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Federal Home Loan Bank Of Cincinnati (1326771) SEC Filing 10-K Annual report for the fiscal year ending Tuesday, December 31, 2013

Federal Home Loan Bank Of Cincinnati

CIK: 1326771

CONTACT:
NewsRelease
John Byczkowski, FHLBank Cincinnati
FOR IMMEDIATE RELEASE
513-852-7085 (office) or 513-382-7615 (cell)
February 20, 2014



FHLBANK CINCINNATI ANNOUNCES 2013 RESULTS

Cincinnati, Ohio – The Federal Home Loan Bank of Cincinnati (FHLBank) today released unaudited financial results for the year ended December 31, 2013. The FHLBank fulfilled its mission by providing readily available and competitively priced wholesale funding to its member financial institutions, supporting its commitment to affordable housing, and paying stockholders a competitive dividend return on their capital investment. Highlights include:
Net income for 2013 was $261 million and return on average equity (ROE) was 5.10 percent. This compares to net income of $235 million and ROE of 6.20 percent for 2012. For the fourth quarter of 2013, net income was $64 million and ROE was 4.78 percent, compared to net income of $65 million and ROE of 6.22 percent for the same period of 2012.
The most significant contributors to the increase in the 2013 net income were significantly higher average Advance balances and lower net amortization, primarily related to purchased premiums on mortgage assets. ROE fell because of growth in average capital ($1.3 billion) to support the Advance growth combined with several factors that lowered income, most notably net gains on securities sales recognized in 2012 that did not reoccur in 2013.
Total assets at December 31, 2013 were a record $103.2 billion, which was an increase of $21.6 billion (27 percent) from year-end 2012. Mission Asset Activity – comprising major activities with members including Advances, Letters of Credit, and the Mortgage Purchase Program – was $85.2 billion at December 31, 2013, an increase of $14.0 billion (20 percent) from year-end 2012. The growth in both assets and Mission Asset Activity was primarily due to increased Advance balances outstanding.
Capital adequacy substantially exceeded all minimum regulatory requirements. On December 31, 2013, GAAP capital, including $621 million of total retained earnings, stood at $5.3 billion or 5.15 percent of total assets. The regulatory capital ratio was 5.27 percent at December 31, 2013. Total retained earnings increased by $17 million in the fourth quarter of 2013 and by $83 million in all of 2013.
The FHLBank paid its stockholders a cash dividend on December 19, 2013 at a 4.00 percent annualized rate, which was 3.76 percentage points above the fourth quarter average 3-month LIBOR. The average quarterly dividend paid for the year was 4.18 percent.
The FHLBank contributed $30 million in 2013 to the Affordable Housing Program pool of funds to be awarded to members in 2014. In addition, the FHLBank continued its voluntary sponsorship of two other housing programs which provide resources to pay for accessibility rehabilitation and emergency repairs for special needs and elderly homeowners and to help members aid their communities following natural disasters.



The following information was filed by Federal Home Loan Bank Of Cincinnati on Thursday, February 20, 2014 as an 8K 2.02 statement, which is an earnings press release pertaining to results of operations and financial condition. It may be helpful to assess the quality of management by comparing the information in the press release to the information in the accompanying 10-K Annual Report statement of earnings and operation as management may choose to highlight particular information in the press release.


 UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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.)
600 Atrium Two, P.O. Box 598,
 
 
Cincinnati, Ohio 
 
45201-0598
(Address of principal executive offices) 
 
(Zip Code)
Registrant's telephone number, including area code
(513) 852-7500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class B Stock, par value $100 per share
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes   x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d).
o Yes   x No

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

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

As of February 28, 2014, the registrant had 43,213,531 shares of capital stock outstanding, which included stock classified as mandatorily redeemable. The capital stock of the registrant is not listed on any securities exchange or quoted on any automated quotation system, only may be owned by members and former members and is transferable only at its par value of $100 per share.

Documents Incorporated by Reference: None

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Table of Contents
 
PART I
 
 
 
 
Item 1.
Business
 
 
 
Item 1A.
Risk Factors
 
 
 
Item 1B.
Unresolved Staff Comments
 
 
 
Item 2.
Properties
 
 
 
Item 3.
Legal Proceedings
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
 
PART II
 
 
 
 
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
 
 
Item 6.
Selected Financial Data
 
 
 
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 8.
Financial Statements and Supplemental Data
 
 
 
 
 
Financial Statements for the Years Ended 2013, 2012, and 2011
 
 
 
 
Notes to Financial Statements
 
 
 
 
Supplemental Financial Data
 
 
 
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
 
 
Item 9A.
Controls and Procedures
 
 
 
Item 9B.
Other Information
 
 
 
 
PART III
 
 
 
 
Item 10.
Directors, Executive Officers and Corporate Governance
 
 
 
Item 11.
Executive Compensation
 
 
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
 
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
 
 
 
Item 14.
Principal Accountant Fees and Services
 
 
 
 
PART IV
 
 
 
 
Item 15.
Exhibits and Financial Statement Schedules
 
 
 
Signatures
 

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PART I

Special Cautionary Notice Regarding Forward Looking Information

This document contains forward-looking statements that describe the objectives, expectations, estimates, and assessments of the Federal Home Loan Bank of Cincinnati (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 investor demand for Consolidated Obligations;

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

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

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

the ability to successfully manage new products and services; and

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

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



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Item 1.
Business.


COMPANY INFORMATION

Organizational Structure

The FHLBank is a regional wholesale bank that provides financial products and services to our member financial institutions. We are one of 12 District Banks in the FHLBank System; our region, known as the Fifth District, comprises Kentucky, Ohio and Tennessee. The U.S. Congress chartered the FHLBank System in the Federal Home Loan Bank Act of 1932 (the FHLBank Act) to improve liquidity in the U.S. housing market. Each District Bank is a GSE of the United States of America and operates as a separate entity with its own stockholders, employees, and Board of Directors. A GSE combines private sector ownership with public sector sponsorship. The FHLBanks are not government agencies and are exempt from federal, state, and local taxation (except real property taxes). The U.S. government does not guarantee, directly or indirectly, the debt securities or other obligations of the FHLBank System.

The FHLBank System also includes the Federal Housing Finance Agency (Finance Agency) and the Office of Finance. The Finance Agency is an independent agency in the executive branch of the U.S. government that regulates the FHLBanks, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The Finance Agency oversees the conservatorships of Fannie Mae and Freddie Mac. The Office of Finance is a joint office of the District Banks regulated by the Finance Agency to facilitate the issuance and servicing of the FHLBank System's Consolidated Obligations (or Obligations).

In addition to being GSEs, the FHLBanks are cooperative institutions, which means our stockholders are also our primary customers. Private-sector financial institutions within our district voluntarily become members of our FHLBank and purchase capital stock in order to gain access to products and services. Only members can purchase capital stock.

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

We require each member to own capital stock as a condition of membership and to hold additional stock above the membership stock amount when utilizing certain services. We issue, redeem, and repurchase capital stock only at its stated par value of $100 per share. By law, our stock may not be publicly traded.

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

The number of our members has been relatively stable in the last 10 years, ranging between 720 and 760. At December 31, 2013, we had 727 members, 199 full-time employees, and 1 part-time employee. Our employees are not represented by a collective bargaining unit.

Mission and Corporate Objectives

The FHLBank's mission is to provide financial intermediation between our member stockholders and the capital markets in order to facilitate and expand the availability of financing and flow of credit for housing and community lending throughout the Fifth District.

We achieve our mission through the cooperative business model. We raise private-sector capital from member stockholders and issue high-quality debt in the capital markets (along with other FHLBanks) in order to provide services to members and a competitive return on their capital investment in the FHLBank through quarterly dividend payments. Our primary services include a reliable, readily available, low-cost source of funds called Advances and purchases of mortgage loans sold by our qualifying members. Our public sector sponsorship allows us to fulfill our mission of providing affordable housing programs and activities to support members in their efforts to assist low- and moderate- income households and their local communities.

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Our corporate objectives are to:

operate safely and soundly, remain able to raise funds in the capital markets, and optimize our counterparty and deposit ratings;

expand business activity with members;

earn and pay a stable long-term competitive return on members' capital stock;

maximize the effectiveness of contributions to Housing and Community Investment programs; and

maintain effective corporate governance processes.

To achieve these objectives, we strive to maintain a risk profile that will ensure we operate safely and soundly, to promote prudent growth in Mission Asset Activity, to consistently generate competitive earnings, and to protect the par value of members' capital stock investment. We believe our business is financially sound and adequately capitalized on a risk-adjusted basis.

We practice this conservative risk philosophy in many ways:

We believe we operate with moderate market risk and limited residual credit risk, liquidity risk, operational risks, and capital impairment risk.

We have a priority to ensure competitive and relatively stable profitability.

We make conservative investment choices in terms of the types of investments we purchase and counterparties with which we engage.

We use derivatives to hedge individual assets and liabilities, not for macro balance sheet hedging.

We normally operate with less financial leverage than regulation permits.

We are judicious in instituting regular, large-scale, district-wide repurchases of excess stock.

We have significantly increased retained earnings in recent years and hold an amount that we assess is consistent with achieving the first corporate objective listed above.

We create a working and operating environment that emphasizes a stable employee base.

Member stockholders derive value from two sources: the competitive prices, terms, and characteristics of our products; and a competitive dividend return on their capital investment. We strike a balance between offering more attractively priced products, which tend to lower dividend payments, and paying attractive dividends.

Because of our cooperative wholesale business model, we tend to price Advances and purchased mortgage loans at relatively narrow spreads over our funding and hedging costs compared to other financial institutions. We believe members' investment in our capital stock is comparable to investing in high-grade short-term, or adjustable-rate, money market instruments or in adjustable-rate preferred equity instruments. Therefore, we structure our balance sheet risk exposures so that earnings tend to move in the same direction as changes in short-term market rates, which provides member stockholders a degree of predictability on their dividend returns. One measure of this success in paying competitive dividends is that relatively few member stockholders have historically chosen, absent mergers and consolidations, to withdraw from membership or to request redemption of their stock held in excess of minimum requirements.

Our conservative risk management principles and having a long-term performance orientation that balance the two sources of membership value are motivated by the FHLBank's cooperative business model in which stockholders and customers are the same entities.


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Business Activities

Our principal activity is offering readily available, competitively priced and fully collateralized Advances to members. Advances and the issuance of collateralized Letters of Credit constitute “Credit Services” business. As a secondary business line, we purchase qualifying residential mortgages through the Mortgage Purchase Program (MPP) and hold them as portfolio investments. This program offers members a competitive alternative to the traditional secondary mortgage market. Together, these product offerings constitute our “Mission Asset Activity.”

In addition, through various Housing and Community Investment programs, we assist members in serving very low-, low-, and moderate-income households and community economic development. These programs provide Advances at below-market rates of interest, as well as direct grants and subsidies, and can help members satisfy their regulatory requirements under the Community Reinvestment Act.

To a more limited extent, we also offer members various correspondent services that assist them in the administration of their operations.

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

Our primary source of funding and liquidity is through participation in the issuance of the FHLBank System's unsecured debt securities - Consolidated Obligations - in the capital markets. Secondary sources of funding are capital and deposits we accept from our members. Obligations are the joint and several obligations of all 12 FHLBanks, backed only by the financial resources of these institutions. A critical component of the success of the System's operations is its ability to maintain a comparative advantage in funding, which is due largely to its GSE status. We regularly issue Obligations under a wide range of maturities, structures, and amounts, and at relatively favorable spreads to benchmark market interest rates (represented by U.S. Treasury securities and the London InterBank Offered Rate (LIBOR)) compared with many other financial institutions. We also execute derivative transactions to help hedge market risk exposure. These capabilities enable us to offer members a wide range of Mission Asset Activity and enable members to access the capital markets, through their activities with the FHLBank, in ways that may not be available to them without our services.

Ratings of Nationally Recognized Statistical Rating Organizations

The System's comparative advantage in funding is acknowledged in its excellent credit ratings from nationally recognized statistical rating organizations (NRSROs). Moody's Investors Service (Moody's) currently assign, and historically has assigned, the System's Obligations the highest ratings available: long-term debt is rated Aaa and short-term debt is rated P-1. It also assigns a Prime-1 short-term bond rating on each FHLBank. It affirmed these ratings in 2013 and updated the outlooks to stable from negative. 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. The lower-than AAA debt ratings from Standard & Poor's, which first occurred in 2011, have not resulted in any discernible impact on our debt issuance capabilities.

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

A credit rating is not a recommendation to buy, sell or hold securities. A rating organization may revise or withdraw its ratings at any time, and each rating should be evaluated independently of any other rating. We cannot predict what future actions, if any, a rating organization may take regarding the System's and our ratings. The System's debt is neither the obligation of, nor is it guaranteed by, the United States government.


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Sources of Earnings

Our major source of revenue is interest income earned on Advances, MPP notes, and investments. Major items of expense are:

interest paid on Consolidated Obligations and deposits to fund assets;

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

non-interest expenses (i.e., other expenses on the Statements of Income).

The largest component of earnings is net interest income, which equals interest income minus interest expense. We derive net interest income from the interest rate spread earned on assets and the use of financial leverage. Each of these can vary over time with changes in market conditions, including most importantly interest rates, business conditions and our risk management activities. The interest rate spread is the difference between the interest we earn on assets and the interest we pay on liabilities. Financial leverage results from funding a portion of interest-earning assets with capital on which we do not pay interest.

Regulatory Oversight

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

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


BUSINESS SEGMENTS

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

Traditional Member Finance

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

We price 13 standard Advance programs every business day and several other standard programs on demand. We also offer customized, non-standard Advances that fall under one of the standard programs. Having diverse programs gives members the flexibility to choose and customize their borrowings according to size, maturity, interest rate, interest rate index (for adjustable-rate coupons), interest rate options, and other features.

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

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

Regular Fixed Rate Advances have terms of three months to 30 years, with interest normally paid monthly and principal repayment normally at maturity. Members may choose to purchase call options on these Advances, although in the last 5 years, balances with call options have been at or close to zero.

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

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

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

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

How We Manage Credit Services Risks. We manage market risk on Advances by tending to match fund Advances with similar-duration Consolidated Obligations including the use of interest rate swaps to match the repricing terms of Obligations (net of the swaps) and the Advances.

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

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

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

The Affordable Housing Program provides funding for the development of affordable housing. The Program consists of a competitive program and a homeownership set-aside program, called the Welcome Home Program. Under the competitive program, we distribute funds in the form of either grants or below-market rate Advances to members that apply and successfully compete in an annual offering. Under the Welcome Home Program, funds are normally available beginning in March until they have been fully committed. For both programs, the income of qualifying individuals or households must be 80 percent or less of the area median income. Up to 35 percent of the Affordable Housing accrual is set aside for the Welcome Home Program and the remainder allocated to the competitive program.

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Our Board of Directors also may allocate funds to voluntary housing programs, which it reviews annually. In January 2013, the Board re-authorized an additional $1.0 million for the Carol M. Peterson Housing Fund. The Carol M. Peterson Housing Fund resources are primarily used as grants to pay for accessibility rehabilitation and emergency repairs for special needs and elderly homeowners. In 2012, the Board of Directors also established the Disaster Reconstruction Program, a $5 million voluntary housing program that provides grants for purchase or rehabilitation of a home to Fifth District residents that have suffered loss or damage to their primary residence as a result of a state or federally declared disaster.

Two other housing programs that fall outside the auspices of the Affordable Housing Program are the Community Investment Program and the Economic Development Program. Advances under the former program have rates equal to our cost of funds, while Advances under the latter program have rates equal to our cost of funds plus three basis points. Members use the Community Investment Program to serve housing needs of low- and moderate-income people and, under certain conditions, community economic development projects. The Economic Development Program is used exclusively for economic development projects.

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

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

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

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

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

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

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

Liquidity management. As their name implies, liquidity investments help us manage liquidity and support our ability to fund most Advances on the same day members request them. We can structure short-term debt issuances so that the liquidity investments mature sooner than this debt, providing a source of liquidity. We also may be able to transform certain investments to cash without a significant loss of value.

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

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

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

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

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

Market risk associated with short-term investments tends to be moderate because of their short maturities and because we typically fund them with similar duration short-term Consolidated Obligations. We mitigate the market risk of mortgage-backed securities, which exists primarily from changes in mortgage prepayment speeds, by limiting their balances to 300 percent of regulatory capital, by issuing and dynamically rebalancing a portfolio of long-term unswapped fixed-rate callable and noncallable Consolidated Bonds, and by managing the market risk exposure of the entire balance sheet within prudent market risk policy limits.

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

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

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

Description of the MPP
Types of Loans and Benefits. Finance Agency Regulations permit the FHLBanks to purchase and hold specified mortgage loans from their members. We offer the MPP, which directly supports our public policy mission of supporting housing finance. We account for MPP loans as mortgage loans held for portfolio. By selling mortgage loans to us, members can increase their balance sheet liquidity and reduce their interest rate and mortgage prepayment risks. The MPP enables small- and medium-sized community-based financial institutions to use their existing relationship with us to participate more effectively in the secondary mortgage market. Finally, the MPP enhances our long-term profitability on a risk-adjusted basis, which augments the return on member stockholders' capital investment.

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

A “conventional” mortgage refers to a non-government-guaranteed mortgage. A “conforming” mortgage refers to the maximum amount permissible to be lent as a regular prime (i.e., non-jumbo, non-subprime) mortgage. For 2014, the Finance Agency established that limit at $417,000, the same as 2006-2013, with loans originated in a limited number of high-cost cities and counties receiving higher conforming limits. We do not purchase conforming mortgages subject to these higher amounts.


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

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

How We Manage MPP Risks
We mitigate MPP's market risk similarly to how we mitigate market risk from mortgage-backed securities, as described above and in Item 7's "Quantitative and Qualitative Disclosures About Risk Management."

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

Credit risk exposure is mitigated for conventional loans through underwriting and pool composition requirements and by applying layered credit enhancements. These enhancements, which apply after a homeowner's equity is exhausted, include (in order of priority) primary mortgage insurance (when applicable), the Lender Risk Account (discussed below), and for loans acquired before February 2011, Supplemental Mortgage Insurance (when applicable) that the PFI purchased from one of our approved third-party providers naming us as the beneficiary. Beginning in February 2011, we discontinued use of Supplemental Mortgage Insurance for new loan purchases and replaced it with expanded use of the Lender Risk Account and aggregation of loan purchases into larger pools to provide diversification in credit risk exposure. These credit enhancements are designed to adequately protect the FHLBank against credit losses in scenarios of severe downward movements in housing prices and unfavorable changes in other factors that can affect loan delinquencies and defaults.

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

We believe we bear no credit risk on purchased FHA loans due to the explicit FHA guarantee and therefore we do not require any credit enhancements beyond underwriting, homeowner's equity, and primary mortgage insurance.

Item 7's “Quantitative and Qualitative Disclosures About Risk Management” has more detail on our credit risk management of the MPP.

Earnings from the MPP
We generate earnings in the MPP from monthly interest payments minus the cost of funding and the cost of hedging the MPP's interest rate risk. Interest income on each loan is computed as the mortgage note rate multiplied by the loan's principal balance:

minus servicing costs (0.25 percent for conventional loans and 0.44 percent for FHA loans);

minus the cost of Supplemental Mortgage Insurance (as applicable); and

adjusted for the amortization of purchase premiums or the accretion of purchase discounts and for the amortization or accretion of fair value adjustments on commitments.


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


CONSOLIDATED OBLIGATIONS

Our primary source of funding is through participation in the sale of Consolidated Obligations. There are two types of Obligations: Consolidated Bonds (Bonds) and Consolidated Discount Notes (Discount Notes). We participate in the issuance of Bonds for three purposes:

to finance and hedge intermediate- and long-term fixed-rate Advances and mortgage assets;

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

to acquire liquidity.

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

The mix of Obligations fluctuates in response to relative changes in short-term versus long-term assets, relative changes in fixed-rate versus adjustable-rate assets, decisions on market risk management (particularly the amount of funding of longer-term assets with short-term Obligations), and differences in relative costs of various Obligations. We use fixed-rate Bonds to fund longer-term fixed-rate Advances and longer-term fixed rate mortgage assets, and use adjustable-rate Bonds to fund adjustable-rate LIBOR Advances. We may transact in interest rate swaps to synthetically convert some fixed-rate Bonds to adjustable-rate terms, mostly indexed to LIBOR. These are used normally to hedge adjustable-rate LIBOR Advances.

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

There are frequent changes in the interest rates and prices of Obligations and in their interest cost relationship to other products such as U.S. Treasury securities and LIBOR. Interest costs are affected by a multitude of factors including (but not limited to): overall economic and credit conditions; credit ratings of the FHLBank System; investor demand and preferences for our debt securities; the level of interest rates and the shape of the U.S. Treasury curve and the LIBOR swap curve; and the supply, volume, timing, and characteristics of debt issuances by the FHLBanks, other GSEs, and other highly rated issuers.

Finance Agency Regulations govern the issuance of Consolidated Obligations. The Office of Finance services Obligations, prepares the FHLBank System's quarterly and annual combined financial statements, and serves as a source of information for the FHLBanks on capital market developments.

We have the primary liability for our portion of Obligations, i.e., those issued on our behalf for which we receive the proceeds. However, we also are jointly and severally liable with the other 11 FHLBanks for the payment of principal and interest on all Obligations. If we do not pay the principal or interest in full when due on any Obligation issued on our FHLBank's behalf, we are prohibited from paying dividends or redeeming or repurchasing shares of capital stock. If another FHLBank were unable to repay its participation in an Obligation for which it is the primary obligor, the Finance Agency could call on each of the other FHLBanks to repay all or part of the Obligation. The Finance Agency has never invoked this authority.

An FHLBank may not issue individual debt securities without Finance Agency approval.

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LIQUIDITY

The FHLBank's operations require a continual and substantial amount of liquidity to provide members access to timely Advance funding and mortgage loan sales in all financial environments and to meet financial obligations (primarily maturing Consolidated Obligations) as they come due in a timely and cost-efficient manner. Liquidity risk is the risk that we will be unable to satisfy these obligations or to meet the Advance and MPP funding needs of members in a timely and cost-efficient manner. Liquidity requirements are significant because Advance balances can be highly volatile, many have short-term maturities, and we strive to offer access to Advances on the same day members request them. We regularly monitor liquidity risks and the investment and cash resources available to meet liquidity needs, as well as statutory and regulatory liquidity requirements.

Because Obligations have favorable credit ratings and because the FHLBank System is one of the largest sellers of debt in the worldwide capital markets, the System historically has been able to satisfy its liquidity needs through debt issuance across a wide range of structures at relatively favorable spreads to benchmark market interest rates. This was the case even during the severe financial crisis of late 2008 and early 2009 and the federal government's political stresses over fiscal policy in mid-2011 and late-2012.

Besides proceeds from debt issuances, we also raise liquidity via our liquidity investment portfolio and the ability to sell certain investments without significant accounting consequences. Our sources of asset liquidity include cash, maturing Advances, maturing investments, principal paydowns of mortgage assets, the ability to sell certain investments, and interest payments received. Uses of liquidity include repayments of Obligations, issuances of new Advances, purchases of loans under the MPP, purchases of investments, and payments of interest.


CAPITAL RESOURCES

Capital Plan

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

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Our Capital Plan has the following basic characteristics:

We offer only one class of capital stock, Class B, which is redeemable upon a member's five-year advance written notice, with certain conditions described below.

The Capital Plan enables us to efficiently expand and contract capital needed to capitalize assets in response to changes in our membership base and their Mission Asset needs, thereby maintaining a prudent amount of financial leverage in compliance with regulatory capital requirements and also consistent with generating earnings to provide competitive dividend returns and a sufficient amount of retained earnings.

The Capital Plan permits us to issue shares of capital stock only under the following circumstances: as required for an institution to become a member or maintain membership; as required for a member to capitalize Mission Asset Activity; and to pay stock dividends.

We may, subject to the restrictions described below, repurchase certain capital stock (i.e., "excess" capital stock) in a timely and prudent manner.

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

By statute and Finance Agency requirement, we must satisfy three capital requirements, the most important of which are a minimum four percent regulatory capital-to-assets ratio and a risk-based capital requirement. Capital requirements are further discussed in the “Capital Adequacy” section of Item 7's “Quantitative and Qualitative Disclosures About Risk Management.”

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

the five-year redemption period for Class B stock;

the option we have to call on members to purchase additional capital if required to preserve safety and soundness; and

the limitations, described below, on our ability to honor requested redemptions of capital if we are at risk of not maintaining safe and sound operations.

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

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

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


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

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

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

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

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

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

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

Retained Earnings

Purposes and Amount of Retained Earnings
Retained earnings are important to protect members' capital stock investment against the risk of impairment and to enhance our ability to pay stable and competitive dividends when earnings may be volatile in light of the risks we face. Impairment risk is the risk that members would have to write down the par value of their capital stock investment in our FHLBank as a result of their analysis of ultimate recoverability. An extreme situation of earnings instability, in which losses exceeded the amount of our retained earnings for a period of time determined to be other-than-temporary, could result in a determination that the value of our capital stock was impaired.

Our Retained Earnings and Dividends 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 minimum retained earnings requirement is currently $375 million, based on mitigating all of our combined 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

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retained earnings in the last several years than required by the Policy. At the end of 2013, our retained earnings totaled $621 million. We believe the current amount of retained earnings is sufficient to protect our capital stock against impairment risk and to provide dividend stability when it may be needed.

Joint Capital Agreement to Augment Retained Earnings
The 12 Federal Home Loan Banks entered into a Joint Capital Enhancement Agreement (the “Capital Agreement”) in February 2011. The Capital Agreement provides that each FHLBank will allocate quarterly at least 20 percent of its net income to a restricted retained earnings account (the “Account”). The 20 percent reserve allocation to the Account is similar to what had been required under the FHLBanks' REFCORP obligation, which was satisfied in 2011. The Account is not available to be distributed as dividends except under certain limited circumstances. The Capital Agreement does not limit the ability to use our retained earnings outside of the Account to pay dividends.

Although we have always maintained compliance with our capital requirements, we believe the Capital Agreement enhances risk mitigation by building a larger capital buffer over time to absorb unexpected losses, if any, that we may experience. Therefore, the Capital Agreement provides additional protection against impairment risk to stockholders' capital investment. It also strengthens the long-term viability of the Affordable Housing Program because the higher amount of retained earnings raises future earnings.


USE OF DERIVATIVES

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

Similar to our participation in debt issuances, derivatives help us hedge market risk created by Advances and mortgage commitments. Derivatives related to Advances most commonly hedge either:

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

Regular Fixed Rate Advances when it may not be as advantageous to issue Obligations or when it may improve our market risk management.

We also use derivatives to hedge the market risk created by commitment periods of Mandatory Delivery Contracts in the MPP.

Other derivatives related to Bonds help us intermediate between the normal preferences of capital market investors for intermediate- and long-term fixed-rate debt securities and the normal preferences of our members for shorter-term or adjustable-rate Advances. We can satisfy the preferences of both groups by issuing long-term fixed-rate Bonds and entering into an interest rate swap that synthetically converts the Bonds to an adjustable-rate LIBOR funding basis that matches up with the short-term and adjustable-rate Advances, thereby preserving a favorable interest rate spread.

Because we have a cooperative business model, our Board of Directors has emphasized the importance of minimizing earnings volatility, including volatility from the use of derivatives. Accordingly, our strategy is to execute derivatives that we expect to be highly effective hedges of market risk exposure. Therefore, the volatility in the market value of equity and earnings from our use of derivatives has historically tended to be moderate. In this context, we have not executed derivatives to hedge market risk exposure outside of specifically and individually identified assets or liabilities. We believe that the economic benefits of using derivatives to hedge risks in the entire balance sheet instead of individual instruments would generally be less than the increased hedging costs and risks, which include potentially higher earnings volatility.



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RISK MANAGEMENT

Our FHLBank faces various risks that could affect the ability to achieve our mission and corporate objectives. We generally categorize risks into 1) business/strategic risk, 2) regulatory/legislative risk), 3) market risk (also referred to as interest rate or prepayment risk), 4) capital adequacy, 5) credit risk, 6) funding/liquidity risk, 7) accounting risk, and 8) operational risk. Our Board of Directors establishes objectives regarding risk philosophy, risk appetite, risk tolerances, and financial performance expectations. We have numerous Board-adopted policies and processes that address risk management. These policies establish risk tolerances, limits, and guidelines, must comply with Finance Agency Regulations, and are designed to achieve continual safe and sound operations and promote achievement of our other corporate objectives. The Board delegates day-to-day responsibility for managing and controlling most of these risks to senior management. Our cooperative business model, corporate objectives, capital structure, and regulatory oversight provide us clear incentives to minimize risk exposures to the extent possible. Risk management practices are infused throughout all of our business activities.

Our policies and operating practices are designed to limit risk exposures from ongoing operations in the following broad ways:

by anticipating potential business risks and developing appropriate responses;

by defining permissible lines of business;

by limiting the kinds of assets we are permitted to hold in terms of their credit risk exposure and the kinds of hedging and financing arrangements we are permitted to use;

by limiting the amount of market risk and capital risk to which we are permitted to be exposed;

by specifying very conservative tolerances for credit risk posed by Advances;

by specifying capital adequacy minimums; and

by requiring strict adherence to internal controls and operating procedures, adequate insurance coverage, and comprehensive Human Resources policies, procedures, and strategies.

We actively manage risk exposures on a departmental basis and through a company-wide enterprise risk management framework. We also manage risk via regular reporting to and discussion with the Board of Directors and its committees, particularly the Finance and Risk Management Committee and the Audit Committee, as well as by continuous discussion and decision-making among key personnel across the FHLBank.


COMPETITION

Numerous economic and financial factors influence the use of Advances by our members as a competitive alternative for their balance sheet funding needs. One of the most important factors that affect Advance demand is the availability to our members of competitively-priced local retail deposits, which most members view as their primary funding source. In addition, both small and large members typically have access to brokered deposits, repurchase agreements and public unit deposits, each of which presents a competitive alternative to Advances. Larger members also have greater access to other competitive sources of funding and asset/liability management facilitated via the national and global credit markets. These sources include subordinated debt, interbank loans, covered bonds, interest rate swaps, options, bank notes, and commercial paper.

Another important source of competition for Advances exists from the various ongoing fiscal and monetary stimuli initiated by the federal government to combat the continued difficulties in the housing market and broader economy. These government actions, and their effects on our business, are discussed in Item 1A's “Risk Factors” and in Item 7's “Executive Overview" and "Conditions in the Economy and Financial Markets."
 
The holding companies of some of our large asset members have membership(s) in other FHLBanks through affiliates chartered in other FHLBank Districts. Others could initiate memberships in other Districts. The competition among FHLBanks for the business of multiple-membership institutions is similar to the FHLBanks' competition with other wholesale lenders and other mortgage investors. We compete with other FHLBanks on the offerings and pricing of Mission Asset Activity, earnings and dividend performance, collateral policies, capital plans, and members' perceptions of our relative safety and soundness.

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Some members may also evaluate benefits of diversifying business relationships among FHLBank memberships. We regularly monitor, to the extent possible, these competitive forces among the FHLBanks.

The primary competitors for loans we purchase in the MPP are Fannie Mae and Freddie Mac, government agencies (Ginnie Mae), private issuers, and, beginning in 2009, the U.S. government. We compete primarily based on price, products, and services. Fannie Mae and Freddie Mac in particular have long-established and efficient programs and are the dominant purchasers of residential conforming fixed-rate conventional mortgages. In addition, a number of private financial institutions have well-established securitization programs, although they may not currently be as active as historically. The MPP also competes with the Federal Reserve to the extent it purchases mortgage-backed securities and affects market prices and availability of supply.

For debt issuance, the FHLBank System competes with issuers in the national and global debt markets, including most importantly the U.S. government and other GSEs. Competitive factors include, but are not limited to, interest rates offered; the amount of debt offered; the market's perception of the credit quality of the issuing institutions and the liquidity of the debt; the types of debt structures offered; investor demand and preferences for our debt structures; and the effectiveness of debt marketing activities.


TAX STATUS

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


Item 1A.    Risk Factors.        

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

An economic downturn could reduce Mission Asset Activity and profitability.

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

After the financial crisis and recession of 2008-2009, the economy has grown at a slow pace, member loan demand has been modest, and members have been less willing to extend credit than is normal for an economic recovery which has been reflected in part by tighter underwriting standards. These economic conditions, combined with a substantial amount of deposit based liquidity being provided to financial institutions through the monetary actions of the Federal Reserve, uncertainties and stresses with federal fiscal policies and a more onerous regulatory environment for our members, have resulted, we believe, in reductions or modest growth in usage of Advances by many of our members.

Acceleration of these conditions or another recession could further decrease the broad-usage of Mission Asset Activity or sharply lower Advance balances which could in turn reduce profitability. In addition, as discussed in another risk factor, an extremely severe economic downturn, especially if combined with significant disruptions in housing or mortgage markets or other adverse external events, could result in additional and substantial credit losses in the MPP and, at the extreme, credit losses on other assets.


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

We operate in a highly competitive environment for our Mission Asset Activity. Increased competition can decrease the amount of Mission Asset Activity and narrow net spreads on that activity, both of which can result in lower profitability and cause stockholders to request withdrawal of capital. Historically, our chief competition has been from other wholesale lenders and debt issuers, including other GSEs. A substantial source of competition in the last six years has come from the federal government's actions to stimulate the economy, especially the actions of the Federal Reserve System through its policies of quantitative easing and maintaining extremely low nominal and real interest rates. Among other effects, these actions have significantly expanded liquidity and excess reserves available to many members. We cannot predict how long these negative effects will continue or what the effects of further government stimulus policies might be. We expect overall, broad-based growth in Advance demand will remain modest until the government reduces these initiatives by tightening monetary policy and winding down its purchases of U.S. Treasury and mortgage-backed securities. Even if these events take place, we cannot assure you the pace or strength of the renewed Advance demand that we would expect would occur.

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

Potential GSE reform considered by the U.S. government could unfavorably affect our business model, financial condition, and results of operations.

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

Because all the GSEs share a common regulator and general housing mission, the FHLBanks could be subject to adverse legislation regarding the ultimate disposition of Fannie Mae and Freddie Mac. There are significant differences between the FHLBank System and Fannie Mae and Freddie Mac, including the System's focus on lending as opposed to guaranteeing mortgages and our distinctive cooperative business model. However, future legislation could inadequately account for these differences, which could imperil the ability of the FHLBanks to continue operating effectively within their current business model or could change the System's business model.

At this time, we are unable to predict if GSE reform will be enacted and, if it is, what the effects would be on the FHLBank System's business model or our financial condition and results of operations, or whether the effects will be positive or negative.

We face a continued heightened regulatory and legislative environment, which could increase unfavorable effects on our business model, financial condition, and results of operations.

In addition to potential GSE reform, the legislative and regulatory environment in which the FHLBank System operates continues to undergo rapid change driven principally by reforms under the Housing and Economic Reform Act of 2008 (HERA) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). There have been numerous new regulations promulgated in the last several years and more are in the process of being promulgated for the FHLBank System. Current and future legislative and regulatory actions could significantly affect us. The summary discussion below is not all inclusive but represents what we believe are the most important newer regulations that we are addressing and monitoring.

The legislative and regulatory actions have raised our operating costs and imparted added uncertainty regarding the business model under which the FHLBanks may operate in the future. We are unable at this time to predict what ultimate effects the heightened regulatory environment will have on the FHLBank System's business model or on our financial condition and results of operations.

19



Core Mission Asset Activity. There has been a renewed regulatory focus on the FHLBanks' core mission activity of utilizing their GSE status to provide funding and liquidity in support of the housing markets. This focus is manifested in several regulatory initiatives, in revamped examination processes, and in an evolving Finance Agency requirement for each FHLBank to develop and include in its 2014 strategic business plan, target minimum benchmark levels for identified core mission activities and actions to achieve and maintain such levels. In response to this focus, we included in our 2014 Strategic Business Plan benchmarks for percentages of core mission asset activity. While we generally support this renewed focus on our primary business activities, we are concerned that the regulatory focus in this area could require us to make changes to our operations, such as lowering the amount of liquidity we maintain or changing the pricing of our mission asset activity, that could adversely affect our financial condition, results of operations, or risk exposures. 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.

Supervision and Regulation of Nonbank Financial Companies. In April 2012, the Financial Stability Oversight Council (the Oversight Council) issued a final rule and guidance on the standards and procedures the Oversight Council will follow in determining whether to designate a nonbank financial company for supervision by the Federal Reserve Board, which would subject such companies to certain heightened prudential standards. The final rule provides that, in making its determinations, the Oversight Council will consider as one factor whether a nonbank financial company is subject to oversight by a primary financial regulatory agency (for the FHLBank, the Finance Agency). We would be designated a nonbank financial company pursuant to a separate rule that has been proposed by the Federal Reserve. If we are designated by the Oversight Council for supervision by the Federal Reserve and subject to additional prudential standards, our operations and business could be adversely impacted by the resulting additional regulatory costs and potential restrictions on our business activities.

Dodd-Frank Act. Along with the other FHLBanks, we continue to monitor rulemaking under the Dodd-Frank Act. Although many of the Dodd-Frank Act's requirements have not yet received final promulgations, we continue to implement the processes and documentation necessary to comply with the law as we currently understand it.

Under the Dodd-Frank Act, the FHLBanks are subject to additional statutory and regulatory requirements for derivatives transactions and reporting. As a result of these requirements, beginning in June 2013, certain interest rate swap transactions were required to begin to be cleared through a third-party central clearinghouse and transacted either directly through a registered swap dealer or through swap execution facilities. Cleared derivatives require initial and variation margin, among other requirements, some of which are still being promulgated.

In 2013, we completed development of the capacity to clear derivatives according to these requirements. However, we have chosen not to actively clear derivatives because we are concerned that the current uncertainties with the regulations and processes have increased the credit and legal risks and uncertainties of clearing to which we are exposed. Until the various regulatory agencies complete the process of adopting regulations related to the Dodd-Frank Act and we are able, within the regulatory framework, to resolve the uncertainties and adequately mitigate the credit and legal risks, we expect to continue to be cautious in transacting derivatives that require clearing.

Guidance on Prudential Management and Operations Standards and Related Regulations. In June 2012, the Finance Agency issued a final rule regarding prudential standards for the management and operations of the FHLBanks. If the Finance Agency determines that the FHLBank has failed to meet one or more of the standards, the FHLBank may be required to file a corrective action plan with potential sanctions for noncompliance. In practice, the Finance Agency has issued, and we expect will continue to issue, a number of regulations and Advisory Bulletins codifying the Prudential Management and Operations Standards. These related regulations and Advisory Bulletins are requiring us to expend considerable resources, including some that require changes in our business process, to ensure compliance.

Proposed Rule on Responsibilities of Boards of Directors; Corporate Practices and Corporate Governance Matters. In January 2014, the Finance Agency published a proposed rule, with comments due March 31, 2014, to relocate and consolidate existing regulations pertaining to director responsibilities, corporate practices, and corporate governance matters for Fannie Mae, Freddie Mac, and the FHLBanks. In addition, the proposed rule would make certain amendments or additions, including provisions to:

revise existing risk management provisions to better align them with recent proposals of the Federal Reserve Board;

require each entity to maintain a compliance program headed by a compliance officer;

20



require each entity’s board to include committees specifically responsible for the risk management, audit, compensation, corporate governance;

require each FHLBank to designate in its bylaws a body of law to follow for its corporate governance practices and governance issues that may arise, for which no federal law controls; and

subject an entity's indemnification policies to review by the Finance Agency for safety and soundness.
 
Capital Stress Testing Rule. In September 2013, the Finance Agency issued a final rule that requires each FHLBank to assess the potential impact of certain sets of economic and financial conditions (including baseline, adverse and severely adverse scenarios) on its earnings, capital, and other related factors, over a nine-quarter forward horizon based on its balance sheet as of September 30 of the previous year. The rule specifies that the first stress test must be submitted by April 30, 2014. The rule provides that the Finance Agency will annually issue guidance on the scenarios and methodologies to be used in conducting the stress tests. Each FHLBank must publicly disclose the results of its adverse economic conditions stress test. We believe that our capital adequacy, including the amount of retained earnings, is sufficient to satisfy the stress tests based on the requirements of the final rule and additional guidance issued.
 
Impaired access to the capital markets for debt issuance could increase liquidity risk, decrease the amount of Mission Asset Activity, lower earnings by raising debt costs and, at the extreme, result in realization of liquidity risk preventing the System from meeting its financial obligations.

Our principal long-term source of funding, liquidity, and market risk management is through access to the capital markets for participation in the issuances of debt securities and execution of derivative transactions at prices and yields that are adequate to support our business model. Access to the capital markets on favorable terms is the fundamental source of the FHLBank System's business franchise. The System's strong debt ratings, the implicit U.S. government backing of our debt, and effective funding management are instrumental in ensuring satisfactory access to the capital markets. The ability to access the capital markets could be adversely affected by external events (such as general economic and financial instabilities, political instability, wars, and natural disasters) and by the System's joint and several liability for Consolidated Obligations, which exposes us to events at other FHLBanks. If access to capital markets were to be impaired for any extended period, the effect on our financial condition and results of operations could be material. At the extreme, the System's ability to achieve its mission and satisfy its financial obligations could be threatened.

Although the last several years have been characterized by ongoing issues with the federal government's fiscal condition, we have been able to maintain access to the capital markets for debt issuances on acceptable terms (including when the FHLBank System's debt was downgraded by Standard & Poor's). However, uncertainty remains regarding possible longer-term effects resulting from these events. Any future downgrades in the System's debt ratings or serious disruptions in the government's fiscal conditions could result in higher funding costs or disruptions in the System's ability to access capital markets for funding and collateral under certain derivative transactions. Although we believe the chance of a liquidity or funding crisis in the FHLBank System is currently remote, we can provide no assurance that this will remain true.

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

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

The FHLBank is a collateral-based asset lender for Advances and Letters of Credit. Although Advances are over-collateralized and we have a perfected first lien position on all pledged loan collateral, most members are on a blanket lien status for Advances which, because it does not require specific loan collateral to be delivered, imparts a degree of uncertainty as to what types of loans members have pledged to collateralize their Advances and what their market values are.


21


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

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

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

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

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

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

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

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

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

The concentration of Mission Asset Activity and capital among a small number of members could reduce dividend rates available if several large members were to withdraw from membership or sharply reduce their activity.

A few members provide the majority of our Mission Asset Activity and capital. These members could decrease their Mission Asset Activity and the amount of their FHLBank capital stock as a result of merger and acquisition activity or their reduced demand for Mission Assets. At December 31, 2013, one member, JPMorgan Chase Bank, N.A., held over half of our Advances and one member PFI, Union Savings Bank, accounted for nearly 25 percent of the outstanding MPP

22


principal balance. Our business model is structured to be able to absorb sharp changes in Mission Asset Activity because we can undertake commensurate reductions in liability balances and capital and because of our relatively low operating expenses. However, an extremely large reduction in Mission Asset Activity for any reason could materially affect our profitability and possibly our ability to pay competitive dividends.

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

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

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

In the last several years, members' regulators have heightened regulatory requirements and scrutiny, especially in the areas of capitalization, asset classifications, reliance on Advances for funding, and interest rate risk management. We believe these activities have resulted in members' decreased utilization of Advances. The FDIC has changed several of its practices that has reduced or could reduce members' ability or preferences to engage in Mission Asset Activity. These practices include raising coverage levels of deposit insurance and requiring certain depository institutions to include Advances when calculating their deposit insurance premiums.

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

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

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

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

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

We rely heavily on internal and third party information systems and other technology to conduct and manage our business. Our operations rely on the secure processing, storage and transmission of confidential and other information in computer systems and networks. Computer systems, software and networks can be vulnerable to failures and interruptions including “cyberattacks” (e.g., breaches, unauthorized access, misuse, computer viruses or other malicious code and other events) that could jeopardize the confidentiality or integrity of information, or otherwise cause interruptions or malfunctions in operations. We can make no assurance that we will be able to prevent, timely and adequately address, or mitigate the negative effects of, failures, interruptions, or cyberattacks in information systems and other technology. If we experience a

23


failure, interruption, or cyberattack in any of these systems, we may be unable to effectively conduct or manage our business activities, operating processes, and risk management, which could significantly harm customer relations, our reputation, or profitability, potentially resulting in material adverse effects on our financial condition and results of operations.


Item 1B.    Unresolved Staff Comments.

None.


Item 2.        Properties.

Our offices are located in 78,794 square feet of leased space in downtown Cincinnati, Ohio. We also maintain a leased, fully functioning, back-up facility in suburban Cincinnati. Additionally, we lease a small office in Nashville, Tennessee for the area marketing representative. We believe that our facilities are in good condition, well maintained, and adequate for our current needs.


Item 3.        Legal Proceedings.

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


Item 4.        Mine Safety Disclosures.

Not applicable.


24


PART II


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

By law our stock is not publicly traded, and only our members (and former members with a withdrawal notice pending) may own our stock. The par value of our capital stock is $100 per share. As of December 31, 2013, we had 727 stockholders and 47 million shares of capital stock outstanding, all of which were Class B Stock.

We paid quarterly dividends in 2013 and 2012 as outlined in the table below.
(Dollars in millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2013
 
 
 
2012
 
 
 
 
Annualized
 
 
 
 
 
 
 
Annualized
 
 
Quarter
 
Amount
 
Rate
 
Form
 
Quarter
 
Amount
 
Rate
 
Form
First
 
$
39

 
4.25
%
 
Cash
 
First
 
$
35

 
4.50
%
 
Cash
Second
 
43

 
4.25

 
Cash
 
Second
 
33

 
4.25

 
Cash
Third
 
49

 
4.25

 
Cash
 
Third
 
33

 
4.25

 
Cash
Fourth
 
47

 
4.00

 
Cash
 
Fourth
 
40

 
4.75

 
Cash
Total
 
$
178

 
4.18

 
 
 
Total
 
$
141

 
4.44

 
 
    

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

A Finance Agency Capital Rule prohibits an FHLBank from issuing new excess capital stock to members, either by paying stock dividends or otherwise, if before or after the issuance the amount of member excess capital stock exceeds or would exceed one percent of the FHLBank's assets. Excess capital stock for this regulatory purpose is calculated as the aggregate of capital stock owned that is in excess of all membership and Mission Asset Activity requirements (as defined in our Capital Plan). In accordance with this Rule, we paid cash dividends in each quarter of 2013 and 2012. Our Board, and we believe our members, continue to have a stated preference for dividends in the form of stock.

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


RECENT SALES OF UNREGISTERED SECURITIES

From time to time, we provide Letters of Credit in the ordinary course of business to support members' obligations issued in support of unaffiliated, third-party offerings of notes, bonds or other securities. We did not provide such credit support during 2013 and 2011. We provided $8 million of such credit support during 2012. To the extent that these Letters of Credit are securities for purposes of the Securities Act of 1933, their issuance is exempt from registration pursuant to section 3(a)(2) thereof.


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Item 6.    Selected Financial Data.

The following table presents selected Statement of Condition data, Statement of Income data and financial ratios for the five years ended December 31, 2013.
 
Year Ended December 31,
(Dollars in millions)
2013
 
2012
 
2011
 
2010
 
2009
STATEMENT OF CONDITION DATA AT PERIOD END:
 
 
 
 
 
 
 
 
 
Total assets
$
103,181

 
$
81,562

 
$
60,397

 
$
71,631

 
$
71,387

Advances
65,270

 
53,944

 
28,424

 
30,181

 
35,818

Mortgage loans held for portfolio
6,826

 
7,548

 
7,871

 
7,782

 
9,366

Allowance for credit losses on mortgage loans
7

 
18

 
21

 
12

 

Investments (1)
22,364

 
19,950

 
21,941

 
33,314

 
24,193

Consolidated Obligations, net:
 
 
 
 
 
 
 
 
 
Discount Notes
38,210

 
30,840

 
26,136

 
35,003

 
23,187

Bonds
58,163

 
44,346

 
28,855

 
30,697

 
41,222

Total Consolidated Obligations, net
96,373

 
75,186

 
54,991

 
65,700

 
64,409

Mandatorily redeemable capital stock
116

 
211

 
275

 
357

 
676

Capital:
 
 
 
 
 
 
 
 
 
Capital stock - putable
4,698

 
4,010

 
3,126

 
3,092

 
3,063

Retained earnings
621

 
538

 
444

 
438

 
412

Accumulated other comprehensive loss
(9
)
 
(11
)
 
(11
)
 
(7
)
 
(8
)
Total capital
5,310

 
4,537

 
3,559

 
3,523

 
3,467

STATEMENT OF INCOME DATA:
 
 
 
 
 
 
 
 
 
Net interest income
$
328

 
$
308

 
$
249

 
$
275

 
$
387

(Reversal) provision for credit losses
(7
)
 
1

 
12

 
13

 

Other income (loss)
20

 
13

 
(5
)
 
20

 
38

Other expenses
64

 
58

 
57

 
56

 
59

Assessments
30

 
27

 
37

 
62

 
98

Net income
$
261

 
$
235

 
$
138

 
$
164

 
$
268

FINANCIAL RATIOS:
 
 
 
 
 
 
 
 
 
Dividend payout ratio (2)
68.10
%
 
60.09
%
 
95.42
%
 
84.13
%
 
68.16
%
Weighted average dividend rate (3)
4.18

 
4.44

 
4.25

 
4.38

 
4.63

Return on average equity
5.10

 
6.20

 
3.89

 
4.67

 
6.38

Return on average assets
0.28

 
0.35

 
0.21

 
0.24

 
0.32

Net interest margin (4)
0.35

 
0.46

 
0.37

 
0.40

 
0.46

Average equity to average assets
5.47

 
5.68

 
5.29

 
5.08

 
4.96

Regulatory capital ratio (5)
5.27

 
5.84

 
6.37

 
5.43

 
5.81

Operating expense to average assets
0.055

 
0.067

 
0.068

 
0.070

 
0.057

(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.


26


Item 7.    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.
 



27


EXECUTIVE OVERVIEW

Financial Condition

Mission Asset Activity
The following table summarizes our financial condition.
 
Year Ended December 31,
 
Ending Balances
 
Average Balances
(In millions)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Total Assets
$
103,181

 
$
81,562

 
$
93,691

 
$
66,702

Mission Asset Activity:
 
 
 
 
 
 
 
Advances (principal)
65,093

 
53,621

 
61,327

 
32,273

Mortgage Purchase Program (MPP):
 
 
 
 
 
 
 
Mortgage loans held for portfolio (principal)
6,643

 
7,366

 
6,881

 
7,821

Mandatory Delivery Contracts (notional)
37

 
124

 
254

 
260

Total MPP
6,680

 
7,490

 
7,135

 
8,081

Letters of Credit (notional)
13,472

 
10,152

 
12,560

 
4,584

Total Mission Asset Activity
$
85,245

 
$
71,263

 
$
81,022

 
$
44,938


In 2013, the FHLBank fulfilled its mission by providing readily available and competitively priced wholesale funding to its member financial institutions, supporting its commitment to affordable housing, and paying stockholders a competitive dividend return on their capital investment. The vast majority of our members had modest demand for new Advance borrowings due to measured economic growth and significant amounts of liquidity available to members as a result of the actions of the Federal Reserve System. We experienced substantial Advance growth as a result of borrowings from one large-asset member and a modest increase in overall Advance usage relative to members' assets.

Total assets at December 31, 2013 increased $21.6 billion (27 percent) from year-end 2012, led by Advances. Average asset balances in 2013 were $27.0 billion (40 percent) higher than 2012's average, mostly due to the substantial growth in Advances from one large-asset member.

The balance of Mission Asset Activity – comprising Advances, Letters of Credit, and the MPP – was $85.2 billion at December 31, 2013, an increase of $14.0 billion (20 percent) from year-end 2012. The growth was led by an $11.5 billion increase in the principal balance of Advances. Average Advance principal balances in 2013 increased $29.1 billion (90 percent) from 2012's average.

The principal balance of mortgage loans held for portfolio at December 31, 2013 fell $0.7 billion (10 percent) from year-end 2012. The decline reflected the principal paydowns and inactivity by large mortgage sellers. Throughout 2013, we purchased $1.2 billion of mortgage loans, while principal paydowns totaled $1.9 billion.

As of December 31, 2013, members funded on average 3.3 percent of their assets with Advances, and the penetration rate was relatively stable over the last year with 65-70 percent of members holding Mission Asset Activity. The number of active sellers and participants in the MPP remained strong with the number of monthly sellers averaging 62 in 2013.

Based on 2013 earnings, we contributed $30 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 two other housing programs which provide resources to pay for accessibility rehabilitation and emergency repairs for special needs and elderly homeowners and to help members aid their communities following natural disasters.
 
Investments
The balance of investments at December 31, 2013 was $22.4 billion, an increase of $2.4 billion (12 percent) from year-end 2012. Investment balances averaged $24.9 billion in 2013, a decrease of $0.9 billion (three percent) from 2012's average. We maintained an adequate amount of asset liquidity throughout the year under a variety of liquidity measures as discussed in the "Liquidity Risk" section of "Quantitative and Qualitative Disclosures About Risk Management."


28


At December 31, 2013, investments included $16.1 billion of mortgage-backed securities and $6.3 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 given the increased authority as a result of the larger capital stock balance. All of our mortgage-backed securities held at December 31, 2013 were issued and guaranteed by Fannie Mae, Freddie Mac or a U.S. agency. We carried a lower balance of liquidity investments at December 31, 2013 due to narrower spreads and fewer eligible counterparties available for these types of investments, and instead held $8.6 billion in deposits at the Federal Reserve, which are reflected in cash and due from banks on the Statements of Condition.

Capital
Capital adequacy was strong in 2013, exceeding all minimum regulatory capital requirements. The GAAP capital-to-assets ratio at December 31, 2013 was 5.15 percent, while the regulatory capital-to-assets ratio was 5.27 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 $773 million and $676 million, respectively, between year-end 2012 and 2013, primarily resulting from members' capital stock purchases to support Advance growth.

Total retained earnings were $621 million at December 31, 2013, an increase of $83 million (15 percent) from year-end 2012. Retained earnings were comprised of $510 million unrestricted and $111 million restricted.

In the first quarter of 2014 we implemented additional steps to effectively manage our capital and financial performance by redeeming and repurchasing $500 million in excess stock from members. This action maintains a prudent amount of financial leverage with the regulatory capital leverage in the range of 4.90 to 5.10 percent, well above the regulatory minimum.

Results of Operations

The table below summarizes our results of operations.
 
Year Ended December 31,
(Dollars in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Net income
$
261

 
$
235

 
$
138

Affordable Housing Program accrual
30

 
27

 
17

Return on average equity (ROE)
5.10
%
 
6.20
%
 
3.89
%
Return on average assets
0.28

 
0.35

 
0.21

Weighted average dividend rate
4.18

 
4.44

 
4.25

Average 3-month LIBOR
0.27

 
0.43

 
0.34

Average overnight Federal funds effective rate
0.11

 
0.14

 
0.10

ROE spread to 3-month LIBOR
4.83

 
5.77

 
3.55

Dividend rate spread to 3-month LIBOR
3.91

 
4.01

 
3.91

ROE spread to Federal funds effective rate
4.99

 
6.06

 
3.79

Dividend rate spread to Federal funds effective rate
4.07

 
4.30

 
4.15


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 member stockholders use to assess the competitiveness of the return on their capital investment in our company. Earnings continued to be sufficient to provide competitive returns 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 average ROE in a stable market rate, interest rate, and business 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 average, is influenced by several one-time factors discussed in "Results of Operations" and the following ongoing factors: 1) the extremely low level of short-term interest rates, 2) cumulative effects of our ability over the last five years to retire a large amount of high-cost Bonds before their final maturities, and 3) relatively muted prepayment speeds of over the last several years of mortgages with coupon rates above current market interest rates.


29


The overall increase in net income in 2013 compared to 2012 resulted from the following factors:
The growth in Advance balances supported by new capital stock, which together improved net interest income by an estimated $77 million. Leveraging the additional capital with mortgage-backed securities contributed to the increase in net interest income.
A decline in net amortization, which improved net interest income by $48 million.
The reversal of incurred losses estimated in the Mortgage Purchase Program, which resulted in an $8 million improvement.

Much of the impact of the favorable factors were offset by:
Several management strategies and actions, along with changes in the market rate environment, related to reducing our market risk exposure, which on a net basis lowered net interest income by an estimated $34 million.
Net gains on securities sales in 2012 that did not reoccur in 2013, which reduced income by $29 million.
Lower prepayment fees on Advances, which reduced net interest income by $18 million.
Lower net Mortgage Purchase Program balances, which reduced net interest income by $13 million.

ROE fell in 2013 because growth in average capital ($1.3 billion) to support Advance growth, combined with the net impact of both the favorable and unfavorable factors, resulted in a relatively small increase in net income compared to the growth in capital.

Business Outlook and Risk Management

This section summarizes the business outlook and what we believe are our current major risk exposures. Item 1A's “Risk Factors” has a detailed discussion of risk factors that could affect our corporate objectives, financial condition, and results of operations. "Quantitative and Qualitative Disclosures About Risk Management" provides details on current risk exposures. Many of the issues related to our financial condition, results of operations, and liquidity discussed throughout this document relate directly to the ongoing effects of the weak economic recovery and to the federal government's actions to stimulate economic growth.

Strategic/Business Risk
Advances. We cannot assure you of the future trend in 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 affect liquidity reserves of financial institutions 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 measured economic growth and significant amounts of liquidity available to members as a result of the actions of the Federal Reserve have continued to moderate 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 recruiting community financial institution members, increasing the number of regular sellers, and maintaining balances at a prudent amount relative to capital. This strategy is guided by our principle of having a moderate amount of market and low amount of credit risk within our business model.

Balances are influenced primarily by activity from large sellers and a Finance Agency regulation requiring that if purchases in a calendar year exceed $2.5 billion, we must enact additional housing goals. Given the uncertainty of the goal requirements and possible operational and economic impacts, we currently plan to limit our calendar year purchases to less than $2.5 billion until further guidance is provided by the Finance Agency.


30


Regulatory and Legislative Risk
General. The FHLBank System currently faces heightened legislative and regulatory risks and uncertainties, which we believe has affected, and could continue to affect, our Mission Asset Activity, capitalization, and results of operations. Item 1A.'s "Risk Factors" provides details of some of the primary current and recent regulatory and legislative initiatives that could affect our business. The legislative and regulatory actions related to our company have raised our operating costs and increased uncertainty regarding the business model under which the FHLBanks may operate in the future. This is due to the uncertainty around potential future GSE reform, and the many regulations and other guidances that have been and continue to be promulgated after the financial crisis of 2008-2009. To date, however, we believe that the regulatory and legislative environment has not resulted in a material adverse impact on our financial condition, results of operations, or business model. The following are noteworthy Finance Agency regulatory pronouncements issued or proposed in 2013.

Core Mission Asset Ratios. Of particular current interest to us is the 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 primarily by an evolving Finance Agency requirement for each FHLBank to develop and include in its 2014 strategic business plan, target minimum benchmark levels for identified core mission activities and actions to achieve and maintain such levels. In response to this focus, we included in our 2014 Strategic Business Plan benchmarks for percentages of core mission asset activity. While we generally support this renewed focus on our primary business activities, we are concerned that the regulatory focus in this area could require us to make undue changes to our operations, such as lowering the amount of liquidity we maintain or changing the pricing of our mission asset activity, that could adversely affect our financial condition, results of operations, or risk exposures.

Market Risk
During 2013, as in 2012, the market risk exposure to changing interest rates was moderate overall, consistent with the normal range of long-term historical exposure, and well within policy limits. 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 an extreme stress scenario, although plausible, is unlikely to occur in the next few years. However, our recent level of profitability compared to short-term rates could decline quickly (even though it would remain competitive) in a fast rising rate environment. This was part of the basis for management's implementation of a strategy in the fourth quarter of 2013 to decrease market risk exposure to higher rates. Decreases in long-term interest rates even up to two percentage points (which would put fixed-rate mortgages at almost two percent) would still result in ROE being above market interest rates.

Capital Adequacy
We maintained 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 place a high value on their capital investment in our company. Capital ratios at December 31, 2013 were well above the regulatory required minimum of four percent.

Credit Risk
We continued in 2013 to experience limited overall residual credit risk exposure from offering Advances, making investments, and executing derivative transactions. We believe policies and procedures related to credit underwriting, Advance collateral management, and transactions with investment and derivative counterparties continue to fully mitigate these risks; and we continued to have no loan loss reserves or impairment recorded for these instruments.

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 $7 million at December 31, 2013.

We also believe we face limited credit risk exposure in our investments. As in prior years, we did not evaluate any investments to be other-than-temporarily impaired in 2013. We held no private label mortgage-backed securities. All 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, or by the National Credit Union Administration (NCUA) or Ginnie Mae, which issues guaranteed securities.

Liquidity investments are either unsecured, guaranteed by the U.S. government, or secured (i.e., collateralized). For unsecured liquidity investments, we invest in the debt securities of highly rated, investment-grade institutions, have appropriate limits on dollar and maturity exposure to each institution, and have strong credit underwriting practices. We mitigate most of the credit risk exposure resulting from interest rate swap transactions through collateralization.


31


Concentration Risk
The large increase over the prior 18 months in Advance borrowings from one member, JPMorgan Chase Bank, N.A.(JPMorgan), has raised borrower concentration ratios compared with levels of the several years prior. 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 largely 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 affected capital adequacy because the Capital Plan requires the Advance growth from the member to be supported by new purchases of capital stock.

Liquidity Risk
We believe our liquidity position remained strong during 2013, as did our overall ability to fund operations through Consolidated Obligation issuances at acceptable interest costs. There were minimal, if any, stresses on our liquidity from the uncertainty surrounding the federal government's recent and ongoing issues with the debt ceiling and risk of Treasury default (prior to resolution). However, reflecting an abundance of caution regarding these issues, we increased our liquidity beginning in late September. 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.


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, measured economic growth 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 deposit based liquidity to stimulate economic growth, as discussed elsewhere. We believe these trends continue to limit many members' demand for Advances.

The relative balance between loan and deposit growth provides an indication of potential member Advance demand. From September 30, 2012 to September 30, 2013 (the most recent period for which data are available), aggregate loan portfolios of Fifth District depository institutions grew $45.2 billion (3.9 percent) while their aggregate deposit balances rose $188.0 billion (10.1 percent). The data include the effect of large mergers and acquisitions only when they are available for both comparison dates. Most of the loan growth in this period occurred from our largest members, which is consistent with the concentration of financial activity among large financial institutions.

Excluding the five members with over $50 billion of assets and recent acquisitions, aggregate loans increased $7.5 billion (4.1 percent) in the 12-month period while aggregate deposits grew $10.8 billion (4.7 percent), which provides a possible explanation for the moderate broad-based growth in Advance demand. In the third and fourth quarters of 2013, there were indications of slower deposit growth.


32


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 tables present key market interest rates (obtained from Bloomberg L.P.).
 
Year 2013
 
Year 2012
 
Year 2011
 
Ending
 
Average
 
Ending
 
Average
 
Ending
 
Average
Federal funds target
0-0.25%

 
0-0.25%

 
0-0.25%

 
0-0.25%

 
0-0.25%

 
0-0.25%

Federal funds effective
0.07

 
0.11

 
0.09

 
0.14

 
0.04

 
0.10

 
 
 
 
 
 
 
 
 
 
 
 
3-month LIBOR
0.25

 
0.27

 
0.31

 
0.43

 
0.58

 
0.34

2-year LIBOR
0.49

 
0.44

 
0.39

 
0.50

 
0.72

 
0.72

5-year LIBOR
1.79

 
1.32

 
0.86

 
0.98

 
1.23

 
1.79

10-year LIBOR
3.09

 
2.47

 
1.84

 
1.88

 
2.04

 
2.90

 
 
 
 
 
 
 
 
 
 
 
 
2-year U.S. Treasury
0.38

 
0.30

 
0.25

 
0.27

 
0.24

 
0.44

5-year U.S. Treasury
1.74

 
1.17

 
0.72

 
0.75

 
0.83

 
1.51

10-year U.S. Treasury
3.03

 
2.34

 
1.76

 
1.78

 
1.88

 
2.76

 
 
 
 
 
 
 
 
 
 
 
 
15-year mortgage current coupon (1)
2.68

 
2.21

 
1.71

 
1.64

 
2.05

 
2.83

30-year mortgage current coupon (1)
3.63

 
3.07

 
2.22

 
2.54

 
2.92

 
3.74

 
 
 
 
 
 
 
 
 
 
 
 
15-year mortgage note rate (2)
3.74

 
3.33

 
2.86

 
3.15

 
3.24

 
3.68

30-year mortgage note rate (2)
4.64

 
4.19

 
3.52

 
3.84

 
3.95

 
4.45

 
Year 2013 by Quarter - Average
 
Quarter 1
 
Quarter 2
 
Quarter 3
 
Quarter 4
Federal funds target
0-0.25%

 
0-0.25%

 
0-0.25%

 
0-0.25%

Federal funds effective
0.14

 
0.12

 
0.09

 
0.09

 
 
 
 
 
 
 
 
3-month LIBOR
0.29

 
0.28

 
0.26

 
0.24

2-year LIBOR
0.41

 
0.42

 
0.52

 
0.43

5-year LIBOR
0.96

 
1.09

 
1.67

 
1.55

10-year LIBOR
2.01

 
2.15

 
2.88

 
2.84

 
 
 
 
 
 
 
 
2-year U.S. Treasury
0.25

 
0.26

 
0.36

 
0.32

5-year U.S. Treasury
0.81

 
0.91

 
1.50

 
1.43

10-year U.S. Treasury
1.93

 
1.98

 
2.70

 
2.73

 
 
 
 
 
 
 
 
15-year mortgage current coupon (1)
1.84

 
1.87

 
2.62

 
2.50

30-year mortgage current coupon (1)
2.57

 
2.77

 
3.52

 
3.41

 
 
 
 
 
 
 
 
15-year mortgage note rate (2)
2.97

 
3.06

 
3.71

 
3.55

30-year mortgage note rate (2)
3.72

 
3.87

 
4.66

 
4.47

(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 interest rates remained at historic lows in 2013. The Federal Reserve maintained the overnight Federal funds target and effective rates between zero and 0.25 percent, with other short-term interest rates generally consistent with their historical relationships to Federal funds. The Federal Reserve has indicated that it currently plans to hold certain short-term interest rates

33


at or near zero until at least mid-2015. This projection could change if actual economic growth or inflation, or its forecast thereof, accelerates.

Expectations for future changes in intermediate- and long-term interest rates are more difficult to form in part because the Federal Reserve has less control over these rates. These rates rose moderately on an absolute basis in the second and third quarters of the year compared with the levels in 2012. In the fourth quarter, these rates were relatively stable compared to the third quarter. Year over year, long-term interest rates rose 1.00 to 1.50 percentage points.

These rate trends affected our results of operations in 2013. The increase in intermediate- and long-term interest rates during 2013 was moderate on an absolute basis and the 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. The low interest rate environment has been a net benefit to our profitability over the last several years relative to levels of interest rates, 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 interest rates have provided us the opportunity to retire many Bonds 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.


34


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)
December 31, 2013
 
December 31, 2012
 
Balance
 
Percent(1)
 
Balance
 
Percent(1)
Adjustable/Variable Rate Indexed:
 
 
 
 
 
 
 
LIBOR
$
49,199

 
75
%
 
$
35,578

 
66
%
Other
413

 
1

 
406

 
1

Total
49,612

 
76

 
35,984

 
67

Fixed-Rate:
 
 
 
 
 
 
 
REPO
4,143

 
7

 
7,655

 
14

Regular Fixed Rate
5,751

 
9

 
4,573

 
9

Putable (2)
2,146

 
3

 
2,587

 
5

Convertible (2)
10

 

 
63

 

Amortizing/Mortgage Matched
2,593

 
4

 
2,353

 
4

Other
838

 
1

 
406

 
1

Total
15,481

 
24

 
17,637

 
33

Total Advances Principal
$
65,093

 
100
%
 
$
53,621

 
100
%
 
 
 
 
 
 
 
 
Letters of Credit (notional)
$
13,472

 
 
 
$
10,152

 
 
(Dollars in millions)
December 31, 2013
 
September 30, 2013
 
June 30, 2013
 
March 31, 2013
 
Balance
Percent(1)
 
Balance
Percent(1)
 
Balance
Percent(1)
 
Balance
Percent(1)
Adjustable/Variable Rate Indexed:
 
 
 
 
 
 
 
 
 
 
 
LIBOR
$
49,199

75
%
 
$
48,981

75
%
 
$
49,277

76
%
 
$
45,280

78
%
Other
413

1

 
324


 
288


 
196


Total
49,612

76

 
49,305

75

 
49,565

76

 
45,476

78

Fixed-Rate:
 
 
 
 
 
 
 
 
 
 
 
REPO
4,143

7

 
4,345

7

 
3,673

6

 
2,477

4

Regular Fixed Rate
5,751

9

 
6,458

10

 
6,277

10

 
4,928

9

Putable (2)
2,146

3

 
2,333

3

 
2,367

3

 
2,469

4

Convertible (2)
10


 
28


 
63


 
63


Amortizing/Mortgage Matched
2,593

4

 
2,503

4

 
2,402

4

 
2,311

4

Other
838

1

 
677

1

 
529

1

 
275

1

Total
15,481

24

 
16,344

25

 
15,311

24

 
12,523

22

Total Advances Principal
$
65,093

100
%
 
$
65,649

100
%
 
$
64,876

100
%
 
$
57,999

100
%
 
 
 
 
 
 
 
 
 
 
 
 
Letters of Credit (notional)
$
13,472

 
 
$
13,332

 
 
$
13,839

 
 
$
11,683

 
(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.

Advance growth was comprised mostly of adjustable-rate LIBOR Advances. Aggregate average Advance balances to other members were $2.3 billion (10 percent) lower at December 31, 2013 compared to the end of 2012.


35


Advances to former members declined by $1.9 billion during 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 repaid, the former members will not be able to replace them with new Advances.

Members increased their available lines in the Letters of Credit program by $3.3 billion in 2013. The lines rose principally because of more activity from a large member which tends to use Letters of Credit heavily. We believe the member increased its usage primarily in response to the year-end 2012 expiration of the government's Transaction Account Guarantee program and, in part also, due to the Basel accord's rules on liquidity. 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.

Advance Usage
The following table shows the unweighted average ratio of each member's Advance balance to its most-recently available figures for total assets.
 
December 31, 2013
 
September 30, 2013
 
June 30, 2013
 
March 31, 2013
 
December 31, 2012
Average Advances-to-Assets for Members
 
 
 
 
 
 
 
 
 
Assets less than $1.0 billion (663 members)
3.27
%
 
3.32
%
 
3.03
%
 
2.89
%
 
3.12
%
Assets over $1.0 billion (64 members)
3.33
%
 
3.05
%
 
3.02
%
 
2.70
%
 
2.90
%
All members
3.28
%
 
3.29
%
 
3.03
%
 
2.87
%
 
3.10
%

Overall Advance usage ratios declined substantially from 2009 to 2012, but rose moderately in 2013. The increase was broad based, occurring from large and mid-sized members with assets between $250 million and $1.0 billion. We do not know if the Advance growth experienced in the last 12 months, primarily from one large-asset member, and the recent growth from mid-sized members, will continue or develop into a broader increase in demand. We believe that the measured economic expansion, significant levels of financial institution liquidity as a result of Federal Reserve actions, and robust member deposit levels have limited overall member demand for our funding.

The following table presents Advances outstanding by member type. Commercial banks continue to hold the overwhelming largest portion of Advances. This reflects, for the Fifth District, both the number of commercial bank members (see "Membership and Stockholders" below) and the fact that there are more large commercial banks than large members with other charter types.
(Dollars in millions)
December 31, 2013
 
December 31, 2012
 
Par Value of Advances
 
Percent of Total Par Value of Advances
 
Par Value of Advances
 
Percent of Total Par Value of Advances
Commercial banks
$
54,909

 
84
%
 
$
43,453

 
81
%
Thrifts and Savings Banks
3,106

 
5

 
2,978

 
5

Credit unions
814

 
1

 
554

 
1

Insurance companies
4,601

 
7

 
3,017

 
6

Community Development Financial Institutions
1

 

 

 

Total member Advances
63,431

 
97

 
50,002

 
93

Former member borrowings
1,662

 
3

 
3,619

 
7

Total par value of Advances
$
65,093

 
100
%
 
$
53,621

 
100
%

36



The following tables present principal balances for our top five Advance borrowers.
(Dollars in Millions)
 
 
 
 
 
 
 
 
 
 
December 31, 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.
 
$
41,700

 
64
%
 
JPMorgan Chase Bank, N.A.
 
$
26,000

 
48
%
U.S. Bank, N.A.
 
4,584

 
7

 
Fifth Third Bank
 
4,732

 
9

The Huntington National Bank
 
1,809

 
3

 
U.S. Bank, N.A.
 
4,586

 
8

Western-Southern Life Assurance Co
 
1,342

 
2

 
PNC Bank, N.A. (1)
 
2,986

 
6

Protective Life Insurance Company
 
1,171

 
2

 
Protective Life Insurance Company
 
1,071

 
2

Total of Top 5
 
$
50,606

 
78
%
 
Total of Top 5
 
$
39,375

 
73
%
(1)Former member.

The top-five concentration ratio rose in 2013 due to increased Advance usage from JPMorgan. As reflected in the table on Advances-to-member assets, large members currently, as well as historically, utilize Advances to fund a similar amount of their assets as smaller members. Therefore, our Advance concentration ratios are influenced by, and generally are similar to, concentration ratios of financial activity among our Fifth District financial institutions. 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 our operating efficiency, increases our earnings and thereby contributions to housing and community investment programs, may enable us over time to obtain more favorable funding costs, and help us to maintain competitively priced Mission Asset Activity.

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 each of the last two years.
(In millions)
2013
 
2012
Balance, beginning of year
$
7,366

 
$
7,752

Principal purchases
1,171

 
2,285

Principal paydowns
(1,894
)
 
(2,671
)
Balance, end of year
$
6,643

 
$
7,366


The decline in principal loan balance in 2013 resulted from moderately fast prepayment rates and, more importantly, from lack of activity from large sellers. The purchases resulted from sales by 92 participating financial institutions (PFIs) in 2013, with the number of monthly sellers averaging 62.


37


The following tables show the percentage of principal balances from PFIs supplying five percent or more of total principal and the percentage of principal balances from all other PFIs.
(Dollars in millions)
December 31, 2013
 
 
December 31, 2012
 
Principal
 
% of Total
 
 
Principal
 
% of Total
Union Savings Bank
$
1,433

 
22
%
 
Union Savings Bank
$
1,984

 
27
%
PNC Bank, N.A. (1)
1,356

 
20

 
PNC Bank, N.A. (1)
1,818

 
25

All others
3,854

 
58

 
Guardian Savings Bank FSB
431

 
6

Total
$
6,643

 
100
%
 
All others
3,133

 
42

 
 
 
 
 
Total
$
7,366

 
100
%

(1)Former member.

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 exposure. MPP principal paydowns in all of 2013 equated to a 21 percent annual constant prepayment rate, down from 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 2013. The weighted average mortgage note rate fell from 4.74 percent at the end of 2012 to 4.53 percent at December 31, 2013. This decline reflected a continuing trend of prepayments of higher rate mortgages and purchases of lower rate mortgages. MPP yields we earned during 2013, relative to funding costs, continued to offer favorable returns relative to their market risk exposure. Almost all loans acquired in 2013 were conventional, with less than one percent of purchases being comprised of FHA loans.

Core Mission Activity

We regularly monitor the dollar and percentage amount of our balance sheet that we consider to be Core Mission Activity, which we define as Advances, Letters of Credit, and the MPP because these are the primary means by which we fulfill our mission with direct connections to members. At December 31, 2013, the principal balance of Core Mission Asset Activity was $85.2 billion (an increase of $14.0 billion (20 percent) from year-end 2012), which constituted 78 percent of adjusted Consolidated Obligations (which equal Obligations plus Letters of Credit). We measure Core Mission Activity against Consolidated Obligations because the latter reflect the major source of our franchise value as a GSE. The daily average percentage for 2013 was 81 percent. These percentage levels were close to the 80 percent benchmark we have established, and based on this and other metrics and our Strategic Business Plan, we believe that we were successful in achieving our mission in 2013. The Core Mission Activity percentage has increased in the last two years due to increases in balances of Advances and Letters of Credit.

Housing and Community Investment

In 2013, we accrued $30 million of earnings for the Affordable Housing Program, which will be awarded to members in 2014. This amount represents a $3 million (eight percent) increase from 2012, due to 2013's higher earnings.

Including funds available in 2013 from previous years, we had $25 million of funds available for the competitive Affordable Housing Program in 2013, which we awarded to 67 projects through a single competitive offering. In addition, $10 million was awarded to 162 members on behalf of more than 2,012 homebuyers through the Welcome Home Program. This Program is a set-aside of the Affordable Housing Program that assists homebuyers with down payments and closing costs. In total, just over one-quarter of members received approval for funding under the total Affordable Housing Program. 
Additionally, in 2013 our Board authorized $1 million to renew the Carol M. Peterson Housing Fund (CMP Fund) and continued its commitment to the $5 million Disaster Reconstruction Program (DRP). Both are voluntary programs beyond the 10 percent of earnings that we are required by law to set aside for the Affordable Housing Program.

Finally, our activities to support affordable housing include offering Advances through the Affordable Housing Program with below-market interest rates at or near zero profit for us. At the end of 2013, Advance balances related to the Affordable Housing Program declined to $116 million due to higher demand for affordable housing subsidy in the form of grants. Under the Community Investment Cash Advance Program, Advances are offered at rates equal to or near our cost of funds in order to support economic development projects. The balance of these Advances increased to $359 million at December 31, 2013.

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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.
(In millions)
2013
 
2012
 
Ending Balance
 
Average Balance
 
Ending Balance
 
Average Balance
Liquidity investments
$
6,303

 
$
10,389

 
$
7,176

 
$
13,943

Mortgage-backed securities
16,061

 
14,320

 
12,774

 
11,375

Other investments (1)

 
161

 

 
408

Total investments
$
22,364

 
$
24,870

 
$
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 2013 corresponded to the growth in Advances. We continued to maintain an adequate amount of asset liquidity using our liquidity measures.

We carried a lower balance of liquidity investments at December 31, 2013, compared to the year's average, due to narrower spreads and fewer eligible counterparties available for these types of investments at year end. The investment balances at December 31, 2013 and 2012 exclude $8,599 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 holdings as close as possible to the regulatory maximum of three times regulatory capital, subject to the availability of securities that we believe provide acceptable risk/return tradeoffs. The balance of mortgage-backed securities at December 31, 2013 represented a 2.96 multiple of regulatory capital and consisted of $14.2 billion of securities issued by Fannie Mae or Freddie Mac (of which $1.8 billion were floating-rate securities), $1.2 billion of floating-rate securities issued by the NCUA, and $0.7 billion of securities issued by Ginnie Mae. We held no private-label mortgage-backed securities at December 31, 2013.
The table below shows principal purchases and paydowns of our mortgage-backed securities for each of the last two years.
(In millions)
Mortgage-backed Securities Principal
 
2013
 
2012
Balance, beginning of year
$
12,757

 
$
11,163

Principal purchases
6,017

 
5,335

Principal paydowns
(2,687
)
 
(3,263
)
Principal sales

 
(478
)
Balance, end of year
$
16,087

 
$
12,757


The $3.3 billion increase in the principal balance outstanding from the end of 2012 to the end of 2013 reflected the growth in capital. Principal paydowns in 2013 equated to a 17 percent annual constant prepayment rate, down from the 25 percent rate in all of 2012. Purchases during 2013 were mostly 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.
 
Only two percent of total pass-through mortgage-backed securities had 30-year fixed-rate mortgages as collateral. Because approximately 75 percent of MPP loans have 30-year original terms, purchasing pass-throughs with shorter than 30-year original terms is one way we diversify mortgage assets to help manage market risk exposure.

39


Consolidated Obligations

The table below presents the ending and average balances of our participations in Consolidated Obligations.
(In millions)
2013
 
2012
 
Ending Balance
 
Average Balance
 
Ending Balance
 
Average Balance
Discount Notes:
 
 
 
 
 
 
 
Par
$
38,217

 
$
34,581

 
$
30,848

 
$
29,504

Discount
(7
)
 
(7
)
 
(8
)
 
(5
)
Total Discount Notes
38,210

 
34,574

 
30,840

 
29,499

Bonds: