10-K 1 form10-k.htm FORM 10-K form10-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, 2008

OR

¨  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________

Commission File Number 000-52004

FEDERAL HOME LOAN BANK OF TOPEKA
(Exact name of registrant as specified in its charter)

Federally chartered corporation
  
48-0561319
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer
Identification No.)
 
One Security Benefit Pl. Suite 100
Topeka, KS
  
 
66606
(Address of principal executive offices)
  
(Zip Code)

Registrant’s telephone number, including area code: 785.233.0507
 
Securities registered pursuant to Section 12(b) of the Act: None
 
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $100 per share par value
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  ¨ Yes  x No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  ¨ 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  ¨ No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):  ¨ Large accelerated filer          ¨ Accelerated filer          x Non-accelerated filer          ¨ Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  ¨ Yes  x No
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 
Shares outstanding as of 03/20/2009
Class A Stock, par value $100
 6,229,550
Class B Stock, par value $100
 14,469,178

Registrant’s common stock is not publicly traded and is only issued to members of the registrant. Such stock is issued, redeemed and repurchased at par value, $100 per share, with all issuances, redemptions and repurchases subject to the registrant’s Capital Plan as well as certain statutory and regulatory requirements.
 
Documents incorporated by reference:  None
FEDERAL HOME LOAN BANK OF TOPEKA

TABLE OF CONTENTS


 
 
 
 
Federal Home Loan Bank of Topeka Board of Directors Compensation Policy  
 
 
 
 
 
 
Important Notice about Information in this Annual Report

In this annual report, unless the context suggests otherwise, references to the “FHLBank,” “FHLBank Topeka,” “we,” “us” and “our” mean the Federal Home Loan Bank of Topeka, and “FHLBanks” mean the 12 Federal Home Loan Banks, including the FHLBank Topeka.
 
The information contained in this annual report is accurate only as of the date of this annual report and as of the dates specified herein.
 
The product and service names used in this annual report are the property of the FHLBank, and in some cases, the other FHLBanks. Where the context suggests otherwise, the products, services and company names mentioned in this annual report are the property of their respective owners.

Special Cautionary Notice Regarding Forward-looking Statements

The information included or incorporated by reference in this annual report on Form 10-K contains certain forward looking statements with respect to our financial condition, results of operations, plans, objectives, projections, estimates, predictions, future financial performance and ongoing business, including without limitation: statements that are not historical in nature, or statements preceded by, followed by or that include words such as “believes,” “expects,” “may,” “will,” “should,” “could,” “anticipates,” “estimates,” “intends” or similar expressions. The FHLBank cautions that, by their nature, forward looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions and actual results may differ materially from those expressed, contemplated or implied by the forward looking statements or could affect the extent to which a certain plan, objective, projection, estimate or prediction is realized.
 
These forward-looking statements involve risks and uncertainties including, but not limited to, the following:
§
Economic and market conditions;
§
Demand for FHLBank advances resulting from changes in FHLBank members’ deposit flows and/or credit demands;
§
The volume of eligible mortgage loans originated and sold by participating members to the FHLBank through its various mortgage finance products (Mortgage Partnership Finance® (MPF®) Program1);
§
Pricing of various mortgage finance products under the MPF Program by the MPF Provider since the FHLBank has only limited input on pricing through our participation on the MPF Governance Committee;
§
Volatility of market prices, rates and indices that could affect the value of investments or collateral held by the FHLBank as security for the obligations of FHLBank members and counterparties to derivatives and similar instruments, or the FHLBank’s ability to liquidate collateral expediently in the event of a default by an obligor;
§
Political events, including legislative, regulatory, judicial, or other developments that affect the FHLBank, its members, counterparties and/or investors in the consolidated obligations of the 12 FHLBanks;
§
Competitive forces including, without limitation, other sources of funding available to FHLBank members including existing and newly created debt programs explicitly guaranteed by the U.S. government, other entities borrowing funds in the capital markets and the ability of the FHLBank to attract and retain skilled individuals;
§
The pace of technological change and the ability to develop and support technology and information systems, including the Internet, sufficient to manage the risks and operations of the FHLBank’s business effectively;
§
Changes in domestic and foreign investor demand for consolidated obligations of the 12 FHLBanks and/or the terms of derivatives and similar instruments including, without limitation, changes in the relative attractiveness of consolidated obligations as compared to other investment opportunities including existing and newly created debt programs explicitly guaranteed by the U.S. government;
§
Timing and volume of market activity;
§
Ability to introduce new FHLBank products and services, and successfully manage the risks associated with those products and services, including new types of collateral used to secure advances;
§
Risks related to the operations of the other 11 FHLBanks that could trigger our joint and several liability for debt issued by the other 11 FHLBanks;
§
Risk of loss arising from litigation filed against the FHLBank; and
§
Inflation/deflation.

For additional information regarding these and other risks, see Item 1A – “Risk Factors.”
 
Any forward-looking statements made or incorporated by reference in this annual report on Form 10-K or that we may make from time to time are representative only as of the date they are made, and we undertake no obligation to update any forward-looking statement.

1    "Mortgage Partnership Finance," "MPF" and "eMPF" are registered trademarks of the Federal Home Loan Bank of Chicago.
3
PART I

Item 1: Business

General
One of 12 FHLBanks, FHLBank Topeka is a federally chartered corporation organized under the authority of the Federal Home Loan Bank Act of 1932, as amended (Bank Act). The FHLBank’s primary business is making collateralized loans and providing other banking services to member institutions and certain qualifying non-members (housing associates). The FHLBank is a cooperative owned by its members and is generally limited to providing products and services only to those members. Each FHLBank operates as a separate corporate entity with its own management, employees and board of directors. The FHLBank is exempt from federal, state and local taxation except real property taxes. The FHLBank does not have any wholly- or partially-owned subsidiaries and the FHLBank does not have an equity position in any partnerships, corporations or off-balance sheet special purpose entities.
 
Since July 30, 2008, the FHLBank has been supervised and regulated by the Federal Housing Finance Agency (Finance Agency), an independent agency in the executive branch of the U.S. government. Prior to July 30, 2008, the Federal Housing Finance Board (Finance Board) supervised and regulated the FHLBank. The Finance Agency is responsible for ensuring that the FHLBank carries out its housing finance mission, remains adequately capitalized and able to raise funds in the capital markets and operates in a safe and sound manner.
 
All federally insured depository institutions and insurance companies whose principal place of business is located in Colorado, Kansas, Nebraska or Oklahoma are eligible to become members of the FHLBank. Except for community financial institutions (CFIs), applicants for membership must demonstrate they are engaged in residential housing finance. CFIs are defined in the Housing and Economic Recovery Act (Recovery Act) as those institutions that have, as of the date of the transaction at issue, less than $1 billion in average total assets over the three years preceding that date (subject to annual adjustment by the Finance Agency director based on the consumer price index).
 
Members of the FHLBank are required to purchase capital stock in the FHLBank as a condition of membership and only members are permitted to purchase capital stock. All FHLBank capital stock transactions are governed by its capital plan implemented on September 30, 2004. The FHLBank’s capital plan is developed under, subject to and operates within specific regulatory and statutory requirements.
 
Member institutions own nearly all of the outstanding capital stock of the FHLBank and may receive dividends on that stock. Former members own capital stock so long as they have outstanding business transactions with the FHLBank. A member must own capital stock in the FHLBank based on the amount of the member’s assets and the level of business activities it engages in with the FHLBank. As a result of these stock purchase requirements, the FHLBank conducts business with related parties in the normal course of its business. For disclosure purposes, the FHLBank includes in its definition of a related party any member institution (or successor) of the FHLBank that is known to be the beneficial owner of more than 5 percent of any class of FHLBank voting securities and any person who is, or at any time since the beginning of the FHLBank’s last fiscal year was, a director, advisory board consultant or executive officer of the FHLBank, among others. Information on business activities with related parties is provided in Tables 94 and 95 under Item 12 – “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
 
The FHLBank’s primary business activities are providing collateralized loans, known as advances, to members and housing associates, and acquiring residential mortgage loans from or through members. By law, only certain general categories of collateral are eligible to secure FHLBank credit. The FHLBank also provides members and housing associates with letters of credit and certain correspondent services, such as safekeeping, wire transfers, derivative intermediation and cash management, as well as technical expertise in the asset/liability, risk management and housing/community development areas.
 
The FHLBank’s primary funding source is consolidated obligations issued through the FHLBanks’ Office of Finance. The Office of Finance is a joint office of the FHLBanks that facilitates the issuance and servicing of the consolidated obligations. The Finance Agency and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the Office of Finance. Consolidated obligations are debt instruments that constitute the joint and several obligations of all FHLBanks. The capital markets have traditionally considered the FHLBanks’ consolidated obligations as “Federal agency” debt. As a result, although the U.S. government does not guarantee the FHLBanks’ debt, the FHLBanks have traditionally had ready access to funding at relatively favorable spreads to U.S. Treasuries.
 
Additional funds are provided by deposits, other borrowings and the issuance of capital stock. Deposits are received from both member and non-member financial institutions. Both the FHLBank itself and FHLBank consolidated obligations are currently rated Aaa/P-1 by Moody’s Investors Service (Moody’s) and AAA/A-1+ by Standard & Poor’s (S&P) based in part on the FHLBank’s relationship with the U. S. government. However, consolidated obligations jointly issued by the FHLBanks as well as deposits or other indebtedness of the FHLBank are not obligations of, nor guaranteed by, the U.S. government.

Business Segments
The FHLBank currently does not segregate its operations by segments.
Advances
The FHLBank makes advances to members and housing associates based on the security of residential mortgages and other eligible collateral. Following is a brief description of the FHLBank’s standard advance product offerings:
§
The line of credit product is a variable rate, non-amortizing, prepayable, revolving line advance that provides an alternative to the purchase of Federal funds or repurchase agreement borrowings;
§
Short-term fixed rate advances are non-amortizing, non-prepayable loans with terms to maturity from three to 93 days;
§
Regular fixed rate advances are non-amortizing loans, prepayable with a fee, with terms to maturity from 94 days to 180 months;
§
Adjustable rate advances are non-amortizing loans, which are: (1) prepayable with fee on interest rate reset dates, if the variable interest rate is tied to any one of a number of standard indices including the London Interbank Offered Rate (LIBOR), Treasury bills, Federal funds, or Prime; or (2) prepayable without fee if the variable interest rate is tied to one of the FHLBank’s short-term fixed rate advance products;
§
Callable advances can have a fixed or variable rate of interest for the term of the advance and contain an option(s) that allows for the prepayment of the advance without a fee on specified dates;
§
Amortizing advances are fixed rate loans, prepayable with fee, that contain a set of predetermined principal payments to be made during the life of the advance;
§
Convertible advances are non-amortizing, fixed rate loans that contain an option(s) that allows the FHLBank to convert the fixed rate advance to a prepayable, adjustable rate advance that re-prices monthly based upon the FHLBank’s one-month short-term, fixed rate advance product. Once the FHLBank exercises its option to convert the advance, it can be prepaid without fee on the initial conversion date or on any interest rate reset date thereafter; and
§
The standby credit facility is a variable rate, non-amortizing, prepayable, revolving standby credit line that provides a greater level of assurance that secured funding can be provided during a market disruption.

The FHLBank may create customized advances on request including advances with embedded floors and caps. All embedded derivatives in customized advances are evaluated to determine whether they are clearly and closely related to the advances. See Note 9 in the Notes to Financial Statements under Item 8 for information on accounting for embedded derivatives. The types of derivatives used to hedge risks embedded in our advance products are indicated in Tables 76 through 79 under Item 7A – “Quantitative and Qualitative Disclosures About Market Risk – Risk Management – Interest Rate Risk Management.”
 
The FHLBank also offers a variety of specialized advance products to address housing and community development needs. The products include advances priced at the FHLBank’s cost of funds plus reasonable administrative expenses, as well as advances priced at the FHLBank’s cost of funds. These advance products address needs for low-cost funding to create affordable rental and homeownership opportunities, and for commercial and economic development activities, including those that benefit low- and moderate-income neighborhoods. Refer to Item 1 – “Business – Other Mission-related Activities” for more details.
 
Table 1 summarizes the FHLBank’s advances outstanding by product as of December 31, 2008 and 2007 (in thousands):

Table 1

   
12/31/2008
    
12/31/2007
  
   
Dollar
    
Percent
    
Dollar
    
Percent
  
Standard advance products:
                        
Line of credit
   $ 7,810,283       22.3 %   $ 6,751,375       21.2 %
Short-term fixed rate advances
     5,508,972       15.7       3,968,390       12.5  
Regular fixed rate advances
     7,379,766       21.1       8,402,504       26.4  
Fixed rate callable advances
     67,000       0.2       16,625       0.1  
Fixed rate amortizing advances
     645,972       1.9       477,331       1.5  
Fixed rate callable amortizing advances
     2,954       0.0       2,037       0.0  
Fixed rate convertible advances
     5,759,422       16.5       4,843,833       15.2  
Adjustable rate advances
     496,230       1.4       494,330       1.6  
Adjustable rate callable advances
     6,296,340       18.0       5,937,644       18.6  
Customized advances:
                                
Advances with embedded caps or floors
     95,000       0.3       142,500       0.4  
Standard housing and community development advances:
                                
Regular fixed rate advances
     504,754       1.4       411,514       1.3  
Fixed rate amortizing advances
     388,940       1.1       358,829       1.1  
Fixed rate callable amortizing advances
     635       0.0       125       0.0  
Adjustable rate callable advances
     28,505       0.1       46,724       0.1  
Fixed rate amortizing advances funded through the Affordable Housing Program (AHP)
     14       0.0       18       0.0  
TOTAL PAR VALUE
   $ 34,984,787       100.0 %   $ 31,853,779       100.0 %

Note that an individual advance may be reclassified to a different product type between periods due to the occurrence of a triggering event such as the passing of a call date (i.e., from fixed rate callable advance to regular fixed rate advance) or conversion of an advance (i.e., from fixed rate convertible advance to adjustable rate callable advance).
In addition to members, the FHLBank makes advances to certain non-members (housing associates). To qualify as a housing associate, the applicant must: (1) be approved under Title II of the National Housing Act; (2) be a chartered institution having succession; (3) be subject to the inspection and supervision of some governmental agency; (4) lend its own funds as its principal activity in the mortgage field; and (5) have a financial condition that demonstrates that advances may be safely made. Housing associates are not subject to certain provisions of the Bank Act that are applicable to members, such as the capital stock purchase requirements, but the same regulatory lending requirements generally apply to them as apply to members. Restrictive collateral provisions apply if the housing associate does not qualify as a state housing finance agency (HFA). The FHLBank currently has three housing associates and all three are state HFAs.
 
The FHLBank, at the time it originates an advance, is required to obtain and maintain a security interest in collateral eligible in one or more of the following categories:
§
Fully disbursed, whole first mortgages on 1-4 family residential property (not more than 90 days delinquent) or securities representing a whole interest in such mortgages;
§
Securities issued, insured or guaranteed by the U.S. government, U.S. government agencies and mortgage GSEs [including, without limitation, mortgage-backed securities (MBS) issued or guaranteed by Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) or Government National Mortgage Association (Ginnie Mae)];
§
Cash or deposits in an FHLBank;
§
Other real estate-related collateral acceptable to the FHLBank, provided such collateral has a readily ascertainable market value and the FHLBank can perfect a security interest in such property (e.g., privately issued collateralized mortgage obligations (CMOs), mortgages on multifamily residential real property); or
§
In the case of any CFI, secured loans to small business, small farm and small agri-business or securities representing a whole interest in such secured loans.

The FHLBank may require additional collateral at any time (whether or not such additional collateral would be eligible to originate an advance) or substitutions of collateral by the member or housing associate. As additional security for a member’s indebtedness, the FHLBank has a statutory lien upon that member’s FHLBank stock.
 
The Bank Act affords any security interest granted to the FHLBank by any member of the FHLBank, or any affiliate of any such member, priority over the claims and rights of any party, including any receiver, conservator, trustee, or similar party having rights of a lien creditor. The only exceptions are claims and rights held by actual bona fide purchasers for value or by parties that are secured by actual perfected security interests, and provided that such claims and rights would otherwise be entitled to priority under applicable law. In addition, the claims of the FHLBank are given certain preferences pursuant to the receivership provisions in the Federal Deposit Insurance Act. Most members provide the FHLBank a blanket lien covering substantially all of the member’s assets and consent for the FHLBank to file a financing statement evidencing the blanket lien. Based on the blanket lien, the financing statement and the statutory preferences, the FHLBank normally does not take control of collateral, other than securities collateral, pledged by blanket lien borrowers. The FHLBank takes control of all securities collateral through delivery of the securities to the FHLBank or an FHLBank-approved, third-party custodian. With respect to non-blanket lien borrowers (typically insurance companies and housing associates), the FHLBank takes control of all collateral. In the event that the financial condition of a blanket lien member warrants such action because of the deterioration of the member’s financial condition, regulatory concerns about the member or other factors, the FHLBank will take control of sufficient collateral to fully collateralize the member’s indebtedness to the FHLBank.
 
The FHLBank’s potential credit risk from advances is concentrated in commercial banks, thrift institutions, insurance companies and credit unions, but also includes potential credit risk exposure to three housing associates. Tables 2 and 3 present information on the FHLBank’s five largest borrowers as of December 31, 2008 and December 31, 2007, respectively (in thousands). The FHLBank had rights to collateral with an estimated fair value in excess of the book value of these advances and, therefore, does not expect to incur any credit losses on these advances.

Table 2

Borrower Name
City
State
  
Advance
Par Value
as of
12/31/2008
    
Percent of
Total
FHLBank
Advances
    
2008
Advance
Income
    
Percent of
Total
FHLBank
Advance
Income
  
U.S. Central Federal Credit Union1
Lenexa
KS
   $ 5,370,000       15.4 %   $ 102,613       9.0 %
MidFirst Bank
Oklahoma City
OK
     5,019,600       14.3       146,534       12.8  
Security Life of Denver Ins.
Denver
CO
     2,825,000       8.1       91,122       7.9  
Capitol Federal Saving Bank
Topeka
KS
     2,596,000       7.4       122,066       10.7  
Pacific Life Insurance Co.
Omaha
NE
     1,650,000       4.7       56,042       4.9  
TOTAL
       $ 17,460,600       49.9 %   $ 518,377       45.3 %
__________
1
U.S. Central Federal Credit Union was placed into conservatorship by the National Credit Union Administration on March 20, 2009.
Table 3

Borrower Name
City
State
  
Advance
Par Value
as of
12/31/2007
    
Percent of
Total
FHLBank
Advances
    
2007
Advance
Income
    
Percent of
Total
FHLBank
Advance
Income
  
MidFirst Bank
Oklahoma City
OK
   $ 5,741,000       18.0 %   $ 278,964       18.9 %
U.S. Central Federal Credit Union
Lenexa
KS
     3,750,000       11.8       230,849       15.6  
Security Life of Denver Ins. Co.
Denver
CO
     3,075,000       9.7       149,564       10.2  
Capitol Federal Savings Bank
Topeka
KS
     2,746,000       8.6       135,193       9.2  
Pacific Life Insurance Co.
Omaha
NE
     1,650,000       5.2       29,836       2.0  
TOTAL
       $ 16,962,000       53.3 %   $ 824,406       55.9 %
 
As of March 20, 2009, U.S. Central Federal Credit Union had one advance outstanding in the amount of $872.0 million that matures on March 31, 2009. While we cannot specifically predict the level of U.S. Central Federal Credit Union's advance business with us for the remainder of 2009 and beyond, we anticipate that U.S. Central Federal Credit Union's advance balances and overall usage of advances will decline in 2009 as a result of its conservatorship. See Note 20 of the Notes to the Financial Statements included under Item 9 – "Financial Statements and Supplementary Data" and Item 7 – "Management's Discussion and Analysis of Financial Condition and Results of Operations – Balance Sheet Analysis – Advances" for more information.
 
Investments
The FHLBank maintains a portfolio of investments for liquidity and income purposes and to fully invest its capital within the established statutory and regulatory limits. The FHLBank maintains a portfolio of short-term loans to and investments in highly rated institutions, including overnight Federal funds, term Federal funds, interest-bearing certificates of deposit (CDs), bank notes and commercial paper. The FHLBank maintains a longer-term investment portfolio, which includes securities issued by the U.S. government, U.S. government agencies and GSEs as well as MBS that are issued by U.S. government agencies and housing GSEs (GSE securities are not explicitly guaranteed by the U.S. government) or privately issued MBS that carry the highest ratings from Moody’s, Fitch or S&P at date of acquisition.
 
The FHLBank is prohibited from investing in certain types of securities including:
§
Instruments, such as common stock, that represent an ownership in an entity, other than stock in small business investment companies or certain investments targeted to low-income persons or communities;
§
Instruments issued by non-U.S. entities other than those issued by U.S. branches and agency offices of foreign commercial banks;
§
Non-investment-grade debt instruments other than certain investments targeted to low-income persons or communities, and instruments that were downgraded after purchase by the FHLBank;
§
Whole mortgages or other whole loans other than: (1) those acquired under the FHLBank’s MPF Program; (2) certain investments targeted to low-income persons or communities; (3) certain marketable direct obligations of state, local, or tribal government units or agencies, having at least the second highest credit rating from a Nationally-Recognized Statistical Rating Organization (NRSRO); (4) MBS or asset-backed securities backed by manufactured housing loans or home equity loans; and (5) certain foreign housing loans authorized under section 12(b) of the Bank Act; and
§
Non-U.S. dollar denominated securities.

The Finance Agency limits the FHLBank’s total investment in MBS by requiring that the total book value of MBS owned by the FHLBank not exceed 300 percent of the FHLBank’s previous month-end total regulatory capital on the day it purchases the securities. The definition of total regulatory capital for the MBS limitation includes mandatorily redeemable capital stock, which is reclassified as a liability under generally accepted accounting principles in the United States of America (GAAP), but excludes other comprehensive income. Under Finance Board Resolution 2008-08, the FHLBanks were granted temporary authority to increase MBS up to 600 percent of previous month-end total regulatory capital under specific conditions. See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Balance Sheet Analysis – Investments” for further discussion of Finance Board Resolution 2008-08 and actions taken by the FHLBank. The FHLBank is prohibited from purchasing:
§
Interest-only or principal-only stripped MBS, CMOs, real estate mortgage investment conduits (REMICs) and eligible asset-backed securities (ABS);
§
Residual-interest or interest-accrual classes of CMOs, REMICs and eligible ABS; and
§
Fixed rate MBS, CMOs, REMICs and eligible ABS, or floating rate MBS, CMOs, REMICs and eligible ABS that on the trade date are at rates equal to their contractual cap or that have average lives which vary by more than six years under an assumed instantaneous interest rate change of 300 basis points.

Mortgage Loans Held for Portfolio
The FHLBank purchases or funds various mortgage products from or through its members under the MPF Program. Under the MPF Program, the FHLBank invests in qualifying five- to 30-year conventional conforming and government-insured or guaranteed (by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Rural Housing Service of the Department of Agriculture (RHS) and the Department of Housing and Urban Development (HUD)) fixed rate mortgage loans on 1-4 family residential properties. Based upon members’ preferences, they may elect to retain or sell servicing rights. Subsequent to any private mortgage insurance (PMI), the FHLBank and the member share in the credit risk of the loans with the FHLBank assuming the first layer of loss coverage as defined by the First Loss Account (FLA). The member assumes mortgage loan losses in excess of the FLA up to the amount of the credit enhancement obligation (CE obligation) as specified in a master commitment agreement for each pool of mortgage loans purchased from the member. Any losses in excess of the FLA and the CE obligation will be the responsibility of the FHLBank. All loss allocations among members and the FHLBank are based upon specific pools of loans covered by each master commitment agreement between the two parties. Members’ CE obligations must be fully collateralized with assets considered acceptable by FHLBank policy. See Item 1 – “Business – Advances” for a discussion of eligible collateral.
The MPF Program incorporates the following broad underwriting and eligibility guidelines with respect to MPF loans:
§
Loans must be conforming loan size, which is established annually by the Finance Agency, as required by the Acquired Member Assets (AMA) Regulation and may not exceed the loan limits set each year by the Finance Agency for the other housing GSEs (e.g., Fannie Mae and Freddie Mac);
§
Loans must be fixed rate, fully-amortizing loans with terms from 5 to 30 years (5 to 30 years for service retained loans and 10 to 30 years for service released loans);
§
Loans are required to be secured by first liens on residential, owner-occupied, primary 1-4 family residences and second homes (primary residences may be up to four units);
§
Condominiums, planned unit developments and manufactured homes are acceptable property types as are mortgages on leasehold estates (although manufactured homes must be on land owned in fee simple by the borrower);
§
A maximum loan-to-value ratio (LTV) of 95 percent is permitted, except for FHLBank approved AHP mortgage loans which may have LTVs up to 100 percent (but may not exceed 105 percent total LTV, which compares the property value to the total amount of all mortgages outstanding against a property) and Government MPF Loans, which may not exceed the LTV limits established by the FHA, VA, HUD Section 184 and USDA GRH Section 502;
§
For each conventional mortgage, which has a LTV of more than 80 percent, standard mortgage insurance issued by an MPF-approved mortgage insurer with no lower than a “AA-” rated claims paying ability assigned by S&P is required;
§
Borrowers must be of legal age and capacity to contract for a mortgage;
§
Only current production loans (no more than 12 principal and interest payments made by the borrower for servicing retained loans of 10 days or less from the closing date for servicing released loans) are eligible;
§
Eligible loan purposes include purchase transactions, cash-out refinances and no-cash-out refinances;
§
Credit reports are required with at least two credit scores for each borrower; for borrowers with no credit score, alternative verification of credit is permitted;
§
Housing expense should be no greater than 33 percent of gross monthly income and total debt, when including the housing expense, should be no greater than 38 percent of gross monthly income (higher qualifying ratios may be appropriate in some cases);
§
Income and other sources of funds, if applicable, must be verified;
§
Complete and customary independent property appraisals are required to determine the fair market value of each property;
§
Customary property or hazard insurance, and flood insurance, if applicable, must be obtained from insurers acceptably rated as detailed in the MPF Origination Guide;
§
Title insurance or, in those areas where title insurance is not customary, an attorney’s opinion of title must be provided to assure the first lien and clear title status of each mortgage. Title insurance is to be provided by an acceptably rated title insurance company as provided in the MPF Guides. Title insurance must be for at least the original principal balance of the MPF loan and on the most current American Land Title Company policy form with applicable endorsements;
§
The mortgage documents, mortgage transaction, and mortgaged property must comply with all applicable laws, and loans must be documented using standard Fannie Mae/Freddie Mac uniform instruments;
§
Loans that cannot be rated by a rating agency are not eligible for delivery under the MPF Program; and
§
Loans that are classified as high cost, high rate, high risk, Home Ownership and Equity Protection Act loans or loans in similar categories defined under predatory or abusive lending laws are not eligible.

A participating member is referred to as a Participating Financial Institution (PFI). Each PFI deals directly with the FHLBank in offering individual or pools of eligible mortgage loans for sale to or funding through the FHLBank under the MPF Program. The FHLBank in turn may purchase or fund some or all of the eligible loans and may offer participations in these mortgage loans to other MPF FHLBanks. The FHLBank has not sold any participation interests in MPF loans to any other FHLBank for the three-year period ended December 31, 2008. Securitized loan pools are not acceptable mortgage assets under the MPF Program. Every PFI provides a measure of credit-loss protection to the FHLBank on mortgage loans generated by the PFI through the MPF Program. In return, the PFI receives a credit enhancement fee (CE fee), which is paid to the PFI monthly based upon the unpaid principal balance of MPF loans outstanding. The credit risk of the mortgage loans is managed by distributing potential credit losses into certain layers and allocating that risk between the borrower, private mortgage insurer, FHLBank and the PFI.
 
Under the MPF Program, the first layer of potential credit loss is absorbed by the borrower’s equity in the real estate securing the loan. As is customary for conventional mortgage loans, PMI is required for MPF loans with down payments of less than 20 percent of the property value in order to raise the effective equity level to at least 20 percent. Losses beyond the borrower’s equity layer, including any PMI, are absorbed by the FHLBank up to the FLA predefined limit for each pool of mortgages covered by a master commitment agreement. If losses beyond the FLA layer are incurred for a pool, they are absorbed by the PFI through the CE obligation for that pool provided by the PFI that sold the mortgage loans to the FHLBank. The CE obligation provided by the PFI ensures that the PFI retains a credit stake in the loans it sells to the FHLBank. For managing this risk, the PFI receives monthly CE fees from the FHLBank. The size of each PFI’s CE obligation for a master commitment agreement is calculated on the pool of mortgage loans sold into the MPF Program by the PFI in such a way that the FHLBank is in a position equivalent to that of an investor in a AA-rated MBS. The CE obligation of the PFI and the CE fee paid by the FHLBank are integral parts of the MPF mortgage loans and cannot be stripped off or otherwise separated from the underlying mortgage loans. The actual loss allocation between each PFI and the FHLBank is based upon the specific pool of mortgage loans covered by each master commitment agreement between the two parties.
Since the inception of the MPF Program, the FHLBank has incurred minimal credit losses on MPF loans that have been acquired under the Program. Credit losses under the FLA are defined differently than losses for financial reporting purposes. The differences reside in the timing of the recognition of the loss and how the components of the loss are recognized. Under the FLA, a credit loss is the difference between the recorded loan value and the total proceeds received from the sale of an MPF property after paying any associated expenses. The credit loss is recognized upon sale of the mortgaged property. For financial reporting purposes, when an MPF loan is deemed a loss loan, the difference between the recorded loan value and the appraised value of the property securing the loan (fair market value) less the estimated costs to sell is recognized as a charge to the Allowance for Credit Losses on Mortgage Loans in the period the loss status is assigned to the loan. After foreclosure, any expenses associated with carrying the loan until sale are recognized as Other Real Estate Owned (OREO) expenses in the current period.
 
A PFI can take advantage of the MPF Program either by selling previously closed loans to the FHLBank or by providing loans on a flow basis. A flow basis loan is also referred to as a “table funded loan,” which means that the PFI has the FHLBank’s funds available to make the mortgage loan to the borrower; the PFI closes the loan “as agent” for the FHLBank and never owns the loan. A variety of MPF products have been developed to meet the differing needs of the FHLBank’s members, but they are all premised on the same risk-sharing concept.
 
The FHLBank currently has loans or loan commitments under various product types designated as Original MPF, MPF 100, MPF 125, MPF Plus and Original MPF for Government Loans, which are described below:
§
Under Original MPF (closed loans), the first layer of shared loss is absorbed by the FHLBank’s FLA. The FLA for this product increases monthly based upon a percentage of the unpaid principal of outstanding mortgage loans (four basis points per annum) over the life of a master commitment agreement for the applicable pool of loans. The second shared loss layer is absorbed by the PFI’s CE obligation for that master commitment. Any loan losses beyond the first two shared loss layers for each master commitment are absorbed by the FHLBank;
§
Under MPF 100 (table funded loans), the first layer of shared loss is absorbed by the FHLBank’s FLA, which is equal to 1.0 percent (100 basis points) of the aggregate principal balance of the loans funded. The second shared loss layer is absorbed by the PFI’s CE obligation for that master commitment. Any loan losses beyond the first shared loss two layers are absorbed by the FHLBank;
§
Under MPF 125 (closed loans), the first layer of shared loss is absorbed by the FHLBank’s FLA, which is equal to 1.0 percent (100 basis points) of the aggregate principal balance of the loans funded. The second shared loss layer is absorbed by the PFI’s CE obligation for that master commitment. Any loan losses beyond the first two shared loss layers are absorbed by the FHLBank;
§
Under MPF Plus (closed loans), the first layer of shared loss is absorbed by the FHLBank’s FLA, which is equal to a specified percentage of the aggregate principal balance of loans in the pool as of the sale date. The second shared loss layer is absorbed by the PFI’s CE obligation for that master commitment. The PFI meets all or a portion of its CE obligation through a supplemental mortgage insurance (SMI) policy. Additional losses not covered by the FLA, the SMI policy or any remaining PFI CE obligation not covered by the SMI are absorbed by the FHLBank; and
§
Under Original MPF for Government Loans (closed loans), the loans are insured or guaranteed by the FHA, VA, HUD or RHS. This program has no FLA or CE obligation. The PFI is responsible for all unreimbursed servicing expenses.

For all of the above MPF products except Original MPF for Government Loans, the PFI’s CE obligation is calculated to provide a second loss credit enhancement up to a “AA” rating equivalent for the pool of mortgages. As mentioned previously, any loss allocation between each PFI and the FHLBank is based upon the specific pool of loans covered by each master commitment between the two parties.
 
Table 4 includes the percentage of principal outstanding balance by each MPF product in the FHLBank’s MPF loan portfolio as of December 31, 2008, 2007 and 2006:

Table 4

   
12/31/2008
    
12/31/2007
    
12/31/2006
  
Original MPF
     56.2 %     52.1 %     48.1 %
MPF 100
     4.4       0.8       0.8  
MPF 125
     17.5       21.0       23.0  
MPF Plus
     15.4       22.4       25.4  
Original MPF for Government Loans
     6.5       3.7       2.7  
NET PRINCIPAL OUTSTANDING
     100.0 %     100.0 %     100.0 %

The FHLBank’s FLA for an Original MPF product master commitment is initially zero on the day the first MPF loan is purchased, but increases monthly over the life of that master commitment. The monthly addition is calculated by taking the unpaid principal balance of loans on the FHLBank’s books (prorated) at the end of the month multiplied by four basis points (bps) and dividing that product by 12. This calculation is completed for each master commitment. Master commitments are generally considered loan pools for the purposes of FLA, credit enhancements and loan loss allocations. The FHLBank’s FLA for the MPF 100 and MPF 125 product master commitments is calculated by taking 100 bps times the loan amount funded or purchased. In the event of a loss on the sale of a foreclosed property, the FHLBank’s FLA absorbs losses after the coverage provided by the borrower’s equity in the property and PMI, if applicable. The FHLBank’s final exposure to risk in each of the MPF products listed, except Original MPF for Government Loans, is subject to the amount of CE obligation borne by the PFI for the specific loan pool.
Table 5 presents a comparison of the different characteristics for each of the MPF products as of December 31, 2008:

Table 5

Product Name
Size of the FHLBank’s FLA
PFI CE Obligation Description
CE Fee
Paid to PFI
CE Fee Offset?1
Servicing Fee
to PFI
Original
MPF
4 basis points added each year based on the unpaid balance
After FLA, to bring to the equivalent of “AA”
10 basis points/year paid monthly
No
25 basis
points/year
           
MPF 100
100 basis points fixed based on gross fundings at closing
After FLA, to bring to the equivalent of “AA”
7 to 10 basis points/year paid monthly; performance based after 3 years
Yes; after first 3 years, to the extent recoverable in future years
25 basis
points/year
           
MPF 125
100 basis points fixed based on gross fundings at closing
After FLA, to bring to the equivalent of “AA”
7 to 10 basis points/year paid monthly; performance based
Yes; to the extent recoverable in future years
25 basis
points/year
           
MPF Plus
Sized to equal expected losses
0 to 20 basis points after FLA and SMI, to bring to the equivalent of “AA”
7 basis points/year plus 6 to 7 basis points/year; performance based (delayed for 1 year); all fees paid monthly
Yes; to the extent recoverable in future years
25 basis
points/year
           
Original
MPF
Government Loans
N/A
N/A (Unreimbursed servicing expenses only)
N/A2
N/A
44 basis
points/year
                    
1
Future payouts of performance-based CE fees are reduced when losses are allocated to the FLA. The offset is limited to fees payable in a given year but could be reduced in subsequent years. The overall reduction is limited to the FLA amount for the life of the pool of loans covered by a master commitment agreement.
2
Two government master commitments have been grandfathered and paid 2 basis points/year. All new government master commitments are not paid a CE fee.

Table 6 presents an illustration of the FLA and CE obligation calculation for each conventional MPF product type listed as of December 31, 2008:

Table 6

Product Name
FLA
CE Obligation Calculation
Original MPF
4 bps x unpaid principal, annually1
(LLCE2 x PSF3) x Gross Fundings
MPF 100
100 bps x loan funded amount
((LLCE x PSF) – FLA) x Gross Fundings
MPF 125
100 bps x loan funded amount
((LLCE x PSF) – FLA) x Gross Fundings
MPF Plus
5 x variable CE Fee
AA equivalent – FLA-SMI4 = PCE5
                    
1
Starts at zero and increases monthly over the life of the master commitment.
2
LLCE represents the weighted average loan level credit enhancement score of the loans sold into the pool of loans covered by the master commitment agreement.
3
The S&P Level’s Pool Size Factor (PSF) is applied at the MPF FHLBank level against the total of loans in portfolio. A PSF is greater than one if the number of loans in portfolio is less than 300 in total.
4
SMI represents the coverage obtained from the supplemental mortgage insurer. The initial premium for the insurance is determined based on a sample $100 million loan pool. The final premium determination is made during the 13th month of the master commitment agreement, at which time any premium adjustment is determined based on actual characteristics of loans submitted. The SMI generally covers a portion of the PFI’s CE obligation which typically ranges from 200 to 250 bps of the dollar amount of loans delivered into a mortgage pool, but the PFI may purchase an additional level of coverage to completely cover the PFI’s CE obligation. The CE fees paid to PFIs for this program are capped at a maximum of 14 bps, which is broken into two components, fixed and variable. The fixed portion of the CE fee is paid to the SMI insurer for the coverage discussed above, and is a negotiated rate depending on the level of SMI coverage, ranging from 6 to 8 bps. The variable portion is paid to the PFI, and ranges from 6 to 8 bps, with payments commencing the 13th month following initial loan purchase under the master commitment agreement.
5
PCE represents the CE obligation that the PFI wishes to retain rather than covering with SMI. Under this MPF product the retained amount can range from 0 to 20 bps.
In order to increase the balance of our mortgage loans held for portfolio and widen the geographic distribution of those mortgages, the FHLBank acquired out-of-district MPF mortgage loans through participation in MPF Plus master commitment agreements that the Federal Home Loan Bank of Chicago (FHLBank of Chicago) entered into with one of its PFIs during 2004. The out-of-district participation percentage was negotiated for each master commitment agreement and could be amended if both FHLBank Topeka and the FHLBank of Chicago agreed to the changes. In addition to owning a percentage share of each mortgage loan sold, the FHLBank is responsible for that participation percentage share of the FLA, which is typically around 35 bps for MPF Plus master commitment agreements. The CE obligations of the PFI and the CE fees paid by the FHLBank are integral parts of the MPF mortgage loans and cannot be stripped off or otherwise separated from the underlying mortgage loans. The FHLBank acquired out-of-district MPF Program mortgage loans totaling $878,918,000 during 2004 through this participation arrangement. The FHLBank of Chicago retained an average participation of 61.1 percent in 2004 loans purchased. The participated mortgage loans were purchased at the same prices as those for similar MPF Program products. No out-of-district mortgage loans were acquired through the FHLBank of Chicago or any other FHLBank during 2005, 2006 or 2007, but the FHLBank did purchase $231.9 million in mortgage loans during 2008 as described in the following paragraph.
 
On April 23, 2008, the FHLBank of Chicago announced that it would no longer purchase mortgage loans from its PFIs under the MPF Program after July 31, 2008. In anticipation of the FHLBank of Chicago ceasing to purchase mortgage loans after July 31, 2008 and in order to minimize potential disruptions in the MPF Program, the FHLBank executed a short-term agreement on July 1, 2008 with the FHLBank of Chicago to acquire up to $300 million in Participation Interests in mortgage loans originated by PFIs in the Chicago district. Under the agreement, all delivery commitments from the Chicago district PFIs were to be issued between July 1 and October 31, 2008. As of the end of 2008, the FHLBank had acquired $231.9 million of out-of-district mortgage loans under this agreement. On September 23, 2008, the FHLBank of Chicago officially announced to its members the rollout of an MPF product (MPF Xtra) that would provide its members with access to the secondary mortgage market without adding to the interest rate risk on the FHLBank of Chicago’s balance sheet. An agreement was executed with Fannie Mae as the first non-FHLBank investor in MPF assets, and participation by Chicago PFIs was made available beginning November 1, 2008.
 
Quarterly, the FHLBank’s Credit Risk Analysis department performs and documents a financial analysis of all out-of-district PFIs through which the FHLBank has purchased loan participations. This analysis addresses the PFI’s capital, asset quality and earnings. This review also includes a reconfirmation that the PFI continues to meet the four suitability standards/ratios used initially in the PFI approval process. The four suitability standards and their acceptable parameters are: (1) leverage capital ratio greater than or equal to 5 percent; (2) risk-based capital ratio greater than or equal to 9 percent; (3) loan loss reserves to non-performing loans ratio greater than or equal to 75 percent; and (4) non-performing assets to net loans ratio less than or equal to 2 percent. If the PFI fails either of the asset quality ratios (last two of the four parameters), further analysis is conducted on the ratios to determine if only 1-4 family real estate loans are included in the calculation. If the analysis discloses any area of significant concern about the PFI’s operations or condition, the analysis is presented to the FHLBank’s Credit Underwriting Committee to determine if any further actions, such as discontinuing mortgage loan purchases from the out-of-district PFI, are warranted.
 
FHLBank Topeka does not provide servicing of the acquired mortgage loans. However, the MPF Program allows the PFI to sell the servicing to an MPF-approved servicer. The approved servicer pays the PFI a service-released premium by the fifth business day of the month following the servicer’s boarding the loan onto its servicing system. Also, a PFI may subcontract the servicing function to an approved MPF subservicer. All servicing-retained and servicing-released PFIs are subject to the rules and requirements set forth in the MPF Servicing Guide.
 
To date, two Topeka district PFIs have been approved to acquire servicing rights under the MPF Program on a concurrent basis. This limitation may reduce the attractiveness of the MPF Program to potential PFIs that do not want to retain servicing. A PFI may negotiate with other PFIs to purchase servicing rights.
 
A majority of the states, and some municipalities, have enacted laws against mortgage loans considered predatory or abusive. Some of these laws impose liability for violations not only on the originator, but also upon purchasers and assignees of mortgage loans. The FHLBank takes measures that it considers reasonable and appropriate to reduce its exposure to potential liability under these laws and is not aware of any claim, action or proceeding asserting that the FHLBank is liable under these laws. However, there can be no assurance that the FHLBank will never have any liability under predatory or abusive lending laws.

Debt Financing – Consolidated Obligations
Consolidated obligations, consisting of bonds and discount notes, are the FHLBank’s primary sources of liabilities and represent the principal funding source used by the FHLBank to fund its advances and mortgage programs and to purchase investments. Consolidated obligations are the joint and several obligations of the FHLBanks, backed only by the financial resources of the 12 FHLBanks. Consolidated obligations are not obligations of the U.S. government, and the U.S. government does not guarantee them. The capital markets have traditionally considered the FHLBanks’ obligations as “Federal agency” debt. Consequently, although the U.S. government does not guarantee the FHLBanks’ debt, the FHLBanks have historically had relatively stable access to funding at relatively favorable spreads to U.S. Treasuries. The FHLBank’s ability to access the capital markets through the sale of consolidated obligations, across the entire maturity spectrum and through a variety of debt structures, helps the FHLBank in attempting to manage its balance sheet effectively and efficiently. Moody’s currently rates the FHLBank consolidated obligations Aaa/P-1, and S&P currently rates them AAA/A-1+. These ratings measure the likelihood of timely payment of principal and interest on consolidated obligations and also reflect the 12 FHLBanks’ status as GSEs, which generally implies the expectation of a very high degree of support by the U.S. government even though its obligations are not guaranteed by the U.S. government.
One of the key measures of performance for a financial institution is the measure of the ability of the institution to cover or make the required payments on its fixed charges. However, for the FHLBank, as interest rates increase so do fixed charges (interest expense), causing the ratio of earnings to fixed charges to decline. Table 7 documents the FHLBank’s ratio of earnings to fixed charges computation for the years ended December 31, 2008, 2007, 2006, 2005 and 2004 (in thousands):

Table 7

   
2008
    
2007
    
2006
    
2005
    
2004
  
Income before assessments
   $ 38,777     $ 204,816     $ 186,041     $ 185,627     $ 127,989  
Add: fixed charges1
     1,642,925       2,517,128       2,238,914       1,500,725       798,103  
Total earnings
   $ 1,681,702     $ 2,721,944     $ 2,424,955     $ 1,686,352     $ 926,092  
Fixed charges1
   $ 1,642,925     $ 2,517,128     $ 2,238,914     $ 1,500,725     $ 798,103  
Ratio of earnings to fixed charges2
     1.02       1.08       1.08       1.12       1.16  
                    
1
Fixed charges consist of interest expense including amortization of premiums, discounts and concessions related to indebtedness – See Item 8 “Financial Statements and Supplementary Data” for additional information.
2
The ratio of earnings to fixed charges has been computed by dividing total earnings by fixed charges.

Finance Agency regulations govern the issuance of debt on behalf of the FHLBanks and related activities, and authorize the FHLBanks to issue consolidated obligations, through the Office of Finance as their agent, under the authority of section 11(a) of the Bank Act. No FHLBank is permitted to issue individual debt under section 11(a) without Finance Agency approval. The FHLBank is primarily and directly liable for the portion of consolidated obligations issued on its behalf. In addition, the FHLBank is jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on the consolidated obligations of all 12 FHLBanks under section 11(a). The Finance Agency, in its discretion, may require any FHLBank to make principal or interest payments due on any consolidated obligations for which the FHLBank is not the primary obligor. Although it has never occurred, to the extent that an FHLBank would be required to make a payment on a consolidated obligation on behalf of another FHLBank, the paying FHLBank would be entitled to reimbursement from the non-complying FHLBank. However, if the Finance Agency determines that the non-complying FHLBank is unable to satisfy its obligations, then the Finance Agency may allocate the non-complying FHLBank’s outstanding consolidated obligation debt among the remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding, or on any other basis the Finance Agency may determine. If the principal or interest on any consolidated obligation issued on behalf of an individual FHLBank is not paid in full when due, the FHLBank may not pay dividends to, or redeem or repurchase shares of stock from, any member of that individual FHLBank.
 
On April 18, 2006 in Finance Board Resolution Number 2006-06, the Finance Board voted to approve a request from the FHLBank of Chicago to issue subordinated debt for which it would be the sole obligor. Consistent with the resolution, the FHLBank of Chicago issued $1.0 billion in subordinated debt in June 2006 as part of a plan to facilitate an orderly redemption by the FHLBank of Chicago of excess stock held by its member institutions. As of the date of this filing, the FHLBank of Chicago had $1.0 billion of 10-year subordinated notes outstanding.
 
Prior to 2009, the FHLBank did not incur any direct obligation with respect to consolidated obligations unless it agreed in advance to accept the funding, pursuant to Finance Agency regulations. In some issuance situations, the FHLBank may receive all of the proceeds from a particular issuance of consolidated obligations, but in other cases the proceeds may be divided among several FHLBanks. In addition to an explicit agreement to accept funding, the FHLBank agreed in the fourth quarter of 2008 to accept its allocation of proceeds from the issuance of FHLBank mandated global bullet consolidated obligations (fixed rate, non-callable debt issuances of $1 billion or more) after January 1, 2009. This allocation might be based on the needs specified by the FHLBank, but it also might be based on relative capital of the FHLBank if FHLBank system demand is below the minimum size of issuance. This agreement resulted from the FHLBank system decision made in the fourth quarter of 2008 to adopt a monthly calendar for scheduled 2009 mandated global bullet consolidated obligation issuance.
 
Table 8 presents the par value of the FHLBank’s consolidated obligations and the combined consolidated obligations of the 12 FHLBanks as of December 31, 2008 and 2007 (in millions):

Table 8

   
12/31/2008
    
12/31/2007
  
Par value of consolidated obligations of the FHLBank
   $ 53,338     $ 51,199  
                 
Par value of consolidated obligations of all 12 FHLBanks
   $ 1,251,542     $ 1,189,706  

Finance Agency regulations provide that the FHLBank must maintain aggregate assets of the following types, free from any lien or pledge, in an amount at least equal to the amount of consolidated obligations outstanding:
§
Cash;
§
Obligations of, or fully guaranteed by, the U.S government;
§
Secured advances;
§
Mortgages, which have any guaranty, insurance or commitment from the U.S. government or any agency of the U.S. government;
§
Investments described in Section 16(a) of the Bank Act, which, among other items, includes securities that a fiduciary or trust fund may purchase under the laws of the state in which the FHLBank is located; and
§
Other securities that are assigned a rating or assessment by an NRSRO that is equivalent to or higher than the rating on consolidated obligations, except securities specifically prohibited in the Investments section of Item 1 – “Business – Investments.”
Table 9 illustrates the FHLBank’s compliance with the Finance Agency’s regulations for maintaining aggregate assets at least equal to the amount of consolidated obligations outstanding for December 31, 2008 and 2007 (in thousands):

Table 9

   
12/31/2008
    
12/31/2007
  
Total non-pledged assets
   $ 58,416,608     $ 55,120,118  
Total carrying value of consolidated obligations
   $ 53,683,046     $ 51,109,456  
                 
Ratio of non-pledged assets to consolidated obligations
     1.09       1.08  

The Office of Finance has responsibility for facilitating and executing the issuance of the consolidated obligations on behalf of the 12 FHLBanks. It also prepares the 12 FHLBanks’ Combined Quarterly and Annual Financial Reports, services all outstanding debt, serves as a source of information for the FHLBanks on capital market developments, administers REFCORP and the Financing Corporation, and manages the FHLBanks’ relationship with the NRSROs with respect to ratings on consolidated obligations.
 
Consolidated Bonds. Consolidated bonds satisfy the FHLBank’s term funding needs. Typically, the maturities of these bonds range from one year to 15 years, but the maturities are not subject to any statutory or regulatory limit. Consolidated bonds can be issued and distributed through negotiated or competitively bid transactions with approved underwriters or selling group members.
 
The FHLBank utilizes the TAP Issue Program for fixed rate, non-callable (bullet) bonds. This competitive auction program uses specific maturities that may be reopened daily during the initial three-month period after the original issue date and as needed through the remaining life of the bond. The goal of the TAP Issue Program is to aggregate frequent smaller issues into a larger bond issue thus giving the larger bond issue greater market liquidity. The FHLBank uses the TAP program primarily to fund non-callable (bullet) advances. The ability to access funding on a smaller and more frequent basis allows the FHLBank to effectively fund member advance activity and reduce interest-rate risk.
 
Consolidated bonds are generally issued with either fixed or variable rate payment terms that use a variety of standardized indices for interest rate resets including, but not limited to, LIBOR, Federal Funds Effective Rate, Constant Maturity Treasury (CMT) and 11th District Cost of Funds Index (COFI). In addition, to meet the specific needs of certain investors in consolidated obligations, both fixed and variable rate bonds may also contain certain embedded features, which may result in complex coupon payment terms and call features. Normally, when such a complex consolidated bond is issued, the FHLBank simultaneously enters into a derivative containing offsetting features to synthetically convert the terms of the complex bond to a simple variable rate bond tied to one of the standardized indices.
 
Consolidated Discount Notes. The Office of Finance also sells consolidated discount notes on behalf of the FHLBanks to meet short- term funding needs. These securities have maturities up to one year and are offered daily through certain securities dealers in a discount note selling group. In addition to the daily offerings of discount notes, the FHLBanks auction specific amounts of discount notes with fixed maturity dates ranging from four to 26 weeks through competitive auctions held twice a week utilizing the discount note selling group. The amount of discount notes sold through the auctions varies based upon market conditions and on the funding needs of the FHLBanks. Discount notes are sold at a discount and mature at par.

Use of Derivatives
The Finance Agency’s Financial Management Policy (FMP) and the FHLBank’s Risk Management Policy (RMP) establish guidelines for the use of derivatives by the FHLBank. The FHLBank can use interest rate swaps, swaptions, interest rate cap and floor agreements, calls, puts, futures, forward contracts and other derivatives as part of its interest-rate risk management and funding strategies. These policies, along with Finance Agency regulations 12 CFR Part 956.5 and Part 956.6, prohibit trading in or the speculative use of derivatives and limit credit risk arising from derivatives. In general, the FHLBank has the ability to use derivatives only to reduce funding costs for consolidated obligations and to manage other risk elements such as: interest-rate risk, mortgage prepayment risk, unsecured credit risk and foreign currency risk.
 
The FHLBank uses derivatives in three general ways: (1) by designating them as either a fair value or cash flow hedge of an underlying financial instrument, a firm commitment or a forecasted transaction (the swapped consolidated obligation bond transactions discussed in the next paragraph fall into this category); (2) by acting as an intermediary between stockholders and the capital markets; or (3) in asset/liability management but not designated for hedge accounting. For example, the FHLBank uses derivatives in its overall interest rate risk management to adjust the interest rate sensitivity of consolidated obligations to approximate more closely the interest rate sensitivity of assets, including advances, investments and mortgage loans, and/or to adjust the interest rate sensitivity of advances, investments and mortgage loans to approximate more closely the interest rate sensitivity of liabilities. In addition to using derivatives to manage mismatches of interest rate terms between assets and liabilities, the FHLBank also uses derivatives to manage embedded options in assets and liabilities, to hedge the market value of existing assets, liabilities and anticipated transactions, to hedge the duration risk of prepayable instruments and to reduce funding costs as discussed below.
 
To reduce funding costs, the FHLBank frequently executes derivatives concurrently with the issuance of consolidated obligation bonds (collectively referred to as swapped consolidated obligation bond transactions). This allows the FHLBank to create synthetic variable rate debt at a cost that is often lower than the cost of a comparable variable rate cash instrument issued directly by the FHLBank. This strategy of issuing bonds while simultaneously entering into derivatives enables the FHLBank to more effectively fund the FHLBank’s variable rate assets and, in some instances, allows the FHLBank to offer a wider range of attractively priced advances to its members than would otherwise be possible. The continued attractiveness of these swapped consolidated obligation bond transactions depends on price relationships in both the FHLBank consolidated obligation market and the derivatives market, primarily the interest rate swap market. If conditions in these markets change, the FHLBank may alter the types or terms of the bonds issued and derivatives transacted to better match its assets and meet its customer needs.
The FHLBank uses interest rate caps and floors, swaptions and callable swaps to manage hedge prepayment and option risk on the MBS and CMOs held in the FHLBank’s held-to-maturity portfolio. Although these derivatives are valid economic hedges against the prepayment and option risk of the portfolio of MBS and CMOs, they are not specifically linked to individual investment securities and, therefore, do not receive either fair value or cash flow hedge accounting under SFAS 133. The derivatives are marked-to-market through earnings. The FHLBank frequently purchases interest rate caps with various terms and strike rates to manage embedded interest rate caps in variable rate MBS and CMOs. During 2008, the FHLBank significantly increased its purchases of variable rate Agency CMOs with embedded interest rate caps. As a result, we also significantly increased our purchases of interest rate caps to offset the interest-rate risk of the embedded caps.
 
Other common ways in which the FHLBank uses derivatives to manage its assets and liabilities are:
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To preserve a favorable interest rate spread between the yield of an asset (e.g., an advance) and the cost of the supporting liability (e.g., the consolidated obligation bond used to fund the advance). Without the use of derivatives, this interest rate spread could be reduced or eliminated if there are non-parallel changes in the interest rate on the advance and/or the interest rate on the bond, or if the rates change at different times;
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To mitigate the adverse earnings effects of the contraction or extension of certain assets (e.g., advances or mortgage assets) and liabilities; and
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To protect the value of existing asset or liability positions or of anticipated transactions.

See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Review – Balance Sheet Analysis – Derivatives” and Item 7A – “Quantitative and Qualitative Disclosures About Market Risk – Risk Management – Interest Rate Risk Management” for further information on derivatives.
 
Accounting for derivatives is addressed in SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of Financial Accounting Standards Board (FASB) Statement No. 133, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, as amended by SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, and as amended by SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (herein referred to as “SFAS 133”).

Deposits
The Bank Act allows the FHLBank to accept deposits from its members, housing associates, any institution for which it is providing correspondent services, other FHLBanks or other government instrumentalities. The FHLBank offers several types of deposit programs to its members and housing associates including demand, overnight and term deposits.
 
Liquidity Requirements. To support deposits, Finance Agency regulations require the FHLBank to have an amount equal to its current deposits invested in obligations of the U.S. government, deposits in eligible banks or trust companies, or advances with maturities not exceeding five years. In addition, the FHLBank must meet the liquidity guidelines outlined in its RMP. See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk Management” for further discussion of the FHLBank’s liquidity requirements and steps taken by the FHLBank in the third and fourth quarter of 2008 to increase liquidity.

Capital, Capital Rules and Dividends
The FHLBank’s capital stock and retained earnings also provide a source of funding. For the years ended December 31, 2008 and 2007, approximately 4.2 percent and 4.1 percent, respectively of the FHLBank’s assets, on average, were funded by total capital.
 
FHLBank Capital Adequacy and Form Rules. The GLB Act allows the FHLBanks to have two classes of stock, and each class may have sub-classes. Class A stock is conditionally redeemable on six months’ written notice from the member, and Class B stock is conditionally redeemable on five years’ written notice from the member, subject in each case to certain conditions and limitations that may restrict the ability of the FHLBanks to effectuate such redemptions. Membership is voluntary. However, other than non-member housing associates (see Item 1 – “Business – Advances”), membership is required in order to utilize the FHLBank’s credit and mortgage finance products. Members that withdraw from membership may not reapply for membership for five years.
 
The GLB Act and the Finance Agency rules and regulations define total capital for regulatory capital adequacy purposes as the sum of an FHLBank’s permanent capital, plus the amounts paid in by its stockholders for Class A stock; any general loss allowance, if consistent with GAAP and not established for specific assets; and other amounts from sources determined by the Finance Agency as available to absorb losses. The GLB Act and Finance Agency regulations define permanent capital for the FHLBanks as the amount paid in for Class B stock plus the amount of an FHLBank’s retained earnings, as determined in accordance with GAAP.
 
Under the GLB Act and the Finance Agency rules and regulations, the FHLBank was subject to risk-based capital rules effective September 30, 2004, when the FHLBank’s capital plan was implemented. Only permanent capital can satisfy the FHLBank’s risk-based capital requirement. In addition, the GLB Act specifies a 5 percent minimum leverage capital requirement based on total FHLBank capital, which includes a 1.5 weighting factor applicable to permanent capital, and a 4 percent minimum total capital requirement that does not include the 1.5 weighting factor applicable to permanent capital. The FHLBank may not redeem or repurchase any of its capital stock without Finance Agency approval if the Finance Agency or the FHLBank’s Board of Directors determines that the FHLBank has incurred, or is likely to incur, losses that result in, or are likely to result in, charges against the capital of the FHLBank, even if the FHLBank is in compliance with its minimum regulatory capital requirements (risk-based, leverage and total capital). Therefore, a stockholder’s right to redeem its excess shares of capital stock is conditional on, among other factors, the FHLBank maintaining its compliance with the three regulatory capital requirements: risk-based, leverage and total capital.
 
See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Review – Capital” for additional information regarding the FHLBank’s capital plan.
Dividends. The FHLBank may pay dividends from retained earnings and current income. The FHLBank’s Board of Directors may declare and pay dividends in either cash or capital stock. Under its capital plan, all FHLBank dividends that are payable in capital stock must be paid in the form of Class B Common Stock, regardless of the class upon which the dividend is being paid.
 
Consistent with Finance Board guidance in Advisory Bulletin (AB) 2003-AB-08, Capital Management and Retained Earnings, the FHLBank adopted a retained earnings policy, which provides guidelines to assess the adequacy of its retained earnings in light of alternative possible future financial and economic scenarios. The FHLBank’s retained earnings target is calculated quarterly and re-evaluated by the Board of Directors as part of each quarterly dividend declaration. The FHLBank’s retained earnings policy includes detailed calculations of four components: (1) market risk, which is based upon the FHLBank’s projected dividend paying capacity under a two-year earnings analysis that includes multiple stress or extreme scenarios (amount necessary for the FHLBank to pay three-month LIBOR over the period); (2) credit risk, which requires that retained earnings be sufficient to credit enhance all of the FHLBank’s assets from their actual rating levels to the equivalent of triple-A ratings (where advances are considered to be triple-A rated); (3) operations risk, which is equal to 30 percent of the total of the market and credit risk amounts, subject to a $10 million floor; and (4) SFAS 133 volatility, which is the projected income impact of SFAS 133 under 100-basis-point shocks in interest rates (maximum SFAS 133 loss under up or down shocks). The retained earnings policy was considered by the Board of Directors when dividends were declared during the last two years, but the retained earnings target calculated in accordance with the policy did not significantly affect the level of dividends declared and paid. Tables 10 and 11 reflect the quarterly retained earnings target calculations utilized during 2008 and 2007 (in thousands), respectively, compared to the actual amount of retained earnings at the end of each quarter:

Table 10

Retained Earnings Component (based upon prior quarter end)
  
12/31/2008
    
09/30/2008
    
06/30/2008
    
03/31/2008
  
Market Risk (dividend paying capacity)
   $ 45,445     $ 0     $ 0     $ 6,814  
Credit Risk
     51,404       33,770       35,572       40,340  
Operations Risk
     29,055       10,131       10,672       14,146  
SFAS 133 Volatility
     39,140       24,584       1,807       7,520  
Total Retained Earnings Target
     165,044       68,485       48,051       68,820  
Retained Earnings at End of Quarter
     156,922       231,843       233,773       207,202  
Overage (Shortage)
   $ (8,122 )   $ 163,358     $ 185,722     $ 138,382  

Table 11

Retained Earnings Component (based upon prior quarter end)
  
12/31/2007
    
09/30/2007
    
06/30/2007
    
03/31/2007
  
Market Risk (dividend paying capacity)
   $ 0     $ 179     $ 0     $ 0  
Credit Risk
     40,790       37,867       34,557       39,546  
Operations Risk
     12,237       11,414       10,367       11,864  
SFAS 133 Volatility
     9,371       7,866       7,840       7,292  
Total
     62,398       57,326       52,764       58,702  
Retained Earnings at End of Quarter
     208,763       196,922       186,505       179,174  
Overage (Shortage)
   $ 146,365     $ 139,596     $ 133,741     $ 120,472  

Under the FHLBank’s retained earnings policy, any shortage of actual retained earnings with respect to the retained earnings target is to be met over a period generally not to exceed two years from the quarter-end calculation. The policy also provides that meeting the established retained earnings target shall have priority over the payment of dividends, but that the Board of Directors must balance dividends on capital stock against the period over which the retained earnings target is met. The retained earnings target level fluctuates from period to period because it is a function of the size and composition of the FHLBank’s balance sheet and the risks contained therein at that point in time. The December 31, 2008, retained earnings target, in particular the market risk component, was significantly distorted by the relationship between the Federal Open Market Committee’s target rate for overnight Federal funds and three-month LIBOR as of the calculation date (retained earnings target used for the fourth quarter was calculated as of September 30, 2008, when the overnight Federal funds target rate was 2.00 percent and three-month LIBOR was 4.05 percent; refer to Table 15 for average overnight Federal funds target rate and three-month LIBOR for 2007 and 2008, and as of December 31, 2008 and 2007). The elevated level of the market risk component was deemed to be an aberration in market conditions at the time of its calculation and did not impact the dividends paid in the fourth quarter 2008. The FHLBank’s SFAS 133 volatility component of the retained earnings target increased during 2008 as the FHLBank significantly increased its purchases of variable rate Agency CMOs with embedded interest rate caps and purchases of interest rate caps to offset the interest-rate risk of the embedded caps. While we expect that the market risk component of the retained earnings target to decrease in future periods, the SFAS 133 volatility component is likely to stay elevated because of the increased usage of these economic hedge instruments.
 
Tax Status
Although the FHLBank is exempt from all federal, state and local taxation except for real property taxes, the FHLBank is obligated to make payments to the Resolution Funding Corporation (REFCORP) in the amount of 20 percent of net earnings after operating expenses and AHP expenses. In addition, the 12 FHLBanks must set aside annually the greater of an aggregate of $100 million or 10 percent of their current year’s income before charges for AHP (but after assessments for REFCORP). In accordance with Finance Agency guidance for the calculation of AHP expense, interest expense on mandatorily redeemable capital stock is added back to income before charges for AHP (but after assessments for REFCORP). Assessments for REFCORP and AHP are equivalent to an effective minimum income tax rate of 26.5 percent, but this effective rate will be higher depending upon the amount of interest expense for mandatorily redeemable capital stock recorded by the FHLBank during the year. For the periods ended December 31, 2008, 2007 and 2006, the FHLBank’s interest expense for mandatorily redeemable capital stock was $609,000, $2,101,000 and $2,594,000, respectively, which did not significantly change the FHLBank’s effective tax rate for 2008, 2007 or 2006. The combined REFCORP assessments and AHP expenses were $10.3 million, $54.5 million and $49.6 million for the periods ended December 31, 2008, 2007 and 2006, respectively. Because of the FHLBank’s tax-exempt status, cash dividends paid to members do not qualify for the corporate dividends received deduction.
Other Mission-related Activities
In addition to supporting residential mortgage lending, one of the core missions of the FHLBank is to support related housing and community development. The FHLBank administers and funds a number of targeted programs specifically designed to fulfill that mission. These programs have provided housing opportunities for thousands of very low-, low- and moderate-income households and strengthened communities primarily in Colorado, Kansas, Nebraska and Oklahoma.
 
Affordable Housing Program (AHP). Amounts specified by the AHP requirements described in Item 1 – “Business – Tax Status” are reserved for this program. AHP provides cash grants or subsidizes the interest rate on FHLBank advances to members, creating a pool of no-cost or low-cost funds to finance the purchase, construction or rehabilitation of very low-, low- and moderate-income owner occupied or rental housing. In the case of a subsidized advance, the amount charged against the AHP liability is the present value of the differences in cash flows between the AHP advance and a hypothetical advance with an interest rate based upon the FHLBank’s estimated cost of funds rate for a comparable maturity. The discount rate for the cash flow differences is the FHLBank’s estimated cost of funds rate for a comparable maturity. Since inception of the AHP, the majority of AHP awards have been in the form of cash grants. Historically, the outstanding principal of AHP-related advances to total advances outstanding has represented a negligible percentage of the FHLBank’s total advances. In addition to the standard competition for AHP funds, customized programs under the FHLBank’s AHP include:
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Rural First-time Homebuyer Program (RFHP) – RFHP provides down payment, closing cost or rehabilitation cost assistance to first-time homebuyers in rural areas and rehabilitation or rebuilding cost assistance to homeowners in rural federally declared disaster areas; and
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Targeted Ownership Program (TOP) – TOP provides down payment, closing cost or rehabilitation cost assistance in rural and urban areas to disabled first-time homebuyers or first-time homebuyer households with a disabled member of the household.

Community Investment Cash Advance (CICA) Program. CICA loans to members specifically target underserved markets in both rural and urban areas, including those areas where normal lending activity has yet to have the desired effect on housing and community development. CICA loans represented 2.6 percent, 2.6 percent and 2.2 percent of total advances outstanding as of December 31, 2008, 2007 and 2006, respectively. Programs under the FHLBank’s CICA Program are funded separately from AHP and include:
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Community Housing Program (CHP) – CHP makes loans available to members for financing the construction, acquisition, rehabilitation and refinancing of owner-occupied housing for households whose incomes do not exceed 115 percent of the area’s median income level and rental housing occupied by or affordable for households whose incomes do not exceed 115 percent of the area’s median income level. For rental projects, at least 51 percent of the units must have tenants that meet the income guidelines, or at least 51 percent of the units must have rents affordable to tenants that meet the income guidelines. The FHLBank provides advances for CHP-based loans to members at the FHLBank’s estimated cost of funds for a comparable maturity plus a markup for administrative costs;
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Community Housing Program Plus (CHP Plus) – CHP Plus makes $25 million in loans available to members annually to help finance the construction, acquisition or rehabilitation of rental housing occupied by or affordable for households whose incomes do not exceed 80 percent of the area’s median income level. At least 51 percent of the units must have tenants that meet the income guidelines, or at least 51 percent of the units must have rents affordable to tenants that meet the income guidelines. The FHLBank provides advances for CHP Plus-based loans to members at the FHLBank’s estimated cost of funds for a comparable maturity;
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Community Development Program (CDP) – CDP provides advances to members to finance CDP-qualified member financing including loans to small businesses, farms, agri-business, public or private utilities, schools, medical and health facilities, churches, day care centers or for other community development purposes that meet one of the following criteria: (1) loans to firms that meet the Small Business Administration’s (SBA) definition of a qualified small business concern; (2) financing for businesses or projects located in an urban neighborhood, census tract or other area with a median income at or below 100 percent of the area median; (3) financing for businesses, farms, ranches, agri-businesses or projects located in a rural community, neighborhood, census tract or unincorporated area with a median income at or below 115 percent of the area median; (4) firms or projects located in a Federal Empowerment Zone, Enterprise Community or Champion Community, Native American Area, Brownfield Area, Federally Declared Disaster Area, Military Base Closing Area or Community Adjustment and Investment Program (CAIP) Area; (5) businesses in urban areas in which at least 51 percent of the employees of the business earn at or below 100 percent of the area median; or (6) businesses in rural areas in which at least 51 percent of the employees of the business earn at or below 115 percent of the area median. The FHLBank provides advances for CDP-based loans to members at the FHLBank’s estimated cost of funds for a comparable maturity plus a mark-up for administrative costs; and
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Housing and Community Development Emergency Loan Program (HELP) – HELP provides up to $25 million in advances annually for members to finance recovery efforts in federally-declared disaster areas. The FHLBank provides advances for HELP-based loans to members at the FHLBank’s estimated cost of funds for a comparable maturity.
 
Other Housing and Community Development Programs. The FHLBank has also established a number of other voluntary housing and community development programs specifically developed for its members. These programs are funded separately from AHP and include the following:
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Joint Opportunities for Building Success (JOBS) – The FHLBank approved $1,250,000 in JOBS funding during 2008 to assist members in promoting employment growth in their communities. $1,225,000 was distributed in 2008 and $25,000 was not used. In 2007, the FHLBank approved and distributed $1,250,000 in JOBS funding. In 2006, the FHLBank approved $996,000 in JOBS funding, of which $921,000 was distributed in 2006, $50,000 was distributed in 2007 and $25,000 was not used. A charitable grant program, JOBS funds are allocated annually to support economic development projects. For 2009, the Board of Directors has approved up to $1,250,000 for this program. The following are elements of JOBS: (1) funds made available only through FHLBank members; (2) $25,000 maximum funding per member ($25,000 per project) annually; (3) loan pools and similar funding mechanisms are eligible to receive more than one JOBS award annually provided there is an eligible project in the pool for each JOBS application funded; (4) members and project participants agree to participate in publicity highlighting their roles as well as the FHLBank’s contribution to the project and community/region; (5) projects that appear to be “bail outs” are not eligible; and (6) members cannot use JOBS funds for their own direct benefit (e.g., infrastructure improvements to facilitate a new branch location) or any affiliate of the member;
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Community Initiatives (formerly known as Regional Needs Initiative) – The Community Initiative is a flexible direct grant program created to address housing and community development needs within the district that are not fully addressed by the FHLBank’s other programs. The FHLBank works cooperatively with Congressional offices and other local housing organizations to identify those needs. In order to provide the maximum flexibility in identifying and addressing housing and community development needs, the program does not have prescribed criteria. The funding available for the Community Initiatives in 2008 was $25,000, of which $17,000 was actually used. The funding available for the Community Initiatives in 2007 was $60,000, of which $26,000 was actually used. The funding available for the Community Initiatives in 2006 was $40,000, of which $22,000 was actually used. The FHLBank has allocated up to $22,000 in funding for this program for 2009; and
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Rural First-time Homebuyer Education Program – The FHLBank provides up to $100,000 annually to support rural homeownership education and counseling while actively encouraging participating organizations to seek supplemental funding from other sources. Goals of the program are to support rural education and counseling in all four states in the district, especially in those areas with RFHP-participating stockholders. This program used $50,000, $75,000 and $75,000 of the available funds during 2008, 2007 and 2006, respectively. Another $100,000 has been allocated to this program for 2009.

Competition
Advances: Demand for the FHLBank’s advances is affected by, among other things, the cost of alternative sources of liquidity available to its members, including deposits from members’ customers and existing or newly created debt programs explicitly guaranteed by the U.S. government that are available to members. The FHLBank individually competes with its members’ depositors as well as other suppliers of wholesale funding, both secured and unsecured. Such other suppliers of wholesale funds may include investment banks, commercial banks, and U.S. government lending programs. Smaller members generally have access to alternative funding sources through brokered deposits and the sale of securities under agreements to repurchase, while larger members typically have access to a broader range of funding alternatives. Large members may also have independent access to the national and global credit markets. The availability of alternative funding sources to members can significantly influence member demand for the FHLBank’s advances and can change as a result of a variety of factors including, among others, market conditions, product availability through the FHLBank, the member’s creditworthiness and availability of member collateral for other types of borrowings.
 
Mortgage Loans Held for Portfolio: The FHLBank is subject to significant competition in purchasing conventional, conforming fixed rate mortgage loans and government-guaranteed mortgage loans. The FHLBank faces competition in customer service, the prices paid for these assets, and in ancillary services such as automated underwriting. The most direct competition for purchasing mortgages comes from the other housing GSEs, which also purchase conventional, conforming fixed rate mortgage loans, specifically Fannie Mae and Freddie Mac. To a lesser extent, the FHLBank also competes with regional and national financial institutions that buy and/or invest in mortgage loans. These investors may seek to hold or securitize conventional, conforming fixed rate mortgage loans. The FHLBank continuously reassesses its potential for success in attracting and retaining customers for its mortgage loan products and services, just as it does with its advance products. The FHLBank competes for the purchase of mortgage loans primarily on the basis of price, products, structures and services offered.
 
Debt Issuance: The FHLBank also competes with the U.S. government (including debt programs explicitly guaranteed by the U.S. government), U.S. government agencies, Fannie Mae, Freddie Mac and other GSEs as well as corporate, sovereign and supranational entities for funds raised through the issuance of unsecured debt in the national and global capital markets. Collectively, Fannie Mae, Freddie Mac and the FHLBanks are generally referred to as the housing GSEs (GSE securities are not explicitly guaranteed by the U.S. government), and the cost of the debt of each can be positively or negatively affected by political, financial or other news that reflects upon any of the three housing GSEs. If the supply of competing debt products increases without a corresponding increase in demand, FHLBank debt costs may rise or less debt may be issued at the same cost than would otherwise be the case. In addition, the availability and cost of funds raised through the issuance of certain types of unsecured debt may be adversely affected by regulatory initiatives that tend to reduce investment by certain depository institutions in unsecured debt with greater price volatility or interest rate sensitivity than similar maturity fixed rate, non-callable instruments of the same issuer.
 
Derivatives: The sale of callable debt and the simultaneous execution of callable interest rate swaps with options that mirror the options in debt has been an important source of competitive funding for the FHLBank. As such, the depth of the markets for callable debt and mirror-image derivatives is an important determinant of the FHLBank’s relative cost of funds. There is considerable competition among high-credit-quality issuers, especially among the three housing GSEs, for callable debt and for derivatives. There can be no assurance that the current breadth and depth of these markets will be sustained.
 
Regulatory Oversight, Audits and Examinations
General: The FHLBank is supervised and regulated by the Finance Agency, which is an independent agency in the executive branch of the U.S. government. Prior to July 30, 2008, the Finance Board, an independent agency in the executive branch of the United States Government, supervised and regulated the FHLBanks and the Office of Finance. Upon enactment of the Recovery Act on July 30, 2008, the Finance Agency became the new regulator for the FHLBanks as well as Fannie Mae and Freddie Mac. The Finance Board was merged into the Finance Agency as of October 27, 2008. The Finance Agency is responsible for ensuring that the FHLBank operates in a safe and sound manner, carries out its housing finance mission, remains adequately capitalized and able to raise funds in the capital markets, maintains adequate internal controls and operates in a manner consistent with the public interest. Also, the Finance Agency establishes regulations governing the operations of the FHLBank. The Finance Agency is headed by a director appointed by the President of the United States for a five-year term, with the advice and consent of the Senate. The Director has designated and prescribed functions, powers and duties to a Deputy Director responsible for explicit oversight of the FHLBanks. The Federal Housing Finance Oversight Board advises the Director with respect to overall strategies and policies in carrying out the duties of the Director. The Federal Housing Finance Oversight Board is comprised of the Secretary of the Treasury, Secretary of Housing and Urban Development, Chairman of the Securities and Exchange Commission and the Director, who serves as the Chairperson of the Board. The Finance Agency is funded in part through assessments from the 12 FHLBanks, with the remainder of its funding provided by Fannie Mae and Freddie Mac; no tax dollars or other appropriations support the operations of the Finance Agency or the FHLBanks. To assess the safety and soundness of the FHLBank, the Finance Agency conducts annual, on-site examinations of the FHLBank, as well as periodic on-site and off-site reviews. Additionally, the FHLBank is required to submit monthly information on its financial condition and results of operations to the Finance Agency. This information is available to all FHLBanks.
The Government Corporation Control Act provides that, before a government corporation issues and offers obligations to the public, the Secretary of the Treasury shall prescribe the form, denomination, maturity, interest rate and conditions of the obligations; the manner and time issued; and the selling price. Prior to the third quarter of 2008, the Bank Act authorized the Secretary of the Treasury, at his or her discretion, to purchase consolidated obligations up to an aggregate principal amount of $4 billion. No borrowings under this authority have been outstanding since 1977. During the third quarter of 2008, each FHLBank entered into a Lending Agreement with the U.S. Treasury in connection with the U.S. Treasury’s establishment of the Government Sponsored Enterprise Credit Facility (GSECF), as authorized by the Recovery Act. The FHLBank signed its Lending Agreement on September 8, 2008. The GSECF is designed to serve as a contingent source of liquidity for the housing government-sponsored enterprises, including each of the 12 FHLBanks. As of December 31, 2008, no FHLBank had drawn on this available source of liquidity. The U.S. Department of the Treasury receives the Finance Agency’s annual report to Congress, monthly reports reflecting securities transactions of the FHLBanks, and other reports reflecting the operations of the FHLBanks.
 
Audits and Examinations: The FHLBank has an internal audit department and the FHLBank’s Board of Directors has an audit committee. The Director of the Internal Audit department reports directly to the Board’s Audit Committee. In addition, an independent registered public accounting firm audits the annual financial statements of the FHLBank. The independent registered public accounting firm conducts these audits following standards of the Public Company Accounting Oversight Board (United States) and Government Auditing Standards issued by the Comptroller General. The FHLBanks, the Finance Agency and Congress all receive the audit reports. The FHLBank must submit annual management reports to Congress, the President of the United States, the Office of Management and Budget, and the Comptroller General. These reports include a statement of financial condition, a statement of operations, a statement of cash flows, a statement of internal accounting and administrative control systems, and the report of the independent public accounting firm on the financial statements.
 
The Comptroller General has authority under the Bank Act to audit or examine the Finance Agency and the individual FHLBanks and to decide the extent to which they fairly and effectively fulfill the purposes of the Bank Act. Furthermore, the Government Corporation Control Act provides that the Comptroller General may review any audit of the financial statements conducted by an independent public accounting firm. If the Comptroller General conducts such a review, then he or she must report the results and provide his or her recommendations to Congress, the Office of Management and Budget, and the applicable FHLBank. The Comptroller General may also conduct his or her own audit of any financial statements of any individual FHLBank.

Personnel
As of March 20, 2009, the FHLBank had 186 employees. The employees are not represented by a collective bargaining unit and the FHLBank considers its relationship with its employees good.

Legislation and Regulatory Developments
Future Legislation: Various legislation, including proposals to substantially change the regulatory system for the FHLBanks and other housing GSEs, is from time to time introduced in Congress. This legislation may change applicable statutes and our operating environment in substantial and unpredictable ways. If enacted, legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among the FHLBanks and other housing GSEs. We cannot predict whether any of this potential legislation will be enacted and, if enacted, the effect that it, or any implementing regulations, could have on our business, results of operations or financial condition.
 
Finance Board Temporary Increase on the Purchase of Mortgage-Backed Securities: On March 24, 2008, the Finance Board authorized, pursuant to Resolution 2008-08, Temporary Authorization to Invest in Additional Agency Mortgage Securities, a temporary increase in the FHLBanks’ MBS investment authority from 300 percent of capital to 600 percent of regulatory capital. The FHLBank Topeka’s Board of Directors approved appropriate strategies to allow the FHLBank to acquire additional Agency MBS/CMOs on March 27, 2008, subject to a limit of 400 percent of total regulatory capital. The FHLBank submitted required information to the Finance Board on March 31, 2008 and began acquiring Agency MBS/CMOs under this expanded authority in April 2008. The FHLBank acquired $2.7 billion of variable rate Agency MBS/CMOs under this expanded MBS investment authority during 2008.
 
Finance Board Approves the Allocation of Elective Directorships: On May 14, 2008, the Finance Board allocated the elective directorships of the FHLBanks in accordance with the rules established by the Finance Board for the annual designation of elective directorships. For the FHLBank, the Finance Board decreased the number of elective directorships by one to a total of eight elective directorships. The Finance Board’s determination was based on the combined number of shares required to be held by the members in each state in the FHLBank’s district.
 
Changes to Regulation of GSEs. On July 30, 2008, the Recovery Act was enacted. The Recovery Act was designed to, among other things, address the current housing finance crisis, expand the Federal Housing Administration’s financing authority and address GSE reform issues. Highlights of significant provisions of the Recovery Act that directly affect the FHLBank include the following:
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Creates a newly established federal agency regulator, the Finance Agency, which is the new federal regulator of the FHLBanks, Fannie Mae and Freddie Mac. The Finance Board, the FHLBanks’ former regulator, was to be abolished within one year after the date of enactment of the Recovery Act. Finance Board regulations, policies, and directives immediately transferred to the new Finance Agency and during the transition, the Finance Board was responsible for winding up its affairs. The FHLBank was responsible for its share of the operating expenses for both the Finance Agency and the Finance Board. The Finance Board wound up its affairs and was merged into the Finance Agency on October 27, 2008.
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Authorizes the U.S. Treasury to purchase obligations issued by the FHLBanks, in any amount deemed appropriate by the U.S. Treasury. This temporary authorization expires December 31, 2009 and supplements the existing limit of $4.0 billion. There have been no such purchases by the U.S. Treasury of obligations issued by the FHLBanks under the existing authority and the FHLBank has no immediate plans to utilize the Treasury lines.
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The director of the Finance Agency (the “Director”) is responsible for setting risk-based capital standards for the FHLBanks and other capital standards and reserve requirements for FHLBank activities and products.
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Provides the Director with broad conservatorship and receivership authority over the FHLBanks.
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Provides that the FHLBank’s Board of Directors shall be comprised of thirteen directors, or such other number as the Director determines appropriate, a majority of which shall be persons who are directors or officers of members, and a minimum of two-fifths of which shall be non-member, “independent” directors (nominated by the FHLBank’s Board of Directors in consultation with the Affordable Housing Advisory Council of the FHLBank). Two of the “independent” directors must have experience in community interests and the remaining directors must have demonstrated financial experience. The statutory “grandfathering” rules for the number of elective director seats by state remain, unless FHLBanks merge.
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Removes the maximum statutory annual limit on board of directors’ compensation.
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Allows the Director to prohibit executive compensation that is not reasonable and comparable with compensation in similar businesses. If the FHLBank is undercapitalized, the Director may also restrict executive compensation. Until December 31, 2009, the Director has additional authority to approve, disapprove or modify executive compensation.
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Requires the Director to issue regulations to facilitate the sharing of information among the FHLBanks to, among other things, assess their joint and several liability obligations.
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Provides the FHLBanks with expressed statutory exemptions from complying with certain provisions of the federal securities laws.
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Allows FHLBanks to voluntarily merge with the approval of the Director and their respective boards of directors, and requires the Director to issue regulations regarding the conditions and procedures for voluntary mergers, including procedures for FHLBank member approval.
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Allows the Director to liquidate or reorganize an FHLBank upon notice and hearing.
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Allows the Finance Agency to reduce the number of FHLBank districts to no less than eight, unless there is a voluntary merger of FHLBanks or as a result of the Director’s action to liquidate an FHLBank.
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Provides FHLBank membership eligibility for “Community Development Financial Institutions,” as defined by the Community Development Banking and Financial Institutions Act of 1994.
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Redefines “Community Financial Institutions” as those institutions that have assets not exceeding $1.0 billion and adds loans for “community development activities” as eligible collateral for Community Financial Institutions.
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Provides that the FHLBank shall establish an office for diversity in management, employment and business activities.
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Provides that the FHLBanks are subject to prompt corrective action enforcement provisions similar to those currently applicable to national banks and federal savings associations.
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Increases the secondary market conforming loan limits for home mortgages eligible for purchase under the MPF Program and authorizes the Director to establish low- and very low-income housing goals for the FHLBanks’ mortgage purchase programs.
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Authorizes the FHLBank on behalf of one or more members to issue letters of credit to support tax-exempt bond issuances without jeopardizing the tax-exempt status of the bonds. This temporary authorization expires December 31, 2010.
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Authorizes an FHLBank under its Affordable Housing Program to provide grants for the refinancing of home loans for families having an income at or below 80 percent of the applicable area median income. This authority expires two years after enactment of the Recovery Act.

Treasury Senior Preferred Stock Agreements with Fannie Mae and Freddie Mac: On September 7, 2008, the Treasury Department and the Finance Agency entered into Senior Preferred Stock Agreements whereby the Treasury Department would provide Fannie Mae and Freddie Mac each with up to $100 billion, which is designed to ensure that both Fannie Mae and Freddie Mac have a positive net worth. The Agreements do not have an expiration date and will last until all debt and mortgage-backed securities are repaid or the facility has been fully utilized. On February 28, 2009, the Treasury Department increased the Agreements to $200 billion each from the original level of $100 billion each.
 
Finance Agency Provides Guidance on Prohibited Golden Parachute and Indemnification Payments: On September 16, 2008, the Finance Agency issued an interim final regulation providing guidance on prohibited golden parachute and indemnification payments. On September 19, 2008, the Finance Agency removed certain restrictions from the rule. On September 23, 2008, the Finance Agency rescinded the aspects of the rule pertaining to indemnification payments, but left intact the regulation as it pertains to golden parachute payments. The comment period for the interim final regulation closed on October 31, 2008. In addition, pursuant to the provisions of the Recovery Act giving the Director of the Finance Agency the power and obligation to prevent FHLBanks from paying executive compensation that is not reasonable and comparable to other institutions, the FHLBanks have been directed, until told otherwise, to submit to the Acting Deputy for Federal Home Loan Bank Supervision all compensation actions relating to the five most highly compensated officers, at least four weeks in advance of any planned action by the board of directors. On January 29, 2009, the Finance Agency issued a final rule on golden parachute payments. The rule sets forth standards which the Director will take into consideration in determining whether to limit or prohibit golden parachute payments.
 
On November 14, 2008, the Finance Agency issued a proposed amendment to the interim final regulation which addresses prohibited and permissible indemnification payments with regard to any administrative proceeding brought by the Finance Agency against any entity-affiliated party of the FHLBanks. The provisions of the proposed amendment addressing indemnification payments are substantially similar to the regulation that limits indemnification by insured depository institutions to institution-affiliated parties. The comment period for the proposed amendment closed on December 29, 2008.
 
Finance Agency Issues an Interim Final Regulation Concerning the Nomination and Election of Directors: On September 26, 2008, the Finance Agency published an interim final regulation to implement the provisions of the Recovery Act concerning the nomination and election of directors. The regulation substantially continues the prior rules governing elected director nominations, balloting, voting and reporting of results, while making certain modifications for the election of independent directors. The regulation: (1) required that the elections for member and independent directors with terms commencing on January 1, 2009 be completed by December 31, 2008; (2) set terms for each directorship commencing after January 1, 2009 at four years, except as adjusted to achieve staggering required by the Recovery Act; and (3) prescribed a process for conducting independent director and member director elections. Under amended Section 7 of the Bank Act, each FHLBank’s board of directors, in consultation with its Affordable Housing Advisory Council, is required to nominate independent director candidates to stand for election by the members of each FHLBank. Under the regulations, an FHLBank must consider anyone who applies using an application form prescribed by the Finance Agency and completed in accordance with the regulation’s requirements. An independent director nominee must receive at least 20 percent of the number of votes eligible to be cast in the election. If no nominee receives 20 percent of the votes eligible to be cast in the election, the FHLBank must conduct elections until the directorship is filled. On October 22, 2008, the FHLBank amended its Bylaws to reflect the requirements of the Recovery Act and Finance Agency regulations affecting director elections. The comment period for the interim final regulation closed November 25, 2008.
FDIC Program to Guarantee Newly Issued Senior Unsecured Debt: On October 14, 2008, the Federal Deposit Insurance Corporation (FDIC) announced a program to guarantee newly issued senior unsecured debt (and the unsecured portion of any secured debt) issued by FDIC-insured institutions as well as bank, thrift and financial holding companies where such debt is issued on or before June 30, 2009. The amount of debt covered by the guarantee may not exceed 125 percent of debt that was outstanding as of September 30, 2008 that was scheduled to mature before June 30, 2009. For eligible debt issued on or before June 30, 2009, coverage would be provided for three years beyond that date, even if the liability has not matured. Additionally, the FDIC has agreed to guarantee funds in non-interest-bearing transaction deposit accounts held by FDIC-insured banks until December 31, 2009. The FDIC issued an interim final rule on October 29, 2008 that provides further detail on the guarantee program. The comment period for the interim final rule closed on November 13, 2008.
 
FDIC Risk-Based Assessment Proposal: On October 16, 2008, the FDIC published a proposed regulation that would increase the deposit insurance assessment for those FDIC-insured institutions that have outstanding FHLBank advances and other secured liabilities above a specified level. The secured liability adjustment is simply one component of a new assessment structure which in total will restore the Deposit Insurance Fund to its required level in five years. Any surcharge added to an FHLBank member’s deposit insurance assessment that includes FHLBank advances could adversely impact the attractiveness of FHLBank advances. The comment period for the proposed regulation closed on November 17, 2008. On December 22, 2008, the FDIC published a final rule that raises the current rates uniformly by 7 basis points for the quarterly assessment beginning January 1, 2009 only. On March 4, 2009, the FDIC published a final rule on deposit insurance assessments. The final rule differs from the proposed rule in that an institution’s ratio of secured liabilities to domestic deposits must be greater than 25 percent for an adjustment to exist, rather than 15 percent as stated in the proposed regulation. The FDIC also amended the restoration plan on March 4, 2009, to extend the period of the restoration plan to seven years.
 
Finance Agency Issues Interim Rule Allowing the Establishment of a Temporary Mortgage Refinance Program under an FHLBank’s Existing Set-Aside Authority: On October 17, 2008, the Finance Agency published an interim final rule in the Federal Register amending the Affordable Housing Program regulation to allow an FHLBank to establish a temporary mortgage refinance program under its existing set aside authority. This rule supersedes a proposed rule published by the Finance Board on April 16, 2008 that would have authorized the FHLBanks to establish Affordable Housing Program homeownership set-aside programs for the purpose of refinancing or restructuring low- or moderate-income households’ nontraditional or subprime mortgage loans. Because of the passage of the Recovery Act, the Finance Agency published the interim final rule, which replaces the proposed rule. The interim final rule permits set-aside funds to be used for two new purposes. First, they may be used to reduce the outstanding principal balance of the refinanced loan below the maximum 90 percent loan-to-value ratio established by the HOPE for Homeowners Program to make monthly payments affordable for the household and, second, they may be used to pay FHA-approved loan closing costs. The comment period for the interim final rule closed on December 16, 2008.
 
Federal Bank and Thrift Regulatory Agencies’ Proposal to Lower Risk Weights for Claims on or Guaranteed by Fannie Mae and Freddie Mac: On October 27, 2008, the Federal Bank and Thrift Regulatory Agencies published a notice of proposed rulemaking which would lower the capital risk weighting of certain claims on or guaranteed by Fannie Mae and Freddie Mac from 20 percent to 10 percent. The notice specifically requested comments on the potential effects of the proposed rule on FHLBank debt. The comment period for the proposed rulemaking closed on November 26, 2008.
 
Federal Reserve Program to Purchase Direct Obligations of FHLBanks: On November 25, 2008, the Federal Reserve Board announced an initiative to commence purchasing up to $100 billion of the debt of the housing GSEs. Following this announcement, FHLBank term debt pricing improved relative to U.S. Treasury securities and interest rate swaps. On March 18, 2009, the Federal Reserve announced that is was increasing its projected purchases of GSE debt from $100 billion to $200 billion. As of December 31, 2008, the Federal Reserve announced total purchases of $15 billion of GSE term debt. An additional $33 billion of purchases were made through March 18, 2009, leaving an additional $152 billion in potential future purchases.
 
Federal Reserve Term Asset-Backed Securities Loan Facility: On November 25, 2008, the Federal Reserve Board announced the creation of the Term Asset-Backed Securities Loan Facility (TALF), a facility established to help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans and loans guaranteed by the Small Business Administration (SBA). Under the TALF, the Federal Reserve will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans. On February 6, 2009, the Federal Reserve released revised terms and conditions of the TALF. On February 10, 2009, the Federal Reserve announced it is prepared to increase the size of the program to up to $1 trillion.
 
Finance Agency Issues Interim Final Rule Establishing Capital Classifications and Critical Capital Levels for the FHLBanks: On January 30, 2009, the Finance Agency issued an interim final rule to define critical capital for the FHLBanks, establish the criteria for each of the capital classifications identified in the Recovery Act and delineate its prompt corrective action authority over the FHLBanks. The rule’s provisions generally mirror those that have been in effect with regard to commercial banks and savings associations since 1992. The interim final rule establishes criteria based on the amount and type of capital held by an FHLBank for four different capital classifications: adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The rule also allows the Director the discretion to take prompt corrective action with respect to any undercapitalized FHLBank. The FHLBank is analyzing the potential impact the interim final rule could have on its business activities. Comments on the interim final rule are due by April 30, 2009.
Mortgage Cram-Down Legislation. In the 111th Congress, several bills have been introduced that are designed to require lenders to modify the mortgage terms of individuals who are at risk of losing their homes to foreclosure. On March 5, 2009, the House of Representatives passed the Helping Families Save Their Homes Act (H.R. 1106), which encouragers lenders to modify loan terms as well as allows bankruptcy judges to modify the terms of loans if an agreement cannot be reached between the lender and the homeowner. The Senate has not yet considered this legislation. Mortgage cram-down legislation could increase the cost of doing business for our member institutions and could therefore affect our business operations in numerous ways. It could also have consequences to the value of our private-label mortgage-backed securities portfolio or requiring us to write-down the value of assets due to other-than-temporary impairment. However, we cannot predict whether any of this potential legislation will be enacted and, if enacted, the effect that it, or any implementing regulations, could have on our business, results of operations or financial condition.

Where to Find Additional Information
We file annual, quarterly and current reports and other information with the SEC. You may read and copy such material at the public reference facilities maintained by the SEC at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-732-0330 for more information on the public reference room. You can also find our SEC filings at the SEC’s Web site at www.sec.gov. We provide a link on our Web site to the SEC’s Web site to access our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act), as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

Item 1A: Risk Factors

Our business has been and may continue to be adversely impacted by recently enacted legislation and other ongoing actions by the U. S. government in response to recent disruptions in the financial markets. Recent disruptions in the financial markets have significantly impacted the financial services industry, the FHLBank and our members. Significant recent regulatory actions include the following:
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In September 2008, the Finance Agency placed Fannie Mae and Freddie Mac into conservatorship;
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The U.S. Treasury initiated a program to purchase equity interest in certain financial institutions, such as Fannie Mae and Freddie Mac, to help them continue to meet their obligations to holders of their debt securities;
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In October 2008, the U.S. government enacted the Emergency Economic Stimulus Act of 2008 (EESA) to address disruptions in the financial markets by permitting the U.S. Treasury to purchase up to $700 billion of equity in U.S. financial institutions or purchase distressed assets, particularly illiquid residential and commercial mortgages and MBS, from U.S. financial institutions through the Troubled Asset Relief Program (TARP);
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On October 14, 2008, the FDIC established the Temporary Liquidity Guarantee Program (TLGP), which guarantees newly issued senior unsecured debt (and the unsecured portion of any secured debt) issued by FDIC-insured institutions as well as bank, thrift and financial holding companies where such debt is issued on or before June 30, 2009;
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In February 2009, the U.S. Treasury proposed its Financial Stability Plan, which establishes three new programs to clean up and strengthen the nation’s banks, bring in private capital to restart lending and to circumvent the banking system by going directly to the markets that consumers and businesses depend on; and
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On March 4, 2009, the FDIC published a final rule that would increase the deposit insurance assessment for those FDIC-insured insitutions that have outstanding FHLBank advances and other secured liabilities above a specified level. 

These initiatives or proposed initiatives have adversely impacted our competitive position with respect to accessing financing as well as the rate that we pay for borrowed funds. For example, the U.S. government’s financial backing of Fannie Mae and Freddie Mac have resulted in the debt securities of Fannie Mae and Freddie Mac being more attractive to investors than the debt securities of the FHLBanks. Additionally, the FDIC’s TLGP has resulted in the debt securities of larger commercial banks being more attractive to members and potential members than the advances offered by the FHLBanks. As a result, our funding costs increased during the last quarter of 2008 and remain elevated in 2009. If these costs continue to increase, our ability to raise funds in the marketplace and price advances competitively may be significantly impacted.
 
The U.S. Treasury’s program to purchase equity interests in certain financial institutions, as well as funds obtained under the TLGP have provided our members with additional access to liquidity that compete with advances. Thus, we have and may continue to experience a decrease in member demand for advances. Additionally, we anticipate that the FDIC’s final rule on deposit insurance assessments could have a negative impact on advance demand by increasing the effective cost of advance borrowings to our members. To the extent that these initiatives, proposed initiatives and other actions by the U.S. government in response to the financial crisis cause a significant decrease in the aggregate amount of advances, our financial condition, results of operations and member value may be adversely affected. See Item 1 – “Business – Competition” and Note 20 of the Footnotes to the Financial Statements included under Item 8 for further discussion of the reduction in member borrowings as a result of competition arising from actions of the U.S. Government.
 
We may become liable for all or a portion of the consolidated obligations of one or more of the other FHLBanks. We are jointly and severally liable with the other FHLBanks for all consolidated obligations issued on behalf of all 12 FHLBanks through the Office of Finance. We cannot pay any dividends to members or redeem or repurchase any shares of our capital stock unless the principal and interest due on all consolidated obligations have been paid in full. If another FHLBank were to default on its obligation to pay principal or interest on any consolidated obligation, the Finance Agency may allocate the outstanding liability among one or more of the remaining FHLBanks on a pro rata basis or on any other basis the Finance Agency may determine. As a result, our ability to pay dividends to our members or to redeem or repurchase shares of our capital stock could be affected not only by our own financial condition, but also by the financial condition of one or more of the other FHLBanks. However, no Federal Home Loan Bank has ever defaulted on its debt obligations since the FHLBank System was established in 1932.
We are subject to a complex body of laws and regulations that could change in a manner detrimental to our operations. The FHLBanks are GSEs organized under the authority of the Bank Act, and, as such, are governed by federal laws and regulations adopted and applied by the Finance Agency. In addition, Congress may amend the Bank Act or pass other legislation that significantly affects the rights and obligations of the FHLBanks and the manner in which the FHLBanks carry out their housing-finance mission and business operations, such as the passage of the Recovery Act, which created the Finance Agency as the single regulator for Fannie Mae, Freddie Mac and the FHLBanks and addressed other reform issues that have impacted the FHLBank.
 
We cannot predict whether new regulations will be promulgated by the Finance Agency or whether Congress will enact new legislation, and we cannot predict the effect of any new regulations or legislation on our operations. Changes in regulatory or statutory requirements could result in, among other things, an increase in our cost of funding, a change in our permissible business activities, or a decrease in the size, scope or nature of our lending, investment or MPF Program activities, which could negatively affect our financial condition and results of operations.
 
We may be negatively affected by the recent changes to GSE regulation. Effective July 30, 2008, an amendment to the Bank Act created the Finance Agency as the new federal regulator of the FHLBanks and the Office of Finance, Fannie Mae and Freddie Mac. Because the business models of Fannie Mae and Freddie Mac are significantly different than that of the FHLBanks, there is a risk that some of the rules and regulations promulgated by the Finance Agency for the GSEs under its authority may have a less than favorable impact on the FHLBank’s operations and/or financial condition.
 
Additionally, there is a risk that our funding costs and access to funds could be adversely affected by changes in investors’ perception of the systemic risks associated with Fannie Mae and Freddie Mac. For example, negative accounting and other announcements by Fannie Mae and Freddie Mac have created pressure on debt pricing, as investors have perceived GSE debt instruments as bearing increased risk. Furthermore, in September 2008, the Finance Agency placed Fannie Mae and Freddie Mac into conservatorship and the U.S. Treasury put in place a set of financing agreements to help them continue to meet their obligations to holders of their debt securities. Although these actions resulted in somewhat decreased spreads on GSE debt, including FHLBank debt relative to U.S. Treasury securities, investor concerns negatively affected the FHLBanks’ business and financial condition. In addition, the special status of Fannie Mae and Freddie Mac debt securities could result in higher relative funding costs on FHLBank debt. As a result of the foregoing, we may have to pay a higher rate of interest on consolidated obligations to make them attractive to investors relative to Fannie Mae and Freddie Mac debt securities. If we maintain our existing pricing on advances, the resulting increase in the cost of issuing consolidated obligations could cause our advances to be less profitable and reduce our net interest margins (the difference between the interest rate received on advances and the interest rate paid on consolidated obligations). If we change the pricing of our advances in response to this potential decrease in net interest margin, the advances may no longer be attractive to our members, and any outstanding advance balances may decrease. In either case, the increased cost of issuing consolidated obligations could negatively affect our financial condition and results of operations.
 
Our funding depends upon our ability to access the capital markets. Our primary source of funds is the sale of consolidated obligations in the capital markets, including the short-term discount note market. Our ability to obtain funds through the sale of consolidated obligations depends in part on prevailing conditions in the capital markets (including investor demand and the effect of the reduction of liquidity in financial markets, which are beyond the FHLBank’s control) at the time. The severe financial and economic disruptions, and the U.S. government’s measures enacted to mitigate their effects, have changed the traditional bases on which market participants value GSE debt securities, particularly FHLBank consolidated obligations, and consequently have affected our funding costs and practices. The FHLBank’s cost of issuing term debt has significantly increased relative to U.S. Treasury obligations and LIBOR as a result of the continued financial market turmoil. Because we have become more reliant on the issuance of consolidated discount notes, with maturities of one year or less, for funding, any significant disruption in the short-term debt markets could have a serious effect on our business and the business of the other FHLBanks. If any significant market disruption were to continue we may not be able to obtain short-term funding on acceptable terms and the high cost of longer-term liabilities would likely cause us to further increase advance rates, which could adversely affect demand for advances and, in turn, our results of operations. Alternatively, continuing to fund longer-term variable rate assets with very short-term liabilities could adversely affect our results of operations if the cost of those short-term liabilities rises to levels above the yields on the long-term variable rate assets being funded. Accordingly, we cannot make any assurance that we will be able to obtain funding on terms acceptable to us, if at all. If we cannot access funding when needed, our ability to support and continue our operations would be adversely affected, negatively affecting our financial condition and results of operations.
 
Changes in interest rates could significantly affect our earnings. Changes in interest rates that are detrimental to our investment position could negatively affect our financial condition and results of operations. Like many financial institutions, we realize income primarily from earnings on our invested capital as well as the spread between interest earned on our outstanding advances, mortgage loans and investments and interest paid on our borrowings and other liabilities. Although we use various methods and procedures to monitor and manage our exposures to risk due to changes in interest rates, we may experience instances when our interest-bearing liabilities will be more sensitive to changes in interest rates than our interest-earning assets, or vice versa. These impacts could be exacerbated by prepayment and extension risk, which is the risk that mortgage-related assets will be refinanced in low interest-rate environments or will remain outstanding at below-market yields when interest rates increase.
 
Changes in our credit ratings may adversely affect our ability to issue consolidated obligations on acceptable terms. Our consolidated obligations currently have the highest credit rating from Moody’s and S&P. A revision in or withdrawal of those ratings could adversely affect us in a number of ways. It could result in a revision or withdrawal of the ratings of the consolidated obligations of the FHLBanks. It could require the posting of additional collateral for derivatives transactions and may influence counterparties to limit the types of transactions they will enter into with us or cause counterparties to cease doing business with us. We have issued letters of credit to support deposits of public unit funds with our members. In some circumstances, loss of our current rating could result in our letters of credit no longer being acceptable to pledge for public unit deposits or other transactions. We have also executed various standby bond purchase agreements with two state HFAs in which we provide a liquidity facility for bonds issued by the HFAs by agreeing to purchase the bonds in the event they are tendered and cannot be remarketed in accordance with specified terms and conditions. If our current short-term ratings are reduced, suspended or withdrawn, the issuers will have the right to terminate these standby bond purchase agreements, resulting in the loss of future fees that would be payable to us under these agreements.
Compliance with regulatory contingency liquidity guidance could adversely impact our earnings. On March 6, 2009, the Finance Agency issued final guidance on operating liquidity for the FHLBanks requiring us to maintain sufficient liquidity through short-term investments in an amount at least equal to our cash outflows under two different scenarios as described under Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity.” Prior to this time, regulations required us to maintain five calendar days of contingent liquidity. The final guidance revises and formalizes preliminary guidance provided to the FHLBanks in the third and fourth quarters of 2008 with a number of different scenarios that the FHLBank calculated daily and provided to the Finance Agency. The final guidance is designed to enhance our liquidity to provide a certain amount of protection against temporary disruptions in access to the FHLBank debt markets in response to a rise in capital markets volatility. To satisfy this additional requirement, we maintain balances in shorter-term investments, which may earn lower interest rates than alternate investment options and may, in turn, negatively impact net interest income. To the extent that, with a positively sloping short-term yield curve, the FHLBank must fund its assets with longer term liabilities and does not pass the additional cost through to members in the form of higher advance rates, the FHLBank's net interest income and net interest spreads will be reduced. In certain circumstances, we may need to fund overnight or shorter-term advances with short-term discount notes that have maturities beyond the maturities of the related advances, thus increasing our short-term advance pricing or reducing net income through lower net interest spread. To the extent the increased cost of maintaining the required liquidity is passed on to our members and makes our advances less competitive, advance levels and, therefore, our net interest income may be negatively impacted.
 
Changes in the credit standing at other FHLBanks, including the credit ratings assigned to those FHLBanks, could adversely affect us. The FHLBanks issue consolidated obligations that are the joint and several liability of all 12 FHLBanks. Significant developments affecting the credit standing of one of the other FHLBanks, including revisions in the credit ratings of one of the other FHLBanks, could adversely affect the cost of consolidated obligations. An increase in the cost of consolidated obligations would affect our cost of funds and negatively affect our financial condition. The consolidated obligations of the FHLBanks have been rated Aaa/P-1 by Moody’s and AAA/A-1+ by S&P. As of March 20, 2009, one of the FHLBanks had ratings of AA+ and one had a rating of AA, but each were assigned a stable outlook by S&P. No FHLBank was assigned a negative outlook by S&P. FHLBank Topeka and the remaining nine FHLBanks were rated AAA with a stable outlook by S&P as of November 26, 2008. Changes in the credit standing or credit ratings of one or more of the other FHLBanks could result in a revision or withdrawal of the ratings of the consolidated obligations by the rating agencies at any time, negatively affecting our cost of funds and may negatively affect our ability to issue consolidated obligations for our benefit.
 
We face competition for loan demand, purchases of mortgage loans and access to funding which could adversely affect our earnings. Our primary business is making advances to our members. We compete with other suppliers of wholesale funding, both secured and unsecured, including U.S. government-guaranteed programs, investment banks, commercial banks and, in certain circumstances, other FHLBanks. Our members have access to alternative funding sources, which may offer more favorable terms on their loans than we offer on our advances, including more flexible credit or collateral standards. In addition, many of our competitors are not subject to the same regulation that is applicable to us. This enables those competitors to offer products and terms that we are not able to offer.
 
The availability of alternative funding sources to our members may significantly decrease the demand for our advances. Any change we might make in pricing our advances, in order to compete more effectively with these competitive funding sources, may decrease our profitability on advances. A decrease in the demand for our advances, or a decrease in our profitability on advances, would negatively affect our financial condition and results of operations.
 
Likewise, our MPF business is subject to significant competition. The most direct competition for purchases of mortgage loans comes from other buyers of conventional, conforming, fixed rate mortgage loans, such as Fannie Mae and Freddie Mac. Increased competition can result in the acquisition of a smaller market share of the mortgage loans available for purchase and, therefore, lower income from this business activity.
 
We also compete in the capital markets with Fannie Mae, Freddie Mac, other GSEs and U.S. government-guaranteed programs, as well as corporate, sovereign and supranational entities for funds raised through the issuance of consolidated obligations, and other debt instruments. We face increased competition in the Agency/GSE and other related debt markets as a result of new debt programs, including those explicitly guaranteed by the U.S. and foreign governments. Increases in the supply of competing debt products in the capital markets may, in the absence of increases in demand, result in higher debt costs to us or lesser amounts of debt issued at the same cost than otherwise would be the case. Although our supply of funds through issuance of consolidated obligations has kept pace with our funding needs, we cannot assure that this will continue.
 
The yield on or value of our MBS investments may be adversely affected by increased delinquency rates and credit losses related to mortgage loans that back our MBS investments. Delinquencies and losses with respect to residential mortgage loans have generally increased, particularly in the nonprime sector, including subprime and alternative documentation loans. In addition, residential property values in many states have declined or remained stable, after extended periods during which those values appreciated. If delinquency and/or default rates on mortgages continue to increase, and/or there is a rapid decline in residential real estate values, we could experience reduced yields or losses on our MBS investments. In addition, market prices for many of the private-label MBS we hold have deteriorated due to market uncertainty and illiquidity. The significant widening of credit spreads that has occurred since December 31, 2007 further reduced the fair value of our MBS portfolio, which includes Agency and private-label MBS. As a result, we could experience additional other-than-temporary impairments on certain investment securities in the future, which could result in significant losses. Furthermore, market illiquidity has increased the amount of management judgment required to value private-label MBS and certain other securities. Subsequent valuations may result in significant changes in the value of private-label MBS and other investment securities. If we decide to sell securities due to credit deterioration, the price we may ultimately realize will depend on the demand and liquidity in the market at that time and may be materially lower than the fair value reflected in our financial statements.
Securities or mortgage loans pledged as collateral by the FHLBank’s borrowers could be adversely affected by the devaluation or inability to liquidate the collateral in the event of a default by the borrower. Although the FHLBank obtains sufficient collateral on advances to protect it from credit losses, changes in market conditions or other factors may cause the collateral to be worth less, which could lead to a credit loss in the event of a default by a borrower and adversely affect the financial condition and results of operations. A reduction in liquidity in the financial markets or otherwise, could have the same affect.
 
Counterparty credit risk could adversely affect us. We assume unsecured credit risk when entering into money-market transactions and financial derivatives transactions with counterparties. The insolvency, or other inability of a significant counterparty to perform on its obligations under such transactions or other agreements, could have an adverse effect on our financial condition and results of operations.
 
Defaults by one or more of our institutional counterparties on its obligations to us could adversely affect our results of operations or financial condition. We have a high concentration of credit risk exposure to financial institutions as counterparties, which recently have been perceived to present a higher degree of risk than they were perceived to present in the past due to the reduction of liquidity in financial markets and due to the current housing market crisis. Our primary exposures to institutional counterparty risk are with: (1) obligations of mortgage servicers that service the loans we have as collateral on advances; (2) third-party providers of credit enhancements on the MBS that we hold in our investment portfolio, including mortgage insurers, bond insurers and financial guarantors; (3) third-party providers of supplemental mortgage insurance for mortgage loans purchased under the MPF programs; and (4) derivative counterparties. The liquidity and financial condition of some of our counterparties may have been adversely affected by the reduction of liquidity in the financial markets and the housing market crisis. A default by a counterparty with significant obligations to us could adversely affect our ability to conduct operations efficiently and at cost-effective rates, which in turn could adversely affect our results of operations or financial condition.
 
We rely upon derivatives to lower our cost of funds and reduce our interest-rate, option and prepayment risk, and we may not be able to enter into effective derivative instruments on acceptable terms. We use derivatives to: (1) obtain funding at more favorable rates; and (2) reduce our interest-rate risk, option risk and mortgage-prepayment risk. Management determines the nature and quantity of hedging transactions using derivatives based on various factors, including market conditions and the expected volume and terms of advances. As a result, our effective use of derivatives depends upon management’s ability to determine the appropriate hedging positions in light of: (1) our assets and liabilities; and (2) prevailing and anticipated market conditions. In addition, the effectiveness of our hedging strategies depends upon our ability to enter into derivatives with acceptable parties, on terms desirable to us and in the quantities necessary to hedge our corresponding obligations, interest-rate risk or other risks. The cost of entering into derivative instruments has increased as a result of: (1) consolidations, mergers and bankruptcy or insolvency of financial institutions, which have led to fewer counterparties, resulting in less liquidity in the derivatives market; and (2) increased uncertainty related to the potential changes in regulations regarding over-the-counter derivatives. If we are unable to manage our hedging positions properly, or are unable to enter into derivative hedging instruments on desirable terms, we may continue to incur higher funding costs and be unable to effectively manage our interest-rate risk and other risks, which could negatively affect our financial condition and results of operations.
 
We may not be able to pay dividends at rates consistent with past practices. Our Board of Directors may only declare dividends on our capital stock, payable to members, from our retained earnings and current income. Our ability to pay dividends also is subject to statutory and regulatory requirements, including meeting all regulatory capital requirements. For example, the potential promulgation of regulations by the Finance Agency that would require higher levels of retained earnings or mandated revisions to our retained earnings policy could lead to higher levels of retained earnings, and thus, lower amounts of net income available to be paid out to our members as dividends. Failure of the FHLBank to meet any of its regulatory capital requirements would prevent us from paying any dividend.
 
Further, events such as changes in our market-risk profile, credit quality of assets held and increased volatility of net income caused by the application of certain generally accepted accounting principles may affect the adequacy of our retained earnings and may require us to increase our target level of retained earnings and correspondingly reduce our dividends from historical dividend payout ratios in order to achieve and maintain the targeted amounts of retained earnings under our retained earnings policy.
 
Our ability to declare dividends may be restricted by Finance Agency Rules regarding excess stock. In December 2006, the Finance Agency adopted a final rule limiting the ability of the FHLBank to create member excess stock under certain circumstances. Under the rule, any FHLBank with excess stock greater than one percent of its total assets will be prohibited from further increasing member excess stock by paying stock dividends or otherwise issuing new excess stock. We believe that the rule could restrict the type of dividends that we might be permitted to pay in the future, which could, in turn, adversely affect demand for our advances.
 
Lack of a public market and restrictions on transferring our stock could result in an illiquid investment for the holder. Under the GLB Act, Finance Agency regulations and our capital plan, our Class A Common Stock may be redeemed upon the expiration of a six-month redemption period and our Class B Common Stock after a five-year redemption period following our receipt of a redemption request. Only capital stock in excess of a member’s minimum investment requirement, capital stock held by a member that has submitted a notice to withdraw from membership or capital stock held by a member whose membership has been terminated may be redeemed at the end of the redemption period. Further, we may elect to repurchase excess capital stock of a member at any time at our sole discretion.
 
We cannot guarantee, however, that a member will be able to redeem its investment even at the end of the redemption periods. The redemption or repurchase of our capital stock is prohibited by Finance Agency regulations and our capital plan if the redemption or repurchase of the capital stock would cause us to fail to meet our minimum regulatory capital requirements. Likewise, under such regulations and the terms of our capital plan, we could not honor a member’s capital stock redemption request if the redemption would cause the member to fail to maintain its minimum capital stock investment requirement. Moreover, since our capital stock may only be owned by our members (or, under certain circumstances, former members and certain successor institutions), and our capital plan requires our approval before a member may transfer any of its capital stock to another member, we cannot assure that a member would be allowed to sell or transfer any excess capital stock to another member at any point in time.
We may also suspend the redemption of capital stock if we reasonably believe that the redemption would prevent us from maintaining adequate capital against a potential risk, or would otherwise prevent us from operating in a safe and sound manner. In addition, approval from the Finance Agency for redemptions or repurchases is required if the Finance Agency or our Board of Directors were to determine that we have incurred, or are likely to incur, losses that result in, or are likely to result in, charges against our capital. Under such circumstances, we cannot assure that the Finance Agency would grant such approval or, if it did, upon what terms it might do so. We may also be prohibited from repurchasing or redeeming our capital stock if the principal and interest due on any consolidated obligations issued through the Office of Finance has not been paid in full or if we become unable to comply with regulatory liquidity requirements or satisfy our current obligations.
 
Accordingly, there are a variety of circumstances that would preclude us from redeeming or repurchasing our capital stock that is held by a member. Since there is no public market for our capital stock and transfers require our approval, we cannot assure that a member’s purchase of our capital stock would not effectively become an illiquid investment.
 
Changes in application of relevant accounting standards, especially SFAS 133, could materially increase earnings volatility. We are subject to earnings volatility because of our use of derivatives and the application of SFAS 133 in accounting for those derivatives. This earnings volatility is caused by hedge ineffectiveness, which is the difference in the amounts recognized in our earnings for the changes in fair value of a derivative and the related hedged item, and by the changes in the fair values of derivatives that do not qualify for hedge accounting under the rules of SFAS 133 (referred to as economic hedges where the change in fair value of the derivative is not offset by any change in fair value on a hedged item). If we did not apply hedge accounting under SFAS 133, the result could be an increase in volatility of our earnings from period to period. Proposed guidance from the Financial Accounting Standards Board to eliminate the current option to hedge the benchmark rate would result in the FHLBank marking the hedged item to full fair value and could result in a significant number of current highly effective benchmark hedges failing to be highly effective if converted to full fair value hedges, which would result in increased earnings volatility. Such increases in earnings volatility could affect our ability to pay dividends, our ability to meet our retained earnings target, and our members’ willingness to hold the stock necessary for membership and/or activity with us, such as advance and mortgage loan activities.
 
We rely heavily upon information systems and other technology. We rely heavily upon information systems and other technology to conduct and manage our business. To the extent that we experience a failure or interruption in any of these systems or other technology, we may be unable to conduct and manage our business effectively, including, without limitation, our funding, hedging and advance activities. While we have implemented disaster recovery and business continuity plans, we can make no assurance that these plans will be able to prevent, timely and adequately address, or mitigate the negative effects of any such failure or interruption. Any failure or interruption could significantly harm our customer relations, risk management and profitability, which could negatively affect our financial condition and results of operations.
 
We could be negatively affected by local and national business and economic conditions, as well as other events that are outside of our control. Local and national economic conditions could be less favorable than expected or could have a more direct and pronounced effect on our business than expected. For example, conditions affecting interest rates, money supply, inflation and capital markets, including those stemming from policies of governmental entities such as the Federal Reserve Board or the U.S. Treasury, have a significant impact on our operations. Changes in these conditions could adversely affect our ability to increase and maintain the quality of our interest-earning assets and could increase the costs of our interest-bearing liabilities. For example, a prolonged or worsening economic downturn or the continued deterioration of property values could cause higher delinquency and default rates on our outstanding mortgage loans and even cause a loss on our advances, although we have never incurred a credit loss on an advance.
 
Furthermore, natural disasters, acts of terrorism and other events outside of our control, especially if they occur in our four-state district, could negatively affect us, including damaging our members’ businesses, our real property and the collateral for our advances and mortgage loans, and in other ways. For example, if there is a natural disaster or other event, such as the terrorist attacks of September 11, 2001, that limits or prevents the FHLBank System from accessing the capital markets for a period of time, our business would be significantly affected, including our ability to provide advances to our members.
 
We could experience a credit loss from insured MBS/CMO, HFA securities and/or portions of MPF Program loans should a monoline mortgage insurance company fail to perform. Increased delinquency rates and credit losses related to mortgage loans pooled into MBS/CMO and HFA securities, which are insured by one of the monoline mortgage insurance companies, could adversely affect the yield on or value of the FHLBank’s MBS/CMO and HFA investments. The magnitude of the losses in the home mortgage loan market could potentially overwhelm one of the monoline mortgage insurance companies resulting in such company’s failure to perform. If the collateral losses exceed the coverage ability of the insurance company, the MBS/CMO or HFA bond holders could experience losses of principal.
 
A third-party insurer (obligated under PMI or SMI) of portions of the FHLBank’s MPF Program loans could also fail to perform as expected. Should a PMI third-party insurer fail to perform, it would increase the FHLBank’s credit risk exposure because the FHLBank’s FLA is the next layer to absorb credit losses on mortgage loan pools. Likewise, if an SMI third-party insurer fails to perform, it would increase the FHLBank’s credit risk exposure because it would reduce the participating member’s CE obligation loss layer since SMI is purchased by PFIs to cover all or a portion of their CE obligation exposure for mortgage pools.
 
Merger or consolidation of our members may result in a loss of business to us. The financial services industry periodically experiences consolidation. If future consolidation occurs within our district, it may reduce the number of current and potential members in our district, resulting in a loss of business to us and a potential reduction in our profitability. If our advances are concentrated in a smaller number of members, our risk of loss resulting from a single event (such as the loss of a member’s business due to the member’s acquisition by a nonmember) would become proportionately greater.

Item 1B: Unresolved Staff Comments

Not applicable.
Item 2: Properties

The FHLBank occupies approximately 62,796 square feet of leased office space at One Security Benefit Place, Suite 100, Topeka, Kansas. The FHLBank also maintains in Topeka a leased off-site back-up facility with approximately 3,000 square feet. Small offices are leased in Nebraska and Oklahoma for member account management personnel.

Item 3: Legal Proceedings

The FHLBank is subject to various pending legal proceedings arising in the normal course of business. After consultation with legal counsel, management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material adverse effect on the FHLBank’s financial condition or results of operations.

Item 4: Submission of Matters to a Vote of Security Holders

Currently, the board is comprised of 14 directors, eight of whom are member directors and six of whom are independent directors. Members holding FHLBank capital stock on December 31 of the preceding year can participate in the annual election process for FHLBank directors. Eligible members may nominate and elect representatives from members in their state to serve four-year terms on the board of directors of the FHLBank as member directors and also may vote for individuals nominated by the Board of Directors who are then elected at-large from the FHLBank’s district to serve four-year terms as independent directors. The Finance Agency may adjust the length of a director’s term in order to achieve staggering of the board. For each directorship to be filled in an election, each member institution is entitled to cast one vote for each share of capital stock that the member was required to hold as of December 31 of the calendar year immediately preceding the election year, provided, however, the number of votes that any member may cast for any one directorship may not exceed the average number of shares of capital stock that were required to be held by all members located in the state on that date. The rules governing the election of directors were established by the Finance Agency and are codified at 12 C.F.R. Section 1261. Guidance specific to the FHLBank, because of its use of the two-class capital stock structure, is contained in Section 10 of the FHLBank’s capital plan, which is consistent with 12 C.F.R. Section 1261. Furthermore, the FHLBank’s Board of Directors has adopted procedures for the nomination and election of independent directors, which are set forth in the FHLBank’s Amended and Restated Bylaws, attached as Exhibit 3.2 to the FHLBank’s Form 8-K filed with the SEC on October 22, 2008 and incorporated herein by this reference.

During 2008, member directorships were open for election in the states of Colorado and Kansas, and two independent directorships were open for the district at-large.

Member Director Elections
On June 30, 2008, the FHLBank commenced its member director election process. However, in anticipation of the issuance of the Finance Agency’s interim final rule on director elections, the FHLBank delayed the election on September 11, 2008. The election re-commenced on October 15, 2008, when the FHLBank mailed ballots to members in Colorado and Kansas. On December 2, 2008, as reported by the FHLBank in its current report on Form 8-K filed on the same day, the FHLBank announced that two incumbent directors were re-elected to terms commencing January 1, 2009. Mr. Michael M. Berryhill was re-elected to a four-year term as a member director from Colorado, and Mr. Ronald K. Wente was re-elected to a four-year term as a member director from Kansas. The election results were as follows:
 
COLORADO
(Total Voting Shares Cast - 664,875; Number of Votes Cast - 97)
 
Elected – Michael M. Berryhill, Chairman, President and CEO, Morgan Federal Bank, Fort Morgan, Colo.
Total Shares - 541,744 or 81 percent
Term Expires - 12/31/2012
 
Sundie L. Seefried, President and CEO, Eagle Legacy Credit Union, Arvada, Colo.
Total Shares - 123,131 or 19 percent
 
KANSAS
(Total Voting Shares Cast - 881,159; Number of Votes Cast - 169)
 
Elected – Ronald K. Wente, President and CEO, Golden Belt Bank, Ellis, Kan.
Total Shares - 750,922 or 85 percent
Term Expires - 12/31/2012
 
Jon W. Pope, President, Peoples State Bank, McDonald, Kan.
Total Shares - 130,237 or 15 percent
 
Independent Director Elections
On November 5, 2008, the FHLBank commenced its independent director election process. Individuals were nominated by the FHLBank’s Board of Directors after consultation with the FHLBank’s Affordable Housing Advisory Council. Those nominees were placed on the ballot for election in the FHLBank’s district at-large. On December 30, 2008, as reported by the FHLBank in its current report on Form 8-K filed on the same day, the FHLBank announced that two incumbent directors were elected to independent director terms commencing January 1, 2009. Due to the need to stagger the expiration date of directorships, Mr. Thomas E. Henning was elected to a three-year term as an independent director, and Mr. Neil F.M. McKay was elected to a four-year term as an independent director. The election results were as follows:
TENTH DISTRICT
(Total Voting Shares Eligible to be Cast - 4,072,221; Number of Voting Members - 491)
 
Thomas E. Henning, Chairman, President and CEO, Assurity Life Insurance Company
Number of Votes Cast for Mr. Henning - 2,370,543
Term Expires - December 31, 2011
 
Neil F.M. McKay, Retired, Former CFO and Treasurer, Capitol Federal Savings Bank
Number of Votes Cast for Mr. McKay - 2,375,153
Term Expires - December 31, 2012
 
In 2008, only four directorships were up for election. Therefore, 10 incumbents remained on the FHLBank’s Board of Directors without being placed on the ballot for election. These incumbent directors were: Mr. Lindel E. Pettigrew; Mr. Robert E. Caldwell, II; Mr. James R. Hamby; Mr. Steven D. Hogan; Mr. Andrew C. Hove, Jr.; Ms. Jane C. Knight; Mr. Richard S. Masinton; Mr. Lawrence L. McCants; Mr. Thomas H. Olson; and Mr. Bruce A. Schriefer. As noted in Item 1, Legislative and Regulatory Developments, on May 14, 2008, the Finance Board decreased the FHLBank’s number of elective directorships by one to a total of eight member directors, effective January 1, 2009. Consequently, the directorship held by Gordon C. “Bud” Smith, Jr. expired on December 31, 2008.

PART II

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

As a cooperative, members own almost all the Class A Common Stock and Class B Common Stock of the FHLBank with the remainder of the capital stock held by former members that are required to retain capital stock ownership to support outstanding advances executed and mortgage loans sold while they were members. Note, however, that in accordance with SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” a portion of the FHLBank capital stock is treated as a liability and not as capital, including the capital stock of former members. There is no public trading market for the FHLBank’s capital stock.
 
All member directors of the FHLBank are elected by and from the membership, and the FHLBank conducts its business in advances and mortgage loan acquisitions almost exclusively with its members. There is no established marketplace for the FHLBank’s stock and it is not publicly traded. Depending on the class of capital stock, it may be redeemed at par value either six months (Class A Common Stock) or five years (Class B Common Stock) after the FHLBank receives a written request by a member, subject to regulatory limits and to the satisfaction of any ongoing stock investment requirements applying to the member under the FHLBank’s capital plan. The FHLBank may repurchase shares held by members in excess of the members’ required stock holdings at its discretion at any time at par value. Par value of all common stock is $100 per share. As of December 31, 2008, the FHLBank had 886 stockholders and 6,686,666 shares of Class A Common Stock and 16,064,741 shares of Class B Common Stock outstanding, including 347,256 shares of Class A Common Stock and 799 shares of Class B Common Stock subject to mandatory redemption by members. The FHLBank is not currently required to register either class of its stock under the Securities Act of 1933 (as amended). The Recovery Act amended the Exchange Act to require the registration of a class of common stock of each FHLBank under Section 12(g) and for each FHLBank to maintain such registration and to be treated as an “issuer” under the Exchange Act, regardless of the number of members holding such a class of stock at any given time. Pursuant to a Finance Agency regulation, the FHLBank was required to file a registration statement in order to register one of its classes of stock pursuant to section 12(g)(1) of the Exchange Act. The FHLBank’s registration was effective July 14, 2006.
 
The FHLBank paid quarterly stock dividends during the years ended December 31, 2008, 2007 and 2006, which includes dividends treated as interest expense for mandatorily redeemable shares. Dividends paid on capital stock are outlined in Tables 12 and 13 (in thousands):

Table 12

   
Class A Common Stock
  
   
Percent
    
Dividends
Paid in Cash1
    
Dividends Paid
in Class B
Common Stock
    
Total
Dividends
Paid
  
12/31/2008
     0.75 %   $ 45     $ 1,204     $ 1,249  
09/30/2008
     1.75       46       2,732       2,778  
06/30/2008
     1.75       48       2,717       2,765  
03/31/2008
     2.75       44       4,428       4,472  
12/31/2007
     4.00       44       6,729       6,773  
09/30/2007
     4.55       45       7,636       7,681  
06/30/2007
     4.45       45       6,943       6,988  
03/31/2007
     4.45       79       6,580       6,659  
12/31/2006
     4.45       45       6,783       6,828  
09/30/2006
     4.45       47       6,108       6,155  
06/30/2006
     4.25       47       5,972       6,019  
03/31/2006
     3.85       46       5,412       5,458  
Table 13

   
Class B Common Stock
  
   
Percent
    
Dividends
Paid in Cash1
    
Dividends Paid
in Class B
Common Stock
    
Total
Dividends
Paid
  
12/31/2008
     2.50 %   $ 37     $ 10,874     $ 10,911  
09/30/2008
     4.75       43       19,892       19,935  
06/30/2008
     4.75       45       17,815       17,860  
03/31/2008
     5.75       40       20,879       20,919  
12/31/2007
     6.25       43       24,045       24,088  
09/30/2007
     6.70       40       23,296       23,336  
06/30/2007
     6.50       46       20,492       20,538  
03/31/2007
     6.50       40       21,018       21,058  
12/31/2006
     6.50       45       21,791       21,836  
09/30/2006
     6.25       46       20,627       20,673  
06/30/2006
     6.05       38       19,298       19,336  
03/31/2006
     5.60       47       17,785       17,832  
                    
1
The cash dividends listed are cash dividends paid for partial shares and dividends paid to former members. Stock dividends are paid in whole shares.

Management anticipates that the FHLBank will continue to pay quarterly dividends in the future, primarily in shares of Class B Common Stock. The FHLBank believes that dividends paid in the form of stock are advantageous to members because FHLBank stock dividends generally qualify as tax-deferred stock dividends under the Internal Revenue Code (IRC) and are, therefore, not taxable at the time declared and credited to a member. Dividends paid in stock can be utilized by members to support future activity with the FHLBank or can be redeemed by the member if the amounts represent excess stock, subject to stock redemption request procedures and limitations. The FHLBank’s dividends generally increase as short-term interest rates rise and decrease as short-term interest rates fall. The dividend percent paid has historically been a function of or closely tied to the FHLBank’s net income for a dividend period. See Item 1 – “Business – Capital, Capital Rules and Dividends – Dividends” for information regarding the FHLBank’s retained earnings policy.
 
On December 28, 2006, the Finance Board adopted a final rule (effective January 29, 2007) limiting the ability of the FHLBank to create member excess stock under certain circumstances. Under the rule, any FHLBank with excess stock greater than one percent of its total assets will be barred from further increasing member excess stock by paying stock dividends or otherwise issuing new excess stock. The FHLBank anticipates that it will be able to manage its excess capital stock position in order to continue to pay stock dividends, but cannot guarantee that it will always be able to do so in the future.
 
The FHLBank has a retained earnings policy that was considered by the Board of Directors when dividends were declared during 2006, 2007 and 2008, but the retained earnings target calculated in accordance with the policy did not significantly affect the level of dividends declared and paid. On August 25, 2005, the Finance Board issued Advisory Bulletin 2005-AB-07, Federal Home Loan Bank Registration With the Securities and Exchange Commission, (AB 2005-AB-07) requiring that until an FHLBank has completed any financial restatements and the registration of its stock has become effective with the SEC, it must demonstrate to the satisfaction of the Finance Board that any proposed dividend payments would comply with the requirements of Section 16(a) of the Bank Act and should declare a dividend only following consultation with and approval by the Finance Board’s Office of Supervision. Because the FHLBank had not filed its Form 10 and therefore its registration with the SEC was not effective, the FHLBank was required to obtain Finance Board approval for the dividends paid to its stockholders on September 30, 2005, December 31, 2005, March 31, 2006 and June 30, 2006. The result of the Finance Board approval process was that the FHLBank paid lower dividend rates on its stock than it would otherwise have paid, with the dividend rates being in the range of 0.15 to 0.75 percent per annum below the rates it otherwise would have paid in those dividend periods. See Item 1 – “Business – Capital, Capital Rules and Dividends” for more information regarding the FHLBank’s capital plan. FHLBank management does not expect that its retained earnings policy will significantly affect dividends paid during 2009. Management expects that the FHLBank will continue to be able to make additions to retained earnings while paying Class B Common Stock dividends at or above short-term market interest rates and Class A Common Stock dividends (paid in cash or in Class B Common Stock) at or slightly below short-term market interest rates, on average. However, there is a possibility that dividend levels might be reduced in order to meet the target level of retained earnings under the policy since the target level fluctuates from period to period, because it is a function of the size and composition of the FHLBank’s balance sheet and the risks contained therein. Dividends may be paid in cash or Class B Common Stock as authorized under the FHLBank’s capital plan and approved by its Board of Directors.
Item 6: Selected Financial Data

Table 14

Selected Financial Data (dollar amounts in thousands):

   
12/31/2008
    
12/31/2007
    
12/31/2006
    
12/31/2005
    
12/31/2004
  
Statement of Condition (at year end)
                              
Total assets
  
$
58,556,231
    
$
55,304,572
    
$
52,672,226
    
$
46,862,021
    
$
44,978,486
  
Investments1
    
19,435,809
      
20,515,451
      
21,497,705
      
17,068,211
      
14,779,489
  
Advances
    
35,819,674
      
32,057,139
      
28,445,245
      
27,086,568
      
27,489,919
  
Mortgage loans held for portfolio, net
    
3,023,805
      
2,352,301
      
2,375,284
      
2,424,258
      
2,437,660
  
Deposits
    
1,703,531
      
1,340,816
      
1,117,006
      
893,253
      
847,718
  
Consolidated obligations, net2
    
53,683,045
      
51,109,456
      
48,775,006
      
43,323,379
      
41,258,302
  
Capital
    
2,395,245
      
2,297,854
      
2,173,376
      
1,919,464
      
1,887,524
  
                                         
Statement of Income (for the year ended)
                                        
Net interest income before loan loss provision/reversal
    
247,287
      
231,825
      
215,240
      
225,505
      
158,290
  
Provision for (reversal of) credit losses on mortgage loans
    
196
      
(25
)
    
358
      
335
      
295
  
Other income (loss)
    
(168,312
)
    
10,220
      
4,370
      
(10,091
)
    
(5,614
) 
Other expenses
    
40,002
      
37,254
      
33,211
      
29,452
      
24,392
  
Income before assessments
    
38,777
      
204,816
      
186,041
      
185,627
      
127,989
  
Assessments
    
10,338
      
54,510
      
49,578
      
49,279
      
33,965
  
Net income
    
28,439
      
150,306
      
136,463
      
136,348
      
94,024
  
                                         
Ratios and Other Financial Data
                                        
Dividends paid in cash3
    
345
      
373
      
354
      
348
      
244
  
Dividends paid in stock3
    
79,935
      
114,647
      
101,189
      
84,912
      
66,334
  
Weighted average dividend rate4
    
4.34
%
    
6.00
%
    
5.72
%
    
4.68
%
    
3.72
%
Dividend payout ratio
    
282.29
%
    
76.52
%
    
74.41
%
    
62.53
%
    
70.81
%
Return on average equity
    
1.17
%
    
6.93
%
    
6.88
%
    
6.97
%
    
5.05
%
Return on average assets
    
0.05
%
    
0.29
%
    
0.28
%
    
0.29
%
    
0.22
%
Average equity to average assets
    
4.15
%
    
4.14
%
    
4.10
%
    
4.21
%
    
4.34
%
Net interest margin5
    
0.43
%
    
0.44
%
    
0.45
%
    
0.49
%
    
0.37
%
Total capital ratio at period end6
    
4.09
%
    
4.15
%
    
4.13
%
    
4.10
%
    
4.20
%
Ratio of earnings to fixed charges7
    
1.02
      
1.08
      
1.08
      
1.12
      
1.16
  
                    
1
Investments also include interest-bearing deposits, securities purchased under agreements to resell and Federal funds sold.
2
Consolidated obligations are bonds and discount notes that the FHLBank is primarily liable to repay. See Note 11 to the financial statements for a description of the total consolidated obligations of all 12 FHLBanks for which the FHLBank is jointly and severally liable under the requirements of the Finance Agency which governs the issuance of debt for the 12 FHLBanks.
3
Dividends reclassified as interest expense on mandatorily redeemable capital stock in accordance with SFAS 150 and not included as GAAP dividends were $609,000, $2,101,000, $2,594,000, $384,000 and $109,000 for the years ended December 31, 2008, 2007, 2006, 2005 and 2004, respectively.
4
Weighted average dividend rates are dividends paid in cash and stock on both classes of stock divided by the average capital stock eligible for dividends.
5
Net interest margin is net interest income before mortgage loan loss provision as a percentage of average earning assets.
6
Total capital ratio is GAAP capital stock, which excludes mandatorily redeemable capital stock in accordance with SFAS 150, plus retained earnings and accumulated other comprehensive income as a percentage of total assets at year-end.
7
The ratio of earnings to fixed charges (interest expense including amortization/accretion of premiums, discounts and capitalized expenses related to indebtedness) is computed by dividing total earnings by fixed charges.

Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations reviews the financial condition of the FHLBank as of December 31, 2008 and 2007, and results of operations for the years ended December 31, 2008, 2007 and 2006. This discussion should be read in conjunction with the FHLBank’s audited financial statements and related notes for the year ended December 31, 2008 included in Item 8 of this report.
FINANCIAL REVIEW

Overview
Despite a very difficult market environment during late 2007 and throughout 2008, the FHLBank continued to fulfill its mission by providing stable funding and ample liquidity to its member financial institutions. As a result, total assets grew 5.9 percent to $58.6 billion at December 31, 2008, up from $55.3 billion at December 31, 2007. The overall increase was primarily due to advance growth during 2008, with advances increasing 11.7 percent from $32.1 billion as of the end of 2007 to $35.8 billion as of the end of 2008. The five largest advance borrowers accounted for only $0.5 billion of the increase in advances, while the remaining increase in advances was spread among the remainder of the FHLBank member borrowers. The MPF Program grew significantly during 2008 with total mortgage loans increasing 28.5 percent from $2.4 billion as of December 31, 2007 to $3.0 billion at December 31, 2008, as the FHLBank offered favorable prices compared to Fannie Mae and Freddie Mac during that period. A portion of this increase resulted from the purchase of $0.2 billion of out-of-district mortgage loans participated through the FHLBank of Chicago. The FHLBank continues to strive for growth in both advances and mortgage loans, but its primary business remains the advance business.
 
The FHLBank’s net income for 2008 was $28.4 million compared to $150.3 million for 2007. The significant changes in the components of net income are as follows:
§
$15.5 million increase in net interest income (increase income);
§
$26.2 million increase in net gains (losses) on trading securities (increase income);
§
$205.3 million decrease in net gains (losses) on derivatives and hedging activities (increase in losses, which results in a decrease in income);
§
$4.8 million loss on other-than-temporarily impaired held-to-maturity securities (decrease income);
§
$3.2 million increase in realized gains (losses) on investments (decrease in losses, which results in an increase in income); and
§
$44.2 million decrease in assessments (increase income).

The FHLBank’s net interest margin was 0.43 percent for 2008, compared to 0.44 percent for 2007. This decrease in net interest margin was more than offset by the increase in average earning assets, which resulted in an increase in net interest income from $231.8 million in 2007 to $247.3 million in 2008. However, return on equity averaged 1.17 percent in 2008 and 6.93 percent in 2007. The increase in net interest income and the positive impact of the change in net gain (loss) on trading securities were offset by the negative impact of the change in net gain (loss) on derivatives and hedging activities and the loss on other-than-temporarily impaired held-to-maturity securities. These two factors are the major reason for the significant decrease in net income and the resulting return on equity for 2008 compared to 2007. The loss on derivatives and hedging activities is primarily due to a change in the relationship between interest rates on GSE debt securities and interest rate swaps during 2008, but also includes losses on purchased interest rate caps that are economic hedges of caps embedded in variable rate MBS/CMOs. Interest rates on GSE debt securities and interest rate swaps typically moved together and were very well correlated until financial difficulties at Fannie Mae and Freddie Mac created a considerable divergence. This divergence caused the losses on derivatives (interest rate swaps) to be much larger than gains on the hedged items (GSE debentures).
 
The average dividend rates paid during 2008 were 2.04 percent and 4.70 percent for Class A Common Stock and Class B Common Stock, respectively, with an overall average dividend rate of 4.34 percent for 2008. This was a decrease over average dividends paid during 2007 of 4.37 percent and 6.48 percent for Class A Common Stock and Class B Common Stock, respectively, with an overall average dividend rate of 6.00 percent for 2007. With short-term interest rates falling to historic lows in December 2008 and into 2009, we anticipate that average 2009 dividend rates will fall from the 2008 levels. Refer to this Item 7 – “Capital Distributions” for further information regarding FHLBank dividend payments.

Financial Market Trends
The primary external factors that affect net interest income are market interest rates and the general state of the economy. Table 15 presents selected market interest rates as of the dates or periods shown.

Table 15

Market Instrument
  
Average Rate
for 2008
    
Average Rate
for 2007
    
December 31, 2008
Ending Rate
    
December 31, 2007
Ending Rate
  
Overnight Federal funds effective/target rate1
     1.94 %     5.03 %  
0.0 to 0.25
 %      4.25 %
FOMC target rate for overnight Federal funds1
     2.08       5.05    
0.0 to 0.25
       4.25  
3-month Treasury bill1
     1.37       4.46       0.08       3.24  
3-month LIBOR1
     2.93       5.30       1.43       4.70  
2-year U.S. Treasury note1
     1.99       4.36       0.77       3.05  
5-year U.S. Treasury note1
     2.79       4.42       1.55       3.44  
10-year U.S. Treasury note1
     3.64       4.63       2.21       4.03  
30-year residential mortgage note rate2
     6.02       6.27       5.03       6.05  
                    
1
Source is Bloomberg (Overnight Federal funds rate is the effective rate for the yearly averages and the target rate for the ending rates).
2
Mortgage Bankers Association weekly 30-year fixed rate mortgage contract rate obtained from Bloomberg.
Critical Accounting Policies and Estimates
The preparation of the FHLBank’s financial statements in accordance with GAAP requires management to make a number of judgments and assumptions that affect the FHLBank’s reported results and disclosures. Several of the FHLBank’s accounting policies are inherently subject to valuation assumptions and other subjective assessments and are more critical than others in terms of their importance to the FHLBank’s results. These assumptions and assessments include the following:
§
Accounting related to derivatives;
§
Fair-value determinations;
§
Accounting for other-than-temporary impairment of investments;
§
Accounting for deferred premium/discount associated with MBS; and
§
Determining the adequacy of the allowance for credit losses.

Changes in any of the estimates and assumptions underlying the FHLBank’s critical accounting policies could have a material effect on the FHLBank’s financial statements.
 
The FHLBank’s accounting policies that management believes are the most critical to an understanding of the FHLBank’s financial results and condition and require complex management judgment are described below.
 
Accounting for Derivatives. The FHLBank carries derivative instruments at fair value on the statement of condition. Any change in the fair value of a derivative is recorded each period in current period earnings or other comprehensive income, depending whether the derivative is designated as part of a hedging relationship and, if it is, the type of hedging relationship. A majority of the FHLBank’s derivatives are structured to offset some or all of the risk exposure inherent in its lending, mortgage purchase, investment and funding activities. Under SFAS 133, the FHLBank is required to recognize unrealized losses or gains on derivative positions, regardless of whether offsetting gains or losses on the underlying assets or liabilities being hedged may be recognized in a symmetrical manner. Therefore, the accounting framework imposed by SFAS 133 introduces the potential for considerable income variability. Specifically, a mismatch can exist between the timing of income and expense recognition from assets or liabilities and the income effects of derivative instruments positioned to mitigate market risk and cash flow variability. Therefore, during periods of significant changes in interest rates and other market factors, the FHLBank’s reported earnings may exhibit considerable variability. The FHLBank emphasizes hedging techniques that are effective under the hedge accounting requirements of SFAS 133. However, in some cases, the FHLBank has elected to retain or enter into derivatives that are economically effective at reducing its risk but do not meet the hedge accounting requirements of SFAS 133, either because the cost of the derivative hedge was economically superior to non-derivative hedging alternatives or because no non-derivative hedging alternative was available. As required by Finance Agency regulation and the FHLBank’s RMP, derivative instruments that do not qualify as hedging instruments pursuant to SFAS 133 may be used only if a non-speculative purpose is documented by the FHLBank at the inception of the derivative transaction.
 
A hedging relationship is created from the designation of a derivative financial instrument as either hedging the FHLBank’s exposure to changes in the fair value of a financial instrument or changes in future cash flows attributable to a balance sheet financial instrument or anticipated transaction. Fair value hedge accounting allows for the offsetting fair value of the hedged risk in the hedged item to also be recorded in current period earnings. Highly effective hedges that use interest rate swaps as the hedging instrument and that meet certain stringent criteria can qualify for “shortcut” fair value hedge accounting. Shortcut accounting allows for the assumption of no ineffectiveness, which means that the change in fair value of the hedged item can be assumed to be equal to the change in fair value of the derivative. If the hedge is not designated for shortcut accounting, it is treated as a “long haul” fair value hedge, where the change in fair value of the hedged item must be measured separately from the derivative, and for which effectiveness testing must be performed regularly with results falling within established tolerances. If the hedge fails effectiveness testing, the hedge no longer qualifies for hedge accounting and the derivative is marked to estimated fair value through current period earnings without any offsetting change in estimated fair value related to the hedged item.
 
For derivative transactions that potentially qualify for long haul fair value hedge accounting treatment, management must assess how effective the derivatives have been, and are expected to be, in hedging offsetting changes in the estimated fair values attributable to the risks being hedged in the hedged items. Hedge effectiveness testing is performed at the inception of the hedging relationship and on an ongoing basis for long haul fair value hedges. The FHLBank performs testing at hedge inception based on regression analysis of the hypothetical performance of the hedging relationship using historical market data. The FHLBank then performs regression testing on an ongoing basis using accumulated actual values in conjunction with hypothetical values. Specifically, each month the FHLBank uses a consistently applied statistical methodology that employs a sample of 30 historical interest rate environments and includes an R-squared test, a slope test and an F-statistic test. These tests measure the degree of correlation of movements in estimated fair values between the derivative and the related hedged item. For the hedging relationship to be considered effective, the R-squared must be greater than or equal to 0.80, the slope must be between or equal to -0.80 and -1.20, and the computed F statistic must be greater than  or equal to 4.0.
 
Given that a derivative qualifies for long haul fair value hedge accounting treatment, the most important element of effectiveness testing is the price sensitivity of the derivative and the hedged item in response to changes in interest rates and volatility as expressed by their effective durations. The effective duration will be influenced mostly by the final maturity and any option characteristics. In general, the shorter the effective duration, the more likely it is that effectiveness testing would fail because of the impact of the LIBOR side of the interest rate swap. In this circumstance, the slope criterion is the more likely factor to cause the effectiveness test to fail.
 
The estimated fair values of the derivatives and hedged items do not have any cumulative economic effect if the derivative and the hedged item are held to maturity, or contain mutual optional termination provisions at par. Since these fair values fluctuate throughout the hedge period and eventually return to par value on the maturity or option exercise date, the earnings impact of fair value changes is only a timing issue for hedging relationships that remain outstanding to maturity or the call termination date.
For derivative instruments and hedged items that meet the requirements of SFAS 133 as described above, the FHLBank does not anticipate any significant impact on its financial condition or operating performance. For derivative instruments where no identified hedged item qualifies for hedge accounting under SFAS 133, changes in the market value of the derivative are reflected in monthly income. As of December 31, 2008 and 2007, the FHLBank held a portfolio of derivatives that are marked to market with no offsetting SFAS 133 qualifying hedged item. This portfolio includes interest rate caps and floors, interest rate swaps hedging trading securities, interest rate swaps hedging DOE risk and interest rate swaps used to lower the FHLBank’s cost of funds. The total fair value of these positions, including accrued net interest, was $(187.9) million and $(3.4) million as of December 31, 2008 and 2007, respectively. While the fair value of these derivative instruments, with no offsetting SFAS 133 qualifying hedged item, will fluctuate with changes in interest rates and the impact on the FHLBank’s earnings can be material, the change in market value of trading securities being hedged by economic hedges is expected to partially offset that impact. The change in fair value of the derivatives classified as economic hedges is only partially offset by the change in the market value of trading securities being hedged by economic hedges because the amount of economic hedges exceeds the amount of swapped trading securities: (1) notional amount of interest rate caps and floors of $6.7 billion as of December 31, 2008 and $3.5 billion as of December 31, 2007 that were not designated as SFAS 133 qualifying hedges (economic hedges of embedded caps in and overall duration of variable-rate MBS); (2) notional amount of interest rate swaps of $0.9 billion as of December 31, 2008 and $0.5 billion as of December 31, 2007 that were not designated as SFAS 133 qualifying hedges (economic hedges of the cost of consolidated obligation bonds); (3) notional amounts of $1.6 billion and $0.8 billion of interest rate swaps that were not designated as SFAS 133 qualifying hedges at December 31, 2008 and 2007, respectively, (economic hedges of GSE debentures in trading securities); and (4) par value of trading securities was only $1.6 billion and $0.8 billion related to economic hedges held by the FHLBank at December 31, 2008 and 2007, respectively. For asset/liability management purposes, all non-mortgage-backed securities currently classified as trading are matched to interest rate swaps that effectively convert the securities from fixed rate investments to variable rate instruments. See Tables 61 through 63 under this Item 7, which show the relationship of gains/losses on economic derivative hedges and gains/losses on the Ginnie Mae and non-mortgage-backed trading securities being hedged by economic derivatives. The FHLBank’s projections of changes in estimated fair value of the derivatives have been consistent with actual results. For the balance sheet risks that these derivatives hedge, changes in value historically have been directionally consistent with changes in actual interest rates.
 
Fair Value. At December 31, 2008 and 2007, certain of the FHLBank’s assets and liabilities, including investments classified as trading, and all derivatives were presented in the statement of condition at fair value. Under GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair values play an important role in the valuation of certain of the FHLBank’s assets, liabilities and derivative transactions. The fair values generated by the FHLBank directly impact the Statements of Condition, Statements of Income, Statements of Capital, Statements of Cash Flows, and risk-based capital, duration of equity and market value of equity disclosures. Management also estimates the fair value of collateral that borrowers pledge against advance borrowings and other credit obligations to confirm that the FHLBank has sufficient collateral to meet regulatory requirements and to protect itself from a credit loss.
 
Fair values are based on market prices when they are available. If market quotes are not available, fair values are based on discounted cash flows using market estimates of interest rates and volatility, or on prices of similar instruments. Pricing models and their underlying assumptions are based on management’s best estimates for discount rates, prepayment speeds, market volatility and other factors. FHLBank management validates its financial models at least annually and the models are calibrated to values from outside sources on a monthly basis. The FHLBank validates modeled values to outside valuation services routinely to determine if the values generated from discounted cash flows are reasonable. The assumptions used may have a significant effect on the reported fair values of assets and liabilities, including derivatives, and the related income and expense. See Note 16 of the Notes to the Financial Statements included under Item 8 – “Financial Statements and Supplementary Data” for a detailed discussion of the assumptions used to calculate fair values. The use of different assumptions as well as changes in market conditions could result in materially different net income and retained earnings.
 
At December 31, 2008, the FHLBank had no fair values that were classified as level 3 valuations for financial instruments that are measured on a recurring basis at fair value, in accordance with SFAS No. 157, Fair value Measurements (herein referred to as “SFAS 157). However, the FHLBank did classify five securities that were considered other-than-temporarily impaired as level 3 valuations. The number of unobservable inputs and assumptions was apparent based on validation with other market participant data and valuation sources, and management concluded that the pricing derived for these particular investments should be considered a level 3 valuation. The total values considered level 3 valuations are a negligible percentage of total investment fair value.
 
Accounting for Other-Than-Temporary Impairment of Investments. The FHLBank regularly evaluates individual securities for potential losses for both those at an unrealized loss position and for any other securities in which there is evidence of a potential indicator of impairment at the end of each quarter. As part of this analysis, the FHLBank assesses its intent and ability to hold a security until such time as all contractual cash flows due are collected. These evaluations are inherently subjective and consider a number of qualitative factors. In addition to monitoring the impact of changes in credit ratings of these securities (i.e., rating agency downgrades), FHLBank management evaluates other factors that may be indicative of other-than-temporary impairment. These include, but are not limited to, an evaluation of the type of security, the length of time and extent to which the fair value of a security has been less than its cost, any credit enhancement or insurance, and certain other collateral-related characteristics such as FICO credit scores, loan-to-value (LTV) ratios, delinquency and foreclosure rates, geographic concentrations and the security’s performance. Increasing levels of analysis are performed as the risk characteristics for any individual security show deterioration including an analysis of cash flows based on a probability of default, a loss severity factor and prepayment assumptions. The analysis of cash flows is completed using a security valuation model with attributes input to the model for each security that are specific to the security and based upon recent historic performance obtained from the trustee and other sources. Assumptions about changes in the economic environment, such as home prices and interest rates, are used to predict borrower behavior and the impact on default frequency, loss severity and prepayment assumptions. This model is used to estimate the expected cash flows from our securities in assessing whether it is probable that we will not collect all of the contractual amounts due. We qualitatively consider all available information when assessing whether impairment is other-than-temporary. The relative importance of this information varies based on the facts and circumstances surrounding each security, as well as the economic environment at the time of assessment. FHLBank management applies significant judgment in determining whether an other-than-temporary impairment loss is appropriate.
The FHLBank will conclude that a loss is other-than-temporary if it is probable that the FHLBank will not receive all of the investment security’s contractual cash flows. If the FHLBank determines that an other-than-temporary impairment exists, the investment security is written down to fair value (its new cost basis), any premiums or discounts related to the investment security are written off, and a realized loss is recognized in other income (loss). A new accretable, or effective, yield is calculated and utilized to accrete the discount on a prospective basis over the remaining life of the investment security based on the amount and timing of future expected cash flows. The fair value measurement the FHLBank uses to determine the amount of other-than-temporary impairment to record may be less than the actual amount we expect to realize by holding the security to maturity. Accordingly, we may subsequently recover some other-than-temporary impairment amounts if we collect all of the contractual principal and interest payments due on the security. The portion of the impairment charges associated with any recoveries is recognized as net interest income in future periods.
 
Deferred Premium/Discount Associated with MBS. When the FHLBank purchases MBS, it often pays an amount that is different than the unpaid principal balance. The difference between the purchase price and the contractual note amount is a premium if the purchase price is higher and a discount if the purchase price is lower. SFAS 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, establishes accounting guidance that permits the FHLBank to amortize (or accrete) the premiums (or discounts) in a manner such that the yield recognized on the underlying asset is constant over the asset’s estimated life. The FHLBank typically pays more than the unpaid principal balances when the interest rates on the MBS are greater than prevailing market rates for similar MBS on the transaction date. The net purchase premiums paid are then amortized in accordance with SFAS 91, using the level-yield method over the expected lives of the MBS as a reduction in yield (decreases interest income). Similarly, if the FHLBank pays less than the unpaid principal balance because interest rates on the MBS are lower than prevailing market rates on similar MBS on the transaction date, the net discounts are accreted in the same manner as the premiums, resulting in an increase in yield (increases interest income). The level-yield amortization method is applied using expected cash flows that incorporate prepayment projections that are based on mathematical models which describe the likely rate of consumer mortgage loan refinancing activity in response to incentives created (or removed) by changes in interest rates. Changes in interest rates have the greatest effect on the extent to which mortgage loans may prepay, although, during the current disruption in the financial market, tight credit and declining home prices, consumer mortgage refinancing behavior is also significantly affected by the borrower's credit score and the value of the home in relation to the outstanding loan value. Generally, however, when interest rates decline, mortgage loan prepayment speeds are likely to increase, which accelerates the amortization of premiums and the accretion of discounts. The opposite occurs when interest rates rise. The FHLBank uses a third-party data service that provides estimates of cash flows, from which the FHLBank determines expected asset lives for the MBS. The level-yield method uses actual prepayments received and projected future mortgage prepayment speeds, as well as scheduled principal payments, to determine the amount of premium/discount that must be recognized in order that the yield of each MBS is constant for each month until maturity. Amortization of MBS premiums could accelerate in falling interest-rate environments or decelerate in rising interest-rate environments. Exact trends will depend on the relationship between market interest rates and coupon rates on outstanding MBS, the historical evolution of mortgage interest rates, the age of the underlying mortgage loans, demographic and population trends, and other market factors such as increased foreclosure activity, falling home prices, tightening credit standards by mortgage lenders and the other housing GSEs, and other repercussions from the current sub-prime credit crisis.
 
Provision for Credit Losses.
§
Advances. The FHLBank has never experienced a credit loss on an advance and management currently does not anticipate any credit losses on advances. Based on the collateral held as security for advances, management’s credit analysis and prior repayment history, no allowance for losses on advances is deemed necessary. The FHLBank is required by statute to obtain and maintain security interests in sufficient collateral on advances to protect against losses, and to accept as collateral on such advances only certain qualified types of collateral, which are primarily U.S. government or government Agency/GSE securities, certain residential mortgage loans, deposits in the FHLBank and other real estate related assets. See Item 1 – “Business – Advances” for a more detailed collateral discussion.
 
§
Mortgage Loans. The FHLBank purchases both conventional mortgage loans and specific government mortgage loans under the MPF Program. FHA/VA, HUD Section 184, and USDA GRH Section 502 loans are government-insured or guaranteed and as such, management has determined that no allowance for losses is necessary for such loans. Conventional loans, in addition to having the related real estate as collateral, are also credit enhanced either by qualified collateral pledged by the member, or by supplemental mortgage insurance purchased by the member. The CE obligation is the PFI’s potential loss in the loss position after borrower equity, PMI and the FHLBank’s FLA. The PFI absorbs a percentage of realized losses through its CE obligation prior to the FHLBank having to incur an additional credit loss in the last loss position.

The allowance considers probable incurred losses that are inherent in the portfolio, but have not yet been realized. The allowance for the FHLBank’s conventional prime loan pools is based on an analysis of the performance of the FHLBank’s loan portfolio and an analysis of loan reserve levels used by Fannie Mae and Freddie Mac. This incorporates best estimates for losses on a seasoned, diversified and national portfolio of prime mortgage loans with similar underwriting standards to the MPF Program. The FHLBank’s loan portfolio review consists of an analysis that includes consideration of various data observations such as past and current performance, the amounts and timing of future cash flows, loan characteristics (e.g., delinquent still performing loans, non-accrual loans, loans that a decision for foreclosure has been made and current loans), loan portfolio characteristics (e.g., loan-to-value ratios, FICO scores for individual loans, debt-to-income ratios and historical loss statistics), collateral valuations, industry data and prevailing economic conditions. The allowance balance determined by this review is then allocated to the FHLBank and the PFIs’ master commitments to determine each party’s respective share of the potential loss. The FHLBank relies on this approach because MPF is a relatively new program and the FHLBank has limited loss history. Management reviews the allowance on a regular basis and anticipates moving away from using peer loan reserve and loss levels and will rely primarily on the actual loss experience of its mortgage loan portfolio. Management will begin to rely primarily on the FHLBank’s actual loss experience when the mortgage loan portfolio is sufficiently seasoned to allow the FHLBank to reasonably estimate probable losses based on its own loss experience.
 
The process of determining the allowance for loan losses requires a high degree of judgment. It is possible that others, given the same information, may at any point in time reach different reasonable conclusions. Because of variability in the data underlying the assumptions made in the process of determining the allowance for loan losses, estimates of the portfolio’s inherent risks will change as warranted by changes in the economy, particularly the residential mortgage loan market and changes in house prices. The degree to which any particular change would affect the allowance for loan losses would depend on the severity of the change.
As of December 31, 2008 and 2007, the allowance for loan losses on the conventional mortgage loan portfolio amounted to $884,000 and $844,000, respectively. The allowances reflect the FHLBank’s estimate of probable incurred losses inherent in its mortgage loan portfolio as of those dates.
 
See Table 25 under this Item 7 for detail of the activity in the allowance for credit losses on mortgage loans.

Impact of Recently Issued Accounting Standards
See Note 2 of the Notes to the Financial Statements included under Item 8 – “Financial Statements and Supplementary Data” for a discussion of recently issued accounting standards.

Balance Sheet Analysis
Overall – Table 16 presents changes in the major components of the FHLBank’s Statements of Condition from December 31, 2007 to December 31, 2008 (in thousands):

Table 16

   
Increase (Decrease)
in Components
  
   
December 31, 2008 vs. 2007
  
   
Dollar
Change
    
Percent
Change
  
Assets:
            
Cash and due from banks
   $ (1,649 )     (95.6 )%
Investments1
     (1,079,642 )     (5.3 )
Advances
     3,762,535       11.7  
Mortgage loans held for portfolio, net
     671,504       28.5  
Derivative assets
     (43,085 )     (55.5 )
Other assets
     (58,004 )     (19.3 )
TOTAL ASSETS
   $ 3,251,659       5.9 %
                 
Liabilities:
                
Deposits
   $ 362,715       27.1 %
Consolidated obligations, net
     2,573,589       5.0  
Derivative liabilities
     295,973       273.1  
Other liabilities
     (78,009 )     (17.4 )
Total liabilities
     3,154,268       6.0  
                 
Capital:
                
Capital stock outstanding
     149,148       7.1  
Retained earnings
     (51,841 )     (24.8 )
Accumulated other comprehensive income
     84       4.0  
Total capital
     97,391       4.2  
TOTAL LIABILITIES AND CAPITAL
   $ 3,251,659       5.9 %
                    
1
Investments also include interest-bearing deposits, Federal funds sold and securities purchased under agreements to resell.

At December 31, 2008, the FHLBank’s assets totaled $58.6 billion, up 5.9 percent from December 31, 2007. This increase is primarily attributable to a $3.8 billion increase in advances and a $0.7 billion increase in mortgage loans offset by a $1.1 billion decrease in investment securities.
 
Total advances increased 11.7 percent at December 31, 2008 to $35.8 billion from $32.1 billion in advance balances at December 31, 2007, primarily due to growth in advances to the FHLBank’s mid-sized to smaller members. Advances to FHLBank’s largest members accounted for only $0.5 billion or 13.3 percent of the increase. Despite the turmoil in the United States economy and the disruptions in the capital market in 2008, loan demand at small and mid-sized member institutions remained strong which in turn resulted in strong advance demand throughout the year. Additionally, funding sources normally available to our members became practically unavailable. As these funding sources began drying up, the demand for advances, primarily short-term advances, increased.
 
Most of the FHLBank’s total asset growth during 2008 was funded with consolidated obligations, which increased from $51.1 billion at December 31, 2007 to $53.7 billion at December 31, 2008, representing a 5.0 percent increase. Consolidated obligations are the FHLBank’s primary funding source. The changes in consolidated obligation balances generally matched the changes in advance balances throughout 2008.
 
Total deposits increased $362.7 million, or 27.1 percent from December 31, 2007 to December 31, 2008. In 2008 and 2007, deposits represented 3.0 and 2.5 percent, respectively of total liabilities. This increase in deposits has had a positive impact on the FHLBank’s overall funding cost and funding structure. FHLBank deposit levels are difficult to predict as they are dependent on member demand, which is affected by such factors as the availability of deposits from member customers, investment opportunities, loan demand experienced by members and disintermediation with other sectors of the economy.
Total capital increased from $2.3 billion at December 31, 2007 to $2.4 billion at December 31, 2008, with most of the increase from capital stock supporting member advance activity. During 2007 and 2008, the FHLBank did not carry out any mandatory repurchases of member capital stock; however, the FHLBank completed periodic exchanges of excess Class B Common Stock for Class A Common Stock under the provisions of its capital plan. These periodic exchanges were performed during all of 2007 and 2008. The frequency of these exchanges was weekly in 2008, thereby reducing the average amount of excess Class B Common Stock held by members. The FHLBank discontinued these periodic exchanges on January 28, 2009 to allow the FHLBank to increase its permanent capital position. The FHLBank anticipates that growth or reduction in capital stock should closely parallel advance increases or decreases in future periods.
 
Advances – Outstanding advances increased from $32.1 billion at December 31, 2007 to $35.8 billion at December 31, 2008. As discussed in more detail below, the mix of balances outstanding by major advance product type shifted from the end of 2007 to the end of 2008 as members shifted out of long-term fixed rate advances in favor of short-term fixed rate advances, line of credit (overnight) advances, convertible advances and adjustable rate callable advances (see Table 1 under Item 1 for a summary of the advance products outstanding at December 31, 2008 and 2007). In 2008, short-term fixed rate advances increased by $1.5 billion, line of credit advances increased by $1.1 billion, convertible advances increased by $0.9 billion and adjustable rate callable advances increased by $0.4 billion while long-term fixed rate advances declined by $1.0 billion. The shift from long-term advances to the line of credit and short-term advances can be attributed to a drop in short-term interest rates due to the deteriorating financial markets and a high demand for liquidity.
 
We expect total advances to decline in 2009: (1) because of the conservatorship of U.S. Central Federal Credit Union, which may result in reduced advance activity (see previous discussion under Item 1 – "Business – Advances" and Note 20 of the Notes to the Financial Statements included under Item 8 – "Financial Statements and Supplementary Data"); and (2) as members begin de-leveraging their balance sheets in order to shore up their capital positions and weather the current recession. We also expect that some members will begin utilizing various U.S. government-guaranteed and Federal Reserve lending programs as an alternative to FHLBank advances. Excess liquidity from maturing investments and from other sources, if available, will likely be used to reduce member demand for wholesale borrowings including advances. However, difficulties in issuing brokered certificates of deposit and in entering into security repurchase transactions could somewhat offset the expected reduction in demand for FHLBank advances at many of the mid-sized to smaller members during 2009. Although the FHLBank experienced a moderate decrease in membership during the two-year period ending December 31, 2008, advance balances continued to grow. The growth in advance balances during 2008 primarily reflects increases in advances outstanding from the FHLBank’s mid-sized and smallest members. The number of members and non-members with outstanding advances was 645 as of December 31, 2007 and increased to 687 as of December 31, 2008 as some of our mid-sized and smaller members utilized advances to meet their liquidity and funding needs.
 
Table 17 summarizes the par amount of FHLBank advances by year of maturity, or next call date for callable advances, as of December 31, 2008 (in thousands):

Table 17

   
Year of Maturity or Next Call Date
  
   
One year or less
    
Over one year through five years
    
Over five years
    
Total
  
December 31, 2008
   $ 23,371,131     $ 6,805,554     $ 4,808,102     $ 34,984,787  

Total advances represented 61.2 percent of total assets as of December 31, 2008 compared with 58.0 percent at the end of 2007. The percentage of total advances to total assets has historically exceeded 60 percent of FHLBank assets; however, with the anticipated member de-leveraging, we expect this percentage to be in the range of 55 to 60 percent of total assets in future years. The average yield on advances was 2.97 percent for the year ended December 31, 2008 compared to 5.26 percent for 2007 and 5.07 percent for 2006. The decrease in average advance yields from the year ended December 31, 2007 to the year ended December 31, 2008 is consistent with the general decrease in market interest rates, especially short-term rates.
 
Short-term rates declined rather dramatically throughout 2008, with the average short-term advance rate dropping 400 basis points by year end. The FOMC lowered the overnight Federal funds target rate several times during 2008 resulting in the current overnight Federal funds target rate being a range from zero to 0.25 percent. As of December 31, 2008, line of credit advances (which re-price daily) and short-term, fixed rate advances (maturities of 93 days or less) represented 38.0 percent of outstanding advances. Adjustable rate advances (re-pricing daily to every three months) represented 19.8 percent, and convertible advances (swapped to three-month LIBOR, synthetically creating three-month advances) represented 16.5 percent. Fixed rate bullet advances and callable advances either swapped to one-month or three-month LIBOR (synthetically creating one-month or three-month advances) represented 12.2 percent.  As of December 31, 2007, line of credit advances and short-term, fixed rate advances represented 33.7 percent of outstanding advances. Adjustable rate advances represented 20.7 percent, and convertible advances represented 15.2 percent. Fixed rate bullet advances and callable advances either swapped to one-month or three-month LIBOR (synthetically creating one-month or three-month advances) represented 12.4 percent. As a result, 86.5 percent of the FHLBank’s advance portfolio as of December 31, 2008 and 82.0 percent of the FHLBank’s advance portfolio as of December 31, 2007 effectively re-priced at least every three months. See Table 1 under Item 1 for a summary of the advance products outstanding at December 31, 2008 and 2007. Because of the relatively short nature of the FHLBank’s advance portfolio, the average yield in this portfolio typically responds quickly to changes in short-term interest rates. The level of short-term interest rates is primarily driven by FOMC decisions on the level of its overnight Federal funds target, but is also influenced by the expectations of capital market participants related to the strength of the economy, future inflationary pressures and other factors. In January 2009, the FOMC left the Federal funds target rate unchanged at zero to 0.25 percent and, given the ongoing recession and worsening economic conditions in early 2009, it does not appear that the FOMC will begin increasing its target range any time soon. Therefore, we anticipate advance yields will remain relatively stable in 2009 unless there is a significant change in our advance mix. See Item 7 – Table 59, Spread and Yield Analysis, and Table 60, Rate and Volume Analysis, in the “Financial Review – Results of Operations” for further information on 2006 through 2008 average balances and yields.
The FHLBank develops its advance programs, as authorized in the Bank Act and in regulations established by the Finance Agency, to meet the specific needs of its members. As a wholesale provider of funds, the FHLBank competes with brokered certificates of deposit, security repurchase agreements and U.S. government lending programs for short- and medium-term maturities. The FHLBank strives to price its advances relative to its marginal cost of funds while trying to remain competitive with these markets. While there is less competition in the long-term maturities, member advance demand for these maturities has historically been lower than the demand for short-term maturities. Nonetheless, long-term advances are also priced at relatively low spreads to the FHLBank’s cost of funds.
 
Prepayment Fees: The FHLBank prices advances based on the FHLBank’s marginal cost of issuing matched-maturity funding while considering its related administrative and operating costs, substitute pricing and desired profitability targets. Advances with a maturity or re-pricing period greater than six months generally incorporate a fee sufficient to make the FHLBank financially indifferent should the borrower decide to prepay the advance.
 
The FHLBank has no foreign advances as of December 31, 2008, 2007, 2006, 2005 and 2004. Table 18 presents the book value of total advances as of December 31, 2008, 2007, 2006, 2005 and 2004 (in thousands):

Table 18

   
12/31/2008
    
12/31/2007
    
12/31/2006
    
12/31/2005
    
12/31/2004
  
Advances
   $ 35,819,674     $ 32,057,139     $ 28,445,245     $ 27,086,568     $ 27,489,919  

Letters of Credit: The FHLBank also issues letters of credit for members. Members must collateralize letters of credit at the date of issuance and at all times thereafter. Letters of credit are secured in accordance with the same requirements as for advances. However, letters of credit issued or confirmed on behalf of a member to: (1) facilitate residential housing finance; or (2) facilitate community lending that is eligible for any of the FHLBank’s CICA programs may also be secured by state and local government securities. Table 19 presents outstanding letters of credit balances as of December 31, 2008, 2007, 2006, 2005 and 2004 (in thousands):

Table 19

   
12/31/2008
    
12/31/2007
    
12/31/2006
    
12/31/2005
    
12/31/2004
  
Letters of Credit
   $ 2,751,362     $ 2,543,265     $ 2,125,187     $ 1,865,163     $ 2,013,764  

Standby Credit Facility: In December 2007, the FHLBank began offering a standby credit facility (SCF) product, which is a commitment to issue an advance. SCF commitments are for terms of one year and any draws on the SCF must be fully collateralized prior to any disbursement of funds and at all times thereafter. Outstanding SCF commitments totaled $1.0 billion and $2.0 billion at December 31, 2008 and 2007, respectively.
 
Housing Associates: The FHLBank is permitted under the Bank Act to make advances to housing associates, which are non-members that are approved mortgagees under Title II of the National Housing Act. Outstanding advances to housing associates totaled $149.0 million and $64.5 million as of December 31, 2008 and 2007, respectively, representing less than one percent of total advances for each period presented. All outstanding housing associates advances as of December 31, 2008 and 2007 were to state housing finance authorities and therefore the restrictive collateral provisions indicated in Item 1 – “Business – Advances” do not apply.
 
MPF Program – The FHLBank participates in the MPF Program through the MPF Provider, which is the FHLBank of Chicago. Under this program, participating members of an FHLBank either sell fixed rate, size-conforming, single-family mortgage loans to the FHLBank (closed loans) or originate these same loans on behalf of the FHLBank (table funded loans). The MPF Program provides an alternative outlet for members that originate fixed rate, single-family mortgage products. During 2008 the balance of the MPF portfolio increased $671.5 million or 28.5 percent. The increase in the balance of the MPF portfolio was the result of $231.9 million of out-of district mortgage loans purchased and $764.4 million of new loans acquired from in-district PFIs. The FHLBank began participating in out-of-district loan purchases as a result of the FHLBank of Chicago announcing on April 23, 2008, that it would no longer purchase mortgage loans from its PFIs under the MPF Program after July 31, 2008. In anticipation of the FHLBank of Chicago ceasing to purchase mortgage loans after July 31, 2008 and in order to minimize potential disruptions in the MPF Program, the FHLBank executed a short-term agreement on July 1, 2008 with the FHLBank of Chicago to acquire up to $300 million in Participation Interests in mortgage loans originated by PFIs in the FHLBank of Chicago’s district. Under the agreement, all delivery commitments from the FHLBank of Chicago district PFIs were to be issued between July 1 and October 31, 2008. On September 23, 2008, the FHLBank of Chicago officially announced to its members the rollout of an MPF product (MPF Xtra) that would provide its members with access to the secondary mortgage market without adding to the interest rate risk on the FHLBank of Chicago’s balance sheet. An agreement was executed with Fannie Mae as the first non-FHLBank investor in MPF assets, and participation by the FHLBank of Chicago’s PFIs was made available beginning November 1, 2008.
The FHLBank has continued its efforts to increase the number of members participating in the MPF Program. As of December 31, 2008 and 2007, agreements were in place with 161 and 142 PFIs, respectively. The number of PFIs that delivered and sold loans was 147 and 126 at December 31, 2008 and 2007, respectively. We anticipate that the number of PFIs delivering and selling loans to the FHLBank will increase during 2009 and beyond as we strive to increase the number of participating members. However, there is no guarantee that our efforts will increase the number of PFIs. The FHLBank devoted resources during 2007 and 2008 to increasing the volume of mortgage loans acquired from PFIs. To increase the number of PFIs, our account managers focused on members that are active mortgage originators or purchasers. In addition, we added an MPF account manager at the beginning of 2008 who is focused solely on increasing the number of PFIs and the dollar amount of mortgage loans sold into the FHLBank’s MPF Program by PFIs. Future volume growth for mortgage loans held in portfolio will depend on a number of factors, including the number of new PFIs and the mortgage loan origination volume of the new PFIs; the amount of mortgage loan activity all existing PFIs expect to deliver in 2009; refinancing activity; the level of interest rates and the shape of the yield curve; the relative competitiveness of MPF pricing to the prices offered by Fannie Mae, Freddie Mac and other buyers of mortgage loans; the willingness of other FHLBanks to allow the FHLBank to participate in a percentage of mortgage loans that their PFIs are selling into the MPF Program; and the willingness of the FHLBank to acquire additional out-of-district mortgage loans at the prevailing relative value (the difference between the yield on the mortgage loans and the FHLBank’s cost of funding and hedging the mortgage loans). Mortgage market conditions early in 2008 led Fannie Mae and Freddie Mac to adjust their practices and prices paid for mortgage loans, which increased the relative competitiveness of the MPF Program. This situation continued for much of 2008, and it assisted the FHLBank in increasing the number of active PFIs delivering mortgage loans into the MPF Program. Toward the end of 2008, the U.S. Treasury and Federal Reserve Banks began direct purchases of mortgages from Fannie Mae and Freddie Mac. These purchases, which are funded with U.S. Treasury debt, resulted in much lower interest rates on residential mortgages. Because the FHLBank’s funding costs were generally higher than those of the U.S. Treasury, there were periods when the FHLBank was unable to profitably acquire mortgages sold under the MPF Program at comparable prices. FHLBank management made it a priority to explore the MPF Xtra product, offered only to-date by the FHLBank of Chicago. It is the FHLBank’s intent to be prepared to add this product to our MPF product mix to ensure our ability to offer a secondary market outlet to our PFIs, specifically the small PFIs, when market conditions deem it undesirable to hold the assets in portfolio.
 
Table 20 presents the FHLBank’s top five PFIs, the outstanding balances (in thousands) of mortgage loans acquired from them as of December 31, 2008 and 2007, and the percentage of those loans to total MPF loans outstanding on those dates. If a PFI was not one of the top five for one of the years presented, the applicable column is left blank.

Table 20

   
MPF Loan
Balance as of
December 31, 2008
    
Percent
of Total
MPF Loans
    
MPF Loan
Balance as of
December 31, 2007
    
Percent
of Total
MPF Loans
  
TierOne Bank
   $ 539,652       17.9 %   $ 504,498       21.5 %
La Salle National Bank, N.A.
     465,906       15.4       526,333       22.4  
Bank of the West1
     378,628       12.5       423,917       18.1  
Central National Bank
     115,646       3.8                  
Security Saving Bank, FSB
     82,368       2.8                  
Sunflower Bank, NA
                     58,406       2.5  
Golden Belt Bank, FSA
                     38,990       1.7  
TOTAL
   $ 1,582,200       52.4 %   $ 1,552,144       66.2 %
                    
1
Formerly Commercial Federal Bank, FSB headquartered in Omaha, NE. Bank of the West acquired Commercial Federal Bank, FSB on December 2, 2005. Bank of the West is a member of the Federal Home Loan Bank of San Francisco.

The average yields on mortgage loans were 5.16 percent, 5.21 percent and 5.12 percent during 2008, 2007 and 2006, respectively. The average yield on mortgage loans decreased in 2008 and is primarily attributable to the falling interest rate environment late in 2008 due to the turmoil in the financial market. The average yield on mortgage loans increased in 2007 and 2006 primarily due to the increase in mortgage interest rates and a decrease in the net write-off of the amortization of premium as a result of the decline in mortgage loan prepayments and the increase in estimated average lives of existing mortgage loans because of increasing mortgage interest rates. The average yield on mortgage loans is expected to decrease in response to anticipated decreases in market interest rates on mortgage loans during 2009. See Table 59, Spread and Yield Analysis, and Table 60, Rate and Volume Analysis, under Item 7 for further information.
 
Asset Quality: The FHLBank classifies conventional real estate mortgage loans as “non-performing” when they are contractually past due 90 days or more and interest is no longer accrued. Interest continues to accrue on government-insured real estate mortgage loans (e.g., FHA, VA, HUD and RHS loans) that are contractually past due 90 days or more. Table 21 presents the unpaid principal for conventional and government-insured mortgage loans as of December 31, 2008, 2007, 2006, 2005 and 2004 (in thousands):

Table 21

   
12/31/2008
    
12/31/2007
    
12/31/2006
    
12/31/2005
    
12/31/2004
  
Conventional mortgage loans
   $ 2,824,928     $ 2,261,562     $ 2,307,079     $ 2,360,896     $ 2,380,202  
Government-insured mortgage loans
     195,619       85,698       63,105       58,275       52,394  
TOTAL OUTSTANDING MORTGAGE LOANS
   $ 3,020,547     $ 2,347,260     $ 2,370,184     $ 2,419,171     $ 2,432,596  
Table 22 presents the unpaid principal for performing mortgage loans, non-performing mortgage loans and mortgage loans 90 or more past due and accruing as of December 31, 2008, 2007, 2006, 2005 and 2004 (in thousands):

Table 22

   
12/31/2008
    
12/31/2007
    
12/31/2006
    
12/31/2005
    
12/31/2004
  
Performing mortgage loans
   $ 3,010,665     $ 2,340,691     $ 2,365,122     $ 2,414,827     $ 2,431,225  
Non-performing mortgage loans
     8,934       5,640       4,379       4,052       727  
Mortgage loans 90 days or more past due and accruing
     948       929       683       292       644  
TOTAL OUTSTANDING MORTGAGE LOANS
   $ 3,020,547     $ 2,347,260     $ 2,370,184     $ 2,419,171     $ 2,432,596  

Information regarding the interest income shortfall on the non-performing loans during the periods ending December 31, 2008 and 2007 is included in Table 23 (in thousands):

Table 23

   
2008
    
2007
  
Interest contractually due during the year on non-performing mortgage loans
   $ 585     $ 365  
Interest income received during the year on non-performing mortgage loans
     494       317  
SHORTFALL
   $ 91     $ 48  

MPF Allowance for Credit Losses on Mortgage Loans: As of December 31, 2008, 2007, 2006, 2005 and 2004, the FHLBank had recorded an allowance for credit losses of $884,000, $844,000, $854,000, $756,000 and $424,000, respectively. The FHLBank bases its allowance on management’s estimate of probable credit losses inherent in the FHLBank’s mortgage loan portfolio as of the Statement of Condition date. The estimate is based on an analysis of industry statistics for similar mortgage loan portfolios (see Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” for further information). Management believes that policies and procedures are in place to effectively manage the credit risk on MPF mortgage loans.
 
The credit risk of MPF loans is managed by structuring potential credit losses into certain layers. As is customary for conventional mortgage loans, PMI is required for MPF loans with down payments of less than 20 percent of the original purchase price (purchase transactions only). Losses beyond the PMI layer are absorbed by an FLA established by the FHLBank for each pool of mortgage loans sold by a PFI up to the amount of the FLA. If losses beyond this layer are incurred, they are absorbed through a CE obligation (see Item 1 – “Business – Mortgage Loans Held for Portfolio” for additional information).
 
Table 24 presents a roll forward analysis of the FLA for the periods ended December 31, 2008 and 2007 (in thousands):

Table 24

   
Increase
to FLA
    
Losses
Incurred1
    
Total
  
Balance at December 31, 2006
   $ 11,888     $ (66 )   $ 11,822  
Increase to FLA
     586       0       586  
Losses incurred
     0       (228 )     (228 )
Balance at December 31, 2007
     12,474       (294 )     12,180  
Increase to FLA
     2,686       0       2,686  
Losses incurred
     0       (197 )     (197 )
Balance at December 31, 2008
   $ 15,160     $ (491 )   $ 14,669  
                    
1
There were de minimis reductions in CE fees paid for losses absorbed in the FLA during 2008 and 2007. Losses did not exceed the FLA balance at any time during 2008 or 2007.

Table 25 presents the allowance for mortgage loan losses as of December 31, 2008, 2007, 2006, 2005 and 2004 (in thousands):

Table 25

   
12/31/2008
    
12/31/2007
    
12/31/2006
    
12/31/2005
    
12/31/2004
  
Balance, beginning of year
   $ 844     $ 854     $ 756     $ 424     $ 129  
Provision for (reversal of) mortgage loan losses
     196       (25 )     358       335       295  
Charge-offs
     (156 )     15       (260 )     (3 )     0  
Balance, end of year
   $ 884     $ 844     $ 854     $ 756     $ 424  

The ratio of net charge-offs/recoveries to average loans outstanding was less than one basis point for the periods ending December 31, 2008, 2007, 2006, 2005 and 2004.
FHLBank Topeka’s mortgage loans held in portfolio are dispersed across all 50 states and the District of Columbia as of December 31, 2008, 2007, 2006, 2005 and 2004. The largest concentration of loans is in the states of Kansas and Nebraska, which as a percent of total loans together represented 52 percent, 51 percent, 49 percent, 46 percent and 41 percent as of December 31, 2008, 2007, 2006, 2005 and 2004, respectively. For the years ended December 31, 2008, 2007, 2006, 2005 and 2004, no zip code represented more than 5 percent of total mortgage loans. The median size of a mortgage loan held in portfolio was approximately $71,000 at December 31, 2008, and $65,000 at December 31, 2007, 2006, 2005 and 2004. Table 26 is a summary of the percentage geographic concentration by region as of December 31, 2008, 2007, 2006, 2005 and 2004:

Table 26

   
12/31/2008
    
12/31/2007
    
12/31/2006
    
12/31/2005
    
12/31/2004
  
Midwest2
     42.2 %     41.7 %     41.5 %     40.3 %     38.9 %
Northeast3
     4.0       5.7       6.3       7.0       7.9  
Southeast4
     5.2       7.3       8.2       9.2       10.7  
Southwest5
     44.9       40.5       38.6       37.3       34.6  
West6
     3.7       4.8       5.4       6.2       7.9  
TOTAL1
     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
                    
1
Percentages are calculated based on the unpaid principal balance at the end of each year.
2
Midwest includes: IA, IL, IN, MI, MN, ND, NE, OH, SD and WI
3
Northeast includes: CT, DE, MA, ME, NH, NJ, NY, PA, RI and VT
4
Southeast includes: AL, DC, FL, GA, KY, MD, MS, NC, SC, TN, VA and WV
5
Southwest includes: AR, AZ, CO, KS, LA, MO, NM, OK, TX and UT
6
West includes: AK, CA, HI, ID, MT, NV, OR, WA and WY

Table 27 provides the weighted average FICO® scores and weighted average LTV at origination for conventional mortgage loans outstanding as of December 31, 2008, 2007, 2006, 2005 and 2004:

Table 27

   
12/31/2008
    
12/31/2007
    
12/31/2006
    
12/31/2005
    
12/31/2004
  
Weighted average FICO® score1 at origination
     744.3       741.0       740.0       739.7       738.5  
Weighted average LTV2 at origination
     73.1 %     72.4 %     72.0 %     71.5 %     71.0 %
                    
1
FICO® is a widely used credit industry model developed by Fair Isaac Corporation to assess borrower credit quality with scores typically ranging from 300 to 850 with the low end of the scale indicating a poor credit risk. A credit score of 620 is frequently cited as a cutoff point, with credit scores below that typically considered “sub-prime.”
2
LTV is a primary variable in credit performance. Generally speaking, higher loan-to-value means greater risk of loss generating a default and also means higher loss severity.

Investments – Investments decreased 5.3 percent from December 31, 2007 to December 31, 2008, while the FHLBank’s assets increased by 5.9 percent for the same period. Investments are generally used by the FHLBank for liquidity purposes as well as to leverage capital during periods when advances decline and capital stock is not likewise reduced. The average yield on investments was 3.49 percent in 2008 compared to 5.29 percent during 2007 and 5.13 percent during 2006. Average yields on investments increased from 2006 to 2007 because of rising short-term interest rates, but declined from 2007 to 2008 due primarily to falling short term interest rates. The FOMC increased its Federal funds target rate on overnight Federal funds from 1.00 percent to 5.25 percent over a two-year period beginning in June 2004 and ending in June 2006. The FOMC kept its Federal funds target rate unchanged at 5.25 percent until it began reducing it in September 2007. The target overnight Federal funds rate was a range from zero to 0.25 percent as of December 31, 2008. The average rate on FHLBank investments rises and falls in conjunction with the level of short-term interest rates primarily because of the short-term nature of the FHLBank’s investment portfolio. Because the FOMC decreased its target rate by 100 basis points during 2007 and by 400 basis points in 2008, the average rate earned on FHLBank investments declined during 2008 (current target rate range of zero to 0.25 percent). See 59, Spread and Yield Analysis, and Table 60, Rate and Volume Analysis, under this Item 7 for further information on yield and balance fluctuations during 2007 and 2008.
Short-term investments used for liquidity purposes consisted primarily of deposits in banks, overnight and term Federal funds, certificates of deposit and commercial paper. Short-term investments, which include investments with remaining maturities of one year or less, were $7.5 billion and $12.5 billion at December 31, 2008 and 2007, respectively. This decrease in short-term investments from 2007 to 2008 is primarily attributable to an increase in long term investments as the FHLBank took advantage of increased MBS/CMO investment authority under Resolution 2008-08, “Temporary Authorization to Invest in Additional Agency Mortgage Securities,” discussed below, and also increased its holdings of unsecured AAA-rated GSE securities in an effort to reduce its exposure to the deteriorating credit profile of many of its traditional unsecured money market counterparties. The FHLBank’s long-term investment portfolio, consisting of GSE securities, MBS and taxable state or local housing finance agency securities were $11.9 billion and $8.0 billion at December 31, 2008 and 2007, respectively. The GSE securities provide attractive returns, serve as excellent collateral (e.g., repos and net derivatives exposure) and qualify for regulatory liquidity once their remaining term to maturity decreases to 36 months or less. All of the FHLBank’s unsecured Agency and GSE instruments are fixed rate bonds, which are swapped from fixed to variable rates. All swapped Agency instruments are classified as trading securities. In September and October 2007, the FHLBank purchased variable rate Agency MBS/CMOs, which were not related to economic hedges, and placed them in a trading portfolio for asset/liability management purposes. In the Statements of Income, the change in fair values of the trading securities flows through “Net gain (loss) on trading securities” at the same time as the change in fair values on any associated derivatives flows through “Net gain (loss) on derivatives and hedging activities.” Net interest payments on these swaps also flow through “Net gain (loss) on derivatives and hedging activities” since the swaps do not qualify for hedge accounting treatment under SFAS 133 (i.e., these are non-SFAS 133 “economic” hedges; see Item 7 – “Financial Review – Derivatives” for further information).
 
On March 24, 2008, the Finance Board issued Resolution 2008-08, “Temporary Authorization to Invest in Additional Agency Mortgage Securities.” In the Resolution the Finance Board stated that the FHLBanks “can address difficulties and liquidity constraints in the housing finance market if the current investment limit in the FMP is increased so the FHLBanks may invest in MBS issued by, or backed by pools of mortgages guaranteed by, Freddie Mac or Fannie Mae.” Consequently, in the Resolution the Finance Board waived the restrictions in the FMP that limit an FHLBank’s investment in Mortgage Securities to 300 percent of its capital and restrict quarterly increases in holdings of Mortgage Securities to no more than 50 percent of capital so that an FHLBank can temporarily invest in Agency Mortgage Securities up to an additional 300 percent of its capital, subject to specified conditions. By allowing the FHLBanks to purchase additional Agency MBS, the Finance Board intended to further its statutory housing finance mission. To the extent the Resolution can increase the demand for Agency MBS, the added liquidity could help to restore the market for these securities and could, in turn, lead to lower liquidity premiums, lower mortgage rates, and increased home purchases. On March 27, 2008, the FHLBank submitted to the Finance Board the notice and information required by Resolution 2008-08 to increase its MBS/CMO holdings from 300 percent to 400 percent of capital. The Finance Board approved the FHLBank’s request on April 10, 2008. The FHLBank acquired $2.7 billion of variable rate Agency MBS/CMOs under this expanded MBS investment authority during 2008.
 
The FHLBank’s Risk Management Policy (RMP) restricts the acquisition of investments to high-quality, short-term money market instruments and highly rated long-term securities. The FHLBank uses the short-term portfolio to sustain the liquidity necessary to meet member credit needs, to provide a reasonable return on member deposits and to maximize the FHLBank’s leverage ratio. Long-term securities are used to provide a reliable income flow and to achieve a desired maturity structure. The majority of these long-term securities are MBS, which provide an alternative means to promote liquidity in the mortgage finance markets while providing attractive returns to the FHLBank. During 2007, the FHLBank added $0.8 billion in MBS to the trading portfolio to give the FHLBank additional flexibility. All of the MBS in the trading portfolio are variable rate U.S. Agency or GSE issues, which was done with the intent of minimizing the volatility of price changes over time.
 
The FHLBank has reduced its participation in the market for taxable state HFA securities outside its four-state area, but remains a supporter of the state HFA market within the FHLBank’s Tenth District. State or local HFAs provide funds for low-income housing and other similar initiatives. By purchasing state or local HFA securities in the primary market, the FHLBank not only receives competitive returns but also provides necessary liquidity to traditionally underserved segments of the housing market. The FHLBank provides standby bond purchase agreements (SBPA) to two state HFAs within the Tenth District. For a predetermined fee, the FHLBank accepts an obligation to purchase the authorities’ bonds if the remarketing agent is unable to resell the bonds to suitable investors, and to hold the bonds until the designated marketing agent can find a suitable investor or the HFA repurchases the bonds according to a schedule established by the SBPA. Currently, the standby bond purchase commitments executed by the FHLBank expire no later than 2014, though some are renewable upon request of the HFA and at the option of the FHLBank. Total commitments for bond purchases under the SBPAs were $1.3 billion and $1.0 billion as of December 31, 2008 and 2007, respectively. The FHLBank was not required to purchase any bonds under these agreements during the periods ended December 31, 2007 or 2006. However, during the third quarter of 2008, the FHLBank was required to purchase several of the bonds issued by the Colorado Housing and Finance Authority (CHFA) and covered under SBPAs because the remarketing agent, Lehman Brothers Holdings, Inc., was liquidated after the bankruptcy of its parent and was unable to adequately remarket all of CHFA’s bonds. All of the bonds purchased during the third quarter under the SBPAs were remarketed and repurchased from the FHLBank prior to the end of the third quarter 2008. In accordance with the SBPAs, the FHLBank purchased and resold the bonds at par value; therefore no gains (losses) were recorded in other comprehensive income on the purchase and subsequent sale of these bonds. During the fourth quarter, the FHLBank continued to purchase and resell at par small amounts of these securities periodically for short periods of time until they were successfully remarketed by the new remarketing agent but there were none that had not been resold by the end of 2008. The HFA securities backed by FHLBank SBPAs have continued to perform well even in the face of failed auctions of auction rate notes and other similar instruments during early 2009. Despite the current capital market disruptions, the FHLBank plans to continue to support the state HFAs in its district by continuing to execute SBPAs where appropriate.
Major Security Types: Securities for which the FHLBank has the ability and intent to hold to maturity are classified as held-to-maturity securities and carried at amortized cost. The FHLBank classifies certain investments as trading securities and carries them at fair value. The FHLBank records changes in the fair values of these investments through other income and original premiums/discounts on these investments are not amortized. The FHLBank does not practice active trading, but holds trading securities for asset/liability management purposes, including liquidity. The FHLBank also classifies certain investments that it may sell before maturity as available-for-sale and carries them at fair value. If fixed rate securities are hedged with interest rate swaps, the FHLBank classifies the securities as trading securities so that the changes in fair values of both the derivatives hedging the securities and the trading securities are recorded in other income. Securities acquired to hedge against duration risk, which were likely to be sold when the duration risk was no longer present, were also classified as available-for-sale securities. See Notes 4 through 6 in the Notes to Financial Statements included in Item 8 to this report for additional information on the FHLBank’s different investment classifications including what types of securities are held under each classification. The carrying value and contractual maturity of the FHLBank’s investments as of December 31, 2008, 2007 and 2006 are summarized by security type in Tables 28 through 30 (in thousands). Expected maturities of certain securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.

Table 28

December 31, 2008
  
Security Type
  
Carrying
Value
    
Due in
one year
or less
    
Due after
one year
through five
years
    
Due after
five years
through 10
years
    
Due after
10 years
  
Interest bearing deposits:
                              
Shared expense deposits
   $ 34     $ 34     $ 0     $ 0     $ 0  
MPF deposits
     24       24       0       0       0  
Interest-bearing deposits in banks
     3,348,154       3,348,154       0       0       0  
Total interest bearing deposits
     3,348,212       3,348,212       0       0       0  
                                         
Federal funds sold
     384,000       384,000       0       0       0  
                                         
Trading securities:
                                        
Non-mortgage-backed securities:
                                        
Certificates of deposit
     1,571,449       1,571,449       0       0       0  
Commercial paper
     673,435       673,435       0       0       0  
FHLBank obligations
     316,618       0       0       316,618       0  
Fannie Mae obligations1
     403,027       0       115,061       287,966       0  
Freddie Mac obligations1
     1,009,074       0       331,010       678,064       0  
Mortgage-backed securities:
                                        
Fannie Mae obligations1
     399,863       0       0       0       399,863  
Freddie Mac obligations1
     277,278       0       0       0       277,278  
Ginnie Mae Obligations2
     1,956       0       0       0       1,956  
Total trading securities
     4,652,700       2,244,884       446,071       1,282,648       679,097  
                                         
Held-to-maturity securities:
                                        
Non-mortgage-backed securities:
                                        
Certificates of deposit
     760,000       760,000       0       0       0  
Commercial paper
     737,271       737,271       0       0       0  
State or local housing agencies
     155,247       10,000       120       1,320       143,807  
Mortgage-backed securities:
                                        
Fannie Mae obligations1
     3,354,012       0       0       78,305       3,275,707  
Freddie Mac obligations1
     3,388,254       0       0       18,932       3,369,322  
Ginnie Mae obligations2
     37,663       0       0       923       36,740  
Other – non-government
     2,618,450       0       0       274,546       2,343,904  
Total held-to-maturity securities
     11,050,897       1,507,271       120       374,026       9,169,480  
                                         
TOTAL
   $ 19,435,809     $ 7,484,367     $ 446,191     $ 1,656,674     $ 9,848,577  
 
1
Fannie Mae and Freddie Mac are GSEs. Both entities were placed into conservatorship by the Finance Agency on September 7, 2008.
2
Ginnie Mae securities are guaranteed by the U.S. government.
Table 29

December 31, 2007
  
Security Type
  
Carrying
Value
    
Due in
one year
or less
    
Due after
one year
through five
years
    
Due after
five years
through 10
years
    
Due after
10 years
  
Interest bearing deposits:
                              
MPF deposits
   $ 10     $ 10     $ 0     $ 0     $ 0  
Total interest bearing deposits
     10       10       0       0       0  
                                         
Federal funds sold
     5,150,000       5,150,000       0       0       0  
                                         
Trading securities:
                                        
Non-mortgage-backed securities:
                                        
FHLBank obligations
     213,046       0       0       213,046       0  
Fannie Mae obligations1
     110,457       0       53,515       56,942       0  
Freddie Mac obligations1
     520,252       99,781       318,461       102,010       0  
Mortgage-backed securities:
                                        
Fannie Mae obligations1
     477,692       0       0       0       477,692  
Freddie Mac obligations1
     330,044       0       0       0       330,044  
Ginnie Mae Obligations2
     2,552       0       0       0       2,552  
Total trading securities
     1,654,043       99,781       371,976       371,998       810,288  
                                         
Held-to-maturity securities:
                                        
Non-mortgage-backed securities:
                                        
Certificates of deposit
     6,122,007       6,122,007       0       0       0  
Commercial paper
     1,143,067       1,143,067       0       0       0  
State or local housing agencies
     191,170       0       10,305       2,600       178,265  
Mortgage-backed securities:
                                        
Fannie Mae obligations1
     1,579,409       0       0       0       1,579,409  
Freddie Mac obligations1
     1,638,400       0       0       19,150       1,619,250  
Ginnie Mae obligations2
     44,033       0       0       1,268       42,765  
Other – non-government
     2,993,312       0       0       15,386       2,977,926  
Total held-to-maturity securities
     13,711,398       7,265,074       10,305       38,404       6,397,615  
                                         
TOTAL
   $ 20,515,451     $ 12,514,865     $ 382,281     $ 410,402     $ 7,207,903  
                    
1
Fannie Mae and Freddie Mac are GSEs. Both entities were placed into conservatorship by the Finance Agency on September 7, 2008.
2
Ginnie Mae securities are guaranteed by the U.S. government.
Table 30

December 31, 2006
  
Security Type
  
Carrying
Value
    
Due in
one year
or less
    
Due after
one year
through five
years
    
Due after
five years
through 10
years
    
Due after
10 years
  
Interest bearing deposits:
                              
MPF deposits
   $ 29     $ 29     $ 0     $ 0     $ 0  
Total interest bearing deposits
     29       29       0       0       0  
                                         
Federal funds sold
     8,054,500       8,054,500       0       0       0  
                                         
Trading securities:
                                        
Non-mortgage-backed securities:
                                        
Federal Farm Credit Bank obligations1
     620       620       0       0       0  
FHLBank obligations
     15,052       15,052       0       0       0  
Fannie Mae obligations1
     181,611       75,218       52,063       54,330       0  
Freddie Mac obligations1
     503,406       0       302,781       200,625       0  
Mortgage-backed securities:
                                        
Ginnie Mae obligations2
     3,436       0       0       0       3,436  
Total trading securities
     704,125       90,890       354,844       254,955       3,436  
                                         
Available-for-sale securities:
                                        
Non-mortgage-backed securities:
                                        
U.S. Treasury obligations
     101,668       49,143       52,525       0       0  
Total available-for-sale securities
     101,668       49,143       52,525       0       0  
                                         
Held-to-maturity securities:
                                        
Non-mortgage-backed securities:
                                        
Certificates of deposit
     3,985,000       3,985,000       0       0       0  
Bank notes
     275,000       275,000       0       0       0  
Commercial paper
     1,774,449       1,774,449       0       0       0  
State or local housing agencies
     238,873       0       10,000       600       228,273  
Fannie Mae obligations1
     100,008       100,008       0       0       0  
Freddie Mac obligations1
     99,940       99,940       0       0       0  
Mortgage-backed securities:
                                        
Fannie Mae obligations1
     1,145,425       0       536       2,395       1,142,494  
Freddie Mac obligations1
     1,379,899       0       0       3,664       1,376,235  
Ginnie Mae obligations2
     17,118       0       275       2,093       14,750  
Other – non-government
     3,621,671       0       0       0       3,621,671  
Total held-to-maturity securities
     12,637,383       6,234,397       10,811       8,752       6,383,423  
                                         
TOTAL
   $ 21,497,705     $ 14,428,959     $ 418,180     $ 263,707     $ 6,386,859  
                    
1
Fannie Mae, Freddie Mac and Federal Farm Credit Bank are GSEs. Fannie Mae and Freddie Mac were placed into conservatorship by the Finance Agency on September 7, 2008.
2
Ginnie Mae securities are guaranteed by the U.S. government.
Table 31 presents the FHLBank’s MBS investment portfolio by categories of securities as of December 31, 2008, 2007 and 2006 (in thousands):

Table 31

   
12/31/2008
    
12/31/2007
    
12/31/2006
  
   
Carrying
Value
    
Percent
of Total
    
Carrying
Value
    
Percent
of Total
    
Carrying
Value
    
Percent
of Total
  
U.S. agency residential MBS
   $ 7,459,026       74.0 %   $ 4,072,130       57.6 %   $ 2,545,878       41.3 %
Private-label residential MBS
     2,573,761       25.5       2,944,090       41.7       3,570,314       57.9  
Private-label commercial MBS
     40,503       0.4       40,521       0.6       40,538       0.7  
Home equity loans
     3,566       0.1       7,734       0.1       9,335       0.1  
Manufactured housing
     620       0.0       967       0.0       1,484       0.0  
TOTAL
   $ 10,077,476       100.0 %   $ 7,065,442       100.0 %   $ 6,167,549       100.0 %

Yield Characteristics: Table 32 presents the yield characteristics of the FHLBank’s non-MBS investments, classified as held-to-maturity securities and trading securities, as of December 31, 2008:

Table 32

   
12/31/2008
  
   
Held-to-maturity
Securities
    
Trading
Securities
  
Due in one year or less
     2.33 %     1.74 %
Due after one year through five years
     7.02       5.55  
Due after five years through 10 years
     6.88       5.20  
Due after 10 years
     4.05       -  

Table 33 presents the yield characteristics of the FHLBank’s MBS investments, classified as held-to-maturity securities and trading securities, as of December 31, 2008:

Table 33

   
12/31/2008
  
   
Held-to-maturity
Securities
    
Trading
Securities
  
Due in one year or less
     - %     - %
Due after one year through five years
     -       -  
Due after five years through 10 years
     4.12       -  
Due after 10 years
     3.55       5.80  

Table 34 presents securities held by the FHLBank from issuers, excluding U.S. government agencies, with book values greater than ten percent of FHLBank capital as of December 31, 2008 (in thousands):

Table 34

12/31/2008
  
Name of Issuer
  
Total
Book Value
    
Total
Fair Value
  
Citicorp Mortgage Securities Inc.
   $ 355,758     $ 298,508  
BNP Paribas
     275,000       275,192  
Toyota Motor Credit Corp.
     244,106       244,595  
Royal Bank of Scotland PLC
     240,000       240,370  
TOTAL
   $ 1,114,864     $ 1,058,665  
                    
Note: None of the issuers of these securities are FHLBank Topeka members or subsidiaries of FHLBank Topeka members.
Securities Ratings: Table 35 presents the percentage of FHLBank investments classified as held-to-maturity or trading securities by rating as of December 31, 2008 and 2007:

Table 35
 
Investment Rating
  
12/31/2008
    
12/31/2007
  
Long-term rating:
            
AAA
     76.1 %     52.3 %
AA
     5.4       26.4  
A
     9.5       13.8  
BBB
     0.0       0.0  
Below Investment Grade
     0.0       0.0  
Short-term rating:
                
A-1 or higher/P-1
     9.0       7.5  
TOTAL
     100.0 %     100.0 %

Private-label mortgage-backed securities. The FHLBank acquires private-label MBS investments that carry the highest ratings from Moody’s, Fitch or S&P. The FHLBank purchases private-label MBS investments with weighted average FICO scores of 700 or above and weighted average loan-to-values of 80 percent or lower.
 
Table 36 presents a summary of the par value of private-label MBS by interest rate type and by type of collateral as of December 31, 2008 and 2007 (in thousands):

Table 36

   
12/31/2008
    
12/31/2007
  
   
Fixed Rate
    
Variable Rate
    
Total
    
Fixed Rate
    
Variable Rate
    
Total
  
Private-label residential MBS:
                                    
Prime
   $ 1,762,925     $ 436,024     $ 2,198,949     $ 1,999,914     $ 514,419     $ 2,514,333  
Alt-A
     231,452       149,991       381,443       260,728       174,503       435,231  
Total private-label residential MBS
     1,994,377       586,015       2,580,392       2,260,642       688,922       2,949,564  
                                                 
Manufactured housing loans:
                                                
Prime
     0       620       620       0       967       967  
                                                 
Private-label commercial MBS:
                                                
Prime
     39,940       0       39,940       39,940       0       39,940  
                                                 
Home equity loans:
                                                
Prime
     0       6,559       6,559       0       7,732       7,732  
                                                 
TOTAL
   $ 2,034,317     $ 593,194     $ 2,627,511     $ 2,300,582     $ 697,621     $ 2,998,203  

During 2008, the FHLBank experienced a significant decline in the estimated fair values of its private-label MBS due to interest rate volatility, illiquidity in the marketplace and credit deterioration in the U.S. mortgage markets. Significant declines in fair values were particularly evident across the market for private-label MBS securitized in 2006 and 2007 primarily because of less stringent underwriting standards used by mortgage originators at that time. While some of the most significant declines in fair values have been in the 2006 and 2007 vintage MBS, the earlier vintages owned by the FHLBank have not been immune to the declines in fair value. Table 37 presents a summary of the FHLBank’s private-label MBS by year of securitization as of December 31, 2008, 2007 and 2006 (in thousands):
Table 37

   
12/31/2008
    
12/31/2007
    
12/31/2006
  
Year of
Securitization
  
Fair Value
    
Par Value1
    
Fair Value
as a % of
Par Value
    
Fair Value
    
Par Value
    
Fair Value
as a % of
Par Value
    
Fair Value
    
Par Value
    
Fair Value
as a % of
Par Value
  
Private-label residential MBS:
                                                      
Prime:
                                                      
2006
   $ 92,957     $ 117,263       79.3 %   $ 132,975     $ 133,310       99.7 %   $ 142,673     $ 143,580       99.4 %
2005
     504,745       629,864       80.1       700,534       708,989       98.8       796,328       804,081       99.0  
2004
     443,195       523,698       84.6       597,238       605,738       98.6       793,194       799,479       99.2  
2003 and earlier
     831,478       928,124       89.6       1,041,972       1,066,296       97.7       1,280,004       1,309,613       97.7  
Total prime
     1,872,375       2,198,949       85.1       2,472,719       2,514,333       98.3       3,012,199       3,056,753       98.5  
                                                                         
Alt-A:
                                                                        
2005
     53,446       73,397       72.8       79,516       83,288       95.5       95,332       96,444       98.8  
2004
     54,940       70,491       77.9       84,341       85,846       98.2       110,125       110,071       100.0  
2003 and earlier
     202,573       237,555       85.3       258,620       266,097       97.2       307,237       312,770       98.2  
Total Alt-A
     310,959       381,443       81.5       422,477       435,231       97.1       512,694       519,285       98.7  
                                                                         
Total private-label residential MBS
     2,183,334       2,580,392       84.6       2,895,196       2,949,564       98.2       3,524,893       3,576,038       98.6  
                                                                         
Manufactured housing loans:
                                                                        
Prime:
                                                                        
2003 and earlier
     608       620       98.1       966       967       99.9       1,483       1,483       100.0  
                                                                         
Private-label commercial MBS:
                                                                        
Prime:
                                                                        
2003 and earlier
     36,031       39,940       90.2       40,040       39,940       100.3       39,366       39,940       98.6  
                                                                         
Home equity loans:
                                                                        
Prime:
                                                                        
2003 and earlier
     2,728       6,559       41.6       7,567       7,732       97.9       9,356       9,333       100.2  
                                                                         
TOTAL
   $ 2,222,701     $ 2,627,511       84.6 %   $ 2,943,769     $ 2,998,203       98.2 %   $ 3,575,098     $ 3,626,794       98.6 %
__________
1
Includes securities with a par value of $8.0 million determined to be other-than-temporarily impaired at December 31, 2008. These securities had a total amortized cost before impairment of $8.0 million and were written down to fair value of $3.2 million at the time of impairment, December 31, 2008.
Table 38 presents the underlying collateral performance and credit enhancement statistics of the FHLBank’s private-label MBS as of December 31, 2008 (in thousands):

Table 38

Year of
Securitization
  
AAA
    
AA
    
A
    
BBB
    
Below
Investment
Grade
    
Total
Par Value
    
Average
Price
    
Estimated
Fair Value
    
Amortized
Cost
    
Gross
Unrealized
Losses
    
Impairment
Charge
Taken
    
Weighted
Average
Original
Credit
Support
    
Weighted-
Average
Current
Credit
Support
    
Minimum
Credit
Support
  
Weighted
Average
Collateral
Delinquency1
  
Monoline
Financial
Guarantee2
  
Private-label residential MBS:
                                                                                                
Prime:
                                                                                                
2006
   $ 27,674     $ 40,837   $ 48,752     $  0     $  0     $ 117,263       79.3     $ 92,957     $ 115,794     $ 22,837     $ 0       3.0 %     3.5 %     2.9 %     1.7 %   $ 0  
2005
     629,864       0     0       0       0       629,864       80.1       504,745       626,520       121,775       1,778       3.4       4.6       3.0       1.9       0  
2004
     521,536       2,162     0       0       0       523,698       84.6       443,195       522,722       79,527       0       3.3       6.9       2.0       2.6       0  
2003 and earlier
     927,335       789     0       0       0       928,124       89.6       831,478       927,346       96,509       0       2.6       5.8       1.6       0.7       789  
Total prime
     2,106,409       43,788     48,752       0       0       2,198,949       85.2       1,872,375       2,192,382       320,648       1,778       3.0       5.6       1.6       1.6       789  
                                                                                                                               
Alt-A:
                                                                                                                              
2005
     73,397       0     0       0       0       73,397       72.8       53,446       73,374       19,928       0       4.1       5.9       4.2       3.9       0  
2004
     70,491       0     0       0       0       70,491       77.9       54,940       70,528       15,760       0       4.9       10.2       7.5       4.8       0  
2003 and earlier
     237,555       0     0       0       0       237,555       85.3       202,573       237,477       34,904       0       4.2       11.1       4.0       2.5       0  
Total Alt-A
     381,443       0     0       0       0       381,443       81.5       310,959       381,379       70,592       0       4.3       9.9       4.0       3.2       0  
                                                                                                                               
Total private-label residential MBS:
     2,487,852       43,788     48,752       0       0       2,580,392       84.6       2,183,334       2,573,761       391,240       1,778       3.2       6.2       1.6       1.8       789  
                                                                                                                               
Manufactured housing loans:
                                                                                                                              
Prime:
                                                                                                                              
2003 and earlier
     620       0     0       0       0       620       98.1       608       620       12       0       22.0       90.6       90.6       1.5       0  
                                                                                                                               
Private-label commercial MBS:
                                                                                                                              
Prime:
                                                                                                                              
2003 and earlier
     39,940       0     0       0       0       39,940       90.2       36,031       40,503       4,472       0       21.5       25.9       25.9       0.0       0  
                                                                                                                               
Home equity loans:
                                                                                                                              
Prime:
                                                                                                                              
2003 and earlier
     0       0     0       2,825       3,734       6,559       41.6       2,728       3,566       838       2,995       0.0       32.7       0.0       36.5       6,559  
                                                                                                                               
TOTAL
   $ 2,528,412     $ 43,788   $ 48,752     $ 2,825     $ 3,734     $ 2,627,511       84.6     $ 2,222,701     $ 2,618,450     $ 396,562     $ 4,773       3.5 %     6.6 %     0.0 %     1.9 %   $ 7,348  
__________
1
Determined based on underlying loans that are 60 days or more past due, including bankruptcies, foreclosures and REO. Collateral delinquency percentages are calculated based on information available from third-party financial data providers.
2    The monoline financial guarantee may exceed the amortized cost if amortized cost has been reduced due to other-than-temporary impairment.
Under the FHLBank’s RMP, acquisitions of private-label MBS are limited to securities where the geographic concentration of loans collateralizing the security are such that no single state represents more than 50 percent of the total by dollar amount. FHLBank management continues to monitor concentration of the underlying collateral for its private-label MBS portfolio for risk management purposes. With decreasing housing prices, especially in the states of California, Florida, Arizona and Nevada, delinquencies and foreclosures have continued to increase. Table 39 presents the FHLBank’s geographic concentration of collateral securing private-label MBS (excluding commercial MBS) as of December 31, 2008 for those states with concentrations of greater than five percent of total private-label MBS (excluding commercial MBS):
 
Table 39

  Security Type  
Percentage of Total Par Value1
  
 
California
    
New York
  
Private-label residential MBS:
            
Prime
     36.9 %     8.5 %
Alt-A
     34.9       5.6  
Total private-label residential MBS
     36.6       8.1  
                 
Manufactured housing loans:
                
Prime
     0.0       6.8  
                 
Home equity loans:
                
Prime
     0.1       0.3  
                 
TOTAL
     36.5 %     8.1 %
__________
1     Calculated based upon weighted average geographic concentrations as available from third-party servicers.
 
As of December 31, 2008, the FHLBank held private-label MBS covered by monoline insurance companies, which provide credit support for these securities. Credit support is defined as the percentage of subordinate tranches and over-collateralization, if any, in a security structure that will absorb losses before the holders of the security will incur losses. Table 40 presents coverage amounts and unrealized losses on the private-label MBS covered by monoline bond insurance as of December 31, 2008 (in thousands):

Table 40

Year of
Securitization
  
AMBAC
Assurance Corp.
    
MBIA
Insurance Corp.
    
Financial Guaranty
Insurance Company
    
Total
  
 
Monoline
Insurance
Coverage
    
Total
Unrealized
Losses
    
Monoline
Insurance
Coverage
    
Total
Unrealized
Losses
    
Monoline
Insurance
Coverage
    
Total
Unrealized
Losses1
    
Monoline
Insurance
Coverage
    
Total
Unrealized
Losses
  
Prime:
                                                
2003 and earlier
   $ 789     $ 229     $ 1,740     $ 838     $ 4,819     $ 0     $ 7,348     $ 1,067  
____________
1
All private-label MBS covered by Financial Guaranty Insurance Company were determined to be other-than-temporarily impaired as of December 31, 2008. These securities were written down to a total fair value of $1.8 million and consequently have no unrealized losses as of December 31, 2008.
As noted previously, the FHLBank only acquires private-label MBS investments that carry the highest ratings from Moody’s, Fitch or S&P. With the current disrupted market environment, downgrades have occurred since acquisition but for less than 4 percent of the FHLBank’s private-label MBS. Table 41 presents a summary of private-label MBS by credit rating as of December 31, 2008 (in thousands):

Table 41
 
Credit Rating
  
Par
Value
    
Amortized
Cost
    
Gross
Unrealized
Losses
    
Weighted Average
Collateral
Delinquency
  
Private-label residential MBS:
                        
Prime:
                        
AAA1
   $ 2,106,409     $ 2,101,021     $ 300,909       1.5 %
AA
     43,788       43,172       7,329       2.0  
A
     48,752       48,189       12,410       2.3  
Total prime
     2,198,949       2,192,382       320,648       1.6  
                                 
Alt-A:
                                
AAA
     381,443       381,379       70,592       3.2  
                                 
Total private-label residential MBS
     2,580,392       2,573,761       391,240       1.8  
                                 
Manufactured housing loans:
                                
Prime:
                                
AAA
     620       620       12       1.5  
                                 
Private-label commercial MBS:
                                
Prime:
                                
AAA
     39,940       40,503       4,472       0.0  
                                 
Home equity loans:
                                
Prime:
                                
BBB
     2,825       2,301       838       27.2  
Below investment grade1
     3,734       1,265       0       43.5  
Total home equity loans
     6,559       3,566       838       36.5  
                                 
TOTAL
   $ 2,627,511     $ 2,618,450     $ 396,562       1.9 %
__________
1     Includes investments on which the FHLBank recognized other-than-temporary impairment as of December 31, 2008.
 
As of December 31, 2008, the FHLBank had carrying values of $2.6 billion of private-label securities with unrealized losses. (See Note 6 of the Notes to the Financial Statements included under Item 8 – “Financial Statements and Supplementary Data” for a summary of held-to-maturity securities with unrealized losses aggregated by major security type and length of time that the individual securities have been in a continuous unrealized loss position.) Table 42 presents characteristics of the FHLBank’s private-label MBS in a gross unrealized loss position (in thousands). The underlying collateral for all prime loans were first lien mortgages.
Table 42

Security Type
  
Par
Value
    
Amortized
Cost
    
Gross
Unrealized
Losses
    
Weighted-
Average
Collateral
Delinquency
Rate
    
Percentage
AAA at
12/31/2008
    
Percentage
AAA at
03/20/2009
    
Percentage
Investment
Grade (other
than AAA) at
03/20/2009
    
Percentage
Below
Investment
Grade at
03/20/2009
    
Percentage
on Negative
Watch at 
03/20/2009
  
Private-label residential MBS:
                                                      
Prime
   $ 2,161,947     $ 2,157,585     $ 320,648       1.6 %     95.7 %     92.8 %     6.8 %     0.4 %     28.1 %
Alt-A
     370,076       370,013       70,592       3.1       100.0       78.7       11.1       10.2       3.5  
Total private-label residential MBS
     2,532,023       2,527,598       391,240       1.8       96.3       90.7       7.4       1.9       24.5  
                                                                         
Manufactured Housing Loans
     620       620       12       1.5       100.0       100.0       0.0       0.0       0.0  
                                                                         
Private-label commercial MBS
     39,940       40,503       4,472       0.0       100.0       100.0       0.0       0.0       0.0  
                                                                         
Home Equity Loans
     1,740       1,740       838       25.7       0.0       0.0       0.0       100.0       0.0  
                                                                         
TOTAL
   $ 2,574,323     $ 2,570,461     $ 396,562       1.8 %     96.3 %     90.8 %     7.3 %     1.9 %     24.1 %

Table 43 presents the amortized cost and fair values of the FHLBank’s private-label MBS by credit rating as of December 31, 2008 and March 20, 2009 for securities that have been downgraded during that period (in thousands). There were no downgrades on the FHLBank’s private-label MBS backed by manufactured housing loans or commercial loans.

Table 43

Credit Rating
  
Amortized
Cost
    
Fair
Value
  
December 31, 2008
March 20, 2009
Private-label residential MBS:              
Prime:
              
AAA
AA
   $ 2,991     $ 1,582  
AAA   
A
     6,267       2,885  
AAA
BBB
     44,245       36,337  
AAA
Below investment grade1
     11,546       6,148  
AA
A
     789       560  
Total prime
       65,838       47,512  
                   
Alt-A:
                  
AAA
AA
     13,124       10,201  
AAA
A 
     5,416       2,731  
AAA
BBB
     22,564       19,584  
AAA
Below investment grade
     37,686       23,661  
Total Alt-A
       78,790       56,177  
                   
Total private-label residential MBS       144,628        103,689  
                   
Home Equity Loans:                  
Prime:                   
BBB
Below investment grade 
     1,740        902  
                   
TOTAL
     $ 146,368     $ 104,591  
__________
1     Includes investments on which the FHLBank recognized other-than-temporary impairment as of December 31, 2008.
Table 44 presents the carrying value of the FHLBank’s private-label MBS portfolio for securities with rating agency actions subsequent to December 31, 2008 (in thousands):

Table 44
 
Security Type
  
Downgraded and Stable
    
Downgraded and
on Negative Watch
    
Negative Watch/No Downgrade
  
 
To AA
    
To A
    
To BBB
    
To Below
Investment
Grade
    
To A
    
To Below
Investment
Grade
    
Rated AAA
    
Rated AA
    
Rated A
  
Private-label residential MBS:
                                                      
Prime
   $ 2,991     $ 789     $ 44,245     $ 1,393     $ 6,267     $ 10,153     $ 482,050     $ 40,220     $ 48,189  
Alt-A
     13,124       5,416       22,564       37,686       0       0       12,836       0       0  
Total private-label residential MBS
     16,115       6,205       66,809       39,079       6,267       10,153       494,886       40,220       48,189  
                                                                         
Home equity loans:
                                                                        
Prime
     0       0       0       1,740       0       0       0       0       0  
                                                                         
TOTAL
   $ 16,115     $ 6,205     $ 66,809     $ 40,819     $ 6,267     $ 10,153     $ 494,886     $ 40,220     $ 48,189  
 
Other-than-temporary Impairment. As mentioned previously, the FHLBank experienced a significant decline in the estimated fair values of its private-label MBS due to interest rate volatility, illiquidity in the marketplace and credit deterioration in the U.S. mortgage markets. With the current disrupted market environment, the fair values of the majority of the FHLBank’s private-label MBS were below amortized cost at December 31, 2008. However, based upon the FHLBank’s extensive other-than-temporary impairment evaluation process that results in a conclusion as to whether or not we will collect all contractual principal and interest on the FHLBank’s private-label MBS, we have concluded that, except for the securities upon which we recognized other-than-temporary impairment, the decline in value at December 31, 2008 is largely due to the illiquidity in the marketplace rather than evidence of losses in the underlying collateral. See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” and Note 6 of the Notes to Financial Statements under Item 8 – “Financial Statement and Supplementary Data” for additional information on the FHLBank’s other-than-temporary impairment evaluation process. The FHLBank recognized other-than-temporary impairment losses of $4.8 million for the year ended December 31, 2008 related to five private-label MBS in its held-to-maturity portfolio. These securities had a total amortized cost of $8.0 million before impairment and a total estimated fair value of $3.2 million at the time of impairment. While the remainder of the FHLBank’s held-to-maturity securities portfolio has also seen a decline in fair value, the decline is considered temporary as the FHLBank has the intent and ability to hold these investments to maturity and based on estimated projected cash flows, expects to collect all contractual principal and interest. Table 45 presents other-than-temporary impairments recorded by security type (in thousands). All securities had been in unrealized loss positions greater than twelve months at the time of impairment. Prior to the fourth quarter 2008, management had concluded that the FHLBank was expected to receive all contractual principal and interest payments on these securities based on the evaluation processes completed during each respective quarter prior to December 31, 2008. During the fourth quarter of 2008, the monoline insurer backing the underlying mortgages on four of these securities was downgraded to CCC (security rating was BB) by the NRSROs and based on further analysis, it was concluded that the claims paying ability of the monoline insurer was not sufficient to cover all outstanding claims. We expect the insurer to perform to some extent and that we will recover the majority of our principal and interest but do not know to what extent the insurer will perform. For the other security, the quality of the underlying collateral deteriorated substantially during the fourth quarter of 2008.

Table 45

Security Type
  
Impairment Charge
  
Private-label residential MBS
   $ 1,778  
Home equity loans
     2,995  
TOTAL
   $ 4,773  

Deposits – The FHLBank offers deposit programs for the benefit of its members and certain other qualifying non-members. Deposit products offered include demand and overnight deposits, short-term certificates of deposit and a limited number of non-interest bearing products. The annualized average rate paid on all interest-bearing deposits was 1.92 percent, 4.93 percent and 4.83 percent for 2008, 2007 and 2006, respectively. The average rate paid on deposits fluctuated in tandem with the movement in short-term interest rates. The level of short-term interest rates is primarily driven by the Federal Open Market Committees (FOMC) decisions on the target rate for overnight Federal funds, but is also influenced by the expectations of capital market participants. Most deposits are very short-term, and the FHLBank, as a matter of prudence, holds short-term assets with maturities similar to the deposits (see Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk Management”). The majority of the FHLBank’s deposits is in overnight or demand accounts that re-price daily based upon a market index such as overnight Federal funds. The level of deposits at the FHLBank is driven by member demand for FHLBank deposit products, which in turn is a function of the liquidity position of members. Factors that influence deposit levels include turnover in member investment and loan portfolios, changes in members’ customer deposit balances, changes in members’ demand for liquidity and the FHLBank’s deposit pricing as compared to other short-term market rates. Total deposits were $1.7 billion and $1.3 billion at December 31, 2008 and 2007, respectively. Declines in the level of FHLBank deposits could occur during 2009 if demand for loans at member institutions increases, if members de-lever their balance sheets or if decreases in the general level of liquidity of members should occur. Because of its ready access to the capital markets through consolidated obligations, however, the FHLBank expects to be able to replace any reduction in deposits with similarly priced borrowings.
At December 31, 2008 and 2007, time deposits in denominations of $100,000 or more totaled $570.3 million and $1.3 million, respectively. Table 46 presents the maturities for these time deposits by remaining maturity as of December 31, 2008 and 2007 respectively (in thousands):

Table 46

   
3 months
or less
    
Over 3 months
but within
6 months
    
Over 6 months
but within
12 months
    
Total
  
Time certificates of deposit (by remaining maturity at December 31, 2008)
   $ 394,455     $ 175,500     $ 385     $ 570,340  
Time certificates of deposit (by remaining maturity at December 31, 2007)
     1,250       0       0       1,250  

Table 47 presents the average amount of and the annual rate paid on deposit types that exceed 10 percent of average deposits for 2008, 2007 and 2006 (in thousands). Deposit types are included if the 10 percent threshold is met in any year.

Table 47

   
12/31/2008
    
12/31/2007
    
12/31/2006
  
   
Amount
    
Rate
    
Amount
    
Rate
    
Amount
    
Rate
  
Member demand deposits
   $ 133,089       1.55 %   $ 97,773       4.72 %   $ 104,914       4.60 %
Member overnight deposits
     1,087,736       1.90       842,415       4.94       669,875       4.87  

Consolidated Obligations – Consolidated obligations are the joint and several debt obligations of the 12 FHLBanks and consist of bonds and discount notes. Consolidated obligations represent the primary source of liabilities used by the FHLBank to fund advances, mortgage loans and investments. As noted in the “Risk Management” section under Item 7A, the FHLBank uses debt with a variety of maturities and option characteristics to manage its DOE and interest rate risk profile. The FHLBank makes extensive use of derivative transactions, executed in conjunction with specific consolidated obligation debt issues, to synthetically structure funding terms and costs.
 
The FHLBank primarily uses consolidated obligation bonds to fund longer-term (one year or greater) advances, mortgage loans and investments. To the extent that the bond is funding variable rate assets or assets swapped to synthetically create variable rate assets, the FHLBank typically either issues a consolidated obligation bond that has variable rates matching the asset index or it swaps a fixed-rate or a complex consolidated obligation bond to match that index. Additionally, the FHLBank sometimes uses fixed-rate or complex consolidated obligation bonds that are swapped to LIBOR to fund short-term advances and money market investments. During 2008, the FHLBank reduced the amount of swapped consolidated obligation bonds used to fund short-term advances and investments primarily due to the dislocation of LIBOR rates, the large volume of calls of swapped consolidated obligation bonds and because of a reduction of short-term investments in response to credit concerns in the market.
 
FHLBank primarily uses consolidated obligation discount notes to fund shorter-term (less than one year) advances and investments. However, at December 31, 2008 the FHLBank had $1.3 billion outstanding of term discount notes swapped to LIBOR to fund longer term advances and investments. This was due to the credit market disruptions which made issuing swapped, longer term consolidated obligation bonds more difficult, more costly and/or inefficient.
 
During 2008, the FHLBank’s total consolidated obligation balances increased slightly as funding needs for advances increased. While consolidated obligations increased 5.0 percent from December 31, 2007 to December 31, 2008, the mix between discount notes and bonds changed over the period. Discount notes increased by $6.4 billion and bonds decreased by $3.8 billion from December 31, 2007 to December 31, 2008. The reasons for the change in the funding mix include: (1) investor demand for consolidated obligation bonds declined, especially longer term bonds; (2) the cost of hedging consolidated obligation bonds with an interest rate swap relative to one- or three-month LIBOR increased significantly relative to the cost of discount notes; and (3) a decreased correlation between rates on discount notes and LIBOR caused the FHLBank to reduce the amount of consolidated obligation bonds swapped to one- or three-month LIBOR used to fund short-term advances or investments which were not indexed to one- or three-month LIBOR. While the FHLBank continues to have relatively stable access to funds in the consolidated obligation market, the trepidation of investors toward any type of term investments has resulted in the FHLBank relying on more discount note funding than it has in the past. As the financial market turmoil continued in the third quarter and extended into the fourth quarter of 2008, constrained investor appetite for term debt at a reasonable cost continued to shorten the term of the consolidated obligations that the FHLBank was issuing for funding purposes. The FHLBank continues to issue consolidated obligation bonds, but not at the frequency or in the amounts we have in the past. We are uncertain as to how long this trend will continue or if it will ever reverse itself and if the FHLBank will begin to issue larger volumes of term debt swapped to LIBOR at favorable rates to discount notes again.
 
During late September and into October 2008, one- and three-month LIBOR began resetting to unprecedented levels relative to the overnight Federal funds target rate. During the same time period of LIBOR dislocation, a number of new debt programs explicitly guaranteed by the U.S. government were introduced. As a result of these new debt programs, investors’ unwillingness to invest in term debt of almost any type, and the conservatorship of Fannie Mae and Freddie Mac, the FHLBank’s cost of issuing debt in the debt markets significantly increased relative to both U.S. Treasury obligations and LIBOR. This had a negative impact on the FHLBank’s net interest spreads during the fourth quarter of 2008. The cost of issuing term consolidated obligation discount notes and bonds relative to both U.S. Treasury obligations and LIBOR has declined and stabilized through the remainder of 2008 and into the first quarter of 2009. While the cost of consolidated obligation bonds has stabilized, the cost is still historically high relative to both U.S. Treasury obligations and LIBOR. We are uncertain if the stabilization of our consolidated obligation bond funding costs will continue or when they will return to historically normal levels in the face of continued economic, financial market and geopolitical uncertainty.
The spread between one- and three-month LIBOR and the overnight Federal funds target rate exceeded 3.00 percent at times during October 2008. This spread had dropped to 0.18625 percent for one-month LIBOR and 1.1750 percent for three-month LIBOR by December 31, 2008. The Federal funds/LIBOR spread difference is of significance because: (1) the FHLBank has historically used consolidated obligation bonds swapped to LIBOR at favorable rates to fund a portion of its short-term fixed rate advance portfolio; (2) the cost of FHLBank short-term consolidated obligation discount notes has been favorable relative to LIBOR; and (3) the FHLBank generally prices its short-term fixed rate advances at a spread over its marginal cost of short-term consolidated obligation discount notes.
 
The FOMC has lowered its overnight Federal funds target rate from 4.25 percent on December 31, 2007 to a target range of zero to 0.25 percent on December 31, 2008. These decreases in the FOMC Federal funds target rate, together with the steepening of the U.S. Treasury curve from the 2-year to the 10-year maturities, resulted in a widening of spreads between the yield on investments and the FHLBank’s cost of funds for the year ended December 31, 2008. Much of the increase in spreads during 2008 can be attributed to the decrease in the FHLBank’s borrowing costs in the short-term consolidated obligation discount note market as there was a “flight to quality” during the credit crisis in the financial markets in 2008. FHLBank short-term discount notes were viewed favorably by market participants primarily because of the FHLBank’s GSE status relative to other short-term investment alternatives. Most of the debt issuance programs that were guaranteed by the U.S. government did not include very short-term debt issues (i.e. debt with maturities less than thirty days) where the FHLBank’s discount issuance costs were the most favorable in late 2008.
 
The period-end balances for December 31, 2008, 2007 and 2006 include fair value adjustments [(debit) credit adjustment] related to SFAS 133 of $397.8 million, ($14.7) million, and ($370.2) million, respectively. The average annualized effective rate paid on consolidated obligations was 2.99 percent during 2008, 5.08 percent during 2007 and 4.91 percent during 2006. The average effective rate paid on consolidated obligations decreased primarily in response to decreasing market interest rates and increased volume in issuances of unswapped long-term debt to replace higher rate debt that was called. While the FOMC’s target rate for overnight Federal funds and U.S. Treasury rates declined in 2008, LIBOR rates did not decline as quickly or to the same extent primarily because of financial market concerns and disruptions. Consequently, LIBOR was higher than anticipated and the FHLBank’s cost of funds was higher relative to Treasuries since a significant portion of our funding is LIBOR-based (i.e., swapped callable consolidated obligations).
 
The FHLBank has consciously increased the optionality in the liability portfolios used to fund assets with prepayment characteristics by increasing the percentage of callable debt used to fund these assets. During the fourth quarter of 2008, the FHLBank issued $1.0 billion of unswapped callable consolidated obligation bonds and issued an additional $1.0 billion by the end of February 2009. These issuances were primarily used to refinance debt that was called, but also was used to fund growth in the FHLBank’s MPF mortgage loan portfolio. This portfolio refinancing has an impact on portfolio spreads by reducing funding costs due to the issuance of new debt at lower funding costs, but this is somewhat offset by increased funding costs due to a greater mix of unswapped callable bonds. For a discussion on yields and spreads see Table 59, Spread and Yield Analysis, and Table 60, Rate and Volume Analysis, under Item 7 – “Financial Review – Results of Operations” for further information.
 
Borrowings with original maturities of one year or less are classified as short-term. Table 48 summarizes short-term borrowings for the years ended December 31, 2008, 2007 and 2006 (in thousands):

Table 48

   
12/31/2008
    
12/31/2007
    
12/31/2006
  
Discount Notes:
                  
Outstanding at end of the period
   $ 26,261,411     $ 19,896,098     $ 16,736,007  
Weighted average rate at end of the period
     1.22 %     4.21 %     5.07 %
Daily average outstanding for the period
   $ 25,214,642     $ 15,688,491     $ 13,539,010  
Weighted average rate for the period
     2.40 %     5.00 %     4.95 %
Highest outstanding at any month-end
   $ 29,700,173     $ 20,803,399     $ 16,736,007  

Derivatives – The FHLBank recorded derivative assets of $34.5 million and $77.6 million and derivative liabilities of $404.4 million and $108.4 million at December 31, 2008 and 2007, respectively. All derivatives are marked to estimated fair values, netted by counterparty with any associated accrued interest, offset by the fair value of any cash collateral received or delivered and included on the Statements of Condition as an asset when there is a net fair value gain or as a liability when there is a net fair value loss. Fair values of the FHLBank’s derivatives fluctuate as interest rates fluctuate.
 
The FHLBank uses derivatives in three ways: (1) by designating them as either a fair value or cash flow hedge of an underlying financial instrument, firm commitment or a forecasted transaction; (2) by acting as an intermediary; and (3) in asset/liability management (i.e., non-SFAS 133 economic hedge). Non-SFAS 133 hedges (economic hedges) are defined as derivatives hedging specific or non-specific underlying assets, liabilities or firm commitments that do not qualify for hedge accounting under the rules of SFAS 133, but are acceptable hedging strategies under the FHLBank’s RMP. To meet the hedging needs of its members, the FHLBank enters into offsetting derivatives, acting as an intermediary between members and other counterparties. This intermediation allows smaller members indirect access to the derivatives market. The derivatives used in intermediary activities do not receive SFAS 133 hedge accounting and are separately marked-to-market through earnings (classified as economic hedges). The notional amounts and estimated fair values (excluding accrued interest and cash collateral) by type of derivative held as of December 31, 2008 and 2007 are included in Table 49 (amounts in thousands):
Table 49

   
12/31/2008
    
12/31/2007
  
   
Notional
    
Fair Value
    
Notional
    
Fair Value
  
Fair value hedges
   $ 25,652,860     $ (436,687 )   $ 31,724,073     $ (132,022 )
Economic derivatives
     9,513,777       (170,999 )     4,928,171       2,407  
TOTAL
   $ 35,166,637     $ (607,686 )   $ 36,652,244     $ (129,615 )

The notional amount of total derivatives outstanding decreased from $36.7 billion at December 31, 2007 to $35.2 billion at December 31, 2008. Decreases occurred in interest rate swaps executed to hedge consolidated obligations (from $23.2 billion at December 31, 2007 to $16.4 billion at December 31, 2008), which were offset somewhat by an increase in interest rate swaps/caps/floors executed to hedge advances from $8.9 billion at December 31, 2007 to $10.1 billion at December 31, 2008) and an increase in interest rate swaps/caps/floors executed to hedge investments (from $4.3 billion at December 31, 2007 to $8.3 billion at December 31, 2008). The decrease in interest rate swaps executed to hedge consolidated obligations was the result of the change in the FHLBank’s funding mix discussed previously. The proportion of swapped consolidated obligation bonds to total debt decreased due to the relative difficulty of issuing longer term consolidated bonds, especially complex structures that could be swapped to a reasonable spread to LIBOR. Also, as reflected in Tables 76 and 79, interest rate swaps hedging consolidated obligation bonds with the more complex structures (fixed rate callable step-up or step-down and complex fixed rate bonds, etc.) decreased from $10.1 billion at December 31, 2007 to $3.4 billion at December 31, 2008 while other less-complex structures (fixed rate non-callable bonds, fixed rate callable bonds, etc.) decreased from $12.7 billion at December 31, 2007 to $10.9 billion at December 31, 2008. The large decrease in the complex structures, which usually represent the most favorable funding levels for consolidated obligation bonds swapped to LIBOR, is the result of the FHLBank’s shift to more cost efficient funding in short-term consolidated obligation discount notes. As reflected in Tables 76 and 79, interest rate caps associated with variable rate MBS with embedded caps increased by $3.2 billion. The increase is due to the FHLBank purchasing interest rate caps to offset the negative effect of the caps embedded in Agency variable rate CMOs acquired during the year.
 
The notional amount serves as a factor in determining periodic interest payments or cash flows received and paid, but does not represent the actual amount exchanged or the FHLBank’s exposure to credit and market risk. The amount potentially subject to credit loss is much less. Table 50 categorizes the notional amount and the estimated fair value of derivatives, excluding accrued interest, by product and type of accounting treatment. The “Fair Value” category represents hedge strategies qualifying for preferable hedge accounting treatment. The “Economic” category represents hedge strategies not qualifying for preferable hedge accounting treatment. Amounts at December 31, 2008 and 2007 are as follows (in thousands):

Table 50

   
12/31/2008
    
12/31/2007
  
   
Notional
    
Fair Value
    
Notional
    
Fair Value
  
Advances:
                        
Fair value
   $ 10,128,698     $ (826,783 )   $ 8,929,677     $ (200,918 )
                                 
Investments:
                                
Economic
     8,295,768       (169,896 )     4,283,614       1,900  
                                 
Mortgage loans:
                                
Stand-alone delivery commitments
     124,423       (1,539 )     21,007       57  
                                 
Consolidated obligation discount notes:
                                
Fair value
     1,287,162       (1,537 )     0       0  
                                 
Consolidated obligation bonds:
                                
Fair value
     14,237,000       391,633       22,794,396       68,896  
Economic
     875,000       302       450,000       346  
Subtotal
     15,112,000       391,935       23,244,396       69,242  
                                 
Intermediary:
                                
Economic
     218,586       134       173,550       104  
                                 
TOTAL
   $ 35,166,637     $ (607,686 )   $ 36,652,244     $ (129,615 )
                                 
Total derivative fair value excluding accrued interest
           $ (607,686 )           $ (129,615 )
Net accrued interest receivable
             70,394               127,545  
Fair value of cash collateral delivered to counterparty
             245,624               30,938  
Fair value of cash collateral received from counterparty
             (78,162 )             (59,640 )
NET DERIVATIVE FAIR VALUE
           $ (369,830 )           $ (30,772 )
                                 
Net derivative assets balance
           $ 34,526             $ 77,611  
Net derivative liabilities balance
             (404,356 )             (108,383 )
NET DERIVATIVE FAIR VALUE
           $ (369,830 )           $ (30,772 )
Capital – Total capital consists of capital stock, accumulated other comprehensive income and retained earnings. Capital increased by 4.2 percent from December 31, 2007 to December 31, 2008. The majority of the increase in capital stock during 2008 was a result of advance growth. Note that under the FHLBank’s capital plan, members must purchase additional activity-based stock as their advances increase or as they sell mortgage assets into the MPF program. As member advance activity and mortgage loan sales through the MPF Program increase, stock held by members to support these activities will likewise increase. From the end of 2007 to the end of 2008, capital stock also grew because of the fact that the FHLBank pays its quarterly dividends in the form of Class B Common Stock. As reflected in Table 52, the amount of excess stock held by members increased from $404 million as of December 31, 2007 to $408 million as of December 31, 2008, which indicates that members are continuing to hold excess stock that could support future activity. FHLBank management believes that under the current capital plan, capital stock growth should increase along with any advance and mortgage loan growth in future periods. Likewise, FHLBank capital stock can generally be expected to decrease if advances and/or mortgage loans decline in future periods. Any discretionary repurchase of excess capital stock by the FHLBank is subject to statutory and regulatory limitations discussed below, including the FHLBank being in compliance with all of its regulatory capital requirements after any such discretionary repurchase by the FHLBank.
 
The FHLBank’s capital stock is not publicly traded. Members may request to redeem any capital stock in excess of the minimum stock purchase requirements, but any repurchase of excess capital stock by the FHLBank prior to the end of the redemption period is entirely at the discretion of the FHLBank (see Item 1 – “Business – Capital, Capital Rules and Dividends”). All redemptions (at member request at the end of the redemption period) or repurchases (at FHLBank discretion, prior to the end of any applicable redemption period if made at a member’s request) are made at the par value of $100 per share. Stock redemption periods are six months for Class A Common Stock and five years for Class B Common Stock, although the FHLBank can, at its discretion, repurchase amounts over a member’s minimum stock purchase requirements at any time prior to the end of the redemption periods as long as the FHLBank will remain in compliance with its regulatory capital requirements after such repurchase. Ownership of the FHLBank’s capital stock is concentrated within the financial services industry, and is stratified across various institutional entities as reflected in Table 51 as of December 31, 2008, 2007, 2006, 2005 and 2004 (in thousands):

Table 51

   
Commercial
Banks
    
Thrifts
    
Credit
Unions
    
Insurance
Companies
    
Total1
  
December 31, 2008
   $ 950,845     $ 561,482     $ 339,074     $ 388,934     $ 2,240,335  
December 31, 2007
     824,534       641,915       259,266       365,472       2,091,187  
December 31, 2006
     759,982       655,421       359,070       232,519       2,006,992  
December 31, 2005
     754,574       645,577       208,697       179,493       1,788,341  
December 31, 2004
     659,869       822,509       169,481       153,210       1,805,069  
                    
1
Mandatorily redeemable capital stock is recorded as a liability and is not reflected in this table.

Following are highlights from the FHLBank’s capital plan:
§
Two classes of authorized stock – Class A Common Stock and Class B Common Stock;
§
Both classes have $100 par value and both are defined as common stock;
§
Class A Common Stock is required for membership. The initial membership requirement is 0.2 percent of total assets at the end of the prior calendar year, with a minimum requirement of 10 shares ($1,000) and a cap of 10,000 shares ($1,000,000). The membership, or asset-based, stock requirement, is recalculated once a year except in the case of mergers. Class A Common Stock, up to a member’s asset-based stock requirement, is used to satisfy a member’s activity-based stock requirement before any Class B Common Stock is purchased by the member;
§
To the extent that a member’s asset-based requirement in Class A Common Stock is insufficient to support its calculated activity-based requirement, Class B Common Stock must be purchased in order to support a member’s activities with the FHLBank. The activity-based requirements listed below are the current requirements, but are subject to change by the FHLBank’s Board of Directors within ranges specified in the capital plan. The activity-based stock requirement is the sum of the stock requirements for each activity less the asset-based stock requirement in Class A Common Stock and is calculated whenever a member enters into a transaction as follows:
o  
Advances – 5.0 percent of outstanding advances (range = 4.0 to 6.0 percent);
o  
Letters of credit – 0.0 percent of outstanding letters of credit (range = 0.0 to 1.0 percent);
o  
Acquired Member Assets – 2.0 percent of the principal amount of member’s MPF loans held by the FHLBank (range = 0.0 to 6.0 percent), limited to a maximum of 1.5 percent of the member’s total assets at the end of the prior calendar year (range = 1.0 to 3.0 percent); and
o  
Derivatives (swaps, caps, floors and equity options) – 0.0 percent of the total notional amount (range = 0.0 to 2.0 percent);
§
Excess stock is calculated periodically. The FHLBank may exchange excess Class B Common Stock for Class A Common Stock, but only if the FHLBank remains in compliance with its regulatory capital requirements after the exchange;
§
A member may hold excess Class A or Class B Common Stock, subject to the FHLBank’s rights to repurchase excess stock or to exchange excess Class B Common Stock for Class A Common Stock, or may ask to redeem all or part of its excess Class A or Class B Common Stock. A member may also ask to exchange all or part of its excess Class A or Class B Common Stock for Class B or Class A Common Stock, respectively, but all such exchanges are completed at the FHLBank’s discretion;
§
As a member increases its activities with the FHLBank above the amount of activity supported by its asset-based requirement, excess Class A Common Stock is first exchanged for Class B Common Stock to meet the activity requirement prior to the purchase of additional Class B Common Stock;
§
Under the plan, the Board of Directors establishes a dividend parity threshold that is a rate per annum expressed as a positive or negative spread relative to a published reference interest rate index (e.g., LIBOR, Federal funds, etc.) or an internally calculated reference interest rate based upon any of the FHLBank’s assets or liabilities (average yield on advances, average cost of consolidated obligations, etc.);
§
Class A and Class B Common Stock share in dividends equally up to the dividend parity threshold, then the dividend rate for Class B Common Stock can exceed the rate for Class A Common Stock, but the Class A Common Stock dividend rate can never exceed the Class B Common Stock dividend rate;
§
Members were notified of the initial reference interest rate and spread that defines the dividend parity threshold prior to implementation of the plan (average three-month LIBOR for a dividend period plus 50 basis points) and will be notified at least 90 days prior to any change thereof (note that the current dividend parity threshold of the average effective overnight Federal funds rate for a dividend period minus 100 basis points was established by the Board of Directors on September 27, 2007; with overnight Federal funds target rate range of zero to 0.25 percent, the dividend parity threshold is effectively floored at zero percent at this time);
§
A member may submit a redemption request to the FHLBank for any or all of its excess Class A and/or Class B Common Stock;
§
Within five business days of receipt of a redemption request for excess Class A Common Stock, the FHLBank must notify the member if it declines to repurchase the excess Class A Common Stock, at which time the six-month waiting period will apply. Otherwise, the FHLBank will repurchase any excess Class A Common Stock within five business days;
§
Within five business days of receipt of a redemption request for excess Class B Common Stock, the FHLBank must notify the member if it declines to repurchase the excess Class B Common Stock, at which time the five-year waiting period will apply. Otherwise, the FHLBank will repurchase any excess Class B Common Stock within five business days;
§
A member may cancel or revoke its written redemption request prior to the end of the redemption period (six months for Class A Common Stock and five years for Class B Common Stock) or its written notice of withdrawal from membership prior to the end of a six-month period starting on the date the FHLBank received the member’s written notice of withdrawal from membership. The FHLBank’s capital plan provides that the FHLBank will charge the member a cancellation fee in accordance with a schedule where the amount of the fee increases with the passage of time. There is no grace period after the submission of a redemption request during which the member may cancel its redemption request without being charged a cancellation fee; and
§
Each required share of Class A and Class B Common Stock is entitled to one vote up to the statutorily imposed voting caps.

The FHLBank’s activity-based requirements are consistent with its cooperative structure: members’ stock ownership requirements generally increase as their activities with the FHLBank increase. To the extent that a member’s asset-based stock purchase requirement is insufficient to cover the member’s activity-based requirement and the member is required to purchase Class B Common Stock, the required purchase of Class B Common Stock may deter the member from entering into additional activity with the FHLBank. Factors that affect members’ willingness to enter into activity with the FHLBank and purchase additionally required activity-based stock include, but are not limited to, the FHLBank’s dividend rates, the risk-based capital weighting of FHLBank capital stock and alternative investment opportunities available to the members. Based on anecdotal evidence (such as member advance activity and discussions with members), FHLBank management believes that its activity-based stock purchase requirement for advances has not significantly reduced advance activity with its members, although that may not hold true in the future. Given the competitiveness of the mortgage loan market and the fact that member balance sheets do not increase as mortgage loans are sold into the secondary market or sold into the MPF Program, it is possible that the FHLBank’s activity-based requirement for AMA might have a significant bearing on a member’s willingness to sell mortgage loans to the FHLBank under its MPF Program. This is one of the reasons that the initial activity-based stock purchase requirement for AMA was set at the lower end of the FHLBank’s permissible range under the capital plan (range = 0.0 to 6.0 percent of the current outstanding balance of AMA originated by or through the member and acquired by the FHLBank). Since the implementation of the FHLBank’s capital plan as of the close of business on September 30, 2004, FHLBank management does not believe that its activity-based stock purchase requirement for AMA assets has had any significant negative influence on members’ willingness to participate in the MPF Program and sell the FHLBank mortgage loans under the MPF Program, although this may not hold true in the future. Table 52 provides a summary of member capital requirements under the FHLBank’s current capital plan as of December 31, 2008 and 2007 (in thousands):
Table 52

Requirement
  
12/31/2008
    
12/31/2007
  
Asset-based (Class A only)
   $ 315,945     $ 307,041  
Activity-based (additional Class B)1
     1,551,417       1,416,752  
Total Required Stock2
     1,867,362       1,723,793  
Excess Stock (Class A and B)
     407,779       403,541  
Total Stock2
   $ 2,275,141     $ 2,127,334  
                 
Activity-based Requirements:
                
Advances3
   $ 1,741,790     $ 1,589,462  
AMA assets (MPF mortgage loans)4
     49,550       39,790  
Total Activity-based Requirement
     1,791,340       1,629,252  
Asset-based Requirement (Class A stock) not supporting member activity1
     76,022       94,541  
Total Required Stock2
   $ 1,867,362     $ 1,723,793  
                    
1
Class A Common Stock, up to a member’s asset-based stock requirement, will be used to satisfy a member’s activity-based stock requirement before any Class B Common Stock is purchased by the member.
2
Includes mandatorily redeemable capital stock.
3
Advances to housing associates have no activity-based requirements since housing associates cannot own FHLBank stock.
4
Out-of-district AMA mortgage loan participations purchased through other FHLBanks do not have activity-based stock requirements since these assets are not purchased from members of FHLBank Topeka.

The FHLBank is subject to three capital requirements under provisions of the GLB Act, the Finance Agency’s capital structure regulation and the FHLBank’s current capital plan: risk-based capital requirement, total capital requirement and leverage capital requirement. Under the risk-based capital requirement, the FHLBank is required to maintain permanent capital at all times in an amount at least equal to the sum of its credit risk, market risk and operations risk capital requirements, calculated in accordance with the rules and regulations of the Finance Agency. Only permanent capital, defined as retained earnings and Class B stock, can be used by the FHLBank to satisfy its risk-based capital requirement. The Finance Agency, in its discretion, may require the FHLBank to maintain a greater amount of permanent capital than is required by the risk-based capital requirements. The FHLBank is required to maintain total capital at all times of at least four percent of total assets. Total capital is the sum of permanent capital, Class A stock, any general loss allowance, if consistent with GAAP and not established for specific assets, and other amounts from sources determined by the Finance Agency as available to absorb losses. Finally, the FHLBank is required to maintain leverage capital of at least five percent of total assets. Leverage capital is defined as the sum of permanent capital weighted 1.5 times and other capital weighted 1.0 times divided by total assets. The FHLBank has been in compliance with each of the aforementioned capital rules and requirements at all times since the implementation of its capital plan. The FHLBank was in compliance with the applicable capital requirements at December 31, 2008 and 2007 as demonstrated in Table 53 (in thousands):

Table 53

   
12/31/2008
    
12/31/2007
  
   
Required
    
Actual
    
Required
    
Actual
  
Regulatory capital requirements:
                        
Risk-based capital
   $ 1,389,373     $ 1,763,395     $ 665,889     $ 1,696,169  
Total capital-to-asset ratio
     4.0 %     4.2 %     4.0 %     4.2 %
Total capital
   $ 2,342,249     $ 2,432,063     $ 2,212,183     $ 2,336,097  
Leverage capital ratio
     5.0 %     5.7 %     5.0 %     5.8 %
Leverage capital
   $ 2,927,812     $ 3,313,760     $ 2,765,229     $ 3,184,181  
As described in Item 1 – “Business – Tax Status,” each of the 12 FHLBanks is required to pay a portion of its earnings to REFCORP. The GLB Act requires quarterly payments of 20 percent of net earnings after AHP for each FHLBank. Beginning in 2000, the 12 FHLBanks started expensing these amounts through their statements of income and will continue to do so until the aggregate amount actually paid by all 12 FHLBanks since 2000 is equivalent to a $300 million annual annuity whose final maturity date is April 15, 2030, at which point the required payment of the 12 FHLBanks to REFCORP will be fully satisfied. The Finance Agency, in consultation with the Secretary of the Treasury, will select the appropriate discounting factors to be used in each annuity calculation. The cumulative amount to be paid to REFCORP by the FHLBank cannot be determined at this time because of the interrelationships of all future FHLBanks’ earnings and other ratios included in the formula. If the FHLBank experienced a net loss during a quarter, but still had net income for the year, the FHLBank’s obligation to REFCORP would be calculated based on the FHLBank’s year-to-date net income. Although an FHLBank makes quarterly payments on its obligation to REFCORP, the REFCORP assessment is an annual calculation. This means that, should an FHLBank have a net loss for any fiscal year, it would be unable to carry any such loss back to recover previous year REFCORP assessments or forward to offset the annual calculation for future REFCORP assessments. However, the FHLBank would be entitled to a credit against future REFCORP assessments, without any time constraints, if amounts paid during a year were in excess of its calculated year-to-date obligation. Any such overpayment would be recorded in other assets on the FHLBank’s Statements of Condition. If the FHLBank had net income in subsequent quarters, it would utilize any credits first and then be required to contribute additional amounts to meet its calculated year-to-date obligation.. The 12 FHLBanks’ aggregate payments through 2008 exceeded the scheduled payments, effectively accelerating payment of the REFCORP obligation and shortening its remaining term to April 15, 2013, effective December 31, 2008. The FHLBanks’ aggregate payments through 2008 have satisfied $42.5 million of the $75.0 million scheduled payment due on April 15, 2013 and all scheduled payments thereafter. This date assumes that all $75.0 million quarterly payments required after December 31, 2008 will be made as scheduled. The FHLBank expensed $7.1 million, $37.6 million and $34.1 million in periods ended December 31, 2008, 2007 and 2006, respectively, for REFCORP interest assessments through its statements of income.
 
Capital Distributions – Dividends may be paid in cash or capital stock as authorized by the FHLBank’s Board of Directors. Quarterly dividends can be paid out of current and previously retained earnings, subject to Finance Agency regulation and the FHLBank’s capital plan. Dividends were paid at average annualized rates of 4.34 percent and 6.00 percent for the years ended December 31, 2008 and 2007, respectively. The dividend payout ratio was 282.29 percent and 76.52 percent for the years ended December 31, 2008 and 2007, respectively. The dividend payout ratio represents the percentage of dividends paid to net income. The significant increase in the dividend payout ratio for 2008 was largely attributable to the net losses on derivatives and hedging activities, primarily in the fourth quarter.
 
Within its capital plan, the FHLBank has the ability to pay different dividend rates to the holders of Class A Common Stock and Class B Common Stock. This differential is implemented through a mechanism referred to as the dividend parity threshold. As defined in the capital plan, the dividend parity threshold means a dividend rate expressed as a percentage per annum up to which the dividends paid per share on Class A Common Stock and Class B Common Stock must be equal before a higher rate can be paid on Class B Common Stock. The dividend parity threshold is a percentage per annum expressed as a positive or negative spread relative to a published reference interest rate index (e.g., LIBOR, Federal funds, etc.) or an internally calculated reference interest rate based upon any of the FHLBank’s assets or liabilities (average yield on advances, average cost of consolidated obligations, etc.), as determined by the Board of Directors from time to time. Class A stockholders and Class B stockholders share in dividends equally up to the dividend parity threshold for a dividend period, then the dividend rate for Class B stockholders can exceed the rate for Class A stockholders, but the dividend rate on Class A Common Stock can never exceed the dividend rate on Class B Common Stock. In essence, the dividend parity threshold: (1) serves as a soft floor to Class A stockholders since the FHLBank must pay Class A stockholders the dividend parity threshold rate before paying a higher rate to Class B stockholders; (2) indicates a potential dividend rate to Class A stockholders so that they can make decisions as to whether or not to hold excess Class A Common Stock; and (3) provides the FHLBank with a tool to manage the amount of excess stock through higher or lower dividend rates by varying the desirability of holding excess shares of Class A Common Stock (i.e., the lower the dividend rate on Class A Common Stock, the less desirable it is to hold excess Class A Common Stock).
 
In December 2005, the Board of Directors set the dividend parity threshold to be equal to the average of three-month LIBOR for a dividend period minus 100 basis points. This dividend parity threshold was effective for dividends paid during 2006 and the first three quarters of 2007. In September 2007, the Board of Directors changed the dividend parity threshold to be equal to the average effective overnight Federal funds rate for a dividend period minus 100 basis points. This dividend parity threshold was effective for dividends paid during the fourth quarter of 2007, paid during all of 2008 and will continue to be effective until such time as it may be changed by the FHLBank’s Board of Directors. With overnight Federal funds target rate range of zero to 0.25 percent, the dividend parity threshold is effectively floored at zero percent at this time. Under the capital plan, all dividends paid in the form of capital stock must be paid in the form of Class B Common Stock. Tables 54 and 55 present the dividend rates per annum paid on capital stock under the FHLBank’s capital plan during 2008 and 2007:

Table 54

Applicable Rate per Annum
  
12/31/2008
    
09/30/2008
    
06/30/2008
    
03/31/2008
  
Class A Common Stock
     0.75 %     1.75 %     1.75 %     2.75 %
Class B Common Stock
     2.50       4.75       4.75       5.75  
Weighted Average1
     2.33       4.40       4.37       5.25  
                                 
Dividend Parity Threshold:
                                
Average effective overnight Federal funds rate
     0.53 %     1.96 %     2.09 %     3.17 %
Spread to index
     (1.00 )     (1.00 )     (1.00 )     (1.00 )
TOTAL (floored at zero percent)
     0.00 %     0.96 %     1.09 %     2.17 %
Table 55

Applicable Rate per Annum
  
12/31/2007
    
09/30/2007
    
06/30/2007
    
03/31/2007
  
Class A Common Stock
     4.00 %     4.55 %     4.45 %     4.45 %
Class B Common Stock
     6.25       6.70       6.50       6.50  
Weighted Average1
     5.78       6.19       6.00       6.03  
                                 
Dividend Parity Threshold:
                                
Average effective overnight Federal funds rate
     4.49 %                        
Average three-month LIBOR2
             5.44 %     5.36 %     5.36 %
Spread to index
     (1.00 )     (1.00 )     (1.00 )     (1.00 )
TOTAL
     3.49 %     4.44 %     4.36 %     4.36 %
                    
1
Weighted average dividend rates are dividends paid in cash and stock on both classes of stock divided by the average of capital stock eligible for dividends.
2
For purposes of the establishment of dividend rates, the FHLBank may project for the dividend period the reference interest rate used in the dividend parity threshold calculation, in the FHLBank’s absolute discretion, and may declare and pay dividends at rates per annum based on such projection without regard to the actual reference interest rate subsequently published or calculated for the dividend period.

FHLBank management anticipates that dividend rates on Class A Common Stock will be at or above the upper end of the current overnight Federal funds target rate range for future dividend periods until such time as the dividend parity threshold calculation results in a positive number. We also expect that the differential between the two classes of stock for 2009 will remain close to the differential for the fourth quarter of 2008, subject to sufficient FHLBank earnings to meet retained earnings targets and still pay such dividends. While there is no assurance that the FHLBank’s Board of Directors will not change the dividend parity threshold in the future, the capital plan requires that the FHLBank provide members with 90 days notice prior to the end of a dividend period in which a different dividend parity threshold is utilized in the payment of a dividend.
 
Table 56 presents dividends paid by type for the periods ending December 31, 2008 and 2007 (in thousands):

Table 56

   
Dividends Paid
in Cash
    
Dividends Paid
in Capital Stock
    
Total
Dividends Paid
  
12/31/20081,2
   $ 345     $ 79,935     $ 80,280  
12/31/20071,2
     373       114,647       115,020  
                    
1
The cash dividends listed represent cash dividends paid for partial shares and dividends paid to former members. Stock dividends are paid in whole shares.
2
In this table, the dividends paid for any shares that are mandatorily redeemable have been treated as interest expense and are not treated as dividends in accordance with SFAS 150.

The FHLBank expects to continue paying dividends primarily in capital stock in 2009, but this may change depending on any future impact of the Finance Agency rule on excess stock that was effective January 29, 2007. The FHLBank believes that dividends paid in the form of capital stock are advantageous to members because FHLBank capital stock dividends generally qualify as tax-deferred stock dividends under the Internal Revenue Code and are, therefore, not taxable at the time declared and credited to a member’s capital stock account. Dividends paid in capital stock can be utilized by members to support future activity with the FHLBank or can be requested by the member to be redeemed if the amounts represent excess capital stock, subject to stock redemption request procedures and limitations (see the discussion of stock redemption requests in Item 1 – “Business – Capital, Capital Rules and Dividends”). If the FHLBank were to change its prior practice and pay dividends in the form of cash, it would utilize liquidity resources. Payment of cash dividends would not have a significant impact on the FHLBank’s liquidity position.
 
Capital Adequacy – As reflected in Table 53 and discussed below, the FHLBank was in compliance with its minimum regulatory capital requirements at December 31, 2008. The FHLBank established within its RMP an internal minimum total capital-to-asset ratio requirement of 4.04 percent, which is in excess of the 4.00 percent regulatory requirement. All regulatory and internal FHLBank capital ratios include as capital mandatorily redeemable capital stock, which is otherwise treated as a liability by the FHLBank in accordance with SFAS 150.
At December 31, 2008, 93.5 percent of the FHLBank’s capital was capital stock, and 6.5 percent was retained earnings and accumulated other comprehensive income. At December 31, 2007, 91.0 percent of the FHLBank’s capital was capital stock, and 9.0 percent was retained earnings and accumulated other comprehensive income. As of December 31, 2008, the FHLBank’s total GAAP capital was 4.09 percent of total assets and its total regulatory capital was 4.15 percent of total assets, including $34.8 million of mandatorily redeemable capital stock. Excluding the $34.8 million of mandatorily redeemable capital stock, the FHLBank’s regulatory total capital ratio would have been 4.09 percent. For regulatory purposes, the Finance Agency considers capital stock subject to member redemption requests (mandatorily redeemable capital stock) as capital, even though it is considered a liability for GAAP purposes under SFAS 150. As of December 31, 2007, the FHLBank’s total GAAP capital was 4.15 percent of total assets and its total regulatory capital was 4.22 percent of total assets, including $36.1 million of mandatorily redeemable capital stock. Excluding the $36.1 million of mandatorily redeemable capital stock, the FHLBank’s regulatory total capital ratio would have been 4.16 percent. The FHLBank expects to maintain a regulatory capital-to-asset percentage greater than the regulatory minimum of 4.0 percent and greater than its risk management policy minimum of 4.04 percent. However, the FHLBank’s GAAP total capital percentage could drop below these levels because mandatorily redeemable capital stock is considered a liability under GAAP.
 
Liquidity – To meet its mission of serving as an economical short-term and long-term funding source for its members and housing associates, the FHLBank must maintain high levels of liquidity. The FHLBank is required to maintain liquidity in accordance with certain Finance Agency regulations and with policies established by management and the Board of Directors (see Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Liquidity Risk Management”). The FHLBank also needs liquidity to repay maturing consolidated obligations, to meet other financial obligations and to repurchase excess capital stock at its discretion, whether upon the request of a member or at its own initiative (mandatory stock repurchases). At December 31, 2008, the FHLBank had pending stock redemption requests of $34.8 million, of which $17,000 of Class A Common Stock and $94,000 of Class B Common Stock was repurchased on January 2, 2009. At December 31, 2007, the FHLBank had pending stock redemption requests of $36.1 million, of which $280,000 of Class A Common Stock and $125,000 of Class B Common Stock was repurchased on January 2, 2008. The remainder of the pending stock redemption requests for both years was for capital stock supporting the outstanding advance and AMA balances of former members. The FHLBank anticipates that it will be able to manage its excess capital stock position in order to continue to pay stock dividends, but cannot guarantee that it will always be able to do so in the future.
 
A primary source of the FHLBank’s liquidity is the issuance of consolidated obligations. The capital markets traditionally have treated FHLBank obligations as U.S. government agency debt. As a result, even though the U.S. government does not guarantee FHLBank debt, the FHLBank has comparatively stable access to funding at relatively favorable spreads to U.S. Treasury rates. The FHLBank is primarily and directly liable for its portion of consolidated obligations (i.e., those obligations issued on its behalf). In addition, the FHLBank is jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on the consolidated obligations of all 12 FHLBanks. See Item 1 – “Business – Debt Financing – Consolidated Obligations” for additional discussion regarding the FHLBanks joint and several liability.
 
The FHLBank’s other primary sources of liquidity include deposit inflows, repayments of advances or mortgage loans, maturing investments and interest income. Primary uses of liquidity include issuing advances, funding or purchasing mortgage loans, purchasing investments, deposit withdrawals, capital redemptions, maturing consolidated obligations and interest expense. The FHLBanks’ ability to meet the liquidity needs of their members and housing associates was tested in 2008 as a result of the disruptions in the capital markets related to the credit crisis. A significant increase in demand for advances occurred in the second half of 2007 at the FHLBanks and continued through the first nine months of 2008 as total advances for the 12 FHLBanks increased from $875.1 billion at December 31, 2007 to $1.0 trillion at September 30, 2008 before declining to $928.6 billion at December 31, 2008. This significant increase in system-wide advance demand was caused by the capital market dislocation, which resulted in some funding sources normally available to the FHLBanks’ members nearly disappearing due to the problems in the sub-prime and Alt-A mortgage markets, the securities repurchase market and the asset-backed commercial paper market. As these funding sources began to dry up, the demand for advances, primarily short-term advances, increased. The FHLBanks were able to meet the funding needs of their members, primarily through issuance of consolidated discount notes, which increased from $378.4 billion par value at December 31, 2007 to $441.1 billion par value at December 31, 2008.
 
While the increase in FHLBank Topeka’s advances balances (from $32.1 billion at December 31, 2007 to $35.8 billion at December 31, 2008) represents a small portion of the total system advance growth, the increased issuance of consolidated obligation discount notes to fund the FHLBank’s advance increase was being transacted in the same market as the other 11 FHLBanks since we issue all debt jointly. The ability of the 12 FHLBanks to fund such a dramatic increase in advances without stressing its funding sources in the form of consolidated obligations demonstrates the ability of the FHLBanks to meet the funding needs of their members while maintaining their ongoing liquidity needs even in times of undue capital market stress.
 
Cash and short-term investments, including commercial paper, totaled $7.5 billion and $12.4 billion as of December 31, 2008 and 2007, respectively. The maturities of these short-term investments are structured to provide periodic cash flows to support the FHLBank’s ongoing liquidity needs. During the third and fourth quarter of 2008, the FHLBank allowed short-term investments to mature and reinvested these funds in the overnight Federal funds market or retained the funds in its Federal Reserve Bank account in order to provide additional sources of liquidity and due to credit precautions taken against non-government guaranteed counterparties. The FHLBank began reinvesting in short-term government guaranteed money market investments in the latter part of the fourth quarter 2008. The FHLBank also maintains a portfolio of GSE debentures that can be pledged as collateral for financing in the securities repurchase agreement market. GSE investments totaled $1.6 billion and $0.8 billion in par value at December 31, 2008 and 2007, respectively. As the capital market and credit crisis intensified during the third and fourth quarter of 2008, securing funding through the securities repurchase agreements at a reasonable rate for anything other than very short-term maturities was severely stressed. The liquidity in the securities repurchase market appears to have stabilized somewhat in the first quarter of 2009. In order to assure that the FHLBank can take advantage of those sources of liquidity that will affect its leverage capital requirements, the FHLBank manages its average capital ratio to stay sufficiently above its minimum regulatory and RMP requirements so that it can utilize the excess capital capacity should the need arise. While the minimum regulatory total capital requirement is 4.00 percent (25:1 asset to capital leverage), and its RMP minimum is 4.04 percent (24.5:1 asset to capital leverage), the FHLBank attempts to manage capital in such a way as to keep its total regulatory capital ratio at or above 4.17 percent (24:1 asset to capital leverage). As a result, should the need arise, the FHLBank has the capacity to borrow an amount approximately equal to at least one-half its current capital position before it reaches any leverage limitation as a result of the minimum regulatory or RMP capital requirements. As an additional precaution, we increased our day-to-day oprating target capital ratio to 4.35 percent (23:1 asset to capital leverage) or above for the first quarter of 2009 through the reduction of short-term investments in order to reduce our exposure to unsecured credit risk and increase our ability to meet the needs of our members during this tumultuous time in the financial markets.
In addition to the liquidity measures discussed above, the Finance Agency provided guidance, effective March 6, 2009, formalizing preliminary guidelines for liquidity that it had provided to the FHLBanks in the third and fourth quarters of  2008. The preliminary guidelines included multiple scenarios that the FHLBank calculated daily but were not being formally used by the FHLBank in its daily liquidity management. This final guidance requires us to maintain sufficient liquidity, through short-term investments, in an amount at least equal to our anticipated cash outflows under two different scenarios. One scenario, referred to as a roll-off scenario, assumes that we cannot access the capital markets for a period of 15 days and that during that time, members do not renew any maturing, prepaid and called advances. The second scenario, referred to as a renew scenario, assumes that we cannot access the capital markets for 5 days and that during that period we will automatically renew maturing and called advances for all members except very large, highly rated members. The new requirement is designed to enhance our protection against temporary disruptions in access to the FHLBank debt markets in response to a rise in capital markets volatility. Given changes made by the FHLBank in its internal liquidity management process during the fourth quarter of 2008, we do not anticipate at this time that the final guidance will significantly impact the FHLBank's net interst spreads in the current interest rate environment. However, given that the final liquidity guidance will, over time, result in increased costs because the effect of the guidance is to have liabilities with terms exceeding those of the FHLBank's assets.  For further discussion of how this may impact us, see Item 1A – “Risk Factors.”
 
The FHLBank entered into a Lending Agreement (the “Agreement”) with the United States Department of the Treasury (Treasury) in the third quarter of 2008. Each of the other 11 FHLBanks also entered into its own Lending Agreement with the Treasury that is identical to the Agreement entered into by the FHLBank. The FHLBanks entered into these Agreements in connection with the Treasury’s establishment of a Government Sponsored Enterprise Credit Facility (GSECF) that is designed to serve as a contingent source of liquidity for the housing GSEs, including the FHLBanks. Any borrowings by one or more of the FHLBanks under the GSECF are considered consolidated obligations with the same joint and several liability as all other consolidated obligations. The terms of any borrowings are agreed to at the time of issuance. Loans under the Agreement are to be secured by collateral acceptable to the Treasury, which consists of FHLBank advances to members that have been collateralized in accordance with regulatory standards and mortgage-backed securities issued by Fannie Mae or Freddie Mac. Each FHLBank is required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the Treasury, a list of eligible advance collateral, updated on a weekly basis. The amount of collateral can be increased or decreased (subject to the approval of the Treasury) at any time through the delivery of an updated listing of advance collateral held by the FHLBank as borrower-in-custody or through the delivery of mortgage-backed securities issued by Fannie Mae or Freddie Mac to a custodial National Book Entry System account established though the Federal Reserve Bank of New York for the benefit of the Treasury. As of December 31, 2008, the FHLBank has not drawn on this available source of liquidity and does not anticipate any need to utilize the GSECF.
 
In addition to the balance sheet sources of liquidity discussed previously, the FHLBank has established lines of credit with numerous counterparties in the Federal funds market as well as with the other 11 FHLBanks. The FHLBank expects to maintain a sufficient level of liquidity for the foreseeable future.
 
In mid-July 2008, the financial markets reacted negatively to growing concern and speculation as to whether Fannie Mae and Freddie Mac had or could raise sufficient capital to cover potential losses related to mortgage loans that these two GSEs either owned or guaranteed. As a result, the stock prices of both fell significantly and their ability to issue debt was hindered. This market unrest also affected the FHLBank’s debt issuance, which is grouped in the same general asset class as Fannie Mae and Freddie Mac (Agency/GSE debentures). As a result, the cost of the FHLBank’s intermediate and long-term debt increased during the second half of July 2008 as there was some reluctance by investors to purchase or invest in any debt security other than ones with very short-term maturities. The passage of a GSE reform bill in late July 2008, which impacts the FHLBanks, Fannie Mae and Freddie Mac, appeared to alleviate some, but not all, of this market disruption. Despite the passage of the bill, heightened concern about Fannie Mae and Freddie Mac resulted in a significant decline in their market capitalizations and the subsequent Finance Agency placement of both entities into conservatorship on September 7, 2008. In addition, the large investment firms that were not owned by bank holding companies, such as Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs, also suffered significant declines in market capitalization. Under this pressure, Lehman Brothers declared bankruptcy on September 15, 2008, Merrill Lynch subsequently agreed to be purchased by Bank of America, and Morgan Stanley and Goldman Sachs requested regulatory approval to convert to bank holding companies. Also during the third quarter of 2008, several of the United States’ largest depository institutions suffered significant declines in investor and regulator confidence resulting in the closure of IndyMac Bank, the financial bailout of AIG by the U.S. government, the sale of the banking operations of Washington Mutual, Inc. to JPMorgan Chase and the sale of the banking operations of Wachovia Corporation to Wells Fargo. Market participants were exceedingly cautious about the creditworthiness of trade counterparties, which severely limited financial market liquidity.
 
As mentioned previously, the Finance Agency placed Fannie Mae and Freddie Mac into conservatorship on September 7, 2008, and Lehman Brothers Holding, Inc. declared bankruptcy on September 15, 2008. Both of these events were catalysts to a worsening in financial market liquidity conditions, even for Agency debt issuance. Investors began a flight to quality that caused costs in the Agency/GSE debt markets to increase and generally limited issuance at reasonable costs to short-term consolidated obligation discount notes. Although market conditions stabilized and improved some during November and December of 2008 and into the first quarter of 2009, issuance limitations persist because of increased issuance of U.S. government obligations, increased competition from government guaranteed debt programs, continuing credit concerns regarding all financial institutions and less than optimal pricing levels for longer-term debt available in the Agency/GSE debt market. At this time we are unable to predict when financial market conditions and the Agency/GSE debt market will return to pre-crisis levels.
During the heightened liquidity concerns in the financial markets due to the market disruptions and uncertainty detailed previously, the FHLBank took steps beginning the third quarter of 2008 and continuing into the fourth quarter of 2008 to increase and manage its short-term liquidity in order to ensure that it could meet member advance demands and other obligations on an ongoing basis without access to the consolidated obligations market for a minimum of five calendar days. This measure is in addition to its operational and contingency liquidity requirements. These actions included: (1) curtailment of money market investments; (2) lengthening the weighted average original days to maturity of the FHLBank’s consolidated obligation discount notes outstanding from 67.0 days as of December 31, 2007 to 98.8 days as of December 31, 2008; and (3) increasing its cash balances in interest-bearing deposits. The FHLBank continues to manage to this measure in the first quarter of 2009 and anticipates it will continue managing to this measure throughout 2009. These actions have created an asset-liability mismatch (assets re-pricing more quickly than liabilities) on the short end of the FHLBank’s balance sheet and resulted in a decrease in the FHLBank’s net interest income in the fourth quarter of 2008 because of the steepness of the very short end of the yield curve and the fact that interest rates decreased fairly dramatically after the FHLBank initially extended its liabilities. While this asset-liability mismatch continues into the first quarter of 2009, the FHLBank has narrowed the mismatch by decreasing weighted average original days to maturity of the FHLBank’s consolidated obligation discount notes to 94.7 days as of March 20, 2009. At the same time, short-term interest rates have stabilized at relatively low levels and the high-cost debt issued in late third quarter and early fourth quarter matured in the first two months of 2009. This, in addition to the improved relative cost of consolidated obligation discount notes in the latter part of the fourth quarter of 2008 and through the first quarter of 2009, and the interest income received on excess reserves held at the Federal Reserve Bank of Kansas City which began in October 2008, should help mitigate the impact of these liquidity measures on net interest income during 2009.
 
Contractual Obligations – Table 57 represents the payment due dates or expiration terms under the specified contractual obligation type, excluding derivatives, by period as of December 31, 2008 (in thousands). Consolidated obligations listed exclude discount notes, which have maturities of one year or less, and are based on contractual maturities. Actual distributions could be influenced by factors affecting potential early redemptions.

Table 57

   
1 Year
or Less
    
After 1
Through 3
Years
    
After 3
Through 5
Years
    
After
5 Years
    
Total
  
Consolidated obligation bonds
   $ 8,044,892     $ 8,315,014     $ 3,689,300     $ 6,971,000     $ 27,020,206  
Capital lease obligations
     6,006       11,150       5,144       0       22,300  
Operating leases
     84       122       72       0       278  
Standby letters of credit
     2,690,768       57,424       3,170       0       2,751,362  
Standby credit facility commitments
     1,000,000       0       0       0       1,000,000  
Standby bond purchase agreements
     80,579       425,844       786,896       18,587       1,311,906  
Commitments to fund mortgage loans
     141,357       0       0       0       141,357  
Expected future pension benefit payments
     256       569       661       4,806       6,292  
Mandatorily redeemable capital stock
     17,168       9,820       1,195       6,623       34,806  
TOTAL
   $ 11,981,110     $ 8,819,943     $ 4,486,438     $ 7,001,016     $ 32,288,507  

Results of Operations (Years Ended December 31, 2008, 2007 and 2006)
The primary source of the FHLBank’s earnings is net interest income (NII), which is interest earned on advances, mortgage loans, and investments less interest paid on consolidated obligations, deposits, and other borrowings. The FHLBank continued to grow NII in 2008 – posting solid increases in both 2007 and 2008. NII before mortgage loan loss provision increased by 7.7 percent between 2006 and 2007 and increased by 6.7 percent between 2007 and 2008. The 2008 NII growth can be attributed to three primary factors. First, the FHLBank experienced strong demand for advances as it provided liquidity to members in a very difficult economic environment. Second, pursuant to the Finance Agency’s temporary increase on the purchase of MBS, the FHLBank re-allocated a portion of its investment portfolio into Agency variable-rate CMOs and out of lower yielding money market assets. Third, general financial market uncertainty and volatility led investors to look for safety in primarily short-term US Treasury and Agency debt, which significantly lowered the FHLBank’s short-term borrowing costs and increased its net interest spreads for much of 2008. See Table 59, Spread and Yield Analysis, and Table 60, Rate and Volume Analysis, under this Item 7 for further information.
 
Although NII continued to grow in 2008, net income was significantly lower than it was for 2007. The FHLBank’s net income increased 10.1 percent from 2006 to 2007 but decreased 81.1 percent from 2007 to 2008. The decrease from 2007 to 2008 is primarily attributable to an increase in net loss on derivatives and hedging activities and net unrealized losses of ($33.3) million on unswapped Agency variable rate MBS/CMOs classified as trading securities. As reflected in Footnote 9, Derivatives and Hedging Activity, of the FHLBank’s financial statements and Table 61, $207.0 million of the $215.5 million net loss on derivatives and hedging activities was applicable to economic hedges. See further discussion of the impact of derivative and hedging activities on net income under this Item 7 – “Net Gain (Loss) on Derivative and Hedging Activities.”
 
Much of the volatility in net income from 2006 to 2008 was attributable to the effect of interest rate movements on income received from interest earning assets, adjusted for gains (losses) on derivatives. See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Net Gain (Loss) on Derivative and Hedging Activities” for a discussion of the impact of derivatives by year. Return on equity (ROE) for 2006 was 6.88 percent which increased to 6.93 percent in 2007 and then decreased to 1.17 percent in 2008. The increase in ROE for 2007 was primarily attributable to the increase in short-term interest rates, and the increased volume and yield on average assets. The decrease in ROE for 2008 can be partially attributable to the decrease in short-term interest rates despite the increased volume (See Table 59, Spread and Yield Analysis, and Table 60, Rate and Volume Analysis, under this Item 7 for further information on the impact of interest rates), but is primarily attributable the increase in net loss on derivatives and hedging activities.
Earnings Analysis – Table 58 presents changes in the major components of the FHLBank’s earnings for the past three years (in thousands):

Table 58

   
Increase (Decrease) In Earnings Components
  
   
Dollar Change
    
Percent Change
  
   
2008 vs. 2007
    
2007 vs. 2006
    
2008 vs. 2007
    
2007 vs. 2006
  
Total interest income
   $ (858,741 )   $ 294,799       (31.2 )%     12.0 %
Total interest expense
     (874,203 )     278,214       (34.7 )     12.4  
Net interest income before mortgage loan loss provision
     15,462       16,585       6.7       7.7  
Provision for (reversal of) credit losses on mortgage loans
     221       (383 )     884.0       (107.0 )
Net interest income after mortgage loan loss provision
     15,241       16,968       6.6       7.9  
Net gain (loss) on trading securities
     26,166       25,763       142.6       347.4  
Net gain (loss) on derivatives and hedging activities
     (205,348 )     (21,683 )     (2,024.1 )     (187.9 )
Other non-interest income
     650       1,770       32.2       716.6  
Total non-interest income (loss)
     (178,532 )     5,850       (1,746.9 )     133.9  
Operating expenses
     2,495       3,217       7.9       11.3  
Other non-interest expense
     253       826       4.5       17.4  
Total other expense
     2,748       4,043       7.4       12.2  
AHP assessments
     (13,706 )     1,474       (80.9 )     9.5  
REFCorp assessments
     (30,466 )     3,458       (81.1 )     10.1  
Total assessments
     (44,172 )     4,932       (81.0 )     9.9  
NET INCOME
   $ (121,867 )   $ 13,843       (81.1 )%     10.1 %

Net Interest Income – Net interest income increased 6.7 percent from 2007 to 2008. This increase is primarily attributable to interest rates on funding sources falling faster than interest rates on assets for most of 2008 (increased net interest spread) coupled with an increase in the FHLBank’s average capital and other non-interest-bearing funds (interest-earning assets over interest-bearing liabilities). Net interest income increased 7.7 percent from 2006 to 2007. This increase is primarily attributable to a combination of the overall increase in the FHLBank’s average capital and other non-interest-bearing funds (interest-earning assets over interest-bearing liabilities), a slight increase in net interest spread from borrowing cost improvements and the increase in the average short-term interest rates. The FHLBank’s net interest margin was 0.43 percent, 0.44 percent and 0.45 percent for 2008, 2007 and 2006, respectively. Net interest spreads improved from 0.20 percent in 2007 to 0.29 percent in 2008 as the FHLBank experienced: (1) some improved pricing leverage on its advances to large members as a result of the financial market disruptions; (2) a re-allocation of a portion of its investment portfolio into Agency variable-rate CMOs and out of lower yielding money market assets (higher spreads in MBS/CMO investments); (3) lower short-term borrowing costs for much of 2008; and (4) improved spreads on short-term investment transactions as a result of the capital market disruptions that started in mid-August 2007 and continued through 2008. However, in the last half of 2008 the increased instability in the global financial markets caused the FHLBank’s cost of callable and non-callable consolidated obligation bonds to increase as LIBOR spiked to unusually high levels relative to other short-term indices (including the cost of consolidated discount notes) and did not return to a more normal relationship to other short-term indices until late 2008, although the spreads between LIBOR and other short-term indices remain somewhat elevated. During the fourth quarter 2008, the FHLBank experienced a significant contraction in net interest spreads and net interest income as it extended its consolidated obligations in the midst of rapidly falling interest rates. During this period, its assets re-priced faster than its liabilities. The extension of the terms of borrowings was to increase liquidity in order to ensure it could meet member advance demand over the end of the year. We expect some downward pressures on the FHLBank’s net interest spreads in 2009 as capital market conditions improve and our pricing leverage dissipates, but the improved relative value of mortgage assets to the FHLBank’s cost of funds could offset some of this pressure on net interest spreads. In addition, much of the high-cost consolidated obligations from the extension of liabilities in late 2008 mature in the first two months of 2009, which should also have a positive impact on net interest spreads. The recent slow down in mortgage prepayments in spite of lower mortgage rates, however, will result in lower spread variable rate MBS/CMOs staying on the FHLBank’s books longer than they would in normal market conditions and slow the replacement with higher spread variable rate MBS/CMOs.
 
The FHLBank increased its issuance of callable bonds during 2007 and 2008 in order to increase the convexity characteristics of the liabilities funding its mortgage-related assets. With interest rates falling during the last half of 2007 and throughout 2008, the FHLBank also had to replace bonds that were being called over this time period. The level of convexity in a given portfolio of financial products, assets or liabilities is proportional to the number of options contained in these products and the levels of the option “strikes” in relation to current interest rates. Mortgage loans include many options, which are simply the many opportunities afforded mortgage borrowers to pay off or refinance their loans without penalty. In order to approximately match these options, the FHLBank must purchase prepayment options from the investors who buy the consolidated obligations issued by the FHLBank. These are callable bonds, which have similar convexity characteristics to the mortgage assets the FHLBank holds. During 2007 and continuing in 2008, the FHLBank’s investment strategy focused more on the purchase of Agency variable rate CMOs with embedded interest rate caps because these securities generally had a higher overall risk-adjusted return relative to the FHLBank’s cost of funds than comparable fixed rate CMOs. Included in this strategy was the purchase of interest rate caps that effectively offset a portion of the negative effect of the caps embedded in the securities purchased. Variable rate instruments were 70.3 percent, 49.0 percent and 40.4 percent of the FHLBank’s held-to-maturity MBS/CMO portfolio at December 31, 2008, 2007 and 2006, respectively. All Agency MBS/CMOs in the FHLBank’s trading portfolio were also variable rate instruments.
SFAS 133 impacted the FHLBank’s net interest spread as well. SFAS 133 requires that the assets and liabilities hedged with derivative instruments designated under fair value hedging relationships be adjusted for changes in fair values even as other assets and liabilities continue to be carried on a historical cost basis. The result is that positive SFAS 133 basis adjustments on advances reduce the average annualized yield and negative SFAS 133 basis adjustments on consolidated obligations increase the average annualized cost. Therefore, the average net interest spread is negatively affected by the basis adjustments included in the asset and liability balances and is not necessarily comparable between years.
 
The spread earned on advances improved in 2008 as the FHLBank experienced strong advance demand as alternative sources of funding for member institutions diminished and the FHLBank was the beneficiary of improved short-term funding costs as investors sought the safe haven of short-term U.S. Treasury and Agency securities on the short end of the maturity spectrum. One additional contributing factor to the improvement in advance spreads is the fact that a substantial portion of the growth in advances in 2008 can be attributed to small and medium sized member institutions. Under the FHLBank’s tiered pricing methodology for advances (based on the dollar amount of the advance), small and medium sized borrowers generally utilize the smaller dollar pricing tier, which carries a higher interest rate for the term/structure selected and thus results in the highest spread to the FHLBank’s cost of funds. Therefore, all things being equal, an increase in advances to small and medium sized borrowers in the smaller dollar advance pricing tier increases the FHLBank’s overall spreads on advances. This spread improvement should reverse itself during 2009 as capital market conditions improve, our pricing leverage dissipates and the favorable pricing on short-term consolidated obligation discount notes disappears. The FHLBank anticipates that demand for advances in 2009 will decrease as economic growth remains subdued and many member institutions de-leverage to improve their liquidity and capital ratios.
 
A significant portion of the FHLBank’s consolidated obligation bonds is comprised of long-term callable bonds swapped to LIBOR. The FHLBank’s funding costs relative to LIBOR had a positive impact on the FHLBank’s spreads on advances during 2006 and the first half of 2007. In the second half of 2007, capital market disruptions caused one-month and three-month LIBOR to climb to unusually high levels relative to other short-term interest rates which resulted in a significant increase in the cost of the FHLBank’s existing sub-LIBOR funding and compressed the FHLBank’s spreads earned on its advance portfolio. The elevated relationship of LIBOR to other short-term indices persisted during 2008 and, in fact, worsened dramatically during the third and fourth quarters of 2008 as global financial markets became even more severely disrupted. In response to this increased cost structure the FHLBank realigned its liability portfolio by reducing its exposure to term LIBOR-based funding to a level consistent with its LIBOR based asset portfolios and increased its issuance of short-term discount notes. This realignment started during 2007, increased during 2008 and ultimately has reduced the FHLBank’s LIBOR basis risk, which represents non-LIBOR based assets (mostly advances) funded with LIBOR-based liabilities.
 
As explained in more detail in Item 7A – “Quantitative and Qualitative Disclosure About Market Risk – Interest Rate Risk Management – Duration of Equity,” the FHLBank’s DOE is relatively short. The historically short DOE is the result of the short maturities (or short reset periods) of the majority of the FHLBank’s assets and liabilities. Accordingly, the FHLBank’s net interest income is quite sensitive to the level of short-term interest rates. As short-term interest rates increased in 2006, so did the FHLBank’s net interest income. After the end of the second quarter of 2006, the FOMC stopped its series of increases in the target rate for overnight Federal funds and the FHLBank’s net interest income stabilized in subsequent quarters until the third quarter of 2007 when the FOMC began to lower the Federal funds target rate. The FOMC dramatically escalated the pace of its easing cycle during early 2008 and continued lowering its overnight Federal funds target rate through December 2008 as the financial crisis continued. The overnight Federal funds target rate as of December 31, 2008 was 0 to 0.25 percent.
Table 59 presents average balances and yields of major earning asset categories and the sources funding those earning assets (in thousands):

Table 59

   
12/31/2008
    
12/31/2007
    
12/31/2006
  
   
Average
Balance
    
Interest
Income/
Expense
    
Yield
    
Average
Balance
    
Interest
Income/
Expense
    
Yield
    
Average
Balance
    
Interest
Income/
Expense
    
Yield
  
Interest-earning assets:
                                                      
Interest-bearing deposits
   $ 828,249     $ 5,539       0.67 %   $ 70,550     $ 3,657       5.18 %   $ 128,281     $ 6,443       5.02 %
Federal funds sold and resale agreements
     2,926,863       73,047       2.50       6,681,960       346,935       5.19       4,302,885       217,370       5.05  
Investments6
     16,490,068       627,798       3.81       13,690,721       731,159       5.34       13,372,856       689,288       5.15  
Advances1,7
     35,245,582       1,045,801       2.97       29,284,624       1,540,876       5.26       27,881,941       1,413,713       5.07  
Mortgage loans held for portfolio1,4,5
     2,607,016       134,470       5.16       2,348,836       122,281       5.21       2,402,454       122,961       5.12  
Other interest-earning assets
     58,940       3,557       6.03       64,006       4,045       6.32       67,257       4,379       6.51  
Total earning assets
     58,156,718       1,890,212       3.25       52,140,697       2,748,953       5.27       48,155,674       2,454,154       5.10  
Other non interest-earning assets
     283,624                       307,402                       227,102                  
Total assets
   $ 58,440,342                     $ 52,448,099                     $ 48,382,776                  
                                                                         
Interest-bearing liabilities:
                                                                        
Deposits
   $ 1,408,743       27,085       1.92     $ 985,293       48,558       4.93     $ 796,357       38,480       4.83  
Consolidated obligations1:
                                                                        
Discount Notes
     25,214,642       605,074       2.40       15,688,491       783,906       5.00       13,539,010       670,818       4.95  
Bonds
     28,682,830       1,007,644       3.51       32,861,902       1,680,751       5.11       31,180,906       1,525,049       4.89  
Other borrowings
     107,677       3,122       2.90       77,212       3,913       5.07       93,916       4,567       4.86  
Total interest-bearing liabilities
     55,413,892       1,642,925       2.96       49,612,898       2,517,128       5.07       45,610,189       2,238,914       4.91  
Capital and other non-interest-bearing funds
     3,026,450                       2,835,201                       2,772,587                  
Total funding
   $ 58,440,342                     $ 52,448,099                     $ 48,382,776                  
                                                                         
Net interest income and net interest spread2
           $ 247,287       0.29 %           $ 231,825       0.20 %           $ 215,240       0.19 %
                                                                         
Net interest margin3
                     0.43 %                     0.44 %                     0.45 %
                    
1
Interest income/expense and average rates include the effect of associated derivatives.
2
Net interest spread is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities.
3
Net interest margin is net interest income as a percentage of average interest-earning assets.
4
The FHLBank nets CE fee payments against interest earnings on the mortgage loans held for portfolio. The expense related to CE fee payments to PFIs was $2.5 million, $2.3 million and $2.5 million for the years ending December 31, 2008, 2007 and 2006, respectively.
5
Mortgage loans held for portfolio average balance includes outstanding principal for non-performing loans. However, these loans no longer accrue interest.
6
The fair value adjustment on available-for-sale securities is excluded from the average balance for calculation of yield since the change runs through equity.
7
Advance income includes prepayment fees on terminated advances.
Changes in the volume of interest-earning assets and the level of interest rates influence changes in net interest income, net interest spread and net interest margin. Table 60 summarizes changes in interest income and interest expense between 2008 and 2007 and between 2007 and 2006 (in thousands):

Table 60

   
2008 vs. 2007
    
2007 vs. 2006
  
   
Increase (Decrease) Due to
    
Increase (Decrease) Due to
  
   
Volume1,3
    
Rate2,3
    
Total
    
Volume1,3
    
Rate2,3
    
Total
  
Interest Income:
                                    
Interest-bearing deposits
   $ 39,277     $ (37,395 )   $ 1,882     $ (2,899 )   $ 113     $ (2,786 )
Federal funds sold and resale agreements
     (194,969 )     (78,919 )     (273,888 )     120,184       9,381       129,565  
Investments
     149,501       (252,862 )     (103,361 )     16,384       25,487       41,871  
Advances
     313,649       (808,724 )     (495,075 )     71,121       56,042       127,163  
Mortgage loans held for portfolio
     13,440       (1,251 )     12,189       (2,744 )     2,064       (680 )
Other assets
     (320 )     (168 )     (488 )     (212 )     (122 )     (334 )
Total earning assets
     320,578       (1,179,319 )     (858,741 )     201,834       92,965       294,799  
Interest Expense:
                                                
Deposits
     20,869       (42,342 )     (21,473 )     9,129       949       10,078  
Consolidated obligations:
                                                
Discount Notes
     475,992       (654,824 )     (178,832 )     106,500       6,588       113,088  
Bonds
     (213,742 )     (459,365 )     (673,107 )     82,217       73,485       155,702  
Other borrowings
     1,545       (2,336 )     (791 )     (812 )     158       (654 )
Total interest-bearing liabilities
     284,664       (1,158,867 )     (874,203 )     197,034       81,180       278,214  
Change in net interest income
   $ 35,914     $ (20,452 )   $ 15,462     $ 4,800     $ 11,785     $ 16,585  
                    
1
Volume changes are calculated by taking (current year average balance – prior year average balance) * prior year calculated yield.
  
2
Rate Changes are calculated by taking (current year average rate – prior year average rate) * current year average balance.
  
3
Amounts used to calculate volume and rate changes are based on numbers in dollars. Accordingly, recalculations using the amounts in thousands as disclosed in this report may not produce the same results.
  

Net Gain (Loss) on Derivative and Hedging Activities – The volatility in other income is predominately driven by derivative and hedging gains (losses) related to SFAS 133. The application of SFAS 133 resulted in a net gain (loss) on derivatives and hedging activities of ($215.5) million, ($10.1) million and $11.5 million in 2008, 2007 and 2006, respectively. The FHLBank’s net gain (loss) from derivative and hedging activities is sensitive to the general level of interest rates. Most of the derivative gains and losses are related to economic hedges, such as interest rate swaps matched to trading securities, interest rate caps and floors, etc. Because of the mix of these economic hedges, the FHLBank generally records gains on its derivatives when the general level of interest rates rises over the period and records losses when the general level of interest rates falls over the period. The 2008 loss on derivatives and hedging activities is primarily due to a change in the relationship between interest rates on GSE debt securities and interest rate swaps during 2008, but also includes losses on purchased interest rate caps that are economic hedges of caps embedded in variable rate MBS/CMOs (both of these economic hedges are included under the “Investment” heading in Table 61). Interest rates on GSE debt securities and interest rate swaps typically moved together and were very well correlated until financial difficulties at Fannie Mae and Freddie Mac created a considerable divergence whereby the cost of GSE debt increased relative to swaps. This divergence caused the losses on derivatives (interest rate swaps) to be much larger than gains on the hedged items (GSE debentures). Table 61 categorizes the 2008 earnings impact by product for hedging activities (in thousands):
Table 61

   
Advances
    
Investments
    
Mortgage
Loans
    
Consolidated
Obligation
Discount
Notes
    
Consolidated
Obligation
Bonds
    
Intermediary
Positions
    
Total
  
Amortization/accretion of hedging activities in net margin
   $ (25,596 )   $ (9 )   $ (228 )   $ 0     $ (4,186 )   $ 0     $ (30,019 )
Net gain (loss) on derivatives and hedging activities:
                                                        
Fair value hedges
     6,980       0       0       (560 )     (14,919 )     0       (8,499 )
Economic hedges – unrealized gain (loss) due to fair value changes
     21       (171,928 )     (3,033 )     0       41       57       (174,842 )
Economic hedges – net interest received (paid)
     (29 )     (30,060 )     0       0       (2,130 )     67       (32,152 )
Subtotal
     6,972       (201,988 )     (3,033 )     (560 )     (17,008 )     124       (215,493 )
                                                         
Net gain (loss) on trading securities hedged on an economic basis with derivatives
     0       77,804       0       0       0       0       77,804  
TOTAL
   $ (18,624 )   $ (124,193 )   $ (3,261 )   $ (560 )   $ (21,194 )   $ 124     $ (167,708 )

Table 62 categorizes the 2007 earnings impact by product for hedging activities (in thousands):

Table 62

   
Advances
    
Investments
    
Mortgage
Loans
    
Consolidated
Obligation
Discount
Notes
    
Consolidated
Obligation
Bonds
    
Intermediary
Positions
    
Total
  
Amortization/accretion of hedging activities in net margin
   $ (48,958 )   $ (2 )   $ (2 )   $ 0     $ (5,927 )   $ 0     $ (54,889 )
Net gain (loss) on derivatives and hedging activities:
                                                        
Fair value hedges
     1,213       0       0       0       (3,317 )     0       (2,104 )
Economic hedges – unrealized gain (loss) due to fair value changes
     0       (10,286 )     212       (94 )     (469 )     (93 )     (10,730 )
Economic hedges – net interest received (paid)
     0       2,096       0       137       338       118       2,689  
Subtotal
     1,213       (8,190 )     212       43       (3,448 )     25       (10,145 )
                                                         
Net gain (loss) on trading securities hedged on an economic basis with derivatives
     0       26,034       0       0       0       0       26,034  
TOTAL
   $ (47,745 )   $ 17,842     $ 210     $ 43     $ (9,375 )   $ 25     $ (39,000 )
Table 63 categorizes the 2006 earnings impact by product for hedging activities (in thousands):

Table 63

   
Advances
    
Investments
    
Mortgage
Loans
    
Consolidated
Obligation
Discount
Notes
    
Consolidated
Obligation
Bonds
    
Intermediary
Positions
    
Total
  
Amortization/accretion of hedging activities in net margin
   $ (56,283 )   $ (3 )   $ 72     $ 0     $ (4,455 )   $ 0     $ (60,669 )
Net gain (loss) on derivatives and hedging activities:
                                                        
Fair value hedges
     1,225       0       0       0       352       0       1,577  
Economic hedges – unrealized gain (loss) due to fair value changes
     0       4,560       (42 )     94       4,547       (202 )     8,957  
Economic hedges – net interest received (paid)
     0       (715 )     0       960       539       220       1,004  
Subtotal
     1,225       3,845       (42 )     1,054       5,438       18       11,538  
                                                         
Net gain (loss) on trading securities hedged on an economic basis with derivatives
     0       (7,415 )     0       0       0       0       (7,415 )
TOTAL
   $ (55,058 )   $ (3,573 )   $ 30     $ 1,054     $ 983     $ 18     $ (56,546 )

Net Gain (Loss) on Trading Securities – Prior to the third quarter of 2007, all of our trading securities related to economic hedges. In the latter part of 2007, the FHLBank purchased $0.8 billion in variable rate Agency MBS/CMOs, which were not related to economic hedges, and placed them in a trading portfolio for asset/liability management purposes. All gains and losses related to trading securities are recorded in the other income as net gain (loss) on trading securities; however, only gains and losses relating to trading securities that are related to economic hedges are included in tables 61 through 63. Unrealized gains (losses) fluctuate as the fair value of our trading portfolio fluctuates. There are a number of factors that can impact the value of a trading security including the movement in absolute interest rates, changes in credit spreads, the passage of time and changes in volatility. Securities in this portfolio that are related to economic hedges, for the most part, are longer dated fixed rate GSE debentures and are more affected by changes in long-term interest rates (e.g., 5-year and 10-year rates) than by changes in short-term interest rates. The MBS/CMOs in this portfolio are Agency variable rate securities that re-price monthly and appear to have been more impacted by the overall lack of liquidity in the market rather than credit spreads or the general level of interest rates. In general, however, because of the influence of the fixed rate bonds in the FHLBank’s trading portfolio, as interest rates rise the value of this portfolio will decrease, causing an unrealized loss to be recorded. The FHLBank realized net gains (losses) of $44.5 million, $18.3 million and ($7.4) million in 2008, 2007 and 2006, respectively.
 
Other Non-Interest Income – Included in other non-interest income are realized gains (losses) from the sale of or call of available-for-sale and held-to-maturity securities. In 2008, a held-to-maturity security with less than three months to maturity was sold and a loss of ($10,000) was realized. In 2007, net losses were realized on the sale of available-for-sale securities totaling ($2.3) million. Additionally in 2007, several held-to-maturity securities that had paid down below 15 percent of the principal outstanding at acquisition were sold for total net losses of ($1.0) million. In 2006, two held-to-maturity securities were called by their issuers at premiums for a net realized gain of $14,000.
 
Also included in other non-interest income are losses on other-than-temporarily impaired held-to-maturity securities of $4.8 million for 2008. See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Balance Sheet Analysis – Investments” for additional information on other-than-temporary impairment.
 
Controllable Operating Expenses – Controllable operating expenses include compensation and benefits and other operating expenses. These expenses as documented in Table 64 increased from $31.7 million for 2007 to $34.2 million for 2008. This compared to $28.5 million for the year ended December 31, 2006. As noted in Table 64, a significant portion of the FHLBank’s operating expenses consists of compensation and benefits expense. Amounts paid for compensation and benefits increased in 2008, 2007 and 2006 as a result of increases in the number of FHLBank staff. Employees added in 2006 and 2007 were added to address increased workloads as a result of SEC registration, Sarbanes-Oxley Section 404 preparation and technology/programming needs. Employees added in 2008 related to the MPF Program, credit risk and modeling, and technology/programming needs. Compensation and benefits for 2008 also increased as a result of a 76.5 percent increase in expense for 2008 compared to 2007 under the FHLBank’s Executive Short Term Incentive Plan (ESTIP), which is available to Named Executive Officers (see Item 11 – “Executive Compensation – Compensation Discussion and Analysis”) and the Short Term Incentive Plan, available to all other employees with award levels assigned based on individual’s relative position in the hierarchy of the FHLBank (collectively with ESTIP referred to herein as STIP). The STIP represented 19.0 percent, 12.2 percent and 12.6 percent of total compensation and benefits in 2008, 2007 and 2006, respectively. STIP expense for 2008 was based on attainment of pre-established annual FHLBank-wide performance objectives. While markets were extremely volatile over the course of 2008, the FHLBank had a solid financial performance overall with member utilization of the FHLBank’s products and services significantly increased from 2007 over the course of 2008 resulting in attainment of the STIP objectives.
In an effort to contain operating costs, management does not plan on providing any normal salary increases in 2009. We expect a small increase in the number of employees. A resulting slight increase in compensation and benefit expenses will be offset by anticipated decreases in the STIP expense for the year ending December 31, 2009 and beyond. The FHLBank expects a modest increase in occupancy costs in 2009 and beyond. Table 64 presents operating expenses for the last three years (in thousands):

Table 64

   
For the Year Ended December 31,
    
Percent Increase (Decrease)
  
   
2008
    
2007
    
2006
      
2008/2007
      
2007/2006
  
Compensation and benefits
   $ 22,381     $ 19,719     $ 18,151       13.5 %     8.6 %
Occupancy cost
     1,349       1,291       1,037       4.5       24.5  
Other operating expense
     10,445       10,670       9,275       (2.1 )     15.0  
TOTAL CONTROLLABLE OPERATING EXPENSES
   $ 34,175     $ 31,680     $ 28,463       7.9 %     11.3 %

Assessments: REFCORP and AHP Expenses – REFCORP and AHP expenses are based on a percentage of net income and fluctuate accordingly. As noted in Item 1 – “Business – Tax Status,” each of the 12 FHLBanks is required to pay a portion of its earnings to REFCORP. Additionally, each FHLBank is required to establish, fund and administer an AHP. As part of its AHP, the FHLBank provides subsidies in the form of direct grants or below-market interest rate advances to members which use the funds to assist in the purchase, construction or rehabilitation of housing for very low-, low- and moderate-income households (see Item 1 – “Business – Other Mission-related Activities” for the specific programs funded through the AHP). The required annual AHP funding is charged to earnings and an offsetting liability is established.

Effects of Inflation
The effect of inflation on the FHLBank and other financial institutions differs significantly from that exerted on industrial entities. Financial institutions are not heavily involved in large capital expenditures used in the production, acquisition or sale of products. Virtually all assets and liabilities of financial institutions are monetary in nature and represent obligations to pay or receive fixed and determinable amounts not affected by future changes in prices. Changes in interest rates have a significant impact on the earnings of financial institutions. Higher interest rates generally follow rising demand from borrowers and the corresponding, increased funding requirements of financial institutions. Although interest rates are viewed as the price of borrowing funds, the behavior of interest rates differs significantly from the behavior of prices of goods and services. Prices of goods and services may be directly related to prices of other goods and services while the price of borrowing is related closely to future inflation rates expected by financial market participants. As a result, when the rate of inflation slows, interest rates tend to decline. On the other hand, prices for goods and services tend to be sticky in the downward direction and generally do not decline in this situation. Interest rates are also subject to restrictions imposed through monetary policy, usury laws and other artificial restraints. The rate of inflation has been relatively low in recent years and given the current historically low level of intermediate and long-term interest rates, financial market participants currently seem to expect that inflation will be well contained for the immediate future.

Risk Management
Proper identification, assessment and management of risks, complemented by adequate internal controls, enables stakeholders to have confidence in the FHLBank’s ability to meet its housing finance mission, serve its members, earn a profit, compete in the industry and prosper over the long term. Active risk management continues to be an essential part of the FHLBank’s operations and a key determinant of its ability to maintain earnings to meet retained earnings targets and return a reasonable dividend to its members. The FHLBank maintains comprehensive risk management processes to facilitate, control and monitor risk taking. Periodic reviews by internal auditors, Finance Agency examiners and independent accountants subject the FHLBank’s practices to additional scrutiny, further strengthening the process.
 
The FHLBank maintains an enterprise-wide risk management program in an effort to enable the identification of all significant risks to the organization and institute the prompt and effective management of any major risk exposures. Under this program, the FHLBank performs annual risk assessments designed to identify and evaluate all material risks that could adversely affect the achievement of the FHLBank’s performance objectives and compliance requirements. Enterprise risk management (ERM) is a structured and disciplined approach that aligns strategy, processes, people, technology and knowledge with the purpose of identifying, evaluating and managing the risks an enterprise faces as it creates value. The FHLBank’s ERM process is a continuous one, attempting to identify, prioritize, assess and ultimately manage risks inherent to the FHLBank’s key processes before they become realized risk events.
 
As part of ERM, the FHLBank’s senior management team periodically participates in entity level risk assessment workshops that help identify and prioritize the universe of risks within the FHLBank. These identified risks are evaluated as to their significance (potential impact on the FHLBank), likelihood (potential occurrence absent discretionary controls) and management’s effectiveness in managing the risks. These risk assessment workshops have resulted in the development of risk management strategies and action plans in an effort to enhance the risk management practices throughout the organization. The results of these activities are summarized in an annual risk assessment report, which is reviewed by senior management and the Board of Directors.
The FHLBank also utilizes a customized business unit risk assessment approach in order to ensure that: (1) risk assessments are completed on an annual basis for all of the FHLBank’s business units; (2) effective internal controls and strategies are in place for managing the identified risks within the key processes throughout the FHLBank; and (3) risk management or internal control weaknesses are properly identified with necessary corrective actions taken. As a result of the FHLBank’s efforts, 21 business unit risk assessments are now completed annually addressing 133 key processes throughout the FHLBank. The number of business unit risk assessments and the number of key processes change over time as part of the FHLBank’s ongoing risk assessment and continuous improvement processes. All risk assessments are reviewed by senior management and presented to the Finance Committee of the Board of Directors on a scheduled basis in order to keep the Board apprised of any weaknesses in the current risk management system of each business unit and the steps undertaken by management to address the identified weaknesses.
 
The FHLBank’s Board of Directors plays an active role in the ERM process by regularly reviewing risk management policies and reports on controls. In addition to the annual and business unit risk assessment reports, the Board of Directors reviews the RMP on at least an annual basis. Various management committees, including the asset/liability, credit underwriting and market risk analysis committees, oversee the FHLBank’s risk management process. The following discussion highlights the FHLBank’s various strategies to diversify and manage these risks.

Credit Risk Management
Credit risk is defined as the risk that counterparties to the FHLBank’s transactions will not meet their contractual obligations. The FHLBank manages credit risk by following established policies, evaluating the creditworthiness of its counterparties and utilizing collateral agreements and settlement netting for derivative transactions. The most important step in the management of credit risk is the initial decision to extend credit. Continuous monitoring of counterparties is completed for all areas where the FHLBank is exposed to credit risk, whether that is through lending, investing or derivative activities.
 
Credit risk arises partly as a result of the FHLBank’s lending and AMA activities (members’ CE obligations on mortgage loans acquired by the FHLBank through the MPF Program). The FHLBank manages its exposure to credit risk on advances and members’ CE obligations on mortgage loans through a combined approach that provides ongoing review of the financial condition of its members coupled with prudent collateralization. See Item 1 – “Business – Advances” for a detailed description of eligible collateral on advances as well as disclosures regarding the FHLBank’s security interest in collateral
 
As provided in the Bank Act, a member’s investment in the capital stock of the FHLBank is pledged as additional collateral for the member’s advances and other credit obligations (letters of credit, CE obligations, etc.). In addition, the FHLBank can call for additional collateral or substitute collateral during the life of an advance or other credit obligation to protect its security interest.
 
Credit risk arising from AMA activities under the FHLBank’s MPF Program falls into three categories: (1) the risk of credit losses on the mortgage loans represented in the FHLBank’s first loss account (FLA) and last loss positions; (2) the risk that a member or non-member PFI will not perform as promised with respect to its loss position provided through its CE obligations on mortgage pools, which are covered by the same collateral arrangements as those described under the advances section; and (3) the risk that a third-party insurer (obligated under PMI or SMI arrangements) will fail to perform as expected. Should a PMI third-party insurer fail to perform, it would increase the FHLBank’s credit risk exposure because the FHLBank’s FLA is the next layer to absorb credit losses on mortgage loan pools. Likewise, if an SMI third-party insurer fails to perform, it would increase the FHLBank’s credit risk exposure because it would reduce the participating member’s CE obligation loss layer since SMI is purchased by PFIs to cover all or a portion of their CE obligation exposure for mortgage pools. The FHLBank’s credit risk exposure to third-party insurers to which the FHLBank has PMI and/or SMI exposure is monitored on a monthly basis and regularly reported to the Board of Directors. The FHLBank performs credit analysis of third-party PMI and SMI insurers on at least an annual basis. On a monthly basis, the FHLBank reviews trends that could identify risks with the mortgage loan portfolio, including low FICO scores and high loan-to-value ratios. Based on the credit underwriting standards under the MPF Program and this monthly review, FHLBank management has concluded that the mortgage loans held by the FHLBank would not be considered sub-prime. Table 65 presents the FHLBank’s exposure to third-party PMI and SMI insurers as of December 31, 2008 (in thousands):

Table 65

Insurer
  
Rating
    
Exposure
  
PMI:
            
Genworth Mortgage Insurance Company
  
BBB
     $ 33,316  
Mortgage Guaranty Insurance Co.
  
A
       24,661  
Republic Mortgage Insurance Co.
  
A
       15,176  
United Guaranty Residential Insurance Co.
  
A
       9,972  
CMG Mortgage Insurance Co.
  
AA
       5,638  
Radian Guaranty, Inc.
  
BBB
       4,891  
PMI Mortgage Insurance Co.
  
BBB
       3,438  
Triad Guaranty Insurance Co.1
  
Not rated
       454  
Total PMI exposure
             97,546  
                 
SMI:
                
Mortgage Guaranty Insurance Co.
  
A
       5,453  
United Guaranty Residential Insurance Co.
  
A
       4,999  
Total SMI exposure
             10,452  
                 
TOTAL EXPOSURE
           $ 107,998  
__________
1     The FHLBank ceased doing business with Triad Guaranty Insurance Co. in May 2008 but still has outstanding transactions with them.
Credit risk also arises from investment and derivative activities. As noted previously, the RMP restricts the acquisition of investments to high-quality, short-term money market instruments and highly rated long-term securities. The short-term investment portfolio represents unsecured credit. Therefore, counterparty ratings are monitored daily while performance and capital adequacy are monitored on a monthly basis in an effort to mitigate unsecured credit risk on the short-term investments. MBS represent the majority of the FHLBank’s long-term investments. The FHLBank holds MBS issued by agencies and GSEs, CMOs securitized by GSEs, and AAA-rated private-issue MBS at the time of purchase and CMOs securitized by whole loans. Some of the FHLBank’s private-issue MBS have been downgraded below AAA subsequent to purchase (see Table 42 under Item 7), but all of the downgraded securities have been paying as expected. Approximately 74 percent of the FHLBank’s MBS/CMO portfolio is securitized by Fannie Mae or Freddie Mac. The FHLBank does not purchase or hold any securities classified as being backed by sub-prime mortgage loans. The FHLBank does have potential credit risk exposure to MBS/CMO securities that are insured by one of the monoline mortgage insurance companies should one or more of the companies fail to meet their insurance obligation in the event of significant mortgage defaults in the supporting collateral. Under the FHLBank's RMP, the insurer should be rated no lower than AA at the time of acquisition. The FHLBank monitors the credit ratings daily, performance at least annually and capital adequacy monthly for all primary mortgage insurers, secondary mortgage insurers and master servicers to which it has potential credit risk exposure. Other long-term investments include U.S. Treasury, unsecured triple-A rated GSE and collateralized state and local housing finance agency securities.
 
Table 66 presents the current ratings and outstanding par value as of December 31, 2008 of the FHLBank’s MBS/CMO securities covered by monoline bond insurance (in thousands):

Table 66

Insurer
Rating1
  
Par Value2
  
Financial Guaranty Insurance Company (FGIC)
CCC
   $ 4,819  
MBIA Insurance Corp.
B
     1,740  
AMBAC Assurance Corp.
BBB
     789  
TOTAL
     $ 7,348  
__________
1    Latest rating available March 20, 2009.
2
Par value represents the FHLBank’s coverage amount. The securities insured by FGIC were considered other-than-temporarily impaired as of December 31, 2008 and have a book value of $1.8 million on that date. The AMBAC insured investment has credit support remaining to absorb future losses. Therefore, the FHLBank has no current exposure to this monoline insurer, but expects the credit support on some of the insured investment to be exhausted prior to the investment being fully repaid, at which point we will be exposed to AMBAC on this security. The MBIA insured investment has no credit support and has a significant amount of delinquent/problem loans, so the FHLBank has exposure to MBIA on this security.

Table 67 presents the FHLBank’s exposure as of December 31, 2008 to monoline bond insurers of HFA securities (in thousands):

Table 67

Insurer
Rating1
  
Exposure2
  
MBIA Insurance Corp.
B
   $ 2,055  
AMBAC Assurance Corp.
BBB
     131  
Financial Security Assurance Inc.
AA
     26  
TOTAL
     $ 2,212  
__________
1     Latest rating available March 20, 2009.
2     Exposure = par value * delinquencies (90-day delinquencies, foreclosures and REO per Bloomberg)
 
The FHLBank has never experienced a loss on a derivative transaction because of a credit default by a counterparty. In derivative transactions, credit risk arises when counterparties to transactions, such as interest rate swaps, are obligated to pay the FHLBank the positive fair value or receivable resulting from the transaction terms. The FHLBank manages this risk by executing derivative transactions with experienced counterparties with high credit quality (rated A or better); by requiring netting of individual derivatives transactions with the same counterparty; diversifying its derivatives across many counterparties and by executing transactions under master agreements that require counterparties to post collateral if the FHLBank is exposed to a potential credit loss on the related derivatives exceeding an agreed-upon threshold. The FHLBank’s credit risk exposure from derivative transactions with member institutions is fully collateralized under the FHLBank’s Advance Pledge and Security Agreement. The FHLBank regularly monitors the exposures on its derivative transactions by determining the market value of positions using internal pricing models. The market values generated by the pricing model are compared to dealer model results on a monthly basis to ensure that the FHLBank’s pricing model is reasonably calibrated to actual market pricing methodologies utilized by the dealers.
 
The FHLBank manages counterparty credit risk through netting procedures, credit analysis, collateral management and other credit enhancements. The FHLBank requires that derivative counterparties enter into collateral agreements which specify maximum net unsecured credit exposure amounts that may exist before collateral requirements are triggered. The maximum amount of the FHLBank’s unsecured credit exposure to any counterparty is based upon the counterparty’s credit rating. That is, a counterparty must deliver collateral if the total market value of the FHLBank’s exposure to that counterparty rises above a specific level (see Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity Risk Management”). As a result of these risk mitigation initiatives, management does not anticipate any credit losses on its derivative transactions.
The contractual or notional amount of derivatives reflects the FHLBank’s involvement in various classes of financial instruments and does not measure the FHLBank’s credit risk. The maximum credit exposure is significantly less than the notional amount. The maximum credit exposure is the estimated cost of replacing the net receivable positions for individual counterparties on interest rate swaps and forward agreements, and purchased interest rate caps, interest rate floors and swaptions, net of the value of any related collateral, in the event of a counterparty default.
 
The FHLBank’s maximum credit exposure to derivative counterparties and members, before considering collateral, was approximately $112.7 million, $137.3 million and $66.6 million at December 31, 2008, 2007 and 2006, respectively. In determining maximum credit exposure, the FHLBank considers accrued interest receivables and payables as well as the legal right to net swap transactions by counterparty. The FHLBank held cash with a fair value of $78.2 million, $59.6 million and $1.4 million as collateral as of December 31, 2008, 2007 and 2006, respectively. Additionally, collateral with respect to derivatives with member institutions includes collateral assigned to the FHLBank, as evidenced by a written security agreement and held by the member institution for the benefit of the FHLBank. The FHLBank’s net credit exposure after collateral was approximately $29.6 million, $75.1 million and $61.8 million at December 31, 2008, 2007 and 2006, respectively.
 
On September 15, 2008, Lehman Brothers Holding, Inc. filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code. Lehman Brothers Holding, Inc. is guarantor of Lehman Brothers Special Financing (LESF) with which the FHLBank had derivative transactions. Consequently, the FHLBank terminated and replaced the derivative instruments outstanding with LESF on September 19, 2008. On October 6, 2008, Lehman Brothers Financial Products (LEFP) filed a petition for protection from its creditors in the U.S. Bankruptcy Court. Consequently, the FHLBank terminated and replaced all derivative instruments outstanding with LEFP on October 15, 2008. The FHLBank concluded that the new derivatives would be highly effective both at inception and on an ongoing basis. In total, the FHLBank terminated and replaced 253 derivative instruments with total notional and fair value (excluding accrued interest) amounts of $6.3 billion and $(54.0) million, respectively. The net realized gain (loss) on the derivative terminations was $(0.6) million. An additional five derivative instruments with LESF with total notional and fair value (excluding accrued interest) amounts of $145.0 million and $(1.2) million, respectively, were not replaced because they were to be called within one week of termination date. Under the FHLBank’s International Swaps and Derivatives Association, Inc. agreements with LESF and LEFP, the derivatives were settled on a net basis from the time that bankruptcy was declared or protection was filed through termination of the agreements. In both instances, the Lehman Brothers entities had net exposure to the FHLBank as the termination of the derivatives resulted in a net amount being owed by the FHLBank to Lehman Brothers.
 
Derivative counterparty credit exposure by whole-letter rating (in the event of a split rating, the FHLBank uses the lowest rating published by Moody’s or S&P) as of December 31, 2008 is indicated in Table 68 (in thousands):

Table 68

   
AAA
    
AA
      
A3
    
Member1
    
Total
  
Total net exposure at fair value
   $ 6,228     $ 1,680     $ 99,805     $ 4,975     $ 112,688  
Collateral held2
     0       0       78,162       0       78,162  
Net positive exposure after cash collateral
     6,228       1,680       21,643       4,975       34,526  
Other collateral
     0       0       0       4,975       4,975  
Net exposure after collateral
   $ 6,228     $ 1,680     $ 21,643     $ 0     $ 29,551  
                                         
Notional amount
   $ 570,876     $ 15,204,795     $ 19,157,250     $ 233,716     $ 35,166,637  
                    
1
Collateral held with respect to derivatives with members represents either collateral physically held by or on behalf of the FHLBank or collateral assigned to the FHLBank as evidenced by a written security agreement and held by the member for the benefit of the FHLBank.
2
Excludes collateral held in excess of exposure for any individual counterparty.
3
Collateral was delivered to the FHLBank subsequent to year end. 
 
Derivative counterparty credit exposure by whole-letter rating (in the event of a split rating, the FHLBank uses the lowest rating published by Moody’s or S&P) as of December 31, 2007 is indicated in Table 69 (in thousands):

Table 69

   
AAA
    
AA
      
A
    
Member1
    
Total
  
Total net exposure at fair value
   $ 4,095     $ 116,989     $ 13,630     $ 2,537     $ 137,251  
Collateral held2
     0       52,705       6,935       0       59,640  
Net positive exposure after cash collateral
     4,095       64,284       6,695       2,537       77,611  
Other collateral
     0       0       0       2,537       2,537  
Net exposure after collateral
   $ 4,095     $ 64,284     $ 6,695     $ 0     $ 75,074  
                                         
Notional amount
   $ 748,194     $ 26,584,251     $ 9,212,017     $ 107,782     $ 36,652,244  
                    
1
Collateral held with respect to derivatives with members represents either collateral physically held by or on behalf of the FHLBank or collateral assigned to the FHLBank as evidenced by a written security agreement and held by the member for the benefit of the FHLBank.
2
Excludes collateral held in excess of exposure for any individual counterparty.
Table 70 presents the derivative counterparties that represent five percent or more of net exposure after collateral and their ratings (in the event of a split rating the FHLBank uses the lowest rating published by Moody’s or S&P) as of December 31, 2008:

Table 70

Counterparty Name
  
Counterparty Rating
    
Percent of Total
Net Exposure
at Fair Value
    
Percent of
Net Exposure
After Collateral
  
Deutsche Bank AG1
  
A+
       15.9 %     60.5 %
Citi Swapco Inc.
  
AAA
       5.5       21.1  
All other counterparties
             78.6       18.4  
                    
1
Collateral was delivered to the FHLBank subsequent to year end that fully collateralized the FHLBank’s exposure to this counterparty as of the end of 2008.

Table 71 presents the derivative counterparties that represent five percent or more of net exposure after collateral and their ratings (in the event of a split rating the FHLBank uses the lowest rating published by Moody’s or S&P) as of December 31, 2007:

Table 71

Counterparty Name
  
Counterparty Rating
    
Percent of Total
Net Exposure
at Fair Value
    
Percent of
Net Exposure
After Collateral
  
Barclays Bank PLC
  
AA
       14.2 %     24.5 %
Goldman Sachs Capital Markets
  
AA-
       49.3       21.3  
Royal Bank of Scotland
  
AA
       6.7       12.3  
UBS AG
  
AA
       5.5       10.1  
Merrill Lynch Capital Services, Inc.
  
A+
       9.1       7.4  
Royal Bank of Canada
  
AA-
       3.4       6.2  
Salomon SWAPCO
  
AAA
       3.0       5.5  
All other counterparties
             8.8       12.7  

Liquidity Risk Management
Maintaining the ability to meet obligations as they come due and to meet the credit needs of the FHLBank’s members and housing associates in a timely and cost-efficient manner is the primary objective of managing liquidity risk. The FHLBank seeks to be in a position to meet its customers’ credit and liquidity needs without maintaining excessive holdings of low-yielding liquid investments or being forced to incur unnecessarily high borrowing costs. Operational liquidity, or the ability to meet operational requirements in the normal course of business, is defined as sources of cash from both the FHLBank’s ongoing access to the capital markets and its holding of liquid assets.
 
To support deposits, Finance Agency regulations require the FHLBank to have an amount equal to its current deposits invested in obligations of the U.S. government, deposits in eligible banks or trust companies, or advances with maturities not exceeding five years. Table 72 summarizes the FHLBank’s compliance with the Bank Act liquidity requirements as of December 31, 2008 and 2007 (in thousands):

Table 72

   
12/31/2008
    
12/31/2007
  
Liquid assets1
   $ 3,732,154     $ 5,150,000  
Total qualifying deposits
     1,703,531       1,340,816  
Excess assets
   $ 2,028,623     $ 3,809,184  
                    
1
Although the FHLBank has other assets that qualify as eligible investments under the liquidity requirements, only Federal funds and interest-bearing deposits with the Federal Reserve are listed because these exceed the liquidity requirements without the consideration of any other eligible investments.

The RMP provides that the FHLBank shall maintain a daily average operational liquidity level each month in an amount not less than:
§
20 percent of the sum of its daily average balance of demand and overnight deposits and other overnight borrowings during the month; plus
§
10 percent of the sum of its daily average term deposits, consolidated obligations and other borrowings that mature within one year.
As set forth in the FHLBank’s RMP, the following investments are eligible for compliance with operational liquidity requirements, with the limitation that a security pledged under a repurchase agreement cannot be used to satisfy liquidity requirements:
§
Overnight funds and overnight deposits;
§
Resale agreements that mature in 31 days or less;
§
Negotiable certificates of deposit, bankers’ acceptances, commercial paper, bank notes and thrift notes which mature in nine months or less;
§
Marketable obligations of the U.S. that mature in 36 months or less;
§
Marketable direct obligations of U.S. government agencies and GSEs that mature in 36 months or less;
§
Cash and collected balances held at the Federal Reserve Banks and eligible financial institutions, net of member pass-throughs; and
§
Assets that are generally accepted as collateral in the repurchase agreement market.

The FHLBank was in compliance with the operational liquidity requirements of the RMP during 2008.
 
Finance Agency regulations and the FHLBank’s RMP require the FHLBank to maintain contingency liquidity, which is defined as sources of cash the FHLBank may use to meet its operational liquidity requirements for a minimum of five business days without access to the consolidated obligation debt markets. Eligible FHLBank investments for meeting the contingency liquidity requirement are defined below. Both the Finance Agency and the FHLBank’s liquidity measures depend on certain assumptions which may or may not prove valid in the event of an actual market disruption. Management believes that under normal operating conditions, routine member borrowing needs and consolidated obligation maturities could be met without access to the consolidated obligation debt markets for at least five business days; however, under extremely adverse market conditions, the FHLBank’s ability to meet a significant increase in member advance demand could be impaired if the FHLBank is denied access to the consolidated obligation debt markets. The FHLBank completes its contingency liquidity calculation weekly, or more often if deemed necessary.
 
The FHLBank is required to maintain daily contingency liquidity in an amount not less than:
§
20 percent of deposits; plus
§
100 percent of Federal funds purchased that mature within one week; plus
§
100 percent of consolidated obligations and other borrowings that mature within one week (less consolidated obligations settling within one week); plus
§
100 percent of consolidated obligations expected to be called within one week; plus
§
100 percent of consolidated obligation amortization payments expected within one week.

For contingency liquidity purposes under its RMP, the FHLBank is authorized to hold the following investments, with the limitation that a security pledged under a repurchase agreement cannot be used to satisfy liquidity requirements:
§
Marketable assets with a maturity of one year or less;
§
Self-liquidating assets with a maturity of seven days or less;
§
Assets that are generally accepted as collateral in the repurchase agreement market; and
§
Irrevocable lines of credit from financial institutions rated not lower than the second highest credit rating category by a NRSRO.

Table 73 summarizes the FHLBank’s compliance with the Finance Agency’s regulatory requirements and the FHLBank’s RMP contingency liquidity requirements as of the most recently available weekly computation dated March 17, 2009 (in thousands):

Table 73
 
   
03/17/2009
  
Sources of Contingency Liquidity:
      
Marketable securities with a maturity less than one year
   $ 3,150,366  
Self liquidating assets with a maturity of 7 days or less
     5,275,467  
Securities available for repurchase agreements
     5,558,247  
Total Sources
     13,984,080  
Uses of Contingency Liquidity:
        
20 percent of deposits
     350,914  
100 percent of consolidated obligations and other borrowings maturing in one week
     3,586,919  
100 percent of consolidated obligations expected to be called in one week
     290,000  
Less 100 percent of consolidated obligations settling in one week
     (69,000 )
Total Uses
     4,158,833  
EXCESS CONTINGENCY LIQUIDITY
   $ 9,825,247  

The FHLBank maintained stable access to the capital markets during the first nine months of 2008 at very favorable rates for the majority of the period in spite of the liquidity/credit crisis in the financial markets. We experienced no liquidity issues and, in fact, the FHLBank System’s short-term borrowing costs decreased relative to other AAA-rated investment alternatives. As reflected in Tables 59 and 60, the FHLBank’s net interest spreads improved during 2008. The current favorable short-term borrowing costs are expected to return to more normal levels relative to other AAA-rated alternatives (closer to historical averages) when financial market conditions stabilize and the flight to quality subsides.
However, as mentioned previously, the Finance Agency placed Fannie Mae and Freddie Mac into conservatorship on September 7, 2008 and Lehman Brothers Holding, Inc. declared bankruptcy on September 15, 2008. Both of these events were catalysts to a worsening in financial market liquidity conditions. Investors began a flight to quality that caused costs in the term Agency/GSE debt markets to increase and generally limited issuance at reasonable costs to short-term consolidated obligation discount notes. Although market conditions stabilized and improved some during November and December of 2008 and into the first quarter of 2009, issuance limitations persist due to increased issuance of U.S. government obligations, increased competition from U.S. government guaranteed debt programs, continuing credit concerns regarding all financial institutions and less than optimal pricing levels for longer-term debt available in the Agency/GSE debt market. At this time we are unable to predict when or if financial market conditions and the Agency/GSE debt market will return to pre-crisis levels.
 
Therefore, because of the heightened liquidity concerns in the financial markets due to the market disruptions and uncertainty detailed previously, the FHLBank took steps beginning the third quarter of 2008 and continuing into the fourth quarter of 2008 to increase and manage its short-term liquidity in order to ensure that it could meet member advance demands and other obligations on an ongoing basis without access to the consolidated obligations market for a minimum of five calendar days. This measure is in addition to its operational and contingency liquidity requirements. These actions included: (1) curtailment of money market investments; (2) lengthening the weighted average original days to maturity of the FHLBank’s consolidated obligation discount notes outstanding from 67.0 days as of December 31, 2007 to 98.8 days as of December 31, 2008; and (3) increasing its cash balances in interest-bearing deposits. The FHLBank continues to manage to this measure in the first quarter of 2009 and anticipates it will continue managing to this measure throughout 2009. These actions have created an asset-liability mismatch (assets re-pricing more quickly than liabilities) on the short end of the FHLBank’s balance sheet and resulted in a decrease in the FHLBank’s net interest income in the fourth quarter of 2008 because of the steepness of the very short end of the yield curve and the fact that interest rates decreased fairly dramatically after the FHLBank initially extended its liabilities. While this asset-liability mismatch continues into the first quarter of 2009, the FHLBank has narrowed the mismatch by decreasing weighted average original days to maturity of the FHLBank’s consolidated obligation discount notes to 94.7 days as of March 20, 2009. At the same time, short-term interest rates have stabilized at relatively low levels and the high-cost debt issued in late third quarter and early fourth quarter matured in the first two months of 2009. This, in addition to the improved relative cost of consolidated obligation discount notes in the latter part of the fourth quarter of 2008 and through the first quarter of 2009, and the interest income received on excess reserves held at the Federal Reserve Bank of Kansas City which began in October 2008, should help mitigate the impact of these liquidity measures on net interest income during 2009. While we do not expect that net interest spreads will return to the levels achieved during the first three quarters of 2008, we do expect them to improve significantly over the levels achieved during the fourth quarter of 2008.
 
An entity’s liquidity position is vulnerable to any rating, event, performance or ratio trigger (collectively called triggers) that would lead to the termination of the entity’s credit availability or the acceleration of repayment of credit obligations owed by the entity. The FHLBank has reviewed the appropriate documents concerning its vulnerability to transactions that contain triggers and fully understands the manner in which risks can arise from such triggers. Triggers adverse to the FHLBank currently exist in agreements for derivatives and SBPAs. The FHLBank’s staff monitors triggers in order to properly manage any type of potential risks from triggers.
 
With respect to advances, letters of credit, standby credit facility commitments and member derivatives, the FHLBank is the beneficiary of certain triggers based on the member’s financial performance as defined in detail in the FHLBank’s policies. See Notes 1 and 7 in Item 8 – “Financial Statements and Supplementary Data – Notes to Financial Statements” for collateral requirements designed for the FHLBank’s credit products.
 
All derivative transactions entered into with non-member counterparties, including interest rate swaps, swaptions, interest rate caps and interest rate floors, have two-way bilateral triggers based on the ratings of the FHLBank or the counterparties, as applicable to the situation (i.e., which party is at risk). These transactions also have two-way rating triggers that provide for early termination, at the option of the FHLBank or the counterparty, if the other party’s rating falls to or below the rating trigger level. Early termination by a counterparty may result in losses to the FHLBank. The FHLBank’s agreements with counterparties incorporate termination triggers at ratings of BBB+ and Baa1 or lower. The triggers are incorporated in a master derivatives credit support annex or bilateral security agreement. Collateral-related triggers are designed to reduce the amount of unsecured credit risk exposure that the FHLBank or counterparty is willing to accept for a given rating level determined by the NRSROs. The maximum threshold amount of unsecured credit risk exposure for each rating level is defined in Table 74:

Table 74

S&P or Fitch Ratings
Moody’s Ratings
Exposure Threshold
AAA
Aaa
$50 million
AA+, AA, AA-
Aa1, Aa2, Aa3
$15 million
A+, A
A1, A2
$3 million
A-
A3
$1 million
Below A-
Below A3
$0

If the FHLBank’s or a counterparty’s exposure to the other ever exceeds the threshold based on the other’s NRSRO rating, an immediate margin call is issued requiring the party to collateralize the amount of credit risk exposure in excess of the exposure threshold. The agreement with one AAA/Aaa-rated special purpose vehicle also includes one ratings trigger event that would result in termination of any outstanding transactions at a mid-market level. The collateral posted by the FHLBank’s counterparties at December 31, 2008 and 2007 was in the form of cash. For additional information regarding the FHLBank’s credit exposure relating to derivative contracts, see Note 9 in Item 8 – “Financial Statements and Supplementary Data – Notes to Financial Statements.”
The FHLBank has executed SBPAs with two in-district state housing finance authorities. All of the SBPAs contain rating triggers beneficial to the FHLBank providing that if the housing finance authority bonds covered by the SBPA are rated below investment grade (BBB-/Baa3), the FHLBank would not be obligated to purchase the bonds even though the FHLBank was otherwise required to do so under the terms of the SBPA contract. In addition, some transactions also contain a provision that allows the FHLBank to terminate its obligation to purchase these bonds under the SBPA upon 30 days prior written notice if the long-term rating on the underlying bonds were to be withdrawn, suspended or reduced below A/A2. The SBPAs also generally provide that the FHLBank can be replaced as the liquidity provider in these transactions should its rating by a specified NRSRO ever fall below triple-A. As of December 31, 2008 and 2007, the FHLBank had 35 and 28 SBPAs that covered $1.3 billion and $1.0 billion in outstanding principal plus interest, respectively.
 
Business Risk Management
Business risk is the risk of an adverse impact on the FHLBank’s profitability resulting from external factors that may occur in both the short and long term. The FHLBank manages business risk, in part, by having a strategic business plan in effect at all times that describes how the business activities will achieve the mission of the FHLBank and also details the operating goals and strategic objectives for each major business activity. Development of a long-term strategic business plan is an intensive annual process that includes a review of the FHLBank’s mission, vision and overall philosophies, and appropriate research and analysis, including modeling of balance sheet composition and income under various economic scenarios. The Board of Directors plays a key role in the development of the strategic business plan and regularly monitors progress in the achievement of business objectives.
 
To manage business concentration risk, ROE simulations are conducted annually with estimated base-, best- and worst-case assumptions. Scenarios also include the effects on the FHLBank if one or more of its larger customers significantly reduced its advance and/or mortgage loan sales levels, or was no longer a member. The total advance growth and distribution for the FHLBank’s top five borrowers is monitored on a monthly basis by the asset/liability committee. Advance concentration to the FHLBank’s top five borrowers was 49.9 percent, 53.3 percent and 58.3 percent at December 31, 2008, 2007 and 2006, respectively.

Operations Risk Management
Operations risk is the risk of unexpected losses attributable to human error, man-made or natural disasters, systems malfunctions, internal and external fraud, unenforceability of legal contracts or circumvention or failure of internal controls and procedures. Mitigating this risk are systems and procedures to monitor transactions and financial positions, documentation of transactions, annual comprehensive risk assessments conducted at the business unit level, Finance Agency compliance reviews and periodic reviews by the FHLBank’s Internal Audit department. The FHLBank has also established and maintains an effective internal control system that addresses the efficiency and effectiveness of FHLBank activities, the safeguarding of FHLBank assets, and the reliability, completeness and timely reporting of financial and management information to the Board of Directors and outside parties, including the Office of Finance, the SEC and the Finance Agency. Reconciliation procedures are also in place to ensure that systems capture critical data. The FHLBank’s Internal Audit department, which reports directly to the Audit Committee of the Board of Directors, regularly monitors the FHLBank’s compliance with established policies and procedures. The FHLBank also maintains an Internal Control Policy that outlines the objectives and principles for the FHLBank’s internal controls, establishes and delineates business unit managers’ responsibilities for implementing internal controls, and establishes the Internal Audit department as the FHLBank business unit responsible for reviewing the adequacy of the FHLBank’s internal controls.
 
The FHLBank manages business disruption and systems failure by having in place at all times a disaster recovery plan, the purpose of which is to provide contingency plans for situations where the operations cannot be carried out in their normal manner. The FHLBank maintains contingency plans that deal with business interruptions lasting from two hours to periods of four weeks or longer. The FHLBank also maintains an off-site recovery operations center that is an important component of its overall disaster recovery planning effort. The recovery center is maintained on a different power grid and is serviced by another telephone central office than the FHLBank’s main headquarters. An on-site portable power generator supports the site in case of total power failure. The off-site recovery center is also used to store back-up tapes, supplies and other resources specifically acquired for disaster recovery purposes. Comprehensive testing is conducted at the off-site recovery location at least once each year with additional limited tests conducted on a quarterly basis. The FHLBank’s disaster recovery plans, including employee emergency contact lists, are reviewed and updated quarterly.

Item 7A: Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk Management
The FHLBank measures interest rate risk exposure by various methods, including the calculation of duration of equity and the market value of equity.
 
Duration of Equity (DOE): DOE aggregates the estimated sensitivity of market value for each of the FHLBank’s financial assets and liabilities to changes in interest rates. In essence, DOE indicates the sensitivity of theoretical market value of equity to changes in interest rates. However, market value of equity should not be considered indicative of the market value of the FHLBank as a going concern or the value of the FHLBank in a liquidation scenario. A positive DOE results when the duration of assets and designated derivatives is greater than the duration of liabilities and designated derivatives. A positive DOE generally indicates that the FHLBank has a degree of interest rate risk exposure in a rising interest rate environment, and a negative DOE indicates a degree of interest rate risk exposure in a declining interest rate environment. Higher DOE numbers, whether positive or negative, indicate greater volatility of market value of equity in response to changing interest rates. That is, if the FHLBank has a DOE of 3.0, a 100-basis-point (1 percent) increase in interest rates will cause the FHLBank’s market value of equity to decline by approximately 3 percent. However, it should be noted that a decline in market value of equity does not translate directly into a decline in near-term income, especially for entities that do not trade financial instruments. Changes in market value may indicate trends in income over longer periods, and knowing the sensitivity of market value to changes in interest rates gives a measure of the risks being taken by the FHLBank.
Under the RMP approved by its Board of Directors, the FHLBank’s DOE is generally limited to a range of ±5.0 assuming current interest rates. The FHLBank’s DOE is generally limited to a range of ±7.0 assuming an instantaneous parallel increase or decrease in interest rates of 200 basis points. During periods of extremely low interest rates, the Finance Agency requires that FHLBanks employ a constrained down shock analysis to limit the evolution of forward interest rates to positive non-zero values. Since the FHLBank’s financial model imposes a zero boundary on post-shock interest rates, no additional calculations are necessary to meet this Finance Agency requirement. Limiting the downward shock in this manner is referred to as a constrained shock scenario. Flooring interest rates has the effect of creating a yield curve which is flat at zero percent from the shortest maturity out to (in one previous time period) the five-year point on the yield curve. This creates a yield curve shape that is extremely unlikely to occur in reality and the application of this assumption has produced some distortion in the reported market value and DOE in the down shocks. This restriction is reasonable because there is a limited potential for declines in interest rates when the rate environment is extremely low.
 
The DOE parameters established by the FHLBank’s Board of Directors represent one way to establish general limits on the amount of interest rate risk that the FHLBank can accept. If the FHLBank’s DOE exceeds the policy limits established by the Board of Directors, management either: (1) takes asset/liability actions to bring the DOE back within the range established in the FHLBank’s RMP; or (2) reviews and discusses potential asset/liability management actions with the Board of Directors at the next regularly scheduled meeting that could bring the DOE back within the ranges established in the RMP and ascertains a course of action, which can include a determination that no asset/liability management actions are necessary.
 
The FHLBank typically maintains DOE within the above ranges through management of the durations of its assets, liabilities and derivatives. Significant resources in terms of staffing, software and equipment are continuously devoted to assuring that the level of interest rate risk existing in the FHLBank’s balance sheet is properly measured and limited to prudent and reasonable levels. The DOE which FHLBank management considers prudent and reasonable is somewhat lower than the RMP limits mentioned above and can change depending upon market conditions and other factors. The FHLBank typically manages the current base DOE to remain in the range of ±2.50. When the FHLBank’s DOE exceeds either the limits established by the RMP or the more narrowly-defined limits to which the FHLBank manages duration, corrective actions taken may include: (1) the purchase of interest rate caps, interest rate floors, swaptions or other derivatives; (2) the sale of assets; and/or (3) the addition to the balance sheet of assets or liabilities having characteristics that are such that they counterbalance the excessive duration observed. For example, if DOE has become more positive than desired due to variable rate MBS that have reached cap limits, the FHLBank may purchase interest rate caps that have the effect of removing those MBS cap limits. The FHLBank would be short caps in the MBS investments and long caps in the offsetting derivative positions, thus reducing the FHLBank’s DOE. If an increase in DOE were due to the extension of mortgage loans, MBS or advance maturities by the FHLBank’s members, the more appropriate action would be to add new long-term liabilities to the balance sheet.
 
Table 75 presents the DOE in the base case and the up and down 100 basis points (referenced as Bps in the tables) and 200 basis points interest rate shock scenarios for December 31, 2008 and 2007:

Table 75

Duration of Equity
  
Period
  
Up 200 Bps
    
Up 100 Bps
    
Base
    
Unconstrained
Down 100 Bps
    
Unconstrained
Down 200 Bps
    
Constrained
Down 200 Bps
  
12/31/2008
     3.2       5.9       7.8       11.3       -0.3       -0.3  
09/30/2008
     -0.4       -0.3       1.1       2.9       2.6       2.6  
06/30/2008
     1.5       2.4       3.3       3.3       1.1       2.4  
03/31/2008
     2.3       3.7       4.9       4.6       3.1       4.5  
12/31/2007
     1.9       2.3       3.0       1.7       -1.1       *  
09/30/2007
     4.2       4.0       2.8       0.6       -2.3       *  
06/30/2007
     5.0       4.6       3.7       1.1       -2.6       *  
03/31/2007
     5.4       4.3       2.3       -1.3       -3.9       *  
______________
*     Constrained shocks are only applied in designated low-rate environments.
 
As noted previously, the FHLBank typically manages the base DOE to remain in the range of ±2.50. From Table 75, the base DOE for December 31, 2008, exceeds not only management’s targeted risk range, but also exceeds the established base case range of ±5.0. Several factors contributed to the increase from the December 31, 2007 duration of 3.0 to the December 31, 2008 duration of 7.8. The primary factor that caused the increase in DOE was the deterioration in MBS prices during most of 2008, particularly near the end of the first quarter when estimated fair values for private-label MBS dropped dramatically. The drop in the estimated fair value of the FHLBank’s MBS portfolio resulted in significant unrealized losses, which causes an artificially high base DOE result. Since the base case market value of equity was lower because of declining MBS prices, the duration calculation was driven lower since the base case market value is the denominator in the DOE equation, and with a smaller denominator, the result is a higher DOE. The depressed MBS prices were a product of deteriorating economic conditions, including the mortgage credit crisis that produced a severe decline in active trades in these securities. This inactivity or essentially illiquidity caused previously functioning pricing mechanisms to become less transparent and somewhat less informative since determining fair value rests largely on market-driven valuations provided by market participants and market-driven pricing processes.
Typically market valuations are determined by quantifying relative risks in the market. However, with the advent of illiquid markets and dysfunctional credit markets, premiums for liquidity risk increasingly dominated historically market driven pricing mechanisms. For instance, standard MBS pricing theory would state that a rational market driven MBS price will typically increase as market rates decline. However, during certain periods in 2008, market prices of MBS actually declined as market interest rates declined. In other words, a historically inverse market price to market yield relationship became uncoupled as non-market rate forces increasingly dominated the pricing mechanisms to the point of creating a direct market price to market yield relationship. This direct relationship poses specific concerns and dilemmas for historic hedging methodologies and asset/liability management actions. A specific dilemma is created when a standard duration calculation results in contrary measurements that are driven by non-market rate factors, such as an increase in the duration of mortgage-related assets in the face of declining interest rates when the duration of mortgage-related assets generally decrease. Again, with unnaturally depressed MBS prices, the denominator in the duration calculation becomes smaller in an atypical manner. This result distorts the duration calculation by producing a duration result that is larger than theoretically expected. Thus the distortion in MBS prices directly impacts the FHLBank’s DOE metric by causing a depressed denominator.
 
Whenever an established limit is exceeded and management determines not to take any asset/liability management action to bring the FHLBank’s DOE back within the RMP range, the Board of Directors is advised by management and the issue is discussed at the next regularly scheduled Board of Directors’ meeting. If after discussion, the Board of Directors determines that asset/liability management action is required, the Board-approved approach is implemented by management to address the situation. Management considers the current interest rate/market price relationship for MBS to be a market anomaly and is actively monitoring the FHLBank’s DOE position and the mortgage market environment for acceptable future asset/liability management actions.
 
As reflected in Table 75, the FHLBank’s DOE at December 31, 2008 was outside of its RMP base case range of ±5.0. The FHLBank also experienced a significant increase in its DOE in the unconstrained down 100 basis points scenario through the up 200 basis points scenario from the end of the third quarter of 2008 to the end of the fourth quarter of 2008 in spite of a general decline in interest rates, including mortgage interest rates. As discussed previously, the FHLBank typically manages a DOE measurement that exceeds the established limits with various asset/liability management actions. However, because the market price to market yield relationship has become distorted (no longer an inverse relationship) and the mortgage market remains dysfunctional, appropriate actions to address this anomaly are limited because normal relationships no longer exist. For example, entering into hedges such as pay-fixed swaptions or issuance of long-term callable or non-callable liabilities intended to shorten DOE in the base case or rising interest rate scenarios, might actually increase the FHLBank’s interest rate risk (DOE is already decreasing in the up shock scenarios as of December 31, 2008). In analyzing potential courses of action, FHLBank management determined that the only potentially acceptable course of action at this time that would bring the FHLBank’s base DOE back within preferred ranges (target and RMP) would be the sale of a portion of its MBS portfolio (realize the unrealized loss and reduce the potential for further losses in a rising interest rate environment, which is the normal relationship). However, given the severely depressed market prices for MBS, management believes, and the Board of Directors concurs, that this is not a prudent course of action and any such sale has the potential to only further depress the market prices for MBS (an already thin market could be moved by almost any MBS sale and the FHLBank would have to make a significant sale of its MBS portfolio to bring its DOE back into compliance).
 
In calculating DOE, the FHLBank also calculates its duration gap, which is the difference between the duration of its assets and the duration of its liabilities. The FHLBank’s base duration gap was 2.9 months, 1.4 months and 1.3 months at December 31, 2008, 2007 and 2006, respectively. All 12 FHLBanks are required to submit this base duration gap number to the Office of Finance as part of the quarterly reporting process created by the Finance Agency.
 
Matching the duration of assets with the duration of liabilities funding those assets is accomplished through the use of different debt maturities and embedded option characteristics, as well as the use of derivatives, primarily interest rate swaps, caps, floors and swaptions. Interest rate swaps increase the flexibility of the FHLBank’s funding alternatives by providing desirable cash flows or characteristics that might not be as readily available or cost-effective if obtained in the standard GSE debt market. Finance Agency regulation prohibits the speculative use of derivatives, and the FHLBank does not engage in derivatives trading for short-term profit. Because the FHLBank does not engage in the speculative use of derivatives through trading or other activities, the primary risk posed to the FHLBank by derivative transactions is credit risk in that a counterparty may fail to meet its contractual obligations on a transaction and thereby force the FHLBank to replace the derivative at market price (see Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Management – Credit Risk Management” for additional information).
 
Another element of interest rate risk management is the funding of mortgage loans and prepayable assets with liabilities that have similar duration or average cash flow patterns over time. To achieve the desired liability durations, the FHLBank issues debt across a broad spectrum of final maturities. Because the durations of mortgage loans and other prepayable assets change as interest rates change, callable debt with similar duration characteristics is frequently issued. The duration of callable debt shortens when interest rates decrease and lengthens when interest rates increase, allowing the duration of the debt to better match the typical duration of mortgage loans and other prepayable assets as interest rates change. As discussed above, this normal funding and hedging relationship became distorted during 2008 with the uncoupling of MBS pricing mechanisms. In addition to actively monitoring this relationship, the funding and hedging profile and process is continually measured and reevaluated. The FHLBank also uses interest rate caps, floors and swaptions to manage the duration of its assets and liabilities. For example, in rising interest rate environments, out-of-the-money caps are purchased to help manage the duration extension of mortgage assets, especially variable rate MBS with periodic and lifetime embedded interest rate caps. The FHLBank also purchases receive-fixed or pay-fixed swaptions (options to enter into receive-fixed rate or pay-fixed rate interest rate swaps) to manage its overall DOE in falling or rising interest rate environments, respectively. During times of falling interest rates, when mortgage assets are prepaying quickly and shortening in duration, the FHLBank may synthetically convert fixed rate debt to variable rate using interest rate swaps in order to shorten the duration of its liabilities to more closely match the shortening duration of its mortgage assets. As the FHLBank needs to lengthen its liability duration, it terminates selected interest rate swaps to effectively extend the duration of the previously swapped debt.
As noted in Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Balance Sheet Analysis – Advances,” total advances as a percentage of total assets increased to 61 percent at December 31, 2008 from 58 percent at December 31, 2007. Over the same period of time, acquired member assets (MPF Program mortgage loans) increased from approximately 4 percent at December 31, 2007 to 5 percent at December 31, 2008, while MBS investments increased from approximately 13 percent at December 31, 2007 to 17 percent at December 31, 2008. Other mortgage-related assets (primarily state HFA bonds) remained at less than 1 percent of total assets. Also during this same period of time, other investments decreased to 15 percent (2 percent long-term and 13 percent short-term) of total assets as of the end of 2008 from 24 percent (1 percent long-term and 23 percent short-term) as of the end of 2007. Hence, on a net basis, advances and mortgage-related assets increased as a percent of total assets while other investments decreased as a percent of total assets. Within these investments, there has been a shift to longer-term assets which tends to increase interest rate risk on the asset side of the balance sheet. Under an increasing interest rate environment, long-term assets on the balance sheet, particularly variable rate Agency MBS and fixed rate mortgage loans purchased under the MPF program, would tend to increase interest rate risk on the asset side while under a decreasing interest rate environment, the opposite effect should occur. In order to offset this increased interest rate risk from the asset side of the FHLBank’s balance sheet, FHLBank management: (1) purchased interest rate caps to offset its short cap position in the variable rate Agency MBS; and (2) increased the net issuance of fixed rate, long-term callable and non-callable debt to manage the increase in fixed rate MPF loans. Callable debt continued to be added in 2008 as the FHLBank consciously increased the optionality in the liability portfolios used to fund its long-term fixed rate assets with prepayment characteristics. The FHLBank managed increases in the interest rate risk caused by the increase in mortgage assets as a percentage of its total assets through its actions on the liability side of the FHLBank’s balance sheet in addition to other asset/liability actions (e.g., purchased interest rate caps) it has taken as a result of other balance sheet shifts. As interest rates declined in 2008, the duration of the FHLBank’s callable debt portfolio shortened as the likelihood of this debt being called increased. At the same time, the FHLBank would expect to experience a commensurate decrease in the level of interest rate risk from the long-term, prepayable assets on its balance sheet (i.e., as interest rates fall, mortgage assets generally shorten). The result of the shortening of callable debt was a net increase in the FHLBank’s DOE in the base case, as the duration on the FHLBank’s prepayable assets did not shorten as much as anticipated because of the mortgage market disruption (e.g., tightened credit standards, falling home prices and other factors decreased the ability of borrowers to refinance mortgages, etc.). All things being equal, as the FHLBank’s callable debt is called and replaced with callable debt with longer duration (or the existing callable debt lengthens in duration if interest rates increase), the FHLBank’s DOE should decline in the base case during 2009 as this in-the-money callable debt is called and replaced with new callable debt. Except for the effect of deteriorating MBS prices experienced in 2008 discussed previously, the history of the FHLBank’s duration measures, as reflected in Table 75, demonstrates the relative stability of the FHLBank’s interest rate risk in spite of the increase in mortgage assets on the FHLBank’s balance sheet and the large swings in the level and slope of the yield curve during this period of time.
 
The management of the FHLBank’s interest rate risk position has become much more challenging with the current disruptions in the financial markets. We currently consider other metrics such as value-at-risk and DOE measurements using the book value of the MBS portfolio in order to eliminate the impact of the severely depressed MBS market prices. While such metrics are informative and assist FHLBank management in managing its interest rate risk, they do not replace our existing DOE limits. We currently believe that, in the long run, the market price driven DOE metrics will continue to be one of our preferred metrics for measuring and managing interest rate risk. However, given the exigent circumstances in which we are operating, FHLBank management believes that the usefulness of the traditional DOE metric is significantly diminished and we must use all available metrics, including the consideration of non-traditional metrics such as DOE using the book value of MBS. We continue to explore and evaluate other interest rate risk measurement and management metrics, but are currently not proposing changes away from the DOE metrics, even under current market conditions.
 
Detail of Derivative Instruments by Type of Instrument by Type of Risk: Various types of derivative instruments are utilized by the FHLBank to mitigate the interest rate risks described in the preceding section. The FHLBank currently employs derivative instruments by designating them as either a fair value or cash flow hedge of an underlying financial instrument or a forecasted transaction; by acting as an intermediary; or in asset/liability management (i.e., an economic hedge). An economic hedge is defined as a derivative hedging specific or non-specific underlying assets, liabilities or firm commitments that does not qualify for hedge accounting but is an acceptable hedging strategy under the FHLBank’s RMP. For hedging relationships that are not designated for shortcut hedge accounting under SFAS 133, paragraph 68 (see additional details in Note 1 – Summary of Significant Accounting Policies under Item 8), the FHLBank formally assesses (both at the hedge’s inception and monthly on an ongoing basis) whether the derivatives used have been highly effective in offsetting changes in the fair values or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. The FHLBank typically uses regression analyses or similar statistical analyses to assess the effectiveness of its long haul hedges. See Note 9 – Derivatives and Hedging Activities in the Notes to Financial Statements under Item 8 for information on effectiveness methods used by the FHLBank. The FHLBank determines the hedge accounting to be applied when the hedge is entered into by completing detailed documentation, which includes a checklist setting forth criteria that must be met to qualify for hedge accounting.
Table 76 presents the notional amount, accounting designation and effectiveness method for derivative instruments by risk and by type of derivative used to address the noted risk for the period ending December 31, 2008 (in thousands):

Table 76

Notional Amount
  
Risk Hedged
Accounting
Designation
Effectiveness
Method
  
Interest Rate
Swaps
    
Caps/Floors
    
Purchase
Commitments
    
Total
  
Advances
                            
Interest rate risk associated with embedded caps and floors clearly and closely related
Fair Value
Hedge
Dollar
Offset
   $ 0     $ 95,000     $ 0     $ 95,000  
Interest rate risk associated with fixed rate non-callable advances
Fair Value
Hedge
Shortcut
     2,059,000       0       0       2,059,000  
Interest rate risk associated with fixed rate non-callable advances
Fair Value
Hedge
Rolling
Regression
     1,378,732       0       0       1,378,732  
Interest rate risk associated with callable fixed rate advances
Fair Value
Hedge
Rolling
Regression
     67,000       0       0       67,000  
Interest rate risk associated with fixed rate convertible advances
Fair Value
Hedge
Rolling
Regression
     6,528,966       0       0       6,528,966  
Investments
                                    
Fair value risk associated with fixed rate non-MBS trading investments
Economic
Hedge
Not
Applicable
     1,550,035       0       0       1,550,035  
Risk of changes in interest rates associated with variable rate MBS with embedded caps
Economic
Hedge
Not
Applicable
     0       6,445,733       0       6,445,733  
Duration of equity risk in a declining interest rate environment
Economic
Hedge
Not
Applicable
     0       300,000       0       300,000  
Mortgage Loans Held for Portfolio
                                    
Fair value risk associated with fixed rate mortgage purchase commitments
Economic
Hedge
Not
Applicable
     0       0       124,423       124,423  
Consolidated Obligation Bonds
                                    
Risk of changes in interest rates creating unacceptable duration changes or increasing costs of funds
Economic
Hedge
Not
Applicable
     875,000       0       0       875,000  
Interest rate risk associated with fixed rate callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     3,620,000       0       0       3,620,000  
Interest rate risk associated with fixed rate callable consolidated obligations
Fair Value
Hedge
Shortcut
     635,000       0       0       635,000  
Interest rate risk associated with fixed rate non-callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     4,207,000       0       0       4,207,000  
Interest rate risk associated with fixed rate non-callable consolidated obligations
Fair Value
Hedge
Shortcut
     2,410,000       0       0       2,410,000  
Interest rate risk associated with fixed rate callable step-up or step-down consolidated obligations
Fair Value
Hedge
Rolling
Regression
     990,000       0       0       990,000  
Interest rate risk associated with complex fixed rate consolidated obligations
Fair Value
Hedge
Rolling
Regression
     2,375,000       0       0       2,375,000  
Consolidated Obligation Discount Notes
                                    
Interest rate risk associated with fixed rate non-callable discount notes
Fair Value
Hedge
Rolling
Regression
     1,287,162       0       0       1,287,162  
Intermediary Derivatives
                                    
Interest rate risk associated with intermediary derivative instruments with members
Economic
Hedge
Not
Applicable
     208,586       10,000       0       218,586  
TOTAL
       $ 28,191,481     $ 6,850,733     $ 124,423     $ 35,166,637  
Table 77 presents the fair value of derivative instruments (excluding accrued interest and cash collateral) by risk and by type of instrument used to address the noted risk for the period ending December 31, 2008 (in thousands):

Table 77

Fair Value
  
Risk Hedged
Accounting
Designation
Effectiveness
Method
  
Interest Rate
Swaps
    
Caps/Floors
    
Purchase
Commitments
    
Total
  
Advances
                            
Interest rate risk associated with embedded caps and floors clearly and closely related
Fair Value
Hedge
Dollar
Offset
   $ 0     $ 102     $ 0     $ 102  
Interest rate risk associated with fixed rate non-callable advances
Fair Value
Hedge
Shortcut
     (104,789 )     0       0       (104,789 )
Interest rate risk associated with fixed rate non-callable advances
Fair Value
Hedge
Rolling
Regression
     (91,949 )     0       0       (91,949 )
Interest rate risk associated with callable fixed rate advances
Fair Value
Hedge
Rolling
Regression
     (278 )     0       0       (278 )
Interest rate risk associated with fixed rate convertible advances
Fair Value
Hedge
Rolling
Regression
     (629,869 )     0       0       (629,869 )
Investments
                                    
Fair value risk associated with fixed rate non-MBS trading investments
Economic
Hedge
Not
Applicable
     (233,370 )     0       0       (233,370 )
Risk of changes in interest rates associated with variable rate MBS with embedded caps
Economic
Hedge
Not
Applicable
     0       37,287       0       37,287  
Duration of equity risk in a declining interest rate environment
Economic
Hedge
Not
Applicable
     0       26,187       0       26,187  
Mortgage Loans Held for Portfolio
                                    
Fair value risk associated with fixed rate mortgage purchase commitments
Economic
Hedge
Not
Applicable
     0       0       (1,539 )     (1,539 )
Consolidated Obligation Bonds
                                    
Risk of changes in interest rates creating unacceptable duration changes or increasing costs of funds
Economic
Hedge
Not
Applicable
     302       0       0       302  
Interest rate risk associated with fixed rate callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     37,722       0       0       37,722  
Interest rate risk associated with fixed rate callable consolidated obligations
Fair Value
Hedge
Shortcut
     19,863       0       0       19,863  
Interest rate risk associated with fixed rate non-callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     86,028       0       0       86,028  
Interest rate risk associated with fixed rate non-callable consolidated obligations
Fair Value
Hedge
Shortcut
     224,536       0       0       224,536  
Interest rate risk associated with fixed rate callable step-up or step-down consolidated obligations
Fair Value
Hedge
Rolling
Regression
     8,670       0       0       8,670  
Interest rate risk associated with complex fixed rate consolidated obligations
Fair Value
Hedge
Rolling
Regression
     14,814       0       0       14,814  
Consolidated Obligation Discount Notes
                                    
Interest rate risk associated with fixed rate non-callable discount notes
Fair Value
Hedge
Rolling
Regression
     (1,537 )     0       0       (1,537 )
Intermediary Derivatives
                                    
Interest rate risk associated with intermediary derivative instruments with members
Economic
Hedge
Not
Applicable
     134       0       0       134  
TOTAL
       $ (669,723 )   $ 63,576     $ (1,539 )   $ (607,686 )
Table 78 presents the notional amount of derivative instruments by risk and by type of instrument used to address the noted risk for the period ending December 31, 2007 (in thousands):

Table 78

Notional Amount
  
Risk Hedged
Accounting
Designation
Effectiveness
Method
  
Interest Rate
Swaps
    
Caps/Floors
    
Purchase
Commitments
    
Total
  
Advances
                            
Interest rate risk associated with embedded caps and floors clearly and closely related
Fair Value
Hedge
Dollar
Offset
   $ 0     $ 142,500     $ 0     $ 142,500  
Interest rate risk associated with fixed rate non-callable advances
Fair Value
Hedge
Shortcut
     2,880,000       0       0       2,880,000  
Interest rate risk associated with callable fixed rate advances
Fair Value
Hedge
Rolling
Regression
     16,500       0       0       16,500  
Interest rate risk associated with fixed rate convertible advances
Fair Value
Hedge
Rolling
Regression
     5,890,677       0       0       5,890,677  
Investments
                                    
Fair value risk associated with fixed rate non-MBS trading investments
Economic
Hedge
Not
Applicable
     812,614       0       0       812,614  
Risk of changes in interest rates associated with variable rate MBS with embedded caps
Economic
Hedge
Not
Applicable
     0       3,171,000       0       3,171,000  
Duration of equity risk in a declining interest rate environment
Economic
Hedge
Not
Applicable
     0       300,000       0       300,000  
Mortgage Loans Held for Portfolio
                                    
Fair value risk associated with fixed rate mortgage purchase commitments
Economic
Hedge
Not
Applicable
     0       0       21,007       21,007  
Consolidated Obligation Bonds
                                    
Risk of changes in interest rates creating unacceptable duration changes or increasing costs of funds
Economic
Hedge
Not
Applicable
     450,000       0       0       450,000  
Interest rate risk associated with fixed rate callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     4,301,000       0       0       4,301,000  
Interest rate risk associated with fixed rate callable consolidated obligations
Fair Value
Hedge
Shortcut
     3,935,100       0       0       3,935,100  
Interest rate risk associated with fixed rate non-callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     125,000       0       0       125,000  
Interest rate risk associated with fixed rate non-callable consolidated obligations
Fair Value
Hedge
Shortcut
     4,383,260       0       0       4,383,260  
Interest rate risk associated with fixed rate callable step-up or step-down consolidated obligations
Fair Value
Hedge
Rolling
Regression
     5,495,000       0       0       5,495,000  
Interest rate risk associated with zero-coupon callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     104,536       0       0       104,536  
Interest rate risk associated with complex fixed rate consolidated obligations
Fair Value
Hedge
Rolling
Regression
     4,450,500       0       0       4,450,500  
Intermediary Derivatives
                                    
Interest rate risk associated with intermediary derivative instruments with members
Economic
Hedge
Not
Applicable
     173,550       0       0       173,550  
TOTAL
       $ 33,017,737     $ 3,613,500     $ 21,007     $ 36,652,244  
Table 79 presents the fair value of derivative instruments (excluding accrued interest and cash collateral) by risk and by type of instrument used to address the noted risk for the period ending December 31, 2007 (in thousands):

Table 79

Fair Value
  
Risk Hedged
Accounting
Designation
Effectiveness
Method
  
Interest Rate
Swaps
    
Caps/Floors
    
Purchase
Commitments
    
Total
  
Advances
                            
Interest rate risk associated with embedded caps and floors clearly and closely related
Fair Value
Hedge
Dollar
Offset
   $ 0     $ (202 )   $ 0     $ (202 )
Interest rate risk associated with fixed rate non-callable advances
Fair Value
Hedge
Shortcut
     (31,811 )     0       0       (31,811 )
Interest rate risk associated with callable fixed rate advances
Fair Value
Hedge
Rolling
Regression
     (9 )     0       0       (9 )
Interest rate risk associated with fixed rate convertible advances
Fair Value
Hedge
Rolling
Regression
     (168,896 )     0       0       (168,896 )
Investments
                                    
Fair value risk associated with fixed rate non-MBS trading investments
Economic
Hedge
Not
Applicable
     (19,367 )     0       0       (19,367 )
Risk of changes in interest rates associated with variable rate MBS with embedded caps
Economic
Hedge
Not
Applicable
     0       11,750       0       11,750  
Duration of equity risk in a declining interest rate environment
Economic
Hedge
Not
Applicable
     0       9,517       0       9,517  
Mortgage Loans Held for Portfolio
                                    
Fair value risk associated with fixed rate mortgage purchase commitments
Economic
Hedge
Not
Applicable
     0       0       57       57  
Consolidated Obligation Bonds
                                    
Risk of changes in interest rates creating unacceptable duration changes or increasing costs of funds
Economic
Hedge
Not
Applicable
     346       0       0       346  
Interest rate risk associated with fixed rate callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     3,812       0       0       3,812  
Interest rate risk associated with fixed rate callable consolidated obligations
Fair Value
Hedge
Shortcut
     10,793       0       0       10,793  
Interest rate risk associated with fixed rate non-callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     2,191       0       0       2,191  
Interest rate risk associated with fixed rate non-callable consolidated obligations
Fair Value
Hedge
Shortcut
     73,139       0       0       73,139  
Interest rate risk associated with fixed rate callable step-up or step-down consolidated obligations
Fair Value
Hedge
Rolling
Regression
     (29,887 )     0       0       (29,887 )
Interest rate risk associated with zero-coupon callable consolidated obligations
Fair Value
Hedge
Rolling
Regression
     79,195       0       0       79,195  
Interest rate risk associated with complex fixed rate consolidated obligations
Fair Value
Hedge
Rolling
Regression
     (70,347 )     0       0       (70,347 )
Intermediary Derivatives
                                    
Interest rate risk associated with intermediary derivative instruments with members
Economic
Hedge
Not
Applicable
     104       0       0       104  
TOTAL
       $ (150,737 )   $ 21,065     $ 57     $ (129,615 )
Market Value of Equity: Market value of equity is the net value of the FHLBank’s assets and liabilities. Estimating sensitivity of the FHLBank’s market value of equity to changes in interest rates is another measure of interest rate risk. However, market value of equity should not be considered indicative of the market value of the FHLBank as a going concern or the value of the FHLBank in a liquidation scenario. The FHLBank generally maintains a market value of equity within limits specified by the Board of Directors in the RMP, which specifies that the market value of equity as a percentage of the FHLBank’s regulatory book value of equity shall not be less than 85 percent in the base case and shall not be less than 80 percent under a ±200 basis point instantaneous shock in interest rates. Table 80 expresses the market value of equity as a percent of book value of equity for the base case and for ±100 basis point and ±200 basis point instantaneous interest rate shock scenarios. As of December 31, 2008, the base case percentage of 75 percent had fallen below the established limit of 85 percent and the up 200 basis point result of 67 percent had fallen below the limit of 80 percent. These measurements are the direct result of the factors related to the depressed MBS prices discussed previously and the corresponding DOE metrics found in Table 75. Considering the traditional function of interest rate risk management as discussed above, the depressed MBS prices caused direct distortion of both risk metric measurements, including the market to book calculation. As stated previously, FHLBank management is not taking any asset/liability management or other actions at this time in order to attempt to bring its market value of equity as a percentage of regulatory book value of equity back within its RMP ranges and the Board of Directors concurs with this course of action. However, we are actively monitoring market conditions and MBS market prices to determine if future action may be necessary.

Table 80

Market Value of Equity as a Percent of Book Value of Equity
  
Period
  
Up 200 Bps
    
Up 100 Bps
    
Base
    
Unconstrained
Down 100 Bps
    
Unconstrained
Down 200 Bps
    
Constrained
Down 200 Bps
  
12/31/2008
     67       70       75       88       88       88  
09/30/2008
     91       91       91       93       98       98  
06/30/2008
     85       87       89       92       95       94  
03/31/2008
     78       80       83       87       92       96  
12/31/2007
     86       88       90       93       93       *  
09/30/2007
     85       89       92       94       93       *  
06/30/2007
     85       89       93       95       95       *  
03/31/2007
     88       92       95       96       93       *  
____________
*     Constrained shocks are only applied in designated low-rate environments.

Item 8: Financial Statements and Supplementary Data

The following financial statements and accompanying notes, including the Report of Independent Registered Public Accounting Firm, are set forth on pages F-1 to F-38 of this Form 10-K.

Audited Financial Statements


Tables 81 and 82 present supplementary quarterly financial information (unaudited) for the years ended December 31, 2008 and 2007 (in thousands):

Table 81

   
2008
  
   
4th Quarter
    
3rd Quarter
    
2nd Quarter
    
1st Quarter
  
Interest income
   $ 416,144     $ 468,985     $ 433,810     $ 571,273  
Interest expense
     381,313       389,629       362,132       509,851  
Net interest income before mortgage loan loss provision
     34,831       79,356       71,678       61,422  
Provision for credit losses on mortgage loans
     57       66       64       9  
Net interest income after mortgage loan loss provision
     34,774       79,290       71,614       61,413  
Other non-interest income (loss)
     (109,486 )     (42,020 )     2,869       (19,675 )
Other non-interest expense
     10,794       9,170       10,432       9,606  
Assessments
     (22,680 )     7,468       17,005       8,545  
NET INCOME/(LOSS)
   $ (62,826 )   $ 20,632     $ 47,046     $ 23,587  
Table 82

   
2007
  
   
4th Quarter
    
3rd Quarter
    
2nd Quarter
    
1st Quarter
  
Interest income
   $ 718,754     $ 718,288     $ 657,351     $ 654,560  
Interest expense
     656,599       657,679       602,778       600,072  
Net interest income before mortgage loan loss provision
     62,155       60,609       54,573       54,488  
Provision for (reversal of) credit losses on mortgage loans
     (16 )     37       (3 )     (43 )
Net interest income after mortgage loan loss provision
     62,171       60,572       54,576       54,531  
Other non-interest income (loss)
     5,386       3,483       2,130       (779 )
Other non-interest expense
     9,919       8,289       9,962       9,084  
Assessments
     15,323       14,836       12,447       11,904  
NET INCOME
   $ 42,315     $ 40,930     $ 34,297     $ 32,764  

The FHLBank’s interest income and expense increased through 2007 but began decreasing in 2008 in response to decreasing short-term market interest rates. Net interest income increased steadily during 2007 through the third quarter of 2008 as net interest spreads, capital and average earning assets all increased. During the fourth quarter 2008, the FHLBank experienced a significant contraction in net interest spreads as it extended its consolidated obligations in the midst of rapidly falling interest rates. As a result of this extension of funding, the FHLBank’s assets re-priced faster than liabilities during the fourth quarter and its net interest income decreased significantly. The extension of the terms of borrowings was to increase liquidity in order to ensure it could meet member advance demand over the end of the year. The increase in interest income for 2007 was primarily volume-driven versus rate-driven while the decrease in interest income in 2008 was primarily rate-driven versus volume-driven (see Table 59 for volume/rate changes). On the other hand, the FHLBank’s net interest income in 2007 was primarily rate-driven versus volume-driven (increase in interest rates accounted for more than volume increases) and in 2008 it was primarily volume-driven versus rate-driven (decrease in interest rates more than offset by volume increases). In the last quarter of 2008, the decreases in both the interest income and net interest income can be primarily attributed to interest rates as the FHLBank increased its liquidity position by extending liabilities while interest rates were falling and assets were shortening as discussed previously. The significant fluctuations that have occurred in non-interest income are primarily the result of the recognition of net gains/losses on derivatives and hedging activities as required under SFAS 133, as well as the mark-to-market revaluations of trading securities required under SFAS 115. See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations” for additional information.

Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

There were no changes in or disagreements with our accountants on accounting and financial disclosure during the two most recent fiscal years.

Item 9A(T): Controls and Procedures

Disclosure Controls and Procedures. The FHLBank’s senior management is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed by the FHLBank in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. The FHLBank’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the FHLBank in the reports that it files or submits under the Exchange Act is accumulated and communicated to the FHLBank’s management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the FHLBank’s disclosure controls and procedures, the FHLBank’s management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
 
Management of the FHLBank evaluated the effectiveness of the design and operation of its disclosure controls and procedures with the participation of the President and Chief Executive Officer (CEO) and Chief Financial Officer (CFO) as of December 31, 2008. Based upon that evaluation, the CEO and CFO have concluded that the FHLBank’s disclosure controls and procedures were effective at a reasonable assurance level at December 31, 2008.
 
Internal Control Over Financial Reporting. Management of the FHLBank is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. The FHLBank’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of the financial statements in accordance with generally accepted accounting principles in the United States of America.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Management of the FHLBank assessed the effectiveness of the FHLBank’s internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our evaluation under the COSO framework, management has concluded that our internal control over financial reporting was effective as of December 31, 2008.
 
This Annual Report does not include an attestation report of the FHLBank’s independent registered public accounting firm, PricewaterhouseCoopers LLP. The FHLBank is a non-accelerated filer as defined in Rule 12b-2 of the Exchange Act, and therefore, was not subject to attestation pursuant to SEC Release No. 34-54942 permitting the FHLBank to furnish, rather than file, management’s report in this Annual Report.
There has been no change in the FHLBank’s internal control over financial reporting that occurred during the last fiscal quarter of the fiscal year for which this annual report on Form 10-K is filed that has materially affected, or is reasonably likely to materially affect, the FHLBank’s internal control over financial reporting.

Item 9B: Other Information

None.

PART III

Item 10: Directors, Executive Officers and Corporate Governance

Table 83 sets forth certain information regarding each of the executive officers of the FHLBank as of the date of this annual report on Form 10-K.

Table 83

Executive Officer
Age
Position Held
Employee of the
FHLBank Since
Andrew J. Jetter
53
President/Chief Executive Officer
May 18, 1987
David S. Fisher
53
SEVP/Chief Operating Officer
January 1, 2006
Mark E. Yardley
53
EVP/Chief Financial Officer
October 1, 1984
Patrick C. Doran
48
SVP/General Counsel/Corporate Secretary
May 1, 2004
Denise L. Cauthon
45
First VP/Controller
August 9, 1989
Thomas E. Millburn
38
First VP/Director of Internal Audit
September 26, 1994

No executive officer has any family relationship with any other executive officer or director. All executive officers serve at the discretion of the Board of Directors.
 
There are no arrangements or understandings between any executive officer and any other person pursuant to which the executive officer was or is to be selected as an officer of the FHLBank, including no employment agreement between any executive officer and the FHLBank.
 
No executive officer serves as a director of any public company.
 
Except as otherwise indicated below, each officer has been engaged in the principal occupation listed above for at least five years:
 
Andrew J. Jetter became President and CEO of the FHLBank in September 2002. He served as Executive Vice President and Chief Operating Officer from January 1998 to September 2002. Mr. Jetter joined the FHLBank in 1987 as an attorney and was promoted to General Counsel in 1989, Vice President in 1993, and Senior Vice President in 1996.
 
David S. Fisher became Executive Vice President and Chief Operating Officer (COO) in January 2006, and was promoted to Senior Executive Vice President in April 2008. Prior to that, from June 2000 until joining the FHLBank, Mr. Fisher was EVP and CFO of Commercial Federal Bank, FSB in Omaha, Nebraska. He was responsible for Treasury, Capital Markets, Accounting, Finance, Real Estate, Strategic Planning, Information Technology, Operations, Human Resources and the Investor Relations departments. He also served as the chairman for the FHLBank Risk Management Advisory Board from April 2004 until December 2005.
 
Mark E. Yardley has been Executive Vice President and CFO since February 2005. He also served as First Senior Vice President and CFO from December 1999 through February 2005 and as First Senior Vice President, Director of Finance, from January 1999 to December 1999. Mr. Yardley joined the FHLBank in 1984 as Director of Internal Audit and was promoted to Assistant Vice President in 1990 and Vice President in 1991.
 
Patrick C. Doran became Senior Vice President, General Counsel and Corporate Secretary in May 2004. Prior to that, he served as Senior Counsel and Vice President of Corporate and Community Affairs for 1st Source Bank, South Bend, Indiana.
 
Denise L. Cauthon has been First Vice President and Controller since March 2007. She joined the FHLBank in 1989 as a staff internal auditor and was promoted to Assistant Liability Manager and then Financial Reporting Accountant in 1998. Ms. Cauthon was promoted to Financial Reporting and Operations Manager in 1999 and was named Assistant Vice President in 2000. She was promoted to Assistant Controller - Financial Reporting in 2002, and then she became Vice President in 2004. Prior to becoming First Vice President and Controller, she served as Vice President and Controller from January 2005 through March 2007.
 
Thomas E. Millburn has been First Vice President, Director of Internal Audit since March 2004. He joined the FHLBank in 1994 as a staff internal auditor and was promoted to Assistant Vice President, Director of Internal Audit in 1999, and then to Vice President in 2000.
Directors
Pursuant to the passage of the Recovery Act, the Finance Agency implemented regulations whereby all new or re-elected directors are to be elected by the members. As of the date of this annual report on Form 10-K, the FHLBank has 14 directors, eight of whom are serving directorships as “member directors” (as such term is defined under the Bank Act) and six of whom are serving directorships as “independent directors” (as such term is also defined under the Bank Act). On December 30, 2008, Thomas E. Henning and Neil F.M. McKay were each elected to a new term as independent directors (previously each had been appointed by the Finance Board) commencing on January 1, 2009. On December 2, 2008, Ronald K. Wente and Michael M. Berryhill were re-elected as member directors commencing on January 1, 2009.
 
The Bank Act (as amended by the Recovery Act) and Finance Agency regulations mandate that the FHLBank’s Board of Directors consist of 13 directors or such other number as may be provided by the Bank Act and Finance Agency regulations, a majority of whom are to be member directors and at least 2/5 of whom are to be independent directors. Due to the interplay of the “method of equal proportions,” which the Finance Agency uses to allocate member directorships to each state in the FHLBank’s four-state district, the requirement that at least 2/5 of the directorate must be comprised of independent directors and the requirement that the number of member directorships allocated to each of those four states must be at least equal to the number allocated to each state on December 31, 1960, the Finance Agency may be required to allocate additional member director seats. For 2009, the Finance Agency has authorized the FHLBank’s Board of Directors to consist of 14 directors, eight of whom are to be member directors and six of whom are to be independent directors (comprised of four previously appointed directors and the two newly elected independent directors), as described above. Under the new regulations, new and re-elected directors will serve four-year terms, subject to adjustment by the Finance Agency to establish staggering of the board. Directors cannot serve more than three consecutive terms, except that a director may be re-elected to a directorship for a term that commences no earlier than two years after the expiration of the third term. Each director must be: (1) a citizen of the United States; (2) either be a resident in the FHLBank’s district or serve as an officer or director of a member located in the FHLBank’s district; and (3) elected by a vote of the members, in accordance with the Bank Act and Finance Agency regulations. Additionally, at least two of the independent directors must qualify as public interest directors.
 
Member directorships are designated to each of the four states in the FHLBank’s district and each member is entitled to nominate and vote for candidates representing the state in which the member’s principal place of business is located. Each member directorship shall be filled by a person who is an officer or director of a member located in such state. A member is entitled to cast, for each applicable member directorship, one vote for each share of capital stock that the member is required to hold, subject to a statutory limitation. Under this limitation, the total number of votes that each member may cast is limited to the average number of shares of the FHLBank’s capital stock that were required to be held by all members in that state as of the record date for voting.
 
Independent directors shall be elected by ballot from among those eligible persons nominated by the Board of Directors after consultation with the Affordable Housing Advisory Council and submitted to the Finance Agency for approval. To be elected for an independent directorship, candidates shall be elected by a plurality of the votes of the members of the FHLBank at large, with each member having one vote for each share of capital stock that the member is required to hold, subject to the statutory limitation discussed above. The FHLBank’s Board of Directors has adopted procedures for the nomination and election of independent directors, which are set forth in the FHLBank’s Amended and Restated Bylaws, attached as Exhibit 3.2 to the FHLBank’s Form 8-K filed with the SEC on October 22, 2008, and incorporated by this reference.
 
There are no arrangements or understandings between any director and any other person pursuant to which the director was or is to be selected as a director or nominee. No director has any family relationship with any other director or executive officer. No director or person nominated to become a director or executive officer of the FHLBank has been involved in any legal proceeding during the past five years that would affect the integrity or ability of such director or nominee to serve in such capacity.
 
The Compensation Committee Report is included following the Compensation Discussion and Analysis in Item 11 – “Executive Compensation.”
 
The 14 directors who currently serve on the Board provided the information set forth below regarding their principal occupation, business experience and other matters. Except as otherwise indicated, each director has been engaged in the principal occupation described below for at least five years:
 
Michael M. Berryhill, 53, has served as an elected director of the FHLBank since January 2003 and was recently elected to a four-year member directorship commencing January 1, 2009. Mr. Berryhill has been Chairman of the board of directors, President and CEO of Morgan Federal Bank, Fort Morgan, Colorado, since 1993.
 
Robert E. Caldwell, II, 38, was appointed as a director of the FHLBank in January 2004, was re-appointed to a one-year term from January 2007 through December 2007, and was re-appointed again to serve from January 2008 through December 2010. He served as Vice Chairman of the FHLBank’s Board of Directors commencing January 2004 through December 2006. Mr. Caldwell has been President and CEO of Hampton Enterprises, Inc., a commercial real estate development, general contracting, construction management and property management firm, since 2006. He previously served as General Counsel for Linweld, Inc. a large independent manufacturer and distributor of industrial/medical gases and welding supplies during and prior to the past five years.
 
James R. Hamby, 57, served as an elected director of the FHLBank from January 1995 through December 2001. He was again elected to the Board of Directors for a term commencing January 2007 through December 2009. Mr. Hamby has been CEO of Vision Bank, Ada, Oklahoma, since 1990.
 
Thomas E. Henning, 56, was recently elected to a three-year independent directorship commencing January 1, 2009. Prior to his election as an independent director, he was appointed as a director in April 2007 to fill the remainder of a term that expired in December 2008. He has been the Chairman, President and CEO of the Assurity Security Group, Inc. (ASGI) in Lincoln, Nebraska since 2005 and was employed by Security Financial Life Insurance Co., a predecessor to ASGI, from 1990 to 2006. He is also the Chairman, President and CEO of ASGI’s wholly owned subsidiary, Assurity Life Insurance Company. Mr. Henning has served on the board of Nelnet, Inc., a provider of education finance and services, headquartered in Lincoln, Nebraska, since 2003.
Steven D. Hogan, 46, became an elected director of the FHLBank in January 2004 and was re-elected to serve from January 2007 through December 2009. Mr. Hogan has been an officer of Yampa Valley Bank, Steamboat Springs, Colorado since April 2007. Mr. Hogan is also currently President of Capital West National Bank, Fort Collins, Colorado. Prior to that, he was President of Centennial Bank of the West where he was employed since 2001. From 2000 to 2001 he was a senior credit officer for Vista Bank, Colorado Springs, Colorado. Mr. Hogan was employed with the Federal Home Loan Bank System, serving in the Dallas district from 1993 to 1996 and the Topeka district from 1996 to 2000. He began his career with the First National Bank of Grapevine where he was employed from 1981 to 1993.
 
Andrew C. Hove, Jr., 74, was appointed as a director of the FHLBank in April 2007 to fill the remainder of a term commencing January 2007 through December 2009. He serves on many boards of directors including NeighborWorks Lincoln in Lincoln, Nebraska; Sovereign Bank, Wyomissing, Pennsylvania; and Great Western Bank, Sioux Falls, South Dakota. Mr. Hove, now retired, previously served as Vice Chairman and Acting Chairman of the Federal Deposit Insurance Corporation for more than 11 years from 1991 to 2001, and prior to that served as the Chairman and CEO of Minden Exchange Bank and Trust, Minden, Nebraska.
 
Jane C. Knight, 65, was appointed as a director of the FHLBank in January 2004, was re-appointed to a one-year term from January 2007 through December 2007, and was re-appointed to serve from January 2008 through December 2010. Ms. Knight, now retired, was Vice President of site-based strategies for Kansas Big Brothers Big Sisters from 2002 through 2005. Prior to that, she directed the Wichita office for Kansas Governor Bill Graves and was in charge of addressing constituent concerns, including housing issues.
 
Richard S. Masinton, 67, was appointed as a director of the FHLBank in April 2007 to fill the remainder of a term commencing January 2007 through December 2009. Mr. Masinton previously served as Chief Financial Officer and Executive Vice President of Russell Stover Candies in Kansas City, Missouri, from 1996 until 2008. Recently retired from Russell Stover, Mr. Masinton was elected Executive Vice President of Quinn Capital, LLC in Leawood, Kansas in January 2009. Also in January 2009, he was elected to the board of directors of No More Homeless Pets Kansas City. Mr. Masinton recently retired from the boards of OneNeck IT Services Corp and Enterprise Financial Services Corporation, a publicly owned bank holding company. He has also served on the board of advisors of the University of Kansas School of Business and presently sits on an advisory board at the University of Oklahoma School of Business.
 
Lawrence L. McCants, 59, became an elected director of the FHLBank in January 2005 and was re-elected to serve from January 2008 through December 2010. He joined First National Bank in Goodland, Kansas, in 1983 and has served as Chairman of the board and President since that time. Mr. McCants was previously employed by the Comptroller of the Currency for 11 years.
 
Neil F.M. McKay, 68, was recently elected to a four-year independent directorship commencing January 1, 2009. Prior to his election as an independent director, Mr. McKay was appointed as a director in April 2007 to fill the remainder of a term that expired in December 2008. From 1994 through March 2006, he was the Chief Financial Officer and Treasurer of Capitol Federal Savings in Topeka, Kansas. Mr. McKay, now retired, has held significant executive positions in various financial institutions including Heartland Federal Savings in Ponca City, Oklahoma and First Nationwide Bank (now part of Citibank) in San Francisco, California. He was also a CPA in public practice for 12 years.
 
Thomas H. Olson, 73, became an elected director of the FHLBank in January 2002, was re-elected for a term commencing January 2005 through December 2007, and was re-elected again for a term commencing January 2008 through December 2010. Mr. Olson has been Chairman of the board of Lisco State Bank, Lisco, Nebraska, as well as served as Chairman of the board or a director of five other banks located in Nebraska, Colorado, and Wyoming during and prior to the past five years.
 
Lindel E. Pettigrew, 66, became an elected director of the FHLBank in January 2002, was re-elected to a term commencing January 2005 through December 2007, and was re-elected again for a term commencing January 2008 through December 2010. He currently serves and has served as the Vice Chairman of the FHLBank’s Board of Directors since January 2007. Mr. Pettigrew has been President and CEO of Chickasha Bank and Trust Company, Chickasha, Oklahoma, since 1974.
 
Bruce A. Schriefer, 59, became an elected director of the FHLBank commencing January 2007. Mr. Schriefer’s term expires in December 2009. Mr. Schriefer joined Bankers’ Bank of Kansas, Wichita, Kansas, in 1996 where he serves as President, CEO and director.
 
Ronald K. Wente, 58, was recently elected to a four-year member directorship commencing January 1, 2009. Prior to his election as a member director, Mr. Wente had served as an elected director of the FHLBank since January 1996. He currently serves as and has served as Chairman of the FHLBank’s Board of Directors since 2000. Mr. Wente has been President and CEO of Golden Belt Bank, FSA, Ellis, Kansas, since 1974.

Code of Ethics
The FHLBank has adopted a Code of Ethics that applies to the FHLBank’s directors, officers (including the FHLBank’s principal executive officer, principal financial officer, principal accounting officer or controller and persons performing similar functions) and employees. The FHLBank has posted its Code of Ethics on its Web site at www.fhlbtopeka.com. The FHLBank will also post on its Web site any amendments to, or waivers from, a provision of its Code of Ethics that applies to the principal executive officer, principal financial officer, principal accounting officer, or persons performing similar functions as required by applicable rules and regulations. The Code of Ethics is available, in print, free of charge, upon request. Written requests may be made to the General Counsel of the FHLBank at One Security Benefit Place, Suite 100, Topeka, Kansas, 66606.
Audit Committee Financial Expert
The FHLBank has a separately-designated audit committee, which consists of Michael M. Berryhill, the chairman of the audit committee, Neil F.M. McKay, James R. Hamby, Andrew C. Hove, Jr., Lawrence L. McCants and Ronald K. Wente.
 
The Board of Directors has determined that Neil F.M. McKay qualifies as an “audit committee financial expert” as that term is defined under SEC regulations. Mr. McKay is “independent” in accordance with the Nasdaq Independence Standards for audit committee members, as those standards apply to the FHLBank.
 
Item 11. Executive Compensation

Compensation Discussion and Analysis

Overview
Our overall compensation philosophy is to establish and provide a total compensation program for our executive officers, including the President and CEO (CEO), the Senior Executive Vice President and COO (COO), the Executive Vice President and CFO (CFO), the Senior Vice President and General Counsel (General Counsel), the Senior Vice President and Director of Risk Analysis (collectively, the Named Executive Officers) and other executive officers identified by the Board of Directors, that assists and supports us in achieving our mission. In determining the appropriate total compensation package for our Named Executive Officers, we consider as the principal objectives of our compensation program: (1) attracting and retaining highly-qualified and talented individuals; and (2) motivating these individuals to achieve individual and FHLBank-wide performance goals through incentive awards that reward such performance.
 
The Compensation Committee of the Board of Directors (Compensation Committee) oversees the compensation of the Named Executive Officers. The Compensation Committee’s responsibilities include:
§
Advising the Board of Directors on the establishment of appropriate compensation, incentive and benefits programs, including recommending performance goals for the ESTIP and the Long Term Incentive Plan (LTIP);
§
Overseeing the base salaries, merit raises and salary adjustments of the COO, the CFO, and the General Counsel; and
§
Recommending to the Board of Directors the base salary, merit raises and salary adjustments of the CEO.

The CEO is responsible for recommending to the Compensation Committee the base salary, merit raises and salary adjustments of the COO, CFO and General Counsel and approving the base salary, merit raises and salary adjustments of the Director of Risk Analysis recommended by the CFO.

Elements of Executive Compensation
To implement our compensation objectives, the elements of our 2008 compensation program for the Named Executive Officers included: (1) annual base salary; (2) annual cash incentive awards; (3) retirement and other benefits; and (4) limited perquisites and other personal benefits. For 2009, our Compensation Committee recommended and the Board of Directors approved a new LTIP that is intended to additionally motivate the Named Executive Officers to achieve longer term FHLBank-wide goals than are provided under the FHLBank’s ESTIP and to achieve a competitive position within our identified labor markets.
 
Annual Base Salary
A significant element of each Named Executive Officer’s compensation is annual base salary. The Compensation Committee has determined that appropriate annual base salaries for each Named Executive Officer should be competitive at the 50th percentile level of the salaries of comparable executive positions within the defined labor markets, as discussed below under “Use of Benchmarks.” Adjustments to annual base salaries for the Named Executive Officers are considered annually and may be made in April following an analysis of our compensation practices in the previous year. In 2008, annual base salaries paid to the Named Executive Officers were determined to be competitive at the 50th percentile level within both the FHLBank System and among Midwestern financial services institutions with assets of $10 billion to $12 billion. Adjustments to annual base salaries of the Named Executive Officers are based on: (1) each Named Executive Officer’s scope of responsibility and accountability; (2) comparisons to the defined labor markets (as described below); (3) performance as measured in terms of FHLBank-wide goals and individual performance goals; and (4) other factors such as experience, time in position, and labor supply and demand considerations. Based on this analysis by the Compensation Committee, the CEO, COO, CFO and General Counsel each received a merit-based increase of between 4.1 and 9.2 percent of their base salary in 2008, and the Director of Risk Analysis received a 2.0 percent merit-based increase in his base salary in 2008.
 
Annual Cash Incentive Awards
The Board of Directors adopted the ESTIP on December 22, 2007, which became effective on January 1, 2008. The ESTIP governs the eligibility and payout of annual cash incentive awards for certain executive officers, including the Named Executive Officers. The purpose of the ESTIP is to motivate certain of our executive officers to achieve annual goals that are aligned with our mission and business objectives and to reward them for attaining such goals. The Board of Directors established performance objectives in December 2007 for award opportunities under the ESTIP in 2008. A detailed discussion related to the establishment of the performance goals under the ESTIP is provided below under “Establishment of Performance Goals for Incentive Opportunities.”
Long Term Incentive Plan
On December 18, 2008, the Board of Directors approved the LTIP, which became effective on January 1, 2009. McLagan Consulting was retained to guide the LTIP design process. The purpose of the establishment of the LTIP is to extend our ability to provide incentives to the Named Executive Officers that will further motivate them to facilitate our longer term strategic objectives and reward performance that results in our growth and financial stability, based on a three-year performance period. Payments awarded under this plan, when combined with base salary, ESTIP awards, and other benefits are designed to provide competitive total compensation to key employees for achieving the FHLBank’s desired strategic objectives. Total compensation is targeted to be at the 50th percentile relative to similar key employee positions at other FHLBanks. If total compensation is above the 50th percentile, then the Compensation Committee may recommend a corresponding decrease in the ESTIP targeted award during that corresponding period. A copy of the LTIP was attached as Exhibit 10.1 to the FHLBank’s current report on Form 8-K filed December 24, 2008.

Retirement and Other Benefits
The Board of Directors and FHLBank are committed to providing competitive, high-quality benefits designed to promote health, well-being, good will and income protection for all employees, including the Named Executive Officers. We offer all employees a core level of benefits and a variety of optional benefits including medical, dental, prescription drug, life insurance, long-term disability, flexible spending accounts, employee assistance program and travel accident insurance. The Named Executive Officers participate in these core benefit programs on the same basis as all other full-time employees.
 
We maintain a comprehensive retirement program for our eligible officers comprised of two qualified retirement plans: (1) a defined-benefit plan (established in 1943); and (2) a defined-contribution plan (established in 1972). For these qualified retirement plans, we participate in the Pentegra Defined Benefit Plan for Financial Institutions, a tax-qualified multiple-employer defined-benefit plan (DB Plan) and the Pentegra Financial Institutions Thrift Plan, a retirement savings plan qualified under the Internal Revenue Code (IRC) for employees of the FHLBank (DC Plan).
 
In 2008, the Named Executive Officers participated in the DB Plan, which required no contributions from the Named Executive Officers.
 
All employees who have met the eligibility requirements can choose to participate in the DC Plan. We match employee contributions based on the length of service and the amount of an employee’s contribution. These employer contributions are immediately 100 percent vested. Matching ratios for all employees, including the Named Executive Officers, under the DC Plan are as follows:
Year 1
No match
Years 2 through 3
100 percent match up to 3 percent of employee’s eligible compensation
Years 4 through 5
150 percent match up to 3 percent of employee’s eligible compensation
After 5 years
200 percent match up to 3 percent of employee’s eligible compensation

In response to federal legislation, which imposed restrictions on the pension benefits payable to its executives, we subsequently established a third retirement plan, the Benefit Equalization Plan (BEP). The BEP is a non-qualified plan which restores the pension benefits that an eligible employee is restricted from receiving because of the limitations imposed by the IRC on the benefits received from or contributions made to our two qualified pension plans. Generally, the BEP is characterized as a non-qualified “excess benefit” plan, which restores those retirement benefits that exceed the IRC limits applicable to the qualified DB Plan and DC Plan. In this respect, the BEP is an extension of our retirement commitment to our Named Executive Officers and other highly compensated employees that preserves and restores the full pension benefits that, due to IRC limitations, are not payable from the qualified pension plans.
 
The BEP was amended, effective January 1, 2008, to allow all participants to defer a percentage of their incentive compensation into the BEP. Previously, participants were only allowed to defer a percentage of their annual base salary into the BEP once the participant maximized his or her contribution into our two qualified retirement plans. This change allows a participant to defer up to 30 percent of both annual base salary and incentive compensation into the BEP. Incentive deferrals into the BEP are not eligible for matching by the FHLBank. On October 31, 2008, the Board of Directors adopted amendments to the BEP primarily to comply with IRC Section 409A. As amended, the BEP eliminates the previous ability of participants to direct the investment of their funds deferred under the BEP and instead credits earnings to a participant’s account based on the FHLBank’s average return on equity. Additionally, the amended BEP eliminates discretion over when election contributions are made to the BEP and when distributions of funds are paid out to participants. A copy of the amended and restated BEP can be found as Exhibit 10.2 to our current report on Form 8-K filed December 24, 2008.

Perquisites and Other Personal Benefits
The Board of Directors views the perquisites afforded to the Named Executive Officers as an element of the total compensation program. Any perquisites provided, however, are not intended to materially add to any Named Executive Officer’s compensation package and, as such, are provided to them primarily as a convenience associated with their respective duties and responsibilities.
 
Examples of perquisites that may be provided to the Named Executive Officers include the following:
§
The personal use of an FHLBank-owned automobile;
§
Financial and tax planning;
§
Relocation assistance;
§
Spousal travel; and
§
Country Club memberships.

Categorical types of perquisites provided to the Named Executive Officers in 2008 are presented and detailed in the Summary Compensation Table (see Table 88 under this Item 11) and accompanying narrative in the case that aggregate perquisites to any single Named Executive Officer exceeded $10,000.
Analysis of Compensation Decisions in 2008
Use of Benchmarks
A key to attracting and retaining highly-qualified executive officers is the identification of the appropriate labor markets within which we must compete for executive talent. We have historically recruited nationally in our efforts to attract highly-qualified candidates for the Named Executive Officer positions. To ensure that we are offering and paying competitive compensation, the Board of Directors and/or Compensation Committee specifically, has periodically retained compensation consultants to benchmark competitive levels of our total compensation with respect to compensation elements of annual base salary, annual incentive awards and benefits for the Named Executive Officers. In 2008, the Compensation Committee engaged an independent compensation consultant, Compensation Planning Group, Inc. for data analysis related to benchmark comparisons.
 
As part of our compensation objective in 2008 to retain our Named Executive Officers by maintaining competitive pay practices within the financial services sector, the Compensation Committee identified two competitive labor markets from which to compare similar executive positions as benchmarks for our Named Executive Officers’ total cash compensation and benefits. These were: (1) GSEs, including the other 11 Federal Home Loan Banks; and (2) financial services institutions in the Midwest labor market.
 
The decision to remain competitive with GSEs and, at the same time, consider the broader labor market of financial services institutions in the Midwest reflects our belief that the knowledge and skills necessary to effectively perform the Named Executive Officers’ duties at the FHLBank may be developed as a result of experience not only at other GSEs, in particular the other 11 Federal Home Loan Banks, but also at a variety of other financial services institutions. The decision to limit its consideration of other financial services institutions to those located in the Midwest reflects our belief that: (1) Topeka’s Midwestern culture is more likely to appeal to candidates from the Midwest, versus the East Coast or the West Coast; and (2) Midwestern compensation practices are the best comparator for a Topeka-based financial services institution.
 
With respect to benchmarking the other GSEs, the compensation consultant summarized compensation data reported by the other GSEs, and in particular the FHLBank System, to assist the Compensation Committee in aligning the Named Executive Officers’ cash compensation with the FHLBanks in accordance with the percentile range identified by the Compensation Committee for such purposes.
 
In June of 2008, the Compensation Committee revised the defined labor market consisting of GSEs to include only the FHLBanks for fiscal year 2009 compensation decisions related to the Named Executive Officers total compensation.
 
We recognize that our organizational structure as a cooperatively owned GSE prevents us from making straightforward comparisons with other Midwestern financial services institutions of similar asset size. Consequently, to allow us to effectively utilize this competitive data, the compensation consultant developed a financial services institutions’ Asset Normalization Model (ANM). The ANM identifies the relationship between total assets and net income levels within the Midwestern financial services institution sector. That relationship is used to identify the range of asset sizes of Midwestern financial services institutions that have net income levels comparable to ours. The 50th percentile market values of executive officer positions at Midwestern financial services institutions within that range of asset sizes are then computed. Based on the ANM, in 2008, the Compensation Committee made a determination that the financial services defined labor market consisted of Midwestern financial services institutions with assets of $10 to $12 billion.
 
The Compensation Committee then utilized the benchmarks identified among the defined labor markets to analyze and make compensation decisions to achieve our 2008 compensation objectives by establishing: (1) total cash compensation in the form of base salaries that are competitive taking into account our status as a cooperative GSE; and (2) opportunities for short term cash incentive awards that support our short-term business strategies and assist in the achievement of our mission and competitive total compensation.
 
In 2008, the 50th percentile market value of similar executive officers’ positions was utilized to benchmark the competitiveness of our annual total cash compensation and benefits for the Named Executive Officers. This percentile was selected to reflect its determination that a median level comparison reflects a reasonable compensation target for our Named Executive Officers that appropriately pays our Named Executive Officers and strives to respect the talent and consistent effort expended on behalf of the FHLBank by our Named Executive Officers and recognizes such loyalty and dedication. The 50th percentile market value of executive officers’ positions was calculated by the Compensation Committee’s executive compensation consultant using: (1) pay data reported in the Form 10-Ks of GSEs; (2) aggregated published pay data for financial services institutions including data from surveys such as the Watson Wyatt Financial Institution Survey, Economic Research Institute Executive Compensation Salary Assessor, Conference Board Executive Compensation Survey, Altman Weil Law Department Compensation Benchmark Survey, and WorkatWork Salary Survey; (3) Form 10-Ks and Proxy Statements; and (4) at the Compensation Committee’s option, unpublished pay data solicited from specific GSEs or comparable Midwestern financial services institution companies. In 2008, the Compensation Committee did not deem it necessary to request such additional data.
Consideration of Individual Performance
In addition to using benchmarking, as described above, the performance of each Named Executive Officer was considered by the Compensation Committee, by the CEO, and by the CFO in the case of the Director of Risk Analysis, in determining whether it was appropriate to increase annual base salaries based on a subjective determination of the perceived merit of each Named Executive Officer. In 2008, the Compensation Committee determined that a threshold condition for eligibility to receive a discretionary merit-based increase in annual base salary for the Named Executive Officers was the achievement of our FHLBank-wide performance goals defined by our Strategic Business Plan and described further below. Additional consideration was given to whether a particular Named Executive Officer substantially exceeded expectations or otherwise contributed to our success during 2008, beyond that which would be recognized through ESTIP awards. For the CEO, adjustments to annual base salary were considered based on the results of performance reviews of the CEO’s performance by all directors, taking into account performance reviews by his direct reports and by our Director of Internal Audit, as well as the CEO’s self assessment. For the Director of Risk Analysis, performance was measured in terms of qualitative and observable results, which were achieved within his areas of supervisory responsibility. The outcomes of this analysis in 2008 were an increase of 2.0 percent of base salary for the Director of Risk Analysis and between 4.1 and 9.2 percent increases of base salaries for the other Named Executive Officers.
 
Consideration of Internal Pay Equity
A final factor that the Compensation Committee considered in 2008 in its effort to reward and retain our Named Executive Officers was the relative difference in compensation between the executive officers as well as the pay relationship between executive officers and other employees at the FHLBank. The Compensation Committee believes that internal pay equity provides an additional perspective as it considers or is presented with benchmarked compensation information. In addition, as discussed below, the Compensation Committee believes that the competitive level of compensation paid to our Executive Officers should not only reflect their individual responsibilities and contributions but also provide incentive to achieve our business and financial goals. Comparisons to compensation levels at companies in our defined labor markets are the primary basis used to assess the overall competitiveness of our compensation program; however, we also believe that our executive compensation practices should be internally consistent and equitable and such analysis was undertaken in 2008 with regard to the CEO’s total compensation in relation to the other Named Executive Officers, and those other Named Executive Officers to other executive officers at the FHLBank.
 
Establishment of Performance Goals for Incentive Award Opportunities
Another key objective of our total compensation program is motivating our Named Executive Officers to accomplish business and financial short-term goals that promote a high level of performance for our members. Consequently, our compensation and benefits programs are designed to motivate our Named Executive Officers to engage in the behaviors and performance necessary to deliver our desired results of operations in a highly competitive environment. We also recognize that well-designed incentive compensation plans provide important opportunities to motivate our Named Executive Officers to accomplish financial and operational goals that promote our mission.
 
To effectively motivate the Named Executive Officers to accomplish short-term goals that promote our performance, we believe that incentive awards must represent pay at risk. In other words, the administration of the FHLBank’s incentive compensation plans must be such that awards are distributed only in exchange for accomplishing pre-established, Board of Directors-approved goals, and are not distributed if such goals are not met. In 2008, we achieved this compensation objective through attainment of annual performance objectives under our ESTIP.
 
In 2007, management and designated members of the Board developed and proposed performance objectives for executive compensation awards under the ESTIP in 2008. The proposed performance objectives were based upon Board and management discussions with respect to our primary mission and stockholder perceptions of success. The Board reviewed, challenged and adjusted the proposed performance objectives for 2008 before finalizing the objectives in December 2007.
 
On December 19, 2007, the Board of Directors finalized the five FHLBank-wide performance objectives from which to measure potential awards to the Named Executive Officers under the ESTIP. The performance objectives against which the Named Executive Officers’ performance were evaluated in 2008 represented a mix of profit-oriented and service-oriented performance measures, and reflected the fact that our primary mission as a cooperatively owned GSE is providing overall benefits to our members in the form of products, services and dividends. These performance objectives are described in Table 84:

Table 84

Performance Objective
Measure
Core Return Spread on Class B Common Stock
Spread between pre-SFAS 133, pre-AHP/REFCORP core return available for Class B Common Stock (weighted by the amount of Class B Common Stock outstanding each day) and the weighted average daily overnight Federal funds effective rate
Net Income After Capital Charge
The dollar amount of pre-SFAS 133 core earnings that exceeds the cost of the required return on capital
Advance Penetration
The average member’s advance-to-asset ratio in relation to the prior year’s ratio adjusted for the national trend in the other borrowings-to-total asset ratio as reported by the Federal Reserve
Core Product Utilization
The weighted average member and housing associate usage of core banking (profit-oriented) products
Mission Product Utilization
Based on the member usage of mission-oriented products consisting of AHP, CHP, DCP, RFHP, TOP and JOBS programs
The profit-oriented objectives of “Core Return Spread on Class B Common Stock” and “Net Income After Capital Charge” (non-GAAP measures) were based on: (1) the belief that profitability is critical to the long-term viability of the organization; and (2) the understanding that the holders of Class B Common Stock represent the members constituting the primary users of our products and services. The “Advance Penetration” performance objective was established to address average advance usage by members as a percentage of each member’s balance sheet. Finally the performance objectives for “Core Product Utilization” and “Mission Product Utilization” address the members’ usage of profit generating products and non-profit generating products, respectively. A key driver in the development of the objectives was the Board’s perspective that it is important for us to serve all members, regardless of asset size. Consequently, the product-oriented objectives represented an average of the ratios calculated across all members unweighted by asset size. The weighting for each performance objective is discussed in detail below.
 
Award levels were set at threshold, target and optimum percentages of annual base salary. All of the FHLBank’s performance objectives are annual goals, but quarterly progress payments are made under the ESTIP in accordance with interim goals established for each performance range and applied to the respective annual performance objective. So long as at least a threshold level of performance was achieved, payouts were made up to a maximum payout percentage set for each Named Executive Officer. In addition, the Compensation Committee established a holdback of twenty percent of the quarterly progress payments, which would only be paid at year-end if we achieved at least a threshold level of performance for the year against the Core Return on Class B Capital Stock performance objective.
 
Table 85 sets forth the specific performance ranges for each of our established performance objectives in 2008:

Table 85

Performance Objective
  
Interim Performance Ranges for Quarterly
Progress Payments Against Annual Awards
    
Annual
Performance
Range
  
 
March 31
    
June 30
    
September 30
  
Core Return Spread on Class B Common Stock
Threshold
     5.10 %     5.10 %     5.10 %     5.10 %
 
Target
     5.69 %     5.69 %     5.69 %     5.69 %
 
Optimum
     6.28 %     6.28 %     6.28 %     6.28 %
Net Income After Capital Charge1
Threshold
   $ 1,700,000     $ 3,400,000     $ 5,100,000     $ 6,800,000  
 
Target
   $ 3,400,000     $ 6,800,000     $ 10,200,000     $ 13,600,000  
 
Optimum
   $ 5,100,000     $ 10,200,000     $ 15,300,000     $ 20,400,000  
Advance Penetration2
Threshold
     0.5 %     0.5 %     0.5 %     0.5 %
 
Target
     3.0 %     3.0 %     3.0 %     3.0 %
 
Optimum
     5.5 %     5.5 %     5.5 %     5.5 %
Core Product Utilization3
Threshold
     40.21 %     40.92 %     40.90 %     40.98 %
 
Target
     40.71 %     41.42 %     41.40 %     41.48 %
 
Optimum
     41.21 %     41.92 %     41.90 %     41.98 %
Mission Product Utilization4
Threshold
     210       350       385       420  
 
Target
     240       400       440       480  
 
Optimum
     265       442       486       530  
__________
1    The performance range for “Net Income After Capital Charge” is based on our cumulative net income per quarter.
2
Measures represent the percentage above the national average. Such national trend data was derived from the Federal Reserve’s Statistical Release H8 “Historical Data – Assets and Liabilities of Commercial Banks in the United States.” We used the data attributed to the subgroup Assets and Liabilities of Small Domestically Chartered Commercial Banks in the Unites States (not seasonally adjusted, adjusted for mergers, billions of dollars).
3
We have identified the following as our core banking products: line of credit advances, regular advances, letters of credit, MPF Program, overnight deposits and safekeeping.
4
The performance range for “Mission Product Utilization” is based on the number of our members at the time of mission product usage that qualify as users of a product at any time during the calendar year. Program participation use is credited and remains credited for the entire calendar year irrespective of whether the participating member is subsequently acquired, merged or otherwise terminates its membership.

Under the ESTIP, the Compensation Committee has the discretion to reduce or eliminate the amount of an award otherwise payable to a Named Executive Officer if, due to extenuating circumstances, the Compensation Committee subjectively determines the reduction or elimination of an award is warranted. Such discretion has not been historically exercised by the Board of Directors under the ESTIP and was not exercised in 2008.
Table 86 provides the weighting for the various performance goals.

Table 86

Performance Objective
Weight %
Core Return Spread on Class B Common Stock
25
Net Income After Capital Charge
25
Advance Penetration
20
Core Product Utilization
20
Mission Product Utilization
10

Award values as a percentage of annual base salary for performance goal achievement were assigned based on the individual’s relative position in the hierarchy of the FHLBank. The particular Named Executive Officer’s position in the hierarchy of the FHLBank partially reflects the individual’s role in the strategic decisions of the FHLBank as well as the individual’s influence over our overall operations and culture. In order to maintain annual total cash compensation parity with the other FHLBanks, however, award levels for the CEO and COO were set at levels below the 50th percentile of the Midwestern financial services institutions with assets between $10 and $12 billion. Incentive levels for the CEO and COO may be considered, therefore, less reflective of these Named Executive Officers’ roles in the strategic decisions of the FHLBank as well as these individuals’ influence over the overall operations and culture of the FHLBank.

Table 87

Position
Target
CEO
55 percent
COO, CFO and General Counsel
45 percent
Director of Risk Analysis
35 percent

While markets were extremely volatile over the course of 2008, the FHLBank had an outstanding year in terms of Net Income After Capital Charge and Core Return Spread on Class B Common Stock (non-GAAP measures) and solid financial performance overall with member utilization of the FHLBank’s products and services significantly increased from 2007 over the course of 2008, which underscored the value the FHLBank provides to our members. Therefore, the Compensation Committee of the Board of Directors approved quarterly and annual payouts under the ESTIP to the Named Executive Officers based upon our actual achievement of the five performance objectives each quarter and at December 31, 2008. The FHLBank achieved threshold level of performance for the Core Return on Class B Capital Stock in 2008, and therefore, all Named Executive Officers received the holdback amount of the ESTIP awards earned for this performance objective.
 
Why We Choose to Pay these Elements
We believe the Compensation Committee’s benchmark analysis, internal analysis related to pay equity among the Named Executive Officers and the Board of Directors’, CEO’s and CFO’s establishment of individual performance objectives for each of the Named Executive Officers establish appropriate compensation levels for each Named Executive Officer that reasonably position us to competitively manage our operations and accomplish our mission.
 
The mix of compensation elements that comprised the total compensation of our Named Executive Officers in 2008, including annual base salary, short-term incentive awards, retirement-related benefits, and other broad-based benefits, allowed us to provide total compensation that we believed appropriately balanced reasonable guaranteed pay through carefully considered base salary determinations with additional cash compensation opportunities at risk to the Named Executive Officers. This means that while we strived to match an appropriate level of compensation comparable to that reflected by our defined labor markets and internal pay analysis through annual base salary and retirement benefits components, we also strived to provide a component of compensation that is at risk but represents an opportunity for reward based on the achievement of our performance goals. Therefore, where we achieved performance goals in 2008, the Named Executive Officers received awards under the ESTIP that were determined to correspond to the respective Named Executive Officer’s contribution to our success.
 
Potential Payments Upon Termination/Retirement
Severance Policy
We provide severance benefits to the Named Executive Officers pursuant to our Officer Severance Policy. The policy’s primary objective is to provide a level of protection to officers, including the Named Executive Officers, from loss of income during a period of unemployment. An officer of the FHLBank is eligible to receive severance pay under the policy if the FHLBank terminates the officer’s employment with or without cause, subject to certain limitations. These limitations include: (1) the officer voluntarily terminates employment; (2) the officer’s employment is terminated by the FHLBank for misconduct; or (3) the officer accepts employment or refuses other employment offered by the FHLBank at or before the time of termination.
Provided the requirements of the policy are met and the officer provides the FHLBank an enforceable release, the officer will receive severance pay equal to the following amount of the officer’s final annual base salary indicated for the officer’s title. Officer titles not specifically listed will be paid the same number of weeks as the next lower ranking title.

President
52 weeks
Executive Vice President
39 weeks
Senior Vice President
26 weeks
Vice President
13 weeks
Assistant Vice President
11 weeks
Other Officer
9 weeks

Other Potential Payments
As of December 31, 2008, the Named Executive Officers would be additionally entitled to the amount listed in Table 92, under the column titled “Aggregate Balance at Last FYE,” within ninety days of any such Named Executive Officer’s termination of employment due to death, disability or retirement. While there was no provision for payout under the BEP upon a change in control event on or prior to December 31, 2008, the amended BEP (as described above) provides for a potential payment to the Named Executive Officers upon a change in control as defined under the amended BEP, effective January 1, 2009.

Finance Agency Oversight
Section 1113 of the Recovery Act requires that the Director of the Finance Agency prevent an FHLBank from paying compensation to its executive officers that is not reasonable and comparable to that paid for employment in similar businesses involving similar duties and responsibilities. The Finance Agency recently initiated a project to determine how best to implement these statutory requirements with respect to the FHLBanks. Until such time as further guidance is issued, the FHLBanks have been directed to provide all compensation actions affecting their five most highly compensated officers to the Finance Agency for review. Accordingly, we have submitted all required compensation actions to the Finance Agency. Nevertheless, we do not expect the statutory requirements to have a material impact on our executive compensation policies and pay practices.

Compensation Committee Report
The Compensation Committee of the FHLBank’s Board of Directors has reviewed and discussed the Compensation Discussion and Analysis with management. Based on its review and discussions with management, the Compensation Committee has recommended to the Board of Directors that the Compensation Discussion and Analysis be included in the FHLBank’s annual report on Form 10-K.
 
The Compensation Committee
of the Board of Directors
Richard S. Masinton, Chairman
Lindel E. Pettigrew
Michael M. Berryhill
Robert E. Caldwell II
Thomas H. Olson
Ronald K. Wente
Table 88 presents the Summary Compensation Table for the Named Executive Officers.

Table 88

Name and
Principal Position
Year
  
Salary
    
Bonus
    
Non-Equity
Incentive Plan
Compensation1
    
Change in
Pension Value
and Nonqualified
Deferred
Compensation
Earnings
    
All Other
Compensation
    
Total
  
Andrew J. Jetter2
2008
   $ 584,255     $ 0     $ 482,010     $ 584,383     $ 49,241     $ 1,699,889  
President & CEO
2007
     560,269       0       278,815       152,048       53,514       1,044,646  
 
2006
     533,750       0       285,347       371,117       59,859       1,250,073  
David S. Fisher3
2008
     381,753       0       257,683       77,857       31,919       749,212  
SEVP & COO
2007
     352,762       0       143,632       39,000       25,399       560,793  
 
2006
     340,000       50,000       148,668       0       21,573       560,241  
Mark E. Yardley4
2008
     292,169       0       197,214       331,086       28,918       849,387  
EVP & CFO
2007
     274,947       0       111,949       96,222       26,803       509,921  
 
2006
     251,837       0       109,816       143,142       21,359       526,154  
Patrick C. Doran5
2008
     233,440       0       157,572       49,499       16,997       457,508  
SVP & General
2007
     223,070       0       90,826       19,171       14,983       348,050  
Counsel
2006
     210,000       0       91,887       16,000       14,102       331,989  
Frank M.Tiernan6
2008
     182,102       0       95,603       237,040       14,887       529,632  
SVP & Director of
2007
     177,744       0       56,640       128,024       14,557       376,965  
Risk Analysis
2006
     171,143       0       59,393       133,020       14,662       378,218  
                    
1
All compensation reported under “non-equity incentive plan compensation” represents performance bonuses earned pursuant to achievement of performance objectives under the FHLBank’s ESTIP (formerly Performance Pay Plan).
2
Above market earnings attributable to the BEP for Mr. Jetter were $15,383, $8,048 and $15,117 for 2008, 2007 and 2006, respectively. The aggregate change in the value of Mr. Jetter’s accumulated benefit under the FHLBank’s DB Plan was $125,000, $53,000 and $46,000 for 2008, 2007 and 2006, respectively. The aggregate change in the value of his accumulated benefit under the defined benefit portion of the FHLBank’s BEP was $444,000, $91,000 and $310,000 for 2008, 2007 and 2006, respectively. All other compensation for Mr. Jetter includes $16,243 in perquisites and personal benefits consisting of an automobile allowance, country club membership, financial and tax planning services and expenses for spousal travel; life insurance premiums in the amount of $1,830; and long term disability premiums in the amount of $1,384 for 2008. The FHLBank’s contribution to the DC Plan was $13,800 for 2008. The FHLBank’s contribution to the defined contribution portion of the BEP was $15,984 for 2008.
3
Above market earnings attributable to the BEP for Mr. Fisher were $857 for 2008. The aggregate change in the value of Mr. Fisher’s accumulated benefit under the FHLBank’s DB Plan was $28,000 and $15,000 for 2008 and 2007, respectively. The aggregate change in the value of his accumulated benefit under the defined benefit portion of the BEP was $49,000 and $24,000 for 2008 and 2007, respectively. All other compensation for Mr. Fisher includes life insurance premiums in the amount of $1,053 and long term disability premiums in the amount of $923 for 2008. The FHLBank’s contribution to the DC Plan was $10,690 for 2008. The FHLBank’s contribution to the defined contribution portion of the BEP was $19,253 for 2008.
4
Above market earnings attributable to the BEP for Mr. Yardley were $6,086, $2,222 and $1,142 for 2008, 2007 and 2006, respectively. The aggregate change in the value of Mr. Yardley’s accumulated benefit under the FHLBank’s DB Plan was $142,000, $60,000 and $53,000 for 2008, 2007 and 2006, respectively. The aggregate change in the value of his accumulated benefit under the defined benefit portion of the BEP was $183,000, $34,000 and $89,000 for 2008, 2007 and 2006, respectively. All other compensation for Mr. Yardley includes life insurance premiums in the amount of $840 and long term disability premiums in the amount of $922 for 2008. The FHLBank’s contribution to the DC Plan was $13,800 for 2008. The FHLBank’s contribution to the defined contribution portion of the BEP was $13,356 for 2008.
5
Above market earnings attributable to the BEP for Mr. Doran were $499 and $171 for 2008 and 2007, respectively. The aggregate change in the value of Mr. Doran’s accumulated benefit under the FHLBank’s DB Plan was $30,000, $13,000 and $10,000 for 2008, 2007 and 2006, respectively. The aggregate change in the value of his accumulated benefit under the defined benefit portion of the BEP was $19,000, $6,000 and $6,000 in 2008, 2007 and 2006, respectively. All other compensation for Mr. Doran includes life insurance premiums in the amount of $671 and long term disability premiums in the amount of $775 for 2008. The FHLBank’s contribution to the DC Plan was $11,729 for 2008. The FHLBank’s contribution to the defined contribution portion of the BEP was $3,822 for 2008.
6
Above market earnings attributable to the BEP for Mr. Tiernan were $40, $24 and $20 for 2008, 2007 and 2006, respectively. The aggregate change in the value of Mr. Tiernan’s accumulated benefit under the FHLBank’s DB Plan was $162,000, $134,000 and $122,000 for 2008, 2007 and 2006, respectively. The aggregate change in the value of his accumulated benefit under the defined benefit portion of the BEP was $75,000, ($6,000) and $11,000 for 2008, 2007 and 2006, respectively. All other compensation for Mr. Tiernan includes life insurance premiums in the amount of $504 and long term disability premiums in the amount of $583 for 2008. The FHLBank’s contribution to the DC Plan was $13,800 for 2008. Mr. Tiernan retired from the FHLBank on February 10, 2009.
Table 89 presents the Grants of Plan Based Awards Table for the Named Executive Officers.

Table 89
 
     
Estimated Possible Payouts
Under Non-Equity
Incentive Plan Awards1
  
Name
Grant
Date2
  
Threshold
    
Target
    
Maximum
  
Andrew J. Jetter
01/01/2008
   $ 31,186     $ 62,372     $ 93,558  
President & CEO
04/01/2008
     32,450       64,900       97,350  
 
07/01/2008
     32,450       64,900       97,350  
 
10/01/2008
     64,584       129,168       193,752  
David S. Fisher
01/01/2008
     16,066       32,131       48,197  
SEVP & COO
04/01/2008
     17,550       35,100       52,650  
 
07/01/2008
     17,550       35,100       52,650  
 
10/01/2008
     34,729       69,458       104,187  
Mark E. Yardley
01/01/2008
     12,522       25,043       37,565  
EVP & CFO
04/01/2008
     13,356       26,712       40,069  
 
07/01/2008
     13,356       26,712       40,069  
 
10/01/2008
     26,504       53,008       79,511  
Patrick C. Doran
01/01/2008
     10,159       20,318       30,477  
SVP & General Counsel
04/01/2008
     10,620       21,240       31,860  
 
07/01/2008
     10,620       21,240       31,860  
 
10/01/2008
     21,125       42,250       63,374  
Frank M. Tiernan
01/01/2008
     6,279       12,558       18,838  
SVP & Director of Risk Analysis
04/01/2008
     6,405       12,810       19,215  
 
07/01/2008
     6,405       12,810       19,215  
 
10/01/2008
     12,779       25,557       38,336  
                    
1
Amounts reflected in this table represent the applicable range of possible payouts under the ESTIP and do not represent amounts actually earned or awarded for the fiscal year ended December 31, 2008.
2
Dates represent the date a cash award was granted to each Named Executive Officer. All awards were payable at a later date.

2008 Executive Short Term Incentive Plan
Under the ESTIP, Named Executive Officers may earn quarterly progress payments for year-to date performance against their annual goal metrics upon achieving performance objectives established by the Board of Directors. As discussed previously, for 2008, these performance objectives included: (1) core return on Class B Stock as a spread over the weighted average daily overnight Federal funds effective rate; (2) net income after capital charge; (3) advance penetration; (4) core product utilization; and (5) mission product utilization.

Performance Ranges
A range of progress payments may be granted each quarter at levels that correspond to exceeding the levels of performance ranges, from threshold, to target, to optimum performance for each goal metric. Within a performance range, threshold represents the lowest acceptable, or rewardable, level of annual performance; target represents the expected level of annual performance; and optimum represents the best attainable level of annual performance. Awards may be earned for performance anywhere within a percentage range of earned base salary. For performance that falls between any two levels of performance, linear interpolation is used to ensure that the annual award is consistent with the level of performance achieved. Named Executive Officers’ may earn the following annual awards, expressed as a percent of their earned base:

Table 90

Position
  
Threshold
Award
    
Target
Award
    
Optimum
Award
  
CEO
     27.5 %     55.0 %     82.5 %
COO, CFO and General Counsel
     22.5       45.0       67.5  
Director of Risk Analysis
     17.5       35.0       52.5  
Calculation of Quarterly Progress payments and Final Awards
Named Executive Officers may receive quarterly progress payments for year-to-date performance against their performance objectives that exceeds the interim quarterly performance levels for the goal metric against which quarterly progress payments are computed. In aggregate, any quarterly progress payment received for such performance may not exceed the value of the annual awards. Twenty percent of the calculated quarterly progress payments are retained by the FHLBank and paid after the end of the ESTIP plan period if: (1) the Named Executive Officer was employed by the FHLBank on the last day of the plan year; and (2) no pro-ration or forfeiture provisions in the ESTIP applied. The formulas for determining quarterly progress payments (QP) and the final award (FA) earned for performance against a single performance objective are:
QP = [(Earned Base) (Award %) (Metric Weight) (100% – Holdback %)] – Previous Payments
FA = [(Earned Base) (Award %) (Metric Weight)] – Previous Payments
 
Forfeiture Provisions
A Named Executive Officer, in the discretion of the Compensation Committee, may be required to forfeit an award earned under the ESTIP if he is: (1) discharged from employment with the FHLBank for Good Cause as defined under the ESTIP; (2) engages in competition with the FHLBank or interferes with the business relationships of the FHLBank during his employment or following his termination; (3) discloses confidential information of the FHLBank; or (4) refuses to report to the FHLBank any discoveries or improvements conceived by him during the course of his employment that relate to the business of the FHLBank. A Named Executive Officer is not eligible to receive progress payments toward annual awards or holdbacks arising out of an annual award for any quarter during which he is terminated for any reason other than death or for subsequent quarters of such Plan period.

Pension Benefits
Table 91 presents the Pension Benefits Table for the Named Executive Officers.

Table 91

Name
Plan Name
  
Number of
Years of
Credited
Services
    
Present Value of
Accumulated
Benefit
    
Payments
During Last
Fiscal Year
  
Andrew J. Jetter
Pentegra Defined Benefit Plan for Financial Institutions
     20.583     $ 532,000     $ 0  
President & CEO
FHLBank Benefit Equalization Plan
     20.583       1,563,000       0  
David S. Fisher
Pentegra Defined Benefit Plan for Financial Institutions
     1.917       43,000       0  
SEVP & COO
FHLBank Benefit Equalization Plan
     1.917       73,000       0  
Mark E. Yardley
Pentegra Defined Benefit Plan for Financial Institutions
     23.250       625,000       0  
EVP & CFO
FHLBank Benefit Equalization Plan
     23.250       506,000       0  
Patrick C. Doran
Pentegra Defined Benefit Plan for Financial Institutions
     3.667       59,000       0  
SVP & General Counsel
FHLBank Benefit Equalization Plan
     3.667       33,000       0  
Frank M. Tiernan
Pentegra Defined Benefit Plan for Financial Institutions
     21.833       1,209,000       0  
SVP & Director of Risk Analysis
FHLBank Benefit Equalization Plan
     21.833       111,000       0  

The FHLBank’s DB Plan covers all full time employees of the FHLBank who have met the eligibility requirements of attainment of age 21 and twelve months of employment and, as of January 1, 2009, was an employee of FHLBank as of December 31, 2008, including the Named Executive Officers. Employees are not fully vested until they have completed five years of employment. The regular form of retirement benefits provides a single life annuity; a lump-sum payment or other additional payment options are also available to a limited degree for those Named Executive Officers who were employed prior to the plan change in 2003. The benefits are not subject to offset for social security or any other retirement benefits received.
 
The DB Plan provides a normal retirement benefit at or after age 65 where a Named Executive Officer has met the vesting requirement of completing five years of employment equal to 2 percent of his/her highest 3-year average salary multiplied by his/her years of benefit service, up to 30 years. Three participants are eligible to receive benefits in excess of 2.00 percent because of a plan change in 2003. The amount in excess of 2.00 percent is a calculated “frozen add-on,” determined at the time of the plan change. The formula for this “frozen add-on” is [old benefit formula as of August 31, 2003 minus new benefit formula as of September 1, 2003 equals the frozen add-on]. Earnings are defined as base salary plus overtime and bonuses, subject to an annual IRC Section 401(a)17 limit of $230,000 on earnings for 2008. Annual benefits provided under the DB Plan also are subject to IRC limits, which vary by age and benefit option selected. The annual IRC Section 415 benefit limit is $185,000 for 2008. Benefits are payable in the event of retirement, death, disability, or termination of employment if vested. Only the portion of the benefit accrued before September 1, 2003 is payable as a lump sum to employees who have attained age 50.
Early retirement benefits are payable at a reduced rate. Upon termination of employment prior to age 65, Named Executive Officers meeting the five year vesting and age 45 early retirement eligibility criteria are entitled to an early retirement benefit. The early retirement benefit amount is calculated by taking the normal retirement benefit amount and reducing it by 3 percent times the difference between the age of the early retiree and age 65. If the Named Executive Officer was employed prior to September 1, 2003 and his/her age and benefit service added together totaled 70 (Rule of 70), the normal retirement benefit amount would be reduced by 1.5 percent for each year between the age of the early retiree and age 65 for the portion of the normal retirement benefit accrued prior to September 1, 2003.
 
The FHLBank’s BEP is, in part, a non-qualified defined benefit plan. The defined benefit portion of the BEP provides benefits under the same terms and conditions as the DB Plan. However, the BEP does not limit the annual earnings or benefits of the Named Executive Officers. Benefits that would otherwise be provided under the BEP are reduced by benefits provided under the DB Plan.
 
The FHLBank’s contributions to the DB Plan through June 30, 1987, represented the normal cost of the plan. Funding and administrative costs of the DB Plan charged to compensation and benefits expense were $2,008,000 in 2008. The DB Plan is a multiple-employer plan and therefore is not required to disclose the accumulated benefit obligations, plan assets and the components of annual pension expense.
 
The measurement date used to determine the current year’s benefit obligation was December 31, 2008. The present value of the current accrued benefit of the DB Plan, calculated through September 1, 2003, was valued at 50 percent of benefit value at 7.75 percent interest and 50 percent of benefit value at 5.00 percent interest, discounted to the current age of each Named Executive Officer at 7.75 percent interest. The present value of benefits accrued after that date is valued at 6.73 percent interest. At December 31, 2008, the actuary’s calculations utilized: (1) the projected unit credit valuation method; (2) the 1994 Group Annuity Static Mortality Table with a five-year mortality improvement projection; (3) a 4.34 percent average salary increase adjustment; and (4) a 6.25 percent discount rate as the primary assumptions attributable to valuation of benefits under the DB portion of the BEP.

Deferred Compensation
Table 92 presents the Nonqualified Deferred Compensation Table for the Named Executive Officers.

Table 92

Name
Executive
Contributions
in Last FY*
Registrant
Contributions
in Last FY
Aggregate
Earnings
in Last FY
Aggregate
Withdrawals/
Distributions
Aggregate
Balance at
Last FYE
Andrew J. Jetter
President & CEO
$
13,278
$
15,984
$
43,3101
$
0
$
703,542
David S. Fisher
SEVP & COO
37,885
19,253
6,6202
0
142,699
Mark E. Yardley
EVP & CFO
60,115
13,356
21,4903
0
385,925
Patrick C. Doran
SVP & General Counsel
6,012
3,822
2,2564
0
43,816
Frank M. Tiernan
SVP & Director of Risk Analysis
0
0
1075
0
1,679
                    
*
All amounts are also included in the salary column of the Summary Compensation Table.
1
For Mr. Jetter, $15,383 of this amount was also reported as above market earnings in the Summary Compensation Table.
2
For Mr. Fisher, $857 of this amount was also reported as above market earnings in the Summary Compensation Table.
3
For Mr. Yardley, $6,086 of this amount was also reported as above market earnings in the Summary Compensation Table.
4
For Mr. Doran, $499 of this amount was also reported as above market earnings in the Summary Compensation Table.
5
For Mr. Tiernan, $40 of this amount was also reported as above market earnings in the Summary Compensation Table.

The BEP is, in part, an unfunded, nonqualified deferred compensation plan (the Supplemental Thrift Plan). The Supplemental Thrift Plan allows the Named Executive Officers, who so choose, to receive a credit for elective contributions in excess of the maximum permitted by the IRC limitations in the FHLBank’s DC Plan in which they participate. If portions of the Named Executive Officer’s regular DC Plan account contributions are returned after the end of the preceding year because of IRC limitations, the Named Executive Officer is credited with make-up contributions under the Supplemental Thrift Plan equal to his returned portions.
 
Named Executive Officers also receive matching contributions from the FHLBank equal to the matching contribution, if any, that would be credited under the qualified DC Plan. Patrick C. Doran and David S. Fisher negotiated higher matches in the Supplemental Thrift Plan for a select period of time upon hire because of the one year waiting requirement before the FHLBank match initiates under the DC Plan. If Mr. Doran’s matching contribution under the FHLBank’s qualified 401(k) plan is less than 5 percent, then he receives a matching contribution equal to the difference between 5 percent and the percentage received. If Mr. Fisher’s matching contribution under the FHLBank’s qualified 401(k) plan is less than 6 percent, then he receives a matching contribution equal to the difference between 6 percent and the percentage received.
The Supplemental Thrift Plan allows Named Executive Officers to elect annually either a rate of return based on the FHLBank’s return on equity for 2008, or the rate of return resulting from investments in options available under the FHLBank’s DC Plan. The latter includes funds representing a variety of investment risk, including index funds, income funds, bond funds, value funds, and growth funds.
 
Named Executive Officers are at all times 100 percent vested in their Supplemental Thrift Plan accounts. In the event of unforeseen emergencies, they may request withdrawals equal to the lesser of the amounts necessary to meet their financial hardships or the amount of their account balances. Upon retirement or termination of employment with the FHLBank, the Named Executive Officer’s account balance would be paid in a lump sum, as soon as practicable.

Director Compensation
Table 93 presents the Director Compensation Table for the FHLBank’s 2008 Board of Directors.

Table 93

Name
Fees Earned
or Paid in Cash
Change in
Pension Value
and Nonqualified
Deferred
Compensation
Earnings1
All Other
Compensation2
Total
Michael M. Berryhill
$
18,739
$
0
$
1,900
$
20,639
Robert Caldwell II
  
18,739
  
0
  
1,000
  
19,739
James R. Hamby
18,739
0
0
18,739
Thomas E. Henning
18,739
0
5,000
23,739
Steven D. Hogan
18,739
0
0
18,739
Andrew C. Hove, Jr.
18,739
0
5,000
23,739
Jane C. Knight
18,739
3171
8,400
27,456
Richard S. Masinton
18,739
0
0
18,739
Lawrence L. McCants
18,739
0
0
18,739
Neil F. M. McKay
18,739
0
0
18,739
Thomas H. Olson
18,739
0
4,300
23,039
Lindel E. Pettigrew
24,986
0
0
24,986
Bruce A. Schriefer
18,739
0
1,000
19,739
Gordon C. Smith, Jr.
18,739
0
0
18,739
Ronald K. Wente
31,232
7,8101
1,500
40,542
                    
1
Values represent above market earnings.
2
All other compensation consists exclusively of charitable matching contributions made by the FHLBank on behalf of the respective director pursuant to the FHLBank’s Matching Gift Program. Contributions made to eligible nonprofit organizations in Colorado, Kansas, Nebraska or Oklahoma are matched on a dollar-for-dollar basis up to an aggregate maximum of $5,000 per calendar year. Due to timing differences between submission of invoices and payment, the actual expenditures listed could exceed $5,000 for the year. The FHLBank’s Matching Gift Program for directors was discontinued in 2009.

In accordance with the Finance Agency’s regulations and the Bank Act, the FHLBank compensated its directors in 2008 in accordance with its formal policy governing the payment to directors of reasonable compensation for the performance of their duties as members of the Board of Directors. The purpose of the policy was to ensure compliance with the restrictions and limitations imposed by the Finance Agency’s regulations and the Bank Act. The maximum fee limitations for board members in 2008, in accordance with statutory restrictions and the FHLBank’s policy, were: Chairman – $31,232, Vice-chairman – $24,986, and all other board members – $18,739.
 
The Recovery Act removed the statutory limits on director compensation. Accordingly, effective January 1, 2009, the FHLBank adopted a new “Board of Directors Compensation Policy” (Directors Compensation Policy) to establish compensation for the FHLBank directors in 2009. The Directors Compensation Policy provides that directors shall be paid a meeting fee for each day in attendance at a regular or special meeting of the Board up to a maximum annual compensation amount as set forth in the Directors Compensation Policy. The Directors Compensation Policy is attached to this annual report on Form 10-K as Exhibit 10.11.
 
The Directors’ Nonqualified Deferred Compensation Program (the Directors’ Plan) allows directors to defer all or a portion of their fees, and elect annually a rate of return based on the FHLBank’s return on equity for 2008, or the rate of return resulting from investment in options available under the FHLBank’s DC Plan. Effective December 31, 2008, the Directors’ Plan was amended primarily to comply with Section 409A of the Code. However, as adopted, the amended Directors’ Plan eliminates a director’s ability to direct the investment of funds deferred under the Directors’ Plan and instead credits earnings to the director’s account based on average FHLBank return on equity. Additionally, the Directors’ Plan, as amended, eliminates the FHLBank’s discretion over when contributions may be made to the Directors’ Plan and when distributions of funds are paid out.
 
Directors are also reimbursed for all necessary and reasonable travel, subsistence and other related expenses incurred in connection with the performance of their duties. Total travel expenses in the amount of $240,000 were paid for the FHLBank’s directors in 2008 for travel integrally and directly related to the performance of the directors’ duties.
Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The FHLBank is a cooperative. Its members or former members own all of the outstanding capital stock of the FHLBank. A majority of the directors of the FHLBank are elected by and from its membership. One of the voting rights of members is for the election of all of the FHLBank’s directors. Each member is eligible to vote for those open member director seats in the state in which its principal place of business is located and for all open independent director seats, which are elected by members of the entire FHLBank district. Membership is voluntary; however, members must give notice of their intent to withdraw from membership. A member that withdraws from membership may not be readmitted to membership for five years after the date upon which its required membership stock (Class A Common Stock) is redeemed by the FHLBank.
 
Management of the FHLBank cannot legally and, therefore, does not, own capital stock of the FHLBank. The FHLBank does not offer any compensation plan to its employees under which equity securities of the FHLBank are authorized for issuance.
 
Table 94 presents information on member institutions holding five percent or more of the total outstanding capital stock, which includes mandatorily redeemable capital stock, of the FHLBank as of December 31, 2008. Of these stockholders, no officer or director currently serves on the FHLBank’s Board of Directors.

Table 94

Member Institutions Holding 5 Percent or More Capital Stock
  
Borrower Name
Address
City
State
  
Number
of Shares
    
Percent
of Total
  
U.S. Central Federal Credit Union1
9701 Renner Blvd
Lenexa
KS
     2,707,604       11.9 %
MidFirst Bank
501 NW Grand Blvd
Oklahoma City
OK
     2,622,946       11.5  
Security Life of Denver Ins Co
1290 Broadway
Denver
CO
     1,421,477       6.2  
Capitol Federal Savings Bank
700 S Kansas Ave
Topeka
KS
     1,312,304       5.8  
TOTAL
           8,064,331       35.4 %
__________
1
U.S. Central Federal Credit Union was placed into conservatorship by the National Credit Union Administration on March 20, 2009. See Note 20 of the Notes to Financial Statements included under Item 8 – “Financial Statements and Supplementary Data” for further discussion regarding U.S. Central Federal Credit Union.

Additionally, because of the fact that a majority of the Board of Directors of the FHLBank is nominated and elected from the membership of the FHLBank (“member directors”), these member directors are officers of member institutions that own the FHLBank’s capital stock. Table 95 presents total outstanding capital stock, which includes mandatorily redeemable capital stock, held as of December 31, 2008, for member institutions whose officers served as directors of the FHLBank in 2008:

Table 95

Total Capital Stock Outstanding to Member Institutions whose Officers Serve as a Director
  
Borrower Name
Address
City
State
  
Number
of Shares
    
Percent
of Total
  
Vision Bank
1800 Arlington St
Ada
OK
     36,691       0.2 %
Liberty Federal Savings Bank
401 W Broadway
Enid
OK
     33,719       0.1  
Golden Belt Bank, FSA
901 Washington Street
Ellis
KS
     30,336       0.1  
First National Bank
PO Box 570
Goodland
KS
     25,684       0.1  
Morgan Federal Bank
321 Ensign Street
Fort Morgan
CO
     18,901       0.1  
Yampa Valley Bank
600 S Lincoln Ave
Steamboat Springs
CO
     11,565       0.1  
Chickasha Bank & Trust Company
1924 S 4th Street
Chickasha
OK
     6,488       0.0  
Bankers Bank of Kansas, NA
555 N Woodlawn
Wichita
KS
     2,430       0.0  
Lisco State Bank
102 Coldwater
Lisco
NE
     981       0.0  
TOTAL
           166,795       0.7 %

Item 13: Certain Relationships and Related Transactions, and Director Independence

Certain Relationships and Related Transactions
Since the FHLBank is a cooperative, ownership of our capital stock is a prerequisite for our members to transact business with us. In recognition of this organizational structure, the SEC granted us an accommodation pursuant to a “no action letter,” dated May 23, 2006, which relieves us from the requirement to make disclosures under Item 404(a) of Regulation S-K for transactions with related persons, such as our members and directors, which occur in the ordinary course of business. Further, the Recovery Act codified this accommodation.
 
Members with beneficial ownership of more than five percent of the total outstanding capital stock of the FHLBank and all of our directors are classified as related persons under SEC regulations. Transactions with members deemed related persons of the FHLBank occur in the ordinary course of our business since we conduct our advance and mortgage loan business almost exclusively with our members. Our member directors are officers or directors of members that own FHLBank capital stock and conduct business with us.
Information with respect to the directors who are officers or directors of our members is set forth under Item 10 – “Directors and Executive Officers of the FHLBank and Corporate Governance – Directors.” Additional information regarding members that are beneficial owners of more than five percent of our total outstanding capital stock is provided in Item 12 – “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
 
See Item 11 for a discussion of the compensation of the FHLBank’s Named Executive Officers and directors.
 
The FHLBank has a written “Related Person Transactions Policy” (Policy) that provides for the review and approval or ratification by our Audit Committee of any transaction with a related person that is outside the ordinary course of business. Under the Policy, transactions with related persons that are in the ordinary course of business are deemed pre-approved.
 
A “Related Person” under the Policy is:
§
Any person who is, or at any time since the beginning of the FHLBank’s last fiscal year was, a director, member of the Affordable Housing Advisory Council, or an executive officer of the FHLBank;
§
Any immediate family member of any of the foregoing persons;
§
Any firm, corporation, or other entity in which any of the foregoing persons is an executive officer, a general partner or principal or in a similar position; or
§
Any member institution (or successor) of the FHLBank who is known to be the beneficial owner of more than five percent of FHLBank voting securities.

“Ordinary course of business” is defined in the Policy as activities conducted with members, including but not limited to providing the FHLBank’s products and services listed in the Member Products and Services Guide to the extent such product and service transactions are conducted on terms no more favorable than the terms of comparable transactions with similarly situated members or housing associates, as applicable, or situations where the FHLBank obtains products or services from a Related Person where the rates and charges involved in the transactions are subject to competitive bidding.
 
Transactions outside the ordinary course of business, with Related Persons that have a direct or indirect material interest, and exceed $120,000 are subject to Audit Committee review and approval under the Policy and include situations in which: (1) the FHLBank obtains products or services from a Related Party of a nature, quantity or quality, or on terms, that are not readily available from alternative sources; or (2) the FHLBank provides products or services to a Related Party on terms not comparable to those provided to unrelated parties.
 
In 2008, there were no Related Party transactions outside the ordinary course of business that necessitated review or approval by the Audit Committee.

Director Independence
Board Operating Guidelines and Nasdaq Standards
The Board Operating Guidelines of the FHLBank (Guidelines), available at www.fhlbtopeka.com, require that the Board of Directors make an affirmative determination as to the independence of each director, as that term is defined by Rule 4200(a)(15) of the Nasdaq Marketplace Rules (the “Nasdaq Independence Standards”).
 
The Board of Directors has affirmatively determined that each one of its directors, both independent and member directors as defined by the Recovery Act (each of whom is listed in Item 10 of this Form 10-K), is independent in accordance with the Nasdaq Independence Standards.
 
In order to assist the Board of Directors in making an affirmative determination of each director’s independence under the Nasdaq Independence Standards, the Board of Directors: (1) applied categorical standards for independence contained in the Guidelines and under the Nasdaq Independence Standards; (2) determined subjectively the independence of each director; and (3) considered the recommendation of the Audit Committee following its assessment of the independence of each director. The Board of Directors’ determination of independence under the Nasdaq Independence Standards rested upon a finding that each director has no relationship which, in the opinion of the Board of Directors, would interfere with that director’s exercise of independent judgment in carrying out the responsibilities of the director. Since under Finance Agency regulations, each independent director must be a bona fide resident of our district, and each member director must be an officer or director of one of our members, the Board of Directors included in its consideration whether any of these relationships would interfere with the exercise of independent judgment of a particular director.

Committee Independence
Audit Committee
In addition to the Nasdaq Independence Standards for committee members, the FHLBank’s Audit Committee members are subject to the independence standards of the Finance Agency. Finance Agency regulations state that a director will be considered sufficiently independent to serve as an Audit Committee member if that director does not have a disqualifying relationship with the FHLBank or its management that would interfere with the exercise of that director’s independent judgment. Disqualifying relationships include but are not limited to:
§
Being employed by the FHLBank in the current year or any of the past five years;
§
Accepting compensation from the FHLBank other than compensation for service as a director;
§
Serving or having served in any of the past five years as a consultant, advisor, promoter, underwriter, or legal counsel of or to the FHLBank; or
§
Being an immediate family member of an individual who is, or has been in any of the past five years, employed by the FHLBank as an executive officer.
In addition to the independence standards for Audit Committee members required under the Finance Agency regulations, the Recovery Act has made Section 10A(m) of the Exchange Act applicable to the Audit Committee members of the FHLBank’s Board of Directors. Section 10A(m) sets forth the independence requirements of directors serving on the Audit Committee of a reporting company. Under Section 10A(m), in order to be considered independent, a member of the Audit Committee may not, other than in his or her capacity as a member of the Board of Directors or any other Board Committee: (1) accept any consulting, advisory, or other compensation from the FHLBank; or (2) be an affiliated person of the FHLBank.
 
As of March 26, 2009, all members of the FHLBank’s Audit Committee were independent under the Finance Agency’s audit committee independence criteria and under the independence criteria of Section 10A(m) of the Exchange Act.
 
The Finance Agency’s criteria for audit committee independence are posted on the corporate governance page of the FHLBank’s Web site at www.fhlbtopeka.com.

Item 14: Principal Accounting Fees and Services

The Audit Committee’s policy is to pre-approve all audit, audit-related and permissible non-audit services provided by the FHLBank’s independent accountants. The Audit Committee pre-approved all such services provided by the independent accountants during 2007 and 2008. These services have included audit services, audit-related services and other services. Pre-approval is generally provided for up to one year and any pre-approval is detailed as to the particular service or category of services and is generally subject to a specific budget. The independent accountants and management are required to periodically report to the Audit Committee regarding the extent of services provided by the independent accountants in accordance with this pre-approval and the fees for the services performed to date. The Audit Committee may also pre-approve particular services on a case-by-case basis.
 
Table 96 sets forth the aggregate fees billed to the FHLBank for the years ended December 31, 2008 and 2007 by its external accounting firm, PricewaterhouseCoopers LLP (dollar amounts in thousands):

Table 96

   
2008
    
2007
  
Audit fees
   $ 662     $ 602  
Audit-related fees
     35       94  
Tax consultation fees
     0       0  
All other fees
     0       12  
TOTAL
   $ 697     $ 708  

Audit fees during the years ended December 31, 2008 and 2007, respectively, were for professional services rendered for the audits of the FHLBank’s annual financial statements and review of financial statements included in the FHLBank’s annual reports on Form 10-K and quarterly reports on Form 10-Q.
 
Audit-related fees for the years ended December 31, 2008 and 2007, respectively, were for assurance and related services primarily related to accounting consultations at both the FHLBank and FHLBank System level.
 
The FHLBank is exempt from all federal, state and local taxation, with the exception of real property tax. Therefore, no tax consultation fees were paid during the years ended December 31, 2008 and 2007.
 
All other fees during the year ended December 31, 2007 were for other non audit-related consulting services and electronic workpaper and audit management software. No fees were paid to the external accounting firm for financial information system design and implementation.
 
Prior to approving PricewaterhouseCoopers LLP as the FHLBank’s independent accountants for 2008, the Audit Committee considered whether PricewaterhouseCoopers LLP’s provision of services other than audit services is compatible with maintaining the accountants’ independence.
PART IV

Item 15: Exhibits, Financial Statement Schedules

a)
The financial statements included as part of this Form 10-K are identified in the index to Audited Financial Statements appearing in Item 8 of this Form 10-K and which index is incorporated in this Item 15 by reference.
b)   Exhibits.
 
The FHLBank has incorporated by reference certain exhibits as specified below pursuant to Rule 12b-32 under the Exchange Act.

Exhibit
No.
Description
3.1
Exhibit 3.1 to the FHLBank’s registration statement on Form 10, filed May 15, 2006, and made effective on July 14, 2006 (File No. 000-52004) (the “Form 10 Registration Statement”), Federal Home Loan Bank of Topeka Articles and Organization Certificate, is incorporated herein by reference as Exhibit 3.1.
3.2
Exhibit 3.2 to the Current Report on Form 8-K, filed October 22, 2008, Amended and Restated Bylaws, is incorporated herein by reference as Exhibit 3.2.
4.1
Exhibit 4.1 to the Form 10 Registration Statement, Federal Home Loan Bank of Topeka Capital Plan, is incorporated herein by reference as Exhibit 4.1.
10.1*
Exhibit 10.2 to the Current Report on Form 8-K, filed December 24, 2008, Federal Home Loan Bank of Topeka Benefit Equalization Plan, is incorporated herein by reference as Exhibit 10.1.
10.2*
Exhibit 10.3 to the Current Report on Form 8-K, filed December 24, 2008, Federal Home Loan Bank of Topeka Directors’ Nonqualified Deferred Compensation Program, is incorporated herein by reference as Exhibit 10.2.
10.4
Exhibit 10.4 to the Form 10 Registration Statement, Federal Home Loan Bank of Topeka Office Complex Lease Agreement, is incorporated herein by reference as Exhibit 10.4.
10.4.1
Exhibit 10.4.1 to the Form 10 Registration Statement, Federal Home Loan Bank of Topeka Office Complex Lease Amendment, is incorporated herein by reference as Exhibit 10.4.1.
10.4.2
Exhibit 10.4.2 to the Form 10 Registration Statement, Federal Home Loan Bank of Topeka Office Second Complex Lease Amendment, is incorporated herein by reference as Exhibit 10.4.2.
10.5
Exhibit 10.5 to the Form 10 Registration Statement, Federal Home Loan Bank of Topeka Lease Agreement, is incorporated herein by reference as Exhibit 10.5.
10.6
Exhibit 10.6 to the Form 10 Registration Statement, Federal Home Loan Bank of Topeka Form of Advance, Pledge and Security Agreement (Specific Pledge), is incorporated herein by reference as Exhibit 10.6.
10.7
Exhibit 10.7 to the Form 10 Registration Statement, Federal Home Loan Bank of Topeka Form of Advance, Pledge and Security Agreement (Blanket Pledge), is incorporated herein by reference as Exhibit 10.7.
10.8
Exhibit 10.8 to the Form 10 Registration Statement, Federal Home Loan Bank of Topeka Form of Confirmation of Advance, is incorporated herein by reference as Exhibit 10.8.
10.9*
Exhibit 10.1 to the Current Report on Form 8-K, filed February 10, 2009, Federal Home Loan Bank of Topeka Executive Short Term Incentive Plan, is incorporated herein by reference as Exhibit 10.9.
10.10*
Exhibit 10.1 to the Current Report on Form 8-K, filed December 24, 2008, Federal Home Loan Bank of Topeka Long-Term Incentive Plan, is incorporated herein by reference as Exhibit 10.10.
10.11*
Federal Home Loan Bank of Topeka Board of Directors Compensation Policy.
12.1
Federal Home Loan Bank of Topeka Statements of Computation of Ratios.
31.1
Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Executive Vice President and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32
Certification of President and Chief Executive Officer and Executive Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1
Exhibit 99.1 to the 2006 Annual Report on Form 10-K, filed on March 30, 2007, Federal Home Loan Bank of Topeka Audit Committee Charter, is incorporated herein by reference as Exhibit 99.1.
99.2
Federal Home Loan Bank of Topeka Audit Committee Report.
                    
*      Represents a management contract or a compensatory plan or arrangement.
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
Federal Home Loan Bank of Topeka
   
 Date: March 26, 2009
By: /s/Andrew J. Jetter
   
 
Andrew J. Jetter
 
President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the dates indicated.

Signature
Title
Date
     
/s/Andrew J. Jetter
President and Chief Executive Officer
March 26, 2009
Andrew J. Jetter
(Principal Executive Officer)
  
     
/s/Mark E. Yardley
Executive Vice President and Chief Financial Officer
March 26, 2009
Mark E. Yardley
(Principal Financial Officer)
  
     
/s/Denise L. Cauthon
First Vice President and Controller
March 26, 2009
Denise L. Cauthon
(Principal Accounting Officer)
  
     
/s/Ronald K. Wente
Chairman of the Board of Directors
March 26, 2009
Ronald K. Wente
    
     
/s/Lindel E. Pettigrew
Vice Chairman of the Board of Directors
March 26, 2009
Lindel E. Pettigrew
    
     
/s/Michael M. Berryhill
Director
March 26, 2009
Michael M. Berryhill
    
     
/s/Robert E. Caldwell, II
Director
March 26, 2009
Robert E. Caldwell, II
    
     
/s/Thomas E. Henning
Director
March 26, 2009
Thomas E. Henning
    
     
/s/Andrew C. Hove, Jr.
Director
March 26, 2009
Andrew C. Hove, Jr.
    
     
/s/Jane C. Knight
Director
March 26, 2009
Jane C. Knight
    
     
/s/Richard S. Masinton
Director
March 26, 2009
Richard S. Masinton
    
     
/s/Lawrence L. McCants
Director
March 26, 2009
Lawrence L. McCants
    
     
/s/Neil F. M. McKay
Director
March 26, 2009
Neil F. M. McKay
    
     
/s/Bruce A. Schriefer
Director
March 26, 2009
Bruce A. Schriefer
    
Report of Independent Registered Public Accounting Firm
 
 
To the Board of Directors and Shareholders of
the Federal Home Loan Bank of Topeka:
 
In our opinion, the accompanying statements of condition and the related statements of income, of capital and of cash flows present fairly, in all material respects, the financial position of Federal Home Loan Bank of Topeka at December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
 
 
 
/s/PricewaterhouseCoopers LLP
Dallas, Texas
March 26, 2009

FEDERAL HOME LOAN BANK OF TOPEKA
STATEMENTS OF CONDITION
(In thousands, except par value)
   
December 31,
  
   
2008
    
2007
  
ASSETS
            
Cash and due from banks (Note 3)
  
$
75
    
$
1,724
  
Interest-bearing deposits
    
3,348,212
      
10
  
Federal funds sold
    
384,000
      
5,150,000
  
Trading securities (Notes 4, 19)
    
4,652,700
      
1,654,043
  
Held-to-maturity securities1 (Note 6)
    
11,050,897
      
13,711,398
  
Advances (Notes 7, 18)
    
35,819,674
      
32,057,139
  
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans of $884 and $844 (Notes 8, 18)
    
3,023,805
      
2,352,301
  
Accrued interest receivable
    
138,770
      
197,016
  
Premises, software and equipment, net
    
16,733
      
17,953
  
Derivative assets (Note 9)
    
34,526
      
77,611
  
Other assets (Notes 13, 17)
    
86,839
      
85,377
  
                 
TOTAL ASSETS
  
$
58,556,231
    
$
55,304,572
  
                 
LIABILITIES AND CAPITAL
                
Liabilities:
                
Deposits (Notes 10, 18):
                
Interest-bearing:
                
Demand
  
$
104,856
    
$
122,364
  
Overnight
    
1,013,800
      
1,210,500
  
Term
    
570,340
      
1,250
  
Non-interest-bearing:
                
Demand
    
36
      
10
  
Other
    
14,499
      
6,692
  
Total deposits
    
1,703,531
      
1,340,816
  
                 
Consolidated obligations, net (Note 11):
                
Discount notes
    
26,261,411
      
19,896,098
  
Bonds
    
27,421,634
      
31,213,358
  
Total consolidated obligations, net
    
53,683,045
      
51,109,456
  
                 
Mandatorily redeemable capital stock (Note 14)
    
34,806
      
36,147
  
Accrued interest payable
    
253,743
      
321,276
  
Affordable Housing Program (Note 12)
    
27,707
      
41,357
  
Payable to Resolution Funding Corp. (REFCORP) (Note 13)
    
0
      
11,067
  
Derivative liabilities (Note 9)
    
404,356
      
108,383
  
Other liabilities (Notes 15 and 17)
    
53,798
      
38,216
  
                 
TOTAL LIABILITIES
    
56,160,986
      
53,006,718
  
                 
Commitments and contingencies (Notes 1, 7, 8, 9, 11, 12, 13, 14, 15 and 17)
                
                 
Capital (Notes 14, 18):
                
Capital stock outstanding – putable:
                
Class A ($100 par value; 6,339 and 6,042 shares issued and outstanding)
    
633,941
      
604,190
  
Class B ($100 par value; 16,064 and 14,870 shares issued and outstanding)
    
1,606,394
      
1,486,997
  
Total capital stock
    
2,240,335
      
2,091,187
  
Retained earnings
    
156,922
      
208,763
  
Accumulated other comprehensive income:
                
Net unrealized loss relating to hedging activities (Notes 1, 9)
    
0
      
(21
)
Defined benefit pension plan – prior service cost (Note 15)
    
15
      
41
  
Defined benefit pension plan – net loss (Note 15)
    
(2,027
)
    
(2,116
)
                 
TOTAL CAPITAL
    
2,395,245
      
2,297,854
  
                 
TOTAL LIABILITIES AND CAPITAL
  
$
58,556,231
    
$
55,304,572
  
                    
1
Fair value: $10,454,592 and $13,636,411 at December 31, 2008 and 2007, respectively.
 
FEDERAL HOME LOAN BANK OF TOPEKA
STATEMENTS OF INCOME
(In thousands)
   
Year ended December 31,
  
   
2008
    
2007
    
2006
  
INTEREST INCOME:
                  
Interest-bearing deposits
   $ 5,539     $ 3,657     $ 6,443  
Federal funds sold and securities purchased under agreements to resell
     73,047       346,935       217,370  
Trading securities (Note 4)
     108,431       44,984       37,029  
Available-for-sale securities (Note 5)
     101       1,633       2,543  
Held-to-maturity securities (Note 6)
     519,266       684,542       649,716  
Advances (Note 7)
     1,043,825       1,540,301       1,412,564  
Prepayment fees on terminated advances (Notes 1, 7)
     1,976       575       1,149  
Mortgage loans held for portfolio (Note 8)
     134,470       122,281       122,961  
Overnight loans to other Federal Home Loan Banks
     76       196       53  
Other
     3,481       3,849       4,326  
Total interest income
     1,890,212       2,748,953       2,454,154  
                         
INTEREST EXPENSE:
                        
Deposits (Note 10)
     27,085       48,558       38,480  
Consolidated obligations (Note 11):
                        
Discount notes
     605,074       783,906       670,818  
Bonds
     1,007,644       1,680,751       1,525,049  
Overnight loans from other Federal Home Loan Banks
     169       205       93  
Securities sold under agreements to repurchase
     954       0       0  
Mandatorily redeemable capital stock (Note 14)
     609       2,101       2,594  
Other
     1,390       1,607       1,880  
Total interest expense
     1,642,925       2,517,128       2,238,914  
                         
NET INTEREST INCOME
     247,287       231,825       215,240  
Provision for (reversal of) credit losses on mortgage loans (Note 8)
     196       (25 )     358  
NET INTEREST INCOME AFTER LOAN LOSS PROVISION/REVERSAL
     247,091       231,850       214,882  
                         
OTHER INCOME (LOSS):
                        
Service fees
     5,261       4,203       3,665  
Net gain (loss) on trading securities (Note 4)
     44,514       18,348       (7,415 )
Net realized gain (loss) on sale of available-for-sale securities (Note 5)
     0       (2,254 )     0  
Net realized gain (loss) on sale or call of held-to-maturity securities (Note 6)
     (10 )     (962 )     14  
Loss on other-than-temporarily impaired held-to-maturity securities (Note 6)
     (4,773 )     0       0  
Net gain (loss) on derivatives and hedging activities (Note 9)
     (215,493 )     (10,145 )     11,538  
Net realized gain (loss) on retirement of debt
     0       0       (4,696 )
Other
     2,189       1,030       1,264  
Total other income (loss)
     (168,312 )     10,220       4,370  
                         
OTHER EXPENSES:
                        
Compensation and benefits (Note 15)
     22,381       19,719       18,151  
Other operating (Note 17)
     11,794       11,961       10,312  
Finance Agency/Finance Board (Note 1)
     1,686       1,547       1,379  
Office of Finance (Note 1)
     1,743       1,739       1,393  
Other
     2,398       2,288       1,976  
Total other expenses
     40,002       37,254       33,211  
                         
INCOME BEFORE ASSESSMENTS
     38,777       204,816       186,041  
                         
Affordable Housing Program (Note 12)
     3,228       16,934       15,460  
REFCORP (Note 13)
     7,110       37,576       34,118  
Total assessments
     10,338       54,510       49,578  
                         
NET INCOME
   $ 28,439     $ 150,306     $ 136,463  
 
FEDERAL HOME LOAN BANK OF TOPEKA
STATEMENTS OF CAPITAL FOR YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
(In thousands)
                     
Accumulated
        
                     
Other
        
   
Capital Stock Class A1
    
Capital Stock Class B1
    
Retained
    
Comprehensive
    
Total
  
   
Shares
    
Par Value
    
Shares
    
Par Value
    
Earnings
    
Income
    
Capital
  
                                           
BALANCE - DECEMBER 31, 2005 as previously reported
    
4,977
    
$
497,759
      
12,906
    
$
1,290,582
    
$
137,270
    
$
(7,434
)
  
$
1,918,177
  
Adjustment (Note 2)
                                    
1,287
              
1,287
  
BALANCE - DECEMBER 31, 2005 as adjusted
    
4,977
      
497,759
      
12,906
      
1,290,582
      
138,557
      
(7,434
)
    
1,919,464
  
Proceeds from issuance of capital stock
    
61
      
6,078
      
6,729
      
672,948
                      
679,026
  
Repurchase/redemption of capital stock
                    
(314
)
    
(31,443
)
                    
(31,443
)
Comprehensive income:
                                                        
Net income
                                    
136,463
                  
Other comprehensive income:
                                                        
Net unrealized gain (loss) on available-for-sale (AFS) securities
                                            
1,185
          
Reclassification adjustment for (gain) loss on hedging activities included in net income
                                            
107
          
Minimum pension liability
                                            
107
          
Total comprehensive income
                                                    
137,862
  
Adjustment to initially apply Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and 132(R)
                                            
(1,058
)
    
(1,058
)
Reclassification of shares to mandatorily redeemable capital stock
    
(987
)
    
(98,757
)
    
(4,314
)
    
(431,364
)
                    
(530,121
)
Net transfer of shares between Class A and Class B
    
1,272
      
127,241
      
(1,272
)
    
(127,241
)
                    
0
  
Dividends on capital stock (Class A – 4.3%, Class B – 6.1%, Note 14):
                                                        
Cash payment
                                    
(354
)
            
(354
)
Stock issued
                    
1,012
      
101,189
      
(101,189
)
            
0
  
BALANCE - DECEMBER 31, 2006 as adjusted
    
5,323
    
$
532,321
      
14,747
    
$
1,474,671
    
$
173,477
    
$
(7,093
)
  
$
2,173,376
  
Proceeds from issuance of capital stock
    
60
      
6,018
      
18,873
      
1,887,354
                      
1,893,372
  
Repurchase/redemption of capital stock
    
(2
)
    
(285
)
    
(743
)
    
(74,272
)
                    
(74,557
)
Comprehensive income:
                                                        
Net income
                                    
150,306
                  
Other comprehensive income:
                                                        
Net unrealized gain (loss) on AFS securities
                                            
2,183
          
Reclassification adjustment for (gain) loss relating to AFS securities included in net income
                                            
2,254
          
Reclassification adjustment for (gain) loss on hedging activities included in net income
                                            
107
          
Amortization of prior service cost on defined benefit pension plan
                                            
(25
)
        
Net gain (loss) on defined benefit pension plan
                                            
210
          
Amortization of net loss on defined benefit pension plan
                                            
268
          
Total comprehensive income
                                                    
155,303
  
Reclassification of shares to mandatorily redeemable capital stock
    
(1,018
)
    
(101,828
)
    
(17,474
)
    
(1,747,439
)
                    
(1,849,267
)
Net transfer of shares between Class A and Class B
    
1,679
      
167,964
      
(1,679)
      
(167,964
)
                    
0
  
Dividends on capital stock (Class A – 4.4%, Class B – 6.5%, Note 14):
                                                        
Cash payment
                                    
(373
)
            
(373
)
Stock issued
                    
1,146
      
114,647
      
(114,647
)
            
0
  
BALANCE - DECEMBER 31, 2007
    
6,042
    
$
604,190
      
14,870
    
$
1,486,997
    
$
208,763
    
$
(2,096
)
  
$
2,297,854
  
                    
1
Putable
 
FEDERAL HOME LOAN BANK OF TOPEKA
STATEMENTS OF CAPITAL FOR YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006 (continued)
(In thousands)
                     
Accumulated
        
                     
Other
        
   
Capital Stock Class A1
    
Capital Stock Class B1
    
Retained
    
Comprehensive
    
Total
  
   
Shares
    
Par Value
    
Shares
    
Par Value
    
Earnings
    
Income
    
Capital
  
                                           
BALANCE - DECEMBER 31, 2007
    
6,042
    
$
604,190
      
14,870
    
$
1,486,997
    
$
208,763
    
$
(2,096
)
  
$
2,297,854
  
Proceeds from issuance of capital stock
    
39
      
3,913
      
20,816
      
2,081,580
                      
2,085,493
  
Repurchase/redemption of capital stock
                    
(1,165
)
    
(116,533
)
                    
(116,533
)
Comprehensive income:
                                                        
Net income
                                    
28,439
                  
Other comprehensive income:
                                                        
Reclassification adjustment for (gain) loss on hedging activities included in net income
                                            
21
          
Amortization of prior service cost on defined benefit pension plan
                                            
(26
)
        
Net gain (loss) on defined benefit pension plan
                                            
(116
)
        
Amortization of net loss on defined benefit pension plan
                                            
205
          
Total comprehensive income
                                                    
28,523
  
Reclassification of shares to mandatorily redeemable capital stock
    
(2,809
)
    
(280,867
)
    
(16,189
)
    
(1,618,880
)
                    
(1,899,747
)
Net transfer of shares between Class A and Class B
    
3,067
      
306,705
      
(3,067
)
    
(306,705
)
                    
0
  
Dividends on capital stock (Class A – 2.0%, Class B – 4.7%, Note 14):
                                                        
Cash payment
                                    
(345
)
            
(345
)
Stock issued
                    
799
      
79,935
      
(79,935
)
            
0
  
BALANCE - DECEMBER 31, 2008
    
6,339
      
633,941
      
16,064
      
1,606,394
      
156,922
      
(2,012
)
    
2,395,245
  
 
FEDERAL HOME LOAN BANK OF TOPEKA
STATEMENTS OF CASH FLOWS
(In thousands)
   
Year ended December 31,
  
   
2008
    
2007
    
2006
  
CASH FLOWS FROM OPERATING ACTIVITIES:
                  
Net income
  
$
28,439
    
$
150,306
    
$
136,463
  
                         
Adjustments to reconcile income to net cash provided by (used in) operating activities:
                        
Depreciation and amortization:
                        
Premiums and discounts on consolidated obligations, net
    
(108,207
)
    
42,948
      
28,375
  
Concessions on consolidated obligation bonds
    
22,045
      
8,797
      
5,743
  
Premiums and discounts on investments, net
    
37
      
7,611
      
(8,459
)
Premiums, discounts and commitment fees on advances
    
(26,449
)
    
(49,725
)
    
(57,234
)
Discounts on Housing and Community Development advances
    
(7
)
    
(6
)
    
(6
)
Premiums, discounts and deferred loan costs on mortgage loans, net
    
3,428
      
533
      
588
  
Fair value adjustments on hedged assets or liabilities
    
30,131
      
54,783
      
60,562
  
Other comprehensive income
    
200
      
350
      
107
  
Premises, software and equipment
    
3,629
      
3,519
      
3,007
  
Provision for (reversal of) credit losses on mortgage loans
    
196
      
(25
) 
    
358
  
Non-cash interest on mandatorily redeemable capital stock
    
606
      
2,091
      
2,588
  
Net realized (gain) loss on sale of available-for-sale securities
    
0
      
2,254
      
0
  
Net realized (gain) loss on sale or call of held-to-maturity securities
    
10
      
962
      
(14
)
Loss on other-than-temporarily impaired held-to-maturity securities
    
4,773
      
0
      
0
  
Net realized (gain) loss on disposals of premises, software and equipment
    
(15
)
    
285
      
0
  
Net realized (gain) loss on retirement of debt
    
0
      
0
      
4,696
  
Other (gains) losses
    
(3
)
    
(73
)
    
(75
)
Net (gain) loss on trading securities
    
(44,514
)
    
(18,348
) 
    
7,415
  
(Gain) loss due to change in net fair value adjustment on derivative and hedging activities
    
137,807
      
(5,526
)
    
(13,030
)
(Increase) decrease in accrued interest receivable
    
58,319
      
(21,027
)
    
(24,865
)
(Increase) decrease in derivative asset - net accrued interest
    
52,512
      
(19,495
)
    
(53,963
)
(Increase) decrease in other assets
    
277
      
321
      
(510
)
Increase (decrease) in accrued interest payable
    
(67,764
)
    
(15,227
) 
    
85,535
  
(Increase) decrease in derivative liability - net accrued interest
    
4,640
      
16,300
      
(8,416
)
Increase (decrease) in Affordable Housing Program liability
    
(13,650
)
    
5,143
      
5,505
  
Increase (decrease) in REFCORP liability
    
(27,082
)
    
1,695
      
(3,912
)
Increase (decrease) in other liabilities
    
20,062
      
669
      
913
  
Total adjustments
    
50,981
      
18,809
      
34,908
  
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
    
79,420
      
169,115
      
171,371
  
                         
CASH FLOWS FROM INVESTING ACTIVITIES:
                        
Net (increase) decrease in interest-bearing deposits
    
(3,562,962
)
    
36,609
      
24,266
  
Net (increase) decrease in Federal funds sold
    
4,766,000
      
2,904,500
      
(3,550,000
)
Net (increase) decrease in short-term trading securities
    
(2,241,883
)
    
0
      
0
  
Proceeds from maturities of and principal repayments on trading securities
    
214,469
      
122,214
      
2,450
  
Purchases of trading securities
    
(926,019
)
    
(1,053,784
)
    
0
  
Proceeds from sale of available-for-sale securities
    
193,730
      
102,377
      
0
  
Purchases of available-for-sale securities
    
(193,730
)
    
0
      
0
  
Net (increase) decrease in short-term held-to-maturity securities
    
5,764,595
      
(1,238,240
) 
    
(889,102
)
Proceeds from sale or call of held-to-maturity securities
    
0
      
81,092
      
704
  
Proceeds from maturities of and principal repayments on long-term held-to-maturity securities
    
1,082,403
      
1,283,920
      
1,359,167
  
Purchases of long-term held-to-maturity securities
    
(4,187,027
)
    
(1,202,886
)
    
(1,345,466
)
Principal collected on advances
    
586,006,410
      
514,729,916
      
444,820,173
  
Advances made
    
(589,136,428
)
    
(518,117,245
)
    
(446,209,623
)
Principal collected on mortgage loans held for portfolio
    
322,207
      
277,825
      
276,456
  
Mortgage loans held for portfolio originated or purchased
    
(999,625
)
    
(254,696
)
    
(228,969
)
Principal collected on other loans made
    
1,413
      
1,321
      
1,236
  
Proceeds from sale of premises, software and equipment
    
40
      
23
      
0
  
Purchases of premises, software and equipment
    
(2,434
)
    
(1,983
)
    
(3,916
)
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
    
(2,898,841
)
    
(2,329,037
)
    
(5,742,624
)
 
FEDERAL HOME LOAN BANK OF TOPEKA
STATEMENTS OF CASH FLOWS (continued)
(In thousands)
   
Year ended December 31,
  
   
2008
    
2007
    
2006
  
CASH FLOWS FROM FINANCING ACTIVITIES:
                  
Net increase (decrease) in deposits
  
$
381,469
    
$
281,810
    
$
217,693
  
Net proceeds from sale of consolidated obligation:
                        
Discount notes
    
1,030,057,715
      
865,622,299
      
824,871,964
  
Bonds
    
21,809,352
      
20,560,658
      
10,959,499
  
Payments for maturing and retired consolidated obligation:
                        
Discount notes
    
(1,023,668,262
)
    
(862,494,431
)
    
(821,606,263
)
Bonds
    
(25,942,059
)
    
(21,761,064
)
    
(8,962,810
)
Net increase (decrease) in other borrowings
    
(5,000
)
    
(5,000
)
    
(5,000
)
Proceeds from financing derivatives
    
130,646
      
0
      
0
  
Net interest payments received (paid) for financing derivatives
    
(13,010
)
    
0
      
0
  
Proceeds from issuance of capital stock
    
2,085,493
      
1,893,372
      
679,026
  
Payments for repurchase/redemption of capital stock
    
(116,533
)
    
(74,557
)
    
(31,443
)
Payments for repurchase of mandatorily redeemable capital stock
    
(1,901,694
)
    
(1,861,443
)
    
(550,832
)
Cash dividends paid
    
(345
)
    
(373
)
    
(354
)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
    
2,817,772
      
2,161,271
      
5,571,480
  
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
(1,649
)
    
1,349
      
227
  
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR
    
1,724
      
375
      
148
  
CASH AND CASH EQUIVALENTS AT END OF THE YEAR
  
$
75
    
$
1,724
    
$
375
  
                         
Supplemental disclosures:
                        
Interest paid
  
$
1,774,064
    
$
2,487,583
    
$
2,043,813
  
                         
Affordable Housing Program payments
  
$
17,246
    
$
12,585
    
$
10,819
  
                         
REFCORP payments
  
$
34,192
    
$
35,881
    
$
38,030
  
 
FEDERAL HOME LOAN BANK OF TOPEKA
Notes to Financial Statements
For the years ended December 31, 2008, 2007 and 2006

BACKGROUND INFORMATION

The Federal Home Loan Bank of Topeka (FHLBank or FHLBank Topeka), a federally chartered corporation, is one of 12 district Federal Home Loan Banks (FHLBanks). The FHLBanks serve the public by enhancing the availability of residential mortgage and targeted community development credit and provide a readily available, low-cost source of funds to their members. The FHLBank is a cooperative whose member institutions own nearly all of the outstanding capital stock of the FHLBank and generally receive dividends on their stock investments. Regulated financial depositories and insurance companies engaged in residential housing finance are eligible to apply for membership. State and local housing authorities that meet certain statutory requirements may become housing associates of the FHLBank and also be eligible to borrow from the FHLBank. While eligible to borrow, housing associates are not members of the FHLBank and, as such, are not permitted or required to hold capital stock.

All members are required to purchase stock in the FHLBank located in their district in accordance with the capital plan of that FHLBank. Under FHLBank Topeka’s capital plan, members must own capital stock in the FHLBank based on the amount of their total assets. Each member is also required to purchase activity-based capital stock as it engages in certain business activities with the FHLBank, including advances and Acquired Member Assets (AMA). Former members that still have outstanding business transactions with the FHLBank are also required to maintain their investment in FHLBank capital stock until the transactions mature or are paid off. As a result of these requirements, the FHLBank conducts business with members in the ordinary course of its business. For financial reporting purposes, the FHLBank defines related parties in accordance with Statement of Financial Accounting Standards (SFAS) No. 57, Related Party Disclosures (herein referred to as “SFAS 57”) as those members: (1) with investments in excess of 10 percent of the FHLBank’s total capital stock outstanding, which includes mandatorily redeemable capital stock; or (2) with an officer or director serving on the FHLBank’s board of directors. See Note 18 for more information on related party transactions.

The Federal Housing Finance Board (Finance Board), an independent agency in the executive branch of the U.S. government, supervised and regulated the FHLBanks and the Office of Finance through July 29, 2008. With the passage of the Housing and Economic Recovery Act of 2008 (Recovery Act), the Federal Housing Finance Agency (Finance Agency) was established and became the new independent Federal regulator of the FHLBanks, effective July 30, 2008. The Finance Board was merged into the Finance Agency as of October 27, 2008. The Finance Agency’s principal purpose is to ensure that the FHLBanks operate in a safe and sound manner. In addition, the Finance Agency ensures that the FHLBanks carry out their housing finance mission, remain adequately capitalized and are able to raise funds in the capital markets. Also, the Finance Agency establishes policies and regulations covering the operations of the FHLBanks. Each FHLBank is operated as a separate entity and has its own management, employees and board of directors. The FHLBanks do not have any special purpose entities or any other type of off-balance sheet conduits. The Office of Finance is a joint office of the FHLBanks established by the Finance Board to facilitate the issuance and servicing of the consolidated obligations of the FHLBanks and to prepare the combined financial report of the 12 FHLBanks.

FHLBank debt instruments (consolidated obligations), which are the joint and several obligations of all FHLBanks, are the primary source of funds for the FHLBanks. Deposits, other borrowings and capital stock issued to members provide other sources of funds for the FHLBanks. The FHLBank primarily uses these funds to provide advances to members and to purchase loans from members through the Mortgage Partnership Finance® (MPF®) Program. In addition to credit services, the FHLBank also offers correspondent services such as wire transfer, security safekeeping and settlement.


NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates: The preparation of financial statements under accounting standards generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions as of the date of the financial statements in determining the reported amounts of assets, liabilities and estimated fair values and in determining the disclosure of any contingent assets or liabilities. Estimates and assumptions by management also affect the reported amounts of income and expense during the reporting period. Many of the estimates and assumptions, including those used in financial models, are based on financial market conditions as of the date of the financial statements. Because of the volatility of the financial markets, as well as other factors that affect management estimates, actual results may vary from these estimates.

Interest-Bearing Deposits and Federal Funds Sold: These investments provide short-term liquidity and are carried at cost.

Investment Securities: The FHLBank classifies certain investments acquired for purposes of liquidity and asset/liability management as trading and carries them at fair value. The FHLBank records changes in the fair value of these investments through other income (loss). While the FHLBank classifies certain securities as trading for financial reporting purposes, it does not actively trade any of these securities with the intent of realizing gains and holds these investments indefinitely as management periodically evaluates its asset/liability and liquidity needs. For asset/liability management purposes, all non-mortgage-backed securities issued by government-sponsored enterprises (GSE) that are currently classified as trading are matched to interest rate swaps that effectively convert the securities from fixed rate investments to variable rate instruments. Short-term money market investments with maturities of three months or less are acquired and classified as trading securities primarily for liquidity purposes. These short-term money market investments are periodically sold to meet the FHLBank’s cash flow needs.
 
The FHLBank also classifies investments that it may sell before maturity as available-for-sale and carries them at fair value. The change in fair value of available-for-sale securities is recorded in other comprehensive income as a net unrealized gain or loss on available-for-sale securities.

The FHLBank carries, at cost, investments for which it has both the ability and intent to hold to maturity, adjusted for periodic principal repayments, amortization of premiums and accretion of discounts. Amortization of premiums and accretion of discounts are computed on the level-yield method. In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (herein referred to as “SFAS 115”), the FHLBank considers the following situations maturities for purposes of assessing ability and intent to hold to maturity: (1) the sale of the security is near enough to maturity (or call date if exercise of the call is probable) that interest rate risk is substantially eliminated as a pricing factor and the changes in market interest rates would not have a significant effect on the security’s fair value; or (2) the sale of a security occurs after the FHLBank has already collected a substantial portion (at least 85 percent) of the principal outstanding at acquisition either due to prepayments on the debt security or to scheduled payments on a debt security payable in equal installments (both principal and interest) over its term. The FHLBank may change its intent to hold to maturity a held-to-maturity investment without changing its intent to hold to maturity other held-to-maturity investments for the following circumstances: (1) evidence of a significant deterioration in the issuer’s creditworthiness; (2) a change in statutory or regulatory requirements significantly modifying either what constitutes a permissible investment or the maximum level of investments in certain kinds of investments, thereby causing the FHLBank to dispose of a held-to-maturity investment; (3) a significant increase by a regulator in the FHLBank’s capital requirements that causes the FHLBank to downsize by selling held-to-maturity investments; or (4) a significant increase in the risk weights of debt securities used for regulatory risk-based capital purposes.

The FHLBank computes the amortization of premiums and accretion of discounts on mortgage-backed securities using the level-yield method over the estimated cash flows of the securities. This method requires a retrospective adjustment of the effective yield each time the FHLBank receives a principal repayment or changes the estimated remaining cash flows as if the actual principal repayments and new estimated cash flows had been known since the original acquisition dates of the securities. The FHLBank uses the Public Securities Association (PSA) prepayment measurement assumptions and Constant Prepayment Rates (CPR) obtained from Bloomberg (broker median) to estimate future cash flows. The FHLBank computes the amortization of premiums and accretion of discounts on other investments using the level-yield method to the contractual maturities of the securities.

Gains and losses on the sales of investment securities are computed using the specific identification method and are included in other income (loss). Sales of investment securities under agreements to repurchase the same, or substantially the same, instruments are treated as collateralized borrowings.

The FHLBank evaluates its individual investment securities holdings for other-than-temporary impairment on at least a quarterly basis. The FHLBank will conclude that a loss is other-than-temporary if it is probable that the FHLBank will not receive all of the investment security’s contractual cash flows. As part of this analysis, the FHLBank must assess its intent and ability to hold a security until recovery of any unrealized losses. These evaluations are inherently subjective and consider a number of qualitative factors. In addition to monitoring the credit ratings of these securities, the FHLBank’s management evaluates other factors that may be indicative of other-than-temporary impairment. These include, but are not limited to, an evaluation of the type of security, the length of time and extent to which the fair value of a security has been less than its cost, any credit enhancement or insurance, and certain other collateral-related characteristics such as FICO credit scores, loan-to-value (LTV) ratios, delinquency and foreclosure rates, geographic concentrations and the security’s performance. If the FHLBank determines that an other-than-temporary impairment exists, the investment security is written down to fair value (its new cost basis), any premiums or discounts related to the investment security are written off, and a realized loss is recognized in other income (loss). A new accretable, or effective, yield is calculated and utilized to accrete the discount on a prospective basis over the remaining life of the investment security based on the amount and timing of future expected cash flows.

When there is an other-than-temporary impairment in the value of an investment, the decline in value is recognized as a “Loss on impaired held-to-maturity securities” and presented in the other income (loss) section of the Statements of Income. The FHLBank recognized an other-than-temporary impairment loss of $4,773,000 in the year ended December 31, 2008 related to private-issue mortgage-backed securities (MBS) in its held-to-maturity portfolio. The FHLBank did not experience any other-than-temporary impairment in the value of investments during 2007 or 2006.

Advances: The FHLBank presents advances net of unearned commitment fees, premiums, discounts and fair value basis adjustments. The FHLBank amortizes the premiums and accretes the discounts on advances to interest income using the level-yield method. Interest on advances is credited to income as earned. In accordance with the Federal Home Loan Bank Act of 1932 (Bank Act), as amended, and as more fully discussed in Note 7, the FHLBank obtains sufficient collateral on advances to protect it from losses. The Bank Act limits collateral on advances to certain investment securities, residential mortgage loans, deposits with the FHLBank and other real estate-related assets. However, community financial institutions (CFI) (redefined by the Recovery Act to also include community development activities) are able to utilize expanded statutory collateral rules. The FHLBank has not experienced any losses on advances since its inception. Because of the collateral pledged as security on the advances and prior repayment history, FHLBank management deems it unnecessary to establish an allowance for credit losses on advances.
 
Commitment Fees: Commitment fees for letters of credit are recorded as deferred credits when received and amortized over the terms of the letters of credit using a straight-line method. The FHLBank believes the likelihood of standby letters of credit being drawn upon is remote based upon past experience.

In 2007, the FHLBank began offering a standby credit facility (SCF) product. The structure of each SCF is reviewed to determine the proper accounting for the commitment fee. Depending on the likelihood of the commitment being exercised, the fee received is accounted for as follows:
§
If remote, the commitment fee is recognized over the commitment period on a straight-line basis and reported as “Service fees” in other income (loss). If the commitment is later exercised and an advance issued, the remaining unamortized commitment fee is reclassified and treated as a basis adjustment of the advance and recognized over the life of the advance as an adjustment to yield.
§
If other than remote, the commitment fee is deferred. If the commitment is subsequently exercised, the fee will be recognized over the life of the advance as an adjustment to yield. If the commitment expires unexercised, the commitment fee is recognized in service fee income upon expiration of the commitment.

Prepayment Fees: The FHLBank charges prepayment fees to its members when certain advances are repaid before their original maturities. The FHLBank records prepayment fees net of hedging fair value basis adjustments included in the book basis of the advance, as “Prepayment fees on terminated advances” in the interest income section of its Statements of Income.

In cases where new advances are issued concurrent with advances terminating or within a short period after termination, the FHLBank evaluates whether new advances meet the accounting criteria to qualify as a modification of an existing advance or as a new advance in accordance with Emerging Issues Task Force (EITF) Issue No. 01-7, Creditor’s Accounting for a Modification or Exchange of Debt Instruments, and SFAS No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases – an amendment of FASB Statements No. 13, 60, and 65 and a rescission of FASB Statement No. 17 (herein referred to as “SFAS 91”). This is accomplished by comparing the advance terms and comparing present value calculations of the cash flows under the terms of the new advance and under the terms of the original advance. If the new advance qualifies as a modification, the net prepayment fee received on the prepaid advance is deferred as a discount and included in the basis of the modified advance. The basis adjustment is amortized over the life of the modified advance to advance interest income. If the modified advance is hedged, the fair value gains or losses of the advance and the prepayment fees are included in the carrying amount of the modified advance, and prior gains or losses and prepayment fees are amortized to interest income over the life of the modified advance using the level-yield method. Modified hedged advances are marked to fair value after the modification, and subsequent fair value changes are recorded in “Net gain (loss) on derivatives and hedging activities” in other income (loss). The basis adjustment amortization amounted to a net increase (decrease) to net interest income of $458,000, $742,000 and $950,000 during 2008, 2007 and 2006, respectively. The net prepayment fees are recorded as “Prepayment fees on terminated advances” in the interest income section of the Statements of Income if it is determined the advance should be treated as a new advance and not a modification of the existing advance.

Mortgage Loans Held for Portfolio: The FHLBank participates in the MPF Program under which the FHLBank invests in government-insured or guaranteed (by the Federal Housing Administration, the Department of Veterans Affairs, the Rural Housing Service of the Department of Agriculture (RHS) and the Department of Housing and Urban Development (HUD)) loans and conventional residential mortgage loans, which are funded by the FHLBank through, or purchased from, its participating members, also referred to as Participating Financial Institutions (PFI). For one of the FHLBank’s MPF products, a member originates mortgage loans as an agent for the FHLBank and the loans are funded directly by the FHLBank. This process is commonly referred to as table funding. For all other MPF products, a member sells closed loans to the FHLBank. The FHLBank manages the liquidity, interest rate and options risks of the loans. Dependent upon the member’s product selection, the servicing rights can be retained or sold by the participating member. The FHLBank and the member share in the credit risk of the loans with the FHLBank assuming the first loss obligation limited by the First Loss Account (FLA) for each pool of mortgage loans sold by the member, and the member assuming mortgage loan losses in excess of the FLA up to the amount of the member’s credit enhancement obligation as specified in the master agreement for each pool of mortgage loans purchased from the member. Any losses in excess of the FLA and the credit enhancement obligation on each pool of mortgage loans purchased from or originated through a participating member are the responsibility of the FHLBank.

The FHLBank classifies MPF Program loans as held for investment and, accordingly, reports them at their principal amount outstanding, net of unamortized premiums, unaccreted discounts, deferred loan fees associated with table funded loans, hedging adjustments and unrealized gains and losses from mortgage purchase commitments.

The FHLBank defers and amortizes/accretes mortgage loan origination fees (agent fees) and premiums/discounts paid to and received from FHLBank members as interest income using the contractual method. The contractual method uses the cash flows required by the loan contracts, as adjusted for actual prepayments, to apply the interest method. The contractual method does not utilize estimates of future prepayments of principal.
 
The FHLBank records credit enhancement fees paid to PFIs as a reduction to mortgage loan interest income. The FHLBank also records non-origination fees received from FHLBank members, such as delivery commitment extension fees and pair off fees as part of the mark-to-market on derivatives to which they relate or as part of the loan basis, as applicable. Delivery commitment extension fees are received when the PFI requires an extension of the delivery commitment on an MPF loan beyond the original stated maturity date. These fees compensate the FHLBank for interest lost as a result of the late funding of the loan and represent the member purchasing a derivative from the FHLBank. Pair off fees are received from the PFI when the sum of the principal amount of the mortgages funded under a delivery commitment is less than 95 percent (i.e., under-delivery) or greater than 105 percent (i.e., over-delivery) of the delivery commitment amount. These fees compensate the FHLBank for hedge costs associated with the under-delivery or over-delivery, respectively. To the extent that pair off fees relate to under-deliveries of loans, they are included in the mark-to-market of the related delivery commitment derivative. If they relate to over-deliveries, they represent purchase price adjustments to the related loans acquired and are recorded as part of the loan basis.

The FHLBank places a conventional mortgage loan on non-accrual status when the collection of the contractual principal or interest from the borrower is 90 days or more past due. However, there may be exceptions, such as when a loan is well-secured and in the process of collection (e.g., through credit enhancements), or when the FHLBank’s agreement with a PFI includes monthly settlement on a schedule/scheduled basis. Monthly settlement on a schedule/scheduled basis means that the PFI is obligated to remit the contractual mortgage payments on mortgage loans sold to the FHLBank, regardless of whether or not the PFI received payment from the mortgagor. When a conventional mortgage loan is placed on non-accrual status, accrued but uncollected interest is reversed against interest income. The FHLBank records cash payments received on non-accrual loans first as interest income and then as a reduction of principal. A government-insured loan is not placed on non-accrual status when the collection of the contractual principal or interest is 90 days or more past due because of the U.S. government guarantee of the loan and the contractual obligation of the loan servicer.

Real estate owned (REO) includes assets that have been received in satisfaction of debt or as a result of actual foreclosures and in-substance foreclosures. REO is initially recorded (and subsequently carried at the lower of cost or fair value less estimated selling costs) as other assets in the Statements of Condition. Fair value is defined as the amount that a willing seller could expect from a willing buyer in an arm’s-length transaction. If the fair value of the real estate owned is less than the recorded investment in the MPF loan at the date of transfer, the FHLBank recognizes a charge-off to the allowance for loan losses. Subsequent realized gains and realized or unrealized losses on REO are included in other income (loss).

The FHLBank bases the allowance for credit losses on mortgage loans on management’s estimate of probable credit losses inherent within the FHLBank’s conventional mortgage loan portfolio as of the Statement of Condition date. Within the FHLBank’s calculation of its allowance for credit losses on mortgage loans, actual losses greater than the FLA for each pool of mortgage loans purchased from a member are offset by the member’s credit enhancement obligation for the pool of loans. The FHLBank performs periodic reviews of its portfolio to identify the inherent losses within the portfolio and to determine the likelihood of collection of the portfolio. The overall allowance is determined by an analysis that includes consideration of various data observations such as past and current performance, the amounts and timing of future cash flows, loan portfolio characteristics (e.g., loan-to-value ratios, debt-to-income ratios and FICO scores for individual loans), collateral valuations, industry data and prevailing economic conditions. The FHLBank has participated in the MPF Program since 2000 with limited historical loss data for its pool of mortgages. The FHLBank has utilized loss history of loan pools at other financial institutions with similar characteristics to determine a reasonable basis for its credit loss allowance. In the event the FHLBank generates a calculated loan loss in excess of the FLA for a master agreement, the FHLBank nets the PFI’s credit enhancement obligation against the calculated reserve to arrive at its share of the anticipated losses. All PFI credit enhancement obligations are fully collateralized with assets allowed by the FHLBank’s Member Products Policy. As a result of this analysis, the FHLBank recorded an allowance for credit losses of $884,000 and $844,000 as of December 31, 2008 and 2007, respectively. No specific allocation of the allowance for credit losses is assigned to loans considered impaired, because there were no impaired loans as of December 31, 2008 and 2007.

MPF Credit Enhancement. The credit enhancement is an obligation on the part of the participating member that ensures the retention of credit risk on loans it originates on behalf of or sells to the FHLBank. The amount of the credit enhancement is determined so that any losses in excess of the credit enhancement for each pool of mortgage loans purchased approximate those experienced by an investor in a AA-rated mortgage-backed security (MBS). The FHLBank pays the participating member a credit enhancement fee for managing this portion of the credit risk in the pool of loans. These fees are paid monthly based upon the remaining unpaid principal balance for the pool of loans. The required credit enhancement obligation amount may vary depending on the various product alternatives selected by the participating member. The credit enhancement obligation of each member must be fully collateralized with assets allowed by FHLBank policy. If a loss exceeds the FLA under the performance-based credit enhancement (CE) fee for products (certain MPF products have guaranteed CEs) where the FHLBank could put back a loss incurred in the FLA to the PFI, the FHLBank would withhold future monthly CE fee payments to the PFI until the FLA loss amount is recovered. In such situations, however, the FHLBank is always at risk that future CE fee payments to the PFI on the applicable pool of loans could be insufficient to cover the amount of the FHLBank’s FLA loss. Credit enhancement fees paid by the FHLBank to participating members for assuming the credit enhancement obligation are netted against interest income when paid.

Premises, Software and Equipment: These assets are stated at cost less accumulated depreciation and amortization of $14,092,000 and $10,661,000 as of December 31, 2008 and 2007, respectively. Depreciation is computed on the straight-line method over the estimated useful lives of the assets ranging from three to 20 years. Leasehold improvements are amortized on the straight-line basis over the shorter of the estimated useful life of the improvement or the remaining term of the lease. Improvements and major renewals are capitalized and ordinary maintenance and repairs are expensed as incurred. Depreciation and amortization expense was $3,629,000, $3,519,000 and $3,007,000 for the years ended December 31, 2008, 2007 and 2006, respectively. Gains and losses on disposals are included in other income (loss). The net realized gain (loss) on disposal of premises, software and equipment was $15,000, $(285,000) and $0 for the years ended December 31, 2008, 2007 and 2006, respectively.
 
Cost of computer software developed or obtained for internal use is accounted for in accordance with Statement of Position (SOP) No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (herein referred to as “SOP 98-1”). SOP 98-1 requires the cost of purchased software and certain costs incurred in developing computer software for internal use to be capitalized and amortized over future periods. As of December 31, 2008 and 2007, the FHLBank had $5,583,000 and $6,138,000, respectively, in unamortized computer software costs included in premises, software and equipment on its Statements of Condition. Amortization is computed on the straight-line method over three years for purchased software and five years for developed software. Amortization of computer software costs charged to expense was $2,212,000, $2,182,000 and $1,953,000 for the years ended December 31, 2008, 2007 and 2006, respectively.

Derivatives: Accounting for derivatives is addressed in SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of Financial Accounting Standards Board (FASB) Statement No. 133, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, as amended by SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, and as amended by SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (herein referred to as “SFAS 133”). Accordingly, all derivatives are recognized on the Statements of Condition at their fair value. Due to the application of FASB Staff Position (FSP) No. FIN 39-1, Amendment of FASB Interpretation No. 39 (herein referred to as “FSP FIN 39-1), derivative assets and liabilities reported on the Statements of Condition include the net cash collateral and accrued interest from counterparties. (See Note 2 – Recently Issued Accounting Standards and Interpretations and Changes in and Adoptions of Accounting Principles for more information on the effect of adopting FSP FIN 39-1.)

In accordance with SFAS 133, each derivative is designated as one of the following:
§
a hedge of the fair value of (a) a recognized asset or liability or (b) an unrecognized firm commitment (a “fair value” hedge);
§
a hedge of (a) a forecasted transaction or (b) the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a “cash flow” hedge);
§
a non-qualifying hedge of an asset or liability (“economic” hedge) for asset/liability management purposes; or
§
a non-qualifying hedge of another derivative (an “intermediary” hedge) that is offered as a product to members.

Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge, along with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk (including changes that reflect losses or gains on firm commitments), are recorded in current-period earnings. Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge, to the extent that the hedge is effective, are recorded in other comprehensive income, a component of capital, until earnings are affected by the variability of the cash flows of the hedged transaction (i.e., until the recognition of interest on a variable rate asset or liability is recorded in earnings). For both fair value and cash flow hedges, any hedge ineffectiveness (which represents the amount by which the change in the fair value of the derivative differs from the change in fair value of the hedged item or the variability in the cash flows of the forecasted transaction) is recorded in current-period earnings. The differentials between accruals of interest receivables and payables on derivatives designated as fair value or cash flow hedges are recognized as an adjustment to the interest income or expense of the designated underlying investment securities, advances, consolidated obligations or other financial instruments. Changes in the fair value of an economic or intermediary hedge are recorded in current-period earnings. The differentials between accruals of interest receivables and payables on intermediated derivatives for members and other economic hedges are recognized as other income (loss). Therefore, both the net interest on the stand-alone derivative and the fair value changes are recorded in other income (loss) as “Net gain (loss) on derivatives and hedging activities.” Cash flows associated with stand-alone derivatives are reflected as cash flows from operating activities in the Statements of Cash Flows.

The FHLBank records derivatives on trade date, but records associated advances or consolidated obligation bonds on settlement date. The FHLBank considers hedges of committed advances and consolidated obligation bonds eligible for the shortcut method of hedge accounting under SFAS 133 so long as settlement of the committed advance or consolidated obligation occurs within the shortest period possible for that type of instrument, the fair value of the swap is zero on the date the FHLBank commits to issue the hedged item and the transaction meets all of the other criteria for shortcut hedge accounting specified in paragraph 68 of SFAS 133. The impact of this accounting policy is that both changes in fair value of the derivative and the hedged item are recorded starting on the date that the FHLBank commits to enter into the transaction. The FHLBank has defined its market settlement conventions for hedged items to be five business days or less for advances and thirty calendar days or less, using a next business day convention, for consolidated obligation bonds. These market settlement conventions are the shortest period possible for each type of advance or consolidated obligation from the time the instruments are committed to the time they settle.

The FHLBank may acquire investments, may issue debt and may make advances in which a derivative instrument is “embedded.” Upon execution of these transactions, the FHLBank assesses whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the advance or debt (the host contract) and whether a separate, non-embedded instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that: (1) the embedded derivative has economic characteristics that are not clearly and closely related to the economic characteristics of the host contract; and (2) a separate, stand-alone instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value and designated as a stand-alone derivative instrument. However, if the entire contract (the host contract and the embedded derivative) is to be measured at fair value, with changes in fair value reported in current earnings (such as an investment security classified as “trading” under SFAS 115 as well as hybrid financial instruments accounted for under SFAS 155), or if the FHLBank cannot reliably identify and measure the embedded derivative for purposes of separating that derivative from its host contract, the entire contract is carried on the Statements of Condition at fair value, and no portion of the contract is separately accounted for as a derivative.
 
Highly effective hedges that use interest rate swaps as the hedging instrument and that meet certain stringent criteria can qualify for “shortcut” fair value hedge accounting. Shortcut hedge accounting allows for the assumption of no ineffectiveness, which means that the change in fair value of the hedged item can be assumed to be equal to the change in fair value of the derivative. This is in contrast to fair value hedges designated under the “long haul” method, where the change in fair value of the hedged item must be measured separately from the derivative, and for which effectiveness testing must be performed regularly with results falling within established tolerances.

When hedge accounting is discontinued because the FHLBank determines that the derivative no longer qualifies as an effective fair value hedge of an existing hedged item, the FHLBank continues to carry the derivative on its Statements of Condition at fair value, ceases to adjust the hedged asset or liability for changes in fair value, and begins amortizing the cumulative basis adjustment on the hedged item into earnings over the remaining life of the hedged item using a level-yield method. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the FHLBank continues to carry the derivative on its Statements of Condition at fair value, removing any asset or liability that was recorded to recognize the firm commitment and recording it as a gain or loss in current-period earnings. When the FHLBank discontinues hedge accounting because it is probable that a forecasted transaction will not occur by the end of the originally specified time period or within an additional two-month period of time thereafter, the gains and losses that were accumulated in other comprehensive income will be recognized immediately in earnings. When hedge accounting is discontinued because the FHLBank determines that the derivative no longer qualifies as an effective cash flow hedge of an existing hedged item, the FHLBank continues to carry the derivative on its Statements of Condition at fair value and amortizes the cumulative other comprehensive income adjustment to earnings when earnings are affected by the original forecasted transaction. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the FHLBank carries the derivative at fair value on its Statements of Condition, recognizing changes in the fair value of the derivative in current-period earnings.

Premiums paid to acquire options, including caps and floors, are included in the initial basis of the derivative and reported in derivative assets or derivatives liabilities on the Statements of Condition. Fair values of derivatives are netted by counterparty where such legal right exists. If these netted amounts are positive, they are classified as a derivative asset and, if negative, a derivative liability. See Note 9 for more information.

Concessions on Consolidated Obligations: Amounts paid to dealers in connection with sales of consolidated obligations are deferred and amortized using a level-yield method over the contractual terms of the consolidated obligations. Concession amounts are prorated to the FHLBank by the Office of Finance based on the percentage of each consolidated obligation issued by the Office of Finance on behalf of the FHLBank. Unamortized concessions were $14,442,000 and $22,934,000 at December 31, 2008 and 2007, respectively, and are included in other assets. Amortization of such concessions is included in consolidated obligation interest expense. Amortization of concessions on bonds totaled $22,045,000, $8,797,000 and $5,743,000 in 2008, 2007 and 2006, respectively. Concessions on discount notes totaled $4,869,000, $1,816,000, and $1,533,000 in 2008, 2007 and 2006, respectively.

Discounts and Premiums on Consolidated Obligations: The discounts on consolidated obligation discount notes are accreted to expense on the straight-line method throughout the terms of the related notes because of their short-term nature. During 2008, the average term of the FHLBank’s discount notes was less than six months. The discounts and premiums on consolidated obligation bonds, including zero coupon bonds, are accreted or amortized to expense over the contractual terms of the bond issues using a level-yield methodology.

Mandatorily Redeemable Capital Stock: In accordance with SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (herein referred to as “SFAS 150”), the FHLBank reclassifies all stock subject to redemption from equity to liability once a member submits a written redemption request, gives notice of intent to withdraw from membership, or attains non-member status by merger or acquisition, charter termination or involuntary termination from membership, since the member shares will then meet the definition of a mandatorily redeemable financial instrument. There is no distinction as to treatment for reclassification from equity to liability between in-district redemption requests and those redemption requests triggered by out-of-district acquisitions. The FHLBank does not take into consideration its members’ right to cancel a redemption request in determining when shares of capital stock should be classified as a liability, because such cancellation would be subject to a substantial cancellation fee. Member and non-member shares meeting the definition of mandatorily redeemable capital stock are reclassified to a liability at fair value, which has been determined to be par value ($100) plus any estimated accrued but unpaid dividends. The FHLBank’s dividends are declared and paid at each quarter-end; therefore, the fair value reclassified equals par value. Dividends declared on member shares for the time after classification as a liability in accordance with SFAS 150 are accrued at the expected dividend rate and reflected as interest expense in the Statements of Income. The repurchase of these mandatorily redeemable financial instruments by the FHLBank will be reflected as financing cash outflows in the Statements of Cash Flows once settled. If a member submits a written request to cancel a previously submitted written redemption request, the capital stock covered by the written cancellation request is reclassified from a liability to capital at fair value. After the reclassification, dividends on the capital stock are no longer classified as interest expense.

Finance Agency/Finance Board Expenses: The FHLBank funded its share of the costs of operating the Finance Board and funds a portion of the costs of operating the Finance Agency since it was created on July 30, 2008. The Finance Board allocated its operating and capital expenditures to the FHLBanks based on each FHLBank’s percentage of total regulatory capital stock plus retained earnings for the 12 FHLBanks through July 29, 2008. The Finance Agency’s expenses and working capital fund are allocated among the FHLBanks based on the pro rata share of the annual assessments based on the ratio between each FHLBank’s minimum required regulatory capital and the aggregate minimum required regulatory capital of every FHLBank. Each FHLBank must pay an amount equal to one-half of its annual assessment twice each year.

Office of Finance Expenses: The Office of Finance allocates its operating and capital expenditures based on a formula that considers each FHLBank’s percentage of: (1) total capital stock for the 12 FHLBanks; (2) consolidated obligations issued; and (3) consolidated obligations outstanding.
 
Housing and Community Development (HCD) Programs: As more fully discussed in Note 12, the FHLBank is required to establish, fund and administer an Affordable Housing Program (AHP). The required annual AHP funding is charged to earnings, and an offsetting liability is established. The AHP funds provide subsidies to members to assist in the purchase, construction or rehabilitation of housing for very low-, low- and moderate-income households.

Resolution Funding Corporation (REFCORP) Assessments: Although the FHLBank is exempt from all federal, state and local taxation except for real property taxes, it is required to make quarterly payments to REFCORP to pay toward interest on bonds issued by the REFCORP. REFCORP is a corporation established by Congress in 1989 to provide funding for the resolution and disposition of insolvent savings institutions. Officers, employees and agents of the Office of Finance are authorized to act for and on behalf of REFCORP to carry out the functions of REFCORP. See Note 13 for more information.
 
Estimated Fair Values: Many of the FHLBank’s financial instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Therefore, the FHLBank has used significant estimates and present value calculations for the purpose of disclosing estimated fair values. All estimated fair values, regardless of re-pricing or maturity, were derived from pricing services or determined by calculating the present values of the expected future cash flows based on market observable inputs. The estimated fair values of the FHLBank’s financial instruments and related assumptions are detailed in Note 16.

Cash Flows: For purposes of the Statements of Cash Flows, the FHLBank considers cash on hand and non-interest-bearing deposits in banks as cash and cash equivalents.

Reclassifications: During 2008, on a retrospective basis, the FHLBank reclassified it investments in certificates of deposit and bank notes, previously reported as interest-bearing deposits, as held-to-maturity securities on the Statements of Condition and Statements of Income based on the definition of a security under SFAS 115. The financial instruments reclassified were classified as held-to-maturity securities based on the FHLBank’s history of holding them to maturity. This reclassification had no effect on total assets, net interest income or net income. Certain other amounts in the 2007 and 2006 financial statements have been reclassified to conform to the 2008 presentations. Such reclassifications have no impact on net income or capital.


NOTE 2 – RECENTLY ISSUED ACCOUNTING STANDARDS AND INTERPRETATIONS AND CHANGES IN AND ADOPTIONS OF ACCOUNTING PRINCIPLES

Issuance of SFAS 161: In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (herein referred to as “SFAS 161”), which is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 (January 1, 2009 for the FHLBank), with early application allowed. The FHLBank has determined that the adoption of SFAS 161 will result in increased financial statement disclosures but will have no impact on the FHLBank’s financial condition, results of operations or cash flows. The FHLBank has chosen to adopt SFAS 161 on January 1, 2009.

Issuance of SFAS 162: In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (herein referred to as “SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP in the United States. Any effect of applying the provisions of the statement shall be reported as a change in accounting principle in accordance with SFAS No. 154, Accounting Changes and Error Corrections (herein referred to as “SFAS 154”). SFAS 162 was effective November 15, 2008. The adoption of this statement did not have a material impact on the FHLBank’s financial condition, results of operations or cash flows.

Issuance of FSP FAS 133-1 and FIN 45-4: In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161 (herein referred to as “FSP FIN 133-1 and FIN 45-4”). FSP FIN 133-1 and FIN 45-4 amended SFAS 133 and FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others – an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34 (herein referred to as “FIN 45”) to improve disclosures about credit derivatives and guarantees and clarify the effective date of SFAS 161. FSP FAS 133-1 and FIN 45-4 amended SFAS 133 to require entities to disclose sufficient information to allow users to assess the potential effect of credit derivatives, including their nature, maximum payment, fair value and recourse provisions. Additionally, FSP FAS 133-1 and FIN 45-4 amended FIN 45 to require a disclosure about the current status of the payment/performance risk of a guarantee, which could be indicated by external credit ratings or categories by which an FHLBank measures risk. While the FHLBank does not currently enter into credit derivatives, it does have guarantees, including FHLBank joint and several liability on consolidated obligations with the other 11 FHLBanks and letters of credit issued on behalf of our members. The adoption of FSP FAS 133-1 and FIN 45-4 resulted in increased financial statement disclosures but did not have any impact on the FHLBank’s financial condition, results of operations or cash flows. The provisions of FSP FAS 133-1 and FIN 45-4 that amend SFAS 133 and FIN 45 are effective for fiscal years and interim periods ending after November 15, 2008 (December 31, 2008 for the FHLBank). Additionally, FSP FAS 133-1 and FIN 45-4 clarifies that the disclosures required by SFAS 161 should be provided for any reporting period (annual or quarterly interim) beginning after November 15, 2008 (January 1, 2009 for the FHLBank).
 
Issuance of FSP FAS 157-3: In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (herein referred to as “FSP FAS 157-3”), which clarifies the application of SFAS No. 157, Fair Value Measurements (herein referred to as “SFAS 157”) in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. Key existing principles of SFAS 157 illustrated in the example include:
§
A fair value measurement represents the price at which a transaction would occur between market participants at the measurement date;
§
In determining a financial asset’s fair value, use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are unavailable; and
§
Broker or pricing service quotes may be an appropriate input when measuring fair value, but they are not necessarily determinative if an active market does not exist for the financial asset.

FSP FAS 157-3 was effective upon issuance, including prior periods for which financial statements have not been issued. While revisions resulting from a change in the valuation technique or its application shall be accounted for as a change in accounting estimate consistent with SFAS 154, the related disclosure provisions for this change in accounting estimate would not be required. The FHLBank’s adoption of FSP FAS 157-3 did not have a material effect on the FHLBank’s financial condition, results of operations or cash flows.

Issuance of FSP EITF 99-20-1: In January 2009, the FASB issued FSP EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20 (herein referred to as “FSP EITF 99-20-1”). FSP EITF 99-20-1 amends the impairment guidance in EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, to align the impairment model in EITF 99-20 with the impairment model in SFAS 115 resulting in a more consistent determination of whether an other-than-temporary impairment has occurred. FSP EITF 99-20-1 also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements in SFAS 115, and other guidance. FSP EITF 99-20-1 is effective for interim and annual reporting periods ending after December 15, 2008 (December 31, 2008 for the FHLBank). Retrospective application to a prior interim or annual period is not permitted. The FHLBank’s adoption of FSP EITF 99-20-1 did not have a material effect on the FHLBank’s financial condition, results of operations or cash flows.

Issuance of FSP FAS 107-1 and APB 28-1: In March 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (herein referred to as “FSP FAS 107-1”). FSP FAS 107-1 amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments (“SFAS 107”) and APB Opinion No. 28, Interim Financial Reporting, to require entities to disclose the fair value of all financial instruments within the scope of SFAS 107 in all interim financial statements. FSP FAS 107-1 also requires disclosure of the method(s) and significant assumptions used to estimate the fair value of those financial instruments. Previously, these disclosures were required only in annual financial statements. FSP FAS 107-1 is effective for interim reporting periods ending after March 15, 2009. In periods after initial adoption, FSP FAS 107-1 requires comparative disclosures only for periods ending subsequent to initial adoption. The adoption of FSP FAS 107-1 did not have any impact on the FHLBank’s financial condition, results of operations or cash flows. The FHLBank will provide the additional interim disclosures required by FSP FAS 107-1 beginning with its Form 10-Q for the quarterly period ending March 31, 2009.

Adoption of SFAS 157: The FHLBank adopted SFAS No. 157, Fair Value Measurements (herein referred to as “SFAS 157”) on January 1, 2008. SFAS 157 applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop assumptions used to determine the fair value and establishes valuation techniques used to measure fair value. To increase consistency and comparability in fair value measurements and related disclosures, the fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels:
§      Level 1 – quoted prices in active markets for identical assets or liabilities;
§      Level 2 – directly or indirectly observable inputs other than quoted prices; and
§      Level 3 – unobservable inputs.

SFAS 157 requires disclosures detailing: (1) the extent to which companies measure assets and liabilities at fair value; (2) the methods and assumptions used to measure fair value; and (3) the effect of fair value measurements on earnings, as applicable. Financial Accounting Standards Board (FASB) Staff Position (FSP) FAS 157-2, Effective Date of FASB Statement No. 157 (herein referred to as “FSP FAS 157-2”) delays the application of SFAS 157 for certain nonfinancial assets and liabilities to fiscal years beginning after November 15, 2008. In accordance with FSP FAS 157-2, the FHLBank has only partially applied SFAS 157. The adoption of SFAS 157 did not have a material impact on the FHLBank’s financial condition, results of operations or cash flows.

Adoption of SFAS 159: The FHLBank adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115 (herein referred to as “SFAS 159”) on January 1, 2008. SFAS 159 permits the FHLBank to choose to measure eligible financial instruments and certain other items at fair value at specified elections dates. Adoption of this statement at its effective date had no material effect on the FHLBank’s financial condition, results of operations or cash flows. However, SFAS 159 amended SFAS No. 95, Statement of Cash Flows, SFAS No. 102, Statement of Cash Flows – Exemption of Certain Enterprises and Classification of Cash Flows from Certain Securities Acquired for Resale, and SFAS 115, which did impact the FHLBank’s Statements of Cash Flows. The amendment requires cash flows resulting from trading securities activity to be categorized in the Statements of Cash Flows based on the nature and purpose for which the securities were acquired. Prior guidance required trading securities activity to be reflected net in the operating section of the Statements of Cash Flows regardless of the nature or purpose. The FHLBank has determined that because its trading securities held for the periods presented are not actively traded or held for resale, cash flows during the periods presented related to trading securities would be more appropriately presented in the investing section of the Statements of Cash Flows. Prior period amounts previously reported in the operating section of the Statements of Cash Flows for purchases of trading securities and proceeds from maturities of and principal repayments on trading securities have been moved to the investing section of the Statements of Cash Flows.
 
Adoption of FSP FIN 39-1: The FHLBank adopted FSP FIN 39-1 on January 1, 2008. FSP FIN 39-1 permits the FHLBank to offset fair value amounts recognized for cash collateral receivable or payable against fair value amounts recognized for derivative instruments executed with the same counterparty under master netting agreements in accordance with paragraph 10 of FIN 39. The FHLBank has elected to implement FSP FIN 39-1 and change its accounting policy to offset fair value amounts recognized for cash collateral receivable and payable against the derivative instruments’ fair values. The adoption of this standard at its effective date did not have a material effect on the FHLBank’s financial condition, results of operations or cash flows. However, the FHLBank is required to recognize the effects of applying FIN 39-1 as a change in accounting principle through retrospective application to all financial statements presented. The prior period amounts reported on the Statements of Condition for interest-bearing deposits, derivative assets, total assets, deposits – interest-bearing other, derivative liabilities, total liabilities, total capital and total liabilities and capital have been revised to reflect the collateral netting process.

Change in Accounting Principle: Effective January 1, 2008, the FHLBank changed its method of amortizing/accreting mortgage loan origination fees (agent fees) and premiums/discounts under SFAS 91. Previously, amortization/accretion of origination fees and premiums/discounts was computed using the estimated life method with retrospective adjustment. Under this method, the income effects of loan origination fees, premiums and discounts were recognized using the interest method over the estimated lives of the assets, which required a retrospective adjustment of the effective yield each time the FHLBank changed its estimate of the loan life, based on actual prepayments received and changes in expected future prepayments. Under the estimated life method, the net investment in the loans was adjusted as if the new estimate had been known since the original acquisition of the mortgage loan. On January 1, 2008, the FHLBank began amortizing/accreting loan origination fees and premiums/discounts using the contractual method. The contractual method does not utilize estimates of future prepayments of principal. While both methods are acceptable under GAAP, the FHLBank believes that the contractual method is preferable to the estimated life method because, under the contractual method, the income effects of loan origination costs, premiums and discounts are recognized in a manner that is reflective of the actual behavior of the mortgage loans during the period in which the behavior occurs while also reflecting the contractual terms of the assets without regard to changes in estimated prepayments based on assumptions about future borrower behavior.

As a result of the change in method of amortizing/accreting loan origination costs and premiums/discounts, the prior period historical financial statements have been retrospectively adjusted to reflect the reporting periods as if the contractual method had been used during those reporting periods.

The impact of the change in amortization/accretion method and adoption of FSP FIN 39-1 on the December 31, 2007 Statement of Condition is summarized in the following table (in thousands):

   
December 31, 2007
As Originally Reported1
    
December 31, 2007
As Adjusted
    
December 31, 2007
Impact of Change
  
ASSETS
                  
Interest-bearing deposits
   $ 30,850     $ 10     $ (30,840 )
Mortgage loans held for portfolio, net of allowance for credit losses on mortgage loans
     2,349,367       2,352,301       2,934  
Accrued interest receivable
     197,114       197,016       (98 )
Derivative assets
     137,251       77,611       (59,640 )
TOTAL ASSETS
   $ 55,392,216     $ 55,304,572     $ (87,644 )
                         
LIABILITIES
                        
Deposits - interest-bearing other
   $ 59,400     $ 0     $ (59,400 )
Accrued interest payable
     321,516       321,276       (240 )
Affordable Housing Program
     41,118       41,357       239  
Payable to Resolution Funding Corp. (REFCORP)
     10,528       11,067       539  
Derivative liabilities
     139,321       108,383       (30,938 )
TOTAL LIABILITIES
     53,096,518       53,006,718       (89,800 )
                         
CAPITAL
                        
Retained earnings
     206,607       208,763       2,156  
TOTAL CAPITAL
     2,295,698       2,297,854       2,156  
TOTAL LIABILITIES AND CAPITAL
   $ 55,392,216     $ 55,304,572     $ (87,644 )
                    
1         Originally reported prior period amounts have already been adjusted for any reclassifications.

The impact of the change in amortization/accretion method on the Statement of Income for the year ended December 31, 2007 is summarized in the following table (in thousands):

   
December 31, 2007
As Originally Reported
    
December 31, 2007
As Adjusted
    
December 31, 2007
Impact of Change
  
INTEREST INCOME
                  
Mortgage loans held for portfolio
   $ 121,691     $ 122,281     $ 590  
INCOME BEFORE ASSESSMENTS
     204,226       204,816       590  
Affordable Housing Program
     16,886       16,934       48  
REFCORP
     37,468       37,576       108  
NET INCOME
   $ 149,872     $ 150,306     $ 434  

The impact of the change in amortization/accretion method on the Statement of Income for the year ended December 31, 2006 is summarized in the following table (in thousands):

   
December 31, 2006
As Originally Reported
    
December 31, 2006
As Adjusted
    
December 31, 2006
Impact of Change
  
INTEREST INCOME
                  
Mortgage loans held for portfolio
   $ 122,368     $ 122,961     $ 593  
INCOME BEFORE ASSESSMENTS
     185,448       186,041       593  
Affordable Housing Program
     15,411       15,460       49  
REFCORP
     34,009       34,118       109  
NET INCOME
   $ 136,028     $ 136,463     $ 435  

The impact of the change in amortization/accretion method on the Statement of Cash Flows for the year ended December 31, 2007 is summarized in the following table (in thousands):

   
December 31, 2007
As Originally Reported1
    
December 31, 2007
As Adjusted
    
December 31, 2007
Impact of Change
  
Net income
   $ 149,872     $ 150,306     $ 434  
Premiums, discounts and deferred loan costs on mortgage loans, net
     1,123       533       (590 )
Increase (decrease) in Affordable Housing Program liability
     5,095       5,143       48  
Increase (decrease) in REFCORP liability
     1,587       1,695       108  
Total adjustments
     19,243       18,809       (434 )
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
   $ 169,115     $ 169,115     $ 0  
                    
1         Originally reported prior period amounts have already been adjusted for any reclassifications.

The impact of the change in amortization/accretion method on the Statement of Cash Flows for the year ended December 31, 2006 is summarized in the following table (in thousands):

   
December 31, 2006
As Originally Reported1
    
December 31, 2006
As Adjusted
    
December 31, 2006
Impact of Change
  
Net income
   $ 136,028     $ 136,463     $ 435  
Premiums, discounts and deferred loan costs on mortgage loans, net
     1,181       588       (593 )
Increase (decrease) in Affordable Housing Program liability
     5,456       5,505       49  
Increase (decrease) in REFCORP liability
     (4,021 )     (3,912 )     109  
Total adjustments
     35,343       34,908       (435 )
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
   $ 171,371     $ 171,371     $ 0  
                    
1         Originally reported prior period amounts have already been adjusted for any reclassifications.
 
 
NOTE 3 – CASH AND DUE FROM BANKS

Balances represent non-interest bearing deposits in banks.

Pass-through Deposit Reserves: The FHLBank acts as a pass-through correspondent for members required to deposit reserves with the Federal Reserve Banks (FRB). The amount shown as cash and due from banks includes $36,000 and $10,000 of average reserve deposits with the FRB as of December 31, 2008 and 2007, respectively.

Although the FHLBanks are not eligible institutions to receive interest from an FRB, beginning on October 9, 2008, the FRB began paying interest to FHLBanks that act as pass-through correspondents for eligible institutions. Accordingly, cash balances in excess of the pass-through correspondent deposits and earning interest as of December 31, 2008 are recorded as Interest-bearing deposits on the FHLBank’s Statements of Condition.
 
NOTE 4 – TRADING SECURITIES

Major Security Types: Trading securities as of December 31, 2008 and 2007 are summarized in the following table (in thousands):

   
Estimated Fair Values
  
   
2008
    
2007
  
Certificates of deposit
   $ 1,571,449     $ 0  
Commercial paper
     673,435       0  
FHLBank1 obligations
     316,618       213,046  
Fannie Mae2 obligations
     403,027       110,457  
Freddie Mac2 obligations
     1,009,074       520,252  
Subtotal
     3,973,603       843,755  
Mortgage-backed securities:
                
Fannie Mae2
     399,863       477,692  
Freddie Mac2
     277,278       330,044  
Ginnie Mae3
     1,956       2,552  
Mortgage-backed securities
     679,097       810,288  
TOTAL
   $ 4,652,700     $ 1,654,043  
                    
1
See Note 19 for transactions with other FHLBanks.
2
Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) are GSE. Both entities were placed into conservatorship by the Finance Agency on September 7, 2008.
3
Government National Mortgage Association (Ginnie Mae) securities are guaranteed by the U.S. government.

Redemption Terms: The estimated fair values of trading securities by contractual maturity as of December 31, 2008 and 2007 are shown in the following table (in thousands). Expected maturities of certain securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.

   
2008
    
2007
  
Due in one year or less
   $ 2,244,884     $ 99,781  
Due after one year through five years
     446,071       371,976  
Due after five years through 10 years
     1,282,648       371,998  
Due after 10 years
     0       0  
Subtotal
     3,973,603       843,755  
Mortgage-backed securities
     679,097       810,288  
TOTAL
   $ 4,652,700     $ 1,654,043  

For securities held as of December 31, 2008, the unrealized net gain (loss) on trading securities during the years ended December 31, 2008, 2007 and 2006 included a net gain (loss) of $44,295,000, $16,809,000 and $(5,863,000), respectively.
 
 
NOTE 5 – AVAILABLE-FOR-SALE SECURITIES

Gains and Losses: As described in Note 17, during the year ended December 31, 2008, the FHLBank was required to purchase several state housing finance agency (HFA) bonds under standby bond purchase agreements (SBPA). In accordance with the SBPAs, the FHLBank purchased and resold the bonds at par value; therefore, no gains (losses) were recorded in other comprehensive income on the purchase and subsequent sale of these bonds. Net losses were realized on the sale of available-for-sale securities during the year ended December 31, 2007 and are included in other income (loss). There were no sales of available-for-sale securities during 2006. Following are details of the 2008 and 2007 sales (in thousands):

   
2008
    
2007
  
Total proceeds
   $ 193,730     $ 102,377  
                 
Gross gains
   $ 0     $ 0  
Gross losses
     0       (2,254 )
NET LOSS
   $  0     $ (2,254 )
 
NOTE 6 – HELD-TO-MATURITY SECURITIES

Major Security Types: Held-to-maturity securities as of December 31, 2008 are summarized in the following table (in thousands):

   
Amortized
Cost
    
Gross
Unrealized
Gains
    
Gross
Unrealized
Losses
    
Estimated
Fair Values
  
Certificates of deposit
   $ 760,000     $ 985     $ 0     $ 760,985  
Commercial paper
     737,271       1,496       0       738,767  
State or local housing agency obligations
     155,247       701       561       155,387  
Subtotal
     1,652,518       3,182       561       1,655,139  
Mortgage-backed securities:
                                
Fannie Mae1
     3,354,012       4,566       107,773       3,250,805  
Freddie Mac1
     3,388,254       7,831       109,019       3,287,066  
Ginnie Mae2
     37,663       1,496       278       38,881  
Other3
     2,618,450       813       396,562       2,222,701  
Mortgage-backed securities
     9,398,379       14,706       613,632       8,799,453  
TOTAL
   $ 11,050,897     $ 17,888     $ 614,193     $ 10,454,592  

Held-to-maturity securities as of December 31, 2007 are summarized in the following table (in thousands):

   
Amortized
Cost
    
Gross
Unrealized
Gains
    
Gross
Unrealized
Losses
    
Estimated
Fair Values
  
Certificates of deposit
   $ 6,122,007     $ 0     $ 0     $ 6,122,007  
Commercial paper
     1,143,067       0       0       1,143,067  
State or local housing agency obligations
     191,170       1,646       112       192,704  
Subtotal
     7,456,244       1,646       112       7,457,778  
Mortgage-backed securities:
                                
Fannie Mae1
     1,579,409       2,671       19,527       1,562,553  
Freddie Mac1
     1,638,400       6,112       16,966       1,627,546  
Ginnie Mae2
     44,033       735       3       44,765  
Other3
     2,993,312       2,448       51,991       2,943,769  
Mortgage-backed securities
     6,255,154       11,966       88,487       6,178,633  
TOTAL
   $ 13,711,398     $ 13,612     $ 88,599     $ 13,636,411  
                    
1
Fannie Mae and Freddie Mac are GSEs. Both entities were placed into conservatorship by the Finance Agency on September 7, 2008.
2
Ginnie Mae securities are guaranteed by the U.S. government.
3
Primarily consists of private-label mortgage-backed securities. 2008 amortized cost reflects the write-down of securities deemed other-than-temporarily impaired.
 
The following table summarizes (in thousands) the held-to-maturity securities with unrealized losses as of December 31, 2008. The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.

   
Less Than 12 Months
    
12 Months or More
    
Total
  
   
Estimated
Fair Values
    
Unrealized
Losses
    
Estimated
Fair Values
    
Unrealized
Losses
    
Estimated
Fair Values
    
Unrealized
Losses
  
State or local housing agency obligations
  
 $
37,170
    
 $
554
    
$
1,363
    
$
7
    
$
38,533
    
 $
561
  
Subtotal
    
37,170
      
554
      
1,363
      
7
      
38,533
      
561
  
Mortgage-backed securities:
                                                
Fannie Mae1
    
2,005,650
      
65,252
      
875,306
      
42,521
      
2,880,956
      
107,773
  
Freddie Mac1
    
2,050,859
      
65,383
      
853,049
      
43,636
      
2,903,908
      
109,019
  
Ginnie Mae2
    
9,726
      
278
      
0
      
0
      
9,726
      
278
  
Other3
    
1,109,510
      
171,665
      
1,064,388
      
224,897
      
2,173,898
      
396,562
  
Mortgage-backed securities
    
5,175,745
      
302,578
      
2,792,743
      
311,054
      
7,968,488
      
613,632
  
TOTAL TEMPORARILY IMPAIRED SECURITIES
  
$
5,212,915
    
$
303,132
    
$
2,794,106
    
$
311,061
    
$
8,007,021
    
$
614,193
  

The following table summarizes (in thousands) the held-to-maturity securities with unrealized losses as of December 31, 2007. The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.

   
Less Than 12 Months
    
12 Months or More
    
Total
  
   
Estimated
Fair Values
    
Unrealized
Losses
    
Estimated
Fair Values
    
Unrealized
Losses
    
Estimated
Fair Values
    
Unrealized
Losses
  
State or local housing agency obligations
  
 $
499
    
 $
2
    
$
6,429
    
$
110
    
$
6,928
    
 $
112
  
Subtotal
    
499
      
2
      
6,429
      
110
      
6,928
      
112
  
Mortgage-backed securities:
                                                
Fannie Mae1
    
1,033,655
      
8,962
      
235,468
      
10,565
      
1,269,123
      
19,527
  
Freddie Mac1
    
1,009,711
      
11,321
      
231,838
      
5,645
      
1,241,549
      
16,966
  
Ginnie Mae2
    
1,157
      
3
      
0
      
0
      
1,157
      
3
  
Other3
    
726,818
      
11,547
      
1,770,037
      
40,444
      
2,496,855
      
51,991
  
Mortgage-backed securities
    
2,771,341
      
31,833
      
2,237,343
      
56,654
      
5,008,684
      
88,487
  
TOTAL TEMPORARILY IMPAIRED SECURITIES
  
$
2,771,840
    
$
31,835
    
$
2,243,772
    
$
56,764
    
$
5,015,612
    
$
88,599
  
                    
1
Fannie Mae and Freddie Mac are GSEs. GSE securities are not guaranteed by the U.S. government.
2
Ginnie Mae securities are guaranteed by the U.S. government
3
Primarily consists of private-label mortgage-backed securities.

Other-than-temporary Impairment: The FHLBank evaluates its individual held-to-maturity investment security holdings for other-than-temporary impairment on at least a quarterly basis, or more frequently if events or changes in circumstances indicate that these investments may be other-than-temporarily impaired. As part of this process, the FHLBank considers its ability and intent to hold each security for a sufficient time to allow for any anticipated recovery of unrealized losses. To determine which individual securities are at risk for other-than-temporary impairment, the FHLBank considers various characteristics of each security including, but not limited to, the following: the credit rating and related outlook or status; the creditworthiness of the issuers of the agency debt securities; the strength of the government-sponsored enterprises’ guarantees of the holdings of agency MBS; the underlying type of collateral; the duration and level of the unrealized loss; any credit enhancements or insurance; and certain other collateral-related characteristics such as FICO credit scores, delinquency rates and the security’s performance. The relative importance of this information varies based on the facts and circumstances surrounding each security, as well as the economic environment at the time of assessment.

As a result of this security-level review, the FHLBank identifies individual securities believed to be at risk for other-than-temporary impairment, which are evaluated further by estimating projected cash flows based on the structure of the security and certain assumptions, such as prepayment speeds, default rates and loss severity, to determine whether the FHLBank expects to receive all of the contractual cash flows on the securities. As a result of these evaluations, the FHLBank recognized other-than-temporary impairment losses of $4,773,000 for the year ended December 31, 2008 related to seven private-label MBS in the held-to-maturity portfolio. This other-than-temporary impairment loss is reported as “Loss on other-than-temporarily impaired held-to-maturity securities” in the other income (loss) section of the Statements of Income. These securities had a total amortized cost of $7,991,000 before impairment and a total fair value of $3,218,000 at the time of impairment, December 31, 2008.
 
The remainder of the FHLBank’s held-to-maturity securities portfolio that has not been designated as other-than-temporarily impaired has experienced significant unrealized losses and a decrease in fair value due to interest rate volatility, illiquidity in the marketplace and credit deterioration in the U.S. mortgage markets during 2008. However, the decline is considered temporary as the FHLBank has the intent and ability to hold these investments to maturity and based on estimated projected cash flows, expects to collect all contractual principal and interest. The ability and intent of the FHLBank is demonstrated by the fact that the FHLBank is well capitalized, has sufficient liquidity and has no need to sell these securities, nor has the FHLBank entered into any contractual constraints that would impact such intent and ability.

Redemption Terms: The amortized cost and estimated fair values of held-to-maturity securities by contractual maturity as of December 31, 2008 and 2007 are shown in the following table (in thousands). Expected maturities of certain securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.

   
2008
    
2007
  
   
Amortized
Cost
    
Estimated
Fair Values
    
Amortized
Cost
    
Estimated
Fair Values
  
Due in one year or less
   $ 1,507,271     $ 1,510,033     $ 7,265,074     $ 7,265,074  
Due after one year through five years
     120       123       10,305       10,840  
Due after five years through 10 years
     1,320       1,339       2,600       2,620  
Due after 10 years
     143,807       143,644       178,265       179,244  
Subtotal
     1,652,518       1,655,139       7,456,244       7,457,778  
Mortgage-backed securities
     9,398,379       8,799,453       6,255,154       6,178,633  
TOTAL
   $ 11,050,897     $ 10,454,592     $ 13,711,398     $ 13,636,411  

The amortized cost of the FHLBank’s mortgage-backed securities included net discounts of $16,504,000 and $12,716,000 as of December 31, 2008 and 2007, respectively. Other investments included net discounts of $2,728,000 and $6,926,000 as of December 31, 2008 and 2007, respectively.

Interest Rate Payment Terms: The following table details interest rate payment terms for held-to-maturity securities as of December 31, 2008 and 2007 (in thousands):

   
2008
    
2007
  
Amortized cost of held-to-maturity securities other than mortgage-backed securities:
            
Fixed rate
   $ 1,416,333     $ 7,359,679  
Variable rate
     236,185       96,565  
Subtotal
     1,652,518       7,456,244  
                 
Amortized cost of held-to-maturity mortgage-backed securities:
                
Pass-through securities:
                
Fixed rate
     923       1,269  
Variable rate
     9,666       17,119  
Collateralized mortgage obligations:
                
Fixed rate
     2,793,227       3,179,470  
Variable rate
     6,594,563       3,057,296  
Subtotal
     9,398,379       6,255,154  
TOTAL
   $ 11,050,897     $ 13,711,398  

Gains and Losses: Net gains (losses) were realized on the sale or call of long-term securities during the years ended December 31, 2007 and 2006 and are included in other income (loss). In 2007, all securities sold had paid down below 15 percent of the principal outstanding at acquisition. In 2006, two held-to-maturity securities were called by the issuers. Following are details of the 2007 and 2006 sales and calls (in thousands):

   
2007
    
2006
  
Total proceeds
   $ 81,092     $ 704  
                 
Gross gains
   $ 378     $ 14  
Gross losses
     (1,340 )     0  
NET GAIN (LOSS)
   $ (962 )   $ 14  
 
In 2008, a short-term security (original maturity of three months or less) was sold to bring the FHLBank in compliance with its unsecured investment limitation for an unsecured counterparty. A net loss was realized on the sale of the security and is included in other income. Proceeds from the sale are included in net (increase) decrease in short-term held-to-maturity securities on the Statements of Cash Flows. Following are details of the sale (in thousands):

         
2008
  
Total proceeds
          
$
59,604
  
                 
Gross gains
          
$
0
  
Gross losses
            
(10
)
NET LOSS
          
$
(10
)
 
NOTE 7 – ADVANCES

Redemption Terms: As of December 31, 2008 and 2007, the FHLBank had advances outstanding at interest rates ranging from zero percent (AHP advances) to 8.64 percent at both year ends as summarized in the following table (in thousands):
 
   
December 31, 2008
    
December 31, 2007
  
Year of Maturity
  
Amount
    
Weighted
Average
Interest Rate
    
Amount
    
Weighted
Average
Interest Rate
  
Due in one year or less
   $ 18,047,311       1.36 %   $ 16,252,321       4.70 %
Due after one year through two years
     3,443,180       4.24       2,867,691       4.79  
Due after two years through three years
     1,788,559       3.94       2,469,243       5.22  
Due after three years through four years
     1,066,763       4.03       1,068,415       4.92  
Due after four years through five years
     1,460,101       3.51       821,707       4.56  
Thereafter
     9,178,873       2.84       8,374,402       4.66  
Total par value
     34,984,787       2.34 %     31,853,779       4.74 %
Discounts on HCD advances
     (37 )             (45 )        
Premiums on other advances
     52               89          
Discounts on other advances
     (13,812 )             (39,710 )        
SFAS 133 fair value adjustments
     848,684               243,026          
TOTAL
   $ 35,819,674             $ 32,057,139          

In general, a borrower is charged a prepayment fee when an advance is repaid before its stated maturity. Prepayment fees are calculated using methods that make the FHLBank financially indifferent to the advance prepayments. The FHLBank’s advances outstanding include advances that contain call options that may be exercised with or without prepayment fees at the borrower’s discretion on specific dates (call dates) before the stated advance maturities (callable advances). The borrowers normally exercise their call options on these advances when interest rates decline (fixed rate advances) or spreads change (adjustable rate advances). The FHLBank’s advances as of December 31, 2008 and 2007, include callable advances totaling $6,395,434,000 and $6,003,155,000, respectively. Of these callable advances, there were $6,324,845,000 and $5,984,368,000 of variable rate advances as of December 31, 2008 and 2007, respectively. The following table summarizes the FHLBank’s advances by year of maturity, or by the next call date for callable advances (in thousands):

Year of Maturity or Next Call Date
  
2008
    
2007
  
Due in one year or less
   $ 23,371,131     $ 21,237,585  
Due after one year through two years
     2,903,380       2,664,563  
Due after two years through three years
     1,507,000       2,341,743  
Due after three years through four years
     956,320       1,037,401  
Due after four years through five years
     1,438,854       700,765  
Thereafter
     4,808,102       3,871,722  
TOTAL PAR VALUE
   $ 34,984,787     $ 31,853,779  
 
The FHLBank’s advances outstanding also include advances that contain conversion options that may be exercised at the FHLBank’s discretion on specific dates (conversion dates) before the stated advance maturities (convertible advances). With convertible advances, the FHLBank effectively purchases put options from the borrowers that allow the FHLBank to convert the fixed rate advances to variable rate advances. In exchange for the options, borrowers are charged interest rates that are below those for fixed rate advances with comparable maturities. The FHLBank normally exercises its conversion options on these advances when interest rates increase. The FHLBank’s advances as of December 31, 2008 and 2007, included convertible advances totaling $5,759,422,000 and $4,843,833,000, respectively. The following table summarizes the FHLBank’s advances by year of maturity, or by the next conversion or put date for convertible advances (in thousands):

Year of Maturity or Next Conversion or Put Date
  
2008
    
2007
  
Due in one year or less
   $ 22,092,269     $ 20,290,004  
Due after one year through two years
     3,179,739       2,808,991  
Due after two years through three years
     1,597,048       1,954,002  
Due after three years through four years
     684,963       573,190  
Due after four years through five years
     1,459,026       391,907  
Thereafter
     5,971,742       5,835,685  
TOTAL PAR VALUE
   $ 34,984,787     $ 31,853,779  

Security Terms: The FHLBank lends to members and approved housing associates involved in housing finance within the Tenth District, which comprises the states of Colorado, Kansas, Nebraska and Oklahoma. Advances are made in accordance with federal statutes, including the Bank Act as amended. The FHLBank is required by statute to obtain security interests in sufficient collateral on advances to protect against losses and to accept as collateral on such advances only U.S. government or government agency securities, residential mortgage loans and securities backed by such, cash, deposits in the FHLBank and other real estate-related assets. As provided in the Bank Act, a borrowing member’s investment in the capital stock of the FHLBank is pledged as additional collateral on the member’s advances. CFIs are defined in the Recovery Act as those institutions that have, as of the date of the transaction at issue, less than $1,000,000,000 in average total assets over the three years preceding that date (subject to annual adjustment by the Finance Agency director based on the consumer price index). CFIs are eligible under expanded statutory collateral rules to pledge as collateral for advances small-business, small-farm and small-agribusiness loans fully secured by collateral other than real estate, or securities representing a whole interest in such secured loans. The Recovery Act also adds secured loans for “community development activities” as a permitted purpose, and as eligible collateral, for advances to CFIs. As of December 31, 2008 and 2007, the FHLBank had security interests in collateral with an estimated value in excess of outstanding advances.

All advances outstanding as of December 31, 2008 and 2007, were collateralized by the above types of collateral pursuant to written security agreements. Based on the financial condition of a member that has advances outstanding, the FHLBank allows two options: (1) members can physically retain collateral assigned to the FHLBank provided they execute written security agreements and agree to hold such collateral for the benefit of the FHLBank; or (2) members can specifically assign or physically place such collateral with the FHLBank or its safekeeping agent.

Beyond these provisions, Section 10(e) of the Bank Act affords any security interest granted by a member to the FHLBank priority over the claims or rights of any other party (including any receiver, conservator, trustee or similar lien creditor). The two exceptions are claims of bona fide purchasers for value and actual secured parties holding perfected security interests, provided that those claims would be entitled to priority under otherwise applicable law.

Credit Risk: While the FHLBank has never experienced a credit loss on an advance to a member, the expanded statutory collateral rules for CFIs provide the potential for additional credit risk for the FHLBank. FHLBank management has policies and procedures in place to appropriately manage the potential for additional credit risk from CFI collateral. To the extent that the expanded eligible collateral for CFIs generally includes higher risk loans and advances to non-member housing associates are made at similar terms to members but without capital stock as collateral, it results in the potential for an increase in the credit risk to the FHLBank. The increased credit risk from CFIs’ and housing associates’ collateral is mitigated by the FHLBank through higher haircuts (lower lending values) on such collateral. Additionally, all non-member borrowers, including housing associates, are placed in possession-collateral status and are required to deliver eligible collateral to the FHLBank in an amount that provides a collateral coverage level sufficient to cover their extensions of credit with the FHLBank. Accordingly, the FHLBank has not established an allowance for credit losses on advances.

The FHLBank’s potential credit risk from advances is concentrated in thrifts (28 percent of total advances), commercial banks (33 percent of total advances), credit unions (18 percent of total advances) and insurance companies (20 percent of total advances). As of December 31, 2008 and 2007, the FHLBank had outstanding advances of $10,389,600,000 and $9,491,000,000 to two members that individually held 10 percent or more of the FHLBank’s advances, and this represents 29.7 percent and 29.8 percent of total outstanding advances, respectively. The income from advances to these members during 2008 and 2007 totaled $249,148,000 and $509,813,000, respectively. One of the members was the same each year. The FHLBank had security interests in collateral with an estimated value in excess of book value of these advances and, therefore, does not expect to incur any credit losses on these advances. See Note 18 for detailed information on transactions with related parties.
 
Interest Rate Payment Terms: The following table details additional interest rate payment terms for advances as of December 31, 2008 and 2007 (in thousands):

   
2008
    
2007
  
   
Amount
    
Percentage
    
Amount
    
Percentage
  
Par amount of advances:
                        
Fixed rate
  
$
20,258,429
      
57.9
%
  
$
18,481,206
      
58.0
%
Variable rate
    
14,726,358
      
42.1
      
13,372,573
      
42.0
  
TOTAL
  
$
34,984,787
      
100.0
%
  
$
31,853,779
      
100.0
%

Information about the estimated fair value of the advances is included in Note 16.
 
NOTE 8 – MORTGAGE LOANS HELD FOR PORTFOLIO

The MPF Program involves the FHLBank investing in mortgage loans, which are either funded by the FHLBank through or purchased from its participating members. The total loans represent held-for-portfolio loans under the MPF Program whereby participating FHLBank members originate and credit enhance home mortgage loans that are owned by the FHLBank. Depending upon a member’s product selection, however, the servicing rights can be retained or sold by the participating member. The FHLBank does not buy or own any mortgage servicing rights.
 
The following table presents information as of December 31, 2008 and 2007 on mortgage loans held for portfolio (in thousands):

   
2008
    
2007
  
Real Estate
            
Fixed rate, medium-term1, single-family mortgages
   $ 808,298     $ 749,689  
Fixed rate, long-term, single-family mortgages
     2,212,249       1,597,571  
Total par value
     3,020,547       2,347,260  
Premiums
     16,985       16,847  
Discounts
     (11,666 )     (10,836 )
Deferred loan costs, net
     812       198  
SFAS 133 fair value adjustments
     (1,989 )     (324 )
Total before Allowance for Credit Losses on Mortgage Loans
     3,024,689       2,353,145  
Allowance for Credit Losses on Mortgage Loans
     (884 )     (844 )
MORTGAGE LOANS, NET
   $ 3,023,805     $ 2,352,301  
                    
1
Medium-term defined as a term of 15 years or less.

The par value of mortgage loans held for portfolio outstanding at December 31, 2008 and 2007 was comprised of government-insured or guaranteed (by the Federal Housing Administration, the Department of Veterans Affairs, RHS and HUD) loans totaling $195,619,000 and $85,698,000, respectively, and conventional, size-conforming mortgage loans totaling $2,824,928,000 and $2,261,562,000, respectively.

The allowance for credit losses on mortgage loans as of December 31, 2008, 2007 and 2006, respectively, was as follows (in thousands):

   
2008
    
2007
    
2006
  
Balance, beginning of year
   $ 844     $ 854     $ 756  
Provision for (reversal of) credit losses on mortgage loans
     196       (25 )     358  
Charge-offs
     (156 )     15       (260 )
Balance, end of year
   $ 884     $ 844     $ 854  

At December 31, 2008 and 2007, the FHLBank had $8,934,000 and $5,640,000, respectively, of non-accrual conventional loans. As of December 31, 2008 and 2007, the FHLBank had $1,442,000 and $814,000, respectively, of REO included in other assets.

Mortgage loans are considered impaired when, based on current information and events, it is probable that the FHLBank will be unable to collect all principal and interest amounts due according to the contractual terms of the mortgage loan agreement. The FHLBank considers the mortgage loans to be collateral dependent, and thus measures impairment based on the fair value of the collateral. At December 31, 2008 and 2007, the FHLBank had no recorded investments in impaired mortgage loans.

The estimated fair value of the mortgage loans held for portfolio as of December 31, 2008 and 2007 is reported in Note 16.
 
The credit enhancement is an obligation on the part of the participating member that ensures the retention of credit risk on loans it originates on behalf of or sells to the FHLBank. The FHLBank pays the participating member a credit enhancement fee for managing this portion of the credit risk in the pool of loans. These fees are paid monthly based upon the remaining unpaid principal balance for the pool of loans. Credit enhancement fees paid by the FHLBank to participating members for assuming the credit enhancement obligation are netted against interest income when paid. Credit enhancement fees paid by the FHLBank to participating members totaled $2,495,000, $2,275,000 and $2,481,000 for the years ended December 31, 2008, 2007 and 2006, respectively.

See Note 18 for detailed information on transactions with related parties.
 
NOTE 9 – DERIVATIVES AND HEDGING ACTIVITIES

Nature of Business Activity: The FHLBank enters into interest rate swaps (including callable and putable swaps), swaptions, and interest rate cap and floor agreements (collectively, derivatives) to manage its exposure to changes in interest rates.

The FHLBank may utilize derivatives to adjust the effective maturity, re-pricing frequency or option characteristics of financial instruments to achieve risk management objectives. The FHLBank uses derivatives in three ways: (1) by designating them as either a fair value or cash flow hedge of an underlying financial instrument or a forecasted transaction; (2) by acting as an intermediary; or (3) in asset/liability management (i.e., an economic hedge). For example, the FHLBank uses derivatives in its overall interest rate risk management to adjust the interest rate sensitivity of consolidated obligations to approximate more closely the interest rate sensitivity of assets (advances, investments and/or mortgage loans), and/or to adjust the interest rate sensitivity of advances, investments or mortgage loans to approximate more closely the interest rate sensitivity of liabilities.

In addition to using derivatives to manage mismatches of interest rate sensitivity between assets and liabilities, the FHLBank also uses derivatives as follows: (1) to manage embedded options in assets and liabilities; (2) to hedge the market value of existing assets and liabilities and anticipated transactions; (3) to hedge the duration risk of prepayable instruments; (4) to exactly offset other derivatives executed with members (when the FHLBank serves as an intermediary); and (5) to reduce funding costs.

Consistent with Finance Agency regulation, the FHLBank enters into derivatives only to reduce the interest rate risk exposures inherent in otherwise unhedged assets and funding positions to achieve risk management objectives and to act as an intermediary between its members and counterparties. Derivatives are used when they represent the most cost-effective alternative to achieve the FHLBank’s financial and risk management objectives. Accordingly, the FHLBank may enter into derivatives that do not necessarily qualify for hedge accounting (economic hedges as discussed above).

An economic hedge is defined as a derivative hedging specific or non-specific underlying assets, liabilities or firm commitments that does not qualify for hedge accounting but is an acceptable hedging strategy under the FHLBank’s Risk Management Policy. These economic hedging strategies also comply with Finance Agency regulatory requirements prohibiting speculative hedge transactions. An economic hedge by definition introduces the potential for earnings variability caused by changes in fair value on the derivative that are recorded in the FHLBank’s income but not offset by corresponding changes in the fair value of the economically hedged asset, liability or firm commitment being recorded simultaneously in income. As a result, the FHLBank recognizes only the change in fair value of these derivatives in other income (loss) as “Net gain (loss) on derivatives and hedging activities” with no offsetting fair value adjustments for the asset, liability or firm commitment.

Hedging Activities: The FHLBank documents all hedging relationships between derivatives designated as hedging instruments and hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value or cash flow hedges to: (1) assets and/or liabilities on the Statements of Condition; (2) firm commitments; or (3) forecasted transactions. For hedging relationships that are not designated for shortcut hedge accounting under SFAS 133, the FHLBank formally assesses (both at the hedge’s inception and at least quarterly on an ongoing basis) whether the derivatives that are used have been highly effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. The FHLBank typically uses regression analyses or similar statistical analyses to assess the effectiveness of its hedging relationships.

The FHLBank discontinues hedge accounting prospectively when: (1) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including hedged items such as firm commitments or forecasted transactions); (2) the derivative and/or the hedged item expires or is sold, terminated or exercised; (3) it is no longer probable that the forecasted transaction will occur in the originally expected period; (4) a hedged firm commitment no longer meets the definition of a firm commitment; or (5) management determines that designating the derivative as a hedging instrument in accordance with SFAS 133 is no longer appropriate.
 
Effectiveness Measurements: Highly effective hedges that use interest rate swaps as the hedging instrument and that meet certain stringent criteria can qualify for “shortcut” fair value hedge accounting. Shortcut hedge accounting allows for the assumption of no ineffectiveness, which means that the change in fair value of the hedged item can be assumed to be equal to the change in fair value of the derivative. This is in contrast to fair value hedges designated under the “long haul” hedge accounting method, where the change in fair value of the hedged item must be measured separately from the derivative, and for which effectiveness testing must be performed regularly with results falling within established tolerances.

Long haul hedge accounting method – For hedge transactions that are not designated under the shortcut hedge accounting method, the FHLBank completes effectiveness testing at inception and on a monthly basis thereafter. The rolling regression method and the dollar offset method are used by the FHLBank to assess hedge effectiveness.
§
Under the rolling regression method, the FHLBank models a series of 30 data points (market values) for the hedged item and the hedge instrument, using market data from the previous 30 calendar month-ends. A regression analysis is performed comparing the values of the hedged financial item and the hedge instrument. The hedge is deemed highly effective if: (1) the slope of the regression line is between or equal to -0.80 and -1.20, meaning that on average the change in value of the hedged financial instrument is offset by the change in value of the hedge instrument; (2) the correlation is 0.80 or higher; and (3) the calculated F statistic is 4 or higher. For new hedge transactions, the 30 data points (market values) are generated using historical market data.
§
The dollar-offset method measures the change in fair value between periods on the hedge instrument versus the change in the fair value between periods on the hedged item. Under this methodology, at inception, the FHLBank evaluates effectiveness of the hedging relationship using interest rate scenario stress testing (interest rate shock scenarios). Thereafter on a monthly basis, the FHLBank compares the change in cumulative fair value of the hedging instrument to the change in cumulative fair value of the hedged item. The amount of dollar-offset between the two items must fall into a range of between 80 percent and 120 percent in order for the hedge to be deemed highly effective.
 
Types of Assets and Liabilities Hedged:
Consolidated Obligations – While consolidated obligations are the joint and several obligations of the 12 FHLBanks, each FHLBank is individually a counterparty to derivatives associated with specific debt issues. For instance, in a typical transaction involving more than one FHLBank, fixed rate consolidated obligation bonds are issued for one or more FHLBanks, including FHLBank Topeka. In connection with its share of the bond issuance, FHLBank Topeka simultaneously enters into a matching derivative in which the counterparty pays fixed cash flows to FHLBank Topeka designed to mirror in timing and amount the cash outflows FHLBank Topeka pays on the consolidated obligation. Such transactions are designated as fair value hedges under SFAS 133. In this type of transaction, FHLBank Topeka typically pays the derivative counterparty a variable cash flow that closely matches the interest payments it receives on short-term or variable rate advances. Note, though, that most of the FHLBank’s swapped consolidated obligation bonds are fixed rate, callable bonds where the FHLBank is the sole issuer of the particular debt issue. The swap transaction with a counterparty for debt upon which the FHLBank is the sole issuer follows the same process reflected above (simultaneous, matching terms, etc.). This intermediation between the capital and derivatives markets permits the FHLBank to raise funds at costs lower than would otherwise be available through the issuance of simple fixed or variable rate consolidated obligations in the capital markets.

Advances – With the issuance of a convertible advance, the FHLBank purchases from the member an option that enables the FHLBank to convert an advance from fixed rate to variable rate if interest rates increase. Once the FHLBank exercises its option to convert an advance to an at-the-market variable rate, the member then owns the option to terminate the converted advance without fee or penalty on the conversion date and each interest rate reset date thereafter. The FHLBank hedges a convertible advance by entering into a cancelable derivative with a non-member counterparty where the FHLBank pays a fixed rate and receives a variable rate. The derivative counterparty may cancel the derivative on a put date. This type of hedge is designated as a fair value hedge under SFAS 133. The counterparty’s decision to cancel the derivative would normally occur in a rising rate environment. If the option is in-the-money, the derivative is cancelled by the derivative counterparty at par (i.e., without any premium or other payment to the FHLBank). When the derivative is cancelled, the FHLBank exercises its option to convert the advance to a variable rate. If a convertible advance is not prepaid by the member upon conversion to an at-the-market variable rate advance (i.e., callable variable rate advance), any hedge-related unamortized basis adjustment is amortized as a yield adjustment.

When fixed rate advances are issued to one or more borrowers, FHLBank Topeka can either fund the advances with fixed rate consolidated obligations with the same tenor or simultaneously enter into a matching derivative in which the counterparty receives fixed cash flows from FHLBank Topeka designed to mirror in timing and amount the cash inflows FHLBank Topeka receives on the advance. Such transactions are designated as fair value hedges under SFAS 133. In this type of transaction, FHLBank Topeka typically receives from the derivative counterparty a variable cash flow that closely matches the interest payments on short-term discount notes or swapped consolidated obligation bonds.

The optionality embedded in certain financial instruments held by the FHLBank can create interest rate risk. For example, when a member prepays an advance, the FHLBank could suffer lower future income if the principal portion of the prepaid advance were invested in lower-yielding assets that continue to be funded by higher-cost debt. To protect against this risk, the FHLBank generally charges a prepayment fee on an advance that makes it financially indifferent to a member’s decision to prepay the advance. When the FHLBank offers advances (other than short-term advances) that a member may prepay without a prepayment fee, it usually finances such advances with callable debt or otherwise hedges the option being sold to the member.
 
Mortgage Loans – The FHLBank invests in fixed rate mortgage loans through the MPF Program. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected lives of these investments, depending on changes in estimated future cash flows, which usually occur as a result of interest rate changes. The FHLBank may manage the interest rate and prepayment risk associated with mortgages through a combination of debt issuance and derivatives. The FHLBank issues both callable and non-callable debt to achieve cash flow patterns and liability durations similar to those expected on the mortgage loans. The FHLBank may use derivatives in conjunction with debt issuance to better match the expected prepayment characteristics of its mortgage loan portfolio.

Interest rate caps and floors, swaptions and callable swaps may also be used to hedge prepayment risk on the mortgage loans. Although these derivatives are valid economic hedges against the prepayment risk of the portfolio of mortgage loans, they are not specifically linked to individual loans and, therefore, do not receive either fair value or cash flow hedge accounting. The derivatives are marked-to-market through earnings.

Firm Commitment Strategies – Commitments that obligate the FHLBank to purchase closed fixed rate mortgage loans from its members are considered derivatives under SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (herein referred to as “SFAS 149”). Accordingly, each mortgage purchase commitment is recorded as a derivative asset or derivative liability at fair value, with changes in fair value recognized in current period earnings. When a mortgage purchase commitment derivative settles, the current market value of the commitment is included with the basis of the mortgage loan and amortized accordingly.

The FHLBank may also hedge a firm commitment for a forward starting advance or consolidated obligation bond through the use of an interest rate swap. In this case, the swap functions as the hedging instrument for both the hedging relationship involving the firm commitment and the subsequent hedging relationship involving the advance or bond. The basis movement associated with the firm commitment is rolled into the basis of the advance or bond at the time the commitment is terminated and the advance or bond is issued. The basis adjustment is then amortized into interest income or expense over the life of the advance or bond.

Investments – The FHLBank invests in U.S. Treasury securities, U.S. agency securities, GSE securities, MBS and the taxable portion of state or local housing finance agency securities. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and derivatives. The FHLBank may manage against prepayment and duration risks by funding investment securities with consolidated obligations that have call features. The FHLBank may also manage the risk arising from changing market prices and volatility of investment securities by entering into derivatives (economic hedges) that offset the changes in fair value or cash flows of the securities. The FHLBank’s derivatives currently associated with investment securities are designated as economic hedges with the changes in fair values of the derivatives being recorded as “Net gain (loss) on derivatives and hedging activities” in other income (loss) in the Statements of Income. The hedged investment securities are classified as “trading” with the changes in fair values recorded as “Net gain (loss) on trading securities” in other income (loss) in the Statements of Income.
 
Interest rate caps and floors, swaptions and callable swaps may also be used to hedge prepayment and option risk on the MBS and CMOs held in the FHLBank’s held-to-maturity portfolio. Although these derivatives are valid economic hedges against the prepayment and option risk of the portfolio of MBS and CMOs, they are not specifically linked to individual investment securities and, therefore, do not receive either fair value or cash flow hedge accounting. The derivatives are marked-to-market through earnings.

Anticipated Debt Issuance – The FHLBank enters into interest rate swaps for the anticipated issuance of fixed rate consolidated obligation bonds to hedge the variability in forecasted interest payments associated with fixed rate debt that has not yet been issued. The interest rate swap is terminated upon issuance of the fixed rate bond, with the realized gain or loss on the interest rate swap recorded in other comprehensive income. Realized gains and losses reported in accumulated other comprehensive income are recognized as earnings in the periods in which earnings are affected by the cash flows of the fixed rate bonds.

Managing Credit Risk on Derivatives: The FHLBank is subject to credit risk due to nonperformance by counterparties to the derivative agreements. The degree of counterparty risk on derivative agreements depends on the extent to which master netting arrangements are included in such contracts to mitigate the risk. The FHLBank manages counterparty credit risk through credit analyses and collateral requirements and by following the requirements set forth in its Risk Management Policy. Based on credit analyses and collateral requirements, FHLBank management does not anticipate any credit losses on its derivative agreements and therefore, there is no adjustment to the derivatives for nonperformance risk at December 31, 2008.

The contractual or notional amount of derivatives reflects the involvement of the FHLBank in the various classes of financial instruments. The notional amount of derivatives does not measure the credit risk exposure of the FHLBank, and the maximum credit exposure of the FHLBank is substantially less than the notional amount. The maximum credit risk is the estimated cost of replacing favorable derivatives if the counterparty defaults, and the related collateral, if any, is of less value to the FHLBank.
 
At December 31, 2008 and 2007, the FHLBank’s maximum credit risk, as defined above, was approximately $112,688,000 and $137,251,000, respectively. These totals include $25,704,000 and $78,216,000, respectively, of net accrued interest receivable. In determining its maximum credit risk, the FHLBank considers accrued interest receivables and payables and the legal right to offset derivative assets and liabilities by counterparty. The FHLBank held cash with a fair value of $78,162,000 and $59,640,000 as collateral as of December 31, 2008 and 2007, respectively. Additionally, collateral with respect to derivatives with member institutions includes collateral assigned to the FHLBank, as evidenced by a written security agreement and held by the member institution for the benefit of the FHLBank. The maximum credit risk reflected above applicable to a single counterparty was $44,112,000 and $67,687,000 as of December 31, 2008 and 2007, respectively. The counterparty was different each year. Counterparty credit exposure by rating (lower of Moody’s Investors Service or Standard & Poor’s) as of December 31, 2008, is indicated in the following table (in thousands):
 
   
AAA
    
AA
      
A
    
Member1
    
Total
  
Total net exposure at fair value
   $ 6,228     $ 1,680     $ 99,805     $ 4,975     $ 112,688  
Cash collateral held2
     0       0       78,162       0       78,162  
Net positive exposure after cash collateral
     6,228       1,680       21,643       4,975       34,526  
Other collateral
     0       0       0       4,975       4,975  
Net exposure after collateral
   $ 6,228     $ 1,680     $ 21,643     $ 0     $ 29,551  
                                         
Notional amount
   $ 570,876     $ 15,204,795     $ 19,157,250     $ 233,716     $ 35,166,637  

Counterparty credit exposure by rating (lower of Moody’s Investors Service or Standard & Poor’s) as of December 31, 2007, is indicated in the following table (in thousands):

   
AAA
    
AA
      
A
    
Member1
    
Total
  
Total net exposure at fair value
   $ 4,095     $ 116,989     $ 13,630     $ 2,537     $ 137,251  
Cash collateral held2
     0       52,705       6,935       0       59,640  
Net positive exposure after cash collateral
     4,095       64,284       6,695       2,537       77,611  
Other collateral
     0       0       0       2,537       2,537  
Net exposure after collateral
   $ 4,095     $ 64,284     $ 6,695     $ 0     $ 75,074  
                                         
Notional amount
   $ 748,194     $ 26,584,251     $ 9,212,017     $ 107,782     $ 36,652,244  
                    
1
Collateral held with respect to derivatives with members represents either collateral physically held by or on behalf of the FHLBank or collateral assigned to the FHLBank as evidenced by a written security agreement and held by the member for the benefit of the FHLBank.
2
Excludes collateral held in excess of exposure for any individual counterparty.
 
On September 15, 2008, Lehman Brothers Holding, Inc. filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code. Lehman Brothers Holding, Inc. is guarantor of Lehman Brothers Special Financing (LESF) with which the FHLBank had derivative transactions. Consequently, the FHLBank terminated and replaced the derivative instruments outstanding with LESF on September 19, 2008. On October 6, 2008, Lehman Brothers Financial Products (LEFP) filed a petition for protection from its creditors in the U.S. Bankruptcy Court. Consequently, the FHLBank terminated and replaced all derivative instruments outstanding with LEFP on October 15, 2008. The FHLBank concluded that the new derivatives would be highly effective both at inception and on an ongoing basis. In total, the FHLBank terminated and replaced 253 derivative instruments with total notional and fair value (excluding accrued interest) amounts of $6,316,812,000 and $(54,031,000), respectively. The net realized gain (loss) on the derivative terminations was $(592,000) and was recorded in net gain (loss) on derivative and hedging activities on the Statement of Income. An additional five derivative instruments with LESF with total notional and fair value (excluding accrued interest) amounts of $145,000,000 and $(1,189,000), respectively, were not replaced because they were to be called within one week of termination date. Under the FHLBank’s International Swaps and Derivatives Association, Inc. agreements with LESF and LEFP, the derivatives were settled on a net basis from the time that bankruptcy was declared or protection was filed through termination of the agreements. As of December 31, 2008, the FHLBank had a net liability of $17,875,000, which includes the final settlement amounts due LESF and LEFP net of any cash collateral delivered and accrued interest, recorded in other liabilities on the Statement of Condition.

The FHLBank transacts a significant portion of its derivatives with major banks and primary broker/dealers. Some of these banks and broker/dealers or their affiliates buy, sell and distribute consolidated obligations. No single entity dominates the FHLBank’s derivatives business. Assets pledged as collateral by the FHLBank to these counterparties are discussed more fully in Note 17. The FHLBank is not a derivatives dealer and thus does not trade derivatives for short-term profit.
 
Intermediary Derivatives –  To assist its members in meeting their hedging needs, the FHLBank acts as an intermediary between the members and other counterparties by entering into offsetting derivatives. This intermediation allows smaller members access to the derivatives market. The derivatives used in intermediary activities do not qualify for SFAS 133 hedge accounting treatment and are separately marked-to-market through earnings. The net result of the accounting for these derivatives does not significantly affect the operating results of the FHLBank. Gains and losses are recorded in other income (loss) and presented as “Net gain (loss) on derivatives and hedging activities.”

As of December 31, 2008 and 2007, the notional principal of derivative agreements in which the FHLBank is an intermediary was $218,587,000 and $173,550,000, respectively.

Financial Statement Impact and Additional Financial Information: For the years ended December 31, 2008, 2007 and 2006, the FHLBank recorded net gain (loss) on derivatives and hedging activities as follows (in thousands):

   
2008
    
2007
    
2006
  
Gain (loss) related to fair value hedge ineffectiveness
   $ (8,499 )   $ (2,104 )   $ 1,577  
Gain (loss) on economic hedges
     (206,994 )     (8,041 )     9,961  
Net gain (loss) on derivatives and hedging activities
   $ (215,493 )   $ (10,145 )   $ 11,538  

There were no amounts for the years ended December 31, 2008, 2007 and 2006 that were reclassified into earnings as a result of the discontinuance of cash flow hedges because it became probable that the original forecasted transactions would not occur by the end of the originally specified time period or within a two-month period thereafter. As of December 31, 2008, no amounts relating to hedging activities remain in accumulated other comprehensive income.

The following table represents outstanding notional balances and estimated fair values of the derivatives outstanding by type of derivative and by hedge designation at December 31, 2008 and 2007 (in thousands):
 
   
2008
    
2007
  
   
Notional
    
Estimated
Fair Value
    
Notional
    
Estimated
Fair Value
  
Interest rate swaps
                        
Fair value
   $ 25,557,860     $ (436,789 )   $ 31,581,573     $ (131,820 )
Economic
     2,633,621       (232,934 )     1,436,164       (18,917 )
                                 
Interest rate caps/floors
                                
Fair value
     95,000       102       142,500       (202 )
Economic
     6,755,733       63,474       3,471,000       21,267  
                                 
Mortgage delivery commitments
                                
Economic
     124,423       (1,539 )     21,007       57  
                                 
TOTAL
   $ 35,166,637     $ (607,686 )   $ 36,652,244     $ (129,615 )
                                 
Total derivative fair value excluding accrued interest
     $ (607,686 )           $ (129,615 )
Net accrued interest receivable
       70,394               127,545  
Fair value of cash collateral delivered to counterparty
       245,624               30,938  
Fair value of cash collateral received from counterparty
       (78,162 )             (59,640 )
NET DERIVATIVE FAIR VALUE
     $ (369,830 )            $ (30,772 )
                                 
Net derivative asset balances
     $ 34,526             $ 77,611  
Net derivative liability balances
       (404,356 )             (108,383 )
NET DERIVATIVE BALANCES
     $ (369,830 )           $ (30,772 )
 
 
NOTE 10 – DEPOSITS

The FHLBank offers demand and overnight deposit programs to its members and to other qualifying non-members. In addition, the FHLBank offers short-term deposit programs to members. A member that services mortgage loans may deposit with the FHLBank funds collected in connection with the mortgage loans, pending disbursement of such funds to owners of the mortgage loans. The FHLBank classifies these items as “Non-interest-bearing other deposits” on its Statements of Condition.

Deposits classified as demand, overnight and other pay interest based on a daily interest rate. Term deposits pay interest based on a fixed rate determined at the issuance of the deposit. The average interest rates paid on average deposits were 1.92 percent, 4.93 percent and 4.83 percent during 2008, 2007 and 2006, respectively.

See Note 18 for detailed information on transactions with related parties.


NOTE 11 – CONSOLIDATED OBLIGATIONS

Consolidated obligations consist of consolidated bonds and discount notes and as provided by the Bank Act or Finance Agency regulation, are backed only by the financial resources of the FHLBanks. The FHLBanks jointly issue consolidated obligations with the Office of Finance acting as their agent. The Office of Finance tracks the amounts of debt issued on behalf of each FHLBank. In addition, the FHLBank separately tracks and records as a liability its specific portion of consolidated obligations for which it is the primary obligor. Prior to 2009, each FHLBank specified the amount of debt it wanted the Office of Finance to issue on its behalf. During December 2008, a debt issuance process was implemented by the FHLBanks and the Office of Finance to provide a scheduled monthly issuance of global bullet consolidated obligation bonds during 2009. As part of this process, management from each of the FHLBanks will determine and communicate a firm commitment to the Office of Finance for an amount of scheduled global debt to be issued on its behalf. If the FHLBanks’ orders do not meet the minimum debt issue size, the proceeds are allocated to all FHLBanks based on the larger of the FHLBank’s commitment or allocated proceeds based on the individual FHLBank’s capital to total system capital. If the FHLBanks’ commitments exceed the minimum debt issue size the proceeds are allocated based on relative capital of the FHLBanks’ with the allocation limited to the lesser of the allocation amount or actual commitment amount. The Finance Agency and the U.S. Secretary of the Treasury have oversight over the issuance of FHLBank debt through the Office of Finance. The FHLBanks can, however, pass on any scheduled calendar slot and not issue any global bullet consolidated obligation bonds upon agreement of 8 of the 12 FHLBanks. Consolidated obligation bonds are issued primarily to raise intermediate- and long-term funds for the FHLBanks and are not subject to any statutory or regulatory limits as to maturities. Consolidated obligation discount notes, which are issued to raise short-term funds, are issued at less than their face amounts and redeemed at par when they mature.

Although the FHLBank is primarily liable for its portion of consolidated obligations (i.e., those issued on its behalf), the FHLBank is also jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all consolidated obligations of each of the FHLBanks. The Finance Agency, at its discretion, may require any FHLBank to make principal or interest payments due on any consolidated obligations for which the FHLBank is not the primary obligor. Although it has never occurred, to the extent that an FHLBank would be required to make a payment on a consolidated obligation on behalf of another FHLBank, the paying FHLBank would be entitled to reimbursement from the non-complying FHLBank. However, if the Finance Agency determines that the non-complying FHLBank is unable to satisfy its obligations, then the Finance Agency may allocate the non-complying FHLBank’s outstanding consolidated obligation debt among the remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding, or on any other basis the Finance Agency may determine.

The par value of outstanding consolidated obligations of all FHLBanks, including outstanding consolidated obligations issued on behalf of the FHLBank, was approximately $1,251,541,664,000 and $1,189,705,970,000 as of December 31, 2008 and 2007, respectively. See Note 19 for FHLBank obligations acquired by FHLBank Topeka as investments. Finance Agency regulations require that each FHLBank maintain qualifying assets, free from any lien or pledge, in an amount at least equal to the amount of that FHLBank’s participation in the total consolidated obligations outstanding. Qualifying assets are defined as cash; obligations of, or fully guaranteed by, the United States; secured advances; mortgages, which have any guaranty, insurance, or commitment from the U.S. or any agency of the United States; investments described in Section 16(a) of the Bank Act (e.g., securities that a fiduciary or trust fund may purchase under the laws of the state in which the FHLBank is located); and other securities that are assigned a rating or assessment by a nationally recognized statistical rating organization (NRSRO) that is equivalent or higher than the rating or assessment assigned by that NRSRO to consolidated obligations.

General Terms: Consolidated obligation bonds are issued with either fixed rate coupon or variable rate coupon payment terms. Variable rate coupon bonds use a variety of indices for interest rate resets including the London Interbank Offered Rate (LIBOR), Constant Maturity Treasuries (CMT) and Eleventh District Cost of Funds Index (COFI). In addition, to meet the specific needs of certain investors in consolidated obligation bonds, fixed rate and variable rate bonds may contain certain features that may result in complex coupon payment terms and call features. When the FHLBank issues such structured bonds that present interest rate or other risks that are unacceptable to the FHLBank, it will simultaneously enter into derivatives containing offsetting features that effectively alter the terms of the complex bonds to the equivalent of simple fixed rate coupon bonds or variable rate coupon bonds tied to indices such as those detailed above.

In addition to consolidated obligation bonds having fixed rate or simple variable rate coupon payment terms, FHLBank also issued or had outstanding consolidated obligation bonds with the following broad terms, regarding either the principal repayment or coupon payment:
§
Optional principal redemption bonds (callable bonds) that may be redeemed in whole or in part at the discretion of the FHLBank on predetermined call dates in accordance with terms of bond offerings;
§
Range bonds that have coupons at fixed or variable rates and pay the fixed or variable rate as long as the index rate is within the established range, but generally pay zero percent or a minimal interest rate if the specified index rate is outside the established range;
§
Step bonds that have coupons at fixed or variable rates for specified intervals over the lives of the bonds. At the end of each specified interval, the coupon rate or variable rate spread increases (decreases) or steps up (steps down). These bond issues generally contain call provisions enabling the bonds to be called at the FHLBank’s discretion on the step dates; and
§
Zero coupon bonds that are long-term, discounted instruments earning fixed yields to maturity or to the optional principal redemption date. All principal and interest payments are made at bond maturity or the optional principal redemption date, if exercised by the FHLBank before bond maturity.

Redemption Terms: Following is a summary of the FHLBank’s participation in consolidated obligation bonds outstanding as of December 31, 2008 and 2007 (in thousands):
 
   
December 31, 2008
    
December 31, 2007
  
Year of Maturity
  
Amount
    
Weighted
Average
Interest Rate
    
Amount
    
Weighted
Average
Interest Rate
  
Due in one year or less
   $ 8,044,892       3.19 %   $ 6,498,100       4.31 %
Due after one year through two years
     6,109,694       2.73       4,399,568       4.64  
Due after two years through three years
     2,205,320       4.13       3,120,616       4.68  
Due after three years through four years
     1,452,300       4.51       2,143,820       5.00  
Due after four years through five years
     2,237,000       4.10       2,943,800       4.91  
Thereafter
     6,971,000       5.78       12,127,827       5.57  
Total par value
     27,020,206       3.98 %     31,233,731       4.99 %
Premium
     18,761               9,596          
Discount
     (15,108 )             (15,270 )        
SFAS 133 fair value adjustments
     397,775               (14,699 )        
TOTAL
   $ 27,421,634             $ 31,213,358          

The FHLBank’s participation in consolidated obligation bonds outstanding as of December 31, 2008 and 2007 includes callable bonds totaling $9,850,000,000 and $20,194,827,000, respectively. The FHLBank uses the unswapped callable bonds for financing its callable advances (Note 7), mortgage-backed securities (Notes 4 and 6) and MPF mortgage loans (Note 8). Contemporaneous with a majority of its fixed rate callable bond issues, the FHLBank will also enter into interest rate swap agreements (in which the FHLBank generally pays a variable rate and receives a fixed rate) with call features that mirror the options in the callable bonds (a sold callable swap). The combined sold callable swap and callable debt transaction allows the FHLBank to obtain attractively priced variable rate financing.

The following table summarizes the FHLBank’s participation in consolidated obligation bonds outstanding by year of maturity, or by the next call date for callable bonds (in thousands):

Year of Maturity of Next Call Date
  
2008
    
2007
  
Due in one year or less
   $ 15,299,892     $ 23,060,927  
Due after one year through two years
     5,984,694       3,457,568  
Due after two years through three years
     1,460,320       1,643,616  
Due after three years through four years
     757,300       580,820  
Due after four years through five years
     1,657,000       498,800  
Thereafter
     1,861,000       1,992,000  
TOTAL PAR VALUE
   $ 27,020,206     $ 31,233,731  
 
Interest Rate Payment Terms: The following table summarizes interest rate payment terms for consolidated obligation bonds as of December 31, 2008 and 2007 (in thousands):

   
2008
    
2007
  
Par value of consolidated obligation bonds:
            
Fixed rate
   $ 20,121,025     $ 21,098,185  
Variable rate
     3,532,500       0  
Range bonds
     2,375,000       4,450,500  
Step ups
     990,000       5,280,000  
Zero coupon
     1,681       190,046  
Step downs
     0       215,000  
TOTAL PAR VALUE
     27,020,206     $ 31,233,731  

Discount Notes: The following table summarizes the FHLBank’s participation in consolidated obligation discount notes, all of which are due within one year (in thousands):

   
Book Value
    
Par Value
    
Weighted
Average
Interest Rates
  
December 31, 2008
   $ 26,261,411     $ 26,317,524       1.23 %
                         
December 31, 2007
   $ 19,896,098     $ 19,964,789       4.21 %

Information about the estimated fair value of the consolidated obligations is included in Note 16.


NOTE 12 – AFFORDABLE HOUSING PROGRAM

The Bank Act, as amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989, requires each FHLBank to establish an AHP. As a part of its AHP, the FHLBank provides subsidies in the form of direct grants or below-market interest rate advances to members that use the funds to assist in the purchase, construction or rehabilitation of housing for very low-, low- and moderate-income households. To fund the AHP, the 12 district FHLBanks as a group must annually set aside the greater of $100,000,000 or 10 percent of the current year’s regulatory income. Regulatory income is defined as income calculated in accordance with GAAP before interest expense related to mandatorily redeemable capital stock under SFAS 150 and the assessment for AHP, but after the assessment to REFCORP. The exclusion of interest expense related to mandatorily redeemable capital stock is a regulatory calculation determined by the Finance Agency. The AHP and REFCORP assessments are calculated simultaneously because of their interdependence on each other. The FHLBank accrues this expense monthly based on its income. Calculation of the REFCORP assessment is discussed in Note 13.

The amount set aside for AHP is charged to expense and recognized as a liability. As subsidies are provided through the disbursement of grants or issuance of subsidized advances, the AHP liability is reduced accordingly. If the FHLBank’s regulatory income before AHP and REFCORP would ever be zero or less, the amount of AHP liability would generally be equal to zero. However, if the result of the aggregate 10 percent calculation described above is less than the $100,000,000 minimum for all 12 FHLBanks, then the Bank Act requires the shortfall to be allocated among the FHLBanks based on the ratio of each FHLBank’s income for the previous year. There was no shortfall in 2008, 2007 or 2006. If an FHLBank determines that its required AHP contributions are exacerbating any financial instability of that FHLBank, it may apply to the Finance Agency for a temporary suspension of its AHP contributions. The FHLBank has never applied to the Finance Agency for a temporary suspension of its AHP contributions.

As of December 31, 2008, the FHLBank’s AHP accrual on its Statements of Condition consisted of $5,080,000 for the 2009 AHP (uncommitted, including amounts recaptured and reallocated from prior years) and $22,627,000 for prior years’ AHP (committed but undisbursed).

The following table details the change in the AHP liability for the years ended December 31, 2008, 2007 and 2006 (in thousands):
 
   
2008
    
2007
    
2006
  
Appropriated and reserved AHP funds as of the beginning of the period
   $ 41,357     $ 36,214     $ 30,709  
AHP set aside based on current year income
     3,228       16,934       15,460  
Direct grants disbursed
     (17,246 )     (12,585 )     (10,819 )
Recaptured funds1
     368       794       864  
Appropriated and reserved AHP funds as of the end of the period
   $ 27,707     $ 41,357     $ 36,214  
                    
1
Recaptured funds are direct grants returned to the FHLBank in those instances where the commitments associated with the approved use of funds are not met and repayment to the FHLBank is required by regulation. Recaptured funds are returned as a result of: (1) AHP-assisted homeowner’s transfer or sale of property within the five-year retention period that the assisted homeowner is required to occupy the property; (2) homeowner’s failure to acquire sufficient loan funding (funds previously approved and disbursed cannot be used); or (3) unused grants. Recaptured funds are reallocated to future periods.

 
NOTE 13 – RESOLUTION FUNDING CORPORATION (REFCORP)

Each FHLBank is required to pay 20 percent of income calculated in accordance with GAAP after the assessment for AHP, but before the assessment for REFCORP. The AHP and REFCORP assessments are calculated simultaneously because of their interdependence on each other. The FHLBank accrues its REFCORP assessment on a monthly basis. Calculation of the AHP assessment is discussed in Note 12. The Resolution Funding Corporation has been designated as the calculation agent for AHP and REFCORP assessments. Each FHLBank provides its interest expense related to mandatorily redeemable capital stock under SFAS 150 and net income before AHP and REFCORP to the Resolution Funding Corporation, which then performs the calculations for each quarter end and levies the assessments to the FHLBanks for the quarter.

The FHLBanks will continue to expense these amounts until the aggregate amounts actually paid by all 12 FHLBanks are equivalent to a $300,000,000 annual annuity (or a scheduled payment of $75,000,000 per quarter) whose final maturity date is April 15, 2030, at which point the required payment of each FHLBank to REFCORP will be fully satisfied. The Finance Agency in consultation with the Secretary of the Treasury selects the appropriate discounting factors to be used in this annuity calculation. The FHLBanks use the actual payments made to determine the amount of the future obligation that has been defeased. The cumulative amount to be paid to REFCORP by FHLBank Topeka cannot be determined at this time because of the interrelationships of all future FHLBanks’ earnings and interest rates. If the FHLBank experienced a net loss during a quarter, but still had net income for the year, the FHLBank’s obligation to REFCORP would be calculated based on the FHLBank’s year-to-date net income. The FHLBank would be entitled to a credit against future REFCORP assessments, without any time constraints, if amounts paid for the full year were in excess of its calculated annual obligation that would be recorded in other assets on the FHLBank’s Statements of Condition. If the FHLBank had net income in subsequent quarters, it would be required to contribute additional amounts to meet its calculated annual obligation. If the FHLBank experienced a net loss for a full year, the FHLBank would have no obligation to REFCORP for the year.

The Finance Agency is required to extend the term of the FHLBanks’ obligation to REFCORP for each calendar quarter in which there is a deficit quarterly payment. A deficit quarterly payment is the amount by which the actual quarterly payment by the 12 FHLBanks falls short of $75,000,000.

The FHLBanks’ aggregate payments through 2008 exceeded the scheduled payments, effectively accelerating payment of the REFCORP obligation and shortening its remaining term to April 15, 2013, effective December 31, 2008. The FHLBanks’ aggregate payments through 2008 have satisfied $42,542,000 of the $75,000,000 scheduled payment due on April 15, 2013 and all scheduled payments thereafter. This date assumes that all $75,000,000 quarterly payments required after December 31, 2008, will be made as scheduled.

The benchmark payments or portions thereof could be reinstated if the actual REFCORP payments of the FHLBanks fall short of $75,000,000 in a quarter in the future. The maturity date of the REFCORP obligation may be extended beyond April 15, 2030, if such extension is necessary to ensure that the value of the aggregate amounts paid by the FHLBanks exactly equals a $300,000,000 annual annuity. Any payment beyond April 15, 2030 will be paid to the Department of the Treasury.

The following table details the change in the REFCORP liability for the years ended December 31, 2008, 2007 and 2006 (in thousands):
 
   
2008
    
2007
    
2006
  
REFCORP obligation as of the beginning of the period
   $ 11,067     $ 9,372     $ 13,284  
REFCORP assessments
     7,110       37,576       34,118  
REFCORP payments
     (34,192 )     (35,881 )     (38,030 )
REFCORP (receivable) obligation as of the end of the period
   $ (16,015 )    $ 11,067     $ 9,372  
 
NOTE 14 – CAPITAL

The FHLBank is subject to three capital requirements (i.e., risk-based capital, total capital-to-asset ratio and leverage capital ratio) under the provisions of the Gramm-Leach-Bliley Act (GLB Act) and the Finance Agency’s capital structure regulation. The FHLBank must maintain at all times permanent capital in an amount at least equal to the sum of its credit risk, market risk and operations risk capital requirements. The risk-based capital requirements are all calculated in accordance with the rules and regulations of the Finance Agency. Only permanent capital, defined as Class B Common Stock and retained earnings, can be used by the FHLBank to satisfy its risk-based capital requirement. The Finance Agency may require the FHLBank to maintain a greater amount of permanent capital than is required by the risk-based capital requirement as defined, but the Finance Agency has not placed any such requirement on the FHLBank to date. In addition, the GLB Act requires the FHLBank to maintain at all times at least a 4.0 percent total capital-to-asset ratio and at least a 5.0 percent leverage capital ratio, with the leverage capital ratio defined as the sum of permanent capital weighted 1.5 times and non-permanent capital (currently only Class A Common Stock) weighted 1.0 times divided by total assets.

The following table illustrates that the FHLBank was in compliance with its regulatory capital requirements at December 31, 2008 and 2007 (in thousands):
 
   
2008
    
2007
  
   
Required
    
Actual
    
Required
    
Actual
  
Regulatory capital requirements:
                        
Risk-based capital
   $ 1,389,373     $ 1,763,395     $ 665,889     $ 1,696,169  
Total capital-to-asset ratio
     4.0 %     4.2 %     4.0 %     4.2 %
Total capital
   $ 2,342,249     $ 2,432,063     $ 2,212,183     $ 2,336,097  
Leverage capital ratio
     5.0 %     5.7 %     5.0 %     5.8 %
Leverage capital
   $ 2,927,812     $ 3,313,760     $ 2,765,229     $ 3,184,181  

Note that for the purposes of the regulatory capital calculations in the above table, actual capital includes all capital stock subject to mandatory redemption that has been reclassified to a liability under SFAS 150.

The FHLBank offers two classes of stock, Class A Common Stock and Class B Common Stock. Each member is required to hold capital stock to become and remain a member of the FHLBank (Asset-based Stock Purchase Requirement; Class A Common Stock) and enter into specified activities with the FHLBank including but not limited to access to the FHLBank’s credit products and selling AMA to the FHLBank (Activity-based Stock Purchase Requirement; Class A Common Stock to the extent of a member’s Asset-based Stock Purchase Requirement, then Class B Common Stock for the remainder). The amount of Class A Common Stock a member must acquire and maintain is the Asset-based Stock Purchase Requirement, which is equal to 0.2 percent of a member’s total assets as of December 31 of the preceding calendar year, with a minimum requirement of $1,000, and a maximum requirement of $1,000,000. The amount of Class B Common Stock a member must acquire and maintain is the Activity-based Stock Purchase Requirement, which is equal to the sum of the following less the member’s Asset-based Stock Purchase Requirement:
§
5.0 percent of the principal amount of advances outstanding to the member; plus
§
2.0 percent of the current outstanding principal balance of AMA originated by or through the member and acquired by the FHLBank subject to a maximum AMA requirement of 1.5 percent of the member’s total assets as of December 31 of the preceding calendar year; plus
§
0 percent of the principal amount of letters of credit outstanding at the request of the member; plus
§
0 percent of the notional principal of any outstanding derivatives with the member.

The percentages listed above are subject to change by the FHLBank within ranges established in its capital plan. Changes to the percentages outside of the capital plan percentages require the FHLBank to request Finance Agency approval of an amended capital plan. See Note 18 for detailed information on transactions with related parties.

Any member may make a written request not in connection with a notice of withdrawal or attaining nonmember status for the redemption of a part of its Class A Common Stock or all or part of its Class B Common Stock (i.e., excess stock redemption request). Within five business days of receipt of a member’s written redemption request, the FHLBank may notify the member that it declines to repurchase the excess stock before the end of that five business day period, at which time the applicable redemption period shall commence. Otherwise, the FHLBank will repurchase any excess stock within the five business day period. The redemption periods are six months for Class A Common Stock and five years for Class B Common Stock. Subject to certain limitations, the FHLBank may choose to repurchase a member’s excess stock on or before the end of the applicable redemption period.

The GLB Act made membership voluntary for all members. As outlined in the FHLBank’s capital plan, members that withdraw from membership must wait five years from the divestiture date for all capital stock that is held as a condition of membership (Class A Common Stock up to member’s Asset-based Stock Purchase Requirement), unless the member cancels its notice of withdrawal prior to that date, before being readmitted to membership in any FHLBank.

The FHLBank’s board of directors may declare and pay non-cumulative dividends, expressed as a percentage rate per annum based upon the par value of capital stock on shares of Class A Common Stock outstanding and on shares of Class B Common Stock outstanding, out of previously retained earnings and current earnings in either cash or Class B Common Stock. There is no dividend preference between Class A Common Stockholders and Class B Common Stockholders up to the Dividend Parity Threshold (DPT). Dividend rates in excess of the DPT may be paid on Class A Common Stock or Class B Common Stock at the discretion of the board of directors, provided, however, that the dividend rate paid per annum on the Class B Common Stock equals or exceeds the dividend rate per annum paid on the Class A Common Stock for any dividend period. The DPT can be changed at any time by the board of directors but will only be effective for dividends paid at least 90 days after the date members are notified by the FHLBank. The DPT effective for dividends paid during 2006 and the first three quarters of 2007 was equal to the average of three-month LIBOR for a dividend period minus 100 basis points. In September 2007, the board of directors changed the DPT to be equal to the average overnight Federal funds effective rate minus 100 basis points. This DPT was effective for dividends paid during the fourth quarter of 2007 and all of 2008 and will continue to be effective until such time as it may be changed by the FHLBank’s board of directors. With the overnight Federal funds effective rate being below 1.00 percent for the fourth quarter of 2008, the DPT was zero percent for that dividend period (DPT is floored at zero).

The board of directors cannot declare a dividend if: (1) the FHLBank’s capital position is below its minimum regulatory capital requirements; (2) the FHLBank’s capital position will be below its minimum regulatory capital requirements after paying the dividend; (3) the principal or interest due on any consolidated obligation of the FHLBank has not been paid in full; (4) the FHLBank fails to provide the Finance Agency the quarterly certification prior to declaring or paying dividends for a quarter; or (5) the FHLBank fails to provide notification upon its inability to provide such certification or upon a projection that it will fail to comply with statutory or regulatory liquidity requirements or will be unable to timely and fully meet all of its current obligations.

The FHLBank is a cooperative whose members and former members own all of the FHLBank’s capital stock. Member shares cannot be purchased or sold except between the FHLBank and its members at its $100 per share par value. If a member cancels its written notice of redemption or notice of withdrawal, the FHLBank will reclassify mandatorily redeemable capital stock from a liability to equity in accordance with SFAS 150. After the reclassification, dividends on the capital stock would no longer be classified as interest expense. For the years ended December 31, 2008, 2007 and 2006, dividends on mandatorily redeemable capital stock in the amount of $609,000, $2,101,000 and $2,594,000, respectively, were recorded as interest expense.

At December 31, 2008 and 2007, the FHLBank had $34,806,000 and $36,147,000, respectively, in capital stock subject to mandatory redemption from members and former members, consisting of $34,726,000 and $35,739,000, respectively, of Class A Common Stock and $80,000 and $408,000, respectively, of Class B Common Stock. These amounts have been classified as a liability (mandatorily redeemable capital stock) in the Statements of Condition in accordance with SFAS 150.

The following table provides the number of members that notified the FHLBank of their respective decisions to voluntarily redeem their capital stock and the number of redemptions during 2008 and 2007:
 
   
2008
    
2007
  
Balance at beginning of period
     13       12  
Capital stock subject to mandatory redemption reclassified from equity:
                
Withdrawals
     3       2  
Other redemptions
     155       162  
Redemption of mandatorily redeemable capital stock:
                
Withdrawals
     (2 )     (1 )
Other redemptions
     (154 )     (162 )
Balance at end of period
     15       13  

The Finance Agency issued a regulatory interpretation confirming that the SFAS 150 accounting treatment for certain shares of FHLBank capital stock does not affect the definition of regulatory capital for purposes of determining the FHLBank’s compliance with its regulatory capital requirements, calculating its mortgage securities investment authority (various percentages of total FHLBank capital depending on the date acquired), calculating its unsecured credit exposure to other GSEs (100 percent of total FHLBank capital) or calculating its unsecured credit limits to other counterparties (various percentages of total FHLBank capital depending on the rating of the counterparty).

The following table shows the amount of mandatorily redeemable capital stock by year of redemption as of December 31, 2008 and 2007 (in thousands). The year of redemption in the table is the later of the end of the redemption period or the maturity date of the activity the stock is related to if the capital stock represents the Activity-based Stock Purchase Requirement for a non-member (former member that withdrew from membership, merged into a non-member or was otherwise acquired by a non-member). The FHLBank will not redeem or repurchase membership stock (Asset-based Stock Purchase Requirement held in form of Class A Common Stock) until six months after the FHLBank receives notice for withdrawal. The FHLBank is not required to redeem or repurchase activity-based stock until any activity-based stock becomes excess stock as a result of an activity no longer remaining outstanding. However, the FHLBank intends to repurchase the excess activity-based stock of non-members to the extent that it can do so and still meet its regulatory capital requirements.
 
Contractual Year of Repurchase
  
2008
    
2007
  
Year 1
   $ 17,168     $ 2,593  
Year 2
     5,907       15,603  
Year 3
     3,913       5,947  
Year 4
     592       3,703  
Year 5
     603       626  
Thereafter
     6,623       7,675  
TOTAL
   $ 34,806     $ 36,147  

The FHLBank’s activity for mandatorily redeemable capital stock was as follows during 2008, 2007 and 2006 (in thousands).

   
2008
    
2007
    
2006
  
Balance at beginning of period
   $ 36,147     $ 46,232     $ 64,355  
Capital stock subject to mandatory redemption reclassified from equity during the period
     1,899,747       1,849,267       530,121  
Redemption or repurchase of mandatorily redeemable capital stock during the period
     (1,901,694 )     (1,861,443 )     (550,832 )
Stock dividend classified as mandatorily redeemable capital stock during the period
     606       2,091       2,588  
Balance at end of period
   $ 34,806     $ 36,147     $ 46,232  

A member may cancel or revoke its written redemption request prior to the end of the redemption period (six months for Class A Common Stock and five years for Class B Common Stock) or its written notice of withdrawal from membership prior to the end of a six-month period starting on the date the FHLBank received the member’s written notice of withdrawal from membership. At the end of the six-month period, the member’s membership is terminated and the Class A Common Stock held to meet its Asset-based Stock Purchase Requirement will be redeemed by the FHLBank, as long as the FHLBank will continue to meet its regulatory capital requirements and as long as the Class A Common Stock is not needed to meet the former member’s Activity-based Stock Purchase Requirements. The FHLBank’s capital plan provides that the FHLBank will charge the member a cancellation fee in accordance with a schedule where the amount of the fee increases with the passage of time, the fee being 1.0 percent for any Class A Common Stock cancellation and starting at 1.0 percent in year one for Class B Common Stock and increasing by 1.0 percent each year to a maximum of 5.0 percent for cancellations in the fifth year for Class B Common Stock. The FHLBank has not received any requests to revoke redemption requests in the periods presented.

Statutory and Regulatory Restrictions on Capital Stock Redemption: In accordance with the GLB Act, each class of FHLBank capital stock is considered putable with restrictions given the significant restrictions on the obligation/right to redeem and the limitation of the redemption privilege to a small fraction of outstanding capital stock. Statutory and regulatory restrictions on the redemption of FHLBank capital stock include the following:
§
In no instance may the FHLBank redeem any capital stock if, following such redemption, the FHLBank would fail to satisfy its minimum regulatory capital requirements (i.e., the statutory risk-based capital requirement and the total capital and weighted leverage ratio requirements established by the GLB Act and by the Finance Agency, all three of which were discussed previously). By law, all member holdings of FHLBank capital stock immediately become non-redeemable if their FHLBank becomes undercapitalized and, at the macro level, only a minimal portion of outstanding stock qualifies for redemption consideration.
§
In no instance may the FHLBank redeem any capital stock if either its board of directors or the Finance Agency determines that it has incurred, or is likely to incur, losses resulting, or expected to result, in a charge against capital.
§
In addition to possessing the authority to prohibit capital stock redemptions, the FHLBank’s board of directors has a right and an obligation to call for additional capital stock purchases by its members, as a condition of membership, as needed to satisfy statutory and regulatory capital requirements. These requirements include the maintenance of a stand-alone “AA” credit rating from an NRSRO.
§
If, during the period between receipt of a capital stock redemption notification or request from a member and the actual redemption (which lasts indefinitely if the FHLBank is undercapitalized, does not have the required credit rating, etc.), the FHLBank becomes insolvent and is either liquidated or forced to merge with another FHLBank, the redemption value of the capital stock will be established either through the market liquidation process or through negotiation with a merger partner. In either case, all senior claims must first be settled at par, and there are no claims which are subordinated to the rights of the FHLBank stockholders.
§
The GLB Act states that the FHLBank may repurchase, at its sole discretion, capital stock investments that exceed the required minimum stock purchase requirements as long as the FHLBank continues to meet its regulatory capital requirements.
§
In no instance may the FHLBank redeem any capital stock if the principal or interest due on any consolidated obligation issued by the Office of Finance has not been paid in full.
§
In no instance may the FHLBank redeem any capital stock if it fails to provide the Finance Agency quarterly certification required by section 966.9(b)(1) of the Finance Agency’s rules prior to declaring or paying dividends for a quarter.
§
In no case may the FHLBank redeem any capital stock if the FHLBank is unable to provide the required certification, projects that it will fail to comply with statutory or regulatory liquidity requirements or will be unable to timely and fully meet all its obligations, actually fails to satisfy these requirements or obligations, or negotiates to enter or enters into an agreement with another FHLBank to obtain financial assistance to meet its current obligations.
 
NOTE 15 – EMPLOYEE RETIREMENT PLANS

The FHLBank participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra Defined Benefit Plan), a tax-qualified defined-benefit pension plan, formerly known as the Financial Institutions Retirement Fund. Substantially all officers and employees of the FHLBank, which began employment prior to January 1, 2009, are covered by the plan. Funding and administrative costs of the Pentegra Defined Benefit Plan charged to compensation and benefits expense were $2,008,000, $2,494,000 and $2,349,000 in 2008, 2007 and 2006, respectively. The Pentegra Defined Benefit Plan is a multiemployer plan and does not segregate its assets, liabilities or costs by participating employer. As a result, disclosure of the accumulated benefit obligations, plan assets and the components of annual pension expense attributable to the FHLBank cannot be made.

The FHLBank also participates in the Pentegra Defined Contribution Plan for Financial Institutions, a tax-qualified defined contribution pension plan, formerly known as the Financial Institutions Thrift Plan. Substantially all officers and employees of the FHLBank are covered by the plan. The FHLBank contributes a matching amount equal to a percentage of voluntary employee contributions, subject to certain limitations. The FHLBank’s contributions of $671,000, $569,000 and $511,000 to the Pentegra Defined Contribution Plan in 2008, 2007 and 2006, respectively, were charged to compensation and benefits expense.

In addition, the FHLBank maintains a benefit equalization plan (BEP) covering certain senior officers. This non-qualified plan contains provisions for a deferred compensation component and a defined benefit pension component. The BEP is, in substance, an unfunded supplemental retirement plan. The cost of the defined benefit pension component of the BEP charged to compensation and benefits expense was $769,000, $771,000 and $650,000 in 2008, 2007 and 2006, respectively. Compensation and benefits expense and other interest expense includes deferred compensation and accrued earnings under the BEP of $254,000, $225,000 and $218,000 in 2008, 2007 and 2006, respectively.

As indicated previously, the BEP is a supplemental retirement plan for covered retirees. There are no funded plan assets that have been designated to provide for the deferred compensation component or defined benefit pension component of the BEP. The obligations and funding status of the defined benefit portion of the FHLBank’s BEP at December 31, 2008 and 2007 were as follows (in thousands):

   
2008
    
2007
  
Change in benefit obligation:
            
Projected benefit obligation at beginning of year
   $ 5,820     $ 5,733  
Service cost
     217       189  
Interest cost
     364       333  
Benefits paid
     (225 )     (225 )
Actuarial (gain) loss
     116       (210 )
Projected benefit obligation at end of year
     6,292       5,820  
Change in plan assets:
                
Fair value of plan assets at beginning of year
     0       0  
Employer contributions
     225       225  
Benefits paid
     (225 )     (225 )
Fair value of plan assets at end of year
     0       0  
FUNDED STATUS
   $ 6,292     $ 5,820  

The following table details the change in the accumulated other comprehensive income balances related to the defined benefit portion of the FHLBank’s BEP for the years ended December 31, 2008 and 2007 (in thousands):

   
2008
    
2007
  
   
Prior
Service
Cost
    
Net
Gain
(Loss)
    
Total
    
Prior
Service
Cost
    
Net
Gain
(Loss)
    
Total
  
Balance at beginning of period
   $ 41     $ (2,116 )   $ (2,075 )   $ 66     $ (2,594 )   $ (2,528 )
Net gain (loss) on defined benefit pension plan
     0       (116 )     (116 )     0       210       210  
Amortization
     (26 )     205       179       (25 )     268       243  
Balance at end of period
   $ 15     $ (2,027 )   $ (2,012 )   $ 41     $ (2,116 )   $ (2,075 )

Components of the net periodic pension cost for the defined benefit portion of the FHLBank’s BEP for the years ended December 31, 2008, 2007 and 2006, were (in thousands):
 
   
2008
    
2007
    
2006
  
Service cost
   $ 217     $ 189     $ 144  
Interest cost
     364       333       297  
Amortization of prior service cost
     (26 )     (25 )     (25 )
Amortization of net loss
     205       268       227  
NET PERIODIC POSTRETIREMENT BENEFIT COST
   $ 760     $ 765     $ 643  
 
The measurement date used to determine the current year’s benefit obligation was December 31, 2008.

Key assumptions and other information for the actuarial calculations for the defined benefit portion of the FHLBank’s BEP for the years ended December 31, 2008, 2007 and 2006 were (dollar amounts in thousands):
 
   
2008
    
2007
    
2006
  
Discount rate
     6.25 %     6.25 %     5.50 %
Salary increases
     4.34 %     4.98 %     5.03 %
Amortization period (years)
     8       9       10  
Accumulated benefit obligation
   $ 5,214     $ 4,737     $ 4,675  
 
The estimated actuarial (gain) loss and prior service cost that will be amortized from accumulated other comprehensive income into net periodic benefits costs over the next fiscal year are (in thousands):

   
2009
  
Net (gain) loss
   $ 197  
Prior service cost
     (9 )
EXPECTED AMORTIZATION
   $ 188  

The FHLBank estimates that its required contributions to the defined benefit portion of the FHLBank’s BEP for the year ended December 31, 2009 will be $256,000.

The estimated benefits to be paid by the FHLBank under the defined benefit portion of the BEP for the next five fiscal years and the combined five fiscal years thereafter are provided in the following table (in thousands):

Year ending December 31,
  
Estimated
Benefit
Payments
  
2009
   $ 256  
2010
     274  
2011
     295  
2012
     318  
2013
     343  
2014 through 2018
     2,263  


NOTE 16 – ESTIMATED FAIR VALUES

The FHLBank adopted SFAS 157 on January 1, 2008. SFAS 157 defined fair value, established a framework for measuring fair value under GAAP and expanded disclosures about fair value measurements. SFAS 157 applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value. Accordingly, SFAS 157 does not expand the use of fair value in any new circumstances.

The FHLBank records trading securities, derivative assets and derivative liabilities at fair value. Fair value is a market-based measurement and is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. In general, the transaction price will equal the exit price and, therefore, represents the fair value of the asset or liability at initial recognition. In determining whether a transaction price represents the fair value of the asset or liability at initial recognition, each reporting entity is required to consider factors specific to the asset or liability, the principal or most advantageous market for the asset or liability, and market participants with whom the entity would transact in that market.

Fair Value Hierarchy. SFAS 157 established a fair value hierarchy to prioritize the inputs of valuation techniques used to measure fair value. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of the market observability of the fair value measurement. SFAS 157 clarifies fair value in terms of the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal (or most advantageous) market for the asset or liability at the measurement date (an exit price). In order to determine the fair value or the exit price, entities must determine the unit of account, highest and best use, principal market and market participants. These determinations allow the reporting entity to define the inputs for fair value and level of hierarchy.

Outlined below is the application of the fair value hierarchy established by SFAS 157 to the FHLBank’s financial assets and financial liabilities that are carried at fair value.
§
Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
§
Level 2 – inputs to the value methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. The types of assets and liabilities carried at Level 2 fair value generally include investment securities and derivative contracts.
§
Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. A significant portion of the unobservable inputs are supported by little or no market activity and reflect the entity’s own assumptions. The types of assets and liabilities carried at Level 3 fair value generally include private-label MBS.
 
The FHLBank utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Fair value is first determined based on quoted market prices or market-based prices, where available. If quoted market prices or market-based prices are not available, fair value is determined based on valuation models that use market-based information available to the FHLBank as inputs to the models.

Fair Value on a Recurring Basis. The following table presents, for each SFAS 157 hierarchy level, the FHLBank’s assets and liabilities that are measured at fair value on a recurring basis on the Statement of Condition at December 31, 2008 (in thousands):

   
Total
    
Level 1
    
Level 2
    
Level 3
    
Net Accrued
Interest on
Derivatives and
Cash Collateral
  
Trading securities
   $ 4,652,700     $ 0     $ 4,652,700     $ 0     $ 0  
                                         
Derivative fair value
     112,688       0       86,983       0       25,705  
Cash collateral (received) delivered
     (78,162 )     0       0       0       (78,162 )
Derivative assets
     34,526       0       86,983       0       (52,457 )
                                         
TOTAL ASSETS MEASURED AT FAIR VALUE
   $ 4,687,226     $ 0       4,739,683     $ 0     $ (52,457 )
                                         
Derivative fair value
   $ 649,980     $ 0       694,669     $ 0     $ (44,689 )
Cash collateral received (delivered)
     (245,624 )     0       0       0       (245,624 )
Derivative liabilities
     404,356       0       694,669       0       (290,313 )
                                         
TOTAL LIABILITIES MEASURED AT FAIR VALUE
   $ 404,356     $ 0       694,669     $ 0     $ (290,313 )

For instruments carried at fair value, the FHLBank reviews the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications, if any, are reported as transfers in/out of Level 3 at fair value in the quarter in which the changes occur. The FHLBank had no financial assets or liabilities measured on a recurring basis at Level 3 fair value at December 31, 2008.

Fair Value on a Nonrecurring Basis. The FHLBank measures certain held-to-maturity securities at fair value on a nonrecurring basis. These held-to-maturity securities are not measured at fair value on an ongoing basis, but are subject to fair value adjustments only in certain circumstances (i.e., when there is evidence of other-than-temporary impairment).

In accordance with the provisions of SFAS 115, as amended by FSP No. 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, the FHLBank recognized an other-than-temporary impairment charge of $4,773,000 during the year ended December 31, 2008 as further described in Note 6. The following table presents these investment securities by level within the SFAS 157 valuation hierarchy, for which a nonrecurring change in fair value has been recorded, and the total change in value of these securities for which a fair value adjustment has been included in the Statements of Income (in thousands):

   
Fair Value Measurements at December 31, 2008
    
For the Year Ended
December 31, 2008
  
   
Total
    
Level 1
    
Level 2
    
Level 3
    
Loss
  
Held-to-maturity securities
   $ 3,218     $ 0     $ 0     $ 3,218     $ 4,773  

Estimated Fair Values. The following estimated fair value amounts have been determined by the FHLBank using available market information and the FHLBank’s best judgment of appropriate valuation methodologies. These estimates are based on pertinent information available to the FHLBank as of December 31, 2008 and 2007. Although the FHLBank uses its best judgment in estimating the fair value of these financial instruments, there are inherent limitations in any estimation technique or valuation methodology. For example, because an active secondary market does not exist for a portion of the FHLBank’s financial instruments, fair values in certain cases are not subject to precise quantification or verification and may change as economic and market factors and evaluation of those factors change. Therefore, these estimated fair values are not necessarily indicative of the amounts that would be realized in current market transactions, although they do reflect the FHLBank’s judgment of how a market participant would estimate the fair values. The Fair Value Summary Tables do not represent an estimate of the overall market value of the FHLBank as a going concern, which would take into account future business opportunities and the net profitability of assets versus liabilities.

Subjectivity of Estimates. Estimates of the fair value of advances with options, mortgage instruments, derivatives with embedded options and consolidated obligation bonds with options using the methods described below and other methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows, prepayment speed assumptions, expected interest rate volatility, methods to determine possible distributions of future interest rates used to value options, and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material effect on the fair value estimates. Since these estimates are made as of a specific point in time, they are susceptible to material near term changes.

Cash and Due From Banks: The estimated fair values approximate the recorded book balances.

Interest-bearing Deposits: The balance is comprised of interest-bearing deposits in banks. Based on the nature of the accounts, the recorded book value approximates the fair value.

Federal Funds Sold: At December 31, 2007, the recorded book value was used to approximate the fair value for all Federal funds based on the short-term nature of the assets. At December 31, 2008, the book value of overnight Federal funds approximates fair value, and term Federal funds are valued using projected future cash flows discounted at the current replacement rate.

Investment Securities: The estimated fair values of investments are determined based on quoted prices, excluding accrued interest, as of the last business day of each year. Certain investments for which quoted prices are not readily available are valued by third parties or by using internal pricing models using the assumptions in the following table:

Investment Type
Method of Valuation
Certificates of deposit
Estimated cash flows discounted at the certificate of deposit market replacement rate based on tenor.
Commercial paper
Estimated cash flows discounted at the commercial paper market replacement rate based on tenor.
FHLBank obligations
Fair value is derived from market trades or quotes for similar securities or estimated cash flows incorporating estimates of future interest rate volatility, if applicable, and discounted using the estimated replacement rate based upon tenor for issuing debt for the FHLBank System.
Fannie Mae obligations and Freddie Mac obligations
Fair value is derived from market trades or quotes for similar securities or estimated cash flows incorporating estimates of future interest rate volatility, if applicable, and discounted using the estimated replacement rate based upon tenor for issuing debt for Fannie Mae and Freddie Mac .
State or local housing agencies
Fair value is derived from market trades or quotes for similar securities.
Mortgage-backed securities
Fair value is derived from market trades or quotes for similar securities or estimated cash flows incorporating actual specific collateral performance, estimates of future specific collateral performance, estimates of future interest rate volatility, and issuer credit indications, if applicable, and discounted using the adjusted benchmark tranche yield.

Advances: The estimated fair values of advances are determined by calculating the present values of the expected future cash flows from the advances. The calculated present values are reduced by the accrued interest receivable. At December 31, 2007, the discount rates used in these calculations were the replacement advance rates for advances with similar terms and tenor for fixed rate advances and the current LIBOR for all variable rate advances. At December 31, 2008, the discount rates used in the fixed rate advance calculations were the replacement advance rates with no distinction for volume discounts. The difference between methods used to estimate fair values is not significant.

Advance Type
Method of Valuation
Fixed rate non-callable and fixed rate callable advances
Valued using discounted cash flows incorporating estimates of future interest rate volatility, if applicable, and discounted using advance replacement rates with no distinction for volume discounts.
Fixed rate convertible and step-up advances
Valued using discounted cash flows incorporating estimates of future interest rate volatility and discounted using LIBOR adjusted for spread to LIBOR on advance replacement rates with no distinction for volume discounts.
All other advances
Valued using discounted cash flows incorporating estimates of future interest rate volatility, if applicable, and discounted using LIBOR.

Mortgage Loans Held for Portfolio: Estimated fair values are determined based on quoted market prices of similar mortgage loans. These prices, however, can change rapidly based upon market conditions and are highly dependent upon the underlying prepayment assumptions.

Commitments to Extend Credit: The estimated fair values of the FHLBank’s commitments to extend credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate mortgage loan commitments, fair value also considers any difference between current levels of interest rates and the committed rates. In accordance with SFAS 149, certain mortgage loan purchase commitments are recorded as derivatives at their fair values. With one particular MPF product, the member originates mortgage loans as an agent for the FHLBank, and the FHLBank funds to close the mortgage loans. The commitments that unconditionally obligate the FHLBank to fund the mortgage loans related to this product are not considered derivatives under SFAS 149. Their estimated fair values were negligible as of December 31, 2008 and 2007.

Accrued Interest Receivable and Payable: The estimated fair values approximate the recorded book balances.

Derivative Assets/Liabilities: The FHLBank bases the estimated fair values of derivatives on instruments with similar terms or available market prices including accrued interest receivable and payable. The estimated fair value is based on the LIBOR swap curve and forward rates at year end and, for agreements containing options, the market’s expectations of future interest rate volatility implied from current market prices of similar options. The estimated fair value uses standard valuation techniques for derivatives, such as discounted cash flow analysis and comparisons to similar instruments. The FHLBank is subject to credit risk in derivative transactions because of the potential nonperformance by the derivative counterparties. To mitigate this risk, the FHLBank enters into master netting agreements for derivative agreements with highly-rated institutions. In addition, the FHLBank has entered into bilateral security agreements with all active derivative dealer counterparties. These agreements provide for delivery of collateral at specified levels tied to counterparty credit ratings to limit the FHLBank’s net unsecured credit exposure to these counterparties. The FHLBank has evaluated the potential for the fair value of the instruments to be impacted by counterparty credit risk and has determined that no adjustments were significant or necessary to the overall fair value measurements of derivatives. The derivative fair values are netted by counterparty where such legal right exists and offset against fair value amounts recognized for the obligation to return cash collateral held or the right to reclaim cash collateral pledged to the particular counterparty. If these netted amounts are positive, they are classified as an asset and, if negative, a liability.

Deposits: The estimated fair values of deposits are determined by calculating the present values of the expected future cash flows from the deposits, regardless of re-pricing or maturity. The calculated present values are reduced by the accrued interest payable. The discount rates used in these calculations were the cost of deposits with similar terms.

Consolidated Obligations: The estimated fair values for consolidated obligation bonds and discount notes are determined based on projected future cash flows. Fixed rate consolidated obligations that do not contain options are discounted using a replacement rate. Variable rate consolidated obligations that do not contain options are discounted using LIBOR. Consolidated obligations that contain optionality are valued using estimates of future interest rate volatility and discounted using LIBOR.

Mandatorily Redeemable Capital Stock: The fair value of capital stock subject to mandatory redemption is generally at par value. Fair value also includes estimated dividends earned at the time of reclassification from equity to liabilities, until such amount is paid, and any subsequently declared stock dividend. FHLBank Topeka’s dividends are declared and paid at each quarter end; therefore, fair value equaled par value at year ends. Stock can only be acquired by members at par value and redeemed or repurchased at par value. Stock is not traded and no market mechanism exists for the exchange of stock outside the cooperative structure.

Standby Letters of Credit: The estimated fair values of standby letters of credit are based on the present value of fees currently charged for similar agreements. The value of these guarantees is recognized and recorded in other liabilities.

Standby Credit Facility: The estimated fair values of the FHLBank’s commitments to extend credit through the SCF product are based on the present value of future fees on existing agreements with fees determined using rates currently charged for similar agreements. The value of these commitments to extend credit through the SCF product is recognized and recorded in other liabilities.

Standby Bond Purchase Agreements: The estimated fair values of the standby bond purchase agreements are estimated using the present value of the future fees on existing agreements with fees determined using rates currently charged for similar agreements.

The carrying value, net unrealized gains (losses) and estimated fair values of the FHLBank’s financial instruments as of December 31, 2008 are summarized in the following table (in thousands):

   
Carrying Value
    
Net Unrealized
Gains (Losses)
    
Estimated
Fair Value
  
Assets:
                  
Cash and due from banks
   $ 75     $ 0     $ 75  
                         
Interest-bearing deposits
     3,348,212       0       3,348,212  
                         
Federal funds sold
     384,000       167       384,167  
                         
Trading securities
     4,652,700       0       4,652,700  
                         
Held-to-maturity securities
     11,050,897       (596,305 )     10,454,592  
                         
Advances
     35,819,674       160,123       35,979,797  
                         
Mortgage loans held for portfolio, net of allowance
     3,023,805       68,908       3,092,713  
                         
Accrued interest receivable
     138,770       0       138,770  
                         
Derivative assets
     34,526       0       34,526  
                         
Liabilities:
                        
Deposits
     1,703,531       (1,952 )     1,705,483  
                         
Consolidated obligation discount notes
     26,261,411       (34,178 )     26,295,589  
                         
Consolidated obligation bonds
     27,421,634       (284,257 )     27,705,891  
                         
Mandatorily redeemable capital stock
     34,806       0       34,806  
                         
Accrued interest payable
     253,743       0       253,743  
                         
Derivative liabilities
     404,356       0       404,356  
                         
Other Asset (Liability):
                        
Standby letters of credit
     (1,321 )     0       (1,321 )
                         
Standby credit facility
     (778 )     0       (778 )
                         
Standby bond purchase agreements
     135       1,390       1,525  

The carrying value, net unrealized gains (losses) and estimated fair values of the FHLBank’s financial instruments as of December 31, 2007 are summarized in the following table (in thousands):

   
Carrying Value
    
Net Unrealized
Gains (Losses)
    
Estimated
Fair Value
  
Assets:
                  
Cash and due from banks
   $ 1,724     $ 0     $ 1,724  
                         
Interest-bearing deposits
     10       0       10  
                         
Federal funds sold
     5,150,000       0       5,150,000  
                         
Trading securities
     1,654,043       0       1,654,043  
                         
Held-to-maturity securities
     13,711,398       (74,987 )     13,636,411  
                         
Advances
     32,057,139       35,059       32,092,198  
                         
Mortgage loans held for portfolio, net of allowance
     2,352,301       (26,009 )     2,326,292  
                         
Accrued interest receivable
     197,016       0       197,016  
                         
Derivative assets
     77,611       0       77,611  
                         
Liabilities:
                        
Deposits
     1,340,816       0       1,340,816  
                         
Consolidated obligation discount notes
     19,896,098       (2,836 )     19,898,934  
                         
Consolidated obligation bonds
     31,213,358       (94,010 )     31,307,368  
                         
Mandatorily redeemable capital stock
     36,147       0       36,147  
                         
Accrued interest payable
     321,276       0       321,276  
                         
Derivative liabilities
     108,383       0       108,383  
                         
Other Asset (Liability):
                        
Standby letters of credit
     (1,193 )     0       (1,193 )
                         
Standby credit facility
     (376 )     0       (376 )
                         
Standby bond purchase agreements
     30       2,489       2,519  


NOTE 17 – COMMITMENTS AND CONTINGENCIES

As described in Note 11, as provided by the Bank Act or Finance Agency regulation, consolidated obligations are backed only by the financial resources of the FHLBanks. FHLBank Topeka is jointly and severally liable with the 11 other FHLBanks for the payment of principal and interest on all of the consolidated obligations issued by the FHLBanks. The par amounts for which FHLBank Topeka is jointly and severally liable were approximately $1,198,203,815,000 and $1,137,995,196,000 as of December 31, 2008 and 2007, respectively. To the extent that an FHLBank makes any consolidated obligation payment on behalf of another FHLBank, the paying FHLBank is entitled to reimbursement from the FHLBank with primary liability. However, if the Finance Agency determines that the primary obligor is unable to satisfy its obligations, then the Finance Agency may allocate the outstanding liability among the remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding, or on any other basis that the Finance Agency may determine. No FHLBank has ever failed to make any payment on a consolidated obligation for which it was the primary obligor. As a result, the regulatory provisions for directing other FHLBanks to make payments on behalf of another FHLBank or allocating the liability among other FHLBanks have never been invoked.

The joint and several obligations are mandated by Finance Agency regulations and are not the result of arms-length transactions among the FHLBanks. As described above, the FHLBanks have no control over the amount of the guaranty or the determination of how each FHLBank would perform under the joint and several liability. Because the FHLBanks are subject to the authority of the Finance Agency as it relates to decisions involving the allocation of the joint and several liability for the FHLBank’s consolidated obligations, FHLBank Topeka’s joint and several obligation is excluded from the initial recognition and measurement provisions of FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34.

FHLBank Topeka regularly monitors the financial condition of the other 11 FHLBanks to determine whether it should expect a loss to arise from its joint and several obligations. If the FHLBank were to determine that a loss was probable and the amount of such loss could be reasonably estimated, the FHLBank would charge to income the amount of the expected loss under the provisions of SFAS No. 5, Accounting for Contingencies. Based upon the creditworthiness of the other FHLBanks at December 31, 2008, FHLBank Topeka believes that a loss accrual is not necessary at this time.

During the third quarter of 2008, each FHLBank entered into a Lending Agreement with the U.S. Treasury in connection with the U.S. Treasury’s establishment of the Government Sponsored Enterprise Credit Facility (GSECF), as authorized by the Recovery Act. The GSECF is designed to serve as a contingent source of liquidity for the housing government-sponsored enterprises, including each of the 12 FHLBanks. Any borrowings by one or more of the FHLBanks under the GSECF are considered obligations with the same joint and several liability as all other consolidated obligations. The terms of the borrowings are agreed to at the time of issuance. Loans under the Lending Agreement are to be secured by collateral acceptable to the U.S. Treasury, which consists of FHLBank advances to members that have been collateralized in accordance with regulatory standards and MBS issued by Fannie Mae or Freddie Mac. Each FHLBank is required to submit to the Federal Reserve Bank of New York, acting as fiscal agent of the U.S. Treasury, a weekly list of eligible advance collateral based upon the Lending Agreement. As of December 31, 2008, the FHLBank had provided the U.S. Treasury with a listing of potential advance collateral amounting to $12,710,547,000. The amount of collateral can be expanded or contracted (subject to the approval of the U.S. Treasury) at any time through the delivery of an updated listing of advance collateral held by the FHLBank as borrower-in-custody or through the delivery of MBS issued by Fannie Mae or Freddie Mac to a custodial National Book Entry System account established through the Federal Reserve Bank of New York for the benefit of the Treasury. As of December 31, 2008, no FHLBank had drawn on this available source of liquidity.

Standby credit facility (SCF) commitments that legally bind and unconditionally obligate the FHLBank for additional advances to stockholders totaled $1,000,000,000 and $2,000,000,000 at December 31, 2008 and 2007, respectively. SCF commitments are executed for members for a fee and are for terms of one year. Standby letters of credit are executed for members for a fee. A standby letter of credit is a short-term financing arrangement between the FHLBank and its member or non-member housing associate. If the FHLBank is required to make payment for a beneficiary’s draw, these amounts are converted into a collateralized advance to the member. As of December 31, 2008 and 2007, outstanding standby letters of credit totaled $2,751,362,000 and $2,543,265,000, respectively, and had original terms of seven days to seven years with a final expiration in 2013. Unearned fees as well as the value of the guarantees related to standby letters of credit are recorded in other liabilities and amounted to $1,321,000 and $1,193,000 at December 31, 2008 and 2007, respectively. The standby letters of credit are fully collateralized with assets allowed by the FHLBank’s Member Products Policy. Based upon management’s credit analysis and collateral requirements, the FHLBank does not expect to incur any credit losses on the letters of credit.

Commitments that unconditionally obligate the FHLBank to fund/purchase mortgage loans from participating FHLBank Topeka members in the MPF Program totaled $141,357,000 and $21,007,000 at December 31, 2008 and 2007, respectively. Commitments are generally for periods not to exceed 60 calendar days. In accordance with SFAS 149, certain commitments are recorded as derivatives at their fair value on the Statements of Condition. The FHLBank recorded mortgage delivery commitment derivative asset (liability) balances of $(1,539,000) and $57,000 at December 31, 2008 and 2007, respectively. With one particular MPF product, the member originates mortgage loans as an agent for the FHLBank, and the FHLBank provides funds to close the mortgage loans. The commitments that unconditionally obligate the FHLBank to fund the mortgage loans related to this product are not considered derivatives under SFAS 149. There were $16,934,000 outstanding commitments for this product at December 31, 2008.

The total FLA, which represents commitments that unconditionally obligate the FHLBank to absorb credit losses associated with PFI master commitments (mortgage loan pools), amounted to $14,669,000 and $12,180,000 at December 31, 2008 and 2007, respectively. Under the MPF Program, the first layer of credit loss is absorbed by the equity of the borrower in the real estate securing the loan. As is customary for conventional mortgage loans, primary mortgage insurance (PMI) is required for MPF loans with down payments of less than 20 percent of the property value in order to raise the effective equity level to at least 20 percent. Losses beyond the equity layer are absorbed by the FHLBank up to the FLA predefined limit for a pool of mortgage loans. If losses beyond this layer are incurred for the pool of mortgage loans, the losses are absorbed through the CE obligation for the pool of mortgage loans provided by the PFI that sold the mortgage loans to the FHLBank. The CE obligation provided by a PFI ensures that the PFI retains a credit stake in the loans it sells to the FHLBank. For managing this risk, the FHLBank pays CE fees to the PFI. The size of each PFI’s CE obligation is generally calculated on pools of mortgage loans sold into the MPF Program by the PFI so that the likelihood of losses on the pool in excess of the second layer is the same as the likelihood of losses for an investor in a AA-rated MBS. As a result of the protection afforded by these procedures, and its credit loss experience through December 31, 2008, the FHLBank anticipates its total exposure to absorbing probable FLA losses related to the MPF Program as of December 31, 2008, will not exceed its allowance for credit losses, which was approximately $884,000 at December 31, 2008.

The FHLBank has entered into standby bond purchase agreements with state housing authorities within its four-state district whereby the FHLBank, for a fee, agrees to purchase and hold the authorities’ bonds until the designated marketing agent can find a suitable investor or the housing authority repurchases the bond according to a schedule established by the standby agreement. Each standby agreement dictates the specific terms that would require the FHLBank to purchase the bond. The bond purchase commitments entered into by the FHLBank expire no later than 2014, though some are renewable at the option of the FHLBank. Total commitments for bond purchases with two state housing authorities were $1,311,906,000 and $962,866,000 at December 31, 2008 and 2007, respectively. The FHLBank was required to purchase $193,730,000 in bonds under these agreements during 2008. These bonds were classified as AFS securities, and were acquired at par and sold at par. The FHLBank was not required to purchase any bonds under these agreements during 2007. The estimated fair values of standby bond purchase agreements as of December 31, 2008 and 2007 are reported in Note 16.

The FHLBank generally executes derivatives with counterparties having ratings of single-A or better by either Standard & Poor’s or Moody’s. These agreements are generally covered under bilateral collateral agreements between the FHLBank and the counterparties. As of December 31, 2008 and 2007, the FHLBank had delivered cash with a book value of $245,600,000 and $30,840,000, respectively, as collateral to broker/dealers that have market-risk exposure to the FHLBank. The delivered collateral is netted against derivative liabilities on the Statements of Condition.

As of December 31, 2008, the FHLBank committed to enter into the sale of consolidated obligation discount notes and bonds at par amounts of $172,557,000 and $440,000,000, respectively, with January 2009 settlement dates.

Net rental costs under operating leases of approximately $94,000, $101,000 and $97,000 in 2008, 2007 and 2006, respectively, for premises and equipment have been charged to other operating expenses. Future minimum net rentals are summarized in the following table (in thousands):
 
Year
  
Premises
    
Equipment
    
Total
  
2009
   $ 38     $ 46     $ 84  
2010
     38       46       84  
2011
     0       38       38  
2012
     0       36       36  
2013
     0       36       36  
Thereafter
     0       0       0  
TOTAL
   $ 76     $ 202     $ 278  
 
During 2002, the FHLBank entered into a 20-year direct financing lease with a member for a building complex and property. In conjunction with this lease transaction, the FHLBank acquired $50,000,000 in industrial revenue bonds (IRBs) from the City of Topeka, which are collateralized by the building complex and property. The IRBs are recorded in other assets. The FHLBank is leasing the building complex and property from the City of Topeka for a period of 10 years. The IRBs have a maturity of 10 years with interest, principal amounts and payment dates that correspond to the FHLBank’s lease with the City of Topeka. All rental payments flow from the FHLBank through a trustee, and FHLBank receives payments on the IRBs. The present value of the net minimum lease payments under this capital lease with the City of Topeka is recorded in other liabilities. The FHLBank is leasing the portion of the property and building occupied by the member back to the member under a 20-year direct financing lease. Either party has the option to terminate this lease after 15 years. The net investment in the direct financing lease with the member is recorded in other assets. The FHLBank’s $7,896,000 up-front payment for its portion of the building complex is recorded in premises, software and equipment. On October 31, 2005, the FHLBank amended its lease to occupy additional building space, thereby reducing the portion of the property previously leased back to the member and decreasing the member’s future lease payments. All other provisions of the original lease remain in effect. The net reduction in the lease receivable is recorded in premises, software and equipment.

The following table shows the future minimum lease receivable under the direct financing lease, as amended, with the member and future minimum lease payment obligation under the capital lease with the City of Topeka as of December 31, 2008 (in thousands):
 
Year
  
Lease
Receivable
    
Lease
Obligation
  
2009
   $ 3,623     $ 6,006  
2010
     3,623       5,719  
2011
     3,623       5,431  
2012
     3,623       5,144  
2013
     3,623       0  
Thereafter
     30,799       0  
Net minimum lease payments
     48,914       22,300  
Less amount representing interest
     (16,827 )     (2,300 )
PRESENT VALUE OF NET MINIMUM LEASE PAYMENTS
   $ 32,087     $ 20,000  

Unearned income on the direct financing lease is recognized in such a manner as to produce a constant periodic rate of return on the net investment in the direct financing lease.

The FHLBank acts as a securities safekeeping custodian on behalf of participating members. Actual securities are held by a third-party custodian acting as agent for the FHLBank. As of December 31, 2008, the total original par value of customer securities held by the FHLBank under this arrangement was $60,221,834,000.

The FHLBank is subject to legal proceedings arising in the normal course of business. After consultation with legal counsel, management does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the FHLBank’s financial condition or results of operations.

Other commitments and contingencies are discussed in Notes 1, 7, 8, 9, 11, 12, 13, 14 and 15.


NOTE 18 – TRANSACTIONS WITH STOCKHOLDERS AND HOUSING ASSOCIATES

The FHLBank is a cooperative whose members own the capital stock of the FHLBank and generally receive dividends on their investments. In addition, certain former members that still have outstanding transactions are also required to maintain their investments in FHLBank capital stock until the transactions mature or are paid off. Nearly all outstanding advances are with current members, and the majority of outstanding mortgage loans held for portfolio were purchased from current or former members. The FHLBank also maintains demand deposit accounts for members primarily to facilitate settlement activities that are directly related to advances and mortgage loan purchases.

As provided by statute, the FHLBank’s members have the right to vote on the election of directors. In accordance with the Bank Act and Finance Agency regulations, members elect all of the FHLBank’s board of directors. Under the statute and regulations, each member directorship is designated to one of the four states in the FHLBank’s district, and a member is entitled to vote only for candidates for the state in which the member’s principal place of business is located. Each independent director is elected by the members at large from among individuals nominated by the FHLBank’s board of directors. A member is entitled to cast, for each applicable directorship, one vote for each share of capital stock that the member is required to hold as of the record date for voting, subject to a statutory limitation. Under this limitation, the total number of votes that a member may cast is limited to the average number of shares of the FHLBank’s capital stock that were required to be held by all members in that state as of the record date for voting. Non-member stockholders are not entitled to cast votes for the election of directors. At December 31, 2008 and 2007, no member owned more than 10 percent of the voting interests of the FHLBank due to the statutory limitation on members’ voting rights as discussed above.

Transactions with members are entered into in the ordinary course of business. In instances where members also have officers or directors who are directors of the FHLBank, transactions with those members are subject to the same eligibility and credit criteria, as well as the same terms and conditions, as other transactions with members. For financial reporting and disclosure purposes, the FHLBank defines related parties in accordance with SFAS 57 as FHLBank directors’ financial institutions and members with investments in excess of 10 percent of the FHLBank’s total regulatory capital stock outstanding, which includes mandatorily redeemable capital stock.

Activity with Members that Exceed a 10 Percent Ownership in FHLBank Capital Stock: The following tables present information as of December 31, 2008 and 2007 on members that own more than 10 percent of outstanding FHLBank regulatory capital stock in either 2008 or 2007 (in thousands). None of the officers or directors of these members currently serve on the FHLBank’s board of directors.

2008
  
Member Name
State
  
Total
Class A
Stock
Par Value
    
Percent
of Total
Class A
    
Total
Class B
Stock
Par Value
    
Percent
of Total
Class B
    
Total
Capital
Stock
Par Value
    
Percent
of Total
Capital
Stock
  
U.S. Central Federal Credit Union
KS
   $ 1,000       0.2 %   $ 269,760       16.8 %   $ 270,760       11.9 %
MidFirst Bank
OK
     2,600       0.4       259,695       16.2       262,295       11.5  
Total
     $ 3,600       0.6 %   $ 529,455       33.0 %   $ 533,055       23.4 %

2007
  
Member Name
State
  
Total
Class A
Stock
Par Value
    
Percent
of Total
Class A
    
Total
Class B
Stock
Par Value
    
Percent
of Total
Class B
    
Total
Capital
Stock
Par Value
    
Percent
of Total
Capital
Stock
  
MidFirst Bank
OK
   $ 5,031       0.8 %   $ 294,111       19.8 %   $ 299,142       14.1 %

Advance and deposit balances with members that own more than 10 percent of outstanding FHLBank regulatory capital stock as of December 31, 2008 and 2007 are summarized in the following table (in thousands). Information is only listed for the year in which the member owned more than 10 percent of outstanding FHLBank regulatory capital stock. If the member did not own more than 10 percent for one of the years presented, the applicable column is left blank.

   
2008
    
2007
    
2008
    
2007
  
Member Name
  
Outstanding
Advances
    
Percent
of Total
    
Outstanding
Advances
    
Percent
Of Total
    
Outstanding
Deposits1
    
Percent
of Total
    
Outstanding
Deposits1
    
Percent
of Total
  
U.S. Central Federal Credit Union
   $ 5,370,000       15.4 %         $   %   $ 40       0.0 %         $   %
MidFirst Bank
     5,019,600       14.3       5,741,000       18.0       940       0.1       26,401       2.0  
TOTAL
   $ 10,389,600       29.7 %   $ 5,741,000       18.0 %   $ 980       0.1 %   $ 26,401       2.0 %
                    
1
Excludes cash pledged as collateral by derivative counterparties, netted against derivative liabilities, and Member Pass-through Deposit Reserves,  classified as non-interest-bearing deposits.

Neither U.S. Central Federal Credit Union nor MidFirst Bank originated mortgage loans for or sold mortgages into the MPF program during the year ended December 31, 2008. Additionally, MidFirst Bank did not originate any mortgage loans for the MPF program during the year ended December 31, 2007.

Transactions with FHLBank Directors’ Financial Institutions: The following tables present information as of December 31, 2008 and 2007 for members that have an officer or director serving on the FHLBank’s board of directors (in thousands) in 2008 or 2007. Information is only listed for the year in which the officer or director served on the FHLBank’s board of directors. Capital stock listed is regulatory capital stock, which includes mandatorily redeemable capital stock.
 
2008
  
Member Name
State
  
Total
Class A
Stock
Par Value
    
Percent
of Total
Class A
    
Total
Class B
Stock
Par Value
    
Percent
of Total
Class B
    
Total
Capital
Stock
Par Value
    
Percent
Of Total
Capital
Stock
  
Vision Bank, NA
OK
   $ 3,611       0.5 %   $ 58       0.0 %   $ 3,669       0.2 %
Liberty Federal Savings Bank
OK
     1,077       0.2       2,295       0.1       3,372       0.1  
Golden Belt Bank, FSA
KS
     699       0.1       2,335       0.1       3,034       0.1  
First National Bank
KS
     1,287       0.2       1,281       0.1       2,568       0.1  
Morgan Federal Bank
CO
     185       0.0       1,705       0.1       1,890       0.1  
Yampa Valley Bank
CO
     364       0.1       792       0.1       1,156       0.1  
Chickasha Bank & Trust Co.
OK
     597       0.1       52       0.0       649       0.0  
Bankers Bank of Kansas
KS
     241       0.0       2       0.0       243       0.0  
Lisco State Bank
NE
     47       0.0       51       0.0       98       0.0  
TOTAL
     $ 8,108       1.2 %   $ 8,571       0.5 %   $ 16,679       0.7 %


2007
  
Member Name
State
  
Total
Class A
Stock
Par Value
    
Percent
of Total
Class A
    
Total
Class B
Stock
Par Value
    
Percent
of Total
Class B
    
Total
Capital
Stock
Par Value
    
Percent
Of Total
Capital
Stock
  
Vision Bank, NA
OK
   $ 3,230       0.5 %   $ 368       0.0 %   $ 3,598       0.2 %
Liberty Federal Savings Bank
OK
     468       0.1       2,787       0.2       3,255       0.2  
Golden Belt Bank, FSA
KS
     770       0.1       2,153       0.1       2,923       0.1  
First National Bank
KS
     949       0.2       920       0.1       1,869       0.1  
Morgan Federal Bank
CO
     244       0.0       1,556       0.1       1,800       0.1  
Chickasha Bank & Trust Co.
OK
     580       0.1       57       0.0       637       0.0  
Yampa Valley Bank
CO
     273       0.0       41       0.0       314       0.0  
Bankers Bank of Kansas
KS
     210       0.0       7       0.0       217       0.0  
Lisco State Bank
NE
     47       0.0       48       0.0       95       0.0  
TOTAL
     $ 6,771       1.0 %   $ 7,937       0.5 %   $ 14,708       0.7 %

Advance and deposit balances with members that have an officer or director serving on the FHLBank’s board of directors as of December 31, 2008 and 2007 are summarized in the following table (in thousands). Information is only listed for the year in which the officer or director served on the FHLBank’s board of directors.

   
2008
    
2007
    
2008
    
2007
  
Member Name
  
Outstanding
Advances
    
Percent
of Total
    
Outstanding
Advances
    
Percent
of Total
    
Outstanding
Deposits
    
Percent
of Total
    
Outstanding
Deposits
    
Percent
of Total
  
Vision Bank, NA
   $ 19,223       0.0 %   $ 22,019       0.0 %   $ 72       0.0 %   $ 5       0.0 %
Liberty Federal Savings Bank
     51,900       0.1       60,325       0.2       254       0.0       213       0.0  
Golden Belt Bank, FSA
     27,933       0.1       27,520       0.1       2,037       0.1       345       0.0  
First National Bank
     32,546       0.1       28,450       0.1       108       0.0       3,007       0.2  
Morgan Federal Bank
     29,633       0.1       28,110       0.1       676       0.1       515       0.1  
Yampa Valley Bank
     20,800       0.1       2,000       0.0       47       0.0       35       0.0  
Chickasha Bank & Trust Co.
     7,204       0.0       2,578       0.0       15,656       0.9       2,943       0.2  
Bankers Bank of Kansas, NA
     0       0.0       0       0.0       14       0.0       7       0.0  
Lisco State Bank
     860       0.0       873       0.0       54       0.0       19       0.0  
TOTAL
   $ 190,099       0.5 %   $ 171,875       0.5 %   $ 18,918       1.1 %   $ 7,089       0.5 %

The following table presents mortgage loans funded or acquired during the years ended December 31, 2008 and 2007 for members that had an officer or director serving on the FHLBank’s board of directors in 2008 or 2007 (in thousands). Information is only listed for the year in which the officer or director served on the FHLBank’s board of directors.

   
2008
    
2007
  
Member Name
  
Total
Mortgage
Loans
    
Percent
of Total
    
Total
Mortgage
Loans
    
Percent
of Total
  
Vision Bank, NA
   $ 0       0.0 %   $ 0       0.0 %
Liberty Federal Savings Bank
     0       0.0       0       0.0  
Golden Belt Bank, FSA
     17,436       1.8       5,730       2.2  
First National Bank
     3,220       0.3       2,508       1.0  
Morgan Federal Bank
     2,226       0.2       0       0.0  
Yampa Valley Bank
     0       0.0       0       0.0  
Chickasha Bank & Trust Co.
     0       0.0       0       0.0  
Bankers Bank of Kansas, NA
     0       0.0       0       0.0  
Lisco State Bank
     0       0.0       0       0.0  
TOTAL
   $ 22,882       2.3 %   $ 8,238       3.2 %


NOTE 19 – TRANSACTIONS WITH OTHER FHLBANKS

FHLBank Topeka had the following business transactions with other FHLBanks during the years ended December 31, 2008, 2007 and 2006 (in thousands). All transactions occurred at market prices.

Business Activity
  
2008
    
2007
    
2006
  
Average overnight interbank loan balances to other FHLBanks1
   $ 5,350     $ 4,085     $ 1,055  
Average overnight interbank loan balances from other FHLBanks1
     7,664       4,167       1,796  
Average deposit balance with FHLBank of Chicago for shared expense transactions2
     33       0       0  
Average deposit balance with FHLBank of Chicago for MPF transactions2
     22       28       25  
Transaction charges paid to FHLBank of Chicago for transaction service fees3
     1,131       962       959  
Par amount of purchases of consolidated obligations issued on behalf of other FHLBanks4
     106,320       209,043       0  
Net premium (discount) on purchases of consolidated obligation issued on behalf of other FHLBanks4
     6,900       6,666       0  
                    
1
Occasionally, the FHLBank loans (or borrows) short-term funds to (from) other FHLBanks. Interest income on loans to other FHLBanks and interest expense on borrowings from other FHLBanks are separately identified on the Statements of Income.
2
Balance is interest bearing and is classified on the Statements of Condition as interest-bearing deposits.
3
Fees are calculated monthly based on 5 basis points of outstanding loans funded since January 1, 2004 and are recorded in other expense.
4
Purchases of consolidated obligations issued on behalf of one FHLBank and purchased by the FHLBank occur at market prices with third parties and are accounted for in the same manner as similarly classified investments. Outstanding balances are presented in Note 4. Interest income earned on these securities totaled $16,455,000, $1,458,000 and $863,000 for the years ended December 31, 2008, 2007 and 2006, respectively.

NOTE 20 – SUBSEQUENT EVENT

The FHLBank’s largest advance borrower as of December 31, 2008, U.S. Central Federal Credit Union, received a paid-in capital contribution from the National Credit Union Share Insurance Fund (NCUSIF) on January 30, 2009 after the member reported that it expected to post a net loss for the year ended December 31, 2008. On March 20, 2009, the National Credit Union Administration announced that U.S. Central Federal Credit Union had been placed under conservatorship. Based on the FHLBank’s collateral practices and the collateral held by the FHLBank to secure the member’s advances, management has concluded that there is no reason to record an allowance for losses related to the member’s outstanding advances with the FHLBank.

There is a general expectation that U.S. Central Federal Credit Union's unsecured borrowings are eligible for NCUSIF guarantee under National Credit Union Administration’s Temporary Corporate Credit Union Liquidity Guarantee Program (TCCULGP). Accordingly, U.S. Central Federal Credit Union would have access to these guaranteed borrowings and could access the TCCULGP in lieu of FHLBank advances.

U.S. Central Federal Credit Union was one of the FHLBank’s largest advance borrowers during 2007 and 2008. The loss of this advance business will have a negative impact on the FHLBank’s financial position and operating results. As of March 20, 2009, it had one advace outstanding for $871,984,000 and that advance matures on March 31, 2009. At this time, we cannot predict the level of U.S. Central Federal Credit Union’s advance business with the FHLBank for the remainder of 2009 and beyond. The following is a summary of its average advance balances and percentage of advance income for 2007 and 2008 (amounts in thousands):

   
2008
    
2007
  
Quarter Ended
  
Average
Advances
    
% Total
Advance
Income
    
Average
Advances
    
% Total
Advance
Income
  
March 31
   $ 3,189,560       10.1 %   $ 3,005,556       11.8 %
June 30
     2,113,736       4.5       2,604,396       10.3  
September 30
     5,245,652       10.7       5,432,065       18.6  
December 31
     7,186,154       10.1       6,679,348       20.5  
Year ended December 31
   $ 4,443,514       9.0 %   $ 4,443,151       15.6 %

The following is a summary of U.S. Central Federal Credit Union’s average advance balances and advance income for the first two months of 2009 (amounts in thousands):

Month
  
Average
Advances
    
% Total
Advance
Income
  
January
   $ 5,810,529       4.3 %
February
     2,491,029       1.7  
Two-month total
   $ 4,235,173       3.2 %

 
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