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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, 2018
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

logoa42.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 every Interactive Data File required to be submitted 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 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, 2018, the aggregate par value of the stock held by current and former members was $2,118,491,099. As of January 31, 2019, registrant had 19,919,641 total outstanding shares of Class B Capital Stock, including mandatorily redeemable capital stock.

1

Table of Contents
logoa44.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.
 
 
 

2

Table of Contents
logoa43.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. 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 125.


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, 2018, we had 462 full time and 6 part time employees.

“Mortgage Partnership Finance”, “MPF”, "eMPF", “MPF Xtra”, “Downpayment Plus”, "DPP", "Downpayment Plus Advantage", "DPP Advantage", 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.

3

Table of Contents
logoa43.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, 2018
 
December 31, 2017
 
Number of Institutions
 
 
 
Number of Institutions
 
 
 
Illinois
 
Wisconsin
 
Total
 
Percent
 
Illinois
 
Wisconsin
 
Total
 
Percent
Commercial banks
322

 
165

 
487

 
70
%
 
335

 
172

 
507

 
70
%
Savings institutions
52

 
21

 
73

 
10
%
 
54

 
24

 
78

 
11
%
Credit unions
45

 
49

 
94

 
13
%
 
43

 
45

 
88

 
12
%
Insurance companies
34

 
11

 
45

 
6
%
 
32

 
11

 
43

 
6
%
Community Development
   Financial Institutions
5

 
1

 
6

 
1
%
 
3

 
1

 
4

 
1
%
Total
458

 
247

 
705

 
100
%
 
467

 
253

 
720

 
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 $1.173 billion (the limit during 2018) in average total assets over three years. This limit is adjusted annually for inflation. See the Glossary of Terms on page 125 for further details.

As of December 31,
 
2018
 
2017
Member Asset Size:
 
 
 
 
Community Financial Institutions
 
91.60
%
 
91.97
%
Larger Non-CFI Institutions
 
8.40
%
 
8.03
%
Total
 
100
%
 
100
%


In 2018, our total membership declined by fifteen institutions.

We lost 27 members due to mergers and acquisitions. Although 22 of these members were acquired by other members in our district, five were acquired by out-of-district institutions.  

We gained 12 new members by adding three commercial banks, six credit unions, two CDFIs, and one insurance company during 2018, 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, 80% and 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 2018 and 2017.

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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(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,
 
2018
 
2017
Advances
 
$
55,476

 
$
46,989

Mortgage assets (Acquired Member Assets - AMA)
 
5,944

 
5,038

Primary mission assets
 
$
61,420

 
$
52,027

Consolidated obligations
 
$
86,388

 
$
77,338

Primary mission asset ratio
 
71.1
%
 
67.3
%
 
 
 
 
 
Supplemental mission assets and activities as of December 31,
 
2018
 
2017
MPF Program Loans held by other third party investors
 
$
18,904

 
$
18,424

Member standby letters of credit
 
24,306

 
19,572

Mission related liquidity
 
6,964

 
6,327

Small Business Administration investments
 
1,752

 
1,710

Housing authority standby bonds purchased and commitments outstanding
 
396

 
367

MPF Loan delivery commitments
 
336

 
371

Advance commitments
 
274

 
151

Member derivatives
 
18

 
26

Community First Fund loans and commitments
 
46

 
44

Supplemental mission assets and activities
 
$
52,996

 
$
46,992


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 issued an advisory bulletin which provides guidance relating to how the FHFA will assess each FHLB’s core mission achievement. As part of this guidance, 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 primary 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 primary mission asset ratio for the year ended December 31, 2018, was 71.1%.

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 primary mission asset ratio will be negatively impacted unless we experience an increased demand for advance products.

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



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 63.

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, London Interbank Offer Rate (LIBOR), Federal Funds, or some other index (such as the Secured Overnight Financing Rate (SOFR)). 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.

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.

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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 $21 million in advances outstanding to non-member housing associates at December 31, 2018, and $22 million at December 31, 2017.

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 the regulatory environment, 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 changes in the 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 17.

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.


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).

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


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, 2018, 19% of the overall unpaid principal balance of MPF Loans we own represents participations in other MPF Banks’ MPF Loans. See Risk Factors on page 17 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:
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

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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 17 and Mortgage Repurchase Risk on page 67 for further information about MPF Loans repurchases.

Loss Structure for Credit Risk Sharing Products

For conventional MPF Loan products held in our portfolio, PFIs 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 65.
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 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.


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


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 71.

Our longer-term investment debt 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 Debt Securities by Rating on page 69. 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 debt 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-U.S. entities, other than those issued by U.S. 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-U.S. 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 debt 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.

Subject to regulatory limitations, we resumed making investments in MBS in June 2018.

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

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


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 74.

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 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 $28 million for the year ended December 31, 2018, and $26 million for the year ended December 31, 2017, for projects designed to provide housing to 2,566 and 2,366 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, 2018 and 2017, we awarded $20 million and $18 million through our Downpayment Plus programs to assist 3,507 and 3,122 very low- to moderate-income homebuyers.

During 2019, we anticipate having $35 million available in total for our Downpayment Plus programs and grants through our competitive AHP.

Community Advances Programs and related letters of credit - We offer 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 Advances programs may be used to finance affordable homeownership 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, 2018, and 2017, we had $570 million and $914 million respectively, in advances outstanding under the Community Advances programs and related letters of credit outstanding of $116 million and $142 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, 2018, had $45 million in loans outstanding and $1 million in unfunded loan commitments.

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.


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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 48 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 17 and Funding on page 50.

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 debt 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, 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 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 debt securities and a possible decrease in our net interest margin.


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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

Final Rule on FHLB Capital Requirements

On February 20, 2019, the FHFA published a final rule, effective January 1, 2020, that adopts, with amendments, the regulations of the Federal Housing Finance Board (predecessor to the FHFA) (“Finance Board”) pertaining to the capital requirements for the FHLBs. The final rule carries over most of the prior Finance Board regulations without material change but substantively revises the credit risk component of the risk-based capital requirement, as well as the limitations on extensions of unsecured credit. The main revisions remove requirements that we calculate credit risk capital charges and unsecured credit limits based on ratings issued by a Nationally Recognized Statistical Rating Organization (NRSRO), and instead require that we establish and use our own internal rating methodology (which may include, but not solely rely on, NRSRO ratings). The rule imposes a new credit risk capital charge for cleared derivatives. The final rule also revises the percentages used in the regulation’s tables to calculate credit risk capital charges for advances and for non-mortgage assets. The final rule also rescinds certain contingency liquidity requirements that were part of the Finance Board regulations, as these requirements are now addressed in an Advisory Bulletin on FHLB Liquidity Guidance issued by the FHFA in 2018 (see “Advisory Bulletin 2018-07 FHLB Liquidity Guidance” below).

We do not expect this rule to materially affect our financial condition or results of operations.

FDIC Final Rule on Reciprocal Deposits

On February 4, 2019, the FDIC published a final rule, effective March 6, 2019, related to the treatment of “reciprocal deposits” that implements Section 202 of the Economic Growth, Regulatory Relief, and Consumer Protection Act. The final rule exempts, for certain insured depository institutions (“depositories”), certain reciprocal deposits - deposits acquired by a depository from a

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network of participating depositories that enables depositors to receive FDIC insurance coverage for the entire amount of their deposits - from being subject to FDIC restrictions on brokered deposits. Under the rule, well-capitalized and well-rated depositories are not required to treat reciprocal deposits as brokered deposits up to the lesser of twenty percent of their total liabilities or $5 billion. Reciprocal deposits held by depositories that are not well-capitalized and well-rated may also be excluded from brokered deposit treatment in certain circumstances.

We continue to evaluate the potential impact of the final rule, but currently do not expect the rule to materially affect our financial condition or results of operations. The rule could, however, enhance depositories’ liquidity by increasing the attractiveness of deposits that exceed FDIC insurance limits. This could affect the demand for certain advance products.

Final Rule on Golden Parachute and Indemnification Payments

On December 20, 2018, the FHFA published a final rule, effective January 22, 2019, on golden parachute and indemnification payments (“Golden Parachute Rule”) to better align the Golden Parachute Rule with areas of the FHFA’s supervisory concern and reduce administrative and compliance burdens. The Golden Parachute Rule sets forth the standards the FHFA would take into consideration when limiting or prohibiting golden parachute and indemnification payments by an FHLB or the Office of Finance to an entity-affiliated party when such entity is in a troubled condition, in conservatorship or receivership, or insolvent. The final rule amendments:

focus the standards on payments to and agreements with executive officers, broad-based plans covering large numbers of employees (such as severance plans), and payments made to non-executive-officer employees who may have engaged in certain types of wrongdoing; and
revise and clarify definitions, exemptions and procedures to implement the FHFA’s supervisory approach.

We do not expect this rule to materially impact our financial condition or results of operations.

Final Rule Amending AHP Regulations

On November 28, 2018, the FHFA published a final rule, effective December 28, 2018, that amends the operating requirements of the FHLBs’ AHP.  The final rule retains a scoring criteria method for awarding competitive AHP subsidies, but allows us to create multiple pools of competitive funds in order to target specific affordable housing needs in our district. The final rule amendments also:

revise the scoring criteria to create different and new scoring priorities;
remove the retention agreement requirement on owner-occupied units using the subsidy solely for rehabilitation;
increase the per-household set-aside grant amount to $22,000 with an annual housing price inflation adjustment (up from the current fixed limit of $15,000);
clarify the requirements for remediating AHP noncompliance;
prohibit our Board of Directors from delegating approval of AHP strategic policy decisions to a committee; and
further align AHP monitoring with certain federal government funding programs.

The majority of the rule’s provisions take effect January 1, 2021, while the owner-occupied retention agreement requirements, take effect January 1, 2020. We do not expect this rule to materially affect our financial condition or results of operations.


FHFA Proposed Rule on Housing Goals

On November 2, 2018, the FHFA published a proposed rule that would amend its existing Federal Home Loan Bank Housing Goals regulation. The proposed amendments are intended to replace existing FHLB housing goals with a more streamlined set of goals. While the existing housing goals are established retrospectively, the proposed rule would establish the levels of annual housing goals in advance, thereby eliminating uncertainty about housing goals from year-to-year. If adopted as proposed, the proposed amendments would:

eliminate the $2.5 billion AMA mortgage purchase volume threshold that triggers the application of housing goals;
establish the target level for the new prospective AMA mortgage purchase housing goal at 20 percent of total AMA mortgage purchases that are for very low-income families, low-income families, or families in low-income areas, and require that at least 75 percent of all mortgage purchases that count toward the goal be for borrowers with incomes at or below 80 percent of the area median income;
establish a goal that 50 percent of AMA program users meet the definition of “small members” whose assets do not exceed the “community financial institution” asset cap, which under FHFA regulations is currently $1.199 billion; and

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allow the FHLBs to request FHFA approval of alternative target percentages for mortgage purchase housing goals and small member participation goals.

We submitted a joint comment letter with the other FHLBs on the proposed rule on January 29, 2019. We continue to evaluate the proposed rule but do not expect this rule, if adopted as proposed, to materially affect our financial condition or results of operations.

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

On October 10, 2018, the OCC, FRB, FDIC, Farm Credit Administration, and the FHFA published a final rule, effective November 9, 2018, that amended each agency’s 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 qualified financial contract (QFC) rules. The final rule also clarifies that a legacy swap would not be deemed to be a covered swap under the Swap Margin Rules if it is amended to conform to the QFC rules. The QFC rules previously published by the OCC, FRB and FDIC require their respective regulated entities to amend covered QFCs to limit a regulated entity’s counterparty’s immediate termination or exercise of default rights in the event of bankruptcy or receivership of the regulated entity or its affiliate(s).

We do not expect this rule to materially affect our financial condition or results of operations.

Final Rule on Indemnification Payments

On October 4, 2018, the FHFA published a final rule establishing standards for identifying when an indemnification payment by an FHLB or the Office of Finance to an officer, director, employee, or other affiliated party in connection with an administrative proceeding or civil action instituted by FHFA is prohibited or permissible. The rule generally prohibits these payments except in the following circumstances:

premiums for any commercial insurance or fidelity bonds for directors and officers, to the extent that the insurance or fidelity bond covers expenses and restitution, but not a judgment in favor of the FHFA or a civil money penalty imposed by the FHFA;
expenses of defending an action, subject to an agreement to repay those expenses in certain instances; and
amounts due under an indemnification agreement entered into with a named affiliated party on or prior to September 20, 2016 (the date the rule was proposed).

The rule also outlines the process the Board of Directors must undergo prior to making a permitted payment related to expenses of defending an action. The rule became effective November 5, 2018. We do not expect this rule to materially affect our financial condition or results of operations.

Advisory Bulletin 2018-07 FHLB Liquidity Guidance

On August 23, 2018, the FHFA issued an Advisory Bulletin on FHLB liquidity (the “Liquidity AB”) that communicates the FHFA’s expectations with respect to the maintenance of sufficient liquidity to enable us to provide advances and letters of credit to members. The Liquidity AB rescinds the 2009 liquidity guidance previously issued by the FHFA. Contemporaneously with the issuance of the Liquidity AB, the FHFA issued a supervisory letter that identifies initial thresholds for measures of liquidity within the established ranges set forth in the Liquidity AB.

The Liquidity AB provides guidance on the level of on balance sheet liquid assets related to base case liquidity. As part of the base case liquidity measure, the guidance also includes a separate provision covering off balance sheet commitments from standby letters of credit (“SLOCs”). In addition, the Liquidity AB provides guidance related to asset/liability maturity funding gap limits.

With respect to base case liquidity, the FHFA revised previous guidance that required us to assume a 5-day period without access to capital markets due to a change in certain assumptions underlying that guidance. Under the Liquidity AB, we are required to hold positive cash flow assuming no access to capital markets and assuming renewal of all maturing advances for a period of between ten to thirty calendar days. The Liquidity AB also sets forth the initial cash flow assumptions and formula to calculate base case liquidity. With respect to SLOCs, the guidance states that we should maintain a liquidity reserve of between one percent and 20 percent of our outstanding SLOC commitments.

With respect to funding gaps and possible asset and liability mismatches, the Liquidity AB provides guidance on maintaining appropriate funding gaps for three-month (-10 to -20 percent) and one-year (-25 to -35 percent) maturity horizons. The Liquidity

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AB provides for these limits to reduce the liquidity risks associated with a mismatch in asset and liability maturities, including an undue reliance on short-term debt funding.

The Liquidity AB also addresses liquidity stress testing, contingency funding plans and an adjustment to our core mission achievement calculation. Portions of the Liquidity AB were implemented on December 31, 2018, with further implementation to take place on March 31, 2019 and full implementation on December 31, 2019. While we are still analyzing the impact of the Liquidity AB, it will require us to hold an additional amount of liquid assets to meet the new guidance, which could reduce our ability to invest in higher-yielding assets, and may in turn negatively impact net interest income. To the extent that we must adjust pricing for our short-term advances and letters of credit, these products may become less competitive, which may adversely affect advance and capital stock levels as well as letters of credit levels. Additionally, subject to market conditions, our cost of funding may increase if we are required to achieve the appropriate funding gap with longer term funding.

Adoption of Single-Counterparty Credit Limits for Bank Holding Companies and Foreign Banking Organizations by Board of Governors of the Federal Reserve System.

On August 6, 2018, the Board of Governors of the Federal Reserve System published a final rule, effective October 5, 2018, establishing single-counterparty credit limits applicable to bank holding companies and foreign banking organizations with total consolidated assets of $250 billion or more, including global systemically important bank holding companies (GSIBs) in the United States. These entities are considered to be covered companies under the rule. The FHLB are themselves exempt from the limits and reporting requirements contained in this rule. However, credit exposure to individual FHLBs must be monitored, and reported on as required, by any entity that is a covered company under this rule.

Under the final rule, a covered company and its subsidiaries may not have aggregate net credit exposure to an FHLB and, if applicable, (in certain cases) economically interdependent entities in excess of 25 percent of the company’s tier 1 capital. Such credit exposure does not include advances from an FHLB, but generally includes collateral pledged to an FHLB in excess of a covered company’s outstanding advances. Also included towards a covered company’s net credit exposure is its investment in FHLB capital stock and debt instruments, deposits with an FHLB, FHLB-issued letters of credit where a covered company is the named beneficiary, and other obligations to an FHLB, including repurchase or reverse repurchase transactions net of collateral that create a credit exposure to an FHLB. Intra-day exposures are exempt from the final rule.

With respect to the FHLBs’ consolidated obligations held by a covered company, the company must monitor, and report on as required, its credit exposure for such obligations. It is not clear if the Federal Reserve will require consolidated obligations to be aggregated with other exposures to an FHLB or the FHLB system.

The final rule gives major covered companies (i.e., the GSIBs) until January 1, 2020 to comply, and all other covered companies will have until July 1, 2020 to comply. We do not expect the rule to materially affect our financial condition or results of operations.

2017 Wisconsin Act 340.
On April 16, 2018, Wisconsin Governor Scott Walker signed into law the 2017 Wisconsin Act 340 which includes three provisions we believe will benefit the Bank and our Wisconsin members.

The first provision clarifies in the Wisconsin public deposit statute that FHLB letters of credit are acceptable collateral substitutes for public unit deposits. This clarification may help our Wisconsin bank and credit union members more easily obtain low-cost local funding.
The second provision provides protections for the Bank under state insurance insolvency law by limiting the stay authority applicable to the Bank and removing the Bank from the voidable preference provisions. These protections will allow our Wisconsin insurance company members to receive improved securities collateral values when borrowing from us.
The third provision allows the Wisconsin Department of Financial Institutions to share their confidential exam reports of state-chartered banks, thrifts, and credit unions with the Bank. Federal law has long required federal banking regulators to share their exam reports with the FHLBs. This provision will help our Wisconsin-chartered depository members receive similar collateral values as federally-chartered institutions when borrowing from us.

Taxation and AHP Assessments

We are exempt, by statute, 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 2018, U.S. economic activity expanded and the Federal Reserve raised interest rates four 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 2018, conditions in the U.S. housing market were mixed, as decreased unemployment, home price appreciation and lower mortgage delinquency rates were tempered by higher mortgage rates that slowed home sales in the second half of the year. If there are additional adverse trends in the mortgage lending sector and general business and economic conditions deteriorate significantly, our members' credit characteristics may deteriorate, which could cause them to become delinquent or to default on their advances and other credit obligations. As of February 28, 2019, 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 the 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 FHLB liquidity and capital requirements, and authority over the scope of permissible FHLB products and activities (including the authority to impose limits on those products and activities). The last Director of the FHFA’s term ended on January 6, 2019 and the acting FHFA Director is now serving until a permanent Director is approved by the U.S. Senate. We may be impacted by any change in regulatory environment resulting from a replacement of the FHFA Director. 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; letter of credit pricing; 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 and the Administration continue to consider reforms to the U.S. housing finance system, including the resolution of Fannie Mae and Freddie Mac, any legislative proposals or administrative actions 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. Additionally, the 2018 adoption of the regulation modifying Dodd-Frank provisions and the rules implementing these changes may make alternative funding sources more attractive to our members, and negatively impact our advances and letters of credit levels. We cannot predict the prospects for any additional future amendments to, or the potential 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 2018, 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 and pricing 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 and maintain compliance with our liquidity requirements, 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 U.S. 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, 2018, our five largest advance borrowers held 59.1 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, 2018, these captive insurance company members had $13.5 billion in advances outstanding at par, which was 25.7 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 5.2 years as of December 31, 2018. 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 primary 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 2018. Twenty-two of these members were acquired by other members in our district and five 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.

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. As further discussed in Recent Legislative and Regulatory Developments on page 15, the FHFA recently issued new guidance on liquidity (the “Liquidity AB”), which goes into effect on March 31, 2019, communicating the FHFA’s expectations with respect to the maintenance of sufficient liquidity to enable the FHLBs to fund advances and letters of credit for members during a sustained capital markets disruption.

To satisfy our current liquidity requirements, we maintain increased balances in short-term investments, and the Liquidity AB will require us to hold additional liquid assets. Maintaining large balances of liquid assets reduces our ability to invest in higher-yielding assets, and may in turn negatively impact net interest income. Additionally, to the extent that the Bank adjusts pricing for its short-term advances and letters of credit as a result of the Liquidity AB, these products may become less competitive, which may adversely affect advance and capital stock levels as well as letters of credit levels, and ultimately our net 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. As a result, our net interest income on investments and advances may be reduced.

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 January 2019 the FHFA published a final rule, as further discussed in Recent Legislative and Regulatory Developments on page 13, that revises the credit risk component of the risk-based capital requirement for the FHLBs, as well as the limitation on extensions of unsecured credit and derivative exposure. The new rules may require us to hold additional capital for certain on-balance sheet and off-balance sheet financial instruments and require us to hold capital for potential exposure on its cleared derivatives, which may adversely impact our 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 or access to funding.

The scope, timing, and effect of any regulatory reform affecting the GSEs, including the ultimate resolution to the conservatorship of Fannie Mae and Freddie Mac and resulting changes in the regulation or status of the GSEs, could have a significant effect on the FHLB system and could negatively change the perception of the risks associated with the GSEs and their debt securities. This change in the perception of risk could adversely affect the FHLBs’ funding costs, access to funding, competitive position, and ultimately, the Bank’s financial condition and results of operations. 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 2018, we experienced moderate growth as purchases 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 2018, 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 at 2018 year end by an amount that is not currently material but which could become so in the future. Regulatory requirements, including our mission asset ratio requirement and liquidity guidance, as further described on pages 5 and 15, respectively, 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. Additionally, as

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described in Recent Legislative and Regulatory Developments on page 15, we are subject to regulatory oversight with respect to maintaining an appropriate funding gap. Subject to market conditions, our cost of funding may increase if we are required to achieve the appropriate funding gap by using longer term funding, on which we generally pay higher interest than on our short-term funding.

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.

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 our products, which contributes to the overall health of the entire cooperative. See Dividend Payments on page 59. Typically, our capital grows when members are required to purchase additional capital stock as they increase certain product usage and our capital declines when we repurchase excess capital stock from members as their usage declines 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 and Dividend Policy section on page 59. If we are unable to maintain a reasonable level 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 products 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 56.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.

A decline and shift in mortgage originations, the competitive landscape, and the loss of certain PFIs in the future may negatively impact our business.

Mortgage originations are declining, with the bulk of new originations coming from non-bank originators, like “FinTech” companies, who are not eligible to be members of the FHLBs and therefore not eligible to participate in our MPF Program. As a result, we may experience a decrease in volume available to purchase from our PFIs. In addition, PFIs may stop selling loans under the MPF Program due to mergers with or into other organizations, or as a result of market competition. To the extent a sufficient number of our PFIs experience a decline in new mortgage originations or discontinue selling under the MPF Program, and we do not gain a sufficient number of new PFIs to offset such decline or departures, we may incur a decrease in volume available to purchase from our PFIs.

During 2018, the top five PFIs, in the aggregate, accounted for 61% of our MPF on balance sheet purchases held in portfolio. To the extent we lose our business with these PFIs and cannot attract comparable replacements, our business may be adversely affected.


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


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. We are currently repurchasing all excess class B2 membership stock on a weekly basis at par, 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.

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.

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 exceeded pay downs of our MPF Loans held in portfolio in 2018, future MPF Loan purchases may be insufficient to offset pay downs and maturities of our MPF Loan portfolio. Additionally, while we resumed making investments in MBS in June 2018 subject to FHFA regulatory limits, the amount of new MBS purchases did not exceed the amount of maturities or pay downs on an average basis year to date. 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. Moreover, any new investments we make 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.


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


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 continued 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 and the impact of government shutdowns. 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. A decrease in this demand could, given the FHLBs’ concentration in money market investors, lead to significant investor outflows and our funding costs and/or access to the capital markets may be adversely affected. Additionally, the FHLB System currently plays a predominant role as lenders in the federal funds market; therefore, any disruption in the federal funds market or any related regulatory or policy change may adversely affect our cash management activities, results of operation and reputation.

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 a loss of up to $25.9 million of currently open (as of December 31, 2018) 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 interest-rate risk exposure, 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 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.


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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, 2018, we held $3.8 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. However, it is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR, whether LIBOR rates will cease to be published or supported before or after 2021, or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere.

In the United States, the Federal Reserve Board and the Federal Reserve Bank of New York convened the Alternative Reference Rates Committee (ARRC) to identify a set of alternative reference interest rates for possible use as market benchmarks. ARRC has proposed the Secured Overnight Financing Rate (SOFR) as its recommended alternative to LIBOR. SOFR is based on a broad segment of the overnight Treasury repurchase market and is intended to be a measure of the cost of borrowing cash overnight collateralized by Treasury securities. The Federal Reserve Bank of New York began publishing SOFR rates in April 2018 and the FHLB System issued its first SOFR-linked debt in the market on November 13, 2018.

As noted throughout this Form 10-K, many of the Bank’s assets and liabilities are indexed to LIBOR. The Bank is evaluating the potential impact of the eventual replacement of the LIBOR benchmark interest rate, including the possibility of SOFR as the dominant replacement. The market transition away from LIBOR and towards SOFR is expected to be gradual and complicated, including the development of term and credit adjustments to accommodate differences between LIBOR and SOFR, or any other alternative rate. There can be no guarantee that SOFR will become widely used and that alternatives may or may not be developed with additional complications. Introduction of an alternative rate also may introduce additional basis risk for market participants including the Bank as an alternative index is utilized along with LIBOR. Additionally, the infrastructure necessary to manage hedging in the alternative reference rate still needs to be built out, and the transition in the markets, and adjustments in the Bank's systems, could be disruptive. The Bank is not able to predict whether LIBOR will cease to be available after 2021,

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whether SOFR will become a widely accepted benchmark in place of LIBOR, or what the impact of a possible transition to SOFR or an alternate replacement will have on the Bank’s business, financial condition, or results of operations.

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. 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. Conversely, 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. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk on page 74 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.

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 2018, 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.


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


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.

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 derivative 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 71.

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 credit loss.  See the table in Investment Securities by Rating on page 69 for a summary of counterparty credit ratings for these investments.


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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 2018, 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, 2018 is $135 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 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, 2018, we had $24 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 67.

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 66.

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 7.



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


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.

A portion of our portfolio represents 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 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.

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 to become delinquent or to default on their advances and other credit obligations to us. For example, three significant hurricanes impacted the southeastern coasts of the United States and Puerto Rico in 2017 and significant wildfires occurred in California in 2018. While we do not expect that the potential losses resulting from these hurricanes and wildfires 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 the internet to conduct our business. The continued occurrence of high-profile data breaches at other financial institutions indicates the continuing existence of an external environment with diverse and sophisticated methods of data exfiltration. Other companies have also reported breaches and other attacks, some severe, intended to disable or degrade services, sabotage systems, and/or obtain improper access to confidential or proprietary information. This environment demands that we engage in ongoing monitoring of the effectiveness of our security controls, engage in proper testing of our security controls and responses, and implement changes as needed to mitigate security vulnerabilities. Despite these efforts, it is possible our security controls over personal data, our training of workers and vendors on data security, and other practices we follow may not prevent the improper access to, or

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


disclosure of personally identifiable information, or other confidential information that we or our vendors store and manage. We are also subject to the risk of unauthorized access to, and transmission of, confidential or proprietary information by workers. The materiality of such risks depends on the nature, extent, and potential magnitude of a potential incident or attack. Improper disclosure of personally identifiable information or other confidential or proprietary information could harm our reputation, financial performance, and customer and vendor relationships, lead to legal exposure to borrowers, subject us to liability under laws that protect personal data, result in litigation or regulatory investigations, and impact our competitive position.

Additionally, cyberattacks, including 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. Efforts 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 workers, 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.

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 hosted by third parties. Maintaining the availability, 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 software updates and 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, cyberattacks 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. A significant control failure, or a lapse in certain operating processes, could materially impact our financial condition and results of operations. We may not be able to foresee, prevent, mitigate, reverse, or repair some or all of 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

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


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 and hosted services that may include hardware, software support, connectivity, and other technology services. Any failure, interruption, or breach in security of these systems or services could result in disruptions in our ability to conduct business. There is no assurance that if or when such incidents 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, interruption, or breach in the security of the Office of Finance's or their third party vendor’s operating systems could disrupt our access to funds, and may harm our business. Moreover, any operational failure of the Office of Finance or their third party vendors 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 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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(Dollars in tables in millions except per share amounts unless otherwise indicated)


Item 1B.    Unresolved Staff Comments.

Not applicable.


Item 2.    Properties.

As of January 31, 2019, 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, 2018, the remaining litigation covers three private-label MBS bonds in the aggregate outstanding principal amount of $37 million. As of February 28, 2019, 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, 2019, we had 19,919,641 shares of capital stock outstanding, including mandatorily redeemable capital stock recorded as a liability, and we had 730 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 and Capital Resources on page 55.

Information regarding our cash dividends declared in each quarter in 2017 and 2018, and information regarding regulatory requirements and restrictions on dividends, is set forth in the Retained Earnings & Dividends Policy section on page 59.

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 55.

As of
 
December 31, 2018
 
December 31, 2017
Commercial banks
  
$
1,123

  
$
967

Savings institutions
  
241

  
174

Credit unions
  
190

  
149

Insurance companies
  
143

  
152

Community Development Financial Institutions
  
1

  
1

Total GAAP capital stock
  
1,698

  
1,443

Stock reclassified as mandatorily redeemable capital stock (liability)
 
313

 
311

Total regulatory capital stock outstanding
 
$
2,011

 
$
1,754




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


Item 6.    Selected Financial Data.
As of or for the years ended December 31,
2018
 
2017
 
2016
 
2015
 
2014
 
Selected statements of condition data
 
 
 
 
 
 
 
 
 
 
Investments a
$
32,684

 
$
30,683

 
$
28,060

 
$
28,324

 
$
32,745

 
Advances
52,628

 
48,085

 
45,067

 
36,778

 
32,485

 
MPF Loans held in portfolio, net
7,103

 
5,193


4,967


4,828


6,057

 
Total assets
92,857

 
84,355

 
78,692

 
70,671

 
71,841

 
Consolidated obligation discount notes
43,166

 
41,191

 
35,949

 
41,564

 
31,054

 
Consolidated obligation bonds
42,250

 
37,121

 
36,903

 
22,582

 
34,251

 
Mandatorily redeemable capital stock (MRCS) recorded as a liability
313

 
311

 
301

 
8

 
9

 
Capital stock
1,698

 
1,443

 
1,711

 
1,950

 
1,902

 
Retained earnings
3,536

 
3,297

 
3,020

 
2,730

 
2,406

 
Total capital
$
5,289

 
$
4,852

 
$
4,695

 
$
4,652

 
$
4,526

 
Other selected data at period end
 
 
 
 
 
 
 
 
 
 
Member standby letters of credit outstanding
$
24,306

 
$
19,572

 
$
10,828

 
$
6,678

 
$
3,617

 
MPF Loans par value outstanding - FHLB System b
58,820

 
51,563

 
46,293

 
43,445

 
43,707

 
MPF Loans par value outstanding - FHLB Chicago PFIs b
14,522

 
12,484

 
11,624

 
10,577

 
10,767

 
FHLB systemwide consolidated obligations par value outstanding
$
1,031,617

 
$
1,034,260

 
$
989,311

 
$
905,202

 
$
847,175

 
Number of members
705

 
720

 
728

 
740

 
751

 
Total employees (full and part time)
468

 
460

 
440

 
422

 
405

 
Selected statements of income data
 
 
 
 
 
 
 
 
 
 
Net interest income after provision for (reversal of) credit losses
$
513

 
$
483

 
$
455

 
$
503

 
$
528

 
Noninterest income
16

 
44

 
76

c 
23

 
32

 
Noninterest expense
191

 
174

 
167

 
138

 
124

 
Net income
$
303

 
$
317

 
$
327

 
$
349

 
$
392

 
Other selected data during the periods ended
 
 
 
 
 
 
 
 
 
 
MPF Loans par value amounts funded - FHLB System b
$
13,617

 
$
11,915

 
$
10,872

 
$
7,225

 
$
5,387

 
Number of PFIs funding MPF products - FHLB System b
902

 
909

 
873

 
843

 
819

 
MPF Loans par value amounts funded - FHLB Chicago PFIs b
$
3,614

 
$
2,521

 
$
3,145

 
$
1,784

 
$
1,191

 
Number of PFIs funding MPF products - FHLB Chicago b
208

 
204

 
191

 
188

 
190

 
Selected ratios (rates annualized)
 
 
 
 
 
 
 
 
 
 
Total regulatory capital to assets ratio
5.97
%
 
5.99
%
 
6.40
%
 
6.63
%
 
6.01
%
 
Market value of equity to book value of equity
105
%
 
107
%
 
108
%
 
108
%
 
114
%
 
Primary mission asset ratio d
71.1
%
 
67.3
%
 
66.2
%
 
58.8
%
 
n/a

 
Investments - % of total assets
35
%
 
36
%
 
36
%
 
40
%
 
46
%
 
Advances - % of total assets
57
%
 
57
%
 
57
%
 
52
%
 
45
%
 
MPF Loans held in portfolio, net - % of total assets
8
%
 
6
%
 
6
%
 
7
%
 
8
%
 
Dividend rate class B1 activity stock-period paid
4.06
%
 
3.19
%
 
2.75
%
 
2.31
%
 
1.58
%
 
Dividend rate class B2 membership stock-period paid
1.65
%
 
1.10
%
 
0.60
%
 
0.50
%
 
0.45
%
 
Return on average assets
0.33
%
 
0.38
%
 
0.42
%
 
0.49
%
 
0.55
%
 
Return on average equity
5.74
%
 
6.84
%
 
7.18
%
 
7.65
%
 
9.35
%
 
Average equity to average assets
5.74
%
 
5.58
%
 
5.87
%
 
6.35
%
 
5.83
%
 
Net yield on average interest earning assets
0.56
%
 
0.59
%
 
0.59
%
 
0.72
%
 
0.74
%
 
Return on average Regulatory Capital spread to 3-month LIBOR index
3.25
%
 
5.25
%
 
5.96
%
 
7.55
%
 
9.61
%
 
Cash dividends
$
64

 
$
40

 
$
37

 
$
25

 
$
14

 
Dividend payout ratio
21.12
%
 
12.62
%
 
11.31
%
 
7.16
%
 
3.57
%
 
a 
Investments includes investment debt 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 7 for details on our various MPF products.
c 
Includes $38 million in litigation settlement awards. See Litigation Settlement Awards on page 43 for further details.
d 
In 2015, the FHFA issued an advisory bulletin that provides guidance relating to a primary mission asset ratio by which the FHFA will assess each FHLB's core mission achievement. See Item 1. Business on page 5 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 pricing increases and the availability of other sources of funding for our members, such as deposits; 

regulatory limits on our investments;

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 and liquidity 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 17.

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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logoa43.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


Executive Summary

2018 Financial Highlights

We recorded net income of $303 million in 2018 compared to $317 million in 2017.
Net interest income for 2018 was $513 million, which included $32 million of income from available-for-sale (AFS) investment security prepayments during the period. For 2017, net interest income was $483 million, which included $27 million of income from AFS investment security prepayments during the period. The increase in net interest income for 2018 was the result of an increase in interest rates and growth in interest earning assets.
Noninterest income was $16 million in 2018 compared to $44 million for 2017, the decrease was primarily due to a $24 million loss relating to our derivatives and hedging activities in 2018 compared to an $8 million gain in 2017.
Noninterest expense was $191 million for 2018 compared to $174 million for 2017, driven by an increase in operating expenses related to information technology and compensation and benefits.
Assets were $92.9 billion at year-end 2018 compared to $84.4 billion at year-end 2017. Strong growth in advances and MPF assets led to the increase. The purchase of MBS investment securities offset the decline in Federal Funds sold and securities purchased under agreements to resell in 2018.
Advances outstanding were $52.6 billion at year-end 2018, up 9% from the previous year-end level of $48.1 billion, reflective of member demand for competitive funding to support member investment and loan growth opportunities.
MPF Loans held in portfolio increased to $7.1 billion at year-end 2018 compared to $5.2 billion at year-end 2017, due to increased utilization by PFIs and the addition of new PFIs to the MPF Program.
Total investment securities increased 23% at year-end 2018 to $21.3 billion, as we increased our purchase of Treasury securities and mortgage-backed securities.
Retained earnings were $3.5 billion at year-end 2018, up from $3.3 billion at the end of 2017, and we remained in compliance with all of our regulatory capital requirements.
Letter of credit commitments increased to $24.3 billion at year-end 2018, up from $19.6 billion at year-end 2017.
Summary and Outlook

Providing Products, Solutions, and Competitive Funding Advantages

During 2018, the Bank maintained its focus on delivering value to members through products and customized funding solutions which contributed to strong growth in advances, letters of credit, and MPF Program products outstanding. At year-end 2018, advances were $52.6 billion, up 9% from year-end 2017. Letters of credit also experienced notable growth. At year-end 2018, 205 members had letters of credit outstanding of $24.3 billion, up 24% from year-end 2017. At year-end 2018, MPF loans outstanding on our balance sheet were $7.1 billion, up 37% from year-end 2017.

Throughout the year, the Board of Directors increased the dividends declared on both Class B1 activity stock and B2 membership stock. The increased dividends enabled the Bank to use its financial strength to enhance the value of its members’ membership by providing a competitive funding advantage and lowering members’ all-in borrowing costs.

Preparing for Industry Transition to SOFR

In 2018, the Bank began preparations to address an industry transition - the switch from LIBOR to its likely alternative, SOFR. The FHLB system, as a leading issuer of LIBOR-indexed securities, has a key role to play in this transition; the FHLB system issued its first SOFR-indexed debt in November 2018. In January 2019, the Bank participated in its first SOFR-indexed floating rate note issuance, and in February 2019, the Bank began offering its first SOFR-indexed advance.


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


Making Members’ Voices Heard

Last year, Bank members voiced their opinions on important matters in the areas of affordable housing and letters of credit. As a result of members’ efforts, the FHFA revised its proposed amendments to the Affordable Housing Program regulations and produced a final rule that allows the program to evolve with the affordable housing needs of the communities members serve and enables the Bank to administer the program more efficiently. For further discussion of this rule, see Recent Legislative and Regulatory Developments on page 14. Also, with substantial help from the Wisconsin Bankers Association and the Wisconsin Credit Union League, legislation was enacted in Wisconsin clarifying that Wisconsin members may use FHLB letters of credit to collateralize local school and municipal deposits, ensure better parity for state bank, thrift, and credit union members regarding their collateral values, and provide protections for an FHLB in the event of a member insurance company insolvency. For further discussion of this rule, see Recent Legislative and Regulatory Developments on page 16.

Supporting Affordable Housing

Providing access to affordable housing is central to the Bank’s mission to help its members support their communities. In 2018, over $28.3 million was awarded through the Bank’s competitive AHP to support 47 affordable housing projects located primarily in Illinois and Wisconsin. These awards will help members’ community partners with the acquisition, rehabilitation, and new construction of 2,566 housing units. In 2018, 199 members reserved over $20 million in DPP grants on behalf of 3,507 homebuyers in their communities; these grants provide down payment and closing cost assistance to help members’ income-eligible customers achieve homeownership. In response to member feedback, the Bank opened the DPP Program in January in 2019 so members can begin reserving funds as soon as possible. Since 1989, the Bank has awarded more than $455 million in competitive AHP grants and more than $193 million in DPP grants.

Taking Care of Communities in Times of Need

In 2018, communities in the Bank’s district experienced multiple weather disasters; communities in northern, western, and central Wisconsin counties were FEMA-declared disaster areas due to severe storms and flooding. The Bank responded to these disasters by making available Community First Disaster Relief Program funding to support the rebuilding efforts. Since the program’s inception in November 2013, the Bank has committed over $1.3 million in disaster relief funding across Illinois and Wisconsin.

Expanding Members’ Community Investment Footprint

Many members are expanding their use of the Bank’s community investment programs and products to deepen their support of local areas through economic development and small business lending. The Community Small Business Advance, introduced in July 2018, is a means for members to support economic revitalization efforts in income-eligible communities. In 2018, $947,795 in interest rate subsidy was reserved, representing $7.5 million in anticipated lending to small businesses. Funding is being used to support a variety of small business needs, such as refinancing a grocery store, a crop farm, and a forestry and logging company; helping a local business expand by hiring more employees; and growing a transportation fleet.

In 2018, $252,304 was committed to the Community First Capacity-Building Grant Program bringing the program’s two-year funding total to $502,304. Over the course of this time period, 11 members partnered with 13 organizations to help expand their capacity, and in turn, increase economic development in the communities they serve across Illinois and Wisconsin. Through this successful program, capacity-building grants up to $50,000 provided assistance to qualifying nonprofit lenders to build their financial, operational, and human capital.

The Bank committed $47 million of the $50 million revolving Community First Fund by year-end 2018 as part of its ongoing effort to directly fund community development financial institutions and community development loan funds.


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logoa43.jpgFederal Home Loan Bank of Chicago 
(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 are 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 validation 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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logoa43.jpgFederal Home Loan Bank of Chicago 
(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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logoa43.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 credit OTTI reversals;
Amortization of fair value and cash flow 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 debt securities. Fair value carrying amount is used to compute average balances for our trading debt 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.

The change in volume is calculated as the change in average balance multiplied by the current year yield. The change in rate is calculated as the change in yield multiplied by the prior year average balance. Any changes due to the combined volume/rate variance have been allocated to volume.



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logoa43.jpgFederal Home Loan Bank of Chicago 
(Dollars in tables in millions except per share amounts unless otherwise indicated)


2018 compared to 2017
 
 
2018
 
2017
 
Increase (decrease) due to
 
 
Average Balance
 
Total Interest  
 
Yield/ Rate
 
Average Balance
 
Total Interest  
 
Yield/ Rate
 
Volume
 
Rate
 
Net Change
For the years ended December 31,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment debt securities
 
$
18,206

 
$
678

 
3.72
%
 
$
18,217

 
$
656

 
3.60
%
 
$

 
$
22

 
$
22

Advances
 
55,479

 
1,157

 
2.09
%
 
46,996

 
560

 
1.19
%
 
174

 
423

 
597

MPF Loans held in portfolio
 
5,891

 
247

 
4.19
%
 
4,946

 
213

 
4.31
%
 
40

 
(6
)
 
34

Federal funds sold and securities purchased under agreements to resell
 
11,368

 
208

 
1.83
%
 
11,040

 
115

 
1.04
%
 
6

 
87

 
93

Other interest bearing assets
 
1,192

 
25

 
2.10
%
 
1,270

 
14

 
1.10
%
 
(2
)
 
13

 
11

Interest bearing assets
 
92,136

 
2,315

 
2.51
%
 
82,469

 
1,558

 
1.89
%
 
246


511

 
757

Noninterest bearing assets
 
828

 
 
 
 
 
821

 
 
 
 
 


 


 


Total assets
 
92,964

 
 
 
 
 
83,290

 
 
 
 
 


 


 


Consolidated obligation discount notes
 
41,336

 
857

 
2.07
%