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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-K

S ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
OR
£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____

Commission File No. 000-51401

logoa32.jpgFederal Home Loan Bank of Chicago 

(Exact name of registrant as specified in its charter)
 
Federally chartered corporation
  
36-6001019
 
 
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer
Identification No.)
 
 
200 East Randolph Drive
Chicago, IL
  
60601
 
 
(Address of principal executive offices)
  
(Zip Code)
 
Registrant's telephone number, including area code: (312) 565-5700

Securities to be registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Class B Capital Stock, par value $100 per share

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

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

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 filings requirements for the past 90 days. Yes x No o

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x     

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large Accelerated Filer o         Accelerated Filer o     Non-accelerated Filer x     Smaller Reporting Company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

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 applicable regulatory and statutory limits. At June 30, 2017, the aggregate par value of the stock held by current and former members was $1,828,755,701. As of January 31, 2018, registrant had 19,936,024 total outstanding shares of Class B Capital Stock, including mandatorily redeemable capital stock.

1

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logoa34.jpgFederal Home Loan Bank of Chicago 

TABLE OF CONTENTS


PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
PART IV
Item 15.
Item 16.
 
 
 

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logoa35.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)



Item 1. Business.

Where to Find More Information

The Federal Home Loan Bank of Chicago a maintains a website located at www.fhlbc.com where we make available our financial statements and other information regarding us and our products free of charge. We are required to file with the Securities and Exchange Commission (SEC) an annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. The SEC maintains a website that contains these reports and other information regarding our electronic filings located at www.sec.gov. These reports may also be read and copied at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. Further information about the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330. Information on these websites, or that can be accessed through these websites, does not constitute a part of this annual report.

A Glossary of Terms can be found on page 122.


Introduction

We are a federally chartered corporation and one of 11 Federal Home Loan Banks (the FHLBs) that, with the Office of Finance, comprise the Federal Home Loan Bank System (the System). The FHLBs are government-sponsored enterprises (GSE) of the United States of America and were organized under the Federal Home Loan Bank Act of 1932, as amended (FHLB Act), in order to improve the availability of funds to support home ownership.

Each FHLB operates as a separate entity with its own management, employees, and board of directors. Each FHLB is a member-owned cooperative with members from a specifically defined geographic district. Our defined geographic district consists of the states of Illinois and Wisconsin. We are supervised and regulated by the Federal Housing Finance Agency (FHFA), an independent federal agency in the executive branch of the United States (U.S.) government.

As a cooperative, we do business with our members and, under limited circumstances, our former members, as well as providing support for the members of other FHLBs through our role operating the Mortgage Partnership Finance® (MPF®) Program. All federally-insured depository institutions, insurance companies engaged in residential housing finance, credit unions, and community development financial institutions located in Illinois and Wisconsin are eligible to apply for membership. All members are required to purchase our capital stock as a condition of membership; our capital stock is not publicly traded.

As of December 31, 2017, we had 447 full time and 13 part time employees.

“Mortgage Partnership Finance”, “MPF”, “MPF Xtra”, “Downpayment Plus”, "DPP" and "Community First" are registered trademarks of the Federal Home Loan Bank of Chicago.


Mission Statement

Our mission is to partner with our member shareholders in Illinois and Wisconsin to provide them competitively priced funding, a reasonable return on their investment in the Bank, and support for community investment activities.
                                                                       

a
Unless otherwise specified, references to we, us, our and the Bank are to the Federal Home Loan Bank of Chicago.

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logoa35.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


Membership Trends

The following table presents the geographic locations of our members by type of institution:

 
December 31, 2017
 
December 31, 2016
 
Number of Institutions
 
 
 
Number of Institutions
 
 
 
Illinois
 
Wisconsin
 
Total
 
Percent
 
Illinois
 
Wisconsin
 
Total
 
Percent
Commercial banks
335

 
172

 
507

 
70
%
 
345

 
179

 
524

 
72
%
Savings institutions
54

 
24

 
78

 
11
%
 
57

 
24

 
81

 
11
%
Credit unions
43

 
45

 
88

 
12
%
 
39

 
40

 
79

 
11
%
Insurance companies
32

 
11

 
43

 
6
%
 
29

 
11

 
40

 
5
%
Community Development
   Financial Institutions
3

 
1

 
4

 
1
%
 
3

 
1

 
4

 
1
%
Total
467

 
253

 
720

 
100
%
 
473

 
255

 
728

 
100
%


The following table presents our members by asset size. Community Financial Institution is defined by our regulator, the FHFA, as FDIC-insured institutions with no more than $1.148 billion (the limit during 2017) in average total assets over three years. This limit is adjusted annually for inflation. See the Glossary of Terms on page 122 for further details.

As of December 31,
 
2017
 
2016
Member Asset Size:
 
 
 
 
Community Financial Institutions
 
91.97
%
 
92.40
%
Larger Non-CFI Institutions
 
8.03
%
 
7.60
%
Total
 
100
%
 
100
%


In 2017, our total membership declined by eight institutions. 

We lost 27 members due to mergers and acquisitions, two of which resulted after the member was placed into receivership by its regulator.  Although 23 of these members were acquired by other members in our district, four were acquired by out-of-district institutions.  In addition, one institution voluntarily withdrew from membership and one institution terminated its membership due to relocation of its principal place of business.

We gained 21 new members by adding six commercial banks, one savings institution, 11 credit unions, and three insurance companies during 2017, as we continue to work toward our goal of building a stronger cooperative by adding new members.

In addition to having access to the Bank as a source of standby liquidity, 83% of our total number of members used one or more of our credit products such as advances, standby letters of credit, or the MPF Program at some point during each of 2017 and 2016.

Business Overview

Our mission-focused business is different from that of a typical financial services firm. As a cooperative, we use our resources to support member utilization of the cooperative, and to support the communities in which members operate. Our strategy revolves around two goals:

Maintaining the member-focused Bank, which involves all areas of the Bank coming together to deliver excellent products and services to our members. Being member-focused means applying the resources of the Bank to enhance the value of membership.

Building the MPF business, which is accepted by most of the other FHLBs as the mortgage aggregation platform for the FHLB System.


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logoa35.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


Mission Asset Ratio

The following table represents our view of the mission-focused business we do as a cooperative bank.

Average par value for the year ended December 31,
 
2017
 
2016
Advances
 
$
46,989

 
$
42,535

Mortgage assets (Acquired Member Assets - AMA)
 
5,038

 
4,727

Primary mission assets
 
$
52,027

 
$
47,262

 
 
 
 
 
Consolidated obligations
 
$
77,338

 
$
71,356

Core mission asset ratio
 
67.3
%
 
66.2
%
 
 
 
 
 
Supplemental mission assets and activities as of December 31,
 
2017
 
2016
MPF Program Loans held by other third party investors
 
$
18,424

 
$
16,972

Member standby letters of credit
 
19,572

 
10,828

Mission related liquidity
 
6,327

 
7,437

Small Business Administration investments
 
1,710

 
1,974

Housing authority standby bonds purchased and commitments outstanding
 
367

 
337

MPF Loan delivery commitments
 
371

 
417

Advance commitments
 
151

 
16

Member derivatives
 
26

 
82

Community First Fund loans and commitments
 
44

 
41

Supplemental mission assets and activities
 
$
46,992

 
$
38,104



We provide credit to members principally in the form of secured loans called advances (inclusive of forward starting advances), as well as through standby letters of credit. We provide liquidity for home mortgage loans to members approved as Participating Financial Institutions (PFIs) through the MPF Program. We also serve as a critical source of standby liquidity for our members.

Our primary funding source is proceeds from the sale to the public of FHLB debt instruments (consolidated obligations) which are, under the FHLB Act, the joint and several liability of all the FHLBs. Consolidated obligations are not obligations of the U.S. government, and the U.S. government does not guarantee them. Additional funds are provided by deposits, other borrowings, and the issuance of capital stock. We also provide members and non-members with correspondent services such as safekeeping, wire transfers, and cash management.

The FHFA has issued an advisory bulletin which provides guidance relating to a core mission asset ratio by which the FHFA will assess each FHLB’s core mission achievement. The FHFA will assess core mission achievement by using a ratio of primary mission assets, which includes advances and mortgage loans acquired from members (also referred to as acquired member assets), to consolidated obligations. The core mission asset ratio will be calculated annually at year-end as part of the FHFA’s examination process, using annual average par values. Based on this ratio, the FHFA has provided the following expectations for each FHLB’s strategic plan:

when the ratio is at least 70% or higher, the strategic plan should include an assessment of the FHLB’s prospects for maintaining this level;
when the ratio is at least 55% but less than 70%, the strategic plan should explain the FHLB’s plan to increase its mission focus; and
when the ratio is below 55%, the strategic plan should include an explanation of the circumstances that caused the ratio to be at that level and detailed plans to increase the ratio. If the FHLB maintains a ratio below 55% over the course of several consecutive reviews, then the board of directors should consider possible strategic alternatives.

Our core mission asset ratio for the year ended December 31, 2017, was 67.3%. During 2017, we held excess liquidity to generate additional net interest income to offset certain costs which resulted in a core mission asset ratio below the 70% level. However, we expect the need to hold excess liquidity will decrease over time and the Bank has set a strategic target to achieve a core mission asset ratio of at least 70% for the year 2019.


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logoa35.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


In 2016, the FHFA issued a final rule making captive insurance companies ineligible for FHLB membership.  Under this rule, our three captive insurance company members will have their memberships terminated by February 2021.  As a result of this regulatory change, once our three captive insurance company members have their membership terminated and their advances mature, our core mission asset ratio will be negatively impacted unless we experience an increased demand for advance products.

Member-Focused Business

Member credit products, which include advances, standby letters of credit, and other extensions of credit to borrowers, are discussed in detail below.

Advances

We provide credit to members principally in the form of secured loans, called advances. Our advances to members:

serve as a reliable source of funding and liquidity;
provide members with enhanced tools for asset-liability management;
provide interim funding for those members that choose to sell or securitize their mortgages;
support residential mortgages held in member portfolios;
support important housing markets, including those focused on very low-, low-, and moderate-income households; and
provide funds to member community financial institutions (CFI) for secured loans to businesses, farms, agri-businesses, and community development activities.
We make secured, fixed- or floating-rate advances to our members. Advances are secured by mortgages and other collateral that our members pledge. We determine the maximum amount and term of advances we will lend to a member as follows:

we value the types of collateral eligible to be pledged to us and apply a margin to secure our advances to members, based on our assessment of the member's creditworthiness and financial condition; and
we conduct periodic collateral reviews with members to establish the amount we will lend against each collateral type.

We are required to obtain and maintain a security interest in eligible collateral at the time we originate or renew an advance. For further detail on our underwriting and collateral guidelines, see Establishing Credit Limits on page 60.

We offer a variety of fixed- and adjustable-rate advances, with maturities ranging from one day to 30 years. Examples of standard advance structures include the following:

Fixed-Rate Advances: Fixed-rate advances have maturities from one day to 30 years.

Variable-Rate Advances: Variable-rate advances include advances that have interest rates that reset periodically at a fixed spread to an FHLB discount note rate-based index, LIBOR, Federal Funds, or some other index. Depending upon the type of advance selected, the member may have an interest-rate cap embedded in the advance to limit the rate of interest the member would have to pay.

Putable Advances: We issue putable, fixed- and floating-rate advances in which we maintain the right to terminate the advance at predetermined exercise dates at par.

Callable Advances: We issue callable, fixed-rate advances in which members have the right to prepay the advance on predetermined dates without incurring prepayment or termination fees.

Other Advances: (1) Open-line advances are designed to provide flexible funding to meet our members' daily liquidity needs and may be drawn for one day. These advances are automatically renewed. Rates are set daily at the close of business. (2) Fixed amortizing advances have maturities that range from one year to 30 years, with the principal repaid over the term of the advances monthly, quarterly, or semi-annually. (3) Fixed Rate with Floating Spread advances are designed to meet our members’ liability duration needs at lower cost than regular fixed rate advances.


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logoa35.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


We also offer features designed to meet our members' business needs such as the following:

Symmetrical prepayment feature where the member would either pay a prepayment fee or prepay the advance below par upon termination, depending on the structure of the advance at the time of termination.

Commitment feature, called “forward-starting advances", to fund an advance on a negotiated funding date at a predetermined interest rate.

Expander feature, which allows a member one or multiple opportunities to increase the principal amount of the advance.

The FHLB Act authorizes us to make advances to eligible non-member housing associates. By regulation, such housing associates must: (i) be approved under Title II of the National Housing Act; (ii) be chartered institutions having succession; (iii) be subject to the inspection and supervision of some governmental agency; (iv) lend their own funds as their principal activity in the mortgage field; and (v) have a financial condition such that advances may be safely made to it. We must approve a housing associate applicant in order for it to be eligible to borrow. We currently have approved four non-member housing associates that are eligible to borrow from the Bank. We had $22 million in advances outstanding to non-member housing associates at December 31, 2017, and $36 million at December 31, 2016.

Competition

Demand for our advances is affected by, among other things, the cost of other sources of funding available to our members, including our members' customer deposits. We compete with suppliers of both secured and unsecured wholesale funding. These competitors may include investment banks, commercial banks, and other FHLBs when our members' affiliated institutions are members of other FHLBs. Under the FHLB Act and FHFA regulations, affiliated institutions in different FHLB districts may be members of different FHLBs.

Some members may have limited access to alternative funding sources while other members may have access to a wider range of funding sources, such as repurchase agreements, brokered deposits, commercial paper, covered bonds collateralized with residential mortgage loans, and other funding sources. Some members, particularly larger members, may have independent access to the national and global credit markets.

The availability of alternative funding sources influences the demand and pricing for our advances and can vary as a result of a number of factors, such as market conditions, products, members' creditworthiness, and availability of collateral. We compete for advances on the basis of the total cost of our products to our members (which include the rates we charge, required capital stock purchases, and any dividends we pay), credit and collateral terms, prepayment terms, product features such as embedded options, and the ability to meet members' specific requests on a timely basis.

In addition, our competitive environment continues to be impacted by the Federal Reserve’s low interest-rate environment and the extent to which our members use our advances primarily as a back-up source of liquidity as opposed to part of their primary funding strategies. For further discussion of the impact of these and other factors on demand for our advances, see Risk Factors on page 16.

Standby Letters of Credit

We provide members with standby letters of credit (also referred to herein as letters of credit) to support obligations to third parties to facilitate residential housing finance, community lending, to achieve liquidity, and for asset-liability management purposes. In particular, members often use letters of credit as collateral for deposits from federal and state governmental agencies. Letters of credit are generally available for terms of up to 20 years or for a one year term renewable annually. If we are required to make payment for a beneficiary's draw, these amounts either must be reimbursed by the member immediately or may be converted to an advance. Our underwriting and collateral requirements for letters of credit are the same as the underwriting and collateral requirements for advances. Letters of credit are not subject to activity capital stock purchase requirements. If any advances were to be made in connection with these standby letters of credit, they would be made under the same standards and terms as any other advance. For more details on our letters of credit see Note 17 - Commitments and Contingencies to the financial statements.


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logoa35.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


Mortgage Partnership Finance® Program

MPF Program Overview

We developed the MPF® Program to provide an additional source of liquidity to our members and to allow us to invest in mortgages to help fulfill our housing mission. The MPF Program is a secondary mortgage market structure under which we purchase mortgage loans from our members and housing associates and members and housing associates of other FHLBs (together with us, the MPF Banks) that participate in the MPF Program (collectively, Participating Financial Institutions or PFIs). These mortgage loans are conventional and government mortgage loans secured by one-to-four family residential properties with maturities ranging from 5 to 30 years or participations in such mortgage loans that are acquired under the MPF Program (MPF Loans).

We purchase MPF Loans to retain in our portfolio for investment, to sell to third parties, or to securitize Government Loans into Ginnie MBS. Our regulatory limit for our investment in MPF Loans held in our portfolio is the lesser of eight times retained earnings or 20% of total assets. Our MPF Loan products are outlined in the chart below:
MPF Product
Mortgage Type
Loan Balance
Held in our Portfolio for Investment?
MPF Original a, MPF 35, MPF 100 b; MPF 125 and MPF Plus b
Conventional
Conforming
Yes
MPF Government c
Government
Determined by the applicable government agency eligibility guidelines
Yes
MPF Xtra
Conventional
Conforming
MPF Loans are concurrently sold to the Federal National Mortgage Association (Fannie Mae).
MPF Direct
Conventional
Non-conforming (jumbo - up to $2,500,000)
MPF Loans are concurrently sold to a third party investor.
MPF Government MBS
Government
Determined by the applicable government agency eligibility guidelines
Government Loans are held in our portfolio for a short period of time until such loans are pooled into Ginnie Mae MBS.
a 
PFIs share in the associated credit risk of these MPF Loan products in accordance with the FHFA Acquired Member Assets (AMA) regulation requirements.
b  
MPF 100 and MPF Plus are not currently offered.
c 
Government Loans are insured or guaranteed by one of the following government agencies: the Federal Housing Administration (FHA); the Department of Veterans Affairs (VA); Rural Housing Service of the Department of Agriculture (RHS); or Department of Housing and Urban Development (HUD) (collectively, Government Loans).

We provide programmatic and operational support in our role as the administrator of the MPF Program on behalf of the other MPF Banks for a fee. MPF Banks may acquire whole loans from their PFIs to retain on their balance sheet and may purchase or sell participations in MPF Loans with other MPF Banks. With participations, the rights and obligations related to the MPF Loans are shared between the MPF Banks based upon their respective percentage participation interest in the related Master Commitment (MC). As of December 31, 2017, 31% of the overall unpaid principal balance of MPF Loans we own represents participations in other MPF Banks’ MPF Loans. See Risk Factors on page 16 for more information about participations. Other MPF Banks’ PFIs that participate in off balance sheet products sell MPF Loans directly to us.

Member PFIs

Members and eligible housing associates become PFIs of their respective MPF Bank by executing a PFI Agreement that provides the MPF Loan selling and servicing terms and conditions. The MPF Guides supplement the PFI Agreement and provides additional requirements for PFI eligibility including maintenance of anti predatory lending policies, errors and omissions insurance and a fidelity bond. All of the PFI's obligations under the PFI Agreement are secured under its advances agreement with the MPF Bank. A PFI is required to deliver collateral for their credit enhancement obligation (as further discussed below) and an MPF Bank can request additional collateral to secure the PFI's other obligations under the PFI Agreement, if necessary.

Mortgage Standards

For conventional MPF Loans held in our portfolio, PFIs are required to deliver mortgage loans that meet the underwriting and eligibility requirements in the PFI Agreement and the MPF Guides, unless a PFI is granted a waiver that exempts such PFI from complying with a specific requirement. MPF Loan requirements include:

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logoa35.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


A maximum loan-to-value (LTV) ratio of 95%;
Mortgage Loans with LTVs greater than 80% must be insured by primary mortgage insurance (PMI);
Compliance with all applicable laws documented using standard Fannie Mae/Freddie Mac Uniform Instruments; and
Meeting the definition of a Qualified Mortgage under the Truth and Lending Act (TILA).

Mortgage loans that are classified as high cost, high rate, or Home Ownership and Equity Protection Act loans, or loans in similar categories defined under predatory lending or abusive lending laws are not eligible under the MPF Program. We perform a quality assurance review of a selected sample of MPF Loans for each PFI in order to determine that the loans complied with the MPF Program requirements at the time of acquisition.

For our off balance sheet products and Government Loan product, PFIs are required to deliver mortgage loans that meet the applicable investor or government agency eligibility and underwriting requirements outlined in the MPF Guides.

We make customary representations and warranties regarding the eligibility of the off balance sheet MPF Loans to third party investors. If a loan eligibility requirement or other warranty is breached, these third parties could require us to repurchase the MPF Loan or provide an indemnity. PFIs make the same representations and warranties to us with respect to the MPF Loans. When a PFI sells a mortgage loan under any MPF Loan product that fails to comply with the representations and warranties, the PFI may be required to provide an indemnification covering related losses or to repurchase the MPF Loans if the failure cannot be cured. See Risk Factors on page 16 and Mortgage Repurchase Risk on page 65 for further information about MPF Loans repurchases.

Loss Structure for Credit Risk Sharing Products

For conventional MPF Loan products held in our portfolio, PFI’s are required to share in the credit risk associated with the mortgage loans. Each MPF Loan delivered by a PFI is linked to a Master Commitment (MC) and losses arising from a mortgage loan are allocated to the appropriate loss layer in that MC. Credit losses not absorbed by the borrower’s equity in the property and any primary mortgage insurance (if available), are allocated between a PFI and their MPF Bank in the following order:

The PFI’s performance based CE Fees. The PFI is paid a monthly credit enhancement fee for sharing the credit risk associated with these mortgage loans (CE Fees) and some of this fee may be performance based. CE Fees vary between 6 to 14 basis points depending on the product. We will withhold a PFI's scheduled performance based CE Fee in order to reimburse ourselves for any losses allocated to the First Loss Account (FLA).
The MPF Bank’s First Loss Account (FLA). The FLA functions as a tracking mechanism for our first layer of credit loss exposure before the PFI's credit enhancement obligation (CE Amount) would cover the next layer of losses. The amount of the FLA is agreed upon when an PFI begins to sell loans into an MC depending on the product. Our FLA exposure varies by MPF Loan product type and it can build over the life of the MC by 3-6 basis points annually or it can be fixed from 35-100 basis points.
The PFI’s CE Amount. The PFI's CE Amount is a direct liability of the PFI to pay credit losses up to a specified amount, which may include proceeds from a provider of supplemental mortgage guaranty insurance (SMI). The CE Amount is determined by the MPF Bank consistent with the AMA Regulation. For further details, see Setting Credit Enhancement Levels on page 63.
The MPF Bank. After the CE Amount has been exhausted, the MPF Bank will absorb any further losses.

MPF Servicing

PFIs can retain the rights and responsibilities for servicing MPF Loans sold under the MPF Program or choose a servicing released option. If PFIs chose to retain servicing rights for MPF Loans sold under the MPF Xtra and MPF Government MBS products, we are contractually obligated to Fannie Mae and Ginnie Mae, respectively, with respect to servicing those loans. The MPF Direct product is servicing released only and we do not have any responsibilities related to the servicing of MPF Loans delivered under the MPF Direct product.

We monitor servicers that service (1) MPF Loans held in our portfolio and (2) MPF Loans that are sold under MPF Xtra and MPF Government MBS when we are contractually responsible to Fannie Mae or Ginnie Mae, respectively, for the loan servicing. If a servicer fails to comply with the servicing requirements, we can charge fees, require mortgage loan repurchase, request indemnification or terminate the servicer’s right to service the MPF Loans.

Competition

We face competition in the markets for conventional loans, non-conforming loans, government loans, and loans with credit risk sharing arrangements from secondary market participants. Secondary market participants include, but are not limited to, dealers, banks, hedge funds, money managers, insurance companies, large mortgage aggregators, private investors, and other GSEs

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such as Fannie Mae and Freddie Mac. Some of these competitors have greater resources, larger volumes of business, and longer operating histories. As a result, our ongoing revenue derived from MPF Loan products may be affected by the volume of business done by our competitors.

Other Activities

Investments

We maintain a portfolio of investments for liquidity purposes and to provide additional earnings. To ensure the availability of funds to meet member credit needs, we maintain a portfolio of short-term liquid assets, principally overnight Federal Funds sold, and securities purchased under agreements to resell, entered into with or issued by highly rated institutions and other eligible counterparties. For further discussion of unsecured credit exposures related to our short-term investment portfolio, see Unsecured Short Term Investments on page 70.

Our longer-term investment securities portfolio includes securities issued by the U.S. government, U.S. government agencies, and GSEs, as well as investments in Federal Family Education Loan Program (FFELP) student loan asset-backed securities (ABS), and mortgage-backed securities (MBS) that are issued by GSEs or that were rated “AAA/Aaa” or “AA/Aa” from Moody's Investors Service (Moody's), Standard and Poor's Rating Service (S&P), or Fitch Ratings, Inc. (Fitch) at the time of purchase. For a discussion of how recent market conditions have affected the carrying value and ratings of these securities, see Investment Securities by Rating on page 67. For this purpose, GSE includes Fannie Mae, Freddie Mac, and the Federal Farm Credit Banks Funding Corporation. Securities issued by GSEs are not guaranteed by the U.S. government.

Under FHFA regulations, we are prohibited from trading securities for speculative purposes or engaging in market-making activities. Additionally, we are prohibited from investing in certain types of securities or loans, including:

instruments, such as common stock, that represent an ownership in an entity, other than common 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, or instruments that were downgraded after purchase;

whole mortgages or other whole loans, other than, (1) those acquired under our MPF Program, (2) certain investments targeted to low-income persons or communities, (3) certain marketable direct obligations of state, local, or tribal government units or agencies, that are investment quality, (4) MBS or asset-backed securities backed by manufactured housing loans or home equity loans; and, (5) certain foreign housing loans authorized under the FHLB Act;

interest-only or principal-only stripped securities;

residual-interest or interest-accrual classes of securities;

fixed-rate MBS or eligible ABS, or floating-rate MBS or eligible ABS, that on the trade date are at rates equal to their contractual cap and that have average lives that vary by more than six years under an assumed instantaneous interest rate change of 300 basis points; and

non-United States dollar-denominated securities.

FHFA regulations further limit our investment in MBS and ABS by requiring that these investments may not exceed 300% of our previous month-end regulatory capital on the day we purchase the securities and we may not exceed our holdings of such securities in any one calendar quarter by more than 50% of our total regulatory capital at the beginning of that quarter. For purposes of calculating the limit on our MBS/ABS portfolio, we value our investments in accordance with FHFA regulations based on amortized cost for securities classified as held-to-maturity or available-for-sale and on fair value for trading securities. Regulatory capital consists of our total capital stock (including the mandatorily redeemable capital stock) plus our retained earnings. This limitation does not apply to newly issued Ginnie Mae securities that have been created through the MPF Government MBS product that are temporarily owned by the Bank.

As we transitioned our primary business to advances, the FHFA previously temporarily waived our regulatory investment limitations to permit us to reinvest a portion of the proceeds from prepayments and maturities of our mortgage assets to

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purchase MBS issued by GSEs and approved our purchase of FFELP student loan ABS. For further discussion of how this may impact us, see Risk Factors on page 16.

We expect to resume making MBS and ABS investments, sometime in 2018, subject to regulatory limitations.

Derivative Activities

We engage in most of our derivative transactions with major broker-dealers as part of our interest rate risk management and hedging strategies.  Additionally, we also enter into interest rate derivatives with our members in order to provide them with indirect access to the derivatives market.  In instances where we do not use interest rate derivatives for our own hedging purposes, we act as an intermediary for our members by entering into an interest rate derivative directly with the member and then entering into an offsetting interest rate derivative transaction with a non-member counterparty. We do not act as a dealer in derivative transactions involving members.

The FHFA's regulations and our internal derivatives and hedging policies all establish guidelines for our use of interest rate derivatives. These regulations prohibit the speculative use of financial instruments authorized for hedging purposes. They also limit the amount of counterparty credit risk allowed. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk on page 73.

Community Investment Activities

We provide financing and direct funding tools that support the affordable housing and community lending initiatives of our members that benefit very low, low, and moderate income individuals, households, businesses and neighborhoods. Outlined below is a more detailed description of the mission-related programs that we administer and fund:

Affordable Housing Program (AHP) - We offer AHP subsidies in the form of direct grants to members to stimulate affordable rental and homeownership opportunities for households with incomes at or below 80% of the area's median income, adjusted for family size. By regulation, we are required to contribute 10% of our income before assessments to fund AHP. Of that required contribution, we may allocate up to the greater of $4.5 million or 35% to provide funds to members participating in our homeownership set-aside programs.

Direct grants are available primarily under our competitive AHP to members in partnership with community sponsors and may be used to fund the acquisition, rehabilitation, and new construction of affordable rental or owner-occupied housing. We awarded competitive AHP subsidies of $26 million for the year ended December 31, 2017, and $26 million for the year ended December 31, 2016, for projects designed to provide housing to 2,366 and 2,260 households, respectively.

In addition, direct grants are available to members under our Downpayment Plus® homeownership set-aside programs and may be provided to eligible homebuyers to assist with down payment, closing, counseling, or rehabilitation costs in conjunction with an acquisition. During the years ended December 31, 2017 and 2016, we awarded $18 million and $16 million through our Downpayment Plus programs to assist 3,122 and 2,703 very low to moderate income homebuyers.

During 2018, we anticipate having $36 million available in total for our Downpayment Plus programs and grants through our competitive AHP.

Community Development Advance/Community Housing Advance Program and related letters of credit - We offer two programs where members may apply for advances or letters of credit to support affordable housing or community economic development lending. These programs provide advance funding at interest rates below regular advance rates for terms typically up to 10 years. Our Community Development Advance and Community Housing Advance programs may be used to finance affordable home ownership housing, multi-family rental projects, industrial and manufacturing facilities, agricultural businesses, healthcare, educational centers, public or private infrastructure projects, or commercial businesses. As of December 31, 2017, and 2016, we had $914 million and $824 million respectively, in advances outstanding under the Community Development Advance and Community Housing Advance programs and related letters of credit outstanding of $142 million and $164 million.

Community First® Fund - Our Board of Directors approved $50 million in 2011 to supplement our current affordable housing and community investment programs, which became the foundation for the Community First Fund (the Fund). The Fund is an innovative revolving credit facility designed to provide low cost, longer term financing to Community Development Financial Institutions, community development loan funds, and state housing finance authorities promoting affordable housing and economic development in our district. We approved our first loans under the Fund in 2014 and as of December 31, 2017, had $34 million in funded loans outstanding and $10 million in unfunded loan commitments.


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Deposits

We accept deposits from our members, institutions eligible to become members, any institution for which we are providing correspondent services, other FHLBs, and other government instrumentalities. We offer several types of deposits to our deposit customers including demand, overnight, and term deposits. For a description of our liquidity requirements with respect to member deposits see Liquidity on page 48.

Funding

Consolidated Obligations

Our primary source of funds is the sale to the public of FHLB debt instruments, called consolidated obligations, in the capital markets. Additional funds are provided by deposits, other borrowings, and the issuance of capital stock. Consolidated obligations, which consist of bonds and discount notes, are the joint and several liability of the FHLBs, although the primary obligation is with the individual FHLB that receives the proceeds from issuance. Consolidated obligations are issued to the public through the Office of Finance using authorized securities dealers. Consolidated obligations are backed only by the financial resources of the FHLBs and are not guaranteed by the U.S. government. See Funding on page 49 for further discussion.

Competition

We compete with the U.S. government, Fannie Mae, Freddie Mac, and other GSEs, as well as corporate, sovereign, and supranational entities, including the World Bank, for funds raised through the issuance of unsecured debt in the domestic and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lesser amounts of debt issued at the same cost than otherwise would be the case. For example, a change in the types or an increase in the amounts of U.S. Treasury issuance may affect our ability to raise funds because it provides alternative investment options. Furthermore, to the extent that investors perceive Fannie Mae and Freddie Mac or other issuers as having a higher level of government support, their debt securities may be more attractive to investors than FHLB System debt.

The FHLBs have traditionally had a diversified funding base of domestic and foreign investors, although investor demand for our debt depends in part on prevailing conditions in the financial markets. For further discussion of market conditions and their potential impact on us, see Risk Factors on page 16 and Funding on page 49.

Although the available supply of funds from the FHLBs' debt issuances has kept pace with the funding requirements of our members, there can be no assurance that this will continue to be the case.

Business Environment

Our financial condition and results of operations are influenced by the interest rate environment, global and national economies, local economies within our districts of Illinois and Wisconsin, and the conditions in the financial, housing, and credit markets. In particular, our net interest income is affected by several external factors, including market interest rate levels and volatility, credit spreads and the general state of the economy.  We endeavor to manage our interest rate risk by entering into fair value hedge relationships utilizing interest rate derivative agreements to hedge a portion of our advances, available for sale securities, and debt.  We are exposed to the variability in the total net proceeds received from forecasted zero-coupon discount note issuances, which is attributable to changes in the benchmark interest rate, London Interbank Offering Rate ("LIBOR). As a result, we enter into cash flow hedge relationships utilizing derivative agreements to hedge the total net proceeds received from our "rolling" forecasted zero-coupon discount note issuances attributable to changes in LIBOR. Additionally, we enter into economic hedges using derivative agreements to hedge our mortgage-related assets, which are sensitive to changes in mortgage rates.

Our profitability is significantly affected by the interest rate environment.  We earn relatively narrow spreads between yields on assets and the rates paid on corresponding liabilities.  A large portion of our advance business is based on our funding costs plus a narrow spread. We also expect our ability to generate significant earnings on capital and short-term investments will be affected by the Federal Reserve’s policy of setting the short-term Federal Funds rate.  Short-term interest rates also directly affect our earnings on invested capital.

Our operating results are affected not only by rising or falling interest rates, but also by the particular path and volatility of changes in market interest rates and the prevailing shape of the yield curve. A flattening of the yield curve tends to compress our net interest margin, while steepening of the curve offers better opportunities to purchase assets with wider net interest spreads. The performance of our MPF Loans held for investment portfolio is particularly affected by shifts in the 10-year maturity range of the yield curve, which heavily influences mortgage rates and potential refinancings. Yield curve shape can also influence the

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pace at which borrowers refinance or prepay their existing loans, as borrowers may select shorter-duration mortgage products in a refinancing. In addition, our higher yielding private label MBS portfolio continues its expected runoff. As higher coupon MPF Loans mature along with higher yielding private label MBS, the return of principal may not be invested in assets with a comparable yield, resulting in a potential decline in the aggregate yield on the remaining MPF Loans held for investment portfolio and investment securities and a possible decrease in our net interest margin.

Lastly, the volume related to our MPF Xtra and MPF Direct programs as well as our Ginnie Mae MBS issuances also are influenced by the interest rate environment, global and national economies, local economies within our districts of Illinois and Wisconsin, and the conditions in the financial, housing and credit markets.

Oversight, Audits, and Legislative and Regulatory Developments

Regulatory Oversight

We are supervised and regulated by the FHFA, an independent federal agency in the executive branch of the U.S. government. The FHFA's operating and capital expenditures are funded by assessments on the FHLBs; no tax dollars or other appropriations support the operations of our regulator. To assess our safety and soundness, the FHFA conducts annual, on-site examinations as well as periodic on-site reviews. Additionally, we are required to submit monthly financial information on our condition and results of operations to the FHFA.

The Government Corporations Control Act, to which we are subject, provides that before a government corporation issues and offers obligations to the public, the Secretary of the Treasury (Secretary) shall prescribe the form, denomination, maturity, interest rate, and conditions of the obligations, the method and time issued, and the selling price. The FHLB Act also authorizes the Secretary discretion to purchase consolidated obligations up to an aggregate principal amount of $4.0 billion. No borrowings under this authority have been outstanding since 1977.

We must submit annual management reports to Congress, the President, the Office of Management and Budget, and the Comptroller General. These reports include a statement of financial condition, a statement of operations, a statement of cash flows, a statement of internal accounting and administrative control systems, and the report of the independent public accounting firm on our financial statements.

Pursuant to FHFA regulations, we plan to publish the results of our annual severely adverse economic conditions stress test to our public website at www.fhlbc.com between November 15 and November 30.

Regulatory Audits

The Comptroller General has authority under the FHLB Act to audit or examine us and to decide the extent to which we are fairly and effectively fulfilling the purposes of the FHLB Act. Furthermore, the Government Corporations Control Act provides that the Comptroller General may review any audit of the financial statements conducted by an independent registered public accounting firm. If the Comptroller General conducts such a review, then the results and any recommendations must be reported to the Congress, the Office of Management and Budget, and the FHLB in question. The Comptroller General may also conduct a separate audit of any of our financial statements.


Recent Legislative and Regulatory Developments

Minority and Women Inclusion

 On July 25, 2017, the FHFA published a final rule, effective August 24, 2017, amending its Minority and Women Inclusion regulations to clarify the scope of the FHLBs' obligation to promote diversity and ensure inclusion. The final rule updates the existing FHFA regulations aimed at promoting diversity and the inclusion and participation of minorities, women, and individuals with disabilities, and the businesses they own (MWDOB) in all FHLB business and activities, including management, employment, customer outreach and access, MWDOB participation in financial transactions with the FHLB, and contracting. The final rule encourages the FHLBs to expand contracting opportunities for MWDOBs and minorities, women, and individuals with disabilities through subcontracting arrangements and to track the cumulative spend associated with such diverse subcontracting arrangements. In addition, the final rule requires each FHLB to:

develop stand-alone, board-approved diversity and inclusion strategic plans or incorporate diversity and inclusion principles into its existing strategic planning processes and adopt strategies for promoting diversity and ensuring inclusion;
amend its policies on equal opportunity in employment by adding sexual orientation, gender identity, and status as a parent to the list of protected classifications;

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establish a process to grant or deny requests for accommodations to employees and job applicants based on their religious beliefs or practices;
provide information in its annual reports to the FHFA about its efforts to advance diversity and inclusion through identifying and selecting MWDOB firms for participation in financial transactions with the FHLB, identifying ways in which it may give consideration to MWDOB business with the FHLB when reviewing and evaluating vendor contract proposals, and enhancing customer access by MWDOB businesses (including through the FHLB's affordable housing and community investment programs;
report data regarding the number of diverse individuals currently in supervisory or managerial positions and its strategies for promoting the diversity of supervisors and managers;
classify and provide additional data in its annual reports about the number of, and amounts paid under, its MWDOB contracts, as well as demographic data regarding the categories of MWDOB entities to which it awards vendor contracts; and
provide data to the FHFA regarding the type of contracts it considers exempt from these diversity and inclusion requirements.

We do not expect this final rule to materially affect our financial condition or results of operations, but we anticipate that it may result in increased costs and substantially increase the amount of data tracking, monitoring, and reporting that will be required of us.

FHLB Capital Requirements

On July 3, 2017, the FHFA published a proposed rule to adopt, with amendments, the Finance Board regulations pertaining to the capital requirements for the FHLBs. The proposed rule would carry over most of the existing regulations without material change, but would substantively revise the credit risk component of the risk-based capital requirement, as well as the limitations on extensions of unsecured credit and derivative exposure. The main revisions would remove requirements that the FHLBs calculate credit risk capital charges and unsecured credit limits based on ratings issued by an NRSRO, and instead require that the FHLBs establish and use their own internal rating methodology. With respect to derivatives, the proposed rule would impose a new capital charge for cleared derivatives, which under the existing rule do not carry a capital charge, and would change the way that the capital charge and risk limits are calculated for uncleared derivatives, in both cases to align with the Dodd-Frank Act’s clearing mandate and derivatives reforms. The proposed rule also would revise the percentages used in the regulation’s tables to calculate credit risk capital charges for advances and for non-mortgage assets. The FHFA proposes to retain for now the percentages used in the tables to calculate capital charges for mortgage-related assets, and to address at a later date the methodology for residential mortgage assets. While a March 2009 regulatory directive pertaining to certain liquidity matters would remain in place, the FHFA also proposes to rescind certain minimum regulatory liquidity requirements and address these liquidity requirements in a new regulatory directive.

We submitted a joint comment letter with the other FHLBs on August 31, 2017. We do not expect this rule, if adopted substantially as proposed, to materially affect our financial condition or results of operations. Additionally, to date, the FHFA has not yet formally proposed new liquidity requirements; however, to the extent that new regulations or guidance increase our liquidity requirements in the future, our business activities and operations could be adversely affected.

Information Security Management Advisory Bulletin

On September 28, 2017, the FHFA issued Advisory Bulletin 2017-02, which supersedes previous guidance on an FHLB’s information security program. The Advisory Bulletin describes three main components of an information security program and reflects the expectation that each FHLB will use a risk-based approach to implement its information security program. The Advisory Bulletin contains expectations related to (i) governance, including guidance related to roles and responsibilities, risk assessments, industry standards, and cyber-insurance; (ii) engineering and architecture, including guidance on network security, software security, and security of endpoints; and (iii) operations, including guidance on continuous monitoring, vulnerability management, baseline configuration, asset life cycle, awareness and training, incident response and recovery, user access management, data classification and protection, oversight of third parties, and threat intelligence sharing.

We do not expect this Advisory Bulletin to materially affect our financial condition or results of operations, but we anticipate that it may result in increased costs relating to enhancements to our information security program.

Mandatory Contractual Stay Requirements for Qualified Financial Contracts (QFCs)

On September 12, 2017, the FRB published a final rule, effective November 13, 2017, requiring certain global systemically important banking institutions (GSIB) regulated by the FRB to amend their covered QFCs to limit a counterparty’s immediate termination or exercise of default rights under the QFCs in the event of bankruptcy or receivership of the GSIB or an affiliate of the GSIB. Covered QFCs include derivatives, repurchase agreements (known as “repos”) and reverse repos, and securities

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lending and borrowing agreements. On September 27, 2017, and on November 29, 2017, the FDIC and OCC respectively adopted final rules that are both substantively identical to the FRB rule, both effective January 1, 2018, with respect to QFCs entered into with certain FDIC- and OCC-supervised institutions.

Although we are not a covered entity under these rules, as a counterparty to covered entities under QFCs, we may be required to amend QFCs entered into with FRB-regulated GSIBs or applicable FDIC- and OCC-supervised institutions.  These rules may impact our ability to terminate business relationships with covered entities and could adversely impact the amount we recover in the event of the bankruptcy or receivership of a covered entity. However, we do not expect these final rules, or the proposed amendments to the Swap Margin Rules (defined below), to materially affect our financial condition or results of operations.

OCC, FRB, FDIC, Farm Credit Administration, and FHFA Proposed Rule on Margin and Capital Requirements for Covered Swap Entities

On February 21, 2018, OCC, FRB, FDIC, Farm Credit Administration, and FHFA published a joint proposed amendment to each agency’s final rule on Margin and Capital Requirements for Covered Swap Entities (Swap Margin Rules) to conform the definition of “eligible master netting agreement” in such rules to the FRB’s, OCC’s, and FDIC’s final QFC rules, and to clarify that a legacy swap will not be deemed to be a covered swap under the Swap Margin Rules if it is amended to conform to the QFC Rules.

Comments on the proposed rule are due by April 23, 2018. We continue to evaluate the proposed rule, but we do not expect this rule, if adopted substantially as proposed, to materially affect our financial condition or results of operations.


Taxation and AHP Assessments

We are exempt from all federal, state, and local taxation except for real estate property taxes, which are a component of our lease payments for office space or on real estate we own as a result of foreclosure on MPF Loans. In lieu of taxes, we set aside funds for our AHP at a calculated rate of 10% of income before assessments. For details on our assessments, see Note 11 - Affordable Housing Program to the financial statements.


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Item 1A.    Risk Factors.

Business Risks

A prolonged downturn in the U.S. housing markets and other economic conditions, and related U.S. government policies may have an adverse impact on the business of many of our members, and our business and results of operations.

Our business and results of operations are sensitive to the U.S. housing and mortgage markets, as well as international, domestic and district-specific market and economic conditions. Although in 2017, U.S. economic activity expanded and the Federal Reserve raised interest rates three times, the Federal Reserve continues to monitor global economic and domestic inflation and employment developments closely. If these conditions deteriorate, including as a result of domestic conditions or global instability, our business and results of operations could be adversely affected.

In 2017, conditions in the U.S. housing market continued to improve, as evidenced by the level of decreased unemployment, home price appreciation and lower mortgage delinquency rates. If adverse trends reappear in the mortgage lending sector and general business and economic conditions deteriorate significantly, these factors could result in deterioration of our members' credit characteristics, which could cause them to become delinquent or to default on their advances and other credit obligations. As of February 28, 2018, we have not experienced any member payment defaults. In addition, declines in real estate prices or loan performance trends or increases in market interest rates could result in a reduction in the fair value of our collateral securing member credit and the fair value of our mortgage-backed securities investments. This change could increase the possibility of under-collateralization and the risk of loss in case of a member's failure, or increase the risk of loss on our mortgage-backed securities investments because of additional credit impairment charges. Also, deterioration in the residential mortgage markets could negatively affect the value of our mortgage loan portfolio and result in possibly additional realized losses if we are forced to liquidate our mortgage portfolio. Moreover, a negative trend in the housing and mortgage markets could result in a decline in advance levels and adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.

Our business and results of operations are also affected by the fiscal and monetary policies of the federal government and its agencies in response to adverse economic conditions, including the Federal Reserve, which regulates of the supply of money and credit in the United States. These policies directly and indirectly influence the yield on interest-earning assets and the cost of interest bearing liabilities and the demand for FHLB debt, which could adversely affect our financial condition, results of operations, and ability to pay dividends.

The Bank and our members are subject to and affected by a complex body of laws and regulations, which could change in a manner detrimental to our business operations, and adversely affect our financial condition.

We are a GSE organized under the authority of the FHLB Act and are governed by Federal laws and regulations of the FHFA. From time to time, Congress has amended the FHLB Act and adopted other legislation in ways that have significantly affected the FHLBs and the manner in which the FHLBs carry out their housing finance mission and business operations. New or modified legislation enacted by Congress or regulations or guidance adopted by the FHFA or other agencies could have a negative effect on our ability to conduct business or our costs of doing business.

The FHFA’s extensive regulatory authority over the FHLBs includes, without limitation, the authority to liquidate, merge, consolidate, or redistrict the FHLBs. The FHFA also has authority over the scope of permissible FHLB products and activities, including the authority to impose limits on those products and activities. We can not predict whether the FHFA may issue future rule changes that could impact our business or our members.

Changes in our statutory or regulatory requirements or policies or in their application could result in changes in, among other things, our membership base, our cost of funds; liquidity requirements; retained earnings and capital requirements; accounting policies; debt issuance limits; dividend payment limits; the form of dividend payments; capital redemption and repurchase limits; permissible business activities; advance pricing and structure; compliance requirements; operational processes; and the size, scope, or nature of our lending, investment, or MPF Program activities; all and any of which could be detrimental to our business operations and financial condition. See Recent Legislative and Regulatory Developments on page 13 for more information about recent regulatory developments.

In addition, as Congress continues to consider possible reforms to the U.S. housing finance system, including the resolution of Fannie Mae and Freddie Mac, any future legislation could directly or indirectly impact GSEs that support the U.S. housing market, including the FHLBs.


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Moreover, new or modified legislation or regulations governing or impacting our members and counterparties may affect our ability to conduct business or cost of doing business. For example, the Bank, its members, and counterparties have been impacted by the regulations under the Dodd-Frank Act, which made significant changes to the overall regulatory framework of the U.S. financial system. Specifically, regulatory changes under Dodd-Frank have impacted how our insured depository members manage their liquidity and capital, and may impact the demand for our advances. Recently, there have been discussions relating to amending or repealing the Dodd-Frank Act. We cannot predict the prospects for the enactment of amendments to, or the repeal of, the Dodd-Frank Act, or how these changes may impact our business.

We face competition for advances and access to funding, which could adversely affect our business.

Our primary business is making advances to members. We compete with other suppliers of wholesale funding, both secured and unsecured, including investment banks, commercial banks, the Federal Reserve, and, in certain circumstances, other FHLBs with which members have a relationship through affiliates. While our advances increased significantly from 2013 through 2017, we cannot predict the volume of future advance borrowings of our members in the longer term. As many members continue to have sufficient levels of liquidity and funds through deposits and investments, decrease the size of their balance sheets to improve their capital positions, diversify or have access to alternative funding sources, our advance levels could decrease. Moreover, if we are unable to structure our advance products to satisfy the liquidity requirements of our depository members and the specific funding requirements of all members, our members may turn to other sources of liquidity and our advance levels could decrease.

We may make changes in policies, programs, and agreements affecting members' access to advances and other credit products, the MPF Program, the AHP, and other programs, products, and services. As a result of these changes some members may choose to obtain financing from alternative sources. For example, we may make changes to our collateral guidelines, including changes in the value we assign to collateral which members are required to pledge to secure their outstanding obligations, including advances. To the extent that members view this tightening of credit and collateral requirements as unfavorable, we may experience a decrease in our levels of business which may negatively impact our results of operations or financial condition. Further, many competitors are not subject to the same regulations as us, which may enable those competitors to offer products and terms that we are not able to offer. Any change made in pricing our advances to compete with these alternative funding sources may decrease our profitability on advances. Additionally, as we manage our refunding risk with respect to short-term discount notes, any resulting increase in advance pricing may decrease demand for our advances. State and federal regulators’ perception of the stability and reliability of our advances can also directly impact the amount of advances used by our members. A decrease in advance demand or a decrease in profitability on advances could adversely impact our financial condition and results of operations.

The FHLBs also compete with the U.S. government, Fannie Mae, Freddie Mac, and other government-sponsored enterprises (GSEs), as well as corporate, sovereign, and supranational entities, including the World Bank, for funds raised through the issuance of unsecured debt in the domestic and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs or lower amounts of debt issued at the same cost. Increased competition could adversely affect our ability to access funding, reduce the amount of funding available to us, or increase the cost and type of funding available to us. For example, a change in the types or an increase in the amount of US Treasury issuances, such as in response to the U.S. government's fiscal budgeting process or statutory debt limits, may affect our ability to raise funds because it provides alternative investment options. In addition, to the extent investors perceive Fannie Mae or Freddie Mac or other issuers as having higher levels of government support, their debt securities may be more attractive to investors than FHLB System debt. To the extent that the FHLB System experiences lower debt funding requirements, including in response to lower advance demands, our debt funding costs could increase. Any of these results could adversely affect our financial condition, results of operations, or ability to pay dividends or redeem or repurchase capital stock.


Our and our members’ inability to adapt products and services to evolving industry standards and customer preference amid a highly competitive and regulated landscape, while managing expenditures, could harm our business.

Our and our members’ success depend on the ability to adapt products and services to evolving industry standards and to meet customer needs, particularly amid a highly competitive and regulated landscape. The widespread adoption of new technologies could require substantial expenditures. We and our members are also faced with increasing operating costs in managing cybersecurity risks. We and our members may not be successful in developing or introducing new products, systems, and services to keep pace with larger competitors, in integrating new products, systems, or services into existing platforms, in responding or adapting to changes in customer behavior or preferences, and in reducing costs, all of which may harm our business and results of operations.


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The loss of significant members could result in lower demand for our products and services, and negatively impact our financial condition and results of operation.

At December 31, 2017, our five largest advance borrowers held 59% percent of total advances outstanding. The loss of significant members or a significant reduction in the level of business they conduct with us would likely lower overall demand for our products and services in the future and adversely impact our financial condition and results of operations.

In 2016, the FHFA adopted regulatory changes that disqualified captive insurance companies from FHLB membership. This rule impacts our three captive insurance company members who will have their memberships terminated by February 2021. As of December 31, 2017, these captive insurance company members had $13.4 billion in advances outstanding at par, which was 28% percent of our total advances outstanding. The advances to our captive insurance company members, which may remain outstanding until they mature, have a weighted remaining tenor of 6.24 years as of December 31, 2017. However, after our captive insurance company members have their membership terminated and once their advances mature, advance and capital stock levels would decrease. Unless we experience an increased demand for our advance products from our current or future members, this will result in a material decrease in our outstanding advance levels and our results of operation may be adversely affected. Further, we could experience lower demand for advances and other products and services, including letters of credit, and our core mission asset ratio may be negatively impacted. The magnitude of the impact will depend, in part, on our size and profitability at the time of membership termination or maturity of related advances.

Additionally, statutory or regulatory requirements have contributed to consolidation in the financial industry, and could reduce the number of current and potential members in our district. Additionally, for a variety of reasons, including regulatory pressure to simplify their organizational structures, parent institutions may decide to dissolve our members or merge our members out of district, resulting in our loss of such members. We lost 27 members due to mergers and acquisitions in 2017(two of which resulted after the member was placed into receivership by its regulator). Twenty three of these members were acquired by other members in our district and four were acquired by out-of-district institutions. As the financial services industry continues to experience consolidation or the pressure to simplify their organizational structures, and to the extent new or modified legislation, the low interest rate environment, and technological challenges negatively impact our members, we may lose a member or members whose business and capital stock investments are significant to our business. This loss of business could negatively impact our business operations, financial condition, and results of operations.

Changes in the perception, status or regulation of GSEs and the related effect on debt issuance could reduce demand or increase the cost of the FHLBs' debt issuance and adversely affect our earnings.

The FHLBs are GSEs organized under the authority of the FHLB Act and are authorized to issue debt securities to fund their operations and finance housing development in the United States. In the past, negative announcements by any of the housing GSEs concerning topics, such as accounting problems, risk-management issues, or regulatory enforcement actions, have created pressure on debt pricing for all GSEs, as investors have perceived such instruments as bearing increased risk. Any such negative information or other factors could result in the FHLBs having to pay a higher rate of interest on consolidated obligations to make them attractive to investors, which could negatively affect the FHLBs' results of operations.

Furthermore, as the U.S. Congress continues to consider GSE and housing finance reforms, the FHLBs’ funding costs and access to funds could be adversely affected as a result of the uncertainty surrounding the timing and pace of any possible changes. Additionally, investor concerns about U.S. agency debt and the U.S. agency debt market may also adversely affect the FHLBs' competitive position and result in higher funding costs, which could negatively affect our earnings.

Failure to scale the size or composition of our balance sheet and our cost infrastructure to the economic environment or member demand for our products, and maintain an appropriate liquidity and funding balance between our assets and liabilities, may have a material adverse effect on our results of operations and financial condition.

During 2017, new MPF Loan purchases moderately exceeded pay downs and maturities within our MPF Loans held in portfolio. However, to the extent our new MPF Loan purchases are insufficient to offset pay downs in the future, our balance sheet would decrease over time. The same risk may apply to our investment securities portfolio in light of our regulatory limitations on purchasing MBS and ABS investments. Additionally, while our advances increased significantly from 2013 through 2017, we cannot predict the volume of future advance borrowings of our members in the longer term. If our increase in expenses outpaces our increase in income, or if we were to become a smaller sized institution, or the composition of our balance sheet significantly changes in some manner, whether as a result of the economic environment or other factors, we would be presented with challenges, such as reducing our cost infrastructure and creating a balance sheet with earning assets that would support that cost infrastructure while providing for future dividends at an appropriate level. Structuring such a balance sheet would be more challenging in a low interest rate environment. In addition, as we incur development and operating costs related to new products and initiatives, we may not generate enough member demand and volume to recover such costs. For example, costs related to operating some of our MPF products exceed the revenue generated by these products to date by an amount that is not currently

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material but which could become so in the future. Regulatory requirements, including our mission asset ratio requirement, as further described on page 5, may also have an effect on how we manage our balance sheet and cost infrastructure. If we are unable to successfully maintain our balance sheet and cost infrastructure at an appropriate composition and size scaled to member demand, our results of operations and financial condition may be negatively impacted.

We are sensitive to maintaining an appropriate liquidity and funding balance between our financial assets and liabilities, and we measure and monitor the risk of refunding such assets as liabilities mature (refunding risk). In measuring the level of assets requiring refunding, we take into account their contractual maturities. In addition, we make certain assumptions about their expected cash flows. However, our earnings and our ability to conduct our business may be adversely impacted to the extent we insufficiently maintain an appropriate liquidity to funding balance between our financial assets and liabilities.

Restrictions on the redemption, repurchase, or transfer of our capital stock could result in an illiquid investment for the holder.

Under the GLB Act and FHFA regulations, and our Capital Plan, our capital stock is subject to redemption upon the expiration of a five-year redemption period. Only capital stock in excess of a member's or former member's minimum investment requirement that was subject to a redemption request, capital stock of a member that has submitted a notice to withdraw from membership, or capital stock held by a member whose membership has been terminated may be redeemed at the end of the applicable redemption period. Further, we may elect to repurchase excess stock from time to time at our sole discretion without regard to the five-year redemption period. Beginning in 2017, we began repurchasing all excess class B2 membership stock on a weekly basis at par value, although members may continue to request repurchase of excess stock in addition to the automatic weekly repurchase.

If the redemption or repurchase of capital stock would cause us to fail to meet our minimum capital requirements or cause the member or former member to fail to maintain its minimum investment requirement, then such redemption or repurchase would be prohibited by FHFA regulations and our Capital Plan. We also may decide to suspend the redemption of capital stock if we reasonably believe that such redemptions would cause us to fail to meet our minimum capital requirements. All repurchases of excess stock, including automatic weekly repurchases, remain subject to our regulatory capital requirements, certain financial and capital thresholds, and prudent business practices. Accordingly, there is no guarantee that we will be able to redeem capital stock held by a shareholder even at the end of the redemption period or to repurchase excess capital stock.

In addition, since our capital stock may only be owned by our members (or, under certain circumstances, former members and certain successor institutions), and our Capital Plan requires our approval before a member or nonmember shareholder may transfer any of its capital stock to another member or nonmember shareholder, we cannot provide assurance that a member or nonmember shareholder would be allowed to transfer any excess capital stock to another member or nonmember shareholder at any time.

In addition, approval from the FHFA for redemptions or repurchases would be required if the FHFA or our Board of Directors were to determine that we incurred, or are likely to incur, losses that result in, or are likely to result in, charges against our capital. Under such circumstances, there can be no assurance that the FHFA would grant such approval or, if it did, upon what terms it might do so.

For further discussion of our minimum capital requirements, see Note 13 - Capital and Mandatorily Redeemable Capital Stock (MRCS) to the financial statements.

Limitations on the payment of dividends and repurchase of excess capital stock or future changes to our capital stock requirements may adversely affect the effective operation of our business model.

Our business model is based on the goal of maintaining a balance between our housing mission and our objective to provide a reasonable return on our members' investment in the cooperative. We work to achieve this balance by delivering low-cost credit to help our members meet the credit needs of their communities while striving to pay a reasonable dividend on our Class B2 membership stock and a higher dividend on Class B1 activity stock in order to recognize those members that are using advances, which contributes to the overall health of the entire cooperative. See Dividend Payments on page 57. Typically, our capital grows when members are required to purchase additional capital stock as they increase their advances borrowings and our capital declines when we repurchase excess capital stock from members as their advances decline such as through our automatic weekly repurchase program.

Under FHFA regulations, the FHLBs may pay dividends on their stock only out of previously retained earnings or current net income, and our ability to pay dividends is subject to statutory and regulatory restrictions and is dependent upon our ability to continue to generate net income. Further, the level of our dividend payments is restricted by our retained earnings and dividend policy as further described under Retained Earnings & Dividends on page 57. If we are unable to maintain a reasonable level

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of net income, we may become unable to pay dividends or maintain a higher dividend on Class B1 activity stock or the level of dividends could be significantly reduced.

To the extent that current and prospective members determine that our dividend is insufficient or our ability to pay future dividends or repurchase excess capital stock becomes limited, we may be unable to expand our membership and may experience decreased member demand for advances requiring capital stock purchases and increased membership requests for withdrawals that may adversely affect our results of operations and financial condition.

In addition, in recent years we’ve made substantial changes to our Capital Plan to reduce the cost of membership through reduced membership stock requirements. We also offer the Reduced Capitalization Advance Program (“RCAP”), which reduces a member’s activity stock requirement for certain advances as further discussed in Reduced Capitalization Advance Program on page 54. To the extent that we are unable to maintain our current capital stock requirements and continue to offer RCAP, or to the extent we effect future changes to our capital plan, member utilization of the Bank may be impacted, which in turn may adversely affect our results of operations and financial condition.

Members' rights in the event of a liquidation, merger, or consolidation of the Bank may be uncertain.

Under the GLB Act, holders of Class B Stock own the retained earnings, surplus, undivided profits, and equity reserves of the Bank. Our Capital Plan provides that, with respect to a liquidation of the Bank, after payment to creditors, Class B Stock will be redeemed at par, or pro rata if liquidation proceeds are insufficient to redeem all of the capital stock in full. Any remaining assets will be distributed on a pro rata basis to those members that were holders of Class B Stock immediately prior to such liquidation. With respect to a merger or consolidation affecting us, members will be subject to the terms and conditions of any plan of merger and/or terms established or approved by the FHFA. Our Capital Plan also provides that its provision governing liquidation or merger is subject to the FHFA's statutory authority to prescribe regulations or orders governing liquidation, reorganization, or merger of an FHLB. Although our members would have an opportunity to ratify any merger agreement in a voluntary merger between us and another FHLB, we cannot predict how the FHFA might exercise its authority with respect to liquidations or reorganizations, or whether any actions taken by the FHFA in this regard would be inconsistent with the provisions of our Capital Plan or the rights of holders of Class B Stock in the retained earnings of the Bank.

Compliance with regulatory contingency liquidity guidance could restrict investment activities and adversely impact net interest income.

We are required to maintain sufficient liquidity through short-term investments in an amount at least equal to our anticipated cash outflows under two hypothetical scenarios for the treatment of maturing advances as described in Liquidity Measures on page 48. This regulatory guidance is designed to provide sufficient liquidity and to protect against temporary disruptions in the capital markets that affect the FHLB System's access to funding. To satisfy this liquidity requirement, we maintain increased balances in short-term investments, which may earn lower interest rates than alternate investment options and may, in turn, negatively impact net interest income.

In certain circumstances, we may need to fund overnight or shorter-term investments and advances with discount notes that have maturities that extend beyond the maturities of the related investments or advances. Net interest income on investments and advances may be reduced. Also, to the extent that short-term advance pricing is increased, our short-term advances may be less competitive, which may adversely affect advance levels and our net interest income.

In July 2017, in connection with proposed modifications to certain FHLB risk-based capital requirements, the FHFA announced it would issue new liquidity requirements in a separate regulatory directive. To date, these liquidity requirements have not yet been formally proposed; however, to the extent that any new regulatory directive increases our liquidity requirements in the future, our business activities and operations could be adversely affected.

Failure to meet minimum regulatory capital requirements could affect our ability to conduct business and could adversely affect our earnings.

We are subject to certain minimum capital requirements under the FHLB Act, as amended, and FHFA rules and regulations that include total capital, leverage capital, and risk-based capital requirements. If we are unable to satisfy our minimum capital requirements, we could be subject to certain capital restoration requirements and prohibited from paying dividends and redeeming or repurchasing capital stock without the prior approval of the FHFA, which could adversely affect a member's investment in our capital stock. Furthermore, any suspension of dividends and/or capital stock repurchases and redemptions could decrease member confidence, which in turn could reduce advance demand and net income should members elect to use alternative sources of wholesale funding. As a result of a risk-based capital shortfall, investors could perceive an increased level of risk or deterioration in our performance, which could result in a downgrade in our outlook or our short- or long-term credit

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ratings. For further discussion of our minimum regulatory capital requirements, see Note 13 - Capital and Mandatorily Redeemable Capital Stock (MRCS) to the financial statements.

FHFA regulations annually require us to perform stress tests under various scenarios and make the results of a severely adverse economic conditions test publicly available. The severity of the required scenarios is subject to the FHFA’s discretion. We use such stress tests as part of our capital planning process and evaluate the adequacy of capital resources available to absorb potential losses arising from those risks. While we believe that our capital base is sufficient to support our current operations given our risk profile, future required scenarios, the results of the stress testing process, and the public disclosure thereof may affect our approach to managing and deploying capital, and the public’s perception of us.

In July 2017, the FHFA published a proposed rule that would substantively revise the credit risk component of our risk-based capital requirement, as further discussed in Recent Legislative and Regulatory Developments on page 13. We cannot predict what this proposed rule will look like in its final form, and whether it will have a negative effect on our ability to conduct our business.

A decline and shift in mortgage originations, the shift from a mortgage loan refinancing market to a purchase market, and the loss of certain PFIs in the future may negatively impact our business.

Some forecasts suggest that mortgage originations are expected to decline in the near future, with the bulk of new originations coming from non-bank originators, like “FinTech” companies, who are not members of the FHLBs and therefore not eligible to participate in our MPF Program. To the extent these forecasts are accurate, we may experience a decrease in volume available to purchase from our PFIs. There has also been a shift from a mortgage loan refinancing market, in which our PFIs are more active, to a purchase market, in which our PFIs have been historically less active. To the extent a sufficient number of our PFIs experience a decline in new mortgage originations, we may incur a decrease in volume available to purchase from our PFIs.

During 2017, the top five PFIs, in the aggregate, accounted for 68% of our MPF on balance sheet purchases. To the extent we lose our business with these PFIs and cannot attract comparable replacements, our business may be adversely affected.

The loss of key personnel or difficulties recruiting and retaining qualified personnel could adversely impact our business and financial results.

Much of our future success depends on the continued availability and service of senior management personnel. The loss of any of our executive officers or other key senior management personnel could harm our business. Additionally, we must continue to recruit, retain and motivate a qualified and diverse pool of employees, both to maintain our current business, including succession planning, and to execute our strategic initiatives. If we are unable to recruit, retain and motivate such employees to maintain our current business and support our projected growth, our business and financial performance may be adversely affected.

Market Risks

To the extent that our MPF Loan portfolio decreases and as our investment securities mature, we may experience a future reduction in our net interest income, which may negatively impact our results of operations and financial condition.

While new MPF Loan purchases moderately exceeded pay downs of our MPF Loans held in portfolio in 2017, future MPF Loan purchases may be insufficient to offset pay downs and maturities of our MPF Loan portfolio. Moreover, FHFA regulations limit our investments in MBS and ABS as discussed in Investments on page 10. Once we resume purchasing MBS and ABS, any new investments may not be on as favorable terms or generate as much expected income as our maturing investments, on either a risk-adjusted or absolute basis. Thus, our overall earning potential may be negatively impacted to the extent that decreases in our MPF Loan portfolio and investments portfolios are not offset by new purchases.

A sustained period of low interest rates, rapid changes in interest rates, or an inability to successfully manage interest-rate risk could have a material adverse effect on our net interest income.

We realize net interest income primarily from the spread between interest earned on our outstanding advances, MPF Loans, and investments less the interest paid on our consolidated obligations and other liabilities. A very low interest-rate environment could adversely impact us in various ways, including lower market yields on investments and faster prepayments on our investments with associated reinvestment risk. Our investment income and, in turn, our financial condition and results of operations, could be adversely impacted as a result. Conversely, when interest rates increase, we may experience extension risk, which is the risk that our mortgage-based investments will remain outstanding longer than expected at below-market yields. Therefore, any rapid change in interest rates could adversely affect our net interest income. See Item 7A. Quantitative and Qualitative

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Disclosures About Market Risk on page 73 for additional discussion and analysis regarding our sensitivity to interest rate changes and the use of derivatives to manage our exposure to interest-rate risk.

Our business and results of operations are affected significantly by the fiscal and monetary policies of the U.S. government and its agencies, including the Federal Reserve Board's policies, which are difficult to predict.  Therefore, our ability to anticipate changes regarding the direction and speed of interest rate changes, or to hedge the related exposures, significantly affects the success of our asset and liability management activities and our level of net interest income. We use a number of measures in our efforts to monitor and manage interest rate risk, including income simulations and duration, market value, and convexity sensitivity analyses. Given the unpredictability of the financial markets, capturing all potential outcomes in these analyses is difficult. Key assumptions include, but are 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. These assumptions are inherently uncertain and they cannot precisely estimate net interest income and the market value of equity. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes and changes in market conditions and management strategies, among other factors. Volatility and disruption in the credit markets may have resulted in a higher level of volatility in our interest-rate risk profile and could negatively affect our ability to management interest-rate risk effectively.

We depend on the FHLBs' ability to access the capital markets in order to fund our business.

Our primary source of funds is the sale of FHLB consolidated obligations in the capital markets, including the short-term capital markets due to our increased reliance on discount note funding. Our ability to obtain funds through the sale of consolidated obligations depends in part on prevailing market conditions, such as investor demand and liquidity in the financial markets, which are beyond the control of the FHLBs. The severe financial and economic disruptions during the most recent financial crisis, and the U.S. government’s dramatic measures enacted to mitigate the effects, affected the FHLBs’ funding costs and practices. Our ability to operate our business, meet our obligations, and generate net interest income depends primarily on the ability of the FHLB System to issue debt frequently to meet member demand and to refinance our existing outstanding consolidated obligations at attractive rates, maturities, and call features, when needed. A significant portion of our advances are issued at interest rates that reset periodically at a fixed spread to an FHLB discount note rate-based index, so member demand for such advances may decrease to the extent that the FHLB System is unable to continue to issue debt at attractive rates.

The sale of FHLB consolidated obligations can also be influenced by factors other than conditions in the capital markets, including legislative and regulatory developments and government programs and policies that affect the relative attractiveness of FHLB consolidated obligations. For example, regulations related to capital and liquidity have impacted how debt dealers are managing their balance sheets. In addition, recent money market reform resulted in a significant increase in demand for government funds, agency debt, and FHLBs’ short-term consolidated obligations. While this increased demand benefited the FHLBs’ ability to raise short-term liquidity at attractive costs, such demand may be short-term in nature as money market investor risk and return preferences and money market regulatory requirements could change over time. To the extent that such regulatory changes or other developments impact dealer demand or capacity for FHLB debt, our funding costs and/or access to the capital markets may be adversely affected.

Additionally, we have a significant amount of discount notes outstanding with maturities of one year or less. We are exposed to liquidity risk if there is any significant disruption in the short-term debt markets. If a disruption were prolonged, we may not be able to obtain funding on acceptable terms. Any significant disruption that would prevent us from re-issuing discount notes for an extended period of time as they mature may require us to recognize into income up to $139 million of currently open (as of December 31, 2017) deferred hedge costs out of accumulated other comprehensive income. Without access to the short-term debt markets, the alternative longer-term funding, if available, would increase funding costs and could cause us to increase advance rates, potentially adversely affecting demand for advances. If we cannot access funding when needed on acceptable terms, our ability to support and continue operations could be adversely affected. As a result, our inability to manage our liquidity position or our contingency liquidity plan to meet our obligations, as well as the credit and liquidity needs of our members, could adversely affect our financial condition and results of operations, and the value of FHLB membership.

Our funding costs and/or access to the capital markets and demand for certain of our products could be adversely impacted by any changes in the credit ratings for FHLB System consolidated obligations or our individual credit ratings.

FHLB System 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 change a rating or outlook or issue negative reports. Because all of the FHLBs have joint and several liability for all FHLB consolidated obligations, negative developments at any FHLB may affect these credit ratings or result in the issuance of a negative report regardless of the financial condition and results of operations of the other FHLBs. In addition, because of the FHLBs' GSE status, the credit ratings of the FHLB System, the FHLBs, and consolidated obligations are directly influenced by the long-term sovereign credit rating of the U.S. government.  For example, downgrades to

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the U.S. sovereign credit rating or outlook may occur if the U.S. government fails to adequately address, based on the credit rating agencies' criteria, its fiscal budget process or statutory debt limit. As a result, if the U.S. sovereign credit ratings or outlooks are downgraded, similar downgrades in the credit ratings or outlook of the FHLBs and FHLB System consolidated obligations would mostly likely occur even though they are not obligations of, nor guaranteed by, the United States.

Future downgrades in credit ratings or outlook may result in higher FHLB funding costs and/or disruptions in access to the capital markets and our ability to maintain adequate liquidity. Any reduction in our individual Bank ratings may also trigger additional collateral posting requirements under certain of our derivative instruments. Further, member demand for certain of our products, such as letters of credit, is influenced by our credit rating and a downgrade of our credit rating could weaken member demand for such products.

Additionally, we are highly dependent on using derivative instruments to obtain low-cost funding and to manage interest rate risk. Negative credit rating events might also have an adverse affect on our ability to enter into derivative instruments with acceptable terms, increasing the cost of funding or limiting our ability to manage interest rate risk effectively.

To the extent that we cannot access funding when needed or enter into derivatives on acceptable terms to effectively manage our cost of funds and exposure to interest rate risk or demand for our products falls, our financial condition, and results of operations could be adversely impacted.

We are subject to various risks on our FFELP ABS investments.

Our FFELP ABS investments are securitizations of student loans that are guaranteed by guarantee agencies whose guaranties are reinsured by the U.S. Department of Education, or re-securitizations of such FFELP ABS. As of December 31, 2017, we held $4.2 billion of FFELP ABS investments.

We are subject to basis risk on these FFELP ABS because the Department of Education is responsible for making interest subsidy payments at a rate that is different from the 3-month LIBOR rate plus a spread on our FFELP ABS investments. Beginning in 2012, the Department of Education permitted holders of FFELP loans to permanently change this interest subsidy payment index rate from the previous 3-month commercial paper rate to a 1-month LIBOR rate plus a spread. All FFELP ABS that the Bank holds now reflect an interest subsidy payment rate of 1-month LIBOR plus a spread. Although the change in interest subsidy payments from a 3-month commercial paper rate to a 1-month LIBOR rate reduces the volatility in basis risk now that both the ABS and interest subsidy rates are indexed to LIBOR, we remain subject to basis risk to the extent that these different LIBOR tenors do not move together in the future.

Because the loans backing our FFELP ABS investments are supported by the U.S. Department of Education, the ratings of FFELP ABS are generally constrained by the sovereign credit rating of the U.S. government.  In addition, ratings may be impacted by changes in rating agency criteria. For example, rating agencies re-evaluated their methodology around the receipt of final payment on student loans in response to borrower assistance plans which have resulted in slower repayment, in some cases beyond the debt’s original maturity date. To the extent that there are future downgrades to the U.S. sovereign credit rating or other rating agency actions which impact the ratings of our FFELP ABS, it may negatively impact the value of our investments.

We are also subject to servicing risk on these FFELP ABS because a guarantee agency may refuse to honor its guarantee if the servicer does not satisfy specific origination and servicing procedures, as prescribed by various U.S. federal and guarantor regulations. If default rates increase on the student loans backing our FFELP ABS, the yield and value on our securities may be negatively impacted to the extent guarantees are not honored by the guarantee agencies.

Changes to, and replacement of, the LIBOR benchmark interest rate could adversely affect our business, financial condition and results of operations.

In July 2017, the United Kingdom’s Financial Conduct Authority (FCA), a regulator of financial services firms and financial markets in the U.K., stated that they will plan for a phase out of regulatory oversight of LIBOR interest rate indices. The FCA has indicated they will support the LIBOR indices through 2021 to allow for an orderly transition to an alternative reference rate. Other financial services regulators and industry groups, including the International Swaps and Derivatives Association (ISDA), are evaluating the possible phase-out of LIBOR and the development of alternate interest rate indices or reference rates.  A mechanism does not yet exist to convert the credit and tenor features of LIBOR into any proposed replacement rate, nor has a market been established which could facilitate such conversion. There is no guarantee that, if such a market were created and functioning at the time of the transition, the transition will be successful. The infrastructure necessary to manage hedging in an alternative reference rate does not yet exist, and any transition from one reference rate to another could also have accounting effects. For example, such a transition could have an effect on our hedge effectiveness, which could affect our results of operations.  Additionally, our risk management measuring, monitoring and valuation tools factor in LIBOR as a reference rate.  Disruptions in the market for LIBOR, and its regulatory framework, could have unanticipated effects on our risk management

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activities as well. As noted throughout this Form 10-K, many of the Bank’s assets and liabilities are indexed to LIBOR. We are not able to predict whether or when LIBOR publication will be discontinued, whether the proposed alternative or replacement rates will become market standards, or what impact such a transition may be on our business, financial condition, and results of operations.

Credit Risks

Our financial condition and results of operations, and the value of Bank membership, could be adversely affected by our exposure to credit risk.

We are exposed to credit risk principally through advances or commitments to our members, MPF Loans and related exposures, derivatives counterparties, unsecured counterparties, and issuers of investment securities or the collateral underlying them. We assume secured and unsecured credit risk exposure associated with the risk that a borrower or counterparty could default, and we could suffer a loss if we are unable to fully recover amounts owed on a timely basis. In addition, we have exposure to credit risk because fair value of collateral may decline as a result of deterioration in the creditworthiness of the obligor or the credit quality of a security instrument, or because the value of the collateral may not be what we assigned to it (whether as a result of misrepresentation or inaccurate valuation). We have a high concentration of credit risk exposure to financial institutions and mortgage assets. If we have insufficient collateral before or after an event of default, or we are unable to liquidate the collateral for the value assigned to it in the event of default, we could experience a credit loss, which could adversely affect our financial condition and results of operations.

We follow guidelines established by our Board of Directors and the FHFA on unsecured extensions of credit, whether on- or off-balance sheet, which limit the amounts and terms of unsecured credit exposure to highly rated counterparties, the U.S. government, other FHLBs, and partners of our Community First Fund. However, there can be no assurance that these activities will prevent losses due to defaults on these assets.

Advances. Despite an improved U.S. economy and housing markets in 2017, some financial institutions, including some of our members, remain under financial stress exposing us to greater risk that one or more of our members may default on their outstanding obligations to us, including the repayment of advances.

To protect against credit risk for advances, we require advances to be collateralized and have policies and procedures in place to reasonably estimate the value of the collateral. In order to remain fully collateralized, we may require a member to pledge additional collateral, when deemed necessary. This requirement may adversely affect those members that lack additional assets to pledge as collateral. If members are unable to secure their obligations, our advance levels could decrease.

If a member defaults on its obligations, or the FDIC, or any other applicable receiver, fails either to promptly repay all of that failed institution's obligations or to assume the outstanding advances, then we may be required to liquidate the collateral pledged by the failed institution. The volatility of market prices and interest rates could affect the value of the collateral we hold as security for the obligations of our members. The proceeds realized from the liquidation of pledged collateral may not be sufficient to fully satisfy the amount of the failed institution's obligations or the operational cost of liquidating the collateral. Default by a member with significant outstanding obligations to us could adversely affect our results of operations and financial condition.

As we continue to work toward building a stronger cooperative and increasing advances by adding new members, we are actively focusing on institutions that have not traditionally been a large part of our membership, such as insurance companies, community development financial institutions, and housing associates. As we increase our membership to include more non-federally insured members and increase credit outstanding to such members, we face uncertainties surrounding the possible resolution of those members, in part due to our lack of experience in dealing with their regulators and any receivers and other liquidators that may be involved in the resolution of these members.

Also, as we update our collateral loan eligibility criteria to accept more complex loan structures and additional commercial loan property types, we face risks relating to valuing and liquidating collateral with these characteristics. Although we will closely monitor our credit and collateral agreement processes, we may experience credit losses and our business may be adversely affected if we are unable to sufficiently collateralize our risk exposures in the event of potential default by or resolution of these members.

Derivatives Counterparties. Our hedging strategies are highly dependent on our ability to enter into cleared and uncleared (over-the-counter) derivative instrument transactions with counterparties on acceptable terms to reduce interest-rate risk and funding costs.


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(Dollars in tables in millions except per share amounts unless otherwise indicated)


If a counterparty defaults on payments due to us, we may need to enter into a replacement derivative contract with a different counterparty, which may be at a higher cost, or we may be unable to obtain a replacement contract. We may also be exposed to collateral losses to the extent that we have pledged collateral and its value changes.

The insolvency of one of our largest derivatives counterparties combined with an adverse change in the market before we are able to transfer or replace the contracts could adversely affect our financial condition and results of operations. Further, to the extent that we have pledged collateral under the requirements of the derivative contract and the fair market value of the collateral increases above the value of the derivatives contract, we may experience delays in having our collateral returned or could experience losses if the counterparty fails to return the collateral.

If we experience further disruptions in the credit markets, it may increase the likelihood that one of our derivatives counterparties fails to meet their obligations to us. See Note 9 - Derivative and Hedging Activities to the financial statements for a description of derivatives credit exposure.

Rating agencies may from time to time change our rating or issue negative reports, which may adversely affect our ability to enter into derivative transactions with acceptable counterparties on satisfactory terms in the quantities necessary to manage our interest-rate risk and funding costs. A reduction in our credit rating or of the FHLB System credit rating may also trigger additional collateral requirements under our derivative contracts. This could negatively affect our financial condition and results of operations and the value of FHLB membership.

Federal Funds. We invest in Federal Funds sold in order to ensure the availability of funds to meet members' credit and liquidity needs. Because these investments are unsecured, our credit policies and FHFA regulations restrict these investments to short-term maturities and certain eligible counterparties. If the credit markets experience disruptions, it may increase the likelihood that one of our Federal Funds counterparties could experience liquidity or financial constraints that may cause them to become insolvent or otherwise default on their obligations to us. For further discussion on our Federal Funds investments, see Unsecured Short Term Investments on page 70.

Securities Purchased Under Agreements to Resell. We also invest in securities purchased under agreements to resell in order to ensure the availability of funds to meet members' liquidity and credit needs.  These investments are secured by marketable securities held by a third-party custodian.  If the credit markets experience disruptions, it may increase the likelihood that one of our counterparties could experience liquidity or financial constraints that may cause them to become insolvent or otherwise default on their obligations to us.  If the collateral pledged to secure those obligations has decreased in value, we may suffer a loss.  See the table in Investment Securities by Rating on page 67 for a summary of counterparty credit ratings for these investments.

Our MPF Program products have different risks than those related to our traditional advances products, which could adversely impact our results of operations.

The MPF Program, as compared to our advances products, is more susceptible to credit losses. As the U.S. housing market continued to improve during 2017, our allowance for credit losses on our MPF Loan portfolio continued to decline consistent with the general positive trends in the housing markets and smaller portfolio of MPF Loans held on our balance sheet. However, to the extent that economic conditions weaken and regional or national home prices decline, we could experience higher delinquency levels and loss severities on our MPF Loan portfolio in the future.

We are exposed to losses on our conventional MPF Loans held in our portfolio through our obligation to absorb losses up to the FLA and to the extent those losses are not recoverable from PFIs from withholding performance based CE Fees (Recoverable CE Fees). Our FLA exposure as of December 31, 2017 is $122 million. The next layer of losses after the FLA is allocated to the PFI, or SMI, as applicable, through the CE Amount. If losses accelerate in the overall mortgage market, we may experience increased losses that are allocated to us through the FLA or that may otherwise exceed the PFI's CE Amount and Recoverable CE Fees. Further, the PFIs may experience credit deterioration and default on their credit enhancement obligations, which, to the extent not offset against collateral provided by the PFIs, could cause us to incur additional losses and have an adverse effect on our results of operations.

Under the MPF Government product, we absorb any associated credit losses if we are unable to recover from the servicer or the insuring or guarantying government agency. We have the same risk with respect to the MPF Government MBS loans we acquired from our members unless the servicing was sold under our servicing released option in which the new servicer assumes our Ginnie Mae issuer responsibilities.

We are exposed to mortgage repurchase liability in connection with our sale of MPF Loans to Fannie Mae under the MPF Xtra product, to third-party investors under the MPF Direct Product, and to Ginnie Mae for MPF Loans securitized in Ginnie Mae MBS. If a loan eligibility requirement or other warranty is breached, these third parties could require us to repurchase the MPF

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Loan or provide an indemnity. If the PFI from which we purchased an ineligible MPF Loan is viable, we can require the PFI to repurchase that MPF Loan from us or indemnify us for related losses. Under the MPF Direct product, if a PFI is insolvent, our repurchase liability is limited to a PFI’s failure to deliver the required loan documentation and excludes repurchases for breaches of loan level representations and warranties. In addition, if we purchase the ineligible MPF Loan from a PFI of another MPF Bank, the MPF Bank will indemnify us for any losses we may incur. As of December 31, 2017, we had $37 million of repurchase requests and indemnifications outstanding to PFIs related to MPF Xtra loans and no outstanding repurchase requests or indemnifications for our MPF Direct and MPF Government MBS products. Because repurchase requests from third-party investors may be made up until full repayment of a loan rather than when a purported defect is first identified, repurchase requests received as of a particular date may not reflect total repurchase liability for loans outstanding as of that date. In certain circumstances, third-party investors may not make a repurchase or indemnification request until a loan becomes past due or defaults. PFIs are also required to repurchase ineligible MPF Loans we hold in our portfolio, as further discussed in Mortgage Repurchase Risk on page 65.
Some of our PFIs from whom we may request repurchase or seek indemnification may be highly leveraged and may be adversely affected by economic and housing market conditions and disruptions in the financial and credit markets, which may impact their ability to fulfill their indemnification or repurchase obligations to us. Although we require members to pledge collateral to secure all outstanding credit obligations, only in certain cases do we require PFIs to collateralize repurchase obligations and indemnifications given their credit condition and size of their repurchase obligation or indemnification. In the event that a PFI becomes insolvent or otherwise defaults on its repurchase or indemnification obligation to us and we cannot offset the credit loss amount against collateral provided by the PFI or, alternatively, the FDIC, we could experience losses on MPF Loans.
We also have geographic concentrations of MPF Loans secured by properties in certain states. To the extent that any of these geographic areas experience significant declines in the local housing markets, declining economic conditions, or a natural or man-made disaster, we could experience increased losses. For further information on these concentrations, see Geographic Concentration on page 64.

For a description of the MPF Program, our obligations with respect to credit losses and the PFI's obligation to provide credit enhancement and comply with anti-predatory lending laws, see Mortgage Partnership Finance Program on page 8.

In certain circumstances, we may rely on other FHLBs to manage credit risk related to our former members and credit enhancement and servicing obligations of PFIs located outside of our district, and if those FHLBs failed to appropriately manage this credit risk or enforce a former member’s or PFI’s obligations, we could experience losses.

In certain circumstances, for example when a member leaves the Bank due to a merger and the acquiring entity is a member of another FHLB, the other FHLB may hold and manage the former member's collateral covering advances and any other amounts still outstanding to us. The other FHLB may subordinate to us collateral it receives from the member by entering into an inter-creditor agreement in an amount sufficient to cover our exposure. If the other FHLB were to inappropriately manage the collateral, we could incur losses in the event that the former member defaults. We may, however, have recourse against the other FHLB depending upon the circumstances surrounding our loss.

We hold a significant portfolio of participation interests in mortgage loans acquired under the MPF Program from other FHLBs. PFIs located in other FHLB districts provide servicing and credit enhancement for these MPF Loans and we rely on the FHLB from the district in which the PFI is located to manage the related credit risk and enforce the PFI's obligations. If there were losses arising from these MPF Loans and the other FHLB were to fail to manage the risk of PFI default or enforce the PFI's obligations, we could incur losses in the event of a PFI default.

We are jointly and severally liable for the consolidated obligations of other FHLBs.

Under the FHLB Act, we are jointly and severally liable with other FHLBs for consolidated obligations issued through the Office of Finance. If another FHLB defaults on its obligation to pay principal or interest on any consolidated obligation, the FHFA has the ability to allocate the outstanding liability among one or more of the remaining FHLBs on a pro rata basis or on any other basis that the FHFA may determine. The likelihood of triggering our joint and several liability obligation depends on many factors, including the financial condition and financial performance of other the other FHLBs. For example, to the extent one or more FHLBs had significant unsecured credit exposures outstanding at the time of counterparty failure, the affected FHLBs may fail to meet their obligations to pay principal or interest on consolidated obligations. If we were required by the FHFA to make payment on consolidated obligations beyond our primary obligation, our financial condition, and results of operations could be negatively affected.


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(Dollars in tables in millions except per share amounts unless otherwise indicated)


The occurrence of a major natural or other disaster, especially one affecting our district, could negatively impact our business and results of operations.

The occurrence of a major natural or environmental disaster, terrorist attack, pandemic, or similar event (a “major disruptive event”), especially one affecting our district, could negatively impact our business and results of operations. A major disruptive event that either damages or destroys real estate securing mortgage loans or negatively impacts the ability of borrowers to continue to make principal and interest payments on mortgage loans could increase delinquency rates and default rates, and negatively impact our collateral, MPF Loan portfolio, MBS investments, community investment programs, or cause our members become delinquent or to default on their advances and other credit obligations to us. For example, during the third quarter of 2017, three significant hurricanes impacted the southeastern coasts of the United States and Puerto Rico. While we do not expect that the potential losses resulting from these hurricanes will have a material effect on our financial condition or results of operations in future periods, there can be no assurance that another major disruptive event, depending on its geographic impact, magnitude, scope and nature, will not generate significant losses to our business.

Additionally, a decline in the local economies in which our members operate resulting from a disruptive event could reduce members’ needs for funding, which could reduce demand for our advances. We could be adversely impacted by the reduction in business volume that would arise from a decline in member funding needs.

Operational Risks

Our information systems may experience an interruption or breach in security.

Our operations rely on the secure processing, storage, and transmission of a large volume of personally identifiable information of mortgage loan borrowers, such as names, residential addresses, social security numbers, credit rating data, and other consumer financial information. We rely heavily on communications, information systems and internet to conduct our business. The continued occurrence of high-profile data breaches at other institutions provides evidence of an external environment with increasing attack vectors and sophisticated methods of personal data infiltration. Other companies have also reported breaches and other attacks, some severe, which have involved targeted attacks intended to disable or degrade service, or sabotage systems. This environment demands that we engage in ongoing monitoring of the effectiveness of our security controls, and implement changes as needed to mitigate security vulnerabilities. Despite these efforts, it is possible our security controls over personal data, our training of employees and vendors on data security, and other practices we follow may not prevent the improper disclosure of personally identifiable information that we or our vendors store and manage. We are also subject to the risk that our employees may intercept and transmit unauthorized confidential or proprietary information. Improper disclosure of this information could harm our reputation, lead to legal exposure to borrowers, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Additionally, cyberattacks, whether through computer hacking, vandalism, malware, phishing, or computer viruses may lead to shutdowns or disruptions in our systems. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate or timely preventative measures. Our cyber risk and other insurance might not be sufficient to cover us against claims related to security incidents, breaches, cyberattacks and other related events. Attempting to protect our information technology networks and systems may cause us to incur increasing costs, including costs to deploy additional personnel and protection technologies, to train employees, and to engage third party security experts and consultants.

We rely on quantitative models to manage risk, to make business decisions, and to value our assets and liabilities. Our business could be adversely affected if those models fail to produce reliable results.

We make significant use of both internal and external business and financial models to measure and monitor our risk exposures; including interest rate, prepayment, and other market risks, as well as credit risk. We also use models in determining the fair value of financial instruments when independent price quotations are not available or reliable. The information provided by these models is also used in making business decisions relating to strategies, initiatives, risk management, transactions, and products, and for financial reporting. Models are inherently imperfect predictors of actual results because they are based on available data and assumptions about factors such as future loan demand, prepayment speeds, default rates, severity rates, and other factors that may overstate or understate future experience. When market conditions change rapidly and dramatically, the assumptions used for our models may not keep pace with changing conditions. Inaccurate data or assumptions in these models are likely to produce unreliable results. For example, uncertainty in the housing and mortgage markets may increase our exposure to the inherent risks associated with the reliance on internal models that use key assumptions to project future trends and performance. Although we regularly adjust our internal models in response to changes in economic conditions and the housing market and rely on our vendors to adjust our external models, the risk remains that our models could produce unreliable results or estimates that vary considerably from actual results.


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(Dollars in tables in millions except per share amounts unless otherwise indicated)


If these models fail to produce reliable results, we may not make appropriate risk management or business decisions, which could adversely affect our earnings, liquidity, capital position, and financial condition. Any strategies that we employ to attempt to manage the risks associated with the use of models may not be effective.

Failures or interruptions in our information systems and other technology, our controls, or our operating processes generally, may harm our business, financial condition, results of operations, and reputation.

Our business is dependent upon our ability to interface effectively with other FHLBs, members, PFIs, and other third parties. Our products and services involve a complex and sophisticated operating environment supported by operating systems and technologies, which may be purchased, custom-developed, or out-sourced. Maintaining the effectiveness and efficiency of the technology used in our operations, including our information systems, is dependent on the continued timely implementation of technology solutions (including security patches) and systems necessary to effectively manage the Bank and mitigate risk, which may require significant capital expenditures. If we are unable to maintain or improve these technological capabilities, including retention of key technology personnel and the development of necessary operating and management processes, we may not be able to remain competitive and our business, financial condition, and results of operations may be significantly compromised. To date, we have not experienced any material effect or losses related to significant interruptions in our information systems, cyber attacks or other breaches.

Additionally, failures in our controls, including internal controls over financial reporting, could result from human error, fraud, design flaws, breakdowns in information and computer systems, or natural or man-made disasters. Moreover, lapses in, and inadequacies with respect to, our operating processes, including manual processes and data management, could affect our overall operations, including collateral maintenance. If significant control failure were to occur, or if a significant lapse in any operating process were to occur, it could materially impact our financial condition and results of operations. We may not be able to foresee, prevent, mitigate, reverse, or repair the negative effects of such failures. If we are unable to correct material weaknesses or deficiencies in internal controls in a timely manner, our ability to record, process, summarize and report financial information accurately and within the time periods specified in the rules and forms of the SEC could be adversely affected. A failure in our internal control over financial reporting or a lapse in our operating processes could cause our members to lose confidence in our reported financial information, in our processes, or in us as a whole, subject us to government enforcement actions, and generally, materially, and adversely impact our business and financial condition.

We purchase a significant portion of our data center services, including disaster recovery capabilities, from third-party vendors, and if our vendors fail to adequately perform the contracted services in the manner necessary to meet our needs, our business, financial condition, and results of operations may be harmed. Additionally any failure in the operating systems of the Office of Finance could disrupt our ability to conduct and manage our business.

We have engaged various vendors to provide us with data center outsourcing services that include hardware, software support, and technology services. Any failure, interruption, or breach in security of these systems, or any disruption of service, could result in disruptions in our ability to conduct business. There is no assurance that if or when such failures do occur, that they will be adequately addressed by us or the third party vendors on whom we rely. The occurrence of any failures or interruptions could have a material adverse effect on our business, financial condition, and results of operations.

Additionally, we rely on the Office of Finance to facilitate the issuance and servicing of our consolidated obligations. A failure or interruption of the Office of Finance's operating systems as a result of breaches, cyberattacks, or technological risks could disrupt our access to funds, and may harm our business. Moreover, any operational failure of the Office of Finance could also expose us to the risk of loss of data or confidential information, or other harm, including reputational damage.

The performance of our MPF Loan portfolio depends in part upon third-party servicers and defaults by one or more of these third parties on its obligations to us could adversely affect our results of operations or financial condition.

Mortgage Servicing. We rely on PFIs and third-party servicers to perform mortgage loan servicing activities for our MPF Loans held in portfolio. With respect to the MPF Xtra and MPF Government MBS products, we are contractually obligated to Fannie Mae and Ginnie Mae, respectively, with respect to servicing of the related MPF Loans under certain servicing options.

Servicing activities include collecting payments from borrowers, paying taxes and insurance on the properties secured by the MPF Loans, advancing principal and interest under scheduled remittance options, maintaining applicable government agency insurance or guaranty, reporting loan delinquencies, loss mitigation, and disposition of real estate acquired through foreclosure or deed-in-lieu of foreclosure. If current housing market trends negatively decline, the number of delinquent mortgage loans serviced by PFIs and third party servicers could increase. Managing a substantially higher volume of non-performing loans could create operational difficulties for our servicers. In the event that any of these entities fails to perform its servicing duties, we could experience a temporary interruption in collecting principal and interest or even credit losses on MPF Loans or incur additional costs associated with obtaining a replacement servicer if the servicer fails to indemnify us for its breaches. Similarly, if

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(Dollars in tables in millions except per share amounts unless otherwise indicated)


any of our servicers become ineligible to continue to perform servicing activities under MPF Program guidelines, we could incur additional costs to obtain a replacement servicer. If a PFI servicer fails to perform its servicing responsibilities, we can potentially recover losses we incur from the collateral pledged to us under our Advances, Collateral Pledge and Security Agreement with the PFI; however, the amount of collateral pledged thereunder is not sized to cover a specific amount related to servicing obligations. If a third-party servicer is not one of our members, we would not have this additional remedy.

We offer servicing released alternatives for all of our MPF Loan products but currently we only have one servicing aggregator for particular products. If a servicing aggregator that is established as an approved servicer for the MPF Program exited the business or was not offering attractive servicing released premiums, or if we should decide to terminate our relationship with the servicer, our MPF Loan volume could be negatively impacted until we could engage replacement servicers.

Master Servicing. We act as master servicer for the MPF Program. In this regard, we have engaged a vendor for master servicing, Wells Fargo Bank N.A., which monitors the servicers' compliance with the MPF Program requirements and issues periodic reports to us. While we manage MPF Program cash flows, if the vendor should refuse or be unable to provide the necessary service, or if we should decide to terminate our relationship with the vendor, we may be required to engage another vendor which could result in delays in reconciling MPF Loan payments to be made to us or increased.


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Item 1B.    Unresolved Staff Comments.

Not applicable.


Item 2.    Properties.

As of January 31, 2018, we occupy 95,105 square feet of leased office space at 200 East Randolph Drive, Chicago, Illinois 60601.  We also maintain 5,518 square feet of leased space for an off-site back-up facility 15 miles northwest of our main facility, which is on a separate electrical distribution grid.


Item 3. Legal Proceedings.

On October 15, 2010, the Bank instituted litigation relating to 64 private label MBS bonds purchased by the Bank in an aggregate original principal amount of $4.29 billion. Of the three cases that were filed by the Bank, only the action filed in the Circuit Court of Cook County, Illinois remains active. As of December 31, 2017, the remaining litigation covers three private-label MBS bonds in the aggregate outstanding principal amount of $38 million. As of February 28, 2018, Morgan Stanley & Co., Incorporated, and certain of its affiliates, remain as the sole defendants in the Illinois action.

In this action, the Bank asserts claims for untrue or misleading statements in the sale of securities, signing or circulating securities documents that contained material misrepresentations, and negligent misrepresentation. The Bank seeks the remedies of rescission, recovery of damages, and recovery of reasonable attorneys' fees and costs of suit.

The Bank may also be subject to various other legal proceedings arising in the normal course of business. After consultation with legal counsel, management is not aware of any other proceedings that might have a material effect on the Bank's financial condition or results of operations.



Item 4. Mine Safety Disclosures.
Not applicable.


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(Dollars in tables in millions except per share amounts unless otherwise indicated)


PART II

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

Our members, and under limited circumstances former members, own our capital stock. Former members may continue to hold our capital stock when they have withdrawn from membership or have merged with out-of-district institutions. Our members elect our directors. We conduct our business almost exclusively with our members. Our stock can only be acquired and redeemed or repurchased at a par value of $100 per share. Our stock is not publicly traded and no market mechanism exists for the exchange of stock outside our cooperative structure.

We issue only one class of capital stock, Class B stock, consisting of two sub-classes of stock, Class B1 stock and Class B2 stock which, under our Capital Plan has a par value of $100 per share. As of January 31, 2018, we had 19,936,024 shares of capital stock outstanding, including mandatorily redeemable capital stock recorded as a liability, and we had 744 stockholders of record. For details on our Capital Plan, on member withdrawals and other terminations, and related amounts classified as mandatorily redeemable capital stock, see Note 13 - Capital and Mandatorily Redeemable Capital Stock (MRCS) to the financial statements.

Information regarding our cash dividends declared in each quarter in 2016 and 2017, and information regarding regulatory requirements and restrictions on dividends, is set forth in the Retained Earnings & Dividends section on page 57.

The following table presents, by type of institution, the outstanding capital stock holdings of our members and former members. Our capital stock may be redeemed upon five years' notice from the member to the Bank, subject to applicable conditions. For a description of our policies and related restrictions regarding capital stock redemptions and repurchases, see Capital Resources on page 53.

As of
 
December 31, 2017
 
December 31, 2016
Commercial banks
  
$
967

  
$
1,148

Savings institutions
  
174

  
270

Credit unions
  
149

  
164

Insurance companies
  
152

  
128

Community Development Financial Institutions
  
1

  
1

Total GAAP capital stock
  
1,443

  
1,711

Stock reclassified as mandatorily redeemable capital stock (liability)
 
311

 
301

Total regulatory capital stock outstanding
 
$
1,754

 
$
2,012



We repurchased capital stock from members totaling $3.1 billion during 2017 and $1.2 billion in 2016, with the 2017 increase driven, in part, by our automatic weekly repurchases.

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Item 6.    Selected Financial Data.

Computation of Ratio of Earnings to Fixed Charges


For the years ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
Net income (loss)
 
$
317

 
$
327

 
$
349

 
$
392

 
$
343

Total assessments
 
36

 
37

 
39

 
44

 
33

Interest expense
 
1,075

 
803

 
744

 
841

 
1,061

Earnings, as adjusted
 
$
1,428

 
$
1,167

 
$
1,132

 
$
1,277

 
$
1,437

 
 
 
 
 
 
 
 
 
 
 
Fixed charges:
 
 
 
 
 
 
 
 
 
 
Interest expense
 
1,075

 
803

 
744

 
841

 
1,061

Total fixed charges
 
$
1,075

 
$
803

 
$
744

 
$
841

 
$
1,061

 
 
 
 
 
 
 
 
 
 
 
Ratio of earnings to fixed charges
 
1.33

 
1.45

 
1.52

 
1.52

 
1.35




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(Dollars in tables in millions except per share amounts unless otherwise indicated)


Selected Financial Data
As of or for the years ended December 31,
2017
 
2016
 
2015
 
2014
 
2013
 
Selected statements of condition data
 
 
 
 
 
 
 
 
 
 
Investments a
$
30,683

 
$
28,060

 
$
28,324

 
$
32,745

 
$
36,402

 
Advances
48,085

 
45,067

 
36,778

 
32,485

 
23,489

 
MPF Loans held in portfolio, net
5,193

 
4,967


4,828


6,057


7,695

 
Total assets
84,355

 
78,692

 
70,671

 
71,841

 
68,797

 
Consolidated obligation discount notes, net
41,191

 
35,949

 
41,564

 
31,054

 
31,089

 
Consolidated obligation bonds, net
37,121

 
36,903

 
22,582

 
34,251

 
31,987

 
Mandatorily redeemable capital stock (MRCS) recorded as a liability
311

 
301

 
8

 
9

 
5

 
Capital stock
1,443

 
1,711

 
1,950

 
1,902

 
1,670

 
Retained earnings
3,297

 
3,020

 
2,730

 
2,406

 
2,028

 
Total capital
$
4,852

 
$
4,695

 
$
4,652

 
$
4,526

 
$
3,765

 
Other selected data at period end
 
 
 
 
 
 
 
 
 
 
Member standby letters of credit outstanding
$
19,572

 
$
10,828

 
$
6,678

 
$
3,617

 
$
2,103

 
MPF Loans par value outstanding - FHLB System b
51,563

 
46,293

 
43,445

 
43,707

 
44,812

 
MPF Loans par value outstanding - FHLB Chicago PFIs b
12,484

 
11,624

 
10,577

 
10,767

 
11,169

 
FHLB systemwide consolidated obligations par value outstanding
$
1,034,260

 
$
989,311

 
$
905,202

 
$
847,175

 
$
766,837

 
Number of members
720

 
728

 
740

 
751

 
759

 
Total employees (full and part time)
460

 
440

 
422

 
405

 
355

 
Selected statements of income data
 
 
 
 
 
 
 
 
 
 
Net interest income after provision for (reversal of) credit losses
$
483

 
$
455

 
$
503

 
$
528

 
$
452

 
Noninterest income
44

 
76

c 
23

 
32

 
(1
)
 
Noninterest expense
174

 
167

 
138

 
124

 
75

d 
Net income
$
317

 
$
327

 
$
349

 
$
392

 
$
343

 
Other selected data during the periods ended
 
 
 
 
 
 
 
 
 
 
MPF Loans par value amounts funded - FHLB System b
$
11,915

 
$
10,872

 
$
7,225

 
$
5,387

 
$
8,995

 
Number of PFIs funding MPF products - FHLB System b
909

 
873

 
843

 
819

 
832

 
MPF Loans par value amounts funded - FHLB Chicago PFIs b
$
2,521

 
$
3,145

 
$
1,784

 
$
1,191

 
$
2,409

 
Number of PFIs funding MPF products - FHLB Chicago b
204

 
191

 
188

 
190

 
190

 
Selected ratios (rated annualized)
 
 
 
 
 
 
 
 
 
 
Total regulatory capital to assets ratio
5.99
%
 
6.40
%
 
6.63
%
 
6.01
%
 
5.38
%
 
Market value of equity to book value of equity
107
%
 
108
%
 
108
%
 
114
%
 
116
%
 
Core mission asset ratio e
67.3
%
 
66.2
%
 
58.8
%
 
n/a

 
n/a

 
Investments - % of total assets
36
%
 
36
%
 
40
%
 
46
%
 
53
%
 
Advances - % of total assets
57
%
 
57
%
 
52
%
 
45
%
 
34
%
 
MPF Loans held in portfolio, net - % of total assets
6
%
 
6
%
 
7
%
 
8
%
 
11
%
 
Dividend rate class B1 activity stock-period paid
3.19
%
 
2.75
%
 
2.31
%
 
1.58
%
 
0.55
%
 
Dividend rate class B2 membership stock-period paid
1.10
%
 
0.60
%
 
0.50
%
 
0.45
%
 
0.30
%
 
Return on average assets
0.38
%
 
0.42
%
 
0.49
%
 
0.55
%
 
0.53
%
 
Return on average equity
6.84
%
 
7.18
%
 
7.65
%
 
9.35
%
 
9.69
%
 
Average equity to average assets
5.58
%
 
5.87
%
 
6.35
%
 
5.83
%
 
5.48
%
 
Net yield on average interest earning assets
0.59
%
 
0.59
%
 
0.72
%
 
0.74
%
 
0.71
%
 
Return on average Regulatory Capital spread to 3-month LIBOR index
5.25
%
 
5.96
%
 
7.55
%
 
9.61
%
 
9.74
%
 
Cash dividends
$
40

 
$
37

 
$
25

 
$
14

 
$
6

 
Dividend payout ratio
12.62
%
 
11.31
%
 
7.16
%
 
3.57
%
 
1.75
%
 
a 
Include investment securities, interest bearing deposits, Federal Funds sold, and securities purchased under agreements to resell.
b 
Includes all MPF products, whether on or off our balance sheet. See Mortgage Partnership Finance Program beginning on page 8 for details on our various MPF products.
c 
Includes $38 million in litigation settlement awards. See Litigation Settlement Awards on page 44 for further details.
d 
In 2013 we reversed a $50 million charge (originally recorded as an expense in 2011) after we received approval from the FHFA and our Board of Directors to implement the Community First Fund as a revolving credit facility. See page 11 in Item 1. Business for more information.
e 
In 2015, the FHFA issued an advisory bulletin that provides guidance relating to a core mission asset ratio by which the FHFA will assess each FHLB's core mission achievement. See page 5 in Item 1. Business for more information.


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(Dollars in tables in millions except per share amounts unless otherwise indicated)


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Information

Statements contained in this report, including statements describing the objectives, projections, estimates, or future predictions of management, may be “forward-looking statements.” These statements may use forward-looking terminology, such as “anticipates,” “believes,” “expects,” “could,” “estimates,” “may,” “should,” “will,” their negatives, or other variations of these terms. We caution that, by their nature, forward-looking statements involve risks and uncertainties related to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. These risks and uncertainties could cause actual results to differ materially from those expressed or implied in these forward-looking statements and could affect the extent to which a particular objective, projection, estimate, or prediction is realized. As a result, undue reliance should not be placed on such statements.

These forward-looking statements involve risks and uncertainties including, but not limited to, the following:

changes in the demand by our members for advances, including the impact of the availability of other sources of funding for our members, such as deposits; 

limits on our investments in long-term assets;

the impact of new business strategies, including our ability to develop and implement business strategies focused on maintaining net interest income; the impact of our efforts to simplify our balance sheet on our market risk profile and future hedging costs; our ability to successfully transition to a new business model, implement business process improvements, and scale our size to our members' borrowing needs; the extent to which our members use our advances as part of their core financing rather than just as a back-up source of liquidity; and our ability to implement product enhancements and new products and generate enough volume in new products to cover our costs related to developing such products;

the extent to which amendments to our Capital Plan, including our ability to implement reduced membership stock and advances activity stock requirements and continue to offer the Reduced Capitalization Advance Program for certain future advance borrowings, and our ability to continue to pay enhanced dividends on our activity stock, impact borrowing by our members;

our ability to meet required conditions to repurchase and redeem capital stock from our members (including maintaining compliance with our minimum regulatory capital requirements and determining that our financial condition is sound enough to support such repurchases), and the amount and timing of such repurchases or redemptions;

general economic and market conditions, including the timing and volume of market activity, inflation/deflation, unemployment rates, housing prices, the condition of the mortgage and housing markets, increased delinquencies and/or loss rates on mortgages, prolonged or delayed foreclosure processes, and the effects on, among other things, mortgage-backed securities; volatility resulting from the effects of, and changes in, various monetary or fiscal policies and regulations, such as those determined by the Federal Reserve Board and Federal Deposit Insurance Corporation; impacts from various measures to stimulate the economy and help borrowers refinance home mortgages; disruptions in the credit and debt markets and the effect on future funding costs, sources, and availability;

volatility of market prices, rates, and indices, or other factors, such as natural disasters, that could affect the value of our investments or collateral; changes in the value or liquidity of collateral securing advances to our members;

changes in the value of and risks associated with our investments in mortgage loans, mortgage-backed securities, and FFELP ABS and the related credit enhancement protections;

changes in our ability or intent to hold mortgage-backed securities to maturity;

changes in mortgage interest rates and prepayment speeds on mortgage assets;

membership changes, including the withdrawal of members due to restrictions on our dividends or the loss of members through mergers and consolidations; changes in the financial health of our members, including the resolution of some members; risks related to expanding our membership to include more institutions with regulators and resolution processes with which we have less experience;

increased reliance on short term funding and changes in investor demand for consolidated obligations and/or the terms of interest rate derivatives and similar agreements, including changes in the relative attractiveness of consolidated obligations

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(Dollars in tables in millions except per share amounts unless otherwise indicated)


as compared to other investment opportunities; changes in our cost of funds due to concerns over U.S. fiscal policy, and any related rating agency actions impacting FHLB consolidated obligations;

political events, including legislative, regulatory, judicial, or other developments that affect us, our members, our counterparties and/or investors in consolidated obligations, including, among other things, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and related regulations and proposals and legislation related to housing finance and GSE reform; changes by our regulator or changes affecting our regulator and changes in the FHLB Act or applicable regulations as a result of the Housing and Economic Recovery Act of 2008 (Housing Act) or as may otherwise be issued by our regulator; the potential designation of us as a nonbank financial company for supervision by the Federal Reserve;

recent regulatory changes to FHLB membership requirements by the FHFA;

the ability of each of the other FHLBs to repay the principal and interest on consolidated obligations for which it is the primary obligor and with respect to which we have joint and several liability;

the pace of technological change and our ability to develop and support technology and information systems, including our ability to protect the security of our information systems and manage any failures, interruptions, or breaches in our information systems or technology services provided to us through third-party vendors;

our ability to attract and retain skilled employees;

the impact of new accounting standards and the application of accounting rules, including the impact of regulatory guidance on our application of such standards and rules;

the impact of the application of audit independence rules to our independent auditor;

the volatility of reported results due to changes in the fair value of certain assets and liabilities; and

our ability to identify, manage, mitigate, and/or remedy internal control weaknesses and other operational risks.

For a more detailed discussion of the risk factors applicable to us, see Risk Factors on page 16.

These forward-looking statements are representative only as of the date they are made, and we undertake no obligation to update any forward-looking statement as a result of new information, future events, changed circumstances, or any other reason.




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(Dollars in tables in millions except per share amounts unless otherwise indicated)


Executive Summary

2017 Financial Highlights

We recorded net income of $317 million in 2017 compared to $327 million in 2016.
Net interest income for 2017 was $483 million, which included $29 million of income from investment security prepayments during the period. For 2016, net interest income was $456 million, which included $47 million of income from investment security prepayments during the period. The increase in net interest income for 2017 was primarily the result of an increase in interest rates and growth in interest earning assets.
Noninterest income was $44 million in 2017 compared to $76 million for 2016 due to $2 million in litigation settlement awards relating to our MBS portfolio in 2017 compared to $38 million in 2016.
Noninterest expense was $174 million for 2017 compared to $167 million for 2016, driven mainly by an increase in compensation and benefits related expenses.
Assets were $84.4 billion at year-end 2017 compared to $78.7 billion at year-end 2016. Growth in liquid investments such as Federal Funds sold and securities purchased under agreements to resell, advances, and a small net increase in MPF Loans held in portfolio helped offset the declines in investment securities.
Advances outstanding were $48.1 billion in 2017, up 7% from the previous year-end level of $45.1 billion, reflective of member demand for competitive funding to support member investment and loan growth opportunities.
MPF Loans held in portfolio increased to $5.2 billion in 2017 compared to $5.0 billion for 2016 as new MPF loan purchases continued to moderately outpace pay down and maturity activity.
Total investment securities decreased 18% in 2017 to $17.3 billion, as our investment portfolio continued to pay down.
Retained Earnings were $3.3 billion at year-end 2017, up from $3.0 billion at the end of 2016, and we remained in compliance with all of our regulatory capital requirements.
Letter of Credit commitments increased to $19.6 billion in 2017, up from $10.8 billion at year-end 2016.

Summary and Outlook

Meeting Member Business Needs

We are committed to offering a suite of products that most appropriately support our members’ businesses. Our success in doing so during 2017 is best illustrated by the growth in our advances and letters of credit products and member participation in MPF Program.

Our practice of providing the benefits of our funding advantage to our members and in designing products to fit our members’ businesses contributed to the strong growth in advances. At year-end 2017, advances stood at $48.1 billion, up 7% from year-end 2016. Letters of credit also experienced significant growth as more members took advantage of those products, particularly the public unit deposit letters of credit. At year-end 2017, 199 members had letters of credit outstanding of $19.6 billion, up 81% from year-end 2016.
 
In 2017, the number of members that sold their single family mortgages into the MPF Program also rose. We served an increased number of PFIs, many of which are selling into the MPF conventional products. At year-end 2017, MPF Loans outstanding on our balance sheet were $5.2 billion, up 5% from year-end 2016. The Bank also supports other FHLBs and their members and growth also occurred on a total MPF Program level. The number of PFIs participating in the MPF Program grew by 4% and loans outstanding increased by 11% from year-end 2016. The MPF Program celebrated 20 years of providing liquidity to FHLB members during 2017.

Finally, our Board of Directors decided to increase the dividends declared on both classes of stock for the fourth quarter of 2017. We pay a higher dividend per share on Class B1 activity stock than on Class B2 membership stock to reward members that use our advances and, thereby, support the entire cooperative. The higher dividend received by members on Class B1 capital stock also has the effect of lowering their cost of borrowing from us.


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(Dollars in tables in millions except per share amounts unless otherwise indicated)


Supporting Member Community Investment Goals

Supporting affordable housing is central to our mission to help our members support their communities. In 2017, 192 members reserved over $17.6 million in down payment assistance grants on behalf of approximately 3,122 homebuyers in their communities. Over $26.4 million was awarded through our competitive program to support 46 affordable housing projects located primarily in Illinois and Wisconsin. These awards will help our members’ partners with the acquisition, rehabilitation, and new construction of over 2,366 housing units. Since 1989, we have awarded more than $427 million in competitive Affordable Housing Program grants and more than $173 million in Downpayment Plus grants that have provided down payment and closing cost assistance for income-eligible families.

Our commitment to assisting our members in serving their communities continued to expand in 2017 with the addition of the Community First Capacity-Building Grant Program. This program offers grants of $10,000 to $50,000 to assist qualifying nonprofit lenders to build their financial, operational, and human capital. In 2017, $250,000 was committed through this new program. True to the mission of our Community First platform, these grants are an opportunity to directly provide support to community development organizations working in our members’ communities in an innovative and effective manner.

We have also committed $44 million of the $50 million revolving Community First Fund by year-end 2017 as part of our ongoing effort to directly fund CDFIs and community development loan funds (CDLFs). This past summer, Cinnaire Lending Corporation, a CDFI member of the Bank, became our ninth Fund partner and will use the funds to support multi-family affordable housing and community facilities throughout our district.


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(Dollars in tables in millions except per share amounts unless otherwise indicated)


Critical Accounting Policies and Estimates

See Note 2 - Summary of Significant Accounting Policies and Note 3 - Recently Issued but Not Yet Adopted Accounting Standards to the financial statements for further details.

Estimating the Allowance for Credit Losses

See Note 2 - Summary of Significant Accounting Policies and Note 8 - Allowance for Credit Losses to the financial statements for further details.

Estimating Fair Value

See Note 16 - Fair Value to the financial statements for further details.

Controls over Internal Valuation Methodologies and Third-Party Pricing Vendors

Segregation of duties is a key control over our internal valuation methodologies and third-party pricing vendors. In this regard, our segregation of duties is outlined below.

Senior management is responsible for our valuation policies. Senior management's responsibility is independent of our investing and treasury functions.

The Asset/Liability Management Committee approves fair value policies and reviews the appropriateness of current valuation methodologies and policies. Model valuation is overseen by the Risk Management Committee of the Board of Directors.

The Audit Committee of the Board of Directors oversees the remediation of gaps in models identified as a result of our governance process.

The Risk Management Group prepares the fair value measurements of our financial instruments, evaluates the appropriateness of the fair values generated by pricing models, and assures the reasonableness and consistent application of valuation approaches and assumptions utilized in cases where unobservable inputs are utilized. In addition, the group performs control processes to ensure the fair values received from third-party pricing services are consistent with GAAP fair value measurement guidance.

The Risk Management Group's responsibility is independent of our investing and treasury management functions.

Other control processes over our internal valuation methodologies include, but are not limited to, the following:

Reviewing the pricing model's theoretical soundness and appropriateness by personnel with relevant expertise who are independent from the fair value measurement function.

Back testing models to subsequent transactions (e.g. termination of a derivative), analysis of actual cash flows to projected cash flows, comparisons with similar observable positions, and comparisons with information received from pricing services for financial instruments where prices or valuations require unobservable inputs.


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(Dollars in tables in millions except per share amounts unless otherwise indicated)


Other control processes over third-party pricing vendors, include, but are not limited to, the following:

Understanding and evaluating the fair value measurements received on each major investment security type to ensure that the amounts reported in our financial statements as well as our fair value disclosures comply with GAAP.

Utilizing all fair value inputs received from multiple third-party pricing vendors to determine the fair value of an individual security unless we determine that exclusion of a fair value input is appropriate based on our control processes.
Discussions with our third-party pricing vendors to ensure that they are in compliance with fair value measurement guidance under GAAP. Such discussions focus on the following:
Understanding their pricing models to the extent possible, as some pricing models are proprietary in nature.
Understanding the principal or most advantageous market selected and our ability to access that market.
Assumptions and significant inputs used in determining the fair value measurement.
The appropriateness of the fair value hierarchy level as of the reporting date.
Whether the market was active or illiquid as of the reporting date.
Whether transactions were between willing buyers and sellers or distressed in nature as of the reporting date.
Whether the fair value measurements as of the reporting date is based on current or stale assumptions and inputs.

Obtaining the third party pricing vendor methodologies and control reports.

Challenging fair value measurements received that represent outliers to the fair value measurements received on the same financial instrument from a different third-party pricing service. We document these challenges on a monthly basis.

Examining the underlying inputs and assumptions for a sample of individual securities across asset classes and average life.

Identifying stale prices, prices changed significantly from prior valuations, and other anomalies that may indicate that a price may not be accurate.

Performing implied yield analysis to identify anomalies.





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logoa35.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


Results of Operations


Net Interest Income

Net interest income is the difference between the amount we recognize into interest income on our interest earning assets and the amount we recognize into interest expense on our interest bearing liabilities. These amounts were determined in accordance with GAAP and were based on the underlying contractual interest rate terms of our interest earning assets and interest bearing liabilities as well as the following items:

Net interest paid or received on interest rate swaps that are accounted for as fair value or cash flow hedges;
Amortization of premiums;
Accretion of discounts and OTTI reversals;
Amortization of hedge adjustments;
Advance and investment prepayment fees; and
MPF credit enhancement fees.

The tables on the following page present the increase or decrease in interest income and expense due to volume or rate variances. The calculation of these components includes the following considerations:
 
Average Balance: Average balances are calculated using daily balances. Amortized cost basis is used to compute the average balances for most of our financial instruments, including MPF Loans held in portfolio that are on nonaccrual status and available for sale securities. The calculation of the yield on our available for sale securities does not give effect to changes in fair value that are reflected as a component of accumulated other comprehensive income (AOCI). Fair value is used to compute average balances for our trading securities and financial instruments carried at fair value under the fair value option.

Total Interest: Total interest includes the net interest income components, as discussed above, applicable to our interest earning assets and interest bearing liabilities.

Yield/Rate: Effective yields/rates are based on total interest and average balances as defined above. Yields/rates are calculated on an annualized basis.

Any changes due to the combined volume/rate variance have been allocated to volume.



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logoa35.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


2017 compared to 2016
 
 
2017
 
2016
 
Increase (decrease) due to
For the years ended December 31,
 
Average Balance
 
Total Interest  
 
Yield/ Rate
 
Average Balance
 
Total Interest  
 
Yield/ Rate
 
Volume
 
Rate
 
Net Change
Investment securities
 
$
18,217

 
$
656