10-Q 1 fhlbcinq2201310-q.htm FORM 10-Q FHLB Cin Q2 2013 10-Q

 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 June 30, 2013
or
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Commission File No. 000-51399
FEDERAL HOME LOAN BANK OF CINCINNATI
(Exact name of registrant as specified in its charter)
Federally chartered corporation 
 
31-6000228
(State or other jurisdiction of
incorporation or organization) 
 
(I.R.S. Employer
Identification No.)
1000 Atrium Two, P.O. Box 598,
 
 
Cincinnati, Ohio 
 
45201-0598
(Address of principal executive offices) 
 
(Zip Code)
(513) 852-7500
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    
x Yes   o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes   o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes   x No

As of July 31, 2013, the registrant had 48,198,790 shares of capital stock outstanding, which included stock classified as mandatorily redeemable. The capital stock of the registrant is not listed on any securities exchange or quoted on any automated quotation system, only may be owned by members and former members and is transferable only at its par value of $100 per share.


Page 1







Table of Contents
 
PART I - FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements (Unaudited):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
PART II - OTHER INFORMATION
 
 
 
Item 1A.
 
 
 
Item 6.
 
 
 
 

2

PART I – FINANCIAL INFORMATION
Item 1.     Financial Statements
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CONDITION
(In thousands, except par value)
(Unaudited)
 
June 30, 2013
 
December 31, 2012
ASSETS
 
 
 
Cash and due from banks
$
22,616

 
$
16,423

Interest-bearing deposits
106

 
151

Securities purchased under agreements to resell
1,450,000

 
3,800,000

Federal funds sold
5,650,000

 
3,350,000

Investment securities:
 
 
 
Trading securities
1,746

 
1,922

Available-for-sale securities
1,025,005

 
—

Held-to-maturity securities (includes $0 and $0 pledged as collateral at June 30, 2013 and December 31, 2012, respectively, that may be repledged) (a)
14,973,839

 
12,798,448

Total investment securities
16,000,590

 
12,800,370

Advances
65,092,995

 
53,943,961

Mortgage loans held for portfolio:
 
 
 
Mortgage loans held for portfolio
6,993,258

 
7,548,019

Less: allowance for credit losses on mortgage loans
9,176

 
17,907

Mortgage loans held for portfolio, net
6,984,082

 
7,530,112

Accrued interest receivable
84,717

 
83,904

Premises, software, and equipment, net
9,729

 
9,143

Derivative assets
4,232

 
5,877

Other assets
20,529

 
22,209

TOTAL ASSETS
$
95,319,596

 
$
81,562,150

LIABILITIES
 
 
 
Deposits:
 
 
 
Interest bearing
$
1,021,655

 
$
1,158,252

Non-interest bearing
19,082

 
18,353

Total deposits
1,040,737

 
1,176,605

Consolidated Obligations, net:
 
 
 
Discount Notes
38,926,196

 
30,840,224

Bonds (includes $100,109 and $3,402,366 at fair value under fair value option at June 30, 2013 and December 31, 2012, respectively)
49,520,641

 
44,345,917

Total Consolidated Obligations, net
88,446,837

 
75,186,141

Mandatorily redeemable capital stock
125,000

 
210,828

Accrued interest payable
106,387

 
106,885

Affordable Housing Program payable
89,643

 
82,672

Derivative liabilities
98,238

 
114,888

Other liabilities
151,611

 
147,362

Total liabilities
90,058,453

 
77,025,381

Commitments and contingencies

 

CAPITAL
 
 
 
Capital stock Class B putable ($100 par value); issued and outstanding shares: 46,904 shares at June 30, 2013 and 40,106 shares at December 31, 2012
4,690,425

 
4,010,622

Retained earnings:
 
 
 
Unrestricted
497,809

 
479,253

Restricted
83,706

 
58,628

Total retained earnings
581,515

 
537,881

Accumulated other comprehensive loss
(10,797
)
 
(11,734
)
Total capital
5,261,143

 
4,536,769

TOTAL LIABILITIES AND CAPITAL
$
95,319,596

 
$
81,562,150

(a)
Fair values: $15,019,950 and $13,177,117 at June 30, 2013 and December 31, 2012, respectively.

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

3

FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF INCOME
(In thousands)
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
INTEREST INCOME:
 
 
 
 
 
 
 
Advances
$
77,694

 
$
57,914

 
$
148,646

 
$
117,903

Prepayment fees on Advances, net
774

 
1,658

 
1,226

 
5,077

Interest-bearing deposits
55

 
165

 
129

 
292

Securities purchased under agreements to resell
464

 
1,085

 
1,323

 
1,799

Federal funds sold
1,570

 
1,523

 
3,571

 
2,322

Trading securities
9

 
11,856

 
17

 
21,831

Available-for-sale securities
516

 
1,010

 
546

 
2,605

Held-to-maturity securities
74,871

 
67,017

 
144,497

 
148,254

Mortgage loans held for portfolio
67,695

 
69,228

 
140,903

 
157,825

Loans to other FHLBanks
1

 
—

 
4

 
1

Total interest income
223,649

 
211,456

 
440,862

 
457,909

INTEREST EXPENSE:
 
 
 
 
 
 
 
Consolidated Obligations - Discount Notes
10,382

 
6,949

 
20,508

 
10,876

Consolidated Obligations - Bonds
132,649

 
149,328

 
262,465

 
307,164

Deposits
88

 
94

 
174

 
180

Loans from other FHLBanks
—

 
—

 
5

 
—

Mandatorily redeemable capital stock
1,417

 
2,658

 
3,040

 
6,134

Other borrowings
—

 
—

 
—

 
1

Total interest expense
144,536

 
159,029

 
286,192

 
324,355

NET INTEREST INCOME
79,113

 
52,427

 
154,670

 
133,554

(Reversal) provision for credit losses
(4,000
)
 
—

 
(6,500
)
 
1,410

NET INTEREST INCOME AFTER (REVERSAL) PROVISION FOR CREDIT LOSSES
83,113

 
52,427

 
161,170

 
132,144

OTHER NON-INTEREST INCOME:
 
 
 
 
 
 
 
Net losses on trading securities
(5
)
 
(11,338
)
 
(4
)
 
(20,218
)
Net realized gains from sale of held-to-maturity securities
—

 
29,292

 
—

 
29,292

Net gains (losses) on Consolidated Obligation Bonds held under fair value option
355

 
(186
)
 
887

 
2,435

Net (losses) gains on derivatives and hedging activities
(1,457
)
 
3,186

 
2,888

 
6,940

Other, net
2,575

 
1,220

 
5,402

 
3,058

Total other non-interest income
1,468

 
22,174

 
9,173

 
21,507

OTHER EXPENSE:
 
 
 
 
 
 
 
Compensation and benefits
7,826

 
7,558

 
16,193

 
15,949

Other operating
4,216

 
3,383

 
8,200

 
6,920

Finance Agency
1,088

 
1,444

 
2,176

 
3,148

Office of Finance
1,122

 
856

 
2,211

 
1,672

Other
1,416

 
484

 
1,903

 
597

Total other expense
15,668

 
13,725

 
30,683

 
28,286

INCOME BEFORE ASSESSMENTS
68,913

 
60,876

 
139,660

 
125,365

Affordable Housing Program assessments
7,033

 
6,354

 
14,270

 
13,150

NET INCOME
$
61,880

 
$
54,522

 
$
125,390

 
$
112,215


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

4

FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Net income
$
61,880

 
$
54,522

 
$
125,390

 
$
112,215

Other comprehensive income adjustments:
 
 
 
 
 
 
 
Net unrealized (losses) gains on available-for-sale securities
(39
)
 
10

 
5

 
1,068

Pension and postretirement benefits
482

 
343

 
932

 
685

Total other comprehensive income adjustments
443

 
353

 
937

 
1,753

Total comprehensive income
$
62,323

 
$
54,875

 
$
126,327

 
$
113,968


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


5

FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CAPITAL
(In thousands)
(Unaudited)
 
Capital Stock
Class B - Putable
 
Retained Earnings
 
 
 
 
 
Shares
 
Par Value
 
Unrestricted
Restricted
Total
 
Accumulated Other Comprehensive
Loss
 
Total
Capital
BALANCE, DECEMBER 31, 2011
31,259

 
$
3,125,895

 
$
432,530

$
11,683

$
444,213

 
$
(11,001
)
 
$
3,559,107

Proceeds from sale of capital stock
1,497

 
149,726

 
 
 
 
 
 
 
149,726

Net shares reclassified to mandatorily
   redeemable capital stock
(169
)
 
(16,918
)
 
 
 
 
 
 
 
(16,918
)
Comprehensive income
 
 
 
 
89,772

22,443

112,215

 
1,753

 
113,968

Dividends on capital stock:
 
 
 
 
 
 
 
 
 
 
 

Cash
 
 
 
 
(68,253
)
 
(68,253
)
 
 
 
(68,253
)
BALANCE, JUNE 30, 2012
32,587

 
$
3,258,703

 
$
454,049

$
34,126

$
488,175

 
$
(9,248
)
 
$
3,737,630

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2012
40,106

 
$
4,010,622

 
$
479,253

$
58,628

$
537,881

 
$
(11,734
)
 
$
4,536,769

Proceeds from sale of capital stock
6,984

 
698,395

 
 
 
 
 
 
 
698,395

Net shares reclassified to mandatorily
   redeemable capital stock
(186
)
 
(18,592
)
 
 
 
 
 
 
 
(18,592
)
Comprehensive income
 
 
 
 
100,312

25,078

125,390

 
937

 
126,327

Dividends on capital stock:
 
 
 
 
 
 
 
 
 
 
 
Cash
 
 
 
 
(81,756
)
 
(81,756
)
 
 
 
(81,756
)
BALANCE, JUNE 30, 2013
46,904

 
$
4,690,425

 
$
497,809

$
83,706

$
581,515

 
$
(10,797
)
 
$
5,261,143




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


6

FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended June 30,
 
2013
 
2012
OPERATING ACTIVITIES:
 
 
 
Net income
$
125,390

 
$
112,215

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
3,567

 
38,192

Change in net fair value adjustment on derivative and hedging activities
21,069

 
64,394

Net change in fair value adjustments on trading securities
4

 
20,218

Net change in fair value adjustments on Consolidated Obligation Bonds held at fair value
(887
)
 
(2,435
)
Other adjustments
(6,503
)
 
(27,876
)
Net change in:
 
 
 
Accrued interest receivable
(786
)
 
6,495

Other assets
1,352

 
2,497

Accrued interest payable
(1,869
)
 
(18,265
)
Other liabilities
11,400

 
24,769

Total adjustments
27,347

 
107,989

Net cash provided by operating activities
152,737

 
220,204

 
 
 
 
INVESTING ACTIVITIES:
 
 
 
Net change in:
 
 
 
Interest-bearing deposits
80,227

 
109,321

Securities purchased under agreements to resell
2,350,000

 
(3,200,000
)
Federal funds sold
(2,300,000
)
 
(1,440,000
)
Premises, software, and equipment
(1,743
)
 
(731
)
Trading securities:
 
 
 
Net increase in short-term
—

 
(87,759
)
Proceeds from maturities of long-term
173

 
100

Available-for-sale securities:
 
 
 
Net (increase) decrease in short-term
(1,025,000
)
 
3,372,157

Held-to-maturity securities:
 
 
 
Net decrease (increase) in short-term
652

 
(461,688
)
Proceeds from maturities of long-term
1,510,639

 
1,646,060

Proceeds from sale of long-term
—

 
507,531

Purchases of long-term
(3,689,311
)
 
(1,816,045
)
Advances:
 
 
 
Proceeds
389,673,082

 
387,176,107

Made
(400,923,970
)
 
(393,937,633
)
Mortgage loans held for portfolio:
 
 
 
Principal collected
1,204,634

 
1,238,201

Purchases
(669,177
)
 
(1,499,639
)
Net cash used in investing activities
(13,789,794
)
 
(8,394,018
)
 
 
 
 
 
 
 
 
 
 
 
 
The accompanying notes are an integral part of these financial statements.
 
 
 
 
 
 
 

7

 
 
 
 
(continued from previous page)
 
 
 
FEDERAL HOME LOAN BANK OF CINCINNATI
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended June 30,
 
2013
 
2012
FINANCING ACTIVITIES:
 
 
 
Net (decrease) increase in deposits and pass-through reserves
$
(138,723
)
 
$
79,243

Net payments on derivative contracts with financing elements
(20,664
)
 
(85,708
)
Net proceeds from issuance of Consolidated Obligations:
 
 
 
Discount Notes
91,030,553

 
125,661,201

Bonds
15,352,722

 
10,039,223

Payments for maturing and retiring Consolidated Obligations:
 
 
 
Discount Notes
(82,948,438
)
 
(121,260,639
)
Bonds
(10,144,419
)
 
(7,568,185
)
Proceeds from issuance of capital stock
698,395

 
149,726

Payments for redemption of mandatorily redeemable capital stock
(104,420
)
 
(27,004
)
Cash dividends paid
(81,756
)
 
(68,253
)
Net cash provided by financing activities
13,643,250

 
6,919,604

Net increase (decrease) in cash and cash equivalents
6,193

 
(1,254,210
)
Cash and cash equivalents at beginning of the period
16,423

 
2,033,944

Cash and cash equivalents at end of the period
$
22,616

 
$
779,734

Supplemental Disclosures:
 
 
 
Interest paid
$
293,986

 
$
344,096

AHP payments, net
$
7,299

 
$
7,552


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


8

FEDERAL HOME LOAN BANK OF CINCINNATI

NOTES TO UNAUDITED FINANCIAL STATEMENTS


Background Information    

The Federal Home Loan Bank of Cincinnati (the FHLBank), a federally chartered corporation, is one of 12 District Federal Home Loan Banks (FHLBanks). The FHLBanks serve the public by enhancing the availability of credit for residential mortgages and targeted community development. The FHLBank is regulated by the Federal Housing Finance Agency (Finance Agency).


Note 1 - Basis of Presentation

The accompanying interim financial statements of the FHLBank have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of financial statements in accordance with GAAP requires management to make assumptions and estimates. These assumptions and estimates affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. Actual results could differ from these estimates. The interim financial statements presented are unaudited, but they include all adjustments (consisting of only normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the financial condition, results of operations, and cash flows for such periods. These financial statements do not include all disclosures associated with annual financial statements and accordingly should be read in conjunction with the audited financial statements and notes included in the FHLBank's annual report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission (SEC). Results for the three and six months ended June 30, 2013 are not necessarily indicative of operating results for the full year.

The FHLBank has certain financial instruments, including derivative instruments and securities purchased under agreements to resell, that are subject to enforceable master netting arrangements or similar agreements. The FHLBank has elected to offset its derivative asset and liability positions, as well as cash collateral received or pledged, when it has the legal right of offset under these master agreements. The FHLBank did not have any offsetting liabilities related to its securities purchased under agreements to resell for the periods presented.

The net exposure for these financial instruments can change on a daily basis; therefore, there may be a delay between the time this exposure change is identified and additional collateral is requested, and the time this collateral is received or pledged. Likewise, there may be a delay for excess collateral to be returned. For derivative instruments, any excess cash collateral received or pledged is recognized as a derivative liability or derivative asset based on the terms of the individual master agreement between the FHLBank and its derivative counterparty. Additional information regarding these agreements is provided in Note 10. Based on the fair value of the related collateral held, the securities purchased under agreements to resell were fully collateralized for the periods presented. For more information about the FHLBank's investments in securities purchased under agreements to resell, see “Item 8. Financial Statements and Supplementary Data - Note 1 - Summary of Significant Accounting Policies” in the FHLBank's 2012 Form 10-K.

The FHLBank has evaluated subsequent events for potential recognition or disclosure through the issuance of these financial statements and believes there have been no material subsequent events requiring additional disclosure or recognition in these financial statements.


Note 2 - Recently Issued Accounting Standards and Interpretations

Inclusion of the Overnight Index Swap Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. On July 17, 2013, the Financial Accounting Standards Board (FASB) amended existing guidance to include the Fed Funds Effective Swap Rate (also referred to as Overnight Index Swap Rate (OIS)) as a U.S. benchmark interest rate for hedge accounting purposes. The amendments also remove the restriction on using different benchmark interest rates for similar hedges. The amendments apply to all entities that elect to apply hedge accounting of the benchmark interest rate, and are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The FHLBank is currently in the process of evaluating the potential effects this guidance may have on its respective hedging strategies


9

Joint and Several Liability Arrangements. On February 28, 2013, the FASB issued guidance for 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. This guidance is effective for interim and annual periods beginning on or after December 15, 2013 and should be applied retrospectively. This guidance will have no effect on the FHLBank's financial condition, results of operations, or cash flows.

Presentation of Comprehensive Income. On February 5, 2013, the FASB issued guidance to improve the transparency of reporting reclassifications out of accumulated other comprehensive income. This guidance requires the FHLBank to present, either on the face of the financial statement where net income is presented or in the footnotes, significant amounts reclassified out of accumulated other comprehensive income by component. These amounts would be presented only if the amount is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, the FHLBank is required to cross-reference to other required disclosures that provide additional detail about these other amounts. This guidance became effective for the FHLBank for interim and annual periods beginning on January 1, 2013 and was applied prospectively. The adoption of this guidance resulted in additional financial statement disclosures, and did not affect the FHLBank's financial condition, results of operations, or cash flows.

Disclosures about Offsetting Assets and Liabilities. On December 16, 2011, the FASB and the International Accounting Standards Board issued common disclosure requirements intended to help investors and other financial statement users better assess the effect or potential effect of offsetting arrangements on a company's financial position, whether a company's financial statements are prepared on the basis of GAAP or International Financial Reporting Standards. This guidance was amended on January 31, 2013 by the FASB to clarify that its scope includes only certain financial instruments that are either offset on the balance sheet or are subject to an enforceable master netting arrangement or similar agreement. The FHLBank is required to disclose both gross and net information about derivative, repurchase and security lending instruments that meet these criteria. This guidance, as amended, became effective for interim and annual periods beginning on January 1, 2013 and was applied retrospectively for all comparative periods presented. The adoption of this guidance resulted in additional financial statement disclosures, and did not affect the FHLBank's financial condition, results of operations, or cash flows.

Framework for Adversely Classifying Loans, Other Real Estate Owned, and Other Assets and Listing Assets for Special Mention. On April 9, 2012, the Finance Agency issued an advisory bulletin that establishes a standard and uniform methodology for adverse classification and identification of special mention assets and off-balance sheet credit exposures at the FHLBanks, excluding investment securities. The adverse classification requirements should be implemented by January 1, 2014, and the charge-off requirements should be implemented no later than January 1, 2015. The FHLBank is currently assessing the provisions of this advisory bulletin and has not yet determined the effect, if any, that this guidance will have on the FHLBank's financial condition, results of operations, or cash flows.


Note 3 - Trading Securities

Table 3.1 - Trading Securities by Major Security Types (in thousands)        
 
June 30, 2013
 
December 31, 2012
 
Fair Value
 
Fair Value
Mortgage-backed securities:
 
 
 
Other U.S. obligation residential mortgage-backed securities (1)
$
1,746

 
$
1,922

Total
$
1,746

 
$
1,922

 
(1)
Consists of Government National Mortgage Association (Ginnie Mae) mortgage-backed securities.


10

Table 3.2 - Net Losses on Trading Securities (in thousands)
 
Six Months Ended June 30,
 
2013
 
2012
Net losses on trading securities held at period end
$
(4
)
 
$
(18,164
)
Net losses on securities matured during the period
—

 
(2,054
)
Net losses on trading securities
$
(4
)
 
$
(20,218
)


Note 4 - Available-for-Sale Securities

Table 4.1 - Available-for-Sale Securities by Major Security Types (in thousands)
 
June 30, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Fair
Value
Certificates of deposit
$
1,025,000

 
$
5

 
$
—

 
$
1,025,005

Total
$
1,025,000

 
$
5

 
$
—

 
$
1,025,005


There were no available-for-sale securities outstanding as of December 31, 2012.

Table 4.2 - Available-for-Sale Securities by Contractual Maturity (in thousands)
 
June 30, 2013
Year of Maturity
Amortized
Cost
 
Fair
Value
Due in one year or less
$
1,025,000

 
$
1,025,005


Table 4.3 - Interest Rate Payment Terms of Available-for-Sale Securities (in thousands)
 
June 30, 2013
Amortized cost of available-for-sale securities:
 
Fixed-rate
$
1,025,000


Realized Gains and Losses. The FHLBank had no sales of securities out of its available-for-sale portfolio during the six months ended June 30, 2013 or 2012.

11


Note 5 - Held-to-Maturity Securities

Table 5.1 - Held-to-Maturity Securities by Major Security Types (in thousands)
 
June 30, 2013
 
Amortized Cost (1)
 
Gross Unrecognized Holding
Gains
 
Gross Unrecognized Holding (Losses)
 
Fair Value
Non-mortgage-backed securities:
 
 
 
 
 
 
 
GSE (2)
$
25,586

 
$
1

 
$
—

 
$
25,587

Total non-mortgage-backed securities
25,586

 
1

 
—

 
25,587

Mortgage-backed securities:
 
 
 
 
 
 
 
Other U.S. obligation residential
   mortgage-backed securities (3)
1,306,642

 
5,678

 
—

 
1,312,320

GSE residential mortgage-backed securities (4)
13,641,611

 
179,890

 
(139,458
)
 
13,682,043

Total mortgage-backed securities
14,948,253

 
185,568

 
(139,458
)
 
14,994,363

Total
$
14,973,839

 
$
185,569

 
$
(139,458
)
 
$
15,019,950

 
 
 
 
 
 
 
 
 
December 31, 2012
 
Amortized Cost (1)
 
Gross Unrecognized Holding
Gains
 
Gross Unrecognized Holding (Losses)
 
Fair Value
Non-mortgage-backed securities:
 
 
 
 
 
 
 
GSE (2)
$
26,238

 
$
2

 
$
—

 
$
26,240

Total non-mortgage-backed securities
26,238

 
2

 
—

 
26,240

Mortgage-backed securities:
 
 
 
 
 
 
 
Other U.S. obligation residential
   mortgage-backed securities (3)
1,410,720

 
4,320

 
—

 
1,415,040

GSE residential mortgage-backed securities (4)
11,361,490

 
375,372

 
(1,025
)
 
11,735,837

Total mortgage-backed securities
12,772,210

 
379,692

 
(1,025
)
 
13,150,877

Total
$
12,798,448

 
$
379,694

 
$
(1,025
)
 
$
13,177,117

 
(1)
Carrying value equals amortized cost.
(2)
Consists of debt securities issued and effectively guaranteed by Freddie Mac and/or Fannie Mae, which have the support of the U.S. government, although they are not obligations of the U.S. government.
(3)
Consists of mortgage-backed securities issued or guaranteed by the National Credit Union Administration (NCUA) and the U.S. government.
(4)
Consists of mortgage-backed securities issued and effectively guaranteed by Freddie Mac and/or Fannie Mae, which have the support of the U.S. government, although they are not obligations of the U.S. government.

Table 5.2 - Net Purchased (Discounts) Premiums Included in the Amortized Cost of Mortgage-backed Securities Classified as Held-to-Maturity (in thousands)
 
June 30, 2013
 
December 31, 2012
Premiums
$
36,578

 
$
41,808

Discounts
(38,186
)
 
(24,965
)
Net purchased (discounts) premiums
$
(1,608
)
 
$
16,843



12

Table 5.3 summarizes the held-to-maturity securities with unrealized losses, which are aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.

Table 5.3 - Held-to-Maturity Securities in a Continuous Unrealized Loss Position (in thousands)
 
June 30, 2013
 
Less than 12 Months
 
12 Months or more
 
Total
 
Fair Value
 
Gross Unrealized (Losses)
 
Fair Value
 
Gross Unrealized (Losses)
 
Fair Value
 
Gross Unrealized (Losses)
Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
GSE residential mortgage-backed securities (1)
$
6,493,311

 
$
(139,458
)
 
$
—

 
$
—

 
$
6,493,311

 
$
(139,458
)
Total
$
6,493,311

 
$
(139,458
)
 
$
—

 
$
—

 
$
6,493,311

 
$
(139,458
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2012
 
Less than 12 Months
 
12 Months or more
 
Total
 
Fair Value
 
Gross Unrealized (Losses)
 
Fair Value
 
Gross Unrealized (Losses)
 
Fair Value
 
Gross Unrealized (Losses)
Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
GSE residential mortgage-backed securities (1)
$
90,130

 
$
(1,025
)
 
$
—

 
$
—

 
$
90,130

 
$
(1,025
)
Total
$
90,130

 
$
(1,025
)
 
$
—

 
$
—

 
$
90,130

 
$
(1,025
)

(1)
Consists of mortgage-backed securities issued and effectively guaranteed by Freddie Mac and/or Fannie Mae, which have the support of the U.S. government, although they are not obligations of the U.S. government.

Table 5.4 - Held-to-Maturity Securities by Contractual Maturity (in thousands)
 
June 30, 2013
 
December 31, 2012
Year of Maturity
Amortized Cost (1)
 
Fair Value
 
Amortized Cost (1)
 
Fair Value
Non-mortgage-backed securities:
 
 
 
 
 
 
 
Due in 1 year or less
$
25,586

 
$
25,587

 
$
26,238

 
$
26,240

Due after 1 year through 5 years
—

 
—

 
—

 
—

Due after 5 years through 10 years
—

 
—

 
—

 
—

Due after 10 years
—

 
—

 
—

 
—

Total non-mortgage-backed securities
25,586

 
25,587

 
26,238

 
26,240

Mortgage-backed securities (2)
14,948,253

 
14,994,363

 
12,772,210

 
13,150,877

Total
$
14,973,839

 
$
15,019,950

 
$
12,798,448

 
$
13,177,117

(1)
Carrying value equals amortized cost.
(2)
Mortgage-backed securities are not presented by contractual maturity because their expected maturities will likely differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment fees.

Table 5.5 - Interest Rate Payment Terms of Held-to-Maturity Securities (in thousands)
 
June 30, 2013
 
December 31, 2012
Amortized cost of non-mortgage-backed securities:
 
 
 
Fixed-rate
$
25,586

 
$
26,238

Total amortized cost of non-mortgage-backed securities
25,586

 
26,238

Amortized cost of mortgage-backed securities:
 
 
 
Fixed-rate
11,895,074

 
9,509,167

Variable-rate
3,053,179

 
3,263,043

Total amortized cost of mortgage-backed securities
14,948,253

 
12,772,210

Total
$
14,973,839

 
$
12,798,448



13

Realized Gains and Losses. The FHLBank did not sell securities out of its held-to-maturity portfolio during the six months ended June 30, 2013. The FHLBank sold securities out of its held-to-maturity portfolio during the six months ended June 30, 2012, each of which had less than 15 percent of the acquired principal outstanding at the time of the sale. These sales are considered maturities for the purposes of security classification.

Table 5.6 - Proceeds and Gross Gains from Sale of Held-to-Maturity Securities (in thousands)
 
Six Months Ended June 30,
 
2013
 
2012
Proceeds from sale of held-to-maturity securities
$
—

 
$
507,531

Gross gains from sale of held-to-maturity securities
—

 
29,292



Note 6 - Other-Than-Temporary Impairment Analysis

The FHLBank evaluates its individual available-for-sale and held-to-maturity investment securities holdings in an unrealized loss position for other-than-temporary impairment on a quarterly basis. As part of its securities' evaluation for other-than-temporary impairment, the FHLBank considers its intent to sell each debt security and whether it is more likely than not that the FHLBank will be required to sell the security before its anticipated recovery. If either of these conditions is met, the FHLBank recognizes an other-than-temporary impairment in earnings equal to the entire difference between the security's amortized cost basis and its fair value at the balance sheet date. For securities in unrealized loss positions that meet neither of these conditions, the FHLBank performs analyses to determine if any of these securities are other-than-temporarily impaired.

For its other U.S. obligations and government-sponsored enterprise investments (mortgage-backed securities and non-mortgage-backed securities), the FHLBank determined that the strength of the issuers' guarantees through direct obligations or support from the U.S. government is sufficient to protect the FHLBank from losses based on current expectations. As a result, the FHLBank determined that, as of June 30, 2013, all of the gross unrealized losses on these investments were temporary as the declines in market value of these securities were not attributable to credit quality. Furthermore, the FHLBank does not intend to sell the investments, and it is not more likely than not that the FHLBank will be required to sell the investments before recovery of their amortized cost bases. As a result, the FHLBank did not consider any of these investments to be other-than-temporarily impaired at June 30, 2013.

The FHLBank did not consider any of its investments to be other-than-temporarily impaired at December 31, 2012.


Note 7 - Advances

The FHLBank offers a wide range of fixed- and variable-rate Advance products with different maturities, interest rates, payment characteristics and optionality. At June 30, 2013 and December 31, 2012, the FHLBank had Advances outstanding, including Affordable Housing Program (AHP) Advances (see Note 13), at interest rates ranging from 0.00 percent to 9.20 percent. Advances with interest rates of 0.00 percent are AHP-subsidized Advances.


14

Table 7.1 - Advance Redemption Terms (dollars in thousands)
 
 
June 30, 2013
 
December 31, 2012
Redemption Term
 
Amount
 
Weighted Average Interest
Rate
 
Amount
 
Weighted Average Interest
Rate
 
 
 
 
 
 
 
 
 
Due in 1 year or less
 
$
10,374,340

 
0.53
%
 
$
12,178,645

 
0.48
%
Due after 1 year through 2 years
 
13,130,092

 
0.57

 
5,020,941

 
1.07

Due after 2 years through 3 years
 
8,411,963

 
0.52

 
6,505,107

 
0.73

Due after 3 years through 4 years
 
8,014,083

 
0.90

 
6,171,525

 
0.86

Due after 4 years through 5 years
 
10,079,135

 
0.72

 
9,131,953

 
0.88

Thereafter
 
14,866,106

 
0.67

 
14,612,607

 
0.74

Total par value
 
64,875,719

 
0.64

 
53,620,778

 
0.75

Commitment fees
 
(800
)
 
 
 
(836
)
 
 
Discount on AHP Advances
 
(17,175
)
 
 
 
(19,308
)
 
 
Premiums
 
3,594

 
 
 
3,774

 
 
Discount
 
(15,653
)
 
 
 
(13,578
)
 
 
Hedging adjustments
 
247,310

 
 
 
353,131

 
 
Total
 
$
65,092,995

 
 
 
$
53,943,961

 
 

The FHLBank offers Advances to members that may be prepaid on specified dates (call dates) without incurring prepayment or termination fees (callable Advances). In exchange for receiving the right to call the Advance on a predetermined call schedule, the member typically pays a higher rate for the Advance relative to an equivalent maturity, non-callable Advance. If the call option is exercised, replacement funding may be available. Other Advances may only be prepaid subject to a fee to the FHLBank (prepayment fee) that makes the FHLBank financially indifferent to the prepayment of the Advance. At June 30, 2013 and December 31, 2012, the FHLBank had callable Advances (in thousands) of $9,894,117 and $12,012,609.

Table 7.2 - Advances by Year of Contractual Maturity or Next Call Date for Callable Advances (in thousands)
Year of Contractual Maturity
or Next Call Date
June 30, 2013
 
December 31, 2012
Due in 1 year or less
$
18,943,686

 
$
20,726,461

Due after 1 year through 2 years
10,560,876

 
3,563,705

Due after 2 years through 3 years
6,663,813

 
4,776,457

Due after 3 years through 4 years
5,116,128

 
3,746,205

Due after 4 years through 5 years
9,253,310

 
6,732,368

Thereafter
14,337,906

 
14,075,582

Total par value
$
64,875,719

 
$
53,620,778


The FHLBank also offers putable Advances. With a putable Advance, the FHLBank effectively purchases a put option from the member that allows the FHLBank to terminate the Advance at predetermined dates. The FHLBank normally would exercise its option when interest rates increase relative to contractual rates. At June 30, 2013 and December 31, 2012, the FHLBank had putable Advances, excluding those where the related put options have expired, totaling (in thousands) $2,367,400 and $2,587,250.


15

Table 7.3 - Advances by Year of Contractual Maturity or Next Put/Convert Date for Putable/Convertible Advances (in thousands)
Year of Contractual Maturity
or Next Put/Convert Date
June 30, 2013
 
December 31, 2012
Due in 1 year or less
$
12,703,540

 
$
14,792,295

Due after 1 year through 2 years
12,651,792

 
4,672,041

Due after 2 years through 3 years
8,367,963

 
6,193,507

Due after 3 years through 4 years
7,482,783

 
6,019,525

Due after 4 years through 5 years
9,181,035

 
8,125,303

Thereafter
14,488,606

 
13,818,107

Total par value
$
64,875,719

 
$
53,620,778


Table 7.4 - Advances by Interest Rate Payment Terms (in thousands)                    
Par value of Advances
June 30, 2013
 
December 31, 2012
Fixed-rate (1)
 
 
 
Due in one year or less
$
7,011,134

 
$
9,412,060

Due after one year
8,299,867

 
8,224,609

Total fixed-rate
15,311,001

 
17,636,669

Variable-rate (1)
 
 
 
Due in one year or less
2,957,171

 
2,363,338

Due after one year
46,607,547

 
33,620,771

Total variable-rate
49,564,718

 
35,984,109

Total par value
$
64,875,719

 
$
53,620,778

(1)
Payment terms based on current interest rate terms, which would reflect any option exercises or rate conversions subsequent to the related Advance issuance.

At June 30, 2013 and December 31, 2012, 26 percent and 24 percent, respectively, of the FHLBank's fixed-rate Advances were swapped to a variable rate.

Table 7.5 - Borrowers Holding Five Percent or more of Total Advances, Including Any Known Affiliates that are Members of the FHLBank (dollars in millions)
June 30, 2013
 
December 31, 2012
 
Principal
 
% of Total
 
 
Principal
 
% of Total
JPMorgan Chase Bank, N.A.
$
42,700

 
66
%
 
JPMorgan Chase Bank, N.A.
$
26,000

 
48
%
U.S. Bank, N.A.
4,585

 
7

 
Fifth Third Bank
4,732

 
9

Total
$
47,285

 
73
%
 
U.S. Bank, N.A.
4,586

 
8

 

 
 
 
PNC Bank, N.A. (1)
2,986

 
6

 
 
 

 
Total
$
38,304

 
71
%
 
(1)
Former member.



16

Note 8 - Mortgage Loans Held for Portfolio

Table 8.1 - Mortgage Loans Held for Portfolio (in thousands)
 
June 30, 2013
 
December 31, 2012
Unpaid principal balance:
 
 
 
Fixed rate medium-term single-family mortgage loans (1)
$
1,538,972

 
$
1,695,018

Fixed rate long-term single-family mortgage loans
5,267,321

 
5,671,123

Total unpaid principal balance
6,806,293

 
7,366,141

Premiums
177,821

 
164,243

Discounts
(3,727
)
 
(3,605
)
Hedging basis adjustments (2)
12,871

 
21,240

Total mortgage loans held for portfolio
$
6,993,258

 
$
7,548,019


(1)
Medium-term is defined as a term of 15 years or less.
(2)
Represents the unamortized balance of the mortgage purchase commitments' market values at the time of settlement. The market value of the commitment is included in the basis of the mortgage loan and amortized accordingly.

Table 8.2 - Mortgage Loans Held for Portfolio by Collateral/Guarantee Type (in thousands)
 
June 30, 2013
 
December 31, 2012
Unpaid principal balance:
 
 
 
Conventional mortgage loans
$
5,967,842

 
$
6,382,835

Government-guaranteed/insured mortgage loans
838,451

 
983,306

Total unpaid principal balance
$
6,806,293

 
$
7,366,141


For information related to the FHLBank's credit risk on mortgage loans and allowance for credit losses, see Note 9.

Table 8.3 - Members, Including Any Known Affiliates that are Members of the FHLBank, and Former Members Selling Five Percent or more of Total Unpaid Principal (dollars in millions)
 
June 30, 2013
 
 
December 31, 2012
 
Principal
 
% of Total
 
 
Principal
 
% of Total
PNC Bank, N.A. (1)
$
1,562

 
23
%
 
Union Savings Bank
$
1,984

 
27
%
Union Savings Bank
1,538

 
23

 
PNC Bank, N.A. (1)
1,818

 
25

Total
$
3,100

 
46
%
 
Guardian Savings Bank FSB
431

 
6

 


 


 
Total 
$
4,233

 
58
%
 
(1)
Former member.    


Note 9 - Allowance for Credit Losses

The FHLBank has established an allowance methodology for each of the FHLBank's portfolio segments: credit products; government-guaranteed or insured mortgage loans held for portfolio; and conventional mortgage loans held for portfolio.

Credit products

The FHLBank manages its credit exposure to credit products through an integrated approach that provides for a credit limit to be established for each borrower, includes an ongoing review of each borrower's financial condition and is coupled with detailed collateral and lending policies to limit risk of loss while balancing borrowers' needs for a reliable source of funding. In addition, the FHLBank lends to financial institutions within its district in accordance with federal statutes, including the Federal Home Loan Bank Act (FHLBank Act), and Finance Agency Regulations, which require the FHLBank to obtain sufficient collateral to fully secure credit products. The estimated value of the collateral required to secure each member's credit products is calculated by applying collateral discounts, or haircuts, to the value of the collateral. The FHLBank accepts certain investment securities, residential mortgage loans, deposits, and other real estate related assets as collateral. In addition, community financial institutions (CFIs) are eligible to utilize expanded statutory collateral provisions for small business and

17

agriculture loans. The FHLBank's capital stock owned by its member borrower is also pledged as collateral. Collateral arrangements and a member’s borrowing capacity vary based on the financial condition and performance of the institution, the types of collateral pledged and the overall quality of those assets. The FHLBank can call for additional or substitute collateral to protect its security interest. Management of the FHLBank believes that these policies effectively manage the FHLBank's credit risk from credit products.

Members experiencing financial difficulties are subject to FHLBank-performed “stress tests” of the impact of poorly performing assets on the member’s capital and loss reserve positions. Depending on the results of these tests and the level of overcollateralization, a member may be allowed to maintain pledged loan assets in its custody, may be required to deliver those loans into the custody of the FHLBank or its agent, and/or may be required to provide details on these loans to facilitate an estimate of their fair value. The FHLBank perfects its security interest in all pledged collateral. The FHLBank Act affords any security interest granted to the FHLBank by a member priority over the claims or rights of any other party except for claims or rights of a third party that would be entitled to priority under otherwise applicable law and that are held by a bona fide purchaser for value or by a secured party holding a prior perfected security interest.

Using a risk-based approach, the FHLBank considers the payment status, collateral mix, and borrower's financial condition to be indicators of credit quality on its credit products. At June 30, 2013 and December 31, 2012, the FHLBank had rights to collateral on a member-by-member basis with an estimated value in excess of its outstanding extensions of credit.

The FHLBank evaluates and makes changes to its collateral guidelines, as necessary, based on current market conditions. At June 30, 2013 and December 31, 2012, the FHLBank did not have any Advances that were past due, in non-accrual status, or impaired. In addition, there were no troubled debt restructurings related to credit products of the FHLBank during the six months ended June 30, 2013 or 2012.

The FHLBank has not experienced any credit losses on Advances since it was founded in 1932. Based upon the collateral held as security, its credit extension and collateral policies, management's credit analysis and the repayment history on credit products, the FHLBank did not record any credit losses on credit products as of June 30, 2013 or December 31, 2012. Accordingly, the FHLBank did not record any allowance for credit losses on Advances.

At June 30, 2013 and December 31, 2012, no liability to reflect an allowance for credit losses for off-balance sheet credit exposures was recorded. See Note 19 for additional information on the FHLBank's off-balance sheet credit exposure.

Mortgage Loans Held for Portfolio - Government-guaranteed or Insured

The FHLBank invests in government-guaranteed or insured fixed-rate mortgage loans secured by one-to-four family residential properties. Government-guaranteed mortgage loans are mortgage loans guaranteed or insured by the Federal Housing Administration (FHA). Any losses from such loans are expected to be recovered from the FHA. Any losses from such loans that are not recovered from the FHA would be due to a claim rejection by the FHA and, as such, would be recoverable from the selling participating financial institutions (PFIs). Therefore, the FHLBank only has credit risk for these loans if the seller or servicer fails to pay for losses not covered by insurance or guarantees. As a result, the FHLBank did not establish an allowance for credit losses on government-guaranteed or insured mortgage loans. Furthermore, due to the government guarantee or insurance, none of these mortgage loans have been placed on non-accrual status.

Mortgage Loans Held for Portfolio - Conventional MPP

The allowance for conventional loans is determined by analyses that include consideration of various data observations such as past performance, current performance, loan portfolio characteristics, collateral-related characteristics, industry data, and prevailing economic conditions. The measurement of the allowance for credit losses consists of: (1) collectively evaluating homogeneous pools of residential mortgage loans; (2) reviewing specifically identified loans for impairment; and (3) considering other relevant qualitative factors.

Collectively Evaluated Mortgage Loans. The credit risk analysis of conventional loans evaluated collectively for impairment considers historical delinquency migration, applies estimated loss severities, and incorporates the associated credit enhancements in order to determine the FHLBank's best estimate of probable incurred losses at the reporting date. The credit risk analysis of all conventional mortgage loans is performed at the individual Master Commitment Contract level to properly determine the credit enhancements available to recover losses on loans under each individual Master Commitment Contract. The Master Commitment Contract is an agreement with a member in which the member agrees to make every attempt to sell a specific dollar amount of loans to the FHLBank over a one-year period. Migration analysis is a methodology for determining, through the FHLBank's experience over a historical period, the rate of default on pools of similar loans. The FHLBank applies

18

migration analysis to loans based on payment status categories such as current, 30, 60, and 90 days past due. The FHLBank then estimates, based on historical experience, how many loans in these categories may migrate to a loss realization event and applies a current loss severity to estimate losses. The estimated losses are then reduced by the probable cash flows resulting from credit enhancements available. Any credit enhancement cash flows that are projected and assessed as not probable of receipt do not reduce estimated losses.

Individually Evaluated Mortgage Loans. Conventional mortgage loans that are considered troubled debt restructurings are specifically identified for purposes of calculating the allowance for credit losses. The FHLBank measures impairment of these specifically identified loans by either estimating the present value of expected cash flows, estimating the loan's observable market price, or estimating the fair value of the collateral if the loan is collateral dependent. Specifically identified loans evaluated for impairment are removed from the collectively evaluated mortgage loan population.

Qualitative Factors. The FHLBank also assesses other qualitative factors in its estimation of loan losses for the homogeneous population. This amount represents a subjective management judgment, based on facts and circumstances that exist as of the reporting date, that is intended to cover other inherent losses that may not otherwise be captured in the methodology described above.

Rollforward of Allowance for Credit Losses on Mortgage Loans. The following tables present a rollforward of the allowance for credit losses on conventional mortgage loans as well as the recorded investment in mortgage loans by impairment methodology. The recorded investment in a loan is the unpaid principal balance of the loan adjusted for accrued interest, unamortized premiums or discounts, hedging basis adjustments and direct write-downs. The recorded investment is not net of any allowance.

Table 9.1 - Rollforward of Allowance for Credit Losses on Conventional Mortgage Loans (in thousands)
 
Three Months Ended June 30,
Allowance for credit losses:
2013
 
2012
Balance, beginning of period
$
14,832

 
$
21,000

Charge-offs
(1,656
)
 
(1,502
)
Reversal for credit losses
(4,000
)
 
—

Balance, end of period
$
9,176

 
$
19,498

 
 
 
 
 
Six Months Ended June 30,
Allowance for credit losses:
2013
 
2012
Balance, beginning of period
$
17,907

 
$
20,750

Charge-offs
(2,231
)
 
(2,662
)
(Reversal) provision for credit losses
(6,500
)
 
1,410

Balance, end of period
$
9,176

 
$
19,498


Table 9.2 - Allowance for Credit Losses and Recorded Investment on Conventional Mortgage Loans by Impairment Methodology (in thousands)
Allowance for credit losses, end of period:
June 30, 2013
 
December 31, 2012
Collectively evaluated for impairment
$
9,094

 
$
17,775

Individually evaluated for impairment
$
82

 
$
132

Recorded investment, end of period:
 
 
 
Collectively evaluated for impairment
$
6,157,407

 
$
6,570,856

Individually evaluated for impairment
7,264

 
5,249

Total recorded investment
$
6,164,671

 
$
6,576,105


Credit Enhancements. The conventional mortgage loans under the MPP are supported by some combination of credit enhancements (primary mortgage insurance (PMI), supplemental mortgage insurance (SMI) and the Lender Risk Account (LRA), including pooled LRA for those members participating in an aggregated MPP pool). The amount of credit enhancements needed to protect the FHLBank against credit losses is determined through use of a third-party default model.

19

These credit enhancements apply after a homeowner's equity is exhausted. Beginning in February 2011, the FHLBank discontinued the use of SMI for all new loan purchases and replaced it with expanded use of the LRA. The LRA is funded by the FHLBank as a portion of the purchase proceeds to cover expected losses. Excess funds over required balances are distributed to the member in accordance with a step-down schedule that is established upon execution of a Master Commitment Contract, subject to performance of the related loan pool. The LRA established for a pool of loans is limited to only covering losses of that specific pool of loans.

Table 9.3 - Changes in the LRA (in thousands)
 
Six Months Ended
 
June 30, 2013
LRA at beginning of year
$
102,680

Additions
10,171

Claims
(2,319
)
Scheduled distributions
(895
)
LRA at end of period
$
109,637



20

Credit Quality Indicators. Key credit quality indicators for mortgage loans include the migration of past due loans, non-accrual loans, and loans in process of foreclosure. The table below summarizes the FHLBank's key credit quality indicators for mortgage loans.

Table 9.4 - Recorded Investment in Delinquent Mortgage Loans (dollars in thousands)
 
June 30, 2013
 
Conventional MPP Loans
 
Government-Guaranteed or Insured Loans
 
Total
Past due 30-59 days delinquent
$
45,191

 
$
49,403

 
$
94,594

Past due 60-89 days delinquent
13,005

 
13,311

 
26,316

Past due 90 days or more delinquent
63,848

 
29,892

 
93,740

Total past due
122,044

 
92,606

 
214,650

Total current mortgage loans
6,042,627

 
761,266

 
6,803,893

Total mortgage loans
$
6,164,671

 
$
853,872

 
$
7,018,543

Other delinquency statistics:
 
 
 
 
 
In process of foreclosure, included above (1)
$
53,697

 
$
14,962

 
$
68,659

Serious delinquency rate (2)
1.04
%
 
3.57
%
 
1.35
%
Past due 90 days or more still accruing interest (3)
$
63,510

 
$
29,892

 
$
93,402

Loans on non-accrual status, included above
$
2,853

 
$
—

 
$
2,853

 
 
 
 
 
 
 
December 31, 2012
 
Conventional MPP Loans
 
Government-Guaranteed or Insured Loans
 
Total
Past due 30-59 days delinquent
$
47,189

 
$
60,056

 
$
107,245

Past due 60-89 days delinquent
18,103

 
18,445

 
36,548

Past due 90 days or more delinquent
77,113

 
37,890

 
115,003

Total past due
142,405

 
116,391

 
258,796

Total current mortgage loans
6,433,700

 
883,381

 
7,317,081

Total mortgage loans
$
6,576,105

 
$
999,772

 
$
7,575,877

Other delinquency statistics:
 
 
 
 
 
In process of foreclosure, included above (1)
$
67,016

 
$
15,843

 
$
82,859

Serious delinquency rate (2)
1.17
%
 
3.82
%
 
1.52
%
Past due 90 days or more still accruing interest (3)
$
76,871

 
$
37,890

 
$
114,761

Loans on non-accrual status, included above
$
2,538

 
$
—

 
$
2,538

(1)
Includes loans where the decision of foreclosure or a 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.
(2)
Loans that are 90 days or more past due or in the process of foreclosure (including past due or current loans in the process of foreclosure) expressed as a percentage of the total loan portfolio class recorded investment amount.
(3)
Each conventional loan past due 90 days or more still accruing interest is on a schedule/scheduled monthly settlement basis and contains one or more credit enhancements. Loans that are well secured and in the process of collection as a result of remaining credit enhancements and schedule/scheduled settlement are not placed on non-accrual status.

The FHLBank did not have any real estate owned at June 30, 2013 or December 31, 2012.

Troubled Debt Restructurings. A troubled debt restructuring is considered to have occurred when a concession is granted to a borrower for economic or legal reasons related to the borrower's financial difficulties and that concession would not have been considered otherwise. The FHLBank does not consider loans with SMI policies that have been discharged in Chapter 7 bankruptcy to be troubled debt restructurings. The FHLBank's troubled debt restructurings involve both loans where an agreement permits the recapitalization of past due amounts up to the original loan amount and loans without SMI policies discharged in Chapter 7 bankruptcy. Under both types of modification, no other terms of the original loan are modified,

21

including the borrower's original interest rate and contractual maturity. The FHLBank had 37 and 26 modified loans considered troubled debt restructurings at June 30, 2013 and December 31, 2012, respectively.

A loan considered a troubled debt restructuring is individually evaluated for impairment when determining its related allowance for credit losses. Credit loss is measured by factoring in expected cash shortfalls (i.e., loss severity rate) incurred as of the reporting date.

Table 9.5 - Recorded Investment in Troubled Debt Restructurings (in thousands)
Troubled debt restructurings:
June 30, 2013
 
December 31, 2012
Conventional MPP Loans
$
7,264

 
$
5,249


Due to the minimal change in terms of modified loans (i.e., no principal forgiven), the FHLBank's pre-modification recorded investment was not materially different than the post-modification recorded investment in troubled debt restructurings.

Certain conventional MPP loans modified within the previous 12 months and considered troubled debt restructurings experienced a payment default as noted in the table below. A borrower is considered to have defaulted on a troubled debt restructuring if their contractually due principal or interest is 60 days or more past due at any time during the periods presented.

Table 9.6 - Recorded Investment of Financing Receivables Modified within the Previous 12 Months and Considered Troubled Debt Restructurings that Subsequently Defaulted (in thousands)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Defaulted troubled debt restructurings:
 
 
 
 
 
 
 
Conventional MPP Loans
$
—

 
$
—

 
$
—

 
$
848


Modified loans that subsequently default may recognize a higher probability of loss when calculating the allowance for credit losses.

Individually Evaluated Impaired Loans. At June 30, 2013 and December 31, 2012, only certain conventional MPP loans individually evaluated for impairment required an allowance for credit losses. Table 9.7 presents the recorded investment, unpaid principal balance, and related allowance associated with these loans.

Table 9.7 - Individually Evaluated Impaired Loan Statistics by Product Class Level (in thousands)
 
June 30, 2013
 
December 31, 2012
Conventional MPP loans:
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
With no related
allowance
$
4,593

 
$
4,514

 
$
—

 
$
2,798

 
$
2,751

 
$
—

With an allowance
2,671

 
2,640

 
82

 
2,451

 
2,423

 
132

Total
$
7,264

 
$
7,154

 
$
82

 
$
5,249

 
$
5,174

 
$
132



22

Table 9.8 - Average Recorded Investment of Individually Evaluated Impaired Loans and Related Interest Income Recognized (in thousands)
 
Three Months Ended June 30,
 
2013
 
2012
Individually impaired loans:
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
Conventional MPP Loans
$
6,709

 
$
90

 
$
3,600

 
$
50

 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
2013
 
2012
Individually impaired loans:
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
Conventional MPP Loans
$
6,281

 
$
168

 
$
3,243

 
$
90



Note 10 - Derivatives and Hedging Activities

Nature of Business Activity

The FHLBank is exposed to interest rate risk primarily from the effect of interest rate changes on its interest-earning assets and on the funding sources that finance these assets. The goal of the FHLBank's interest-rate risk management strategy is not to eliminate interest-rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, the FHLBank has established policies and procedures, which include guidelines on the amount of exposure to interest rate changes it is willing to accept. In addition, the FHLBank monitors the risk to its interest income, net interest margin and average maturity of interest-earning assets and funding sources.

The FHLBank transacts most of its derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute Consolidated Obligations. Derivative transactions may be either over-the-counter with a counterparty (bilateral derivatives) or over-the-counter cleared through a Futures Commission Merchant (i.e., clearing member) with a Central Counterparty Clearinghouse (Clearinghouse). At June 30, 2013 the FHLBank did not have any transactions cleared through a Clearinghouse. The FHLBank is not a derivatives dealer and does not trade derivatives for short-term profit.

Consistent with Finance Agency Regulations, the FHLBank enters into derivatives to manage the interest rate risk exposures inherent in otherwise unhedged assets and funding positions, to achieve the FHLBank's risk management objectives and to act as an intermediary between its members and counterparties. The use of derivatives is an integral part of the FHLBank's financial management strategy. However, Finance Agency Regulations and the FHLBank's financial management policy prohibit trading in or the speculative use of derivative instruments and limit credit risk arising from them.

The most common ways in which the FHLBank uses derivatives are to:

▪
reduce the interest rate sensitivity and repricing gaps of assets and liabilities;

▪
manage embedded options in assets and liabilities;

▪
reduce funding costs by combining a derivative with a Consolidated Obligation Bond, as the cost of a combined funding structure can be lower than the cost of a comparable Consolidated Obligation Bond;

▪
preserve a favorable interest rate spread between the yield of an asset (e.g., an Advance) and the cost of the related liability (e.g., the Consolidated Obligation Bond used to fund the Advance); without the use of derivatives, this interest rate spread could be reduced or eliminated when a change in the interest rate on the Advance does not match a change in the interest rate on the Bond; and

▪
protect the value of existing asset or liability positions.

23


Types of Derivatives

The FHLBank may enter into interest rate swaps (including callable and putable swaps), swaptions, interest rate cap and floor agreements, calls, puts, futures, and forward contracts to manage its exposure to changes in interest rates.

An interest rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be paid and the manner in which the cash flows will be calculated. One of the simplest forms of an interest rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional principal amount at a predetermined fixed rate for a given period of time. In return for this promise, this party receives cash flows equivalent to the interest on the same notional principal amount at a variable-rate index for the same period of time. The variable-rate transacted by the FHLBank in its derivatives is the London Interbank Offered Rate (LIBOR).

Application of Interest Rate Swaps

The FHLBank generally uses derivatives as fair value hedges of underlying financial instruments. However, because the FHLBank uses interest rate swaps when they are considered to be the most cost-effective alternative to achieve the FHLBank's financial and risk management objectives, it may enter into interest rate swaps that do not necessarily qualify for hedge accounting (economic hedges). The FHLBank re-evaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new strategies.

Types of Hedged Items

The FHLBank documents at inception all relationships between derivatives designated as hedging instruments and the hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value hedges to assets and liabilities on the Statements of Condition. The FHLBank also formally assesses (both at the hedge's inception and at least quarterly) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value of the hedged items and whether those derivatives may be expected to remain effective in future periods. The FHLBank currently uses regression analyses to assess the effectiveness of its hedges. The types of assets and liabilities currently hedged with derivatives are:

▪
Consolidated Obligations
▪
Advances
▪
Firm Commitments

Financial Statement Effect and Additional Financial Information

The notional amount of derivatives serves as a factor in determining periodic interest payments or cash flows received and paid. The notional amount represents neither the actual amounts exchanged nor the overall exposure of the FHLBank to credit and market risk. The risks of derivatives only can be measured meaningfully on a portfolio basis that takes into account the derivatives, the items being hedged and any offsets between the derivatives and the items being hedged.



24

Table 10.1 summarizes the fair value of derivative instruments. For purposes of this disclosure, the derivative values include the fair value of derivatives and the related accrued interest.

Table 10.1 - Fair Value of Derivative Instruments (in thousands)
 
June 30, 2013
 
Notional Amount of Derivatives
 
Derivative Assets
 
Derivative Liabilities
Derivatives designated as fair value hedging instruments:
 
 
 
 
 
Interest rate swaps
$
6,167,340

 
$
47,406

 
$
264,763

Derivatives not designated as hedging instruments:
 
 
 
 
 
Interest rate swaps
233,000

 
144

 
8,428

Mortgage delivery commitments
101,673

 
78

 
1,876

Total derivatives not designated as hedging instruments
334,673

 
222

 
10,304

Total derivatives before netting and collateral adjustments
$
6,502,013

 
47,628

 
275,067

Netting adjustments
 
 
(43,396
)
 
(43,396
)
Cash collateral and related accrued interest
 
 
—

 
(133,433
)
Total collateral and netting adjustments (1)
 
 
(43,396
)
 
(176,829
)
Total derivative assets and total derivative liabilities
 
 
$
4,232

 
$
98,238

 
 
 
 
 
 
 
December 31, 2012
 
Notional Amount of Derivatives
 
Derivative Assets
 
Derivative Liabilities
Derivatives designated as fair value hedging instruments:
 
 
 
 
 
Interest rate swaps
$
8,262,375

 
$
66,836

 
$
372,959

Derivatives not designated as hedging instruments:
 
 
 
 
 
Interest rate swaps
3,774,000

 
2,686

 
15,930

Mortgage delivery commitments
123,588

 
155

 
584

Total derivatives not designated as hedging instruments
3,897,588

 
2,841

 
16,514

Total derivatives before netting and collateral adjustments
$
12,159,963

 
69,677

 
389,473

Netting adjustments
 
 
(61,900
)
 
(61,900
)
Cash collateral and related accrued interest
 
 
(1,900
)
 
(212,685
)
Total collateral and netting adjustments (1)
 
 
(63,800
)
 
(274,585
)
Total derivative assets and total derivative liabilities
 
 
$
5,877

 
$
114,888

 
(1)
Amounts represent the effects of legally enforceable master netting agreements, other arrangements, or by operation of law that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties.





25

Table 10.2 presents the components of net (losses) gains on derivatives and hedging activities as presented in the Statements of Income.

Table 10.2 - Net (Losses) Gains on Derivatives and Hedging Activities (in thousands)
 
Three Months Ended June 30,
 
2013
 
2012
Derivatives and hedged items in fair value hedging relationships:
 
 
 
Interest rate swaps
$
2,015

 
$
3,391

Derivatives not designated as hedging instruments:
 
 
 
Economic hedges:
 
 
 
Interest rate swaps
1,815

 
(865
)
Forward rate agreements
—

 
(5,100
)
Net interest settlements
(243
)
 
(801
)
Mortgage delivery commitments
(5,044
)
 
6,561

Total net losses related to derivatives not designated as hedging instruments
(3,472
)
 
(205
)
Net (losses) gains on derivatives and hedging activities
$
(1,457
)
 
$
3,186

 
 
 
 
 
Six Months Ended June 30,
 
2013
 
2012
Derivatives and hedged items in fair value hedging relationships:
 
 
 
Interest rate swaps
$
4,937

 
$
6,845

Derivatives not designated as hedging instruments:
 
 
 
Economic hedges:
 
 
 
Interest rate swaps
6,046

 
3,721

Forward rate agreements
—

 
(8,149
)
Net interest settlements
170

 
(2,024
)
Mortgage delivery commitments
(8,265
)
 
6,547

Total net (losses) gains related to derivatives not designated as hedging instruments
(2,049
)
 
95

Net gains on derivatives and hedging activities
$
2,888

 
$
6,940



26

Table 10.3 presents by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the FHLBank's net interest income.

Table 10.3 - Effect of Fair Value Hedge Related Derivative Instruments (in thousands)
 
Three Months Ended June 30,
2013
Gain/(Loss) on Derivative
 
Gain/(Loss) on Hedged Item
 
Net Fair Value Hedge Ineffectiveness
 
Effect of Derivatives on Net Interest Income(1)
Hedged Item Type:
 
 
 
 
 
 
 
Advances
$
68,359

 
$
(66,374
)
 
$
1,985

 
$
(28,336
)
Consolidated Bonds
(9,407
)
 
9,437

 
30

 
7,522

Total
$
58,952

 
$
(56,937
)
 
$
2,015

 
$
(20,814
)
2012
 
 
 
 
 
 
 
Hedged Item Type:
 
 
 
 
 
 
 
Advances
$
22,918

 
$
(19,760
)
 
$
3,158

 
$
(78,140
)
Consolidated Bonds
(1,903
)
 
2,136

 
233

 
9,332

Total
$
21,015

 
$
(17,624
)
 
$
3,391

 
$
(68,808
)
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
2013
Gain/(Loss) on Derivative
 
Gain/(Loss) on Hedged Item
 
Net Fair Value Hedge Ineffectiveness
 
Effect of Derivatives on Net Interest Income(1)
Hedged Item Type:
 
 
 
 
 
 
 
Advances
$
108,779

 
$
(104,157
)
 
$
4,622

 
$
(57,088
)
Consolidated Bonds
(18,054
)
 
18,369

 
315

 
16,010

Total
$
90,725

 
$
(85,788
)
 
$
4,937

 
$
(41,078
)
2012
 
 
 
 
 
 
 
Hedged Item Type:
 
 
 
 
 
 
 
Advances
$
99,420

 
$
(92,476
)
 
$
6,944

 
$
(159,245
)
Consolidated Bonds
(624
)
 
525

 
(99
)
 
18,213

Total
$
98,796

 
$
(91,951
)
 
$
6,845

 
$
(141,032
)
 
(1)
The net interest on derivatives in fair value hedge relationships is included in the interest income/expense line item of the respective hedged item.


27

Offsetting of Derivative Assets and Derivative Liabilities

The FHLBank enters into derivative instruments that are subject to enforceable master netting arrangements, other arrangements, or by operation of law that provide the legal right of offset. Where the FHLBank has a legal right of offset, the FHLBank has elected to offset, by counterparty, the gross derivative assets and gross derivative liabilities, and the related cash collateral received or pledged and associated accrued interest.

Table 10.4 presents separately the fair value of derivative instruments with and without the legal right of offset, including the related collateral received from or pledged to counterparties. At June 30, 2013 and December 31, 2012, the FHLBank did not receive or pledge any non-cash collateral. Any overcollateralization at an individual master agreement is not included in the determination of the net unsecured amount.

Table 10.4 - Offsetting of Derivative Assets and Derivative Liabilities (in thousands)
 
June 30, 2013
 
Derivative Assets
 
Derivative Liabilities
Derivative instruments with legal right of offset:
 
 
 
Gross recognized amount
$
47,550

 
$
273,191

Gross amounts of netting adjustments and cash collateral
(43,396
)
 
(176,829
)
Net amounts after offsetting adjustments
4,154

 
96,362

Derivative instruments without legal right of offset
78

 
1,876

Net unsecured amount
$
4,232

 
$
98,238

 
 
 
 
 
December 31, 2012
 
Derivative Assets
 
Derivative Liabilities
Derivative instruments with legal right of offset:
 
 
 
Gross recognized amount
$
69,522

 
$
388,889

Gross amounts of netting adjustments and cash collateral
(63,800
)
 
(274,585
)
Net amounts after offsetting adjustments
5,722

 
114,304

Derivative instruments without legal right of offset
155

 
584

Net unsecured amount
$
5,877

 
$
114,888


Managing Credit Risk on Derivatives

The FHLBank is subject to credit risk due to the risk of nonperformance by counterparties to its derivative agreements. For bilateral derivatives, the degree of credit risk depends on the extent to which master netting arrangements are included in the contracts to mitigate the risk. The FHLBank manages this credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in FHLBank policies and Finance Agency Regulations. The FHLBank requires collateral agreements on all derivatives that establish collateral delivery thresholds. Based on credit analyses and collateral requirements at June 30, 2013 and December 31, 2012, the FHLBank management did not anticipate any credit losses on its derivative agreements. See Note 18 for discussion regarding the FHLBank's fair value methodology for derivative assets/liabilities, including the evaluation of the potential for the fair value of these instruments to be affected by counterparty credit risk and Note 19 for a discussion of a dispute with a past counterparty.

Certain of the FHLBank's bilateral interest rate swap contracts contain provisions that require the FHLBank to post additional collateral with its counterparties if there is deterioration in the FHLBank's credit ratings. The aggregate fair value of all bilateral interest rate swaps with credit-risk-related contingent features that were in a liability position at June 30, 2013 was (in thousands) $229,795, for which the FHLBank had posted collateral with a fair value of (in thousands) $133,433 in the normal course of business.

If one of the FHLBank's credit ratings had been lowered to the next lower rating that would have triggered additional collateral to be delivered, the FHLBank would have been required to deliver up to an additional (in thousands) $25,000 of collateral at fair value to its derivatives counterparties at June 30, 2013.


28


Note 11 - Deposits

Table 11.1- Deposits (in thousands)
 
June 30, 2013
 
December 31, 2012
Interest bearing:
 
 
 
Demand and overnight
$
866,298

 
$
1,014,399

Term
135,200

 
118,425

Other
20,157

 
25,428

Total interest bearing
1,021,655

 
1,158,252

 
 
 
 
Non-interest bearing:
 
 
 
Other
19,082

 
18,353

Total non-interest bearing
19,082

 
18,353

Total deposits
$
1,040,737

 
$
1,176,605


The average interest rate paid on interest bearing deposits was 0.03 percent in each of the three- and six-month periods ended June 30, 2013 and 2012.

The aggregate amount of time deposits with a denomination of $100 thousand or more was (in thousands) $135,100 and $118,350 as of June 30, 2013 and December 31, 2012.


Note 12 - Consolidated Obligations

Table 12.1 - Consolidated Bonds Outstanding by Contractual Maturity (dollars in thousands)
 
 
June 30, 2013
 
December 31, 2012
Year of Contractual Maturity
 
Amount
 
Weighted Average Interest Rate
 
Amount
 
Weighted Average Interest Rate
Due in 1 year or less
 
$
30,635,000

 
0.47
%
 
$
18,656,450

 
0.82
%
Due after 1 year through 2 years
 
3,021,500

 
2.31

 
11,371,500

 
0.83

Due after 2 years through 3 years
 
2,333,000

 
2.05

 
2,566,000

 
1.96

Due after 3 years through 4 years
 
2,728,000

 
2.24

 
2,550,000

 
2.62

Due after 4 years through 5 years
 
2,987,000

 
1.50

 
2,654,000

 
1.81

Thereafter
 
7,667,000

 
2.41

 
6,369,000

 
2.53

Index amortizing notes
 
40,193

 
5.07

 
56,162

 
5.08

Total par value
 
49,411,693

 
1.12

 
44,223,112

 
1.30

Premiums
 
88,958

 
 
 
80,956

 
 
Discounts
 
(19,830
)
 
 
 
(18,851
)
 
 
Hedging adjustments
 
39,711

 
 
 
58,334

 
 
Fair value option valuation adjustment and
   accrued interest
 
109

 
 
 
2,366

 
 
Total
 
$
49,520,641

 
 
 
$
44,345,917

 
 


29

Table 12.2 - Consolidated Discount Notes Outstanding (dollars in thousands)
 
Book Value
 
Par Value
 
Weighted Average Interest Rate(1)
June 30, 2013
$
38,926,196

 
$
38,934,149

 
0.10
%
December 31, 2012
$
30,840,224

 
$
30,848,612

 
0.13
%
(1)
Represents an implied rate without consideration of concessions.

Table 12.3 - Consolidated Bonds Outstanding by Features (in thousands)
 
June 30, 2013
 
December 31, 2012
Par value of Consolidated Bonds:
 
 
 
Non-callable
$
42,994,693

 
$
36,724,112

Callable
6,417,000

 
7,499,000

Total par value
$
49,411,693

 
$
44,223,112


Table 12.4 - Consolidated Bonds Outstanding by Contractual Maturity or Next Call Date (in thousands)            
Year of Contractual Maturity or Next Call Date
 
June 30, 2013
 
December 31, 2012
Due in 1 year or less
 
$
36,427,000

 
$
24,370,450

Due after 1 year through 2 years
 
3,276,500

 
11,466,500

Due after 2 years through 3 years
 
2,163,000

 
1,936,000

Due after 3 years through 4 years
 
1,908,000

 
1,860,000

Due after 4 years through 5 years
 
1,980,000

 
1,907,000

Thereafter
 
3,617,000

 
2,627,000

Index amortizing notes
 
40,193

 
56,162

Total par value
 
$
49,411,693

 
$
44,223,112


Table 12.5 - Consolidated Bonds by Interest-rate Payment Type (in thousands)
 
June 30, 2013
 
December 31, 2012
Par value of Consolidated Bonds:
 
 
 
Fixed-rate
$
24,321,693

 
$
29,393,112

Variable-rate
25,090,000

 
14,830,000

Total par value
$
49,411,693

 
$
44,223,112


At June 30, 2013 and December 31, 2012, 10 percent and 26 percent of the FHLBank's fixed-rate Consolidated Bonds were swapped to a variable rate.

Concessions on Consolidated Obligations. Unamortized concessions included in other assets were (in thousands) $13,972 and $14,299 at June 30, 2013 and December 31, 2012. The amortization of these concessions is included in Consolidated Obligation interest expense and totaled (in thousands) $1,894 and $4,908 during the three months ended June 30, 2013 and 2012, respectively, and (in thousands) $3,627 and $10,233 during the six months ended June 30, 2013 and 2012, respectively.


Note 13 - Affordable Housing Program (AHP)

Table 13.1 - Analysis of the FHLBank's AHP Liability (in thousands)
Balance at December 31, 2012
$
82,672

Expense (current year additions)
14,270

Subsidy uses, net
(7,299
)
Balance at June 30, 2013
$
89,643



30


Note 14 - Capital

Table 14.1 - Capital Requirements (dollars in thousands)
 
June 30, 2013
 
December 31, 2012
 
Required
 
Actual
 
Required
 
Actual
 
 
 
 
 
 
 
 
Risk-based capital
$
621,417

 
$
5,396,940

 
$
488,754

 
$
4,759,331

Capital-to-assets ratio (regulatory)
4.00
%
 
5.66
%
 
4.00
%
 
5.84
%
Regulatory capital
$
3,812,784

 
$
5,396,940

 
$
3,262,486

 
$
4,759,331

Leverage capital-to-assets ratio (regulatory)
5.00
%
 
8.49
%
 
5.00
%
 
8.75
%
Leverage capital
$
4,765,980

 
$
8,095,410

 
$
4,078,108

 
$
7,138,997


Restricted Retained Earnings. At June 30, 2013 and December 31, 2012 the FHLBank had (in thousands) $83,706 and $58,628 in restricted retained earnings. These restricted retained earnings are not available to pay dividends but are available to absorb unexpected losses, if any, that the FHLBank may experience.

Table 14.2 - Mandatorily Redeemable Capital Stock Roll Forward (in thousands)
Balance, December 31, 2012
$
210,828

Capital stock subject to mandatory redemption reclassified
   from equity:
 
Withdrawals
14,985

Other redemptions
3,607

Redemption (or other reduction) of mandatorily redeemable
   capital stock:
 
Withdrawals
(100,813
)
Other redemptions
(3,607
)
Balance, June 30, 2013
$
125,000


Table 14.3 - Mandatorily Redeemable Capital Stock by Contractual Year of Redemption (in thousands)
Contractual Year of Redemption
 
June 30, 2013
 
December 31, 2012
Due in 1 year or less
 
$
2,020

 
$
1,750

Due after 1 year through 2 years
 
121,618

 
207,439

Due after 2 years through 3 years
 
—

 
130

Due after 3 years through 4 years
 
—

 
—

Due after 4 years through 5 years
 
—

 
—

Past contractual redemption date due to remaining activity(1)
 
1,362

 
1,509

Total par value
 
$
125,000

 
$
210,828


(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.



31

Note 15 - Accumulated Other Comprehensive (Loss) Income

The following tables summarize the changes in accumulated other comprehensive (loss) income for the three and six months ended June 30, 2013 and 2012.

Table 15.1 - Accumulated Other Comprehensive (Loss) Income (in thousands)
 
Net unrealized gains (losses) on available-for-sale securities
 
Pension and postretirement benefits
 
Total accumulated other comprehensive (loss) income
BALANCE, MARCH 31, 2012
$
44

 
$
(9,645
)
 
$
(9,601
)
Other comprehensive income before reclassification:
 
 
 
 
 
Net unrealized gains
10

 
—

 
10

Reclassifications from other comprehensive income to net income:
 
 
 
 
 
Amortization - pension and postretirement benefits
—

 
343

 
343

Net current period other comprehensive income
10

 
343

 
353

BALANCE JUNE 30, 2012
$
54

 
$
(9,302
)
 
$
(9,248
)
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, MARCH 31, 2013
$
44

 
$
(11,284
)
 
$
(11,240
)
Other comprehensive income before reclassification:
 
 
 
 
 
Net unrealized losses
(39
)
 
—

 
(39
)
Reclassifications from other comprehensive income to net income:
 
 
 
 
 
Amortization - pension and postretirement benefits
—

 
482

 
482

Net current period other comprehensive income
(39
)
 
482

 
443

BALANCE JUNE 30, 2013
$
5

 
$
(10,802
)
 
$
(10,797
)

 
Net unrealized (losses) gains on available-for-sale securities
 
Pension and postretirement benefits
 
Total accumulated other comprehensive (loss) income
BALANCE, DECEMBER 31, 2011
$
(1,014
)
 
$
(9,987
)
 
$
(11,001
)
Other comprehensive income before reclassification:
 
 
 
 
 
Net unrealized gains
1,068

 
—

 
1,068

Reclassifications from other comprehensive income to net income:
 
 
 
 
 
Amortization - pension and postretirement benefits
—

 
685

 
685

Net current period other comprehensive income
1,068

 
685

 
1,753

BALANCE JUNE 30, 2012
$
54

 
$
(9,302
)
 
$
(9,248
)
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, DECEMBER 31, 2012
$
—

 
$
(11,734
)
 
$
(11,734
)
Other comprehensive income before reclassification:
 
 
 
 
 
Net unrealized gains
5

 
—

 
5

Reclassifications from other comprehensive income to net income:
 
 
 
 
 
Amortization - pension and postretirement benefits
—

 
932

 
932

Net current period other comprehensive income
5

 
932

 
937

BALANCE JUNE 30, 2013
$
5

 
$
(10,802
)
 
$
(10,797
)
 


32

Note 16 - Pension and Postretirement Benefit Plans

Qualified Defined Benefit Multi-employer Plan. The FHLBank participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra Defined Benefit Plan), a tax-qualified defined benefit pension plan. Under the Pentegra Defined Benefit Plan, contributions made by one participating employer may be used to provide benefits to employees of other participating employers because assets contributed by an employer are not segregated in a separate account or restricted to provide benefits only to employees of that employer. Also, in the event a participating employer is unable to meet its contribution requirements, the required contributions for the other participating employers could increase proportionately. The Pentegra Defined Benefit Plan covers substantially all officers and employees of the FHLBank who meet certain eligibility requirements. Contributions to the Pentegra Defined Benefit Plan charged to compensation and benefit expense were $1,229,000 and $1,090,000 in the three months ended June 30, 2013 and 2012, respectively, and $2,458,000 and $2,179,000 in the six months ended June 30, 2013 and 2012, respectively.

Qualified Defined Contribution Plan. The FHLBank also participates in the Pentegra Defined Contribution Plan for Financial Institutions, a tax-qualified, defined contribution pension plan. The FHLBank contributes a percentage of the participants' compensation by making a matching contribution equal to a percentage of voluntary employee contributions, subject to certain limitations. The FHLBank contributed $172,000 and $173,000 in the three months ended June 30, 2013 and 2012, respectively, and $524,000 and $514,000 in the six months ended June 30, 2013 and 2012, respectively.

Nonqualified Supplemental Defined Benefit Retirement Plan. The FHLBank maintains a nonqualified, unfunded defined benefit plan. The plan ensures that participants receive the full amount of benefits to which they would have been entitled under the qualified defined benefit plan in the absence of limits on benefit levels imposed by the IRS. There are no funded plan assets. The FHLBank has established a grantor trust to meet future benefit obligations and current payments to beneficiaries.

Postretirement Benefits Plan. The FHLBank also sponsors a postretirement benefits plan that includes health care and life insurance benefits for eligible retirees. Future retirees are eligible for the postretirement benefits plan if they were hired prior to August 1, 1990, are age 55 or older, and their age plus years of continuous service at retirement are greater than or equal to 80. Spouses are covered subject to required contributions. There are no funded plan assets that have been designated to provide postretirement benefits.

Table 16.1 - Net Periodic Benefit Cost (in thousands)
 
Three Months Ended June 30,
 
Defined Benefit
Retirement Plan
 
Postretirement Benefits Plan
 
2013
 
2012
 
2013
 
2012
Net Periodic Benefit Cost
 
 
 
 
 
 
 
Service cost
$
113

 
$
139

 
$
9

 
$
16

Interest cost
250

 
254

 
34

 
56

Amortization of net loss
450

 
335

 
32

 
8

Net periodic benefit cost
$
813

 
$
728

 
$
75

 
$
80

 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
Defined Benefit
Retirement Plan
 
Postretirement Benefits Plan
Net Periodic Benefit Cost
2013
 
2012
 
2013
 
2012
Service cost
$
225

 
$
278

 
$
28

 
$
31

Interest cost
500

 
507

 
99

 
113

Amortization of net loss
900

 
671

 
32

 
14

Net periodic benefit cost
$
1,625

 
$
1,456

 
$
159

 
$
158




33

Note 17 - Segment Information

The FHLBank has identified two primary operating segments based on its method of internal reporting: Traditional Member Finance and the MPP. These segments reflect the FHLBank's two primary Mission Asset Activities and the manner in which they are managed from the perspective of development, resource allocation, product delivery, pricing, credit risk and operational administration. The segments identify the principal ways the FHLBank provides services to member stockholders.

Table 17.1 - Financial Performance by Operating Segment (in thousands)
 
Three Months Ended June 30,
 
Traditional Member
Finance
 
MPP
 
Total
2013
 
 
 
 
 
Net interest income
$
55,766

 
$
23,347

 
$
79,113

Reversal for credit losses
—

 
(4,000
)
 
(4,000
)
Net interest income after reversal for credit losses
55,766

 
27,347

 
83,113

Other income (loss)
6,511

 
(5,043
)
 
1,468

Other expenses
13,588

 
2,080

 
15,668

Income before assessments
48,689

 
20,224

 
68,913

Affordable Housing Program assessments
5,011

 
2,022

 
7,033

Net income
$
43,678

 
$
18,202

 
$
61,880

Average assets
$
86,698,404

 
$
7,129,429

 
$
93,827,833

Total assets
$
88,309,400

 
$
7,010,196

 
$
95,319,596

 
 
 
 
 
 
2012
 
 
 
 
 
Net interest income
$
40,888

 
$
11,539

 
$
52,427

Provision for credit losses
—

 
—

 
—

Net interest income after provision for credit losses
40,888

 
11,539

 
52,427

Other income
20,712

 
1,462

 
22,174

Other expenses
11,844

 
1,881

 
13,725

Income before assessments
49,756

 
11,120

 
60,876

Affordable Housing Program assessments
5,242

 
1,112

 
6,354

Net income
$
44,514

 
$
10,008

 
$
54,522

Average assets
$
56,726,411

 
$
8,171,355

 
$
64,897,766

Total assets
$
59,340,435

 
$
8,125,740

 
$
67,466,175


34

 
 
 
 
 
 
 
Six Months Ended June 30,
 
Traditional Member
Finance
 
MPP
 
Total
2013
 
 
 
 
 
Net interest income
$
104,371

 
$
50,299

 
$
154,670

Reversal for credit losses
—

 
(6,500
)
 
(6,500
)
Net interest income after reversal for credit losses
104,371

 
56,799

 
161,170

Other income (loss)
17,436

 
(8,263
)
 
9,173

Other expenses
26,499

 
4,184

 
30,683

Income before assessments
95,308

 
44,352

 
139,660

Affordable Housing Program
9,835

 
4,435

 
14,270

Net income
$
85,473

 
$
39,917

 
$
125,390

Average assets
$
81,884,300

 
$
7,265,792

 
$
89,150,092

Total assets
$
88,309,400

 
$
7,010,196

 
$
95,319,596

 
 
 
 
 
 
2012
 
 
 
 
 
Net interest income
$
92,571

 
$
40,983

 
$
133,554

Provision for credit losses
—

 
1,410

 
1,410

Net interest income after provision for credit losses
92,571

 
39,573

 
132,144

Other income (loss)
23,106

 
(1,599
)
 
21,507

Other expenses
24,392

 
3,894

 
28,286

Income before assessments
91,285

 
34,080

 
125,365

Affordable Housing Program
9,742

 
3,408

 
13,150

Net income
$
81,543

 
$
30,672

 
$
112,215

Average assets
$
55,787,044

 
$
8,085,047

 
$
63,872,091

Total assets
$
59,340,435

 
$
8,125,740

 
$
67,466,175



Note 18 - Fair Value Disclosures

The fair value amounts recorded on the Statements of Condition and presented in the related note disclosures have been determined by the FHLBank using available market information and the FHLBank's best judgment of appropriate valuation methods. The fair values reflect the FHLBank's judgment of how a market participant would estimate the fair values.

Fair Value Hierarchy. The FHLBank records trading securities, available-for-sale securities, derivative assets, derivative liabilities and certain Consolidated Obligation Bonds at fair value on a recurring basis. The fair value hierarchy requires an entity 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 measurement is determined. This overall level is an indication of how market observable the fair value measurement is. An entity must disclose the level within the fair value hierarchy in which the measurements are classified.

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 an active market that the reporting entity 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 or liabilities in active markets; (2) quoted prices for identical or similar assets or 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.

35


Level 3 Inputs - Unobservable inputs for the asset or liability.

The FHLBank reviews the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the valuation inputs may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in/out at fair value as of the beginning of the quarter in which the changes occur. The FHLBank did not have any transfers of assets or liabilities recorded at fair value on a recurring basis during the six months ended June 30, 2013 or 2012.

Table 18.1 presents the carrying value, fair value, and fair value hierarchy of financial assets and liabilities of the FHLBank. 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 versus liabilities.
 
Table 18.1 - Fair Value Summary (in thousands)
 
June 30, 2013
 
 
 
Fair Value
Financial Instruments
Carrying Value
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustments and Cash Collateral (1) 
Assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
22,616

 
$
22,616

 
$
22,616

 
$
—

 
$
—

 
$
—

Interest-bearing deposits
106

 
106

 
—

 
106

 
—

 
—

Securities purchased under resale
agreements
1,450,000

 
1,450,000

 
—

 
1,450,000

 
—

 
—

Federal funds sold
5,650,000

 
5,650,000

 
—

 
5,650,000

 
—

 
—

Trading securities
1,746

 
1,746

 
—

 
1,746

 
—

 
—

Available-for-sale securities
1,025,005

 
1,025,005

 
—

 
1,025,005

 
—

 
—

Held-to-maturity securities
14,973,839

 
15,019,950

 
—

 
15,019,950

 
—

 
—

Advances
65,092,995

 
64,857,596

 
—

 
64,857,596

 
—

 
—

Mortgage loans held for portfolio,
net
6,984,082

 
7,084,985

 
—

 
7,027,405

 
57,580

 
—

Accrued interest receivable
84,717

 
84,717

 
—

 
84,717

 
—

 
—

Derivative assets
4,232

 
4,232

 
—

 
47,628

 
—

 
(43,396
)
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Deposits
1,040,737

 
1,040,602

 
—

 
1,040,602

 
—

 
—

Consolidated Obligations:
 
 
 
 
 
 
 
 
 
 
 
Discount Notes
38,926,196

 
38,914,561

 
—

 
38,914,561

 
—

 
—

Bonds (2)
49,520,641

 
49,600,992

 
—

 
49,600,992

 
—

 
—

Mandatorily redeemable capital
stock
125,000

 
125,000

 
125,000

 
—

 
—

 
—

Accrued interest payable
106,387

 
106,387

 
—

 
106,387

 
—

 
—

Derivative liabilities
98,238

 
98,238

 
—

 
275,067

 
—

 
(176,829
)
 
 
 
 
 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
 
 
 
 
Standby bond purchase agreements
—

 
4,166

 
—

 
4,166

 
—

 
—

(1)
    Amounts represent the effects of legally enforceable master netting agreements, other arrangements, or by operation of law that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties.
(2)
    Includes (in thousands) $100,109 of Consolidated Bonds recorded under the fair value option at June 30, 2013.


36

 
December 31, 2012
 
 
 
Fair Value
Financial Instruments
Carrying Value
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustments and Cash Collateral (1) 
Assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
16,423

 
$
16,423

 
$
16,423

 
$
—

 
$
—

 
$
—

Interest-bearing deposits
151

 
151

 
—

 
151

 
—

 
—

Securities purchased under resale agreements
3,800,000

 
3,800,000

 
—

 
3,800,000

 
—

 
—

Federal funds sold
3,350,000

 
3,350,000

 
—

 
3,350,000

 
—

 
—

Trading securities
1,922

 
1,922

 
—

 
1,922

 
—

 
—

Held-to-maturity securities
12,798,448

 
13,177,117

 
—

 
13,177,117

 
—

 
—

Advances
53,943,961

 
54,070,350

 
—

 
54,070,350

 
—

 
—

Mortgage loans held for portfolio, net
7,530,112

 
7,860,090

 
—

 
7,790,290

 
69,800

 
—

Accrued interest receivable
83,904

 
83,904

 
—

 
83,904

 
—

 
—

Derivative assets
5,877

 
5,877

 
—

 
69,677

 
—

 
(63,800
)
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Deposits
1,176,605

 
1,176,474

 
—

 
1,176,474

 
—

 
—

Consolidated Obligations:
 
 
 
 
 
 
 
 
 
 
 
Discount Notes
30,840,224

 
30,843,064

 
—

 
30,843,064

 
—

 
—

Bonds (2)
44,345,917

 
45,069,294

 
—

 
45,069,294

 
—

 
—

Mandatorily redeemable capital stock
210,828

 
210,828

 
210,828

 
—

 
—

 
—

Accrued interest payable
106,885

 
106,885

 
—

 
106,885

 
—

 
—

Derivative liabilities
114,888

 
114,888

 
—

 
389,473

 
—

 
(274,585
)
 
 
 
 
 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
 
 
 
 
Standby bond purchase agreements
—

 
1,198

 
—

 
1,198

 
—

 
—

(1)
Amounts represent the effects of legally enforceable master netting agreements, other arrangements, or by operation of law that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties.
(2)
Includes (in thousands) $3,402,366 of Consolidated Bonds recorded under the fair value option at December 31, 2012.

Summary of Valuation Methodologies and Primary Inputs.

Cash and due from banks: The fair value equals the carrying value.

Interest-bearing deposits: The fair value is determined based on each security's quoted prices, excluding accrued interest, as of the last business day of the period.

Securities purchased under agreements to resell: The fair value approximates the carrying value. Based on the fair value of the related collateral held, the securities purchased under agreements to resell were fully collateralized for the periods presented.

Federal funds sold: The fair value of overnight Federal funds sold approximates the carrying value. The fair value of term Federal funds sold is determined by calculating the present value of the expected future cash flows. The discount rates used in these calculations are the rates for Federal funds with similar terms, as approximated by adding an estimated current spread to the LIBOR Swap Curve for Federal funds with similar terms. The fair value excludes accrued interest.


37

Trading securities: The FHLBank's trading portfolio generally consists of mortgage-backed securities issued by Ginnie Mae. Quoted market prices in active markets are not available for these securities.

To value mortgage-backed security holdings, the FHLBank obtains prices from four designated third-party pricing vendors when available. The pricing vendors use various proprietary models to price mortgage-backed securities. The inputs to those models are derived from various sources including, but not limited to: benchmark yields, reported trades, dealer estimates, issuer spreads, benchmark securities, bids, offers and other market-related data. Because many mortgage-backed securities do not trade on a daily basis, the pricing vendors use available information such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing to determine the prices for individual securities. Each pricing vendor has an established challenge process in place for all mortgage-backed security valuations, which facilitates resolution of potentially erroneous prices identified by the FHLBank.

The FHLBank has conducted reviews of the pricing methods employed by the third-party vendors, to confirm and further augment its understanding of the vendors' pricing processes, methodologies and control procedures for specific instruments.

The FHLBank's valuation technique first requires the establishment of a “median” price for each security. If four prices are received, the average of the middle two prices is the median price; if three prices are received, the middle price is the median price; if two prices are received, the average of the two prices is the median price; and if one price is received, it is the median price (and also the final price) subject to validation. All prices that are within a specified tolerance threshold of the median price are included in the “cluster” of prices that are averaged to compute a “default” price.

All prices that are outside the threshold (“outliers”) are subject to further analysis (including, but not limited to, comparison to prices provided by an additional third-party valuation service, prices for similar securities, non-binding dealer estimates, and/or use of an internal model that is deemed most appropriate) to determine if an outlier is a better estimate of fair value. If an outlier (or some other price identified in the analysis) is determined to be a better estimate of fair value, then the outlier (or the other price as appropriate) is used as the final price rather than the default price. Alternatively, if the analysis confirms that an outlier is in fact not representative of fair value and the default price is the best estimate, then the default price is used as the final price. In all cases, the final price is used to determine the fair value of the security.

If all prices received for a security are outside the tolerance threshold level of the median price, then there is no default price, and the final price is determined by an evaluation of all outlier prices as described above.

Four vendor prices were received for most of the FHLBank's mortgage-backed security holdings and the final prices for those securities were computed by averaging the prices received. Based on the FHLBank's review of the pricing methods and controls employed by the third-party pricing vendors and the relative lack of dispersion among the vendor prices, the FHLBank believes its final prices result in reasonable estimates of fair value and further that the fair value measurements are classified appropriately in the fair value hierarchy.

Available-for-sale securities: The FHLBank's available-for-sale portfolio generally consists of certificates of deposit. Quoted market prices in active markets are not available for these securities. Therefore, the fair value is determined based on each security's indicative fair value obtained from a third-party vendor. The FHLBank performs several validation steps in order to verify the accuracy and reasonableness of these fair values. These steps may include, but are not limited to, a detailed review of instruments with significant periodic price changes and a derived fair value from an option-adjusted discounted cash flow methodology using market-observed inputs for the interest rate environment and similar instruments.

Held-to-maturity securities: The FHLBank's held-to-maturity portfolio generally consists of discount notes issued by Freddie Mac and/or Fannie Mae (non-mortgage-backed securities), and mortgage-backed securities. Quoted market prices are not available for these securities. The fair value for each individual mortgage-backed security is determined by using the third-party vendor approach described above. In general, in order to determine the fair value of its non-mortgage backed securities, the FHLBank can use either (a) an income approach based on a market-observable interest rate curve that may be adjusted for a spread, or (b) prices received from third-party pricing vendors. The income approach uses indicative fair values derived from a discounted cash flow methodology. The FHLBank believes that both methodologies result in fair values that are reasonable and similar in all material respects based on the nature of the financial instruments being measured.

For its discount notes issued by Freddie Mac, and/or Fannie Mae, the FHLBank determines the fair value using the income approach. The market-observable interest rate curve used by the FHLBank includes the U.S. Government Agency Fair Value Curve.
 

38

Advances: The FHLBank determines the fair values of Advances by calculating the present value of expected future cash flows from the Advances excluding accrued interest. The discount rates used in these calculations are the replacement rates for Advances with similar terms, as approximated either by adding an estimated current spread to the LIBOR Swap Curve or by using current indicative market yields, as indicated by the FHLBank's pricing methodologies for Advances with similar current terms. Advance pricing is determined based on the FHLBank's rates on Consolidated Obligations. In accordance with Finance Agency Regulations, Advances with a maturity and repricing period greater than six months require a prepayment fee sufficient to make the FHLBank financially indifferent to the borrower's decision to prepay the Advances. Therefore, the fair value of Advances does not assume prepayment risk.

For swapped option-based Advances, the fair value is determined (independently of the related derivative) by the discounted cash flow methodology based on the LIBOR Swap Curve and forward rates at period end adjusted for the estimated current spread on new swapped Advances to the swap curve. For swapped Advances with a conversion option, the conversion option is valued by taking into account the LIBOR Swap Curve and forward rates at period end and the market's expectations of future interest rate volatility implied from current market prices of similar options.

Mortgage loans held for portfolio, net: The fair values of performing mortgage loans are determined based on quoted market prices offered to approved members as indicated by the FHLBank's MPP pricing methodologies for mortgage loans with similar current terms excluding accrued interest. The quoted prices offered to members are based on Fannie Mae price indications on to-be-announced mortgage-backed securities and FHA price indications on government-guaranteed loans. The FHLBank then adjusts these indicative prices to account for particular features of the FHLBank's MPP that differ from the Fannie Mae and FHA securities. These features include, but may not be limited to the MPP's credit enhancements, and marketing adjustments that reflect the FHLBank's cooperative business model and preferences for particular kinds of loans and mortgage note rates. These quoted prices, however, can change rapidly based upon market conditions and are highly dependent upon the underlying prepayment assumptions. In order to determine the fair values, the loan amounts are also reduced for the FHLBank's estimate of expected net credit losses. The fair value of non-performing conventional mortgage loans are based on the estimated values of the underlying collateral or the present value of future cash flows and as such are classified as Level 3 in the fair value hierarchy.

Accrued interest receivable and payable: The fair value approximates the carrying value.

Derivative assets/liabilities: The FHLBank's derivative assets/liabilities generally consist of interest rate swaps, to-be-announced mortgage-backed securities (forward rate agreements), and mortgage delivery commitments. The FHLBank's interest rate swaps are not listed on an exchange. Therefore, the FHLBank determines the fair value of each individual interest rate swap using market value models that use readily observable market inputs as their basis (inputs that are actively quoted and can be validated to external sources). The FHLBank uses a mid-market pricing convention as a practical expedient for fair value measurements within a bid-ask spread. These models reflect the contractual terms of the interest rate swaps, including the period to maturity, as well as the significant inputs noted below. The fair value determination uses the standard valuation technique of discounted cash flow analysis.

The FHLBank performs several validation steps to verify the reasonableness of the fair value output generated by the primary market value model. In addition to an annual model validation, the FHLBank prepares a monthly reconciliation of the model's fair values to estimates of fair values provided by the derivative counterparties. The FHLBank believes these processes provide a reasonable basis for it to place continued reliance on the derivative fair values generated by the model.

The fair value of TBA mortgage-backed securities is based on independent indicative and/or quoted prices generated by market transactions involving comparable instruments. The FHLBank determines the fair value of mortgage delivery commitments using market prices from the TBA/mortgage-backed security market or TBA/Ginnie Mae market and adjustments noted below.

The FHLBank's discounted cash flow analysis uses market-observable inputs. Inputs, by class of derivative, are as follows:

Interest-rate swaps:
▪
Forward interest rate assumption. LIBOR Swap Curve;
▪
Discount rate assumption. Overnight Index Swap Curve; and
▪
Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options.


39

To-be-announced mortgage-backed securities:
▪
Market-based prices by coupon class and expected term until settlement.

Mortgage delivery commitments:
▪
TBA price. Market-based prices of TBAs by coupon class and expected term until settlement, adjusted to reflect the contractual terms of the mortgage delivery commitments, similar to the mortgage loans held for portfolio process. The adjustments to the market prices are market observable, or can be corroborated with observable market data.

The FHLBank is subject to credit risk in derivatives transactions due to potential nonperformance by its derivatives counterparties, all of which are highly-rated institutions. To mitigate this risk, the FHLBank has entered into master netting agreements with all of its derivative counterparties. In addition, to limit the FHLBank's net unsecured credit exposure to these counterparties, the FHLBank has entered into bilateral security agreements with all active derivatives dealer counterparties that provide for delivery of collateral at specified levels. The FHLBank has evaluated the potential for the fair value of the instruments to be impacted by counterparty credit risk and has determined that no adjustments were significant or necessary to the overall fair value measurements at June 30, 2013 or December 31, 2012.

The fair values of the FHLBank's derivatives include accrued interest receivable/payable and cash collateral remitted to/received from counterparties. The estimated fair values of the accrued interest receivable/payable and cash collateral approximate their carrying values due to their short-term nature. The fair values of derivatives are netted by counterparty pursuant to the provisions of the FHLBank's master netting agreements. If these netted amounts are positive, they are classified as an asset and if negative, they are classified as a liability.

Deposits: The FHLBank determines the fair values of FHLBank deposits with fixed rates by calculating the present value of expected future cash flows from the deposits and reducing this amount for accrued interest payable. The discount rates used in these calculations are the cost of deposits with similar terms.

Consolidated Obligations: The FHLBank determines the fair values of Discount Notes by calculating the present value of expected future cash flows from the Discount Notes excluding accrued interest. The discount rates used in these calculations are current replacement rates for Discount Notes with similar current terms, as approximated by adding an estimated current spread to the LIBOR Swap Curve. Each month's cash flow is discounted at that month's replacement rate.

The FHLBank determines the fair values of non-callable Consolidated Obligation Bonds (both unswapped and swapped) by calculating the present value of scheduled future cash flows from the bonds excluding accrued interest. Inputs used to determine fair value of these Consolidated Obligation Bonds are as follows:

▪
The discount rates used, which are estimated current market yields, as indicated by the Office of Finance, for bonds with similar current terms. 

The FHLBank determines the fair values of callable Consolidated Obligation Bonds (both unswapped and swapped) by calculating the present value of expected future cash flows from the bonds excluding accrued interest. The fair values are determined by the discounted cash flow methodology based on the following inputs for these Consolidated Obligations:

▪
LIBOR Swap Curve;
▪
Volatility assumption. Market-based expectations of future interest rate volatility implied from current market prices for similar options; and
▪
Spread adjustment. Represents an adjustment to the curve.
 
Adjustments may be necessary to reflect the 12 FHLBanks' credit quality when valuing Consolidated Obligation Bonds measured at fair value. Due to the joint and several liability for Consolidated Obligations, the FHLBank monitors its own creditworthiness and the creditworthiness of the other FHLBanks to determine whether any credit adjustments are necessary in its fair value measurement of Consolidated Obligation Bonds. No adjustments were considered necessary at June 30, 2013 or December 31, 2012.

Mandatorily redeemable capital stock: The fair value of capital stock subject to mandatory redemption is par value for the dates presented, as indicated by member contemporaneous purchases and sales at par value. FHLBank stock can only be acquired by members at par value and redeemed at par value. FHLBank stock is not traded and no market mechanism exists for the exchange of stock outside the cooperative structure. 

40


Commitments: The fair values of standby bond purchase agreements are based on the present value of the estimated fees taking into account the remaining terms of the agreements.

Subjectivity of estimates. Estimates of the fair values of financial assets and liabilities using the methods described above and other methods are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows, prepayment speeds, interest rate volatility, distributions of future interest rates used to value options, and discount rates that appropriately reflect market and credit risks. The judgments also include the parameters, methods, and assumptions used in models to value the options. The use of different assumptions could have a material effect on the fair value estimates. Since these estimates are made as of a specific point in time, they are susceptible to material near term changes.

Fair Value Measurements.

Table 18.2 presents the fair value of financial assets and liabilities, which are recorded on a recurring basis at June 30, 2013 or December 31, 2012, by level within the fair value hierarchy.

Table 18.2 - Fair Value Measurements (in thousands)

 
Fair Value Measurements at June 30, 2013
 
Total  
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment and Cash Collateral (1)
Recurring Fair Value Measurements - Assets
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
Other U.S. obligation residential mortgage-backed securities
$
1,746

 
$
—

 
$
1,746

 
$
—

 
$
—

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
Certificates of deposit
1,025,005

 
—

 
1,025,005

 
—

 
—

Derivative assets:
 
 
 
 
 
 
 
 
 
Interest rate swaps
4,154

 
—

 
47,550

 
—

 
(43,396
)
Mortgage delivery commitments
78

 
—

 
78

 
—

 
—

Total derivative assets
4,232

 
—

 
47,628

 
—

 
(43,396
)
Total assets at fair value
$
1,030,983

 
$
—

 
$
1,074,379

 
$
—

 
$
(43,396
)
 
 
 
 
 
 
 
 
 
 
Recurring Fair Value Measurements - Liabilities
 
 
 
 
 
 
 
 
 
Consolidated Obligation Bonds (2)
$
100,109

 
$
—

 
$
100,109

 
$
—

 
$
—

Derivative liabilities:
 
 
 
 
 
 
 
 
 
Interest rate swaps
96,362

 
—

 
273,191

 
—

 
(176,829
)
Mortgage delivery commitments
1,876

 
—

 
1,876

 
—

 
—

Total derivative liabilities
98,238

 
—

 
275,067

 
—

 
(176,829
)
Total liabilities at fair value
$
198,347

 
$
—

 
$
375,176

 
$
—

 
$
(176,829
)
(1)
Amounts represent the effects of legally enforceable master netting agreements, other arrangements, or by operation of law that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties.
(2)
Represents Consolidated Obligation Bonds recorded under the fair value option.



41

 
Fair Value Measurements at December 31, 2012
 
Total  
 
Level 1
 
Level 2
 
Level 3
 
Netting Adjustment and Cash Collateral (1)
Recurring Fair Value Measurements - Assets
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
Other U.S. obligation residential mortgage-backed securities
$
1,922

 
$
—

 
$
1,922

 
$
—

 
$
—

Derivative assets:
 
 
 
 
 
 
 
 
 
Interest rate swaps
5,722

 
—

 
69,522

 
—

 
(63,800
)
Mortgage delivery commitments
155

 
—

 
155

 
—

 
—

Total derivative assets
5,877

 
—

 
69,677

 
—

 
(63,800
)
Total assets at fair value
$
7,799

 
$
—

 
$
71,599

 
$
—

 
$
(63,800
)
 
 
 
 
 
 
 
 
 
 
Recurring Fair Value Measurements - Liabilities
 
 
 
 
 
 
 
 
 
Consolidated Obligation Bonds (2)
$
3,402,366

 
$
—

 
$
3,402,366

 
$
—

 
$
—

Derivative liabilities:
 
 
 
 
 
 
 
 
 
Interest rate swaps
114,304

 
—

 
388,889

 
—

 
(274,585
)
Mortgage delivery commitments
584

 
—

 
584

 
—

 
—

Total derivative liabilities
114,888

 
—

 
389,473

 
—

 
(274,585
)
Total liabilities at fair value
$
3,517,254

 
$
—

 
$
3,791,839

 
$
—

 
$
(274,585
)

(1)
Amounts represent the effects of legally enforceable master netting agreements, other arrangements, or by operation of law that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties.
(2)
Represents Consolidated Obligation Bonds recorded under the fair value option.

Fair Value Option. The fair value option provides an irrevocable option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments, and written loan commitments not previously carried at fair value. It requires a company to display the fair value of those assets and liabilities for which it has chosen to use fair value on the face of the Statements of Condition. Fair value is used for both the initial and subsequent measurement of the designated assets, liabilities and commitments, with the changes in fair value recognized in net income. If elected, interest income and interest expense on Advances and Consolidated Bonds carried at fair value are recognized based solely on the contractual amount of interest due or unpaid and any transaction fees or costs are immediately recognized into other non-interest income or other non-interest expense. Additionally, concessions paid on Consolidated Obligations designated under the fair value option are expensed as incurred in other non-interest expense.

The FHLBank has elected the fair value option for certain Consolidated Obligation Bond transactions. The FHLBank elected the fair value option for these transactions so as to mitigate the income statement volatility that can arise when only the corresponding derivatives are marked at fair value in transactions that do not, or may not, meet hedge effectiveness requirements or otherwise qualify for hedge accounting (i.e., economic hedging transactions).


42

Table 18.3 – Fair Value Option Financial Liabilities (in thousands)
 
Three Months Ended June 30,
 
2013
 
2012
 
Consolidated Bonds
 
Consolidated Bonds
Balance at beginning of period
$
(2,002,068
)
 
$
(4,202,540
)
New transactions elected for fair value option
—

 
(1,250,000
)
Maturities and terminations
1,900,000

 
765,000

Net gains (losses) on instruments held under fair value option
355

 
(186
)
Change in accrued interest
1,604

 
(270
)
Balance at end of period
$
(100,109
)
 
$
(4,687,996
)
 
 
 
 
 
Six Months Ended June 30,
 
2013
 
2012
 
Consolidated Bonds
 
Consolidated Bonds
Balance at beginning of period
$
(3,402,366
)
 
$
(4,900,296
)
New transactions elected for fair value option
—

 
(2,365,000
)
Maturities and terminations
3,300,000

 
2,575,000

Net gains on instruments held under fair value option
887

 
2,435

Change in accrued interest
1,370

 
(135
)
Balance at end of period
$
(100,109
)
 
$
(4,687,996
)

Table 18.4 – Changes in Fair Values for Items Measured at Fair Value Pursuant to the Election of the Fair Value Option (in thousands)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
Consolidated Bonds
 
Consolidated Bonds
 
Consolidated Bonds
 
Consolidated Bonds
Interest expense
$
(701
)
 
$
(2,308
)
 
$
(2,060
)
 
$
(5,199
)
Net gains (losses) on changes in fair value under fair value option
355

 
(186
)
 
887

 
2,435

Total changes in fair value included in current period earnings
$
(346
)
 
$
(2,494
)
 
$
(1,173
)
 
$
(2,764
)

For instruments recorded under the fair value option, the related contractual interest income and contractual interest expense are recorded as part of net interest income on the Statement of Income. The remaining changes in fair value for instruments in which the fair value option has been elected are recorded as “Net gains (losses) on Consolidated Obligation Bonds held under fair value option” in the Statements of Income. The FHLBank has determined that no adjustments to the fair values of its instruments recorded under the fair value option for instrument-specific credit risk were necessary as of June 30, 2013 or December 31, 2012.

The following table reflects the difference between the aggregate unpaid principal balance outstanding and the aggregate fair value for Consolidated Bonds for which the fair value option has been elected.

Table 18.5 – Aggregate Unpaid Balance and Aggregate Fair Value (in thousands)
 
June 30, 2013
 
December 31, 2012
 
Aggregate Unpaid Principal Balance
 
Aggregate Fair Value
 
Fair Value Over/(Under) Aggregate Unpaid Principal Balance
 
Aggregate Unpaid Principal Balance
 
Aggregate Fair Value
 
Fair Value Over/(Under) Aggregate Unpaid Principal Balance
Consolidated Bonds
$
100,000

 
$
100,109

 
$
109

 
$
3,400,000

 
$
3,402,366

 
$
2,366


43


Note 19 - Commitments and Contingencies

Table 19.1 - Off-Balance Sheet Commitments (in thousands)
 
June 30, 2013
 
December 31, 2012
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
$
13,670,400

 
$
168,730

 
$
13,839,130

 
$
9,958,329

 
$
193,635

 
$
10,151,964

Commitments for standby bond purchases
88,595

 
268,130

 
356,725

 
313,055

 
66,760

 
379,815

Commitment to purchase mortgage loans
101,673

 
—

 
101,673

 
123,588

 
—

 
123,588

Unsettled Consolidated Bonds, at par (1)
5,000

 
—

 
5,000

 
110,000

 
—

 
110,000

Unsettled Consolidated Discount Notes, at par (1)
17,879

 
—

 
17,879

 
750,000

 
—

 
750,000

(1)
Expiration is based on settlement period rather than underlying contractual maturity of Consolidated Obligations.

Legal Proceedings. The FHLBank is subject to legal proceedings arising in the normal course of business. In March 2010, the FHLBank was advised by representatives of the Lehman Brothers Holdings, Inc. bankruptcy estate that they believed that the FHLBank had been unjustly enriched in connection with the close out of its interest rate swap transactions with Lehman at the time of the Lehman bankruptcy in 2008 and that the bankruptcy estate was entitled to the $43 million difference between the settlement amount the FHLBank paid Lehman in connection with the automatic early termination of those transactions and the market value payment the FHLBank received when replacing the swaps with new swaps transacted with other counterparties. In May 2010, the FHLBank received a Derivatives Alternative Dispute Resolution notice from the Lehman bankruptcy estate with a settlement demand of $65.8 million, plus interest accruing primarily at LIBOR plus 14.5 percent since the bankruptcy filing, based on their view of how the settlement amount should have been calculated. In accordance with the Alternative Dispute Resolution Order of the Bankruptcy Court administering the Lehman estate, senior management of the FHLBank participated in a non-binding mediation in New York in August 2010, and counsel for the FHLBank continued discussions with the court-appointed mediator for several weeks thereafter. The mediation concluded in October 2010 without a settlement of the claims asserted by the Lehman bankruptcy estate. In April 2013 Lehman Brothers Special Financing Inc., through Lehman Brothers Holdings Inc. and the Plan Administrator under the Modified Third Amended Joint Chapter 11 Plan of Lehman Brothers Holdings Inc. and Its Affiliated Debtors, filed an adversary complaint in the United States Bankruptcy Court for the Southern District of New York against the FHLBank seeking (a) a declaratory judgment on the interpretation of certain provisions and the calculation of amounts due under the agreement governing the 2008 swap transactions described above, and (b) additional amounts alleged as due as part of the termination of such transactions. The FHLBank believes that it correctly calculated, and fully satisfied its obligation to Lehman in September 2008, and the FHLBank intends to vigorously defend itself.

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

Note 20 - Transactions with Other FHLBanks

The FHLBank notes all transactions with other FHLBanks on the face of its financial statements. Occasionally, the FHLBank loans short-term funds to and borrows short-term funds from other FHLBanks. These loans and borrowings are transacted at then current market rates when traded. There were no such loans or borrowings outstanding at June 30, 2013 or December 31, 2012. The following table details the average daily balance of lending and borrowing between the FHLBank and other FHLBanks for the six months ended June 30.

Table 20.1 - Lending and Borrowing Between the FHLBank and Other FHLBanks (in thousands)
 
Average Daily Balances for the Six Months Ended June 30,
 
2013
 
2012
Loans to other FHLBanks
$
4,779

 
$
2,005

Borrowings from other FHLBanks
8,287

 
—


44


The FHLBank may, from time to time, assume the outstanding primary liability for Consolidated Obligations of another FHLBank (at then current market rates on the day when the transfer is traded) rather than issuing new debt for which the FHLBank is the primary obligor. The FHLBank then becomes the primary obligor on the transferred debt. There were no Consolidated Obligations transferred to the FHLBank during six months ended June 30, 2013 or 2012. The FHLBank had no Consolidated Obligations transferred to other FHLBanks during these periods.


Note 21 - Transactions with Stockholders

Transactions with Directors' Financial Institutions. In the ordinary course of its business, the FHLBank may provide products and services to members whose officers or directors serve as directors of the FHLBank (Directors' Financial Institutions). Finance Agency Regulations require that transactions with Directors' Financial Institutions be made on the same terms as those with any other member. The following table reflects balances with Directors' Financial Institutions for the items indicated below.

Table 21.1 - Transactions with Directors' Financial Institutions (dollars in millions)
 
June 30, 2013
 
December 31, 2012
 
Balance
 
% of Total (1)
 
Balance
 
% of Total (1)
Advances
$
1,003

 
1.5
%
 
$
948

 
1.8
%
MPP
45

 
0.7

 
41

 
0.6

Mortgage-backed securities
—

 
—

 
—

 
—

Regulatory capital stock
234

 
4.9

 
229

 
5.4

Derivatives
—

 
—

 
—

 
—

(1)
Percentage of total principal (Advances), unpaid principal balance (MPP), principal balance (mortgage-backed securities), regulatory capital stock, and notional balances (derivatives).

Concentrations. The following table shows regulatory capital stock balances, outstanding Advance principal balances, and unpaid principal balances of mortgage loans held for portfolio at the dates indicated to members and former members holding five percent or more of regulatory capital stock and include any known affiliates that are members of the FHLBank.

Table 21.2 - Capital Stock, Advances, and MPP Principal Balances to Members and Former Members (dollars in millions)
 
Regulatory Capital Stock
 
Advance
 
MPP Unpaid
June 30, 2013
Balance
 
% of Total
 
 Principal
 
Principal Balance
JPMorgan Chase Bank, N.A.
$
1,533

 
32
%
 
$
42,700

 
$
—

U.S. Bank, N.A.
592

 
12

 
4,585

 
49

Fifth Third Bank
401

 
8

 
632

 
4

Total
$
2,526

 
52
%
 
$
47,917

 
$
53


 
Regulatory Capital Stock
 
Advance
 
MPP Unpaid
December 31, 2012
Balance
 
% of Total
 
Principal
 
Principal Balance
JPMorgan Chase Bank, N.A.
$
865

 
20
%
 
$
26,000

 
$
—

U.S. Bank, N.A.
592

 
14

 
4,586

 
55

Fifth Third Bank
401

 
9

 
4,732

 
6

Total
$
1,858

 
43
%
 
$
35,318

 
$
61


Nonmember Affiliates. The FHLBank has relationships with three nonmember affiliates, the Kentucky Housing Corporation, the Ohio Housing Finance Agency and the Tennessee Housing Development Agency. The FHLBank had no investments in or borrowings extended to any of these nonmember affiliates at June 30, 2013 or December 31, 2012.

45

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

This document contains forward-looking statements that describe the objectives, expectations, estimates, and assessments of the Federal Home Loan Bank of Cincinnati (FHLBank). These statements use words such as “anticipates,” “expects,” “believes,” “could,” “estimates,” “may,” and “should.” By their nature, forward-looking statements relate to matters involving risks or uncertainties, some of which we may not be able to know, control, or completely manage. Actual future results could differ materially from those expressed or implied in forward-looking statements or could affect the extent to which we are able to realize an objective, expectation, estimate, or assessment. Some of the risks and uncertainties that could affect our forward-looking statements include the following:

▪
the effects of economic, financial, credit, market, and member conditions on our financial condition and results of operations, including changes in economic growth, general liquidity conditions, inflation and deflation, interest rates, interest rate spreads, interest rate volatility, mortgage originations, prepayment activity, housing prices, asset delinquencies, and members' mergers and consolidations, deposit flows, liquidity needs, and loan demand;

▪
political events, including legislative, regulatory, federal government, judicial or other developments that could affect us, our members, our counterparties, other FHLBanks and other government-sponsored enterprises (GSEs), and/or investors in the Federal Home Loan Bank System's (FHLBank System) debt securities, which are called Consolidated Obligations or Obligations;

▪
competitive forces, including those related to other sources of funding available to members, to purchases of mortgage loans, and to our issuance of Consolidated Obligations;

▪
the financial results and actions of other FHLBanks that could affect our ability, in relation to the FHLBank System's joint and several liability for Consolidated Obligations, to access the capital markets on favorable terms or preserve our profitability, or could alter the regulations and legislation to which we are subject;

▪
changes in ratings assigned to FHLBank System Obligations or our FHLBank that could raise our funding cost;

▪
changes in investor demand for Obligations;

▪
the volatility of market prices, interest rates, credit quality, and other indices that could affect the value of investments and collateral we hold as security for member obligations and/or for counterparty obligations;

▪
the ability to attract and retain skilled management and other key employees;

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

▪
the risk of loss arising from failures or interruptions in our ongoing business operations, internal controls, information systems or other operating technologies;

▪
the ability to successfully manage new products and services; and

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

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



46

EXECUTIVE OVERVIEW

The following table presents selected Statement of Condition information, Statement of Income data and financial ratios for the periods indicated.
(Dollars in millions)
June 30, 2013
 
March 31, 2013
 
December 31, 2012
 
September 30, 2012
 
June 30, 2012
STATEMENT OF CONDITION DATA AT QUARTER END:
 
 
 
 
 
 
 
 
 
Total assets
$
95,320

 
$
86,729

 
$
81,562

 
$
67,171

 
$
67,466

Advances
65,093

 
58,282

 
53,944

 
36,002

 
35,095

Mortgage loans held for portfolio
6,993

 
7,228

 
7,548

 
7,866

 
8,114

Allowance for credit losses on mortgage loans
9

 
15

 
18

 
18

 
20

Investments (1)
23,101

 
20,772

 
19,950

 
23,170

 
23,359

Consolidated Obligations, net:
 
 
 
 
 
 
 
 
 
Discount Notes
38,926

 
34,076

 
30,840

 
31,535

 
30,539

Bonds
49,521

 
45,937

 
44,346

 
29,828

 
31,319

Total Consolidated Obligations, net
88,447

 
80,013

 
75,186

 
61,363

 
61,858

Mandatorily redeemable capital stock
125

 
134

 
211

 
219

 
265

Capital:
 
 
 
 
 
 
 
 
 
Capital stock - putable
4,690

 
4,466

 
4,010

 
3,428

 
3,259

Retained earnings
582

 
563

 
538

 
513

 
488

Accumulated other comprehensive loss
(11
)
 
(11
)
 
(11
)
 
(9
)
 
(9
)
Total capital
5,261

 
5,018

 
4,537

 
3,932

 
3,738

 
 
 
 
 
 
 
 
 
 
STATEMENT OF INCOME DATA FOR THE QUARTER:
 
 
 
 
 
 
 
 
 
Net interest income
$
79

 
$
75

 
$
91

 
$
83

 
$
53

Reversal for credit losses
(4
)
 
(3
)
 
—

 
(1
)
 
—

Other income (loss)
2

 
8

 
(4
)
 
(4
)
 
22

Other expenses
16

 
15

 
15

 
15

 
14

Assessments
7

 
7

 
7

 
7

 
6

Net income
$
62

 
$
64

 
$
65

 
$
58

 
$
55

Dividend payout ratio (2)
69.98
%
 
60.55
%
 
61.00
%
 
57.67
%
 
60.41
%
Weighted average dividend rate (3)
4.25

 
4.25

 
4.75

 
4.25

 
4.25

Return on average equity
4.80

 
5.49

 
6.22

 
6.05

 
6.03

Return on average assets
0.26

 
0.31

 
0.36

 
0.34

 
0.34

Net interest margin (4)
0.34

 
0.36

 
0.51

 
0.49

 
0.33

Average equity to average assets
5.51

 
5.56

 
5.79

 
5.64

 
5.61

Regulatory capital ratio (5)
5.66

 
5.95

 
5.84

 
6.19

 
5.95

Operating expense to average assets
0.051

 
0.059

 
0.064

 
0.062

 
0.068

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

47

Financial Condition

Mission Asset Activity
The following table summarizes our financial condition.
 
Ending Balances
 
Average Balances
 
June 30,
 
December 31,
 
Six Months Ended June 30,
 
Year Ended December 31,
(In millions)
2013
 
2012
 
2012
 
2013
 
2012
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
Total Assets
$
95,320

 
$
67,466

 
$
81,562

 
$
89,150

 
$
63,872

 
$
66,702

Mission Asset Activity:
 
 
 
 
 
 
 
 
 
 
 
Advances (principal)
64,876

 
34,602

 
53,621

 
58,572

 
28,983

 
32,273

Mortgage Purchase Program (MPP):
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans held for portfolio (principal)
6,806

 
7,955

 
7,366

 
7,069

 
7,925

 
7,821

Mandatory Delivery Contracts (notional)
102

 
236

 
124

 
116

 
366

 
260

Total MPP
6,908

 
8,191

 
7,490

 
7,185

 
8,291

 
8,081

Letters of Credit (notional)
13,839

 
3,997

 
10,152

 
11,836

 
4,321

 
4,584

Total Mission Asset Activity
$
85,623

 
$
46,790

 
$
71,263

 
$
77,593

 
$
41,595

 
$
44,938


In the first six months of 2013, the FHLBank continued to effectively fulfill its mission by providing readily available and competitively priced wholesale funding to its member financial institutions, supporting its commitment to affordable housing, and paying stockholders a competitive dividend return on their capital investment. As in the last few years, the vast majority of our members had limited demand for new Advance borrowings due to the tepid economic expansion and significant amounts of liquidity available to members as a result of the actions of the Federal Reserve System. We have, however, experienced substantial Advance growth as a result of borrowings from one newer, large-asset member.

Total assets at June 30, 2013 increased $13.8 billion (17 percent) from year-end 2012, led by Advances. Average asset balances in the first six months of 2013 were $25.3 billion (40 percent) higher than the same period of 2012, mostly due to the substantial growth in Advances.

The balance of Mission Asset Activity – comprising Advances, Letters of Credit, and the MPP – was $85.6 billion at June 30, 2013, an increase of $14.4 billion (20 percent) from year-end 2012. The growth was led by a $11.3 billion increase in the principal balance of Advances. Average Advance principal balances in the first six months of 2013 increased $29.6 billion (102 percent) from the same period of 2012.

The principal balance of mortgage loans held for portfolio at June 30, 2013 fell $0.6 billion (eight percent) from year-end 2012. The decline reflected the relatively high amount of principal paydowns and inactivity by several large mortgage sellers. During the first six months of 2013, the FHLBank purchased $0.6 billion of mortgage loans, while principal paydowns totaled $1.2 billion.

As of June 30, 2013, members funded on average 3.0 percent of their assets with Advances, and the penetration rate was relatively stable with 65-70 percent of members holding Mission Asset Activity. The number of active sellers and participants in the MPP remained strong.

Based on our earnings during the first two quarters of 2013, we contributed $14 million to the Affordable Housing Program pool of funds to be awarded to members in 2014. In addition, the FHLBank continued its voluntary sponsorship of other housing programs with contributions to the Carol M. Peterson Housing Fund and the Disaster Reconstruction Program. In the first six months of the year, we disbursed $1.0 million under these programs.

Other Assets
The balance of investments at June 30, 2013 was $23.1 billion, an increase of $3.2 billion (16 percent) from year-end 2012. Average investment balances were $22.9 billion in the first six months of 2013, a decrease of $3.2 billion (12 percent) from the same period in 2012.


48

At June 30, 2013, investments included $14.9 billion of mortgage-backed securities and $8.2 billion of other investments, which are mostly short-term liquidity instruments. Most of the increase in the total investment balance was from purchases of mortgage-backed securities. We maintained an adequate amount of asset liquidity throughout the year under a variety of liquidity measures. All of our mortgage-backed securities held at June 30, 2013 were issued and guaranteed by Fannie Mae, Freddie Mac or a U.S. agency.

Capital
Capital adequacy continued to be strong in the first six months of 2013, exceeding all minimum regulatory capital requirements. The GAAP capital-to-assets ratio at June 30, 2013 was 5.52 percent, while the regulatory capital-to-assets ratio was 5.66 percent. Both ratios were well above the regulatory required minimum of four percent. Regulatory capital includes mandatorily redeemable capital stock accounted for as a liability under GAAP. The amounts of GAAP and regulatory capital increased $724 million and $638 million, respectively, between year-end 2012 and the end of the second quarter of 2013, primarily resulting from members' capital stock purchases to support Advance growth.

Total retained earnings were $582 million at June 30, 2013, an increase of $44 million (eight percent) from year-end 2012. Retained earnings were comprised of $498 million unrestricted and $84 million restricted.

Results of Operations

The table below summarizes our results of operations.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
Year Ended December 31,
(Dollars in millions)
2013
 
2012
 
2013
 
2012
 
2012
 
 
 
 
 
 
 
 
 
 
Net income
$
62

 
$
55

 
$
125

 
$
112

 
$
235

Affordable Housing Program accrual
7

 
6

 
14

 
13

 
27

Return on average equity (ROE)
4.80
%
 
6.03
%
 
5.13
%
 
6.26
%
 
6.20
%
Return on average assets
0.26

 
0.34

 
0.28

 
0.35

 
0.35

Weighted average dividend rate
4.25

 
4.25

 
4.25

 
4.38

 
4.44

Average 3-month LIBOR
0.28

 
0.47

 
0.28

 
0.49

 
0.43

Average overnight Federal funds effective rate
0.12

 
0.15

 
0.13

 
0.13

 
0.14

ROE spread to 3-month LIBOR
4.52

 
5.56

 
4.85

 
5.77

 
5.77

Dividend rate spread to 3-month LIBOR
3.97

 
3.78

 
3.97

 
3.89

 
4.01

ROE spread to Federal funds effective rate
4.68

 
5.88

 
5.00

 
6.13

 
6.06

Dividend rate spread to Federal funds effective rate
4.13

 
4.10

 
4.12

 
4.25

 
4.30


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

Using our current balance sheet and operating expense structure, we estimate that the long-term average ROE in a stable market and interest rate environment would be in the range of 2.50 to 3.50 percentage points above short-term interest rates. The current elevated trend level of ROE spread to market interest rates, compared to the long-term historical range, is influenced by the following ongoing factors: 1) the extremely low level of short-term rates, 2) our continued ability to retire a large amount of high-cost Bonds before their final maturities, and 3) relatively muted acceleration of mortgage prepayment speeds.

The overall increase in net income in the 2013 periods compared with the 2012 periods resulted from the following factors:
▪
Net interest income after credit losses increased in the three- and six-month comparisons by $30 million and $29 million, respectively. This was the result of several favorable factors, most notably 1) higher interest income from growth in Advance balances, 2) lower net amortization, 3) replacement of maturities and calls of high-cost Consolidated Obligations with lower cost Obligations, and 4) net reversals of incurred credit losses in the MPP reflecting improvements in the housing market.

49

Growth in Advance balances supported by new capital stock improved net interest income by an estimated $21 million and $38 million in the three- and six-month periods, respectively. For example, the average principal balance of Advances increased $29.6 billion in the first six months of 2013 versus the same period of 2012.
Net amortization declined $28 million and $33 million, for the three- and six-month comparisons, respectively. Credit losses declined $4 million and $7 million, respectively, for the same periods.
The favorable factors were substantially offset by several unfavorable factors that affect net interest margin including, among others 1) replacement of a portion of the short-term lower-cost debt that funded fixed-rate mortgages with longer-term higher-cost debt to improve market risk positioning in the low interest rate environment, 2) narrower spreads on LIBOR-indexed assets to Consolidated Discount Note funding, which represents a reversion to historical normal levels, and 3) a reduction in the amount of higher-coupon liquidity investments.
▪
Other non-interest income declined $20 million and $12 million in the three- and six-month comparisons, respectively, primarily due to net gains on securities sales in the second quarter of 2012 that did not reoccur in 2013.

ROE fell in both periods because of $1.3 billion growth in average capital (in the six-month comparison) to support the Advance growth combined with numerous factors (both favorable and unfavorable) that resulted in a relatively small increase in net income compared to the growth in capital.

Business Outlook and Risk Management

This section summarizes and updates from our 2012 Form 10-K filing our major current risk exposures and current business outlook. “Quantitative and Qualitative Disclosures About Risk Management” provides details on current risk exposures.

Strategic/Business Risk
Advances. We cannot predict the future trend of Advance demand for individual members or the broad membership base. Advance demand depends on, among other things, the state of the economy, conditions in the housing markets, actions of the Federal Reserve to change liquidity reserves and the money supply, the willingness and ability of financial institutions to expand lending, and regulatory initiatives--all of which are difficult to predict and affect in terms of their impact on demand for our products and services. Our business is cyclical and Mission Asset Activity normally grows slowly, stabilizes, or declines in periods of difficult macro-economic conditions, when financial institutions have ample liquidity, or when there is significant growth in the money supply.

All of these conditions continue to exist. The increase in Advances over the last year has been driven primarily by the borrowings of a large-asset member. We believe the tepid economic expansion and significant amounts of liquidity available to members as a result of the actions of the Federal Reserve System have continued to limit many members' demand for Advances. We would expect to see a broad-based increase in Advance demand when the economy experiences a sustained improvement or if changes in Federal Reserve policy reduce other sources of liquidity available to our members. Additionally, there are $1.7 billion of Advances held by former members that will mature over the next several years.

MPP. Our strategy for the MPP continues to emphasize maintaining balances at a prudent amount relative to capital. This strategy is guided by our principle of having a moderate amount of market and credit risk within our current business model. We will continue to focus on recruiting community financial institution members and increasing the number of regular sellers.

The primary regulation currently affecting MPP growth is that if purchases in a calendar year exceed $2.5 billion, we are required to enact affordable housing goals for the MPP. We believe housing goals could be operationally costly to administer and could increase our credit risk exposure and reputational risk. As a result, we currently plan to limit our calendar year purchases to less than $2.5 billion as long as this requirement is in place.


50

Regulatory and Legislative Risk
The FHLBank System currently faces heightened legislative and regulatory risks and uncertainties, which we believe has affected, and could continue to affect, Mission Asset Activity, capitalization, and results of operations. To date, however, we believe the impacts have been moderate. The "Risk Factors" section of the 2012 Form 10-K provides details of some of the current and recent regulatory and legislative initiatives that could affect our business. We believe that the overall legislative and regulatory environment related to our company has raised our operating costs and, due particularly to the uncertainty around eventual GSE reform, has imparted added uncertainty regarding the business model under which the FHLBanks may operate in the future.

Of particular current interest to us is elevated regulatory focus on the FHLBanks' core mission activity of utilizing their GSE status to provide funding and liquidity to support the housing markets. This focus is manifested in several regulatory initiatives. The Finance Agency is requiring each FHLBank to develop and submit for approval by October 2013 an amendment to its strategic business plan that details targeted benchmark levels for identified core mission activities and actions to achieve and maintain such levels. We are unable at this time to determine if such a requirement will ultimately result in any significant changes to our business model, products or services, financial condition, or results of operations.

Risk Exposure
The FHLBank believes that its net liquidity position remained strong during the first six months of 2013, as did its overall ability to fund operations through Consolidated Obligation issuances at acceptable interest costs. While there can be no assurances, we believe there is only a remote possibility of a funding or liquidity crisis in the FHLBank System that could impair our FHLBank's ability to access the capital markets, service debt or pay competitive dividends.

In July 2013, Moody's affirmed the Aaa ratings on the long-term deposits of each FHLBank and on the long-term Bond rating of the FHLBank System, and updated the outlooks to stable. Moody's also affirmed the short-term ratings at Prime-1 for each FHLBank and the FHLBank System. In June 2013, Standard & Poor's affirmed its issuer credit ratings on each FHLBank and its AA+ ratings on the System's senior debt, and raised the outlooks to stable. The actions of both rating agencies were prompted by similar actions regarding the U.S. sovereign rating.

Market risk exposure remained moderate in the first six months of the year, well within the FHLBank's policy limits, and consistent with the normal historical range. We believe that profitability would not become uncompetitive unless long-term rates were to increase immediately and permanently by five percentage points or more combined with short-term rates increasing to at least eight percent. We believe such a scenario is extremely unlikely to occur.

Residual credit risk exposure from offering Advances, purchasing investments, and executing derivative transactions was limited, with no loan loss reserves or impairment recorded for these instruments. We believe policies and procedures related to credit underwriting, Advance collateral management, and transactions with investment and derivative counterparties continue to mitigate these risks. Residual credit risk exposure in the mortgage loan portfolio continued to be moderate and manageable. The allowance for credit losses in the MPP continued to decline and was $9 million at June 30, 2013.

As of June 30, 2013, all of our mortgage-backed securities were issued and guaranteed by Fannie Mae or Freddie Mac (which we believe have the backing of the U.S. government), the National Credit Union Administration, or Ginnie Mae. For unsecured liquidity investments, we invest in the debt securities of highly rated, investment-grade institutions, have limits on dollar and maturity exposure to each institution, and have strong credit underwriting practices. We mitigate the credit risk exposure resulting from interest rate swap transactions through collateralization.

The large increase over the prior 12 months in Advance borrowings from one member, JPMorgan Chase Bank, N.A.(JPMorgan), has substantially raised borrower concentration ratios compared with levels of the last several years. We assess concentration risks from business activity, and we believe that the current concentration of Advance activity is consistent with our risk management philosophy. Our business is designed to support significant changes in asset levels without having to undergo material changes in staffing, operations, risk practices, or general resource needs.

Advance concentration has a minor effect on market risk exposure because Advances are normally match funded. We believe the effect on credit risk exposure is minimal because of our application of normal credit risk mitigations, the most important of which is over-collateralization. In the extremely remote possibility that a high concentration member would fail, combined with the Federal Deposit Insurance Corporation's decision not to repay Advances, we would implement our plan to liquidate collateral to recover losses from losing principal and interest on the Advances balances. Finally, the increase in Advance concentration has not compromised capital adequacy because the Capital Plan requires the Advance growth from the member to be supported by new purchases of capital stock.

51


Capital Adequacy
We continue to maintain compliance with our regulatory capital requirements. We believe that the amount of our retained earnings is sufficient to protect against impairment risk of capital stock and to provide the opportunity to stabilize dividends. Our Capital Plan has safeguards to prevent financial leverage from increasing beyond regulatory minimums or below safe levels. We believe members continue to place a high value on their capital investment in our company. Capital ratios at June 30, 2013 were well above the regulatory required minimum of four percent.


CONDITIONS IN THE ECONOMY AND FINANCIAL MARKETS

Effect of Economy and Financial Markets on Mission Asset Activity

The primary external factors that affect our Mission Asset Activity and earnings are the general state and trends of the economy and financial institutions, especially in our Fifth District; conditions in the financial, credit, mortgage, and housing markets; interest rates; and competitive alternatives to our products, such as retail deposits and other sources of wholesale funding.

In the last several years, the tepid economic expansion has resulted in slow growth in consumer, mortgage and commercial loans across the broad membership both in absolute terms and relative to deposit growth. Other important factors continuing to negatively impact broad-based demand for our credit services are the extremely low levels of interest rates and the Federal Reserve's ongoing actions to provide an extraordinary amount of liquidity to stimulate economic growth, as discussed elsewhere. We believe these trends have limited many members' demand for Advances.

The relative balance of modest loan and deposit growth provides an indication of member Advance demand. From March 31, 2012 to March 31, 2013 (the most recent period for which data are available), aggregate loan portfolios of Fifth District depository institutions' grew $51.6 billion (4.5 percent) while their aggregate deposit balances rose $118.1 billion (6.4 percent). Most of the loan growth in this period occurred from our largest members, which is consistent with nationwide trends in the last several years of increasing concentration of financial activity. Excluding the five members with over $50 billion of assets, aggregate loans increased only $4.6 billion (2.6 percent) in the 12-month period while aggregate deposits grew $4.0 billion (1.7 percent). These data provide a possible explanation for the limited broad-based growth in Advance demand. We have no reason to believe that these trends changed materially in the second quarter of 2013.


52

Interest Rates

Trends in market interest rates affect members' demand for Mission Asset Activity, earnings, spreads on assets, funding costs and decisions in managing the tradeoffs in our market risk/return profile. The following table presents key market interest rates (obtained from Bloomberg L.P.).
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
Quarter 2 2013
 
Quarter 1 2013
 
2013
 
2012
 
Year 2012
 
Ending
 
Average
 
Ending
 
Average
 
Average
 
Average
 
Ending
 
Average
Federal funds target
0-0.25%

 
0-0.25%

 
0-0.25%

 
0-0.25%

 
0-0.25%

 
0-0.25%

 
0-0.25%

 
0-0.25%

Federal funds effective
0.07

 
0.12

 
0.09

 
0.14

 
0.13

 
0.13

 
0.09

 
0.14

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
3-month LIBOR
0.27

 
0.28

 
0.28

 
0.29

 
0.28

 
0.49

 
0.31

 
0.43

2-year LIBOR
0.51

 
0.42

 
0.42

 
0.41

 
0.41

 
0.59

 
0.39

 
0.50

5-year LIBOR
1.57

 
1.09

 
0.95

 
0.96

 
1.03

 
1.13

 
0.86

 
0.98

10-year LIBOR
2.70

 
2.15

 
2.01

 
2.01

 
2.08

 
2.03

 
1.84

 
1.88

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2-year U.S. Treasury
0.36

 
0.26

 
0.24

 
0.25

 
0.26

 
0.28

 
0.25

 
0.27

5-year U.S. Treasury
1.40

 
0.91

 
0.77

 
0.81

 
0.86

 
0.83

 
0.72

 
0.75

10-year U.S. Treasury
2.49

 
1.98

 
1.85

 
1.93

 
1.95

 
1.91

 
1.76

 
1.78

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year mortgage current coupon (1)
2.44

 
1.87

 
1.72

 
1.84

 
1.85

 
1.85

 
1.71

 
1.64

30-year mortgage current coupon (1)
3.34

 
2.77

 
2.65

 
2.57

 
2.67

 
2.84

 
2.22

 
2.54

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year mortgage note rate (2)
3.55

 
3.06

 
3.02

 
2.97

 
3.01

 
3.12

 
2.86

 
3.15

30-year mortgage note rate (2)
4.46

 
3.87

 
3.79

 
3.72

 
3.79

 
3.86

 
3.52

 
3.84

(1)
Simple average of current coupon rates of Fannie Mae and Freddie Mac par mortgage-backed security indications.
(2)
Simple weekly average of 125 national lenders' mortgage rates for prime borrowers having a 20 percent down payment as surveyed and published by Freddie Mac.
 
 
 
 
 
 
 
 
Short-term rates remained at historic lows in the first six months of 2013. The Federal Reserve maintained the overnight Federal funds target and effective rates between zero and 0.25 percent, with other short-term rates generally consistent with their historical relationships to Federal funds. Intermediate- and long-term rates, especially those on fixed-rate mortgages, rose moderately on an absolute basis in the first, and in particular, second quarters of the year compared to the levels in 2012.

The interest rate trends had several effects on our results of operations in the first two quarters of 2013, as discussed in "Executive Overview" and "Results of Operations." The Federal Reserve has indicated that it currently plans to hold certain short-term rates at or near zero until at least mid-2015. This projection could change if actual economic growth or inflation, or its forecast thereof, accelerates. Future changes in long-term rates are more difficult to predict since the Federal Reserve has less control over these rates. As discussed in "Executive Overview" and the "Market Risk" section of "Quantitative and Qualitative Disclosures About Risk Management," we believe our market risk profile is positioned to remain moderate and our profitability competitive across a wide range of interest rate environments.

The low rate environment continues to be a net benefit to our profitability relative to interest rate levels, for several reasons:
▪
Reductions in, and low, market interest rates raise ROE compared to market rates to the extent we fund a portion of long-term assets with shorter-term debt.
▪
The low intermediate- and long-term rates have provided us the opportunity to retire many Bonds before their final maturities and replace them with lower cost Obligations, at a pace exceeding mortgage paydowns.
▪
Earnings generated from funding assets with interest-free capital have not decreased as much as the reduction in overall interest rates because long-term assets do not reprice immediately to the lower rates.
Although intermediate- and long-term rates rose during the first six months of 2013, the increase was moderate and the interest rate environment remained favorable for our results of operations in terms of the spread between our level of profitability (ROE) and the levels of interest rates.

53



ANALYSIS OF FINANCIAL CONDITION
    
Credit Services

Credit Activity and Advance Composition
The tables below show annual and quarterly trends in Advance balances by major programs and in the notional amount of Letters of Credit.
 
 
 
 
 
 
 
 
(Dollars in millions)
June 30, 2013
 
March 31, 2013
 
December 31, 2012
 
Balance
Percent(1)
 
Balance
Percent(1)
 
Balance
Percent(1)
Adjustable/Variable Rate Indexed:
 
 
 
 
 
 
 
 
LIBOR
$
49,277

76
%
 
$
45,280

78
%
 
$
35,578

66
%
Other
288

—

 
196

—

 
406

1

Total
49,565

76

 
45,476

78

 
35,984

67

Fixed-Rate:
 
 
 
 
 
 
 
 
REPO
3,673

6

 
2,477

4

 
7,655

14

Regular Fixed Rate
6,277

10

 
4,928

9

 
4,573

9

Putable (2)
2,367

3

 
2,469

4

 
2,587

5

Convertible (2)
63

—

 
63

—

 
63

—

Amortizing/Mortgage Matched
2,402

4

 
2,311

4

 
2,353

4

Other
529

1

 
275

1

 
406

1

Total
15,311

24

 
12,523

22

 
17,637

33

Other Advances
—

—

 
—

—

 
—

—

Total Advances Principal
$
64,876

100
%
 
$
57,999

100
%
 
$
53,621

100
%
 
 
 
 
 
 
 
 
 
Letters of Credit (notional)
$
13,839

 
 
$
11,683

 
 
$
10,152

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

The increase in Advance balances during 2013 occurred mostly from borrowings by JPMorgan. Aggregate average Advance balances to other members declined $2.5 billion (10 percent) in the first six months of 2013 compared to the end of 2012. Advance growth was comprised primarily of adjustable-rate LIBOR Advances.

Advances to former members declined by $1.9 billion in the first six months of 2013. Former members hold $1.7 billion in Advances (three percent), of which approximately $1.1 billion are scheduled to mature by the end of 2014. When these are paid down, the former members will not be able to replace them with new Advances.

The following table shows the unweighted average ratio of each member's Advance balance to its most-recently available figures for total assets. Overall Advance usage ratios declined slightly in the first six months of 2013, continuing a trend from the last several years, although the reductions have decelerated.
 
June 30, 2013
 
March 31, 2013
 
December 31, 2012
Average Advances-to-Assets for Members
 
 
 
 
 
Assets less than $1.0 billion (670 members)
3.03
%
 
2.89
%
 
3.12
%
Assets over $1.0 billion (64 members)
3.02
%
 
2.70
%
 
2.90
%
All members
3.03
%
 
2.87
%
 
3.10
%


54

We do not know if the Advance growth experienced in the last 12 months, primarily from one member, will continue or develop into increased demand more broadly. The anemic economic expansion, significant levels of financial institution liquidity as a result of Federal Reserve actions, and strong member deposit levels have limited overall member demand for our funding.
 
 
 
 
 
 
 
 
The following tables present principal balances for our top five Advance borrowers.
(Dollars in millions)
 
 
 
 
 
 
 
 
 
 
June 30, 2013
 
December 31, 2012
Name
 
Par Value of Advances
 
Percent of Total Par Value of Advances
 
Name
 
Par Value of Advances
 
Percent of Total Par Value of Advances
 
 
 
 
 
 
 
 
 
 
 
JPMorgan Chase Bank, N.A.
 
$
42,700

 
66
%
 
JPMorgan Chase Bank, N.A.
 
$
26,000

 
48
%
U.S. Bank, N.A.
 
4,585

 
7

 
Fifth Third Bank
 
4,732

 
9

Protective Life Insurance Company
 
1,262

 
2

 
U.S. Bank, N.A.
 
4,586

 
8

Western-Southern Life Assurance Co
 
1,157

 
2

 
PNC Bank, N.A. (1)
 
2,986

 
6

PNC Bank, N.A. (1)
 
1,032

 
1

 
Protective Life Insurance Company
 
1,071

 
2

Total of Top 5
 
$
50,736

 
78
%
 
Total of Top 5
 
$
39,375

 
73
%
(1)Former member.

We believe that having large financial institutions who actively use our Mission Asset Activity augments the value of membership to all members because it improves operating efficiency, increases financial leverage and earnings, and may enable us over time to obtain more favorable funding costs and maintain competitively priced Mission Asset Activity.

Members increased their available lines in the Letters of Credit program by $3.7 billion in the first six months of 2013. The lines rose principally because of more activity from a large member who uses Letters of Credit heavily and whose usage can be volatile. We believe the member increased its usage in response to the year-end 2012 expiration of the government's Transaction Account Guarantee program. We generally earn fees on Letters of Credit based on the actual notional amount of the Letters utilized, which normally is less than the available lines.

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

Our focus for the MPP continues to be on recruiting community-based members to sell us mortgage loans and on increasing the number of regular sellers. The number of regular sellers remains at a high level compared to historical trends, and a substantial number of other members either are actively interested in joining or are in the process of joining the MPP.

The table below shows principal paydowns and purchases of loans in the MPP for the first six months of 2013.
(In millions)
MPP Principal
Balance at December 31, 2012
$
7,366

Principal purchases
647

Principal paydowns
(1,207
)
Balance at June 30, 2013
$
6,806


The decline in principal loan balance in the first six months of 2013 resulted from the moderately fast prepayments and lack of activity from several large sellers. However, the purchases reflected sales by 68 community-based financial institutions in the first six months of the year, with the number of monthly sellers averaging 67.
 
 
 
 
 
 
 
 
 
We closely track the refinancing incentives of our mortgage assets (including those in the MPP and mortgage-backed securities) because the option for homeowners to change their principal payments normally represents a large portion of our market risk

55

exposure. MPP principal paydowns in the first six months of 2013 equated to a 27 percent annual constant prepayment rate, close to the 29 percent rate for all of 2012.

The MPP's composition of balances by loan type, original final maturity, and weighted-average mortgage note rate did not change materially in the first six months of 2013. The weighted average mortgage note rate fell from 4.74 percent at the end of 2012 to 4.60 percent at June 30, 2013. This decline reflected a continuing trend of prepayments of higher rate mortgages and purchases of lower rate mortgages. MPP yields earned during the first six months of 2013, relative to funding costs, continued to offer favorable risk-adjusted returns.

Investments

We hold investments in order to provide liquidity, enhance earnings, and help manage market risk. We hold both shorter-term investments, which we refer to as "liquidity investments" because most of them serve to augment asset liquidity, and longer-term mortgage-backed securities. The table below presents the ending and average balances of our investments.
 
Six Months Ended
 
Year Ended
(In millions)
June 30, 2013
 
December 31, 2012
 
Ending Balance
 
Average Balance
 
Ending Balance
 
Average Balance
Liquidity investments
$
8,151

 
$
9,530

 
$
7,176

 
$
13,943

Mortgage-backed securities
14,950

 
13,169

 
12,774

 
11,375

Other investments (1)
—

 
195

 
—

 
408

Total investments
$
23,101

 
$
22,894

 
$
19,950

 
$
25,726

(1)
The average balance includes the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end.

Liquidity investment levels can vary significantly based on liquidity needs, the availability of acceptable net spreads, the number of eligible counterparties that meet our unsecured credit risk criteria, and changes in the amount of Mission Assets. The decline in the average amount of liquidity investments in the first six months of 2013 corresponded to the growth in Advances. We continued to maintain an adequate amount of asset liquidity using our liquidity measures.

The investment balances at June 30, 2013 and December 31, 2012 exclude $23 million and $16 million, respectively, in funds held in deposits at the Federal Reserve, which are reflected in cash and due from banks on the Statements of Condition.

Our overarching strategy for mortgage-backed securities is to keep our holdings as close as possible to the regulatory maximum of three times regulatory capital, subject to the availability of securities that we believe provide acceptable risk/return tradeoffs. The balance of mortgage-backed securities at June 30, 2013 represented a 2.77 multiple of regulatory capital and consisted of $13.6 billion of securities issued by Fannie Mae or Freddie Mac (of which $1.7 billion were floating-rate securities) and $1.3 billion of floating-rate securities issued by the National Credit Union Administration. We held no private-label mortgage-backed securities at June 30, 2013.
The table below shows principal purchases and paydowns of our mortgage-backed securities for the first six months of 2013.
(In millions)
Mortgage-backed Securities Principal
Balance at December 31, 2012
$
12,757

Principal purchases
3,705

Principal paydowns
(1,510
)
Balance at June 30, 2013
$
14,952


Principal paydowns in the first two quarters equated to a 21 percent annual constant prepayment rate, down slightly from the 25 percent rate in all of 2012. Purchases during the first six months were in fixed-rate collateralized mortgage obligations (CMOs) and 20-year pass-through securities, with purchase prices near par or at discounts. Yields earned on new purchases, relative to funding costs, continued to offer acceptable risk-adjusted returns.
 

56

Consolidated Obligations

The table below presents the ending and average balances of our participations in Consolidated Obligations.
 
Six Months Ended
 
Year Ended
(In millions)
June 30, 2013
 
December 31, 2012
 
Ending Balance
 
Average Balance
 
Ending Balance
 
Average Balance
Discount Notes:
 
 
 
 
 
 
 
Par
$
38,934

 
$
34,815

 
$
30,848

 
$
29,504

Discount
(8
)
 
(9
)
 
(8
)
 
(5
)
Total Discount Notes
38,926

 
34,806

 
30,840

 
29,499

Bonds:
 
 
 
 
 
 
 
Unswapped fixed-rate
21,867

 
22,929

 
21,689

 
18,680

Unswapped adjustable-rate
25,090

 
19,353

 
14,830

 
3,086

Swapped fixed-rate
2,455

 
4,974

 
7,704

 
9,197

Total par Bonds
49,412

 
47,256

 
44,223

 
30,963

Other items (1)
109

 
120

 
123

 
128

Total Bonds
49,521

 
47,376

 
44,346

 
31,091

Total Consolidated Obligations (2)
$
88,447

 
$
82,182

 
$
75,186

 
$
60,590

(1)
Includes unamortized premiums/discounts, fair value option valuation adjustments, hedging and other basis adjustments.
(2)
The 12 FHLBanks have joint and several liability for the par amount of all of the Consolidated Obligations issued on their behalves. The par amount of the outstanding Consolidated Obligations of all 12 FHLBanks was (in millions) $704,504 and $687,902 at June 30, 2013 and December 31, 2012, respectively.

The increase in the ending and average balances of unswapped adjustable-rate Bonds and short-term Discount Notes reflected the growth in Advances and our decision to avoid transacting new interest rates swaps (i.e., swapped fixed-rate Bonds) in light of the current unresolved uncertainties with costs, operating and regulatory processes, and credit risks associated with derivatives clearing requirements under the Dodd-Frank Act. The increase in the average balance of unswapped fixed-rate Bonds reflected growth in average mortgage assets and reduction in the average amount of balance sheet short funding in the first six months of 2013 compared to all of 2012. The relative stability in the ending balance of unswapped fixed-rate Bonds reflected normal rebalancing of market risk exposure via changes in the amount of short funding.

Long-term Bonds normally have an interest cost at a spread above U.S. Treasury securities and below LIBOR. Discount Notes, swapped Bonds, and adjustable-rate Bonds normally have interest costs below LIBOR. The level of these spreads and their volatility in the first six months of 2013 were comparable to historical ranges.
 
 
 
 
 
 
 
Deposits

Members' deposits with us are normally a relatively minor source of low-cost funding. Total interest bearing deposits at June 30, 2013 were $1.0 billion, a decrease of $0.1 billion (12 percent) from year-end 2012. The average balance of total interest bearing deposits in the first six months of 2013 was $1.2 billion, an increase of less than one percent from the average balance during the same period of 2012.

Derivatives Hedging Activity and Liquidity

Our use of and accounting for derivatives is discussed in the "Effect of the Use of Derivatives on Net Interest Income" section in "Results of Operations." Liquidity is discussed in the "Liquidity Risk" section in “Quantitative and Qualitative Disclosures About Risk Management.” We did not change our strategy of using derivatives solely to manage market risk exposure in the first six months of 2013.


57

Capital Resources

The following tables present capital amounts and capital-to-assets ratios, on both a GAAP and regulatory basis.
GAAP and Regulatory Capital
Six Months Ended
 
Year Ended
 
June 30, 2013
 
December 31, 2012
(In millions)
Period End
 
Average
 
Period End
 
Average
GAAP Capital Stock
$
4,690

 
$
4,369

 
$
4,010

 
$
3,297

Mandatorily Redeemable Capital Stock
125

 
157

 
211

 
252

Regulatory Capital Stock
4,815

 
4,526

 
4,221

 
3,549

Retained Earnings
582

 
575

 
538

 
501

Regulatory Capital
$
5,397

 
$
5,101

 
$
4,759

 
$
4,050

GAAP and Regulatory Capital-to-Assets Ratio
Six Months Ended
 
Year Ended
 
June 30, 2013
 
December 31, 2012
 
Period End
 
Average
 
Period End
 
Average
GAAP
5.52
%
 
5.53
%
 
5.56
%
 
5.68
%
Regulatory
5.66

 
5.72

 
5.84

 
6.07

 
 
 
 
Both the GAAP and regulatory capital-to-assets ratios were well above the regulatory required minimum of four percent.
We consider the regulatory ratio to be a better representation of financial leverage than the GAAP ratio because, although the GAAP ratio treats mandatorily redeemable capital stock as a liability, it protects investors in our debt in the same way that GAAP capital stock and retained earnings do. Financial leverage is defined as the inverse of capital ratios, and therefore increases as capital ratios decline.

In the first six months of 2013, our capital base increased due mostly to required stock purchases to support Advance growth, while the amount of financial leverage, as represented by a lower regulatory capital-to-assets ratio, was relatively stable.
 
 
 
 
The amount of excess capital stock was $1.2 billion at June 30, 2013. The substantial amount of excess stock provides a base of capital to manage financial leverage at prudent levels, augment loss protections for bondholders, and capitalize a portion of potential growth in new Mission Assets. A Finance Agency Regulation prohibits us from paying stock dividends if the amount of our regulatory excess stock (as defined by the Finance Agency) exceeds one percent of total assets on a dividend payment date. Since the end of 2008, this regulatory threshold has been exceeded and, therefore, we have been required to pay cash dividends.

At June 30, 2013, the total amount of retained earnings were comprised of $498 million unrestricted (an increase of $19 million from year-end 2012) and $84 million restricted (an increase of $25 million), which are not permitted to be distributed as dividends. We believe that the amount of retained earnings is sufficient to protect against impairment risk of capital stock and to provide the opportunity to stabilize dividends if earnings experience exceptional stress. Further discussion is in the "Capital Adequacy" section of "Quantitative and Qualitative Disclosures About Risk Management."

Membership and Stockholders

In the first six months of 2013, we added three new member stockholders and lost 11 members, ending the second quarter at 734. The 11 lost members included eight that merged with other Fifth District members, one that merged out of the District, and two that failed and were taken into FDIC receivership. The impact on our earnings and Mission Asset Activity from the members lost was negligible. We will continue to recruit the remaining institutions eligible for membership in order to maintain and expand our customer base.
 
 
 
 
 
 
 
 
 
 
 
 
 

58

RESULTS OF OPERATIONS

Components of Earnings and Return on Equity

The following table is a summary income statement for the three and six months ended June 30, 2013 and 2012. Each ROE percentage is computed by dividing income or expense for the category by the average amount of stockholders' equity for the period. Factors determining the level of, and changes in, net income and ROE are explained in the remainder of this section.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(Dollars in millions)
2013
 
2012
 
2013
 
2012
 
Amount
 
ROE (a)
 
Amount
 
ROE (a)
 
Amount
 
ROE (a)
 
Amount
 
ROE (a)
Net interest income
$
79

 
6.14
 %
 
$
53

 
5.80
 %
 
$
155

 
6.32
 %
 
$
133

 
7.45
 %
Reversal (provision) for credit losses
4

 
0.31

 
—

 
—

 
6

 
0.27

 
(1
)
 
(0.08
)
Net interest income after reversal (provision) for credit losses
83

 
6.45

 
53

 
5.80

 
161

 
6.59

 
132

 
7.37

Net (losses) gains on derivatives and hedging activities
(1
)
 
(0.11
)
 
3

 
0.35

 
3

 
0.12

 
7

 
0.39

Other non-interest income
3

 
0.22

 
19

 
2.10

 
6

 
0.25

 
14

 
0.81

Total non-interest income
2

 
0.11

 
22

 
2.45

 
9

 
0.37

 
21

 
1.20

Total revenue
85

 
6.56

 
75

 
8.25

 
170

 
6.96

 
153

 
8.57

Total other expense
(16
)
 
(1.21
)
 
(14
)
 
(1.52
)
 
(31
)
 
(1.25
)
 
(28
)
 
(1.58
)
Assessments
(7
)
 
(0.55
)
 
(6
)
 
(0.70
)
 
(14
)
 
(0.58
)
 
(13
)
 
(0.73
)
Net income
$
62

 
4.80
 %
 
$
55

 
6.03
 %
 
$
125

 
5.13
 %
 
$
112

 
6.26
 %
(a)
The ROE amounts have been computed using dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) in this table may produce nominally different results.

The most significant individual contributors to the higher net income in the first six months of 2013 were higher Advance balances, lower net amortization, and reversals in the provision for credit losses in the MPP. ROE fell in both periods because of $1.3 billion growth in average capital (in the six-month comparison) to support the Advance growth combined with several factors that lowered income offsetting much of impact of the favorable factors. The most notable unfavorable factors were changes in income from asset-liability management actions and net gains on securities sales recognized in 2012 that did not reoccur in the first six months of 2013.
 


59

Net Interest Income

Components of Net Interest Income
The following table shows the major components of net interest income. Reasons for the variance in net interest income between the comparison periods are discussed below.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(Dollars in millions)
2013
 
2012
 
2013
 
2012
 
Amount
Pct of Earning Assets
 
Amount
Pct of Earning Assets
 
Amount
Pct of Earning Assets
 
Amount
Pct of Earning Assets
Components of net interest rate spread:
 
 
 
 
 
 
 
 
 
 
 
Other components of net interest rate spread
$
70

0.30
%
 
$
68

0.42
 %
 
$
136

0.31
%
 
$
138

0.44
 %
Net (amortization)/accretion (1) (2)
(1
)
—

 
(29
)
(0.17
)
 
(1
)
—

 
(34
)
(0.11
)
Prepayment fees on Advances, net (2)
1

—

 
2

0.01

 
1

—

 
5

0.02

Total net interest rate spread
70

0.30

 
41

0.26

 
136

0.31

 
109

0.35

Earnings from funding assets with interest-free capital
9

0.04

 
12

0.07

 
19

0.04

 
24

0.07

Total net interest income/net interest margin (3)
$
79

0.34
%
 
$
53

0.33
 %
 
$
155

0.35
%
 
$
133

0.42
 %
(1)
Includes (amortization)/accretion of premiums/discounts on mortgage assets and Consolidated Obligations and deferred transaction costs (concession fees) for Consolidated Obligations.
(2)
These components of net interest rate spread have been segregated here to display their relative impact.
(3)
Net interest margin is net interest income before (reversal)/provision for credit losses as a percentage of average total interest earning assets.

Earnings From Capital. The earnings from funding assets with interest-free capital has become a smaller proportion of net interest income due to the continued extremely low interest rate environment. The earnings from capital fell in each of the two comparison periods due to a reduction in average interest rates.

Net Amortization/Accretion. Net amortization/accretion (generally referred to as "amortization") includes monthly recognition of premiums and discounts paid on purchases of mortgage assets, as well as premiums, discounts and concessions paid on Consolidated Obligations. Periodic amortization adjustments do not necessarily indicate a trend in economic return over the entire life of mortgage assets, although amortization over the entire life is one component of lifetime economic returns.

The amount of net amortization was low in the three and six months ended June 30, 2013. The substantial decrease in net amortization in each of the two comparison periods resulted primarily from a decline in actual and projected prepayment speeds due to an increase in mortgage rates in the second quarter of 2013.

At June 30, 2013, the net premium balance of mortgage assets totaled $185 million compared to $199 million at the end of 2012. The decline was mostly due to the purchase of mortgage-backed securities at prices near par or in some cases at slight discounts, compared to the premiums on mortgage assets that paid down. MPP loans continued to be purchased mostly at premium prices in the first six months of 2013 (as they have been in the last several years), although at a lower amount.

Prepayment Fees on Advances. Fees for members' early repayment of certain Advances are designed to make us economically indifferent to whether members hold Advances to maturity or repay them before maturity. Although Advance prepayment fees can be, and in the past have been, significant, they were modest in each of the periods presented.

Other Components of Net Interest Rate Spread. Excluding net amortization and prepayment fees, the total other components of net interest rate spread changed only $2 million (two percent) in the first six months of 2013 versus the same period in 2012. The following factors, discussed below in estimated approximate order of impact from largest to smallest, accounted for the changes in net interest rate spread due to other components.




60

Six-Months Comparison
▪
Advance growth-Favorable: The growth in average Advance balances and new capital stock purchased to support the growth improved net interest income by an estimated $38 million. A portion of the gain to net interest from this factor included leveraging the additional capital with mortgage-backed securities.
▪
Asset-liability management-Unfavorable: Management strategies and actions, along with changes in the market rate environment, related to asset-liability management and market risk exposure lowered earnings on a net basis, as follows:
1)
We decreased the amount of fixed-rate mortgages funded with short-term debt, which lowered earnings by an estimated $16 million.
2)
We normally use short-term Discount Notes to fund a substantial amount of LIBOR-indexed assets. The average spread between LIBOR and Discount Notes was narrower in the first six months of 2013, lowering net interest income by an estimated $11 million.
3)
We replaced, over the prior 12 months, a substantial amount of high-cost debt (Consolidated Bonds) with issuance of new debt at lower rates. This effect exceeded the impact of paydowns of high-yielding mortgage assets. These two factors combined increased net interest income by an estimated $15 million.
We estimate that the overall impact of asset-liability management actions decreased interest income $12 million.

▪
Trading securities-Unfavorable: In the first six months of 2012, we held a large amount of investments in short-term trading securities (including instruments of the U.S. Treasury and government-sponsored enterprises) in order to enhance asset liquidity and manage counterparty credit risk. No short-term trading securities were held in 2013. Many of the trading securities were purchased with above-market coupon rates, which resulted in an estimated $19 million increase in net interest income in the first half of 2012. However, this was offset by earnings reductions in other non-interest income (specifically, net unrealized market value losses on trading securities), with the resulting combined earnings from the trading securities reflecting at-market rates. See "Non-Interest Income and Non-Interest Expense" below for a discussion of the net losses on trading securities.
▪
Lower balances on MPP loans-Unfavorable: The average balance of MPP loans declined $856 million, which reduced net interest income by an estimated $7 million.

Three-Months Comparison
For the three-months comparison, the same factors generally affected the other components of net interest rate spread as in the six-months comparison and in approximately the same relative magnitude.

61

Average Balance Sheet and Rates
The following tables provide average rates and average balances for major balance sheet accounts, which determine the changes in the net interest rate spread. All data include the impact of interest rate swaps, which we allocate to each asset and liability category according to their designated hedging relationship. The changes in the net interest rate spread and net interest margin between the periods shown occurred mostly from the net impact of the factors discussed above in “Components of Net Interest Income.”
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
Three Months Ended
 
Three Months Ended
 
June 30, 2013
 
June 30, 2012
 
Average Balance
 
Interest
 
Average Rate (1)
 
Average Balance
 
Interest
 
Average Rate (1)
Assets
 
 
 
 
 
 
 
 
 
 
 
Advances
$
62,713

 
$
78

 
0.50
%
 
$
30,686

 
$
60

 
0.78
%
Mortgage loans held for portfolio (2)
7,115

 
68

 
3.82

 
8,158

 
69

 
3.41

Federal funds sold and securities purchased under resale agreements
8,559

 
2

 
0.10

 
7,024

 
3

 
0.15

Interest-bearing deposits in banks (3) (4) (5)
1,505

 
1

 
0.15

 
2,782

 
1

 
0.17

Mortgage-backed securities
13,769

 
75

 
2.18

 
10,459

 
66

 
2.53

Other investments (4)
26

 
—

 
0.13

 
5,616

 
13

 
0.94

Loans to other FHLBanks
2

 
—

 
0.16

 
1

 
—

 
—

Total earning assets
93,689

 
224

 
0.96

 
64,726

 
212

 
1.32

Less: allowance for credit losses on mortgage loans
14

 
 
 
 
 
21

 
 
 
 
Other assets
153

 
 
 
 
 
193

 
 
 
 
Total assets
$
93,828

 
 
 
 
 
$
64,898

 
 
 
 
Liabilities and Capital
 
 
 
 
 
 
 
 
 
 
 
Term deposits
$
136

 
—

 
0.17

 
$
119

 
—

 
0.22

Other interest bearing deposits (5)
1,003

 
—

 
0.01

 
1,051

 
—

 
0.01

Short-term borrowings
36,381

 
10

 
0.11

 
28,211

 
7

 
0.10

Unswapped fixed-rate Consolidated Bonds
23,622

 
123

 
2.08

 
18,892

 
143

 
3.04

Unswapped adjustable-rate Consolidated Bonds
22,698

 
9

 
0.16

 
1,731

 
1

 
0.26

Swapped Consolidated Bonds
3,993

 
1

 
0.11

 
10,080

 
5

 
0.21

Mandatorily redeemable capital stock
131

 
2

 
4.35

 
267

 
3

 
3.99

Other borrowings
—

 
—

 
—

 
—

 
—

 
—

Total interest-bearing liabilities
87,964

 
145

 
0.66

 
60,351

 
159

 
1.06

Non-interest bearing deposits
19

 
 
 
 
 
18

 
 
 
 
Other liabilities
674

 
 
 
 
 
890

 
 
 
 
Total capital
5,171

 
 
 
 
 
3,639

 
 
 
 
Total liabilities and capital
$
93,828

 
 
 
 
 
$
64,898

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest rate spread
 
 
 
 
0.30
%
 
 
 
 
 
0.26
%
Net interest income and net interest margin (6)
 
 
$
79

 
0.34
%
 
 
 
$
53

 
0.33
%
Average interest-earning assets to interest-bearing liabilities
 
 
 
 
106.51
%
 
 
 
 
 
107.25
%
(1)
Amounts used to calculate average rates are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
(2)
Non-accrual loans are included in average balances used to determine average rate.
(3)
Includes certificates of deposit and bank notes that are classified as available-for-sale securities.
(4)
Includes available-for-sale securities based on their amortized costs. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders' equity for available-for-sale securities.
(5)
The average balance amounts include the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end.
(6)
Net interest margin is net interest income before (reversal)/provision for credit losses as a percentage of average total interest earning assets.

62

 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
Six Months Ended
 
Six Months Ended
 
June 30, 2013
 
June 30, 2012
 
Average Balance
 
Interest
 
Average Rate (1)
 
Average Balance
 
Interest
 
Average Rate (1)
Assets
 
 
 
 
 
 
 
 
 
 
 
Advances
$
58,858

 
$
150

 
0.51
%
 
$
29,530

 
$
123

 
0.84
%
Mortgage loans held for portfolio (2)
7,253

 
141

 
3.92

 
8,072

 
158

 
3.93

Federal funds sold and securities purchased under resale agreements
8,808

 
5

 
0.11

 
6,545

 
4

 
0.13

Interest-bearing deposits in banks (3) (4) (5)
891

 
1

 
0.15

 
3,456

 
3

 
0.17

Mortgage-backed securities
13,169

 
144

 
2.21

 
10,811

 
146

 
2.72

Other investments (4)
26

 
—

 
0.13

 
5,275

 
24

 
0.92

Loans to other FHLBanks
5

 
—

 
0.17

 
2

 
—

 
0.10

Total earning assets
89,010

 
441

 
1.00

 
63,691

 
458

 
1.45

Less: allowance for credit losses on mortgage loans
16

 
 
 
 
 
21

 
 
 
 
Other assets
156

 
 
 
 
 
202

 
 
 
 
Total assets
$
89,150

 
 
 
 
 
$
63,872

 
 
 
 
Liabilities and Capital
 
 
 
 
 
 
 
 
 
 
 
Term deposits
$
125

 
—

 
0.18

 
$
108

 
—

 
0.23

Other interest bearing deposits (5)
1,045

 
—

 
0.01

 
1,059

 
—

 
0.01

Short-term borrowings
34,806

 
21

 
0.12

 
27,758

 
11

 
0.08

Unswapped fixed-rate Consolidated Bonds
22,997

 
243

 
2.13

 
18,781

 
294

 
3.14

Unswapped adjustable-rate Consolidated Bonds
19,353

 
16

 
0.16

 
1,586

 
2

 
0.28

Swapped Consolidated Bonds
5,026

 
3

 
0.13

 
9,765

 
12

 
0.24

Mandatorily redeemable capital stock
157

 
3

 
3.91

 
271

 
6

 
4.54

Other borrowings
8

 
—

 
0.12

 
1

 
—

 
0.37

Total interest-bearing liabilities
83,517

 
286

 
0.69

 
59,329

 
325

 
1.10

Non-interest bearing deposits
19

 
 
 
 
 
17

 
 
 
 
Other liabilities
681

 
 
 
 
 
923

 
 
 
 
Total capital
4,933

 
 
 
 
 
3,603

 
 
 
 
Total liabilities and capital
$
89,150

 
 
 
 
 
$
63,872

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest rate spread
 
 
 
 
0.31
%
 
 
 
 
 
0.35
%
Net interest income and net interest margin (6)
 
 
$
155

 
0.35
%
 
 
 
$
133

 
0.42
%
Average interest-earning assets to interest-bearing liabilities
 
 
 
 
106.58
%
 
 
 
 
 
107.35
%
(1)
Amounts used to calculate average rates are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
(2)
Non-accrual loans are included in average balances used to determine average rate.
(3)
Includes certificates of deposit and bank notes that are classified as available-for-sale securities.
(4)
Includes available-for-sale securities based on their amortized costs. The yield information does not give effect to changes in fair value that are reflected as a component of stockholders' equity for available-for-sale securities.
(5)
The average balance amounts include the rights or obligations to cash collateral, which are included in the fair value of derivative assets or derivative liabilities on the Statements of Condition at period end.
(6)
Net interest margin is net interest income before (reversal)/provision for credit losses as a percentage of average total interest earning assets.

The net interest spread and net interest margin decreased in the six-months comparison due, most importantly, to a significant increase in the composition of Advances to total assets and, secondarily, to the unfavorable earnings factors discussed in the previous section. Although the Advance growth resulted in an overall benefit to net interest income because of a larger asset base, the growth lowered the spread and margin because Advances tend to have lower spreads to funding costs compared to mortgage assets. Net interest spread and margin increased in the three-months comparison since the unfavorable factors

63

mentioned in the six-month comparison were more than offset by a significant decrease in net amortization (leading to the increase in average rate on mortgage loans held for portfolio) in the second quarter of 2013.

For both comparison periods, the decline in the average rate on total earning assets resulted from the continued low rate environment and changes in the composition of the balance sheet due to Advance growth and related funding at lower-than-average rates.

Volume/Rate Analysis
Changes in both average balances (volume) and interest rates influence changes in net interest income. The following table summarizes these changes and trends in interest income and interest expense.
(In millions)
Three Months Ended
June 30, 2013 over 2012
 
Six Months Ended
June 30, 2013 over 2012
 
Volume (1)(3)
 
Rate (2)(3)
 
Total
 
Volume (1)(3)
 
Rate (2)(3)
 
Total
Increase (decrease) in interest income
 
 
 
 
 
 
 
 
 
 
 
Advances
$
45

 
$
(27
)
 
$
18

 
$
88

 
$
(61
)
 
$
27

Mortgage loans held for portfolio
(9
)
 
8

 
(1
)
 
(16
)
 
(1
)
 
(17
)
Federal funds sold and securities purchased under resale agreements
—

 
(1
)
 
(1
)
 
1

 
—

 
1

Interest-bearing deposits in banks
—

 
—

 
—

 
(2
)
 
—

 
(2
)
Mortgage-backed securities
19

 
(10
)
 
9

 
29

 
(31
)
 
(2
)
Other investments
(7
)
 
(6
)
 
(13
)
 
(13
)
 
(11
)
 
(24
)
Loans to other FHLBanks
—

 
—

 
—

 
—

 
—

 
—

Total
48

 
(36
)
 
12

 
87

 
(104
)
 
(17
)
Increase (decrease) in interest expense
 
 
 
 
 
 
 
 
 
 
 
Term deposits
—

 
—

 
—

 
—

 
—

 
—

Other interest-bearing deposits
—

 
—

 
—

 
—

 
—

 
—

Short-term borrowings
2

 
1

 
3

 
3

 
7

 
10

Unswapped fixed-rate Bonds
31

 
(51
)
 
(20
)
 
57

 
(108
)
 
(51
)
Unswapped adjustable-rate Bonds
8

 
—

 
8

 
15

 
(1
)
 
14

Swapped Bonds
(2
)
 
(2
)
 
(4
)
 
(5
)
 
(4
)
 
(9
)
Mandatorily redeemable capital stock
(1
)
 
—

 
(1
)
 
(2
)
 
(1
)
 
(3
)
Other borrowings
—

 
—

 
—

 
—

 
—

 
—

Total
38

 
(52
)
 
(14
)
 
68

 
(107
)
 
(39
)
Increase (decrease) in net interest income
$
10

 
$
16

 
$
26

 
$
19

 
$
3

 
$
22

(1)
Volume changes are calculated as the change in volume multiplied by the prior year rate.
(2)
Rate changes are calculated as the change in rate multiplied by the prior year average balance.
(3)
Changes that are not identifiable as either volume-related or rate-related, but rather are equally attributable to both volume and rate changes, have been allocated to the volume and rate categories based upon the proportion of the absolute value of the volume and rate changes.


64

Effect of the Use of Derivatives on Net Interest Income
The following table shows the effect of using derivatives on net interest income. The table does not show the effect on earnings from the non-interest components of derivatives related to market value adjustments. This is provided in the next section “Non-Interest Income and Non-Interest Expense.”
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In millions)
2013
 
2012
 
2013
 
2012
Advances:
 
 
 
 
 
 
 
Amortization/accretion of hedging activities in net interest income
$
(1
)
 
$
(1
)
 
$
(2
)
 
$
(1
)
Net interest settlements included in net interest income
(27
)
 
(77
)
 
(55
)
 
(158
)
Mortgage loans:
 
 
 
 
 
 
 
Amortization of derivative fair value adjustments in net interest income
(1
)
 
(2
)
 
(1
)
 
(3
)
Consolidated Obligation Bonds:
 
 
 
 
 
 
 
Net interest settlements included in net interest income
7

 
9

 
16

 
18

Decrease to net interest income
$
(22
)
 
$
(71
)
 
$
(42
)
 
$
(144
)

Most of our derivatives synthetically convert the intermediate- and long-term fixed interest rates on certain Advances and Bonds to adjustable-coupon rates tied to short-term LIBOR (mostly one- and three-month repricing resets). These adjustable-rate coupons normally carry lower interest rates than the fixed rates. The use of derivatives lowered net interest income in each period primarily because the Advances that were swapped to short-term LIBOR had higher fixed interest rates than the Bonds that were swapped to short-term LIBOR. This reduction in earnings was acceptable because it enabled us, as designed, to significantly lower market risk exposure by creating a much closer match of actual cash flows between assets and liabilities than would occur otherwise. The reduction was significantly smaller in the three- and six-month periods of 2013 compared to the same periods in 2012 primarily due to a decrease in the notional amount of swaps outstanding.

See the section “Use of Derivatives in Market Risk Management” in “Quantitative and Qualitative Disclosures About Risk Management” for further information on our use of derivatives.

Provision for Credit Losses

In the first six months of 2013, we recorded a $6.5 million reversal for estimated incurred credit losses in the MPP compared to a provision for credit losses of $1.4 million in the same period of 2012. The change in estimated credit losses was mostly a result of improvements in the housing market related to higher home prices and improved delinquency trends. Further information is in the "Credit Risk - MPP" section in "Quantitative and Qualitative Disclosures About Risk Management" and Note 9 of the Notes to Unaudited Financial Statements.

65

Non-Interest Income and Non-Interest Expense

The following table presents non-interest income and non-interest expense for each of the three and six months ended June 30, 2013 and 2012.
(Dollars in millions)
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Other Non-Interest Income
 
 
 
 
 
 
 
Net gains on held-to-maturity securities
$
—

 
$
29

 
$
—

 
$
29

Net (losses) gains on derivatives and hedging activities
(1
)
 
3

 
3

 
7

Other non-interest income (loss), net
3

 
(10
)
 
6

 
(15
)
Total other non-interest income
$
2

 
$
22

 
$
9

 
$
21

 
 
 
 
 
 
 
 
Other Expense
 
 
 
 
 
 
 
Compensation and benefits
$
8

 
$
8

 
$
16

 
$
16

Other operating expense
4

 
3

 
8

 
7

Finance Agency
1

 
1

 
2

 
3

Office of Finance
1

 
1

 
3

 
2

Other
2

 
1

 
2

 
—

Total other expense
$
16

 
$
14

 
$
31

 
$
28

Average total assets
$
93,828

 
$
64,898

 
$
89,150

 
$
63,872

Average regulatory capital
5,313

 
3,916

 
5,101

 
3,885

Total other expense to average total assets (1)
0.07
%
 
0.09
%
 
0.07
%
 
0.09
%
Total other expense to average regulatory capital (1)
1.18

 
1.41

 
1.21

 
1.46

(1)
Amounts used to calculate percentages are based on dollars in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.        

The net gains on held-to-maturity securities in 2012 occurred from the sales of $478 million of mortgage-backed securities. Each of the securities sold had less than 15 percent of the original acquired principal remaining and were sold under our periodic clean-up process.

Other non-interest income (loss), net increased in the 2013 periods due primarily to losses recorded on trading securities in 2012 that were no longer held in 2013. As discussed above in “Components of Net Interest Income,” the losses on the trading securities occurred because these securities had above-market coupon rates and, therefore, were purchased at prices above par. The related premiums paid are reflected as mark-to-market losses to the securities as their fair values approach par at maturity. As noted earlier, the resulting net earnings from the trading securities reflected at-market returns.

Other expenses continued to experience modest increases in 2013.


66

Effect of Derivatives and Hedging Activities
(In millions)
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Net (losses) gains on derivatives and hedging activities
 
 
 
 
 
 
 
Advances:
 
 
 
 
 
 
 
Gains on fair value hedges
$
2

 
$
3

 
$
4

 
$
7

Gains (losses) on derivatives not receiving hedge accounting
2

 
(2
)
 
6

 
(2
)
Mortgage loans:
 
 
 
 
 
 
 
(Losses) gains on derivatives not receiving hedge accounting
(5
)
 
1

 
(8
)
 
(2
)
Consolidated Obligation Bonds:
 
 
 
 
 
 
 
Gains on derivatives not receiving hedge accounting
—

 
1

 
1

 
4

Total net (losses) gains on derivatives and hedging activities
(1
)
 
3

 
3

 
7

Net gains on financial instruments held at fair value (1)
—

 
—

 
1

 
2

Total net effect of derivatives and hedging activities
$
(1
)
 
$
3

 
$
4

 
$
9

(1)
Includes only those gains or losses on financial instruments held at fair value that have an economic derivative "assigned."

The changes in net (losses) gains on derivatives and hedging activities represented unrealized market value adjustments. The amounts of income volatility in derivatives and hedging activities were minor compared to the notional principal amounts, well within the range of normal historical fluctuation, and consistent with the close hedging relationships of our derivative transactions. In each of the periods shown, the market value adjustment, as a percentage of notional derivatives principal, was less than 0.10 percentage points.

Affordable Housing Program Assessments

In the first six months of 2013, assessments totaled $14 million and lowered ROE by 0.58 percentage points. In the first six months of 2012, assessments totaled $13 million and lowered ROE by 0.73 percentage points. The smaller impact of assessments on ROE in the first six months of 2013 was due primarily to the growth in capital throughout 2012 and the first six months of 2013.
 
 
 
 
 
 

67

Segment Information

Note 17 of the Notes to Unaudited Financial Statements presents information on our two operating business segments. We manage financial operations and market risk exposure primarily at the macro level, and within the context of the entire balance sheet, rather than exclusively at the level of individual segments. Under this approach, the market risk/return profile of each segment may not match, or possibly even have the same trends as, what would occur if we managed each segment on a stand-alone basis. The tables below summarize each segment's operating results for the periods shown.
(Dollars in millions)
Traditional Member Finance
 
Mortgage Purchase Program
 
Total
Three Months Ended June 30, 2013
 
 
 
 
 
Net interest income after reversal for credit losses
$
56

 
$
27

 
$
83

Net income
$
44

 
$
18

 
$
62

Average assets
$
86,698

 
$
7,130

 
$
93,828

Assumed average capital allocation
$
4,779

 
$
392

 
$
5,171

Return on Average Assets (1)
0.20
%
 
1.02
%
 
0.26
%
Return on Average Equity (1)
3.67
%
 
18.62
%
 
4.80
%
 
 
 
 
 
 
Three Months Ended June 30, 2012
 
 
 
 
 
Net interest income after provision for credit losses
$
41

 
$
12

 
$
53

Net income
$
45

 
$
10

 
$
55

Average assets
$
56,727

 
$
8,171

 
$
64,898

Assumed average capital allocation
$
3,181

 
$
458

 
$
3,639

Return on Average Assets (1)
0.32
%
 
0.49
%
 
0.34
%
Return on Average Equity (1)
5.63
%
 
8.80
%
 
6.03
%
(1)
Amounts used to calculate returns are based on numbers in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.
 
 
 
 
 
 

68

 
 
 
 
 
 
(Dollars in millions)
Traditional Member Finance
 
Mortgage Purchase Program
 
Total
Six Months Ended June 30, 2013
 
 
 
 
 
Net interest income after reversal for credit losses
$
104

 
$
57

 
$
161

Net income
$
85

 
$
40

 
$
125

Average assets
$
81,884

 
$
7,266

 
$
89,150

Assumed average capital allocation
$
4,531

 
$
402

 
$
4,933

Return on Average Assets (1)
0.21
%
 
1.11
%
 
0.28
%
Return on Average Equity (1)
3.80
%
 
20.03
%
 
5.13
%
 
 
 
 
 
 
Six Months Ended June 30, 2012
 
 
 
 
 
Net interest income after provision for credit losses
$
92

 
$
40

 
$
132

Net income
$
81

 
$
31

 
$
112

Average assets
$
55,787

 
$
8,085

 
$
63,872

Assumed average capital allocation
$
3,147

 
$
456

 
$
3,603

Return on Average Assets (1)
0.29
%
 
0.76
%
 
0.35
%
Return on Average Equity (1)
5.21
%
 
13.53
%
 
6.26
%
(1)
Amounts used to calculate returns are based on numbers in thousands. Accordingly, recalculations based upon the disclosed amounts (millions) may not produce the same results.

Traditional Member Finance Segment
The increase in net interest income in both the three- and six-month comparison periods reflected the net effect of the factors related to this segment as discussed in "Components of Net Interest Income."

ROE decreased even though net income did not change significantly due primarily to an increase in average total capital to support Advance growth, which diluted ROE because earnings were spread over a larger capital base.

MPP Segment
The MPP continued to earn a substantial level of return compared with market interest rates, with a moderate amount of market risk and credit risk. In the first six months of 2013, the MPP averaged eight percent of total average assets while accounting for 32 percent of earnings.

MPP's net income and ROE increased significantly in the first six months of 2013 compared to the same period in 2012 due to decreases in MPP net amortization and credit losses, in addition to management actions to call and replace MPP-related long-term funding at lower rates. ROE also benefited from a smaller base of allocated capital corresponding to the increase in financial leverage of the overall balance sheet. These favorable factors were partially offset by a decrease in the MPP loan balances with principal paydowns of high-yielding loans and a decrease in the amount of short-funding allocated to the segment.

Compared to the Traditional Member Finance segment, the MPP segment can exhibit more earnings volatility relative to short-term interest rates and more credit risk exposure, but also provides the opportunity for enhancing risk-adjusted returns which normally augments earnings. As discussed elsewhere, although mortgage assets are the largest source of our market risk, we believe that we have historically managed the risk prudently and that these assets do not excessively elevate the balance sheet's overall market risk exposure.



69

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK MANAGEMENT

Market Risk

Market Value of Equity and Duration of Equity - Entire Balance Sheet
Market risk exposure is the risk that net income and the value of stockholders' capital investment in the FHLBank may decrease, and that our profitability may be uncompetitive as a result of changes in the market environment and business conditions. Along with business/strategic risk, market risk is normally one of our largest residual risks. We attempt to maintain a moderate amount of market risk exposure while earning a competitive return on members' capital stock investment.

Two key measures of long-term market risk exposure are the sensitivities of the market value of equity and the duration of equity to changes in interest rates and other variables, as presented in the following tables for various instantaneous and permanent interest rate shocks. Average results are compiled using data for each month end. Given the current very low level of rates, the down rate shocks are nonparallel scenarios, with short-term rates decreasing less than long-term rates so that no rate falls below zero.

Market Value of Equity
(Dollars in millions)
Down 300
 
Down 200
 
Down 100
 
Flat Rates
 
Up 100
 
Up 200
 
Up 300
Average Results
 
 
 
 
 
 
 
 
 
 
 
 
 
2013 Year-to-Date
 
 
 
 
 
 
 
 
 
 
 
 
 
Market Value of Equity
$
5,254

 
$
5,257

 
$
5,241

 
$
5,141

 
$
5,000

 
$
4,837

 
$
4,675

% Change from Flat Case
2.2
 %
 
2.3
 %
 
1.9
 %
 
—

 
(2.7
)%
 
(5.9
)%
 
(9.1
)%
2012 Full Year
 
 
 
 
 
 
 
 
 
 
 
 
 
Market Value of Equity
$
4,281

 
$
4,279

 
$
4,292

 
$
4,330

 
$
4,337

 
$
4,186

 
$
3,955

% Change from Flat Case
(1.1
)%
 
(1.2
)%
 
(0.9
)%
 
—

 
0.2
 %
 
(3.3
)%
 
(8.7
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Month-End Results
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
Market Value of Equity
$
5,458

 
$
5,490

 
$
5,427

 
$
5,237

 
$
5,026

 
$
4,806

 
$
4,598

% Change from Flat Case
4.2
 %
 
4.8
 %
 
3.6
 %
 
—

 
(4.0
)%
 
(8.2
)%
 
(12.2
)%
December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
Market Value of Equity
$
4,991

 
$
4,976

 
$
4,947

 
$
4,878

 
$
4,759

 
$
4,585

 
$
4,401

% Change from Flat Case
2.3
 %
 
2.0
 %
 
1.4
 %
 
—

 
(2.4
)%
 
(6.0
)%
 
(9.8
)%

Duration of Equity
 
(In years)
Down 300
 
Down 200
 
Down 100
 
Flat Rates
 
Up 100
 
Up 200
 
Up 300
Average Results
 
 
 
 
 
 
 
 
 
 
 
 
 
2013 Year-to-Date
1.2

 
1.0

 
1.7

 
3.0

 
3.1

 
3.5

 
3.4

2012 Full Year
1.8

 
1.3

 
0.4

 
(1.4
)
 
2.0

 
4.9

 
6.4

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Month-End Results
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2013
0.3

 
1.3

 
3.6

 
3.9

 
4.4

 
4.5

 
4.4

December 31, 2012
1.8

 
1.8

 
1.8

 
1.9

 
3.2

 
4.1

 
4.1


During the first six months of 2013, as in 2012, the market risk exposure to changing interest rates was moderate overall, consistent with long-term historical average exposure, and well within policy limits. Overall market risk and earnings exposure to further reductions in long-term rates continued to benefit from slower mortgage prepayment speeds (given the level of rates and composition of mortgage assets), than would be expected under normal conditions for housing markets.



70

The effect of the moderate absolute amount of increases in interest rates experienced in the last two months of the second quarter of 2013 had a small impact on measured market risk exposure to further rising rates, which is primarily attributable to our hedging practices and the stable cashflow expectations of the composition of mortgage-backed securities collateral. Moderate increases in market risk exposure to increasing rates measured at the end of the second quarter were largely driven by a greater portion of long-term assets being funded with shorter-term liabilities, which is a result of normal variations within standard business activity.

Based on the totality of our market risk analysis, we expect that profitability, defined as the level of ROE compared with short-term market rates, will remain competitive unless interest rates change by extremely large amounts in a short period of time. Decreases in long-term interest rates even up to two percentage points (which would put fixed-rate mortgages at two percent or less) would still result in ROE being above market interest rates. We believe that profitability would not become uncompetitive in a rising rate environment unless long-term rates were to permanently increase in a short period of time by as much as five percentage points or more combined with short-term rates increasing to at least eight percent. Such large changes in interest rates would not result in negative earnings, unless these rate environments occurred quickly, lasted for a long period of time, and were coupled with very unfavorable changes in other market and business variables for our business model. We believe such a scenario is extremely unlikely to occur.

Market Capitalization Ratio
The following table presents the market capitalization ratios for the interest rate environments for which we have policy limits.
 
June 30, 2013
 
December 31, 2012
Market Value of Equity to Par Value of Regulatory Capital Stock
109
%
 
116
%
Market Value of Equity to Par Value of Regulatory Capital Stock - Down Shock of 200 bps
113

 
117

Market Value of Capital to Par Value of Regulatory Capital Stock - Up Shock of 200 bps
100

 
109


In the first six months of 2013, the market capitalization ratios in the scenarios indicated continued to be at or above 100 percent and in compliance with policy limits. However, the ratios declined during this period primarily due to a decline in the amount of mortgage asset leverage due to the increase in our capital base as explained elsewhere in this filing. Moderately lower market prices on mortgage assets, the purchase of new mortgage-backed securities investments at discounted prices, and higher mortgage rates (which normally lowers the market value of equity) were contributing factors as well.

The market capitalization ratio can be a valuable measure of risk exposure, particularly when the fluctuations observed in the metric are driven by market risk factors. However, the recently observed declines have been largely due to more capital and the corresponding reduction in mortgage asset leverage, which has inherently reduced our overall exposure to market risk.

Even with the recent decline, the ratios remain at favorable levels due to the combination of 1) the fact that retained earnings are currently 12 percent of regulatory capital stock, 2) we have maintained market risk exposure at moderate levels, and 3) market prices of some mortgage assets continue to be at elevated levels compared to the prices of our Bonds.



71

Market Risk Exposure of the Mortgage Assets Portfolio
The mortgage assets portfolio normally accounts for almost all of our market risk exposure because of prepayment volatility that we cannot completely hedge while maintaining positive net spreads. Sensitivities of the market value of equity allocated to the mortgage assets portfolio under interest rate shocks (in basis points) are shown below. At June 30, 2013 the mortgage assets portfolio had an assumed par-value equity (capital) allocation of $1.3 billion based on the entire balance sheet's regulatory capital-to-assets ratio. Average results are compiled using data for each month-end. The market value sensitivities are one measure we use to analyze the portfolio's estimated market risk exposure.

% Change in Market Value of Equity-Mortgage Assets Portfolio
 
Down 300
 
Down 200
 
Down 100
 
Flat Rates
 
Up 100
 
Up 200
 
Up 300
Average Results
 
 
 
 
 
 
 
 
 
 
 
 
 
2013 Year-to-Date
2.8
 %
 
4.5
 %
 
5.4
 %
 
—
 
(12.6
)%
 
(26.9
)%
 
(41.6
)%
2012 Full Year
(9.2
)%
 
(8.2
)%
 
(5.4
)%
 
—
 
2.0
 %
 
(8.2
)%
 
(24.7
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Month-End Results
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2013
9.4
 %
 
13.7
 %
 
11.5
 %
 
—
 
(16.3
)%
 
(33.5
)%
 
(50.2
)%
December 31, 2012
3.5
 %
 
3.5
 %
 
3.1
 %
 
—
 
(10.0
)%
 
(24.0
)%
 
(39.1
)%

The sensitivities indicate that the market risk exposure of the mortgage assets portfolio had similar trends across interest rate shocks as those of the entire balance sheet. The dollar amount of exposure for any individual rate shock can be obtained by multiplying the percentage change by the assumed equity allocation.

The measured risk exposure of our mortgage assets portfolio, on average, increased in the first six months of 2013 relative to all of 2012. Much of the change resulted from prepayment modeling enhancements made in 2012 to better capture the evolving dynamics of borrower prepayment behavior in the unprecedented housing and mortgage markets. The net impact of these changes was a moderate reduction in expected mortgage prepayment speeds, and consequently, a projected extension of mortgage cashflows, which have increased measured market risk in rising rate environments.

We believe the mortgage assets portfolio continues to have an acceptable amount of market risk exposure relative to the inherent market risks of owning mortgages and relative to their actual and expected profitability. We believe this exposure is consistent with our risk philosophy and cooperative business model.

Use of Derivatives in Market Risk Management
In addition to issuing long-term Bonds, we may engage in derivative transactions, primarily interest rate swaps and forward settlement agreements of mortgage-backed securities, to manage market risk exposure. Our hedging and risk management strategies for when we use derivatives did not change, nor were there any changes in the accounting treatment of new or existing derivative hedge transactions that materially affected our results of operations.

However, the notional amount of derivatives decreased significantly, by $5.7 billion (47 percent), from the end of 2012 to June 30, 2013, with most of the decrease occurring in swaps associated with Consolidated Bonds. The reduction was due primarily to our decision to avoid transacting new interest rates swaps (i.e., swapped fixed-rate Bonds) in light of the current unresolved uncertainties with costs, operating and regulatory processes, and credit risks associated with derivatives clearing requirements under the Dodd-Frank Act. The decrease in interest rate swaps did not materially affect our market risk exposure or profitability because the reduction in Bond-related swaps was replaced with short-term Discount Notes and unswapped adjustable-rate Bonds, each of which have a similar interest rate risk profile and interest cost as the interest rate risk profile resulting from hedging Bonds with interest rate swaps.

Capital Adequacy

Capital Leverage
Prudent risk management dictates that we maintain effective financial leverage to minimize risk to our capital stock while preserving profitability and that we hold an adequate amount of retained earnings. We have always complied with each capital requirement. The regulatory capital ratio averaged 5.72 percent in the first six months of 2013 and at June 30, 2013 was 5.66 percent. The latter metric means that, given the amount of regulatory capital, total assets could increase by approximately $40 billion with no new stock purchases before the capital-to-assets ratio would fall to four percent. This amount of growth in assets

72

is unlikely to occur and, if it did, our Capital Plan would require us to obtain additional amounts of capital well before the four percent policy limit on capitalization would be reached.

See the “Capital Resources” section of “Analysis of Financial Condition” and Note 14 of the Notes to Unaudited Financial Statements for more information on our capital adequacy.

Retained Earnings
Our Board-approved Retained Earnings and Dividend Policy sets forth a range for the amount of retained earnings we believe is needed to mitigate impairment risk and augment dividend stability in light of the risks we face. The current minimum retained earnings requirement is $375 million, based on mitigating quantifiable risks under stress scenarios to at least a 99 percent confidence level. Given the recent financial and regulatory environment, we have been carrying a greater amount of retained earnings in the last several years than required by the Policy. As discussed elsewhere, we will continue to bolster capital adequacy over time by allocating a portion of earnings to a separate restricted retained earnings account in accordance with the FHLBank System's Capital Agreement.
 
 
 
 
 
 
Credit Risk

Overview
We assume a substantial amount of inherent credit risk exposure in our dealings with members, purchases of investments, and transactions of derivatives. For the reasons detailed below, we believe we have a minimal overall amount of residual credit risk exposure related to our Credit Services, purchases of investments, and transactions in derivatives and a moderate amount of legacy credit risk exposure related to the MPP.

Credit Services
Overview. We have policies and practices to manage credit risk exposure from our secured lending activities, which include Advances and Letters of Credit. The objective of our credit risk management is to equalize risk exposure across members and counterparties to a zero level of expected losses, consistent with our risk management appetite to have no residual credit risk related to member borrowings.

Despite continued, although stabilizing, effects from the deterioration in the credit conditions of many of our members and in the value of some pledged collateral over the last five years, we believe that credit risk exposure in our secured lending activities continued to be minimal in the first six months of 2013, for the same reasons described in the 2012 Form 10-K. We have never established a loan loss reserve for Advances and expect to collect all amounts due according to the contractual terms of Advances and Letters of Credit.

Collateral. We require each member to provide us a security interest in eligible collateral before it can undertake any secured borrowing. At June 30, 2013, our policy of over-collateralization resulted in total collateral pledged of $211.5 billion to serve members' total borrowing capacity of $162.2 billion. The estimated value of pledged collateral is discounted in order to offset market, credit, and liquidity risks that may affect the collateral's realizable value in the event it must be liquidated. Over-collateralization by one member is not applied to another member.

The table below shows the total pledged collateral (unadjusted for CMRs) on June 30, 2013 and December 31, 2012.
 
June 30, 2013
 
December 31, 2012
(Dollars in billions)
 
 
Percent of Total
 
 
 
Percent of Total
 
Collateral Amount
 
Pledged Collateral
 
Collateral Amount
 
Pledged Collateral
Single family loans
$
115.4

 
55
%
 
$
111.6

 
56
%
Multi-family loans
29.7

 
14

 
17.6

 
9

Commercial real estate
23.3

 
11

 
19.2

 
10

Bond securities
22.6

 
11

 
25.0

 
13

Home equity loans/lines of credit
20.0

 
9

 
24.1

 
12

Farm real estate
0.5

 
(a)

 
0.5

 
(a)

Total
$
211.5

 
100
%
 
$
198.0

 
100
%

(a)
Less than one percent of total pledged collateral.


73

At June 30, 2013, 64 percent of collateral was related to residential mortgage lending in single family loans and home equity lines. The increase in multi-family loans and commercial real estate during the first half of 2013 was due to the collateral pledged by our largest member.

Borrowing Capacity/Lendable Value. We determine borrowing capacity against pledged collateral by establishing minimum levels of over-collateralization ("Collateralized Maintenance Requirements" or "CMRs"). CMRs are determined by statistical analysis and certain management assumptions applied to the estimated value of pledged collateral. All securities collateral and loan collateral pledged by certain members is subject to an ongoing market valuation process. CMRs result in a lendable value, or borrowing capacity, that is less than the amount of pledged collateral. CMRs vary based on the financial strength of the member institution, the issuer of bond collateral or the quality of securitized assets, the marketability of the pledged assets, the payment performance of pledged loan collateral, and the quality of loan collateral as reflected in the manner in which it was underwritten and is administered.

The table below indicates the range of lendable values remaining after the application of CMRs for each major collateral type pledged at June 30, 2013.
 
Lending Values Applied to Collateral
Blanket Status
 
Prime 1-4 family loans
67-83%
Multi-family loans
51-65%
Prime home equity loans/lines of credit
53-71%
Commercial real estate loans
59-74%
Farm real estate loans
65-80%
Listing Status/Physical Delivery
 
Cash/U.S. Government/U.S. Treasury/U.S. agency securities
78-100%
U.S. agency MBS/CMOs
87-98%
Private-label residential MBS
42-83%
Private-label commercial MBS
31-83%
Small Business Administration certificates
90-93%
1-4 family loans
65-91%
Multi-family loans
57-83%
Home equity loans/lines of credit
57-83%
Commercial real estate loans
65-91%
Farm real estate loans
67-91%

The ranges of lendable values exclude subprime and nontraditional mortgage loan collateral. Loans pledged under a Blanket collateral status generally are discounted more heavily than loans on which we have detailed loan structure and underwriting information. We periodically evaluate the CMRs applied by completing internal evaluations or engaging third-party specialists.

Subprime and Nontraditional Mortgage Loan Collateral. Based on our collateral reviews, we estimate that approximately 20 to 25 percent of pledged residential loan collateral has one or more subprime characteristics and that approximately two to five percent of pledged collateral meets the industry definition of “nontraditional.” We apply significantly higher adjustments to the standard CMRs on almost all collateral identified as subprime and/or nontraditional mortgages. No security known to have more than one-third subprime collateral is eligible for pledge to support additional credit borrowings.

Internal Credit Ratings. We assign all member and nonmember borrowers an internal credit rating, based on a combination of internal credit analysis and consideration of available credit ratings from independent credit rating organizations. The credit ratings are used in conjunction with other measures of the credit risk posed by members and pledged collateral, as described above, in managing credit risk exposure to Advances.


74

The following tables show the distribution of internal credit ratings we assigned to member and nonmember borrowers, which we use to help manage credit risk exposure. The lower the numerical rating, the higher our assessment of the member's credit quality.
(Dollars in billions)
 
 
 
 
 
 
June 30, 2013
 
December 31, 2012
 
 
Borrowers
 
 
 
Borrowers
 
 
 
 
Collateral-Based
 
 
 
 
 
Collateral-Based
Credit
 
 
 
Borrowing
 
Credit
 
 
 
Borrowing
Rating
 
Number
 
Capacity
 
Rating
 
Number
 
Capacity
1-3
 
490

 
$
97.5

 
1-3
 
485

 
$
67.9

4
 
134

 
59.0

 
4
 
126

 
66.2

5
 
58

 
4.5

 
5
 
71

 
4.3

6
 
35

 
0.6

 
6
 
31

 
0.8

7
 
27

 
0.6

 
7
 
38

 
1.2

Total
 
744

 
$
162.2

 
Total
 
751

 
$
140.4


A “4” rating is our assessment of the lowest level of satisfactory performance. Some members continue to be adversely affected by the last recession and the slow economic recovery. The housing market, the primary factor negatively affecting member institutions, has experienced consistent signs of recovery beginning in most regions during the second quarter of 2012. As of June 30, 2013, 120 borrowers (16 percent of the total) had credit ratings of 5 through 7, a net decrease of 20 from the end of 2012. These members had $5.7 billion of borrowing capacity at June 30, 2013. There was a net increase of 8 members who had a 4 credit rating and a net increase of 5 members with credit ratings of 1, 2, or 3. We believe these trends indicate a general stabilization and improvement in the overall financial condition of our members, although the improvement to date has been most evident among members with already-acceptable "4" credit ratings.

Member Failures, Closures, and Receiverships. There were two member failures in 2013 through the date of this filing. All Advance exposure to these members was fully collateralized by assets held in our custody at the time of failure. These members had $54 million of Advances outstanding, all of which have since been repaid. We had no other outstanding exposure to these members.

Member Concentration. Borrower concentration increased substantially compared with levels over the last several years due to an increase in borrowings from one member, JPMorgan, over the prior 12 months. We believe the effect on credit risk exposure is minimal because of our application of normal credit risk mitigations, the most important of which is over-collateralization. In the extremely remote possibility that a high concentration member would fail, combined with the Federal Deposit Insurance Corporation's decision not to repay Advances, we would implement our member failure plan to liquidate collateral to recover losses from losing principal and interest on the Advances balances.

MPP
Overview. We believe that the residual amount of credit risk exposure to loans in the MPP is moderate and declining, based on the same factors described in the 2012 Form 10-K. Charge-offs totaled $2.2 million in the first six months of 2013 and $12.0 million program-to-date through June 30, 2013 in relation to $6.0 billion of conventional loans unpaid principal balance at June 30, 2013. In addition to the low program-to-date charge-offs, we believe based on our financial analysis that future credit losses will not harm capital adequacy and will not significantly affect profitability except under the most extreme and unlikely credit conditions.


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Portfolio Loan Characteristics. The following table shows Fair Isaac and Company (FICO®) credit scores of homeowners at origination dates for the conventional loan portfolio.
FICO® Score (1)                    
 
June 30, 2013
 
December 31, 2012
< 620
 
—
%
 
—
%
620 to < 660
 
3

 
3

660 to < 700
 
9

 
9

700 to < 740
 
18

 
18

>= 740
 
70

 
70

 
 
 
 
 
Weighted Average
 
757

 
757

(1)
Represents the FICO® score at origination.

There was little change in the distribution of FICO® scores at origination in the first six months of 2013 compared with 2012. We believe the distribution of FICO® scores at origination is one indication of the portfolio's overall favorable credit quality. At June 30, 2013, 70 percent of the portfolio had scores at an excellent level of 740 or above and 88 percent had scores above 700 which is a threshold generally considered indicative of homeowners' with good credit quality.

The following tables show loan-to-value ratios for conventional loans based on values estimated at the origination dates and current values estimated at the noted periods. The estimated current ratios are based on original loan values, principal paydowns that have occurred since origination, and a third-party estimate of changes in historical home prices for the zip code in which each loan resides. Both measures are weighted by current unpaid principal.
 
 
Based on Estimated Origination Value
 
 
 
Based On Estimated Current Value
Loan-to-Value
 
June 30, 2013
 
December 31, 2012
 
Loan-to-Value
 
June 30, 2013
 
December 31, 2012
<= 60%
 
19
%
 
20
%
 
<= 60%
 
35
%
 
27
%
> 60% to 70%
 
18

 
18

 
> 60% to 70%
 
28

 
20

> 70% to 80%
 
53

 
52

 
> 70% to 80%
 
25

 
29

> 80% to 90%
 
6

 
6

 
> 80% to 90%
 
8

 
14

> 90%
 
4

 
4

 
> 90% to 100%
 
2

 
5

 
 
 
 
 
 
> 100%
 
2

 
5

Weighted Average
 
71
%
 
70
%
 
Weighted Average
 
64
%
 
69
%

Overall loan-to-value ratios continue to show positive trends as the overall housing market continues to display strong signs of sustained recovery. At June 30, 2013, 12 percent of loans were estimated to have current loan-to-value ratios above 80 percent, up from ten percent at origination which indicates that some housing regions are still recovering. However, we estimate the portfolio on aggregate to have a weighted average loan-to-value ratio of 64 percent, which is 7 percent lower than what was estimated at origination. We believe the overall trend is consistent with an acceptable credit quality of the portfolio, in light of the significant deterioration in national average housing prices in recent years.

Based on the available data, we believe we have little exposure to loans in the MPP considered to have characteristics of “subprime” or “alternative/nontraditional” loans. Further, we do not knowingly purchase any loan that violates the terms of our Anti-Predatory Lending Policy.
 
 
 
 
 
Lender Risk Account. The Lender Risk Account is one way we mitigate our exposure to credit losses. The Account is a purchase-price holdback that PFIs may receive back from us, starting after five years from the loan purchase date, for managing credit risk to pre-defined acceptable levels of exposure on loan pools they sell to us. The amount of loss claims against the Lender Risk Account in the first six months of 2013 was approximately $2 million. The Account had balances of $110 million and $103 million at June 30, 2013 and December 31, 2012, respectively. For more information, see Note 9 of the Notes to Unaudited Financial Statements.


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Credit Performance. The table below provides an analysis of conventional loans delinquent or in foreclosure, along with the national average serious delinquency rate.
 
Conventional Loan Delinquencies
(Dollars in millions)
June 30, 2013
 
December 31, 2012
Early stage delinquencies - unpaid principal balance (1)
$
57

 
$
64

Serious delinquencies - unpaid principal balance (2)
63

 
76

Early stage delinquency rate (3)
1.0
%
 
1.0
%
Serious delinquency rate (4)
1.1

 
1.2

National average serious delinquency rate (5)
3.2

 
3.7

(1)
Includes conventional loans 30 to 89 days delinquent and not in foreclosure.
(2)
Includes conventional loans that are 90 days or more past due or where the decision of foreclosure or a similar alternative such as pursuit of deed-in-lieu has been reported.
(3)
Early stage delinquencies expressed as a percentage of the total conventional loan portfolio.
(4)
Serious delinquencies expressed as a percentage of the total conventional loan portfolio.
(5)
National average number of fixed-rate prime conventional loans that are 90 days or more past due or in the process of foreclosure is based on the most recent national delinquency data available. The June 30, 2013 rate is based on March 31, 2013 data.

The MPP has experienced a moderate amount of delinquencies and foreclosures. These rates continued to be well below national averages and we expect this to continue to be the case. We believe that these data, both early and serious delinquency levels, indicate an improving trend in housing market conditions. We continue to closely monitor these data to evaluate the sustainability of the trend.

We consider a high risk loan as having a current loan-to-value ratio above 100 percent. At June 30, 2013, high risk loans had experienced relatively moderate serious delinquencies (i.e., delinquencies that are 90 days or more past due or in the process of foreclosure). For example, of the $147 million of conventional principal balances with current estimated loan-to-values above 100 percent, only $13 million (nine percent) were seriously delinquent. We believe these data further support our view that the overall portfolio is comprised of high quality loans.

Credit Losses. The following table shows the effects of credit enhancements on the determination of the allowance for credit losses at the noted periods.
(In millions)
June 30, 2013
 
December 31, 2012
Estimated incurred credit losses, before credit enhancements
$
(35
)
 
$
(56
)
Estimated amounts deemed recoverable by:
 
 
 
Primary mortgage insurance
3

 
5

Supplemental mortgage insurance
19

 
25

Lender Risk Account
4

 
8

Allowance for credit losses, after credit enhancements
$
(9
)
 
$
(18
)
 
The data presented above are aggregated information on the health of the overall portfolio. Credit risk exposure depends on the actual and potential credit performance of the loans in each pool compared to the pool's equity (on individual loans) and credit enhancements, including primary mortgage insurance (PMI) (for individual loans), the Lender Risk Account, and supplemental mortgage insurance (SMI).

The reduction in the allowance for credit losses at June 30, 2013 compared to the end of 2012 was driven primarily by improvements in the housing market as reflected by an estimated six percent growth in national home prices in the first six months of 2013 and an improving trend of delinquencies. We cannot predict the future course of factors that determine incurred credit losses, including home prices, macro-economic conditions such as unemployment rates, estimated loss severities, the health of mortgage insurance providers, and regulatory or accounting guidance.

In addition to the allowance for credit losses recorded, we regularly analyze, using recognized third-party credit and prepayment models, potential ranges of additional lifetime credit risk exposure for the loans in the MPP. Even under adverse scenarios for either home prices or unemployment rates, we do not expect further credit losses to significantly decrease our overall annual profitability or dividends payable to members, or to materially affect our capital adequacy. For example, for an

77

additional 20 percent decline in all home prices over the next two years, we estimate that our lifetime credit losses, net of the effect of credit enhancements, could increase by approximately $34 million, which would decrease annual ROE by approximately 0.10 percentage points over the next five years (most of the losses are estimated to occur in the next five years).

Credit Risk Exposure to Insurance Providers.
PMI
Some of our conventional loans carry PMI as a credit enhancement feature. Based on the guidelines of the MPP, we have assessed that we do not have any credit risk exposure to the primary mortgage insurance providers.

SMI
Another credit enhancement feature is SMI purchased from Genworth and MGIC. Beginning February 1, 2011, we discontinued use of SMI as a credit enhancement for new loan purchases; instead, we augment credit enhancements with a greater amount of the purchase proceeds added to the Lender Risk Account. However, we have $2.8 billion of conventional loans purchased prior to February 2011 with outstanding SMI coverage through Genworth and MGIC that are paying down over time.

In a scenario in which home prices do not change and both providers fail to pay their insurance coverage on defaulting loans (with an assumption that we would obtain a 50 percent recovery rate), we estimate our exposure at June 30, 2013 to the providers over the life of the MPP loans to be approximately $12 million. In an adverse scenario in which home prices decline an additional 20 percent over the next two years and both providers fail to pay claims (with the same recovery assumption), we estimate exposure to be approximately $21 million.

Based on our most-recent analysis including consulting with a third-party rating agency, we believe it is likely each provider will fulfill its contractual insurance obligations. However, because of the uncertainty of this assessment we concluded, as of June 30, 2013, that payments on a portion of our SMI coverage may not be probable and have incorporated an estimate of such in our loan loss reserve. We believe that $0.9 million of payments may not be probable at June 30, 2013. The estimation of SMI exposure, similar to overall trends of our loan losses, has declined in the last year.




78

Investments
Liquidity Investments. The following table presents the carrying value of liquidity investments outstanding in relation to the counterparties' lowest long-term credit ratings provided by Standard & Poor's, Moody's, and/or Fitch Advisory Services. For resell agreements, the ratings shown are based on ratings on the associated collateral.
(In millions)
June 30, 2013
 
Long-Term Rating
 
AAA
 
AA
 
A
 
Total
Unsecured Liquidity Investments
 
 
 
 
 
 
 
Federal funds sold
$
—

 
$
2,235

 
$
3,415

 
$
5,650

Certificates of deposit
—

 
600

 
425

 
1,025

Total unsecured liquidity investments
—

 
2,835

 
3,840

 
6,675

Guaranteed/Secured Liquidity Investments
 
 
 
 
 
 
 
Securities purchased under agreements to resell
—

 
1,450

 
—

 
1,450

Government-sponsored enterprises (1)
—

 
26

 
—

 
26

Total guaranteed/secured liquidity investments
—

 
1,476

 
—

 
1,476

Total liquidity investments
$
—

 
$
4,311

 
$
3,840

 
$
8,151

 
December 31, 2012
 
Long-Term Rating
 
AAA
 
AA
 
A
 
Total
Unsecured Liquidity Investments
 
 
 
 
 
 
 
Federal funds sold
$
—

 
$
1,640

 
$
1,710

 
$
3,350

Total unsecured liquidity investments
—

 
1,640

 
1,710

 
3,350

Guaranteed/Secured Liquidity Investments
 
 
 
 
 
 
 
Securities purchased under agreements to resell
—

 
3,800

 
—

 
3,800

Government-sponsored enterprises (1)
—

 
26

 
—

 
26

Total guaranteed/secured liquidity investments
—

 
3,826

 
—

 
3,826

Total liquidity investments
$
—

 
$
5,466

 
$
1,710

 
$
7,176

(1)
Consists of securities that are issued and effectively guaranteed by Fannie Mae and/or Freddie Mac, which have the support of the U.S. government, although they are not obligations of the U.S. government.

We actively monitor our credit exposure and the credit quality of all of our counterparties. This includes ongoing assessments of each counterparty's financial condition, performance, and capital adequacy, sovereign support, the market's current perceptions of the counterparty's market presence and activities, and general macro-economic, political, and market conditions. We believe all of the liquidity investments were purchased from counterparties that have a strong ability to repay principal and interest. We currently limit such investments to counterparties with credit ratings at time of purchase at single-A or above, and we are aggressive in restricting maturities, reducing dollar exposure, and suspending new investments with counterparties we deem to represent elevated credit risk.

In the last few years, we have generally invested in secured resale agreements, guaranteed investments, overnight Federal funds, and certificates of deposit which are negotiable and held in available-for-sale accounts. At June 30, 2013 and December 31, 2012, a portion of liquidity investments were purchased from counterparties for which the investments are secured with collateral (securities purchased under agreements to resell). We believe these investments present no credit risk exposure to us.




79

The following table presents credit ratings of our unsecured investment credit exposures 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.
(In millions)
 
June 30, 2013
 
 
 
 
Counterparty Rating (1)
 
 
Domicile of Counterparty
 
Sovereign Rating (1)
 
AA
 
A
 
Total
Domestic
 
AA+
 
$
350

 
$
690

 
$
1,040

U.S. branches and agency offices of foreign commercial banks:
 
 
 
 
 
 
 
 
Australia
 
AAA
 
995

 
—

 
995

Canada
 
AAA
 
—

 
960

 
960

Sweden
 
AAA
 
—

 
960

 
960

United Kingdom
 
AA+
 
—

 
750

 
750

Finland
 
AAA
 
745

 
—

 
745

Netherlands
 
AAA
 
745

 
—

 
745

Norway
 
AAA
 
—

 
480

 
480

Total U.S. branches and agency offices of foreign commercial banks
 

 
2,485

 
3,150

 
5,635

Total unsecured investment credit exposure
 

 
$
2,835

 
$
3,840

 
$
6,675

(1)
Represents the lowest long-term credit rating provided by Standard & Poor's, Moody's, and/or Fitch Advisory Services.

The following table presents the remaining contractual maturity of our unsecured investment credit exposure 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.
(In millions)
 
June 30, 2013
Domicile of Counterparty
 
Overnight
 
Due 2 days through 30 days
 
Due 31 days through 90 days
 
Total
Domestic
 
$
640

 
$
50

 
$
350

 
$
1,040

U.S. branches and agency offices of foreign commercial banks:
 
 
 
 
 
 
 
 
Australia
 
745

 
—

 
250

 
995

Canada
 
585

 
375

 
—

 
960

Sweden
 
960

 
—

 
—

 
960

United Kingdom
 
750

 
—

 
—

 
750

Finland
 
745

 
—

 
—

 
745

Netherlands
 
745

 
—

 
—

 
745

Norway
 
480

 
—

 
—

 
480

Total U.S. branches and agency offices of foreign commercial banks
 
5,010

 
375

 
250

 
5,635

Total unsecured investment credit exposure
 
$
5,650

 
$
425

 
$
600

 
$
6,675


At June 30, 2013, all of the $6.7 billion of unsecured liquidity exposure was to counterparties with holding companies domiciled in countries receiving either triple-A or double-A long-term sovereign ratings. Furthermore, the majority of unsecured lending is restricted to overnight maturities, which further limits the risks to these counterparties. By Finance Agency Regulations, all counterparties exposed to non-U.S. countries are required to be domestic U.S. branches of foreign counterparties.

We believe we face minimal exposure in our unsecured investments to counterparties and countries that could have significant direct or indirect exposure to European sovereign debt, especially to those countries currently experiencing financial distress, and we are aggressive in limiting exposure to such counterparties. The exposure to non-U.S. countries at June 30, 2013 was comprised of lending to 12 institutions.

80


Mortgage-Backed Securities.
 
GSE Mortgage-Backed Securities
Historically, almost all of our mortgage-backed securities have been residential GSE securities issued by Fannie Mae and Freddie Mac, which provide credit safeguards by guaranteeing either timely or ultimate payments of principal and interest, and agency securities issued by Ginnie Mae, which the federal government guarantees. We believe that the conservatorships of Fannie Mae and Freddie Mac lower the chance that they would not be able to fulfill their credit guarantees; we believe the securities issued by these two GSEs are effectively government guaranteed. In addition, based on the data available to us and on our purchase practices, we believe that most of the mortgage loans backing our GSE mortgage-backed securities are of high quality with acceptable credit performance.

Mortgage-Backed Securities Issued by Other Government Agencies
We may also invest in mortgage-backed securities issued and guaranteed by the National Credit Union Administration. These investments totaled $1.3 billion at June 30, 2013. These securities have floating rate coupons tied to one-month LIBOR with interest rate caps ranging from seven to eight percent. We believe that the strength of the issuer's guarantee and backing by the full faith and credit of the U.S. government is sufficient to protect us against credit losses on these securities.

Private Label Mortgage-Backed Securities
The FHLBank held no private-label mortgage-backed securities at June 30, 2013.

Derivatives
Credit Risk Exposure. The table below presents the gross credit risk exposure (i.e., the market value) and net exposure of derivatives outstanding at June 30, 2013. Based on both the gross and net exposures, we had a minimal amount of residual credit risk exposure throughout the first six months of 2013, totaling $4 million. Gross exposure would likely increase if interest rates rise and could increase if the composition of our derivatives change; however, contractual collateral provisions in these derivatives limit our exposure to acceptable levels.
(In millions)
 
 
 
 
 
 
 
Credit Rating (1)
Total Notional
 
Gross Credit Exposure
 
Cash Collateral Held
 
Credit Exposure Net of Cash Collateral Held
Aaa/AAA
$
—

 
$
—

 
$
—

 
$
—

Aa/AA
810

 
4

 
—

 
4

A
3,739

 
—

 
—

 
—

Baa/BBB
1,851

 
—

 
—

 
—

Member institutions (2)
102

 
—

 
—

 
—

Total
$
6,502

 
$
4

 
$
—

 
$
4


(1)
Each category includes the related plus (+) and minus (-) ratings (i.e., “A” includes “A+” and “A-” ratings).
(2)
Represents Mandatory Delivery Contracts.


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The following table presents counterparties that provided 10 percent or more of the total notional amount of interest rate swap derivatives outstanding.
(In millions)
 
 
 
 
 
 
 
 
 
 
June 30, 2013
 
 
 
 
 
December 31, 2012
 
 
 
 
Counterparty
Credit Rating
Category
Notional
Principal
 
Net Unsecured
Exposure
 
Counterparty
Credit Rating
Category
Notional
Principal
 
Net Unsecured
Exposure
Citigroup Financial Products Inc.
Baa/BBB
$
1,282

 
$
—

 
BNP Paribas
A
$
2,181

 
$
—

Royal Bank of
   Scotland PLC
A
1,211

 
—

 
Citigroup Financial Products Inc.
Baa/BBB
1,542

 
—

Wells Fargo Bank, N.A.
Aa/AA
790

 
4

 
Wells Fargo Bank, N.A.
Aa/AA
1,365

 
4

All others
   (10 counterparties)
Baa/BBB to Aa/AA
3,117

 
—

 
Royal Bank of
   Scotland PLC
A
1,324

 
—

Total
 
$
6,400

 
$
4

 
All others
   (10 counterparties)
Baa/BBB to Aa/AA
5,624

 
2

 
 

 

 
Total
 
$
12,036

 
$
6


Although we cannot predict if we will realize credit risk losses from any of our derivatives counterparties, we do not believe that any of them will be unable to continue making timely interest payments or, more generally, to continue to satisfy the terms and conditions of their derivative contracts with us.

As of June 30, 2013, we had $0.3 billion of notional principal of interest rate swaps outstanding to one member, JPMorgan, which also had outstanding credit services with us totaling $42.7 billion. Due to the amount of market value collateralization, we had no outstanding derivatives credit exposure to this counterparty.

Lehman Brothers Derivatives. On September 15, 2008, Lehman Brothers Holdings, Inc. ("Lehman Brothers") filed a petition for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. We had 87 derivative transactions (interest rate swaps) outstanding with a subsidiary of Lehman Brothers, Lehman Brothers Special Financing, Inc. ("LBSF"), with a total notional principal amount of $5.7 billion. Under the provisions of our master agreement with LBSF, all of these swaps automatically terminated immediately prior to the bankruptcy filing by Lehman Brothers. The close-out provisions of the Agreement required us to pay LBSF a net settlement of approximately $189 million, which represented the swaps' total estimated market value at the close of business on Friday, September 12, 2008. We paid LBSF approximately $14 million to settle all of the transactions, comprised of the $189 million market value amount minus the value of collateral we had delivered previously and other interest and expenses. On September 16, 2008, we replaced these swaps with new swaps transacted with other counterparties. The new swaps had the same terms and conditions as the terminated LBSF swaps. The counterparties to the new swaps paid us a net amount of approximately $232 million to enter into these transactions based on the estimated market values at the time we replaced the swaps.

The $43 million difference between the settlement amount we paid Lehman and the market value payment we received on the replacement swaps represented an economic gain to us based on changes in the interest rate environment between the termination date and the replacement date. Although the difference was a gain to us in this instance, because it represented exposure from terminating and replacing derivatives, it could have been a loss if the interest rate environment had been different. We are amortizing the gain into earnings according to the swaps' final maturities, most of which occurred by the end of 2012.

In March 2010, representatives of the Lehman bankruptcy estate advised us that they believed that we had been unjustly enriched and that the bankruptcy estate was entitled to the $43 million difference between the settlement amount we paid Lehman and the market value payment we received on the replacement swaps. In May 2010, we received a Derivatives Alternative Dispute Resolution notice from the Lehman bankruptcy estate with a settlement demand of $65.8 million, plus interest accruing primarily at LIBOR plus 14.5 percent since the bankruptcy filing, based on their view of how the settlement amount should have been calculated. In accordance with the Alternative Dispute Resolution Order of the Bankruptcy Court administering the Lehman estate, senior management participated in a non-binding mediation in New York in August 2010, and our legal counsel continued discussions with the court-appointed mediator for several weeks thereafter. The mediation concluded in October 2010 without a settlement of the claims asserted by the Lehman bankruptcy estate. In April 2013 Lehman Brothers Special Financing Inc., through Lehman Brothers Holdings Inc. and the Plan Administrator under the Modified Third Amended Joint Chapter 11 Plan of Lehman Brothers Holdings Inc. and Its Affiliated Debtors, filed an adversary complaint in

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the United States Bankruptcy Court for the Southern District of New York against us seeking (a) a declaratory judgment on the interpretation of certain provisions and the calculation of amounts due under the agreement governing the 2008 swap transactions described above, and (b) additional amounts alleged as due as part of the termination of such transactions. We believe that we correctly calculated, and fully satisfied, our obligation to Lehman in September 2008, and we intend to vigorously defend ourselves.

Liquidity Risk

Liquidity Overview
Our principal long-term source of funding and liquidity is from cost effective access to the capital markets through participation in the issuance of FHLBank System debt securities (Consolidated Obligations) and through execution of derivative transactions. We also raise liquidity via our liquidity investment portfolio and the ability to sell certain investments without significant accounting consequences. As shown on the Statements of Cash Flows, in the first six months of 2013, our participations in the System's debt issuances totaled $91.0 billion for Discount Notes and $15.4 billion for Bonds. The System's favorable debt ratings, the implicit U.S. government backing of our debt, and our effective funding management were, and continue to be, instrumental in ensuring satisfactory access to the capital markets.

Our liquidity position remained strong during the first two quarters of 2013 and our overall ability to fund our operations through debt issuances at acceptable interest costs remained sufficient. Although we can make no assurances, we expect this to continue to be the case, and we believe the possibility of a liquidity or funding crisis in the FHLBank System that would impair our FHLBank's ability to participate in issuances of new debt, service outstanding debt, maintain adequate capitalization, or pay competitive dividends is remote.

We must meet both operational and contingency liquidity requirements. We satisfied the operational liquidity requirement both by meeting the contingency liquidity requirement and because we were able to adequately access the capital markets to issue Obligations. In addition, Finance Agency guidance requires us to target at least 15 consecutive days of positive liquidity based on specific assumptions. In practice, we normally hold over 20 days of positive liquidity. The amount of liquidity per the Finance Agency guidance and our internal operational liquidity measures was generally in the range of $8 billion to $15 billion during the first six months of 2013.

Contingency Liquidity Requirement
Contingency liquidity risk is the potential inability to meet liquidity needs because our access to the capital markets to issue Consolidated Obligations is restricted or suspended for a period of time due to a market disruption, operational failure, or real or perceived credit quality problems. We continued to hold an ample amount of liquidity reserves to protect against contingency liquidity risk.
Contingency Liquidity Requirement (in millions)
June 30, 2013
 
December 31, 2012
Total Contingency Liquidity Reserves (1)
$
22,675

 
$
23,199

Total Requirement (2)
(9,834
)
 
(10,942
)
Excess Contingency Liquidity Available
$
12,841

 
$
12,257


(1)
Includes, among others, cash, overnight Federal funds, overnight deposits, self-liquidating term Federal funds, 95 percent of the market value of available-for-sale negotiable securities, and 75 percent of the market value of certain held-to-maturity obligations, including obligations of the United States, U.S. government agency obligations and mortgage-backed securities.

(2)
Includes net liabilities maturing in the next seven business days, assets traded not yet settled, Advance commitments outstanding, Advances maturing in the next seven business days, and a three percent hypothetical increase in Advances.


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Deposit Reserve Requirement
To support our member deposits, we also must meet a statutory deposit reserve requirement. The sum of our investments in obligations of the United States, deposits in eligible banks or trust companies, and Advances with a final maturity not exceeding five years must equal or exceed the current amount of member deposits. The following table presents the components of this liquidity requirement.
Deposit Reserve Requirement (in millions)
June 30, 2013
 
December 31, 2012
Total Eligible Deposit Reserves
$
68,742

 
$
54,943

Total Member Deposits
(1,022
)
 
(1,158
)
Excess Deposit Reserves
$
67,720

 
$
53,785


Contractual Obligations
The following table summarizes our contractual obligations at June 30, 2013. The allocations according to the expiration terms and payment due dates of these obligations were not materially different from those at the end of 2012. Changes reflected normal business variations. We believe that, as in the past, we will continue to have sufficient liquidity, including from access to the debt markets to issue Consolidated Obligations, to satisfy these obligations timely.
(In millions)
< 1 year
 
1<3 years
 
3<5 years
 
> 5 years
 
Total
Contractual Obligations
 
 
 
 
 
 
 
 
 
Long-term debt (Bonds) - par (1)
$
30,635

 
$
5,395

 
$
5,715

 
$
7,667

 
$
49,412

Operating leases (include premises and equipment)
1

 
1

 
2

 
7

 
11

Mandatorily redeemable capital stock
3

 
122

 
—

 
—

 
125

Commitments to fund mortgage loans
102

 
—

 
—

 
—

 
102

Pension and other postretirement benefit obligations
3

 
6

 
4

 
18

 
31

Total Contractual Obligations
$
30,744

 
$
5,524

 
$
5,721

 
$
7,692

 
$
49,681


(1)
Does not include Discount Notes and contractual interest payments related to Bonds. Total is based on contractual maturities; the actual timing of payments could be affected by factors affecting redemptions.

Off-Balance Sheet Arrangements
The following table summarizes our off-balance sheet items at June 30, 2013. The allocations according to the expiration terms and payment due dates of these items were not materially different from those at the end of 2012, and changes reflected normal business variations.
(In millions)
< 1 year
 
1<3 years
 
3<5 years
 
> 5 years
 
Total
Off-balance sheet items (1)
 
 
 
 
 
 
 
 
 
Standby Letters of Credit
$
13,670

 
$
86

 
$
27

 
$
56

 
$
13,839

Standby bond purchase agreements
89

 
268

 
—

 
—

 
357

Consolidated Obligations traded, not yet settled
18

 
—

 
—

 
5

 
23

Total off-balance sheet items
$
13,777

 
$
354

 
$
27

 
$
61

 
$
14,219

(1)
Represents notional amount of off-balance sheet obligations.

Operational Risk

There were no material developments regarding our operational risk exposure during the first six months of 2013.


Item 3.
Quantitative and Qualitative Disclosures About Market Risk.

Information required by this Item is set forth under the caption “Quantitative and Qualitative Disclosures About Risk Management” in Part I, Item 2, of this filing.



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Item 4.
Controls and Procedures.


DISCLOSURE CONTROLS AND PROCEDURES

As of June 30, 2013, the FHLBank's management, including its principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, these two officers each concluded that as of June 30, 2013, the FHLBank maintained effective disclosure controls and procedures to ensure that information required to be disclosed in the reports that it files under the Exchange Act is (1) accumulated and communicated to management as appropriate to allow timely decisions regarding disclosure and (2) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.


CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

As of June 30, 2013, the FHLBank's management, including its principal executive officer and principal financial officer, evaluated the FHLBank's internal control over financial reporting. Based upon that evaluation, these two officers each concluded that there were no changes in the FHLBank's internal control over financial reporting that occurred during the quarter ended June 30, 2013 that materially affected, or are reasonably likely to materially affect, the FHLBank's internal control over financial reporting.



PART II - OTHER INFORMATION

Item 1A.
Risk Factors.        

Information relating to this Item is set forth under the caption “Business Outlook and Risk Management” in Part I, Item 2, of this filing.


Item 6.
Exhibits.

(a)
Exhibits.

See Index of Exhibits



85


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, as of the 8th day of August 2013.

FEDERAL HOME LOAN BANK OF CINCINNATI
(Registrant)


By:
  /s/ Andrew S. Howell
 
 
Andrew S. Howell
 
 
President and Chief Executive Officer
(principal executive officer)
 
 
 
 
By:
  /s/ Donald R. Able
 
 
Donald R. Able
 
 
Executive Vice President - Chief Operating Officer (principal financial officer)
 


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INDEX OF EXHIBITS
Exhibit
Number (1)
 
Description of exhibit
 
Document filed or
furnished, as indicated below
 
 
 
 
 
31.1
 
Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer
 
Filed Herewith
 
 
 
 
 
31.2
 
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer
 
Filed Herewith
 
 
 
 
 
32
 
Section 1350 Certifications
 
Furnished Herewith
 
 
 
 
 
101.INS
 
XBRL Instance Document
 
Furnished Herewith
 
 
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
Furnished Herewith
 
 
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
Furnished Herewith
 
 
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
Furnished Herewith
 
 
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
Furnished Herewith
 
 
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 
Furnished Herewith
(1)
Numbers coincide with Item 601 of Regulation S-K.


87