10-Q 1 fhlbt9301410q.htm 10-Q FHLBT 9.30.14 10Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
 
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
 
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  x  Yes  ¨  No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. ¨ 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
November 5, 2014
Class A Stock, par value $100
1,884,269
Class B Stock, par value $100
9,201,143




.FEDERAL HOME LOAN BANK OF TOPEKA
TABLE OF CONTENTS
 
 
 
PART I 
Item 1. 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
Item 3.
Item 4.
Part II 
Item 1.
Item 1A. 
Item 2. 
Item 3. 
Item 4. 
Item 5. 
Item 6. 


2


Important Notice about Information in this Quarterly Report

In this quarterly 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 quarterly report is accurate only as of the date of this quarterly report and as of the dates specified herein.

The product and service names used in this quarterly 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 quarterly report are the property of their respective owners.

Special Cautionary Notice Regarding Forward-looking Statements

The information contained in this Form 10-Q contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include statements describing the objectives, projections, estimates or future predictions of the FHLBank’s operations. These statements may be identified by the use of forward-looking terminology such as “anticipates,” “believes,” “may,” “is likely,” “could,” “estimate,” “expect,” “will,” “intend,” “probable,” “project,” “should,” or their negatives or other variations of these terms. The FHLBank cautions that by their nature forward-looking statements involve risk or uncertainty and that actual results may differ materially from those expressed in any forward-looking statements as a result of such risks and uncertainties, including but not limited to:
Governmental actions, including legislative, regulatory, judicial or other developments that affect the FHLBank; its members, counterparties or investors; housing government sponsored enterprises (GSE); or the FHLBank System in general;
Regulatory actions and determinations, including those resulting from the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act);
Changes in the FHLBank’s capital structure;
Changes in economic and market conditions, including conditions in the mortgage, housing, and capital markets;
Changes in demand for advances or consolidated obligations of the FHLBank and/or of the FHLBank System;
Effects of derivative accounting treatment, other-than-temporary impairment (OTTI) accounting treatment, and other accounting rule requirements;
The effects of amortization/accretion;
Gains/losses on derivatives or on trading investments and the ability to enter into effective derivative instruments on acceptable terms;
Volatility of market prices, interest rates and indices and the timing and volume of market activity;
Membership changes, including changes resulting from member failures or mergers, changes in the principal place of business of members or changes in the Federal Housing Finance Agency (Finance Agency) regulations on membership standards;
Our ability to declare dividends or to pay dividends at rates consistent with past practices;
Soundness of other financial institutions, including FHLBank members, nonmember borrowers, and the other FHLBanks;
Changes in the value or liquidity of collateral underlying advances to FHLBank members or nonmember borrowers or collateral pledged by reverse repurchase and derivative counterparties;
Competitive forces, including competition for loan demand, purchases of mortgage loans and access to funding;
The ability of the FHLBank to introduce new products and services to meet market demand and to manage successfully the risks associated with new products and services;
Our ability to keep pace with technological changes and the ability of the FHLBank to develop and support technology and information systems, including the ability to access the internet and internet-based systems and services, sufficient to effectively manage the risks of the FHLBank’s business;
The ability of each of the other FHLBanks to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which the FHLBank has joint and several liability;
Changes in the U.S. government’s long-term debt rating and the long-term credit rating of the senior unsecured debt issues of the FHLBank System;
Changes in the fair value and economic value of, impairments of, and risks associated with, the FHLBank’s investments in mortgage loans and mortgage-backed securities (MBS) or other assets and related credit enhancement (CE) protections; and
The volume and quality of eligible mortgage loans originated and sold by participating members to the FHLBank through its various mortgage finance products (Mortgage Partnership Finance® (MPF®) Program1).

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



Readers of this report should not rely solely on the forward-looking statements and should consider all risks and uncertainties addressed throughout this report, as well as those discussed under Item 1A – “Risk Factors” in our annual report on Form 10-K for the fiscal year ended December 31, 2013, incorporated by reference herein.

All forward-looking statements contained in this Form 10-Q are expressly qualified in their entirety by this cautionary notice. The reader should not place undue reliance on such forward-looking statements, since the statements speak only as of the date that they are made and the FHLBank has no obligation and does not undertake publicly to update, revise or correct any forward-looking statement for any reason.


PART I

Item 1: Financial Statements


4


FEDERAL HOME LOAN BANK OF TOPEKA
 
 
STATEMENTS OF CONDITION - Unaudited
 
 
(In thousands, except par value)
 
 
 
09/30/2014
12/31/2013
ASSETS
 
 
Cash and due from banks
$
2,571,350

$
1,713,940

Interest-bearing deposits
146

1,116

Securities purchased under agreements to resell (Note 11)
1,075,000


Federal funds sold
1,450,000

575,000

 
 
 
Investment securities:
 
 
Trading securities (Note 3)
1,476,212

2,704,777

Held-to-maturity securities1 (Note 3)
5,074,263

5,423,659

Total investment securities
6,550,475

8,128,436

 
 
 
Advances (Notes 4, 6)
20,574,600

17,425,487

 
 
 
Mortgage loans held for portfolio, net:
 
 
Mortgage loans held for portfolio (Notes 5, 6)
6,169,413

5,956,228

Less allowance for credit losses on mortgage loans (Note 6)
(4,591
)
(6,748
)
Mortgage loans held for portfolio, net
6,164,822

5,949,480

 
 
 
Accrued interest receivable
63,232

72,526

Premises, software and equipment, net
10,869

11,146

Derivative assets, net (Notes 7, 11)
26,098

27,957

Other assets
41,452

45,216

 
 
 
TOTAL ASSETS
$
38,528,044

$
33,950,304

 
 
 
LIABILITIES
 
 
Deposits (Notes 8)
$
677,069

$
961,888

 
 
 
Consolidated obligations, net:
 
 
Discount notes (Note 9)
15,947,588

10,889,565

Bonds (Note 9)
20,025,472

20,056,964

Total consolidated obligations, net
35,973,060

30,946,529

 
 
 
Mandatorily redeemable capital stock (Note 12)
4,371

4,764

Accrued interest payable
71,757

62,447

Affordable Housing Program payable (Note 10)
31,944

35,264

Derivative liabilities, net (Notes 7, 11)
51,417

108,353

Other liabilities
28,028

29,839

 
 
 
TOTAL LIABILITIES
36,837,646

32,149,084

 
 
 
Commitments and contingencies (Note 15)



1    Fair value: $5,085,070 and $5,415,205 as of September 30, 2014 and December 31, 2013, respectively.
The accompanying notes are an integral part of these financial statements.
5


FEDERAL HOME LOAN BANK OF TOPEKA
 
 
STATEMENTS OF CONDITION - Unaudited
 
 
(In thousands, except par value)
 
 
 
09/30/2014
12/31/2013
 
 
 
CAPITAL
 
 
Capital stock outstanding - putable:
 
 
Class A ($100 par value; 1,515 and 4,300 shares issued and outstanding)
$
151,519

$
430,063

Class B ($100 par value; 9,388 and 8,222 shares issued and outstanding)
938,744

822,186

Total capital stock
1,090,263

1,252,249

 
 
 
Retained earnings:
 
 
Unrestricted
547,555

515,589

Restricted
67,637

51,743

Total retained earnings
615,192

567,332

 
 
 
Accumulated other comprehensive income (loss) (Note 13)
(15,057
)
(18,361
)
 
 
 
TOTAL CAPITAL
1,690,398

1,801,220

 
 
 
TOTAL LIABILITIES AND CAPITAL
$
38,528,044

$
33,950,304



The accompanying notes are an integral part of these financial statements.
6


FEDERAL HOME LOAN BANK OF TOPEKA
 
 
 
 
STATEMENTS OF INCOME - Unaudited
 
 
 
 
(In thousands)
 
 
 
 
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
INTEREST INCOME:
 
 
 
 
Interest-bearing deposits
$
40

$
56

$
120

$
257

Securities purchased under agreements to resell
96

42

138

821

Federal funds sold
358

285

840

989

Trading securities
12,330

14,285

37,972

42,483

Held-to-maturity securities
11,271

14,408

35,663

44,222

Advances
31,360

30,689

89,349

93,736

Prepayment fees on terminated advances
107

287

931

3,529

Mortgage loans held for portfolio
51,099

48,675

152,701

145,050

Other
374

409

1,149

1,252

Total interest income
107,035

109,136

318,863

332,339

 
 
 
 
 
INTEREST EXPENSE:
 
 
 
 
Deposits
166

179

604

768

Consolidated obligations:
 
 
 
 
Discount notes
2,688

2,041

6,250

6,746

Bonds
47,552

52,319

144,488

166,037

Mandatorily redeemable capital stock (Note 12)
13

6

29

19

Other
44

45

127

121

Total interest expense
50,463

54,590

151,498

173,691

 
 
 
 
 
NET INTEREST INCOME
56,572

54,546

167,365

158,648

Provision (reversal) for credit losses on mortgage loans (Note 6)
82

530

(1,732
)
2,061

NET INTEREST INCOME AFTER MORTGAGE LOAN LOSS PROVISION
56,490

54,016

169,097

156,587

 
 
 
 
 
OTHER INCOME (LOSS):
 
 
 
 
Total other-than-temporary impairment losses on held-to-maturity securities

(5
)

(19
)
Net amount of impairment losses on held-to-maturity securities reclassified to/(from) accumulated other comprehensive income (loss)
(20
)
(295
)
(443
)
(433
)
Net other-than-temporary impairment losses on held-to-maturity securities (Note 3)
(20
)
(300
)
(443
)
(452
)
Net gain (loss) on trading securities (Note 3)
(11,419
)
(6,768
)
(22,431
)
(37,687
)
Net gain (loss) on derivatives and hedging activities (Note 7)
(2,218
)
(5,592
)
(26,551
)
2,875

Standby bond purchase agreement commitment fees
1,594

1,408

4,711

3,774

Letters of credit fees
757

736

2,349

2,298

Other
501

685

1,734

1,613

Total other income (loss)
(10,805
)
(9,831
)
(40,631
)
(27,579
)
 
 
 
 
 

The accompanying notes are an integral part of these financial statements.
7


FEDERAL HOME LOAN BANK OF TOPEKA
 
 
 
 
STATEMENTS OF INCOME - Unaudited
 
 
 
 
(In thousands)
 
 
 
 
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
OTHER EXPENSES:
 
 
 
 
Compensation and benefits
$
8,779

$
6,879

$
22,973

$
20,208

Other operating
3,016

3,364

9,914

10,206

Federal Housing Finance Agency
564

481

1,854

1,698

Office of Finance
541

622

1,662

1,844

Other
980

1,084

3,759

3,872

Total other expenses
13,880

12,430

40,162

37,828

 
 
 
 
 
INCOME BEFORE ASSESSMENTS
31,805

31,755

88,304

91,180

 
 
 
 
 
Affordable Housing Program (Note 10)
3,181

3,176

8,833

9,120

 
 
 
 
 
NET INCOME
$
28,624

$
28,579

$
79,471

$
82,060



The accompanying notes are an integral part of these financial statements.
8


FEDERAL HOME LOAN BANK OF TOPEKA
 
 
STATEMENTS OF COMPREHENSIVE INCOME - Unaudited
 
 
(In thousands)
 
 
 
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
Net income
$
28,624

$
28,579

$
79,471

$
82,060

 
 
 
 
 
Other comprehensive income:
 
 
 
 
Net non-credit portion of other-than-temporary impairment losses on held-to-maturity securities:
 
 
 
 
Non-credit portion

(5
)

(19
)
Reclassification of non-credit portion included in net income
20

300

443

452

Accretion of non-credit portion
1,002

738

2,734

3,467

Total net non-credit portion of other-than-temporary impairment losses on held-to-maturity securities
1,022

1,033

3,177

3,900

 
 
 
 
 
Defined benefit pension plan:
 
 
 
 
Amortization of net loss
38

101

127

302

Total defined benefit pension plan
38

101

127

302

 
 
 
 
 
Total other comprehensive income
1,060

1,134

3,304

4,202

 
 
 
 
 
TOTAL COMPREHENSIVE INCOME
$
29,684

$
29,713

$
82,775

$
86,262

 


The accompanying notes are an integral part of these financial statements.
9


FEDERAL HOME LOAN BANK OF TOPEKA
 
 
 
 
 
 
 
STATEMENTS OF CAPITAL - Unaudited
 
 
 
 
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
Capital Stock1
 
 
 
Other
 
 
Class A
Class B
Total
Retained Earnings
Comprehensive
Total
 
Shares
Par Value
Shares
Par Value
Shares
Par Value
Unrestricted
Restricted
Total
Income (Loss)
Capital
Balance at December 31, 2012
4,053

$
405,304

8,592

$
859,152

12,645

$
1,264,456

$
453,346

$
27,936

$
481,282

$
(25,257
)
$
1,720,481

Proceeds from issuance of capital stock
8

827

3,858

385,857

3,866

386,684

 
 
 
 
386,684

Repurchase/redemption of capital stock
(1,594
)
(159,414
)
(134
)
(13,385
)
(1,728
)
(172,799
)
 
 
 
 
(172,799
)
Comprehensive income
 
 
 
 
 
 
65,649

16,411

82,060

4,202

86,262

Net reclassification of shares to mandatorily redeemable capital stock
(290
)
(28,973
)
(1,782
)
(178,177
)
(2,072
)
(207,150
)
 
 
 
 
(207,150
)
Net transfer of shares between Class A and Class B
2,097

209,697

(2,097
)
(209,697
)


 
 
 
 

Dividends on capital stock (Class A - 0.3%, Class B - 3.5%):
 
 
 
 
 
 
 
 
 
 
 
Cash payment
 
 
 
 
 
 
(214
)
 
(214
)
 
(214
)
Stock issued
 
 
245

24,478

245

24,478

(24,478
)
 
(24,478
)
 

Balance at September 30, 2013
4,274

$
427,441

8,682

$
868,228

12,956

$
1,295,669

$
494,303

$
44,347

$
538,650

$
(21,055
)
$
1,813,264

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
Capital Stock1
 
 
 
Other
 
 
Class A
Class B
Total
Retained Earnings
Comprehensive
Total
 
Shares
Par Value
Shares
Par Value
Shares
Par Value
Unrestricted
Restricted
Total
Income (Loss)
Capital
Balance at December 31, 2013
4,300

$
430,063

8,222

$
822,186

12,522

$
1,252,249

$
515,589

$
51,743

$
567,332

$
(18,361
)
$
1,801,220

Proceeds from issuance of capital stock
12

1,161

6,279

627,890

6,291

629,051

 
 
 
 
629,051

Repurchase/redemption of capital stock
(5,850
)
(584,978
)
(93
)
(9,343
)
(5,943
)
(594,321
)
 
 
 
 
(594,321
)
Comprehensive income
 
 
 
 




63,577

15,894

79,471

3,304

82,775

Net reclassification of shares to mandatorily redeemable capital stock
(77
)
(7,711
)
(2,204
)
(220,391
)
(2,281
)
(228,102
)
 
 
 
 
(228,102
)
Net transfer of shares between Class A and Class B
3,130

312,984

(3,130
)
(312,984
)


 
 
 
 

Dividends on capital stock (Class A - 0.6%, Class B - 5.0%):
 
 
 
 




 
 
 
 
 

Cash payment
 
 
 
 




(225
)
 
(225
)
 
(225
)
Stock issued
 
 
314

31,386

314

31,386

(31,386
)
 
(31,386
)
 

Balance at September 30, 2014
1,515
$
151,519

9,388
$
938,744

10,903
$
1,090,263

$
547,555

$
67,637

$
615,192

$
(15,057
)
$
1,690,398

                   
1    Putable


The accompanying notes are an integral part of these financial statements.
10


FEDERAL HOME LOAN BANK OF TOPEKA
 
 
STATEMENTS OF CASH FLOWS - Unaudited
 
 
(In thousands)
 
 
 
Nine Months Ended
 
09/30/2014
09/30/2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
Net income
$
79,471

$
82,060

Adjustments to reconcile income (loss) to net cash provided by (used in) operating activities:
 
 
Depreciation and amortization:
 
 
Premiums and discounts on consolidated obligations, net
(12,246
)
(22,913
)
Concessions on consolidated obligations
3,774

4,956

Premiums and discounts on investments, net
(232
)
(1,178
)
Premiums, discounts and commitment fees on advances, net
(9,306
)
(11,375
)
Premiums, discounts and deferred loan costs on mortgage loans, net
11,178

16,772

Fair value adjustments on hedged assets or liabilities
9,214

11,436

Premises, software and equipment
1,345

1,470

Other
127

302

Provision (reversal) for credit losses on mortgage loans
(1,732
)
2,061

Non-cash interest on mandatorily redeemable capital stock
27

18

Net other-than-temporary impairment losses on held-to-maturity securities
443

452

Net realized (gain) loss on sale of premises and equipment
6

(19
)
Other (gains) losses
105

114

Net (gain) loss on trading securities
22,431

37,687

(Gain) loss due to change in net fair value adjustment on derivative and hedging activities
47,674

11,963

(Increase) decrease in accrued interest receivable
9,331

13,766

Change in net accrued interest included in derivative assets
4,841

(213
)
(Increase) decrease in other assets
2,076

2,048

Increase (decrease) in accrued interest payable
9,308

(612
)
Change in net accrued interest included in derivative liabilities
(19,874
)
(16,832
)
Increase (decrease) in Affordable Housing Program liability
(3,320
)
2,031

Increase (decrease) in other liabilities
(2,306
)
(862
)
Total adjustments
72,864

51,072

NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
152,335

133,132

 
 
 

The accompanying notes are an integral part of these financial statements.
11


FEDERAL HOME LOAN BANK OF TOPEKA
 
 
STATEMENTS OF CASH FLOWS - Unaudited
 
 
(In thousands)
 
 
 
Nine Months Ended
 
09/30/2014
09/30/2013
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
Net (increase) decrease in interest-bearing deposits
$
61,924

$
99,746

Net (increase) decrease in securities purchased under resale agreements
(1,075,000
)
1,399,288

Net (increase) decrease in Federal funds sold
(875,000
)
305,000

Net (increase) decrease in short-term trading securities
260,000

(539,914
)
Proceeds from maturities of and principal repayments on long-term trading securities
946,134

264,772

Purchases of long-term trading securities

(500,279
)
Proceeds from maturities of and principal repayments on long-term held-to-maturity securities
693,339

1,185,321

Purchases of long-term held-to-maturity securities
(340,977
)
(1,645,872
)
Principal collected on advances
42,425,603

54,345,379

Advances made
(45,643,549
)
(56,722,373
)
Principal collected on mortgage loans
572,403

1,029,054

Purchase of mortgage loans
(799,769
)
(1,030,602
)
Proceeds from sale of foreclosed assets
4,009

3,556

Principal collected on other loans made
1,572

1,469

Proceeds from sale of premises, software and equipment
2

47

Purchases of premises, software and equipment
(1,076
)
(3,679
)
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
(3,770,385
)
(1,809,087
)
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
Net increase (decrease) in deposits
(283,055
)
(419,122
)
Net proceeds from issuance of consolidated obligations:
 
 
Discount notes
41,055,791

72,658,386

Bonds
7,182,363

6,361,367

Payments for maturing and retired consolidated obligations:
 
 
Discount notes
(35,998,826
)
(69,141,787
)
Bonds
(7,237,500
)
(7,146,000
)
Proceeds from financing derivatives

170

Net interest payments received (paid) for financing derivatives
(49,296
)
(50,233
)
Proceeds from issuance of capital stock
629,051

386,684

Payments for repurchase/redemption of capital stock
(594,321
)
(172,799
)
Payments for repurchase of mandatorily redeemable capital stock
(228,522
)
(207,649
)
Cash dividends paid
(225
)
(214
)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
4,475,460

2,268,803

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
857,410

592,848

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
1,713,940

369,997

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
2,571,350

$
962,845

 
 
 
Supplemental disclosures:
 
 
Interest paid
$
150,276

$
182,984

 
 
 
Affordable Housing Program payments
$
12,372

$
7,298

 
 
 
Net transfers of mortgage loans to real estate owned
$
3,590

$
4,724


The accompanying notes are an integral part of these financial statements.
12


FEDERAL HOME LOAN BANK OF TOPEKA
Notes to Financial Statements - Unaudited
September 30, 2014


NOTE 1 – BASIS OF PRESENTATION

Basis of Presentation: The accompanying interim financial statements of the FHLBank are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instruction provided by Article 10, Rule 10-01 of Regulation S-X. The financial statements contain all adjustments which are, in the opinion of management, necessary for a fair statement of the FHLBank’s financial position, results of operations and cash flows for the interim periods presented. All such adjustments were of a normal recurring nature. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full fiscal year or any other interim period.

The FHLBank’s significant accounting policies and certain other disclosures are set forth in the notes to the audited financial statements for the year ended December 31, 2013. The interim financial statements presented herein should be read in conjunction with the FHLBank’s audited financial statements and notes thereto, which are included in the FHLBank’s annual report on Form 10-K filed with the Securities and Exchange Commission (SEC) on March 14, 2014 (annual report on Form 10-K). The notes to the interim financial statements highlight significant changes to the notes included in the annual report on Form 10-K.

Use of Estimates: The preparation of financial statements under 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. The most significant of these estimates include the fair value of trading securities, the fair value of derivatives, the determination of OTTI on investments and the allowance for credit losses. 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.

Reclassifications: Certain amounts in the financial statements and related footnotes have been reclassified to conform to current period presentations. These reclassifications have no impact on total assets, net income, total comprehensive income, total capital or cash flows.


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

Classification of Certain Government-Guaranteed Mortgage Loans Upon Foreclosure. In August 2014, the Financial Accounting Standards Board (FASB) issued guidance to change the accounting for government-guaranteed mortgage loans, including Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA) loans. The amendments require that a mortgage loan be derecognized and a separate receivable be recognized upon foreclosure if: (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the property to the guarantor and make a claim on that guarantee and the ability to recover under that claim; and (3) at the time of foreclosure, any amount of the claim determined on the basis of fair value is fixed. This receivable should be based upon the principal and interested expected to be recovered from the guarantor. The amendments are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014, which is January 1, 2015 for the FHLBank. The adoption of this amendment is not expected to a have a material impact on the FHLBank's financial condition, results of operations, or cash flows.

Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. In June 2014, the FASB issued guidance to change the accounting for repurchase-to-maturity transactions and linked repurchase financings to that of secured borrowings, which is consistent with the accounting for repurchase agreements. The amendments also require two new disclosures:(1) information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements; and (2) increased transparency about the types of collateral pledged for repurchase agreements and similar transactions accounted for as secured borrowings. The amendments are effective for the first interim or annual period beginning after December 15, 2014, which is January 1, 2015 for the FHLBank. The adoption of this amendment is not expected to a have a material impact on the FHLBank's financial condition, results of operations, or cash flows.


13


Revenue Recognition. In May 2014, the FASB issued guidance to introduce a new revenue recognition model in which an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance also requires disclosures sufficient to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This standard is effective for fiscal years beginning after December 15, 2016 (January 1, 2017 for the FHLBank), including interim periods within that reporting period. The FHLBank is currently evaluating the new guidance to determine the impact it will have, if any, on its financial condition, results of operations, or cash flows.

Receivables - Troubled Debt Restructurings by Creditors. In January 2014, the FASB issued amendments intended to clarify when a creditor should be considered to have received physical possession of the residential real estate property collateralizing a consumer mortgage loan. These amendments clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, when either: (a) the creditor obtains legal title to the residential real estate property upon completion of a foreclosure; or (b) the borrower conveys all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The amendments are effective for interim and annual periods beginning after December 15, 2014 (January 1, 2015 for the FHLBank). Early adoption is permitted. The guidance may be adopted using a modified retrospective transition method or a prospective transition method. The adoption of this amendment is not expected to a have a material impact on the FHLBank's financial condition, results of operations, or cash flows.

Joint and Several Liability. In February 2013, the FASB issued guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date. This guidance requires an entity to measure these obligations as the sum of: (1) the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors; and (2) any additional amount the reporting entity expects to pay on behalf of its co-obligors. In addition, this guidance requires an entity to disclose the nature and amount of the obligation as well as other information about these obligations. This guidance was effective for interim and annual periods beginning on or after December 15, 2013 (January 1, 2014 for the FHLBank) and was applied retrospectively to obligations with joint and several liabilities existing at the beginning of the current fiscal year. The adoption of this guidance did not have a material effect on the FHLBank’s financial condition, results of operations, or cash flows.



14


NOTE 3 – INVESTMENT SECURITIES

Major Security Types: Trading and held-to-maturity securities as of September 30, 2014 are summarized in Table 3.1 (in thousands):

Table 3.1
 
09/30/2014
 
Trading
Held-to-maturity
 
Fair
Value
Amortized
Cost
OTTI
Recognized
in OCI
Carrying Value
Gross
Unrecognized
Gains
Gross
Unrecognized
Losses
Fair
Value
Non-mortgage-backed securities:
 
 
 
 
 
 
 
U.S. Treasury obligations
$
25,031

$

$

$

$

$

$

Government-sponsored enterprise obligations1,2
1,306,245







State or local housing agency obligations

130,341


130,341

151

6,594

123,898

Non-mortgage-backed securities
1,331,276

130,341


130,341

151

6,594

123,898

Mortgage-backed securities:
 
 
 
 
 
 
 
U.S. obligation residential3
986

60,190


60,190

106


60,296

Government-sponsored enterprise residential4
143,950

4,630,825


4,630,825

29,706

17,181

4,643,350

Private-label mortgage-backed securities:
 
 
 
 
 
 
 
Residential loans

264,554

12,755

251,799

10,316

7,142

254,973

Home equity loans

1,179

71

1,108

1,445


2,553

Mortgage-backed securities
144,936

4,956,748

12,826

4,943,922

41,573

24,323

4,961,172

TOTAL
$
1,476,212

$
5,087,089

$
12,826

$
5,074,263

$
41,724

$
30,917

$
5,085,070

                   
1 
Represents debentures issued by other FHLBanks, Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac), Federal Farm Credit Bank (Farm Credit), and Federal Agricultural Mortgage Corporation (Farmer Mac). GSE securities are not guaranteed by the U.S. government. Fannie Mae and Freddie Mac were placed into conservatorship by the Finance Agency on September 7, 2008 with the Finance Agency named as conservator.
2 
See Note 17 for transactions with other FHLBanks.
3 
Represents MBS issued by Government National Mortgage Association (Ginnie Mae), which are guaranteed by the U.S. government.
4 
Represents single-family and multi-family MBS issued by Fannie Mae and Freddie Mac.


15


Trading and held-to-maturity securities as of December 31, 2013 are summarized in Table 3.2 (in thousands):

Table 3.2
 
12/31/2013
 
Trading
Held-to-maturity
 
Fair
Value
Amortized
Cost
OTTI
Recognized
in OCI
Carrying Value
Gross
Unrecognized
Gains
Gross
Unrecognized
Losses
Fair
Value
Non-mortgage-backed securities:
 
 
 
 
 
 
 
Certificates of deposit
$
260,009

$

$

$

$

$

$

U.S. Treasury obligations
25,012







Government-sponsored enterprise obligations1,2
2,247,966







State or local housing agency obligations

63,472


63,472

19

8,619

54,872

Non-mortgage-backed securities
2,532,987

63,472


63,472

19

8,619

54,872

Mortgage-backed securities:
 
 
 
 
 
 
 
U.S obligation residential3
1,090

68,977


68,977

217

14

69,180

Government-sponsored enterprise residential4
170,700

4,974,649


4,974,649

21,744

27,108

4,969,285

Private-label mortgage-backed securities:
 

 

 

 
 

 

 
Residential loans

331,158

15,825

315,333

12,459

8,691

319,101

Home equity loans

1,406

178

1,228

1,539


2,767

Mortgage-backed securities
171,790

5,376,190

16,003

5,360,187

35,959

35,813

5,360,333

TOTAL
$
2,704,777

$
5,439,662

$
16,003

$
5,423,659

$
35,978

$
44,432

$
5,415,205

                    
1 
Represents debentures issued by other FHLBanks, Fannie Mae, Freddie Mac, Farm Credit, and Farmer Mac. GSE securities are not guaranteed by the U.S. government. Fannie Mae and Freddie Mac were placed into conservatorship by the Finance Agency on September 7, 2008 with the Finance Agency named as conservator.
2 
See Note 17 for transactions with other FHLBanks.
3 
Represents MBS issued by Ginnie Mae, which are guaranteed by the U.S. government.
4 
Represents single-family and multi-family MBS issued by Fannie Mae and Freddie Mac.


16


Table 3.3 summarizes (in thousands) the held-to-maturity securities with unrealized losses as of September 30, 2014. The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.

Table 3.3
 
09/30/2014
 
Less Than 12 Months
12 Months or More
Total
 
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Non-mortgage-backed securities:
 
 
 
 
 
 
State or local housing agency obligations
$
6,143

$
34

$
38,175

$
6,560

$
44,318

$
6,594

Non-mortgage-backed securities
6,143

34

38,175

6,560

44,318

6,594

Mortgage-backed securities:
 
 
 
 
 
 
Government-sponsored enterprise residential1
306,369

1,355

1,142,550

15,826

1,448,919

17,181

Private-label mortgage-backed securities:
 
 
 
 
 
 
Residential loans
19,133

88

144,439

11,513

163,572

11,601

Mortgage-backed securities
325,502

1,443

1,286,989

27,339

1,612,491

28,782

TOTAL TEMPORARILY IMPAIRED SECURITIES
$
331,645

$
1,477

$
1,325,164

$
33,899

$
1,656,809

$
35,376

                    
1 
Represents single-family and multi-family MBS issued by Fannie Mae and Freddie Mac.

Table 3.4 summarizes (in thousands) the held-to-maturity securities with unrealized losses as of December 31, 2013. The unrealized losses are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.

Table 3.4
 
12/31/2013
 
Less Than 12 Months
12 Months or More
Total
 
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Non-mortgage-backed securities:
 
 
 
 
 
 
State or local housing agency obligations
$
6,660

$
367

$
38,743

$
8,252

$
45,403

$
8,619

Non-mortgage-backed securities
6,660

367

38,743

8,252

45,403

8,619

Mortgage-backed securities:
 
 
 
 
 
 
U.S obligation residential1
25,814

14



25,814

14

Government-sponsored enterprise residential2
2,099,923

16,699

384,530

10,409

2,484,453

27,108

Private-label mortgage-backed securities:
 
 
 
 
 
 
Residential loans
21,053

109

175,474

14,252

196,527

14,361

Mortgage-backed securities
2,146,790

16,822

560,004

24,661

2,706,794

41,483

TOTAL TEMPORARILY IMPAIRED SECURITIES
$
2,153,450

$
17,189

$
598,747

$
32,913

$
2,752,197

$
50,102

                    
1 
Represents MBS issued by Ginnie Mae, which are guaranteed by the U.S. government.
2 
Represents single-family and multi-family MBS issued by Fannie Mae and Freddie Mac.


17


Redemption Terms: The amortized cost, carrying value and fair values of held-to-maturity securities by contractual maturity as of September 30, 2014 and December 31, 2013 are shown in Table 3.5 (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 3.5
 
09/30/2014
12/31/2013
 
Amortized
Cost
Carrying
Value
Fair
Value
Amortized
Cost
Carrying
Value
Fair
Value
Non-mortgage-backed securities:
 
 
 
 
 
 
Due in one year or less
$

$

$

$

$

$

Due after one year through five years






Due after five years through 10 years
18,625

18,625

18,436

21,240

21,240

19,582

Due after 10 years
111,716

111,716

105,462

42,232

42,232

35,290

Non-mortgage-backed securities
130,341

130,341

123,898

63,472

63,472

54,872

Mortgage-backed securities
4,956,748

4,943,922

4,961,172

5,376,190

5,360,187

5,360,333

TOTAL
$
5,087,089

$
5,074,263

$
5,085,070

$
5,439,662

$
5,423,659

$
5,415,205


Interest Rate Payment Terms: Table 3.6 details interest rate payment terms for the amortized cost of held-to-maturity securities as of September 30, 2014 and December 31, 2013 (in thousands):

Table 3.6
 
09/30/2014
12/31/2013
Non-mortgage-backed securities:
 
 
Fixed rate
$
10,751

$
12,232

Variable rate
119,590

51,240

Non-mortgage-backed securities
130,341

63,472

Mortgage-backed securities:
 
 
Pass-through securities:
 
 
Fixed rate
34

78

Variable rate
1,208,896

1,298,146

Collateralized mortgage obligations:
 
 
Fixed rate
454,322

541,126

Variable rate
3,293,496

3,536,840

Mortgage-backed securities
4,956,748

5,376,190

TOTAL
$
5,087,089

$
5,439,662


Gains and Losses: Net gains (losses) on trading securities during the three and nine months ended September 30, 2014 and 2013 are shown in Table 3.7 (in thousands):

Table 3.7
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
Net gains (losses) on trading securities held as of September 30, 2014
$
(11,414
)
$
(5,296
)
$
(21,812
)
$
(33,925
)
Net gains (losses) on trading securities sold or matured prior to September 30, 2014
(5
)
(1,472
)
(619
)
(3,762
)
NET GAIN (LOSS) ON TRADING SECURITIES
$
(11,419
)
$
(6,768
)
$
(22,431
)
$
(37,687
)


18


Other-than-temporary Impairment: For those securities for which an OTTI was determined to have occurred as of September 30, 2014 (that is, securities for which the FHLBank determined that it was more likely than not that the amortized cost basis would not be recovered), Table 3.8 presents a summary of the significant inputs used to measure the amount of credit loss recognized in earnings during this period as well as related current credit enhancement. Credit enhancement is defined as the percentage of subordinated tranches and over-collateralization, if any, in a security structure that will generally absorb losses before the FHLBank will experience a loss on the security. The calculated averages represent the dollar-weighted averages of all the private-label MBS/asset-backed securities (ABS) investments in each category shown. Private-label MBS/ABS are classified as prime, Alt-A and subprime based on the originator’s classification at the time of origination or based on classification by a Nationally Recognized Statistical Rating Organization (NRSRO) upon issuance of the MBS/ABS.

Table 3.8
Private-label residential MBS
Year of Securitization
Significant Inputs
Current
Credit
Enhancements
Prepayment
Rates
Default
Rates
Loss
Severities
Prime:
 
 
 
 
2004 and prior
16.1
%
10.4
%
30.8
%
27.4
%
Alt-A:
 

 

 

 

2004 and prior
16.7

12.2

34.3

11.3

2005
15.9

9.5

34.4

4.1

Total Alt-A
16.2

10.3

34.4

6.4

TOTAL
16.2
%
10.3
%
34.4
%
6.6
%
 
 
 
 
 
Home Equity Loan ABS
Year of Securitization
Significant Inputs
Current
Credit
Enhancements
Prepayment
Rates
Default
Rates
Loss
Severities
Subprime:
 
 
 
 
2004 and prior
1.1
%
7.8
%
84.9
%
15.8
%

For the 26 outstanding private-label securities with OTTI during the lives of the securities, the FHLBank’s reported balances as of September 30, 2014 are presented in Table 3.9 (in thousands):

Table 3.9
 
09/30/2014
 
Unpaid
Principal
Balance
Amortized
Cost
Carrying
Value
Fair
Value
Private-label residential MBS:
 
 
 
 
Prime
$
14,092

$
13,221

$
12,106

$
13,295

Alt-A
60,625

54,809

43,169

51,120

Total private-label residential MBS
74,717

68,030

55,275

64,415

Home equity loans:
 

 

 

 

Subprime
2,977

1,179

1,108

2,553

TOTAL
$
77,694

$
69,209

$
56,383

$
66,968



19


Table 3.10 presents a roll-forward of OTTI activity for the three and nine months ended September 30, 2014 and 2013 related to credit losses recognized in earnings (in thousands):

Table 3.10
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
Balance, beginning of period
$
9,560

$
10,698

$
9,917

$
11,291

Additional charge on securities for which OTTI was previously recognized1
20

300

443

452

Amortization of credit component of OTTI2
(89
)
(762
)
(869
)
(1,507
)
Balance, end of period
$
9,491

$
10,236

$
9,491

$
10,236

                    
1 
For the three months ended September 30, 2014 and 2013, securities previously impaired represent all securities that were impaired prior to July 1, 2014 and 2013, respectively. For the nine months ended September 30, 2014 and 2013, securities previously impaired represent all securities that were impaired prior to January 1, 2014 and 2013, respectively.
2 
The FHLBank amortizes the credit component based on estimated cash flows prospectively up to the amount of expected principal to be recovered. The discounted cash flows will move from the discounted loss value to the ultimate principal to be written off at the projected date of loss. If the expected cash flows improve, the amount of expected loss decreases which causes a corresponding decrease in the calculated amortization. Based on the level of improvement in the cash flows, the amortization could become a positive adjustment to income.

As of September 30, 2014, the fair value of a portion of the FHLBank’s held-to-maturity MBS portfolio was below the amortized cost of the securities due to interest rate volatility, illiquidity in the marketplace and credit deterioration in the U.S. mortgage markets that began in early 2008. However, the decline in fair value of these securities is considered temporary as the FHLBank expects to recover the entire amortized cost basis on the remaining held-to-maturity securities in unrecognized loss positions and neither intends to sell these securities nor is it more likely than not that the FHLBank will be required to sell these securities before its anticipated recovery of the remaining amortized cost basis. For state and local housing agency obligations, the FHLBank determined that all of the gross unrealized losses on these bonds were temporary because the strength of the underlying collateral and credit enhancements was sufficient to protect the FHLBank from losses based on current expectations.


NOTE 4 – ADVANCES

General Terms: The FHLBank offers a wide range of fixed and variable rate advance products with different maturities, interest rates, payment characteristics and optionality. As of September 30, 2014 and December 31, 2013, the FHLBank had advances outstanding at interest rates ranging from 0.12 percent to 8.01 percent and 0.11 percent to 8.01 percent, respectively. Table 4.1 presents advances summarized by year of contractual maturity as of September 30, 2014 and December 31, 2013 (in thousands): 

Table 4.1
 
09/30/2014
12/31/2013
Year of Contractual Maturity
Amount
Weighted Average Interest Rate
Amount
Weighted Average Interest Rate
Due in one year or less
$
9,502,514

0.57
%
$
5,431,364

0.77
%
Due after one year through two years
1,455,970

2.14

1,643,200

1.77

Due after two years through three years
1,692,486

2.59

1,650,222

1.98

Due after three years through four years
1,900,952

2.55

2,353,661

2.59

Due after four years through five years
1,071,416

1.39

1,302,199

2.42

Thereafter
4,788,697

1.23

4,812,973

1.09

Total par value
20,412,035

1.23
%
17,193,619

1.45
%
Discounts
(27,989
)
 
(36,782
)
 
Hedging adjustments
190,554

 
268,650

 
TOTAL
$
20,574,600

 
$
17,425,487

 



20


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). In exchange for receiving the right to call the advance on a predetermined call schedule, the borrower may pay a higher fixed rate for the advance relative to an equivalent maturity, non-callable, fixed rate advance. The borrower normally exercises its call options on these advances when interest rates decline (fixed rate advances) or spreads change (adjustable rate advances). The FHLBank’s advances as of September 30, 2014 and December 31, 2013 include callable advances totaling $4,592,551,000 and $5,056,133,000, respectively. Of these callable advances, there were $4,463,796,000 and $4,932,869,000 of variable rate advances as of September 30, 2014 and December 31, 2013, respectively.

Convertible advances allow the FHLBank to convert an advance from one interest payment term structure to another. When issuing convertible advances, the FHLBank may purchase put options from a member that allow the FHLBank to convert the fixed rate advance to a variable rate advance at the current market rate or another structure after an agreed-upon lockout period. A convertible advance carries a lower interest rate than a comparable-maturity fixed rate advance without the conversion feature. As of September 30, 2014 and December 31, 2013, the FHLBank had convertible advances outstanding totaling $1,656,242,000 and $1,685,242,000, respectively.

Table 4.2 presents advances summarized by contractual maturity or next call date (for callable advances) and by contractual maturity or next conversion date (for convertible advances) as of September 30, 2014 and December 31, 2013 (in thousands):

Table 4.2
 
Year of Contractual Maturity
or Next Call Date
Year of Contractual Maturity
or Next Conversion Date
Redemption Term
09/30/2014
12/31/2013
09/30/2014
12/31/2013
Due in one year or less
$
13,766,143

$
10,172,524

$
11,037,156

$
7,038,106

Due after one year through two years
1,256,402

1,392,527

1,325,720

1,555,100

Due after two years through three years
1,498,853

1,175,623

1,266,886

1,528,722

Due after three years through four years
1,533,311

1,856,012

1,051,660

1,381,719

Due after four years through five years
672,595

1,062,253

1,058,416

979,999

Thereafter
1,684,731

1,534,680

4,672,197

4,709,973

TOTAL PAR VALUE
$
20,412,035

$
17,193,619

$
20,412,035

$
17,193,619


Interest Rate Payment Terms:  Table 4.3 details additional interest rate payment terms for advances as of September 30, 2014 and December 31, 2013 (in thousands):

Table 4.3
 
09/30/2014
12/31/2013
Fixed rate:
 
 
Due in one year or less
$
1,885,334

$
1,733,559

Due after one year
6,621,162

6,923,555

Total fixed rate
8,506,496

8,657,114

Variable rate:
 

 

Due in one year or less
7,617,180

3,697,805

Due after one year
4,288,359

4,838,700

Total variable rate
11,905,539

8,536,505

TOTAL PAR VALUE
$
20,412,035

$
17,193,619


See Note 6 for information related to the FHLBank’s credit risk on advances and allowance for credit losses.



21


NOTE 5 – MORTGAGE LOANS

The MPF Program involves the FHLBank investing in mortgage loans, which have been funded by the FHLBank through or purchased from its participating members. These mortgage loans are government-insured or guaranteed (by the FHA, the VA, the Rural Housing Service of the Department of Agriculture (RHS) and/or the Department of Housing and Urban Development (HUD)) loans and conventional residential loans credit-enhanced by participating financial institutions (PFI). Depending upon a member’s product selection, the servicing rights can be retained or sold by the participating member. The FHLBank does not buy or own any mortgage servicing rights.

Mortgage Loans Held for Portfolio: Table 5.1 presents information as of September 30, 2014 and December 31, 2013 on mortgage loans held for portfolio (in thousands):

Table 5.1
 
09/30/2014
12/31/2013
Real estate:
 
 
Fixed rate, medium-term1, single-family mortgages
$
1,547,993

$
1,611,289

Fixed rate, long-term, single-family mortgages
4,516,799

4,245,351

Total unpaid principal balance
6,064,792

5,856,640

Premiums
99,213

95,755

Discounts
(3,180
)
(3,659
)
Deferred loan costs, net
879

1,087

Other deferred fees
(175
)
(212
)
Hedging adjustments
7,884

6,617

Total before Allowance for Credit Losses on Mortgage Loans
6,169,413

5,956,228

Allowance for Credit Losses on Mortgage Loans
(4,591
)
(6,748
)
MORTGAGE LOANS HELD FOR PORTFOLIO, NET
$
6,164,822

$
5,949,480

                   
1 
Medium-term defined as a term of 15 years or less at origination.


Table 5.2 presents information as of September 30, 2014 and December 31, 2013 on the outstanding unpaid principal balance (UPB) of mortgage loans held for portfolio (in thousands):

Table 5.2
 
09/30/2014
12/31/2013
Conventional loans
$
5,426,691

$
5,212,048

Government-guaranteed or insured loans
638,101

644,592

TOTAL UNPAID PRINCIPAL BALANCE
$
6,064,792

$
5,856,640


See Note 6 for information related to the FHLBank’s credit risk on mortgage loans and allowance for credit losses.


NOTE 6 – ALLOWANCE FOR CREDIT LOSSES

The FHLBank has established an allowance methodology for each of its portfolio segments: credit products (advances, letters of credit and other extensions of credit to borrowers); government mortgage loans held for portfolio; conventional mortgage loans held for portfolio; the direct financing lease receivable; term Federal funds sold; and term securities purchased under agreements to resell. Based on management’s analyses of each portfolio segment, the FHLBank has only established an allowance for credit losses on its conventional mortgage loans held for portfolio.


22


Roll-forward of Allowance for Credit Losses: As of September 30, 2014, the FHLBank determined that an allowance for credit losses was only necessary on conventional mortgage loans held for portfolio. Table 6.1 presents a roll-forward of the allowance for credit losses for the three and nine months ended September 30, 2014 as well as the method used to evaluate impairment relating to all portfolio segments regardless of whether or not an estimated credit loss has been recorded as of September 30, 2014 (in thousands):

Table 6.1
 
09/30/2014
 
Conventional
Loans
Government
Loans
Credit
Products1
Direct
Financing
Lease
Receivable
Total
Allowance for credit losses:
 
 
 
 
 
Balance, beginning of three-month period
$
4,658

$

$

$

$
4,658

Charge-offs
(149
)



(149
)
Provision (reversal) for credit losses
82




82

Balance, end of three-month period
$
4,591

$

$

$

$
4,591

 
 
 
 
 
 
Balance, beginning of nine-month period
$
6,748

$

$

$

$
6,748

Charge-offs
(425
)



(425
)
Provision (reversal) for credit losses
(1,732
)



(1,732
)
Balance, end of nine-month period
$
4,591

$

$

$

$
4,591

 
 
 
 
 
 
Allowance for credit losses, end of period:
 

 

 

 

 

Individually evaluated for impairment
$

$

$

$

$

Collectively evaluated for impairment
$
4,591

$

$

$

$
4,591

Recorded investment2, end of period:
 

 

 

 

 

Individually evaluated for impairment3
$

$

$
20,595,448

$
21,959

$
20,617,407

Collectively evaluated for impairment
$
5,543,946

$
655,541

$

$

$
6,199,487

                   
1 
The recorded investment for credit products includes only advances. The recorded investment for all other credit products is insignificant.
2 
The recorded investment in a financing receivable is the UPB, adjusted for accrued interest, net deferred loan fees or costs, unamortized premiums or discounts, fair value hedging adjustments and direct write-downs. The recorded investment is not net of any valuation allowance.
3 
No financing receivables individually evaluated for impairment were determined to be impaired.


23


Table 6.2 presents a roll-forward of the allowance for credit losses for the three and nine months ended September 30, 2013 as well as the method used to evaluate impairment relating to all portfolio segments regardless of whether or not an estimated credit loss has been recorded as of September 30, 2013 (in thousands):

Table 6.2
 
09/30/2013
 
Conventional
Loans
Government
Loans
Credit
Products1
Direct
Financing
Lease
Receivable
Total
Allowance for credit losses:
 
 
 
 
 
Balance, beginning of three-month period
$
6,590

$

$

$

$
6,590

Charge-offs
(229
)



(229
)
Provision (reversal) for credit losses
530




530

Balance, end of three-month period
$
6,891

$

$

$

$
6,891

 
 
 
 
 
 
Balance, beginning of nine-month period
$
5,416

$

$

$

$
5,416

Charge-offs
(586
)



(586
)
Provision (reversal) for credit losses
2,061




2,061

Balance, end of nine-month period
$
6,891

$

$

$

$
6,891

 
 
 
 
 
 
Allowance for credit losses, end of period:
 

 

 

 

 

Individually evaluated for impairment
$

$

$

$

$

Collectively evaluated for impairment
$
6,891

$

$

$

$
6,891

Recorded investment2, end of period:
 

 

 

 



Individually evaluated for impairment3
$

$

$
18,826,525

$
24,049

$
18,850,574

Collectively evaluated for impairment
$
5,280,393

$
667,431

$

$

$
5,947,824

                   
1 
The recorded investment for credit products includes only advances. The recorded investment for all other credit products is insignificant.
2 
The recorded investment in a financing receivable is the UPB, adjusted for accrued interest, net deferred loan fees or costs, unamortized premiums or discounts, fair value hedging adjustments and direct write-downs. The recorded investment is not net of any valuation allowance.
3 
No financing receivables individually evaluated for impairment were determined to be impaired.


24


Credit Quality Indicators: The FHLBank’s key credit quality indicators include the migration of: (1) past due loans; (2) non-accrual loans; (3) loans in process of foreclosure; and (4) impaired loans, all of which are used either on an individual or pool basis to determine the allowance for credit losses.

Table 6.3 summarizes the delinquency aging and key credit quality indicators for all of the FHLBank’s portfolio segments as of September 30, 2014 (dollar amounts in thousands):

Table 6.3
 
09/30/2014
 
Conventional
Loans
Government
Loans
Credit
Products1
Direct
Financing
Lease
Receivable
Total
Recorded investment2:
 
 
 
 
 
Past due 30-59 days delinquent
$
30,679

$
20,282

$

$

$
50,961

Past due 60-89 days delinquent
6,992

5,287



12,279

Past due 90 days or more delinquent
14,886

5,968



20,854

Total past due
52,557

31,537



84,094

Total current loans
5,491,389

624,004

20,595,448

21,959

26,732,800

Total recorded investment
$
5,543,946

$
655,541

$
20,595,448

$
21,959

$
26,816,894

 
 
 
 
 
 
Other delinquency statistics:
 

 

 

 

 

In process of foreclosure, included above3
$
5,964

$
2,705

$

$

$
8,669

Serious delinquency rate4
0.3
%
0.9
%
%
%
0.1
%
Past due 90 days or more and still accruing interest
$

$
5,968

$

$

$
5,968

Loans on non-accrual status5
$
18,843

$

$

$

$
18,843

                   
1 
The recorded investment for credit products includes only advances. The recorded investment for all other credit products is insignificant.
2 
The recorded investment in a financing receivable is the UPB, adjusted for accrued interest, net deferred loan fees or costs, unamortized premiums or discounts, fair value hedging adjustments and direct write-downs. The recorded investment is not net of any valuation allowance.
3 
Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu has been reported. Loans in process of foreclosure are included in past due or current loans dependent on their delinquency status.
4 
Loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the total recorded investment for the portfolio class.
5 
Loans on non-accrual status include $1,580,000 of troubled debt restructurings. Troubled debt restructurings are restructurings in which the FHLBank, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider.


25


Table 6.4 summarizes the key credit quality indicators for the FHLBank’s mortgage loans as of December 31, 2013 (dollar amounts in thousands):

Table 6.4
 
12/31/2013
 
Conventional
Loans
Government
Loans
Credit
Products1
Direct
Financing
Lease
Receivable
Total
Recorded investment2:
 
 
 
 
 
Past due 30-59 days delinquent
$
31,653

$
21,605

$

$

$
53,258

Past due 60-89 days delinquent
7,873

5,672



13,545

Past due 90 days or more delinquent
18,040

8,720



26,760

Total past due
57,566

35,997



93,563

Total current loans
5,265,483

626,379

17,446,437

23,540

23,361,839

Total recorded investment
$
5,323,049

$
662,376

$
17,446,437

$
23,540

$
23,455,402

 
 
 
 
 
 
Other delinquency statistics:
 

 

 

 

 

In process of foreclosure, included above3
$
7,665

$
2,968

$

$

$
10,633

Serious delinquency rate4
0.4
%
1.3
%
%
%
0.1
%
Past due 90 days or more and still accruing interest
$

$
8,720

$

$

$
8,720

Loans on non-accrual status5
$
21,294

$

$

$

$
21,294

                   
1 
The recorded investment for credit products includes only advances. The recorded investment for all other credit products is insignificant.
2 
The recorded investment in a financing receivable is the UPB, adjusted for accrued interest, net deferred loan fees or costs, unamortized premiums or discounts, fair value hedging adjustments and direct write-downs. The recorded investment is not net of any valuation allowance.
3 
Includes loans where the decision of foreclosure or similar alternative such as pursuit of deed-in-lieu has been reported. Loans in process of foreclosure are included in past due or current loans dependent on their delinquency status.
4 
Loans that are 90 days or more past due or in the process of foreclosure expressed as a percentage of the total recorded investment for the portfolio class.
5 
Loans on non-accrual status include $1,515,000 of troubled debt restructurings. Troubled debt restructurings are restructurings in which the FHLBank, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider.

The FHLBank had $4,622,000 and $4,307,000 classified as real estate owned recorded in other assets as of September 30, 2014 and December 31, 2013, respectively.



26


NOTE 7 – DERIVATIVES AND HEDGING ACTIVITIES

Table 7.1 represents outstanding notional balances and fair values (includes net accrued interest receivable or payable on the derivatives) of the derivatives outstanding by type of derivative and by hedge designation as of September 30, 2014 and December 31, 2013 (in thousands):

Table 7.1
 
09/30/2014
12/31/2013
 
Notional
Amount
Derivative
Assets
Derivative
Liabilities
Notional
Amount
Derivative
Assets
Derivative
Liabilities
Fair value hedges:
 

 

 

 

 

 

Interest rate swaps
$
11,091,152

$
101,356

$
216,727

$
10,285,231

$
127,059

$
347,123

Interest rate caps/floors
247,000


1,366

247,000


2,648

Total fair value hedges
11,338,152

101,356

218,093

10,532,231

127,059

349,771

Economic hedges:
 
 
 
 
 
 
Interest rate swaps
2,616,820

1,305

81,466

3,691,820

4,260

120,166

Interest rate caps/floors
4,205,800

17,196

50

4,627,800

41,463

103

Mortgage delivery commitments
64,698

85

53

65,620

24

289

Total economic hedges
6,887,318

18,586

81,569

8,385,240

45,747

120,558

TOTAL
$
18,225,470

119,942

299,662

$
18,917,471

172,806

470,329

Netting adjustments1
 
(179,800
)
(179,800
)
 
(161,161
)
(161,161
)
Cash collateral2
 
85,956

(68,445
)
 
16,312

(200,815
)
DERIVATIVE ASSETS AND LIABILITIES
 
$
26,098

$
51,417

 
$
27,957

$
108,353

                   
1 
Amounts represent the application of the netting requirements that allow the FHLBank to settle positive and negative positions and also cash collateral, including initial or variation margin, and related accrued interest held or placed with the same clearing agent and/or derivative counterparty.
2 
Exposure can change on a daily basis; and thus, there is often a short lag time between the date the exposure is identified, collateral is requested and collateral is actually received. Likewise, there is a lag time for excess collateral to be returned.

The following tables provide information regarding gains and losses on derivatives and hedging activities by type of hedge and type of derivative and gains and losses by hedged item for fair value hedges.


27


For the three and nine months ended September 30, 2014 and 2013, the FHLBank recorded net gain (loss) on derivatives and hedging activities as presented in Table 7.2 (in thousands):

Table 7.2
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
Derivatives and hedge items in fair value hedging relationships:
 
 
 
 
Interest rate swaps
$
141

$
856

$
(708
)
$
(4,441
)
Total net gain (loss) related to fair value hedge ineffectiveness
141

856

(708
)
(4,441
)
Derivatives not designated as hedging instruments:
 
 
 
 
Economic hedges:
 
 
 
 
Interest rate swaps
11,469

5,524

26,332

31,116

Interest rate caps/floors
(4,089
)
(3,908
)
(25,569
)
7,514

Net interest settlements
(9,799
)
(9,966
)
(29,585
)
(28,352
)
Mortgage delivery commitments
60

1,903

2,979

(2,945
)
Intermediary transactions:
 
 
 
 
Interest rate swaps

(1
)

(17
)
Total net gain (loss) related to derivatives not designated as hedging instruments
(2,359
)
(6,448
)
(25,843
)
7,316

NET GAIN (LOSS) ON DERIVATIVES AND HEDGING ACTIVITIES
$
(2,218
)
$
(5,592
)
$
(26,551
)
$
2,875


The FHLBank carries derivative instruments at fair value on its Statements of Condition. Any change in the fair value of derivatives designated under a fair value hedging relationship is recorded each period in current period earnings. 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. For the three months ended September 30, 2014 and 2013, the FHLBank recorded net gain (loss) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the FHLBank’s net interest income as presented in Table 7.3 (in thousands):

Table 7.3
 
Three Months Ended
 
09/30/2014
09/30/2013
 
Gain (Loss) on Derivatives
Gain (Loss) on Hedged Items
Net Fair Value Hedge Ineffectiveness
Effect of Derivatives on Net Interest Income1
Gain (Loss) on Derivatives
Gain (Loss) on Hedged Items
Net Fair Value Hedge Ineffectiveness
Effect of Derivatives on Net Interest Income1
Advances
$
47,481

$
(46,986
)
$
495

$
(35,539
)
$
10,788

$
(10,509
)
$
279

$
(38,948
)
Consolidated obligation bonds
(21,925
)
21,571

$
(354
)
23,343

(6,137
)
6,714

$
577

28,297

TOTAL
$
25,556

$
(25,415
)
$
141

$
(12,196
)
$
4,651

$
(3,795
)
$
856

$
(10,651
)
                   
1 
The differentials between accruals of interest receivables and payables on derivatives designated as fair value hedges as well as the amortization/accretion of hedging activities are recognized as adjustments to the interest income or expense of the designated underlying hedged item.


28


For the nine months ended September 30, 2014 and 2013, the FHLBank recorded net gain (loss) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the FHLBank’s net interest income as presented in Table 7.4 (in thousands):

Table 7.4
 
Nine Months Ended
 
09/30/2014
09/30/2013
 
Gain (Loss) on Derivatives
Gain (Loss) on Hedged Items
Net Fair Value Hedge Ineffectiveness
Effect of Derivatives on Net Interest Income1
Gain (Loss) on Derivatives
Gain (Loss) on Hedged Items
Net Fair Value Hedge Ineffectiveness
Effect of Derivatives on Net Interest Income1
Advances
$
68,762

$
(67,956
)
$
806

$
(106,619
)
$
145,881

$
(143,497
)
$
2,384

$
(119,789
)
Consolidated obligation bonds
32,233

(33,747
)
$
(1,514
)
69,123

(122,886
)
116,061

$
(6,825
)
81,098

TOTAL
$
100,995

$
(101,703
)
$
(708
)
$
(37,496
)
$
22,995

$
(27,436
)
$
(4,441
)
$
(38,691
)
                   
1 
The differentials between accruals of interest receivables and payables on derivatives designated as fair value hedges as well as the amortization/accretion of hedging activities are recognized as adjustments to the interest income or expense of the designated underlying hedged item.

Based on credit analyses and collateral requirements, FHLBank management does not anticipate any credit losses on its derivative agreements. The maximum credit risk applicable to a single counterparty was $29,039,000 and $21,045,000 as of September 30, 2014 and December 31, 2013, respectively. The counterparty was the same each period.

Certain of the FHLBank’s bilateral derivative instruments contain provisions that require the FHLBank to post additional collateral with its counterparties if there is deterioration in the FHLBank’s credit rating. If the FHLBank’s credit rating is lowered by an NRSRO, the FHLBank may be required to deliver additional collateral on bilateral derivative instruments in net liability positions. The aggregate fair value of all bilateral derivative instruments with derivative counterparties containing credit-risk-related contingent features that were in a net derivative liability position (before cash collateral and related accrued interest) as of September 30, 2014 and December 31, 2013 was $92,446,000 and $308,776,000, respectively, for which the FHLBank has posted collateral with a fair value of $41,323,000 and $200,815,000, respectively, in the normal course of business. If the FHLBank’s credit rating had been lowered one level (e.g., from double-A to single-A), the FHLBank would have been required to deliver an additional $35,000,000 and $77,830,000 of collateral to its bilateral derivative counterparties as of September 30, 2014 and December 31, 2013.

For cleared derivatives, the Clearinghouse determines initial margin requirements and generally, credit ratings are not factored into the initial margin. However, clearing agents may require additional initial margin to be posted based on credit considerations, including but not limited to credit rating downgrades. The FHLBank was not required to post additional initial margin by its clearing agents as of September 30, 2014 or December 31, 2013.

The FHLBank’s net exposure on derivative agreements is presented in Note 11.



29


NOTE 8 – DEPOSITS

The FHLBank offers demand, overnight and short-term deposit programs to its members and to other qualifying non-members. Table 8.1 details the types of deposits held by the FHLBank as of September 30, 2014 and December 31, 2013 (in thousands):

Table 8.1
 
09/30/2014
12/31/2013
Interest-bearing:
 
 
Demand
$
208,032

$
214,645

Overnight
377,900

686,100

Term
53,500

23,800

Total interest-bearing
639,432

924,545

Non-interest-bearing:
 
 
Demand
37,637

37,343

Total non-interest-bearing
37,637

37,343

TOTAL DEPOSITS
$
677,069

$
961,888



NOTE 9 – CONSOLIDATED OBLIGATIONS

Consolidated Obligation Bonds: Table 9.1 presents the FHLBank’s participation in consolidated obligation bonds outstanding as of September 30, 2014 and December 31, 2013 (in thousands):

Table 9.1
 
09/30/2014
12/31/2013
Year of Contractual Maturity
Amount
Weighted
Average
Interest
Rate
Amount
Weighted
Average
Interest
Rate
Due in one year or less
$
5,289,500

0.49
%
$
6,177,700

0.74
%
Due after one year through two years
3,611,250

0.96

3,182,300

0.69

Due after two years through three years
1,561,000

1.65

1,635,750

1.70

Due after three years through four years
1,451,375

2.24

1,397,935

2.56

Due after four years through five years
1,774,250

1.46

1,333,940

1.79

Thereafter
6,294,150

2.34

6,312,600

2.28

Total par value
19,981,525

1.46
%
20,040,225

1.49
%
Premiums
29,936

 
36,613

 
Discounts
(4,254
)
 
(4,605
)
 
Hedging adjustments
18,265

 
(15,269
)
 
TOTAL
$
20,025,472

 
$
20,056,964

 
                   


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 LIBOR, U.S. Treasury bills, Prime and Constant Maturity Treasuries. 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 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.


30


The FHLBank’s participation in consolidated obligation bonds outstanding as of September 30, 2014 and December 31, 2013 includes callable bonds totaling $9,436,000,000 and $8,302,000,000, respectively. The FHLBank uses the unswapped callable bonds for financing its callable advances (Note 4), MBS (Note 3) and mortgage loans (Note 5). Contemporaneous with a portion of its fixed rate callable bond issuances, 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. Table 9.2 summarizes the FHLBank’s participation in consolidated obligation bonds outstanding by year of maturity, or by the next call date for callable bonds as of September 30, 2014 and December 31, 2013 (in thousands):

Table 9.2
Year of Maturity or Next Call Date
09/30/2014
12/31/2013
Due in one year or less
$
14,555,500

$
14,189,700

Due after one year through two years
3,296,250

3,248,300

Due after two years through three years
957,000

1,126,750

Due after three years through four years
639,375

761,935

Due after four years through five years
176,250

378,940

Thereafter
357,150

334,600

TOTAL PAR VALUE
$
19,981,525

$
20,040,225


Table 9.3 summarizes interest rate payment terms for consolidated obligation bonds as of September 30, 2014 and December 31, 2013 (in thousands):

Table 9.3
 
09/30/2014
12/31/2013
Fixed rate
$
11,681,525

$
11,705,225

Simple variable rate
5,355,000

5,895,000

Step up/step down
2,720,000

2,220,000

Range
120,000

90,000

Fixed to variable rate
80,000

45,000

Variable to fixed rate
25,000

85,000

TOTAL PAR VALUE
$
19,981,525

$
20,040,225


Consolidated Discount Notes: Consolidated discount notes are issued to raise short-term funds. Consolidated discount notes are consolidated obligations with original maturities of up to one year. These consolidated discount notes are generally issued at less than their face amount and redeemed at par value when they mature.

Table 9.4 summarizes the FHLBank’s participation in consolidated obligation discount notes, all of which are due within one year (in thousands):

Table 9.4
 
Book Value
Par Value
Weighted
Average
Interest
Rate1
September 30, 2014
$
15,947,588

$
15,949,485

0.07
%
 
 
 
 
December 31, 2013
$
10,889,565

$
10,890,528

0.08
%
                   
1 
Represents yield to maturity excluding concession fees.



31


NOTE 10 – AFFORDABLE HOUSING PROGRAM

The Federal Home Loan Bank Act (Bank Act), as amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989, requires each FHLBank to establish an Affordable Housing Program (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. By regulation, 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 net earnings. For purposes of the AHP calculation, the term “net earnings” is defined as income before interest expense related to mandatorily redeemable capital stock and the assessment for AHP. The FHLBank accrues this expense monthly based on its net earnings.

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 net earnings before AHP 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 the 12 FHLBanks as a group, 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. 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.

Table 10.1 details the change in the AHP liability for the three and nine months ended September 30, 2014 and 2013 (in thousands):

Table 10.1
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
Appropriated and reserved AHP funds as of the beginning of the period
$
34,937

$
32,501

$
35,264

$
31,198

AHP set aside based on current year income
3,181

3,176

8,833

9,120

Direct grants disbursed
(6,227
)
(2,547
)
(12,372
)
(7,298
)
Recaptured funds1
53

99

219

209

Appropriated and reserved AHP funds as of the end of the period
$
31,944

$
33,229

$
31,944

$
33,229

                   
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); (3) over-subsidized projects; or (4) unused grants.


NOTE 11 – ASSETS AND LIABILITIES SUBJECT TO OFFSETTING

The FHLBank presents certain financial instruments, including derivatives, repurchase agreements and securities purchased under agreements to resell, on a net basis by clearing agent by Clearinghouse, or by counterparty, when it has met the netting requirements. For these financial instruments, the FHLBank has elected to offset its asset and liability positions, as well as cash collateral, including initial and variation margin, received or pledged and associated accrued interest.


32


Tables 11.1 and 11.2 present the fair value of financial assets, including the related collateral received from or pledged to clearing agents or counterparties, based on the terms of the FHLBank’s master netting arrangements or similar agreements as of September 30, 2014 and December 31, 2013 (in thousands):

Table 11.1
09/30/2014
Description
Gross Amounts
of Recognized
Assets
Gross Amounts
Offset
in the
Statement of
Condition
Net Amounts
of Assets
Presented
in the
Statement of
Condition
Gross Amounts
Not Offset
in the
Statement of
Condition1
Net
Amount
Derivative assets:
 
 
 
 
 
Bilateral derivatives
$
117,701

$
(108,573
)
$
9,128

$
(85
)
$
9,043

Cleared derivatives
2,241

14,729

16,970


16,970

Total derivative assets
119,942

(93,844
)
26,098

(85
)
26,013

Securities purchased under agreements to resell
1,075,000


1,075,000

(1,075,000
)

TOTAL
$
1,194,942

$
(93,844
)
$
1,101,098

$
(1,075,085
)
$
26,013

                   
1 
Represents noncash collateral received on financial instruments that: (1) do not qualify for netting on the Statement of Condition; or (2) are not subject to an enforceable netting agreement (e.g., mortgage delivery commitments).

Table 11.2
12/31/2013
Description
Gross Amounts
of Recognized
Assets
Gross Amounts
Offset
in the
Statement of
Condition
Net Amounts
of Assets
Presented
in the
Statement of
Condition
Gross Amounts
Not Offset
in the
Statement of
Condition1
Net
Amount
Derivative assets:
 
 
 
 
 
Bilateral derivatives
$
165,894

$
(150,968
)
$
14,926

$
(24
)
$
14,902

Cleared derivatives
6,912

6,119

13,031


13,031

Total derivative assets
172,806

(144,849
)
27,957

(24
)
27,933

TOTAL
$
172,806

$
(144,849
)
$
27,957

$
(24
)
$
27,933

                   
1 
Represents noncash collateral received on financial instruments that: (1) do not qualify for netting on the Statement of Condition; or (2) are not subject to an enforceable netting agreement (e.g., mortgage delivery commitments).


33


Tables 11.3 and 11.4 present the fair value of financial liabilities, including the related collateral received from or pledged to counterparties, based on the terms of the FHLBank’s master netting arrangements or similar agreements as of September 30, 2014 and December 31, 2013 (in thousands):

Table 11.3
09/30/2014
Description
Gross Amounts
of Recognized
Liabilities
Gross Amounts
Offset
in the
Statement of
Condition
Net Amounts
of Liabilities
Presented
in the
Statement of
Condition
Gross Amounts
Not Offset
in the
Statement of
Condition1
Net
Amount
Derivative liabilities:
 
 
 
 
 
Bilateral derivatives
$
285,371

$
(233,954
)
$
51,417

$
(103
)
$
51,314

Cleared derivatives
14,291

(14,291
)



Total derivative liabilities
299,662

(248,245
)
51,417

(103
)
51,314

TOTAL
$
299,662

$
(248,245
)
$
51,417

$
(103
)
$
51,314

                   
1 
Represents noncash collateral received on financial instruments that: (1) do not qualify for netting on the Statement of Condition; or (2) are not subject to an enforceable netting agreement (e.g., mortgage delivery commitments).

Table 11.4
12/31/2013
Description
Gross Amounts
of Recognized
Liabilities
Gross Amounts
Offset
in the
Statement of
Condition
Net Amounts
of Liabilities
Presented
in the
Statement of
Condition
Gross Amounts
Not Offset
in the
Statement of
Condition1
Net
Amount
Derivative liabilities:
 
 
 
 
 
Bilateral derivatives
$
470,290

$
(361,937
)
$
108,353

$
(392
)
$
107,961

Cleared derivatives
39

(39
)



Total derivative liabilities
470,329

(361,976
)
108,353

(392
)
107,961

TOTAL
$
470,329

$
(361,976
)
$
108,353

$
(392
)
$
107,961

                   
1 
Represents noncash collateral received on financial instruments that: (1) do not qualify for netting on the Statement of Condition; or (2) are not subject to an enforceable netting agreement (e.g., mortgage delivery commitments).



34


NOTE 12 – CAPITAL

The FHLBank is subject to three capital requirements under the provisions of the Gramm-Leach-Bliley Act (GLB Act) and the Finance Agency’s capital structure regulation. Regulatory capital does not include accumulated other comprehensive income (AOCI) but does include mandatorily redeemable capital stock.
Risk-based capital. 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.
Total regulatory capital. The GLB Act requires the FHLBank to maintain at all times at least a 4.0 percent total capital-to-asset ratio. Total regulatory capital is defined as the sum of permanent capital, Class A Common 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.
Leverage capital. The FHLBank is required to maintain at all times a leverage capital-to-assets ratio of at least 5.0 percent, 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.

Table 12.1 illustrates that the FHLBank was in compliance with its regulatory capital requirements as of September 30, 2014 and December 31, 2013 (in thousands):

Table 12.1
 
09/30/2014
12/31/2013
 
Required
Actual
Required
Actual
Regulatory capital requirements:
 
 
 
 
Risk-based capital
$
376,228

$
1,554,019

$
414,914

$
1,389,646

Total regulatory capital-to-asset ratio
4.0
%
4.4
%
4.0
%
5.4
%
Total regulatory capital
$
1,541,122

$
1,709,826

$
1,358,012

$
1,824,345

Leverage capital ratio
5.0
%
6.5
%
5.0
%
7.4
%
Leverage capital
$
1,926,402

$
2,486,835

$
1,697,515

$
2,519,168


Mandatorily Redeemable Capital Stock: 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 a price equal to the $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. After the reclassification, dividends on the capital stock would no longer be classified as interest expense.

Table 12.2 provides the related dollar amounts for activities recorded in “Mandatorily redeemable capital stock” during the three and nine months ended September 30, 2014 and 2013 (in thousands):

Table 12.2
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
Balance at beginning of period
$
4,519

$
5,410

$
4,764

$
5,665

Capital stock subject to mandatory redemption reclassified from equity during the period
58,794

99,455

228,102

207,150

Redemption or repurchase of mandatorily redeemable capital stock during the period
(58,954
)
(99,687
)
(228,522
)
(207,649
)
Stock dividend classified as mandatorily redeemable capital stock during the period
12

6

27

18

Balance at end of period
$
4,371

$
5,184

$
4,371

$
5,184



35


Table 12.3 shows the amount of mandatorily redeemable capital stock by contractual year of redemption as of September 30, 2014 and December 31, 2013 (in thousands). The year of redemption in Table 12.3 is the end of the redemption period in accordance with the FHLBank’s capital plan. The FHLBank is not required to redeem or repurchase membership stock until 6 months (for Class A Common Stock) or 5 years (for Class B Common Stock) after the FHLBank receives notice for withdrawal. Additionally, 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.

Table 12.3
Contractual Year of Repurchase
09/30/2014
12/31/2013
Year 1
$

$
166

Year 2
53

52

Year 3
1


Year 4
24


Year 5

74

Past contractual redemption date due to remaining activity1
4,293

4,472

TOTAL
$
4,371

$
4,764

                   
1 
Represents mandatorily redeemable capital stock that is past the end of the contractual redemption period because there is activity outstanding to which the mandatorily redeemable capital stock relates.

Excess Capital Stock: Excess capital stock is defined as the amount of stock held by a member (or former member) in excess of that institution’s minimum stock purchase requirement. Finance Agency rules limit the ability of the FHLBank to create excess member stock under certain circumstances. For example, the FHLBank may not pay dividends in the form of capital stock or issue new excess stock to members if the FHLBank’s excess stock exceeds one percent of its total assets or if the issuance of excess stock would cause the FHLBank’s excess stock to exceed one percent of its total assets. As of September 30, 2014, the FHLBank’s excess stock was less than one percent of total assets.

Capital Classification Determination: The Finance Agency implemented the prompt corrective action (PCA) provisions of the Housing and Economic Recovery Act of 2008. The rule established four capital classifications (i.e., adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized) for FHLBanks and implemented the PCA provisions that apply to FHLBanks that are not deemed to be adequately capitalized. The Finance Agency determines each FHLBank’s capital classification on at least a quarterly basis. If an FHLBank is determined to be other than adequately capitalized, the FHLBank becomes subject to additional supervisory authority by the Finance Agency. Before implementing a reclassification, the Director of the Finance Agency is required to provide the FHLBank with written notice of the proposed action and an opportunity to submit a response. As of the most recent review by the Finance Agency, the FHLBank has been classified as adequately capitalized.



36


NOTE 13ACCUMULATED OTHER COMPREHENSIVE INCOME

Table 13.1 summarizes the changes in AOCI for the three months ended September 30, 2014 and 2013 (in thousands):

Table 13.1
 
Three Months Ended
 
Net Non-credit Portion of OTTI Losses on
Held-to-maturity Securities
Defined Benefit Pension Plan
Total AOCI
Balance at June 30, 2013
$
(17,979
)
$
(4,210
)
$
(22,189
)
Other comprehensive income (loss) before reclassification:
 
 
 
Non-credit OTTI losses
(5
)
 
(5
)
Accretion of non-credit loss
738

 
738

Reclassifications from other comprehensive income (loss) to net income:
 
 


Non-credit OTTI to credit OTTI1
300

 
300

Amortization of net loss - defined benefit pension plan2
 
101

101

Net current period other comprehensive income (loss)
1,033

101

1,134

Balance at September 30, 2013
$
(16,946
)
$
(4,109
)
$
(21,055
)
 
 
 
 
Balance at June 30, 2014
$
(13,848
)
$
(2,269
)
$
(16,117
)
Other comprehensive income (loss) before reclassification:
 
 
 
Accretion of non-credit loss
1,002

 
1,002

Reclassifications from other comprehensive income (loss) to net income:
 
 
 
Non-credit OTTI to credit OTTI1
20

 
20

Amortization of net loss - defined benefit pension plan2
 
38

38

Net current period other comprehensive income (loss)
1,022

38

1,060

Balance at September 30, 2014
$
(12,826
)
$
(2,231
)
$
(15,057
)
                   
1 
Recorded in “Net other-than-temporary impairment losses on held-to-maturity securities” on the Statements of Income. Amount represents a debit (decrease to other income (loss)).
2 
Recorded in “Compensation and benefits” on the Statements of Income. Amount represents a debit (increase to other expenses).


37


Table 13.2 summarizes the changes in AOCI for the nine months ended September 30, 2014 and 2013 (in thousands):

Table 13.2
 
Nine Months Ended
 
Net Non-credit Portion of OTTI Losses on
Held-to-maturity Securities
Defined Benefit Pension Plan
Total AOCI
Balance at December 31, 2012
$
(20,846
)
$
(4,411
)
$
(25,257
)
Other comprehensive income (loss) before reclassification:
 
 
 
Non-credit OTTI losses
(19
)
 
(19
)
Accretion of non-credit loss
3,467

 
3,467

Reclassifications from other comprehensive income (loss) to net income:
 
 
 
Non-credit OTTI to credit OTTI1
452

 
452

Amortization of net loss - defined benefit pension plan2
 
302

302

Net current period other comprehensive income (loss)
3,900

302

4,202

Balance at September 30, 2013
$
(16,946
)
$
(4,109
)
$
(21,055
)
 
 
 
 
Balance at December 31, 2013
$
(16,003
)
$
(2,358
)
$
(18,361
)
Other comprehensive income (loss) before reclassification:
 
 
 
Accretion of non-credit loss
2,734

 
2,734

Reclassifications from other comprehensive income (loss) to net income:
 
 
 
Non-credit OTTI to credit OTTI1
443

 
443

Amortization of net loss - defined benefit pension plan2
 
127

127

Net current period other comprehensive income (loss)
3,177

127

3,304

Balance at September 30, 2014
$
(12,826
)
$
(2,231
)
$
(15,057
)
                   
1 
Recorded in “Net other-than-temporary impairment losses on held-to-maturity securities” on the Statements of Income. Amount represents a debit (decrease to other income (loss)).
2 
Recorded in “Compensation and benefits” on the Statements of Income. Amount represents a debit (increase to other expenses).


NOTE 14FAIR VALUES

The fair value amounts recorded on the Statements of Condition and presented in the note disclosures have been determined by the FHLBank using available market and other pertinent information and reflect the FHLBank’s best judgment of appropriate valuation methods. Although the FHLBank uses its best judgment in estimating the fair value of its financial instruments, there are inherent limitations in any valuation technique. Therefore, the fair values may not be indicative of the amounts that would have been realized in market transactions as of September 30, 2014 and December 31, 2013.

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. The use of different assumptions could have a material effect on the fair value estimates.

Fair Value Hierarchy: The FHLBank records trading securities, derivative assets and derivative liabilities at fair value on a recurring basis and on occasion, certain private-label MBS/ABS and non-financial assets on a non-recurring basis. The fair value hierarchy requires the FHLBank to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring 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 for the asset or liability. The FHLBank must disclose the level within the fair value hierarchy in which the measurements are classified for all assets and liabilities.

38



The fair value hierarchy prioritizes the inputs used to measure fair value into three broad levels:
Level 1 Inputs –  Quoted prices (unadjusted) for identical assets or liabilities in active markets that the FHLBank can access on the measurement date.
Level 2 Inputs –  Inputs other than quoted prices within Level 1 that are observable inputs for the asset or liability, either directly or indirectly. If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include the following: (1) quoted prices for similar assets and liabilities in active markets; (2) quoted prices for similar assets and liabilities in markets that are not active; (3) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals and implied volatilities); and (4) inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3 Inputs –  Unobservable inputs for the asset or liability.

The FHLBank reviews its fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation inputs may result in a reclassification of certain assets or liabilities. These reclassifications, if any, are reported as transfers in/out as of the beginning of the quarter in which the changes occur. There were no transfers during the three and nine months ended September 30, 2014 and 2013.

The carrying value and fair value of the FHLBank’s financial assets and liabilities as of September 30, 2014 and December 31, 2013 are summarized in Tables 14.1 and 14.2 (in thousands). These values 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 and liabilities.

Table 14.1
 
09/30/2014
 
Carrying
Value
Total
Fair
Value
Level 1
Level 2
Level 3
Netting
Adjustment
and Cash
Collateral
Assets:
 
 
 
 
 
 
Cash and due from banks
$
2,571,350

$
2,571,350

$
2,571,350

$

$

$

Interest-bearing deposits
146

146


146



Securities purchased under agreements to resell
1,075,000

1,075,000


1,075,000



Federal funds sold
1,450,000

1,450,000


1,450,000



Trading securities
1,476,212

1,476,212


1,476,212



Held-to-maturity securities
5,074,263

5,085,070


4,703,646

381,424


Advances
20,574,600

20,635,315


20,635,315



Mortgage loans held for portfolio, net of allowance
6,164,822

6,331,505


6,331,505



Accrued interest receivable
63,232

63,232


63,232



Derivative assets
26,098

26,098


119,942


(93,844
)
Liabilities:
 
 
 
 
 
 
Deposits
677,069

677,069


677,069



Consolidated obligation discount notes
15,947,588

15,947,112


15,947,112



Consolidated obligation bonds
20,025,472

19,975,760


19,975,760



Mandatorily redeemable capital stock
4,371

4,371

4,371




Accrued interest payable
71,757

71,757


71,757



Derivative liabilities
51,417

51,417


299,662


(248,245
)
Other Asset (Liability):
 
 
 
 
 
 
Standby letters of credit
(777
)
(777
)

(777
)


Standby bond purchase agreements
276

6,009


6,009



Advance commitments

(784
)

(784
)




39


Table 14.2
 
12/31/2013
 
Carrying
Value
Total
Fair
Value
Level 1
Level 2
Level 3
Netting
Adjustment
and Cash
Collateral
Assets:
 
 
 
 
 
 
Cash and due from banks
$
1,713,940

$
1,713,940

$
1,713,940

$

$

$

Interest-bearing deposits
1,116

1,116


1,116



Federal funds sold
575,000

575,000


575,000



Trading securities
2,704,777

2,704,777


2,704,777



Held-to-maturity securities
5,423,659

5,415,205


5,038,465

376,740


Advances
17,425,487

17,461,489


17,461,489



Mortgage loans held for portfolio, net of allowance
5,949,480

5,991,371


5,991,371



Accrued interest receivable
72,526

72,526


72,526



Derivative assets
27,957

27,957


172,806


(144,849
)
Liabilities:
 


 
 
 
 
Deposits
961,888

961,888


961,888



Consolidated obligation discount notes
10,889,565

10,889,682


10,889,682



Consolidated obligation bonds
20,056,964

19,808,605


19,808,605



Mandatorily redeemable capital stock
4,764

4,764

4,764




Accrued interest payable
62,447

62,447


62,447



Derivative liabilities
108,353

108,353


470,329


(361,976
)
Other Asset (Liability):
 
 
 
 
 
 
Standby letters of credit
(996
)
(996
)

(996
)


Standby bond purchase agreements
208

6,868


6,868



Standby credit facility
(45
)
(45
)

(45
)


Advance commitments

(182
)

(182
)


 
Fair Value Measurements: Tables 14.3 and 14.4 present, for each hierarchy level, the FHLBank’s assets and liabilities that are measured at fair value on a recurring or nonrecurring basis on the Statements of Condition as of September 30, 2014 and December 31, 2013 (in thousands). The FHLBank measures certain held-to-maturity securities at fair value on a nonrecurring basis due to the recognition of a credit loss. For held-to-maturity securities that had credit impairment recorded at period end for which no total impairment was recorded (the full amount of additional credit impairment was a reclassification from non-credit impairment previously recorded in AOCI), these securities were recorded at their carrying values and not fair value. Real estate owned is measured at fair value when the asset’s fair value less costs to sell is lower than its carrying amount.


40


Table 14.3
 
09/30/2014
 
Total
Level 1
Level 2
Level 3
Netting
Adjustment
and Cash
Collateral1
Recurring fair value measurements - Assets:
 
 
 
 
 
Trading securities:
 
 
 
 
 
U.S. Treasury obligations
$
25,031

$

$
25,031

$

$

Government-sponsored enterprise obligations2,3
1,306,245


1,306,245



U.S. obligation residential MBS4
986


986



Government-sponsored enterprise residential MBS5
143,950


143,950



Total trading securities
1,476,212


1,476,212



Derivative assets:
 
 
 
 
 
Interest-rate related
26,013


119,857


(93,844
)
Mortgage delivery commitments
85


85



Total derivative assets
26,098


119,942


(93,844
)
TOTAL RECURRING FAIR VALUE MEASUREMENTS - ASSETS
$
1,502,310

$

$
1,596,154

$

$
(93,844
)
 
 
 
 
 
 
Recurring fair value measurements - Liabilities:
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
Interest-rate related
$
51,364

$

$
299,609

$

$
(248,245
)
Mortgage delivery commitments
53


53



Total derivative liabilities
51,417


299,662


(248,245
)
TOTAL RECURRING FAIR VALUE MEASUREMENTS - LIABILITIES
$
51,417

$

$
299,662

$

$
(248,245
)
 
 
 
 
 
 
Nonrecurring fair value measurements - Assets:
 
 
 
 
 
Real estate owned6
$
1,368

$

$

$
1,368

$

TOTAL NONRECURRING FAIR VALUE MEASUREMENTS - ASSETS
$
1,368

$

$

$
1,368

$

                   
1 
Represents the effect of legally enforceable master netting agreements that allow the FHLBank to net settle positive and negative positions and also derivative cash collateral and related accrued interest held or placed with the same clearing agent or derivative counterparty.
2 
Represents debentures issued by other FHLBanks, Fannie Mae, Freddie Mac, Farm Credit, and Farmer Mac. GSE securities are not guaranteed by the U.S. government. Fannie Mae and Freddie Mac were placed into conservatorship by the Finance Agency on September 7, 2008 with the Finance Agency named as conservator.
3 
See Note 17 for transactions with other FHLBanks.
4 
Represents MBS issued by Ginnie Mae, which are guaranteed by the U.S. government.
5 
Represents single-family and multi-family MBS issued by Fannie Mae and Freddie Mac.
6 
Includes real estate owned written down to fair value during the quarter ended September 30, 2014 and still outstanding as of September 30, 2014.


41


Table 14.4
 
12/31/2013
 
Total
Level 1
Level 2
Level 3
Netting
Adjustment
and Cash
Collateral1
Recurring fair value measurements - Assets:
 
 
 
 
 
Trading securities:
 
 
 
 
 
Certificates of deposit
$
260,009

$

$
260,009

$

$

U.S. Treasury obligations
25,012


25,012



Government-sponsored enterprise obligations2,3
2,247,966


2,247,966



U.S. obligation residential MBS4
1,090


1,090



Government-sponsored enterprise residential MBS5
170,700


170,700



Total trading securities
2,704,777


2,704,777



Derivative assets:
 
 
 
 
 
Interest-rate related
27,933


172,782


(144,849
)
Mortgage delivery commitments
24


24



Total derivative assets
27,957


172,806


(144,849
)
TOTAL RECURRING FAIR VALUE MEASUREMENTS - ASSETS
$
2,732,734

$

$
2,877,583

$

$
(144,849
)
 
 
 
 
 
 
Recurring fair value measurements - Liabilities:
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
Interest-rate related
$
108,064

$

$
470,040

$

$
(361,976
)
Mortgage delivery commitments
289


289



Total derivative liabilities
108,353


470,329


(361,976
)
TOTAL RECURRING FAIR VALUE MEASUREMENTS - LIABILITIES
$
108,353

$

$
470,329

$

$
(361,976
)
 
 
 
 
 
 
Nonrecurring fair value measurements - Assets:
 
 
 
 
 
Held-to-maturity securities6:
 
 
 
 
 
Private-label residential MBS
$
237

$

$

$
237

$

Real estate owned7
497



497


TOTAL NONRECURRING FAIR VALUE MEASUREMENTS - ASSETS
$
734

$

$

$
734

$

                   
1 
Represents the effect of legally enforceable master netting agreements that allow the FHLBank to net settle positive and negative positions and also derivative cash collateral and related accrued interest held or placed with the same clearing agent or derivative counterparty.
2 
Represents debentures issued by other FHLBanks, Fannie Mae, Freddie Mac, Farm Credit, and Farmer Mac. GSE securities are not guaranteed by the U.S. government. Fannie Mae and Freddie Mac were placed into conservatorship by the Finance Agency on September 7, 2008 with the Finance Agency named as conservator.
3 
See Note 17 for transactions with other FHLBanks.
4 
Represents MBS issued by Ginnie Mae, which are guaranteed by the U.S. government.
5 
Represents single-family and multi-family MBS issued by Fannie Mae and Freddie Mac.
6 
Excludes impaired securities with carrying values less than their fair values at date of impairment.
7 
Includes real estate owned written down to fair value during the quarter ended December 31, 2013 and still outstanding as of December 31, 2013.



42


NOTE 15COMMITMENTS AND CONTINGENCIES

Joint and Several Liability: As provided by the Bank Act or Finance Agency regulation and as described in Note 9, consolidated obligations are backed only by the financial resources of the FHLBanks. FHLBank Topeka is jointly and severally liable with the other 11 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 $781,018,828,000 and $735,906,150,000 as of September 30, 2014 and December 31, 2013, 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 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 the loss could be reasonably estimated, the FHLBank would charge to income the amount of the expected loss. Based upon the creditworthiness of the other 11 FHLBanks as of September 30, 2014, FHLBank Topeka has concluded that a loss accrual is not necessary at this time.

Off-balance Sheet Commitments: As of September 30, 2014 and December 31, 2013, off-balance sheet commitments are presented in Table 15.1 (in thousands):

Table 15.1
 
09/30/2014
12/31/2013
Notional Amount
Expire
Within
One Year
Expire
After
One Year
Total
Expire
Within
One Year
Expire
After
One Year
Total
Standby letters of credit outstanding
$
2,231,143

$
10,655

$
2,241,798

$
2,530,810

$
12,038

$
2,542,848

Standby credit facility commitments outstanding



50,000


50,000

Advance commitments outstanding

24,796

24,796

6,000


6,000

Commitments for standby bond purchases
586,911

993,348

1,580,259

363,777

1,293,972

1,657,749

Commitments to fund or purchase mortgage loans
64,698


64,698

65,620


65,620

Commitments to issue consolidated bonds, at par
57,000


57,000

75,000


75,000

Commitments to issue consolidated discount notes, at par
400,000


400,000

650,000


650,000


Commitments to Extend Credit: 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 September 30, 2014, outstanding standby letters of credit had original terms of 2 days to 10 years with a final expiration in 2020. As of December 31, 2013, outstanding standby letters of credit had original terms of 7 days to 10 years with a final expiration in 2020. Unearned fees as well as the value of the guarantees related to standby letters of credit are recorded in other liabilities and amounted to $777,000 and $996,000 as of September 30, 2014 and December 31, 2013, respectively. Standby letters of credit are fully collateralized with assets allowed by the FHLBank’s Member Products Policy (MPP). Standby credit facility (SCF) commitments legally bind and unconditionally obligate the FHLBank for additional advances to stockholders. These commitments are executed for members for a fee and are for terms of up to one year. Unearned fees are recorded in other liabilities and amounted to $45,000 as of December 31, 2013. Advance commitments legally bind and unconditionally obligate the FHLBank for additional advances up to 24 months in the future. Based upon management’s credit analysis of members and collateral requirements under the MPP, the FHLBank does not expect to incur any credit losses on the letters of credit, SCF commitments or advance commitments.


43


Standby Bond-Purchase Agreements: The FHLBank has entered into standby bond purchase agreements with state housing authorities 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 2017, though some are renewable at the option of the FHLBank.  As of September 30, 2014 and December 31, 2013, the total commitments for bond purchases were with two in-district and one out-of-district state housing authorities as well as one participation interest in a standby bond purchase agreement between another FHLBank and a state housing authority in its district. The FHLBank was not required to purchase any bonds under any agreements during the three and nine months ended September 30, 2014 and 2013.

Commitments to Fund or Purchase Mortgage Loans: These commitments that unconditionally obligate the FHLBank to fund/purchase mortgage loans from participating FHLBank Topeka members in the MPF Program are generally for periods not to exceed 60 calendar days. Certain commitments are recorded as derivatives at their fair values on the Statements of Condition. The FHLBank recorded mortgage delivery commitment net derivative asset (liability) balances of $32,000 and $(265,000) as of September 30, 2014 and December 31, 2013, respectively.


NOTE 16TRANSACTIONS WITH STOCKHOLDERS

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.

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 as FHLBank directors’ financial institutions and members with capital stock 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: Tables 16.1 and 16.2 present information as of September 30, 2014 and December 31, 2013 on members that owned more than 10 percent of outstanding FHLBank regulatory capital stock in 2014 or 2013 (amounts in thousands). None of the officers or directors of these members currently serve on the FHLBank’s board of directors.

Table 16.1
09/30/2014
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
Capitol Federal Savings Bank
KS
$
500

0.3
%
$
212,554

22.6
%
$
213,054

19.5
%
Bank of Oklahoma, NA
OK
500

0.3

154,903

16.5

155,403

14.2

MidFirst Bank
OK
500

0.3

123,619

13.2

124,119

11.3

TOTAL
 
$
1,500

0.9
%
$
491,076

52.3
%
$
492,576

45.0
%

Table 16.2
12/31/2013
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
$
500

0.1
%
$
136,870

16.7
%
$
137,370

10.9
%
Capitol Federal Savings Bank
KS
2,100

0.5

126,995

15.4

129,095

10.3

TOTAL
 
$
2,600

0.6
%
$
263,865

32.1
%
$
266,465

21.2
%


44


Advance and deposit balances with members that owned more than 10 percent of outstanding FHLBank regulatory capital stock as of September 30, 2014 and December 31, 2013 are summarized in Table 16.3 (amounts in thousands). Information is only listed for the period in which the member owned more than 10 percent of outstanding FHLBank regulatory capital stock.

Table 16.3
 
09/30/2014
12/31/2013
09/30/2014
12/31/2013
Member Name
Outstanding Advances
Percent of Total
Outstanding Advances
Percent of Total
Outstanding Deposits
Percent of Total
Outstanding Deposits
Percent of Total
Capitol Federal Savings Bank
$
3,375,000

16.5
%
$
2,525,000

14.7
%
$
408

0.1
%
$
611

0.1
%
Bank of Oklahoma, NA
3,453,400

16.9

 
 
1,447

0.2

 
 
MidFirst Bank
2,711,500

13.3

2,720,000

15.8

566

0.1

538

0.1

TOTAL
$
9,539,900

46.7
%
$
5,245,000

30.5
%
$
2,421

0.4
%
$
1,149

0.2
%

MidFirst Bank and Capitol Federal Savings Bank did not sell any mortgage loans into the MPF Program during the three and nine months ended September 30, 2014 and 2013. Bank of Oklahoma, NA did not sell any mortgage loans in the MPF Program during the three and nine month periods ended September 30, 2014.

Transactions with FHLBank Directors’ Financial Institutions: Table 16.4 presents information as of September 30, 2014 and December 31, 2013 for members that had an officer or director serving on the FHLBank’s board of directors in 2014 or 2013 (amounts in thousands). Information is only included for the period 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.

Table 16.4
 
09/30/2014
12/31/2013
 
Outstanding Amount
Percent of Total
Outstanding Amount
Percent of Total
Advances
$
212,683

1.0
%
$
203,310

1.2
%
 
 
 
 
 
Deposits
$
7,938

1.2
%
$
6,220

0.6
%
 
 
 
 
 
Class A Common Stock
$
3,611

2.3
%
$
9,380

2.1
%
Class B Common Stock
7,137

0.8

8,332

1.0

TOTAL CAPITAL STOCK
$
10,748

1.0
%
$
17,712

1.4
%

Table 16.5 presents mortgage loans acquired during the three and nine months ended September 30, 2014 and 2013 for members that had an officer or director serving on the FHLBank’s board of directors in 2014 or 2013 (amounts in thousands).

Table 16.5
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
 
Amount
Percent of Total
Amount
Percent of Total
Amount
Percent of Total
Amount
Percent of Total
Mortgage loans acquired
$
24,855

8.3
%
$
8,759

3.5
%
$
66,009

8.4
%
$
49,851

4.9
%


45


NOTE 17TRANSACTIONS WITH OTHER FHLBANKS

FHLBank Topeka had the following business transactions with other FHLBanks during the three and nine months ended September 30, 2014 and 2013 as presented in Table 17.1 (in thousands). All transactions occurred at market prices.

Table 17.1
 
Three Months Ended
Nine Months Ended
Business Activity
09/30/2014
09/30/2013
09/30/2014
09/30/2013
Average overnight interbank loan balances to other FHLBanks1
$
543

$
3,261

$
1,176

$
1,817

Average overnight interbank loan balances from other FHLBanks1
5,000

44,837

1,832

18,278

Average deposit balances with FHLBank of Chicago for interbank transactions2
807

2,098

640

2,434

Transaction charges paid to FHLBank of Chicago for transaction service fees3
824

782

2,422

2,341

Par amount of purchases of consolidated obligations issued on behalf of other FHLBanks4

105,500


150,500

_________
1 
Occasionally, the FHLBank loans (or borrows) short-term funds to (from) other FHLBanks. Interest income on loans to other FHLBanks is included in Other Interest Income and interest expense on borrowings from other FHLBanks is included in Other Interest Expense on the Statements of Income.
2 
Balances are interest bearing and are classified on the Statements of Condition as interest-bearing deposits.
3 
Fees are calculated monthly based on outstanding loans at the per annum rate in effect at origination.
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 fair value balances totaling $227,227,000 and $260,318,000 as of September 30, 2014 and December 31, 2013, respectively, are included in the non-MBS GSE obligations totals presented in Note 3. Interest income earned on these securities totaled $2,252,000 and $2,050,000 for the three months ended September 30, 2014 and 2013, respectively, and $6,766,000 and $4,882,000 for the nine months ended September 30, 2014 and 2013, respectively.


46


Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to assist the reader in understanding our business and assessing our operations both historically and prospectively. This discussion should be read in conjunction with our interim financial statements and related notes presented under Part I Item 1 of this quarterly report on Form 10-Q and the annual report on Form 10-K for the year ended December 31, 2013, which includes audited financial statements and related notes for the year ended December 31, 2013. Our MD&A includes the following sections:
Executive Level Overview – a general description of our business and financial highlights;
Financial Market Trends – a discussion of current trends in the financial markets and overall economic environment, including the related impact on our operations;
Critical Accounting Policies and Estimates – a discussion of accounting policies that require critical estimates and assumptions;
Results of Operations – an analysis of our operating results, including disclosures about the sustainability of our earnings;
Financial Condition – an analysis of our financial position;
Liquidity and Capital Resources – an analysis of our cash flows and capital position;
Risk Management – a discussion of our risk management strategies;
Impact of Recently Issued Accounting Standards; and
Legislative and Regulatory Developments.

Executive Level Overview
We are a regional wholesale bank that makes advances (loans) to, purchases mortgages from, and provides limited other financial services to our member institutions. We are one of 12 district FHLBanks which, together with the Office of Finance, a joint office of the FHLBanks, make up the FHLBank System. As independent, member-owned cooperatives, the FHLBanks seek to maintain a balance between their public purpose and their ability to provide adequate returns on the capital supplied by their members. The FHLBanks are supervised and regulated by the Finance Agency, an independent agency in the executive branch of the U.S. government. The Finance Agency’s mission is to ensure that the housing GSEs operate in a safe and sound manner so that they serve as a reliable source of liquidity and funding for housing finance and community investment.

Our 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 oversee 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. Although consolidated obligations are not obligations of, nor guaranteed by, the U.S. government, the capital markets have traditionally considered the FHLBanks’ consolidated obligations as “Federal agency” debt. As a result, the FHLBanks have traditionally had ready access to funding at relatively favorable spreads to U.S. Treasuries. Additional funds are provided by deposits (received from both member and non-member financial institutions), other borrowings, and the issuance of capital stock.

We serve eligible financial institutions in Colorado, Kansas, Nebraska, and Oklahoma (collectively, the Tenth District of the FHLBank System). Initially, members are required to purchase shares of Class A Common Stock based on the member’s total assets. Each member may be required to purchase activity-based capital stock (Class B Common Stock) as it engages in certain business activities with the FHLBank, including advances and Acquired Member Assets (AMA), at levels determined by management with the Board of Director’s approval and within the ranges stipulated in the Capital Stock Plan. Currently, our capital increases when members are required to purchase additional capital stock in the form of Class B Common Stock to support an increase in advance borrowings. In the past, capital stock also increased when members sold additional mortgage loans to us; however, members are no longer required to purchase capital stock for AMA activity (former members previously required to purchase AMA activity-based stock are subject to the prior requirement as long as there are unpaid principal balances outstanding). At our discretion, we may repurchase excess Class B Common Stock if there is a decline in a member’s advances. We believe it is important to manage our business and the associated risks so that we can always strive to meet the following objectives: (1) achieve our liquidity, housing finance and community development missions by meeting member credit needs by offering advances, supporting residential mortgage lending through the MPF Program and through other products; (2) repurchase excess capital stock in order to appropriately manage the size of our balance sheet; and (3) pay appropriate dividends.


47


Table 1 presents Selected Financial Data for the periods indicated (dollar amounts in thousands):

Table 1
 
09/30/2014
06/30/2014
03/31/2014
12/31/2013
09/30/2013
Statement of Condition (as of period end):
 
 
 
 
 
Total assets
$
38,528,044

$
33,320,873

$
32,099,092

$
33,950,304

$
36,144,769

Investments1
9,075,621

8,774,310

9,524,184

8,704,552

10,328,938

Advances
20,574,600

17,449,516

16,112,925

17,425,487

18,805,283

Mortgage loans, net2
6,164,822

6,090,846

5,984,655

5,949,480

5,912,377

Total liabilities
36,837,646

31,859,399

30,369,008

32,149,084

34,331,505

Deposits
677,069

776,902

1,020,230

961,888

757,216

Consolidated obligation bonds, net3
20,025,472

19,405,969

19,765,733

20,056,964

21,055,434

Consolidated obligation discount notes, net3
15,947,588

11,462,971

9,356,707

10,889,565

12,185,294

Total consolidated obligations, net3
35,973,060

30,868,940

29,122,440

30,946,529

33,240,728

Mandatorily redeemable capital stock
4,371

4,519

4,641

4,764

5,184

Total capital
1,690,398

1,461,474

1,730,084

1,801,220

1,813,264

Capital stock
1,090,263

877,592

1,165,809

1,252,249

1,295,669

Total retained earnings
615,192

599,999

581,425

567,332

538,650

Accumulated other comprehensive income (loss)
(15,057
)
(16,117
)
(17,150
)
(18,361
)
(21,055
)
Statement of Income (for the quarterly period ended):
 
 
 
 
 
Net interest income
56,572

56,299

54,494

59,125

54,546

Provision (reversal) for credit losses on mortgage loans
82

(2,109
)
295

(135
)
530

Other income (loss)
(10,805
)
(13,153
)
(16,673
)
(3,239
)
(9,831
)
Other expenses
13,880

13,498

12,784

14,934

12,430

Income before assessments
31,805

31,757

24,742

41,087

31,755

AHP assessments
3,181

3,177

2,475

4,109

3,176

Net income
28,624

28,580

22,267

36,978

28,579

Selected Financial Ratios and Other Financial Data (for the quarterly period ended):
 
 
 
 
 
Dividends paid in cash4
75

71

79

77

73

Dividends paid in stock4
13,356

9,935

8,095

8,219

8,162

Weighted average dividend rate5
5.15
%
4.22
%
2.60
%
2.51
%
2.31
%
Dividend payout ratio6
46.92
%
35.01
%
36.71
%
22.43
%
28.81
%
Return on average equity
6.93
%
7.48
%
4.91
%
7.94
%
5.87
%
Return on average assets
0.32
%
0.35
%
0.27
%
0.40
%
0.31
%
Average equity to average assets
4.56
%
4.69
%
5.57
%
5.09
%
5.37
%
Net interest margin7
0.63
%
0.69
%
0.67
%
0.65
%
0.60
%
Total capital ratio8
4.39
%
4.39
%
5.39
%
5.31
%
5.02
%
Regulatory capital ratio9
4.44
%
4.45
%
5.46
%
5.37
%
5.09
%
Ratio of earnings to fixed charges10
1.63

1.64

1.48

1.80

1.58

                   
1 
Includes trading securities, held-to-maturity securities, interest-bearing deposits, securities purchased under agreements to resell and Federal funds sold.
2 
The allowance for credit losses on mortgage loans was $4,591,000, $4,658,000, $6,877,000, $6,748,000 and $6,891,000 as of September 30, 2014, June 30, 2014, March 31, 2014, December 31, 2013 and September 30, 2013, respectively.
3 
Consolidated obligations are bonds and discount notes that we are primarily liable to repay. See Note 15 to the financial statements for a description of the total consolidated obligations of all 12 FHLBanks for which we are jointly and severally liable.
4 
Dividends reclassified as interest expense on mandatorily redeemable capital stock and not included as dividends recorded in accordance with GAAP were $13,000, $12,000, $4,000, $6,000 and $6,000 for the quarters ended September 30, 2014, June 30, 2014, March 31, 2014, December 31, 2013 and September 30, 2013, respectively.
5 
Dividends paid in cash and stock on both classes of stock as a percentage of average capital stock eligible for dividends.
6 
Ratio disclosed represents dividends declared and paid during the year as a percentage of net income for the period presented, although the Finance Agency regulation requires dividends be paid out of known income prior to declaration date.
7 
Net interest income as a percentage of average earning assets.
8 
GAAP capital stock, which excludes mandatorily redeemable capital stock, plus retained earnings and AOCI as a percentage of total assets.
9 
Regulatory capital (i.e., permanent capital and Class A Common Stock) as a percentage of total assets.
10 
Total earnings divided by fixed charges (interest expense including amortization/accretion of premiums, discounts and capitalized expenses related to indebtedness).

48



Net income remained unchanged at $28.6 million for the third quarter of 2014 compared to the third quarter of 2013, while net income for the nine months ended September 30, 2014 was $79.5 million compared to $82.1 million for the nine months ended September 30, 2013. The FHLBank's largest source of revenue, net interest income before loan loss provision, increased $2.0 million, or 3.7 percent, in the third quarter of 2014 compared to the same period of 2013, and increased $8.7 million, or 5.5 percent, for the nine months ended September 30, 2014 compared to the same period of 2013, despite declines in interest income on investments and a decline in prepayment fees on terminated advances for both periods. The increase in net interest income before provision/reversal for credit losses between periods was due primarily to a decrease in the overall cost of borrowing compared to the prior year, an increase in the average yield on mortgage loans, and an increase in the average balance of advances. The FHLBank has experienced a decrease in the provision/reversal for credit losses for the three and nine months ended September 30, 2014 as a result of continued improvement in the housing market along with refinements to our allowance for credit loss methodology, which resulted in an increase in net income of $0.4 million and $3.8 million for the three and nine months ended September 30, 2014, respectively. These increases in income were offset by net fair value declines on derivatives and hedging activities and trading securities due largely to the impact of interest rates on the fair values of the derivative instruments or hedged items. Detailed discussion relating to the fluctuations in net interest income, net gain (loss) on derivatives and hedging activities, and net gain (loss) on trading securities can be found under this Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations.”

Total assets increased $4.6 billion, or 13.5 percent, from December 31, 2013 to September 30, 2014. This increase was due to a $3.1 billion, or 18.1 percent, increase in advances, a net $2.8 billion increase in cash and investments with overnight maturities, and a $0.2 billion, or 3.6 percent, increase in mortgage loans, partially offset by a $1.6 billion, or 19.4 percent, decrease in investment securities. The increase in advances was largely due to an increase in short-term advances, which was attributed to the increase in dividend rates (discussed below), which effectively reduces the cost of the advance to the member and increases the member's ability to profitably deploy the funding. The FHLBank has been actively promoting the impact of the dividend on the effective borrowing cost of advances to increase member awareness of the benefit of higher dividends. The increase in cash and investments with overnight maturities was a result of repayments of line of credit products on the last day of the quarter, the majority of which were re-advanced shortly thereafter. The increase in mortgage loans was a result of growth in the level of loans funded under the MPF Program relative to the level of prepayments. Additionally, the number of selling PFIs has increased during 2014. The decrease in investment securities was due to paydowns and maturities that were not reinvested as part of the balance sheet initiative described in greater detail below.

Total liabilities increased $4.7 billion, or 14.6 percent, from December 31, 2013 to September 30, 2014. This increase was primarily due to a $5.1 billion increase in consolidated obligation discount notes, partially offset by a $0.3 billion decrease in deposits. The increase in discount notes was the result of an increase in our line of credit product balance and short-term advances, which are generally funded by discount notes. The decrease in deposits was due to fluctuations in member liquidity and collateral positions between periods. For additional information, see Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition.”

The dividend rate for Class A Common Stock remained at 1.00 percent and the dividend rate for Class B Common Stock increased from 5.00 to 6.00 percent from the second to the third quarter of 2014. Changes in the weighted average dividend rates between the quarters ended September 30, 2014 (5.15 percent) and 2013 (2.31 percent) occurred primarily due to the dividend rate increases and a reduction in Class A Common Stock due to excess stock repurchases under our current capital management practices. Other factors impacting the stock class mix and average dividend rates include: (1) a reduction in our activity stock (Class B Common Stock) requirement for AMA in the third quarter of 2013; (2) a reduction in our activity stock (Class B Common Stock) requirement for advances in the second quarter of 2014; (3) weekly exchanges of excess Class B Common Stock to Class A Common Stock; and (4) periodic repurchases of excess Class A Common Stock.

We changed our management of capital levels, including a reduction in our activity-based stock purchase requirement (see “Liquidity and Capital Resources – Capital” under this Item 2), establishing periodic repurchases of excess stock and increasing our dividend payout ratio among other practices, while maintaining sufficient levels of liquidity to fulfill our mission. 

Our strategic business plan for the period of fiscal years 2014-2016 included balance sheet management strategies focusing on improving our core mission asset ratios and include the establishment of benchmark ratios of: (1) advances to consolidated obligations (Tier 1 ratio); and (2) advances plus AMA to consolidated obligations (Tier 2 ratio) (see further discussion of these benchmark ratios under Item 1A – "Risk Factors” in our annual report on Form 10-K, incorporated by reference herein). Benchmarks established for 2014 entailed a reduced allocation to MBS, money market, and other investments over time through paydowns and maturities, but without the sale of any assets.


49


Financial Market Trends
The primary external factors that affect net interest income are market interest rates and the general state of the economy.

General discussion of the level of market interest rates:
Table 2 presents selected market interest rates as of the dates or for the periods shown.

Table 2
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
 
 
 
Market Instrument
Three-month
Three-month
Nine-month
Nine-month
09/30/2014
12/31/2013
09/30/2013
Average
Average
Average
Average
Ending Rate
Ending Rate
Ending Rate
Overnight Federal funds effective/target rate1
0.09
%
0.09
%
0.08
%
0.12
%
0.0 to 0.25%
0.0 to 0.25%
0.0 to 0.25%
Federal Open Market Committee (FOMC) target rate for overnight Federal funds1
0.0 to 0.25

0.0 to 0.25

0.0 to 0.25

0.0 to 0.25

0.0 to 0.25
0.0 to 0.25
0.0 to 0.25
3-month U.S. Treasury bill1
0.02

0.03

0.03

0.05

0.02
0.07
0.01
3-month LIBOR1
0.23

0.26

0.23

0.28

0.24
0.25
0.25
2-year U.S. Treasury note1
0.50

0.36

0.42

0.29

0.58
0.38
0.33
5-year U.S. Treasury note1
1.69

1.50

1.64

1.07

1.76
1.73
1.41
10-year U.S. Treasury note1
2.49

2.70

2.62

2.20

2.49
3.00
2.64
30-year residential mortgage note rate2
4.32

4.66

4.42

4.10

4.33
4.72
4.49
                   
1 
Source is Bloomberg (overnight Federal funds rate is the effective rate for the averages and the target rate for the ending rates).
2 
Mortgage Bankers Association weekly 30-year fixed rate mortgage contract rate obtained from Bloomberg.

At the most recent meeting, the Federal Open Market Committee (FOMC) announced that it would conclude the asset purchase program in October 2014. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of Agency debt and Agency MBS and of rolling over maturing U.S. Treasury securities at auction. The decision to conclude the asset purchase program was supported by strength in the overall economy, including continued improvement in the outlook for the labor market. Minutes from the September meeting indicated concern about the global outlook and the strengthening of the U.S. dollar, which market participants interpreted as a delay in the increase in the Federal funds rate, although no indication was given of when an increase in the Federal funds rate would occur. The FOMC has indicated that a lower than normal target rate may be necessary for an extended period of time, depending on a broad range of economic indicators. The rates on U.S. Treasuries and Agency MBS are expected to increase once the Federal Reserve is no longer making those purchases, although rates have not yet increased significantly as a result of the reduction in asset purchases. We issue debt at a spread above U.S. Treasury securities, so higher interest rates increase the cost of issuing FHLBank consolidated obligations and increase the cost of advances to our members and housing associates.

During the third quarter of 2014, U.S. Treasury rates were fairly range-bound and volatility remained low, resulting in a steady funding environment. The market volatility that started in the last half of 2013 began to subside in late 2013 and early 2014 and has positively impacted demand for our longer-term debt, despite investors still being somewhat cautious about bond purchases due to the possibility of continued increases in market rates. The spread over U.S. Treasuries at which we can issue longer-term bullet and callable bonds has narrowed from what we experienced in 2013 due to the aforementioned market correction. We fund a large portion of our fixed rate mortgage assets and some fixed rate advances with callable bonds. For further discussion see this Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Consolidated Obligations.”

Other factors impacting FHLBank consolidated obligations:
Investors continue to view FHLBank consolidated obligations as carrying a relatively strong credit profile. Historically our strong credit profile has resulted in steady investor demand for FHLBank discount notes and short-term bonds, which allowed the overall cost to issue short-term consolidated obligations to remain relatively low throughout 2014. The U.S. government reached an agreement to suspend the nation's borrowing limit through March 15, 2015; therefore, concerns over the federal debt ceiling limit, which could result in increased liquidity concerns for market participants, have eased.


50


Critical Accounting Policies and Estimates
The preparation of our financial statements in accordance with GAAP requires management to make a number of judgments and assumptions that affect our reported results and disclosures. Several of our accounting policies are inherently subject to valuation assumptions and other subjective assessments and are more critical than others in terms of their importance to results. These assumptions and assessments include the following:
Accounting related to derivatives;
Fair value determinations;
Accounting for OTTI 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 critical accounting policies could have a material effect on our financial statements.

The accounting policies that management believes are the most critical to an understanding of our financial results and condition and require complex management judgment are described under Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” in the annual report on Form 10-K, incorporated by reference herein. There were no material changes to our critical accounting policies and estimates during the quarter ended September 30, 2014.


Results of Operations
Earnings Analysis: Table 3 presents changes in the major components of our earnings (dollar amounts in thousands):

Table 3
 
Increase (Decrease) in Earnings Components
 
Three Months Ended
Nine Months Ended
 
09/30/2014 vs. 09/30/2013
09/30/2014 vs. 09/30/2013
 
Dollar Change
Percentage Change
Dollar Change
Percentage Change
Total interest income
$
(2,101
)
(1.9
)%
$
(13,476
)
(4.1
)%
Total interest expense
(4,127
)
(7.6
)
(22,193
)
(12.8
)
Net interest income
2,026

3.7

8,717

5.5

Provision (reversal) for credit losses on mortgage loans
(448
)
(84.5
)
(3,793
)
(184.0
)
Net interest income after mortgage loan loss provision
2,474

4.6

12,510

8.0

Net gain (loss) on trading securities
(4,651
)
(68.7
)
15,256

40.5

Net gain (loss) on derivatives and hedging activities
3,374

60.3

(29,426
)
(1,023.5
)
Other non-interest income
303

12.0

1,118

15.5

Total other income (loss)
(974
)
(9.9
)
(13,052
)
(47.3
)
Operating expenses
1,552

15.2

2,473

8.1

Other non-interest expenses
(102
)
(4.7
)
(139
)
(1.9
)
Total other expenses
1,450

11.7

2,334

6.2

AHP assessments
5

0.2

(287
)
(3.1
)
NET INCOME
$
45

0.2
 %
$
(2,589
)
(3.2
)%

Net income remained unchanged at $28.6 million for both quarters ended September 30, 2014 and 2013. However, there was an increase in net interest income, a decrease in the provision/reversal for loan loss, and an increase in fair value of derivatives and hedging activities, which was more than offset by a decrease in fair value of trading securities. Return on average equity (ROE) was 6.93 percent and 5.87 percent for the three months ended September 30, 2014 and September 30, 2013, respectively. The increase in ROE was a result of the changes in capital management practices that went into effect during the second quarter of 2014, which caused a decrease in average capital for the period due to the repurchase of excess stock. Dividends paid to members totaled $13.4 million for the quarter ended September 30, 2014 compared to $8.2 million for the same period in the prior year.


51


Net income for the nine months ended September 30, 2014 was $79.5 million compared to $82.1 million for the nine months ended September 30, 2013. The decrease in net income was due to declines in fair value of derivatives and hedging activities, partially offset by an increase in fair value of trading securities, an increase in net interest income, and a decrease in the provision/reversal for loan loss. ROE was 6.36 percent and 5.85 percent for the nine months ended September 30, 2014 and 2013, respectively. The increase in ROE was primarily a result of the changes in capital management practices that went into effect during the second quarter of 2014, causing a decrease in average capital for the period due to the repurchase of excess stock, which was only partially offset by the decrease in net income. The change in capital management practices also resulted in an increase in dividend rates. Dividends paid to members totaled $31.6 million for the nine months ended September 30, 2014 compared to $24.7 million for the same period in the prior year.

Net Interest Income: Net interest income, which includes interest earned on advances, mortgage loans, and investments less interest paid on consolidated obligations, deposits, and other borrowings is the primary source of our earnings. Net interest income increased $2.0 million for the quarter ended September 30, 2014 and $8.7 million for the nine months ended September 30, 2014 compared to the prior year periods. The increase in net interest income for both periods was due to an increase in our net interest spread and margin despite a decrease in average interest-earning assets (see Tables 4 and 6). The increases in net interest spread and margin were driven primarily by an overall decrease in the cost of borrowing and also by an increase in the average yield on mortgage loans, which is discussed in greater detail below.

The average yield on investments, which consists of interest-bearing deposits, Federal funds sold, securities purchased under agreements to resell (reverse repurchase agreements), and investment securities, remained flat, at 1.06 percent for the quarters ended September 30, 2014 and 2013. The average yield on investments increased one basis point, from 1.08 percent for the nine months ended September 30, 2013 to 1.09 percent for the nine months ended September 30, 2014. The yields for the three and nine month periods were impacted by compositional changes in the investment securities portfolio, including maturities of lower yielding securities and purchases of higher yielding securities, and increases in the average balance of lower yielding instruments. The impact of the higher yielding securities was partially offset by an overall decrease in the average balance of the portfolio as part of our strategic core mission asset initiative.

The average yield on advances decreased four basis points, from 0.65 percent for the quarter ended September 30, 2013 to 0.61 percent for the current quarter. The average yield on advances decreased six basis points, from 0.71 percent for the nine months ended September 30, 2013 to 0.65 percent for the nine months ended September 30, 2014. The decrease in the average yield on advances was due to an increase in our lowest yielding advance product relative to total advances and a decrease in prepayment fees between periods. Prepayment fees were higher in 2013 as a result of borrowers restructuring a higher level of non-callable advances into new advances and incurring a fee. Further, the low interest rate environment in the prior year generally resulted in a higher fee calculation for prepaid advances.


52


The average yield on mortgage loans increased five basis points, from 3.25 percent for the quarter ended September 30, 2013 to 3.30 percent for the quarter ended September 30, 2014. The average yield on mortgage loans increased 12 basis points, from 3.26 percent for the nine months ended September 30, 2013 to 3.38 percent for the nine months ended September 30, 2014. The increase in yield is due to a decline in premium amortization as mortgage rates have increased and prepayments on higher coupon loans have decreased (yields on interest earning assets decline as premiums are amortized; amortization accelerates as prepayments increase). We expect this yield to remain relatively steady for the next several quarters, as mortgage interest rates are not anticipated to fluctuate significantly from current levels, but our average yield on mortgage loans could decline if prepayments increase and premium amortization accelerates.

The average cost of consolidated obligation bonds decreased four basis points, from 0.99 percent for the quarter ended September 30, 2013 to 0.95 percent for the current quarter. The average cost of consolidated obligation bonds decreased seven basis points, from 1.04 percent for the nine months ended September 30, 2013 to 0.97 percent for the current nine month period. This decrease was largely a result of: (1) replacing some called and matured higher-cost consolidated obligation bonds with debt at a much lower cost in late 2013; (2) the decrease in the average one- and three-month LIBOR rates during 2014 compared to 2013 (a considerable portion of our consolidated obligation bonds are swapped to LIBOR); and (3) a general decline in rates in 2014 which allowed us to issue and to call and replace higher rate debt at lower rates. The average balance of lower rate discount notes has increased between periods while average bond balances have declined, which has reduced the total cost of our interest-bearing liabilities. We expect short-term interest rates to remain low for an extended period of time, so we expect our total interest bearing liability cost to remain relatively stable over the next few quarters. When we call and replace callable debt, it generally increases interest costs in the short term due to the acceleration of the unamortized concessions on the debt when it is called because concession costs are amortized to contractual maturity using the level-yield method. However, this increase is offset by the lower rate on the new debt and the funding benefit due to the timing differences between the date the debt is called and the forward settlement date of the new debt (conventionally not exceeding 30 days). For further discussion of how we use callable bonds, see Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Consolidated Obligations.”

Our net interest spread is impacted by derivative and hedging activities, as the assets and liabilities hedged with derivative instruments designated under fair value hedging relationships are adjusted for changes in fair values, while other assets and liabilities are carried at historical cost. Further, net interest payments or receipts on interest rate swaps designated as fair value hedges and the amortization/accretion of hedging activities are recognized as adjustments to the interest income or expense of the hedged asset or liability. However, net interest payments or receipts on derivatives that do not qualify for hedge accounting (economic hedges) flow through net gain (loss) on derivatives and hedging activities instead of net interest income (net interest received/paid on economic derivatives is identified in Tables 8 through 11 under this Item 2), which distorts yields, especially for trading investments that are swapped to a variable rate.


53


Table 4 presents average balances and annualized yields of major earning asset categories and the sources funding those earning assets (dollar amounts in thousands):

Table 4
 
Three Months Ended
 
09/30/2014
09/30/2013
 
Average
Balance
Interest
Income/
Expense
Yield
Average
Balance
Interest
Income/
Expense
Yield
Interest-earning assets:
 

 

 

 

 

 

Interest-bearing deposits
$
192,006

$
40

0.08
%
$
246,316

$
56

0.09
%
Securities purchased under agreements to resell
421,196

96

0.09

217,017

42

0.08

Federal funds sold
1,684,413

358

0.08

1,350,739

285

0.08

Investment securities1
6,746,386

23,601

1.39

9,037,857

28,693

1.26

Advances2,3
20,591,124

31,467

0.61

19,020,279

30,976

0.65

Mortgage loans2,4,5
6,138,316

51,099

3.30

5,947,227

48,675

3.25

Other interest-earning assets
22,562

374

6.58

27,348

409

5.94

Total earning assets
35,796,003

107,035

1.19

35,846,783

109,136

1.21

Other non-interest-earning assets
95,201

 

 

154,128

 

 

Total assets
$
35,891,204

 

 

$
36,000,911

 

 

 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 

 

 

 

 

Deposits
$
761,192

166

0.09

$
810,198

179

0.09

Consolidated obligations2:
 

 

 

 

 

 

Discount Notes
13,312,234

2,688

0.08

11,610,756

2,041

0.07

Bonds
19,807,397

47,552

0.95

20,866,435

52,319

0.99

Other borrowings
11,833

57

1.89

52,469

51

0.39

Total interest-bearing liabilities
33,892,656

50,463

0.59

33,339,858

54,590

0.65

Capital and other non-interest-bearing funds
1,998,548

 

 

2,661,053

 

 

Total funding
$
35,891,204

 

 

$
36,000,911

 

 

 
 
 
 
 
 
 
Net interest income and net interest spread6
 

$
56,572

0.60
%
 

$
54,546

0.56
%
 
 
 
 
 
 
 
Net interest margin7
 

 

0.63
%
 

 

0.60
%
                   
1 
The non-credit portion of the OTTI discount on held-to-maturity securities is excluded from the average balance for calculations of yield since the change runs through equity.
2 
Interest income/expense and average rates include the effect of associated derivatives.
3 
Advance income includes prepayment fees on terminated advances.
4 
CE fee payments are netted against interest earnings on the mortgage loans. The expense related to CE fee payments to PFIs was $1.2 million for the three months ended September 30, 2014 and 2013.
5 
Mortgage loans average balance includes outstanding principal for non-performing conventional loans. However, these loans no longer accrue interest.
6 
Net interest spread is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities.
7 
Net interest margin is net interest income as a percentage of average interest-earning assets.


54


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 5 summarizes changes in interest income and interest expense (in thousands):

Table 5
 
Three Months Ended
 
09/30/2014 vs. 09/30/2013
 
Increase (Decrease) Due to
 
Volume1,2
Rate1,2
Total
Interest Income:
 

 

 

Interest-bearing deposits
$
(12
)
$
(4
)
$
(16
)
Securities purchased under agreements to resell
46

8

54

Federal funds sold
72

1

73

Investment securities
(7,803
)
2,711

(5,092
)
Advances
2,467

(1,976
)
491

Mortgage loans
1,581

843

2,424

Other assets
(76
)
41

(35
)
Total earning assets
(3,725
)
1,624

(2,101
)
Interest Expense:
 

 

 

Deposits
(10
)
(3
)
(13
)
Consolidated obligations:
 

 

 

Discount notes
321

326

647

Bonds
(2,594
)
(2,173
)
(4,767
)
Other borrowings
(65
)
71

6

Total interest-bearing liabilities
(2,348
)
(1,779
)
(4,127
)
Change in net interest income
$
(1,377
)
$
3,403

$
2,026

                   
1 
Changes in interest income and interest expense not identifiable as either volume-related or rate-related have been allocated to volume and rate based upon the proportion of the absolute value of the volume and rate changes.
2 
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.


55


Table 6 presents average balances and yields of major earning asset categories and the sources funding those earning assets (dollar amounts in thousands):

Table 6
 
Nine Months Ended
 
09/30/2014
09/30/2013
 
Average
Balance
Interest
Income/
Expense
Yield
Average
Balance
Interest
Income/
Expense
Yield
Interest-earning assets:
 

 

 

 

 

 

Interest-bearing deposits
$
202,361

$
120

0.08
%
$
280,293

$
257

0.12
%
Securities purchased under agreements to resell
212,271

138

0.09

835,219

821

0.13

Federal funds sold
1,438,974

840

0.08

1,140,934

989

0.12

Investment securities1
7,283,099

73,635

1.35

8,782,057

86,705

1.32

Advances2,3
18,580,837

90,280

0.65

18,238,839

97,265

0.71

Mortgage loans2,4,5
6,048,213

152,701

3.38

5,949,473

145,050

3.26

Other interest-earning assets
23,719

1,149

6.48

26,391

1,252

6.35

Total earning assets
33,789,474

318,863

1.26

35,253,206

332,339

1.26

Other non-interest-earning assets
92,353

 

 

147,945

 

 

Total assets
$
33,881,827

 

 

$
35,401,151

 

 

 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 

 

 

 

 

Deposits
$
918,443

604

0.09

$
1,112,159

768

0.09

Consolidated obligations2:
 

 

 

 

 

 

Discount Notes
10,949,484

6,250

0.08

10,422,235

6,746

0.09

Bonds
19,929,653

144,488

0.97

21,250,568

166,037

1.04

Other borrowings
9,288

156

2.24

26,505

140

0.71

Total interest-bearing liabilities
31,806,868

151,498

0.64

32,811,467

173,691

0.71

Capital and other non-interest-bearing funds
2,074,959

 

 

2,589,684

 

 

Total funding
$
33,881,827

 

 

$
35,401,151

 

 

 
 
 
 
 
 
 
Net interest income and net interest spread6
 

$
167,365

0.62
%
 

$
158,648

0.55
%
 
 
 
 
 
 
 
Net interest margin7
 

 

0.66
%
 

 

0.60
%
                   
1 
The non-credit portion of the OTTI discount on held-to-maturity securities is excluded from the average balance for calculations of yield since the change runs through equity.
2 
Interest income/expense and average rates include the effect of associated derivatives.
3 
Advance income includes prepayment fees on terminated advances.
4 
CE fee payments are netted against interest earnings on the mortgage loans. The expense related to CE fee payments to PFIs was $3.6 million and $3.5 million for the nine months ended September 30, 2014 and 2013, respectively.
5 
Mortgage loans average balance includes outstanding principal for non-performing conventional loans. However, these loans no longer accrue interest.
6 
Net interest spread is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities.
7 
Net interest margin is net interest income as a percentage of average interest-earning assets.


56


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 7 summarizes changes in interest income and interest expense (in thousands):

Table 7
 
Nine Months Ended
 
09/30/2014 vs. 09/30/2013
 
Increase (Decrease) Due to
 
Volume1,2
Rate1,2
Total
Interest Income:
 

 

 

Interest-bearing deposits
$
(60
)
$
(77
)
$
(137
)
Securities purchased under agreements to resell
(471
)
(212
)
(683
)
Federal funds sold
221

(370
)
(149
)
Investment securities
(15,111
)
2,041

(13,070
)
Advances
1,796

(8,781
)
(6,985
)
Mortgage loans
2,435

5,216

7,651

Other assets
(129
)
26

(103
)
Total earning assets
(11,319
)
(2,157
)
(13,476
)
Interest Expense:
 

 

 

Deposits
(128
)
(36
)
(164
)
Consolidated obligations:
 

 

 

Discount notes
329

(825
)
(496
)
Bonds
(9,976
)
(11,573
)
(21,549
)
Other borrowings
(137
)
153

16

Total interest-bearing liabilities
(9,912
)
(12,281
)
(22,193
)
Change in net interest income
$
(1,407
)
$
10,124

$
8,717

                   
1 
Changes in interest income and interest expense not identifiable as either volume-related or rate-related have been allocated to volume and rate based upon the proportion of the absolute value of the volume and rate changes.
2 
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 Derivatives and Hedging Activities: The volatility in other income (loss) is predominately driven by fair value fluctuations on derivative and hedging transactions, which include interest rate swaps, caps and floors. Net gain (loss) from derivatives and hedging activities is sensitive to several factors, including: (1) the general level of interest rates; (2) the shape of the term structure of interest rates; and (3) implied volatilities of interest rates. The fair value of options, particularly interest rate caps and floors, are also impacted by the time value decay that occurs as the options approach maturity, but this factor represents the normal amortization of the cost of these options and flows through income irrespective of any changes in the other factors impacting the fair value of the options (level of rates, shape of curve and implied volatility).

As demonstrated in Tables 8 through 11, the majority of the derivative gains and losses are related to economic hedges, such as interest rate swaps matched to GSE debentures classified as trading securities and interest rate caps and floors, which do not qualify for hedge accounting treatment under GAAP. Net interest payments or receipts on these economic hedges flow through net gain (loss) on derivatives and hedging activities instead of net interest income, which distorts yields, especially for trading investments that are swapped to variable rates. Net interest received/paid on economic hedges is identified in Tables 8 through 11. Ineffectiveness on fair value hedges contributes to gains and losses on derivatives, but to a much lesser degree. We generally record net fair value gains on derivatives when the overall level of interest rates rises over the period and record net fair value losses when the overall level of interest rates falls over the period, due to the mix of the economic hedges.


57


The losses on economic derivatives for the three months ended September 30, 2014 declined compared to the same period in the prior year, primarily as a result of gains on interest rate swaps matched to GSE debentures. The losses on economic derivatives for the nine months ended September 30, 2014 were primarily a result of losses on our interest rate cap portfolio as fair values declined due to a lower forward curve, decreased long-term cap volatility and time value decay compared to gains recognized during the same period of 2013 as fair values increased due to an increase and steepening of the general level of the interest rate swap curve with the gains somewhat limited by a decrease in long-term cap volatility at the end of the 2013 third quarter as well.
While the net interest received (paid) on the associated economic interest rate swap is recorded in net gain (loss) on derivatives and hedging activities, the interest on the underlying hedged items, the GSE debentures, is recorded in interest income, with any changes in fair value recognized in net gain (loss) on trading securities.See Tables 38 and 39 under Item 3 – “Quantitative and Qualitative Disclosures About Market Risk” for additional detail regarding notional and fair value amounts of derivative instruments.

Tables 8 through 11 categorize the earnings impact by product for hedging activities (in thousands):

Table 8
 
Three Months Ended 09/30/2014
 
Advances
Investments
Mortgage Loans
Consolidated
Obligation Bonds
Total
Impact of derivatives and hedging activities in net interest income:
 
 
 
 
 
Net amortization/accretion of hedging activities
$
(2,457
)
$

$
(441
)
$
(16
)
$
(2,914
)
Net interest settlements
(33,082
)


23,359

(9,723
)
Subtotal
(35,539
)

(441
)
23,343

(12,637
)
Net gain (loss) on derivatives and hedging activities:
 

 

 

 

 

Fair value hedges:
 
 
 
 
 
Interest rate swaps
495



(354
)
141

Economic hedges – unrealized gain (loss) due to fair value changes:
 
 
 
 
 
Interest rate swaps

12,392


(923
)
11,469

Interest rate caps/floors

(4,089
)


(4,089
)
Mortgage delivery commitments


60


60

Economic hedges – net interest received (paid)

(11,148
)

1,349

(9,799
)
Subtotal
495

(2,845
)
60

72

(2,218
)
Net impact of derivatives and hedging activities
(35,044
)
(2,845
)
(381
)
23,415

(14,855
)
Net gain (loss) on trading securities hedged on an economic basis with derivatives

(11,651
)


(11,651
)
TOTAL
$
(35,044
)
$
(14,496
)
$
(381
)
$
23,415

$
(26,506
)


58


Table 9
 
Three Months Ended 09/30/2013
 
Advances
Investments
Mortgage Loans
Consolidated
Obligation Bonds
Intermediary
Positions
Total
Impact of derivatives and hedging activities in net interest income:
 

 

 

 

 

 

Net amortization/accretion of hedging activities
$
(3,161
)
$

$
(621
)
$
(27
)
$

$
(3,809
)
Net interest settlements
(35,787
)


28,324


(7,463
)
Subtotal
(38,948
)

(621
)
28,297


(11,272
)
Net gain (loss) on derivatives and hedging activities:
 

 

 

 

 

 

Fair value hedges:
 

 

 

 

 

 

Interest rate swaps
279



577


856

Economic hedges – unrealized gain (loss) due to fair value changes:
 

 

 

 

 



Interest rate swaps

6,781


(1,257
)
(1
)
5,523

Interest rate caps/floors

(3,908
)



(3,908
)
Mortgage delivery commitments


1,903



1,903

Economic hedges – net interest received (paid)

(11,619
)

1,652

1

(9,966
)
Subtotal
279

(8,746
)
1,903

972


(5,592
)
Net impact of derivatives and hedging activities
(38,669
)
(8,746
)
1,282

29,269


(16,864
)
Net gain (loss) on trading securities hedged on an economic basis with derivatives

(5,865
)



(5,865
)
TOTAL
$
(38,669
)
$
(14,611
)
$
1,282

$
29,269

$

$
(22,729
)

59



Table 10
 
Nine Months Ended 9/30/2014
 
Advances
Investments
Mortgage Loans
Consolidated
Obligation Bonds
Total
Impact of derivatives and hedging activities in net interest income:
 
 
 
 
 
Net amortization/accretion of hedging activities
$
(8,001
)
$

$
(1,414
)
$
214

$
(9,201
)
Net interest settlements
(98,618
)


68,909

(29,709
)
Subtotal
(106,619
)

(1,414
)
69,123

(38,910
)
Net gain (loss) on derivatives and hedging activities:
 

 

 

 

 

Fair value hedges:
 
 
 
 
 
Interest rate swaps
806



(1,514
)
(708
)
Economic hedges – unrealized gain (loss) due to fair value changes:
 
 
 
 
 
Interest rate swaps

24,878


1,454

26,332

Interest rate caps/floors

(25,569
)


(25,569
)
Mortgage delivery commitments


2,979


2,979

Economic hedges – net interest received (paid)

(33,116
)

3,531

(29,585
)
Subtotal
806

(33,807
)
2,979

3,471

(26,551
)
Net impact of derivatives and hedging activities
(105,813
)
(33,807
)
1,565

72,594

(65,461
)
Net gain (loss) on trading securities hedged on an economic basis with derivatives

(22,315
)


(22,315
)
TOTAL
$
(105,813
)
$
(56,122
)
$
1,565

$
72,594

$
(87,776
)


60


Table 11
 
Nine Months Ended 9/30/2013
 
Advances
Investments
Mortgage Loans
Consolidated
Obligation Bonds
Intermediary
Positions
Total
Impact of derivatives and hedging activities in net interest income:
 
 
 
 
 
 
Net amortization/accretion of hedging activities
$
(9,023
)
$

$
(1,867
)
$
(533
)
$

$
(11,423
)
Net interest settlements
(110,766
)


81,631


(29,135
)
Subtotal
(119,789
)

(1,867
)
81,098


(40,558
)
Net gain (loss) on derivatives and hedging activities:
 

 

 

 

 

 

Fair value hedges:
 
 
 
 
 
 
Interest rate swaps
2,384



(6,825
)

(4,441
)
Economic hedges – unrealized gain (loss) due to fair value changes:
 
 
 
 
 


Interest rate swaps

37,209


(6,093
)
(17
)
31,099

Interest rate caps/floors

7,514




7,514

Mortgage delivery commitments


(2,945
)


(2,945
)
Economic hedges – net interest received (paid)

(34,009
)

5,654

3

(28,352
)
Subtotal
2,384

10,714

(2,945
)
(7,264
)
(14
)
2,875

Net impact of derivatives and hedging activities
(117,405
)
10,714

(4,812
)
73,834

(14
)
(37,683
)
Net gain (loss) on trading securities hedged on an economic basis with derivatives

(37,004
)



(37,004
)
TOTAL
$
(117,405
)
$
(26,290
)
$
(4,812
)
$
73,834

$
(14
)
(74,687
)

Net Gain (Loss) on Trading Securities: All gains and losses related to trading securities are recorded in other income (loss) 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 8 through 11. Unrealized gains (losses) fluctuate as the fair value of our trading portfolio fluctuates. There are a number of factors that can impact the fair value of a trading security including the movement in absolute interest rates, changes in credit spreads, the passage of time and changes in price volatility. Table 12 presents the major components of the net gain (loss) on trading securities (in thousands):

Table 12
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
GSE debentures
$
(11,637
)
$
(6,360
)
$
(22,721
)
$
(37,122
)
U.S. Treasury note

40

20

27

Agency MBS/CMO
218

(450
)
279

(563
)
Short-term money market securities

2

(9
)
(29
)
TOTAL
$
(11,419
)
$
(6,768
)
$
(22,431
)
$
(37,687
)


61


The majority of the volatility in the net gain (loss) of our trading portfolio can be attributed to fair value changes on GSE debentures. The largest component of our trading portfolio is comprised of fixed and variable rate GSE debentures, and generally most of the fixed rate securities are related to economic hedges. The fair values of the fixed rate GSE debentures are more affected by changes in intermediate interest rates (e.g., two-year to four-year rates) and are swapped to three-month LIBOR. The variable rate securities reset daily based on the Federal funds effective rate or monthly based on the one-month LIBOR index. During 2012 and especially in 2013, interest rates and GSE credit spreads increased, which resulted in fair value losses on the GSE debentures. During 2014, the relative change in interest rates compared to 2013 and the decrease in GSE credit spreads reduced the magnitude of losses in the first half of 2014 compared to the first half of 2013, but spreads widened and interest rates increased during the third quarter of 2014, resulting in greater decreases in the fair value of our GSE debentures. In addition to interest rates and credit spreads, the value of these securities is affected by time decay. These fixed rate GSE debentures possess coupons which are well above current market rates for similar securities and, therefore, are currently valued at substantial premiums. As these securities approach maturity, their prices will converge to par resulting in a decrease in their current premium price (i.e., time decay). Given that the variable rate GSE debentures re-price daily, they generally account for a very small portion of the net gain (loss) on trading securities unless current market spreads on these variable rate securities diverge from the spreads at the time of our acquisition of the securities.

Operating Expenses: Operating expenses include compensation and benefits and other operating expenses. The largest component of operating expenses, compensation and benefits, increased by $1.9 million, or 27.6 percent, for the quarter ended September 30, 2014 compared to the prior year quarter. Compensation and benefits increased by $2.8 million, or 13.7 percent, for the nine months ended September 30, 2014, compared to the same period in the prior year. The majority of the increase is related to the timing of the funding of the pension plan, which occurred in the fourth quarter of 2013 and in the third quarter of 2014. The increase is also due to the hiring of additional employees and an increase in the base salaries of existing employees, with a corresponding increase in incentive compensation.

Non-GAAP Measures
We fulfill our mission by: (1) providing liquidity to our members through the offering of advances to finance housing, economic development and community lending; (2) supporting residential mortgage lending through the MPF Program and purchases of MBS; and (3) providing regional affordable housing programs that create housing opportunities for low- and moderate-income families. In order to effectively accomplish our mission, we must obtain adequate funding amounts at acceptable interest rate levels. We use derivatives as tools to reduce our funding costs and manage interest rate risk and prepayment risk. We also acquire and classify certain investments as trading securities for liquidity and asset-liability management purposes. Although we manage the risks mentioned and utilize these transactions for asset-liability tools, we do not manage the fluctuations in the fair value of our derivatives or trading securities. We are essentially a “hold-to-maturity” investor and transact derivatives only for hedging purposes, even though some derivative hedging relationships do not qualify for hedge accounting under GAAP (referred to as economic hedges) and therefore can add significant volatility to our GAAP net income.

Adjusted income is a non-GAAP financial measure used by management to evaluate the quality of our ongoing earnings. We believe that the presentation of income as measured for management purposes enhances the understanding of our performance by highlighting our underlying results and profitability. By removing volatility created by fair value fluctuations and items such as prepayment fees, we can compare longer-term trends in earnings that might otherwise be indeterminable. We note however that non-GAAP financial measures have inherent limitations as analytical tools and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.

Our third quarter 2014 adjusted income (defined below), which excludes fair value changes in derivatives and trading securities as well as prepayment fees on terminated advances included in net interest margin, increased by $1.8 million compared to the third quarter of 2013. For the nine months ended September 30, 2014, adjusted net income increased by $12.8 million compared to the nine months ended September 30, 2013 (see Table 13). These increases parallel the increase in GAAP net interest income before provision/reversal for loan loss.


62


Table 13 presents a reconciliation of GAAP net income to adjusted income (in thousands):

Table 13
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
Net income, as reported under GAAP
$
28,624

$
28,579

$
79,471

$
82,060

AHP assessments
3,181

3,176

8,833

9,120

Income before AHP assessments
31,805

31,755

88,304

91,180

Derivative-related and other excluded items1
3,730

1,993

18,466

2,817

Adjusted income (a non-GAAP measure)2
$
35,535

$
33,748

$
106,770

$
93,997

                   
1 
Consists of fair value changes on derivatives and hedging activities (excludes net interest settlements on derivatives not qualifying for hedge accounting) and trading securities as well as prepayment fees on terminated advances.
2 
Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied and are not audited. To mitigate these limitations, we have procedures in place to calculate these measures using the appropriate GAAP components. Although these non-GAAP measures are frequently used by our stakeholders in the evaluation of our performance, they have limitations as analytical tools and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP. 

Table 14 presents a comparison of adjusted ROE (a non-GAAP measure) to the average overnight Federal funds rate, which we use as a key measure of effective utilization and management of members’ capital (dollar amounts in thousands). The increase in adjusted ROE spread is a result of the increase in net interest margin and the change in capital requirements and management practices that went into effect during the second quarter of 2014 (see additional discussion under this Item 2 - "Liquidity and Capital Resources - Capital"). The impact of the increase in net interest margin is more apparent with adjusted ROE spread because it excludes the volatility in fair values, as described above. The changes in our capital management plan resulted in the repurchase of excess stock, which caused a decrease in the average GAAP total capital of 15.2 percent and 11.0 percent for the three and nine months ended September 30, 2014, when compared to the same periods in 2013.

Table 14
 
Three Months Ended
Nine Months Ended
 
09/30/2014
09/30/2013
09/30/2014
09/30/2013
Average GAAP total capital for the period
$
1,637,802

$
1,932,127

$
1,669,445

$
1,874,901

ROE, based upon GAAP net income
6.93
%
5.87
%
6.36
%
5.85
%
Adjusted ROE, based upon adjusted income1
8.61
%
6.93
%
8.55
%
6.70
%
Average overnight Federal funds effective rate
0.09
%
0.09
%
0.08
%
0.12
%
Adjusted ROE as a spread to average overnight Federal funds effective rate1
8.52
%
6.84
%
8.47
%
6.58
%
                   
1 
Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied and are not audited. To mitigate these limitations, we have procedures in place to calculate these measures using the appropriate GAAP components. Although these non-GAAP measures are frequently used by our stakeholders in the evaluation of our performance, they have limitations as analytical tools and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.


63


As part of evaluating our financial performance, we adjust net income reported in accordance with GAAP for the impact of: (1) AHP assessments (equivalent to an effective minimum income tax rate of 10 percent); (2) fair value changes on derivatives and hedging activities (excludes net interest settlements related to derivatives not qualifying for hedge accounting); and (3) other items excluded because they are not considered a part of our routine operations or ongoing business model, such as prepayment fees, gain/loss on retirement of debt, gain/loss on mortgage loans held for sale and gain/loss on securities. The result is referred to as “adjusted income,” which is a non-GAAP measure of income. Adjusted income is used to compute an adjusted ROE that is then compared to the average overnight Federal funds effective rate, with the difference referred to as adjusted ROE spread. Components of adjusted income and adjusted ROE spread are used: (1) to measure performance under our incentive compensation plans; (2) as a measure in determining the level of quarterly dividends; and (3) in strategic planning. While we utilize adjusted income as a key measure in determining the level of dividends, we consider GAAP net income volatility caused by gain (loss) on derivatives and hedging activities and trading securities in determining the adequacy of our retained earnings as determined under GAAP. Because the adequacy of GAAP retained earnings is considered in setting the level of our quarterly dividends, gain (loss) on derivatives and hedging activities and trading securities can play a factor when setting the level of our quarterly dividends. Because we are primarily a “hold-to-maturity” investor and do not trade derivatives, we believe that adjusted income, adjusted ROE and adjusted ROE spread are helpful in understanding our operating results and provide a meaningful period-to-period comparison. In contrast, GAAP net income, ROE based on GAAP net income and ROE spread based on GAAP net income can vary significantly from period to period because of fair value changes on derivatives and certain other items that management excludes when evaluating operational performance. Management believes such volatility prevents a consistent measurement analysis.

Derivative and hedge accounting affects the timing of income or expense from derivatives. However, when held to maturity or call dates, there is no economic income or expense impact from these derivatives. For example, interest rate caps are purchased with an upfront fixed cost to provide protection against the risk of rising interest rates. Under derivative accounting guidance, these instruments are then marked to fair value each month, which can result in having to recognize significant gains and losses from year to year, producing volatility in our GAAP net income. However, if held to maturity, the sum of such gains and losses over the term of a derivative will equal its original purchase price.

In addition to impacting the timing of income and expense from derivatives, derivative accounting also impacts the presentation of net interest settlements on derivatives and hedging activities. This presentation differs under GAAP for economic hedges when compared to hedges that qualify for hedge accounting. Net interest settlements on economic hedges are included with the economic derivative fair value changes and are recorded in net gain (loss) on derivatives and hedging activities while the net interest settlements on qualifying fair value or cash flow hedges are included in net interest margin. Therefore, only the economic derivative fair value changes and the ineffectiveness for qualifying hedges included in the net gain (loss) on derivatives and hedging activities are removed to arrive at adjusted income (i.e., net interest settlements on economic hedges, which represent actual cash inflows or outflows and do not create fair value volatility, are not removed).


Financial Condition


64


Overall: As a percentage of assets as of September 30, 2014 compared to December 31, 2013, cash, short-term investments and advances increased while long-term investment securities and mortgage loans decreased. These changes correspond with the increase in discount notes and decrease in bonds as a percentage of total liabilities and equity as of September 30, 2014 compared to December 31, 2013. Table 15 presents the percentage concentration of the major components of our Statements of Condition:

Table 15
 
Component Concentration
 
09/30/2014
12/31/2013
Assets:
 
 
Cash and due from banks
6.7
%
5.1
 %
Interest-bearing deposits, securities purchased under agreements to resell and Federal funds sold
6.5

1.7

Investment securities
17.0

23.9

Advances
53.4

51.3

Mortgage loans, net
16.0

17.5

Other assets
0.4

0.5

Total assets
100.0
%
100.0
 %
 
 
 
Liabilities:
 
 
Deposits
1.8
%
2.8
 %
Consolidated obligation discount notes, net
41.4

32.1

Consolidated obligation bonds, net
52.0

59.1

Other liabilities
0.4

0.7

Total liabilities
95.6

94.7

 
 
 
Capital:
 
 
Capital stock outstanding
2.8

3.7

Retained earnings
1.6

1.7

Accumulated other comprehensive income (loss)

(0.1
)
Total capital
4.4

5.3

Total liabilities and capital
100.0
%
100.0
 %


65


Table 16 presents changes in the major components of our Statements of Condition (dollar amounts in thousands):

Table 16
 
Increase (Decrease)
in Components
 
09/30/2014 vs. 12/31/2013
 
Dollar
Change
Percent
Change
Assets:
 
 
Cash and due from banks
$
857,410

50.0
 %
Investments1
371,069

4.3

Advances
3,149,113

18.1

Mortgage loans, net
215,342

3.6

Derivative assets, net
(1,859
)
(6.6
)
Other assets
(13,335
)
(10.3
)
Total assets
$
4,577,740

13.5
 %
 
 
 
Liabilities:
 

 

Deposits
$
(284,819
)
(29.6
)%
Consolidated obligations, net
5,026,531

16.2

Derivative liabilities, net
(56,936
)
(52.5
)
Other liabilities
3,786

2.9

Total liabilities
4,688,562

14.6

 
 
 
Capital:
 
 
Capital stock outstanding
(161,986
)
(12.9
)
Retained earnings
47,860

8.4

Accumulated other comprehensive income (loss)
3,304

18.0

Total capital
(110,822
)
(6.2
)
Total liabilities and capital
$
4,577,740

13.5
 %
                   
1    Investments also include interest-bearing deposits, Federal funds sold and securities purchased under agreements to resell.



66


Advances: Our advance programs are developed, as authorized in the Bank Act and in regulations established by the Finance Agency, to meet the specific liquidity and term funding needs of our members. As a wholesale provider of funds, we compete with brokered certificates of deposit and security repurchase agreements. We strive to price our advances relative to our marginal cost of funds while trying to remain competitive with the wholesale funding markets. While there is less competition in the long-term maturities, member demand for advances in these maturities has historically been lower than the demand for advances with short- and medium-term maturities. Nonetheless, long-term advances are also priced at relatively low spreads to our cost of funds.

Table 17 summarizes advances outstanding by product (dollar amounts in thousands):
 
Table 17
 
09/30/2014
12/31/2013
 
Dollar
Percent
Dollar
Percent
Adjustable rate:
 

 

 

 

Standard advance products:
 

 

 

 

Line of credit
$
7,299,743

35.7
%
$
3,471,636

20.2
%
Regular adjustable rate advances
15,000

0.1

5,000


Adjustable rate callable advances
4,380,709

21.5

4,849,409

28.2

Customized advances:
 

 

 

 

Adjustable rate advances with embedded caps or floors
127,000

0.6

127,000

0.8

Standard housing and community development advances:
 

 

 

 

Adjustable rate callable advances
83,087

0.4

83,460

0.5

Total adjustable rate advances
11,905,539

58.3

8,536,505

49.7

Fixed rate:
 

 

 

 

Standard advance products:
 

 

 

 

Short-term fixed rate advances
365,085

1.8

54,380

0.3

Regular fixed rate advances
5,087,538

24.9

5,483,902

31.9

Fixed rate callable advances
85,045

0.4

83,720

0.5

Standard housing and community development advances:
 

 

 

 
Regular fixed rate advances
315,096

1.6

276,366

1.6

Fixed rate callable advances
2,000




Total fixed rate advances
5,854,764

28.7

5,898,368

34.3

Convertible:
 

 

 

 

Standard advance products:
 

 

 

 

Fixed rate convertible advances
1,656,242

8.1

1,685,242

9.8

Amortizing:
 

 

 

 

Standard advance products:
 

 

 

 

Fixed rate amortizing advances
493,695

2.4

546,120

3.2

Fixed rate callable amortizing advances
34,550

0.2

34,185

0.2

Standard housing and community development advances:
 

 

 

 
Fixed rate amortizing advances
460,085

2.3

487,840

2.8

Fixed rate callable amortizing advances
7,160


5,359


Total amortizing advances
995,490

4.9

1,073,504

6.2

TOTAL PAR VALUE
$
20,412,035

100.0
%
$
17,193,619

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).


67


Advances are one of the primary ways we fulfill our mission of providing liquidity to our members and constituted the largest component of our balance sheet at September 30, 2014 and December 31, 2013. The 18.7 percent increase in advance par value (see Table 17) was due to a significant increase in our line of credit product and short-term fixed rate advances, which were offset by slight declines in adjustable rate callable advances and regular fixed rate advances. The increases were a result of efforts to retain maturing advances and to promote the pricing advantages of line of credit and short-term advances when taking our dividend payment rates into consideration. We expect advances as a percent of total assets to increase as part of our strategic initiative to achieve an increased core mission asset focus (see “Executive Level Overview” under this Item 2).

As of September 30, 2014 and December 31, 2013, 65.6 percent and 64.1 percent, respectively, of our members carried outstanding advance balances. The overall demand for our advances can be largely attributed to the demand for loans that our depository members are experiencing in their communities and their ability to fund those loans with deposit growth. It is also influenced by our insurance company members’ need for operational liquidity and the ability of both depository and insurance company members to profitably invest advance funding. For the most part, a large number of our member institutions continue to reduce outstanding advances as liquidity remains high with deposit costs and interest rates on the short end of the curve remaining low. However, the growth in advances experienced in the second and third quarters of 2014 is a result of a smaller number of members increasing short-term advances, which is helping to offset the members who have reduced their outstanding advances. Advances with many members could decline or remain flat until greater levels of funding can be reallocated from short-term liquid assets into higher-yielding loans or assets. If members reduce the volume of their advances, we expect to continue our past practice of repurchasing excess capital stock, when and as requested. In addition, when, and if, member advance demand changes, a few larger members could have a significant impact on the amount of total outstanding advances, much like what occurred during 2013.

Rather than match funding long-term, large dollar advances, we elect to swap a significant portion of large dollar advances with longer maturities to short-term indices (one- or three-month LIBOR) to synthetically create adjustable rate advances. Consequently, advances that effectively re-price at least every three months represent 84.5 percent and 79.2 percent of our total advance portfolio as of September 30, 2014 and December 31, 2013, respectively.

Table 18 presents information on our five largest borrowers (dollar amounts in thousands). If the borrower was not one of our top five borrowers for one of the periods presented, the applicable columns are left blank. We have rights to collateral with an estimated fair value in excess of the book value of these advances and, therefore, do not expect to incur any credit losses on these advances.

Table 18
 
09/30/2014
12/31/2013
Borrower Name
Advance
Par Value
Percent of Total
Advance Par
Advance
Par Value
Percent of Total
Advance Par
Bank of Oklahoma, NA
$
3,453,400

16.9
%
$
1,005,650

5.8
%
Capitol Federal Savings Bank
3,375,000

16.5

2,525,000

14.7

MidFirst Bank
2,711,500

13.3

2,720,000

15.8

United of Omaha Life Insurance Co.
597,445

2.9





American Fidelity Assurance Co.
521,500

2.6





Security Benefit Life Insurance Co.




1,015,000

5.9

Security Life of Denver Insurance Co.


700,000

4.1

TOTAL
$
10,658,845

52.2
%
$
7,965,650

46.3
%


68


Table 19 presents the interest income associated with the five borrowers with the highest interest income for the periods presented (dollar amounts in thousands). If the borrower was not one of our five borrowers with the highest income for one of the periods presented, the applicable columns are left blank.

Table 19
 
Three Months Ended
 
09/30/2014
09/30/2013
Borrower Name
Advance Income
Percent of Total
Advance Income1
Advance Income
Percent of Total
Advance Income1
Capitol Federal Savings Bank
$
14,947

23.2
%
$
14,861

22.4
%
American Fidelity Assurance Co.
4,482

7.0

4,501

6.8

Security Benefit Life Insurance Co.
2,337

3.6

2,353

3.5

MidFirst Bank
1,977

3.1





Ent Federal Credit Union
1,628

2.5





Pacific Life Insurance Co.
 
 
2,022

3.0

United of Omaha Life Insurance Co.
 
 
1,812

2.7

TOTAL
$
25,371

39.4
%
$
25,549

38.4
%
                   
1 
Total advance income by borrower excludes net interest settlements on derivatives hedging the advances. Total advance income for all borrowers is net of interest receipts/(payments) on derivatives hedging advances of $(33.1) million and $(35.8) million for the three months ended September 30, 2014 and 2013, respectively.

Table 20 presents the interest income associated with the five borrowers with the highest interest income for the periods presented (dollar amounts in thousands). If the borrower was not one of our five borrowers with the highest income for one of the periods presented, the applicable columns are left blank.

Table 20
 
Nine Months Ended
 
09/30/2014
09/30/2013
Borrower Name
Advance Income
Percent of Total
Advance Income1
Advance Income
Percent of Total
Advance Income1
Capitol Federal Savings Bank
$
42,279

22.5
%
$
46,194

22.6
%
American Fidelity Assurance Co.
13,434

7.2

13,338

6.5

Security Benefit Life Insurance Co.
7,555

4.0

7,053

3.5

MidFirst Bank
5,149

2.7





United of Omaha Life Insurance Co.
4,972

2.7

5,592

2.7

Pacific Life Insurance Co.
 
 
6,002

2.9

TOTAL
$
73,389

39.1
%
$
78,179

38.2
%
                   
1 
Total advance income by borrower excludes net interest settlements on derivatives hedging the advances. Total advance income for all borrowers is net of interest receipts/(payments) on derivatives hedging advances of $(98.6) million and $(110.8) million for the nine months ended September 30, 2014 and 2013, respectively.

MPF Program: The MPF Program is considered an attractive secondary market alternative for our members, especially the smaller institutions in our district. We participate in the MPF Program through the MPF Provider, a division of FHLBank of Chicago. Under the MPF Program, participating members can sell us conventional and government fixed rate, size-conforming, single-family residential mortgage loans.


69


The principal amount of new mortgage loans acquired and held on balance sheet from in-district PFIs during the first nine months of 2014 was $784.6 million. These new originations and acquisitions, net of loan payments received and excluding amounts participated to other FHLBanks, resulted in an increase of 3.6 percent in the outstanding net balance of our mortgage loan portfolio from December 31, 2013 to September 30, 2014. Net mortgage loans as a percentage of total assets decreased from 17.5 percent as of December 31, 2013 to 16.0 percent as of September 30, 2014.

The primary factors that may influence future growth in mortgage loans held for portfolio include: (1) the number of new and delivering PFIs; (2) the mortgage loan origination volume of current PFIs; (3) refinancing activity; (4) the level of interest rates and the shape of the yield curve; (5) the relative competitiveness of MPF pricing to the prices offered by other buyers of residential mortgage loans; and (6) reclassifying and selling specific mortgage loan pools. In an effort to manage the level of mortgage loans on our books, management has researched and continues to review options that may help manage the overall level of our mortgage loan portfolio. Those options include participating loan volume or selling whole loans to other FHLBanks, members, or other investors. As described below, we have pursued participations and, although we may determine to sell whole loans from time to time, we have not identified any specific loans to be sold as of September 30, 2014.

Historically, we have used the MPF Xtra product and mortgage loan participations with another FHLBank to effectively restrict the growth in mortgage loans held for portfolio and provide management with adequate means to control the amount of mortgage loan portfolio volume retained on our balance sheet to maintain our desired asset composition. The MPF Xtra product is a structure where our PFIs sell mortgage loans to FHLBank of Chicago and simultaneously to Fannie Mae. We receive a counterparty fee from FHLBank of Chicago (Fannie Mae seller-servicer) for our PFI participating in the MPF Xtra product. We discontinued our mortgage loan participations in the first quarter of 2014 because of lower origination volumes with PFIs, but we continue to consider and develop other options to manage the size of the mortgage loan portfolio while maintaining reliable support of our members’ residential lending programs.

The number of approved PFIs increased from 276 as of December 31, 2013 to 282 as of September 30, 2014. During the nine months ended September 30, 2014, we purchased loans from 183 PFIs with no one PFI accounting for more than 6.0 percent of the total volume purchased. Although there is no guarantee, we anticipate that the number of PFIs delivering loans will continue to increase during 2014 as other secondary mortgage outlets become less competitive or less available to many of our members. Table 21 presents the outstanding balances of mortgage loans sold to us, net of participations, (dollar amounts in thousands) from our top five PFIs and the percentage of those loans to total mortgage loans outstanding. If a PFI was not one of the top five for one of the periods presented, the applicable columns are left blank. The outstanding balance for Bank of America (non-member that acquired a former PFI and currently does not have the ability to sell loans to us under the MPF Program) has declined with the prepayment of loans held in the portfolio.

Table 21
 
09/30/2014
12/31/2013
 
Mortgage
Loan Balance
Percent of Total
Mortgage Loans
Mortgage
Loan Balance
Percent of Total
Mortgage Loans
Mutual of Omaha Bank
$
260,454

4.3
%
$
286,762

4.9
%
FirstBank of Colorado
199,507

3.3

170,004

2.9

Tulsa Teachers Credit Union
159,445

2.6

129,134

2.2

SAC Federal Credit Union
133,385

2.2





Farmers Bank & Trust N.A.
124,911

2.1

124,810

2.1

Bank of America, N.A.1
 
 
127,084

2.2

TOTAL
$
877,702

14.5
%
$
837,794

14.3
%
                   
1 
Formerly La Salle Bank, N.A., an out-of-district PFI with which we previously participated in mortgage loans with FHLBank of Chicago.

Two indications of credit quality are scores provided by Fair Isaac Corporation (FICO®) and loan-to-value (LTV) ratios. FICO is a widely used credit industry indicator to assess borrower credit quality with scores typically ranging from 300 to 850 with the low end of the scale indicating greater credit risk. The MPF Program requires a minimum FICO score of 620 for all conventional loans. LTV is a primary variable in credit performance. Generally speaking, a higher LTV ratio means greater risk of loss in the event of a default and also means higher loss severity. The weighted average FICO score and LTV recorded at origination for conventional mortgage loans outstanding as of September 30, 2014 was 751 and 73.0 percent, respectively. See Note 6 of the Notes to the Financial Statements under Item 1 for additional information regarding credit quality indicators.


70


Allowance for Credit Losses on Mortgage Loans Held for Portfolio – The allowance for credit losses on mortgage loans held for portfolio is based on our estimate of probable credit losses inherent in our portfolio as of the Statement of Condition date. The estimate is based on an analysis of our historical loss experience and observed trends in loan delinquencies. During the second quarter of 2014, we refined the technique used to estimate the allowance, which resulted in a decrease in the provision for credit losses and an immaterial decrease in the allowance balance as a percent of unpaid principal balance at June 30, 2014 compared to December 31, 2013. With the recent improvements in home prices and overall decrease in our delinquency rate, we believe that our refinement in technique better reflects current economic conditions at September 30, 2014. We also believe that policies and procedures are in place to effectively manage the credit risk on mortgage loans held in portfolio. See Note 6 of the Notes to the Financial Statements under Item 1 for a summary of the allowance for credit losses on mortgage loans, and delinquency aging and key credit quality indicators for our mortgage loan portfolio.

Investments: Investments are used to provide liquidity and to provide primary and secondary market support for the U.S. housing securities market. Total investments increased 4.3 percent primarily due to an overall increase in short-term investments, including Federal funds sold and reverse repurchase agreements. These investments are generally transacted with government agencies and large financial institutions that we consider to be of investment quality. The Finance Agency defines investment quality as a security with adequate financial backings so that full and timely payment of principal and interest on such security is expected and there is minimal risk that the timely payment of principal and interest would not occur because of adverse changes in economic and financial conditions during the projected life of the security.

Short-term Investments – Short-term investments, which are used to provide funds to meet the credit needs of our members, maintain liquidity, and meet other financial obligations such as debt servicing, consist primarily of reverse repurchase agreements, deposits in banks, overnight Federal funds sold, term Federal funds sold, certificates of deposit and commercial paper. The Bank Act and Finance Agency regulations and guidelines set liquidity requirements for us, and our board of directors has also adopted additional liquidity policies. In addition, we maintain a contingency liquidity plan in the event of operational disruptions. See “Risk Management – Liquidity Risk Management” under this Item 2 for a discussion of our liquidity management.

Within our portfolio of short-term investments, we face credit risk from unsecured exposures. Our short-term unsecured credit investments have maturities generally ranging between overnight and three months and include the following types:
Interest-bearing deposits. Unsecured deposits that earn interest.
Federal funds sold. Unsecured loans of reserve balances at the Federal Reserve Banks between financial institutions that are made on either an overnight or term basis.
Commercial paper. Unsecured debt issued by corporations, typically for the financing of accounts receivable, inventories, and meeting short-term liabilities.
Certificates of deposit. Unsecured negotiable promissory notes issued by banks and payable to the bearer at maturity.

Table 22 presents the carrying value of our unsecured credit exposure with private counterparties by investment type (in thousands). The unsecured investment credit exposure presented may not reflect the average or maximum exposure during the period as the balances presented reflect the balances at period end.

Table 22
 
09/30/2014
12/31/2013
Interest-bearing deposits
$

$
48

Federal funds sold
1,450,000

575,000

Certificates of deposit

260,009

TOTAL UNSECURED INVESTMENT CREDIT EXPOSURE1
$
1,450,000

$
835,057

                   
1 
Excludes unsecured investment credit exposure to U.S. government, U.S. government agencies, instrumentalities, GSEs and supranational entities and does not include related accrued interest.
 
We actively monitor our credit exposures and the credit quality of our counterparties, including an assessment of each counterparty’s financial performance, capital adequacy, sovereign support and the current market perceptions of the counterparties. General macro-economic, political and market conditions may also be considered when deciding on unsecured exposure. As a result, we may further limit existing exposures.


71


Finance Agency regulations: (1) include limits on the amount of unsecured credit an individual FHLBank may extend to a counterparty or to a group of affiliated counterparties; (2) permit us to extend additional unsecured credit for overnight extensions of credit, subject to limitations; and (3) prohibit us from investing in financial instruments issued by non-U.S. entities other than those issued by U.S. branches and agency offices of foreign commercial banks. For additional information on our management of unsecured credit exposure, see Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Investments” in our Form 10-K. As of September 30, 2014, we were in compliance with all Finance Agency regulations relating to unsecured credit exposure.

We manage our credit risk by conducting pre-purchase credit due diligence and on-going surveillance described previously and generally investing in unsecured investments of highly-rated counterparties. From time to time, we extend unsecured credit to qualified members by investing in overnight Federal funds issued by them. In general, we treat members as any other market participant. However, since they are members and we have more access to specific financial information about our members, we have a lower capital requirement than for non-members, but members must still meet our credit ratings requirements. As of September 30, 2014, all unsecured term investments were rated as investment grade based on NRSROs (see Table 26).

Table 23 presents the amount of our unsecured investment credit exposure (in thousands) by remaining contractual maturity and by the domicile of the counterparty or the domicile of the counterparty’s parent for U.S. branches and agency offices of foreign commercial banks as of September 30, 2014. We also mitigate the credit risk on investments by generally investing in investments that have short-term maturities.

Table 23
Domicile of Counterparty
Overnight
U.S. subsidiaries of foreign commercial banks
$
200,000

U.S. Branches and agency offices of foreign commercial banks:
 

Canada
500,000

Germany
250,000

Netherlands
250,000

Norway
150,000

United Kingdom
100,000

Total U.S. Branches and agency offices of foreign commercial banks
1,250,000

TOTAL UNSECURED INVESTMENT CREDIT EXPOSURE1
$
1,450,000

                   
1 
Excludes unsecured investment credit exposure to U.S. government, U.S. government agencies, instrumentalities, GSEs and supranational entities and does not include related accrued interest.

Unsecured credit exposure continues to be cautiously placed, with exposure concentrated in the United States, United Kingdom, Canada, Germany, and the Nordic countries. In addition, we anticipate continued future investment in reverse repurchase agreements, which are secured investments, and limiting unsecured exposure, especially to foreign financial institutions, as long as the interest rates are comparable (e.g., these investments were extremely low the latter half of 2013 and remained low at year end so we had limited investments in reverse repurchase agreements during that time frame). To enhance our liquidity position, we classify our unsecured short-term investment securities in our trading portfolio, which allows us to sell these securities if necessary.

Long-term investments – Our long-term investment portfolio consists primarily of Agency debentures, MBS/ABS, and state housing finance agency securities. Our Risk Management Policy (RMP) restricts the acquisition of investments to highly rated long-term securities. The majority of these long-term securities are Agency MBS/CMOs, which provide an alternative means to promote liquidity in the mortgage finance markets while providing attractive returns. Agency debentures are the other significant investment class that we hold in our long-term investment portfolio. They provide attractive returns, can serve as excellent collateral (e.g., repurchase agreements and net derivatives exposure), and are classified as trading securities to enhance our liquidity position. Over half of our unsecured Agency debentures are fixed rate bonds, which are swapped from fixed to variable rates. The swaps do not qualify for hedge accounting, which results in the net interest payments or receipts on these economic hedges flowing through net gain (loss) on derivatives and hedging activities instead of net interest income. All swapped Agency debentures are classified as trading securities.


72


According to Finance Agency regulation codified at 12 C.F.R. §1267.3, no additional MBS purchases can be made if the amortized cost of our mortgage securities exceeds 300 percent of our regulatory capital. Further, quarterly increases in holdings of mortgage securities are restricted to no more than 50 percent of regulatory capital. As of September 30, 2014, the amortized cost of our MBS/CMO portfolio represented 298 percent of our regulatory capital. As of September 30, 2014, we held $144.4 million of par value in MBS/CMOs in our trading portfolio for liquidity purposes and to provide additional balance sheet flexibility. All of the MBS/CMOs in the trading portfolio are variable rate Agency securities.

Major Security Types – Securities for which we have the ability and intent to hold to maturity are classified as held-to-maturity securities and recorded at carrying value, which is the net total of par, premiums, discounts and credit and non-credit OTTI discounts. We classify certain investments as trading securities and carry them at fair value. Changes in the fair values of these investments are recorded through other income and original premiums/discounts on these investments are not amortized. We do not practice active trading, but hold trading securities for asset/liability management purposes, including liquidity. Certain investments that we may sell before maturity are classified as available-for-sale and carried at fair value, although we had no available-for-sale securities as of September 30, 2014 or December 31, 2013. If fixed rate securities are hedged with interest rate swaps, we classify 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 as asset/liability management tools to manage duration risk, which are likely to be sold when the duration risk is no longer present, are classified as available-for-sale or trading securities. See Note 3 in the Notes to Financial Statements included in Item 1 to this report for additional information on our different investment classifications including what types of securities are held under each classification. The carrying value of our investments is summarized by security type in Table 24 (in thousands).

Table 24
 
09/30/2014
12/31/2013
Trading securities:
 

 

Certificates of deposit
$

$
260,009

U.S. Treasury obligations
25,031

25,012

GSE debentures
1,306,245

2,247,966

Mortgage-backed securities:
 

 

U.S. obligation residential MBS
986

1,090

GSE residential MBS
143,950

170,700

Total trading securities
1,476,212

2,704,777

Held-to-maturity securities:
 

 

State or local housing agency obligations
130,341

63,472

Mortgage-backed or asset-backed securities:
 

 

U.S. obligation residential MBS
60,190

68,977

GSE single-family and multi-family residential MBS
4,630,825

4,974,649

Private-label residential MBS
251,799

315,333

Home equity loan ABS
1,108

1,228

Total held-to-maturity securities
5,074,263

5,423,659

Total securities
6,550,475

8,128,436

 
 
 
Interest-bearing deposits
146

1,116

 
 
 
Federal funds sold
1,450,000

575,000

 
 
 
Securities purchased under agreements to resell
1,075,000


TOTAL INVESTMENTS
$
9,075,621

$
8,704,552



73


The contractual maturities of our investments are summarized by security type in Table 25 (dollar amounts 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 25
 
09/30/2014
 
Due in
one year
or less
Due after
one year
through five years
Due after
five years
through 10 years
Due after
10 years
Carrying
Value
Trading securities:
 

 

 

 

 

U.S. Treasury obligations
$
25,031

$

$

$

$
25,031

GSE debentures
267,576

929,395

109,274


1,306,245

Mortgage-backed securities:
 
 
 
 
 

U.S. obligation residential MBS



986

986

GSE residential MBS



143,950

143,950

Total trading securities
292,607

929,395

109,274

144,936

1,476,212

Yield on trading securities
0.11
%
5.20
%
3.25
%
2.38
%
 

Held-to-maturity securities:
 

 

 

 

 

State or local housing agency obligations


18,625

111,716

130,341

Mortgage-backed or asset-backed securities:
 

 

 

 

 

U.S. obligation residential MBS
5

29


60,156

60,190

GSE single-family and multi-family residential MBS

68,154

1,539,112

3,023,559

4,630,825

Private-label residential MBS

25,151

10,217

216,431

251,799

Home equity loans ABS



1,108

1,108

Total held-to-maturity securities
5

93,334

1,567,954

3,412,970

5,074,263

Yield on held-to-maturity securities
6.95
%
2.56
%
2.17
%
2.04
%
 

 
 
 
 
 
 
Total securities
292,612

1,022,729

1,677,228

3,557,906

6,550,475

Yield on total securities
0.11
%
4.94
%
2.24
%
2.05
%
 

 
 
 
 
 
 
Interest-bearing deposits
146




146

 
 
 
 
 
 
Federal funds sold
1,450,000




1,450,000

 
 
 
 
 
 
Securities purchased under agreements to resell
1,075,000




1,075,000

TOTAL INVESTMENTS
$
2,817,758

$
1,022,729

$
1,677,228

$
3,557,906

$
9,075,621



74


Securities Ratings – Tables 26 and 27 present the carrying value of our investments by rating (in thousands). The ratings presented are the lowest ratings available for each security based on NRSROs. We also utilize other credit quality factors when analyzing potential investments including, but not limited to, collateral performance, marketability, asset class or sector considerations, local and regional economic conditions, and/or the financial health of the underlying issuer.

Table 26
 
09/30/2014
 
Carrying Value1
 
Investment Grade
Below Triple-B
Unrated
Total
 
Triple-A
Double-A
Single-A
Triple-B
Interest-bearing deposits2
$

$
146

$

$

$

$

$
146

 
 
 
 
 
 
 
 
Federal funds sold2

250,000

1,200,000




1,450,000

 
 
 
 
 
 
 
 
Securities purchased under agreements to resell3


100,000



975,000

1,075,000

 
 
 
 
 
 
 
 
Investment securities:
 

 

 

 

 

 

 

Non-mortgage-backed securities:
 

 

 

 

 

 

 

U.S. Treasury obligations

25,031





25,031

GSE debentures

1,306,245





1,306,245

State or local housing agency obligations
85,606

30,000


14,735



130,341

Total non-mortgage-backed securities
85,606

1,361,276


14,735



1,461,617

Mortgage-backed or asset-backed securities:
 

 

 

 

 

 

 

U.S. obligation residential MBS

61,176





61,176

GSE single-family and multi-family residential MBS

4,774,775





4,774,775

Private label residential MBS

9,339

10,077

90,440

141,874

69

251,799

Home equity loan ABS




665

443

1,108

Total mortgage-backed securities

4,845,290

10,077

90,440

142,539

512

5,088,858

 
 
 
 
 
 
 
 
TOTAL INVESTMENTS
$
85,606

$
6,456,712

$
1,310,077

$
105,175

$
142,539

$
975,512

$
9,075,621

                   
1 
Investment amounts represent the carrying value and do not include related accrued interest receivable of $12.2 million at September 30, 2014.
2 
Amounts include unsecured credit exposure with overnight original maturities.
3 
Amounts represent collateralized overnight borrowings by counterparty rating.



75


Table 27
 
12/31/2013
 
Carrying Value1
 
Investment Grade
Below Triple-B
Unrated
Total
 
Triple-A
Double-A
Single-A
Triple-B
Interest-bearing deposits2
$
48

$
1,068

$

$

$

$

$
1,116

 
 
 
 
 
 
 
 
Federal funds sold2

375,000

200,000




575,000

 
 
 
 
 
 
 
 
Investment securities:
 

 

 

 

 

 

 

Non-mortgage-backed securities:
 

 

 

 

 

 

 

Certificates of deposit2

260,009





260,009

U.S. Treasury obligations

25,012





25,012

GSE debentures

2,247,966





2,247,966

State or local housing agency obligations
16,477

30,000


16,995



63,472

Total non-mortgage-backed securities
16,477

2,562,987


16,995



2,596,459

Mortgage-backed or asset-backed securities:
 

 

 

 

 

 

 

U.S. obligation residential MBS

70,067





70,067

GSE single-family and multi-family residential MBS

5,145,349





5,145,349

Private label residential MBS
2,148

16,053

13,939

125,939

157,174

80

315,333

Home equity loan ABS




749

479

1,228

Total mortgage-backed securities
2,148

5,231,469

13,939

125,939

157,923

559

5,531,977

 
 
 
 
 
 
 
 
TOTAL INVESTMENTS
$
18,673

$
8,170,524

$
213,939

$
142,934

$
157,923

$
559

$
8,704,552

                   
1 
Investment amounts represent the carrying value and do not include related accrued interest receivable of $22.2 million at December 31, 2013.
2 
Amounts include unsecured credit exposure with original maturities ranging between overnight and 95 days.



76


Private-label Mortgage-backed and Asset-backed Securities – The carrying value of our portfolio of private-label MBS/ABS is less than one percent of total assets. We classify private-label MBS/ABS as prime, Alt-A and subprime based on the originator’s classification at the time of origination or based on classification by an NRSRO upon issuance of the MBS/ABS.

Table 28 presents a summary of the UPB of private-label MBS/ABS by interest rate type and by type of collateral (in thousands):

Table 28
 
09/30/2014
12/31/2013
 
Fixed
Rate1
Variable
Rate1
Total
Fixed
Rate1
Variable
Rate1
Total
Private-label residential MBS:
 

 

 

 

 

 

Prime
$
32,505

$
97,248

$
129,753

$
50,734

$
115,983

$
166,717

Alt-A
70,647

71,120

141,767

90,124

82,100

172,224

Total private-label residential MBS
103,152

168,368

271,520

140,858

198,083

338,941

Home equity loan ABS:
 

 

 

 

 

 

Subprime

2,977

2,977


3,348

3,348

TOTAL
$
103,152

$
171,345

$
274,497

$
140,858

$
201,431

$
342,289

                   
1 
The determination of fixed or variable rate is based upon the contractual coupon type of the security.


77


Ninety-seven percent of our private-label MBS/ABS were securitized prior to 2006, and there are no securities in the portfolio issued after April 2006. As a result of this higher quality, well-seasoned portfolio, we have not experienced significant losses in our private-label MBS/ABS portfolio from OTTI. Table 29 presents statistical information for our private-label MBS/ABS by year of securitization and rating (dollar amounts in thousands):

Table 29
09/30/2014
Private-Label MBS/ABS By Year of Securitization
 
Total
2006
2005
2004 and Prior
Private-label residential MBS:
 

 

 

 

UPB by credit rating:
 

 

 

 

Double-A
$
9,354

$

$

$
9,354

Single-A
10,106



10,106

Triple-B
90,536


2,726

87,810

Double-B
57,969


2,325

55,644

Single-B
30,933

3,417


27,516

Triple-C
37,130


20,842

16,288

Double-C
17,793

3,617

10,866

3,310

Single-D
19,677

205

19,472


Unrated
999



999

TOTAL
$
274,497

$
7,239

$
56,231

$
211,027

 
 
 
 
 
Amortized cost
$
265,733

$
6,838

$
50,502

$
208,393

Gross unrealized losses
(11,601
)

(3,480
)
(8,121
)
Fair value
257,526

7,053

47,723

202,750

 
 
 
 
 
OTTI:
 

 

 

 

Credit-related OTTI charge taken year-to-date
$
443

$
27

$
327

$
89

Non-credit-related OTTI charge taken year-to-date
(443
)
(27
)
(327
)
(89
)
TOTAL
$

$

$

$

 
 
 
 
 
Weighted average percentage of fair value to UPB
93.8
%
97.4
%
84.9
%
96.1
%
Original weighted average credit support1
5.0

3.1

5.9

4.9

Weighted average credit support1
10.9

10.2

4.4

12.6

Weighted average collateral delinquency2
11.0

15.7

14.1

10.0

                   
1 
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.
2 
Collateral delinquency is based on the sum of loans greater than 60 days delinquent plus loans in foreclosure plus loans in bankruptcy plus REO.

Other-than-temporary Impairment – Based upon our OTTI evaluation process that results in a conclusion as to whether a credit loss exists (present value of our best estimate of the cash flows expected to be collected is less than the amortized cost basis of each individual security), we have concluded that, except for 26 outstanding private-label MBS upon which we have recognized OTTI, there is no evidence of a likely credit loss in our other 103 private-label MBS/ABS; there is no intent to sell, nor is there any requirement to sell; and, thus, there is no OTTI for the remaining private-label MBS that have declined in value.


78


Table 30 presents a summary of the significant inputs used to evaluate all non-Agency MBS for OTTI as well as related current credit enhancement. Credit enhancement is defined as the percentage of subordinated tranches and over-collateralization, if any, in a security structure that will generally absorb losses before we will experience a loss on the security. The calculated averages represent the dollar-weighted averages of all the private-label MBS investments, except for those securities that are qualitatively evaluated, in each category shown. The classification (prime, Alt-A and subprime) is based on the classification at the time of origination.

Table 30
Private-label residential MBS
 
Significant Inputs
Current
Credit
Enhancements
Year of Securitization
Prepayment
Rates
Default
Rates
Loss
Severities
Prime:
 
 
 
 
2004 and prior
14.5
%
5.5
%
30.3
%
12.2
%
2005
14.3

8.4

32.8

7.1

2006
14.8

9.7

37.4

10.2

Total Prime
14.5

5.9

30.8

11.9

Alt-A:
 

 

 

 

2004 and prior
16.3

8.5

32.6

13.5

2005
14.7

13.6

35.8

4.1

Total Alt-A
15.7

10.3

33.8

10.1

TOTAL
15.1
%
8.2
%
32.3
%
11.0
%
 
 
 
 
 
Home Equity Loan ABS
Year of Securitization
Significant Inputs
Current
Credit
Enhancements
Prepayment
Rates
Default
Rates
Loss
Severities
Subprime:
 
 
 
 
2004 and prior
3.6
%
5.6
%
81.2
%
2.3
%

We also evaluate other non-mortgage related investment securities, primarily consisting of municipal bonds issued by housing finance authorities, for potential impairment. During the third quarter of 2014, we did not identify any non-MBS/ABS securities as having impairment.

In addition to evaluating all of our private-label MBS/ABS under a base case (or best estimate) scenario for generating expected cash flows, a cash flow analysis is also performed for each security under a more stressful housing price scenario. The more stressful scenario is designed to provide an indication of the sensitivity of our private-label MBS/ABS to the deterioration in housing prices beyond our base case estimates. The stress test scenario and associated results do not represent our current expectations and therefore, should not be construed as a prediction of future results, market conditions or the actual performance of these securities. Rather, the results from the hypothetical stress test scenario provide a measure of the credit losses that we might incur if home price declines (and subsequent recoveries) are more adverse than those projected as our best estimate in our OTTI assessment. OTTI related to credit loss under the hypothetical stress test scenario for the quarter ended September 30, 2014 is $139.2 thousand compared to $20.0 thousand recorded under the base case scenario.


79


Deposits: Total deposits decreased 29.6 percent from December 31, 2013 to September 30, 2014, marked most significantly by a decrease in overnight balances. Deposit products offered primarily include demand and overnight deposits and short-term certificates of deposit. Demand deposit programs are offered primarily to facilitate customer transactions with us, such as cash flows associated with advances and mortgage loan transactions. Overnight deposits provide an alternative short-term investment option to members. The majority of deposits are in overnight or demand accounts that generally re-price daily based upon a market index such as overnight Federal funds. However, because of the extremely low interest rate environment, we have established a current floor of 5 bps on demand deposits and 10 bps on overnight deposits. The level of deposits is driven by member demand for 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 our deposit pricing as compared to other short-term market rates. Declines in the level of deposits could occur during 2014 if demand for loans at member institutions increases, if members choose to de-leverage their balance sheets or if decreases in the general level of liquidity of members should occur. Fluctuations in deposits have little impact on our ability to obtain liquidity. We historically have had stable and ready access to the capital markets through consolidated obligations and can replace any reduction in deposits with similarly or even lower priced borrowings.
 
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 we use to fund advances, mortgage loans and investments. As noted under Item 3 – “Quantitative and Qualitative Disclosures About Market Risk,” we use debt with a variety of maturities and option characteristics to manage our interest rate risk profile. We make extensive use of derivative transactions, executed in conjunction with specific consolidated obligation debt issues, to synthetically structure funding terms and costs.
 
Bonds are primarily used to fund longer-term (one year or greater) advances, mortgage loans and investments. To the extent that the bond is funding variable rate assets, we typically either issue a bond that has variable rates matching the asset index or utilize an interest rate swap to change the bond’s characteristics in order to match the asset’s index. Additionally, we sometimes use fixed rate, variable rate or complex consolidated obligation bonds that are swapped or indexed to LIBOR to fund short-term advances and money market investments or as a liquidity risk management tool.
 
Discount notes are primarily used to fund: (1) shorter-term advances or adjustable rate advances with indices and resets based on our short-term cost of funds; and (2) investments with maturities of three months or less. However, we sometimes use discount notes to fund longer-term assets, including fixed rate assets, variable rate assets, assets swapped to synthetically create variable rate assets, and short-term anticipated cash flows generated by longer-term fixed rate assets.
 
Total consolidated obligations increased 16.2 percent from December 31, 2013 to September 30, 2014. Discount notes increased from 35.2 percent of total outstanding consolidated obligations as of December 31, 2013 to 44.3 percent as of September 30, 2014 primarily as a result of the increase in our line of credit product and other short-term advance products (see this Item 2 – “Financial Condition – Advances”). We have also begun efforts to reduce our balance sheet allocation to money market securities and some other investments and plan to continue this throughout the remainder of 2014, which may continue to have some impact on the composition mix of our liabilities between bonds and discount notes.

While we currently have stable access to funding markets, future developments could impact the cost of replacing outstanding debt. Some of these include, but are not limited to, a large increase in call volume, significant increases in advance demand, legislative and regulatory changes, geopolitical events, proposals addressing GSEs, derivative and financial market reform, a decline in investor demand for consolidated obligations, further rating agency downgrades of U.S. Treasury obligations that will in turn impact the rating on FHLBank consolidated obligations and changes in Federal Reserve policies and outlooks.

Derivatives: All derivatives are marked to fair value with any associated accrued interest, and netted by clearing agent by Derivative Clearing Organization (Clearinghouse), or by counterparty and offset by the fair value of any swap cash collateral received or delivered where the legal right of offset has been determined, 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 our derivatives primarily fluctuate as the OIS and LIBOR/Swap interest rate curves fluctuate. Other factors such as implied price/interest rate volatility, the shape of the above interest rate curves and time decay can also drive the market price for derivatives.
 

80


We use 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., economic hedge). Economic hedges are defined as derivatives hedging specific or non-specific underlying assets, liabilities or firm commitments that either do not qualify for hedge accounting or for which we have not elected hedge accounting under GAAP, but are acceptable hedging strategies under our RMP. To meet the hedging needs of our members, we enter into offsetting derivatives, acting as an intermediary between members and other counterparties. This intermediation allows smaller members indirect access to the derivatives market. However, because of increased regulatory requirements with clearing intermediated derivatives we have placed an indefinite moratorium on these intermediated derivative transactions. The derivatives used in intermediary activities do not receive hedge accounting and are separately marked-to-market through earnings (classified as economic hedges).
 

Liquidity and Capital Resources
Liquidity: To meet our mission of serving as an economical funding source for our members and housing associates, we must maintain high levels of liquidity. We are required to maintain liquidity in accordance with certain Finance Agency regulations and guidelines and with policies established by management and the Board of Directors. We need liquidity to repay maturing consolidated obligations and other borrowings, to meet advance needs of our members, to make payments of dividends to our members and to repurchase excess capital stock at our discretion, whether upon the request of a member or at our own initiative (mandatory stock repurchases).

A primary source of our 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, we generally have comparatively stable access to funding at relatively favorable spreads to U.S. Treasury rates. We are primarily and directly liable for our portion of consolidated obligations (i.e., those obligations issued on our behalf). In addition, we are jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on the consolidated obligations of all 12 FHLBanks.

Our other sources of liquidity include deposit inflows, repayments of advances or mortgage loans, maturing investments, interest income, and proceeds from reverse repurchase agreements or the sale of unencumbered assets. Uses of liquidity include issuing advances, purchasing mortgage loans, purchasing investments, deposit withdrawals, capital repurchases, maturing or called consolidated obligations, interest expense, dividend payments to members, other contractual payments, and contingent funding or purchase obligations including letters of credit and any required purchases of securities under standby bond purchase agreements.

Total cash and short-term investments with remaining maturities of one year or less, which include term and overnight Federal funds sold, certificates of deposit, commercial paper and reverse repurchase agreements, increased from $3.5 billion as of December 31, 2013 to $5.4 billion as of September 30, 2014 as a result of repayments of line of credit products on the last day of the quarter, the majority of which were re-advanced shortly thereafter. The maturities of our short-term investments are structured to provide periodic cash flows to support our ongoing liquidity needs. To enhance our liquidity position, short-term investment securities (i.e., commercial paper and marketable certificates of deposit) are also classified as trading so that they can be readily sold should liquidity be needed immediately. We also maintain a portfolio of GSE debentures and U.S. Treasury obligations that can be pledged as collateral for financing in the securities repurchase agreement market and are classified as trading to enhance our liquidity position. These debentures decreased to $1.3 billion in par value as of September 30, 2014 from $2.2 billion in par value as of December 31, 2013, reflecting maturities of these debentures during 2014.

In order to assure that we can take advantage of those sources of liquidity that will affect our leverage capital requirements, we manage our average capital ratio to stay sufficiently above our minimum regulatory and RMP requirements so that we can utilize the excess capital capacity should the need arise. Managing our average capital ratio sufficiently above minimum regulatory and RMP requirements helps ensure our ability to meet the liquidity needs of our members and to increase our ability to repurchase excess stock either: (1) initiated at our discretion to adjust our balance sheet size or manage the amount of excess capital stock; or (2) upon the submission of a redemption request by a member. On April 4, 2014, we repurchased $276 million of excess Class A Common Stock as part of our strategic core mission asset initiatives. This excess capital stock repurchase was generally funded through the issuance of additional discount notes, thus effectively decreasing our capital-to-assets ratio. Going forward, we plan to repurchase all excess Class A Common Stock on a regular basis, which will generally be at least monthly. Ultimately, we anticipate this reduction in excess capital stock will allow us to maintain a consistent capital-to-asset ratio while continuing to reduce our level of investments.


81


We are subject to five metrics for measuring liquidity, and have remained in compliance with each of these liquidity requirements throughout the third quarter of 2014 (see “Risk Management – Liquidity Risk Management” under this Item 2 for additional discussion on our liquidity requirements). In order to ensure a sufficient liquidity cushion, we generally maintain a relatively longer weighted-average maturity on our consolidated obligation discount notes than the weighted average maturity of short-term investments. The weighted average remaining days to maturity of discount notes outstanding increased to 60 days as of September 30, 2014 from 39 days as of December 31, 2013. The weighted average remaining maturity of our money market investment portfolio (Federal funds sold, marketable certificates of deposit, commercial paper and reverse repurchase agreements) and non-earning cash left in our Federal Reserve Bank account decreased to 1 day as of September 30, 2014 from 7 days as of December 31, 2013 because we only held short-term investments with overnight maturities as of September 30, 2014. As a result of the decrease in the weighted average maturity of these short-term assets, the mismatch of discount notes and our money market investment portfolio increased from 32 days on December 31, 2013 to 59 days on September 30, 2014. Over time, especially as the yield curve steepens on the short end, maintaining the differential between the weighted average original maturity between discount notes and money market investments will marginally increase our cost of funds and reduce our net interest income.

We sometimes leave cash in our non-earning Federal Reserve Bank account at the end of the day for several reasons including: (1) advance payoffs that occur late in the day; (2) insufficient returns in the Federal funds market to compensate us for the associated credit risk; (3) general shortage of liquid investments in the market; and (4) the desire not to increase our balance sheet allocation to other investment categories. The balance in our Federal Reserve Bank account was $2.6 billion at September 30, 2014 compared to $1.7 billion at December 31, 2013 primarily due to an influx of cash on the last day of the third quarter and insufficient returns and a general shortage of liquid investments in the market.

In addition to the balance sheet sources of liquidity discussed previously, we have established lines of credit with numerous counterparties in the Federal funds market as well as with the other 11 FHLBanks. Accordingly, we expect to maintain a sufficient level of liquidity for the foreseeable future.

Capital: Total capital consists of capital stock, retained earnings and AOCI.

Capital stock declined 12.9 percent from December 31, 2013 to September 30, 2014, primarily due to an increase in repurchases of excess stock and a reduction in the activity-based stock purchase requirement for advances. Under our capital plan, members must purchase additional activity-based stock as they enter into advance transactions with us. The amount required is subject to change within ranges established under our capital plan. Beginning May 5, 2014, the activity-based stock purchase requirement for advances was reduced from 5.0 percent to 4.5 percent. Excess stock represents the amount of stock held by a member in excess of that institution’s minimum stock requirement. Upon reducing the activity-based stock purchase requirement, excess stock is created since the member no longer needs the same level of activity-based capital stock. If our excess stock exceeds 1.0 percent of our assets before or after the payment of a dividend in the form of stock, we would be prohibited by Finance Agency regulation from paying dividends in the form of stock. To manage the amount of excess stock, we repurchase excess Class A Common Stock over maximum amounts held by any individual member as of specific dates throughout the year. As discussed previously, in April 2014, we began the practice of repurchasing all outstanding excess Class A Common Stock, generally on a monthly basis. The current practice of regular weekly exchanges of all excess Class B Common Stock over $50,000 for Class A Common Stock is still in effect. As reflected in Table 31, the amount of excess stock held by members decreased. This decrease is at least partially attributable to: (1) our capital management practices initiated; (2) a common practice by some of our members to request redemptions of excess stock; and (3) our subsequent discretionary repurchase of member requests.

Under our cooperatively structured capital plan, our capital stock balances should fluctuate along with any growth (increased capital stock balances) or reduction (decreased capital stock balances) in advance balances in future periods. Any repurchase of excess capital stock is at our discretion and subject to statutory and regulatory limitations, including being in compliance with all of our regulatory capital requirements after any such discretionary repurchase.


82


Our activity-based stock purchase requirements are consistent with our cooperative structure: members’ stock ownership requirements and the dollar amount of dividends received generally increases as their activities with us increase. To the extent that a member’s asset-based stock purchase requirement is insufficient to cover the member’s activity-based stock purchase requirement and the member is required to purchase Class B Common Stock, we believe the value of our products and services is enhanced by dividend yields that exceed the return available from other investments with similar terms and credit quality. Factors that affect members’ willingness to enter into activity with us and purchase additional required activity-based stock include, but are not limited to, our dividend rates, the risk-based capital weighting of our capital stock and alternative investment opportunities available to the members. Based on anecdotal evidence (such as member advance activity and discussions with members), we believe that our activity-based stock purchase requirement for advances has not reduced advance activity with our members, although that may not hold true in the future. Table 31 provides a summary of member capital requirements under our current capital plan as of September 30, 2014 and December 31, 2013 (in thousands):

Table 31
Requirement
09/30/2014
12/31/2013
Asset-based (Class A only)
$
154,311

$
155,282

Activity-based (additional Class B)1
825,251

765,590

Total Required Stock2
979,562

920,872

Excess Stock (Class A and B)
115,072

336,141

Total Stock2
$
1,094,634

$
1,257,013

Activity-based Requirements:
 

 

Advances3
$
916,108

$
857,562

AMA assets (mortgage loans)4
2,107

2,467

Total Activity-based Requirement
918,215

860,029

Asset-based Requirement (Class A Common Stock) not supporting member activity1
61,347

60,843

Total Required Stock2
$
979,562

$
920,872

                   
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 because housing associates cannot own FHLBank stock.
4 
Non-members are subject to the AMA activity-based stock requirement as long as there are UPBs outstanding, but the requirement is currently zero percent for members.

The increase in retained earnings from December 31, 2013 to September 30, 2014 is attributable to the net income for the nine months ended September 30, 2014 of $79.5 million exceeding the $31.6 million payment of dividends for the same period of 2014. Our Board of Directors concluded that it was appropriate and prudent to aggressively grow our retained earnings during this period when our earnings were strong, while still allowing us to pay an acceptable dividend on our members’ capital stock investments. Another factor for the increase is the Joint Capital Enhancement Agreement with the other 11 FHLBanks effective February 28, 2011 that provides that, upon the satisfaction of the FHLBanks’ obligations to the Resolution Funding Corporation effective June 30, 2011, each FHLBank, on a quarterly basis, allocates at least 20 percent of its net income to a separate restricted retained earnings account until the balance of that account equals at least one percent of that FHLBank’s average balance of outstanding consolidated obligations for the previous quarter. These restricted retained earnings are not available to pay dividends.

We are subject to three capital requirements under provisions of the GLB Act, the Finance Agency’s capital structure regulation and our current capital plan: risk-based capital requirement, total capital requirement and leverage capital requirement. We have been in compliance with each of the aforementioned capital rules and requirements at all times since the implementation of our capital plan. See Note 12 in the Notes to Financial Statements included under Item 1 for additional information and compliance as of September 30, 2014 and December 31, 2013.

Capital Distributions: Dividends may be paid in cash or capital stock as authorized by our Board of Directors. Quarterly dividends can be paid out of current and previous unrestricted retained earnings, subject to Finance Agency regulation and our capital plan.


83


Within our capital plan, we have 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. Holders of Class A Common Stock and Class B Common Stock share in dividends equally up to the dividend parity threshold for a dividend period, then the dividend rate for holders of Class B Common Stock can exceed the rate for holders of Class A Common Stock, 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 holders of Class A Common Stock since we must pay holders of Class A Common Stock the dividend parity threshold rate before paying a higher rate to holders of Class B Common Stock; (2) indicates a potential dividend rate to holders of Class A Common Stock so that they can make decisions as to whether or not to hold excess Class A Common Stock; and (3) provides us 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).

The current dividend parity threshold is equal to the average effective overnight Federal funds rate for a dividend period minus 100 bps. This dividend parity threshold was effective for dividends paid for all of 2013 and 2014 and will continue to be effective until such time as it may be changed by our Board of Directors. With the overnight Federal funds target rate range of 0.0 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. Table 32 presents the dividend rates per annum paid on capital stock under our capital plan for the periods indicated:

Table 32
Applicable Rate per Annum
09/30/2014
06/30/2014
03/31/2014
12/31/2013
09/30/2013
Class A Common Stock
1.00
%
1.00
%
0.25
%
0.25
%
0.25
%
Class B Common Stock
6.00

5.00

4.00

3.75

3.50

Weighted Average1
5.15

4.22

2.60

2.51

2.31

Dividend Parity Threshold:
 

 

 

 

 

Average effective overnight Federal funds rate
0.09
%
0.09
%
0.07
%
0.09
%
0.09
%
Spread to index
(1.00
)
(1.00
)
(1.00
)
(1.00
)
(1.00
)
TOTAL (floored at zero percent)
%
%
%
%
%
                   
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.

We increased the dividend rate to 6.00 percent on Class B Common Stock for the third quarter of 2014, as a result of a change in our capital management practices intended to result in a higher percentage payout of quarterly earnings and slower growth in retained earnings. We expect to recommend maintaining the current dividend rates on Class A Common Stock and Class B Common Stock for a considerable time in keeping with the desire to pay out a larger percentage of income than in the past. We caution, however, that market conditions can be unpredictable and adverse changes may result in lower dividends rates in future quarters. While there is no assurance that our Board of Directors will not change the dividend parity threshold in the future, the capital plan requires that we 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.

We expect to continue paying dividends primarily in the form of capital stock in 2014, but future dividends may be paid in cash. The payment of cash dividends instead of stock dividends should not have a significant impact from a liquidity perspective, as the subsequent redemption of excess stock created by stock dividends would utilize liquidity resources in the same manner as a cash dividend.


Risk Management
Active risk management continues to be an essential part of our operations and a key determinant of our ability to maintain earnings to return an acceptable dividend to our members and meet retained earnings thresholds. We maintain an enterprise risk management (ERM) 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. Our ERM program is a structured and disciplined approach that aligns strategy, processes, people, technology and knowledge with the purpose of identifying, evaluating and managing the uncertainties we face as we create value. It is a continuous process of identifying, prioritizing, assessing and managing inherent enterprise risks (i.e., business, compliance, credit, liquidity, market and operations) before they become realized risk events. See Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Risk Management” in our Form 10-K for more information on our ERM program. A separate discussion of market risk is included under Item 3 – “Quantitative and Qualitative Disclosures About Market Risk” of this Form 10-Q.


84


Credit Risk Management: Credit risk is defined as the risk that counterparties to our transactions will not meet their contractual obligations. We manage credit risk by following established policies, evaluating the creditworthiness of our counterparties, and utilizing collateral agreements and settlement netting for derivative transactions where enforceability of the legal right of offset has been determined. 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 we are exposed to credit risk, whether that is through lending, investing or derivative activities.

Lending and AMA Activities – Credit risk with members arises partly as a result of our lending and AMA activities (members’ CE obligations on conventional mortgage loans that we acquire through the MPF Program). We manage our exposure to credit risk on advances, letters of credit, derivatives, and members’ CE obligations on conventional mortgage loans through a combined approach that provides ongoing review of the financial condition of our members coupled with prudent collateralization.

As provided in the Bank Act, a member’s investment in our capital stock is held as additional collateral for the member’s advances and other credit obligations (letters of credit, CE obligations, etc.). In addition, we can call for additional collateral or substitute collateral during the life of an advance or other credit obligation to protect our security interest.

Credit risk arising from AMA activities under our MPF Program falls into three categories: (1) the risk of credit losses on the mortgage loans represented in our First Loss Account (FLA) and last loss positions; (2) the risk that a PFI will not perform as promised with respect to its loss position provided through its CE obligations on conventional mortgage loan pools, which are covered by the same collateral arrangements as those described for advances; and (3) the risk that a third-party insurer (obligated under primary mortgage insurance (PMI) or supplemental mortgage insurance (SMI) arrangements) will fail to perform as expected. Should a PMI third-party insurer fail to perform, it would increase our credit risk exposure because our FLA is the next layer to absorb credit losses on conventional mortgage loan pools. Likewise, if an SMI third-party insurer fails to perform, it would increase our 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. Credit risk exposure to third-party insurers to which we have PMI and/or SMI exposure is monitored on a monthly basis and regularly reported to the Board of Directors. We perform credit analysis of third-party PMI and SMI insurers on at least an annual basis. On a quarterly basis, we review trends that could identify risks with our mortgage loan portfolio, including low FICO scores and high LTV ratios. Based on the credit underwriting standards under the MPF Program and this monthly review, we have concluded that the mortgage loans we hold would not be considered subprime.

Investments – Our 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 and reverse repurchase agreements. 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 our short-term investments. Collateral valuation and compliance with collateral eligibility and transaction margin requirements are monitored daily to limit secured credit risk on our reverse repurchase agreements. MBS represent the majority of our long-term investments. We hold MBS issued by agencies and GSEs, CMOs securitized by GSEs, private-issue MBS/ABS rated triple-A at the time of purchase and CMOs securitized by whole loans. Approximately 93 percent of our MBS/CMO portfolio is securitized by Fannie Mae or Federal Home Loan Mortgage Corporation (Freddie Mac). All of our private-label MBS/ABS have been downgraded below triple-A subsequent to purchase (see Table 26), but the downgraded securities have been and are currently paying according to contractual agreements with the exception of three securities that experienced immaterial cash flow shortfalls. The securities we hold that are classified as being backed by subprime mortgage loans are private-label home equity ABS. We also have potential credit risk exposure to MBS/CMOs and ABS that are insured by two of the monoline mortgage insurance companies, one of which is in rehabilitation after having previously entered into bankruptcy proceedings. We analyze these securities quarterly as part of the OTTI determination and assume no coverage potential from this monoline insurance provider. Under the RMP in effect at the time of acquisition, the insurer had to be rated no lower than double-A. We monitor the credit ratings daily, financial performance at least annually and capital adequacy quarterly for all primary mortgage insurers, secondary mortgage insurers and master servicers to which we have potential credit risk exposure. Other long-term investments include unsecured GSE debentures and unsecured or collateralized state and local housing finance agency securities that were rated at least double-A at the time of purchase.

Derivatives – We transact most of our derivatives with large banks and major broker-dealers. Over-the-counter derivative transactions may be either executed with a counterparty (bilateral derivatives) or with an executing broker and cleared through a Futures Commission Merchant (i.e., clearing agent), with a Derivative Clearing Organization (cleared derivatives).

We are subject to credit risk due to the risk of nonperformance by counterparties to our derivative transactions. The amount of credit risk on derivatives depends on the extent to which netting procedures and collateral requirements are used and are effective in mitigating the risk. We manage this risk through credit analysis and collateral management. We are also required to follow the requirements set forth by applicable regulation.


85


Bilateral Derivatives. We are subject to non-performance by the counterparties to our bilateral derivative transactions. We generally require collateral on bilateral derivative transactions. For some counterparties, the amount of net unsecured credit exposure that is permissible with respect to the counterparty depends on the credit rating of that counterparty. For other counterparties, collateral is required on all net unsecured credit exposure. For a counterparty with credit rating thresholds, a counterparty generally must deliver collateral to us if the total market value of our exposure to that counterparty rises above a specific trigger point. Our credit risk exposure from derivative transactions with member institutions is fully collateralized under our Advance, Pledge and Security Agreement. As a result of these risk mitigation initiatives, we do not anticipate any credit losses on our bilateral derivative transactions as of September 30, 2014.

Cleared Derivatives. We are subject to nonperformance by the Clearinghouse(s) and clearing agent(s). The requirement that we post initial and variation margin, through the clearing agent, to the Clearinghouse, exposes us to institutional credit risk in the event that the clearing agent or the Clearinghouse fails to meet its obligations. The use of cleared derivatives is intended to mitigate credit risk exposure because a central counterparty is substituted for individual counterparties and collateral is posted daily for changes in the value of cleared derivatives through a clearing agent. We do not anticipate any credit losses on our cleared derivatives as of September 30, 2014.

We regularly monitor the exposures on our derivative transactions by determining the market value of positions using internal pricing models. The market values generated by the pricing model used to value derivatives are compared to dealer model results on a monthly basis to ensure that our derivative pricing model is reasonably calibrated to actual market pricing methodologies utilized by the dealers. In addition, we have our internal pricing model validated annually by an independent consultant. As a result of these risk mitigation initiatives, management does not anticipate any credit losses on our derivative transactions. See Note 7 of the Notes to Financial Statements under Item 1 for additional information on managing credit risk on derivatives.

The contractual or notional amount of derivative transactions reflects our involvement in the various classes of financial instruments. The maximum credit risk with respect to derivative transactions is the estimated cost of replacing the derivative transactions if there is a default, minus the value of any related collateral posted to satisfy the initial margin (if required) and the variation margin. Our derivative transactions are subject to variation margin which is derived from the change in market value of the transaction and must be posted by the net debtor on demand. Cleared transactions are subject to initial margin as well as variation margin. The initial margin is intended to protect the Clearinghouse against default of a clearing agent and to protect the clearing agent against default of a customer. Initial margin is calculated to cover the potential price volatility of the derivative transaction between the time of the default and the assignment of the transaction to another clearing agent or termination of the transaction. The initial margin remains outstanding for the life of the transaction; thus, it is possible that we could either have: (1) net credit exposure with a Clearinghouse even if our net creditor position has been fully satisfied by the receipt of variation margin; or (2) net credit exposure with a Clearinghouse despite being the net debtor (i.e., being in a liability position). In determining maximum credit risk, we consider accrued interest receivables and payables as well as the netting requirements to net assets and liabilities.


86


Tables 33 and 34 present derivative notional amounts and counterparty credit exposure, net of collateral, by whole-letter rating (in the event of a split rating, we use the lowest rating published by Moody’s or S&P) for derivative positions with counterparties to which we had credit exposure (in thousands):

Table 33
09/30/2014
Credit Rating
Notional Amount
Net Derivatives Fair Value Before Collateral
Cash Collateral Pledged From (To) Counterparty
Net Credit Exposure to Counterparties
Asset positions with credit exposure:
 
 
 
 
Bilateral derivatives:
 
 
 
 
Double-A
$
701,000

$
853

$

$
853

Single-A
3,968,950

36,317

29,433

6,884

Liability positions with credit exposure:
 
 
 
 
Bilateral derivatives2:
 
 
 
 
Single-A
3,288,162

(85,063
)
(86,369
)
1,306

Cleared derivatives1
2,276,596

(12,050
)
(29,020
)
16,970

TOTAL DERIVATIVE POSITIONS WITH CREDIT EXPOSURE
$
10,234,708

$
(59,943
)
$
(85,956
)
$
26,013

                   
1 
Represents derivative transactions cleared with Clearinghouses, which are not rated.
2 
Exposure can change on a daily basis; and thus, there is often a short lag time between the date the exposure is identified, collateral is requested and collateral is actually returned.

Table 34

12/31/2013
Credit Rating
Notional Amount
Net Derivatives Fair Value Before Collateral
Cash Collateral Pledged From (To) Counterparty
Net Credit Exposure to Counterparties
Asset positions with credit exposure:
 
 
 
 
Bilateral derivatives:
 
 
 
 
Double-A
$
96,000

$
1,459

$

$
1,459

Single-A
5,159,825

33,616

27,669

5,947

Cleared derivatives1
1,146,500

6,912

(5,954
)
12,866

Liability positions with credit exposure:
 
 
 
 
Bilateral derivatives2:
 
 
 
 
Single-A
1,217,500

(30,328
)
(37,824
)
7,496

Cleared derivatives1
10,000

(38
)
(203
)
165

TOTAL DERIVATIVE POSITIONS WITH CREDIT EXPOSURE
$
7,629,825

$
11,621

$
(16,312
)
$
27,933

                   
1 
Represents derivative transactions cleared with Clearinghouses, which are not rated.
2 
Exposure can change on a daily basis; and thus, there is often a short lag time between the date the exposure is identified, collateral is requested and collateral is actually returned.


87


Foreign Counterparty Risk  Loans, acceptances, interest-bearing deposits with other banks, other interest-bearing investments and any other monetary assets payable to us by entities of foreign countries, regardless of the currency in which the claim is denominated are referred to as "cross-border outstandings." Our cross-border outstandings consist primarily of short-term trading securities and Federal funds sold issued by banks and other financial institutions, which are non-sovereign entities, and derivative asset exposure with counterparties that are also non-sovereign entities. Secured reverse repurchase agreements outstanding are excluded from cross-border outstandings because they are fully collateralized.

In addition to credit risk, cross-border outstandings have the risk that, as a result of political or economic conditions in a country, borrowers may be unable to meet their contractual repayment obligations of principal and/or interest when due because of the unavailability of, or restrictions on, foreign exchange needed by borrowers to repay their obligations. Unsecured credit exposure continues to be cautiously placed, with non-derivatives exposure concentrated in the United States, United Kingdom, Canada, Germany, and the Nordic countries.

Table 35 presents the fair value of cross-border outstandings to countries in which we do business that amounted to at least one percent of our total assets as of September 30, 2014 (dollar amounts in thousands):

Table 35
 
Canada
Other1
Total
 
Amount
Percent of
Total Assets
Amount
Percent of
Total Assets
Amount
Percent of
Total Assets
Federal funds sold2
$
500,000

1.3
%
$
750,000

2.0
%
$
1,250,000

3.3
%
 
 
 
 
 
 
 
Derivative assets:
 

 

 
 
 
 
Net exposure at fair value
(22,450
)
 
(50,342
)
 
(72,792
)
 
Cash collateral held
22,762

 
55,076

 

77,838

 
Net exposure after cash collateral
312


4,734


5,046


 
 
 
 
 
 
 
TOTAL
$
500,312

1.3
%
$
754,734

2.0
%
$
1,255,046

3.3
%
                   
1 
Represents other foreign countries where individual exposure is less than one percent of total assets. There were no cross-border outstandings to countries that individually represented between 0.75 and 1.0 percent of our total assets as of September 30, 2014.
2 
Consists solely of overnight Federal funds sold.

Liquidity Risk Management: Maintaining the ability to meet our obligations as they come due and to meet the credit needs of our members and housing associates in a timely and cost-efficient manner is the primary objective of managing liquidity risk. We seek to be in a position to meet the credit needs of our members, as well as our debt service 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 currently defined in our RMP as sources of cash from both our ongoing access to the capital markets and our holding of liquid assets. We manage exposure to operational liquidity risk by maintaining appropriate daily liquidity levels above the thresholds established by our RMP. We are also required to manage liquidity in order to meet statutory and contingency liquidity requirements and Finance Agency liquidity guidelines by maintaining a daily liquidity level above certain thresholds also outlined in the RMP, federal statutes, Finance Agency regulations and other Finance Agency guidance not issued in the form of regulations. We remained in compliance with each of these liquidity requirements throughout the third quarter of 2014.

We generally maintained stable access to the capital markets for the quarter ended September 30, 2014. For additional discussion of the market for our consolidated obligations and the overall market affecting liquidity see “Financial Market Trends” under this Item 2.

Certain of our derivative instruments contain provisions that require us to post additional collateral with our counterparties if there is deterioration in our credit rating. See Note 7 of the Notes to Financial Statements under Item 1 for additional information on collateral posting requirements and credit-risk-related contingent features. We believe that our liquidity position as of September 30, 2014 was sufficient to satisfy the additional collateral that would be required in the event of a downgrade in our credit rating from double-A to single-A if the downgrade was effective at that time, and such amounts would not have a material impact to our financial condition or results of operations.



88


Impact of Recently Issued Accounting Standards
See Note 2 of the Notes to the Financial Statements included under Item 1 – “Financial Statements” for a discussion of recently issued accounting standards.

Legislative and Regulatory Developments
The legislative and regulatory environment in which we and our members operate continues to evolve as a result of regulations enacted pursuant to the Housing and Economic Recovery Act of 2008, as amended (Housing Act) and the Dodd-Frank Act. Our business operations, funding costs, rights, obligations, and/or the environment in which we carry out our housing finance mission are likely to continue to be significantly impacted by these changes. Significant regulatory actions and developments for the period covered by this report are summarized below.

Joint Final Rule on Credit Risk Retention for Asset-Backed Securities. On October 22, 2014, the Finance Agency and other U.S. federal regulators jointly approved a final rule requiring sponsors of ABS to retain credit risk in those transactions. The final rule largely retains the risk retention framework contained in the proposal issued by the agencies in August 2013 and generally requires sponsors of ABS to retain a minimum five percent economic interest in a portion of the credit risk of the assets collateralizing the ABS, unless all the securitized assets satisfy specified qualifications. The final rule specifies criteria for qualified residential mortgage (QRM), commercial real estate, auto, and commercial loans that would make them exempt from the risk retention requirement. The definition of QRM is aligned with the definition of “qualified mortgage” (QM) as provided in Section 129C of the Truth in Lending Act, and its implementing regulations, as adopted by the Consumer Financial Protection Bureau. The QM definition requires, among other things, full documentation and verification of consumers’ debt and income and a debt-to-income ratio that does not exceed 43 percent and restricts the use of certain product features, such as negative amortization and interest-only and balloon payments.

Other exemptions from the credit risk requirement include certain mortgage loans secured by three-to-four unit residential properties that meet the criteria for QM and certain types of community-focused residential mortgages (including extensions of credit made by community development financial institutions). The final rule also includes a provision that requires the agencies to periodically review the definition of QRM, the exemption for certain community-focused residential mortgages, and the exemption for certain three-to-four unit residential mortgage loans and consider whether they should be modified.

The final rule exempts agency MBS from the risk retention requirements as long as the sponsoring agency is operating under the conservatorship or receivership of the Finance Agency and fully guarantees the timely payment of principal and interest on all assets in the issued security. Further, MBS issued by any limited-life regulated entity succeeding to either Fannie Mae or Freddie Mac operating with capital support from the United States would be exempt from the risk retention requirements. The final rule will be effective one year after publication in the Federal Register for residential mortgage-backed securitizations and two years after publication for all other securitization types. We are currently assessing the impact of the final rule and have not yet determined the effect, if any, that this rule, may have on our operations.

Federal Home Loan Bank Capital Stock and Capital Plans. The Finance Agency issued on October 8, 2014, a proposed rule that would transfer existing parts 931 and 933 of the Federal Housing Finance Board regulations, which address requirements for FHLBanks’ capital stock and capital plans, to new Part 1277 of the Finance Agency regulations (Capital Proposed Rule). The Capital Proposed Rule would not make any substantive changes to these requirements, but would delete certain provisions that applied only to the one-time conversion of FHLBank stock to the new capital structure required by the GLB Act. The Capital Proposed Rule would also make certain clarifying changes so that the rules would more precisely reflect long-standing practices and requirements with regard to transactions in FHLBank stock. The Capital Proposed Rule would add appropriate references to ‘‘former members’’ to clarify when former FHLBank members can be required to maintain investment in FHLBank capital stock after withdrawal from the FHLBank. We are currently evaluating the Capital Proposed Rule. Comments on the Capital Proposed Rule are due by December 8, 2014.


89


Finance Agency Proposed Rule on Members of the FHLBanks. On September 12, 2014, the Finance Agency issued a proposed rule that would:
Impose a new test on all FHLBank members that requires them to maintain at least 1 percent of their assets in first-lien home mortgage loans, including MBS, on an ongoing basis, with maturities of five years or more to maintain their membership in the FHLBanks. The proposal also suggests the possibility of a 2 percent or a 5 percent test as options;
Require all insured depository members (other than FDIC-insured depositories with less than $1.1 billion in assets) to maintain, on an ongoing basis, at least 10 percent of their assets in a broader range of residential mortgage loans, including those secured by junior liens and MBS, in order to maintain their membership in the FHLBanks;
Eliminate all currently eligible captive insurance companies from FHLBank membership. Current captive insurance company members would have their memberships terminated five years after the rule is finalized; there would be restrictions on the level and maturity of advances that FHLBanks could make to these members during the sunset period; and any new captive insurance members admitted after the date of this proposal would have their membership and advances terminated upon issuance of a final rule; and
Clarify how an FHLBank should determine the “principal place of business” of an insurance company or community development financial institution for purposes of membership. Current rules define an institution’s “principal place of business” as the state in which it maintains its home office. The proposal would add a second component requiring an institution to conduct business operations from the home office for that state to be considered its principal place of business. The changes would apply prospectively.

We are currently evaluating the proposed rule, and its effect on our financial condition and results of operations has not yet been determined. Comments on the proposed rule are due by January 12, 2015.

Basel Committee on Bank Supervision - Liquidity Coverage Ratio. On September 3, 2014, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation finalized the liquidity coverage ratio (LCR) rule, applicable to: (i) U.S. banking organizations with $250 billion or more in consolidated total assets or $10 billion or more in total on-balance sheet foreign exposure, and their consolidated subsidiary depository institutions with $10 billion or more in total consolidated assets; and (ii) certain other U.S. bank or savings and loan holding companies having at least $50 billion in total consolidated assets. The LCR rule requires such covered companies to maintain a stock of high quality liquid assets (HQLA) that is no less than 100 percent of their total net cash outflows over a prospective 30-day stress period. Among other things, the final rule defines the various categories of HQLA, called Levels 1, 2A, or 2B. The treatment of HQLAs for the LCR is most favorable under the Level 1 category, less favorable under the Level 2A category, and least favorable under the Level 2B category.

Under the final rule, collateral pledged to us not securing existing borrowings may be considered eligible HQLA to the extent the collateral itself qualifies as eligible HQLA; qualifying FHLBank System consolidated obligations are categorized as Level 2A HQLAs; and the amount of a covered company’s funding that is assumed to run off includes 25 percent of FHLBank advances maturing within 30 days, to the extent such advances are not secured by level 1 or level 2A HQLA, where 0 percent and 15 percent run-off assumptions apply, respectively. At this time, the impact of the final rule is uncertain. The final rule requires that all covered companies be fully compliant by January 1, 2017.

Margin and Capital Requirements for Covered Swap Entities. On September 3, 2014, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the Finance Agency (collectively, the Agencies) jointly proposed a rule to establish minimum margin collection requirements for registered swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants (collectively, Swap Entities) that are subject to the jurisdiction of one of the Agencies (the Proposed Rule). In addition, the Proposed Rule affords the Agencies discretion to subject other persons to the Proposed Rule’s requirements (such persons, together with Swap Entities, are referred to as Covered Swap Entities). Comments on the Proposed Rule are due by November 24, 2014.

In addition, on September 17, 2014, the Commodity Futures Trading Commission (CFTC) adopted its version of the Proposed Rule (the CFTC Proposed Rule) that generally mirrors the Proposed Rule. The CFTC Proposed Rule will only apply to a limited number of registered swap dealers and major swap participants that are not subject to the jurisdiction of one of the Agencies. Comments on the CFTC Proposed Rule are due by December 2, 2014.

The Proposed Rule would subject non-cleared swaps and non-cleared security-based swaps between Covered Swap Entities, and between Covered Swap Entities and financial end users that have material swaps exposure, to a mandatory two-way initial margin requirement.  The amount of initial margin required to be posted would be either the amount calculated using a standardized schedule set forth in the Proposed Rule, which provides the gross initial margin (as a percentage of total notional exposure) for certain asset classes, or an internal margin model conforming to the requirements of the Proposed Rule that is approved by the applicable Agency. The Proposed Rule specifies the types of collateral that may be posted as initial margin (generally, cash, government securities, liquid debt, equity securities and gold); and sets forth haircuts for certain collateral asset classes. Initial margin must be segregated with an independent, third-party custodian and may not be rehypothecated.

90



The Proposed Rule would require variation margin to be exchanged daily for non-cleared swaps and non-cleared security-based swaps between Covered Swap Entities and between Covered Swap Entities and all financial end users (without regard to the swaps exposure of the particular financial end-user). The variation margin amount is the daily mark-to-market change in the value of the swap to the Covered Swap Entity, taking into account variation margin previously paid or collected. Variation margin may only be paid in cash, is not subject to segregation with an independent, third-party custodian, and may, if permitted by contract, be rehypothecated.

Under the Proposed Rule, the variation margin requirement would become effective on December 1, 2015 and the initial margin requirement would be phased in over a four-year period commencing on that date. For entities that have less than a $1 trillion notional amount of non-cleared derivatives, the Proposed Rule’s initial margin requirement would not come into effect until December 1, 2019.

We would not be a Covered Swap Entity under the Proposed Rule, although the Finance Agency has discretion to designate us a Covered Swap Entity. Rather, we would be a financial end-user under the Proposed Rule, and we would likely have material swap exposure upon the effective date of the Proposed Rule’s initial margin requirement.

Since we are currently posting and collecting variation margin on our non-cleared swaps, it is not anticipated that the Proposed Rule’s variation margin requirement, if adopted, would have a material impact on our costs. However, if the Proposed Rule’s initial margin requirement is adopted, it is anticipated that our cost of engaging in non-cleared swaps would increase.

Money Market Mutual Fund Reform. On June 19, 2013, the SEC proposed two alternatives for amending rules that govern money market mutual funds under the Investment Company Act of 1940. On July 23, 2014, the SEC approved final rule amendments that, among other things, the final regulations will:
Require institutional prime money market funds (including institutional municipal money market funds) to sell and redeem shares based on their floating net asset value, which would result in the daily share prices of the money market funds fluctuating along with changes in the market-based value of the funds’ investments;
Allow money market fund boards of directors to directly address a run on a fund by imposing liquidity fees or suspending redemptions temporarily; and
Include enhanced diversification, disclosure and stress testing requirements, as well as provide updated reporting by money market funds and private funds that operate like money market funds.

The rule amendments do not change the existing regulatory treatment of FHLBank consolidated obligations as liquid assets. FHLBank consolidated discount notes continue to be included in the definition of “daily liquid assets” and the definition of “weekly liquid assets” continues to include FHLBank consolidated discount notes with a remaining maturity up to 60 days. At this time, the future impact of these regulations on demand for FHLBank consolidated obligations are unknown.

Finance Agency Issues Advisory Bulletin on Classification of Assets. On April 9, 2012, the Finance Agency issued Advisory Bulletin 2012-02, Framework for Adversely Classifying Loans, Other Real Estate Owned (“REO”), and Other Assets and Listing Assets for Special Mention (AB 2012-02). The guidance in AB 2012-02 is generally consistent with the Uniform Retail Credit Classification and Account Management Policy issued by the federal banking regulators in June 2000. AB 2012-02 establishes a standard and uniform methodology for classifying assets, prescribes the timing of asset charge-offs (excluding investment securities), provides measurement guidance with respect to determining our allowance for credit losses, and fair value measurement guidance for REO (e.g., use of appraisals). Subsequent to the issuance of AB 2012-02, the Finance Agency issued interpretative guidance clarifying that implementation of the asset classification framework may occur in two phases. The asset classification provisions in AB 2012-02 were implemented on January 1, 2014. The charge-off provisions have been extended and should be implemented no later than January 1, 2015. We do not expect implementation of the charge-off provisions of AB 2012-02 to have a material impact on our financial condition, results of operations, or cash flows.


Item 3: Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk Management
We measure interest rate risk exposure by various methods, including the calculation of duration of equity (DOE) and market value of equity (MVE) in different interest rate scenarios.

Duration of Equity: DOE aggregates the estimated sensitivity of market value for each of our financial assets and liabilities to changes in interest rates. In essence, DOE indicates the sensitivity of MVE to changes in interest rates. However, MVE should not be considered indicative of our market value as a going concern or our value in a liquidation scenario.


91


We manage DOE within ranges approved by our Board of Directors as described under Item 7A - "Quantitative and Qualitative Disclosures About Market Risk" in the annual report on Form 10-K, incorporated by reference herein. All of our DOE measurements were inside Board of Director established policy limits and operating ranges as of September 30, 2014. On an ongoing basis, we actively monitor portfolio relationships and overall DOE dynamics as a part of our evaluation processes for determining acceptable future asset/liability management actions. Table 36 presents the DOE in the base case and the up and down 200 basis point interest rate shock scenarios:

Table 36
Duration of Equity
Date
Up 200 Basis Points
Base
Down 200 Basis Points
09/30/2014
1.3
-0.7
1.4
06/30/2014
2.3
-0.2
1.3
03/31/2014
2.7
0.1
0.4
12/31/2013
2.1
-0.2
0.3
09/30/2013
2.0
-1.8
-0.9

The DOE as of September 30, 2014 decreased in the base and up 200 basis point shock scenarios and increased slightly in the down 200 basis point shock scenario from June 30, 2014. The primary factors contributing to these changes in duration during the period were: (1) the general decline of longer term interest rates and the relative level of mortgage rates during the period; (2) the increase in the fixed rate mortgage loan portfolio during the period along with the reduced weighting of the portfolio as a percent of total assets with the growth in the balance sheet and overall increase in capital levels as advance balances increased significantly; and (3) asset/liability actions taken by management throughout the period, including the continued call and re-issuance of long-term, unswapped callable consolidated obligation bonds with short lock-out periods and the issuance of discount notes funding the growth in advances.

The decrease in longer-term interest rates during the second quarter of 2014 generally resulted in a shortening duration profile for both the fixed rate mortgage loan portfolio and the associated unswapped callable consolidated obligation bonds funding these assets. With the increase in our mortgage loan portfolio during the period, as discussed in Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – MPF Program,” the portfolio level duration profile changed as expected since a general decrease in interest rates typically generates faster prepayments for both new production mortgage loans, as well as the outstanding fixed rate mortgage loan portfolio. Generally, lower interest rates indicate a relative increase in refinancing incentive for borrowers.

Even though the fixed rate mortgage loan portfolio increased in net outstanding balance during the period, the portfolio actually decreased as an overall percentage of assets as the balance sheet expanded, decreasing from 18.3 percent of total assets as of June 30, 2014 to 16.0 percent as of September 30, 2014. Even with this weighting decrease, the mortgage loan portfolio continues to represent a sizable portion of the balance sheet and changes occurring with this portfolio tend to be magnified in terms of DOE. Since the mortgage loan portfolio continues to comprise a considerable percentage of overall assets and has such a high duration relative to other FHLBank assets, its behavior is quite visible in the duration risk profile and changes in this portfolio are typically magnified as the composition of assets change. This magnification occurs when a portfolio market value weighting as a percent of the overall net market value of the balance sheet changes, causing the remaining portfolios to be a smaller or larger component of the total balance sheet composition. For example, during the third quarter of 2014, advance balances increased significantly causing the mortgage loan portfolio weighting to decrease as a total proportion of total assets. This relationship then causes the duration of the mortgage loan portfolio to have a smaller contribution impact to the overall DOE since DOE is a market value weighted measurement and as the capital level increased in response to the growth in advances, the contribution of the mortgage portfolio also declined. Although there was an absolute growth in the mortgage loan portfolio during the period, the mortgage loan portfolio became a smaller percentage of the balance sheet, reducing the mortgage loan portfolio's overall contribution to DOE. However, as stated previously, the mortgage loan portfolio continues to remain a significant portion of the balance sheet and changes in the duration and weighting of the portfolio continues to be a large contributor to the overall DOE profile. With these balance sheet dynamics, we continue to actively manage and monitor the contributing factors of our risk profile, including DOE. As the relationship of the fixed rate mortgage loan assets and the associated callable liabilities vary based on market conditions, we evaluate and manage these market driven sensitivities as both portfolios change in balance level and overall proportion.


92


New loans were continually added to the mortgage loan portfolio to replace loans that were prepaid during the period and we continue to actively manage this ongoing growth to position the balance sheet sensitivity to perform within our expected risk tolerances. To effectively manage these changes in the mortgage loan portfolio (including new production loans) and related sensitivity to changes in market conditions, a continued issuance of unswapped callable consolidated obligation bonds with short lock-out periods (generally three months) positioned us to replace called bonds as the interest rate environment continued to remain at historically low levels. The call of higher rate callable bonds and reissuance of these bonds at lower interest rates in this manner generally extends the duration profile of this portfolio as bonds are called that are in-the-money (above market rates) and subsequently reissued at lower interest rates (at market rates). This liability extension corresponds with the expected longer duration profile of the new fixed rate mortgage loans, all else being equal.

As discussed above, as longer term interest rates decreased during the period and as we continued to experience measured prepayments of the fixed rate mortgage loan portfolio, the short lock-out periods of the callable bonds plus some maturities of non-callable bonds provided the opportunity to continue the refinancing of our liabilities. The decrease in longer term interest rates during the period also caused the duration profile of the existing portfolio of unswapped callable bonds to shorten. This liability shortening demonstrates the specific duration sensitivity to changes in interest rates at certain shock scenarios. In addition, issuance of discount notes continued, and actually increased, in response to the growth in advances and in order to provide adequate liquidity sources to appropriately address customer short-term advance growth and associated capital stock activity during the period. The combination of these factors contributed to the net DOE decrease in the base and up 200 basis point shock scenarios and the slight increase in DOE in the down 200 basis point shock scenario.

With respect to the Agency variable rate MBS/CMO portfolio, we generally purchase interest rate caps to offset the impact of embedded caps in this portfolio in rising interest rate scenarios. As expected, these interest rate caps are a satisfactory interest rate risk hedge to rising interest rates and provide an off-setting risk response to the risk profile changes in Agency variable rate CMOs with embedded caps. We periodically assess derivative strategies to ensure that overall balance sheet risk is appropriately hedged within established risk appetite and make adjustments to the derivative portfolio as needed. This evaluation is completed considering not only the par value of the variable rate MBS/CMO investments with embedded caps being hedged with purchased caps, but the composition of the purchased cap portfolio and expected prepayments of the variable rate MBS/CMO investments with embedded caps. This evaluation of the relative relationship between the variable rate investment portfolio and the purchased cap portfolio continues to indicate a sufficient hedging relationship. We did not purchase Agency variable rate MBS/CMO securities or additional interest rate caps during the third quarter of 2014.

In calculating DOE, we also calculate our duration gap, which is the difference between the duration of our assets and the duration of our liabilities. Our base duration gap was -0.4 month and -0.1 month for September 30, 2014 and June 30, 2014, respectively. As discussed previously, the relatively stable performance of the duration gap was primarily the result of the changes in the fixed rate mortgage loan portfolio and the associated funding decisions made by management in response to changes in the interest rate environment and balance sheet during the third quarter of 2014. 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.

Market Value of Equity: MVE is the net value of our assets and liabilities. Estimating sensitivity of MVE to changes in interest rates is another measure of interest rate risk. We generally maintain a MVE within limits specified by the Board of Directors in the RMP. The RMP measures our market value risk in terms of the MVE in relation to total regulatory capital stock outstanding (TRCS). TRCS includes all capital stock outstanding, including stock subject to mandatory redemption. As a cooperative, we believe using the TRCS results in an appropriate measure because it reflects our market value relative to the book value of our capital stock. Our RMP stipulates MVE shall not be less than: (1) 90 percent of TRCS under the base case scenario; or (2) 85 percent of TRCS under a ±200 basis point instantaneous parallel shock in interest rates. Table 37 presents MVE as a percent of TRCS. As of September 30, 2014, all scenarios are well above the specified limits and much of the relative level in the ratios during the periods covered by the table can be attributed to the relative level of the fixed rate mortgage loan market values as rates have continued to remain historically low, the general value impact of the refinancing activities of the associated unswapped callable consolidated obligation bonds and the relative level of outstanding capital. The MVE to TRCS ratios can be greatly impacted by the level of capital outstanding based on our capital management approach. We lowered our AMA capital stock requirement during the third quarter of 2013 and exercised significant repurchases of excess capital stock following this change and these actions inherently increased our ratio of MVE to TRCS as the capital level declined. However, during the third quarter of 2014, as advance balances increased and the associated capital levels increased in response, the ratio declined since the new advances were primarily short-term with market values at or near par. The impact of the changing capital levels continues to be a significant contributor of the recent changes in the ratios and specifically in the decrease of the MVE to TRCS ratio from June 30, 2014 to September 30, 2014 in all interest rate scenarios in the table below.


93


Table 37
Market Value of Equity as a Percent of Total Regulatory Capital Stock
Date
Up 200 Basis Points
Base
Down 200 Basis Points
09/30/2014
181
180
188
06/30/2014
200
199
210
03/31/2014
166
171
178
12/31/2013
165
169
172
09/30/2013
163
165
162

Detail of Derivative Instruments by Type of Instrument by Type of Risk: Various types of derivative instruments are utilized to mitigate the interest rate risks described in the preceding sections as well as to better match the terms of assets and liabilities. We currently employ 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 either does not qualify for hedge accounting, or for which we have not elected hedge accounting, but is an acceptable hedging strategy under our RMP. For hedging relationships that are not designated for shortcut hedge accounting, we formally assess (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. We typically use regression analyses or similar statistical analyses to assess the effectiveness of our long haul hedges. We determine 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.

Tables 38 and 39 present the notional amount and fair value amount (fair value includes net accrued interest receivable or payable on the derivative) for derivative instruments by hedged item, hedging instrument, hedging objective and accounting designation (in thousands):


94


Table 38
09/30/2014
Hedged Item
Hedging Instrument
Hedging Objective
Accounting Designation
Notional Amount
Fair Value Amount
Advances
 
 
 
 
 
Fixed rate non-callable advances
Pay fixed, receive variable interest rate swap
Convert the advance’s fixed rate to a variable rate index
Fair Value Hedge 
$
3,254,114

$
(78,392
)
Fixed rate callable advances
Pay fixed, receive variable interest rate swap
Convert the advance’s fixed rate to a variable rate index and offset option risk in the advance
Fair Value Hedge 
76,000

329

Fixed rate convertible advances
Pay fixed, receive variable interest rate swap
Convert the advance’s fixed rate to a variable rate index and offset option risk in the advance
Fair Value Hedge 
1,654,242

(101,246
)
Variable rate advances with embedded caps clearly and closely related
Interest rate cap
Offset the interest rate cap embedded in a variable rate advance
Fair Value Hedge 
247,000

(1,366
)
Firm commitment to issue a fixed rate advance
Forward settling interest rate swap
Protect against fair value risk
Fair Value Hedge
24,796

230

Investments
 
 
 
 
 
Fixed rate non-MBS trading investments
Pay fixed, receive variable interest rate swap
Convert the investment’s fixed rate to a variable rate index
Economic Hedge 
961,820

(80,706
)
Adjustable rate MBS with embedded caps
Interest rate cap
Offset the interest rate cap embedded in a variable rate investment
Economic Hedge 
4,159,800

17,146

Mortgage Loans Held for Portfolio
 
 
 
 
 
Fixed rate mortgage purchase commitments
Mortgage purchase commitment
Protect against fair value risk
Economic Hedge 
64,698

32

Consolidated Obligation Bonds
 
 
 
 
 
Fixed rate non-callable consolidated obligation bonds
Receive fixed, pay variable interest rate swap
Convert the bond’s fixed rate to a variable rate index
Fair Value Hedge 
2,202,000

82,465

Fixed rate callable consolidated obligation bonds
Receive fixed, pay variable interest rate swap
Convert the bond’s fixed rate to a variable rate index and offset option risk in the bond
Fair Value Hedge 
1,040,000

6,584

Complex consolidated obligation bonds
Receive variable with embedded features, pay variable interest rate swap
Reduce interest rate sensitivity and re-pricing gaps by converting the bond’s variable rate to a different variable rate index and/or to offset embedded options risk in the bond
Fair Value Hedge
120,000

(2,305
)
Callable step-up/step-down consolidated obligation bonds
Receive variable interest rate with embedded features, pay variable interest rate swap
Reduce interest rate sensitivity and repricing gaps by converting the bond’s variable rate to a different variable rate index and/or to offset embedded options risk in the bond
Fair Value Hedge 
2,720,000

(23,036
)
Variable rate consolidated obligation bonds
Receive variable interest rate, pay variable interest rate swap
Reduce basis risk by converting an undesirable variable rate index in the bond to a more desirable variable rate index
Economic Hedge 
1,655,000

545

Intermediary Derivatives
 
 
 
 
 
Interest rate caps executed with members
Interest rate cap
Offset interest rate caps executed with members by executing interest rate caps with derivatives counterparties
Economic Hedge 
46,000


TOTAL
 
 
 
$
18,225,470

$
(179,720
)


95


Table 39
12/31/2013
Hedged Item
Hedging Instrument
Hedging Objective
Accounting Designation
Notional Amount
Fair Value Amount
Advances
 
 
 
 
 
Fixed rate non-callable advances
Pay fixed, receive variable interest rate swap
Convert the advance’s fixed rate to a variable rate index
Fair Value Hedge 
$
3,268,989

$
(113,832
)
Fixed rate callable advances
Pay fixed, receive variable interest rate swap
Convert the advance’s fixed rate to a variable rate index and offset option risk in the advance
Fair Value Hedge 
76,000

1,660

Fixed rate convertible advances
Pay fixed, receive variable interest rate swap
Convert the advance’s fixed rate to a variable rate index and offset option risk in the advance
Fair Value Hedge 
1,683,242

(137,562
)
Variable rate advances with embedded caps clearly and closely related
Interest rate cap
Offset the interest rate cap embedded in a variable rate advance
Fair Value Hedge 
247,000

(2,648
)
Firm commitment to issue a fixed rate advance
Forward settling interest rate swap
Protect against fair value risk
Fair Value Hedge
6,000

120

Investments
 
 
 
 
 
Fixed rate non-MBS trading investments
Pay fixed, receive variable interest rate swap
Convert the investment’s fixed rate to a variable rate index
Economic Hedge 
1,061,820

(115,098
)
Adjustable rate MBS with embedded caps
Interest rate cap
Offset the interest rate cap embedded in a variable rate investment
Economic Hedge 
4,511,800

40,861

Fixed rate private-label MBS/ABS
Interest rate floor
Limit DOE risk from MBS/ABS prepayments in a declining interest rate environment
Economic Hedge 
50,000

499

Mortgage Loans Held for Portfolio
 
 
 
 
 
Fixed rate mortgage purchase commitments
Mortgage purchase commitment
Protect against fair value risk
Economic Hedge 
65,620

(265
)
Consolidated Obligation Bonds
 
 
 
 
 
Fixed rate non-callable consolidated obligation bonds
Receive fixed, pay variable interest rate swap
Convert the bond’s fixed rate to a variable rate index
Fair Value Hedge 
2,286,000

104,904

Fixed rate callable consolidated obligation bonds
Receive fixed, pay variable interest rate swap
Convert the bond’s fixed rate to a variable rate index and offset option risk in the bond
Fair Value Hedge 
655,000

3,251

Complex consolidated obligation bonds
Receive variable with embedded features, pay variable interest rate swap
Reduce interest rate sensitivity and re-pricing gaps by converting the bond’s variable rate to a different variable rate index and/or to offset embedded options risk in the bond
Fair Value Hedge
90,000

(4,900
)
Callable step-up/step-down consolidated obligation bonds
Receive variable interest rate with embedded features, pay variable interest rate swap
Reduce interest rate sensitivity and repricing gaps by converting the bond’s variable rate to a different variable rate index and/or to offset embedded options risk in the bond
Fair Value Hedge 
2,220,000

(73,705
)
Variable rate consolidated obligation bonds
Receive variable interest rate, pay variable interest rate swap
Reduce basis risk by converting an undesirable variable rate index in the bond to a more desirable variable rate index
Economic Hedge 
2,630,000

(808
)
Intermediary Derivatives
 
 
 
 
 
Interest rate caps executed with members
Interest rate cap
Offset interest rate caps executed with members by executing interest rate caps with derivatives counterparties
Economic Hedge 
66,000


TOTAL
 
 
 
$
18,917,471

$
(297,523
)


96


Item 4: Controls and Procedures

Disclosure Controls and Procedures
Senior management is responsible for establishing and maintaining a system of disclosure controls and procedures designed to ensure that information required to be disclosed in the reports filed or submitted under the Securities Exchange Act of 1934, as amended (Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our 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. Our disclosure controls and procedures are designed to provide a reasonable level of assurance in achieving their desired objectives; however, in designing and evaluating our disclosure controls and procedures, 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 evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-(e) under the Exchange Act) with the participation of the President and Chief Executive Officer (CEO), our principal executive officer, and Chief Accounting Officer (CAO), our principal financial officer, as of September 30, 2014. Based upon that evaluation, the CEO and CAO have concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2014.

Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fiscal quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


Part II. OTHER INFORMATION

Item 1: Legal Proceedings
We are 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 our financial condition or results of operations. Additionally, management does not believe that we are subject to any material pending legal proceedings outside of ordinary litigation incidental to our business.

Item 1A: Risk Factors
There have been no material changes to the risk factors previously disclosed in our annual report on Form 10-K filed on March 14, 2014, incorporated by reference herein.

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.

Item 3: Defaults Upon Senior Securities
Not applicable.

Item 4: Mine Safety Disclosures
Not applicable.

Item 5: Other Information
None.


97


Item 6: Exhibits
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 September 26, 2014, Amended and Restated Bylaws, is incorporated herein by reference as Exhibit 3.2.
4.1
Exhibit 99.2 to the Current Report on Form 8-K, filed August 5, 2011, Federal Home Loan Bank of Topeka Capital Plan, is incorporated herein by reference as Exhibit 4.1.
31.1
Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Senior Vice President and Chief Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32
Certification of President and Chief Executive Officer and Senior Vice President and Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document


98


SIGNATURES

Pursuant to the requirements 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
 
 
 
 
November 6, 2014
By: /s/ Andrew J. Jetter
Date
Andrew J. Jetter
 
President and Chief Executive Officer
 
 
November 6, 2014
By: /s/ Denise L. Cauthon
Date
Denise L. Cauthon
 
Senior Vice President and Chief Accounting Officer
 
(Principal Financial Officer and Principal Accounting Officer)


99