results of operations.
 
Year Ended December 31,
(Dollars in millions)
2015
 
2014
 
2013
Net income
$
249

 
$
244

 
$
261

Affordable Housing Program accrual
28

 
28

 
30

Return on average equity (ROE)
4.90
%
 
4.93
%
 
5.10
%
Return on average assets
0.24

 
0.24

 
0.28

Weighted average dividend rate
4.00

 
4.00

 
4.18

Average 3-month LIBOR
0.32

 
0.23

 
0.27

Average overnight Federal funds effective rate
0.13

 
0.09

 
0.11

ROE spread to 3-month LIBOR
4.58

 
4.70

 
4.83

Dividend rate spread to 3-month LIBOR
3.68

 
3.77

 
3.91

ROE spread to Federal funds effective rate
4.77

 
4.84

 
4.99

Dividend rate spread to Federal funds effective rate
3.87

 
3.91

 
4.07


Net income in 2015 was $5 million (two percent) higher than in 2014. ROE was similar in the last two years and we paid the same dividend rate in each of the last nine quarters. Although there were a number of factors that affected earnings, in the aggregate they nearly offset one another and no individual factor experienced a change that significantly affected operating results or indicated a concern about future profitability. This steady performance reflected the net impact of a stable business and interest rate environment, a modest increase in average assets, a relatively constant composition of assets, a consistent and conservative management of risk, a moderate increase in operating expenses, and a prudent use of derivative transactions.

The spreads between ROE and short-term interest rates, 3-month LIBOR and Federal funds, are market benchmarks we believe member stockholders use to assess the competitiveness of the return on their capital investment in our company. Earnings continued to be sufficient to provide competitive returns on stockholders' capital investment. Consistent with experience over the last several years, ROE was significantly above short-term rates, resulting in the ROE spreads being wider than the long-term historical average spread.


26


Effect of Interest Rate Environment
Trends in market interest rates strongly influence the results of operations via how they affect members' demand for Mission Asset Activity, 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.).
 
Year 2015
 
Year 2014
 
Year 2013
 
Ending
 
Average
 
Ending
 
Average
 
Ending
 
Average
Federal funds effective
0.20
%
 
0.13
%
 
0.06
%
 
0.09
%
 
0.07
%
 
0.11
%
3-month LIBOR
0.61

 
0.32

 
0.26

 
0.23

 
0.25

 
0.27

2-year LIBOR
1.18

 
0.88

 
0.90

 
0.62

 
0.49

 
0.44

10-year LIBOR
2.19

 
2.18

 
2.28

 
2.65

 
3.09

 
2.47

2-year U.S. Treasury
1.05

 
0.67

 
0.67

 
0.45

 
0.38

 
0.30

10-year U.S. Treasury
2.27

 
2.13

 
2.17

 
2.53

 
3.03

 
2.34

15-year mortgage current coupon (1)
2.32

 
2.13

 
2.10

 
2.34

 
2.68

 
2.21

30-year mortgage current coupon (1)
3.02

 
2.88

 
2.85

 
3.23

 
3.63

 
3.07

 
Year 2015 by Quarter - Average
 
Quarter 1
 
Quarter 2
 
Quarter 3
 
Quarter 4
Federal funds effective
0.11
%
 
0.13
%
 
0.13
%
 
0.16
%
3-month LIBOR
0.26

 
0.28

 
0.31

 
0.41

2-year LIBOR
0.84

 
0.86

 
0.88

 
0.93

10-year LIBOR
2.09

 
2.24

 
2.28

 
2.10

2-year U.S. Treasury
0.59

 
0.60

 
0.68

 
0.82

10-year U.S. Treasury
1.97

 
2.15

 
2.22

 
2.18

15-year mortgage current coupon (1)
1.96

 
2.09

 
2.25

 
2.20

30-year mortgage current coupon (1)
2.71

 
2.88

 
2.98

 
2.94

(1)
Simple average of current coupon rates of Fannie Mae and Freddie Mac par mortgage-backed security indications.

Short-term interest rates remained low in 2015. In December 2015, the Federal Reserve increased its target overnight Federal funds from a zero to 0.25 percent range to a 0.25 to 0.50 percent range. Other short-term interest rates remained consistent with their historical relationships to Federal funds during 2015. Average long-term rates were modestly lower in 2015 compared to 2014.

The persistence in 2015 of the low interest rate environment continued to favorably affect our results of operations relative to the level of interest rates for the following reasons:

Reductions in, and low, market interest rates raise ROE compared to market rates to the extent we fund a portion of long-term assets with shorter-term debt.
The long-standing low rate environment has provided us the opportunity to retire many Consolidated Bonds and replace them with lower cost Obligations, at a pace exceeding paydowns of high-yielding mortgage assets, which have been slower than would be expected in more normal housing and mortgage environments.
Earnings generated from funding assets with interest-free capital have not decreased as much as the reduction in overall interest rates because long-term assets do not reprice immediately to the lower rates.

The current trend level of ROE spread to market interest rates is above the long-term average trend because of the factors referenced above. However, these factors have improved our net income by a smaller amount more recently because they have been present for many years. For example, over time paydowns of high-yielding mortgage assets cumulatively have increased, which has offset much of the benefit from previously retiring high-cost Bonds.


27


Business Outlook and Risk Management

This section summarizes the business outlook and what we believe are our current major risk exposures. Item 1A's “Risk Factors” has a detailed discussion of risk factors that could affect our corporate objectives, financial condition, and results of operations. "Quantitative and Qualitative Disclosures About Risk Management" provides details on current risk exposures.

Strategic/Business Risk
Advances. Our business is cyclical and Mission Asset Activity normally grows slowly, stabilizes, or declines in periods of difficult macro-economic conditions, when financial institutions have ample liquidity, or when there is significant growth in the money supply. Since the end of the recession in 2009, measured economic growth has resulted in relatively slow growth in consumer, mortgage and commercial loans across the broad membership both in absolute terms and relative to deposit growth. Other factors continuing to constrain widespread demand for Advances are the extremely low levels of interest rates and little deviation in Advance rates versus deposit rates, and the Federal Reserve's ongoing actions to provide an extraordinary amount of deposit-based liquidity to attempt to stimulate economic growth.

In the last several years, the percentage of assets that members funded with Advances showed little variation, in the range of three to four percent. We would expect to see a broad-based increase in Advance demand when the economy experiences an improved and sustained growth trend or if changes in Federal Reserve policy reduce other sources of liquidity available to members.

The relative balance between loan and deposit fluctuations can provide an indication of potential member Advance demand. From September 30, 2014 to September 30, 2015 (the most recent period for which data are available), aggregate loan portfolios of Fifth District depository institutions grew $106.8 billion (8.4 percent) while their aggregate deposit balances fell $29.9 billion (1.4 percent). The data include the effect of large mergers and acquisitions only when they are available for both comparison dates. Most of the loan growth and deposit decline in this period occurred from our largest members, which is consistent with the concentration of financial activity.

Excluding the five members with over $50 billion of assets and recent acquisitions, aggregate loans increased $13.1 billion (6.6 percent) in the 12-month period while aggregate deposits grew $12.1 billion (5.1 percent). This more recent trend of loan growth exceeding deposit growth could produce increased demand for Advances over time.

MPP. MPP balances are influenced by conditions in the housing and mortgage markets, the competitiveness of prices we offer to purchase loans as well as program features, and activity from our largest sellers.

Our ongoing strategy for the MPP has two components: 1) increase the number of regular sellers and participants in the program; and 2) increase purchases while maintaining balances at a prudent level relative to capital and total assets to effectively manage market and credit risks consistent with our risk appetite.

Regulatory and Legislative Risk
General. The FHLBank System currently faces heightened legislative and regulatory risks and uncertainties, which we believe has affected, and could continue to affect, our Mission Asset Activity, capitalization, and results of operations. Legislative and regulatory actions applicable to the FHLBank System in the last eight years have raised our operating costs and increased uncertainty regarding the business model under which the FHLBanks may operate in the future. This is due primarily to the uncertainty around potential future GSE reform, which shows no signs of resolution. See Item 1A's "Risk Factors" for more discussion.

Core Mission Achievement. Over the years, we have adopted numerous indicators to assess achievement of our mission. These include metrics related to Mission Asset Activity, profitability, capital adequacy and safety and soundness. In July 2015, the Finance Agency issued an Advisory Bulletin to formalize a measure of FHLBank mission achievement across the System. The Advisory Bulletin established a goal for the sum of average Advances and purchased mortgage loans (collectively called Primary Mission Assets) to equal or exceed 70 percent of average Consolidated Obligations (i.e., the Primary Mission Assets ratio). Consolidated Obligations is used as a comparison because it reflects the major source of our franchise value as a GSE. If the metric falls below the 70 percent preferred ratio, an FHLBank would be expected to include in its strategic plan actions aimed at increasing the ratio, which could include consideration of Supplemental Mission Assets and Activities, such as Letters of Credit issued to members. During 2015, our Primary Mission Assets metric exceeded the Finance Agency's preferred ratio.

28



Membership Requirements. In January 2016, the Finance Agency issued a final rule on membership requirements. The primary changes to membership requirements are to:

ban currently-eligible captive insurance companies as eligible members in an FHLBank, and

clarify matters related to defining the principal place of business for eligible financial institution members for purposes of determining their appropriate FHLBank district.

As a result, our current captive insurance company members must terminate their memberships one year after the rule's effective date. In addition, the rule allows these members until the end of the one-year period to repay their existing Advances, but prohibits them from taking new Advances or renewing existing Advances that expire after the rule’s effective date.

We believe that the final rule will not materially affect our financial condition or results of operations despite the loss of current and potential captive insurance members. However, we are concerned that the rule could constrain the ability of the FHLBanks to fulfill their mission of promoting housing finance through providing liquidity and funding to financial institutions engaged in housing finance activities. We believe captive insurance companies are important institutions in helping to deepen and diversify the flow of funds in the mortgage markets.

Privately Insured Credit Unions. In December 2015, the U.S. Congress passed into law a provision permitting privately-insured state-chartered credit unions to apply for membership in the FHLBank System. Based on the number and size of such institutions in our district, we believe that this change in eligible members will have only a small effect on Mission Asset Activity.

Dodd-Frank Act and Related Regulations. Regulatory agencies continue to promulgate rules covering derivatives activities as required by the Dodd-Frank Act. A joint rule of several agencies issued in 2015 that will affect the FHLBanks mandates the exchange of initial and variation margin for interest rate swaps not cleared through a central clearinghouse. Margins are based on swaps' market value and their relative risk. The rule is effective April 1, 2016 and has a staggered implementation schedule of up to four years. We already post and collect margin on uncleared swaps. Therefore, we believe the largest impact of the rule will be the elimination of thresholds permitted on daily variation margin for new swaps transacted after the implementation date. This will eliminate the amount of uncollateralized exposure between derivative counterparties and reduce counterparty risk. We believe the impact of the rule will not be material to our company.

Market Risk
During 2015, as in 2014, the market risk exposure to changing interest rates was moderate overall and well within policy limits. We believe that profitability would not become uncompetitive unless long-term rates were to permanently increase over the next 12 months by five percentage points or more combined with short-term rates increasing to at least seven percent. We believe such a stress scenario is extremely unlikely to occur in the foreseeable future. Our market risk exposure to lower long-term interest rates, even up to two percentage points, would result in ROE remaining well above market interest rates.

Capital Adequacy
We believe members place a high value on their capital investment in our company. We maintained compliance with regulatory capital requirements. Capital ratios at December 31, 2015 and all throughout the year exceeded the regulatory required minimum of four percent. We believe that the amount of our retained earnings is sufficient to protect against impairment risk of capital stock and to provide the opportunity to stabilize dividends. Our Capital Plan has safeguards to prevent financial leverage from increasing beyond regulatory minimums or below safe levels.

Credit Risk
In 2015, we continued to experience a de minimis level of overall residual credit risk exposure from our Credit Services, making investments, and executing derivative transactions. We believe policies and procedures related to credit underwriting, Advance collateral management, and transactions with investment and derivative counterparties continue to fully mitigate these risks. Therefore, we have never experienced any credit losses and we continue to have no loan loss reserves or impairment recorded for these instruments.

Residual credit risk exposure in the mortgage loan portfolio was minimal. The allowance for credit losses in the MPP continued to decline and was $2 million at December 31, 2015.


29


Liquidity Risk
Our liquidity position remained strong during 2015, as did our overall ability to fund operations through the issuance of Consolidated Obligations at acceptable interest costs. Investor demand for FHLBank System debt continued to be robust. There were no substantive stresses on market access or liquidity from external market and political events. Although we can make no assurances, we expect this to continue to be the case and believe there is only a remote possibility of a liquidity or funding crisis in the FHLBank System that could impair our ability to participate, on a cost-effective basis, in issuances of new debt, service outstanding debt, maintain adequate capitalization, or pay competitive dividends.


ANALYSIS OF FINANCIAL CONDITION

Mission Asset Activity

Mission Assets are the primary means by which we fulfill our mission with direct connections to members. We regularly monitor the balance sheet concentration of Mission Asset Activity. In 2015, our Primary Mission Asset ratio, as defined in "Regulatory and Legislative Risk" of the Executive Overview, was 79 percent. In assessing mission achievement, we also consider supplemental sources of Mission Asset Activity, the most significant of which is Letters of Credit issued to members.

30



Credit Services

Credit Activity and Advance Composition
The tables below show trends in Advance balances by major programs and in the notional amount of Letters of Credit.
(Dollars in millions)
December 31, 2015
 
December 31, 2014
 
Balance
 
Percent(1)
 
Balance
 
Percent(1)
Adjustable/Variable Rate Indexed:
 
 
 
 
 
 
 
LIBOR
$
47,312

 
65
%
 
$
51,839

 
74
%
Other
617

 
1

 
515

 
1

Total
47,929

 
66

 
52,354

 
75

Fixed-Rate:
 
 
 
 
 
 
 
REPO
10,568

 
14

 
5,201

 
7

Regular Fixed-Rate
9,248

 
13

 
7,398

 
11

Putable (2)
1,046

 
1

 
1,617

 
2

Amortizing/Mortgage Matched
2,706

 
4

 
2,734

 
4

Other
1,745

 
2

 
995

 
1

Total
25,313

 
34

 
17,945

 
25

Total Advances Principal
$
73,242

 
100
%
 
$
70,299

 
100
%
 
 
 
 
 
 
 
 
Letters of Credit (notional)
$
19,555

 
 
 
$
17,780

 
 
(Dollars in millions)
December 31, 2015
 
September 30, 2015
 
June 30, 2015
 
March 31, 2015
 
Balance
 
Percent(1)
 
Balance
 
Percent(1)
 
Balance
 
Percent(1)
 
Balance
 
Percent(1)
Adjustable/Variable-Rate Indexed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
LIBOR
$
47,312

 
65
%
 
$
49,313

 
64
%
 
$
48,242

 
68
%
 
$
49,103

 
73
%
Other
617

 
1

 
565

 
1

 
597

 
1

 
407

 
1

Total
47,929

 
66

 
49,878

 
65

 
48,839

 
69

 
49,510

 
74

Fixed-Rate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
REPO
10,568

 
14

 
12,023

 
16

 
8,499

 
12

 
4,061

 
6

Regular Fixed-Rate
9,248

 
13

 
9,385

 
12

 
8,184

 
11

 
7,977

 
12

Putable (2)
1,046

 
1

 
1,557

 
2

 
1,570

 
2

 
1,580

 
3

Amortizing/Mortgage Matched
2,706

 
4

 
2,723

 
3

 
2,703

 
4

 
2,662

 
4

Other
1,745

 
2

 
1,637

 
2

 
1,223

 
2

 
825

 
1

Total
25,313

 
34

 
27,325

 
35

 
22,179

 
31

 
17,105

 
26

Total Advances Principal
$
73,242

 
100
%
 
$
77,203

 
100
%
 
$
71,018

 
100
%
 
$
66,615

 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Letters of Credit (notional)
$
19,555

 
 
 
$
17,594

 
 
 
$
19,006

 
 
 
$
16,905

 
 
(1)
As a percentage of total Advances principal.    
(2)
Excludes Putable Advances where the related put options have expired. Such Advances are classified based on their current terms.

The modest growth and variability in Advance balances in 2015 was driven primarily by changes in variable-rate and short-term repurchase (REPO) Advances as the reduction in the need for variable-rate funding from our largest member was more than offset by REPO Advance borrowings. The increase in REPO Advance borrowings was primarily from new insurance company members. However, the borrowings from these new members are required to be paid off over the next year due to the Finance Agency's 2016 final rule on membership requirements, which is discussed further in the "Executive Overview."

Members increased their available lines in the Letters of Credit program by $1.8 billion (10 percent) in 2015. Letters of Credit balances averaged $17.7 billion during 2015, an increase of $2.5 billion (17 percent) from the average balance during 2014. We

31


normally earn fees on Letters of Credit based on the actual average amount of the Letters utilized, which generally is less than the notional amount issued.

Advance Usage
In addition to analyzing Advance balances by dollar trends and the number of members utilizing them, we monitor the degree to which members use Advances to fund their balance sheets. The following table shows the unweighted, average ratio of each member's Advance balance to its most-recently available figures for total assets.
 
December 31, 2015
 
September 30, 2015
 
June 30, 2015
 
March 31, 2015
 
December 31, 2014
Average Advances-to-Assets for Members
 
 
 
 
 
 
 
 
 
Assets less than $1.0 billion (623 members)
3.26
%
 
3.20
%
 
3.14
%
 
3.06
%
 
3.24
%
Assets over $1.0 billion (76 members)
4.35

 
4.75

 
3.90

 
3.08

 
3.75

All members
3.37

 
3.35

 
3.22

 
3.06

 
3.29


Advance usage ratios were slightly higher at year-end 2015 compared to year-end 2014, driven primarily by an increase in short-term borrowings and the inclusion of borrowings from several new insurance company members. Usage ratio trends for members with assets less than $1.0 billion were stable within a narrow range during the same time periods.

The following table shows Advance usage of members by charter type.
(Dollars in millions)
December 31, 2015
 
December 31, 2014
 
Par Value of Advances
 
Percent of Total Par Value of Advances
 
Par Value of Advances
 
Percent of Total Par Value of Advances
Commercial Banks
$
53,479

 
73
%
 
$
59,119

 
84
%
Thrifts and Savings Banks
5,220

 
7

 
4,067

 
6

Credit Unions
957

 
1

 
1,110

 
1

Insurance Companies
13,428

 
19

 
5,408

 
8

Community Development Financial Institutions
2

 

 
1

 

Total member Advances
73,086

 
100

 
69,705

 
99

Former member borrowings
156

 

 
594

 
1

Total par value of Advances
$
73,242

 
100
%
 
$
70,299

 
100
%

The following tables present principal balances for the five members with the largest Advance borrowings.
(Dollars in millions)
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
December 31, 2014
Name
 
Par Value of Advances
 
Percent of Total Par Value of Advances
 
Name
 
Par Value of Advances
 
Percent of Total Par Value of Advances
JPMorgan Chase Bank, N.A.
 
$
35,350

 
48
%
 
JPMorgan Chase Bank, N.A.
 
$
41,300

 
59
%
U.S. Bank, N.A.
 
10,086

 
14

 
U.S. Bank, N.A.
 
8,338

 
12

Capstead Insurance, LLC
 
2,875

 
4

 
The Huntington National Bank
 
2,083

 
3

Nationwide Life Insurance Company
 
2,279

 
3

 
Nationwide Life Insurance Company
 
1,761

 
3

Third Federal Savings and Loan Association
 
2,162

 
3

 
Western-Southern Life Assurance Co
 
1,623

 
2

Total of Top 5
 
$
52,752

 
72
%
 
Total of Top 5
 
$
55,105

 
79
%

Advance concentration ratios are influenced by, and generally similar to, concentration ratios of financial activity among our Fifth District financial institutions. We believe that having large financial institutions that actively use our Mission Asset Activity augments the value of membership to all members. For example, such activity improves our operating efficiency, increases our earnings and thereby contributions to housing and community investment programs, may enable us over time to obtain more favorable funding costs, and helps us maintain competitively priced Mission Asset Activity.


32


Mortgage Loans Held for Portfolio (Mortgage Purchase Program, or "MPP")

The table below shows principal purchases and reductions of loans in the MPP for each of the last two years.
(In millions)
2015
 
2014
Balance, beginning of year
$
6,796

 
$
6,643

Principal purchases
2,348

 
1,226

Principal reductions
(1,386
)
 
(1,073
)
Balance, end of year
$
7,758

 
$
6,796


The increase in principal loan balances in 2015 resulted from higher amounts of loan purchases, particularly from our two largest sellers who drive program balances. In 2015, 99 members sold us mortgage loans, with the number of monthly sellers averaging 65. All loans acquired in 2015 were conventional loans.

The following tables show the percentage of principal balances from PFIs supplying five percent or more of total principal and the percentage of principal balances from all other PFIs. As shown in the table below, MPP activity is concentrated amongst a few members.
(Dollars in millions)
December 31, 2015
 
 
December 31, 2014
 
Principal
 
% of Total
 
 
Principal
 
% of Total
Union Savings Bank
$
2,242

 
29
%
 
Union Savings Bank
$
1,593

 
23
%
PNC Bank, N.A. (1)
839

 
11

 
PNC Bank, N.A. (1)
1,074

 
16

Guardian Savings Bank FSB
633

 
8

 
Guardian Savings Bank FSB
406

 
6

All others
4,044

 
52

 
All others
3,723

 
55

Total
$
7,758

 
100
%
 
Total
$
6,796

 
100
%
(1)Former member.

We closely track the refinancing incentives of our mortgage assets (including loans in the MPP and mortgage-backed securities) because the option for homeowners to change their principal payments normally represents a large portion of our market risk exposure. MPP principal paydowns in all of 2015 equated to a 14 percent annual constant prepayment rate, up from the 12 percent rate for all of 2014, as the refinancing incentives for many of our mortgage assets increased.

The MPP's composition of balances by loan type, original final maturity, and weighted-average mortgage note rate did not change materially in 2015. The weighted average mortgage note rate fell from 4.36 percent at the end of 2014 to 4.14 percent at the end of 2015. This decline reflected a continuing trend of prepayments of higher rate mortgages and purchases of lower rate mortgages. MPP yields earned in 2015, after consideration of funding costs, continued to offer favorable returns relative to their market risk exposure.

Housing and Community Investment

In 2015, we accrued $28 million of earnings for the Affordable Housing Program, which will be awarded to members in 2016. This amount represents no change from 2014 due to the similar amount of earnings in each year.

Including funds available in 2015 from previous years, we had $27 million available for the competitive Affordable Housing Program in 2015, which we awarded to 70 projects through a single competitive offering. In addition, we disbursed $9 million to 171 members on behalf of 1,869 homebuyers through the Welcome Home Program, which assists homebuyers with down payments and closing costs. In total, just over one-quarter of members received approval for funding under the two Affordable Housing Programs. 
Additionally, in 2015 our Board committed $1 million to the Carol M. Peterson Housing Fund (CMP Fund), which helped 151 homeowners, and continued its commitment to the $5 million Disaster Reconstruction Program. Both are voluntary programs beyond the 10 percent of earnings that we are required by law to set aside for the Affordable Housing Program.

Our activities to support affordable housing and economic development also include offering Advances through the Affordable Housing Program, Community Investment Program and Economic Development Program with below-market interest rates at

33


or near zero profit for us. At the end of 2015, Advance balances under these programs totaled $449 million. AHP Advance balances have declined in recent years, reflecting our preference to distribute AHP subsidy in the form of grants.

Investments

The table below presents the ending and average balances of the investment portfolio.
(In millions)
2015
 
2014
 
Ending Balance
 
Average Balance
 
Ending Balance
 
Average Balance
Liquidity investments
$
22,110

 
$
12,590

 
$
11,319

 
$
11,856

Mortgage-backed securities
15,246

 
14,664

 
14,688

 
15,594

Other investments (1)

 
85

 

 
98

Total investments
$
37,356

 
$
27,339

 
$
26,007

 
$
27,548

(1)
The average balance includes 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.

We continued to maintain an ample amount of asset liquidity. Liquidity investment levels can vary significantly based on liquidity needs, the availability of acceptable net spreads, the number of eligible counterparties that meet our unsecured credit risk criteria, and changes in the amount of Mission Assets. It is normal for liquidity investments to vary by up to several billion dollars on a daily basis.

Certain dealers, who play a large role in facilitating the distribution of our debt to investors, are being more reluctant to expand the amount of our debt on their balance sheets over quarter- and year-ends primarily due to the perceived growing burden of their regulatory capital environment associated with Basel. Because of this, we conservatively carried a larger amount of liquidity leading up to year-end 2015 to satisfy any potential member borrowing needs during a period where accessing additional liquidity may be more challenging.

Our overarching strategy for mortgage-backed securities is to keep holdings as close as possible to the regulatory maximum of three times regulatory capital, subject to the availability of securities that we believe provide acceptable risk/return tradeoffs. The balance of mortgage-backed securities at December 31, 2015 represented a 2.91 multiple of regulatory capital and consisted of $11.3 billion of securities issued by Fannie Mae or Freddie Mac (of which $1.7 billion were floating-rate securities), $0.9 billion of floating-rate securities issued by the National Credit Union Administration (NCUA), and $3.0 billion of securities issued by Ginnie Mae (a majority of which are fixed rate). The NCUA securities have coupons tied to one-month LIBOR with interest rate caps ranging from seven to eight percent. We held no private-label mortgage-backed securities.
The table below shows principal purchases and paydowns of our mortgage-backed securities for each of the last two years.
(In millions)
Mortgage-backed Securities Principal
 
2015
 
2014
Balance, beginning of year
$
14,715

 
$
16,087

Principal purchases
3,099

 
722

Principal paydowns
(2,611
)
 
(2,094
)
Balance, end of year
$
15,203

 
$
14,715


Principal paydowns in 2015 equated to a 16 percent annual constant prepayment rate, up from a 13 percent rate in 2014. Purchases have outpaced paydowns this year due to the availability of mortgage securities offering attractive risk/return trade-offs.


34


Consolidated Obligations

The table below presents the ending and average balances of our participations in Consolidated Obligations.
(In millions)
2015
 
2014
 
Ending Balance
 
Average Balance
 
Ending Balance
 
Average Balance
Discount Notes:
 
 
 
 
 
 
 
Par
$
77,225

 
$
52,714

 
$
41,238

 
$
35,996

Discount
(26
)
 
(8
)
 
(6
)
 
(4
)
Total Discount Notes
77,199

 
52,706

 
41,232

 
35,992

Bonds:
 
 
 
 
 
 
 
Unswapped fixed-rate
26,962

 
26,350

 
26,124

 
25,513

Unswapped adjustable-rate
4,065

 
13,385

 
27,610

 
29,355

Swapped fixed-rate
4,010

 
6,489

 
5,390

 
3,697

Total par Bonds
35,037

 
46,224

 
59,124

 
58,565

Other items (1)
68

 
90

 
93

 
116

Total Bonds
35,105

 
46,314

 
59,217

 
58,681

Total Consolidated Obligations (2)
$
112,304

 
$
99,020

 
$
100,449

 
$
94,673

(1)
Includes unamortized premiums/discounts, fair value option valuation adjustments, hedging and other basis adjustments.
(2)
The 11 FHLBanks have joint and several liability for the par amount of all of the Consolidated Obligations issued on their behalves. The par amount of the outstanding Consolidated Obligations for all of the FHLBanks was (in millions) $905,202 and $847,175 at December 31, 2015 and 2014, respectively.

Our preferred sources of funding for LIBOR-indexed assets are Discount Notes, adjustable-rate Bonds, and swapped fixed-rate Bonds because they give us the ability to effectively match the LIBOR rate reset periods embedded in these assets. During 2015, we shifted the composition of this funding more towards Discount Notes. This change provided lower funding costs in the current market environment and therefore improved earnings as discussed in the "Net Interest Income" section of "Results of Operations." Discount Note balances also increased due to growth in Advance balances, most of which was in the short-term REPO program, as well as liquidity investments in order to ensure that member borrowing needs were met at year-end 2015.

This change in funding composition increases risk to changes in spreads between cashflows received on LIBOR-indexed assets and interest paid on Discount Notes. We believe the increased usage of Discount Note funding did not materially raise this risk because of the historically favorable relationship between the two rate indices.

The composition of unswapped fixed-rate Bonds, which typically have initial maturities greater than one year, was relatively stable in 2015 compared to 2014. The following table shows the allocation on December 31, 2015 of unswapped fixed-rate Bonds according to their final remaining maturity and next call date (for callable Bonds). We believe that the allocations of Bonds among these classifications provide effective mitigation of market risk exposure to both higher and lower interest rates.
(In millions)
Year of Maturity
 
Year of Next Call
 
Callable
Noncallable
Amortizing
Total
 
Callable
Due in 1 year or less
$
30

$
3,343

$
1

$
3,374

 
$
6,229

Due after 1 year through 2 years
410

3,628


4,038

 
240

Due after 2 years through 3 years
1,270

3,205


4,475

 

Due after 3 years through 4 years
995

3,020


4,015

 

Due after 4 years through 5 years
553

2,383


2,936

 

Thereafter
3,211

4,913


8,124

 

Total
$
6,469

$
20,492

$
1

$
26,962

 
$
6,469


35



Deposits

Total deposits with us are normally a relatively minor source of low-cost funding. Total interest bearing deposits at December 31, 2015 were $0.8 billion, an increase of 10 percent from year-end 2014. The average balance of total interest bearing deposits in 2015 was $0.8 billion, a decrease of one percent from the average balance during 2014.

Derivatives Hedging Activity and Liquidity

Our use of and accounting for derivatives is discussed in the "Effect of the Use of Derivatives on Net Interest Income" section in "Results of Operations." Liquidity is discussed in the "Liquidity Risk" section in “Quantitative and Qualitative Disclosures About Risk Management.”

Capital Resources

The GLB Act and Finance Agency regulations specify limits on how much we can leverage capital by requiring that we maintain, at all times, at least a four percent regulatory capital-to-assets ratio. A lower ratio indicates more leverage. If 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 capitalization remains strong and in compliance with regulatory limits.

We have always complied with our regulatory capital requirements. The following tables present capital amounts and capital-to-assets ratios, on both a GAAP and regulatory basis.
 
Year Ended December 31,
(In millions)
2015
 
2014
 
Period End
 
Average
 
Period End
 
Average
GAAP and Regulatory Capital
 
 
 
 
 
 
 
GAAP Capital Stock
$
4,429

 
$
4,344

 
$
4,267

 
$
4,298

Mandatorily Redeemable Capital Stock
38

 
61

 
63

 
105

Regulatory Capital Stock
4,467

 
4,405

 
4,330

 
4,403

Retained Earnings
765

 
745

 
689

 
666

Regulatory Capital
$
5,232

 
$
5,150

 
$
5,019

 
$
5,069

 
2015
 
2014
 
Period End
 
Average
 
Period End
 
Average
GAAP and Regulatory Capital-to-Assets Ratio
 
 
 
 
 
 
 
GAAP
4.36
%
 
4.81
%
 
4.63
%
 
4.90
%
Regulatory
4.40

 
4.88

 
4.71

 
5.01


We consider the regulatory ratio to be a better representation of financial leverage than the GAAP ratio because, although the GAAP ratio treats mandatorily redeemable capital stock as a liability, it protects investors in our debt in the same manner as GAAP capital stock and retained earnings. Both GAAP and regulatory capital-to-assets ratios remained above the regulatory required minimum of four percent. The reduction in these ratios at December 31, 2015 was a temporary result of the elevated liquidity we carried at that time due to the reasons discussed above.

36


The following table presents the sources of change in regulatory capital stock balances in 2015 and 2014.
(In millions)
2015
 
2014
Regulatory stock balance at beginning of year
$
4,330

 
$
4,814

Stock purchases:
 
 
 
Membership stock
13

 
11

Activity stock
178

 
73

Stock repurchases/redemptions:
 
 
 
Redemption of member excess
(1
)
 
(1
)
Repurchase of member excess

 
(498
)
Withdrawals
(53
)
 
(69
)
Regulatory stock balance at the end of the year
$
4,467

 
$
4,330


The table below shows the amount of excess capital stock.
(In millions)
December 31, 2015
 
December 31, 2014
Excess capital stock (Capital Plan definition)
$
461

 
$
504

Cooperative utilization of capital stock
$
521

 
$
441

Mission Asset Activity capitalized with cooperative capital stock
$
13,034

 
$
11,020


A portion of capital stock is excess, meaning it is not required as a condition to being a member and not required to capitalize Mission Asset Activity. Excess capital stock provides a base of capital to manage financial leverage at prudent levels, augments loss protections for bondholders, and capitalizes a portion of growth in Mission Assets. The amount of excess capital stock, as defined by our Capital Plan, was $461 million at December 31, 2015, a decrease of $43 million from year-end 2014.

Membership and Stockholders

In 2015, we added 21 new member stockholders and lost 27 members, ending the year at 699. Most members lost merged with other Fifth District members and, therefore, the impact on our earnings and Mission Asset Activity was small. Of the members lost, 17 merged with other members, eight merged out of the District, one merged with a District non-member, and one relocated its charter out of District.

In 2015, there were no material changes in the allocation of membership by state, charter type, or asset size. At the end of 2015, the composition of membership by state was Ohio with 304, Tennessee with 199, and Kentucky with 196.

The Finance Agency issued a final rule on FHLBank membership in January 2016. This rule imposes new membership requirements and eliminates all currently eligible captive insurance companies from FHLBank membership, as discussed in "Executive Overview." The ruling also requires that these entities, which represented 15 members totaling $6.6 billion in Advances at December 31, 2015, pay off existing Advances within one year and cease any new borrowings. The subsequent loss of this membership segment will not significantly affect our financial condition or results of operations.

The following table provides the number of member stockholders by charter type.
 
December 31,
 
2015
 
2014
Commercial Banks
418

 
442

Thrifts and Savings Banks
99

 
101

Credit Unions
124

 
120

Insurance Companies
54

 
38

Community Development Financial Institutions
4

 
4

Total
699

 
705



37


The following table provides the ownership of capital stock by charter type.
(In millions)
December 31,
 
2015
 
2014
Commercial Banks
$
3,425

 
$
3,441

Thrifts and Savings Banks
378

 
376

Credit Unions
128

 
121

Insurance Companies
497

 
328

Community Development Financial Institutions
1

 
1

Total GAAP Capital Stock
4,429

 
4,267

Mandatorily Redeemable Capital Stock
38

 
63

Total Regulatory Capital Stock
$
4,467

 
$
4,330


Credit union members hold relatively less stock than their membership proportion because they tend to be smaller than the average member and borrow less. Insurance company members hold relatively more stock than their membership proportion because they tend to be larger than the average member and borrow more.

The following table provides a summary of member stockholders by asset size.
 
December 31,
Member Asset Size (1)
2015
 
2014
Up to $100 million
177

 
182

> $100 up to $500 million
370

 
381

> $500 million up to $1 billion
76