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Registrant's telephone number, including area code: (i317) i465-0200
Securities registered pursuant to Section 12(b) of the Act:
Title
of each class
Trading Symbol(s)
Name of each exchange on which registered
None
None
None
Securities registered pursuant to Section 12(g) of the Act:
iClass B capital 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 xiNo
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes xiNo
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. xiYeso No
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). xiYeso No
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,""accelerated filer,""smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
☐
Large accelerated filer
☐
Accelerated
filer
i☐
Emerging growth company
x
iNon-accelerated
filer
i☐
Smaller reporting company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate
by check mark whether the registrant has filed a report on and attestation on its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C 7262(b)) by the registered public accounting firm that prepared or issued its audit report. i☒ Yes o No
If securities are registered pursuant to Section 12(b) of the Act, indicate
by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. o
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). o
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Act). i☐ Yes ☒ No
Registrant's stock is not publicly traded and is only issued to members of the registrant. Such stock is issued and redeemed at par value, $100 per share, subject to certain regulatory and statutory limits. At June 30, 2022, the aggregate par value of the Class B stock held by members and former members of the
registrant was approximately $i2.3 billion. At February 28, 2023, including mandatorily redeemable capital stock, we had izero
outstanding shares of Class A stock and i25,313,845 outstanding shares of Class B stock.
advance: Secured loan to members, former members or Housing Associates
AFS: Available-for-Sale
Agency: GSE and Ginnie Mae
AHP: Affordable Housing Program
AMA:
Acquired Member Assets
AOCI: Accumulated Other Comprehensive Income (Loss)
Bank Act: Federal Home Loan Bank Act of 1932, as amended
bps: basis points
CDFI: Community Development Financial Institution
CFI: Community Financial Institution, a Federal Deposit Insurance Corporation-insured depository institution with average total assets below an annually- adjusted limit established by the Finance Agency Director based on the Consumer Price Index
CFPB: Bureau of Consumer Financial Protection
Clearinghouse:
A United States Commodity Futures Trading Commission-registered derivatives clearing organization
CO bond: Consolidated Obligation bond
DB Plan: Pentegra Defined Benefit Pension Plan for Financial Institutions, as amended
DC Plan: Collectively, the Pentegra Defined Contribution Retirement Savings Plan for Financial Institutions, as amended, in effect through October 1, 2020 and the Federal Home Loan Bank of Indianapolis Retirement Savings Plan, commencing October 2, 2020
DDCP: Directors' Deferred Compensation Plan
EFFR: Effective
Federal Funds Rate
Exchange Act: Securities Exchange Act of 1934, as amended
Fannie Mae: Federal National Mortgage Association
FASB: Financial Accounting Standards Board
FHA: Federal Housing Administration
FHLBank: A Federal Home Loan Bank
FHLBanks: The 11 Federal Home Loan Banks or a subset thereof
FHLBank System: The 11 Federal Home Loan Banks and the Office of Finance
FICO®: Fair Isaac Corporation, the creators of the FICO credit score
Finance Agency: Federal
Housing Finance Agency
FOMC: Federal Open Market Committee
Form 8-K: Current Report on Form 8-K as filed with the SEC under the Exchange Act
Form 10-K: Annual Report on Form 10-K as filed with the SEC under the Exchange Act
Form 10-Q: Quarterly Report on Form 10-Q as filed with the SEC under the Exchange Act
Freddie Mac: Federal Home Loan Mortgage Corporation
GAAP: Generally Accepted Accounting Principles in the United States of America
Ginnie Mae: Government National Mortgage Association
GSE: United States Government-Sponsored
Enterprise
Housing Associate: Approved lender under Title II of the National Housing Act of 1934 that is either a government agency or is chartered under federal or state law with rights and powers similar to those of a corporation
Securities Act: Securities Act of 1933, as amended
SERP: Collectively, the 2005 FHLBank of Indianapolis Supplemental Executive Retirement Plan, as amended, and the FHLBank of Indianapolis Supplemental Executive Retirement Plan, frozen effective December 31, 2004
SETP: Federal
Home Loan Bank of Indianapolis 2016 Supplemental Executive Thrift Plan, as amended and restated
SMI: Supplemental Mortgage Insurance
SOFR: Secured Overnight Financing Rate
TBA: To Be Announced, a forward contract for the purchase or sale of MBS at a future agreed-upon date for an established price
Statements in this Form 10-K, including statements describing our objectives, projections, estimates or predictions, may be considered to be "forward-looking statements." These statements may use forward-looking terminology, such as "anticipates,""believes,""could,""estimates,""may,""should,""expects,""will," or their negatives or other variations on these terms. We caution that, by their nature, forward-looking statements involve risk or uncertainty and that actual results either could differ materially from those expressed or implied in these
forward-looking statements or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. These forward-looking statements involve risks and uncertainties including, but not limited to, the following:
•economic and market conditions, including the timing and volume of market activity, inflation or deflation, changes in the value of global currencies, and changes in the financial condition of market participants;
•volatility of market prices, interest rates, and indices or the availability of suitable interest rate indices, or other factors, resulting from the effects of, and changes in, various monetary or fiscal policies and regulations, including those of the Federal Reserve, the Finance Agency and the Federal Deposit Insurance Corporation, or a decline in liquidity
in the financial markets, that could affect the value of investments, or collateral we hold as security for the obligations of our members and counterparties;
•changes in demand for our advances and purchases of mortgage loans resulting from:
◦changes in our members' deposit flows and credit demands;
◦changes in products or services we are able to provide;
◦federal or state regulatory developments impacting suitability or eligibility of membership classes;
◦membership changes, including, but not limited to, mergers, acquisitions and consolidations of charters;
◦changes
in the general level of housing activity in the United States and particularly in our district states of Michigan and Indiana, the level of refinancing activity and consumer product preferences;
◦competitive forces, including, without limitation, other sources of funding available to our members; and
◦changes in the terms and conditions of ownership of our capital stock;
•changes in mortgage asset prepayment patterns, delinquency rates and housing values or improper or inadequate mortgage originations and mortgage servicing;
•ability to introduce and successfully manage new products and services, including new types of collateral securing advances;
•political
events, including federal government shutdowns, administrative, legislative, regulatory, or other developments, changes in international political structures and alliances, and judicial rulings that affect us, our status as a secured creditor, our members (or certain classes of members), prospective members, counterparties, GSE's generally, one or more of the FHLBanks and/or investors in the consolidated obligations of the FHLBanks;
•national or international crises, including a pandemic, war, acts of terrorism or natural disasters, and the effects of any such crises on our and our counterparties' operations, member demand, market liquidity, and the global funding markets, and the governmental, regulatory, and fiscal interventions undertaken to stabilize local, national, and global economic conditions;
•ability to access the capital
markets and raise capital market funding on acceptable terms;
•changes in our credit ratings or the credit ratings of the other FHLBanks and the FHLBank System;
•changes in the level of government guarantees provided to other United States and international financial institutions;
•dealer commitment to supporting the issuance of our consolidated obligations;
•ability of one or more of the FHLBanks to repay its portion of the consolidated obligations, or otherwise meet its financial obligations;
•ability to attract and retain skilled personnel;
•ability to develop,
implement and support technology and information systems sufficient to manage our business effectively;
•nonperformance of counterparties to uncleared and cleared derivative transactions;
•changes in terms of derivative agreements and similar agreements;
•loss arising from natural disasters, acts of war, riots, insurrection or acts of terrorism;
•changes in or differing interpretations of accounting guidance; and
•other risk factors identified in our filings with the SEC.
Although we undertake no obligation to revise or update any forward-looking statements, whether as a
result of new information, future events or otherwise, additional disclosures may be made through reports filed with the SEC in the future, including our reports on Forms 10-K, 10-Q and 8-K. This Form 10-K, including Business, Risk Factors and Management’s Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with our financial statements and notes, which are included in Item 8.
As used in this
Form 10-K, unless the context otherwise requires, the terms "Bank,""we,""us," and "our," refer to the Federal Home Loan Bank of Indianapolis or its management. Acronyms and terms used throughout this Item are defined herein or in the Defined Terms.
Unless otherwise stated, amounts disclosed in this Item are rounded to the nearest million; therefore, dollar amounts of less than one million may not be reflected or, due to rounding, may not appear to agree to the amounts presented in thousands in the Financial Statements and related Notes to Financial Statements. Amounts used to calculate dollar and percentage changes are based on numbers in the thousands. Accordingly, calculations based upon the disclosed amounts (millions) may not produce
the same results.
Background Information
The Federal Home Loan Bank of Indianapolis is a regional wholesale bank that serves its member financial institutions in Michigan and Indiana. We are one of 11 regional FHLBanks across the United States, which, along with the Office of Finance, compose the FHLBank System established in 1932. Each FHLBank is a federal instrumentality of the United States of America that is privately capitalized and funded, receives no Congressional appropriations, and operates as an independent entity with its own board of directors, management, and employees.
Our mission is to provide reliable and readily available liquidity to our member institutions
to support housing finance and community investment. Our advance and mortgage purchase programs provide funding to assist members with asset/liability management, interest-rate risk management, mortgage pipelines, and other liquidity needs. In addition to funding, we provide various correspondent services, such as securities safekeeping and wire transfers. We also help to meet the economic and housing needs of communities and families through grants and low-cost advances that help support affordable housing and economic development initiatives.
As a financial cooperative, our members are also our primary customers. We are generally limited to making advances to and purchasing mortgage loans from members. We do not lend directly to or purchase mortgage loans directly from the general public.
Our principal funding source is the proceeds from the
sale to the public of FHLBank debt instruments, known as consolidated obligations, which consist of CO bonds and discount notes. The Office of Finance was established as a joint office of the FHLBanks to facilitate the issuance and servicing of consolidated obligations. The United States government does not guarantee, directly or indirectly, our consolidated obligations, which are the joint and several obligations of all FHLBanks.
We are wholly owned by our member institutions. All federally insured depository institutions (including commercial banks, savings associations and credit unions), CDFIs certified by the CDFI Fund of the United States Treasury, certain non-federally insured credit unions, and non-captive insurance companies are eligible to become members if they have a principal place of business, or are domiciled, in our district states of Michigan or Indiana. Applicants for membership must meet
specific requirements that demonstrate that they are engaged in residential housing finance.
All member institutions are required to purchase a minimum amount of our Class B capital stock as a condition of membership. Only members may own our capital stock, except for former members or their legal successors holding stock during their stock redemption period. Our capital stock is not publicly traded; it is purchased by members from us and redeemed or repurchased by us at the stated par value. With our written approval, a member may transfer any of its capital stock in excess of the required minimum to another member at par value. For additional information regarding our capital plan, see Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Each FHLBank was organized under the authority of the Bank Act as a GSE, which is an entity that combines elements of private capital, public sponsorship, and public policy. The public sponsorship and public policy attributes of the FHLBanks include:
•an exemption from federal, state, and local taxation, except employment and real estate taxes;
•an exemption from registration under the Securities Act (although the FHLBanks are required by federal law to register a class of their equity securities under the Exchange Act);
•the requirement that at least 40% of our directors be non-member "independent" directors;
that two of these "independent" directors have more than four years of experience representing consumer or community interests in banking services, credit needs, housing, or consumer financial protections; and that the remaining "independent" directors have demonstrated knowledge or experience in auditing or accounting, derivatives, financial management, organizational management, project development or risk management practices, or other expertise established by Finance Agency regulations;
•the United States Treasury's authority to purchase up to $4.0 billion of FHLBank consolidated obligations; and
•the required allocation of 10% of annual net earnings before interest expense on MRCS to fund the AHP.
As an FHLBank, we seek to maintain a balance between fulfilling
our public policy mission and providing sufficient returns on our members' capital, while maintaining an appropriate risk profile. Consistent with our business model, we place the highest priority on being able to meet our members' liquidity and funding needs in all business and market environments.
The Finance Agency is the federal regulator of the FHLBanks, Fannie Mae and Freddie Mac. The Finance Agency's stated mission is to ensure that the housing GSEs operate in a safe and sound manner so that they serve as a reliable source of liquidity and funding for housing finance and community investment.
Membership
Our membership territory is comprised of the states of Michigan
and Indiana. The following table presents the composition of our members by type of financial institution.
In 2022, 5 new members were added and 7 members merged, consolidated, relocated or terminated, including Flagstar Bank, FSB, formerly one of our largest members and our largest borrower at December 31, 2022.
Governance
Our
board of directors is responsible for the overall oversight and management of the Bank pursuant to the Bank Act. The combination of public sponsorship and private ownership that drives our business model is reflected in the composition of our board of directors. A majority of the directors must be officers and/or directors of our member institutions, while at least 40% of the board must be independent directors. The professional backgrounds of our independent directors cover a wide range of industries and expertise in areas such as financial markets and economics, affordable housing, accounting and technology, including cybersecurity.
We maintain a Strategic Business Plan that provides the framework for our future business direction. The goals and strategies for the Bank's major business activities are encompassed in this plan, which is updated and approved by the board of directors at least annually and
at any other time that revisions are deemed necessary.
We manage our operations by grouping products and services within two operating segments. The segments identify the principal ways we provide services to our members. These segments reflect our two primary mission-asset activities and the manner in which they are managed from the perspective of development, resource allocation, product delivery, pricing, credit risk and operational administration.
These operating segments are (i) traditional, which consists of credit products, investments, and correspondent services and deposits; and (ii) mortgage loans, which consist substantially of mortgage loans purchased from our members through our MPP. The revenues, profit or loss, and total assets for each segment are disclosed in Notes to Financial Statements - Note 15 - Segment Information.
Traditional.
Credit Products. We offer our members a wide variety of credit products, including advances, standby letters of credit, and lines of credit. We approve member credit requests based on our assessment of the member's creditworthiness and financial condition, as well as its collateral position.
All credit products must be fully collateralized by a member's pledge of eligible assets.
Our primary credit product is advances. Members use advances for a wide variety of purposes including, but not limited to:
•funding for single-family mortgages and multi-family mortgages held in portfolio, including both conforming and non-conforming mortgages (as determined in accordance with secondary market criteria);
•temporary funding during the origination, packaging, and sale of mortgages into the secondary market;
•funding for commercial real-estate loans and, especially with respect to CFIs, funding for small business, small farm, and small agri-business portfolio loans;
•acquiring
or holding MBS;
•short-term liquidity;
•asset/liability and interest-rate risk management;
•a cost-effective alternative to holding short-term investments to meet contingent liquidity needs;
•a competitively-priced alternative source of funds, especially with respect to smaller members with less-diverse funding sources; and
•at-cost funding to help support affordable housing and economic development initiatives.
We
offer standby letters of credit, typically for up to 10 years in term, which are rated Aaa by Moody's and AA+ by S&P. Letters of credit are performance contracts that guarantee the performance of a member to a third party and are subject to the same collateralization and borrowing limits that are applicable to advances. Letters of credit may be offered to assist members in facilitating residential housing finance, community lending, asset/liability management, or liquidity. We also offer a standby letter of credit product to collateralize public deposits.
We also offer lines of credit which allow members to fund short-term cash needs without submitting a new application for each funding request.
Advances. We offer a wide array
of fixed-rate and adjustable-rate advances, on which interest is generally due monthly. The maturities of advances currently offered typically range from 1 day to 10 years, although the maximum maturity may be longer in some instances. Our primary advance products include:
•Fixed-rate Bullet Advances, which have fixed rates throughout the term of the advances. These advances are typically referred to as "bullet" advances because no principal payment is due until maturity. Prepayments prior to maturity may be subject to prepayment fees. These advances can include a feature that allows for delayed settlement;
•Putable Advances, which are fixed-rate advances that give us an option to terminate the advance prior to maturity based on a predetermined schedule.
We consider exercising our option when interest rates have increased since the origination of the advance. Upon our exercise of the option, the member must repay the putable advance, but replacement funding will be available to the member at current market rates;
•Fixed-rate Amortizing Advances, which are fixed-rate advances that require principal payments either monthly, annually, or based on a specified amortization schedule and may have a balloon payment of remaining principal at maturity;
•Adjustable-rate Advances, which are sometimes called "floaters," reprice periodically based on a variety of indices, including EFFR, SOFR and the FHLBanks cost of funds index. We no longer offer new LIBOR-indexed adjustable-rate advances. Prepayment terms are agreed to before the advance
is extended. Most frequently, no prepayment fees are required if a member prepays an adjustable-rate advance on a reset date, after a pre-determined lock-out period, with the required notification. No principal payment is due prior to maturity;
•Other Variable-rate Advances, which reprice daily. These advances may be extended on terms from one day to six months and may be prepaid on any given business day during that term without fee or penalty. No principal payment is due until maturity; and
•Callable Advances, which are fixed-rate advances that give the member an option to prepay the advance before maturity on call dates with no prepayment fee, which members normally would exercise when interest rates have decreased since the origination of the advance.
We
also offer customized advances to meet the particular needs of our members. Our entire menu of advance products is generally available to each creditworthy member, regardless of the member's asset size. Finance Agency regulations require us to price our credit products consistently and without discrimination to any member applying for advances. We are also prohibited from pricing our advances below our marginal cost of matching term and maturity funds in the marketplace, including embedded options, and the administrative cost associated with extending such advances to members. Therefore, advances are typically priced at standard spreads above our cost of funds. Our board-approved credit policy allows us to offer lower rates on certain types of advances transactions. Determinations of such rates are based on factors such as volume, maturity, product type, funding availability and costs, and competitive factors in regard to other sources of funds.
Collateral.
All credit products extended to a member must be fully collateralized by the member's pledge of eligible assets. Each borrowing member and its affiliates that hold pledged collateral are required to grant us a security interest in such collateral.
Collateral Status Categories.We take collateral under a blanket, specific listings or possession status depending on the credit quality of the borrower, the type of institution, and our lien position on assets owned by the member (i.e., blanket, specific, or partially subordinated). The blanket status is the least restrictive and allows the member to retain possession of the pledged collateral, provided that the member executes a written security agreement and agrees to hold the collateral for our benefit. Under the specific listings status, the member maintains possession of the
specific collateral pledged, but the member generally provides listings of loans pledged with detailed loan information such as loan amount, payments, maturity date, interest rate, LTV, collateral type and FICO® scores. Members under possession status are required to place the collateral with us or with an approved third-party custodian in amounts sufficient to secure all outstanding obligations.
Eligible Collateral. Eligible collateral types include certain investment
securities, one-to-four family first mortgage loans, multi-family first mortgage loans, deposits in our Bank, certain other real estate-related collateral assets (such as commercial MBS, municipal securities, commercial real estate loans and home equity loans), and small business loans or farm real estate loans from CFIs. While we only extend credit based on the borrowing capacity for such approved collateral, our contractual arrangements typically allow us to take other assets as collateral to provide additional protection. In addition, under the Bank Act, we have a lien on the borrower's stock in our Bank as security for all of the borrower's indebtedness.
We have an Anti-Predatory Lending Policy and a Subprime and Nontraditional Residential Mortgage Policy that establish guidelines for any subprime or nontraditional loans included in the collateral pledged to us. Loans that are delinquent or violate those
policies do not qualify as acceptable collateral and are required to be removed from any collateral value calculation. Consistent with the CFPB home mortgage lending rules, we accept loans that comply with or are exempt from the ability-to-pay requirements as collateral.
In order to help mitigate the market, credit, liquidity, operational and business risk associated with collateral, we apply an over-collateralization requirement to the book value or market value of pledged collateral to establish its lending value. Collateral that we have determined to contain a low level of risk, such as United States government obligations, is over-collateralized at a lower rate than collateral that carries a higher level of risk, such as small business loans. Standard requirements range from 100% for deposits (cash) to 140% - 155% for residential mortgages pledged through
blanket status. Over-collateralization requirements for eligible securities range from 103% to 190%; less traditional types of collateral have standard over-collateralization ratios up to 360%.
The over-collateralization requirement applied to asset classes may also vary depending on collateral status, because lower requirements are applied as our levels of information and control over the assets increase. Over-collateralization requirements are applied using market values for collateral in listing and possession status and book value for collateral pledged through blanket status. In no event, however, would market values assigned to whole loan collateral exceed par value. For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Advances and Other Credit Products.
Collateral
Review and Monitoring. We verify collateral balances by performing periodic, collateral audits on our borrowers, which allows us to verify loan pledge eligibility, credit strength and documentation quality, as well as adherence to our Anti-Predatory Lending Policy, our Subprime and Nontraditional Residential Mortgage Policy, and other collateral policies. In addition, collateral audit findings are used to adjust over-collateralization amounts to mitigate credit risk and collateral liquidity concerns.
Investments. We maintain a portfolio of investments, purchased from approved counterparties, members and their affiliates, or other FHLBanks, to provide liquidity, utilize balance sheet capacity and supplement our earnings. Higher earnings bolster our ability to support affordable housing and community investment.
Our
short-term investments are placed with large, high-quality financial institutions with investment-grade long-term credit ratings. Such investments typically include interest-bearing demand deposit accounts, unsecured federal funds sold and securities purchased under agreements to resell, which are secured by U.S. Treasury obligations. Each may be purchased with either overnight or term maturities, or in the case of demand deposit accounts, redeemed at any time during business hours. In the aggregate, the FHLBanks may represent a significant percentage of the federal funds sold market at any one time, although each FHLBank manages its investment portfolio separately.
Our liquidity portfolio also includes investments in U.S. Treasury obligations.
The longer-term investments typically generate higher returns and consist of (i) securities issued by
the United States government, its agencies, and certain GSEs, and (ii) Agency MBS.
All unsecured investments are subject to certain selection criteria. Each unsecured counterparty must be approved and has an exposure limit, which is computed in the same manner regardless of the counterparty's status as a member, affiliate of a member or unrelated party. These criteria determine the permissible amount and maximum term of the investment. For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Investments.
Under Finance Agency regulations, except for certain investments authorized under state trust law for our retirement plans, we are prohibited from investing in the following types of securities:
•instruments, such as common stock, that represent an equity ownership in an entity, other than stock in small business investment companies, or certain investments targeted to low-income persons or communities;
•instruments issued by non-United States entities, other than those issued by United States branches and agency offices of foreign commercial banks;
•non-investment
grade debt instruments, other than certain investments targeted to low-income persons or communities and instruments that were downgraded after their purchase;
•whole mortgages or other whole loans, except for:
◦those acquired under an AMA program, such as MPP;
◦certain investments targeted to low-income persons or communities; and
◦certain foreign housing loans authorized under Section 12(b) of the Bank Act; and
•non-United States dollar denominated securities.
In addition, we are prohibited from purchasing certain types of investments, such as interest-only
or principal-only stripped MBS, Collateralized Mortgage Obligations ("CMO") and Real Estate Mortgage Investment Conduits ("REMIC"); residual-interest or interest-accrual classes of CMOs, REMICs and MBS; and CMOs or REMICs with underlying collateral containing pay option/negative amortization mortgage loans, unless those loans or securities are guaranteed by the United States government, Fannie Mae, Freddie Mac or Ginnie Mae.
Finance Agency regulation further provides that the total book value of our investments in MBS must not exceed 300% of our total regulatory capital, consisting of Class B stock, Class A stock, if any, retained earnings, and MRCS, as of the day we purchase the investments, based on the capital amount most recently reported to the Finance Agency. If the outstanding balances of our investments in MBS exceed the limitation at any time, but were in compliance at the time we purchased
the investments, we would not be considered out of compliance with the regulation, but we would not be permitted to purchase additional investments in MBS until these outstanding balances were within the capital limitation. Generally, our goal is to maintain these investments near the 300% limit.
Deposit Products. Deposit products provide a small portion of our funding resources. We offer several types of deposit products to our members and other institutions including overnight and demand deposits. We may accept uninsured deposits from:
•our members, which they can use to help satisfy their liquidity requirements;
•institutions eligible to become members;
•any
institution for which we are providing correspondent services;
•interest-rate swap counterparties;
•other FHLBanks; or
•other federal government instrumentalities.
Mortgage Loans. Mortgage loans held for portfolio consist substantially of residential mortgage loans purchased from our members through our MPP. We may also purchase or participate in mortgage loans under other AMA programs. These programs help fulfill the FHLBank System's housing mission and provide an additional source of liquidity to FHLBank members that choose to sell mortgage loans into the secondary market rather than holding them in their own portfolios. AMA programs are a core mission activity of the FHLBanks,
as defined by Finance Agency regulations.
Mortgage Purchase Program.
Overview. We purchase mortgage loans directly from our members through our MPP. Members that participate in the MPP are known as PFIs. By regulation, we are not permitted to purchase loans directly from any institution that is not a member or Housing Associate of the FHLBank System, and we may not use a trust or other entity to purchase the loans. We purchase conforming, medium- or long-term, fixed-rate, fully amortizing, level payment loans predominantly for primary, owner-occupied, detached residences, including single-family properties, and two-, three-, and four-unit properties. Additionally, to a lesser degree, we purchase loans for primary, owner-occupied, attached residences (including condominiums and planned unit developments),
and second/vacation homes.
Our mortgage loan purchases are governed by the Finance Agency's AMA regulation. Further, while the regulation does not expressly limit us to purchasing fixed-rate loans, before purchasing adjustable-rate loans we would need to analyze whether such purchases would require Finance Agency approval under its New Business Activity regulation. Such regulation provides that any material change to an FHLBank's business activity that results in new risks or operations needs to be pre-approved by the Finance Agency.
Under
Finance Agency regulations, all pools of mortgage loans currently purchased by us, other than government-insured mortgage loans, must have sufficient credit enhancement to be rated by us as at least investment grade. We operate our credit enhancement model and methodology accordingly to estimate the amount of credit enhancement required for those pools. Other than for FHA mortgage loans, the PFIs provide or arrange for the credit enhancement. In this way, the PFIs share the credit risk with us on conventional mortgage loans. We manage the interest-rate risk, prepayment option risk, and liquidity risk.
Our original MPP, which we ceased offering for conventional loans in 2010, relied on credit enhancement from LRA and SMI to achieve an implied credit rating of at least AA based on a NRSRO model in compliance with Finance Agency regulations. In 2010, we began offering Advantage MPP for new conventional MPP
loans, which utilizes an enhanced fixed LRA account for credit enhancement consistent with Finance Agency regulations, instead of utilizing a spread LRA with coverage from SMI providers. The only substantive difference between the two programs is the credit enhancement structure. Upon implementation of Advantage MPP, the original MPP was phased out and is no longer being used for acquisitions of new conventional loans. Under Advantage MPP, the funds in the LRA are established at the time of loan purchase. As a result, at the time of pool closing, the LRA is sufficient to cover expected losses in excess of the borrower's equity and PMI, if any, on a pool basis.
In 2012 - 2014, we purchased participating interests from another FHLBank in mortgage loans originated by certain of its PFIs through their participation in the Mortgage Partnership Finance® Program. In 2016, we sold a 90% participating interest in
a $100 million MCC of certain newly acquired MPP loans to another FHLBank.
Mortgage Standards.All loans we purchase must meet the guidelines for our MPP or be specifically approved as an exception based on compensating factors. Our guidelines generally meet or exceed the underwriting standards of Fannie Mae and Freddie Mac. For example, the maximum LTV ratio for any conventional mortgage loan at the time of purchase is 95%, and borrowers must meet certain minimum credit scores depending upon the type of property or loan. In addition, we will not knowingly purchase any loan that violates the terms of our Anti-Predatory Lending Policy or our Subprime and Nontraditional Residential Mortgage Policy. Furthermore, we require our members to warrant to us that all of the loans sold to us are in compliance with all applicable laws, including prohibitions on predatory
lending. All loans purchased through our MPP must qualify as "Safe-Harbor Qualified Mortgages" under CFPB rules.
Under our guidelines, a PFI must:
•be an active originator of conventional mortgages and have servicing capabilities, if applicable, or use a servicer that we approve;
•advise us if it has been the subject of any adverse action by either Fannie Mae or Freddie Mac; and
•along with its parent company, if applicable, meet the capital requirements of each state and federal regulatory agency with jurisdiction over the member's or parent company's activities.
Credit Enhancement.FHA mortgage loans are backed by insurance provided by the United States government and, therefore, no additional credit enhancements (such as an LRA or SMI) are required.
For conventional mortgage loans, the credit enhancement required to reach the minimum credit rating is determined by using a credit risk model. The model is used to evaluate each MCC or pool of MCCs to ensure the LRA percentage as credit enhancement is sufficient. The model evaluates the characteristics of the loans the PFIs actually delivered for the likelihood of timely payment of principal and interest. The model's results are based on numerous standard borrower and loan attributes, such as the LTV ratio and borrower's credit score, as well as housing market factors, such as the Home Price Index and zip code. Based on the credit assessment, we are required to hold risk-based capital to help mitigate the potential
credit risk in accordance with the Finance Agency regulations.
Credit losses on defaulted mortgage loans in a pool are absorbed by these sources, until they are exhausted, in the following order:
•borrower's equity;
•PMI, if applicable;
•LRA;
•SMI, if applicable; and
•our
Bank.
LRA. We use either a "spread LRA" or a "fixed LRA" for credit enhancement. The spread LRA is used in combination with SMI for credit enhancement of conventional mortgage loans purchased under our original MPP, and the fixed LRA is used for all acquisitions of conventional mortgage loans under Advantage MPP.
•Original MPP. The spread LRA is funded through a reduction to the net yield earned on the loans, and the corresponding purchase price paid to the PFI reflects our reduced net yield. The LRA for each pool of loans is funded monthly at an annual rate ranging from 6 to 20 bps, depending on the terms of the MCC, and is used to pay loan loss claims or is held until the LRA accumulates to a required "release point." The
release point is 20 to 85 bps of the then outstanding principal balances of the loans in that pool, depending on the terms of the original contract. If the LRA exceeds the required release point, the excess amount is eligible for return to the PFI(s) that sold us the loans in that pool, generally subject to a minimum five-year lock-out period after the pool is closed to acquisitions.
•Advantage MPP. The LRA for Advantage MPP differs from our original MPP in that the funding of the fixed LRA occurs at the time we acquire the loan and is based on the principal amount purchased. Depending on the terms of the MCC, the LRA funding amount varies between 110 bps and 130 bps of the principal amount. LRA funds not used to pay loan losses may be returned to
the PFI subject to a retention schedule detailed in each MCC based on the original LRA amount. Per the retention schedule, no LRA funds are returned to the PFI for the first five years after the pool is closed to acquisitions. We absorb any losses in excess of available LRA funds.
SMI. For pools of loans acquired under our original MPP, we have credit protection from loss on each loan, where eligible, through SMI, which provides insurance to cover credit losses to approximately 50% of the property's original value, depending on the SMI contract terms, and subject, in certain cases, to an aggregate stop-loss provision in the SMI policy. Some MCCs that equal or exceed a contract amount
of $35 million of total initial principal include an aggregate loss/benefit limit or "stop-loss" that is equal to the total initial principal balance of loans under the MCC multiplied by the stop-loss percentage (ranges from 200 - 400 bps), as is then in effect, and represents the maximum aggregate amount payable by the SMI provider under the SMI policy for that pool. Even with the stop-loss provision, the aggregate of the LRA and the amount payable by the SMI provider under an SMI stop-loss contract will be equal to or greater than the amount of credit enhancement required for the pool to have an implied NRSRO credit rating of at least AA at the time of purchase. Non-credit losses, such as uninsured property damage losses that are not covered by the SMI, can be recovered from the LRA to the extent that there are releasable LRA funds available. We absorb any non-credit
losses greater than the available LRA. We do not have SMI coverage on loans purchased under Advantage MPP.
Pool Aggregation. We offer pool aggregation under our MPP. Our pool aggregation program is designed to reduce the credit enhancement costs to small and mid-size PFIs. Under pool aggregation, a PFI's loans are pooled with similar loans originated by other PFIs to create aggregate pools of approximately $100 million original UPB or greater. The combination of small and mid-size PFIs' loans into one pool also assists in the evaluation of the amount of LRA needed for the overall credit enhancement.
Conventional Loan Pricing. We consider the cost of the credit enhancement (LRA and SMI, if applicable) when we formulate conventional loan pricing. Each of these credit enhancement structures is accounted
for, not only in our expected return on acquired mortgage loans, but also in the risk review performed during the accumulation/pooling process.
We typically receive a 0.25% fee on cash-out refinancing transactions with LTVs between 75% and 80%. Our current guidelines do not allow cash-out refinance loans above 80% LTV. We also adjust the market price we pay for loans depending upon market conditions. We continue to evaluate the scope and rate of such fees as they evolve in the industry. We do not pay a PFI any fees other than the servicing fee when the PFI retains the servicing rights.
Servicing.
We do not service the mortgage loans we purchase. PFIs may elect to retain servicing rights for the loans sold to us, or they may elect to sell servicing rights to an MPP-approved servicer.
Those PFIs that retain servicing rights receive a monthly servicing fee and may be required to undergo a review by a third-party quality control contractor that advises the PFIs of any deficiencies in servicing procedures or processes and then notifies us so that we can monitor the PFIs' performance. The PFIs that retain servicing rights can sell those rights at a later date with our approval. If we deem servicing to be inadequate, we can require that the servicing of those loans be transferred to a servicer that is acceptable to us.
The servicers are responsible for all aspects of servicing, including, among other responsibilities, the administration of any
foreclosure and claims processes from the date we purchase the loan until the loan has been fully satisfied. Our MPP was designed to require loan servicers to foreclose and liquidate in the servicer's name rather than in our name. As the servicer progresses through the process from foreclosure to liquidation, we are paid in full for all unpaid principal and accrued interest on the loan through the normal remittance process.
It is the servicer's responsibility to initiate claims for losses on the loans. If a loss is expected, no claims are settled until we have reviewed and approved the claim. For loans that are credit-enhanced with SMI, if it is determined that a loss is covered, the SMI provider pays the claim in full and seeks reimbursement from the LRA funds. The SMI provider is entitled to reimbursement for credit losses from funds available in the LRA that are equal to the aggregate
amounts contributed to the LRA less any amounts paid for previous claims and any amounts that have been released to the PFI from the LRA or paid to us to cover prior claims. If the LRA has been depleted but is still being funded, based on our contractual arrangement, we and/or the SMI provider are entitled to reimbursement from those funds as they are received, up to the full reimbursable amount of the claim. These claim payments would be reflected as additional deductions from the LRA as they were paid.
Funding Sources
The primary source of funds for each of the FHLBanks is the sale of consolidated obligations, which consist of CO bonds and discount notes. The Finance Agency and the United States Secretary of the Treasury oversee
the issuance of this debt in the capital markets. Finance Agency regulations govern the issuance of debt on our behalf and authorize us to issue consolidated obligations through the Office of Finance, under Section 11(a) of the Bank Act. No FHLBank is permitted to issue individual debt without the approval of the Finance Agency.
While the primary liability for consolidated obligations issued to provide funds for a particular FHLBank rests with that FHLBank, consolidated obligations are the joint and several obligations of all of the FHLBanks under Section 11(a). Although each FHLBank is a GSE, consolidated obligations are not obligations of, and are not guaranteed by, the United States government. Consolidated obligations are backed only by the financial resources of all of the FHLBanks and are rated Aaa by Moody's and AA+ by S&P.
Consolidated
Obligation Bonds. CO bonds satisfy term funding requirements and are issued with a variety of maturities and terms under various programs. The maturities of these securities may range from 3 months to 30 years,but the maturities are not subject to any statutory or regulatory limit. CO bonds can be fixed- or adjustable-rate and callable or non-callable. Those issued with adjustable-rate payment terms use a variety of indices for interest rate resets, including United States Treasury Bill, Constant Maturity Swap, Prime Rate, SOFR, and others. CO bonds are issued and distributed through negotiated or competitively bid transactions with approved underwriters or selling group members.
Consolidated Obligation Discount Notes. We also issue discount notes to provide short-term funds. These securities can have maturities that
range from one day to one year, and are offered daily through a discount note selling group and other authorized securities dealers. Discount notes are generally sold below their face values and are redeemed at par when they mature.
Office of Finance. The issuance of consolidated obligations is facilitated and executed by the Office of Finance, which also services all outstanding debt, provides information on capital market developments to the FHLBanks, and manages our relationship with the NRSROs with respect to consolidated obligations. The Office of Finance also prepares and publishes the FHLBanks' combined quarterly and annual financial reports.
As the FHLBanks' fiscal agent for debt issuance, the Office of Finance can control the timing and amount of each issuance. Through its oversight of the United States financial
markets, the United States Treasury can also affect debt issuance for the FHLBanks. For more information, see Item 1. Business - Supervision and Regulation - Government Corporations Control Act.
Derivatives are an integral part of our financial management strategies to manage identified risks inherent in our lending, investing and funding activities and to achieve our
risk management objectives. Finance Agency regulations and our risk management policies establish guidelines for the use of derivatives. Permissible derivatives include interest-rate swaps, swaptions, interest-rate cap and floor agreements, calls, puts, futures, and forward contracts. We are only permitted to execute derivative transactions to manage interest-rate risk exposure inherent in otherwise unhedged asset or liability positions, hedge embedded options in assets and liabilities including mortgage prepayment risk positions, hedge any foreign currency positions, and act as an intermediary between our members and interest-rate swap counterparties. We are prohibited from trading in or the speculative use of these instruments.
Our use of derivatives is the primary way we align the preferences of investors for the
types of debt securities they want to purchase and the preferences of member institutions for the types of advances they want to hold and the types of mortgage loans they want to sell. Consistent with our risk management philosophy, we use interest-rate exchange agreements (i.e., interest-rate swaps) to convert many of the fixed-rate CO bonds that we issue to variable-rate instruments that periodically reset based on an index such as SOFR. Generally, we receive a coupon on the interest-rate swap that is identical to the coupon we pay on the CO bond while paying variable-rate coupon on the interest-rate swap that resets based on the applicable index. Typically, the formula for the variable-rate coupon also includes a spread to the index. For more information, see Notes to Financial Statements - Note 8 - Derivatives and Hedging Activities and Item 7A. Quantitative and Qualitative Disclosures About Market
Risk - Use of Derivative Hedges.
Competition
We operate in a highly competitive environment. Demand for advances is affected by, among other factors, the cost and availability of other sources of liquidity for our members, including customer deposits, brokered deposits, reciprocal deposits and public funds. We compete with other suppliers of wholesale funding, both secured and unsecured. Such other suppliers may include the United States government, the Federal Reserve Banks, corporate credit unions, the Central Liquidity Facility, investment banks, commercial banks, and in certain circumstances other FHLBanks. Large institutions may also have independent access to the national and global credit markets. Also,
the availability of alternative funding sources to members, such as growth in deposits from members' banking customers, can significantly influence the demand for advances and can vary as a result of several factors, including legislative or regulatory changes, market conditions, members' creditworthiness, and availability of collateral.
Likewise, our MPP is subject to significant competition. Direct competition for purchases of mortgages comes from other buyers of conventional, conforming, fixed-rate mortgage loans, such as Fannie Mae and Freddie Mac. In addition, PFIs face increased origination competition from originators that are not our members.
We also compete with Fannie Mae, Freddie Mac, and other GSEs as well as corporate, sovereign, and supranational entities for funds raised through the issuance of CO bonds and discount notes. Increases
in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs to us or lesser amounts of debt issued at the same cost than otherwise would be the case.
Affordable Housing Programs, Community Investment and Small Business Grants
Each FHLBank is required to set aside 10% of its annual net earnings before interest expense on MRCS to fund its AHP. Through our AHP, we may provide cash
grants or interest subsidies on advances to our members, which are, in turn, provided to awarded projects or qualified individuals to finance the purchase, construction, or rehabilitation of very low- to moderate-income owner-occupied or rental housing. Our AHP includes the following:
•Competitive Program, which is the primary grant program to finance the purchase, construction or rehabilitation of housing for individuals with incomes at or below 80% of the median income for the area, and to finance the purchase, construction, or rehabilitation of rental housing, with at least 20% of the units occupied by, and affordable for, very low-income households. Each year, 65% of our annual available AHP funds are granted through this program. AHP-related advances, of which none were outstanding at December 31, 2022, are also part
of this program.
•Set-Aside Programs, which include 35% of our annual available AHP funds, are administered through the following:
◦Homeownership Opportunities Program, which provides assistance with down payments and closing costs to first-time homebuyers;
◦Neighborhood Impact Program, which provides rehabilitation assistance to homeowners to help improve neighborhoods;
◦Accessibility Modifications Program, which provides funding for accessibility modifications and minor home rehabilitation for eligible senior homeowners or owner-occupied households with one or more individuals having a permanent disability; and
◦Disaster
Relief Program, which may be activated at our discretion in cases of federal or state disaster declarations for rehabilitation or down payment assistance targeted to low- or moderate-income homeowner disaster victims. The disaster relief program was not activated in 2022.
In addition to our required allocation, which totaled $20 million in 2022, we support and provide voluntary funding to our AHP and various affordable housing, small business and community investment programs. In 2022, such voluntary funding included an additional 2.5% of net earnings.
Under our Elevate program, we support the growth and development of small businesses in Michigan and Indiana by providing grant funding for capital expenditures, workforce training, or other business-related needs. The total amounts awarded in 2022 were $0.5 million.
Community
Mentors is an annual community engagement and economic development leadership program which includes a workshop and accompanying implementation grant of $10 thousand to one Michigan and one Indiana community which is awarded following an application process.
Our voluntary allocation in 2022 totaled $6 million. As a result, our combined required and voluntary allocation in 2022 totaled $26 million.
In addition, we offer a variety of specialized advance programs to support housing and community development needs. Through our Community Investment Program, we offer advances to our members involved in community economic development activities benefiting low- or moderate-income families or neighborhoods. These funds can be used for the development of housing, infrastructure improvements, or assistance to small businesses or businesses that are creating
or retaining jobs in the member's community for low- and moderate-income families. These advances typically have maturities ranging from overnight to 20 yearsand are priced at our cost of funds plus reasonable administrative expenses. At December 31, 2022, we had $1.0 billion of outstanding principal on Community Investment Program-related advances.
The
Bank’s human capital is a significant contributor to the successful achievement of our strategic business objectives. In managing the Bank’s human capital, we focus on our workforce profile and the various associated programs and philosophies.
Workforce Profile.
Our workforce is substantially comprised of corporate office-based employees, with our operations in Indianapolis, Indiana and limited activities in a newly-established hub in Detroit, Michigan. As of December 31, 2022, the Bank had 257 full-time and 1 part-time employee, of which 58% were male and 42% were female, while 73% were non-minority and 27% were minority.
Our workforce historically has included a large number of longer-tenured
employees. As of December 31, 2022, the average tenure of the Bank’s employees was 7.9 years. There are no collective bargaining agreements with our employees.
We seek to attract, develop, and retain talented employees to achieve our strategic business objectives, enhance business performance and provide a reasonable risk-return balance for our cooperative members, both as users of our products and as shareholders, tailored to our status and risk appetite as a housing GSE. We strive to both develop talent from within and hire externally, as needed. We believe that developing talent internally results in building bench strength, retaining institutional knowledge, increasing workforce continuity and promoting loyalty and commitment in our employee base, while adding new employees contributes to new ideas, continuous improvement, and our goals of a diverse and
inclusive workforce.
Total Rewards.
We recognize and reward performance through a combination of competitive total rewards and development opportunities, including the following:
•Cash compensation
◦Salaries and wages; and
◦Incentive opportunities;
•Benefits and perquisites
◦Medical, dental, and vision insurance;
◦Wellness incentive opportunities;
◦Life,
long-term disability, and other insurance coverages;
◦401(k) retirement savings plan for which the Bank matches certain contributions;
◦Pension benefits or additional, non-elective defined contributions by the Bank;
◦Health Savings Account and Flexible Spending Accounts; and
◦Additional voluntary benefit opportunities
•Wellness programs
◦Employee assistance program;
◦Health coaching;
◦Interactive
education sessions; and
◦Use of our insurance provider's rewards app to inspire achievement of fitness and health goals;
•Employee engagement
◦Employee resource groups; and
◦Cultural awareness and inclusion activities/events;
•Work/Life balance
◦100% paid salary continuation for short-term disability, parental and military leave, bereavement, jury duty, and certain court appearances;
◦Hybrid workforce model; and
◦Vacation,
sick time, birthday holiday, Bank holidays, and certain volunteer opportunities;
•Development
◦Training focused on leadership development, employee engagement, and skill enhancement;
◦Educational assistance programs and student loan repayment assistance;
◦Internal educational and development opportunities; and
◦Fee reimbursement for external educational and development programs;
•Management succession planning.
◦Our board and executive leadership actively engage in succession
planning, with a defined plan for our President-CEO, Executive Vice Presidents, and Senior Vice Presidents.
Our performance management framework includes establishing individual performance goals tailored to reflect business and development objectives while also reflecting our guiding principles for our corporate culture, periodic performance check-ins, and annual performance reviews. Overall annual performance ratings are calibrated and salary adjustments are differentiated for our highest performers.
Diversity,
Equity, and Inclusion Program.
Our Diversity, Equity, and Inclusion program is a strategic business priority. Our Senior Vice President – Chief Human Resources and Diversity, Equity, & Inclusion Officer is a member of our executive management team, reports directly to our President-CEO, and serves as a liaison to the board of directors. We recognize that diversity increases capacity for innovation and creativity, that equity recognizes the essential contributions of all of our employees, and that inclusion allows us to leverage the unique perspectives of all employees and strengthens our retention efforts. We evaluate inclusive behaviors as part of our annual performance management process.
Our commitment is demonstrated through the development and execution of a three-year
Diversity, Equity, and Inclusion Strategic Plan ("DEI Strategic Plan"). The DEI Strategic Plan focuses on Workforce, Workplace, Community, Supplier Diversity, and Capital Markets and includes quantifiable metrics to measure the program's success, which are reported regularly to senior management and the board of directors. We consider learning an important component of our DEI Strategic Plan, so we offer a range of opportunities for our employees to connect and grow personally and professionally through our Diversity, Equity, and Inclusion Council, Cultural Ambassadors, FHLBI Cares, cultural awareness events, and employee resource groups.
Supervision and Regulation
Our business is subject to extensive regulation and supervision.
The laws and regulations to which we are subject cover all key aspects of our business, and directly and indirectly affect our product and service offerings, pricing, competitive position, strategic plan, relationships with members and third parties, capital structure, cash needs and uses, and information security. As discussed throughout this Form 10-K, such regulations can have a significant effect on key drivers of our results of operations.
We are supervised and regulated by the Finance Agency, an independent agency in the executive branch of the United States government, established by the Housing and Economic Recovery Act of 2008.
The Bank Act. The Finance Agency's responsibility is to ensure that, pursuant to the Bank Act and regulations promulgated by the Finance Agency, each FHLBank:
•carries
out its housing finance mission;
•remains adequately capitalized and able to raise funds in the capital markets; and
•operates in a safe and sound manner.
The Finance Agency is headed by a Director, who is appointed to a five-year term by the President of the United States, with the advice and consent of the Senate. The Director appoints a Deputy Director for the Division of Enterprise Regulation, a Deputy Director for the Division of FHLBank Regulation, and a Deputy Director for Housing Mission and Goals, who oversees the housing mission and goals of Fannie Mae and Freddie Mac, as well as the housing finance and community and economic development mission of the FHLBanks.
The Housing and Economic Recovery
Act of 2008 also established the Federal Housing Finance Oversight Board, comprised of the Secretaries of the Treasury and the United States Department of Housing and Urban Development, the Chair of the SEC, and the Finance Agency Director. The Federal Housing Finance Oversight Board functions as an advisory body to the Finance Agency Director.
The Finance Agency's operating expenses are funded by assessments on the FHLBanks, Fannie Mae and Freddie Mac. As such, no tax dollars or other appropriations support the operations of the Finance Agency or the FHLBanks. In addition to reviewing our submissions of monthly and quarterly information on our financial condition and results of operations, the Finance Agency conducts annual examinations and performs periodic reviews in order to assess our safety and soundness.
The United States Treasury receives a copy of the Finance Agency's annual report to Congress, monthly reports reflecting the FHLBank System's securities transactions, and other reports reflecting the FHLBank System's operations. Our annual financial statements are audited by an independent registered public accounting firm in accordance with standards issued by the Public Company Accounting Oversight Board, as well as the government auditing standards issued by the United States Comptroller General. The Comptroller General has authority under the Bank Act to audit or examine the Finance Agency and the FHLBank System and to decide the extent to which they fairly and effectively fulfill the purposes of the Bank Act. The Finance Agency's Office of Inspector General also has investigation authority over the Finance Agency and the FHLBank System.
Each
FHLBank is required to maintain a capital structure comprised of Class A stock, Class B stock, or both. A member can redeem Class A stock upon six months' prior written notice to its FHLBank. A member can redeem Class B stock upon five years' prior written notice to its FHLBank. Class B stock has a higher weighting than Class A stock for purposes of calculating the minimum leverage requirement applicable to each FHLBank.
The Bank Act requires that each FHLBank maintain permanent capital and total capital in sufficient amounts to comply with specified, minimum risk-based capital and leverage capital requirements. From time to time, for reasons of safety and soundness, the Finance Agency may require one or more individual FHLBanks to maintain more permanent capital or total capital than is required by the regulations. Failure to comply with these requirements or the minimum capital requirements could result
in the imposition of operating agreements, cease and desist orders, civil money penalties, and other regulatory action, including involuntary merger, liquidation, or reorganization as authorized by the Bank Act.
Government Corporations Control Act. We are subject to the Government Corporations Control Act, which provides that, before we can issue and offer consolidated obligations to the public, the Secretary of the United States Treasury must prescribe the form, denomination, maturity, interest rate, and conditions of the obligations; the way and time issued; and the selling price.
Furthermore, this Act provides that the United States Comptroller General may review any audit of the financial statements of an FHLBank conducted by an independent registered public accounting firm. If the Comptroller General undertakes such
a review, the results and any recommendations must be reported to Congress, the Office of Management and Budget, and the FHLBank in question. The Comptroller General may also conduct a separate audit of any of our financial statements.
Federal Securities Laws. Our shares of Class B stock are registered with the SEC under the Exchange Act, and we are generally subject to the information, disclosure, insider trading restrictions, and other requirements under the Exchange Act, with certain exceptions. Our capital plan authorizes us to also issue Class A stock, but we have not issued any such stock. We are not subject to the registration provisions of the Securities Act.
Federal and State Banking Laws. We are generally not subject to the state and federal banking laws affecting United States retail depository
financial institutions. However, the Bank Act requires the FHLBanks to submit reports to the Finance Agency concerning transactions involving loans and other financial instruments that involve fraud or possible fraud. In addition, we are required to maintain an anti-money laundering program, under which we are required to report suspicious transactions to the Financial Crimes Enforcement Network pursuant to the Bank Secrecy Act and the USA Patriot Act.
We contract with third-party compliance firms to perform certain services on our behalf to assist us with our compliance with these regulations as they are applicable to us. Finance Agency regulations require that we monitor and assess our third-party firms' performance of the services. As we identify deficiencies in our third-party firms' performance, we seek to remediate
the deficiencies. Under certain circumstances, we are required to notify the Finance Agency about the deficiencies and our response to assure our compliance with these regulations.
As a wholesale secured lender and a secondary market purchaser of mortgage loans, we are not, in general, directly subject to the various federal and state laws regarding consumer credit protection, such as anti-predatory lending laws. However, as non-compliance with these laws could affect the value of these loans as collateral or acquired assets, we require our members to warrant that all of the loans pledged or sold to us are in compliance with all applicable laws.
Regulatory Enforcement Actions. While examination reports are confidential between the Finance Agency and an FHLBank, the Finance Agency may publicly disclose supervisory actions
or agreements that the Finance Agency has entered into with an FHLBank. We are not subject to any such Finance Agency actions, and we are not aware of any current Finance Agency actions with respect to other FHLBanks that could have a material adverse effect on our financial results.
Our Annual, Quarterly and Current Reports on Forms 10-K, 10-Q, and 8-K, are filed
with the SEC through the EDGAR filing system. A link to EDGAR is available through our public website at www.fhlbi.com by selecting "Resources" and then "Investor Relations."
We have a Code of Ethics for Senior Financial Officers ("Code of Ethics") that applies to our principal executive officer, principal financial officer, and principal accounting officer. We additionally have a Code of Conduct and Conflict of Interest Policy for Affordable Housing Advisory Council Members, a Code of Conduct and Conflict of Interest Policy for Directors, and a Code of Conduct and Conflict of Interest Policy for Employees and
Contractors (collectively, the "Codes of Conduct"). The Code of Ethics and Codes of Conduct are available on our website at www.fhlbi.com by selecting "About" and then "Corporate Governance."
Our 2023 Targeted Community Lending Plan describes our plan to address the credit needs and market opportunities in our district states of Michigan and Indiana. It is available on our website at www.fhlbi.com
by selecting "Products and Services" and then selecting "Community Development - Community Investment Program (CIP) - CIP Forms & Applications."
The written charters adopted by the board for its Audit, Executive/Governance, and Human Resources Committees are available on our website at www.fhlbi.com by selecting "About" and then selecting "Corporate Governance." These charters were most recently amended by the board of directors as to the Audit Committee on March 18, 2022, as to the Executive/Governance Committee on January
20, 2023, and as to the Human Resources Committee on January 20, 2023.
We provide our website address and the SEC's website address solely for information. Except where expressly stated, information appearing on our website and the SEC's website is not incorporated into this Form 10-K.
Anyone may also request a copy of any of
our public financial reports, our Code of Ethics, our Codes of Conduct, or our 2023 Targeted Community Lending Plan through our Corporate Secretary at FHLBank of Indianapolis, 8250 Woodfield Crossing Boulevard, Indianapolis, IN46240, (317) 465-0200.
We use acronyms and terms throughout this Item that are defined herein or in the Defined Terms.
We have identified the following risk factors that could have a material adverse effect on our Bank. There may be other risks and uncertainties, including those discussed elsewhere in this Form 10-K, that are not described in these risk factors.
Business Risk - Economic
Economic Conditions and Policy, Global Political or Economic Events Could Have an Adverse Effect on Our Business, Liquidity, Financial Condition, and Results of Operations.
Our business, liquidity, financial condition, and results
of operations are sensitive to general domestic and international business and economic conditions, and the strength of the local economies in which we conduct business.
Our business and results of operations are significantly affected by the monetary and fiscal policies of the United States government and its agencies, including the Federal Reserve through its regulation of the supply of money and credit in the United States. These policies are directly impacted by prevailing economic conditions in the United States. For example, the FOMC's policy statements in 2022 and into 2023 provide that inflation continues to exceed the Federal Reserve's target. As a result, the FOMC has continued a series of rapid increases in the federal funds target rate throughout 2022. Such increases either directly or indirectly influence the yield on interest-earning assets, volatility of interest rates, prepayment speeds, the
cost of interest-bearing liabilities and the demand for advances and for our debt. This, in turn, directly impacts our liquidity, financial condition and results of operations.
As another example, a breach or near-breach of the federal debt limit could affect us. The U.S. Treasury has advised that the debt limit has been reached and that it is taking certain cash management measures to avoid breaching the limit. The U.S. Treasury has also advised that it believes it can continue such cash management measures until some time in June 2023. If Congress does not increase the debt limit prior to the time that such measures are exhausted, the U.S. Treasury would lose its borrowing authority at such time and a broad range of government payments could not be satisfied. Such an occurrence or near occurrence is likely to cause disruptions in the capital markets and could result in higher interest rates and borrowing
costs for the FHLBanks. To the extent that we cannot access funding when needed on acceptable terms to effectively manage our cost of funds, our liquidity, financial condition and results of operations could be adversely affected.
Further, a breach of the federal debt limit could trigger an economic recession resulting from the federal government's failure to make its payments and the resulting loss of market confidence. Such a recession could be severe. Any recession could adversely affect our members and, in turn, could adversely affect their demand for advances and other products and services, thereby adversely affecting our results of operations.
Additionally, we are affected by the global economy through member ownership and investments, and through capital markets exposures. Global political, economic, and business uncertainty can lead to
increased volatility in capital markets. One example of this has been realized through the COVID-19 pandemic and related developments, which resulted in market uncertainty causing substantial disruptions in the financial markets and increased volatility. While the disruptions have been short-lived, the pandemic continues and a resurgence could result in further disruptions and increased volatility that could be more severe or long-lasting than prior disruptions. Disruptions could adversely affect us in many ways, including reduced market access to funding and increased costs of funding. Prolonged disruptions may also result in decreased valuations of, and reduced market and book yields on, our assets.
Another example has been realized through the geopolitical instability brought about by ongoing hostilities between Russia and Ukraine, which have led to economic and trade disruptions as well as sanctions.
These and related developments have created uncertainty leading to increased volatility in certain capital markets from time to time. They have also been cited by the FOMC as contributing to upward pressure on inflation and weighing on global economic activity.
We Are Directly Impacted by the Condition of the Housing and Mortgage Markets Especially Those Markets' Conditions in Our District.
Of particular note among business and economic conditions, our business and results of operations are sensitive to the condition
of the housing and mortgage markets. Adverse trends in the mortgage lending sector, including declines in home prices or loan performance, could reduce the value of collateral securing our advances and the fair value of our MBS. Such reductions in value would increase the possibility of under-collateralization, thereby increasing the risk of loss in case of a member's failure. Also, deterioration in the residential mortgage markets could negatively affect the value of our MPP portfolio, resulting in an increase in the allowance for credit losses on mortgage loans.
Our district is comprised of the states of Michigan and Indiana. Increases in unemployment and foreclosure rates or decreases in job or income growth rates in either state could result in less demand for mission-related assets and in turn, adversely affect our profitability and results of operations.
Business
Risk - Legislative and Regulatory
Changes in the Legislative and Regulatory Environment for FHLBanks, Our Members, Our Debt Underwriters and Investors, or Other Housing GSEs May Adversely Affect Our Business, Demand for Products, the Cost of Debt Issuance, and the Value of FHLBank Membership.
We could be adversely affected by: the adoption of new or revised laws, policies, regulations or accounting guidance; new or revised interpretations or applications of laws, policies, or regulations by the Finance Agency, the SEC, the United States Commodity Futures Trading Commission, the CFPB, the Financial Stability Oversight Council, the Comptroller General, the FASB or other federal or state financial regulatory bodies; or judicial decisions that alter the present regulatory environment. Likewise, whenever federal elections result in changes in the executive
branch or in the balance of political parties’ representation in Congress, there is increased uncertainty as to potential administrative, regulatory and legislative actions that may adversely affect our business.
As an example of one source of potential regulatory change, the Director of the Finance Agency has stated that the Finance Agency is engaged in a comprehensive review of the FHLBank System. The Director of the Finance Agency has also stated that this review includes the FHLBanks' mission, purpose, organization, operational efficiency, products, services, collateral requirements, and membership eligibility, among other aspects subject to the review. Following the conclusion of the review in the coming months, the Finance Agency is expected to release a report of its findings that could include statutory and regulatory recommendations that, if accepted, could significantly alter one or more aspects
of the way we do business, demand for our products and services, and the value of Bank membership. Any such regulatory change could adversely affect our results of operations, financial condition, liquidity and capital resources.
Environmental, Social and Governance, or ESG, matters could also lead to enhanced governmental, regulatory or societal attention on us or the FHLBank System in general. Such attention could lead to additional legislation or regulations increasing our compliance costs and operational burdens. For example, the SEC has proposed a rule on climate change disclosures which, if adopted as proposed, would result in significant additional climate-related disclosure requirements. Further, we could become subject to obligations to monitor the use of the proceeds of advances to avoid their deployment to societally-disfavored industries. Such impacts could adversely affect our financial condition
and results of operations.
Members.Changes impacting the environment in which our members provide financial products and services could negatively impact their ability to take full advantage of our products and services, their desire to maintain membership in our Bank, or our ability to rely on their pledged collateral. For example, recent increases in interest rates and the corresponding declines in the values of certain assets could cause one or more of our members to not have positive tangible capital. We are generally prohibited from making advances to members that do not have positive tangible capital. Thus, further rises in market interest rates could prevent us from making advances to certain members and, in turn, adversely affect our financial condition and results of operations.
Products and Services.Changes that limit or prohibit the creation of new products or services could negatively impact our earnings and reduce the value of FHLBank membership. For example, our earnings could be negatively impacted by legislative or regulatory changes that (i) reduce demand for advances or limit advances we make to our members, (ii) further restrict the products and services we are able to provide to our members or how we do business with our members and counterparties, (iii) further restrict the types, characteristics or volume of mortgages that we may purchase through our MPP or otherwise reduce the economic value of MPP to our members, or (iv) otherwise require us to change the composition of our assets and liabilities. Any resulting inability to adapt products and services
to evolving industry standards and member preferences in a highly competitive and regulated environment, while managing our expenses, could harm our business.
Assets and Collateral.Changes that impact the types or values of assets we own or the collateral we hold could increase our risk of credit loss. For example, the CFPB has issued rules that include standards for mortgage lenders to follow during the loan approval process to determine whether a borrower has the ability to repay. Failure to satisfy those standards provides the borrower with certain rights that could impede or prevent the lender from foreclosing in the event of the borrower’s default. Any party that acquires the loan from the lender could be similarly impeded or prevented from foreclosing. We accept mortgage loans as collateral and purchase mortgage loans under AMA programs, particularly MPP.
Our risk of credit loss would tend to be higher on mortgage loans that did not comply with the CFPB’s standards given the possibility of the related borrower to impede or prevent us from realizing upon the mortgage loan in the event of default. Accordingly, the CFPB’s rules could increase our risk of credit loss. The possible impacts of the realization of an increased risk of credit loss are discussed under "An Increase in Our Exposure to Credit Losses Could Adversely Affect Our Financial Condition and Results of Operations."
Liquidity and Capital.Changes impacting liquidity or capital could adversely affect our results of operations. For example, we are subject to various liquidity requirements, which may constrain our ability to invest excess cash flow in higher yielding assets from time to time. If liquidity requirements are
increased, we could be further restrained from otherwise investing in higher yielding assets thereby adversely affecting our earnings. Similarly, we are subject to various capital requirements. If such requirements are increased, it could result in the realization of the risks discussed under "A Failure to Meet Minimum Regulatory Capital Requirements Could Affect Our Ability to Pay Dividends, Redeem or Repurchase Capital Stock, Retain Existing Members and Attract New Members."By way of further example, we, together with the other FHLBanks, currently play a predominant role as lenders in the federal funds markets. Accordingly, any disruptions in the federal funds market or any related regulatory or policy change may adversely affect our cash management activities, results of operations and reputation.
Growth.Changes
may either directly or indirectly restrict our growth. For example, the Finance Agency could issue an order requiring us to further constrain our growth in acquisition of assets via MPP.
Underwriters and Investors.Changes affecting our debt underwriters and investors, particularly revised capital and liquidity requirements, could also adversely affect our cost of issuing debt in the capital markets. For example, a significant number of investors in FHLBank short-term consolidated obligations are money market funds. However, if these investors risk and return preferences or regulatory requirements shift, their demand for this debt could decrease. Such a decrease could, due to the FHLBanks’ concentration in money market investors, lead to an inability to access funding on acceptable terms.
Other
Housing GSEs.Changes impacting other housing GSEs, including those that give preference to certain sectors, business models, regulated entities, assets, or activities, could negatively impact us. For example, changes in the statuses of Fannie Mae and Freddie Mac as a result of legislative or regulatory changes, may impact funding costs for the FHLBanks, which could negatively affect our business and results of operations.In addition, negative news articles, industry reports, and other announcements pertaining to GSEs, including Fannie Mae, Freddie Mac or the FHLBanks, could cause an increase in interest rates on all GSE debt, as investors may perceive these issuers or their debt instruments as bearing increased risk.
FHLBank Membership.Changes that reduce the benefits
of FHLBank membership or restrict the eligibility for FHLBank membership could negatively impact our results of operations.
A Failure to Meet Minimum Regulatory Capital Requirements Could Affect Our Ability to Pay Dividends, Redeem or Repurchase Capital Stock, Retain Existing Members and Attract New Members.
We are required to maintain sufficient capital to meet specific minimum requirements established by the Finance Agency. If we violate any of these requirements or if our board 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, we would not be able to redeem or repurchase any capital stock while such charges are continuing or expected to continue, even if the statutory redemption period had expired for some or all of such stock. Violations of, or regulator-mandated adjustments to, our capital requirements could also restrict our ability to pay dividends, lend, invest, or purchase mortgage loans or participating interests in mortgage loans, or other business activities. Moreover, the Finance Agency could set varying expectations for FHLBanks’ capital levels in ways that have potentially negative impacts on FHLBanks’ business activities. Additionally, the Finance Agency could direct us to call upon our members to purchase additional capital stock to meet our minimum regulatory capital requirements. Members may be unable or unwilling to satisfy such calls for additional capital, thereby
adversely affecting their ability to continue doing business with us and their desire to remain as members. Moreover, failure to pay dividends or redeem or repurchase stock at par, or a call upon our members to purchase additional stock to restore capital, could make it more difficult for us to attract new members.
The formula for calculating risk-based capital includes factors that depend on interest rates and other market metrics outside our control and could cause our minimum requirement to increase to a point exceeding our capital level. Further, if our retained earnings were to become inadequate, the Finance Agency could initiate restrictions consistent with those associated with a failure of a minimum capital requirement.
Restrictions on the Redemption, Repurchase, or Transfer of the Bank's Capital Stock Could Result in an Illiquid Investment
for the Holder, Which Could Affect Member Interest in Our Products with Capital Stock Purchase Requirements and Our Ability to Retain Existing Members and Attract New Members.
Under the Gramm-Leach Bliley Act of 1999, as amended, Finance Agency regulations, and our capital plan, our capital stock may be redeemed upon the expiration of a five-year redemption period, subject to certain conditions. In addition, subject to applicable law, we may elect to repurchase some or all of the excess capital stock of a shareholder at any time at our sole discretion.
There is no guarantee, however, that we will be able to redeem shareholders' capital stock, even at the end of the prescribed redemption period, or to repurchase their excess capital stock. If a redemption or repurchase of capital stock would cause us to fail to meet our minimum regulatory capital
requirements, Finance Agency regulations and our capital plan would prohibit the redemption or repurchase. Restrictions on the redemption or repurchase of our capital stock could result in an illiquid investment for holders of our stock. In addition, because our capital stock may only be owned by our members (or, under certain circumstances, former members and certain successor institutions), and our capital plan requires our approval before a member or nonmember shareholder may transfer any of its capital stock to another member or nonmember shareholder, we cannot provide assurance that we would allow a member or nonmember shareholder to transfer any excess capital stock to another member or nonmember shareholder at any time.
Any such illiquidity could negatively affect member interest in conducting business with us when such business includes a requirement to purchase capital stock. Further, it could cause
existing members to take steps to withdraw from membership and disincentivize prospective members from joining us. Any resulting loss of business could then negatively affect our results of operations and financial condition.
A Loss of Significant Borrowers, PFIs, Acceptable Loan Servicers or Other Financial Counterparties Could Adversely Impact Our Profitability, Our Ability to Achieve Business Objectives, Our Ability to Pay Dividends or Redeem or Repurchase Capital Stock, and Our Risk Concentration.
Significant
Borrowers. The loss of any significant borrower or PFI could adversely impact our profitability and our ability to achieve business objectives. This could result from a variety of factors, including acquisition, consolidation of charters within a bank holding company, a member's loss of market share, resolution of a financially distressed member, or regulatory changes relating to FHLBank membership. As the financial industry continues to consolidate into a smaller number of institutions, this could lead to a further loss of large members and a related decrease in advances outstanding.
For example, in December 2022, Flagstar Bancorp, Inc., the parent company of Flagstar Bank, FSB ("Flagstar"), completed its merger with a non-member depository institution. At December 31, 2022, Flagstar
was our largest borrower with advances outstanding totaling $4.6 billion, or 12% of our total advances outstanding, at par. As a result of the merger, Flagstar became ineligible for Bank membership and is no longer eligible to renew its advances or use any additional Bank products and services. Loss of other large advance borrowers, without replacement of such advances by existing or new members, would be expected to reduce our interest income and profitability accordingly.
Significant PFIs.During the year ended December 31, 2022, our top-selling PFI sold us mortgage loans totaling $272 million, or 24% of the total mortgage loans purchased by the Bank in 2022. Our larger PFIs originate mortgages on properties in several states. We also purchase mortgage loans from
many smaller PFIs that predominantly originate mortgage loans on properties in Michigan and Indiana. Our concentration of MPP loans on properties in Michigan and Indiana could continue to increase over time, as we do not currently limit such concentration.
Loan Servicers.We do not service the mortgage loans we purchase. PFIs may elect to retain servicing rights for the loans sold to us, or they may elect to sell servicing rights to an MPP-approved servicer. A scarcity of qualified mortgage servicers could adversely affect our results of operations.
Financial Counterparties.The number of counterparties that meet our internal and regulatory standards for derivative, repurchase, federal funds sold, TBA, and other financial transactions, such as broker-dealers
and their affiliates, has decreased over time. In addition, since the Dodd-Frank Act, the requirements for posting margin or other collateral to financial counterparties has tended to increase, both in terms of the amount of collateral to be posted and the types of transactions for which margin is now required. For example, Financial Industry Regulatory Authority Rule 4210, which is currently proposed to take effect on October 25, 2023, would require us to exchange margin on certain MBS transactions. Materially greater margin requirements - due to this rule, or otherwise - could adversely affect the availability and pricing of our derivative transactions, making such trades more costly and less attractive as risk management tools. New and expanded margin requirements on derivatives and MBS could also change our risk exposure to our counterparties and may require us to further enhance our systems and processes. These factors
tend to increase the risk exposure that we have to any one counterparty, and as such may tend to increase our reliance upon each of our existing counterparties. A failure of any one of our major financial counterparties, or continuing market consolidation, could affect our profitability, results of operations, and ability to enter into additional transactions with existing counterparties without exceeding internal or regulatory risk limits.
Competition Could Negatively Impact Advances, the Supply of Mortgage Loans for our MPP, Our Access to Funding and Our Earnings.
We
operate in a highly competitive environment. Demand for advances is affected by, among other factors, the cost and availability of other sources of liquidity for our members, including customer deposits, brokered deposits, reciprocal deposits and public funds. We compete with other suppliers of wholesale funding, both secured and unsecured. Such other suppliers may include the United States government, the Federal Reserve Banks, corporate credit unions, the Central Liquidity Facility, investment banks, commercial banks, and in certain circumstances other FHLBanks. Large institutions may also have independent access to the national and global credit markets. Also, the availability of alternative funding sources to members, such as growth in deposits from members' banking customers, can significantly influence the demand for advances and can vary as a result of several factors, including legislative or regulatory changes, market conditions, members' creditworthiness, and
availability of collateral. By way of example, on March 12, 2023, the Federal Reserve implemented a bank term funding program to support federally-insured depository institutions in response to prevailing market uncertainty about the banking industry resulting from the insolvencies of certain regional depository institutions. Loans under the program are generally made on very favorable terms, and our depository institution members may determine to request loans under that program rather than requesting advances from us. For additional information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Accounting and Regulatory Developments - Legislative and Regulatory Developments.
Likewise, our MPP is subject to significant competition.
Direct competition for purchases of mortgages comes from other buyers of conventional, conforming, fixed-rate mortgage loans, such as Fannie Mae and Freddie Mac.
In addition, PFIs face increased origination competition from originators that are not our members. Increased competition can result in a smaller share of the mortgages available for purchase through our MPP and, therefore, lower earnings.
We also compete with Fannie Mae, Freddie Mac, and other GSEs as well as corporate, sovereign, and supranational entities for funds raised through the issuance of CO bonds and discount notes. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs to us or lesser amounts of debt issued at the same cost than otherwise would be the case. There can be no assurance that our supply of funds
through issuance of consolidated obligations will be sufficient to meet our future operational needs.
Downgrades of Our Credit Rating, the Credit Rating of One or More of the Other FHLBanks, or the Credit Rating of the Consolidated Obligations Could Adversely Impact Our Cost of Funds, Our Ability to Access the Capital Markets, and/or Our Ability to Enter Into Derivative Instrument Transactions on Acceptable Terms.
The FHLBanks' consolidated obligations are rated Aaa/P-1 with a stable outlook by Moody's and AA+/A-1+ with a stable outlook by S&P. Rating agencies may from time to time lower a rating or issue negative reports. Because each FHLBank has joint and several liability for all FHLBank consolidated obligations, negative developments at any FHLBank may affect these credit ratings or result in the issuance of a negative report regardless
of an individual FHLBank's financial condition and results of operations. In addition, because of the FHLBanks' GSE status, the credit ratings of the respective FHLBanks are generally influenced by the sovereign credit rating of the United States.
Based on the credit rating agencies' criteria, downgrades to the United States' sovereign credit rating and outlook may occur. As a result, similar downgrades in the credit ratings and outlook on the FHLBanks and the FHLBanks' consolidated obligations may also occur, even though they are not obligations of the United States. S&P downgraded the United States' sovereign credit rating in 2011, which corresponded with a near breach of the federal debt limit. It is possible that a credit rating agency could again downgrade the United States' sovereign credit rating in connection with the current debate in U.S. Congress concerning whether or not the federal debt limit
will be raised. If the sovereign credit rating is downgraded, the credit rating of each FHLBank and the FHLBanks' consolidated obligations and outlooks may also be downgraded.
Downgrades in the credit ratings and outlooks, especially a downgrade to an S&P AA rating or equivalent, could result in higher funding costs, additional collateral posting requirements for certain derivative instrument transactions, or disruptions in our access to capital markets. To the extent that we cannot access funding when needed on acceptable terms to effectively manage our cost of funds, our financial condition and results of operations and the value of membership in our Bank may be negatively affected.
The Inability to Identify Eligible Nominees for our Board of Directors and to Attract and Retain Key Personnel Could Adversely Affect Our Operations, Our Results of Operations, and Our Ability to Satisfy our Mission.
Board of Directors.The talent and experience of our board of directors is critical to our ability to satisfy our mission given the global nature and resulting, ever-growing complexities of the finance industry. However, our directors are subject to legal requirements that could disqualify prospective nominees that would otherwise have the talent and experience necessary for the role. For example, at least 40% of our board of directors' seats must be held by independent directors, who must meet certain specialized and
narrow eligibility requirements (including citizenship, residency and expertise) but are subject to specific term limits. Seven of the directorships are designated for independent directors, but two of these directorships are held by directors who will be term-limited as of December 31, 2023. Each has served as a director of the Bank for 15 or more years. Thus, the term limits will result in our inability to re-nominate those directors resulting in the board's loss of their talent and experience. While our board's Human Resources Committee engages in succession planning for directorships, such legal requirements may challenge our ability to find prospective nominees who have specific expertise and specialized skills that meet the eligibility requirements.
Key Personnel.We rely on key personnel for many of our
functions and have a relatively small workforce, given the size and complexity of our business. Our ability to attract and retain personnel with the required technical expertise and specialized skills is important for us to manage our business and conduct our operations successfully. However, competition for such personnel from within the financial services industry, including for risk management professionals, and from businesses outside the financial services industry, including the technology industry, have challenged and may continue to challenge our ability to recruit and retain such personnel. For example, we have experienced and continue to experience higher employee turnover and increased competition in hiring and retaining skilled key personnel due to the significant disruptions and changes to the U.S. labor market that have resulted from the COVID-19 pandemic. Increased remote-working opportunities have also increased competition in hiring and retaining skilled
key personnel. Failure to attract and retain skilled key personnel, or failure to develop and implement an effective succession plan for key personnel, could adversely affect our business and operations and, in turn, our results of operations.
Credit Risk
An Increase in Our Exposure to Credit Losses Could Adversely Affect Our Financial Condition and Results of Operations.
We are exposed to credit risk as part of our normal business operations through member products, mortgage servicers, investment securities and counterparty obligations. Periods of economic downturn, and periods of economic and financial disruptions and uncertainties, may increase credit risk.
Member Products.
Advances.
If a member fails and the appointed receiver or rehabilitator (or another applicable entity) does not either (i) promptly repay all of the failed institution's obligations to us or (ii) properly assign or assume the outstanding advances, we may be required to liquidate the collateral pledged by the failed institution. The proceeds realized from the liquidation may not be sufficient to fully satisfy the amount of the failed institution's obligations plus the operational cost of liquidation, particularly if market price and interest-rate volatility adversely affect the value of the collateral. Price volatility could also adversely impact our determination of over-collateralization requirements, which could ultimately cause a collateral deficiency in a liquidation scenario. In some cases, we may not be able to liquidate the collateral for the value assigned to it or in a timely manner. Any of these scenarios could cause us to experience a credit loss,
which in turn could adversely affect our financial condition and results of operations.
A deterioration of residential or commercial real estate property values could further affect the mortgages or MBS pledged as collateral for advances.In order to remain fully collateralized, we may require members to pledge additional collateral when we deem it necessary. If members are unable to fully collateralize their obligations with us, our advances could decrease further, negatively affecting our results of operations or ability to pay dividends or redeem or repurchase capital stock.
Mortgage Loans. If delinquencies in our fixed-rate mortgages increase and residential property values decline, we could experience reduced yields or losses exceeding the protection provided by the LRA and
SMI credit enhancement, as applicable, on mortgage loans that we have purchased.
We are the beneficiary of third-party PMI and SMI (where applicable) coverage on conventional mortgage loans that we acquire through our MPP, and we rely in part on such coverage to reduce the risk of losses on those loans. As a result of actions by their respective state insurance regulators, however, certain of our PMI providers may pay less than 100% of the claim amounts. The remaining amounts are deferred until the funds are available or the PMI provider is liquidated. It is possible that insurance
regulators may impose restrictions on the ability of our other PMI/SMI providers to pay claims. If our PMI/SMI providers further reduce the portion of mortgage insurance claims they will pay to us or further delay or condition the payment of mortgage insurance claims, or if additional adverse actions are taken by their state insurance regulators, we could experience higher losses on mortgage loans.
Mortgage Servicers. We are also exposed to credit losses from servicers of mortgage loans that we have purchased if they fail to perform their contractual obligations.
Investment Securities. The MBS market continues to face uncertainty over the potential changes in the Federal Reserve's holdings of MBS and the effect of any new or proposed actions. Additionally,
future declines in housing prices, as well as other factors, such as increased loan default rates and loss severities and decreased prepayment speeds, may result in unrealized losses, which could adversely affect our financial condition.
Counterparty Obligations.We assume unsecured credit risk when entering into money market transactions and financial derivatives transactions with domestic and foreign counterparties or through derivatives clearing organizations. A counterparty default could result in losses if our credit exposure to that counterparty is not fully collateralized or if our credit obligations associated with derivative positions are over-collateralized. The insolvency or other inability of a significant counterparty, including a clearing organization, to perform its obligations under such transactions or other agreements
could have an adverse effect on our financial condition and results of operations, as well as our ability to engage in routine derivative transactions. If we are unable to transact additional business with those counterparties, our ability to effectively use derivatives could be adversely affected, which could impair our ability to manage some aspects of our interest-rate risk.
Moreover, our ability to engage in routine derivatives, funding and other transactions could be adversely affected by the actions and commercial soundness of financial institutions that transact business with our counterparties. Financial services institutions are interrelated as a result of trading, clearing, counterparty and/or other relationships. Consequently, financial difficulties experienced by one or more financial services institutions could lead to market-wide disruptions that may impair our ability to find suitable counterparties
for routine business transactions.
Providing Financial Support to Other FHLBanks Could Negatively Impact the Bank's Liquidity, Earnings and Capital and Our Members.
We are jointly and severally liable with the other FHLBanks for the consolidated obligations issued on behalf of the FHLBanks through the Office of Finance. If another FHLBank were to default on its obligation to pay principal and interest on any consolidated obligations, the Finance Agency may allocate the outstanding liability among one or more of the remaining FHLBanks on a pro-rata basis or on any other basis the Finance Agency may determine. In addition to possibly making payments due on consolidated obligations under our joint and several liability, we may voluntarily or involuntarily provide financial assistance to another FHLBank in order to resolve a condition of financial
distress. Such assistance could negatively affect our financial condition, our results of operations and the value of membership in our Bank. Moreover, a Finance Agency regulation provides each FHLBank to contribute at least 10% of its annual net earnings before interest expense on MRCS subject to an FHLBank System-wide annual minimum contribution to AHP of $100 million. If the required contribution is increased or we become liable for a pro-rata share of the System's annual minimum contribution, our net earnings could be reduced or eliminated. Thus, these requirements could adversely affect our ability to pay dividends to our members or to redeem or repurchase capital stock.
Changes in Response to the Replacement of the LIBOR Benchmark Interest Rate Could Adversely Affect Our Business, Financial Condition and Results of Operations.
Cessation of the Use of LIBOR. A portion of our assets and liabilities remain directly or indirectly indexed to LIBOR. The one-week and two-month U.S. dollar LIBOR settings and all non-U.S. dollar LIBOR settings ceased to be provided by any administrator and were no longer representative as of January 1, 2022. The remaining U.S. dollar LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after June 30, 2023. Although the United Kingdom Financial Conduct Authority has indicated that it does not expect the
remaining U.S. dollar LIBOR settings to become unrepresentative before the cessation date, there is no assurance that any of them will continue to be published or be representative through any particular date.
We have endeavored to identify and amend our agreements that may require adding or adjusting fallback language, including advances, investments and derivatives. Despite these efforts, the contractual consequences of LIBOR cessation for some existing LIBOR-indexed instruments may still lack clarity in some instances. Further, as LIBOR has been a principal floating-rate benchmark in the financial markets, its cessation has affected, and may continue to affect, the financial markets generally and our business, financial condition, and results of operations.
Adoption of SOFR. We continue to take steps to adopt SOFR, the
alternative to U.S. dollar LIBOR recommended by the Alternative Reference Rates Committee for our relevant products, services and financial instruments. The market transition from LIBOR to SOFR or another alternate reference rate has been and is expected to continue to be complicated, including the development of term and credit adjustments to accommodate differences between LIBOR and SOFR or any other alternate reference rate as well as other market conventions. In addition, the overnight Treasury repurchase market underlying SOFR has experienced and could continue to experience disruptions from time to time, which has resulted and may continue to result in unexpected fluctuations in SOFR. The introduction of alternate reference rates also creates challenges in hedging and asset-liability management and may result in additional basis risk and increased volatility. While market activity in SOFR- linked financial instruments continues to develop, the progress has been
uneven in the commercial loan market, and there can be no guarantee that SOFR will become widely accepted and used across market segments and financial products in a timely manner and any other alternative reference rate may or may not be developed. Any disruption in the market transition towards SOFR or another alternate reference rate could result in increased financial, operational, legal or reputational risks to us.
Changes in Interest Rates or Changes in the Differences Between Short-Term Rates and Long-Term Rates Could Have an Adverse Effect on Our Earnings.
Our ability to prepare for changes in interest rates, or to hedge related exposures such as volatility or basis risk, significantly affects the success of our asset and liability management activities and our level of net interest income.
The
effect of interest rate changes can be exacerbated by prepayment and extension risks, which are the risks that mortgage-based investments will be refinanced by borrowers in low interest-rate environments or will remain outstanding longer than expected at below-market yields when interest rates increase. Decreases in interest rates typically cause mortgage prepayments to increase, which may result in increased premium amortization expense and a decrease in the yield of our mortgage assets as we experience a return of principal that we must re-invest in a lower rate environment. While these prepayments would reduce the asset balance, our balance of consolidated obligations may remain outstanding. Conversely, increases in interest rates typically cause mortgage prepayments to decrease or mortgage cash flows to slow, possibly resulting in the debt funding the portfolio to mature and the replacement debt to be issued at a higher cost, thus reducing our interest spread.
A
flattening or inverted yield curve, in which the difference between short-term interest rates and long-term interest rates is lower or negative, respectively, relative to prior market conditions, will tend to reduce, and has reduced, the net interest margin on new loans added to the MPP portfolio. Until such time as the yield curve becomes steeper, we may continue to earn lower spread income from that portfolio.
The Inability to Access Capital Markets
on Acceptable Terms Could Adversely Affect Our Liquidity, Operations, Financial Condition and Results of Operations, and the Value of Membership in Our Bank.
Our primary source of funds is the sale of consolidated obligations in the capital markets. Our ability to obtain funds through the sale of consolidated obligations depends in part on prevailing conditions in the capital markets, such as investor demand and liquidity, and on dealer commitment to inventory and support our debt. Any disruption in the debt market could have an adverse impact on our interest spreads, opportunities to call and reissue existing debt or roll over maturing debt, or our ability to satisfy the Finance Agency's liquidity requirements.
Operational Risk
A Cybersecurity Event; Interruption in Our Information
Systems; Unavailability of, or an Interruption of Service at, Our Main Office or Our Backup Facilities; or Failure of or an Interruption in Information Systems of Third-Party Vendors or Service Providers Could Adversely Affect Our Business, Risk Management, Financial Condition, Results of Operations, and Reputation.
Cybersecurity.We rely heavily on our information systems and other technology to conduct and manage our business, which inherently involves large financial transactions with our members and other counterparties. Our operations rely on the secure processing, storage and transmission of confidential and other information, both in our and third parties' computer systems and networks, including those of backup service providers. These computer systems, software and networks are vulnerable to breaches, unauthorized access, damage, misuse, computer viruses
or other malicious code and other events that could potentially jeopardize the confidentiality of such information or otherwise cause interruptions or malfunctions in our operations, either directly or through a third party. Similarly, work-from-home arrangements that we have used and that have been and are used by third party vendors present additional risks of cybersecurity events. We have not experienced a disruption in our information systems that has had a material adverse effect on us.
However, as malicious threat tactics continue to become more pervasive and more sophisticated, and as regulatory scrutiny of cybersecurity risk management increases, we are required to implement more advanced mitigating controls, which increases our costs. Moreover, if we experience a significant cybersecurity event, either directly or through a third party, we may suffer significant financial or data loss; be unable
to conduct and manage our business functions effectively; incur significant expenses in remediating such incidents; and suffer reputational harm. Any such occurrence could result in increased regulatory scrutiny of our operations. There can be no assurance that our or any third parties' cybersecurity controls will timely detect or prevent all cybersecurity incidents. Although we carry cybersecurity insurance, its coverage may not be broad enough or adequate to cover losses we may incur if a significant cybersecurity event occurs.
Information Systems; Facilities; Unavailability or Interruption of Service.In addition, our operations rely on the availability and functioning of our main office, our business resumption center and other facilities. If we experience a significant failure or interruption in our business continuity, disaster recovery or certain information
systems, we may be unable to conduct and manage our business functions effectively; incur significant expenses in remediating such incidents; and suffer reputational harm. Moreover, any of these occurrences could result in increased regulatory scrutiny of our operations.
Office of Finance.The Office of Finance is a joint office of the FHLBanks established to facilitate the issuance and servicing of consolidated obligations, among other activities. A failure or interruption of the Office of Finance's services as a result of breaches, cyber attacks, or technological outages (either in the Office of Finance or certain of its third party service providers, including those of backup service providers) could constrain or otherwise negatively affect our business operations, including disruptions to our access to funding through the sale of consolidated obligations.
Moreover, any operational failure of the Office of Finance or of its third party providers could expose us to the risk of loss of data or confidential information, or other harm, including reputational damage.
Other Third Parties.Despite our policies, procedures, controls and initiatives, some operational risks are beyond our control, and the failure of other parties to adequately address their performance standards and operational risks could adversely affect us. In addition to internal computer systems, we outsource certain communication
and information systems and other services critical to our business infrastructure, and regulatory compliance to third-party vendors and service providers, including derivatives clearing organizations, loan servicers, and the Federal Reserve as to funds transfers.
Compromised security or operational errors at any third party with whom we conduct business, or at any third party's contractors, could expose us to cyber attacks, other breaches or service failures or interruptions. If one or more of these external parties were not able to perform their functions for a period of time, at an acceptable service level, or with increased volumes, our business operations could be constrained, disrupted, or otherwise negatively affected. In addition, any failure, interruption or breach in security of these systems, any disruption of service, or any external party's failure to perform its contractual obligations could
result in failures or interruptions in our ability to conduct and manage our business effectively, including, without limitation, our advances, MPP, funding, hedging activities and regulatory compliance. There is no assurance that such failures or interruptions will not occur or, if they do occur, that they will be timely detected or adequately addressed by us or the third parties on which we rely. Any failure, interruption, or breach could significantly harm our customer relations and business operations, which could negatively affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.
A Failure of the Business and Financial Models and Related Processes Used to Evaluate Various Financial Risks and Derive Certain Estimates in Our Financial Statements Could Produce Unreliable Projections or Valuations, which Could Adversely Affect Our Business,
Financial Condition, Results of Operations and Risk Management.
We are exposed to market, business and operational risk, in part due to the significant use of business and financial models when evaluating various financial risks and deriving certain estimates in our financial statements. Our business could be adversely affected if these models fail to produce reliable projections or valuations. These models, which rely on various inputs including, but not limited to, loan volumes and pricing, market conditions for our consolidated obligations, interest-rate spreads and prepayment speeds, implied volatility of options contracts, and cash flows on mortgage-related assets, require management to make critical judgments about the appropriate assumptions that are used in the determinations of such risks and estimates and
may overstate or understate the value of certain financial instruments, future performance expectations, or our level of risk exposure. Our models could produce unreliable results for a number of reasons, including, but not limited to, invalid or incorrect assumptions underlying the models, the need for manual adjustments in response to rapid changes in economic conditions, incorrect coding of the models, incorrect data being used by the models or inappropriate application of a model to products or events outside the model's intended use. In particular, models can be less dependable when the economic environment is outside of historical experience, as has been the case in recent years. While we take steps to review and validate our models to minimize inaccuracies, there can be no assurance that all inaccuracies will be identified timely. The reliance on inaccurate models could result in unreliable projections or valuations, which could result in sub-optimal strategies
and, in turn, adversely affect our business, financial condition, results of operations and risk management.
General Risks
Natural Disasters, Including those Resulting from Significant Climate Change, and Similar Catastrophic Events Could Adversely Affect Our Business and Our Members.
Regions in which we operate are subject to natural disasters, including risks from hurricanes, tornadoes, floods, wild fires, drought and other natural disasters. Climate change is increasing the frequency, intensity and duration of these weather events. Likewise, similar catastrophic events, such as epidemics or pandemics (as was realized in the COVID-19 pandemic), acts of war or terrorism, and/or disruptions in the availability of critical infrastructure on which we rely due to a cyber incident or otherwise
could occur. Any such natural disasters or similar catastrophic events could destroy or damage our assets or collateral that members have pledged to us; disrupt our business; increase the probability of power or other outages; negatively affect the livelihood of borrowers of our members; or otherwise cause significant economic dislocation in the affected regions. Any of these situations may adversely affect our financial condition and results of operations.
We own an office building containing approximately 117,000 square feet of office and storage space at 8250 Woodfield Crossing Boulevard, Indianapolis, IN, of which we lease 8,800 square feet to a single tenant. In addition, we lease office space in Detroit, MI, which is used for community and member engagement, and in Anderson, IN, which is used for business resumption activities in the event of a loss of or a disruption to the primary facility.
We also maintain two geographically dispersed, co-located data centers which are on electrical distribution
grids that are separate from each other and from our office buildings. For more information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Operational Risk Management.
In the opinion of management, our physical properties are suitable and adequate. All of our properties are insured to approximately replacement cost.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, we may from time to time become a party to lawsuits involving various business matters. We are unaware of any lawsuits presently pending which, individually
or in the aggregate, could have a material effect on our financial condition or results of operations.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
We
use acronyms and terms throughout this Item that are defined herein or in the Defined Terms.
No Trading Market
Our capital stock is not publicly traded, and there is no established market for such stock. Members may be required to purchase additional shares of stock from time to time to meet minimum stock purchase requirements under our capital plan.
Our Class B stock is registered under the Exchange Act and may be purchased, sold, redeemed and repurchased only at par. Because our shares of capital stock are "exempt securities" under the Securities Act, purchases and sales of stock by our members are not subject to registration under the Securities Act.
Depending on the class of capital stock,
it may be redeemed either six months (Class A Common Stock) or five years (Class B Common Stock) after we receive a written request by a member, subject to regulatory limits and to the satisfaction of any ongoing stock investment requirements applying to the member under our capital plan. We may repurchase shares held by members in excess of their required holdings at our discretion at any time in accordance with our capital plan.
Capital Structure
Our capital plan provides for two sub-series of Class B capital stock: Class B-1 and Class B-2. Class B-1 stock is held by our members to satisfy their membership stock requirements, while Class B-2 stock is held to satisfy members’ activity-based stock requirements. Class B-1 stock is automatically reclassified as Class B-2 as needed to help fulfill a member’s activity-based stock requirement
and before the member is required to purchase additional Class B-2 stock to fully meet its capital stock requirement. Excess Class B-2 stock is automatically reclassified as Class B-1.
Under our capital plan, PFIs may opt in to an activity-based stock requirement in connection with their sales of mortgage loans to us under Advantage MPP. PFIs may elect this stock requirement each time they enter into an MCC with us based on the outstanding principal balance of loans purchased. As of December 31, 2022, such Class B-2 stock issued and outstanding totaled $85 million.
Our capital plan also permits the board of directors to authorize the issuance of Class A stock. Under the plan, Class A stock may be used at the member’s election,
in lieu of Class B-2 stock, to satisfy the member’s activity-based stock requirement. Class A stock is subject to the same redemption requirements and limitations as Class B stock, except the applicable redemption period for Class A stock is six months. As of December 31, 2022, the board of directors had not authorized the issuance of Class A stock.
Number of Shareholders
As of February 28, 2023, we had 359 shareholders and $2.5 billion par value of regulatory capital stock, which includes Class B stock and MRCS issued and outstanding. As of February 28, 2023, we had no Class A stock outstanding.
Dividends
We
may, but are not required to, pay dividends on our capital stock. Dividends are authorized by our board of directors and subject to Finance Agency regulations. Dividends are non-cumulative and may be paid in cash or capital stock out of current net earnings, or from unrestricted retained earnings, or from restricted retained earnings after that balance exceeds 1.5% of the average balance of our outstanding consolidated obligations for the previous quarter. No dividend may be declared or paid if we are or would be, as a result of such payment, in violation of our minimum capital requirements. Moreover, we may not pay dividends if any principal or interest due on any consolidated obligation issued on behalf of any of the FHLBanks has not been paid in full or, under certain circumstances, if we fail to satisfy liquidity requirements under applicable Finance Agency regulations.
Under Finance Agency regulations,
stock dividends cannot be paid if our excess stock is greater than 1% of our total assets. At December 31, 2022, our excess stock was 0.82% of our total assets.
Under our capital plan, the board of directors may declare a dividend rate on Class B-2 stock that equals or exceeds the rate on Class B-1 stock. Similarly, the board of directors may declare a dividend rate on Class A stock that equals or exceeds the rate on Class B-1 stock.
The amount of the
dividend to be paid is based on the average number of shares of each sub-series held by a member during the dividend payment period (applicable quarter).
For more information, see Notes to Financial Statements - Note 12 - Capital and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources.
ITEM 6. [Reserved]
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Presentation
This
discussion and analysis by management of the Bank's financial condition and results of operations should be read in conjunction with the Financial Statements and related Notes to Financial Statements contained in this Form 10-K.
As used in this Item, unless the context otherwise requires, the terms "Bank", "we,""us," and "our," refer to the Federal Home Loan Bank of Indianapolis or its management. Acronyms and terms used throughout this Item are defined herein or in the Defined Terms.
Unless otherwise stated, amounts disclosed in this Item are rounded to the nearest million; therefore, dollar amounts of less than one million may not be reflected or, due to rounding, may not appear
to agree to the amounts presented in thousands in the Financial Statements and related Notes to Financial Statements. Amounts used to calculate dollar and percentage changes are based on numbers in the thousands. Accordingly, calculations based upon the disclosed amounts (millions) may not produce the same results.
Executive Summary
Overview. As an FHLBank, we are a regional wholesale bank that serves as a financial intermediary between the capital markets and our members. The Bank is structured as a financial cooperative, which allows our business to be scalable
and self-capitalizing without taking undue risks, diminishing capital adequacy or jeopardizing profitability. Therefore, the Bank is generally designed to expand and contract in asset size as the needs of our members and their communities change.
We primarily make secured loans in the form of advances to our members and purchase whole mortgage loans from our members. Additionally, we purchase other investments and provide other financial services to our members.
Our principal source of funding is the proceeds from the sale to the public of FHLBank debt instruments, called consolidated obligations, which are the joint and several obligation of all FHLBanks. We obtain additional funds from deposits, other borrowings, and by issuing capital stock to our members.
Our
primary source of revenue is interest earned on advances, mortgage loans, and investments, including MBS.
Our net interest income is primarily determined by the size of our balance sheet and the spread between the interest rate earned on our assets and the interest rate paid on our share of the consolidated obligations. A substantial portion of net interest income may also be derived from deploying our capital which has no associated interest cost, i.e., interest-free capital. We use funding and hedging strategies to manage the related interest-rate risk.
Due to our cooperative ownership structure and wholesale nature, we typically earn a narrow interest spread. Accordingly, our net income is relatively low compared to our total assets and capital.
In addition, as a cooperative,
some members utilize our products more heavily and own more capital stock than others. As a result, we must achieve a balance in generating membership value from rates we charge on advances or prices we pay to purchase mortgage loans and paying a competitive dividend rate.
We group our products and services within two operating segments: traditional and mortgage loans.
For more background information on the Bank, see Item 1. Business.
Business
Environment. The Bank's financial performance is influenced by several key national economic and market factors, including fiscal and monetary policies, the conditions in the housing markets and the level and volatility of market interest rates.
Economy and Financial Markets. The U.S. economy closed out an uneven 2022 with fourth quarter U.S. real gross domestic product rising at an annual rate of 2.7%. The rate was down slightly from the third quarter annual rate of 3.2%, as economic activity slightly cooled in the fourth quarter. Consumer spending helped drive the fourth quarter gain, while the housing market weakened and businesses cut back their spending on equipment, according to the U.S Commerce Department. U.S. real gross domestic product increased by 2.1% for the year 2022.
Workers' wage
gains in 2022 helped consumer spending, the economy's main engine, grow at an annual pace of 2.1% in the fourth quarter, compared to the third quarter, and 1.9% compared to the fourth quarter of 2021.
High inflation has clearly cut into households' purchasing power. However, inflation eased in December 2022 for the sixth straight month following a mid-2022 peak.
Easing inflation follows several signs that U.S economic activity cooled in the fourth quarter. Job and wage growth slowed in December, though the labor market remained tight with historically low unemployment continuing at 3.5% in December 2022. Improving supply chains and reduced demand have relieved price pressures on goods, but services prices continued to climb in part because of wage gains in a tight labor market. Federal Reserve officials are concerned that tight U.S. labor markets
could sustain higher prices in the years to come.
According to the Bureau of Labor Statistics, the overall consumer price index increased 6.5% in December from a year ago. Consumer inflation, excluding volatile energy and food prices, the so-called core consumer-price-index, rose 5.7% in December from a year earlier. The index had accelerated to a new four-decade high in September of 6.6%, compared to a year earlier.
Many economists are worried about the possibility of a recession within the next 12 months. They expect the Federal Reserve's efforts to combat high inflation by raising interest rates to further weigh on the economy by triggering spending cutbacks and job losses.
Conditions in U.S. Housing Markets. Home sales slipped to cap their worst year since
2014, primarily driven by higher home prices and higher mortgage interest rates. According to the National Association of Realtors ("NAR"), existing-home sales fell for the eleventh straight month in December 2022, the slowest sales pace since November 2010, as the once-booming housing market has become a bigger drag on the U.S. economy. Sales in December were down 34% from a year earlier. Sales in 2022 fell 17.8% from the prior year.
Despite the sharp decline in sales, home prices have risen on a year-over-year basis, in part because supply remained tight. But price growth has slowed from its red-hot pace earlier in the year. According to the NAR, the median sales price of an existing home climbed in December by only 2.3% from a year earlier. Prices fell for the sixth straight month.
Total housing inventory at the end of December was enough
to cover 2.9 months of sales, still historically low.
The Federal Reserve's rate increases have fueled higher mortgage rates. In late October, the average rate on a 30-year fixed-rate mortgage, according to Freddie Mac, reached its highest level in two decades at 7.08%. However, it had declined by the end of the year to 6.42%
With sustained price appreciation and higher mortgage rates, affordability continues to be a challenge for potential home buyers.
Interest Rate Levels and Volatility.The Federal Reserve seeks to achieve maximum employment and inflation at the rate of 2% over the longer run. In support of these goals, at its meeting in November 2022, the FOMC raised the target range for the federal funds rate by another 75 bps to 3.75%
to 4.0% and, at its meeting in December 2022, it raised the target range by another 50 bps to 4.25% to 4.50%.
The level and volatility of interest rates, including the shape of the yield curve during the three and twelve months ended 2022 were affected by several factors, principally efforts by the Federal Reserve to raise interest rates and tighten monetary policy to combat high inflation.
In 2022, as the FOMC raised short-term rates, portions of the Treasury yield curve became inverted. Investors use the 10-year Treasury yield as an indicator of investor confidence. In recent months, the 2-year rate has been consistently higher than the 10-year rate, and the 3-month rate nudged above the 10-year rate for the first time since before the Covid-19 pandemic. That change inverted what many regard as a critical relationship in the U.S. yield curve, signaling a coming recession.
At its
meeting on February 1, 2023, the FOMC decided to raise the target range for the federal funds rate by another 25 bps to 4.50% to 4.75%.
The FOMC stated that "recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation has eased somewhat but remains elevated. The Committee is highly attentive to inflation risks. The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run."
"The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time."
"In
addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans."
Impact on Operating Results. Market interest rates and trends affect yields and margins on earning assets, including advances, purchased mortgage loans, and our investment portfolio, which contribute to our overall profitability. Additionally, market interest rates drive mortgage origination and prepayment activity, which can lead to net interest margin volatility in our MPP and MBS portfolios. A flat or inverted yield curve, in which the difference between short-term interest rates and long-term interest rates is low, or negative, respectively, may have an unfavorable impact on our net interest margins. A steep yield curve, in which the difference between short-term and long-term interest rates
is high, may have a favorable impact on our net interest margins. The level of interest rates also directly affects our earnings on assets funded by our interest-free capital.
Lending and investing activity by our member institutions is a key driver for our balance sheet and income growth. Such activity is a function of both prevailing interest rates and economic activity, including local economic factors, particularly relating to the housing and mortgage markets. Positive economic trends can drive interest rates higher, which can impair growth of the mortgage market. A less active mortgage market can affect demand for advances and activity levels in our Advantage MPP. However, borrowing patterns between our insurance company and depository members can differ during various economic and market conditions, thereby easing the potential magnitude of core business fluctuations during business cycles. Member demand
for liquidity during stressed market conditions can lead to advances growth.
Results of Operations and Changes in Financial Condition
Results of Operations for the Years Ended December 31, 2022 and 2021. The following table presents the comparative highlights of our results of operations ($ amounts in millions).
Years
Ended December 31,
Condensed Statements of Comprehensive Income
2022
2021
$ Change
% Change
Net interest income
$
291
$
252
$
39
16
%
Provision
for (reversal of) credit losses
—
—
—
Net interest income after provision for credit losses
291
252
39
16
%
Other
income (loss)
19
(34)
53
Other expenses
113
113
—
Income before assessments
197
105
92
88
%
AHP
assessments
20
11
9
Net income
177
94
83
88
%
Total
other comprehensive income (loss)
(159)
28
(187)
Total comprehensive income
$
18
$
122
$
(104)
(85)
%
The
increase in net income for the year ended December 31, 2022 compared to the prior year was primarily due to higher earnings on the portion of the Bank's assets funded by its capital, and lower accelerated amortization of mortgage purchase premiums resulting from lower principal prepayments by borrowers, each driven by the increase in market interest rates, but partially offset by declines in the fair values of the investments indirectly funding the liabilities under certain employee benefit plans.
The decrease in total OCI for the year ended December 31, 2022 compared to the prior year was primarily due to the unrealized losses on AFS securities, in particular investments in MBS, driven by the increase in market interest rates.
The following table
presents the returns on average assets and returns on average equity.
Years Ended December 31,
Ratios
2022
2021
Return on average assets
0.28
%
0.15
%
Return
on average equity
5.03
%
2.64
%
Results of Operations for the Years Ended December 31, 2021 and 2020. A comparison of our results of operations for the years ended December 31, 2021 and 2020 is contained in the corresponding Item 7in our 2021 Form 10-K, filed with the SEC on March 10, 2022.
Changes in Financial Condition for the Year Ended December 31, 2022. The following table presents the comparative highlights of our changes in financial condition ($ amounts in millions).
(1) Includes cash, interest-bearing deposits, securities purchased under agreements to resell, federal funds sold and trading securities.
(2) Includes
AFS and HTM securities.
(3) Includes restricted retained earnings at December 31, 2022 and 2021 of $323 million and $287 million, respectively.
(4) Total capital less AOCI plus MRCS.
Total assets at December 31, 2022 were$72.3 billion, a net increase of $12.3 billion, or 20%, from December 31, 2021, driven primarily by a net increase in advances outstanding.
Advances outstanding at December 31,
2022, at carrying value, totaled $36.7 billion, a net increase of $9.2 billion, or 33%, from December 31, 2021. The par value of advances outstanding increased by 37% to $37.3 billion, which included a net increase in short-term and long-term advances of 85% and 17%, respectively. The par value of advances to depository institutions — comprising commercial banks, savings institutions and credit unions — and insurance companies increased by 63% and 6%, respectively.
Purchases of mortgage loans from the Bank's members for the year ended December 31, 2022 totaled $1.2 billion. Mortgage loans held for portfolio at December 31, 2022 totaled $7.7 billion, a net increase of $71 million, or 0.9%, from December 31,
2021, as the Bank's purchases slightly exceeded principal repayments by borrowers.
Liquidity investments, which consist of cash and short-term investments as well as U.S. Treasury obligations, at December 31, 2022 totaled $10.8 billion, a net decrease of $190 million, or 2%, from December 31, 2021. Cash and short-term investments increased by $1.5 billion, or 22%, to $8.6 billion to support the increase in advances. U.S. Treasury obligations, classified as trading securities, decreased by $1.7 billion, or 43%, to $2.2 billion, as substantially all of the Bank's purchases of U.S. Treasury obligations in 2022 were classified as available-for-sale. As a result, cash and short-term investments represented 79% of the total liquidity investments at December 31, 2022,
while U.S. Treasury obligations represented 21%.
Other investment securities, which consist substantially of mortgage-backed securities and U.S. Treasury obligations classified as held-to-maturity or available-for-sale, at December 31, 2022 totaled $16.4 billion, a net increase of $2.9 billion, or 22%, from December 31, 2021, due to purchases of U.S. Treasury obligations.
The Bank's consolidated obligations outstanding at December 31, 2022 totaled $67.3 billion, a net increase of $12.8 billion, or 23%, from December 31, 2021, which reflected increased funding needs associated with the net increase in the Bank's total assets.
Total capitalat December 31, 2022 was $3.4 billion, a net decrease of $172 million, or 4.8%, from December 31, 2021. The net decrease primarily resulted from a transfer of capital stock to MRCS upon a member's merger into a non-member, repurchases of capital stock, and unrealized losses on investments in MBS driven by the increase in market interest rates, partially offset by capital stock issuances to support the increase in advances and a net increase in retained earnings.
The Bank's regulatory capital-to-assets ratio at December 31, 2022 was 5.23%, which exceeds all applicable regulatory
capital requirements.
Outlook. We believe that our financial performance will continue to provide sufficient, risk-adjusted returns for our members across a wide range of business, financial, and economic environments.
During 2022, demand by our members for advances was strong, primarily due to our depository members' loan growth outpacing their deposit growth, the rapid rise in market interest rates, including the adverse impact on their investment portfolios, and the availability of suitable products to assist our members in managing their balance sheets in the uncertain economic environment. We expect these factors to continue to favorably impact demand for advances in 2023. However, we expect total advances outstanding to moderately decline in 2023, based on a slowing economy resulting from the Federal Reserve's actions
to combat persistent inflation, a resurgence of brokered deposits and the Federal Reserve's new bank term funding program as competitive wholesale funding alternatives, and the inability of Flagstar Bank, FSB ("Flagstar"), historically one of our largest and most active borrowers, to renew its advances outstanding as a result of the consummation of the merger of its parent company into a non-member depository institution in late 2022.
Despite rising mortgage interest rates, we expect our mortgage loan balance outstanding to slightly increase in 2023 due to continuing strong demand by our members to participate in our Advantage MPP and lower levels of prepayments by our borrowers.
The loss of Flagstar as a member is expected to reduce the level of liquidity we regularly need to maintain. However,
we expect to continue to maintain relatively high levels of liquidity to be able to timely support our members' needs.
We continue to seek to maintain investments in MBS up to 300% of total regulatory capital. We expect to continue purchasing U.S. Treasury obligations as AFS while other long-term investments, such as Agency debentures, are expected to decline.
Access to debt markets has been reliable, while the cost of our consolidated obligations increased significantly in 2022. Going forward, we expect the cost to further increase, with the extent of the increase dependent upon several factors, including the direction and level of market interest rates, competition from other issuers of Agency debt, changes in the investment preferences of potential buyers of Agency debt securities, global demand, pricing in the interest-rate swap market, and
other technical market factors. As LIBOR continues to be phased out, our adjustable-rate funding continues to be replaced by SOFR-indexed instruments.
Despite the expected increase in funding costs, our overall interest spreads are expected to increase in 2023 as the ongoing rise in market interest rates drives asset yields higher and results in higher earnings on the portion of our assets funded by our capital.
We will continue to engage in various hedging strategies and use derivatives to assist in mitigating the volatility of earnings that arises from the maturity structure of our financial assets and liabilities. Although derivatives are used to mitigate market risk, they also introduce the potential for short-term earnings volatility, in part due to basis risk.
In the first quarter
of 2023, we retired two swapped CO bonds prior to their contractual maturity dates and recognized net gains on debt extinguishment in other income of $19.8 million.
Considering our inherent relatively low margins as a cooperative, we continue to strive to keep our operating expense ratios relatively low. However, in 2023, we must absorb significant cost increases resulting from inflation and we plan to continue to invest in technology to enhance our operating systems and member service capabilities. As a result, we expect a moderate increase in our operating expenses in 2023.
As a result of all of the foregoing factors, we have forecasted net income in 2023 to be significantly higher than net income in 2022.
Our board of directors seeks to reward our members with a sufficient, risk-adjusted return on their investment, particularly those who actively utilize our products and services. On February 23, 2023, our board of directors declared a cash dividend on Class B-2 activity-based stock at an annualized rate of 6.0% and on Class B-1 non-activity-based stock at an annualized rate of 2.0%, resulting in a spread between the rates of 4.0 percentage points. The overall weighted-average annualized rate paid was 4.84%. While the overall dividend rate in 2023 will depend on many factors, we expect the board to continue to declare a competitive dividend and maintain a meaningful spread between the rates on activity-based stock and non-activity-based stock.
The
ultimate effects of economic and financial markets activity, including fiscal and monetary policies, the conditions in the housing markets and the level and volatility of market interest rates, as well as legislative and regulatory actions, continue to evolve and are highly uncertain and, therefore, the future impact on our business is difficult to predict.
Interest Income. Interest income on advances, mortgage loans held for portfolio, and investment securities is our primary source of revenue. Interest income for the year ended December 31, 2022 totaled $1.4 billion,
an increase of $921 million compared to the prior year, primarily driven by an increase in yields resulting from the increase in market interest rates.
Interest Expense. Interest expense on consolidated obligations is our primary expense. Interest expense for the year ended December 31, 2022 totaled $1.1 billion, an increase of $882 million compared to the prior year, primarily driven by an increase in our cost of funds resulting from the increase in market interest rates.
Net Interest Income.As a result, net interest income is our primary source of earnings. The increase in net interest income for the year ended December 31, 2022
compared to the prior year was primarily due to higher earnings on the portion of the Bank's assets funded by its capital, and lower accelerated amortization of mortgage purchase premiums resulting from lower prepayments on mortgage loans, each driven by the increase in market interest rates.
For the hedging relationships that qualified for hedge accounting, the differences between those changes in fair value (i.e. hedge ineffectiveness) are recorded in net interest income and resulted in net hedging gains of $3 million for the year ended December 31, 2022, compared to net hedging gains of $8 million for the year ended December 31, 2021.
Our net gains (losses) on derivatives fluctuate due tovolatility
in the overall interest-rate environment as we hedge our asset or liability risk exposures. In general, we hold derivatives and associated hedged items to the maturity, call, or put date. Therefore, due to timing, nearly all of the cumulative net gains and losses for these financial instruments will generally reverse over the remaining contractual terms of the hedged item. However, there may be instances when we terminate these instruments prior to the maturity, call or put date, which may result in a realized gain or loss. For more information, see Notes to Financial Statements - Note 8 - Derivatives and Hedging Activities.
The
following table presents average daily balances, interest income/expense, and average yields/cost of funds of our major categories of interest-earning assets and their funding sources ($ amounts in millions).
Net
spread on interest-earning assets less interest-bearing liabilities
0.32
%
0.38
%
0.32
%
Net
interest margin (7)
0.45
%
0.40
%
0.38
%
Average
interest-earning assets to interest-bearing liabilities
1.08
1.06
1.07
(1) Includes hedging gains (losses) on qualifying fair-value hedging relationships. Excludes impact of purchase discount (premium) recorded through mark-to-market gains (losses)
on trading securities and net interest settlements on derivatives hedging trading securities.
(2) The average balances of AFS securities are based on amortized cost; therefore, the resulting yields do not reflect changes in the estimated fair value that are a component of OCI.
(3) Except for AFS securities, interest income/expense and average yield/cost of funds include all components of interest, including the impact of net interest payments or receipts on derivatives in qualifying hedge relationships, amortization of hedge accounting basis adjustments, and prepayment fees on advances. Excludes net interest payments or receipts on derivatives in economic hedging relationships, including those hedging trading securities.
(5) Consists of interest-bearing deposits and loans to other FHLBanks (if applicable). Includes the rights or obligations to cash collateral, except for variation margin payments characterized as daily settled contracts.
(6) Includes cumulative changes in the estimated fair value of AFS securities and grantor trust assets.
(7) Net interest income expressed
as a percentage of the average balance of interest-earning assets.
Changes in both volume and interest rates determine changes in net interest income and net interest margin. Changes in interest income and interest expense that are not identifiable as either volume-related or rate-related, but are attributable to both volume and rate changes, have been allocated to the volume and rate categories based upon the proportion of the volume and rate changes. The following table presents the changes in interest income and interest expense by volume and rate ($ amounts in millions).
Average Balances. The average balances outstanding of interest-earning assets for the year ended December 31, 2022 increased by 2% compared to the prior year. The average balances of advances outstanding increased by 5%, reflecting higher member utilization of advances. However, the average balances of MBS outstanding decreased by 8%, reflecting the reduced capacity
to purchase MBS during part of 2022 due to the negative impact of a capital stock repurchase on total regulatory capital. Such decrease in this higher-yielding asset resulted in an overall decrease in interest income due to changes in volume. The average balances outstanding of interest-bearing liabilities for the year ended December 31, 2022 increased by 0.3% compared to the prior year. The average balances of discount notes outstanding increased by 29%, reflecting a change in mix of funding. The average balances of CO bonds decreased by 8%. Such decrease in this previously higher-costing liability resulted in an overall decrease in interest expense due to changes in volume. As a result, the average balances of total interest-earning assets, net of interest-bearing liabilities, increased by 28%. Such increase contributed to
the increase in interest income on the portion of the Bank's assets funded by its interest-free capital.
Yields/Cost of Funds. The average yield on total interest-earning assets for the year ended December 31, 2022, including the impact of net hedging gains/losses but excluding certain impacts of trading securities, was 2.15%, an increase of 141 bps compared to 2021, resulting primarily from increases in market interest rates that led to higher yields on all of our interest-earning assets. Such increase contributed to the increase in interest income on the portion of the Bank's assets funded by its interest-free capital. The average cost of funds of total interest-bearing liabilities for the year ended December 31, 2022, including the impact of net hedging gains/losses but excluding
certain impacts of funding trading securities, was 1.83%, an increase of 147 bps due to higher funding costs on all of our interest-bearing liabilities. The net effect was a decrease in the net interest spread of 6 bps to 0.32% for the year ended December 31, 2022 from 0.38% for the year ended December 31, 2021.
Other Income.The following table presents a comparison of the components
of other income ($ amounts in millions).
Years Ended December 31,
Components
2022
2021
Net unrealized gains (losses) on trading securities (1)
$
(1)
$
(15)
Net
realized gains (losses) on trading securities (2)
(22)
(33)
Net gains (losses) on trading securities
(23)
(48)
Net gains (losses) on derivatives hedging trading securities
19
15
Net
gains (losses) on other derivatives not designated as hedging instruments
(4)
(2)
Net interest settlements on economic derivatives (3)
33
(9)
Net gains (losses) on derivatives
48
4
Change
in fair value of investments indirectly funding the liabilities under the SERP
(8)
5
Other, net
2
5
Total other income (loss)
$
19
$
(34)
(1) Includes
impact of purchase discount (premium) recorded through mark-to-market gains (losses). Excludes impact of associated derivatives.
(2) Includes, at maturity, 100% of original discount (premium) as gain (loss). Excludes impact of associated derivatives.
(3) Generally offsetting interest income on trading securities or interest expense on the associated funding is included in net interest income.
The increase in total other income for the year ended December 31, 2022 compared to 2021 was due primarily to higher net interest settlements received on economic derivatives, particularly on swaps hedging trading securities, and lower net losses on trading securities, partially
offset by declines in the fair values of the investments indirectly funding the liabilities under the SERP. The assets are held in a grantor trust and consist of a diversified portfolio of mutual funds that are invested in equity securities, bonds and alternative investments which declined in value in 2022 as a result of changes in economic conditions and increases in market interest rates.
Net Gains (Losses) on Trading Securities. We purchase fixed-rate U.S. Treasury obligations to enhance our liquidity. The shorter-term securities are classified as trading securities and are recorded at fair value, with changes in fair value reported in other income. Such changes include the impact of purchase discount (premium) recorded through mark-to-market gains (losses) on these securities. There are a number of factors that affect the fair value of these securities, including changes in interest
rates, the passage of time, and volatility. These trading securities are economically hedged, so that over time the gains (losses) on these securities will be generally offset by the change in fair value of the associated derivatives, except for any purchase discount/premium.
Other Expenses. The following table presents a comparison of the components of other expenses ($ amounts in millions).
Years Ended December 31,
Components
2022
2021
Compensation
and benefits
$
59
$
61
Other operating expenses
31
30
Finance Agency and Office of Finance
12
12
Voluntary
contributions to AHP and related programs
6
—
Other
5
10
Total other expenses
$
113
$
113
The
slight increase in total other expenses for the year ended December 31, 2022 compared to 2021 was due primarily to voluntary contributions to our AHP and related programs, substantially offset by a decrease in other expenses due to accelerated amortization of net actuarial loss due to settlements in 2021 under our SERP.
EachFHLBank is assessed a portion of the operating costs of our regulator, the Finance Agency. The portion of the Finance Agency's expenses and working capital fund not allocated to Freddie Mac and Fannie Mae is allocated among the FHLBanks as assessments, which are based on the ratio of each FHLBank's minimum required regulatory capital to the aggregate minimum required regulatory capital of every FHLBank. For the years ended December 31, 2022
and 2021, our portion totaled $7 million and $6 million, respectively.
Our proportionate share of the Office of Finance's operating and capital expenditures is calculated based upon two components as follows: (i) two-thirds based on our share of total consolidated obligations outstanding and (ii) one-third based on equal pro-rata allocation. For the years ended December 31, 2022 and 2021, our assessments to fund the Office of Finance totaled $5 million and $6 million, respectively.
In 2022, other expenses include an additional 2.5% of net earnings accrued for
voluntary contributions to our AHP of $4 million and voluntary allocations to various affordable housing, small business and community investment programs totaling $2 million, both to be available in 2023. The combined required and voluntary contributions and allocations in 2022 totaled $26 million and further demonstrate our commitment to promoting affordable, sustainable and equitable housing in Michigan and Indiana.
AHP Assessments. The FHLBanks are required to set aside annually, in the aggregate, the greater of $100 million or 10% of their net earnings to fund the AHP. For purposes of the AHP calculation, net earnings is defined as income before assessments, plus interest expense related to MRCS, if applicable. For the years ended December 31,
2022 and 2021, our AHP assessment was $20 million and $11 million, respectively. Our AHP assessment fluctuates in accordance with our net earnings.
Our voluntary contributions to AHP and other related programs are reported in other expenses.
Total Other Comprehensive Income (Loss). Total OCI for the year ended December 31, 2022 consisted primarily of net unrealized losses on AFS securities, compared to net unrealized gains on AFS securities for 2021. These amounts were primarily impacted by changes in interest rates, credit spreads and volatility.
Our products and services are grouped within two operating segments:traditional and mortgage loans.
Traditional. The traditional segment consists of (i) credit products (including advances, standby letters of credit, and lines of credit), (ii) investments (including federal funds sold, securities purchased under agreements to resell, interest-bearing demand deposit accounts, and investment securities), and (iii) correspondent services and deposits. The following table presents the financial performance
of our traditional segment ($ amounts in millions).
Years Ended December 31,
Traditional
2022
2021
Net interest income
$
241
$
230
Provision
for (reversal of) credit losses
—
—
Other income (loss)
20
(33)
Other expenses
97
97
Income before assessments
164
100
AHP
assessments
17
10
Net income
$
147
$
90
The increase in net income for the traditional segment for the year ended December 31, 2022 compared
to the prior year was primarily due to higher earnings on the portion of Bank's assets funded by its capital, driven by the increase in market interest rates.
Mortgage Loans. The mortgage loans segment consists substantially of mortgage loans purchased from our members through our MPP. The following table presents the financial performance of our mortgage loans segment ($ amounts in millions).
Years Ended
December 31,
Mortgage Loans
2022
2021
Net interest income
$
50
$
22
Provision for (reversal of) credit losses
—
—
Other
income (loss)
(1)
(1)
Other expenses
16
16
Income before assessments
33
5
AHP assessments
3
1
Net
income
$
30
$
4
The increase in net income for the mortgage loans segment for the year ended December 31, 2022 compared to the prior year was substantially due to lower accelerated amortization of mortgage purchase premiums resulting from lower principal prepayments, driven by the increase in market interest rates.
(1) Includes accrued interest receivable, premises, software and equipment, derivative assets and other miscellaneous assets.
Total assets as of December 31, 2022 were $72.3 billion, an
increase of $12.3 billion, or 20%, compared to December 31, 2021, primarily driven by net increases in advances outstanding to members. The mix of our assets at December 31, 2022 changed compared to December 31, 2021 in that advances as a percent of total assets increased from 46% to 51%. In addition, substantially all of our purchases of U.S. Treasury obligations in 2022 were classified as AFS securities.
Advances. In general, advances fluctuate in accordance with our members' funding needs, primarily determined by their deposit levels, mortgage pipelines, loan growth, investment opportunities, available collateral, other balance sheet strategies, and the cost of alternative funding options.
Advances at December 31, 2022 at carrying value totaled $36.7 billion, a net increase of $9.2 billion, or 33%, compared to December 31, 2021. This increase reflects higher demand by our members for advances primarily in response to our depository members' loan growth outpacing their deposit growth, rising market interest rates, including the adverse impact on their investment portfolios, and the availability of suitable products to assist our members in managing their balance sheets in the current economic environment.
Our advances portfolio is well-diversified with advances to commercial banks and savings institutions, credit unions, and insurance companies. As a percent of total advances outstanding at par value, at December 31,
2022, advances to depository institutions were 64%, while advances to insurance companies were 36%.
(1) Captive insurance companies that were admitted as FHLBank members prior to September 12, 2014, and did not meet the definition of "insurance company" or fall within another category of institution that is eligible for FHLBank
membership under the Final Rule on FHLBank Membership, had their memberships terminated on February 19, 2021. The outstanding advances to one captive insurer are not required to be repaid prior to their various maturity dates through 2024.
Our advances portfolio includes fixed- and variable-rate advances, as well as callable or prepayable and putable advances. Prepayable advances may be prepaid on specified dates without incurring repayment or termination fees. All other advances may only be prepaid by the borrower paying a fee that is sufficient to make us financially indifferent to the prepayment.
The following table presents the par value of advances outstanding by product type and redemption term, some of which contain call or put options ($ amounts in millions).
(1) Includes amortizing/mortgage matched advances.
During the year ended December 31, 2022, the par value of advances due in one year or less increased by 85%, while advances
due after one year increased by 17%. As a result, advances due in one year or less, as a percentage of the total outstanding at par, totaled 39% at December 31, 2022, an increase from 29% at December 31, 2021. However, during the year ended December 31, 2022, in response to our exercise of an option on certain long-term putable advances, several members replaced that funding with short-term advances without put options. Based on the earlier of the redemption or the next put date, advances due in one year or less increased by 50%, while advances due after one year increased by 23%. As a result, advances due in one year or less on that basis, as a percentage of the total outstanding at par, totaled 54% and 49% at December 31, 2022 and 2021,
respectively. For additional information, see Notes to Financial Statements - Note 5 - Advances.
The shift from LIBOR-indexed advances to SOFR-indexed advances is due to our continued steps to transition our LIBOR-linked financial instruments and contracts to SOFR. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Replacement of the LIBOR Benchmark Interest Rate.
Mortgage Loans Held for Portfolio.We
purchase fixed-rate mortgage loans from our members to support our housing mission, provide an additional source of liquidity to our members, diversify our assets, and generate additional earnings. In general, our volume of mortgage loans purchased is affected by several factors, including interest rates, competition, the general level of housing and refinancing activity in the United States, consumer product preferences, our balance sheet capacity and risk appetite, and regulatory considerations.
Mortgage loans held for portfolio at December 31, 2022, at carrying value, totaled $7.7 billion, a net increase of $71 million, or 1%, from December 31, 2021, as the Bank's purchases from its members slightly exceeded principal repayments
by borrowers.
The following table summarizes the activity in the UPB of mortgage loans held for portfolio ($ amounts in millions).
Mortgage Loans Activity
2022
2021
2020
Balance,
beginning of year
$
7,434
$
8,323
$
10,585
Purchases
1,146
2,082
2,022
Principal repayments
(1,047)
(2,971)
(4,284)
Balance,
end of year
$
7,533
$
7,434
$
8,323
A breakdown of the UPB of mortgage loans held for portfolio by primary product type is presented below ($ amounts in millions).
We
maintain an allowance for credit losses based on our best estimate of expected losses over the remaining life of each loan. The following table presents the components of the allowance for credit losses, including the credit enhancement waterfall for MPP ($ amounts in millions).
MPP expected losses remaining after borrower's equity, before credit enhancements
$
4.7
$
2.4
Portion of expected losses recoverable from credit enhancements:
PMI
(1.4)
(0.5)
LRA
(1)
(3.0)
(1.3)
SMI
(0.2)
(0.4)
Total portion recoverable from credit enhancements
(4.6)
(2.2)
Allowance for unrecoverable PMI/SMI
—
—
Allowance
for MPP credit losses
0.1
0.2
Allowance for Mortgage Partnership Finance® Program credit losses
0.1
0.1
Allowance for credit losses
$
0.2
$
0.3
(1) Amounts
recoverable are limited to (i) the expected losses remaining after borrower's equity and PMI and (ii) the remaining balance in each pool's portion of the LRA. The remainder of the total LRA balance is available to cover any losses not yet expected and to distribute any excess funds to the PFIs.
Our MPP was designed to require loan servicers to foreclose loans and liquidate properties in the servicer's name rather than in the Bank's name. Therefore, we do not take title to any foreclosed property or enter into any other legal agreement under which the borrower conveys all interest in the property to the Bank to satisfy the loan. Upon completion of a triggering event (short sale, deed in lieu of foreclosure, foreclosure sale or post-sale confirmation or ratification, as applicable), the servicer is required to remit to us the full UPB and
accrued interest at the next feasible remittance. Upon receipt of the full UPB and accrued interest, the mortgage loan is derecognized from the statement of condition. As a result of these factors, we do not classify as Real Estate Owned any foreclosed properties collateralizing MPP loans that were previously recorded on the statement of condition.
As the servicer progresses through the process from foreclosure to liquidation, the Bank is paid in full and the servicer files a claim against the various credit enhancements for reimbursement of losses incurred. The claim is then reviewed and paid as appropriate under the various credit enhancement policies or guidelines. At December 31, 2022, principal previously paid in full by our MPP servicers totaling $0.4 million remains subject to potential claims by those
servicers for any losses resulting from past or future liquidations of the underlying properties. An estimate of the losses is included in the MPP allowance for credit losses.
In the case of a delay in receiving final payoff from the servicer beyond the second remittance cycle after a triggering event, we reclassify the amount owed from mortgage loans to a separate amount receivable from the servicer. The receivable is then evaluated for the amount expected to be recovered.
Liquidity and Other Investment Securities.
We maintain our investment portfolio for liquidity purposes, to use balance sheet capacity and to supplement our earnings. The earnings on our investments bolster our capacity to meet our commitments to affordable housing and community investments and to cover operating expenses. The following table presents a comparison of the components of our liquidity investments and other investment securities at carrying value ($ amounts in millions).
Cash and Short-Term Investments.Cash andshort-term investments at December 31,
2022 totaled $8.6 billion, an increase of $1.5 billion, or 22%, from December 31, 2021 to support the increase in advances. Cash and short-term investments as a percent of total assets at December 31, 2022 and December 31, 2021 each totaled 12%.
Trading Securities. The Bank has purchased fixed-rate U.S. Treasury obligations as trading securities to enhance its liquidity. Such securities outstanding at December 31, 2022 totaled $2.2 billion, a decrease of $1.7 billion, or 43%, from December 31, 2021, as substantially all of the Bank's purchases of U.S. Treasury obligations in 2022
were classified as AFS.
Liquidity investments at December 31, 2022 totaled $10.8 billion, a decrease of $190 million, or 2%, from December 31, 2021. The total outstanding balance and composition of our liquidity investments are influenced by our liquidity needs, regulatory requirements, actual and anticipated member advance activity, market conditions, and the availability of short-term investments at attractive interest rates, relative to our cost of funds.
Other Investment Securities.AFS securities at December 31, 2022 totaled $12.2 billion, a net increase of $3.0 billion, or 33%, from December 31, 2021. The increase resulted primarily from purchases of U.S. Treasury obligations classified as AFS.
Net unrealized losses on AFS securities at December 31, 2022 totaled $(10) million, a net decrease of $162 million compared to December 31, 2021, primarily due to changes in interest rates, credit spreads and volatility.
HTM
securities at December 31, 2022 totaled $4.2 billion, a net decrease of $74 million, or 2%, from December 31, 2021. The decrease was due to repayments of HTM securities exceeding purchases.
Interest-Rate Payment Terms. Our investment securities are presented below by interest-rate payment terms ($ amounts in millions).
(1) Carrying value is equal to estimated fair value.
The mix of fixed- vs. variable-rate AFS and HTM securities at December 31, 2022 changed slightly from December 31,
2021, primarily due to purchases of fixed-rate U.S. Treasury obligations. However, all of the fixed-rate AFS securities are swapped to effectively create variable-rate securities, consistent with our balance sheet strategies to manage interest-rate risk.
Investments by Year of Contractual Maturity.The following table provides, by year of contractual maturity, carrying values and yields for AFS and HTM securities as of December 31, 2022 ($ amounts in millions).
Due
after
Due after
Due in
one year
five years
Due after
one year
through
through
ten
Investments
or
less
five years
ten years
years
Total
AFS Securities:
U.S. Treasury obligations
$
—
$
—
$
4,210
$
—
$
4,210
GSE
and TVA debentures
131
1,595
177
—
1,903
GSE MBS (1)
19
2,245
3,476
327
6,067
Total
AFS securities
150
3,840
7,863
327
12,180
HTM Securities:
Other
U.S. obligations - guaranteed MBS (1)
—
—
—
2,992
2,992
GSE MBS(1)
—
2
261
985
1,248
Total
HTM securities
—
2
261
3,977
4,240
Total AFS and
HTM securities, carrying value
$
150
$
3,842
$
8,124
$
4,304
$
16,420
Yield
on AFS securities (2)
2.03
%
2.60
%
2.77
%
2.87
%
Yield on HTM securities (2)
—
%
4.59
%
3.41
%
2.98
%
(1) Year
of redemption on our MBS is based on contractual maturity. Their actual maturities will likely differ from contractual maturities as borrowers have the right to prepay their obligations with or without prepayment fees.
(2) The weighted average yields on AFS and HTM securities are calculated as the sum of each debt security using the period end balances multiplied by the coupon rate adjusted by the impact of amortization and accretion of premiums and discounts, divided by the total debt securities in the applicable AFS or HTM portfolio. The result is then multiplied by 100 to express it as a percentage.
At December 31, 2022, based on contractual maturities, as a percentage of total carrying value, AFS and HTM securities due in one year or less were 1%, due after one
year through five years were 23%, due after 5 years through 10 years were 50%, and due after 10 years were 26%.
The following table presents our variable-rate MBS outstanding by the associated interest-rate index ($ amounts in millions).
The
shift from LIBOR-indexed MBS to SOFR-indexed MBS is due to our continued steps to transition our LIBOR-linked financial instruments and contracts to SOFR. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Replacement of the LIBOR Benchmark Interest Rate.
Under the Finance Agency's Prudential Management and Operations Standards, if our non-advance assets were to grow by more than 30% over the six calendar quarters preceding a Finance Agency determination that we have failed to meet any of these standards, the Finance Agency would be required to impose one or more sanctions on us, which could include, among others, a limit on asset growth, an increase in the level of retained earnings, and a prohibition on dividends or the redemption or repurchase
of capital stock. Through the six-quarter period ended December 31, 2022, our growth in non-advance assets did not exceed 30%.
Total Liabilities. Total liabilities at December 31, 2022 were $68.9 billion, a net increase of $12.5 billion, or 22%, from December 31, 2021, substantially due to an increase in consolidated obligations.
Deposits
(Liabilities).Total deposits at December 31, 2022 were $596 million, a net decrease of $770 million, or 56%, from December 31, 2021. These deposits provide a relatively small portion of our funding. The balances of these accounts can fluctuate from period to period and vary depending upon such factors as the attractiveness of our deposit pricing relative to the rates available on alternative money market instruments, members' preferences with respect to the maturity of their investments, and members' liquidity.
At December 31, 2022, we had uninsured deposits totaling $24 million. The maturities of these deposits are $12 million in three months
or less, $3 million in three months to six months and $9 million in six through 12 months. We had no uninsured deposits outstanding at December 31, 2021. For details on the average balances and average rates paid, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations and Changes in Financial Condition - Analysis of Results of Operations for the Years Ended December 31, 2022 and 2021.
Consolidated Obligations.The overall balance of our consolidated obligations fluctuates in relation to our total assets and the availability of alternative sources of funds. The carrying value
of consolidated obligations outstanding at December 31, 2022 totaled $67.3 billion, a net increase of $12.8 billion, or 23%, from December 31, 2021, which reflected increased funding needs associated with the net increase in the Bank's total assets.
The composition of our consolidated obligations can fluctuate significantly based on comparative changes in their cost levels, supply and demand conditions, demand for various types and maturities of advances, and our overall balance sheet management strategy. Discount notes are issued to provide short-term funds, while CO bonds are generally issued to provide a longer-term mix of funding. Some CO bonds are issued with terms which permit us to repay them when more favorable funding opportunities emerge. We apply a
variety of strategies to effectively manage the balance and structure of our consolidated obligations as market conditions and our asset levels change.
The following table presents a breakdown by term of our consolidated obligations outstanding ($ amounts in millions).
The mix of our funding has changed from December 31, 2021 as discount notes outstanding increased and CO bonds outstanding decreased, primarily due to the increase in short-term advances. We continue
to seek to maintain a sufficient liquidity and funding balance between our financial assets and financial liabilities.
Additionally, in light of each FHLBank's large reliance on short-term funding, the FHLBanks work collectively to manage FHLB System-wide liquidity and funding and jointly monitor System-wide refinancing risk, i.e. the potential difficulty or inability to roll over short-term consolidated obligations when market conditions change. In managing and monitoring the amounts of assets that require refunding, the FHLBanks may consider contractual maturities of the financial assets, as well as certain assumptions regarding expected cash flows (i.e., estimated prepayments and scheduled amortizations).
All of our variable-rate CO bonds outstanding at December 31, 2022 and 2021
were indexed to SOFR.
Derivatives.We classify interest-rate swaps as derivative assets or liabilities according to the net estimated fair value of the interest-rate swaps with each counterparty. Asof December 31, 2022 and 2021, we had derivative assets, net of collateral held or posted, including accrued interest, with estimated fair values of $434 million and $220 million, respectively, and derivative liabilities, net of collateral held or posted, including accrued interest, with estimated fair values of $19 million and $12 million, respectively. The estimated fair values are based on a wide range of factors, including current
and projected levels of interest rates, credit spreads and volatility. Increases and decreases in the fair value of derivatives are primarily caused by changes in the derivatives' respective underlying interest-rate indices.
The volume of derivative hedges is often expressed in terms of notional amounts, which is the amount upon which interest payments are calculated. The following table presents the notional amounts by type of hedged item regardless of whether it is in a qualifying hedge relationship ($ amounts in millions).
The increase in the total notional amount during the year-ended December 31, 2022 of $17.2 billion, or 31%, was substantially due to an increase in derivatives hedging CO bonds, driven primarily by an increase in long-term callable CO bonds, and an increase in fixed-rate AFS securities, driven primarily by the purchases of U.S. Treasury obligations.
The following table presents the notional amounts of derivatives (cleared and uncleared) indexed to a variable
interest rate ($ amounts in millions).
The shift from LIBOR-indexed derivatives to SOFR-indexed derivatives is due to our continued steps to transition our LIBOR-linked financial instruments and contracts to SOFR. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Replacement of the LIBOR Benchmark Interest Rate.
The following table presents the cumulative impact of fair-value hedging basis
adjustments on our statement of condition ($ amounts in millions).
Cumulative fair-value hedging basis adjustments on hedged items
$
(616)
$
(1,100)
$
2,148
$
432
Estimated fair value of associated
derivatives, net
618
1,361
(2,160)
(181)
Net cumulative fair-value hedging basis adjustments
$
2
$
261
$
(12)
$
251
The
cumulative gains on AFS securities resulted from our strategy of terminating certain interest-rate swaps associated with the MBS DUS and entering into short-cut hedging relationships with new interest-rate swaps in connection with our LIBOR transition.
Total Capital. Total capital at December 31, 2022 was $3.4 billion, a net decrease of $172 million, or 5%, from December 31, 2021. The net decrease primarily resulted from a transfer of capital stock to MRCS upon a member's merger into a non-member, repurchases of capital stock, and unrealized losses on investments in MBS driven by the increase in market interest rates, partially offset by capital stock issuances to support the increase in advances and a net increase in retained earnings.
The changes in the components of GAAP capital at December 31, 2022 compared to December 31, 2021 were primarily due to net unrealized losses on AFS securities during 2022.
The following table presents a reconciliation of GAAP capital to regulatory capital ($ amounts in millions).
We endeavor to manage our liquidity in order to be able at all times to satisfy our members'
needs for short- and long-term funds, repay maturing consolidated obligations, redeem or repurchase excess stock and meet other financial obligations. We are required to maintain liquidity in accordance with the Bank Act, certain Finance Agency regulations and related policies established by our management and board of directors.
Our primary sources of liquidity are holdings of liquid assets, comprised of cash, short-term investments, and trading securities, as well as the issuance of consolidated obligations.
Historically, our status as a GSE and favorable credit ratings have provided us with excellent access to capital markets. Our ability to obtain funds through the issuance of consolidated obligations at acceptable interest costs depends on prevailing conditions in the capital markets, particularly the short-term capital markets, and the capital
markets' perception of the riskiness of those obligations. Our consolidated obligations are not obligations of, and they are not guaranteed by, the United States government, although they have historically received the same credit rating as the United States government bond credit rating. The rating has not been affected by rating actions taken with respect to individual FHLBanks. During the year ended December 31, 2022, we maintained sufficient access to funding; our net proceeds from the issuance of consolidated obligations totaled $853.6 billion.
In addition, by statute, the United States Secretary of the Treasury may acquire our consolidated obligations up to an aggregate principal amount outstanding of $4.0 billion. This statutory authority may be exercised only if alternative means cannot be effectively
employed to permit us to continue to supply reasonable amounts of funds to the mortgage market, and the ability to supply such funds is substantially impaired because of monetary stringency and a high level of interest rates. Any funds borrowed would be repaid at the earliest practicable date. As of this date, this authority has never been exercised.
However, to protect us against temporary disruptions in access to the debt markets, the Finance Agency currently requires us to: (i) maintain contingent liquidity sufficient to cover, at a minimum, 20 calendar days of inability to issue consolidated obligations; (ii) have available at all times an amount greater than or equal to our members' current deposits invested in specific assets; (iii) maintain, in the aggregate, unpledged qualifying assets in an amount at least equal to our participation in total consolidated obligations outstanding; and (iv) maintain,
through short-term investments, an amount at least equal to our anticipated cash outflows under hypothetical adverse scenarios. We anticipate our liquidity will continue to meet or exceed the Finance Agency's standards going forward.
The Finance Agency also provides guidance related to asset/liability maturity funding gap limits. Funding gap metrics measure the difference between assets and liabilities that are scheduled to mature during a specified period of time and are expressed as a percentage of total assets. As of December 31, 2022, we were operating within those limits.
To support member deposits, the Bank Act requires us to have at all times a liquidity deposit reserve in an amount equal to the current deposits received from our members invested in (i) obligations of the United States, (ii) deposits in eligible banks or trust companies, or (iii) advances with a maturity not exceeding five years. The following table presents our excess liquidity deposit reserves ($ amounts in millions).
The
increase in liquidity deposit reserves is primarily due to an increase in advances maturing in five years or less as well as purchases of U.S. Treasury obligations.
We must maintain assets that are free from any lien or pledge in an amount at least equal to the amount of our consolidated obligations outstanding from among the following types of qualifying assets:
•cash;
•obligations of, or fully guaranteed by, the United States;
•advances;
•mortgages that have any guaranty, insurance, or commitment from the United States or any agency of the United States; and
•investments
described in Section 16(a) of the Bank Act, which include, among others, securities that a fiduciary or trustee may purchase under the laws of the state in which the FHLBank is located.
The following table presents the aggregate amount of our qualifying assets to the total amount of our consolidated obligations outstanding ($ amounts in millions).
Aggregate qualifying assets in excess of consolidated obligations
$
4,477
$
5,184
Ratio
of aggregate qualifying assets to consolidated obligations
1.07
1.10
We also maintain a contingency liquidity plan designed to enable us to meet our obligations and the liquidity needs of our members in the event of short-term capital market disruptions, or operational disruptions at our Bank and/or the Office of Finance.
New or revised regulatory guidance from the Finance Agency could continue to increase the amount and change the characteristics of liquidity that we are required to maintain. We have not identified any other trends, demands, commitments, or events that are likely to materially increase or decrease our liquidity.
Changes
in Cash Flow.The cash flows fromour assets and liabilities support our mission to provide our members with competitively priced funding, a reasonable return on their investment in our capital stock, and support for community investment activities. The balances of our assets and liabilities can vary significantly in the normal course of business due to the amount and timing of cash flows, which are affected by member-driven activities and market conditions. Net cash provided by operating activities for the year ended December 31, 2022 was $1.5 billion, compared to net cash provided by operating activities for the year ended December 31, 2021 of $444 million. The net increase in cash provided of $1.0 billion was substantially due to the fluctuation in variation
margin payments on cleared derivatives. Such payments are treated by the Clearinghouses as daily settled contracts.
Our financial strategies are generally designed to enable us to safely expand and contract our assets, liabilities,
and capital in response to changes in our member base and in our members' credit needs. Our capital generally grows when members are required to purchase additional capital stock as they increase their advances borrowings or other business activities with us and from the consistent accumulation of retained earnings. We may also repurchase excess capital stock from our members as business activities with them decline. In addition, in order to meet internally established thresholds or to meet our regulatory capital requirement, we, at the discretion of our board of directors, could undertake capital preservation initiatives such as: (i) voluntarily reducing or eliminating dividend payments; (ii) suspending excess capital stock repurchases; or (iii) raising capital stock holding requirements for our members.
Total Regulatory Capital Stock. The following table provides a breakdown of our
outstanding capital stock and MRCS by type of member ($ amounts in millions).
(1) Represents
a captive insurance company whose membership was terminated on February 19, 2021. On that date, we repurchased its excess stock of $18 million. The remaining balance will not be redeemed until the associated credit products and other obligations are no longer outstanding.
(2) Decrease in capital stock and increase in MRCS due to transfer of the capital stock of Flagstar Bank, FSB resulting from the merger of its parent company into a non-member institution.
Excess
Capital Stock. Capital stock that is not required as a condition of membership or to support outstanding obligations of members or former members to us is considered excess capital stock under our capital plan. In general, the level of excess capital stock fluctuates with our members' level of credit products and, to the extent members have opted-in to AMA activity-based stock requirements, principal amounts of MDCs.
The following table presents the composition of our regulatory capital stock ($ amounts in millions).
Member capital stock not subject to outstanding redemption requests
445
798
Member
capital stock subject to outstanding redemption requests
—
14
MRCS
148
28
Total excess capital stock
593
840
Total
regulatory capital stock
$
2,496
$
2,296
Excess stock as a percentage of regulatory capital stock
24
%
37
%
The increase in required capital
stock at December 31, 2022 was due to the increase in advances outstanding. The decrease in total excess stock during the year ended December 31, 2022 resulted primarily from repurchases totaling $167 million to comply with our capital plan as a result of our regulatory capital ratio exceeding 6.0% at January 31, 2022.
Under our capital plan, the Bank is required to repurchase excess stock if its regulatory capital ratio as of the last day of any month exceeds a specific ratio established by the board of directors from time to time, currently 5.75%, by at least 25 bps. As a result, the current threshold for repurchase is a regulatory capital ratio of 6.0%. Our regulatory capital ratio at December 31, 2022 was
i5.23%. Excess stock must be repurchased under these circumstances only to the extent required to reduce the Bank's regulatory capital ratio to such specified ratio. Otherwise, we are not required to redeem excess stock from a member until five years (or, in the case of Class A stock, six months) after the earliest of (i) termination of the membership, (ii) our receipt of notice of voluntary withdrawal from membership, or (iii) the member's request for redemption of its excess stock. At our discretion, we may also voluntarily repurchase, and have repurchased from
time to time, excess stock upon approval of our board of directors and with 15 days' notice to the member in accordance with our capital plan.
Statutory and Regulatory Restrictions on Capital Stock Redemption. In accordance with the Bank Act, each class of FHLBank stock is considered putable by the member. However, there are significant statutory and regulatory restrictions on our obligation to redeem, or right to repurchase, the outstanding stock, including the following:
•We may not redeem or repurchase any capital stock if, following such action, we would fail to satisfy any of our minimum capital requirements. By law, no capital stock may be redeemed or repurchased at any time at which we are undercapitalized.
•We
may not redeem or repurchase 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 while such charges are continuing or expected to continue.
Additionally, we may not redeem or repurchase shares of capital stock from any member if (i) the principal or interest due on any consolidated obligation has not been paid in full when due; (ii) we fail to certify in writing to the Finance Agency that we will remain in compliance with our liquidity requirements and will remain capable of making full and timely payment of all of our current obligations; (iii) we notify the Finance Agency that we cannot provide the foregoing certification, project that we will fail to comply with statutory or regulatory liquidity requirements or will be
unable to timely and fully meet all of our obligations; (iv) we actually fail to comply with statutory or regulatory liquidity requirements or to timely and fully meet all of our current obligations; or (v) we enter or negotiate to enter into an agreement with one or more FHLBanks to obtain financial assistance to meet our current obligations.
If, during the period between receipt of a stock redemption notification from a member and the actual redemption (which may last indefinitely if any of the restrictions on capital stock redemption discussed above have occurred), the Bank is liquidated, merged involuntarily,
or merged upon our board of directors' approval or consent with one or more other FHLBanks, the consideration for the stock or the redemption value of the stock will be established after the settlement of all senior claims. Generally, no claims would be subordinated to the rights of our shareholders.
Our capital plan permits us, at our discretion, to retain the proceeds of redeemed or repurchased stock if we determine that there is an existing or anticipated collateral deficiency related to any obligations of the member to us until the member delivers other collateral to us, such obligations have been satisfied or the anticipated collateral deficiency is otherwise resolved to our satisfaction.
If the Bank were to be liquidated, after payment in full to our creditors, our shareholders would be entitled to receive the par value of their capital stock
as well as retained earnings, if any, in an amount proportional to the shareholder's allocation of total shares of Class B stock at the time of liquidation. In the event of a merger or consolidation, our board of directors must determine the rights and preferences of our shareholders, subject to any terms and conditions imposed by the Finance Agency.
Capital Distributions. Our board of directors seeks to reward our members with a sufficient, risk-adjusted return on their investment, particularly those who actively utilize our products and services. Our board of directors' decision to declare dividends is influenced by our financial condition, adequacy of retained earnings and overall financial performance, as well as actual and anticipated developments in the overall economic and financial environment, including the level of interest rates and conditions in the mortgage and credit markets.
In addition, our board of directors considers several other factors, including our risk profile, regulatory requirements, our relationship with our members and the stability of our current capital stock position and membership.
The following table summarizes our weighted-average dividend rate and dividend payout ratio.
(1) Dividends paid in cash during the year divided by the average amount of Class B stock eligible for dividends under our capital plan, including MRCS.
(2) Dividends paid in cash during the year divided by net income for the year.
On February 23,
2023, our board of directors declared a cash dividend on Class B-2 activity-based stock at an annualized rate of 6.0% and on Class B-1 non-activity-based stock at an annualized rate of 2.0%, resulting in a spread between the rates of 4.0 percentage points. The overall weighted-average annualized rate paid was 4.84%. The dividends were paid in cash on February 24, 2023. For more information on our capital plan and dividend payments, see Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Retained Earnings. The overall adequacy of the Bank's level of retained earnings is evaluated in the context of our overall capitalization. However, we seek to maintain a level of retained earnings that exceeds our estimate of the Bank's
economic risk that incorporates specified market, credit, operations, and accounting risk estimates. We also seek to maintain competitive dividends on our capital stock, consistent with the mission objective of providing a sufficient return to our members that reflects the Bank's risk profile and makes stock ownership a desirable investment alternative.
Restricted Retained Earnings. In accordance with the Joint Capital Enhancement Agreement, we allocate i20%
of our net income each quarter to a restricted retained earnings account until the balance of that account equals at least i1% of the average balance of outstanding consolidated obligations for the previous quarter. These restricted retained earnings will not be available from which to pay dividends except to the extent the restricted retained earnings balance exceeds 1.5% of our average balance of
outstanding consolidated obligations for the previous quarter. We do not expect either level to be reached for several years.
Adequacy of Capital.In addition to possessing the authority to prohibit stock redemptions, our board of directors has the right to require our members to make additional capital stock purchases as needed to satisfy statutory and regulatory capital requirements.
Our board of directors has a statutory obligation to review and adjust member capital stock requirements in order to
comply with our minimum capital requirements, and each member must comply promptly with any such requirement. However, a member could reduce its outstanding business with us as an alternative to purchasing stock.
We are required to maintain a ratio of total regulatory capital stock to total assets, measured on a daily average basis at month end, of at least two percent.
Our board of directors assesses the adequacy of our capital every quarter, prior to the declaration of our quarterly dividend, by reviewing various measures set forth in our Capital Markets Policy. We developed our Capital Markets Policy based on guidance from the Finance Agency.
We must maintain sufficient permanent capital to meet the combined credit risk, market risk and operational risk components of the risk-based
capital requirement.
•Permanent capital is defined as the amount of our Class B stock (including MRCS) plus our retained earnings. We are required to maintain permanent capital at all times in an amount equal to our risk-based capital requirement, which includes the following components:
◦Credit risk, which represents the sum of our credit risk charges for all assets, off-balance sheet items and derivative contracts, calculated using the methodologies and risk weights assigned to each classification in the regulations;
◦Market risk, which
represents the sum of the market value of our portfolio at risk from movements in interest rates, foreign exchange rates, commodity prices, and equity prices that could occur during periods of market stress, and the amount by which the market value of total capital is less than 85% of the book value of total capital; and
◦Operational risk, which represents 30% of the sum of our credit risk and market risk capital requirements.
The following table presents our risk-based capital requirement in relation to our permanent capital at December 31, 2022 and 2021 ($ amounts in millions).
Permanent capital as a percentage of required risk-based capital
773
%
318
%
The decrease in our total risk-based capital
requirement was primarily caused by a decrease in the market risk component due primarily to model updates incorporating LIBOR's cessation, changes in the market environment, including changes in interest rates, CO bond-swap basis, volatility, and option-adjusted spreads, and balance sheet composition. The operational risk component is calculated as 30% of the credit and market risk components. Our permanent capital at December 31, 2022 remained well in excess of our total risk-based capital requirement.
By regulation, the Finance Agency may mandate us to maintain a greater amount of permanent capital than is generally required by the risk-based capital requirements as defined, in order to promote safe and sound operations. In addition, a Finance Agency rule authorizes the Director to issue an order temporarily increasing the minimum capital level for an FHLBank
if the Director determines that the current level is insufficient to address such FHLBank's risks. The rule sets forth several factors that the Director may consider in making this determination.
The Finance Agency has established four capital classifications for the FHLBanks - adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The Finance Agency determines our capital classification on at least a quarterly basis. If we are determined to be other than adequately capitalized, we would become subject to additional supervisory authority by the Finance Agency. Before implementing a reclassification, the Finance Agency Director would be required to provide us with written notice of the proposed action and an opportunity to respond. The Finance Agency's most recent determination is that we hold sufficient capital to be adequately capitalized and meet both
our minimum capital and risk-based capital requirements. For more information, see Notes to Financial Statements - Note 12 - Capital.
For details of our off-balance-sheet commitments, see Notes to Financial Statements - Note 17 - Commitments and Contingencies.
Critical Accounting Estimates
The preparation of financial statements
in accordance with GAAP requires management to make a number of judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities (if applicable), and the reported amounts of income and expenses. We review these estimates and assumptions based on historical experience, changes in business conditions and other relevant factors that we believe to be reasonable under the circumstances. Changes in estimates and assumptions have the potential to significantly affect our financial position and results of operations and, in any given reporting period, our actual results may differ from the estimates and assumptions used in preparing our financial statements.
We consider two of our accounting estimates to be critical because they require management to make particularly difficult, subjective, and/or complex judgments about matters that
are inherently uncertain resulting in an increased likelihood that materially different amounts could be reported under different conditions or when using different assumptions. These accounting estimates pertain to:
•Derivatives and hedging activities (for more information, see Notes to Financial Statements - Note 8 - Derivatives and Hedging Activities); and
•Fair value estimates (for more information, see Notes to Financial Statements - Note 16 - Estimated Fair Values).
Accounting for Derivatives and Hedging Activities. All derivatives are recorded on the statement of condition at their estimated fair values.
Changes in the estimated fair value of derivatives are recorded in current period earnings. Therefore, even though derivatives are used to mitigate market risk, derivatives introduce the potential for earnings volatility. Specifically, a mismatch can exist between the timing of income and expense recognition from assets or liabilities and the income effects of derivative instruments positioned to mitigate the market risk associated with those assets or liabilities. Therefore, during periods of significant changes in interest rates and other market factors, our earnings may experience greater volatility.
Generally, we endeavor to use derivatives that qualify for fair-value hedge accounting. To qualify, a hedging instrument must be expected to be "highly effective" in offsetting changes in the fair value of the associated hedged item attributable to the hedged risk. A fair-value
hedge relationship is considered highly effective only if certain specified criteria are met. In addition, at inception of a fair-value hedge relationship, we must formally document our risk management objective and strategy for undertaking the hedge, including the identification of the hedging instrument, hedged item, nature of the risk being hedged, and the method being used to measure hedge ineffectiveness. In all cases involving a fair-value hedge of a recognized asset, liability or firm commitment, the designated risk being hedged is the risk of changes in the fair value of the hedged item attributable to changes in the designated benchmark interest rate.
For hedging relationships that qualify for hedge accounting and are designated as fair-value hedges, the change in the fair value of the hedged item attributable to the hedged risk is recorded in current period earnings, thereby providing an offset
to the change in fair value of the derivative. Any difference in the change in fair value of the derivative and the change in the fair value of the hedged item attributable to the hedged risk represents "hedge ineffectiveness". If a fair-value hedging relationship qualifies for the shortcut method of hedge accounting, the change in the fair value of the derivative is considered perfectly effective in offsetting the change in the fair value of the hedged item attributable to the hedged risk and, as a result, no ineffectiveness is recorded in earnings. To qualify for shortcut accounting treatment, a number of strict conditions must be met.
When applying the shortcut method, we document at hedge inception a quantitative method to assess hedge effectiveness if we would later determine its application was not or is no longer appropriate. By documenting a quantitative method at inception, the risk associated
with inappropriately applying the shortcut method is reduced as the quantitative method can be applied, if certain qualifying criteria are met, without having to dedesignate the hedge relationship as of the date it was determined the hedge no longer qualified for the shortcut method.
Derivatives that are in fair-value hedging relationships but do not qualify for the shortcut method are accounted for using a long-haul method, either the total contractual coupon or benchmark component method. For more information on our long-haul methods and techniques, see Notes to Financial Statements - Note 1 - Summary of Significant Accounting Policies.
If a long-haul hedge relationship fails the effectiveness test at inception, we do not apply hedge accounting. If a long-haul hedge relationship fails the effectiveness test during the life of the relationship (assessed monthly), we discontinue hedge accounting prospectively.
Although substantially all of our derivatives qualify for fair-value hedge accounting, we treat all derivatives that do not qualify as economic hedges for asset/liability management purposes.
The fair values of our interest-rate related derivatives and hedged items are determined using standard valuation techniques such as discounted cash-flow analysis, which utilizes market estimates of interest rates and volatility, and comparisons to similar
instruments. As such, the use of these estimates can have a significant impact on current period earnings. Although changes in estimated fair value can cause earnings volatility during the periods the derivative instruments are held, for hedges that qualify for fair-value hedge accounting, such changes do not have any net long-term economic effect or result in any net cash flows if the derivative and the hedged item are held to maturity. Since these estimated fair values eventually return to zero (or par value) on the maturity date, the effect of such fluctuations throughout the life of the hedging relationship is usually only a timing issue.
As of December 31, 2022, the Bank’s derivatives portfolio included $50.0 billion (notional amount) that was accounted for using a long-haul method, substantially the total contractual coupon method, $16.1 billion (notional
amount) that was accounted for using the shortcut method, and $6.8 billion (notional amount) that did not qualify for hedge accounting. By comparison, at December 31, 2021, the Bank’s derivatives portfolio included $37.6 billion (notional amount) that was accounted for using the long-haul method, $8.8 billion (notional amount) that was accounted for using the shortcut method, and $9.2 billion (notional amount) that did not qualify for hedge accounting.
Fair Value Estimates. We report certain assets and liabilities on the statement of condition at estimated fair value, including investments classified as trading and AFS, grantor trust assets, and all derivatives. "Fair value" is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at
the measurement date. We are required to consider factors specific to the asset or liability, the principal or most advantageous market for the asset or liability, and the participants with whom we would transact in that market. In general, the transaction price will equal the exit price and, therefore, represents the fair value of the asset or liability at initial recognition.
Estimated fair values are based on quoted market prices or market-based prices, if such prices are available. If quoted market prices or market-based prices are not available, estimated fair values are determined based on valuation models that use either:
•discounted cash flows, using market estimates of interest rates and volatility; or
•dealer prices on similar
instruments.
For external valuation models, we review the vendors' valuation processes, methodologies, and control procedures for reasonableness. For internal valuation models, the underlying assumptions are based on management's best estimates for:
•discount rates;
•prepayments;
•market volatility; and
•other factors.
The assumptions used in both external and internal valuation models could have a significant effect on the reported fair values of assets and liabilities, including the related income and expense. The use of different assumptions,
as well as changes in market conditions, could result in materially different values. We continue to refine our valuation methodologies as markets and products develop and the pricing for certain products becomes more or less transparent.
We categorize our financial instruments reported at estimated fair value into a three-level hierarchy. The valuation hierarchy is based upon the transparency (observable or unobservable) of inputs to the valuation of an asset or liability as of the measurement date. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. Level 1 instruments are those for which inputs to the valuation methodology are observable and are derived from quoted prices (unadjusted) for identical assets or liabilities in active markets that we can access on the measurement date. Level 2 instruments are those for which inputs
are observable, either directly or indirectly, and include quoted prices for similar assets and liabilities. Finally, level 3 instruments are those for which inputs are unobservable or are unable to be corroborated by external market data.
Accounting Developments. For a description of how recent accounting developments may impact our financial condition, results
of operations or cash flows, see Notes to Financial Statements - Note 2 - Recently Adopted and Issued Accounting Guidance.
Legislative and Regulatory Developments. The following is a summary of significant regulatory actions and developments for the period covered by this report.
Proposed SEC Rule on Climate-Related Disclosures. On March 21, 2022, the SEC proposed a new rule that would require us to make specific climate-related disclosures in our periodic reports. The proposed rule would require us to account for and disclose certain direct, indirect and third-party greenhouse gas emissions, provide additional disclosures of material impact of climate-change risks on our strategy,
business model and outlook, disclose climate-event impacts, discuss board and management governance and oversight of climate-related risks, climate-change risk management framework considering both physical and transitional risks, and plans to reduce such risks, and provide and discuss climate-related financial impact metrics and expenditure metrics. We are unable to predict when a rule will be finalized and the extent to which a final rule will apply or deviate from the proposal. Should the rule become final in its current form, we anticipate a significant increase in our compliance costs given the complexity of these prospective obligations.
Finance Agency’s Review and Analysis of the Federal Home Loan Bank System. On July 20, 2022, Finance Agency Director Sandra L. Thompson provided testimony to the U.S. House
Committee on Financial Services, indicating that the Finance Agency would conduct a review and analysis of the FHLBank System. As part of its review and analysis, the Finance Agency has held a series of public listening sessions and regional roundtable discussions, and has requested written comments from stakeholders. The review has been examining matters covering such areas as the FHLBanks’ adequate fulfillment of their mission and purpose in a changing marketplace; their organization, operational efficiency and effectiveness; their role in promoting affordable, sustainable, equitable, and resilient housing and community investment; their role in addressing the unique needs of rural and financially vulnerable communities; member products, services, and collateral requirements; and membership eligibility and requirements. We anticipate that the Finance Agency’s review and analysis will culminate in a written report. The report may involve recommendations for changes
related to a number of areas such as the FHLBanks’ fulfillment of their mission, membership requirements, contributions to affordable housing and support to community investment and may lead to recommendations for statutory revisions, proposals for new or modified regulations, regulatory guidance under existing regulations, and/or other regulatory or supervisory actions consistent with the Finance Agency’s statutory authority.
Federal Reserve Bank Term Funding Program. Effective March 12, 2023, the Federal Reserve implemented a bank term funding program, which offers loans for a term of up to one year to eligible borrowers, secured by eligible collateral owned as of March 12, 2023. Eligible borrowers include any federally-insured depository institution or U.S. branch or agency of a foreign
bank that is eligible for primary credit with the Federal Reserve. Eligible collateral is any collateral eligible for purchase by the FOMC, which includes U.S. Treasury obligations, agency debt and MBS, among other assets. Eligible collateral will be valued at par, and loans will be made at a fixed rate equal to the one-year overnight index swap rate plus 10 basis points. Loans can be requested under the program until at least March 11, 2024. The program is backstopped by the U.S. Department of Treasury, which will provide up to $25 billion in credit protection to the Federal Reserve in connection with the program. While it is difficult to predict the impact of this new program on our business, financial condition and results of operations at this time, the program is likely to provide an alternative funding source for our members and could reduce their demand for advances during the term of the program.
Amendment
to Financial Industry Regulatory Authority ("FINRA") Rule 4210: Margining of Covered Agency Transactions. On February 24, 2023, FINRA filed a proposed rule change with the SEC, with immediate effect, further extending the implementation date from April 24, 2023 to October 25, 2023 of the margining requirements set by FINRA Rule 4210 dated July 29, 2022, for covered agency transactions. Once the margining requirements are effective, we may be required to collateralize transactions that are covered agency transactions, which include TBAs. These collateralization requirements could have the effect of reducing the overall profitability of engaging in covered agency transactions, including TBAs. Further, the collateralization requirements could expose
us to credit risk from our counterparties for such transactions.
Final Rule Implementing the Adjustable Interest Rate (LIBOR) Act. On December 16, 2022, the Federal Reserve Board of Governors adopted a final rule that implements the Adjustable Interest Rate (LIBOR) Act, enacted in March 2022. The rule, which went into effect on February 27, 2023, establishes benchmark replacement rates based on SOFR for certain contracts,
to apply following the first London banking day after June 30, 2023 (the "LIBOR replacement date"). Generally, the rule provides that Federal Reserve Board-selected benchmark replacements will apply by operation of law to contracts governed by U.S. law which have the following characteristics: (a) contain no fallback provisions; (b) contain fallback provisions but fail to specify either the fallback rate or the party that can determine the fallback rate; or (c) contain a fallback provision that identifies the party that can determine the fallback rate, but the determining party has failed to do so before (i) the LIBOR replacement date or (ii) the latest date to select a benchmark replacement according to the contract terms. For advances
that have any of the above characteristics, the final rule sets the replacement benchmark rate as the Fallback Rate (SOFR) in the International Swaps and Derivatives Association 2020 IBOR Fallbacks Protocol. For any other FHLBank contract with the above characteristics, references to overnight LIBOR would be replaced with SOFR and one-, three-, six, or 12-month LIBOR will be replaced with 30-day Average SOFR, in each case plus the applicable tenor spread adjustment specified in the Adjustable Interest Rate (LIBOR) Act.
We continue to monitor these developments as they evolve and to evaluate their potential impact on us.
We have exposure to a number of risks in pursuing our business objectives. These risks may be broadly classified as market, credit, liquidity, operational, and business. Market risk is discussed in Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Active risk management is an integral part of our operations because these risks are an inherent part of our business activities. We manage these risks by, among other actions, setting and enforcing appropriate limits and developing and maintaining internal policies and processes
to ensure an appropriate risk profile. In order to enhance our ability to manage Bank-wide risk, our enterprise risk management function is structured to segregate risk measurement, monitoring, and evaluation from our business units where risk-taking occurs through financial transactions and positions.
Effective risk management programs include not only conformance of specific risk management practices to certain risk-related compliance requirements established by the Finance Agency, but also the active involvement of our board of directors. Our board of directors has established a Risk Appetite Statement that summarizes the amounts, levels and types of enterprise-wide risk that our management is authorized to undertake in pursuit of achieving our mission and executing our strategic plans. The Risk Appetite Statement includes high level qualitative and quantitative risk limits and tolerances.
Our board of directors has also established a Risk Oversight Committee that provides focus, direction and accountability for our risk management process. Further, our Enterprise Risk Management Policy serves as a key policy to address our exposures to market, credit, liquidity, operational and business risks, and various other key risk-related policies approved by our board of directors address operational risk management, model risk management, credit, capital markets, and enterprise information security.
Our internal Risk Committee focuses exclusively on risk management, as it:
•oversees the identification, monitoring, measurement, evaluation and reporting of risks;
•promotes
cross-functional communication and exchange of ideas pertaining to oversight of our risk profile in accordance with guidelines and objectives established by our board of directors and senior management; and
•oversees the actions of the Information Security Steering Committee, which oversees our Information Security Program, which includes enterprise information security, cybersecurity, and physical security.
Each of our other internal management committees is responsible for overseeing its respective business activities in accordance with specified policies, in addition to ongoing consideration of pertinent risk-related issues.
Broadly, our enterprise risk management team leads the implementation of our enterprise risk management program and assists the board of directors by establishing,
monitoring, and maintaining the program and seeking amendments and approvals of the risk management policies from time to time. Our Enterprise Risk Management Policy specifies that breaches of material risk limits from the risk management policies and program policies will be reported to the board of directors or a designated committee of the board, which committee is typically the board's Risk Oversight Committee.
Our chief risk officer leads our enterprise risk management team, reports directly to our chief executive officer and provides reports directly to the board of directors or the Risk Oversight Committee. Our Enterprise Risk Management Policy specifies that the chief risk officer:
•is independent while remaining a part of the management team;
•has
unfettered access to the board of directors, including the Risk Oversight Committee, and senior management on key risk issues; and
•is empowered to obtain information deemed necessary to fulfill the responsibilities of the role.
We have a formal process for the assessment of Bank-wide risk and risk-related issues. Our risk assessment process is designed to identify and evaluate material risks, including both quantitative and qualitative aspects, which could adversely affect achievement of our financial performance objectives and compliance with applicable requirements. Business unit managers play a significant role in this process, as they are best positioned to identify and understand the risks inherent in their respective operations. These assessments evaluate the inherent risks within each of the key processes as well as the controls and
strategies in place to manage those risks, identify primary weaknesses, and recommend actions that should be undertaken to address the identified weaknesses. The results of these assessments are summarized in an annual risk assessment report, which is reviewed by senior management and our board of directors.
Credit Risk Management. Credit risk is the risk that members or other counterparties may be unable to meet their contractual obligations to us, or that the values of those obligations will decline as a result of deterioration in the members' or other counterparties' creditworthiness. Credit
risk arises when our funds are extended, committed, invested or otherwise exposed to risk of non-repayment. We face credit risk on advances and other credit products, investments, mortgage loans, derivative financial instruments, and AHP grants.
The most important step in the management of credit risk is the initial decision to extend credit. We also manage credit risk by following established policies, evaluating the creditworthiness of our members and counterparties, and utilizing collateral agreements and settlement netting. Periodic monitoring of members and other counterparties is performed whenever we are exposed to credit risk.
Advances and Other Credit Products.We manage our exposure to credit risk on advances primarily through a combination of our security interests in assets pledged
by our borrowers and ongoing reviews of our borrowers' financial strength. Credit analyses are performed on existing borrowers, with the frequency and scope determined by the financial strength of the borrower and/or the amount of our credit products outstanding to that borrower. We establish limits and other requirements for advances and other credit products.
Section 10(a) of the Bank Act prohibits us from making an advance without sufficient collateral to fully secure the advance. Security is provided via thorough underwriting and perfecting our position in eligible assets pledged by the borrower as collateral before an advance is made. Each member's collateral reporting requirement is based on its collateral status, which reflects its financial condition and type of institution, and our review of conflicting liens, with our level of control over the collateral increasing when a member's financial performance
deteriorates. We continually evaluate the quality and value of collateral pledged to support advances and work with members to improve the accuracy of valuations.
At December 31, 2022, advances outstanding to our insurance company members represented 36% of our total advances outstanding, at par. The significant level of advances to insurance company members reflect the significant portion of total financial assets held by insurance companies in our district. Insurance companies have different risk characteristics than our depository members. Some of the ways we mitigate this risk include requiring insurance companies to deliver collateral to us or our custodian and using industry-specific underwriting approaches as part of our ongoing evaluation of our insurance company members' financial strength.
Borrowing
Limits. Generally, we maintain a credit products borrowing limit of 40% of a depository member's total assets. As of December 31, 2022, we had no advances outstanding to a depository member whose total credit products exceeded 40% of its total assets.
The borrowing limit for our insurance company members (excluding captive insurance companies) is 25% of their total general account assets. As of December 31, 2022, we had no advances outstanding to an insurance company member whose total credit products exceeded 25% of their general account assets.
The credit products borrowing limit for our non-depository CDFI members is 25% of their
total restricted assets. As of December 31, 2022, we had no advances outstanding to a non-depository CDFI member whose total credit products exceeded 25% of their total unrestricted assets.
Any credit extensions to a member whose total credit products exceed the applicable threshold require an additional approval as provided in our credit policy. The approval is based upon a number of factors that may include the member's financial condition, collateral quality, business plan and earnings stability. We also monitor these members more closely on an ongoing basis. We may impose additional restrictions on extensions of credit to our members at our discretion.
Concentration. Our credit risk is magnified due to the concentration of advances in a few borrowers. As of December 31, 2022, our top borrower held 12% of total advances outstanding, at par, and our top five borrowers held 41% of total advances outstanding, at par. The following tables present the par value of advances outstanding to our largest borrowers ($ amounts in millions).
Because of this concentration in advances, we perform frequent credit and collateral reviews on our largest borrowers. In addition, we regularly analyze the implications to our financial management and profitability if we were to lose the business of one or more of these borrowers.
At our discretion, and provided the borrower meets our contractual requirements, advances to borrowers that are no longer members may remain outstanding until maturity, subject to certain regulatory requirements.
For
the years ended December 31, 2022, 2021 and 2020, we did not have gross interest income on advances, excluding the effects of interest-rate swaps, from any one borrower that exceeded 10% of our total interest income.
Collateral Requirements. We generally require all borrowers to execute a security agreement that grants us a blanket lien on substantially all assets of the member. Our agreements with borrowers require each borrowing entity to fully secure all outstanding extensions of credit at all times, including advances, accrued interest receivable, standby letters of credit, correspondent services, certain AHP transactions, and all indebtedness, liabilities or obligations arising or incurred as a result
of a member transacting business with us. We may also require a member to pledge additional collateral to cover exposure resulting from any applicable prepayment fees on advances.
In accordance with the Bank Act, we accept the following assets as collateral:
•fully disbursed, whole first mortgages on improved residential property, or securities representing a whole interest in such mortgages;
•securities issued, insured, or guaranteed by the United States government or any Agency thereof (including, without limitation, MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae);
•cash or deposits in an FHLBank; and
•other
real estate-related collateral acceptable to us if such collateral has a readily ascertainable value and we can perfect our interest in the collateral.
Additionally, for any CFI, we may also accept secured loans for small business, agricultural and community development activities.
In addition to our internal credit risk management policies and procedures, Section 10(e) of the Bank Act affords priority of any security interest granted to us, by a member or such member's affiliate, over the claims or rights of any other
party, including any receiver, conservator, trustee, or similar entity that has the rights of a lien creditor, except for claims held by bona fide purchasers for value or by parties that are secured by prior perfected security interests, provided that such claims would otherwise be entitled to priority under applicable law. Moreover, with respect to federally-insured depository institution borrowers, our claims are given certain preferences pursuant to the receivership provisions of the Federal Deposit Insurance Act. With respect to insurance company members, however, Congress provided in the McCarran-Ferguson Act of 1945 that state law generally governs the regulation of insurance and shall not be preempted by federal law unless the federal law expressly regulates the business of insurance. Thus, if a court were to determine that the priority provision of Section 10(e) of the Bank Act conflicts with state insurance law applicable to our insurance company members, the
court might then determine that the priority of our security interest would be governed by state law, not Section 10(e). Under these circumstances, the "super lien" priority protection afforded to our security interest under Section 10(e) may not fully apply when we lend to such insurance company members.However, we monitor applicable states' laws, and our security interests in collateral posted by insurance company members have express statutory protections in the jurisdictions where our members are domiciled. In addition, we take all necessary action under applicable state law to obtain and maintain a prior perfected security interest in the collateral, including by taking possession or control of the collateral as appropriate.
Collateral Status. When an institution becomes a member, we assign the member to a collateral status
after the initial underwriting review. The assignment of a member to a collateral status category reflects, in part, our philosophy of increasing our level of control over the collateral pledged by the member, when warranted, based on our underwriting conclusions and a review of our lien priority. Some members pledge and report collateral under a blanket lien established through the security agreement, while others are placed on specific listings or possession status or a combination of the three via a hybrid status. We take possession of all collateral posted by insurance companies to further ensure our position as a first-priority secured creditor. A depository institution member may elect a more restrictive collateral status to receive a higher lendable value for their collateral.
The primary features of these three collateral status categories are:
Blanket:
•only
certain financially sound depository institutions are eligible;
•institutions that have granted a blanket lien to another creditor may be eligible if an inter-creditor or subordination agreement is executed;
•review and approval by underwriting and collateral operations management is required;
•member retains possession of eligible whole loan collateral pledged to us;
•member executes a written security agreement and agrees to hold such collateral for our benefit; and
•member provides periodic reports of all eligible collateral.
Specific Listings:
•applicable
to depository institutions that demonstrate potential weakness in their financial condition or seek lower over-collateralization requirements;
•may be available to institutions that have granted a blanket lien to another creditor if an inter-creditor or subordination agreement is executed;
•member retains possession of eligible whole loan collateral pledged to us;
•member executes a written security agreement and agrees to hold such collateral for our benefit; and
•member provides loan level detail on the pledged collateral on at least a monthly basis.
Possession:
•applicable
to all insurance companies, non-depository CDFI's, Housing Associates, and those depository institutions demonstrating less financial strength than those approved for specific listings;
•required for all de novo institutions and institutions that have granted a blanket lien to another creditor but have not executed an inter-creditor or subordination agreement;
•safekeeping for securities pledged as collateral can be with us or a third-party custodian that we have pre-approved;
•original notes and other documents related to whole loans pledged as collateral are held with a third-party custodian that we have pre-approved;
•member executes a written security agreement; and
•member
provides loan level detail on the pledged collateral on at least a monthly basis.
Collateral Valuation. In order to mitigate the market, credit, liquidity, operational and business risk associated with collateral, we apply an over-collateralization requirement to the book value or market value of pledged collateral to establish its lendable value. Collateral that we have determined to contain a low level of risk, such as United States government obligations, is over-collateralized at a lower rate than collateral that carries a higher level of risk, such as small business loans. The over-collateralization requirement
applied to asset classes may vary depending on collateral status, because lower requirements are applied as our levels of information and control over the assets increase.
We have made changes to, and continue to update, our internal valuation model to gain greater consistency between model-generated valuations and observed market prices, resulting in adjustments to lendable values on whole loan collateral. We routinely engage outside pricing vendors to benchmark our modeled pricing on residential and commercial real estate collateral, and we modify valuations where appropriate.
The following table provides information regarding credit products outstanding with borrowers based on their reporting status, along with their corresponding collateral balances at December 31, 2022. The table only lists
collateral that was identified and pledged by borrowers with outstanding credit products, and therefore does not include all assets against which we have security interests ($ amounts in millions).
Collateral
Types
Collateral Status
# of Borrowers
1st lien Residential
Other Real Estate Related-Collateral/CFI
Securities/Delivery
Total Collateral
Lendable Value(1)
Credit
Outstanding (2)
Blanket
85
$
19,141
$
11,113
$
4,171
$
34,425
$
22,761
$
14,150
Specific
listings
77
20,426
3,509
4,699
28,634
20,411
7,740
Possession
30
5,552
12,533
11,260
29,345
20,032
13,612
Hybrid
(3)
3
5,520
1,744
549
7,813
5,177
2,261
Total
195
$
50,639
$
28,899
$
20,679
$
100,217
$
68,381
$
37,763
(1)
Lendable Value is the borrowing capacity, based upon collateral pledged after a market value has been estimated (excluding blanket-pledged collateral) and an over-collateralization requirement has been applied.
(2) Credit outstanding includes advances (at par value), lines of credit used, and standby letters of credit.
(3) Hybrid collateral status is a combination of any of the others: blanket, specific listings and possession.
Collateral Review and Monitoring. Our agreements with borrowers allow us, at any time and in our sole discretion, to require substitution of collateral, adjust the over-collateralization requirements applied to collateral, or refuse to make extensions of credit against any collateral. We also
may require borrowers to pledge additional collateral regardless of whether the collateral would be eligible to originate a new extension of credit. Our agreements with our borrowers also afford us the right, in our sole discretion, to declare any borrower to be in default if we deem the Bank to be inadequately secured.
Underwriting and collateral operations management continually monitors members' collateral status and may require a member to change its collateral status based upon deteriorating financial performance, results of collateral verification reviews, or a high level of borrowings as a percentage of its assets. The blanket lien created by the security agreement remains in place regardless of a member's collateral status.
We conduct regular collateral verification reviews of loan collateral pledged by members to confirm the existence of
the pledged collateral, confirm that the collateral conforms to our eligibility requirements, and score the collateral for concentration and credit risk. Based on the results of such collateral verification reviews, a member may have its over-collateralization requirements adjusted, limitations may be placed on the amount of certain asset types accepted as collateral or, in some cases, the member may be changed to a more stringent collateral status. We may conduct a review of any borrower's collateral at any time.
Credit Review and Monitoring. We monitor the financial condition of all member and non-member borrowers by reviewing certain available financial data, such as regulatory call reports filed by depository institution borrowers, regulatory financial statements filed with the appropriate state insurance department by insurance company borrowers, SEC filings, and rating agency
reports, to ensure that potentially troubled institutions are identified as soon as possible. In addition, we have the ability to obtain borrowers' regulatory examination reports and, when appropriate, may contact borrowers' management teams to discuss performance and business strategies. We analyze this information on a regular basis and use it to determine the appropriate collateral status for our borrowers.
We use models to assign a quarterly financial performance measure for all depository and insurance borrowers. This measure, combined with other credit monitoring tools and the level of a member's usage
of credit products, determines the frequency and depth of underwriting analysis for depository borrowers. The frequency and depth of underwriting analysis is the same for all insurance borrowers.
Investments. We are also exposed to credit risk through our investment portfolio. Our policies restrict the acquisition of investments to high-quality, short-term money market instruments and high-quality long-term securities.
Short-Term Investments. Our short-term investments typically include securities purchased under agreements to resell, which are secured by United States Treasuries. Although we are permitted to purchase these securities for terms of up to 275 days,
most mature overnight. Our short-term investments can also include federal funds sold, which can be overnight or term placements of our funds. We place these funds with large, high-quality financial institutions with investment-grade long-term credit ratings on an unsecured basis for terms of up to 275 days, though most mature overnight. Our short-term investments also include interest-bearing demand deposit accounts which are commercial deposit accounts generally opened with large, high-quality domestic financial institutions. The funds within these accounts are available for withdrawal at any time during business hours.
We monitor counterparty creditworthiness, ratings, performance, and capital adequacy in an effort to mitigate unsecured credit risk on the short-term investments, with an emphasis on the potential impacts of changes in global economic conditions. As a result, we may limit or suspend exposure
to certain counterparties.
Finance Agency regulations include limits on the amount of unsecured credit we may extend to a private counterparty or to a group of affiliated counterparties. These regulations require, among other things, that we calculate credit risk capital charges and unsecured credit limits based on our own internal rating methodology.
Finance Agency regulations also permit us to extend additional unsecured credit for overnight federal funds sold up to a total unsecured exposure to a single counterparty of 2% to 30% of the eligible amount of regulatory capital, based on our internal credit rating of the counterparty.
Additionally, we are prohibited by Finance Agency regulation from investing in financial instruments issued
by non-United States entities other than those issued by United States branches and agency offices of foreign commercial banks. Our unsecured credit exposures to United States branches and agency offices of foreign commercial banks include the risk that, as a result of political or economic conditions in a country, the counterparty may be unable to meet its contractual repayment obligations. During the year ended December 31, 2022, our unsecured investment credit exposure to United States branches and agency offices of foreign commercial banks was limited to federal funds sold. Our unsecured credit exposures to domestic counterparties and United States subsidiaries of foreign commercial banks include the risk that these counterparties have extended credit to foreign counterparties.
The
following table presents the unsecured investment credit exposure to private counterparties, categorized by the domicile of the counterparty's ultimate parent, based on the lowest of the counterparty's NRSRO long-term credit ratings, stated in terms of the S&P equivalent. The table does not reflect the foreign sovereign government's credit rating ($ amounts in millions).
Trading Securities. Our liquidity portfolio includes U.S. Treasury obligations, which are direct obligations of the U.S. government and are classified as trading securities.
Other Investment Securities. Our long-term investments include MBS guaranteed by the housing GSEs (Fannie Mae and Freddie Mac), other U.S. obligations - guaranteed MBS (Ginnie Mae), and debentures issued by Fannie Mae, Freddie Mac, the TVA and the Federal Farm Credit Banks.
Generally, our goal is to maintain investments in MBS near the 300% regulatory limit in order to enhance earnings and capital for our members and diversify our revenue stream. At December 31, 2022, these investments totaled 292% of total regulatory capital.
The following table presents the carrying values of our investments, excluding
accrued interest, grouped by credit rating and investment category. Applicable rating levels are determined using the lowest relevant long-term rating from S&P and Moody's, each stated in terms of the S&P equivalent. Rating modifiers are ignored when determining the applicable rating level for a given counterparty. Amounts reported do not reflect any subsequent changes in ratings, outlook, or watch status ($ amounts in millions).
Mortgage Loans Held for Portfolio.We are exposed to credit risk on the loans purchased from our PFIs through the MPP. Each loan we purchase must meet the guidelines for our MPP or be specifically approved as an exception based on compensating factors. For example, the maximum LTV ratio for any conventional mortgage loan purchased is 95%, and
the borrowers must meet certain minimum credit scores depending upon the type of loan or property.
Credit enhancements for conventional loans include (in order of priority):
•PMI (when applicable);
•LRA; and
•SMI (as applicable) purchased by the seller from a third-party provider naming us as the beneficiary.
PMI. For a conventional loan, PMI, if applicable, covers losses or exposure down to approximately an LTV ratio between 65% and 80% based upon the original appraisal, original LTV ratio, term, and amount of PMI coverage. As
of December 31, 2022, we had PMI coverage on $781 million or 11% of our conventional MPP mortgage loans, which included coverage of $0.6 million on seriously delinquent loans, i.e., 90 days or more past due or in the process of foreclosure, of $1.9 million.
LRA. We use either a "spread LRA" or a "fixed LRA" for credit enhancement. The spread LRA was used in combination with SMI for credit enhancement of conventional mortgage loans purchased under our original MPP, and the fixed LRA is used for credit enhancement of conventional mortgage loans purchased under Advantage MPP. At this time, substantially all of the additions are from Advantage MPP, and substantially all of the claims paid are from the original MPP.
The following table presents the changes in the
LRA for original MPP and Advantage MPP ($ amounts in millions).
2022
LRA Activity
Original
Advantage
Total
Liability,
beginning of year
$
4
$
227
$
231
Additions
—
14
14
Claims paid
—
—
—
Distributions
to PFIs
(2)
(8)
(10)
Liability, end of year
$
2
$
233
$
235
SMI. Losses that exceed
available LRA funds are covered by SMI (for original MPP loans) up to a severity of approximately 50% of the original property value of the loan, depending on the SMI contract terms. We absorb any losses in excess of available LRA funds and SMI.
Our current SMI providers are Mortgage Guaranty Insurance Corporation and Enact Mortgage Insurance (formerly known as Genworth Mortgage Insurance Corporation). For pools of loans acquired under the original MPP, we entered into the insurance contracts directly with the SMI providers, including a contract for each pool or aggregate pool. Pursuant to Finance Agency regulation, the PFI must be responsible
for all expected creditlosses on the mortgages sold to us. Therefore, the PFI was the purchaser of the SMI policy, and we are designated as the beneficiary. The premiums are the PFI's obligation. As an administrative convenience, we collect the SMI premiums from the monthly mortgage remittances received from the PFIs or their designated servicer and remit them to the SMI provider.
As of December 31, 2022, we were the beneficiary of SMI coverage, under our original MPP, on conventional mortgage pools with a total UPB of $237 million. The lowest credit rating from S&P and Moody's stated in terms of the S&P equivalent, for each of our SMI companies is BBB+ for Mortgage Guaranty Insurance Corporation and BBB for Enact Mortgage Insurance. We evaluate the recoverability related to PMI
and SMI for mortgage loans that we hold, including insurance companies placed under enhanced supervision of state regulators. We also evaluate the recoverability of outstanding receivables from our PMI and SMI providers related to outstanding and unpaid claims.
Mortgage Loan Characteristics. Two indicators of credit quality at origination are LTV ratios and credit scores provided by FICO®. FICO® provides a commonly used measure to assess a borrower’s credit quality, with scores ranging from a
low of 300 to a high of 850.The combination of a lower FICO® score and a higher LTV ratio is a key driver of potential mortgage delinquencies and defaults.
The following tables present these two characteristics at origination of our conventional loan portfolio as a percentage of the UPB outstanding ($ amounts in millions).
(1)
Represents the FICO® score at origination of the lowest scoring borrower for the related loan.
For borrowers in our conventional loan portfolio at December 31, 2022, 99.7% of the borrowers had FICO® scores greater than 660 at origination and the weighted average FICO® score at origination was 760.
(2) These conventional loans were required to have PMI at origination.
For borrowers in our conventional loan portfolio at December 31, 2022, 84% of the borrowers had an LTV ratio of 80% or lower at origination and the weighted average LTV ratio at origination was 72%.
We believe these two measures indicate that these loans have a low risk of default.
Mortgage Loan Concentration. During 2022, our top-selling PFI sold us mortgage loans totaling $272 million, or 24% of the total mortgage loans that we purchased in 2022. Our five top-selling PFIs sold us 50% of the total. Because
of this concentration, we regularly analyze the implications to our financial management and profitability if we were to lose the business of one or more of these sellers.
For the years ended December 31, 2022, 2021, and 2020, no aggregate mortgage loans outstanding previously purchased from any one PFI contributed interest income that exceeded 10% of our total interest income.
The
properties underlying the mortgage loans in our portfolio are dispersed across 50 states, the District of Columbia and the Virgin Islands, with concentrations in Michigan and Indiana, the two states in our district. The following table presents the percentage of UPB of conventional loans outstanding at December 31, 2022 for the five largest state concentrations.
Mortgage Loan Credit Performance. The credit ratios of our mortgage loans are presented in the table below along with the amounts used in those calculations ($ amounts in millions).
Average loans outstanding during the year ended (UPB)
$
7,517
$
7,665
Mortgage loans held for portfolio (UPB)
7,533
7,434
Non-accrual
loans (UPB)(1)
11
23
Allowance for credit losses on mortgage loans held for portfolio
(0.2)
(0.2)
Net recoveries during the year ended
(0.1)
—
Ratio
of net charge-offs to average loans outstanding during the year ended (2)
—
%
—
%
Ratio of allowance for credit losses to mortgage loans held for portfolio (2)
—
%
—
%
Ratio of non-accrual loans to mortgage loans held for portfolio
0.15
%
0.31
%
Ratio
of allowance for credit losses to non-accrual loans
1.82
%
0.85
%
(1) Non-accrual loans are defined as conventional mortgage loans where either (i) the collection of interest or principal is doubtful, or (ii) interest or principal is past due for 90 days or more, except when the loan is well secured and in the process of collection (e.g., through credit enhancements and monthly servicer remittances on a scheduled/scheduled basis).
(2) Ratios of —% represent results less than 0.1%.
The
serious delinquency rate for conventional mortgages was 0.16% at December 31, 2022, compared to 0.40% at December 31, 2021. The serious delinquency rate for government-guaranteed or -insured mortgages was 1.07% at December 31, 2022, compared to 0.86% at December 31, 2021. We rely on insurance provided by the FHA, which generally provides coverage for 100% of the principal balance of the underlying mortgage loan and defaulted interest at the debenture rate. However, we would receive defaulted interest at the contractual rate from the servicer. Both rates were below the national serious delinquency rate.
We establish
credit enhancements in each mortgage pool purchased under our original MPP at the time of the pool's origination that are sufficient to absorb loan losses up to approximately 50% of the property's original value (subject, in certain cases, to an aggregate stop-loss provision in the SMI policy).
Derivatives.Our over-the-counter derivative transactions are either (i) entered into directly with a counterparty (uncleared derivatives)
or (ii) cleared through a Futures Commission Merchant (i.e., clearing agent) with a Clearinghouse (cleared derivatives).
•Uncleared Derivatives. We are subject to credit risk due to the potential non-performance by the counterparties to our uncleared derivative transactions. We require collateral agreements with our uncleared derivative counterparties. The exposure thresholds above which collateral must be delivered vary; the threshold is zero in most cases.
•Cleared Derivatives. We are subject to credit risk due to the potential non-performance by the Clearinghouse and clearing agent because we are required to post initial and variation margin through the clearing agent, on behalf of the Clearinghouse, which exposes us to institutional credit risk if either
the clearing agent or the Clearinghouse fails to meet its obligations. Collateral is required to be posted daily for changes in the value of cleared derivatives to mitigate each counterparty's credit risk.
The contractual or notional amount of derivative transactions reflects the extent of our participation in the various classes of financial instruments. Our credit risk with respect to derivative transactions is the estimated cost of replacing the derivative positions if there is a default, minus the value of any related collateral. In determining credit risk, we consider accrued interest receivables and payables as well as the requirements to net assets and liabilities. For more information, see Notes to Financial Statements - Note 8 - Derivatives and Hedging Activities.
The following table presents key information on derivative
positions with counterparties on a settlement date basis using the lower credit rating from S&P and Moody's, stated in terms of the S&P equivalent ($ amounts in millions).
Total
derivative positions with credit exposure to non-member counterparties
57,401
(509)
943
434
Total derivative positions with credit exposure to member institutions (2)
9
—
—
—
Subtotal
- derivative positions with credit exposure
57,410
$
(509)
$
943
$
434
Derivative positions without credit exposure
15,565
Total
derivative positions
$
72,975
(1) Represents derivative transactions cleared by two Clearinghouses, each rated AA- .
(2) Includes MDCs from member institutions under our MPP.
AHP.Our AHP requires members and project sponsors to make commitments with respect to the usage of the AHP grants to assist very low-, low-, and moderate-income families, as defined by regulation.
If these commitments are not met, we may have an obligation to recapture these funds from the member or project sponsor to replenish the AHP fund. This credit exposure is addressed in part by evaluating project feasibility at the time of an award and the member’s ongoing monitoring of AHP projects.
Liquidity Risk Management. The primary objectives of liquidity risk management are to maintain the ability to meet obligations as they come due and to meet the credit needs of our member borrowers in a timely and cost-efficient manner. We routinely monitor the
sources of cash available to meet liquidity needs and use various tests and guidelines to manage our liquidity risk.
Daily projections of required liquidity are prepared to help us maintain adequate funding for our operations. Operational liquidity levels are determined assuming sources of cash from both the FHLBank System's ongoing access to the capital markets and our holding of liquid assets to meet operational requirements in the normal course of business. Contingent liquidity levels are determined based upon the assumption of an inability to readily access the capital markets for a period of 20 calendar days. These analyses include projections of cash flows and funding needs, targeted funding terms, and various funding alternatives for achieving those terms. A contingency plan allows us to maintain sufficient liquidity in the event of operational disruptions at our Bank, at the Office of Finance, or in
the capital markets.
For more information on liquidity management, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity.
Operational Risk Management. Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events. Our management has established policies, procedures, and controls and acquired insurance coverage to mitigate operational risk. Our Internal Audit department, which reports directly to the Audit Committee of the board of directors, regularly monitors our adherence to established policies, procedures, applicable regulatory requirements and best practices.
Our enterprise risk
management function and business units complete a comprehensive annual risk and control self-assessment that reinforces our focus on maintaining strong internal controls by identifying significant inherent risks and the mitigating internal controls in order for the residual risks to be assessed and the appropriate strategy designed to accept, transfer, avoid or mitigate such risks. The risk assessment process provides management and the board of directors with a detailed and transparent view of our identified risks and related internal control structure.
We use various financial models to quantify financial risks and analyze potential strategies. We maintain a model risk management program that includes a validation process intended to mitigate the risk of loss resulting from model errors or the incorrect use or application of model output, which could potentially lead to inappropriate business or operational
decisions.
Our operations rely on the secure processing, storage and transmission of sensitive/confidential and other information in our computer systems, software and networks. As a result, our Information Security Program is designed to protect our information assets, information systems and sensitive data from internal, external, vendor and third party cyber risks, including due diligence, risk assessments, and ongoing monitoring of critical vendors by our Vendor Management Office. The Information Security Program includes processes for monitoring existing, emerging and imminent threats as well as cyber attacks impacting our industry in order to develop appropriate risk management strategies. Information Security controls designed to protect and detect are in place, including procedures to respond to and mitigate the impacts of security incidents.
In
order to ensure our ongoing ability to provide liquidity and service to our members, we have business continuity plans designed to restore critical business processes and systems in the event of a business interruption. We operate both a business resumption center and a disaster recovery data center, at separate locations, with the objective of being able to fully recover all critical activities in a timely manner. Both facilities are subject to periodic testing to demonstrate the Bank's resiliency in the event of a disaster. In addition, all Bank staff have the capabilities to work remotely. We also have a back-up agreement in place with the FHLBank of Cincinnati in the event critical business operations at our primary and back-up facilities are inoperable.
We have insurance coverage for cybersecurity, employee fraud, forgery and wrongdoing, as well as Directors' and Officers' liability coverage that provides
protection for claims alleging breach of duty, misappropriation of funds, neglect, acts of omission, employment practices, and fiduciary liability. We also have property, casualty, computer equipment, automobile, and other various types of insurance coverage. We complete periodic reviews to ensure the Bank maintains all insurance coverages at commercially appropriate levels.
Business Risk Management. Business risk is the risk of an adverse impact on our profitability and financial condition resulting from external factors that may occur in both the short and
long term. Business risk includes economic, political, strategic, reputation, legislative and regulatory developments or events that are beyond our control. Examples of external factors may include, but are not limited to: continued financial services industry consolidation, a declining membership base, changes in the mix and/or concentration of borrowing among members, the introduction of new competing products and services, increased non-bank competition, enhanced liquidity at member institutions due to governmental programs, weakening of the FHLBank System's GSE status, changes in the deposit and mortgage markets for the Bank's members, changes that could occur as a result of new legislation, and other factors that may have a significant direct or indirect impact on our ability to achieve our mission and strategic objectives. Our board of directors and management seek to mitigate these risks by, among other actions, maintaining an open and constructive dialogue with
regulators, providing input on potential legislation, conducting long-term strategic planning and continually monitoring general economic conditions and the external environment.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk that the market value or estimated fair value of our overall portfolio of assets and liabilities, including derivatives, or our net earnings will decline as a result of changes in interest rates or financial market volatility. Market risk includes the risks related to:
•movements in interest rates over time;
•changes
in mortgage prepayment speeds over time;
•advance prepayments;
•actual and implied interest-rate volatility;
•the change in the relationship between short-term and long-term interest rates (i.e., the slope of the consolidated obligation yield curve);
•the change in the relationship of FHLBank System debt spreads to relevant indices (commonly referred to as "basis" risk); and
•the change in the relationship between fixed rates and variable rates.
The goal of market risk management is to preserve our financial strength at all times, including during periods
of significant market volatility and across a wide range of possible interest-rate scenarios. We regularly assess our exposure to changes in interest rates using a diverse set of analyses and measures. As appropriate, we may rebalance our portfolio to help attain our risk management objectives.
Our general approach toward managing interest-rate risk is to acquire and maintain a portfolio of assets and liabilities that, together with their associated hedges, limit our expected interest-rate sensitivity to within our specified tolerances. Additionally, in order to manage the exposure to mortgage contraction (prepayment) and extension risk, the outstanding balance of mortgage loans is limited to a proportion of total assets and the total amount of our investments in MBS must not exceed 300% of our total regulatory capital on the day of purchase. Derivative financial instruments, primarily interest-rate swaps,
are frequently employed to hedge the interest-rate risk and/or embedded option risk on advances, debt, GSE debentures and Agency MBS held as investments.
The prepayment option on an advance can create interest-rate risk. If a member prepays an advance, we could suffer lower future income if the principal portion of the prepaid advance is reinvested in lower yielding assets that continue to be funded by higher cost debt. To protect against this risk, we charge a prepayment fee, thereby substantially reducing market risk associated with the prepayment of an advance.
We have significant investments in mortgage loans and MBS. The prepayment options embedded in mortgages can result in extensions or contractions in the expected weighted average life of these investments, depending on changes in interest rates and other economic factors. We primarily
manage the interest-rate and prepayment risk associated with mortgages through debt issuance, which includes both callable and non-callable debt, to achieve cash-flow patterns and liability durations similar to those expected on the mortgage portfolios. Due to the use of call options and lockouts, and by selecting appropriate maturity sectors, callable debt provides an element of protection for the prepayment risk in the mortgage portfolios. The average life of callable debt, like that of a mortgage, shortens when interest rates decrease and lengthens when interest rates increase.
Significant
resources, including analytical computer models and an experienced professional staff, are devoted to properly measuring the level of interest-rate risk in the balance sheet, thus allowing us to monitor the risk against policy and regulatory limits. We use asset and liability models to calculate market values under alternative interest-rate scenarios. The models analyze our financial instruments, including derivatives, using broadly accepted algorithmswith consistent and appropriate behavioral assumptions, market prices, market data (such as rates, volatility, etc.) and current position data. On at least an annual basis, we review the major assumptions and methodologies used in the models, including discounting curves, spreads for discounting, and prepayment assumptions.
Types of Key Market Risks
Our
market risk results from various factors, such as:
•Interest Rates - level of interest rates and parallel and non-parallel shifts in the yield curve;
•Basis Risk - the risk that changes to one interest-rate index will not perfectly offset changes to another interest-rate index;
•Volatility - varying values of assets or liabilities created by the changing expectations of the magnitude or frequency of changes in interest rates;
•Embedded Options - includes consideration of potential variability in the cash flows of financial instruments (i.e., advances, investments or derivatives)
resulting from any options embedded in the instruments, such as prepayment options in mortgages and callable bonds; and
•Prepayment Speeds - expected levels of principal payments on mortgage loans held in a portfolio or supporting an MBS, variations from which alter their cash flows, yields, and values, particularly in cases where the loans or MBS are acquired at a premium or discount.
Measuring Market Risks
To evaluate market risk, we utilize multiple risk measurements, including Value-at-Risk ("VaR"), duration of equity, convexity, changes in MVE, duration gap, and earnings at risk. Periodically, we conduct stress tests to measure and analyze the effects that extreme movements in the level of interest rates and the shape of the yield curve
would have on our risk position.
Market Risk-Based Capital Requirement. The market risk-based capital requirement is an estimate of the market value decline of the portfolio at risk from movements in interest rates and other factors that could occur during times of market stress. We use an internal, VaR-based model to make the estimate. The model:
•is intended to result in an estimate such that the probability of loss greater than the estimate is no more than one percent; and
•uses certain interest-rate and market price scenarios we develop in accordance with Finance Agency guidance.
The table below presents the VaR estimate ($ amounts in millions).
Duration of Equity. Duration of equity is a measure of interest-rate risk and is one of the primary metrics used to manage our market risk exposure. It is a linear estimate of the percentage change in our MVE that could be caused by a 100 bps parallel upward or downward shift in the interest-rate curves. We value our portfolios using a mix of the EFFR/SOFR curve, Agency curve, U.S. Treasury curve and external prices. The market
value and interest-rate sensitivity of each asset, liability, and off-balance sheet position is determined to compute our duration of equity. We calculate duration of equity using the interest-rate curve as of the date of calculation and for defined interest rate shock scenarios, including scenarios for which the interest-rate curve is 100 bps and 200 bps higher or lower than the base level. Our board of directors determines acceptable ranges for duration of equity for the base scenario. A negative duration of equity suggests adverse exposure to falling rates and a favorable response to rising rates, while a positive duration suggests adverse exposure to rising rates and a favorable response to falling rates.
The Bank's duration of equity is impacted by the convexity of its financial instruments. Convexity measures the rate of change of duration, or curvature, as a function of interest-rate changes. Measurement of convexity is important because of the optionality embedded in the mortgage assets and callable debt liabilities. The mortgage assets exhibit negative convexity due to embedded prepayment options. Callable debt liabilities exhibit positive convexity due to embedded options that we can exercise to redeem the debt prior to maturity. Management routinely reviews the net convexity exposure and considers it when developing funding and hedging strategies for the acquisition of mortgage-based assets. A primary strategy for managing convexity risk arising from our mortgage portfolio is the issuance of callable debt. The negative convexity of the
mortgage assets tends to be partially offset by the positive convexity contributed by underlying callable debt liabilities.
Market Value of Equity. MVE represents the difference between the estimated market value of total assets and the estimated market value of total liabilities, including any off-balance sheet positions. It measures, in present value terms, the long-term economic value of current capital and the long-term level and volatility of net interest income.
We also monitor the sensitivities of MVE to potential interest-rate scenarios. We measure potential changes in the market value to book value of equity based on the current month-end level of rates versus various large parallel and non-parallel shifts in rates. Our board of directors determines acceptable ranges for the change in MVE for 200 bps parallel upward
or downward shift in the interest-rate curves as well as certain flattening and steepening scenarios.
Key Metrics. The following table presents certain market and interest-rate metrics under different interest-rate scenarios ($ amounts in millions).
The changes in those key metrics from December 31, 2021 resulted primarily from the change in market value of the Bank's assets and liabilities in response to changes in the market environment, changes in portfolio composition and our hedging strategies.
Duration Gap. A related measure of interest-rate risk
is duration gap, which is the difference between the estimated durations (market value sensitivity) of assets and liabilities. Duration gap measures the sensitivity of assets and liabilities to interest-rate changes. Duration generally indicates the expected change in an instrument's market value resulting from an increase or a decrease in interest rates. Higher duration numbers, whether positive or negative, indicate greater volatility of market value in response to changing interest rates. The base case duration gap at December 31, 2022 and 2021 was (0.03)% and (0.11)% , respectively.
As part of our overall interest-rate risk management process, we continue to evaluate strategies to manage interest-rate risk.
We use derivatives to hedge our market risk exposures. The primary types of derivatives used are interest-rate swaps, forward contracts and caps. Derivatives increase the flexibility of our funding alternatives by providing specific cash flows or characteristics that might not be as readily available or cost effective if obtained in the cash debt market. We do not speculate using derivatives and do not engage in derivatives trading.
Hedging Debt Issuance. When CO bonds are issued, we often use the derivatives market to create funding that is more attractively priced than the
funding available in the consolidated obligations market. A typical hedge of this type occurs when a CO bond is issued, while we simultaneously execute a matching interest rate swap. The counterparty pays a rate on the swap to us, which is designed to mirror the interest rate we pay on the CO bond. In this transaction we typically pay a variable interest rate which closely matches the interest payments we receive on short-term or variable-rate advances or investments. This intermediation between the bond and swap markets permits the acquisition of funds by us at lower all-in costs than would otherwise be available through the issuance of simple fixed- or floating-rate consolidated obligations in the bond markets. The continued attractiveness of such debt depends on yield relationships between the debt and derivative markets. If conditions in these markets change, we may alter the types or terms of the CO bonds that we issue. Occasionally, interest rate swaps are executed
to hedge discount notes.
Hedging Advances. Interest-rate swaps are also used to increase the flexibility of advance offerings by effectively converting the specific cash flows or characteristics that the borrower prefers into cash flows or characteristics that may be more readily or cost effectively funded in the debt markets.
Hedging Mortgage Loans. We use Agency TBAs to hedge MDC positions.
Hedging Investments. Some interest-rate swaps are executed to hedge investments. In addition, interest-rate caps are purchased to reduce the risk inherent in floating-rate instruments that include caps as part of the structure.
Other Hedges. We
occasionally use derivatives, such as swaptions, to maintain our risk profile within the approved risk limits set forth in our risk management policies. We are permitted to act as an intermediary between certain smaller member institutions and the capital markets by executing interest-rate swaps with members, but have not done so.
The volume of derivative hedges is often expressed in terms of notional amount, which is the amount upon which interest payments are calculated. The following table highlights the notional amounts by type of hedged item, hedging instrument, and hedging objective ($ amounts in millions).
Converts the bond’s fixed rate to a variable-rate index.
Fair-value
2,869
1,041
Economic
140
200
Receive
fixed or structured, pay floating interest-rate swap (with options)
Converts the bond’s fixed rate to a variable-rate index and offsets option risk in the bond.
Fair-value
27,921
19,341
Economic
10
—
Receive
float, pay float basis swap
Reduces interest-rate sensitivity and repricing gaps by converting the bond’s variable rate to a different variable-rate index.
Economic
—
595
Sub-total CO bonds
30,940
21,177
Discount
notes:
Receive fixed, pay floating interest-rate swap
Converts the discount note’s fixed rate to a variable-rate index.
Economic
2,000
—
Sub-total discount notes
2,000
—
Stand-alone
derivatives:
MDCs
Not Applicable
N/A
31
96
Sub-total stand-alone derivatives
31
96
Total
notional
$
72,975
$
55,811
The use of different types of derivatives varies based on our balance sheet size, our members' demand for advances, mortgage loan purchase activity, and consolidated obligation issuance levels.
Interest-Rate Swaps. The following table presents the amount swapped by interest-rate payment terms for trading and AFS securities, advances, CO bonds, and discount notes ($ amounts in millions).
Financial Instrument and Interest-Rate Payment Term
Total Outstanding
Amount Swapped
% Swapped
Total Outstanding
Amount Swapped
% Swapped
Trading securities:
Total
fixed-rate
$
2,230
$
2,230
100
%
$
3,947
$
3,947
100
%
Total
trading securities, fair value
$
2,230
$
2,230
100
%
$
3,947
$
3,947
100
%
AFS
securities:
Total fixed-rate
$
12,190
$
12,190
100
%
$
9,008
$
9,008
100
%
Total
AFS securities, amortized cost
$
12,190
$
12,190
100
%
$
9,008
$
9,008
100
%
Advances:
Total
fixed-rate
$
31,397
$
21,739
69
%
$
22,316
$
17,234
77
%
Total variable-rate
5,894
2,300
39
%
4,994
3,850
77
%
Total
advances, par value
$
37,291
$
24,039
64
%
$
27,310
$
21,084
77
%
CO
bonds:
Total fixed-rate
$
39,226
$
30,939
79
%
$
37,616
$
20,582
55
%
Total
variable-rate
2,776
—
—
%
4,934
595
12
%
Total CO bonds, par value
$
42,002
$
30,939
74
%
$
42,550
$
21,177
50
%
Discount
notes:
Total fixed-rate
$
27,534
$
2,000
7
%
$
12,118
$
—
—
%
Total
discount notes, par value
$
27,534
$
2,000
7
%
$
12,118
$
—
—
%
The change in the percentage of swapped
advances at December 31, 2022 compared to December 31, 2021, is due to the shift in the relative amount of shorter-term fixed-rate advances funded primarily by discount notes. The general decline in LIBOR floating-rate advances formerly hedged with LIBOR basis swaps drove the reduced amount of variable-rate advances as members shifted those advances to other indices.
The increase in the percentage of swapped fixed-rate CO bonds is due to increases in short-term assets, as well as liquidity assets and fixed-rate advances requiring swapped funding. The variable-rate CO bonds at December 31, 2022 were SOFR floating-rate liabilities with no requirements for swaps.
For information on credit risk related
to derivatives, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management - Credit Risk Management - Derivatives.
Replacement of the LIBOR Benchmark Interest Rate
In March 2021, the United Kingdom Financial Conduct Authority ("FCA") confirmed that the publication of the principal tenors of U.S. dollar LIBOR (i.e., overnight, one-month, three-month, six-month and 12-month LIBOR) will cease immediately following a final publication on June 30, 2023. As of January 1, 2022, the one-week and two-month U.S. dollar LIBOR settings and all non-U.S. dollar LIBOR settings ceased to be provided by any
administrator. The FCA has indicated that it does not expect the remaining U.S. dollar LIBOR settings to become unrepresentative before the cessation date.
A portion of our advances, investments, derivative assets, derivative liabilities, and related collateral remain directly or indirectly indexed to U.S. dollar LIBOR with maturity dates that extend beyond June 30, 2023. As a result, we have taken and will continue to take steps to transition our LIBOR-linked financial instruments and contracts. To that end, and consistent with a Finance Agency supervisory letter sent to the FHLBanks in September 2019, we ceased purchasing investments that reference LIBOR and mature after December 31, 2021. Effective March
31, 2020, we ceased to enter into LIBOR-linked structured advances and, effective June 30, 2020, we ceased to enter into all other LIBOR-linked transactions, with maturities that extend beyond December 31, 2021. Further, we have endeavored to identify and amend our financial instruments and contracts including advances, investments and derivatives that may require adding or adjusting fallback language.
We
continue to take steps to adopt SOFR, the alternative to U.S. dollar LIBOR recommended by the Alternative Reference Rates Committee, for our relevant products, services and financial instruments. In October 2020, the clearinghouses transitioned the rate for discounting all U.S. dollar interest-rate cleared swaps to SOFR and SOFR is now the dominant index in the market for any new financial transactions. We have fully transitioned to utilize interest-rate swaps based on SOFR or the EFFR as alternative interest-rate hedging strategies.
We have also adhered to the International Swaps and Derivatives Association 2020 Interbank Offered Rate Fallbacks Protocol and will work with its counterparties, as necessary, to address its over-the-counter derivative agreements referencing U.S. dollar LIBOR as a part of its LIBOR transition efforts. We continue to monitor the market-wide efforts to address fallback language
related to derivatives and investment securities, as well as fallback language for new activities and issuances of financial instruments.
Further, each clearinghouse announced its own proposal for the conversion process of LIBOR-linked cleared derivatives to risk-free rates. The conversions are scheduled to occur in several tranches based on product type and are generally expected to be completed before the effective date of LIBOR cessation for all covered products that are utilized by the Bank.
We continue to implement our transition plan that has reduced our exposure to the transition arising from the cessation of the publication of LIBOR and has the flexibility to evolve with market developments and standards, member needs, and guidance provided by the issuers of Agency securities. As a result, we do not expect the replacement
of LIBOR by June 30, 2023 to have a material adverse impact on the Bank's business, results of operations or financial condition.
For more information, see Item 1A. Risk Factors - Changes in Response to the Replacement of the LIBOR Benchmark Interest Rate Could Adversely Affect Our Business, Financial Condition and Results of Operations.
The following table presents our LIBOR-rate indexed financial instruments outstanding at December 31, 2022 and 2021 by year of maturity ($ amounts in millions).
(1) Year
of maturity on our advances is based on redemption term.
(2) Year of maturity on our MBS, interest-rate swaps, and interest-rate caps is based on contractual maturity. The actual maturities on MBS will likely differ from contractual maturities as borrowers have the right to prepay their obligations with or without prepayment fees.
Management's
Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting ("ICFR"), as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Our ICFR is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
•pertain to the maintenance of our records that, in reasonable detail, accurately and fairly reflect our transactions and asset dispositions;
•provide reasonable assurance that our transactions are recorded as
necessary to permit the preparation of our financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and board of directors; and
•provide reasonable assurance regarding the prevention or timely detection of any unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
Reasonable assurance, as defined in Section 13(b)(7) of the Exchange Act, is the level of detail and degree of assurance that would satisfy prudent officials in the conduct of their own affairs in devising and maintaining a system of internal accounting controls.
Because of its inherent limitations, ICFR may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our principal executive officer, principal financial officer and principal accounting officer, we assessed the effectiveness of our ICFR as of December 31, 2022. Our assessment included extensive documentation, evaluation, and testing of the design and operating effectiveness of our ICFR. In making this assessment, our management used the criteria established in Internal Control — Integrated Framework(2013) issued by the
Committee of Sponsoring Organizations of the Treadway Commission. These criteria include the areas of control environment, risk assessment, control activities, information and communication, and monitoring. Based on our assessment using these criteria, our management concluded that we maintained effective ICFR as of December 31, 2022.
Report of Independent Registered Public Accounting Firm
To
the Board of Directors and Shareholders of the Federal Home Loan Bank of Indianapolis
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying statements of condition of the Federal Home Loan Bank of Indianapolis (the "Bank") as of December 31, 2022 and 2021, and the related statements of income, of comprehensive income, of capital and of cash flows for each of the three years in the period ended December 31, 2022, including the related notes (collectively referred to as the "financial statements"). We also have audited the Bank's internal control over financial reporting as of December 31,
2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Bank as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Bank maintained, in all material respects, effective internal control over financial reporting as of December 31,
2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Bank's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 8. Our responsibility is to express opinions on the Bank's financial statements and on the Bank's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Bank in accordance
with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the
company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Valuation
of Interest-Rate Related Derivatives and Hedged Items
As described in Notes 8 and 16 to the financial statements, the Bank uses derivatives to reduce funding costs and to manage its exposure to interest-rate risks, among other objectives. The total notional amount of derivatives as of December 31, 2022 was $73 billion, of which 91% were designated as hedging instruments, and the net fair value of derivative assets and liabilities as of December 31, 2022 was $434 million and $19 million, respectively. The fair values of interest-rate related derivatives and hedged items are generally estimated using standard valuation techniques such as discounted cash-flow analysis and comparisons to similar instruments. The discounted cash-flow analysis uses market-observable inputs, such as interest rate curves and volatility
assumptions.
The principal considerations for our determination that performing procedures relating to the valuation of interest-rate related derivatives and hedged items is a critical audit matter are the significant audit effort in evaluating the interest rate curves and volatility assumptions used to fair value these derivatives and hedged items, and the audit effort involved the use of professionals with specialized skill and knowledge.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the financial statements. These procedures included testing the effectiveness of controls relating to the valuation of interest-rate related derivatives and hedged items, including controls over the method, data and assumptions. These procedures also included, among others, the
involvement of professionals with specialized skill and knowledge to assist in developing an independent range of prices for a sample of interest-rate related derivatives and hedged items and comparison of management’s estimate to the independently developed ranges. Developing the independent range of prices involved testing the completeness and accuracy of data provided by management and independently developing the interest rate curves and volatility assumptions.
Net
proceeds (payments) on derivative contracts with financing elements
i900
(i25,365)
(i3,694)
Net
proceeds from issuance of consolidated obligations:
Discount notes
i835,663,808
i291,172,745
i355,337,396
Bonds
i17,914,235
i43,151,651
i48,663,468
Payments
for matured and retired consolidated obligations:
Discount notes
(i820,497,490)
(i295,668,613)
(i356,372,123)
Bonds
(i18,461,850)
(i43,819,310)
(i50,052,784)
Proceeds
from issuance of capital stock
i368,041
i99,638
i266,906
Payments
for redemption/repurchase of capital stock
(i161,885)
(i56,277)
(i621)
Payments
for redemption/repurchase of mandatorily redeemable
capital stock
(i7,151)
(i205,076)
(i104,925)
Partial
recovery of prior capital distribution to Financing Corporation
i—
i—
i10,574
Dividend
payments on capital stock
(i67,454)
(i54,142)
(i76,415)
Net
cash provided by (used in) financing activities
i14,160,491
(i5,413,558)
(i1,917,687)
Net
increase (decrease) in cash and due from banks
(i846,719)
(i943,664)
i1,591,250
Cash
and due from banks at beginning of year
i867,880
i1,811,544
i220,294
Cash
and due from banks at end of year
$
i21,161
$
i867,880
$
i1,811,544
Supplemental
Disclosures:
Cash activities:
Interest payments
$
i738,492
$
i265,209
$
i804,173
Affordable
Housing Program payments
i16,914
i14,073
i14,399
Non-cash
activities:
Purchases of investment securities, traded but not yet settled
i72,788
i—
i236,507
The
accompanying notes are an integral part of these financial statements.
95
Notes to Financial Statements, continued
($ amounts in thousands unless otherwise indicated)
i
These
Notes to Financial Statements should be read in conjunction with the Statements of Condition as of December 31, 2022 and 2021, and the Statements of Income, Comprehensive Income, Capital, and Cash Flows for the years ended December 31, 2022, 2021, and 2020. Acronyms and terms used throughout these Notes to Financial Statements are defined herein or in the Defined Terms. Unless the context otherwise requires, the terms "Bank,""we,""us," and "our" refer to the Federal Home Loan Bank of Indianapolis or its management.
Background Information
The
Federal Home Loan Bank of Indianapolis, a federally chartered corporation, is one of i11 regional wholesale FHLBanks in the United States. The FHLBanks are GSEs that were organized under the Bank Act to serve the public by enhancing the availability of credit for residential mortgages and targeted community development. Even though the Bank is part of the FHLBank System, we operate as a separate entity with our own management, employees, shareholders and board of directors.
Each FHLBank is a financial cooperative that provides a readily
available, competitively-priced source of funds to its member institutions. Regulated financial depositories and non-captive insurance companies engaged in residential housing finance that have their principal place of business located in, or are domiciled in, our district states of Michigan or Indiana are eligible for membership. Additionally, qualified CDFIs are eligible to be members. Housing Associates, including state and local housing authorities, that meet certain statutory and regulatory criteria may also borrow from us, but are not members and, as such, are not allowed to hold our capital stock.
Each member must purchase a minimum amount of our capital stock based on the amount of its total assets. A member may be required to purchase additional activity-based capital stock as it engages in certain business activities with us. Members and former members own all of our capital stock. Former members
(including certain non-member institutions that own our capital stock as a result of a merger with or acquisition of a member) hold our capital stock beyond the redemption period solely to support credit products or mortgage loans still outstanding on our statement of condition. All owners of our capital stock, to the extent declared by our board of directors, receive dividends on their capital stock, subject to applicable regulations.
The FHLBanks' Office of Finance facilitates the issuance and servicing of the debt instruments of the FHLBanks, known as consolidated obligations, consisting of bonds and discount notes, and prepares and publishes the FHLBanks' combined quarterly and annual financial reports.
Proceeds from the issuance of consolidated obligations are the primary source of funds for the FHLBanks. Deposits, other borrowings and capital
stock issued to members provide additional funds. We primarily use these funds to:
•disburse advances to members;
•acquire mortgage loans from PFIs through our MPP;
•maintain liquidity; and
•invest in other opportunities to support the residential housing market.
We also provide correspondent services, such as wire transfer, security safekeeping, and settlement services, to our members.
The Finance Agency is the independent federal regulator of the FHLBanks, Freddie Mac, and Fannie Mae. The Finance Agency's stated mission is to ensure that
the housing GSEs operate in a safe and sound manner so that they serve as a reliable source of liquidity and funding for housing finance and community investment.
($ amounts in thousands unless otherwise indicated)
Note 1 - Summary of Significant Accounting
Policies
i
Basis of Presentation. The accompanying financial statements have been prepared in accordance with GAAP and SEC requirements.
The financial statements contain all adjustments that are, in the opinion of management, necessary for a fair statement of the Bank's financial position, results of operations and cash flows for the periods presented. All such adjustments were of a normal recurring nature.
i
Use
of Estimates.When preparing financial statements in accordance with GAAP, we are required to make subjective assumptions and estimates that may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of income and expense. Although the reported amounts and disclosures reflect our best estimates, actual results could differ significantly from these estimates. The most significant estimates pertain to the fair values of financial instruments.
Estimated Fair Value.The estimated fair value amounts, recorded on the statement of condition and presented in the accompanying disclosures, reflect appropriate valuation methods and were determined based on the assumptions that we believe market participants would use in pricing the asset or liability.
Although we use our best judgment in estimating fair value, there are inherent limitations in any valuation technique. Therefore, these estimated fair values may not be indicative of the amounts that would have been realized in market transactions on the reporting dates. For more information, see Note 16 - Estimated Fair Values.
Changes in Estimates.Changes in estimates are accounted for prospectively, i.e. in the period of change, and do not result in a revision or restatement of prior period amounts.
iReclassifications.We
have reclassified certain amounts reported in prior periods to conform to the current period presentation. These reclassifications had no effect on total assets, total liabilities, total capital, net income, total comprehensive income or net cash flows.
iInterest-Bearing Deposits, Securities Purchased under Agreements to Resell, and Federal Funds Sold. These investments provide short-term liquidity and are
carried at cost. Securities purchased under agreements to resell are treated as short-term, collateralized financings and are generally transacted with an overnight term. These securities are held in safekeeping in the Bank's name by third-party custodians approved by us. For securities outstanding longer than overnight, if the market value of the underlying assets declines below the market value required as collateral, the counterparty must (i) place an equivalent amount of additional securities in safekeeping in the Bank's name, and/or (ii) remit an equivalent amount of cash. Federal funds sold are short-term, unsecured loans that are generally transacted with an overnight term. Finance Agency regulations include a limit on the amount of unsecured credit an individual FHLBank may extend to a counterparty.
i
Investment
Securities.Purchases and sales of securities are recorded on a trade date basis. We classify investments as trading, HTM or AFS at the date of acquisition.
Trading Securities. Securities classified as trading are held for liquidity purposes and carried at fair value. Changes in the fair value of these securities are recorded through other income as net gains (losses) on trading securities. Finance Agency regulation and our risk management policies prohibit the speculative use of these instruments and limit the credit risk arising from these securities.
HTM Securities. Securities for which we have both the positive intent and ability to hold to maturity are classified as HTM and carried at amortized cost. The carrying value includes
adjustments made to the cost basis of the security for purchase discount and related accretion, purchase premium and related amortization, and collection of principal.
($ amounts in thousands unless otherwise indicated)
AFS Securities. Securities that are not classified as trading or HTM are classified as AFS and carried at estimated
fair value. Changes in the fair value of these securities are recorded in OCI as net change in unrealized gains (losses) on AFS securities, except for AFS securities in hedging relationships that qualify as fair-value hedges. For those securities, the portion of the change in fair value attributable to the risk being hedged is recorded in interest income together with the related change in the fair value of the derivative, and the remainder of the change in the fair value of the security is recorded in OCI as net change in unrealized gains (losses) on AFS securities. In general, securities classified as AFS may be sold at any time, although specific consideration is given to securities in an unrealized loss position.
Amortization of Purchase Premiums and Discounts.Since we hold a large number of similar loans underlying our MBS, for which
prepayments are probable and the timing and amount of prepayments can be reasonably estimated, we amortize or accrete premiums, discounts, and cumulative fair-value hedging basis adjustments on MBS to interest income using a level-yield under the retrospective interest method. This method requires that we estimate prepayments over the estimated life of each security and retrospectively adjust the effective yield each time the estimated remaining cash flows change as if the new estimate had been used since the original acquisition date. Changes in interest rates are a significant assumption used in estimating the timing and amount of prepayments.
For all non-MBS securities, we amortize or accrete premiums, discounts, and cumulative fair-value hedging basis adjustments using a level-yield methodology over the contractual life of each security, with the exception
of our callable non-MBS securities, on which the purchase premium is amortized to the next call date. For all non-MBS securities, prepayments are not estimated but only taken into account as they actually occur.
Gains and Losses on Sales. We compute gains and losses on sales of investment securities using the specific identification method and include these gains and losses in other income as net realized gains (losses) from sale of securities.
i
Advances.We record advances at amortized cost, adjusted to include deferred swap termination fees associated with modified advances, net of deferred prepayment fees, and cumulative fair-value hedging basis adjustments. We amortize such fees and hedging basis adjustments to interest income using a level-yield methodology over the contractual life of the advance. When an advance is prepaid, we amortize to interest income a proportionate share of the remaining balance of those adjustments.
Prepayment Fees. We charge a prepayment fee when a borrower repays certain advances prior to maturity. We report prepayment fees, net of any associated swap termination fees and cumulative fair-value hedging basis adjustments, in interest income on advances.
Advance
Modifications. When we fund a new advance concurrent with, or within a short period of time after, the prepayment of an original advance, we determine whether the transaction is effectively either (i) two separate transactions (the prepayment of the original advance and the disbursement of a new advance), defined as an advance extinguishment, or (ii) the continuation of the original advance as modified, defined as an advance modification.
We account for the transaction as an extinguishment if both of the following criteria are met: (i) the effective yield of the new advance is at least equal to the effective yield for a comparable advance to a member with similar collection risks who is not prepaying, and (ii) modifications of the original advance are determined to be more than minor, i.e., if the present value of the cash flows under the terms of the new advance is at least i10%
different from the present value of the remaining cash flows under the original advance or through an evaluation of qualitative factors, which may include changes in the interest-rate exposure to the member by moving from a fixed to an adjustable-rate advance. In all other instances, the transaction is accounted for as an advance modification.
If the transaction is determined to be an advance extinguishment, we recognize income from nonrefundable prepayment fees, net of associated swap termination fees, in the period that the extinguishment occurs. Alternatively, if no prepayment fees are received (e.g., the member requests that we embed the prepayment fee into the rate of the new advance), the excess of the present value of the cash flows of the new advance over those of an advance with a current market rate and otherwise comparable terms is immediately recognized in income, and the basis of the new advance
is adjusted accordingly.
($ amounts in thousands unless otherwise indicated)
If the transaction is determined to be an advance modification, the nonrefundable prepayment fees, net of associated swap termination
fees, are not immediately recognized in income but are (i) included in the carrying value of the modified advance and amortized into interest income over the life of the new advance using a level-yield methodology or (ii) embedded into the rate of the modified advance and recorded as an adjustment to the interest accrual.
i
Mortgage Loans Held for Portfolio.We classify mortgage loans, for which we have the positive
intent and ability to hold for the foreseeable future or until maturity or payoff, as held for portfolio. Accordingly, these mortgage loans are reported at amortized cost, adjusted to include premiums paid to and discounts received from PFIs, hedging basis adjustments, and the allowance for credit losses.
Amortization of Purchase Premiums and Discounts.We amortize or accrete premiums and discounts and hedging basis adjustments to interest income using a level-yield methodology over the contractual life of each loan. When a loan is prepaid, we amortize to interest income a proportionate share of the remaining balance of those adjustments.
Non-accrual Loans. We place a conventional mortgage loan on non-accrual status if it is determined
that either (i) the collection of interest or principal is doubtful, or (ii) interest or principal is past due for 90 days or more, except when the loan is well secured and in the process of collection (e.g., through credit enhancements and monthly servicer remittances on a scheduled/scheduled basis in which we receive monthly principal and interest payments from the servicer regardless of whether the borrower has made payments to the servicer). Monthly servicer remittances for loans on an actual/actual basis may also be well secured; however, servicers on actual/actual remittance do not advance principal and interest due, regardless of borrower creditworthiness, until the payments are received from the borrower or when the loan is repaid. As a result, these loans are placed on non-accrual status once they become 90 days delinquent.
A government-guaranteed or -insured mortgage loan is not placed on non-accrual
status when the collection of the contractual principal or interest is 90 days or more past due because of the contractual obligation of the loan servicer to pay defaulted interest at the contractual rate.
For those mortgage loans placed on non-accrual status, accrued but uncollected interest is reversed against interest income (for any interest accrued in the current year) and/or the allowance for credit losses (for any interest accrued in the previous year). We record payments received on non-accrual loans as a direct reduction of the amortized cost of the loan. When the amortized cost has been fully collected, any additional amounts collected are recognized as interest income. A loan on non-accrual status may be restored to accrual status when it becomes current (zero days past due) and three consecutive and timely monthly payments have been received.
Loan
Participations.All participating interests in loans acquired from our PFIs that are sold to other FHLBanks meet the accounting requirements for a sale and, therefore, are derecognized from our reported mortgage loan balances and a pro-rata portion of the fixed LRA is assumed by the participating FHLBank for its use in loss mitigation. As a result, available funds remaining in our LRA are limited to our pro-rata portion of the fixed LRA that is associated with the participating interests retained by us. The portion of the participation fees received related to our upfront costs is recognized immediately into income, while the remaining portion related to our ongoing costs is deferred and amortized to income over the remaining life of the participated loans.
i
Troubled
Debt Restructuring ("TDR"). A TDR related to MPP loans typically occurs when a concession is granted to a borrower for economic or legal reasons related to the borrower's financial difficulties that would not have been otherwise considered. Although we do not participate in government-sponsored loan modification programs, we do consider certain conventional loan modifications to be TDRs when the modification agreement permits the recapitalization of past due amounts, generally up to the original loan amount. If a borrower is having financial difficulty and a significant concession has been granted by the PFI with our approval, the loan modification is considered a TDR. No other terms of the original loan are modified, except for the possible extension of the contractual maturity date on a case-by-case basis. In no event does the borrower's original interest rate change.
Modifications
of government loans are not considered or accounted for as TDRs because we anticipate no loss of principal or interest accrued at the original contract rate, or significant delay, due to the government guarantee or insurance.
($ amounts in thousands unless otherwise indicated)
i
Charge-Offs.
A charge-off is recorded to the extent that the amortized cost (including UPB, unamortized premiums or discounts, and hedging basis adjustments) of a loan will not be fully recovered. We record a charge-off on a conventional mortgage loan against the credit loss allowance upon the occurrence of a confirming event. Confirming events include, but are not limited to, the settlement of a claim against any of the credit enhancements, delinquency in excess of 180 days unless we determine that the delinquent loan is well-secured and in-process of collection, and filing for bankruptcy protection. We charge off the portion of the outstanding conventional mortgage loan balance in excess of the fair value of the underlying property, less costs to sell and adjusted for any available credit enhancements.
Allowance for Credit Losses on Financial Instruments.Our financial
instruments, i.e. interest-bearing deposits, securities purchased under agreements to resell, federal funds sold, investment securities, advances (including off-balance sheet credit exposures), and mortgage loans held for portfolio, are evaluated quarterly for expected credit losses. If necessary, an allowance for credit losses is recorded with a corresponding adjustment to the provision for credit losses. The allowance for credit losses excludes uncollectible accrued interest receivable for all instruments, which is measured separately. Any uncollectible accrued interest is written off by a reversal of interest income.
For more information on the allowance methodology related to our financial instruments, see Note 4 - Investments, Note 5 - Advances, Note 6 - Mortgage Loans Held for Portfolio, and Note 17 - Commitments and Contingencies.
iFinancial
Instruments Meeting Netting Requirements.We present certain financial instruments on a net basis when we have a legal right of offset and all other requirements for netting are met (collectively referred to as the netting requirements).
i
Derivatives and Hedging Activities.We record derivative instruments, including related cash collateral and accrued interest, on a net basis, by clearing agent and/or by counterparty,
as either derivative assets or derivative liabilities at their estimated fair values. Changes in the estimated fair value of derivatives are recorded in current period earnings.
For derivative instruments that meet the netting requirements, any excess cash collateral received or pledged is recognized as a derivative liability or derivative asset, respectively. For derivative instruments that do not meet the netting requirements, cash collateral is recognized as an interest-bearing asset or liability, as appropriate.Additional information regarding these transactions is provided in Note 8 - Derivatives and Hedging Activities.
Designations. Derivatives are recorded beginning on the trade date and typically
executed and designated in a qualifying hedging relationship at the same time as the acquisition of the associated hedged item. We may also designate the hedging relationship upon the Bank's commitment to disburse an advance, purchase financial instruments, or trade a consolidated obligation in which settlement occurs within the shortest period of time possible for the type of instrument based on market settlement conventions. Each derivative is designated as one of the following:
(i)a qualifying hedge of the change in fair value of a recognized asset or liability (e.g., advances, AFS investments, and CO bonds) or an unrecognized firm commitment (fair-value hedge); or
(ii)a non-qualifying hedge for asset/liability management purposes (economic hedge).
In
all cases involving a fair-value hedge of a recognized asset, liability or firm commitment, the designated risk being hedged is the risk of changes in the fair value of the hedged item attributable to changes in the designated benchmark interest rate.
Accounting for Qualifying Hedges. Hedging relationships must meet certain criteria including, but not limited to, formal documentation of the hedging relationship and an expectation to be highly effective to qualify for hedge accounting. Two approaches to account for qualifying fair-value hedge relationships include:
(i)Shortcut hedge accounting - Hedging relationships that meet certain criteria qualify for the shortcut method of hedge accounting. Under the shortcut method, an assumption can be made that the entire change in fair
value of a hedged item, due to changes in the benchmark interest rate, equates to the entire change in fair value of the related derivative. As a result, the derivative is considered to be perfectly effective in achieving offsetting changes in the fair value of the hedged asset or liability attributable to the hedged risk. When applying the shortcut method, we document, at inception of the hedging relationship, a quantitative long-haul method that we can apply should we subsequently determine a hedging relationship no longer qualifies for shortcut hedge accounting; or
($ amounts in thousands unless otherwise indicated)
(ii)Long-haul hedge accounting - The application of long-haul hedge accounting requires us to assess whether the derivatives used in hedging relationships are highly effective in achieving offsetting changes in the fair value of hedged items or forecasted transactions attributable to the hedged risk and whether those derivatives may be expected to remain highly effective in future periods. As part of the assessment, a regression analysis is performed at the inception of each hedging relationship and at each month-end thereafter.
While a number of long-haul methods and techniques are permissible, we utilize the following:
•Total
Contractual Coupon Method -In calculating the change in fair value of the hedged item attributable to changes in the benchmark interest rate, the estimated coupon cash flows are based on the full contractual coupon.
•Benchmark Component Method - In calculating the change in fair value of the hedged item attributable to changes in the benchmark interest rate, the credit and any other risks embedded in the contractual coupon rate are excluded from the estimated cash flows by aligning the interest component of the derivative with the hedged item. Given this alignment, the application of the benchmark component method generally results in less hedge ineffectiveness in comparison to the total contractual coupon method.
Changes in the fair value of a
derivative that is designated and qualifies as a fair-value hedge, along with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk, are recorded in net interest income in the same line as the earnings effect of the hedged item.
Accounting for Non-Qualifying Hedges.An economic hedge is defined as a derivative that hedges specific or non-specific underlying assets, liabilities, or firm commitments and does not qualify, or was not designated, for hedge accounting. As a result, we recognize the net interest settlements and the change in fair value of these derivatives in other income (loss) with no offsetting fair-value adjustments in earnings for the hedged assets, liabilities, or firm commitments. An economic hedge by definition, therefore, introduces the potential for earnings variability.
Accrued
Interest Receivables and Payables. The difference between the interest receivable and payable on a derivative designated as a qualifying hedge is recognized as a net adjustment to the interest income or expense of the designated hedged item. The difference between the interest receivable and payable on an economic hedge is recognized in other income as net gains (losses) on derivatives.
Discontinuance of Hedge Accounting. We discontinue hedge accounting prospectively when: (i) the hedging relationship ceases to be highly effective or is otherwise discontinued; (ii) the derivative and/or the hedged item expires or matures, is sold, terminated, transferred or exercised; or (iii) a hedged firm commitment no longer meets the definition of a firm commitment.
When hedge accounting is discontinued and the
derivative and hedged item remain, we: (i) continue to carry the derivative on the statement of condition at fair value as an economic hedge; (ii) cease adjusting the hedged asset or liability for changes in fair value; and (iii) amortize the cumulative basis adjustment on the hedged item into interest income over the remaining life of the hedged item using a level-yield methodology.
When we discontinue a qualifying hedge relationship by terminating the derivative and subsequently designating the associated hedged item into a new qualifying hedge relationship, we: (i) recognize the cumulative gain (loss) on the derivative in current period earnings; (ii) pay or receive a termination fee with the counterparty, substantially offsetting the recognized gain (loss) on the derivative; (iii) cease adjusting the hedged asset or liability for changes in fair value; and (iv) amortize the cumulative basis adjustment
on the hedged item into interest income over the remaining life of the hedged item using a level-yield methodology.
Embedded Derivatives. We may issue consolidated obligations, disburse advances, or purchase financial instruments in which a derivative instrument is embedded. In order to determine whether an embedded derivative must be bifurcated from the host instrument and separately valued, we must assess, upon execution of the transaction, whether the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the remaining component of the consolidated obligation, advance or purchased financial instrument (the host contract) and whether a separate, non-embedded instrument with the same terms as the embedded instrument would meet the
definition of a derivative instrument.
($ amounts in thousands unless otherwise indicated)
If we determine that (i) the embedded derivative has economic characteristics that are not clearly and closely related to the economic characteristics of the host contract and (ii) a separate, stand-alone
instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and designated as a stand-alone derivative instrument pursuant to an economic hedge. The host contract is accounted for based on the guidance applicable to instruments of that type that are not hedged. However, if (i) the entire contract (the host contract and the embedded derivative) is required to be measured at fair value, with changes in fair value reported in earnings (such as an investment security classified as trading), or (ii) we cannot reliably
identify and measure the embedded derivative for purposes of separating that derivative from its host contract, the entire contract is carried at fair value, and no portion of the contract is designated as a hedging instrument.
iPremises,
Software, and Equipment. We record premises, software, and equipment at cost, less accumulated depreciation and amortization, in other assets, and compute depreciation and amortization using the straight-line method over their respective estimated useful lives, which range from i3 to i40
years. W/e capitalize improvements and major renewals, but expense maintenance and repairs when incurred. We depreciate building improvements using the straight-line method over the estimated useful life of the improvement. In addition, we capitalize software development costs for internal use software with an estimated economic useful life of at least one year. If capitalized, we use the straight-line method for computing amortization. We include any gain or loss on disposal (other than abandonment) of premises, software, and equipment in other income. Any loss on abandonment is included in other operating expenses.
i
Consolidated
Obligations. Consolidated obligations are recorded at amortized cost, adjusted to include concessions, discounts, premiums, principal payments, and cumulative fair-value hedging basis adjustments.
Concessions. Concessions are paid to dealers in connection with the issuance of certain consolidated obligations. The Office of Finance prorates the amount of our concession based upon the percentage of the debt issued on the Bank's behalf. We record concessions paid on consolidated obligations as a direct deduction from their carrying amounts, consistent with the presentation of discounts on consolidated obligations. The concessions are deferred and amortized, using a level-yield methodology, to interest expense over the term to contractual maturity of the corresponding consolidated obligation. When we prepay a CO bond, a proportionate share
of any remaining balance of concessions is recognized as interest expense.
Discounts and Premiums. We accrete or amortize the discounts and premiums as well as cumulative fair-value hedging basis adjustments to interest expense using a level-yield methodology over the term to contractual maturity of the corresponding CO bond. When we prepay a CO bond, a proportionate share of the remaining balance of those adjustments is recognized as interest income.
Debt Extinguishments.When we extinguish a CO prior to the contractual maturity date on other than a call date, any gain or loss resulting from the extinguishment is recorded in other income (loss) as the difference between the cash paid (market price) and the current carrying
value. We do not consider these gains or losses to be extraordinary.
i
Mandatorily Redeemable Capital Stock. When a member withdraws or attains non-member status by merger or acquisition, charter termination, relocation or other involuntary termination from membership, the member's shares are then subject to redemption, at which time a ifive-year
redemption period commences for Class B stock. Since the shares meet the definition of a mandatorily redeemable financial instrument, the shares are reclassified from capital to liabilities as MRCS at estimated fair value, which is equal to par value. Dividends declared on shares classified as a liability are accrued at the expected dividend rate and reported as interest expense.
We reclassify MRCS from liabilities to capital when non-members subsequently become members through either acquisition, merger, or election. After the reclassification, dividends declared on that capital stock are no longer classified as interest expense.
/
iRestricted
Retained Earnings. In accordance with our Joint Capital Enhancement Agreement, as amended, among the 11 FHLBanks, we allocatei20% of the Bank's net income each quarter to a separate restricted retained earnings account until the balance of that account, calculated as of the/
last day of each calendar quarter, equals at least i1% of the average balance of the Bank's outstanding consolidated obligations for the current quarter.
($ amounts in thousands unless otherwise indicated)
i
Employee Retirement and Deferred Compensation Plans. We recognize the required contribution to the DB Plan ratably over the plan year to which it relates. Without a prefunding election, any contribution made in excess of the minimum required contribution is recorded as an expense in the quarterly reporting period in which the contribution is made; with a prefunding election, such excess
contribution is recorded as a prepaid asset.
Settlement gains and losses are recognized in earnings only when the total cost of all settlements during a year exceeds the sum of the service and interest cost components of the net periodic pension cost for the year.
iFinance Agency Expenses. The portion of the Finance Agency's expenses and working capital fund not allocated to Freddie Mac and Fannie Mae is allocated among the FHLBanks as assessments, which are based on the
ratio of each FHLBank's minimum required regulatory capital to the aggregate minimum required regulatory capital of every FHLBank. We record our share of these assessments in other expenses.
iOffice of Finance Expenses. Our proportionate share of the Office of Finance's operating and capital expenditures is calculated based upon itwo
components as follows: (i) two-thirds based on our share of total consolidated obligations outstanding and (ii) one-third based on equal pro-rata allocation. We record our share of these expenditures in other expenses./
iCash Flows.We consider cash and due from banks on the statement of condition
as cash and cash equivalents within the statement of cash flows because of their highly liquid nature. Federal funds sold, securities purchased under agreements to resell, and interest-bearing deposits are not treated as cash and cash equivalents, but instead are treated as short-term investments. Accordingly, their associated cash flows are reported in the investing activities section of the statement of cash flows.
Cash flows associated with derivatives are reported as cash flows from operating activities in the statement of cash flows unless the derivatives contain financing elements, in which case they are reflected as cash flows from financing activities. Derivative instruments that include non-standard terms, or require an upfront cash payment, or both, often contain a financing element.
($ amounts in thousands unless otherwise indicated)
i
Note 2 - Recently Adopted and Issued Accounting
Guidance
i
Recently Adopted Accounting Guidance.
Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (ASU 2020-04). On March 12, 2020, the FASB issued optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform. Specifically, the guidance provides accounting relief
related to the following:
Contract modifications. Entities can elect not to apply certain modification accounting requirements to contracts affected by reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination.
Hedging relationships. Entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships
affected by reference rate reform, if certain criteria are met.
Sales or transfers of debt securities classified as HTM. Entities can make a one-time election to sell and/or reclassify HTM securities that were purchased prior to January 1, 2020 and reference an interest rate affected by reference rate reform.
This guidance was originally effective from March 12, 2020 through December 31, 2022 but was extended with the issuance of ASU 2022-06. The guidance will be applied when we implement the fallback provisions associated with our financial instruments that remain indexed to LIBOR on the cessation date; however, its effect on the Bank's financial condition,
results of operations, and cash flows is not expected to be material.
Reference Rate Reform (Topic 848): Deferral of the Sunset Date (ASU 2022-06). On December 21, 2022, the FASB issued guidance to extend the sunset (or expiration) date of ASU 2020-04 (Topic 848) to December 31, 2024. This change takes into account the United Kingdom Financial Conduct Authority's extension of the cessation date of the overnight 1-, 3-, 6-, and 12-month LIBOR tenors to June 30, 2023, which is beyond the original expiration date of the guidance.
Recently Issued Accounting Guidance.
Fair-Value Hedging - Portfolio Layer Method (ASU
2022-01).On March 28, 2022, the FASB issued guidance expanding the existing last-of-layer fair-value hedging method by allowing entities to hedge multiple layers of a single closed portfolio of prepayable financial assets rather than a single (or last) layer only. To reflect the change, the last-of-layer method was renamed the portfolio layer method.
The guidance became effective for the interim and annual periods beginning on January 1, 2023. Upon adoption, this guidance had no impact on the Bank's financial condition, results of operations, or cash flows.
Troubled Debt Restructurings ("TDR") and Vintage Disclosures (ASU 2022-02).On March 31, 2022, the FASB issued guidance eliminating the accounting guidance for TDRs by creditors that have adopted the current expected credit losses methodology while enhancing disclosure requirements for certain loan refinancings and restructurings made to borrowers experiencing financial difficulty. Additionally, the guidance requires disclosure of current-period gross write-offs by year of origination.
The guidance became effective for the interim and annual periods beginning on January 1, 2023. Upon adoption, this guidance did not have a material impact on the Bank's financial condition, results of operations, or cash flows, nor do we expect it to have a material impact on our future disclosures.
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Note
3 - Cash and Due from Banks
Compensating Balances. Periodically, we maintain cash balances with commercial banks in return for certain services. These agreements contain no legal restrictions on the withdrawal of funds. The average cash balances for the years ended December 31, 2022, 2021, and 2020, were $i104,501,
$i227,913, and $i65,945,
respectively.
($ amounts in thousands unless otherwise indicated)
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Note
4 - Investments
Short-term Investments. We invest in interest-bearing deposits, securities purchased under agreements to resell, and federal funds sold to provide short-term liquidity. These investments are generally transacted with counterparties that maintain a credit rating of triple-B or higher (investment grade) by an NRSRO. At December 31, 2022 and 2021, iinone/
of these investments were with counterparties rated below triple-B. The NRSRO ratings may differ from any internal ratings of the investments, if applicable.
Allowance for Credit Losses.
Interest-Bearing Deposits. Interest-bearing deposits are considered overnight investments given our ability to withdraw funds from these accounts at any time. As such, iino/
allowance for credit losses was recorded for these investments at December 31, 2022 and 2021.
Securities Purchased Under Agreements to Resell.We use the collateral maintenance provision with our counterparties as a practical expedient for securities purchased under agreements to resell whereby a credit loss is recognized only if there is a collateral shortfall which we do not believe the counterparty is willing or able to replenish in accordance with the contractual terms. The credit loss would be limited to the difference between the estimated fair value of the collateral and the investment’s amortized cost. Based upon the collateral held as security and collateral maintenance provisions with our counterparties, iino/
allowance for credit losses was recorded for securities purchased under agreements to resell at December 31, 2022 and 2021.
Federal Funds Sold. As our investments in federal funds sold are typically transacted on an overnight term, we would only evaluate these instruments for expected credit losses if they were not repaid according to their contractual terms at maturity. At December 31, 2022 and 2021, all investments in federal funds sold were repaid according to their contractual terms and, therefore, iino/
allowance for credit losses was recorded.
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Investment Securities.
Trading Securities.
Major Security Types.iThe
following table presents our trading securities by type of security.
Net
Gains (Losses) on Trading Securities.iThe following table presents net gains (losses) on trading securities, excluding any offsetting effect of gains (losses) on the associated derivatives.
(1) Includes
adjustments made to the cost basis for purchase discount or premium and related accretion or amortization, and, if applicable, fair-value hedging basis adjustments. Includes at December 31, 2022 and 2021 net unamortized discounts totaling $(i294,587) and net unamortized premiums totaling $i14,344,
respectively. The applicable fair value hedging basis adjustments at December 31, 2022 and 2021 totaled net losses of $(i1,099,886) and net gains of $i206,199,
respectively. Excludes accrued interest receivable at December 31, 2022 and 2021 of $i53,358 and $i32,127,
respectively.
Unrealized Loss Positions.iThe following table presents impaired AFS securities (i.e., in an unrealized loss position), aggregated by major security type and length of time that individual securities have been in a continuous unrealized loss position.
($ amounts in thousands unless otherwise indicated)
Realized Gains and Losses. During the year ended December 31, 2020, for strategic, economic and operational reasons, we sold certain of our GSE multifamily MBS. Proceeds from the sales totaled $i96,779,
resulting in net realized gains from the sale of AFS securities of $i504, comprised of realized gains of $i715 and realized losses of $(i211)
determined by the specific identification method.
Contractual Maturity.iThe amortized cost and estimated fair value of non-MBS AFS securities are presented below by contractual maturity. MBS are not presented by contractual maturity because their actual maturities will likely differ from their contractual maturities as borrowers have the right to prepay their obligations with or without prepayment
fees.
Allowance
for Credit Losses. At December 31, 2022 and 2021, ii100/%
of our AFS securities were rated single-A, or above, by an NRSRO, based on the lowest long-term credit rating for each security. The NRSRO ratings may differ from any internal ratings of the securities, if applicable.
We individually evaluate our AFS securities for impairment. Impairment exists when the estimated fair value of the investment is less than its amortized cost (i.e., in an unrealized loss position). In assessing whether a credit loss exists on an impaired security, we consider whether there could be a shortfall in receiving all cash flows that are contractually due by evaluating several qualitative factors. In those instances where we determine a shortfall could exist, we compare the present value of cash flows to be collected from the security to its amortized cost. If the present value of cash flows is less than amortized cost, an allowance for credit losses is recorded,
but the allowance is limited to the amount of the unrealized loss.
If we do not intend to sell an impaired AFS security and it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis, net of the allowance for credit losses, any difference between the security’s estimated fair value and net amortized cost is recorded to net unrealized gains (losses) on AFS securities within OCI. If we intend to sell an impaired AFS security, or more likely than not we will be required to sell the security before recovery of its amortized cost basis, any allowance for credit losses is reversed and the amortized cost is written down to the security’s estimated fair value at the reporting date with any such impairment reported in earnings.
At December 31, 2022
and 2021, certain of our AFS securities were in an unrealized loss position; however, we did iinot/
record an allowance for credit losses because those losses were considered temporary and we expected to recover the entire amortized cost basis on these securities at maturity based upon the following qualitative factors: (i) all securities were highly-rated, (ii) we have not experienced, nor do we expect, any payment defaults on the securities, (iii) the U.S., GSE, and other Agency obligations carry an explicit or implicit government guarantee such that we consider the risk of nonpayment to be zero, and (iv) we had no intention of selling any of these securities nor did we consider it more likely than not that we will be required to sell any of these securities before recovery of each security's remaining amortized cost basis.
(1) Carrying
value equals amortized cost, which includes adjustments made to the cost basis for purchase discount or premium and related accretion or amortization. Net unamortized premium at December 31, 2022 and 2021 totaled $i26,125 and $i28,440,
respectively.
Contractual
Maturity. HTM securities are not presented by contractual maturity because they consisted entirely of MBS, whose actual maturities will likely differ from their contractual maturities as borrowers have the right to prepay their obligations with or without prepayment fees.
Realized Gains and Losses. During the year ended December 31, 2022, for operational reasons, we sold a portion of our HTM MBS. Proceeds from the sales totaled $i69,919,
resulting in net realized losses of $(i1,059) determined by the specific identification method. For each of these HTM securities, we had previously collected at least 85% of the principal outstanding at the time of acquisition. As such, the sales were considered maturities for purposes of security classification.
Allowance
for Credit Losses. At December 31, 2022 and 2021, ii100/%
of our HTM securities were rated single-A, or above, by an NRSRO, based on the lowest long-term credit rating for each security. The NRSRO ratings may differ from any internal ratings of the securities, if applicable.
Our HTM securities are evaluated for expected credit losses on a collective, or pooled, basis unless an individual assessment is deemed necessary, e.g. the securities do not possess similar risk characteristics. We consider several qualitative factors when evaluating the potential for credit losses on our HTM securities and, if deemed necessary, an allowance for credit losses is recorded.
At December 31, 2022 and 2021, we did iino/t
record an allowance for credit losses on any of our HTM securities based on the following qualitative factors: (i) all securities were highly-rated, (ii) we have not experienced, nor do we expect, any payment defaults on the securities, and (iii) the U.S., GSE, and other Agency obligations carry an explicit or implicit government guarantee such that we consider the risk of nonpayment to be zero.
($ amounts in thousands unless otherwise indicated)
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Note 5 - Advances
We offer a wide range of fixed- and adjustable-rate advance products with various maturities, interest rates, payment characteristics and optionality. Adjustable-rate advances have interest rates that reset periodically at a fixed spread to SOFR, LIBOR or another specified index.
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The
following table presents advances outstanding by redemption term.
Unamortized
swap termination fees associated with modified advances, net of deferred prepayment fees
i6,856
i9,112
Total
advances(1)
$
i36,682,459
$
i27,497,835
(1) Carrying
value equals amortized cost, which excludes accrued interest receivable at December 31, 2022 and 2021 of $i50,446 and $i13,075,
respectively.
We offer our members certain advances that provide them the right, at predetermined future dates, to call (i.e., prepay) the advance prior to maturity without incurring prepayment or termination fees. We also offer certain adjustable-rate advances that may be contractually prepaid by the borrower at the interest-rate reset date without incurring prepayment or termination fees. All other advances may only be prepaid by paying a fee that is sufficient to make us financially indifferent to the prepayment of the advance.
We also offer putable advances. Under the terms of a putable advance, we retain the right to extinguish or put the fixed-rate advance to the member on predetermined future dates and offer replacement funding at current market rates, subject to certain conditions.
The
following table presents advances outstanding by the earlier of the redemption date or the next call date and next put date.
($ amounts in thousands unless otherwise indicated)
Advance Concentrations. At December 31, 2022 and 2021, our top five borrowers held i41%
and i43%, respectively, of total advances outstanding at par. Our top borrower at December 31, 2022 and 2021 held ii12/%.
Allowance
for Credit Losses. Advances are evaluated for expected credit losses on a collective, or pooled, basis unless an individual assessment is deemed necessary, e.g. the advances do not possess similar risk characteristics.
Using a risk-based approach, we consider the amount and quality of the collateral pledged and the borrower's financial condition to be the primary indicators of an advance's credit quality. We manage our exposure to advances outstanding through an integrated approach that generally includes establishing a credit limit for each borrower, and an ongoing review of each borrower's financial condition, coupled with conservative collateral/lending policies intended to limit the risk of loss while balancing the borrower's needs for a reliable source of funding. In addition, we lend to eligible borrowers in accordance with federal statutes and Finance
Agency regulations. Specifically, we comply with the Bank Act, which requires us to obtain sufficient collateral to fully secure credit products. We evaluate and update our collateral guidelines, as necessary, based on current market conditions.
We accept certain investment securities, residential mortgage loans, deposits, and other real estate-related assets as collateral. In addition, certain members that qualify as CFIs are eligible to utilize expanded statutory collateral provisions for small business and agriculture loans. Under the Bank Act, our capital stock owned by our members serves as additional security. Collateral arrangements may vary depending upon borrower credit quality, financial condition and performance; borrowing capacity; and overall credit exposure to the borrower. As part of our risk-based approach, we also evaluate and determine whether a borrower may retain physical possession of
the collateral pledged to us or must specifically deliver the collateral to us or our document custody agent.
Our evaluation of credit losses on advances utilizes a framework that considers the adequacy of the advances' associated collateral and the associated member's willingness and ability to pledge additional collateral to satisfy any current or anticipated future deficiency. Our agreements with borrowers allow us, at any time and in our sole discretion, to require substitution of collateral, adjust the over-collateralization requirements applied to collateral, or refuse to make extensions of credit against any collateral. We also may require borrowers to pledge additional collateral regardless of whether the collateral would be eligible to originate a new extension of credit. Our agreements with our borrowers also afford us the right, in our sole discretion, to declare any borrower to be in default
if we deem the Bank to be inadequately secured.
We determine the estimated value of the collateral required to secure each member's advances by applying collateral discounts, or haircuts, to the market value or UPB of the collateral, as applicable. At December 31, 2022 and 2021, we had rights to collateral on a borrower-by-borrower basis with an estimated lendable value equal to or in excess of our advances outstanding.
At December 31, 2022 and 2021, we did iiiiiino/////t
have any advances that were past due, on non-accrual status, or considered impaired. In addition, there were iiino//
troubled debt restructurings related to advances during the years ended December 31, 2022, 2021, or 2020.
Based upon the collateral held as security, our credit extension and collateral policies, our credit analysis and the repayment history on advances, we have inot recorded an allowance for credit losses on advances.
($ amounts in thousands unless otherwise indicated)
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Note 6 - Mortgage Loans Held for Portfolio
Mortgage
loans held for portfolio consist substantially of residential loans acquired from our members through the MPP. The mortgage loans are fixed-rate and either credit enhanced by PFIs, if conventional, or guaranteed or insured by government agencies.
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The following tables present information on mortgage loans held for portfolio by term and type.
Conventional
MPP.Our management of credit risk considers the several layers of loss protection that are defined in our agreements with the PFIs. Our loss protection consists of the following loss layers, in order of priority, (i) borrower equity; (ii) PMI up to coverage limits (when applicable for the acquisition of mortgages with an initial LTV ratio of over i80% at the time of purchase); (iii) available funds remaining in the LRA; and (iv) SMI coverage (as applicable) purchased by the seller from a third-party provider naming the Bank as the beneficiary, up to the policy
limits. Any losses not absorbed by the loss protection are borne by the Bank.
Government-Guaranteed or -Insured MortgageLoans.These fixed-rate mortgage loans are guaranteed or insured by the FHA, Department of Veterans Affairs, Rural Housing Service of the Department of Agriculture, or United States Department of Housing and Urban Development. The servicer provides and maintains a guaranty or insurance from the applicable government agency. The servicer is responsible for compliance with all government agency requirements and for obtaining the benefit of the applicable guaranty or insurance with respect to defaulted government-guaranteed or -insured mortgage loans. Any losses incurred on these loans that are not recovered from the insurer or guarantor are absorbed
by the servicers.
($ amounts in thousands unless otherwise indicated)
Credit Quality Indicators for Conventional Mortgage Loans and Other Delinquency Statistics.Payment
status is the key credit quality indicator for conventional mortgage loans and allows us to monitor the migration of past due loans. Past due loans are those where the borrower has failed to make timely payments of principal and/or interest in accordance with the terms of the loan. Other delinquency statistics include non-accrual loans and loans in process of foreclosure.
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The tables below present the key credit quality indicators and other delinquency statistics for our mortgage loans held for portfolio
aggregated by (i) the most recent five origination years and (ii) all other prior origination years. Amounts are based on amortized cost, which excludes accrued interest receivable.
Past
due 90 days or more still accruing interest (3)
$
i15,725
$
i1,364
$
i17,089
On
non-accrual status (4)
$
i23,487
$
i—
$
i23,487
(1) Includes
loans for which the decision of foreclosure or similar alternative, such as pursuit of deed-in-lieu of foreclosure, has been reported. Loans in process of foreclosure are included in past due categories depending on their delinquency status, but are not necessarily considered to be on non-accrual status.
(2) Represents loans i90 days or more past due (including loans in process of foreclosure) expressed as a percentage of the total mortgage loans. The percentage excludes principal and interest amounts previously paid in full by the servicers
on conventional loans that are pending resolution of potential loss claims. Our servicers repurchase seriously delinquent government loans, including FHA loans, when certain criteria are met.
(3) Although our past due scheduled/scheduled MPP loans are classified as loans past due i90 days or more based on the loan's delinquency status, we do not consider these loans to be on non-accrual status as they are well-secured and in the process of collection.
(4) As of December 31,
2022 and 2021, of these conventional mortgage loans on non-accrual status, $i3,160 and $i11,701,
respectively, of UPB did not have a related allowance for credit losses because these loans were either previously charged off to the expected recoverable value and/or the fair value of the underlying collateral, including any credit enhancements, exceeded the amortized cost of the loans.
Allowance for Credit Losses. We apply a systematic approach for estimating expected credit losses on our conventional mortgage loans over their estimated remaining lives through analyses that include, among other considerations, various loan portfolio and collateral-related characteristics, past loan performance, historical and current economic conditions, and reasonable and supportable forecasts of expected economic conditions.
We estimate expected losses on our conventional mortgage loans on a collective basis, pooling loans
with similar risk characteristics. If a mortgage loan no longer shares risk characteristics with other loans, it is removed from the pool and evaluated for expected losses on an individual basis. In addition, we individually evaluate all troubled debt restructurings, any remaining exposure to delinquent conventional MPP loans paid in full by servicers, and collateral-dependent loans. Loans are considered collateral-dependent when a borrower is experiencing financial difficulty and repayment is expected to be substantially through the sale of the underlying collateral. We estimate expected losses on collateral-dependent loans by applying a practical expedient that considers the expected loss of a collateral-dependent loan to be equal to the difference between the amortized cost of the loan and the estimated fair value of the collateral, less estimated selling costs.
When determining the
allowance for credit losses, we consider how credit enhancements are expected to mitigate credit losses and then reduce the allowance accordingly because the credit enhancements are entered into in conjunction with the purchase of a loan and cannot be both legally detached and separately exercised.
($ amounts in thousands unless otherwise indicated)
Collectively
Evaluated Mortgage Loans. Conventional loans current to i179 days past due are collectively evaluated at the pool level using a recognized third-party credit and prepayment model, which considers both historical and current information and events and reasonable and supportable forecasts that rely upon certain key inputs and assumptions, to estimate potential ranges of credit loss exposure over the estimated lives of the loans. One such key input is a 3-year forecast
of housing prices with a 2-year gradual transition to full reversion to historical inputs after 5 years. Additionally, the evaluation is based upon distinct underlying loan characteristics, including loan vintage (year of origination), geographic location, credit support features and other factors, and a projected migration of loans through the various stages of delinquency.
Seriously delinquent conventional loans i180 days or more past due
and not charged-off are also collectively evaluated at the pool level based on loan-specific attribution data, including the use of loan-level property values from a third-party.
Individually Evaluated Mortgage Loans.Certain conventional mortgage loans, primarily troubled debt restructurings, are specifically identified and evaluated for purposes of determining the allowance for credit losses. The measurement of our allowance for individually evaluated loans considers loan-specific attribution data similar to homogeneous pools of delinquent loans evaluated on a collective basis, including the use of loan-level property values from a third-party.
We also individually evaluate any remaining exposure to delinquent MPP conventional loans paid in full by the servicers. An estimate of the loss, if any,
is equal to the estimated cost associated with maintaining and disposing of the property (which includes the UPB, interest owed on the delinquent loan to date, and estimated costs associated with disposing of the collateral) less the estimated fair value of the collateral (net of estimated selling costs) and the amount of credit enhancements including the PMI, LRA and SMI. The estimated fair value of the collateral is obtained from United States Department of Housing and Urban Development statements, sales listings or other evidence of current expected liquidation amounts.
Qualitative Factors.We also assess multiple qualitative factors in our estimation of credit losses. These factors represent a subjective management judgment based on facts and circumstances that exist as of the reporting date that are not ascribed
to any specific measurable economic or credit event and therefore may not otherwise be captured in our methodology.
Rollforward of Allowance for Credit Losses.iThe table below presents a rollforward of our allowance for credit losses.
Rollforward
of Allowance
2022
2021
2020
Balance, beginning of year
$
i200
$
i350
$
i300
Charge-offs
(i11)
(i81)
(i140)
Recoveries
i85
i39
i50
Provision
for (reversal of) credit losses
(i74)
(i108)
i140
Balance,
end of year
$
i200
$
i200
$
i350
Government-Guaranteed
or -Insured Mortgage Loans. Based on the U.S. government guarantee or insurance on these loans, our assessment of our servicers, and the collateral backing the loans, we did iinot/
record an allowance for credit losses for government-guaranteed or -insured mortgage loans at December 31, 2022 or 2021. Furthermore, inone of these mortgage loans have been placed on non-accrual status due to the U.S. government guarantee or insurance on these loans and the contractual obligation of the loan servicer to repurchase the loans when certain criteria are met.
The
depreciation and amortization expense for premises, software and equipment for the years ended December 31, 2022, 2021, and 2020 was $i8,182, $i7,833,
and $i7,198, respectively, including amortization of computer software costs of $i5,935, $i5,547, and
$i5,315, respectively.
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Note
8 - Derivatives and Hedging Activities
Nature of Business Activity. We are exposed to interest-rate risk primarily from the effect of changes in market interest rates on our interest-earning assets and on our interest-bearing liabilities that finance those assets. The goal of our interest-rate risk management strategies is not to eliminate interest-rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, we have established policies and procedures, which include guidelines on the extent of exposure to changes in interest rates that we are willing to accept. In addition, we monitor the risk to our interest income, net interest margin and average maturity of interest-earning assets and interest-bearing liabilities.
We use derivative financial instruments when they are the most cost-effective alternative
to achieve our financial and risk management objectives. The most common ways in which we use derivatives are to:
•reduce the interest-rate sensitivity and repricing gaps of assets and liabilities;
•protect the value of existing asset and liability positions or of commitments and forecasted transactions;
•mitigate the adverse earnings effects of the shortening or extension of the duration of certain assets (e.g., advances or mortgage assets) and liabilities;
•reduce funding costs by executing a derivative concurrently with the issuance of a consolidated obligation as the cost of a combined funding structure can be lower than the cost of a comparable CO bond;
•preserve
a favorable interest-rate spread between the yield of an asset (e.g., an advance) and the cost of the related liability (e.g., CO bond used to fund advance);
•manage embedded options in assets and liabilities; and
•manage our overall asset/liability structure.
We reevaluate our hedging strategies from time to time and, consequently, we may adopt new strategies or change our hedging techniques. However, Finance Agency regulation and our risk management policies prohibit trading in, or the speculative use of, these derivative instruments and limit credit risk arising from these instruments.
We transact most of our derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers
or their affiliates buy, sell, and distribute consolidated obligations. We are not a derivatives dealer and thus do not trade derivatives for short-term profit. Derivative transactions may be either executed with a counterparty over-the-counter (uncleared derivatives) or cleared through a Futures Commission Merchant (i.e., clearing agent) with a Clearinghouse (cleared derivatives). Once a derivative transaction has been accepted for clearing by a Clearinghouse, the derivative transaction is novated, and the executing counterparty is replaced by the Clearinghouse.
($ amounts in thousands unless otherwise indicated)
Types of Derivatives. We use the following types of derivative instruments.
Interest-Rate Swaps. We use interest-rate swaps to hedge the risk of changes in the fair value of certain of our assets and liabilities due to changes in market interest rates. The variable rate we receive or pay in most interest-rate swaps is currently indexed to LIBOR, EFFR, or SOFR.
Interest-Rate Cap and Floor Agreements. We use caps and floors to protect against interest rates on variable-rate assets or liabilities falling below or rising above certain levels.
Interest-Rate
Swaptions. We utilize payer or receiver swaptions to protect against the adverse effects of sudden increases or decreases in interest rates, respectively.
Forward Contracts. We normally sell TBA MBS or other derivatives for forward settlement to protect against changes in the market values of fixed-rate MDCs resulting from changes in market interest rates.
Types of Hedged Items. We document at inception all relationships between the derivatives designated as hedging instruments and the hedged items, our risk management objectives and strategies for undertaking various hedge transactions, and our method of assessing effectiveness. We have the following types of hedged items:
Investments.We primarily invest in Agency MBS, U.S. Treasury obligations, and GSE and TVA debentures, which may be classified as trading, HTM or AFS securities. The interest-rate, prepayment and duration risks associated with these investment securities are managed through a combination of debt issuance and derivatives. We may manage those risks by funding these investment securities with CO bonds that contain call features. We may also hedge the prepayment risk with caps or floors, callable swaps or swaptions. We may manage the risk and volatility arising from changing market prices of investment securities by matching the cash outflows on the derivatives with the cash inflows on the investment securities. Certain of these derivatives qualify as fair-value hedges while others are designated as economic hedges.
Advances.We offer a wide range of fixed-
and adjustable-rate advance products with various maturities, interest rates, payment characteristics, and optionality. We may use derivatives to manage the repricing and/or options characteristics of advances in order to more closely match the characteristics of our funding liabilities. In general, whenever a member executes a fixed-rate advance or an adjustable-rate advance with embedded options, we may simultaneously execute a derivative with terms that offset the terms and embedded options in the advance. For example, we may hedge a fixed-rate advance with an interest-rate swap where we pay a fixed rate and receive a variable rate, effectively converting the fixed-rate advance to an adjustable-rate advance. This type of hedge is typically treated as a fair-value hedge. In addition, we may hedge a callable, prepayable or putable advance by entering into a cancellable interest-rate swap.
Mortgage
Loans.We invest in fixed-rate mortgage loans. The prepayment options embedded in these mortgage loans can result in extensions or contractions in the expected repayment of these loans, depending on changes in prepayment speeds. We may purchase interest-rate caps and floors, swaptions, callable swaps, calls, and puts to minimize the prepayment risk embedded in the loans. These derivatives are considered economic hedges against the prepayment risk of the loans, but they are not specifically linked to individual loans.
Consolidated Obligations.We may enter into derivatives to hedge the interest-rate risk associated with our debt issuances. We manage the risk and volatility arising from changing market prices of consolidated obligations by matching the cash inflows on the derivatives with the cash outflows on the consolidated
obligations.
In a typical transaction, we issue a fixed-rate consolidated obligation and simultaneously enter into a matching derivative in which the counterparty pays fixed cash flows to us designed to match in timing and amount the cash outflows we pay on the consolidated obligation. In turn, we pay a variable cash flow to the counterparty that closely matches the interest payments we receive on short-term or variable-rate advances. These transactions are typically treated as fair-value hedges. Additionally, we may issue variable-rate CO bonds indexed to SOFR or the United States prime rate and simultaneously execute interest-rate swaps to hedge the basis risk of the variable-rate debt.
($ amounts in thousands unless otherwise indicated)
Firm Commitments.In connection with our purchases of mortgage loans, we enter into MDCs. Certain MDCs entered into by us are considered derivatives. The MDC and the TBA used in the firm commitment hedging strategy are treated as an economic hedge and are marked to fair value through earnings. When the MDC settles, the current fair value of the commitment is included with the basis of the mortgage loan and amortized accordingly.
Managing Credit Risk on Derivatives.
We are subject to credit risk due to the risk of nonperformance by the counterparties to our derivative transactions. We manage counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in our policies, the United States Commodity Futures Trading Commission regulations, and Finance Agency regulations.
Uncleared Derivatives. For uncleared derivatives, the degree of credit risk depends on the extent to which master netting arrangements are included in such contracts to mitigate the risk. We require collateral agreements with our uncleared derivatives. The exposure thresholds above which collateral must be delivered vary; the threshold is zero in most cases. Additionally, collateral related to derivatives with member
institutions includes collateral assigned to us as evidenced by a written security agreement and held by the member institution for our benefit.
For certain of our uncleared derivatives, we have credit support agreements that contain provisions requiring us to post additional collateral with our counterparties if there is deterioration in our credit rating. If our credit rating is lowered by an NRSRO, we could be required to deliver additional collateral on uncleared derivative instruments in net liability positions. There were ino
uncleared derivative instruments with credit-risk-related contingent features that were in a net liability position (before cash collateral and related accrued interest on cash collateral) at December 31, 2022.
Cleared Derivatives. For cleared derivatives, the Clearinghouse is our counterparty. We use LCH.Clearnet LLC and CME Clearing as Clearinghouses for all cleared derivative transactions. Collateral is required to be posted daily for changes in the value of cleared derivatives to mitigate each counterparty's credit risk. The Clearinghouse notifies the clearing agent of the required initial and variation margin, and the clearing agent notifies us. The requirement that we post initial and variation margin through the clearing agent for the benefit of the Clearinghouse exposes us to institutional credit risk in the event that the clearing
agent or Clearinghouse fails to meet its obligations.
At both Clearinghouses, initial margin is considered cash collateral and variation margin is characterized as a daily settlement payment.
The Clearinghouse determines margin requirements which are generally not based on credit ratings. However, clearing agents may require additional margin to be posted by us based on credit considerations, including but not limited to any credit rating downgrades. At December 31, 2022, we were not required by our clearing agents to post any additional margin.
($ amounts in thousands unless otherwise indicated)
Financial Statement Effect and Additional Financial Information.
The notional amount of derivatives serves as a factor in determining periodic interest payments, or cash flows received and paid. The notional amount of derivatives also reflects the extent of our involvement in the various classes of financial instruments but represents neither the actual amounts exchanged nor our overall exposure to credit and market risk; the overall risk is much smaller. The risks of derivatives can be measured meaningfully
on a portfolio basis that takes into account the counterparties, the types of derivatives, the items being hedged and any offsets between the derivatives and the hedged items.
We record derivative instruments, related cash collateral received or pledged/posted and associated accrued interest on a net basis, by clearing agent and/or by counterparty when the netting requirements have been met.
i
The following table
presents the notional amount and estimated fair value of derivative assets and liabilities.
Derivatives
not designated as hedging instruments:
Economic hedges:
Interest-rate
swaps
i6,200,000
i599
i525
i8,595,000
i357
i148
Interest-rate
caps/floors
i611,000
i1,310
i—
i625,500
i1,077
i—
Interest-rate
forwards
i30,200
i131
i—
i98,200
i1
i199
MDCs
i30,855
i50
i102
i96,424
i45
i105
Total
derivatives not designated as hedging instruments
i6,872,055
i2,090
i627
i9,415,124
i1,480
i452
Total
derivatives before adjustments
$
i72,975,275
i921,179
i2,179,524
$
i55,810,575
i106,926
i413,776
Netting
adjustments and cash collateral (1)
(i486,758)
(i2,160,315)
i113,276
(i401,591)
Total
derivatives, net
$
i434,421
$
i19,209
$
i220,202
$
i12,185
(1) Represents
the application of the netting requirements that allow us to settle (i) positive and negative positions and (ii) cash collateral and related accrued interest held or placed, with the same clearing agent and/or counterparty. Cash collateral pledged to counterparties at December 31, 2022 and 2021, including accrued interest, totaled $i1,854,876 and $i515,761,
respectively. Cash collateral received from counterparties and held at December 31, 2022 and 2021, including accrued interest, totaled $i181,319 and $i894,
respectively. At December 31, 2022 and 2021, iino/
securities were pledged as collateral.
($ amounts in thousands unless otherwise indicated)
i
The
following table presents separately the estimated fair value of derivative instruments meeting and not meeting netting requirements, including the effect of the related collateral.
($ amounts in thousands unless otherwise indicated)
i
The
following table presents the impact of qualifying fair-value hedging relationships on net interest income by hedged item, excluding any offsetting interest income/expense of the associated hedged items.
Net impact of fair-value hedging relationships on net interest income:
Net
interest settlements on derivatives (1)
$
(i135,342)
$
(i109,907)
$
i51,091
$
(i194,158)
Net
gains (losses) on derivatives (2)
(i384,880)
(i507,403)
i21,467
(i870,816)
Net
gains (losses) on hedged items (3)
i382,167
i494,481
(i13,617)
i863,031
Net
impact on net interest income
$
(i138,055)
$
(i122,829)
$
i58,941
$
(i201,943)
Total
interest income (expense) recorded in the Statement of Income (4)
$
i329,675
$
i103,658
$
(i461,953)
$
(i28,620)
(1) Represents
interest income/expense on derivatives in qualifying fair-value hedging relationships. Net interest settlements on derivatives that are not in qualifying fair-value hedging relationships are reported in other income.
(2)Includes increases (decreases) in estimated fair value and price alignment interest.
(3)Includes increases (decreases) in estimated fair value and amortization of net losses on ineffective and discontinued fair-value hedging relationships.
(4) For advances, AFS securities and CO bonds only.
($ amounts in thousands unless otherwise indicated)
i
The following table presents the components of net gains (losses) on derivatives reported in other income.
Years
Ended December 31,
Type of Hedge
2022
2021
2020
Net gain (loss) on derivatives not designated as hedging instruments:
Economic hedges:
Interest-rate
swaps
$
i15,731
$
i13,347
$
i1,488
Swaptions
i—
i—
(i324)
Interest-rate
caps/floors
i233
(i36)
i898
Interest-rate
forwards
i7,824
i3,350
(i13,377)
Net
interest settlements (1)
i33,391
(i9,137)
(i46,927)
MDCs
(i8,750)
(i3,840)
i9,880
Net
gains (losses) on derivatives in other income
$
i48,429
$
i3,684
$
(i48,362)
(1) Relates
to derivatives that are not in qualifying fair-value hedging relationships. The interest income/expense of the associated hedged items is recorded in net interest income.
/
i
The following table presents the amortized cost of, and the related cumulative basis
adjustments on, hedged items in qualifying fair-value hedging relationships.
Cumulative
basis adjustments included in amortized cost:
For active fair-value hedging relationships (2)
$
i178,543
$
(i184,724)
$
(i247,699)
For
discontinued fair-value hedging relationships
i572
i390,923
i—
Total
cumulative fair-value hedging basis adjustments on hedged items
$
i179,115
$
i206,199
$
(i247,699)
(1) Includes
the amortized cost of the hedged items in active or discontinued fair-value hedging relationships.
(2) Includes effective and ineffective fair-value hedging relationships. Excludes any offsetting effect of the net estimated fair value of the associated derivatives.
($ amounts in thousands unless otherwise indicated)
i
Note 9 - Deposit Liabilities
We offer demand and overnight deposits to members and qualifying non-members. In addition, we offer short-term interest-bearing deposit programs to members. A member that services mortgage loans may deposit funds collected in connection with the mortgage loans, pending disbursement of such funds to the owners of the mortgage
loans. We classify these items as other deposits.
Demand, overnight, and other deposits pay interest based on a daily interest rate. Time deposits pay interest based on a fixed rate determined at the origination of the deposit.
i
The following table presents the types of our interest-bearing and non-interest-bearing deposits.
(1)
Includes pass-through deposit reserves from members.
//
i
Note 10 - Consolidated Obligations
Consolidated
obligations consist of CO bonds and discount notes. CO bonds may be issued to raise short-, intermediate- and long-term funds for the FHLBanks and are not subject to any statutory or regulatory limits on maturity. Discount notes are issued primarily to raise short-term funds and have original maturities of up to ione year. These notes generally sell at less than their face amount and are redeemed at par value when they mature.
The
FHLBanks issue consolidated obligations through the Office of Finance as their agent under the oversight of the Finance Agency and the United States Secretary of the Treasury. In connection with each debt issuance, each FHLBank specifies the amount of debt to be issued on its behalf. Each FHLBank records as a liability the specific portion of consolidated obligations issued on its behalf and for which it is the primary obligor.
In addition to being the primary obligor for all consolidated obligations issued on our behalf, we are jointly and severally liable with each of the other FHLBanks for the payment of the principal and interest on all of the FHLBanks' consolidated obligations outstanding. The par values of the FHLBanks' consolidated obligations outstanding at December 31, 2022 and 2021 totaled $i1.2
trillionand $i652.9 billion, respectively. As provided by the Bank Act and Finance Agency regulations, consolidated obligations are backed only by the financial resources of all FHLBanks.
The Finance Agency, in its discretion, may require any FHLBank to make principal or interest payments due on any consolidated obligation whether or not the consolidated obligation represents a primary
liability of that FHLBank. Although an FHLBank has never paid the principal or interest payments due on a consolidated obligation on behalf of another FHLBank, if that event should occur, Finance Agency regulations provide that the paying FHLBank is entitled to reimbursement for any payments made on behalf of another FHLBank and other associated costs, including interest to be determined by the Finance Agency. If, however, the Finance Agency determines that such other FHLBank is unable to satisfy its repayment obligations to the paying FHLBank, then the Finance Agency may allocate the outstanding liability of such other FHLBank among the remaining FHLBanks on a pro-rata basis in proportion to their participation in all outstanding consolidated obligations, or in any other manner it may determine to ensure that the FHLBanks operate in a safe and sound manner. We do not believe that it is probable that we will be asked or required to make principal or interest payments
on behalf of another FHLBank.
Consolidated
obligations are issued with either fixed-rate or variable-rate coupon payment terms that may use a variety of indices for interest-rate resets, such as SOFR or the United States prime rate. To meet the specific needs of certain investors in CO bonds, both fixed-rate and variable-rate CO bonds may contain features that result in complex coupon payment terms and call options. When these CO bonds are issued, we may enter into derivatives containing features that offset the terms and embedded options, if any, of the CO bonds.
CO bonds may also be callable. Such bonds may be redeemed in whole or in part, at our discretion, on predetermined call dates according to the terms of the offerings.
i
The
following tables present the par value of our CO bonds outstanding by call features and the earlier of the year of contractual maturity or next call date.
($ amounts in thousands unless otherwise indicated)
In addition to CO bonds with fixed-rate or simple variable-rate interest payment terms, step-up CO bonds pay interest at increasing fixed rates for specified intervals over their lives and generally contain provisions enabling us to call them at our option on the step-up dates.
The following table presents the par value of our CO bonds outstanding by interest-rate payment type.
The Bank Act requires each FHLBank to establish an AHP, in which the FHLBank provides subsidies in the form of direct grants to members that use the funds to assist in the purchase, construction, or rehabilitation of housing for very low-, low-, and moderate-income households. Annually, the FHLBanks must set aside for the AHP the greater of the aggregate of $i100 million or i10%
of each FHLBank's net earnings. For purposes of the AHP calculation, net earnings is defined in a Finance Agency Advisory Bulletin as income before assessments, plus interest expense related to MRCS.
Our required AHP expense in 2022, 2021, and 2020 was $i19,876, $i10,720,
and $i10,717, respectively.
Additionally, in 2022, we voluntarily contributed $i4,159
to our AHP, which is reported in other expenses.
i
The following table summarizes the activity in our AHP funding obligation.
AHP
Activity
2022
2021
2020
Liability at beginning of year
$
i31,049
$
i34,402
$
i38,084
Assessment
(expense)
i19,876
i10,720
i10,717
Voluntary
contribution
i4,159
i—
i—
Subsidy
usage, net(1)
(i16,914)
(i14,073)
(i14,399)
Liability
at end of year
$
i38,170
$
i31,049
$
i34,402
//
(1) Subsidies
disbursed are reported net of returns/recaptures of previously disbursed subsidies.
($ amounts in thousands unless otherwise indicated)
i
Note
12 - Capital
We are a financial cooperative whose member and former member institutions (or legal successors) own all of our outstanding capital stock. Former members (including certain non-member institutions that own our capital stock as a result of a merger with or acquisition of a member) own our capital stock solely to support credit products or mortgage loans still outstanding on our statement of condition.
Member shares cannot be purchased or sold except between us and our members or, with our written approval, among our members, at the par value of ione
hundred dollars per share, as mandated by our capital plan and Finance Agency regulation.
Classes of Capital Stock. Our capital plan divides our Class B stock into itwo sub-series: Class B-1 and Class B-2. Class B-1 stock is held by our members to satisfy their membership stock requirements, while Class B-2 stock is held to satisfy their activity-based stock requirements. A member's Class B-1 stock is reclassified as B-2 as needed to help fulfill the member's activity-based
stock requirement, and the member may be required to purchase additional Class B-2 stock to fully meet that requirement. Any excess stock (i.e., the amount of stock held by a member or former member in excess of the stock ownership requirement for that institution) is automatically classified as Class B-1.
i
The following table presents the capital stock outstanding by sub-series.
Our
capital plan also permits the board of directors to authorize the issuance of Class A stock although, as of December 31, 2022, the board of directors had not authorized such issuance. If authorized, a member may elect to purchase Class A stock, rather than Class B-2 stock, to satisfy the member’s activity-based stock requirement, subject to certain restrictions.
Dividends. Our board of directors may, but is not required to, declare and pay dividends on our Class B stock in either cash or capital stock or a combination thereof, as long as we are in compliance with Finance Agency regulations. The amount of the dividend to be paid is based on the average number of shares of each sub-series held by the member during the dividend payment period (applicable quarter).
Our capital
plan does not mandate a specific difference between Class B-1 and Class B-2 dividend rates. Rather, the board of directors may declare a dividend rate on Class B-2 stock that is equal to or greater than the rate on Class B-1 stock. The plan also authorizes the board of directors to declare a dividend rate on Class A stock (if issued and outstanding) that is equal to or greater than the rate on Class B-1 stock.
Stock Redemption and Repurchase. In accordance with the Bank Act, our capital stock is considered putable by the member. Members can redeem Class B stock, subject to certain restrictions, by giving five years' written notice. Members can redeem Class A stock, subject to certain restrictions, by giving six months written notice. Any member that withdraws from membership or otherwise has had its membership terminated may not be readmitted
as a member for a period of five years from the divestiture date for all capital stock that was held as a condition of membership, as set forth in our capital plan and Finance Agency regulations, unless the member has canceled or revoked its notice of withdrawal prior to the end of the applicable redemption period. This restriction does not apply if the member is transferring its membership from one FHLBank to another on an uninterrupted basis.
We are not required to redeem a member's required capital stock until the expiration of the notice of redemption, or until the activity to which the capital stock relates no longer remains outstanding, whichever is later. However, we may repurchase, at our sole discretion, any member's capital stock that exceeds the required minimum amount, subject to significant statutory and regulatory restrictions on our right to repurchase, or obligation to redeem, the outstanding
stock. As a result, whether or not a member may have its capital stock repurchased or redeemed will depend, in part, on whether we are in compliance with those restrictions.
($ amounts in thousands unless otherwise indicated)
A member may
cancel or revoke its written notice of redemption or its notice of withdrawal from membership prior to the conclusion of the applicable redemption period. However, our capital plan provides that we may charge a cancellation fee to a member that cancels or revokes its withdrawal notice.
Mandatorily Redeemable Capital Stock.When a member withdraws or otherwise attains non-member status, the member's shares are then subject to redemption and become mandatorily redeemable, resulting in a reclassification of the member's capital stock to a liability as MRCS at estimated fair value, which is equal to par value. iThe
following table presents the activity in our MRCS.
MRCS Activity
2022
2021
2020
Liability at beginning of year
$
i50,422
$
i250,768
$
i322,902
Reclassification
from capital stock
i329,232
i4,730
i32,791
Redemptions/repurchases
(i7,151)
(i205,076)
(i104,965)
Accrued
distributions
i—
i—
i40
Liability
at end of year
$
i372,503
$
i50,422
$
i250,768
i
The
following table presents MRCS by contractual year of redemption. The year of redemption is the later of (i) the final year of the five-year redemption period, or (ii) the first year in which a non-member no longer has an activity-based stock requirement.
(1) Balance
represents Class B stock that will not be redeemed until the associated credit products and other obligations are no longer outstanding.
(2) Balance at December 31, 2022 and 2021 includes $i9,585
and $i11,835, respectively of Class B stock held by one captive insurance company whose membership was terminated on February 19, 2021. The stock is not past its contractual redemption date, but will be redeemed as soon as the associated credit products and other obligations are no longer outstanding.
/
If
a member's membership status changes to a non-member during a quarterly dividend period, but not at the beginning or the end of a quarterly period, any dividends for that quarterly period are allocated between distributions from retained earnings for the shares held as capital stock during that period and interest expense for the shares held as MRCS during that period. Therefore, the distributions from retained earnings represent dividends to former members for only the portion of the period that they were members. The amounts recorded to interest expense represent dividends to former members for the portion of that period and subsequent periods that they were not members.
The following table presents the distributions related to MRCS.
($ amounts in thousands unless otherwise indicated)
Capital Requirements. We are subject to ithree capital requirements under our capital
plan and Finance Agency regulations:
(i)Risk-based capital. We must maintain at all times permanent capital, defined as Class B stock (including MRCS) and retained earnings, in an amount at least equal to the sum of our credit risk, market risk, and operational risk capital requirements, all of which are calculated in accordance with Finance Agency regulations. The Finance Agency may require us to maintain a greater amount of permanent capital than is required by the risk-based capital requirements as defined.
(ii)Total regulatory capital. We are required to maintain at all times a total capital-to-assets ratio of at least i4%.
Total regulatory capital is the sum of permanent capital, any general loss allowance, if consistent with GAAP and not held against specific assets, and other amounts from sources determined by the Finance Agency as available to absorb losses. For regulatory capital purposes, AOCI is not considered capital.
(iii)Leverage capital. We are required to maintain at all times a leverage capital-to-assets ratio of at least i5%. Leverage capital is defined as the sum of (a) permanent capital weighted i1.5
times and (b) all other components of total capital.
i
As presented in the following table, we were in compliance with these Finance Agency's capital requirements at December 31, 2022 and 2021.
Partial
Recovery of Prior Capital Distribution to Financing Corporation. The Competitive Equality Banking Act of 1987 was enacted in August 1987, which, among other things, provided for the recapitalization of the Federal Savings and Loan Insurance Corporation through a newly-chartered entity, FICO. The capitalization of FICO was provided by capital distributions from the FHLBanks to FICO in 1987, 1988 and 1989 that aggregated to $i680 million in exchange for FICO nonvoting capital stock. Upon passage of the Financial Institutions
Reform, Recovery and Enforcement Act of 1989, the Bank's previous investment in capital stock of FICO was determined to be non-redeemable and, therefore, the Bank charged-off its prior capital distributions to FICO directly against retained earnings.
Upon the dissolution of FICO in October 2019, FICO determined that excess funds aggregating to $i200 million were available for distribution to its sole stockholders, the FHLBanks. Specifically,
the Bank received $i10,574 during the year ended December 31, 2020 which was determined based on our proportionate ownership of FICO's nonvoting capital stock. The Bank treated the receipt of these funds as a partial recovery of the prior capital distributions made by the Bank to FICO. These funds were credited to unrestricted retained earnings.
($ amounts in thousands unless otherwise indicated)
i
Note 14 -
Employee Retirement and Deferred Compensation Plans
Qualified Defined Contribution Plan.The Bank participated in a tax-qualified multiple-employer retirement savings plan through October 1, 2020. Effective October 2, 2020, the Bank adopted a tax-qualified single-employer plan. The terms of such plans are substantially the same.
This DC plan covers our officers and other employees who meet certain eligibility requirements. The Bank makes a matching contribution equal to a percentage of voluntary employee contributions, subject to certain limitations. In addition, the Bank makes a non-elective contribution to the account of each participant who is not eligible to participate in the Bank's DB plan. During
the years ended December 31, 2022, 2021 and 2020, we contributed a total of $i2,742, $i2,682,
and $i2,810, respectively.
Qualified Defined Benefit Pension Plan.We participate in a tax-qualified, defined benefit pension plan for financial institutions administered by Pentegra Retirement Services. This DB Plan is treated as a multiemployer plan for accounting purposes but operates as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. As a result, certain multiemployer
plan disclosures are not applicable.
Under the DB Plan, contributions made by a participating employer may be used to provide benefits to employees of other participating employers because assets contributed by an employer are not segregated in a separate account or restricted to provide benefits to employees of that employer only. Also, in the event that a participating employer is unable to meet its contribution or funding requirements, the required contributions for the other participating employers (including us) could increase proportionately.
Our contributions to the DB Plan for the fiscal years ended December 31, 2022, 2021 and 2020 were not more than iii5//%
of the total contributions to the DB Plan by all participating employers for the plan years ended June 30, 2021, 2020 and 2019, respectively.
Our DB Plan covers our officers and other employees who meet certain eligibility requirements, including an employment date prior to February 1, 2010. The DB Plan operates on a fiscal year from July 1 through June 30 and files one Form 5500 on behalf of all participating employers. The most recent Form 5500 available for the DB Plan is for the plan year ended June 30, 2021. The Employer Identification Number is i13-5645888
and the three digit plan number is i333. There are no collective bargaining agreements in place.
The DB Plan's annual valuation process includes calculating its funded status and separately calculating the funded status of each participating employer. The funded status is calculated as the market value of plan assets divided by the funding target which is equal to 100% of the present value of all benefits accrued, utilizing a discount rate calculation methodology prescribed by the 2012 Moving Ahead for Progress in the 21st Century Act ("MAP-21").
Such methodology continued to result in an otherwise higher discount rate at the plan valuation dates, which resulted in a lower funding target and a higher funded status each year. Over time, the favorable impact of MAP-21 may decline. As permitted by the Employee Retirement Income Security Act of 1974, the DB Plan accepts contributions for the prior plan year up to eight and a half months after the asset valuation date. As a result, the market value of plan assets at the valuation date (July 1) will increase by any subsequent contributions designated for the immediately preceding plan year ended June 30.
($ amounts in thousands unless otherwise indicated)
i
The following table presents a summary of net pension costs charged to compensation and benefits expense and the DB Plan's funded status.
DB
Plan Net Pension Cost and Funded Status
2022
2021
2020
Net pension cost charged to compensation and benefits expense
for the year ended December 31(1)
$
i7,009
$
i5,482
$
i3,211
DB
Plan funded status as July 1
i119
%
(a)
i130
%
(b)
i108
%
Our
funded status as of July 1
i110
%
i126
%
i104
%
(1) Includes
voluntary contributions for the years ended December 31, 2022, 2021 and 2020of $i6,301, $i4,112,
and $i1,944, respectively.
(a) The DB Plan's funded status as of July 1, 2022 is preliminary and may increase because the participating employers are permitted to make designated contributions through March 15, 2023 for the plan year ended June 30, 2022. Any such contributions will be included in the final valuation
as of July 1, 2022. The final funded status as of July 1, 2022 will not be available until the Form 5500 for the plan year ended June 30, 2023 is filed (no later than April 2024).
(b) The DB Plan's final funded status as of July 1, 2021 will not be available until the Form 5500 for the plan year ended June 30, 2022 is filed (no later than April 2023).
/
Nonqualified Defined Benefit Supplemental Retirement Plan.We
participate in a nonqualified, single-employer, unfunded supplemental executive retirement plan. This SERP restores all of the defined benefits to participating employees who have had their qualified defined benefits limited by Internal Revenue Service regulations. Because the SERP is a nonqualified unfunded plan, no contributions are required to be made. However, we may elect to make contributions to a related grantor trust that we established to indirectly fund the SERP in order to maintain a desired funding level. Payments of benefits may be made from the related grantor trust or from our general assets.
i
The
following table presents the changes in our SERP benefit obligation.
Change in benefit obligation
2022
2021
2020
Projected benefit obligation at beginning of
year
$
i50,577
$
i58,330
$
i42,719
Service
cost
i2,127
i3,528
i2,489
Interest
cost
i856
i1,067
i1,086
Actuarial
(gain) loss
(i1,121)
i119
i12,551
Benefits
paid
(i523)
(i523)
(i515)
Settlements
i—
(i5,665)
i—
Plan
amendment
i—
(i6,279)
i—
Projected
benefit obligation at end of year
$
i51,916
$
i50,577
$
i58,330
/
The
actuarial (gain) loss includes the impact of the changes in the discount rate, compensation, mortality, demographics and other components used to calculate the projected benefit obligation at December 31 of each year.
i
The following table presents the key assumptions used in the actuarial calculations of the benefit obligation.
($ amounts in thousands unless otherwise indicated)
The discount rate represents a weighted average that was determined by a discounted cash-flow approach, which incorporates the timing of each expected future benefit payment. We estimate future benefit payments based on the census data of the SERP's participants, benefit formulas and provisions, and valuation assumptions reflecting the probability of decrement and survival. We then determine the present value of the future benefit payments by using duration-based interest-rate yields from the Financial Times Stock Exchange Pension Discount Curve as of the measurement
date, and solving for the single discount rate that produces the same present value of the future benefit payments.
The accumulated benefit obligation for the SERP, which excludes projected future salary increases as of December 31, 2022 and 2021 was $i41,457 and $i36,545,
respectively.
The unfunded benefit obligation is reported in other liabilities. Although there are no plan assets, the assets in the related grantor trust, included as a component of other assets, had a total estimated fair value at December 31, 2022 and 2021 of $i46,688 and
$i55,008, respectively.
i
The following table presents the components of the net periodic benefit
cost for the SERP.
The
net periodic benefit cost for the SERP, including the net amount to be amortized, for the year ending December 31, 2023 is projected to be approximately $i4,722.
i
The
following table presents the estimated future benefit payments reflecting scheduled benefit payments for retired participants and the estimated payments to active participants, based on the form of payment elected by the participant and the actuarial probability of the participant retiring. Actual payments may differ significantly.
•Traditional,
which consists of credit products (including advances, standby letters of credit, and lines of credit), investments (including federal funds sold, securities purchased under agreements to resell, interest-bearing demand deposit accounts, and investment securities), and correspondent services and deposits; and
•Mortgage loans, which consists substantially of mortgage loans purchased from our members through our MPP.
These segments reflect our two primary mission asset activities and the manner in which they are managed from the perspective of development, resource allocation, product delivery, pricing, credit risk and operational administration. The segments identify the principal ways we provide services to members.
We measure the performance of each segment based upon the net
interest spread of the underlying portfolio(s). Therefore, each segment's performance begins with net interest income.
Traditional net interest income is derived primarily from the spread between the interest income earned on advances and investments and the borrowing costs related to those assets, net interest settlements and changes in fair value related to certain interest-rate swaps, and related premium and discount amortization. Traditional also includes the costs related to holding deposits for members and other miscellaneous borrowings. Mortgage loan net interest income is derived primarily from the spread between the interest income earned on mortgage loans, including the premium and discount amortization, and the borrowing costs related to those loans.
Direct other income and expense also affect each segment's results. The traditional
segment includes the direct earnings impact of certain derivatives and hedging activities related to advances, investments and consolidated obligations as well as all other miscellaneous income and expense not associated with mortgage loans. The mortgage loans segment includes the direct earnings impact of derivatives and hedging activities as well as direct compensation, benefits and other expenses (including an allocation for indirect overhead) associated with operating the MPP and volume-driven costs associated with master servicing and quality control fees.
/
The AHP assessments have been allocated to each segment based upon its proportionate share of income before assessments.
We
have not symmetrically allocated assets to each segment based upon financial results as it is impracticable to measure the performance of our segments from a total assets perspective. As a result, there is asymmetrical information presented in the tables above including, among other items, the allocation of depreciation without an allocation of the depreciable assets, derivatives and hedging earnings adjustments with no corresponding allocation to derivative assets, if any, and the recording of interest income with no allocation to accrued interest receivable.
i
The
following table presents our asset balances by operating segment.
($ amounts in thousands unless otherwise indicated)
i
Note 16 - Estimated Fair Values
i
We
estimate fair value amounts by using available market and other pertinent information and the most appropriate valuation methods. Although we use our best judgment in estimating the fair values of financial instruments, there are inherent limitations in any valuation technique. Therefore, these estimated fair values may not be indicative of the amounts that would have been realized in market transactions at the reporting dates.
Certain estimates of the fair value of financial assets and liabilities are highly subjective and require judgments regarding significant factors such as the amount and timing of future cash flows, prepayment speeds, interest-rate volatility, and the discount rates that appropriately reflect market and credit risks. The use of different assumptions could have a material effect on the fair value estimates.
Fair Value Hierarchy. GAAP
establishes a fair value hierarchy and requires us to maximize the use of significant observable inputs and minimize the use of significant unobservable inputs when measuring estimated fair value. The inputs are evaluated, and an overall level for the estimated fair value measurement is determined. This overall level is an indication of the extent of the market observability of the estimated fair value measurement for the asset or liability.
The fair value hierarchy prioritizes the inputs used to measure fair value into three broad levels:
Level 1Inputs. Quoted prices (unadjusted) for identical assets or liabilities in an active market that we can access on the measurement date. An active market for the asset or liability is a market in which the transactions for the asset
or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 Inputs.Inputs other than quoted prices within level 1 that are observable inputs for the asset or liability, either directly or indirectly. If the asset or liability has a specified or contractual term, a level 2 input must be observable for substantially the full term of the asset or liability. Level 2 inputs include (i) quoted prices for similar assets or liabilities in active markets; (ii) quoted prices for identical or similar assets or liabilities in markets that are not active; (iii) inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates and yield curves that are observable at commonly quoted intervals and implied volatilities); and (iv) inputs that are derived principally from or corroborated
by observable market data by correlation or other means.
Level 3 Inputs.Unobservable inputs for the asset or liability. Valuations are derived from techniques that use significant assumptions not observable in the market, which include pricing models, discounted cash flow models, or similar techniques.
iWe review the fair value hierarchy classifications on a quarterly basis. Changes in the observability of the inputs may result in a reclassification
of certain assets or liabilities.There were no such reclassifications during the years ended December 31, 2022, 2021, or 2020.
($ amounts in thousands unless otherwise indicated)
i
The
following tables present the carrying value and estimated fair value of each of our financial instruments. The total of the estimated fair values does not represent an estimate of our overall market value as a going concern, which would take into account, among other considerations, future business opportunities and the net profitability of assets and liabilities.
(1) Represents
the application of the netting requirements that allow us to settle (i) positive and negative positions and (ii) cash collateral and related accrued interest held or placed with the same clearing agent and/or counterparty.
(2) Included in other assets on the statement of condition.
Summary of Valuation Techniques and Significant Inputs. The valuation techniques and significant inputs used to develop our measurement of estimated fair value for assets and liabilities that are measured at fair value on a recurring or non-recurring basis in the Statement Condition are listed below.
Investment Securities - MBS. The estimated fair value incorporates prices from multiple third-party pricing vendors, when available. These pricing vendors
use various proprietary models to price MBS. The inputs to those models are derived from various sources, including, but not limited to, benchmark yields, reported trades, dealer estimates, issuer spreads, benchmark securities, bids, offers, and other market-related data.
We conduct reviews of the pricing vendors' processes, methodologies and control procedures to confirm and further augment our understanding of the vendors' prices for our MBS. Each pricing vendor has an established challenge process in place for all MBS valuations, which facilitates resolution of potentially erroneous prices identified by us.
Our valuation technique for estimating the fair values of MBS initially requires the establishment of a "median" price for each security. All prices that are within a specified tolerance threshold of the median price are then included
in the "cluster" of prices that are averaged to compute a "default" price. All prices that are outside the threshold (i.e., outliers) are subject to further analysis (including, but not limited to, comparison to prices provided by an additional third-party valuation service, prices for similar securities, and/or non-binding dealer estimates) to determine if an outlier is a better estimate of fair value. If so, then the outlier (or the other price as appropriate) is used as the final price rather than the default price. In all cases, the final price is used to determine the estimated fair value of the security.
($ amounts in thousands unless otherwise indicated)
As of December 31, 2022 and 2021, we obtained iitwo/
or iithree/
prices for substantially all of our MBS.
Investment Securities - non-MBS. The estimated fair value is determined using market-observable price quotes from third-party pricing vendors, such as the Composite Bloomberg Bond Trader screen, thus falling under the market approach.
Derivative assets/liabilities. We base the estimated fair values of derivatives with similar terms on market prices when available. However, active markets do not exist for many of our derivatives. Consequently, fair values for these instruments are generally estimated using standard valuation techniques such as discounted cash-flow analysis and comparisons to similar instruments. In limited instances, fair value estimates for derivatives are obtained from dealers and are corroborated by using a pricing model and observable
market data (e.g., the LIBOR or EFFR/SOFR curves).
A discounted cash flow analysis utilizes market-observable inputs (inputs that are actively quoted and can be validated to external sources). Inputs by class of derivative are as follows:
Interest-rate related:
•LIBOR curve or the EFFR/SOFR curve, as applicable, to project cash flows for collateralized interest-rate swaps and the EFFR/SOFR curve only to discount those cash flows; and
•Volatility assumption - market-based expectations of future interest-rate volatility implied from current market prices for similar options.
TBAs:
•TBA
securities prices - market-based prices are determined by coupon, maturity and expected term until settlement.
MDCs:
•TBA securities prices - prices are then adjusted for differences in coupon, average loan rate and seasoning.
The estimated fair values of our derivative assets and liabilities include accrued interest receivable/payable and related cash collateral. The estimated fair values of the accrued interest receivable/payable and cash collateral equal their carrying values due to their short-term nature.
We adjust the estimated fair values of our derivatives for counterparty nonperformance risk, particularly credit risk, as appropriate. We compute our nonperformance risk adjustment by using
observable credit default swap spreads and estimated probability default rates applied to our exposure after considering collateral held or placed.
Grantor Trust Assets. Grantor trust assets, included as a component of other assets, are carried at estimated fair value based on quoted market prices as of the last business day of the reporting period.
($ amounts in thousands unless otherwise indicated)
Estimated Fair Value Measurements. iThe following tables present, by level within the fair value hierarchy, the estimated fair value of our financial assets and liabilities that are recorded at estimated fair value on a recurring or non-recurring basis on our statement of condition.
Total
liabilities at recurring estimated fair value
$
i12,185
$
i—
$
i413,776
$
i—
$
(i401,591)
(1)Represents
the application of the netting requirements that allow us to settle (i) positive and negative positions and (ii) cash collateral and related accrued interest held or placed with the same clearing agent and/or counterparty.
ii
Note
17 - Commitments and Contingencies
i
The following table presents our off-balance-sheet commitments at their notional amounts.
Commitments
to fund or purchase mortgage loans, net (3)
i30,855
i—
i30,855
Unsettled
CO bonds, at par
i75,000
i—
i75,000
Unsettled
discount notes, at par
i5,000
i—
i5,000
(1)
Maximum line of credit amount per member is $i100,000.
(2) Generally for periods up to i6 months.
(3) Generally
for periods up to i91 days.
/
Commitments to Extend Credit.A standby letter of credit is a financing arrangement between us and one of our members for which we charge the member a commitment fee. If we are required
to make a payment for a beneficiary's draw, the payment amount is converted into a collateralized advance to the member. Substantially all of these standby letters of credit, including related commitments, range from i3 months to i20 years, although some are renewable at
our option. Unearned fees on standby letters of credit are recorded in other liabilities and totaled $i12,454 at December 31, 2022. Lines of credit allow members to fund short-term cash needs (up to ione
year) without submitting a new application for each request for funds.
($ amounts in thousands unless otherwise indicated)
Liability for Credit Losses. We monitor the creditworthiness of our members that have standby letters of credit
and lines of credit. As standby letters of credit and lines of credit are subject to the same collateralization and borrowing limits that apply to advances and are fully collateralized at the time of issuance, we have not recorded a liability for credit losses on these credit products.
Commitments to Fund or Purchase Mortgage Loans.Commitments that unconditionally obligate us to fund or purchase mortgage loans are generally for periods not to exceed i91
days. Such commitments are reported as derivative assets or derivative liabilities at their estimated fair value and are reported net of participating interests sold to other FHLBanks.
Pledged Collateral.At December 31, 2022 and 2021, we had pledged cash collateral of $i1,849,797 and $i515,740,
respectively, to counterparties and clearing agents. At December 31, 2022 and 2021, we had not pledged any securities as collateral.
Legal Proceedings. We are subject to legal proceedings arising in the normal course of business. We record an accrual for a loss contingency when it is probable that a loss for which we could be liable has been incurred and the amount can be reasonably estimated. After consultation with legal counsel, management is not aware of any such proceedings where the ultimate liability, if any, could have a material effect on our financial condition, results of operations or cash flows.
Additional discussion of other commitments and contingencies is provided in
Note 5 - Advances; Note 6 - Mortgage Loans Held for Portfolio; Note 8 - Derivatives and Hedging Activities; Note 10 - Consolidated Obligations; Note 12 - Capital; and Note 16 - Estimated Fair Values.
i
Note 18 - Related Party and Other Transactions
We are
a financial cooperative whose members and former members (or legal successors) own all of our outstanding capital stock. For more information, see Note 12 - Capital.
Under GAAP, transactions with related parties include transactions with principal owners, i.e, owners of more than 10% of the voting interests of the entity. Due to the statutory limits on members' voting rights and the number of our members, no shareholder owned more than 10 percent of the total voting interests as of and for the three-year period ended December 31, 2022. Therefore, the Bank had no transactions with principal owners for any of the periods presented.
Under GAAP, transactions with related parties also include transactions with management. Management is defined as persons
who are responsible for achieving the objectives of the entity and who have the authority to establish policies and make decisions by which those objectives are to be pursued. For this purpose, management typically includes those who serve on our board of directors.
Transactions with Directors Financial Institutions. The Bank provides, in the ordinary course of its business, products and services to members whose officers or directors may also serve as directors of the Bank, i.e., directors' financial institutions. However, Finance Agency regulations require that transactions with directors' financial institutions be made on the same terms as those with any other member. Therefore, all of our transactions with directors' financial institutions are subject to the same eligibility and credit criteria, as well as the same conditions, as comparable transactions with all other members.
i
The
following table presents our transactions with directors' financial institutions, taking into account the beginning and ending dates of the directors' terms, merger activity and other changes in the composition of directors' financial institutions.
Years Ended December 31,
Transactions with Directors' Financial Institutions
2022
2021
2020
Net
capital stock issuances (redemptions and repurchases)
($ amounts in thousands unless otherwise indicated)
i
The following table presents the aggregate balances of capital stock and advances outstanding for directors' financial institutions and their balances as a percent of the total
balances on our statement of condition.
The
composition of directors' financial institutions changed on January 1, 2022, due to changes in board membership resulting from the 2021 director election, and on August 5, 2022 and November 8, 2022 due to director resignations.
Transactions with Members and Former Members. Substantially all advances are made to members, and all whole mortgage loans held for portfolio are purchased from members. We also maintain demand deposit accounts for members, primarily to facilitate settlement activities that are directly related to advances or mortgage loan purchases. Such transactions with members are entered into in the ordinary course of business. In addition, we may purchase investments in federal funds sold, securities purchased under agreements
to resell, certificates of deposit, and MBS from members or their affiliates. All purchases are transacted at market prices without preference to the status of the counterparty or the issuer of the security as a member, nonmember, or affiliate thereof.
Under our AHP, we provide subsidies to members, which may be in the form of direct grants or below-market-rate advances. All AHP subsidies are made in the ordinary course of business. Under our Community Investment Program and our Community Investment Cash Advances program, we provide subsidies in the form of below-market-rate advances to members or standby letters of credit to members for community lending and economic development projects. All Community Investment Cash Advances subsidies are made in the ordinary course of business.
Transactions with Other FHLBanks. Occasionally,
we loan or borrow short-term funds to/from other FHLBanks. There were iiiino///
loans to or borrowings from other FHLBanks that remained outstanding at December 31, 2022 or 2021.
Transactions
with the Office of Finance. Our proportionate share of the cost of operating the Office of Finance is identified in our statement of income. For the determination of our proportionate share, see Note 1 - Summary of Significant Accounting Policies.
advance: Secured loan to members, former members or Housing Associates
AFS: Available-for-Sale
Agency: GSE and Ginnie Mae
AHP: Affordable Housing Program
AMA: Acquired Member Assets
AOCI: Accumulated Other Comprehensive Income (Loss)
Bank Act: Federal Home Loan Bank Act of 1932, as amended
bps: basis points
CDFI: Community Development Financial Institution
CFI: Community Financial Institution, a Federal Deposit Insurance Corporation-insured depository institution with average total assets below an annually- adjusted limit established by the Finance Agency
Director based on the Consumer Price Index
CFPB: Bureau of Consumer Financial Protection
Clearinghouse: A United States Commodity Futures Trading Commission-registered derivatives clearing organization
CO bond: Consolidated Obligation bond
DB Plan: Pentegra Defined Benefit Pension Plan for Financial Institutions, as amended
DC Plan: Collectively, the Pentegra Defined Contribution Retirement Savings Plan for Financial Institutions, as amended, in effect through October 1, 2020 and the Federal Home Loan Bank of Indianapolis Retirement Savings Plan, commencing October
2, 2020
DDCP: Directors' Deferred Compensation Plan
EFFR: Effective Federal Funds Rate
Exchange Act: Securities Exchange Act of 1934, as amended
Fannie Mae: Federal National Mortgage Association
FASB: Financial Accounting Standards Board
FHA: Federal Housing Administration
FHLBank: A Federal Home Loan Bank
FHLBanks: The 11 Federal Home Loan Banks or a subset thereof
FHLBank System: The 11 Federal Home Loan Banks and the Office of
Finance
FICO®: Fair Isaac Corporation, the creators of the FICO credit score
Finance Agency: Federal Housing Finance Agency
FOMC: Federal Open Market Committee
Form 8-K: Current Report on Form 8-K as filed with the SEC under the Exchange Act
Form 10-K: Annual Report on Form 10-K as filed with the SEC under the Exchange Act
Form 10-Q: Quarterly Report on Form 10-Q as filed with the SEC under the Exchange Act
Freddie Mac: Federal Home Loan Mortgage Corporation
GAAP: Generally Accepted Accounting
Principles in the United States of America
Ginnie Mae: Government National Mortgage Association
GSE: United States Government-Sponsored Enterprise
Housing Associate: Approved lender under Title II of the National Housing Act of 1934 that is either a government agency or is chartered under federal or state law with rights and powers similar to those of a corporation
Securities Act: Securities Act of 1933, as amended
SERP: Collectively, the 2005 FHLBank of Indianapolis Supplemental Executive
Retirement Plan, as amended, and the FHLBank of Indianapolis Supplemental Executive Retirement Plan, frozen effective December 31, 2004
SETP: Federal Home Loan Bank of Indianapolis 2016 Supplemental Executive Thrift Plan, as amended and restated
SMI: Supplemental Mortgage Insurance
SOFR: Secured Overnight Financing Rate
TBA: To Be Announced, a forward contract for the purchase or sale of MBS at a future agreed-upon date for an established price
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
We
use acronyms and terms throughout this Item that are defined herein or in the Defined Terms.
Evaluation of Disclosure Controls and Procedures
We are responsible for establishing and maintaining disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in our reports filed under the Exchange Act is: (a) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms; and (b) accumulated and communicated to our management, including our principal executive officer, principal financial officer, and principal accounting officer, to allow timely decisions regarding required disclosures.
As of December 31,
2022, we conducted an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer (the principal executive officer), Chief Financial Officer (the principal financial officer) and Chief Accounting Officer (the principal accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. In making this assessment, our management used the criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer concluded that our disclosure controls and procedures were effective as of December 31, 2022. For Management's Report on Internal Control over Financial Reporting and the Report of Independent
Registered Public Accounting Firm, see Item 8. Financial Statements and Supplementary Data.
Internal Control Over Financial Reporting
Changes in Internal Control Over Financial Reporting.There were no changes in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15(d)-15(f) of the Exchange Act, that occurred during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on the Effectiveness of Controls.We do not expect that our disclosure controls and procedures and other internal controls
will prevent all error and fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the
likelihood of future events, and there can only be reasonable assurance that any design will succeed in achieving its stated goals under all potential future conditions. Additionally, over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
ITEM 9B. OTHER INFORMATION
None.
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS
THAT PREVENT INSPECTIONS
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We use acronyms and terms throughout this Item that are defined herein or in the Defined Terms.
Board of Directors
The
Bank Act divides FHLBank directorships into two categories, "member" directorships and "independent" directorships. Both types of directorships are filled by a vote of the members. Elections for member directors are held on a state-by-state basis. Member directors are elected by a plurality vote of the members in their state. Independent directors are elected at-large by all the members in the FHLBank district without regard to the state. No member of management of an FHLBank may serve as a director of an FHLBank.
Under the Bank Act, member directorships must make up a majority of the board of directors' seats, while the independent directorships must comprise at least 40% of the entire board. A Finance Agency order issued June 1, 2022 provides that we have 15 seats on our board of directors for 2023, consisting of five Indiana member directors,
three Michigan member directors, and seven independent directors. The term of office for directors is four years, unless otherwise adjusted by the Director in order to achieve an appropriate staggering of terms, with approximately one-fourth of the directors' terms expiring each year. Directors may not serve more than three consecutive full terms.
Finance Agency regulations permit, but do not require, the board of directors to conduct an annual assessment of the skills and experience possessed by the board as a whole and to determine whether the capabilities of the board would be enhanced through the addition of individuals with particular skills and experience. We may identify those qualifications and inform the voting members as part of our nomination and balloting process; however, by regulation as described below, we may not exclude a member director nominee from the election ballot on the basis of those
qualifications. For the 2022 director elections, our board listed in its request for nominations certain desirable candidate attributes and experiences, personal characteristics, and other competencies, but no particular qualifications beyond the eligibility criteria were required as part of the nomination, balloting and election process.
Finance Agency regulations require each FHLBank to develop, implement, and maintain policies and procedures to ensure, to the maximum extent possible in balance with financially safe and sound business practices, the consideration of minorities, women, and individuals with disabilities for employment, and consideration of minority-, women-, and disabled-owned businesses to be engaged for all business and activities. In particular, those regulations require our policies and procedures to (among other things) encourage the consideration of diversity in nominating or soliciting
nominees for positions on our board of directors.
Nomination of Member Directors. The Bank Act and Finance Agency regulations require that member director nominees meet certain statutory and regulatory criteria in order to be eligible to be elected and serve as directors. To be eligible, an individual must: (i) be an officer or director of a member institution located in the state in which there is an open member director position; (ii) represent a member institution that is in compliance with the minimum capital requirements established by its regulator; and (iii) be a United States citizen. These are the only eligibility and qualifications criteria that member directors must meet.
Each eligible institution may nominate representatives from member institutions in its state to serve as member directors. Only our shareholders
may nominate and elect member directors. Our board of directors is not permitted to nominate or elect member directors, except to fill a vacancy for the remainder of an unexpired term or to fill a vacancy for which no nominations were received. No director, officer, employee, attorney or agent of our Bank (except in his or her personal capacity) may, directly or indirectly, support the nomination or election of a particular individual for a member directorship. Finance Agency regulations do not require member institutions to communicate the reasons for their nominations, and we have no power to require them to do so.
Nomination of Independent Directors. Independent director nominees are also subject to certain statutory and regulatory eligibility criteria. Each independent director must be a United States citizen and a bona fide resident of Michigan or Indiana. The Bank Act and Finance
Agency regulations prohibit an independent director from serving as a director, officer, or employee of a member of the FHLBank on whose board the director sits, or of a recipient of an advance from that FHLBank, or as an officer of any FHLBank, and also prohibit the nomination or election as an independent director of an individual serving in any such capacity.
Under the Bank Act, there are two types of independent directors:
•Public interest directors -
We are required to have at least two public interest directors. Each must have more than four years of experience representing consumer or community interests in banking services, credit needs, housing, or consumer financial protections.
•Other independent directors - Independent directors must have demonstrated knowledge or experience in auditing or accounting, derivatives, financial management, organizational management, project development or risk management practices, or other expertise established by Finance Agency regulations.
Before nominating an individual for an independent directorship, other than for a public interest directorship, our board must determine that the nominee's knowledge or experience is commensurate with that needed to oversee a financial institution with a size and complexity
that is comparable to that of our Bank. Pursuant to the Bank Act and Finance Agency regulations, the board of directors, after consultation with our Affordable Housing Advisory Council, nominates candidates for the independent director positions. Individuals interested in serving as independent directors may submit an application for consideration by the Executive/Governance Committee, which performs certain functions for our board that are similar to those of a board nominating committee with respect to the nomination of candidates for election as independent directors. The application form is available on our website at www.fhlbi.com, by clicking on "About,""Board of Directors"
and "Become a Board Member." Our members may also nominate independent director candidates. The conclusion that an independent director nominee may qualify to serve as a director is based upon the nominee's satisfaction of the eligibility criteria listed above and verified through application and eligibility certification forms prescribed by the Finance Agency. The board then submits the slated independent director candidates to the Finance Agency for review and comment. Once the Finance Agency has accepted candidates for the independent director positions, we hold a district-wide election for those positions.
Under Finance Agency regulations, if the board of directors nominates only one independent director candidate for each open seat, each candidate must receive at least 20% of the votes that are eligible to be cast in order to be elected. If there is more than one candidate for each open independent
director seat, then such requirement does not apply.
2022 Member and Independent Director Elections. The Bank Act and Finance Agency regulations set forth the voting rights and processes with respect to the election of member directors and independent directors. The board of directors does not solicit proxies, nor are eligible institutions permitted to solicit or use proxies to cast their votes in an election for directors. For the election of both member directors and independent directors, each eligible institution is entitled to cast one vote for each share of stock that it was required to hold as of the record date (i.e., December 31 of the year prior to the year in which the election is held); however, the number of votes that a member institution may cast for each directorship cannot exceed the average number of shares of stock that were required to be held by all member institutions
located in the applicable state on the record date.
The only matter submitted to a vote of our shareholders in 2022 was the fourth quarter election of one Michigan member director and one Indiana member director. No meeting of the members was held with regard to the 2022 election. The 2022 election was conducted in accordance with the Bank Act and Finance Agency regulations.
Board of Directors Vacancies. Vacancies on our board of directors are filled by a majority vote of the remaining directors. The term of any such filled directorship is the unexpired term of office of the vacant directorship. Any individual so elected must satisfy the eligibility requirements applicable to his or her predecessor. Before an election to fill a vacant directorship occurs, we must obtain an executed
eligibility certification form from each individual being considered to fill the vacancy, and must verify each individual's eligibility. We must also verify the qualifications of any potential independent director. Before electing an independent director, we must deliver to the Finance Agency for review a copy of the application form of each individual being considered by the board. Promptly following an election to fill a vacancy on the board, we must send a notice to our members and the Finance Agency providing information about the elected director, including his or her name, company affiliation, title, term expiration date and, for member directors, the voting state that the director represents.
(1) Our board of directors, with input from the Executive/Governance Committee, elects a Chair and a Vice Chair to two-year terms. On November 18, 2022, our board elected Ms. Gregerson as Chair and Mr. Fisher as Vice Chair for 2023-2024.
(2) Ms. Narayanan and Mr. Sears have been designated public interest directors.
There
are two open seats on our board: a Michigan member seat with a term expiration of December 31, 2023 (previously held by Brian D.J. Boike, who resigned from the board on November 8, 2022) and an independent director seat with a term expiration of December 31, 2024 (previously held by Lisa D. Cook, who resigned from the board on May 12, 2022.) We expect the board will fill these vacancies with successor directors whose service will commence during the second quarter of 2023.
The following is a summary of the background and business experience of each of our directors. Except as otherwise indicated, for at least the last five years, each director has been engaged in his or her principal occupation as described below.
Karen
F. Gregersonjoined the board in 2013, and currently serves as Chair. Ms. Gregerson is the President and CEO of The Farmers Bank in Frankfort, Indiana, and President of The Farmers Bancorp, a bank holding company in Frankfort, Indiana, having been appointed to each of those positions in 2016. She is also a director of both entities. Prior to those appointments, Ms. Gregerson was Senior Vice President and Chief Financial Officer of STAR Financial Bank in Fort Wayne, Indiana, a position she held beginning in 1997. She also serves as a member of the board of directors of the Indiana Statewide Certified Development Corporation. Ms. Gregerson holds a bachelor of science degree in accounting from Ball State University and a master of science degree in organizational leadership from the Indiana Institute of Technology. She is a CPA. The board of directors has determined that Ms. Gregerson is an Audit Committee Financial Expert due primarily to her
experience as a director, CEO and Chief Financial Officer of a commercial bank and as a CPA.
Robert M. Fisherjoined the board in 2019 and currently serves as Vice Chair. Mr. Fisher is President - CEO of Lake-Osceola State Bank in Baldwin, Michigan, and has held that position since 2018. He also serves as the Vice Chair and Secretary of that bank's board of directors, and is the President and Secretary of Lake Financial Holding Company, Baldwin, Michigan, its bank holding company. Prior to 2018, Mr. Fisher served as President - Chief Operating Officer of Lake-Osceola State Bank since 2005. Mr. Fisher is Chair of the board of Baldwin Family Health Care, a community healthcare program, where he has served as Chair for the past 12 years. Mr. Fisher holds a bachelor of business leadership degree from Baker
College. The board of directors has determined that Mr. Fisher is an Audit Committee Financial Expert due primarily to his experience as President - CEO and Chief Operating Officer of a commercial bank.
Michael E. Bosway retired from Stifel Nicolaus & Company in Indianapolis, Indiana, in January 2022, where he had served as Managing Director of Investments for the Central Great Lakes Division commencing in 2017. Previously he was President and CEO of City Securities Corporation from 1999 until its merger with Stifel Nicolaus & Company in 2017. Mr. Bosway serves on the Indy Chamber Board of Directors, the Indianapolis Zoo Board, and the University of Dayton Investment Committee. He previously served on the Indiana Chamber of Commerce Board and Executive Committee. Mr. Bosway holds a bachelor of
arts degree in economics from the University of Dayton and a master of business administration degree from The Ohio State University.
Clifford M. Clarke has served as the board Vice Chair of Three Rivers Federal Credit Union in Fort Wayne, Indiana, since 2020, and as a director of the credit union since 2012. Mr. Clarke is the founder, Principal Consultant, and President of C2 IT Advisors LLC, a strategic information technology consulting firm formed in 2008. He also served as the
Chief Information Officer of the Public Technology Institute, a national nonprofit organization advising local municipal executives on technology, research, and best practices, located in Washington, DC, from 2009-2020. He also serves as a Director for Indiana Tech in Fort Wayne, Indiana. Previously, Mr. Clarke served as the Executive Director in the Office of Information Technology of Ivy Tech Community College, Fort Wayne, Indiana from 2010-2019. He has previously served as board Chair of Big Brothers Big Sisters Northeast Indiana and Leadership Fort Wayne. He is on the Fort Wayne Black Chamber of Commerce and previously served as its board president. Mr. Clarke holds a bachelor of science degree in data science and a master of business administration degree, each from Indiana Institute of Technology, where he is pursuing a PhD in global leadership. Mr. Clarke holds several professional certifications including CRISC, CGEIT, CISM, CSSGB, and PMP.
Charlotte
C. Deckerserved as Chief Information Technology Officer for the UAW Retiree Medical Benefits Trust, in Detroit, Michigan, from December 2014 through January 2022. She is a director of Quaker Chemical Corporation (also known as Quaker Houghton), a chemicals company whose board of directors she joined in 2020. Ms. Decker previously served as a Senior Consultant for Data Consulting Group, an information technology consulting services company in Detroit, Michigan, from 2014 through 2015. Prior to that, she was Vice President - Chief Technology Officer for Auto Club Group of Michigan, an insurance and financial services company in Dearborn, Michigan, from 2008-2014. She was a Director of Global Computing for General Motors Corporation in Detroit, Michigan, from 2004-2007. Ms. Decker also held various information technology leadership positions at Borders Group (2000-2004) and Ford Motor Company (1986-2000). Ms. Decker holds a bachelor of science
degree in computer engineering, a master of science degree in computer engineering, and a master of business administration degree in corporate strategy, each from the University of Michigan.
Perry G. Hines is the President and CEO of The Hines Group, a data driven consulting firm operating as an advisor to businesses and non-profit organizations, a position he has held since 2007. Mr. Hines has served as the Chief Development Officer of Wheeler Mission in Indianapolis, Indiana since May 2021 and has been named President and CEO effective in March 2023. Previously, he served as the Director of Advancement for the Covenant Christian Schools of Indianapolis, Inc. from 2017–2021. Prior to such position, he served as the Director of Development for the Shepherd Community Center from 2015–2017. From 2002-2007,
he served as the Senior Vice President – Chief Marketing Officer and Communications Officer of Irwin Mortgage Corporation, a division of Irwin Financial Corporation headquartered in Columbus, IN. During his tenure, he also oversaw the Irwin Mortgage Corporation Foundation, which provided grant dollars to organizations engaged in providing affordable housing to communities pursuant to the Community Reinvestment Act. Mr. Hines currently serves as an independent director on the Board of Horace Mann Educators Corporation, a financial services company that provides educators and administrators with insurance and retirement solutions, where he has served since 2018. Mr. Hines is also currently a member of the Board of Directors for the Indiana University Lilly Family School of Philanthropy. Mr. Hines previously served on the Goodwill Foundation of Central & Southern Indiana board of directors from 2016-2022. Mr. Hines holds a bachelor of arts degree in journalism and government
from Western Kentucky University, a master of business administration degree in marketing from the University of Minnesota Carlson School of Business, and is a certified fund-raising manager from the Indiana University Lilly School of Philanthropy.
Robert D. Long retired from KPMG LLP on December 31, 2006, where he had been the Office Managing Partner in the Indianapolis, Indiana office since 1999, and had served as an audit partner since 1988. As an audit partner, Mr. Long served a number of companies with public, private and cooperative ownership structures in a variety of industries, including banking, finance and insurance. Mr. Long is a CPA. Mr. Long served on the board of Celadon Group, Inc., a transportation and logistics company, from 2014-2021,
including serving as its Audit Committee Chair and Audit Committee financial expert from 2014 through the termination of such Committee in 2019. From 2010-2015, Mr. Long was a member of the board and Chair of the Audit Committee for Beefeaters Holding Company, Inc., a pet food company. He holds a bachelor of science degree from Indiana University. The board of directors has determined that Mr. Long is an Audit Committee Financial Expert due primarily to his previous experience as an audit partner at a major public accounting firm and as the Audit Committee Chair of multiple companies.
Michael J. Manicais the Vice Chair and a director of United Bank Financial Corporation, a bank holding company, and is Vice Chair and a director of its banking subsidiary, United Bank of Michigan, in Grand Rapids, Michigan,
and has held those positions since 2019. Before his appointments as Vice Chair, Mr. Manica had served as a director and President and CEO of those entities beginning in 2014. His career with United Bank of Michigan began in 1980. He holds a bachelor of arts degree in economics from the University of Michigan and completed the Graduate School of Banking program at the University of Wisconsin.
Larry W. Myersis the President and CEO of First Savings Financial Group, Inc., a bank holding company, and its banking
subsidiary, First Savings Bank, in Clarksville, Indiana, and has held those positions since 2009 and 2007, respectively. Previously he served as the Chief Operations Officer of First Savings Bank, and has served as a director of that bank since 2005. Mr. Myers has over 35 years' experience in retail banking, commercial lending and wealth management. Mr. Myers has served as Chair of the Indiana Bankers Association, currently serves as a director on the Board of the American Bankers Association and its FHLBank Committee. He additionally serves as an Advisory Director for the Community Depository Institutions Advisory Council of the Federal Reserve Bank of St. Louis from 2013-2015. Mr. Myers holds a bachelor of science degree and a master of business administration degree, both from the University of Kentucky. The board of directors has determined that Mr. Myers is an Audit Committee Financial Expert due primarily to his extensive experience as director, CEO, and chief
operations officer of a commercial bank.
Christine Coady Narayanan is the President and CEO of Opportunity Resource Fund, a U.S. Treasury-certified CDFI with offices in Lansing, Grand Rapids, and Detroit, Michigan, having served in that position since 2004. Opportunity Resource Fund is a non-profit CDFI that provides social impact investment opportunities for individuals and corporations throughout Michigan and engages in lending for affordable housing and community development purposes. Ms. Narayanan has held various positions with the Opportunity Resource Fund and its predecessor organization since 1989, and served as its Executive Director from 1997-2004. She also serves as Chair of the Board of the Detroit CDFI Coalition and Secretary of the Board of the Michigan CDFI Coalition. She holds
a bachelor of arts degree from Spring Arbor University. Ms. Narayanan is a graduate of the National Internship in Community Economic Development and Michigan Municipal League's Elected Officials Academy and has completed certification through the Indiana University Center of Philanthropy. She holds a Certificate of Strategic Perspectives in Nonprofit Management from the Harvard Business School’s Executive Education.
Sherri L. Reagin is Executive Vice President and Chief Operations Officer of the North Salem Bank in North Salem, Indiana, where she previously served as Executive Vice President and Chief Financial Officer from October 2011 through February 2023. Ms. Reagin was elected as a Director of the North Salem State Bank in September 2022. She also serves as the Investment Officer and Board Member
of NSSB Investments, Inc., a position she has held since 2013. She serves as the national representative for community banks on the U.S. Coin Task Force, a group selected by the Federal Reserve to address the coin circulation challenges resulting from the pandemic. Ms. Reagin served as a member of the Independent Community Bankers of American Payments and Operations Committee from 2017 until March 2023 when she will transition off that committee and begin her service as the Federal Delegate for the State of Indiana by the Independent Community Bankers of America. Ms. Reagin serves as Treasurer of the Hendricks County Community Foundation. Ms. Reagin holds a bachelor’s degree in human resources and management from Indiana University and a Certificate of Executive Leadership from the University of Wisconsin-Madison’s Graduate School of Banking. She is a CPA. The board of directors has determined that Ms. Reagin is an Audit Committee Financial Expert due primarily to her
experience as a Chief Financial Officer of a commercial bank.
Todd E. Sears is the Chief Investment Officer and Chief Financial Officer of Valeo Financial Advisors, a registered investment advisor based in Indiana, a position he has held since 2022. He was previously the Executive Vice President of Research, Policy and Strategy at Kittle Property Group, Inc. (formerly Herman & Kittle Properties, Inc.), in Indianapolis, Indiana, a national multifamily housing property developer, having served in that position since 2021. Prior to that appointment, he served as Executive Vice President from 2018-2021, after serving as Executive Vice President - Portfolio Management and Analysis beginning in 2014. He joined Kittle Property Group Inc. in 2005. Since 2017, Mr. Sears has served as an adjunct professor of real
estate finance at Butler University. He previously served on our Affordable Housing Advisory Council from 2012-2018. He is the founder of Pyxso, LLC, a consulting firm through which he has provided advisory services to not-for-profit companies since 2011. Mr. Sears holds a bachelor of science degree in finance from Indiana University, Bloomington, Indiana, and a master of arts degree in economics from Indiana University, Indianapolis, Indiana. Mr. Sears is a CFA® charterholder and holds a Chartered Alternative Investment Analyst designation. The board of directors has determined that Mr. Sears is an Audit Committee Financial Expert due primarily to his CFA® and Chartered Alternative Investment Analyst designations, his experience serving as a Chief Financial Officer, and his educational background.
Ryan M. Warneris
Chairman of Bippus State Bank in Huntington, Indiana, and has held that position since 2019. He also serves on the Board of the Bippus State Corporation, its bank holding company. Previously, Mr. Warner served as President - CEO and a director of that bank since 1987. He has been employed by that bank since 1977. Mr. Warner previously served as one of our directors from 2017-2020. Mr. Warner previously served as a member of the Huntington County Economic Development board of directors from 2012-2021. Mr. Warner holds an associate degree in accounting from International Business College, and a Certificate of Banking from the Graduate School of Banking program at the University of Wisconsin - Madison.
Committee
Assignments.Each of our directors serves on one or more committees of our board. Committee assignments are made annually, based on board consensus, with input from the President - CEO. Committee assignments take into consideration several factors, including the committees’ responsibilities and needs, directors' preferences and expertise, the benefits of rotations in committee memberships, and balancing the committees' responsibilities among all directors.
The following table presents the committees on which each director serves as of the filing date of this Form 10-K, as well as whether the director is the Chair (C), Vice Chair (VC), member (x), alternate (A), or Ex-Officio member (EO).
* Ms. Reagin was appointed as Audit Committee Vice Chair in July 2022 in anticipation of Mr. Jackson's resignation from the Board in August 2022.
Audit Committee Report. Our Audit Committee operates under a written charter adopted by the board of directors. The Audit Committee charter is available on our website
at www.fhlbi.com by selecting "About" and then selecting "Corporate Governance." In accordance with its charter, the Audit Committee assists the board in fulfilling its fiduciary responsibilities and overseeing the internal and external audit functions. The Audit Committee is responsible for evaluating the Bank's compliance with laws, regulations, policies and procedures (including the Code of Conduct), and for determining that the Bank has adequate administrative, operating and internal controls. In addition, the Audit Committee is responsible for providing reasonable assurance regarding the integrity of financial and other data used by the board, the Finance Agency, our members and the public. Furthermore, the Audit Committee oversees the programs, policies, and systems of the Bank designed
to ensure the integrity and reliability of Bank operations and technology, including cybersecurity. To fulfill these responsibilities, the Audit Committee may, in accordance with its charter, conduct or authorize investigations into any matters within the Committee's scope of responsibilities. The Audit Committee may also retain independent counsel, accountants, or others to assist in any investigation.
The Audit Committee annually reviews its charter and practices and has determined that its charter and practices are consistent with all applicable laws, regulations and policies. In addition, during 2022, the Audit Committee
met 13 times and among other duties:
•reviewed the scope of and overall plans for the external and internal audit programs;
•reviewed and recommended board approval of our policy with regard to the hiring of former employees of our independent registered public accounting firm, PricewaterhouseCoopers ("PwC");
•reviewed and approved our policy for the pre-approval of audit and permitted non-audit services by the independent registered public accounting firm ("independent auditor");
•received reports pursuant to our policy for the submission and confidential treatment of communications from employees and others about accounting, internal
controls and auditing matters;
•reviewed the adequacy of our internal controls, including for purposes of evaluating the fair presentation of our financial statements in connection with certifications made by our principal executive officer, principal financial officer and principal accounting officer;
•discussed with management and PwC significant matters, including Critical Audit Matters, arising during the audit and other areas of significant judgment or estimation in preparing the financial statements;
•reviewed and challenged management and PwC, as necessary, on how they have established materiality thresholds for establishing the controls over financial reporting and their audit process; and
•discussed
with management the use and appropriateness of any non-GAAP measures in the financial statements.
The Sarbanes-Oxley Act of 2002 requires the Audit Committee to establish and maintain procedures for the confidential submission of employee concerns regarding questionable accounting, internal controls or auditing matters. The Audit Committee has established procedures for the receipt, retention and treatment, on a confidential basis, of any related concerns we receive. The Audit Committee encourages employees and third-party individuals and organizations to report concerns about accounting, controls, auditing matters or anything else that appears to involve financial or other wrongdoing pertaining to the Bank.
The Bank is one of 11 regional FHLBanks across the United States which, along with the Office of Finance,
compose the FHLBank System. Each FHLBank operates as a separate entity with its own management, employees, board of directors, and shareholders and each is regulated by the Finance Agency. The Office of Finance has responsibility for the issuance of consolidated obligations on behalf of the FHLBanks, and for publishing combined financial reports of the FHLBanks. Accordingly, the FHLBank System has determined that it is optimal to have the same independent auditor to coordinate and perform the separate audits of the financial statements of each FHLBank and the FHLBanks' combined financial reports. The FHLBanks and the Office of Finance cooperate in selecting, setting the compensation of, and evaluating the performance of the independent auditor, but the responsibility for the appointment of and oversight of the independent auditor remains solely with the Audit Committee of each FHLBank and the Office of Finance.
PwC
has been the independent auditor for the FHLBank System and the Bank since 1990. The Audit Committee engages in thorough evaluations each year when appointing an independent auditor. In connection with the appointment of the Bank's independent auditor, the Audit Committee's evaluation included consultation with the Audit Committees of the other FHLBanks and the Office of Finance. In the course of these evaluations, the Audit Committee considers, among other factors:
•an analysis of the risks and benefits of retaining the same firm as independent auditor versus engaging a different firm, including consideration of:
◦PwC engagement audit partner, engagement quality review partner and audit team rotation;
◦PwC's tenure as the Bank's
and the FHLBank System's independent auditor;
◦benefits associated with engaging a different firm as independent auditor; and
◦potential disruption and risks associated with changing the Bank's independent auditor;
•PwC's familiarity with our operations and businesses, accounting policies and practices and internal control over financial reporting;
•PwC's historical and recent performance of our audit, including feedback from Bank management as to PwC's service and quality;
•an analysis of PwC's known legal risks and significant proceedings;
•both engagement
and external data relating to audit quality and performance, including recent Public Company Accounting Oversight Board audit quality inspection reports on PwC and its peer firms as well as metrics indicative of audit quality;
•the appropriateness of PwC's fees, on both an absolute basis and as compared to fees charged to other banks both within and beyond the FHLBank System and trends therein; and
•the diversity of PwC's ownership and staff assigned to the engagement.
The Audit Committee reviews and approves
the amount of fees paid to PwC for audit, audit-related and other services. Audit fees represent fees for professional services provided in connection with the audit of our annual financial statements and internal control over financial reporting and reviews of our quarterly financial statements, regulatory filings, and other SEC matters. The Audit Committee has determined that PwC did not provide any non-audit services that would impair its independence. To the Audit Committee's knowledge, there are no other matters which cause the Audit Committee to believe PwC is not independent.
In accordance with SEC rules, audit partners are subject to rotation requirements to limit the number of consecutive years an individual partner may provide service to our Bank. For engagement audit and quality review partners, the maximum number of consecutive years of service in that capacity is five years. The process for selection
of our lead audit partner pursuant to this rotation policy involves a meeting between the Chair of the Audit Committee and the candidate(s) for the role, as well as discussion by the full Audit Committee and with management. The Bank's current lead audit partner has served since 2021.
Based on its evaluation and review, the Audit Committee appointed PwC as our independent auditor for the year ended December 31, 2022.
Management has the primary responsibility for the integrity and reliability of our financial statements, accounting and financial reporting principles, and internal controls and procedures designed to assure compliance with accounting standards and applicable laws and regulations. An independent auditor is responsible for performing an independent audit of our
financial statements and of the effectiveness of internal control over financial reporting in accordance with auditing standards promulgated by the Public Company Accounting Oversight Board and standards applicable to financial audits in accordance with Government Auditing Standards, issued by the Comptroller General of the United States. Our internal auditors are responsible for preparing an annual audit plan and conducting internal audits under the direction of our Chief Internal Audit Officer, who reports to the Audit Committee.
The Audit Committee's responsibility is to monitor and oversee these processes. The Audit Committee has certain other responsibilities with respect to the internal audit function, including facilitation of independent, direct communications between the board and our internal auditors. The Audit Committee also reviews the scope of internal
audit services required, internal audit findings, and management responses. In addition, the Audit Committee is responsible for the selection, compensation, performance evaluation and independence of the Chief Internal Audit Officer, who may be removed only with the Audit Committee’s approval. The Audit Committee also approves the incentive compensation plans and awards for internal audit employees; the charter for the internal audit department; and the staffing, budget, and risk-based internal audit plan.
Prior to their issuance, the Audit Committee reviews and discusses the quarterly and annual earnings releases, financial statements (including the presentation of any non-GAAP financial information) and additional disclosures under "Management's Discussion and Analysis of Financial Condition and Results of Operations" with management, our internal auditors and PwC. The Audit Committee also oversees
our internal auditors' review of our policies and practices with respect to financial risk assessment, and our processes and practices with respect to enterprise risk assessment and management (although the board's Risk Oversight Committee has primary responsibility for the review of our risk assessment and risk management matters). The Audit Committee discussed with PwC matters required to be discussed by Auditing Standard No. 1301 Communications with Audit Committee, as amended, and Rule 2-07 (Communication with Audit Committees) of Regulation S-X; received the disclosures and letter from PwC required by applicable requirements of the Public Company Accounting Oversight Board concerning independence, and has discussed PwC's independence with PwC. The Audit Committee met with PwC and with our internal auditors, in each case with and without other members of management present, to discuss the results of their respective audits; their views regarding the appropriateness
of management's estimates, judgments, selection of accounting policies, and systems of internal controls; and the overall quality and integrity of our financial reporting. Management represented to the Audit Committee that our financial statements were prepared in accordance with accounting principles generally accepted in the United States of America.
Based on its discussions with our management, our internal auditors and PwC, as well as its review of the representations of management and PwC's report, the Audit Committee recommended to the board, and the board has approved, the inclusion of the audited financial statements in our Annual Report on Form 10-K for the year ended December 31, 2022, for filing with the SEC.
Audit Committee Financial Experts. On March 18, 2022, our board of directors determined that Audit Committee Chair Robert D. Long, Audit Committee Vice Chair Jeffrey G. Jackson, and Audit Committee members Karen F. Gregerson, Larry W. Myers, Todd E. Sears, and Sherri L. Reagin were Audit Committee Financial Experts under SEC rules. For information concerning our incumbent
directors' qualifications to be so designated, please refer to their respective biographical summaries above in this Item 10.
Executive Officers
Our Executive Officers, as determined under SEC rules, are listed in the table below. Each officer serves a term of office of one calendar year or until the election and qualification of his or her successor, provided, however, that pursuant to the Bank Act, our board of directors may dismiss any officer at any time. Except as indicated, each officer has been employed in the principal occupation listed below for at least five years.
Senior Vice President - Community Investment & Underwriting/Collateral Operations Officer
(1) Ms. Konich
was appointed by our board of directors to serve as President - CEO in July 2013. As an FHLBank President, she serves on the Board of Directors of the FHLBanks Office of Finance, and is a member of its Governance Committee. Ms. Konich holds an MBA and is a CPA.
(2) Mr. McGrath was promoted to Executive Vice President - Chief Risk Officer effective January 2021. Previously, he was appointed Senior Vice President - Chief Risk Officer effective May 2020, after having been appointed Senior Vice President - Chief Analytics Officer effective January 2019, and First Vice President - Director of Credit Risk Analysis effective January 2017. Mr. McGrath holds a masters of science in accounting, is a CPA and a CFA® charterholder.
(3) Mr. Streitenberger was promoted to Executive Vice President
- CBOO effective January 2019, after having been appointed Senior Vice President - CBOO effective January 2016. Mr. Streitenberger holds an MBA.
(4) Mr. Teare was promoted to Executive Vice President - CFO effective January 2017, after having been appointed Senior Vice President - CFO in February 2015. Mr. Teare holds an MBA.
(5) Mr. Brandt was appointed Senior Vice President - Treasurer effective January 2016. Mr. Brandt holds an MBA.
(6) Ms. Clifford was appointed Senior Vice President - General Counsel effective March 2020, and was appointed Senior Vice President - General Counsel & Chief Compliance Officer effective May 2020. Ms. Clifford also serves as one of the Bank's Ethics Officers. Previously, Ms. Clifford was a Partner at the law firm Faegre Drinker
Biddle & Reath LLP from January 2003 to February 2020. Ms. Clifford holds a JD and is licensed to practice law in the State of Indiana.
(7) Ms. Cunningham was promoted to Senior Vice President - Senior Director of Compliance & Operational Risk Analysis effective May 2020. Previously, she was appointed First Vice President - Senior Director of Compliance + Operational Risk Analysis effective November 2018, after having been appointed First Vice President - Director of Operational Risk Analysis effective January 2018, and Vice President - Director of Operational Risk Analysis in March 2016. Ms. Cunningham holds an MBA and a CRMA certification, and is a CPA.
(8) Mr. Dawson was promoted to Senior Vice President - Chief Information Officer effective January 2019, after having been appointed First Vice President - Chief Technology
Officer in November 2015. Mr. Dawson holds an MBA.
(9) Mr. Griffin was appointed Senior Vice President - Chief Business Development Officer in June 2018, after serving as Senior Vice President - Chief Marketing Officer from 2017-2018. Mr. Griffin holds an MBA and is a CFA® charterholder.
(10) Ms. Lottie was promoted to Senior Vice President - Chief Human Resources and Diversity & Inclusion Officer in July 2019, which position was redesignated as Senior Vice President - Chief Human Resources
and Diversity, Equity, & Inclusion Officer in September 2020. Previously, she had been appointed First Vice President - Director of Human Resources and Diversity & Inclusion in November 2018, after having been appointed First Vice President - Director of Human Resources effective January 2018. Ms. Lottie was appointed Vice President - Director of Human Resources effective January 2016. Ms. Lottie also serves as one of the Bank's Ethics Officers. She holds an MBA and a JD and is licensed to practice law in the State of Indiana. She also holds SPHR and SHRM-SCP certifications.
(11) Mr. McKee was promoted to Senior Vice President - Chief Internal Audit Officer effective January 2015. Mr. McKee holds an MBA and is a CPA.
(12) Mr. Short was appointed Senior Vice President - Chief Accounting Officer in August 2009. Mr. Short
holds an MBA and is a CPA.
(13) Ms. Wott was appointed to Senior Vice President - Community Investment & Underwriting/Collateral Operations Officer in August 2021. Previously Ms. Wott served as Senior Vice President - Community Investment Officer effective July 2019, after having been appointed First Vice President - Community Investment Officer in July 2013. Ms. Wott holds an MBA.
Code of Ethics and Codes of Conduct
We have a Code of Ethics for Senior Financial Officers ("Code of Ethics") that applies to our principal executive officer, our principal financial officer, and our principal accounting officer ("Senior Financial Officers"). The Code of Ethics sets forth the obligations of the Senior Financial Officers related to honest and ethical conduct;
full, fair, accurate, timely, and understandable disclosures; compliance with applicable laws, rules and regulations; prompt internal reporting of Code of Ethics violations; and accountability for adherence to the Code of Ethics. The Bank intends to post information regarding any amendments to, or waivers from, its Code of Ethics on its website. Additionally, we have a Code of Conduct and Conflict of Interest Policy for Affordable Housing Advisory Council Members, a Code of Conduct and Conflict of Interest Policy for Directors and a Code of Conduct and Conflict of Interest Policy for Employees and Contractors (collectively, the "Codes of Conduct").
The Codes of Conduct and the Code of Ethics are available on our website
at www.fhlbi.com, by selecting "About" and then "Corporate Governance." Interested persons may also request a copy of the Codes of Conduct and the Code of Ethics by contacting us, Attention: General Counsel, Federal Home Loan Bank of Indianapolis, 8250 Woodfield Crossing Boulevard, Indianapolis, IN46240.
We use acronyms and terms throughout this Item that are defined herein or in the Defined Terms.
Compensation Committee Interlocks and Insider Participation
The Human Resources Committee ("HR Committee") is a standing committee that serves as our board of directors' compensation committee. It is comprised solely of directors. During the year ended December 31, 2022:
•directors
Fisher, Reagin, Boike, Bosway, Clarke, Gregerson, and Hines were members of the HR Committee, with director Moore serving in ex-officio capacity;
•none of those directors was, or has at any time been, a Bank officer or employee;
•none of those directors had any relationship that would be disclosable under Item 404 of SEC Regulation S-K; and
•none of our executive officers has served on any board of directors or compensation committees of any entities whose executive officers served on the HR Committee.
Compensation Committee Report
OnMarch 9, 2023, the HR
Committee reviewed and discussed with Bank management the "Compensation Discussion and Analysis" that follows and, based on such review and discussions, recommended to our board of directors that the Compensation Discussion and Analysis be included in this report.
Overview. To provide perspective on our compensation programs and practices for our NEOs, we have included certain information in this Compensation Discussion and Analysis relating to Executive Officers (as defined in SEC rules) and employees other than the NEOs. The NEOs consist of (i) our principal executive officer, who is our CEO, (ii) our principal financial officer, who is our CFO, and (iii) our other three most highly
compensated executive officers determined by the sum of salary, non-equity incentive compensation, and all other compensation (but excluding change in pension value and non-qualified deferred compensation earnings) for the year ended December 31, 2022. Our NEOsare:
Our executive compensation program is overseen by the Executive/Governance Committee (with respect to the CEO's performance and compensation) and the HR Committee (with respect to the other NEOs' compensation), and ultimately by the entire board of directors. The HR Committee meets at scheduled times throughout the year (six times in 2022) and reports its recommendations to the board. The HR Committee has the authority to obtain advice and assistance from outside legal counsel, compensation consultants, and other advisors as the HR Committee deems necessary, with all fees and expenses paid by our Bank. The Executive/Governance Committee assists the board in the governance of our Bank, including nominations of the Chair and Vice Chair of the board and its committee structures and assignments, and in overseeing the affairs of our Bank during intervals
between regularly scheduled meetings of the board, as provided in our bylaws. The Executive/Governance Committee meets as needed throughout the year (six times in 2022) and reports its recommendations to the board.
Finance Agency Oversight of Executive Compensation.
Bank Act and Finance Agency Executive Compensation Rule. The Finance Agency provides oversight of FHLBank compensation,
which influences compensation decisions impacting the NEOs. Aspects of this oversight include:
•the Director of the Finance Agency's authority to prevent the FHLBanks from paying compensation to executive officers that is not "reasonable and comparable" to compensation paid at institutions of similar size and function for similar duties and responsibilities;
•a Finance Agency rule on executive compensation which, among other provisions, requires us to provide information to the Finance Agency for review and non-objection concerning all compensation actions impacting NEOs; and
•a Finance Agency rule on golden parachute payments, under which the Finance Agency may limit or prohibit certain payments to NEOs, particularly if such
payments may be made in connection with the termination of an NEO.
The Finance Agency has also issued an advisory bulletin setting forth certain principles on executive compensation. These principles provide that executive compensation should be: comparable to similar positions at comparable institutions; consistent with sound risk management; and tied to longer-term performance and outcome indicators with a percentage to be deferred accordingly. These principles have been incorporated into the development, implementation, and review of compensation policies and practices for the NEOs.
Compensation Philosophy and Objectives.In 2022, our board of directors adopted a resolution updating our statement of compensation philosophy. Pursuant to the resolution, our compensation philosophy
is to provide a market-competitive compensation and benefits package that will enable us to effectively recruit, promote, retain and motivate highly qualified employees, management and leadership talent for the benefit of our Bank, its members, and other stakeholders in alignment with the Bank's diversity, equity, and inclusion objectives. We desire to be competitive and forward-thinking while maintaining the Bank's safety and soundness. Thus, our compensation program encourages operational excellence, superior member service, responsible growth and prudent risk-taking while delivering a competitive pay package.
Specifically, our compensation program is designed to reward:
•attainment of performance goals;
•implementation
of short- and long-term business strategies;
•accomplishment of our public policy mission;
•effective and appropriate management of financial, operational, reputational, regulatory, and human resources risks;
•growth and enhancement of senior management leadership and functional competencies; and
•accomplishment of goals to maintain an efficient, cooperative system of FHLBanks.
The board of directors regularly reviews these goals and the compensation alternatives available and may make changes in the program from time to time to better achieve these goals or to comply with Finance Agency directives. As a cooperative, we are not able to offer
equity-based compensation, and only member institutions (or their legal successors) may own our stock. Without equity incentives to attract, reward and retain NEOs and senior management, we provide alternative compensation and benefits such as cash incentive opportunities, pension (with respect to Ms. Konich, Mr. Teare, and Mr. McGrath) or additional non-elective contributions (with respect to Mr. Streitenberger and Mr. Dawson) and other retirement benefits (to all NEOs). This approach generally will lead to a mix of compensation for NEOs that emphasizes base salary, provides meaningful incentive opportunities, and creates a competitive total compensation opportunity relative to the market.
Role of the Executive/Governance and HR Committees in Setting Executive Compensation. The Executive/Governance and HR Committees intend that our executive compensation program be aligned with our Bank-wide short-term and long-term business objectives and focus executives' efforts on fulfilling these objectives. The Executive/Governance Committee reviews the CEO's performance and researches and recommends the CEO's salary to the board of directors. The CEO determines the salaries of the other NEOs, generally after consulting with the HR Committee, as discussed below. The HR Committee recommends, for approval by the board, the percentage of salary increases that will apply to merit and promotional or internal pay equity adjustments for each year's budget. The retirement benefit plans that will be offered, and any material
changes to those plans from time to time, are approved by the board after review and recommendation by the HR Committee. The HR Committee also recommends the goals, payouts and qualifications for both the annual incentive awards and the deferred incentive awards for the board's review and approval.
Our Executive/Governance and HR Committees operate under written charters adopted by the board of directors, most recently reviewed by the board as of January 20, 2023. Those charters are available on our websitewww.fhlbi.com by selecting
"About" and then selecting "Corporate Governance."
Role of Compensation Consultants in Setting Executive Compensation. For each of the last 12 years, McLagan Partners, Inc. ("McLagan"), an Aon plc company, has been engaged to work with the HR Committee to evaluate the Bank's compensation for certain positions, including the NEOs' positions, as we seek to maintain compensation that is reasonable and competitive.
The evaluation uses the competitor groups identified by McLagan. The competitor groups are comprised of selected firms that participated in McLagan's Financial Industry Salary Survey. The firms included in the competitor groups can change year-to-year, based on changes in the composition of the McLagan survey participants, changes in financial metrics of firms that participated in the survey for
that year, and McLagan's analysis.
As a guideline, McLagan considers compensation for a role within 15 percent of the correlating positions at the competitor groups to be within the competitive market range. We consider this general range along with our financial performance, stability, prudent risk-taking and conservative operating philosophies, internal pay equity, and our compensation philosophy in setting compensation.
For 2022, McLagan's competitor groups consisted of three peer groups. The first peer group is comprised of the 10 other FHLBanks. The positions used from the other FHLBanks are comparable to the positions at our Bank (e.g., CEO to CEO).
The second peer group consists of a number of large financial institutions and regional commercial banks, as well as the Federal Reserve Banks. There are 85 institutions in the second peer group. The positions used from the large financial institutions and regional commercial banks include the divisional/functional heads, rather than the overall head of the bank, to account for the difference in scale of activities at such institutions compared to an FHLBank (e.g., Head of Corporate Banking is used, rather than a large financial institution's or regional bank's CEO, as the appropriate comparison to the FHLBank's CEO). While the positions from the large financial institutions and regional/commercial banks capture the functional responsibility of our
positions, they do not capture the executive responsibility that exists at the Bank.
AIB
Federal Reserve Banks*
OneMain Financial
Ally Financial Inc.
Fifth Third Bank
Pinnacle Financial
Partners, Inc.
Arvest Bank
First Citizens Bank - NC
PNC Bank
Associated Bank
First National Bank of Omaha
Rabobank
Australia & New Zealand Banking Group
First Republic Bank
Regions Financial Corporation
Bank of America
Freddie
Mac
Royal Bank of Canada
Bank of New York Mellon
Frost Bank
Sallie Mae
Bank of Nova Scotia
Hancock Whitney Bank
Santander Bank, NA
Bank of the West
Helaba Landesbank Hessen-Thuringen
Signature Bank - NY
BMO
Financial Group
HSBC
Societe Generale
BNP Paribas
Huntington Bancshares, Inc.
Standard Chartered Bank
BOK Financial Corporation
ICBC Financial Services
State Street Corporation
Brown Brothers Harriman
ING
Sterling
National Bank
Capital One
JP Morgan Chase
Sumitomo Mitsui Trust Bank
CIBC World Markets
KBC Bank
SVB Financial Group
Citigroup
KeyCorp
Synovus Financial Corporation
Citizens Financial Group
Lloyds
Banking Group
TD Securities
City National Bank
M&T Bank Corporation
Texas Capital Bank
Comerica
Macquarie Bank
Truist
Commerce Bank
MUFG Bank, Ltd.
U.S. Bancorp
Commerzbank
National
Australia Bank
UMB Financial Corporation
Commonwealth Bank of Australia
Natixis
Valley National Bancorp
Crédit Agricole CIB
NatWest
Webster Bank
Credit Industriel et Commercial – N.Y.
Nomura Securities
Wells Fargo Bank
East
West Bancorp, Inc.
Nord/LB
Zions Bancorporation
Fannie Mae
Northern Trust Corporation
*Includes the Federal Reserve Banks of Atlanta, Boston, Cleveland, Kansas City, Minneapolis, New York, Richmond, San Francisco, and St. Louis.
The
third peer group consists of publicly-traded regional/commercial banks with assets of $10 billion to $20 billion. There are 27 banks in the third peer group. The positions used from this peer group include the NEOs reported in their proxy statements, which capture the executive responsibilities encompassed in our positions.
Apple Financial Holdings
FB Financial Corporation
Northwest
Bank - PA
Bank of North Dakota
First Financial Bancorp - OH
OceanFirst Bank
Banner Bank
First Interstate BancSystem, Inc.
PlainsCapital Bank
Berkshire Bank
First Merchants Corporation
Provident Financial Services
Bremer Financial Corporation
First
United Bank - OK
Renasant Corporation
Community Bank System, Inc.
Heartland Financial USA, Inc.
Sandy Spring Bank
Customers Bank
Independent Bank - TX
TowneBank
CVB Financial Corp.
Mechanics Bank
TriState Capital Bank
Enterprise
Financial Services Corp.
NBT Bancorp Inc.
Washington Trust Bank
The positions selected by McLagan from the competitor groups collectively capture the functional and executive responsibilities of our NEO positions, represent comparable market opportunities and represent realistic employment opportunities. We establish threshold, target and maximum base and anticipated incentive pay levels based on this analysis, while actual pay levels are based on our financial performance, stability, prudent risk-taking and conservative operating philosophies, internal pay equity, and our compensation philosophy, as discussed above.
Role of the Named Executive Officers in the Compensation
Process. The NEOs may assist the HR Committee and the board of directors by providing data and background information to any compensation consultants engaged by management, the board or the HR Committee. The Human Resources department assists the HR Committee and compensation consultants by gathering research on the Bank's hiring and turnover statistics, compensation trends, peer groups, cost of living, and other market data requested by the CEO, the HR Committee, the Finance/Budget Committee, the Audit Committee, the Executive/Governance Committee, or the board. Senior management (including the NEOs) prepares the strategic plan financial forecasts, which are then considered by the Finance/Budget Committee and by the board when establishing the goals and anticipated payout terms for the incentive compensation plan. The CRO oversees the Enterprise Risk Management department's review, from a risk perspective, of the incentive compensation plan's
risk-related performance goals and target achievement levels.
Compensation Risk. The HR Committee and the Executive/Governance Committee review our policies and practices of compensating our employees, including non-executive officers, and have determined that none of these policies or practices result in any risk that is reasonably likely to have a material adverse effect on the Bank. Further, based on such reviews, the HR Committee and the Executive/Governance Committee believe that our plans and programs contain features that reduce the likelihood of employees taking excessive risks relating to the compensation-related aspects of their duties. In addition, the material plans and programs operate within a strong governance, review and regulatory structure that serves and supports risk mitigation.
Elements of Compensation Used to Achieve Compensation Philosophy and Objectives. The total compensation mix for NEOs in 2022 consisted of:
(1) base salaries;
(2) annual and deferred incentive opportunities;
(3) retirement benefits;
(4) perquisites and other benefits; and
(5) potential payments upon termination or change in control.
The board of directors has structured the compensation programs to comply with Internal Revenue Code Section 409A. If an executive is entitled to nonqualified
deferred compensation benefits that are subject to Internal Revenue Code Section 409A, and such benefits do not comply with Internal Revenue Code Section 409A, then the benefits are taxable in the first year they are not subject to a substantial risk of forfeiture. In such case, the executive is subject to payment of regular federal income tax, interest and an additional federal income tax of 20% of the benefit includable in income. The Key Employee Severance Agreement ("KESA") between our Bank and our CEO contains provisions that "gross-up" certain benefits paid thereunder in the event she should become liable for an excise tax on such benefits. Other elements of our NEOs' compensation may be adjusted to reflect the tax effects of such compensation.
Base Salaries.Unless otherwise described, the term "base salary" as used in this Item 11
refers to an individual's annual salary, including any adjustments, before considering incentive compensation, deferred compensation, perquisites, taxes, or any other adjustments that may be elected or required. We recruit and desire to retain senior management from national markets. Consequently, the cost of living in Indiana is not a direct factor in determining base salary. Merit increases to base salaries are used, in part, to keep our NEO salary levels competitive with those in the Competitor Groups.
The CEO's base salary is established annually by the board after review and recommendation by the Executive/Governance Committee. Our board has concluded that the level of scrutiny to which the base salary determination for the CEO is subjected is appropriate in light of the nature of the position and the extent to which she is responsible for the overall performance of our Bank. In setting the CEO's base
salary, the Executive/Governance Committee and the board have discretion to consider a wide range of factors, including the overall performance of our Bank, the CEO's individual performance, her tenure, and the amount of her base salary relative to the base salaries of executives in similar positions in companies in our Competitor Groups. Although a policy or a specific formula has not been developed for such purpose, the Executive/Governance Committee and the board also consider the amount and relative percentage of the CEO's total compensation that is derived from her base salary. In light of the variety of factors that are considered, the Executive/Governance Committee and the board have not attempted to rank or otherwise assign relative weights to the factors they consider. Rather, the Executive/Governance Committee and the board consider all the factors as a whole, including data and recommendations from McLagan.
After
an advisory consultation with the HR Committee, the base salaries for our other NEOs are set or approved annually by the CEO, who has discretion to consider a wide range of factors including competitive benchmark data from McLagan, each NEO's qualifications, responsibilities, assessed performance contribution, tenure, position held, amount of base salary relative to similarly-positioned executives in our Competitor Groups and our overall salary budget. Although a policy or a specific formula has not been developed for such purpose, the CEO also considers the amounts and relative percentages of the NEOs' total compensation that are derived from their base salaries, including data and recommendations from McLagan.
The NEOs’ base salaries for 2022 were effective January 1, 2022 and are presented in the Summary Compensation Table.
Annual
and Deferred Incentive Opportunities.Generally, as an executive's level of responsibility increases, a greater percentage of total compensation is variable and based on the Bank's overall performance. The board adopts incentive plans to grant this variable element of executive compensation. Our incentive plans include a measurement framework that rewards achievement of specific goals consistent with our mission. As discussed below, our incentive plan is performance-based and represents a reasonable risk-return balance for our cooperative members both as users of our products and as shareholders, and is appropriate to our status and risk appetite as a housing GSE.
The current incentive compensation plan, which was originally adopted by the board effective January 1, 2012 and has been amended and restated from time to time ("Incentive Plan"), provides incentive compensation opportunities for all employees. The Incentive Plan provides cash award opportunities based on achievement of performance goals. The purpose of the Incentive Plan is to attract, retain and motivate employees, including the NEOs, and to focus their efforts on a reasonable level of profitability while maintaining safety and soundness. Employees in the Internal Audit department are excluded from the Incentive Plan but are eligible to participate in a separate incentive compensation plan established by the Audit Committee. With certain exceptions, any eligible employee hired before
October 1 of a calendar year becomes a participant in the Incentive Plan for that calendar year. A "Level I Participant" is the Bank's CEO, an EVP, or a SVP, while a "Level II Participant" is any other participating employee. All NEOs identified as of each December 31 are included among the eligible Level I Participants and must execute an agreement with us containing certain non-solicitation and non-disclosure provisions.
Performance goals and the relative weight to be accorded to each goal are established annually by the HR Committee and approved by the board of directors for each calendar-year period ("Performance Period") and three-calendar-year period ("Deferral Performance Period"). The board also approves the "Threshold,""Target" and "Maximum" achievement levels for each performance goal to determine how much of an award may be earned. The achievement
of performance goals determines the value of awards, which for Level I Participants (including the NEOs) may be Annual Awards (relating to achievement of performance goals over a Performance Period) and Deferred Awards (relating to achievement of performance goals over a Deferral Performance Period), and for Level II Participants includes Annual Awards only. The board may adjust the performance goals to ensure the purposes of the Incentive Plan are served, but made no such adjustments during 2020, 2021 or 2022. The board establishes maximum awards under the plan before the beginning of each Performance Period. Each award equals a percentage of the Participant's annual compensation, which is generally defined as the Participant's base salary excluding any bonus, incentive compensation, deferred compensation payments, lump sum payouts for accrued but unused vacation time, long-term disability insurance payments paid for the current or a prior year, overtime, or hours paid
under the Bank's paid-time-off policies.
With respect to the NEOs' Annual Awards and Deferred Awards, 50% of an award to a Level I Participant will become earned and vested on the last day of the Performance Period (Annual Award), subject to the achievement of specified Bank performance goals over such period, the attainment of a specific minimum individual performance rating for such period, and active employment on the last day of such period (subject to certain limited exceptions relating to the circumstances of employment termination before the end of the Performance Period). The remaining 50% will become earned and vested on the last day of the Deferral Performance Period (Deferred Award), subject to the attainment of a specific minimum individual performance rating for each year of such period, and active employment on the last day of such period (subject to certain limited exceptions relating to the
circumstances of employment termination before the end of the Deferral Performance Period), and further subject to the Bank's achievement during the Deferral Performance Period of additional performance goals relating to our profitability, retained earnings, regulatory capital-to-assets ratio, and distributions in compliance with AHP funding requirements, through which the Level I Participant's compensation is impacted by our performance for a longer term. Depending on our performance during the Deferral Performance Period, the final award (i.e., the amount of the earned and vested Deferred Award ultimately paid to the Level I Participant) will be worth 75% at Threshold, 100% at Target or 125% at Maximum of the original amount of the Deferred Award. The level of achievement of those additional goals could thereby result in an increase or decrease to the Deferred Awards.
2022
Annual Award (Paid in 2023).The table below presents the incentive opportunity, earned, and deferred percentages of base salary for Level I Participants for the 2022 Performance Period.
Effective January 1, 2022, the board of directors established Annual Award Performance Goals for 2022 for Level I Participants relating to specific mission goals for financial performance and operational efficiency; member activity; Enterprise Risk Management ("ERM"); Diversity, Equity & Inclusion; and operational excellence.The weights and specific achievement levels for each 2022 mission goal are presented below.
2022
Mission Goals
Weighted Value
Performance Levels
Actual Result
Achievement Percentage
Weighted Average Achievement
Bank (1)
ERM
Threshold
Target
Maximum
Bank
(1)
ERM
Financial Performance and Operational Efficiency
Profitability (2)
35
%
25
%
323 bps
334 bps
379 bps
513 bps
100%
35.0
%
25.0
%
Member
Activity
Member Education and Outreach (3)
20
%
10
%
75%
of all members
85% of all members
90% of all members
93%
100%
20.0
%
10.0
%
Fee Income Increase (4)
10
%
5
%
5.0%
10.0%
20.0%
31.0%
100%
10.0
%
5.0
%
CIP
Advances Originated (5)
5
%
5
%
$37.5m
$75m
$150m
$519.9m
100%
5.0
%
5.0
%
Enterprise
Risk Management
ERM objectives (6)
10
%
35
%
1
2
3
3
100%
10.0
%
35.0
%
Diversity,
Equity, and Inclusion
DEI quantitative goals (7)
10
%
10
%
10 of 19
13 of 19
16 of 19
17
100%
10.0
%
10.0
%
Operational
Excellence
Member Facing Technology - Phase 2 objectives (8)
5
%
5
%
1
2
3
3
100%
5.0
%
5.0
%
Automation
First Strategy objectives (9)
5
%
5
%
1
2
3
4
100%
5.0
%
5.0
%
Total
100
%
100
%
100.0
%
100.0
%
(1) For all NEOs other than the CRO. The CRO's weighted average achievement percentages are presented under the ERM column.
(2) For purposes of this goal, profitability is defined as the Bank’s core net income, as defined below, as a percentage of average total regulatory capital stock, in excess of the Bank's weighted average cost of funds. Core net income is reduced by the portion of net income to be added to restricted retained earnings under the Joint Capital Enhancement Agreement dated August 5, 2011, as amended, by and among the Federal Home Loan Banks and increased by the Bank’s accruals for incentive compensation, net of the AHP assessment. Core net income represents GAAP Net Income adjusted to exclude: (i) debt extinguishment
costs and Advance prepayment fees received in cash on unswapped Advances that are not restructured, net of the AHP assessment, (ii) mark-to-market adjustments and other transitory effects from derivatives and trading/hedging activities, net of the AHP assessment, (iii) interest expense on MRCS, (iv) realized gains and losses on sales of investment securities, net of the AHP assessment, (v) accelerated amortization of concession fees on called COs, net of the AHP assessment, and (vi) other non-recurring components of GAAP earnings that do not necessarily reflect the underlying results of the operations of the Bank, net of the AHP assessment. However, certain excluded amounts may require amortization included in other periods to properly state core net income. This goal assumes no material change in investment authority under the FHFA's regulation, policy, directive, guidance, or law.
(3) Member education
and outreach events for purposes of achievement include symposia, conferences, workshops, webinars, educational events, presentations at trade conferences, presentation to member Boards of Directors or Committees thereof or to management committees, in-person joint presentations to members and other events where Bank outreach staff (Account Managers, Senior Officers, CID Outreach Partners or Subject Matter Experts) educate, present, or engage Bank member representatives about Advances, MPP, the Bank’s community investment products and activities, industry trends, and other products and services. Status and reporting on this Goal and its attainment will be supported by the Bank’s Customer Relationship Management (CRM) system. Achievement towards this goal will be calculated by dividing the number of members that participated in one of the above events (defined as a member at the time of participation in the event) during the calendar year by the simple average of the
total number of members of the Bank as of the end of each month of 2022.
(4) Fee income consists of fees earned on Bank products and services, including letters of credit, lines of credit, participation in MPP by other Federal Home Loan Banks, safekeeping services, correspondent services, and other products and services as may be approved by the board from time to time. The goal is defined as the percentage increase in the total fee income relative to total fee income earned in 2021.
(5) "CIP"
means Community Investment Program. "CIP Advances" are newly originated Community Investment Cash Advances, including CIP and other qualifying Advances and CIP qualified letters of credit, provided in support of targeted projects as defined in 12 C.F.R. Part 1291 and the Federal Home Loan Bank Act.
(6) The criteria and milestones to successfully complete each objective will be reviewed and approved by the Risk Committee. Status and reporting of this goal, and its attainment, will be provided in writing to the Risk Committee. The Enterprise Risk Management Excellence objectives are:
Objective #1: Liquidity Risk Measurement & Reporting. ERM will expand its measurement, monitoring, and reporting of liquidity risk for Risk Committee and Risk Oversight Committee reporting. A proposal for expanded measurement and reporting, including
any additional limits or key-risk indicators if applicable, will be presented to and reviewed by the Risk Committee and put into production prior to December 31, 2022.
Objective #2: Non-Parallel Risk Management & Reporting. ERM will develop a methodology to enhance and expand its measurement, monitoring, and reporting of non-parallel changes in the term structure of rates and related impacts to the Bank's market value of equity or other metrics. A proposal for the methodology and expanded measurement and reporting will be presented to and reviewed by the Risk Committee by December 31, 2022.
Objective #3: Climate Risk. Establishment of climate change risk definition, governance and roadmap by December
31, 2022. ERM, in collaboration with the Risk Committee and Bank management, will establish a governance body related to climate change risk. The governance body will consist of key stakeholders from across the Bank, and ERM will facilitate the establishment of a key point-of-contact for climate change risk governance. Additionally, ERM, in collaboration with the climate change risk governance body, will develop a climate change risk roadmap in order to outline the Bank's climate change risk framework and goals. The roadmap is to serve as a living document and will include details on governance, responsibilities across the organization, risk identification and mitigants, policy considerations, along with forward-looking plans and goals related to the Bank's climate change risk strategy. The roadmap will be presented to and reviewed by the Risk Committee by December 31, 2022.
(7) This
includes any strategies with a quantitative target, of which there are 19, as outlined in the 2022-2024 DEI Strategic Plan (as approved by the Board in November 2021 or as amended thereafter).
(8) The criteria and milestones for achievement will be reviewed and approved by the Information Technology Steering Committee at its first meeting in 2022. Status and monitoring of this goal and its attainment will be provided in writing to the Information Technology Steering Committee.
Objective #1: Redesign and migration of the public website (fhlbi.com) to a third-party hosted solution.
Objective #2: Transition Loan Acquisition System from physical RSA tokens
to One Bank Access Model.
Objective #3: Transition remaining core functionality from legacy Member Portal to One Bank Portal.
(9) The criteria and milestones for achievement will be reviewed and approved by the Information Technology Steering Committee at its first meeting in 2022. Status and monitoring of this goal and its attainment will be provided in writing to the Information Technology Steering Committee.
Objective #1: Develop and approve Cloud Infrastructure Strategy (Infrastructure Agility)
Objective #2: Develop a Lean/Process Improvement Program (Process Efficiency)
Objective #3: Develop and approve Intelligent Automation
Program (Empowering Staff through Automation)
Objective #4: Develop and approve Data Warehouse Strategy (Improving Capabilities & Driving Down On-going Expenses)
Objective #5: Develop and approve a DevSecOps Strategy supporting the secure development and delivery of solutions (Delivery Agility)
Objective #6: Develop a Center of Excellence for Data Management and Utilization (Empowering Staff with improved access and capabilities for data analytics)
There
is no guaranteed payout under the provisions of the Incentive Plan. Therefore, the minimum that could be paid out to an NEO was $0. The maximum amounts that could have been earned for the Annual Award Performance Period are presented below. The actual amounts earned are also presented below and in the Non-Equity Incentive Plan Compensation table.
2019
Deferred Award (Paid in 2023). Fifty percent of each Level I Participant's 2019 Award ("2019 Deferred Award") was deferred for a three-year period that ended December 31, 2022 ("2020-2022 Deferral Performance Period"). The 2019 Deferred Award became earned and vested on that date, subject to the achievement of specific Bank performance goals over the 2020-2022 Deferral Performance Period and other conditions described below. The following table presents the performance goals for the 2019 Deferred Award relating to our profitability, retained earnings and prudential management standards, together with actual results and specific achievement levels for each mission goal.
2020-2022
Mission Goals
Weighted Value
Performance Levels (1)
Actual Result
Achievement %
Weighted Average Achievement
Threshold
Target
Maximum
Profitability
(2)
35%
25 bps
50 bps
150 bps
370 bps
125%
44%
Retained Earnings (3)
35%
3.5%
3.9%
4.3%
6.16%
125%
44%
Prudential
Standards (see below)
30%
Achieve 1 Prudential Standard
(a)
Achieve both Prudential Standards
2
125%
37%
Prudential Standard 1: Maintain a regulatory capital-to-assets ratio of at least 4.16% as measured on each quarter-end in 2020 through 2022.
Prudential
Standard 2: Award to FHLBI members the annual AHP funding requirement in each plan year.
Total
100%
125%
(1)Deferred Awards are subject to additional performance goals for the Deferral Performance Period. Depending on our performance during the Deferral Performance Period, the Final
Award will be worth 75% at Threshold, 100% at Target or 125% at Maximum of the original amount.
(2) Attainment of this goal will be computed using the simple average of annual profitability measures over the three-year period.
For purposes of this goal for 2020, profitability is defined as the Bank's profitability rate in excess of the Bank's cost of funds rate. Profitability is the Bank's adjusted net income reduced by the portion of net income to be added to restricted retained earnings under the Joint Capital Enhancement Agreement and increased by the Bank's accruals for incentive compensation. Adjusted net income represents GAAP net income adjusted: (i) for the net impact of certain current and prior period advance prepayments and debt extinguishments, net of the AHP assessment, (ii) to exclude mark-to-market
adjustments on derivatives and certain other effects from derivatives and hedging activities, net of the AHP assessment, and (iii) to exclude the effects from interest expense on MRCS. The Bank's profitability rate is profitability, as defined above, as a percentage of average total regulatory capital stock (B1 weighted at 100% and B2 weighted at 80% to reflect the relative weights of the Bank's dividend). This goal assumes no material change in investment authority under the Finance Agency's regulation, policy, directive, guidance, or law.
Beginning
in 2021, the definition of profitability was updated to reflect core net income (instead of adjusted net income) to further exclude realized gains and losses on sales of investment securities, accelerated amortization of concession fees on called COs, and other non-recurring components of GAAP earnings that do not necessarily reflect the underlying results of the operations of the Bank. Additionally, certain excluded amounts may require amortization included in other periods to properly state core net income.
For purposes of this goal for 2021 and 2022, profitability is defined as the Bank’s profitability rate in excess of the Bank’s cost of funds rate. Profitability is the Bank’s core net income reduced by the portion of net income to be added to restricted retained earnings under the JCE Agreement and increased by the Bank’s accruals for incentive compensation, net of the AHP assessment.
Core net income represents GAAP Net Income adjusted to exclude: (i) debt extinguishment costs and Advance prepayment fees received in cash on unswapped Advances that are not restructured, net of the AHP assessment, (ii) mark-to-market adjustments and other transitory effects from derivatives and trading/hedging activities, net of the AHP assessment, (iii) interest expense on MRCS, (iv) realized gains and losses on sales of investment securities, net of the AHP assessment, (v) accelerated amortization of concession fees on called COs, net of the AHP assessment, and (vi) other non-recurring components of GAAP earnings that do not necessarily reflect the underlying results of the operations of the Bank, net of the AHP assessment. However, certain excluded amounts may require amortization included in other periods to properly state core net income. The Bank’s profitability rate is profitability, as defined above, as a percentage of average total regulatory capital stock.
This goal assumes no material change in investment authority under the FHFA's regulation, policy, directive, guidance, or law.
(3) Total retained earnings divided by the sum of the carrying value of the MBS and AMA portfolios. The calculation is the simple average of 36 month-end calculations.
(a) There is no target level for this goal.
Each NEO received at least the minimum required performance rating for each year of the 2020-2022 Deferral Performance Period and each was employed by the Bank on the last day of that period, thereby satisfying the two remaining conditions applicable to our NEOs for payment of the 2019 Deferred Award.
The following table presents the payouts of the 2019 Deferred Awards
to the NEOs by applying the total achievement level of the performance goals for the 2019 Deferred Award. These payouts are also presented in the Non-Equity Incentive Plan Compensation table.
2019 Deferred Award - 2020-2022 Performance Period
Other
Incentive Plan Provisions. The Incentive Plan provides that a termination of service of a Level I Participant during a Performance Period or Deferral Performance Period may result in the forfeiture of the award. However, the Incentive Plan recognizes certain exceptions to this general rule if the termination of service is (i) due to the Level I Participant's death, "Disability," or "Retirement"; (ii) for "Good Reason"; or (iii) without "Cause" due to a "Reduction in Force" (in each case as defined in the Incentive Plan). If one of these exceptions applies, a Level I Participant's Annual Award or Deferred Awards generally will be treated as earned and vested, and will be calculated using certain assumptions with respect to our achievement of applicable performance goals for the applicable Performance Period or Deferral Performance Period. Additionally, payment of an award may be accelerated if the participant dies
or becomes "Disabled" while an employee of the Bank, or if the termination is without "Cause" due to a "Reduction in Force".
The Incentive Plan provides that awards may be reduced or forfeited in certain circumstances. If, during a Deferral Performance Period, we realize actual losses or other measures or aspects of performance related to the Performance Period or Deferral Performance Period that would have caused a reduction in the final award for the Performance Period or Deferral Performance Period, the remaining amount of the final award to be paid at the
end of the Deferral Performance Period will be reduced to reflect this additional information. In addition, all or a portion of an award may be forfeited at the direction of the board of directors if we have failed to remediate to the satisfaction of the board an unsafe or unsound practice or condition (as identified by the Finance Agency) that is material to our financial operation and within the Level I Participant's area(s) of responsibility. Under such circumstances, the board may also direct the cessation of payments for a vested award. Further, the board may reduce or eliminate an award that is otherwise earned but not yet paid if the board finds that a serious, material safety-soundness problem or a serious, material risk management deficiency exists at our Bank, or in certain other circumstances.
Retirement Benefits.We maintain a comprehensive retirement
program for our employees, which includes our qualified (DB Plan) and non-qualified (SERP) defined benefit plans and our qualified (DC Plan) and non-qualified (SETP) defined contribution plans. The benefits provided by these plans are components of the total compensation opportunity for our employees. The board of directors believes these plans serve as valuable retention tools and provide significant tax deferral opportunities and resources for the participants' long-range financial planning. These plans are discussed below.
DB Plan and SERP. All employees who met the eligibility requirements and were hired before February 1, 2010 participate in the DB Plan, a tax-qualified, multiple employer defined benefit pension plan. The plan neither requires nor permits employee contributions. Pension benefits vest upon completion of five years
of service. Benefits under the DB Plan are based upon compensation up to the annual compensation limit established by the Internal Revenue Service ("IRS"), which was $305,000 in 2022. In addition, benefits payable to participants in the DB Plan may not exceed a maximum benefit limit established by the IRS, which in 2022 was $245,000, payable as a single life annuity at normal retirement age.
In connection with the DB Plan, the board of directors established a supplemental non-qualified plan in 1993 in response to federal legislation that imposed restrictions on the retirement benefits otherwise earned by certain management or highly-compensated employees. The original supplemental non-qualified plan was frozen effective December 31, 2004, and is now referred to as the "Frozen SERP." A separate SERP ("2005 SERP")
was established effective January 1, 2005 to conform to Internal Revenue Code Section 409A requirements. The SERP is an extension of our retirement commitment to the NEO participants and certain highly-compensated employees. The SERP restores the full pension benefits of NEO participants and certain other employees under the DB Plan that would otherwise be limited by IRS regulations regarding compensation, years of service or benefits payable. The DB Plan and SERP provide benefits based on a combination of a participant's length of service, age and annual compensation. In determining whether a participant is entitled to a restoration of retirement benefits, the SERP utilizes the identical benefit formula applicable to the DB Plan. Benefits payable under the 2005 SERP are reduced by (among other things) benefit amounts that would have been payable under the Frozen SERP, calculated as if the participant in the Frozen SERP
had terminated employment on December 31, 2004. SERP benefits are funded by a grantor trust we have established as part of the Bank's general assets. The assets of the grantor trust are subject to the claims of our general creditors. Any rights created under the SERP are unsecured contractual rights of the participants against the Bank.
Our board of directors amended the DB Plan, effective for all employees hired on or after July 1, 2008, to provide a reduced benefit. All eligible employees hired on or before June 30, 2008 were grandfathered under the benefit formula and the terms of the DB Plan in effect as of June 30, 2008 ("Grandfathered DB Plan") and are eligible to continue under the Grandfathered
DB Plan, subject to future plan amendments made by the board of directors. All eligible employees hired on or after July 1, 2008 but before February 1, 2010 are enrolled in the amended DB Plan ("Amended DB Plan").
During 2010, our board of directors discontinued eligibility in the Amended DB Plan for new employees. As a result, no employee hired on or after February 1, 2010 is enrolled in that plan, while participants in the Grandfathered DB Plan or Amended DB Plan as of January 31, 2010 continue to be eligible for the Grandfathered DB Plan or Amended DB Plan (and, as applicable, the 2005 SERP) and accrue benefits thereunder until termination of employment.
Effective
August 1, 2021, our board of directors amended the 2005 SERP to enhance the retention of participating employees. The amendment provides greater predictability of the dollar amount of benefits payable upon separation of employment or retirement from the Bank. The applicable retirement plan interest rates and mortality tables used to calculate benefits are set as of May 2021 and June 2021, respectively, rather than as of the employee's date of separation of employment or retirement. The amendment included similar provisions for the calculation of death benefits payable, except that the applicable retirement plan interest rates and mortality tables are set as of July 2021 and June 2021, respectively. While the long-term impact of the amendment on employees' pension values is expected to be favorable to the employee, the amendment had a one-time unfavorable impact on employees' pension values in 2021.
The following sections describe the differences in the benefits provided under these plans.
Grandfathered DB Plan.The estimated annual benefits are calculated in accordance with the formula currently in effect for specified years of service and compensation for individuals participating in both the Grandfathered DB Plan and the SERP, and hired prior to July 1, 2008, which includes Ms. Konich and Mr. McGrath.
•Formula:
The combined Grandfathered DB Plan and SERP benefit equals 2.5% times years of benefit service times the high three-consecutive-year average compensation. Benefit service begins one year after employment, and benefits are vested after five years. Benefit payments commencing before age 65 are reduced by applying an early retirement factor based on the participant's age when payments begin. The allowance payable at age 65 would be reduced by 3.0% for each year the employee is under age 65. However, if the sum of age and years of vesting service at termination of employment is at least 70 ("Rule of 70"), the retirement allowance would be reduced by 1.5% for each year the employee is under age 65. Beginning at age 66, retirees are also provided an annual retiree cost of living adjustment of 3.0% per year.
•Example: The estimated annual benefits payable upon retirement at age 65 by combining the Grandfathered
DB Plan and the SERP for an eligible employee with 25 years of service and high 3-consecutive-year average compensation of $1,000,000 would be $625,000 ($1,000,000 * 2.5% * 25).
Amended DB Plan.The estimated annual benefits are calculated in accordance with the formula currently in effect for specified years of service and compensation for individuals participating in both the Amended DB Plan and the SERP, hired on or after July 1, 2008 but before February 1, 2010, which includes Mr. Teare.
•Formula:
The combined Amended DB Plan and 2005 SERP benefit equals 1.5% times years of benefit service times the high five-consecutive-year average compensation. Benefit service begins one year after employment, and benefits are vested after five years. The allowance payable at age 65 would be reduced according to the actuarial equivalent based on actual age when early retirement commences. Benefit payments commencing before age 65 are reduced by applying an early retirement factor based on the participant's age when payments begin. If a participant satisfied the Rule of 70 at termination of employment, the retirement allowance would be reduced by 3.0% for each year the participant is under age 65.
•Example: The estimated annual benefits payable upon retirement at age 65 by combining the Amended DB Plan and the SERP for an eligible employee with 20 years of service and high 5-consecutive-year average compensation
of $1,000,000 would be $300,000 ($1,000,000 * 1.5% * 20).
The following table sets forth a comparison of the Grandfathered DB Plan and the Amended DB Plan.
DB Plan Provisions
Grandfathered DB Plan (All Employees Hired on or before June 30, 2008)
•Eligible
compensation includes salary (before any employee contributions to tax qualified plans), short-term incentive, bonus (including Annual Awards under the Incentive Plan), and any other compensation that is reflected on the IRS Form W-2 (but not including long-term incentive payments, such as Deferred Awards under the Incentive Plan).
•Retirement benefits from the DB Plan are paid in the form of a lump sum, annuity, or a combination of the two, at the election of the retiree at the time of retirement. Any payments involving a lump sum are subject to spousal consent.
•Retirement benefits from the 2005 SERP may be paid in the form of a lump sum payment, or annual installments up to 20 years, or a combination of lump sum and annual payments.
DC Plans and SETP. The Bank participated in the Pentegra Defined Contribution Retirement Savings Plan for Financial Institutions, as amended, a multiple employer retirement savings plan qualified under Internal Revenue Code Section 401(k), through October 1, 2020. Effective October 2, 2020, the Bank adopted the Federal Home Loan Bank of Indianapolis Retirement Savings Plan, which is a single employer retirement savings plan qualified under Internal Revenue Code Section 401(k). The terms of such plans are substantially the same and are collectively referred to as the "DC Plan."
All employees who have met the eligibility requirements
may participate in the DC Plan. All of the NEOs participate in the DC Plan. The DC Plan generally provides for an immediate (after the first month of hire) fully vested employer match of 100% on the first 6% of base salary of the participant's biweekly contributions on a pre-tax, post-tax, and/or Roth basis.
Eligible compensation in the DC Plan is defined as base salary. A participant in the DC Plan may elect to contribute up to 50% of eligible compensation, subject to the following limits. Under IRS regulations, in 2022 an employee could contribute up to $20,500 of eligible compensation on a pre-tax basis, and an employee age 50 or over could contribute up to an additional $6,500 on a pre-tax basis. Participant contributions over that amount may be made on an after-tax basis but are also limited by Section 415 of the IRC. A total of $61,000 per year ($67,500 per year including catch-up contributions
for employees age 50 or over) could have been contributed to a participant's account in 2022, including our matching contribution and the participant's pre-tax and after-tax contributions. In addition, no more than $305,000 of annual compensation could have been taken into account in computing eligible compensation in 2022. The amount deferred on a pre-tax basis is taxed to the participant as ordinary income when distributed from the DC Plan. The plan permits participants to self-direct the investment of their DC Plan account into one or more investment funds. All returns are at the market rate of the respective fund(s) selected by the participant.
The DC Plan also permits a participant (in addition to making pre-tax elective deferrals) to fund a separate "Roth Elective Deferral Account" (also known as a "Roth 401(k)") with after-tax contributions. A participant may make both pre-tax and Roth
401(k) contributions, subject to the limitations described in the preceding paragraph. All Bank contributions are allocated to the participant's DC Plan account, subject to the maximum match amount described above. Under current IRS rules, withdrawals from a Roth 401(k) account (including investment gains) are tax-free after the participant reaches age 59 1/2 and if the withdrawal occurs at least five years after January 1 of the first year in which a contribution to the Roth 401(k) account occurs. In addition, the DC Plan permits in-plan Roth conversions, which allow participants to convert certain vested contributions into Roth contributions, similar to a Roth Individual Retirement Account conversion.
Effective January 1, 2018, the board of directors established, within the DC Plan, an employer-funded non-elective contribution ("NEC") program. The
NEC provides an additional employer-funded benefit for all employees who have met the eligibility requirements to participate in the DC Plan who were hired on or after February 1, 2010 and therefore do not participate in the Grandfathered DB Plan or the Amended DB Plan. The Bank makes this additional NEC of 4% of base salary per year to the DC Plan account of each participant. The NEC is subject to a vesting schedule based on a participant's years of service at the Bank. Partial vesting begins when a participant has attained at least two years of service. Participants become fully vested in their NECs when they have attained five years of service. Mr. Streitenberger and Mr. Dawson receive the NEC and are fully vested.
In November 2015, the board of directors established
the SETP, effective January 1, 2016. As described below, the purpose of the SETP is to permit the NEOs and certain other employees to elect to defer compensation in addition to compensation deferred under the DC Plan. The DC Plan and SETP provide benefits based upon amounts deferred by the participant and employer-matching contributions.
Each DC Plan participant who is an officer with a title of First Vice President or more senior (which includes all NEOs) is automatically eligible to become a SETP participant. In addition, the board of directors in its discretion may designate other DC Plan participants as eligible to participate. The SETP constitutes a nonqualified deferred compensation arrangement that complies with Internal Revenue Code Section 409A regulations and permits a participant to elect to have all or a portion of such participant's
base salary and/or annual incentive plan payment withheld and credited to the participant's SETP account. Under this plan, subject to certain limitations, the Bank will contribute to the participant's account each plan year, up to the contribution that would have been made for the benefit of the participant under the DC Plan, including, if applicable, the NECs described above, without regard to benefit or compensation limits imposed by the Internal Revenue Code. The plan permits participants to self-direct the investment of their SETP account into one or more investment funds. All returns are at the market rate of the respective fund(s) selected by the participant. Plan benefits are paid out of an investment account established for each participant under a grantor trust that we have established as part of our general assets. The assets of the grantor trust are subject to the claims of our general creditors. The trust will be maintained such that the SETP is at all times
considered unfunded and constitutes a mere promise by the Bank to make benefit payments in the future. Any rights created under this plan are unsecured contractual rights against the Bank.
Effective January 1, 2022, the board of directors authorized the Bank to begin making an additional NEC of 6% of base salary per year to the SETP ("SETP NEC") for executive officers that do not participate in either the Grandfathered DB Plan or the Amended DB Plan. The SETP NEC is subject to a vesting schedule based on a participant's years of service at the Bank. Partial vesting begins when
a participant has attained at least two years of service. Participants become fully vested in their SETP NECs when they have attained five years of service. Mr. Streitenberger and Mr. Dawson are both fully vested in the SETP NEC.
The DB Plan, the 2005 SERP, the DC Plan and the SETP have all been amended from time to time to comply with changes in laws and IRS regulations and to clarify or modify other benefit features.
Perquisites and Other Benefits.We offer the following additional perquisites and other benefits to all employees, including the NEOs, under the same general terms and conditions:
•medical, dental, and vision insurance (subject to employee expense sharing);
•vacation
leave, which increases based upon officer title and years of service;
•life and long-term disability insurance (the CEO, CFO, and CBOO are eligible for enhanced monthly benefits under our disability insurance program);
•travel and accident insurance, as well as special crime coverage, which include life insurance benefits;
•educational assistance;
•employee relocation assistance, where appropriate, for new hires; and
•student loan repayment assistance.
In addition, we provide as a taxable benefit to the NEOs and certain other officers limited spouse/guest travel to board of
directors meetings and preapproved industry activities.
Potential Payments Upon Termination or Change in Control.
Severance Pay Plan. The board of directors has adopted a Severance Pay Plan that pays each NEO, upon a qualifying termination as described below (or in the Bank's discretion on a case-by-case basis), up to a maximum 52 weeks of base salary computed at the rate of four weeks of severance pay for each year of service with a minimum of eight weeks of base salary to be paid. In addition, the plan pays a lump sum amount equal to the NEO's cost to maintain health insurance coverage under a Consolidated Omnibus Budget Reconciliation Act ("COBRA")-like coverage for the time period applicable under the severance pay schedule. The Severance Pay Plan may be amended or eliminated by the board at any time. Receipt
of benefits under the Severance Pay Plan is conditioned on the execution of a binding separation contract.
The Severance Pay Plan does not apply to NEOs who have entered into a KESA with the Bank or who are participants under the Bank's Key Employee Severance Policy ("KESP") if a qualifying event has triggered payment under the terms of the KESA or the KESP. As of the filing date of this Form 10-K, Ms. Konich is the only NEO with whom we have a KESA; all other NEOs are participants under the KESP. If any NEO's employment is terminated, but a qualifying event under the KESA or the KESP, as applicable, has not occurred, the provisions of the Severance Pay Plan apply.
The following qualifying events will trigger an NEO's right to severance benefits under
the Severance Pay Plan:
•the elimination of a job or position;
•a reduction in force;
•a substantial job modification, to the extent the incumbent NEO is no longer qualified for, or is unable to perform, the restructured job;
•the reassignment of staff requiring the relocation by more than 75 miles of the NEO's primary residence; or
•termination of employment in connection with a reorganization, merger or other change of control of the Bank.
In addition, the Bank has discretion under the Severance Pay Plan to provide additional pay or outplacement
services to amicably resolve employment separations involving our NEOs and other employees.
The following table presents the estimated amounts that would have been payable to the NEOs under the Severance Pay Plan if triggered as of December 31, 2022, absent a qualifying event that would result in payments under Ms. Konich's KESA or the KESP.
The amounts listed above do not include payments and benefits to the extent that they are provided on a nondiscriminatory basis to NEOs generally upon termination of employment. These payments and benefits include:
•accrued salary and vacation pay;
•distribution
of benefits under the DB Plan; and
•distribution of plan balances under the DC Plan.
Similarly, the amounts listed above also do not include payments from the SERP or the SETP. Amounts payable from the SERP may be found in the Pension Benefits Table. Account balances for the SETP may be found in the Non-Qualified Deferred Compensation Table.
Key Employee Severance Agreement and Key Employee Severance Policy. In general, key employee severance arrangements are intended to promote retention of certain officers in the event of discussions concerning a possible reorganization or change in control of the Bank, to ensure that merger or reorganization opportunities are evaluated objectively, and to provide compensation and other benefits to covered employees under
certain circumstances in the event of a consolidation, change in control or reorganization of the Bank. As described in the following paragraphs, these arrangements provide for payment and, in some cases, continued and/or increased benefits if the officer's employment terminates under certain circumstances in connection with a reorganization, merger or other change in control of the Bank. If we were not in compliance with all applicable regulatory capital or regulatory leverage requirements at the time payment under the KESA or KESP becomes due, or if the payment would cause our Bank to fall below applicable regulatory requirements, the payment would be deferred until such time as we achieve compliance with such requirements. Moreover, if we were insolvent, have had a receiver or conservator appointed, or were in "troubled condition" at the time payment under an arrangement becomes due, the Finance Agency could deem such a payment to be subject to its rules limiting
golden parachute payments.
Key Employee Severance Agreement.Ms. Konich's KESA was entered into during 2007. Under the terms of her agreement, Ms. Konich is entitled to a lump sum payment equal to a multiplier of the average of her three preceding calendar years':
•base salary (less salary deferrals), bonus, and other cash compensation;
•salary deferrals and employer matching contributions under the DC Plan and SETP; and
•taxable portion of automobile allowance, if any.
Ms. Konich is entitled to a multiplier of 2.99, if she terminates for "good reason"
or is terminated "without cause" during a period beginning 12 months before and ending 24 months after a reorganization. This agreement also provides that benefits payable to Ms. Konich pursuant to the SERP would be calculated as if she were three years older and had three more years of benefit service. The agreement with Ms. Konich also provides her with coverage for 36 months under our medical and dental insurance plans in effect at the time of termination (subject to her payment of the employee portion of the cost of such coverage).
We do not believe payments to Ms. Konich under the KESA would be subject to the restriction on change-in-control payments under Internal Revenue Code Section 280G or the excise tax applicable to excess change-in-control payments, because we are exempt from these requirements as a tax-exempt instrumentality of the United States government. If it were determined, however,
that Ms. Konich is liable for such excise tax payment, the agreement provides for a "gross-up" of the benefits to cover such excise tax payment. This gross-up of approximately $3.5 million is not shown as a component of the value of the KESA in the table below.
Further, the agreement with Ms. Konich provides that she will be reimbursed for all reasonable accounting, legal, financial advisory and actuarial fees and expenses she incurs with respect to execution of the agreement or at the time of payment under the agreement. The agreement also provides that Ms. Konich will be reimbursed for all reasonable legal
fees and expenses she incurs if we contest the enforceability of the KESA or the calculation of the amounts payable under the agreement, so long as she is wholly or partially successful on the merits or the parties agree to a settlement of the dispute.
If a reorganization of our Bank had triggered payments under Ms. Konich's KESA on December 31, 2022, the value of the payments for her would have been approximately as follows:
Benefit
Value
2.99
times average of the 3 prior calendar years base salary, bonuses and other cash compensation paid to the executive except for salary deferrals which are included below
$
5,458,720
2.99 times average of the executive's salary deferrals and employer matching contributions under the DC Plan and SETP for the 3 prior calendar years
431,017
Additional amount under the SERP equal to the additional benefit calculated as if the executive were 3 years older and had 3 more years of credited service
2,152,659
Medical
and dental insurance coverage for 36 months
86,158
Reimbursement of reasonable accounting, legal, financial advisory, and actuarial services (1)
15,000
Total value of KESA
$
8,143,554
(1) The amount of $15,000 for reimbursement of reasonable accounting, legal, financial advisory, and actuarial services is an estimate and does not represent a minimum
or maximum amount that could be paid.
Key Employee Severance Policy.We maintain the KESP, which establishes three participation levels for covered employees: (i) Level 1 Participants, which include any Executive Vice President, (ii) Level 2 Participants, which include any Senior Vice President, and (iii) Level 3 Participants, which include any other officer designated by the HR Committee to be a Level 3 Participant from time to time. Thus, covered executives under the KESP (as of the filing date of this Form 10-K) include all NEOs other than Ms. Konich. Mr. Teare, Mr. McGrath, and Mr. Streitenberger are Level 1 Participants. Mr. Dawson is a Level 2 Participant.
Under the KESP, if the covered employee terminates for "good reason" or is terminated without "cause,"
in either case within six months before or 24 months after a reorganization, the covered employee is entitled to a lump-sum payment equal to a multiple (2.0 for Level 1 Participants, 1.5 for Level 2 Participants and 1.0 for Level 3 Participants) of the average of his or her three preceding calendar years' base salary (inclusive of amounts deferred under a qualified or nonqualified plan) and gross bonus (inclusive of amounts deferred under a qualified or nonqualified plan); provided that, for any calendar year in which the covered employee received base salary for less than the entire year, the gross amount shall be annualized as if such amount had been payable for the entire calendar year. All amounts payable under the KESP are capped at an amount equal to one dollar ($1) less than the aggregate amount which would otherwise cause any such payments to be considered a "parachute payment" within the meaning of Section 280G of the Internal Revenue Code.
In
addition, to the extent the covered employee is eligible, he or she will continue after a compensated termination to be covered by the Bank’s medical and dental insurance plans in effect immediately prior to the compensated termination, subject to the covered employee’s payment of the employee’s portion of the cost of such continued coverage. The coverage will continue for Level 1, Level 2 and Level 3 Participants for 24 months, 18 months and 12 months, respectively. In the event the covered employee is ineligible under the terms of such plans for continuing coverage or such plans shall have been modified, the Bank will provide through other sources coverage which is substantially equivalent to the coverage provided immediately prior to the compensated termination, subject to the covered employee’s payment of a comparable portion of the cost of such continued coverage as under the Bank’s medical and dental insurance plans. The KESP also provides for outplacement services
for all covered employees.
(1) Salary
reflects 26 biweekly pay periods for 2022 and 2021 and 27 biweekly pay periods for 2020.
(2) The Non-Equity Incentive Plan Compensation table below presents the components of the "Non-Equity Incentive Plan Compensation" column and the dates that these amounts were paid.
(3) These amounts represent a change in pension value under the Grandfathered DB Plan, Amended DB Plan and the SERP, as applicable. No NEO received preferential or above-market earnings on deferred compensation.
(4) Includes contributions to the DC Plan, NEC program, the SETP, and the SETP NEC, as applicable, for Ms. Konich ($59,325), Mr. Teare ($29,054), Mr. McGrath ($17,291), Mr. Streitenberger ($74,648), and Mr. Dawson ($47,946). Also includes life insurance
policy premiums and income tax gross-ups provided to all employees related to gift cards and years of service awards, as applicable. None of the NEOs received more than $10,000 in perquisites or other personal benefits and there were no other perquisites or benefits that are available to the NEOs that are not available to all other employees.
(5) Ms. Konich is our Principal Executive Officer. The change in pension values under the DB Plan and SERP for Ms. Konich in 2021 was a decrease of $1,462,000. In accordance with SEC guidance, the amount reported in the table is $0.
(6) Mr. Teare is our Principal Financial Officer. The change in pension values under the DB Plan and SERP for Mr. Teare in 2022 was a decrease of $57,000. In accordance with SEC guidance, the amount reported in the table is $0.
(7) Mr.
McGrath was not an NEO for 2020. The change in pension values under the DB Plan and SERP for Mr. McGrath in 2022 was a decrease of $758,000. In accordance with SEC guidance, the amount reported in the table is $0.
(8) Mr. Dawson was not an NEO for 2021 or 2020.
No portion of the change in pension value was received by any of the NEOs; in fact, no portion of the change in pension value will be realizable or made available to any of the NEOs until a qualifying event, such as retirement, occurs. The change in pension value represents the difference between the present value of pension benefits accrued through the beginning and ending valuation dates and is based on the provisions of the applicable plan and the portion of each NEO's total pension benefits that are derived from each applicable plan. The calculations incorporate
various assumptions and changes in compensation, age and tenure, and utilize discount interest rates based on applicable interest rates. Therefore, changes in applied interest rates can have a significant impact on the change in pension value. See the Pension Benefits section below for more information about the pension values as of December 31, 2022, including the assumptions and discount interest rates used.
(1) The
amounts payable (i.e., not deferred) for the Annual Award and the Deferred Award were paid on March 3, 2023, March 4, 2022, and March 5, 2021, for 2022, 2021, and 2020, respectively.
(2) Amounts earned in 2022, 2021, and 2020 represent the 2019, 2018, and 2017 Deferred Awards, respectively.
(3) Mr. McGrath elected to defer 15% of his 2021 Annual Award payable in 2022 pursuant to the terms of the SETP. Mr. McGrath was not eligible for a 2018 Deferred Award.
(4) Mr. Streitenberger elected to defer 10% of his 2018 Deferred Award payable in 2022 and 10% of his 2017 Deferred Award payable in 2021, pursuant to the
terms of the SETP.
Grants
of Plan-Based Awards Table for 2022
Estimated Future
Payouts Under Non-Equity Incentive Plans
(1) The
Incentive Plan - Annual payout is the amount expected to be paid when meeting the respective achievement level for each of the components of the 2022 Annual Award Performance Period Goals. There was no guaranteed payout under the 2022 Annual Award provisions of the Incentive Plan. Therefore, the minimum that could be paid out under this plan is $0 for each NEO.
(2) The Incentive Plan - Deferred threshold payout is based upon the amount earned under the Incentive Plan - Annual and is further dependent on attaining the threshold over the Deferral Performance Period (2023-2025). The threshold is the amount expected to be paid when meeting the threshold for achievement under the Deferred Award provisions of the Incentive Plan over the three-year period. Depending on our performance during the Deferral Performance Period, the Final Award will be worth 75% at Threshold, 100% at Target or 125% at Maximum
of the original amount of the Deferred Award (from the Incentive Plan - Annual Award Performance Period table previously presented). There is no guaranteed payout under the Deferred Award provisions of the Incentive Plan. Therefore, the minimum that could be paid out to an NEO under this plan is $0.
The Non-Equity Incentive Plan Compensation - 2022 table previously presented shows the amounts actually earned and paid under the 2022 Annual Award provisions of the Incentive Plan.
(1) Mr.
Streitenberger and Mr. Dawson are not eligible to participate in the DB Plan or the SERP.
(2) For each of the NEOs, the years of credited service have been rounded to the nearest whole year.
(3) Ms. Konich is eligible to retire under the DB Plan and SERP due to the combination of her age and years of credited service.
(4) Mr. Teare earned six years of credited service in the DB Plan as an employee of the FHLBank of Seattle and is eligible to retire under the DB Plan and SERP due to the combination of his age and years of credited service.
(5) Mr. McGrath is not eligible to retire under the DB Plan and SERP.
No
portion of the present value of accumulated benefits is realizable or available to the NEOs until a qualifying event, such as retirement, occurs. Such values are determined by calculating the present values of accumulated benefits accrued through the valuation date. The calculations incorporate the provisions of the applicable plan, the portion of an NEO's total pension benefits that are derived from each plan, various assumptions, and changes in compensation, age and service, and utilize discount interest rates based on market interest rates or the rates specified in the plan. The present value of the accumulated benefits is based upon a retirement age of 65. Benefits under the DB Plan are based on a discount rate of 5.02% and the PRI-2012 white collar worker annuitant tables (with Scale MP-2021) for qualified annuities or the IRS applicable mortality table for 2022 for qualified lump sums. SERP benefits are based on age 65 lump sums valued with IRS May 2021 Lump Sum
Segment Rates (0.61%, 2.84%, 3.54%), discounted to current age at 4.86% and the IRS applicable mortality table for 2021. The discount rates for the DB Plan and the SERP are based on the Financial Times Stock Exchange ("FTSE") Pension Liability Index and the FTSE Pension Discount Curve, respectively, both of which are determined by yields on high-quality corporate bonds at the valuation dates.
(1) The
contributions by Ms. Konich and Mr. Teare are included in the "Salary" reported in the Summary Compensation Table for 2022. Of the contributions by Mr. McGrath, $3,181 are included in the "Salary" reported in the Summary Compensation Table for 2022. The remaining $23,799 of contributions by Mr. McGrath reflect the amounts deferred related to the 2021 Annual Award. Of the contributions by Mr. Streitenberger, $18,530 are included in the "Salary" reported in the Summary Compensation Table for 2022. The remaining $14,830 of contributions by Mr. Streitenberger reflect the amounts deferred related to the 2018 Deferred Award reported as "Non-Equity Incentive Plan Compensation" in the Summary Compensation Table for 2021. Contributions are net of certain taxes, as applicable.
(2) The amounts are included as a component of "All Other Compensation" in the Summary Compensation
Table. In addition, the amounts for Mr. Streitenberger and Mr. Dawson include the portion of the NEC in excess of the IRS limit applicable to the DC Plan.
(3) The amounts are not reported in the Summary Compensation Table because these amounts are not above market or preferential.
(4) The amounts have been reported in the Summary Compensation Table either in 2022 or prior years, with the exception of aggregate earnings.
The SETP is described in more detail above in "Retirement
Benefits - DC Plan and SETP." Participants in the SETP elect the timing of distribution of their benefits; provided, however, that a participant is permitted to withdraw all or a portion of the amount in his or her account, in a single lump sum, if the participant has experienced an unforeseeable emergency (as defined by the SETP and determined by an administrative committee appointed by our board) or in certain other, limited circumstances. None of the NEOs made a withdrawal or received a distribution from the SETP during 2022.
Principal Executive Officer Pay Ratio Disclosure
Our CEO is our Principal Executive Officer ("PEO"). As described below, for the year ended December 31, 2022, we determined the ratio of the total compensation, as determined in the Summary
Compensation Table ("Total Compensation"), of our PEO to the Total Compensation of the Bank's median employee.
Total Compensation includes, among other components, salary, non-equity incentive compensation, and change in pension value. Amounts reported as change in pension value are attributable to the Bank's Grandfathered DB Plan, Amended DB Plan and the SERP, as applicable. Such change in pension value represents the difference between the present value of pension benefits accrued through the beginning valuation date and the present value of pension benefits accrued through the ending valuation date. The present value calculations incorporate many assumptions and utilize discount rates based on market interest rates. Therefore, changes in market interest rates can have a significant impact on the change in pension value. Additionally, the change in pension value varies considerably among employees
based upon their tenure at the Bank, their annual compensation and several other factors. Finally, no portion of this change in pension value was received by the PEO or median employee; in fact, no portion of the change in pension value will be realizable or made available to the PEO or median employee until a qualifying event, such as retirement, occurs.
For 2022, the Total Compensation of the PEO was $3,723,303. As of December 31, 2022, our PEO had 38 years of credited service under the Grandfathered DB Plan and SERP. Her Total Compensation therefore includes the change in the present value of her pension benefits, which is reported as $1,713,000, and, as a result, constituted 46% of her reported 2022 Total Compensation.
As required by SEC rules, we identified a new median employee for our pay
ratio disclosures in 2020. For each of our full-time and part-time employees on the last pay date of 2020, we first determined the actual or annualized total of salary, wages, bonuses (if any) and incentive awards (collectively, "cash compensation") for 2020. We then ranked the 2020 annual cash compensation for all such employees from lowest to highest, excluding the PEO.
The employee at the median based on cash compensation does not participate in any pension plan. We therefore selected as the median employee the individual whose 2020 annual cash compensation was closest to that of the actual median employee and who participates in the same pension plan as our PEO (the Grandfathered DB Plan). We made no other material assumptions or adjustments in identifying the median employee. We then calculated the median employee's Total Compensation in the same manner that we calculated Total Compensation for
the PEO. This approach ensures that the median employee's Total Compensation, like the PEO's Total Compensation, includes a change in pension value under the same plan and thereby provides an appropriate comparison.
For 2022, the Total Compensation of the median employee was $153,623. As of December 31, 2022, our median employee had 15 years of credited service in the DB Plan. However, the median employee had a decrease in the present value of the employee's pension benefits. Therefore, in accordance with SEC guidance, the change in pension value used in the calculation of the median employee's Total Compensation is $0. As a result, the ratio of the PEO’s Total Compensation to that of the median employee was 24:1. Excluding the 2022 changes in pension value from the Total Compensation of both the PEO and the median employee, the ratio was 13:1.
Finance Agency regulations provide that each FHLBank may pay its directors reasonable compensation for the time required of them and their necessary expenses in the performance of their duties, as determined by a compensation policy to be adopted annually by the FHLBank's board of directors. The Finance Agency Director annually reviews the compensation and expenses of FHLBank directors and has the authority to determine that the compensation and/or expenses paid to directors are not reasonable. In such case, the Director could order the FHLBank to refrain from making any further payments; however, such an order would only be applied prospectively and would not affect any compensation earned but unpaid or expenses incurred but not yet reimbursed.
2022
Compensation. In November 2021, after considering McLagan market data research and a director fee comparison among the FHLBanks, the board of directors adopted a director compensation and expense reimbursement policy for 2022 ("2022 Policy"). Under the 2022 Policy, each director had an opportunity to earn an annual fee (divided into quarterly payments), subject to the combined fee limit shown below. The fees were intended to reflect the time required of directors in the performance of official Bank and board business, measured principally by meeting attendance thresholds and participation at board and committee meetings and secondarily by performance of other duties, which include:
•preparing for board and committee meetings;
•chairing meetings as appropriate;
•reviewing
materials sent to directors on a periodic basis;
•attending other related events such as management conferences, FHLBank System meetings, director training and new director orientation; and
•fulfilling the responsibilities of directors.
Additional compensation is paid for serving as chair or vice chair of the board of directors or as chair of a board committee. Because we are a cooperative and only member institutions may own our stock, no director may receive equity-based compensation. The 2022 Policy provides that director fees were to be paid at the end of each quarter.
The 2022 Policy authorizes a reduction of a director’s fourth quarterly payment if a majority of disinterested directors determines that such
director’s performance, ethical conduct or attendance is significantly deficient. No such reductions occurred for 2022.
The following table summarizes the annual fee limits of the 2022 Policy as approved by the board of directors.
Position
Annual Fee
Limit
Chair
$
142,000
Vice Chair
126,500
Audit
Committee Chair
125,500
Affordable Housing Committee Chair
122,500
Finance/Budget
Committee Chair
122,500
Human Resources Committee Chair
122,500
Risk
Oversight Committee Chair
122,500
Succession Planning Committee Chair
122,500
Technology
Committee Chair
122,500
All other directors
112,000
Other
Committee Chair
(a)
(a) Directors serving as Chair of newly-formed Committees, or serving as Chair of an additional Committee, were entitled to an additional $10,000 fee per year, prorated by the number of quarters for which the director served as Chair.
(1) Mr.
Boike resigned from the Board effective November 8, 2022. The Fees Earned or Paid in Cash represent fees earned on a pro rata basis for service through that date.
(2) Ms. Cook resigned from the Board effective May 12, 2022. The Fees Earned or Paid in Cash represent fees earned on a pro rata basis for service through the day prior.
(3) Mr. Jackson resigned from the Board effective August 4, 2022. The Fees Earned or Paid in Cash represent fees earned on a pro rata basis for service through that date.
We provide various travel, accident, and kidnapping insurance coverages for all of our directors, officers and employees.
These policies provide a life insurance benefit in the event of death within the scope of the policy. We also reimburse directors or directly pay for reasonable travel and related expenses in accordance with the director compensation and travel reimbursement policy.
Directors'
Deferred Compensation Plan. In 2015, we established the DDCP, effective January 1, 2016. The DDCP permits members of our board of directors to elect to defer all or a portion of the fees payable to them for a calendar year for their services as directors. The DDCP constitutes a deferred compensation arrangement that complies with Section 409A of the Internal Revenue Code, as amended. Any duly elected and serving member of our board may become a participant in the DDCP. The DDCP was amended and restated effective January 1, 2021 to increase flexibility as to when distributions may be made.
All contributions credited to a participant’s account will be invested in an irrevocable grantor trustestablished to provide for the DDCP's benefits. The
DDCP is administered by an administrative committee appointed by our board, currently the HR Committee. The trust will be maintained such that the DDCP at all times for income tax purposes will be unfunded and constitutes a mere promise by the Bank to make DDCP benefit payments in the future. Any rights created under the DDCP are unsecured contractual rights against the Bank. The Bank establishes an investment account for each participant under the trust, which at all times remains an asset of the Bank, subject to claims of the Bank’s general creditors. The DDCP permits participants to allocate their investment account among investment options established by the HR Committee or the board. No above-market or preferential earnings are paid on any balances under the DDCP. In general, a participant may elect to have his or her deferred compensation paid in a single lump sum payment, in annual installment payments over a period of two to five years, or in a combination of
both such methods.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth the beneficial ownership of our Class B common stock as of February 28, 2023, by each shareholder that beneficially owned more than 5% of the outstanding shares. Each shareholder named (with its parent holding company) has sole
voting and investment power over the shares beneficially owned.
Name and Address of Shareholder
Number of Shares Owned
% of Outstanding Shares
Flagstar Bank, FSB - 102 Duffy Avenue, Hicksville, NY
3,286,357
13.0
%
The
Lincoln National Life Insurance Company - 1301 S Harrison Street, Fort Wayne, IN
1,971,000
7.8
%
Old National Bank - 123 Main Street, Evansville, IN
1,845,213
7.3
%
Jackson National Life Insurance Company - 1 Corporate Way, Lansing MI
1,464,644
5.8
%
Total
8,567,214
33.9
%
The
majority of our directors are officers and/or directors of our members. The following table sets forth the members that have an officer and/or director serving on our board of directors as of February 28, 2023.
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
We use acronyms and terms throughout this Item that are defined herein or in the Defined Terms.
Related Parties
We are a cooperative institution and owning shares of our stock is generally a prerequisite to transacting business with us. As such, we are wholly-owned by financial institutions that are also our customers (with the exception of shares held by former members, or their legal successors, in the process of redemption). In addition, a majority of our directors serve as officers and/or directors of our members, and we conduct our advances and AMA business almost exclusively with our members. Therefore, in the normal course of business, we extend credit to and purchase mortgage
loans from members with officers or directors who may serve as our directors. However, such transactions are on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not related to us (i.e., other members), and that do not involve more than the normal risk of collectability or present other unfavorable terms.
Also, in the normal course of business, some of our member directors and independent directors are officers of entities that may directly or indirectly participate in our AHP. All AHP transactions, however, including those involving (i) a member (or its affiliate) that owns more than 5% of the Bank's capital stock, (ii) a member with an officer or director who serves as our director, or (iii) an entity with an officer, director or general partner who serves as our director (and that has a direct or indirect interest
in the AHP transaction), are subject to the same eligibility and other program criteria and requirements and the same Finance Agency regulations governing AHP operations.
We do not extend credit to or conduct other business transactions with our directors, executive officers or any of our other officers or employees. Executive officers may obtain loans under certain employee benefit plans but only on the same terms and conditions as are applicable to all employees who participate in such plans.
We
have a Code of Conduct and Conflict of Interest Policy for Directors, a Code of Conduct and Conflict of Interest Policy for Affordable Housing Advisory Council ("AHAC") Members, a Code of Conduct and Conflict of Interest Policy for Employees and Contractors, and a Code of Ethics for Senior Financial Officers. These codes require all directors, AHAC members, officers and employees to disclose any related party interests through ownership or family relationship. These disclosures are reviewed to determine the potential for a conflict of interest. The review is performed by our ethics officers for disclosures relating to officers and employees, and by our General Counsel and board of directors (or, when appropriate, the disinterested members of our board of directors) for directors and AHAC members. In the event of a conflict, appropriate action is taken, which may include: recusal of a director from the discussion and vote on a transaction in which the director
has a related interest; removal of an employee from a project with a related party vendor; disqualification of related vendors from transacting business with us; requiring directors, officers or employees to divest their ownership interest in a related party; or removal of an AHAC member. The General Counsel and ethics officers maintain records of all related party disclosures, and there have been no transactions involving our directors, officers or employees that would be required to be disclosed herein.
Director Independence
General. As of the filing date of this Form 10-K, the board has 15 directorships, consisting of eight member and seven independent directorships. However, one member seat and one independent seat are vacant, resulting in 13 filled seats. Pursuant to the Bank Act, member directors and independent directors
were elected or re-elected by our member institutions. None of our directors are "inside" directors, that is, none of our directors are employees or officers of our Bank. Further, our directors are prohibited from personally owning stock in our Bank. Each of our member directors, however, is a senior officer or director of an institution that is our member and may engage in transactions with us on a regular basis.
Our board of directors is required to evaluate and report on the independence of our directors under two distinct director independence standards. First, Finance Agency regulations establish independence criteria for directors who serve as members of our Audit Committee. Second, SEC rules require that our board of directors apply the independence criteria of a national securities exchange or automated quotation system in assessing the independence of our directors.
Finance
Agency Regulations Regarding Independence. The Finance Agency director independence standards prohibit an individual from serving as a member of our Audit Committee if he or she has one or more disqualifying relationships with the Bank or our management that would interfere with the exercise of his or her independent judgment. Relationships considered to be disqualifying by our board of directors are: employment with us at any time during the last five years; acceptance of compensation from us other than for service as a director; serving as a consultant, advisor, promoter, underwriter or legal counsel for our Bank at any time within the last five years; and being an immediate family member of an individual who is or who has been an Executive Officer within the past five years. Our board of directors assesses the independence of each director under the Finance Agency's independence standards, regardless of whether he or she serves on the Audit
Committee. As of the date of this Form 10-K, each of our directors is "independent" under these criteria relating to disqualifying relationships.
SEC Rules Regarding Independence. SEC rules require our board of directors to adopt a standard of independence with which to evaluate our directors. Pursuant thereto, our board adopted the independence standards of the New York Stock Exchange ("NYSE").
As noted above, some of our directors who are "independent" (as defined in and for purposes of the Bank Act) are employed by companies that may from time to time have (or seek to have) limited business relationships with us due to those companies' participation in projects funded in part through our AHP. None of those companies, however, has, or within the past three most recently completed fiscal years had, a
relationship with us that resulted in payments to, or receipts from, the Bank in excess of the limits set forth in the NYSE independence standards. Moreover, any business relationship between those directors' respective companies and the Bank is established and conducted on the same terms and conditions provided to similarly-situated third parties. After applying the NYSE independence standards, our board determined that, as of the date of this Form 10-K, the six directors currently seated (Directors Bosway, Decker, Hines, Long, Narayanan, and Sears) who are "independent" directors, as defined in and for purposes of the Bank Act, are also independent under the NYSE standards.
Based
upon the fact that each member director is a senior officer or director of an institution that is a member of the Bank (and thus the member is an equity holder in the Bank), that each such institution may routinely engage in transactions with us (which may include advances, MPP and AHP transactions), and that such transactions may occur frequently in the ordinary course of our business and our member institutions' respective businesses, our board of directors concluded for the present time that none of the member directors meet the independence criteria under the NYSE independence standards. It is possible that, under a strict reading of the NYSE objective criteria for independence (particularly the criterion regarding the amount of business conducted with us by the director's institution), a member director could meet the independence standard on a particular day. However, because the amount of business conducted by a member director's institution may change frequently,
and because we generally desire to increase the amount of business we conduct with each member institution, we believe it is inappropriate to draw distinctions among the member directors based upon the amount of business conducted with us by any director's institution at a specific time.
The board of directors has a standing Audit Committee and a standing Human Resources Committee. For the reasons noted above, the board of directors determined that none of the current member directors on these committees (including Directors Clarke, Fisher, Reagin, Myers, Warner, and Gregerson (ex-officio)) are "independent" under the NYSE standards. The board determined that all of the independent directors on these committees (including Directors Decker, Hines, Long and Narayanan) are independent under NYSE standards.
Audit Committee members are subject
to further tests of independence under the NYSE standards. To be considered independent under those standards, a member of the Audit Committee may not, other than in his or her capacity as a member of the board or any board committee (i) accept any consulting, advisory, or other compensation from us or (ii) be an affiliated person of the Bank. All members of the Audit Committee were determined to be independent under these criteria.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table sets forth the aggregate fees billed or to be billed for the years ended December 31, 2022 and 2021 by our independent
registered public accounting firm, PricewaterhouseCoopers LLP ($ amounts in thousands).
2022
2021
Audit fees
$
936
$
950
Audit-related
fees
64
61
Tax fees
—
—
All other fees
1
1
Total fees
$
1,001
$
1,012
Audit
fees were incurred for professional services rendered for the audits of our financial statements. Audit-related fees were incurred for certain FHLBank System assurance and related services, as well as fees related to PwC's participation at FHLBank conferences. All other fees for non-audit services were incurred for an annual license for PwC's disclosure software.
We are exempt from all federal, state, and local taxation, except employment and real estate taxes. Therefore, no fees were paid for tax services during the years presented.
Our Audit Committee has adopted Independent Accountant Pre-approval Policies and Procedures ("Pre-approval Policy"). In accordance with the Pre-approval Policy and applicable law, on an annual basis, the Audit Committee reviews the list of specific services and projected fees for services to be provided for the
next 12 months by our independent registered public accounting firm and pre-approves audit services, audit-related services, tax services and non-audit services, as applicable. Pre-approvals are valid until the end of the next calendar year, unless the Audit Committee specifically provides otherwise.
Under the Pre-approval Policy, the Audit Committee may delegate pre-approval authority to one or more of its members subject to a pre-approval fee limit. The Audit Committee has designated the Committee Chair as the member to whom such authority is delegated. Pre-approved actions by the Committee Chair as designee are reported to the Audit Committee at its next scheduled meeting. New services that have not been pre-approved by the Audit Committee that are in excess of the pre-approval fee level established by the Audit Committee must be presented to the entire Audit Committee for pre-approval.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements
of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated below:
