FEDERAL HOME LOAN BANK OF CINCINNATI – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Accordingly, recalculations based upon the disclosed amounts (millions)

may not produce the same results.

    The net gains on held-to-maturity securities in 2012 occurred from the sales of $478 million of mortgage-backed securities. Each of the securities sold had less than 15 percent of the original acquired principal remaining and were sold under the FHLBank's periodic clean-up process. The gains represent potential future lost income from the higher yielding securities sold.  The larger other non-interest loss in 2012 and 2011 was due primarily to higher losses on trading securities. As discussed above in "Components of Net Interest Income," the losses on the trading securities occurred because these securities had above-market coupon rates and, therefore, were purchased at prices above par. The related premiums paid are reflected as mark-to-market losses to the securities as their fair values approach par at maturity. As noted earlier, the resulting net earnings from the trading securities reflected at-market returns.  

Other expenses continued to be relatively stable in 2012 compared to 2011 and 2010.

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  Effect of Derivatives and Hedging Activities (In millions)                                        2012           2011    

2010

 Net gains (losses) on derivatives and hedging activities Advances: Gains on fair value hedges                       $        7     $        8     $         8 Losses on derivatives not receiving hedge accounting                                               (5 )           (9 )            (7 ) Mortgage loans: Gains (losses) on derivatives not receiving hedge accounting                                          1             (4 )             2 Consolidated Obligation Bonds: Gains on fair value hedges                                -              1               1 Gains on derivatives not receiving hedge accounting                                                6              2               4 Total net gains (losses) on derivatives and hedging activities                                        9             (2 )             8 Net gains (losses) on financial instruments held at fair value (1)                                         2             (3 )             - Total net effect of derivatives and hedging activities                                       $       11     $       (5 )   $         8   (1)    Includes only those gains or losses on financial instruments held at fair        value that have an economic derivative "assigned."    The changes in net gains (losses) on derivatives and hedging activities represented unrealized market value adjustments. The amounts of income volatility in derivatives and hedging activities were relatively modest compared to the notional principal amounts, well within the range of normal historical fluctuation, and consistent with the close hedging relationships of our derivative transactions. In each of the years shown, the market value adjustment, as a percentage of notional derivatives principal, was less than 0.10 percentage points.  

REFCORP and Affordable Housing Program Assessments

  Until the third quarter of 2011, assessments against earnings had included both a REFCORP obligation and expenses for the Affordable Housing Program. The FHLBank System's REFCORP obligation was satisfied at the end of the second quarter of 2011. Under the Capital Agreement of 2011, the REFCORP obligation, which had been recorded as reduction to net income, was replaced with a 20 percent allocation of net income to restricted retained earnings for all FHLBanks. Although the restricted retained earnings are not recorded in the income statement, they are not available to be distributed as dividends to stockholders. Therefore, the replacement of REFCORP with the Capital Agreement had only a marginal impact on net earnings available for distribution as dividends. See Item 1's "Capital Resources" section for more information.  This change resulted in a $19 million increase in 2012's net income compared to that in 2011 and a corresponding reduction in assessments. There have been no changes in our Affordable Housing Program.  

In 2012, assessments totaled $27 million and lowered ROE by 0.72 percentage points. In 2011, assessments totaled $37 million and lowered ROE by 1.03 percentage points. The smaller impact of assessments on ROE in 2012 was due to the satisfaction of the REFCORP obligation.

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Analysis of Quarterly ROE

The following table summarizes the components of 2012's quarterly ROE and provides quarterly ROE for 2011 and 2010.

                                   1st Quarter   2nd Quarter   3rd Quarter   4th Quarter     Total Components of 2012 ROE: Net interest income: Other net interest income             9.39  %       8.75  %       9.37  %       8.12  %       8.88  % Net (amortization)/accretion         (0.63 )       (3.13 )       (0.85 )       (0.61 )       (1.27 ) Prepayment fees                       0.39          0.18          0.19          1.26          0.53 Total net interest income             9.15          5.80          8.71          8.77          8.14 (Provision)/reversal for credit losses                               (0.16 )           -          0.05         (0.05 )       (0.04 ) Net interest income after (provision)/reversal for credit losses                                8.99          5.80          8.76          8.72          8.10 Net gains (losses) on derivatives and   hedging activities                  0.42          0.35          0.36         (0.16 )        0.23 Other non-interest (loss) income     (0.50 )        2.10         (0.80 )       (0.22 )        0.12 Total non-interest (loss) income     (0.08 )        2.45         (0.44 )       (0.38 )        0.35 Total revenue                         8.91          8.25          8.32          8.34          8.45 Total other expense                  (1.64 )       (1.52 )       (1.57 )       (1.40 )       (1.53 ) Assessments                          (0.77 )       (0.70 )       (0.70 )       (0.72 )       (0.72 ) 2012 ROE                              6.50  %       6.03  %       6.05  %       6.22  %       6.20  %  2011 ROE                              4.80  %       4.28  %       2.07  %       4.44  %       3.89  %  2010 ROE                              4.98  %       4.66  %       4.11  %       4.94  %       4.67  %    Quarterly ROEs increased to levels above six percent in 2012 due to the factors discussed above, most notably management's asset-liability and market risk strategies, higher Advance prepayment fees, lower net amortization, and the reduction in provision for credit losses. The growth in Advance balances affected primarily the third and fourth quarters of the year. In the second quarter of 2012, almost all of the unfavorable impact of an increase in net amortization was offset by gains from the clean-up sale of mortgage-backed securities, which is accounted for in the "Other non-interest (loss) income" component in the table above. Because quarterly ROE was modestly volatile in 2012 and significantly higher than short-term interest rates, we were able to distribute relatively stable quarterly dividend returns to stockholders in 2012.  

ROE in the third quarter of 2011 was negatively affected mostly by a large increase in net amortization due to declines in mortgage rates in that quarter. Excluding that quarter, quarterly ROE was relatively stable in 2010 and 2011.

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Segment Information

  Note 19 of the Notes to Financial Statements presents information on our two operating business segments. We manage financial operations and market risk exposure primarily at the macro level, and within the context of the entire balance sheet, rather than exclusively at the level of individual segments. Under this approach, the market risk/return profile of each segment may not match, or possibly even have the same trends as, what would occur if we managed each segment on a stand-alone basis. The tables below summarize each segment's operating results for the periods shown.    (Dollars in millions)                        Traditional Member      Mortgage Purchase                                                    Finance                Program              Total 2012 Net interest income after provision for credit losses                                $          210          $          97          $      307 Net income                                   $          154          $          81          $      235 Average assets                               $       58,708          $       7,994          $   66,702 Assumed average capital allocation           $        3,335          $         454          $    3,789 Return on Average Assets (1)                           0.26 %                 1.01 %              0.35 % Return on Average Equity (1)                           4.62 %                17.76 %              6.20 %  2011 Net interest income after provision for credit losses                                $          176          $          61          $      237 Net income                                   $          100          $          38          $      138 Average assets                               $       59,563          $       7,725          $   67,288 Assumed average capital allocation           $        3,148          $         408          $    3,556 Return on Average Assets (1)                           0.17 %                 0.49 %              0.21 % Return on Average Equity (1)                           3.18 %                 9.35 %              3.89 %  2010 Net interest income after provision for credit losses                                $          180          $          82          $      262 Net income                                   $          109          $          55          $      164 Average assets                               $       60,632          $       8,735          $   69,367 Assumed average capital allocation           $        3,077          $         444          $    3,521 Return on Average Assets (1)                           0.18 %                 0.63 %              0.24 % Return on Average Equity (1)                           3.55 %                12.45 %              4.67 %  

(1) Amounts used to calculate returns are based on numbers in thousands.

Accordingly, recalculations based upon the disclosed amounts (millions)

       may not produce the same results.      Traditional Member Finance Segment The increase in net income and ROE in 2012 reflected primarily the following factors (each factor is discussed in more detail in sections above):  

? the ending of the REFCORP obligation;

? our actions on asset-liability management and market risk exposure;

? higher Advance prepayment fees;

? gains on sales of mortgage-backed securities;

  ? Advance growth;                                           52

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? increase in unrealized gains on derivatives and hedging activities; and

? a $14 million decrease in net amortization of mortgage-backed securities,

       due to our actions to reduce the premium balance of mortgage-backed        securities.    MPP Segment The MPP continued to earn a substantial level of return compared with market interest rates, with a moderate amount of market risk and credit risk. In 2012, the MPP averaged 12 percent of total average assets but accounted for 34 percent of earnings. The substantial increase in the MPP's net income and ROE in 2012 reflected the following factors in estimated order of importance, which are discussed in more detail above; ? our actions related to asset-liability management and market risk exposure;   

? the decrease in the provision for credit losses; and

? the ending of the REFCORP obligation.

   The previous factors were partially offset by lower spreads on new MPP loans relative to spreads earned on MPP principal paid down. The amount of MPP net amortization was similar in 2012 and 2011, $38 million versus $35 million, respectively.  Compared to the Traditional Member Finance segment, the MPP segment can exhibit more earnings volatility relative to short-term interest rates and more credit risk exposure, but also provides the opportunity for enhancing risk-adjusted returns which normally augments earnings. As discussed elsewhere, although mortgage assets are the largest source of our market risk, we believe that we have historically managed the risk prudently and that these assets do not excessively elevate the balance sheet's overall market risk exposure.   

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK MANAGEMENT

Market Risk

Overview

 Market risk exposure is the risk that net income and the value of stockholders' capital investment in the FHLBank may decrease, and that our profitability may be uncompetitive as a result of changes and volatility in the market environment and business conditions. Along with business/strategic risk, market risk is normally one of our largest residual risks. We attempt to minimize market risk exposure within a prudent range while earning a competitive return on members' capital stock investment. There is normally a tradeoff between long-term market risk exposure and shorter-term exposure. Effective management of both components is important in order to attract and retain members and capital and to support Mission Asset Activity.  The primary challenges in managing market risk exposure arise from 1) the tradeoff between earning a competitive return and correlating profitability with short-term interest rates and 2) the market risk exposure of owning mortgage assets. Mortgage assets grant homeowners prepayment options that tend to adversely affect us when interest rates increase or decrease. We mitigate the market risk of mortgage assets primarily with a portfolio of long-term unswapped fixed-rate callable and noncallable Bonds that have expected cash flows similar to the aggregate cash flows expected from mortgage assets under a wide range of interest rate and prepayment environments. Because it is normally cost-prohibitive to completely mitigate mortgage prepayment risk, a residual amount of market risk normally remains after funding and hedging activities.  We analyze market risk using numerous analytical measures under a variety of interest rate and business scenarios, including stressed scenarios, and perform sensitivity analyses on the many variables that can affect market risk, using several market risk models from third-party software companies. These models employ rigorous valuation techniques for the optionality that exists in mortgage prepayments, call and put options, and caps/floors. We regularly assess the effects of different assumptions, techniques and methodologies on the measurements of market risk exposure, including comparisons to alternative models and information from brokers/dealers.  We have historically emphasized strategies aimed at ensuring a moderate level of market risk, with the goal of providing a competitive earnings stream over a wide variety of market and business environments and having a relatively small amount of earnings volatility. These strategies include, among others: 1) conservative management of market risk exposure, 2) controlled growth in mortgage assets and 3) accounting and hedging practices that attempt to appropriately minimize earnings volatility from the use of derivatives.                                          53

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  Policy Limits on Market Risk Exposure We have five sets of policy limits regarding market risk exposure, which primarily address long-term market risk exposure. We determine compliance with our policy limits at every month end or more frequently if market or business conditions change significantly or are volatile.  ?      Market Value of Equity Sensitivity. The market value of equity for the        entire balance sheet in two hypothetical interest rate scenarios (up 200        basis points and down 200 basis points from the current interest rate        environment) must be between positive and negative 15 percent of the        current balance sheet's market value of equity. The interest rate

movements are "shocks," defined as instantaneous, permanent, and parallel

       changes in interest rates in which every point on the yield curve is        changed by the same amount.   

? Duration of Equity. The duration of equity for the entire balance sheet in

the current ("flat rate" or "base case") interest rate environment must be

between positive and negative six years. In addition, the duration of

equity in each of the two interest rate shock scenarios must be within

       positive and negative eight years.    ?      Market Capitalization. The market capitalization ratio (defined as the

ratio of the market value of equity to the par value of regulatory stock)

must be above 95 percent in the current rate environment and must be above

       85 percent in each of the two interest rate shock scenarios.   

? Mortgage Assets Portfolio. The net market value of the mortgage assets

portfolio as a percentage of the book value of portfolio assets must be

between positive and negative three percent in each of the two interest

rate shock scenarios. Net market value is defined as the market value of

assets minus the market value of liabilities, with no assumed capital

       allocation.    ?      Mortgage Assets as a Multiple of Regulatory Capital. The amount of

mortgage assets must be less than seven times the amount of regulatory

        capital.    In addition, Finance Agency Regulations and an internal policy provide controls on market risk exposure by restricting the types of mortgage loans, mortgage-backed securities and other investments we can hold. Historically, our purchases of collateralized mortgage obligations have tended to be the front-end prepayment tranches, which can have less prepayment volatility than other tranches. We also manage market risk exposure by charging members prepayment fees on many Advance programs where an early termination of an Advance would result in an economic loss to us.                                          54

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  Market Value of Equity and Duration of Equity - Entire Balance Sheet Two key measures of long-term market risk exposure are the sensitivities of the market value of equity and the duration of equity to changes in interest rates and other variables, as presented in the following tables for various instantaneous and permanent interest rate shocks. Average results are compiled using data for each month end. Given the current very low level of rates, the down rate shocks are nonparallel scenarios, with short-term rates decreasing less than long-term rates so that no rate falls below zero.  Market Value of Equity (Dollars in millions)    Down 300      Down 200      Down 100       Flat Rates       Up 100        Up 200        Up 300 Average Results 2012 Full Year Market Value of Equity  $  4,281      $  4,279      $  4,292      $      4,330     $  4,337      $  4,186      $  3,955 % Change from Flat Case     (1.1 )%       (1.2 )%       (0.9 )%              -          0.2  %       (3.3 )%       (8.7 )% 2011 Full Year Market Value of Equity  $  3,944      $  3,972      $  4,026      $      4,108     $  4,075      $  3,904      $  3,692 % Change from Flat Case     (4.0 )%       (3.3 )%       (2.0 )%              -         (0.8 )%       (5.0 )%      (10.1 )%   Month-End Results December 31, 2012 Market Value of Equity  $  4,991      $  4,976      $  4,947      $      4,878     $  4,759      $  4,585      $  4,401 % Change from Flat Case      2.3  %        2.0  %        1.4  %              -         (2.4 )%       (6.0 )%       (9.8 )% December 31, 2011 Market Value of Equity  $  3,958      $  3,964      $  3,996      $      4,090     $  4,191      $  4,102      $  3,915 % Change from Flat Case     (3.2 )%       (3.1 )%       (2.3 )%              -          2.5  %        0.3  %       (4.3 )%    Duration of Equity 

(In years) Down 300 Down 200 Down 100 Flat Rates Up 100

  Up 200    Up 300 Average Results 2012 Full Year        1.8         1.3         0.4         (1.4 )       2.0       4.9       6.4 2011 Full Year       (0.2 )      (0.8 )      (1.4 )       (1.1 )       3.2       5.3       6.0   Month-End Results December 31, 2012     1.8         1.8         1.8          1.9         3.2       4.1       4.1 December 31, 2011     0.5        (0.3 )      (1.2 )       (3.8 )       0.5       3.7       5.5    In 2012, the average market risk exposure to both higher and lower interest rates, similar to 2011, was moderate, well within policy limits, and below long-term historical average exposure. Overall market risk exposure and earnings trends to further reductions in long-term rates are benefiting from slower mortgage prepayment speeds, given the level of rates, than would be expected under normal conditions for housing markets where homeowner equity is widely sufficient and credit is more accessible.  Consistent with 2011, there were several periods in 2012 where long-term rates fell to historical lows, which were key contributors in the moderate levels of market risk exposure, particularly to rising rate scenarios.  Late in the second quarter and during the third quarter of 2012, we took actions to moderately raise market risk exposure, primarily by increasing beyond the long-term historical average the amount of long-term mortgage assets we funded with short-term debt and lowering the average maturity of long-term Bonds. The elevated market risk exposure substantially raised earnings in the third quarter and somewhat less for the full year, as discussed in "Results of Operations." In the fourth quarter, we reduced market risk exposure to within the historical range by issuing long-term Bonds.  Over the last several years and especially in the latter half of 2012, we and our model vendors made several changes to the market risk and prepayment models we use, in order to adapt them to the constantly evolving and unprecedented conditions in                                         55

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  the mortgage and housing markets. These modeling enhancements modestly slowed prepayment speeds in many rate environments and reduced the sensitivity of the market risk measures to rate changes. Overall, the impacts of the modeling changes were to moderately increase measured market risk exposure to rising interest rate scenarios and to moderately increase expected earnings trends. We have no current plans to implement any additional model enhancements, but there is a possibility we will make future improvements as conditions in the mortgage and housing markets continue to evolve.  Based on the totality of our market risk analysis, we expect that profitability, defined as the level of ROE compared with short-term market rates, will remain competitive unless interest rates change by extremely large amounts in a short period of time. Decreases in long-term interest rates even up to two percentage points (which would put fixed-rate mortgages at two percent or less) would still result in ROE being above market interest rates. We believe that profitability would not become uncompetitive unless long-term rates were to permanently increase in a short period of time by four percentage points or more combined with short-term rates increasing to at least seven percent. Such large changes in interest rates would not result in negative earnings, unless these rate environments occurred quickly, lasted for a long period of time, and were coupled with very unfavorable changes in other market and business variables or our business model. We believe such a scenario is extremely unlikely to occur.  Market Capitalization Ratio The ratio of the market value of equity to the par value of regulatory capital stock (called the "market capitalization ratio") indicates the theoretical net market value of portfolio assets after subtracting the theoretical net market cost of liabilities. The market capitalization ratio excludes retained earnings in the denominator and therefore shows the ability of the market value of equity to protect the value of stockholders' investment in our company.  To the extent the market capitalization ratio differs from 100 percent, it can represent potential real economic gains or losses, unrealized opportunity benefits or costs, temporary fluctuations in asset or liability prices, or market value remaining in a liquidation of the FHLBank in which all assets were sold and all liabilities were terminated or transferred. The ratio does not sufficiently measure the value of our company as a going concern because it does not consider franchise value, future new business activity, future risk management strategies, or the net profitability of assets after funding costs.  

The following table presents the market capitalization ratios for the interest rate environments for which we have policy limits, as described above.

                                                        Monthly Average                                                            Year Ended                                                           December 31,                                    December 31, 2012          2012          December 31, 2011 Market Value of Equity to Par Value of Regulatory Capital Stock           116 %                 121 %              120 % Market Value of Equity to Par Value of Regulatory Capital Stock - Down Shock of 200 bps                     117                   120       

118

 Market Value of Capital to Par Value of Regulatory Capital Stock - Up Shock of 200 bps                       109                   117                121    In 2012, the market capitalization ratios in the scenarios indicated continued to be well above 100 percent and in compliance with policy limits, but trended modestly lower during the fourth quarter of 2012. The overall favorable level of these measures provides additional support for our assessment that we have a moderate amount of overall market risk exposure.  Even with the recent decline, the ratios remain at favorable (high) levels due to the combination of 1) the fact that retained earnings are currently 13 percent of regulatory capital stock, 2) we have maintained market risk exposure at moderate levels, and 3) market prices of mortgage assets continue to be at elevated levels compared to prices of our Bonds. The factors causing the modest reduction observed in the fourth quarter were moderately lower mortgage asset pricing and an overall reduction in total mortgage assets relative to capital.                                          56

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  Market Risk Exposure of the Mortgage Assets Portfolio The mortgage assets portfolio accounts for almost all of our market risk exposure because of prepayment volatility that we cannot completely hedge while maintaining positive net spreads. Sensitivities of the market value of equity allocated to the mortgage assets portfolio under interest rate shocks (in basis points) are shown below. At December 31, 2012 the mortgage assets portfolio had an assumed par-value equity (capital) allocation of $1.2 billion based on the entire balance sheet's regulatory capital-to-assets ratio. Average results are compiled using data for each month-end. The market value sensitivities are one measure we use to analyze the portfolio's estimated market risk exposure.  

% Change in Market Value of Equity-Mortgage Assets Portfolio

                  Down 300    Down 200    Down 100    Flat Rates    Up 100     Up 200     Up 300 Average Results 2012 Full Year      (9.2 )%     (8.2 )%     (5.4 )%            -     2.0  %    (8.2 )%   (24.7 )% 2011 Full Year     (20.1 )%    (15.8 )%     (9.2 )%            -    (1.0 )%   (14.6 )%   (32.1 )%   Month-End Results December 31, 2012    3.5  %      3.5  %      3.1  %            -   (10.0 )%   (24.0 )%   (39.1 )% December 31, 2011  (17.1 )%    (15.2 )%    (10.3 )%            -    10.3  %     4.2  %   (10.6 )%    The sensitivities indicate that the market risk exposure of the mortgage assets portfolio had similar trends across interest rate shocks as those of the entire balance sheet. The dollar amount of exposure for any individual rate shock can be obtained by multiplying the percentage change by the assumed equity allocation. We believe the mortgage assets portfolio continues to have a moderate amount of market risk exposure relative to the inherent market risks of owning mortgages and relative to their actual and expected profitability. We believe this exposure is consistent with our conservative risk philosophy and cooperative business model.                                          57

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  Use of Derivatives in Market Risk Management The following table presents the notional principal amounts of the derivatives used to hedge other financial instruments classified by how we designate the hedging relationship. (In millions)                                              December 31, 2012                       December 31, 2011 Hedged Item/Hedging Instrument                  Hedging Objective     Fair Value Hedge    Economic Hedge      Fair Value Hedge     Economic Hedge Advances: Pay-fixed, receive       Converts the Advance's floating interest rate       fixed rate to a swap (without options)    variable rate index.   $      1,519       $              -     $        2,269      $              - Pay-fixed, receive       Converts the Advance's floating interest rate       fixed rate to a swap (with options)      variable rate index and                          offsets option risk in                               the Advance.              2,604                    174              7,326                   184 Pay-float with embedded   Reduces interest-rate features, receive            sensitivity and floating interest rate      repricing gaps by swap (non-callable)        offsetting embedded                            option risk in the                                 Advance.                   35                      -                 70                     - Total Advances                                          4,158                    174              9,665                   184 Mortgage Loans: Forward settlement          Protects against agreement                changes in market value                          of fixed rate Mandatory                            Delivery Contracts                          resulting from changes                            in interest rates.               -                      -                  -                   375 Consolidated Obligations Bonds: Receive-fixed, pay         Converts the Bond's floating interest rate       fixed rate to a swap (without options)    variable rate index.          2,269                  3,400              2,229                 3,570 Receive-fixed, pay         Converts the Bond's floating interest rate       fixed rate to a swap (with options)      variable rate index and                          offsets option risk in                                 the Bond.               1,835                    200              1,780                 1,325 Total Consolidated Obligations   Bonds                                                 4,104                  3,600              4,009                 4,895 Stand-Alone Derivatives: Mandatory Delivery        Protects against fair Contracts                 value risk associated                              with fixed rate                             mortgage purchase                               commitments.                  -                    124                  -                   431 Total                                            $      8,262       $          3,898     $       13,674      $          5,885     

In addition to issuing long-term Bonds, an important way that we manage and hedge market risk exposure is by engaging in derivatives transactions, primarily interest rate swaps. Our hedging and risk management strategies in using derivatives did not change materially in 2012 from 2011, nor were there any changes in the accounting treatment of new or existing derivative hedge transactions that materially affected our results of operations.

  The amount of derivatives we used to hedge Advances decreased in 2012 because such Advances matured, whereas most of the Advance growth in 2012 was funded by unswapped Consolidated Obligations.  

In 2011, we began to account for certain Bond-related derivatives using an accounting election called "fair value option," which is included in the economic hedge category in the table. This change in accounting election resulted in a negligible amount of additional unrealized earnings volatility from accounting for derivatives. See "Critical Accounting Policies and Estimates" for further discussion.

The differences between accounting under "fair value option" and under "fair value hedge" are:

1) "Fair value hedge" accounting carries the risk that hedge effectiveness

testing may fail, which results in recording the derivative at its fair

market value with no offsetting changes in the market value of the hedged

instrument.

2) "Fair value option" accounting records the fair market value of the hedged

instrument at its full fair value instead of only the value of hedging the

       benchmark interest rate (designated to be LIBOR for these swaps).                                            58

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  Table of Contents  Capital Adequacy  Capital Leverage Prudent risk management dictates that we maintain effective financial leverage to minimize risk to our capital stock while preserving profitability and that we hold an adequate amount of retained earnings. Pursuant to these objectives, Finance Agency Regulations stipulate that we must comply with three limits on capital leverage and risk-based capital.  

? We must maintain at least a four percent minimum regulatory

capital-to-assets ratio. This has historically been the regulatory capital

requirement that has the greatest effect on our operations.

? We must maintain at least a five percent minimum leverage ratio of capital

divided by total assets, which includes a 1.5 weighting factor applicable

       to permanent capital. Because all of our Class B stock is permanent        capital, this requirement is met automatically if we satisfy the four        percent unweighted capital requirement.  

? We are subject to a risk-based capital rule, as discussed below.

    We have always complied with each capital requirement. The regulatory capital ratio averaged 6.07 percent in 2012. The regulatory capital-to-assets ratio at December 31, 2012 was 5.84 percent, which means that, given the amount of regulatory capital, total assets could increase by at least $37 billion before the capital-to-assets ratio would fall to four percent. This amount of growth in assets is unlikely to occur and, if it did, our Capital Plan would require us to obtain additional amounts of capital well before the four percent policy limit on capitalization would be reached.  See the "Capital Resources" section of "Analysis of Financial Condition" and Note 16 of the Notes to Financial Statements for more information on our capital adequacy.  Retained Earnings Our Board-approved Retained Earnings and Dividend Policy sets forth a range for the amount of retained earnings we believe is needed to mitigate impairment risk and augment dividend stability in light of the risks we face. The current minimum retained earnings requirement is $375 million, based on mitigating quantifiable risks under stress scenarios to at least a 99 percent confidence level. Given the recent financial and regulatory environment, we have been carrying a greater amount of retained earnings in the last several years than required by the Policy. As discussed elsewhere, we will continue to bolster capital adequacy over time by allocating a portion of earnings to a separate restricted retained earnings account in accordance with the FHLBank System's Capital Agreement.  Risk-Based Capital Regulatory Requirement We must hold sufficient capital to protect against exposure to market risk, credit risk, and operational risk. The GLB Act and Finance Agency Regulations require total permanent capital, which includes retained earnings and the regulatory amount of Class B capital stock, to be at least equal to the amount of risk-based capital. Risk-based capital is the sum of market, credit, and operational risk-based capital as specified by the Regulations. The following table shows the amount of risk-based capital required based on the measurements, the amount of permanent capital, and the amount of excess permanent capital.                                                                Monthly Average (Dollars in millions)                       Year-end 2012            2012            Year-end 2011 Market risk-based capital                  $         171       $        148         $         125 Credit risk-based capital                            205                178                   173 Operational risk-based capital                       113                 98                    89 Total risk-based capital requirement                 489                424                   387 Total permanent capital                            4,759              4,050                 3,845 Excess permanent capital                   $       4,270       $      3,626         $       3,458 Risk-based capital as a percent of permanent capital                                     10 %               10 %                  10 %    The risk-based capital requirement has historically not been a constraint on operations and we do not use it to actively manage any of our risks. It has normally ranged from 10 to 20 percent, which is significantly less than the amount of permanent capital. This measure has been at the low end of the range for several years, primarily due to the low level of interest rates during this period truncating estimated exposure to extreme lower rate scenarios.                                          59

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  Table of Contents  Credit Risk  Overview We assume a substantial amount of inherent credit risk exposure in our dealings with members, purchases of investments, and transactions of derivatives. For the reasons detailed below, we believe we have a minimal overall amount of residual credit risk exposure related to our Credit Services, purchases of investments, and transactions in derivatives and a moderate amount of legacy credit risk exposure related to the MPP.  Credit Services Overview. We have policies and practices to manage credit risk exposure from our secured lending activities, which include Advances and Letters of Credit. The objective of our credit risk management is to equalize risk exposure across members and counterparties to a zero level of expected losses, consistent with our conservative risk management principles and desire to have no residual credit risk related to member borrowings. Despite continued effects from the deterioration in the last five years in the credit conditions of many of our members and in the value of some pledged collateral, we believe that credit risk exposure in our secured lending activities continued to be minimal in 2012. We base this assessment on the following factors:  

? a conservative approach to collateralizing credit services that results in

significant over-collateralization;

? close monitoring of members' financial conditions and repayment capacities;

  ?      a risk-focused process for reviewing and verifying the quality,        documentation, and administration of pledged loan collateral;  

? significant upward adjustments on collateral margins assigned to almost

all of the subprime and nontraditional mortgages pledged as collateral;

and

? a history of never experiencing a credit loss or delinquency on any Advance.

Because of these factors, we have never established a loan loss reserve for Advances. We expect to collect all amounts due according to the contractual terms of Advances and Letters of Credit.

  Collateral. We require each member to provide us a security interest in eligible collateral before it can undertake any secured borrowing. At December 31, 2012, our policy of over-collateralization resulted in total collateral pledged of $198.0 billion to serve members' total borrowing capacity of $140.4 billion. Lower borrowing capacity results because we apply Collateral Maintenance Requirements (CMRs) to discount the estimated value of pledged collateral in order to mitigate market, credit, and liquidity risks that may affect the collateral's realizable value in the event we must liquidate it. Over-collateralization by one member is not applied to another member.  

The table below shows the total pledged collateral (unadjusted for CMRs) on December 31, 2012 and 2011.

December 31, 2012

December 31, 2011

                             Collateral Amount       Percent of Total       Collateral Amount       Percent of Total                                ($ Billions)        Pledged Collateral         ($ Billions)        Pledged Collateral Single family loans       $         111.6                      56 %      $          97.0                      62 % Bond securities                      25.0                      13                   13.5                       8 Home equity loans/lines of credit                            24.1                      12                   26.2                      17 Commercial real estate               19.2                      10                   17.1                      11 Multi-family loans                   17.6                       9                    2.6                       2 Farm real estate                      0.5                     (a)                    0.4                     (a) Total                     $         198.0                     100 %      $         156.8                     100 %   

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

    At December 31, 2012, 68 percent of collateral was related to residential mortgage lending in single family loans and home equity lines. The increase in multi-family loans and bond securities between these two periods was due to the collateral pledged by a large new member.                                          60--------------------------------------------------------------------------------
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  We assign each member one of four levels of collateral status-Blanket, Securities, Listing, and Physical Delivery-based in part on our internal credit rating model that reflects our view of the member's current financial condition, capitalization, level of problem assets, and other risk factors. Blanket collateral status, which we assign to approximately 85 percent of borrowers, is the least restrictive status and is available for lower risk institutions. Over 90 percent of single family mortgage loan collateral and commercial real estate collateral and almost all home equity loan collateral are under the Blanket status. We monitor eligible collateral pledged under Blanket status using quarterly regulatory financial reports or periodic collateral "Certification" documents submitted by all significant borrowers.  Under Listing collateral status, a member pledges and provides us detailed information on specifically identified individual loans and securities that meet certain minimum qualifications. Physical Delivery is the most restrictive collateral status, which we assign to members experiencing significant financial difficulties, insurance companies pledging loans, and newly chartered institutions. We require borrowers assigned to Physical Delivery to deliver into our possession securities and/or original notes, mortgages or deeds of trust. Some members may pledge bond securities, which we hold in Physical Delivery collateral status. We regularly estimate market values of collateral under Listing and Physical status using detailed information on the collateral and a third-party pricing service.  Borrowing Capacity/Lendable Value. We determine borrowing capacity against pledged collateral by applying CMRs. CMRs are intended to capture market, credit, liquidity, and prepayment risks that may affect the realizable value of each pledged asset in the event we must liquidate collateral. CMRs are discounts determined by statistical analysis and certain management assumptions applied to the estimated market value of pledged collateral, and therefore their application results in borrowing capacity that is less than the amount of pledged collateral. The discounts are determined by dividing one by the CMR; for example, a CMR of 150 percent translates into a discount of 66.7 percent, which means that 66.7 percent of the value is eligible for borrowing. Members and collateral with a higher risk profile, more risky credit quality, and/or less favorable performance are generally assigned higher CMRs.  The table below indicates the range of lendable values remaining after the application of CMRs for each major collateral type pledged at December 31, 2012.                                                           Lending Values                                                             Applied to                                                             Collateral Blanket Status 1-4 family loans                                              67-83% Multi-family loans                                            41-53% Home equity loans/lines of credit                             48-63% Commercial real estate loans                                  44-56% Farm real estate loans                                        51-69%  
Listing Status/Physical Delivery Cash/U.S. Government/U.S. Treasury/U.S. agency securities     93-100% U.S. agency MBS/CMOs
                                          90-96% Private-label MBS/CMOs                                        65-87% Commercial mortgage-backed securities                         48-83% Small Business Administration certificates                      91% 1-4 family loans                                              70-83% Multi-family loans                                            57-83% Home equity loans/lines of credit                             53-69% Commercial real estate loans                                  53-67%    The ranges of lendable values for Blanket collateral status are expressed as percentages of collateral book value and exclude subprime and nontraditional mortgage loan collateral. The ranges of lendable value for Listing and Physical collateral status are expressed as a percentage of estimated market value. Loans pledged under a Blanket status generally are discounted more heavily than loans on which we have detailed loan structure and underwriting information.  We periodically evaluate the CMRs applied by completing internal evaluations or engaging third-party specialists. Beginning in June, we engaged a market-recognized vendor to perform this regular update to the CMRs. The first update, completed in July, addressed collateral composed of multi-family loans because the amount of that collateral type grew materially in June. The                                         61
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  result of the update was to increase lendable values approximately 20 to 33 percent, for this type of collateral pledged by members to whom we assign strong internal credit ratings and who elect to pledge collateral under Listing status. The second update, implemented in the first quarter of 2013, addressed all other collateral types and generally increased lendable values by a range of 5 to 30 percent, with the most notable increases existing in commercial real estate collateral. Some collateral types received no changes or minor decreases in lendable values.  The changes in CMRs were influenced by the general stabilization in the credit environment. We believe these updated CMRs maintain a rigorous amount of credit protection consistent with our conservative risk management principles.  Subprime and Nontraditional Mortgage Loan Collateral. We have policies and processes to identify subprime loans pledged by members to which we have high credit risk exposure or have extended significant credit. We perform on-site collateral reviews, sometimes engaging third parties, of members we deem to have high credit risk exposure. The reviews include identification of loans that meet our definitions of subprime and nontraditional. Our definitions of subprime loans and nontraditional mortgage loans (NTM) are expansive and conservative. During the review process, we estimate overall subprime and nontraditional mortgage exposure levels by performing random statistical sampling of residential loans in the members' pledged portfolios.  Based on our collateral reviews, we estimate that approximately 20 to 25 percent of pledged residential loan collateral has one or more subprime characteristics and that approximately five to seven percent of pledged collateral meets the industry definition of "nontraditional." These percentages have increased slightly over the last several years. We apply significantly higher adjustments to the standard CMRs on almost all collateral identified as subprime and/or nontraditional mortgages. No security known to have more than one-third subprime collateral is eligible for pledge to support additional credit borrowings.  Internal Credit Ratings. We assign all member and nonmember borrowers an internal credit rating, based on a combination of internal credit analysis and consideration of available credit ratings from independent credit rating organizations. The analysis focuses on asset quality, financial performance, earnings quality, liquidity, and capital adequacy. The credit ratings are used in conjunction with other measures of the credit risk posed by members and pledged collateral, as described above, in managing credit risk exposure of Advances. A lower internal credit rating can cause us to 1) decrease the institution's borrowing capacity via higher CMRs, 2) require the institution to provide an increased level of detail on pledged collateral, 3) require it to deliver collateral into our custody, and/or 4) prompt us to more closely and/or frequently monitor the institution using several established processes.  Collateralization of Former Members. Underwriting criteria, including the forms of collateral that may be pledged, are generally the same for members and former members. One exception is that former members of our FHLBank with outstanding Advances must either deliver sufficient collateral into our custody to cover their Advances (regardless of whether they would qualify for Blanket or Listing status as a member) or have their Advances covered by a subordination or other acceptable form of intercreditor agreement from/by another FHLBank. On December 31, 2012, we had $3,619 million of Advances outstanding to former members. Of this amount, $3,029 million was supported by subordination or other intercreditor security agreements with other FHLBanks, with collateral totaling $3,786 million based on our required collateral levels. The remaining $590 million of Advances was collateralized by $20 million of marketable securities and $1,521 million in loan collateral held in our custody. Subordination agreements mitigate our risk in the event of borrower default by giving our claim to the value of collateral priority over the interests of the subordinating FHLBank, thus providing that FHLBank an incentive to ensure pledged collateral values are sufficient to cover all parties.                                           62
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  The following tables show the distribution of internal credit ratings we assigned to member and nonmember borrowers, which we use to help manage credit risk exposure. The lower the numerical rating, the higher our assessment of the member's credit quality. (Dollars in billions)                December 31, 2012                             December 31, 2011                             Borrowers                                 Borrowers                               Collateral-Based                         Collateral-Based    Credit                         Borrowing        Credit                  Borrowing    Rating          Number         Capacity         Rating   Number         Capacity      1-3              485    $             67.9     1-3        420    $             57.0       4               126                  66.2      4         181                  41.0       5                71                   4.3      5          72                   2.0       6                31                   0.8      6          34                   0.7       7                38                   1.2      7          46                   1.8     Total             751    $            140.4    Total       753    $            102.5    A "4" rating is our assessment of the lowest level of satisfactory performance. Many members continue to be adversely affected by the last recession, the weak economic recovery, and the continued distress in the housing market, although at a lower overall level compared to trends in 2008-2011. As of December 31, 2012, 140 borrowers (19 percent of the total) had credit ratings of 5 through 7, a net decrease of 12 from the end of 2011. These members had $6.3 billion of borrowing capacity at year end. There was a net decrease of 55 members who had a 4 credit rating and a net increase of 65 members with credit ratings of 1, 2, or 3. There was a net decrease of 11 members with the two lowest credit ratings. We believe these trends indicate a general stabilization and improvement in the overall financial condition of our members, although the improvement to date has been most evident among members with already-acceptable "4" credit ratings.  
Member Failures, Closures, and Receiverships. There were three member failures during 2012. These institutions had no Advances outstanding with us.
MPP
Overview. We believe that the residual amount of credit risk exposure to loans in the MPP is moderate, based on the following factors:
?      various credit enhancements for conventional loans, which are designed to
       protect us against credit losses;   ?      conservative underwriting and loan characteristics consistent with        favorable expected credit performance;   ?      a relatively moderate overall amount of delinquencies and defaults        experienced when compared to national averages;   ?      charge-offs totaling only $4.3 million in 2012 and $9.7 million
       program-to-date through December 31, 2012 in relation to $6.4 billion of
       conventional loans unpaid principal balance at December 31, 2012; and  
?      in addition to the low program-to-date charge-offs, financial analysis
       suggesting that future credit losses will not harm capital adequacy and
       will not significantly affect profitability except under the most extreme
       and unlikely credit conditions.                                           63
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  Portfolio Loan Characteristics. The following table shows Fair Isaac and Company (FICO®) credit scores of homeowners at origination dates for the conventional loan portfolio. FICO® Score (1)              December 31, 2012     December 31, 2011 < 620                                   - %                   - % 620 to < 660                            3                     4 660 to < 700                            9                    10 700 to < 740                           18                    18 >= 740                                 70                    68  Weighted Average                      757                   754  
(1) Represents the original FICO® score.
    There was little change in the FICO® score distribution in 2012 compared with 2011. We believe the distribution of FICO® scores at origination is one indication of the portfolio's overall favorable credit quality. At the end of 2012, 70 percent of the portfolio had scores at an excellent level of 740 or above and 88 percent had scores above 700 which is a threshold generally considered indicative of homeowners' good credit quality.  A high loan-to-value ratio, in which a homeowner has little or no equity at stake, is a driver in many mortgage delinquencies and defaults. The following tables show loan-to-value ratios for conventional loans based on values estimated at the origination dates and current values estimated at the noted periods. The estimated current ratios are based on original loan values, principal paydowns that have occurred since origination, and a third-party estimate of changes in historical home prices for the metropolitan statistical area in which each loan resides. Both measures are weighted by current unpaid principal.                        Based on Estimated Origination Value                                 Based On Estimated Current Value Loan-to-Value      December 31, 2012         December 31, 2011      Loan-to-Value      December 31, 2012        December 31, 2011 <= 60%                      20 %                      21 %          <= 60%                       27 %                     26 % > 60% to 70%                18                        18            > 60% to 70%                 20                       17 > 70% to 80%                52                        52            > 70% to 80%                 29                       29 > 80% to 90%                 6                         6            > 80% to 90%                 14                       14 > 90%                        4                         3            > 90% to 100%                 5                        6                                                                     > 100%                        5                        8 Weighted Average            70 %                      70 %          Weighted Average             69 %                     72 %    Overall loan-to-value ratios of the current portfolio of loans have deteriorated moderately since origination. At December 31, 2012, 24 percent of loans were estimated to have current loan-to-value ratios above 80 percent, up from 10 percent at origination. We believe the overall trend is consistent with an acceptable credit quality of the portfolio, in light of the significant deterioration in national average housing prices in recent years. In 2012, the loan-to-value ratios improved modestly; the percentage of loans having estimated current loan-to-value ratios above 80 percent declined by four percent. We believe this decline results from, in part, the overall sustained improvement in the housing market observed in 2012.  Based on the available data, we believe we have little exposure to loans in the MPP considered to have characteristics of "subprime" or "alternative/nontraditional" loans. Further, we do not knowingly purchase any loan that violates the terms of our Anti-Predatory Lending Policy.                                          64
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The geographical allocation of conventional loans in the MPP is concentrated in Ohio, as shown on the following table based on unpaid principal balance.
            December 31, 2012                December 31, 2011 Ohio                  56 %       Ohio                  53 % Kentucky              11         Kentucky              11 Indiana                9         Indiana                8 California             3         California             3 Tennessee              2         Maryland               2 All others            19         All others            23 Total                100 %       Total                100 %    Lender Risk Account. Conventional mortgage loans are supported against credit losses by various combinations of primary mortgage insurance (PMI), supplemental mortgage insurance (SMI) and the Lender Risk Account. The Lender Risk Account is a purchase-price holdback that PFIs may receive back from us, starting after five years from the loan purchase date, for managing credit risk to pre-defined acceptable levels of exposure on loan pools they sell to us. The Lender Risk Account is funded by the FHLBank from a portion of the purchase proceeds to cover expected credit losses for a specific pool of loans. As a result, some pools of loans may have sufficient credit enhancements to recapture all losses while other pools of loans may not have enough credit enhancements to recapture all losses. The amount of loss claims against the Lender Risk Account in 2012 was approximately $3 million. The Account had balances of $103 million and $69 million at December 31, 2012 and 2011, respectively. The increase in the balance of the Account from year-end 2011 is a result of the discontinued use of SMI in 2011 as a credit enhancement and instead, augmenting credit enhancement with a greater amount of the purchase proceeds added to the Lender Risk Account. For more information, see Note 10 of the Notes to Financial Statements.  
Credit Performance. The table below provides an analysis of conventional loans delinquent or in foreclosure, along with the national average serious delinquency rate.
                                                                 Conventional Loan Delinquencies (Dollars in millions)                                     December 31, 2012         December 31, 2011 Early stage delinquencies - unpaid principal balance (1) $           64           $              82 Serious delinquencies - unpaid principal balance (2)                 76                          91 Early stage delinquency rate (3)                                    1.0 %                       1.3 % Serious delinquency rate (4)                                        1.2                         1.4 National average serious delinquency rate (5)                       3.7                         4.1   
(1) Includes conventional loans 30 to 89 days delinquent and not in foreclosure.
(2)    Includes conventional loans that are 90 days or more past due or where the
       decision of foreclosure or a similar alternative such as pursuit of        deed-in-lieu has been reported.   (3)    Early stage delinquencies expressed as a percentage of the total        conventional loan portfolio.  
(4)    Serious delinquencies expressed as a percentage of the total conventional
       loan portfolio.
(5)    National average number of fixed-rate prime conventional loans that are 90
       days or more past due or in the process of foreclosure is based on the        most recent national delinquency data available. The December 31, 2012        rate is based on September 30, 2012 data.    The MPP has experienced a moderate amount of delinquencies and foreclosures. The rates continued to be well below national averages and we expect this to continue to be the case. Delinquency rates for both the early stage and serious categories declined in 2012. We are cautiously optimistic that these data indicate an improving trend in housing market conditions, and we continue to closely monitor these data to evaluate the sustainability of the trend.  We consider a high risk loan as having a current loan-to-value ratio above 100 percent. At December 31, 2012, high risk loans had experienced relatively moderate serious delinquencies (i.e., delinquencies that are 90 days or more past due or in the process of foreclosure). For example, of the $299 million of conventional principal balances with current estimated loan-to-values above 100 percent, only $26 million (nine percent) were seriously delinquent. We believe these data further support our view that the overall portfolio is comprised of high quality loans.                                          65
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Credit Losses. The following table shows the effects of credit enhancements on the determination of the allowance for credit losses at the noted periods: (In millions)
                                   December 31, 2012             December 31, 2011 Estimated incurred credit losses, before credit enhancements                          $               (56 )         $               (64 ) Estimated amounts deemed recoverable by: Primary mortgage insurance                                     5                             5 Supplemental mortgage insurance                               25                            30 Lender Risk Account                                            8                             8 Allowance for credit losses, after credit enhancements                                 $               (18 )         $               (21 )    The data presented above are aggregated information on the health of the overall portfolio. Credit risk exposure depends on the actual and potential credit performance of the loans in each pool compared to the pool's equity (on individual loans) and credit enhancements, including PMI (for individual loans), the Lender Risk Account, and SMI.  The reduction in the allowance for credit losses at the end of 2012 compared to the end of 2011 was based primarily on a modest growth in national home prices of approximately 5 to 7 percent. This growth in national home prices resulted in a stabilization of loss severities and contributed to the decrease in the number of loans assessed to have incurred losses. We cannot predict the future course of factors that determine incurred credit losses, including home prices, macro-economic conditions such as unemployment rates, estimated loss severities, the health of mortgage insurance providers, and regulatory or accounting guidance.  In addition to the allowance for credit losses recorded, we regularly analyze, using recognized third-party credit and prepayment models, potential ranges of additional lifetime credit risk exposure for the loans in the MPP. Even under adverse scenarios for either home prices or unemployment rates (and assuming the two SMI providers continue to pay claims), we do not expect further credit losses to significantly decrease our overall annual profitability or dividends payable to members, or to materially affect our capital adequacy. For example, for an additional 20 percent decline in all home prices over the next two years, we estimate that our lifetime credit losses could increase by approximately $60 million, which would decrease annual ROE by approximately 0.23 percentage points over the next five years (most of the losses are estimated to occur in the next five years).  Credit Risk Exposure to Insurance Providers. Primary Mortgage Insurance Some of our conventional loans carry PMI as a credit enhancement feature. Based on the guidelines of the MPP, we have assessed that we do not have any credit risk exposure to the primary mortgage insurance providers.  Supplemental Mortgage Insurance Another credit enhancement feature is SMI purchased from Genworth and MGIC. Beginning February 1, 2011, we discontinued use of SMI as a credit enhancement for new loan purchases; instead, we augment credit enhancements with a greater amount of the purchase proceeds added to the Lender Risk Account. However, we have $3.3 billion of conventional loans purchased prior to February 2011 with outstanding SMI coverage through Genworth and MGIC. Over time, as existing loans in the MPP are paid off and replaced with new loans that do not rely on SMI, the amount of SMI exposure will diminish.  We subject both SMI providers to a standard credit underwriting analysis. Both providers have experienced weakened financial conditions in the last several years. Currently, the lowest credit rating from nationally recognized statistical rating organizations (NRSROs) is B- for MGIC and B for Genworth, with both on negative outlook. Our exposure to these providers is that they may be unable to fulfill their contractual coverage on loss claims. In a scenario in which home prices do not change and both providers fail to pay their insurance coverage on defaulting loans (with an assumption that we would obtain a 50 percent recovery rate), we estimate our exposure at December 31, 2012 to the providers over the life of the MPP loans to be approximately $17 million. In an adverse scenario in which home prices decline an additional 20 percent over the next two years and both providers fail to pay claims (with the same recovery assumption), we estimate exposure to be approximately $28 million.  
Based on our most-recent analysis including consulting with a third-party rating agency, we believe it is likely each provider will fulfill its contractual insurance obligations. However, this assessment is uncertain because of the combination
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  of potential impacts on the mortgage insurance industry from the current conditions in the economy and housing markets, the providers' stressed financial performance and condition, and their below-investment grade credit ratings and negative outlooks. Based on these factors, we concluded, as of December 31, 2012, that payments on a portion of our SMI coverage may not be probable and have incorporated an estimate of such in our loan loss reserve. Of the total amount of estimated exposure from the providers (assuming a 50 percent recovery rate), we believe that $2.0 million of payments may not be probable at December 31, 2012.  
Investments
 Liquidity Investments. The following table presents the carrying value of liquidity investments outstanding in relation to the counterparties' lowest long-term credit ratings provided by Standard & Poor's, Moody's, and/or Fitch Advisory Services. (For resell agreements, the ratings shown are based on ratings on the associated collateral.) (In millions)                                             December 31, 2012                                                            Long-Term Rating                                                  AAA       AA         A     
   Total
 Unsecured Liquidity Investments Federal funds sold                              $  -    $ 1,640    $ 1,710    $ 3,350 Total unsecured liquidity investments              -      1,640      1,710  
    3,350
 Guaranteed/Secured Liquidity Investments Securities purchased under agreements to resell    -      3,800          -  
    3,800
 Government-sponsored enterprises (1)               -         26          -  
       26
Total guaranteed/secured liquidity investments     -      3,826          - 
    3,826 Total liquidity investments                     $  -    $ 5,466    $ 1,710    $ 7,176                                                             December 31, 2011                                                            Long-Term Rating                                                 AAA        AA         A         Total Unsecured Liquidity Investments Federal funds sold                             $   -    $   540    $ 1,730    $  2,270 Certificates of deposit                            -      2,329      1,625       3,954 Other (2)                                        217          -          -         217 Total unsecured liquidity investments            217      2,869      3,355  
     6,441
 Guaranteed/Secured Liquidity Investments U.S. Treasury obligations                          -        331          -  
       331
 Government-sponsored enterprises (1)               -      2,554          -  
     2,554
 TLGP (3)                                           -      1,411          -  
     1,411
Total guaranteed/secured liquidity investments     -      4,296          - 
     4,296 Total liquidity investments                    $ 217    $ 7,165    $ 3,355    $ 10,737  
(1)    Consists of securities that are issued and effectively guaranteed by
       Fannie Mae and/or Freddie Mac, which have the support of the U.S.
       government, although they are not obligations of the U.S. government.
  (2)    Consists of debt securities issued by International Bank for        Reconstruction and Development.   (3)    Represents corporate debentures issued or guaranteed by the Federal        Deposit Insurance Corporation (FDIC) under the Temporary Liquidity        Guarantee Program (TLGP).    We actively monitor our credit exposure and the credit quality of all of our counterparties. This includes ongoing assessments of each counterparty's financial condition, performance, and capital adequacy, sovereign support, the market's current perceptions of the counterparty's market presence and activities, and general macro-economic, political, and market conditions. We believe all of the liquidity investments were purchased from counterparties that have a strong ability to repay principal and interest. We currently limit such investments to counterparties with credit ratings at time of purchase at single-A or above, and we are aggressive in restricting maturities, reducing dollar exposure, and suspending new investments with counterparties we deem to represent elevated credit risk.  In the last few years, we have generally invested in secured resale agreements, guaranteed investments, overnight Federal funds, and certificates of deposit which are negotiable and held in available-for-sale accounts. At December 31, 2012 and 2011, a substantial amount of liquidity investments were purchased from counterparties that provide explicit guarantees from the U.S.                                         67
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  government, that are effectively guaranteed (government-sponsored enterprises), or that are secured with collateral (securities purchased under agreements to resell). We believe the guaranteed and secured investments represent no credit risk exposure to us.  The following table presents credit ratings of our unsecured investment credit exposures by the domicile of the counterparty or the domicile of the counterparty's parent for U.S. branches and agency offices of foreign commercial banks. More discussion on the reduction in unsecured balances can be found in "Analysis of Financial Condition." (In millions)                                           December 31, 2012                                                     Counterparty Rating (1)                                      Sovereign                                       Rating Domicile of Counterparty                (1)            AA              A            Total Domestic                                AA+      $          -     $      555     $      555 U.S. branches and agency offices of foreign commercial banks: Canada                                  AAA                 -            770            770 Australia                               AAA               595              -            595 Finland                                 AAA               595              -            595 Netherlands                             AAA               450              -            450 Sweden                                  AAA                 -            385            385 Total U.S. branches and agency offices of foreign commercial banks                                                   1,640          1,155          2,795 Total unsecured investment credit exposure                                         $      1,640     $    1,710     $    3,350   (1)    Represents the lowest long-term credit rating provided by Standard &        Poor's, Moody's, and/or Fitch Advisory Services.      At December 31, 2012, all of the $3.4 billion of unsecured liquidity exposure was to counterparties with holding companies domiciled in countries receiving between triple-A and double-A long-term sovereign ratings, and all of the unsecured investments had overnight maturities. By Finance Agency Regulations, all counterparties exposed to non-U.S. countries are required to be domestic U.S. branches of foreign counterparties.  We believe we face minimal exposure in our unsecured investments to counterparties and countries that could have significant direct or indirect exposure to European sovereign debt, especially to those countries currently experiencing financial distress, and we are aggressive in limiting exposure to such counterparties. The exposure to non-U.S. countries at December 31, 2012 was comprised of lending to six institutions.  
Mortgage-Backed Securities.
GSE Mortgage-Backed Securities Historically, almost all of our mortgage-backed securities have been residential GSE securities issued by Fannie Mae and Freddie Mac, which provide credit safeguards by guaranteeing either timely or ultimate payments of principal and interest, and agency securities issued by Ginnie Mae, which the federal government guarantees. We believe that the conservatorships of Fannie Mae and Freddie Mac lower the chance that they would not be able to fulfill their credit guarantees; we believe the securities issued by these two GSEs are effectively government guaranteed. In addition, based on the data available to us and on our purchase practices, we believe that most of the mortgage loans backing our GSE mortgage-backed securities are of high quality with acceptable credit performance.  Mortgage-Backed Securities Issued by Other Government Agencies Beginning in the fourth quarter of 2010, we invested in mortgage-backed securities issued and guaranteed by the National Credit Union Administration. These investments totaled $1.4 billion at December 31, 2012. These securities have floating rate coupons tied to one-month LIBOR with interest rate caps ranging from seven to eight percent. We believe that the strength of the issuer's guarantee and backing by the full faith and credit of the U.S. government is sufficient to protect us against credit losses on these securities.  
Private Label Mortgage-Backed Securities The FHLBank did not hold any private-label mortgage-backed securities at December 31, 2012.
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Derivatives
 Credit Risk Exposure. The table below presents the gross credit risk exposure (i.e., the market value) and net exposure of derivatives outstanding at December 31, 2012. Based on both the gross and net exposures, we had a minimal amount of residual credit risk exposure throughout 2012, totaling $6 million at the end of the year. Gross exposure would likely increase if interest rates rise and could increase if the composition of our derivatives change; however, contractual collateral provisions in these derivatives limit our exposure to acceptable levels. (In millions)                                                                                                         Credit Exposure                                                              Gross Credit                                 Net of Cash Credit Rating (1)                      Total Notional          Exposure         Cash Collateral Held    Collateral Held Aaa/AAA                               $             -     $              -     $              -         $            - Aa/AA                                           1,385                    5                    -                      5 A                                               8,051                    3                   (2 )                    1 Baa/BBB                                         2,600                    -                    -                      - Member institutions (2)                           124                    -                    -                      - Total                                 $        12,160     $              8     $             (2 )       $            6   
(1)    Each category includes the related plus (+) and minus (-) ratings (i.e.,
       "A" includes "A+" and "A-" ratings).
(2) Represents Mandatory Delivery Contracts.
    The following table presents counterparties that provided 10 percent or more of the total notional amount of interest rate swap derivatives outstanding. (In millions) December 31, 2012                                                           December 31, 2011                   Credit                   Rating     Notional        Net Unsecured                 
        Credit Rating   Notional        Net Unsecured Counterparty     Category    Principal         Exposure        Counterparty
           Category      Principal         Exposure BNP Paribas          A     $     2,181     $             -     Barclays Bank PLC          A       $     3,596     $             - Citigroup Financial Products Inc.     Baa/BBB        1,542                   -     BNP Paribas                A             2,830                   - Wells Fargo Bank, N.A.         Aa/AA         1,365                   4     Deutsche Bank AG           A             2,116                   - Royal Bank of                                                  Royal Bank of   Scotland PLC       A           1,324                   -       Scotland PLC             A             1,981                   - All others   (10             Baa/BBB                                      All others counterparties)  to Aa/AA        5,624                   2       (9 counterparties)  A to Aa/AA         8,230                   3 Total                      $    12,036     $             6     Total                              $    18,753     $             3    Although we cannot predict if we will realize credit risk losses from any of our derivatives counterparties, we do not believe that any of them will be unable to continue making timely interest payments or, more generally, to continue to satisfy the terms and conditions of their derivative contracts with us.  Several of our larger members are approved as eligible unsecured counterparties; however, our preference is to conduct lending to these members through Advance activities. In addition, because of their credit ratings from NRSROs, several of these members are currently suspended as unsecured counterparties. The actual amount of any unsecured lending to our members depends also on members' preferences for borrowing Advances versus funds in the money market, yields available for Advances compared to unsecured lending, and the timing of members' intra-day funding needs.  As of December 31, 2012, we had $0.6 billion of notional principal of interest rate swaps outstanding to one member, JPMorgan Chase Bank, N.A., which also had outstanding credit services with us totaling $26.0 billion. Due to the amount of market value collateralization, we had no outstanding derivatives credit exposure to this counterparty.                                          69
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  Lehman Brothers Derivatives. On September 15, 2008, Lehman Brothers Holdings, Inc. ("Lehman Brothers") filed a petition for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. We had 87 derivative transactions (interest rate swaps) outstanding with a subsidiary of Lehman Brothers, Lehman Brothers Special Financing, Inc. ("LBSF"), with a total notional principal amount of $5.7 billion. Under the provisions of our master agreement with LBSF, all of these swaps automatically terminated immediately prior to the bankruptcy filing by Lehman Brothers. The close-out provisions of the Agreement required us to pay LBSF a net settlement of approximately $189 million, which represented the swaps' total estimated market value at the close of business on Friday, September 12, 2008. We paid LBSF approximately $14 million to settle all of the transactions, comprised of the $189 million market value amount minus the value of collateral we had delivered previously and other interest and expenses. On September 16, 2008, we replaced these swaps with new swaps transacted with other counterparties. The new swaps had the same terms and conditions as the terminated LBSF swaps. The counterparties to the new swaps paid us a net amount of approximately $232 million to enter into these transactions based on the estimated market values at the time we replaced the swaps.  The $43 million difference between the settlement amount we paid Lehman and the market value payment we received on the replacement swaps represented an economic gain to us based on changes in the interest rate environment between the termination date and the replacement date. Although the difference was a gain to us in this instance, because it represented exposure from terminating and replacing derivatives, it could have been a loss if the interest rate environment had been different. We are amortizing the gain into earnings according to the swaps' final maturities, most of which occurred by the end of 2012.  In March 2010, representatives of the Lehman bankruptcy estate advised us that they believed that we had been unjustly enriched and that the bankruptcy estate was entitled to the $43 million difference between the settlement amount we paid Lehman and the market value payment we received on the replacement swaps. In May 2010, we received a Derivatives Alternative Dispute Resolution notice from the Lehman bankruptcy estate with a settlement demand of $65.8 million, plus interest accruing primarily at LIBOR plus 14.5 percent since the bankruptcy filing, based on their view of how the settlement amount should have been calculated. In accordance with the Alternative Dispute Resolution Order of the Bankruptcy Court administering the Lehman estate, senior management participated in a non-binding mediation in New York in August 2010, and our legal counsel continued discussions with the court-appointed mediator for several weeks thereafter. The mediation concluded in October 2010 without a settlement of the claims asserted by the Lehman bankruptcy estate. We believe that we correctly calculated, and fully satisfied, our obligation to Lehman in September 2008, and we intend to vigorously dispute any claim for additional amounts.  
Liquidity Risk
  Liquidity Overview Our principal long-term source of funding and liquidity is from cost effective access to the capital markets through participation in the issuance of FHLBank System debt securities (Consolidated Obligations) and through execution of derivative transactions. We also raise liquidity via our liquidity investment portfolio and the ability to sell certain investments without significant accounting consequences. As shown on the Statements of Cash Flows, in 2012, our participations in the System's debt issuances totaled $250.6 billion for Discount Notes and $35.1 billion for Bonds. The System's favorable debt ratings, the implicit U.S. government backing of our debt, and our effective funding management were, and continue to be, instrumental in ensuring satisfactory access to the capital markets.  Our liquidity position remained strong during 2012 and our overall ability to fund our operations through debt issuances at acceptable interest costs remained sufficient. Although we can make no assurances, we expect this to continue to be the case, and we believe the possibility of a liquidity or funding crisis in the FHLBank System that would impair our FHLBank's ability to participate in issuances of new debt, service outstanding debt, maintain adequate capitalization, or pay competitive dividends is remote.  We must meet both operational and contingency liquidity requirements. We satisfied the operational liquidity requirement both by meeting the contingency liquidity requirement and because we were able to adequately access the capital markets to issue Obligations. In addition, Finance Agency guidance requires us to target at least 15 consecutive days of positive liquidity based on specific assumptions. In practice, we tend to hold over 20 days of positive liquidity. The amount of liquidity per the Finance Agency guidance and our internal operational liquidity measures was generally in the range of $4 billion to $8 billion during 2012.                                          70
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  Contingency Liquidity Requirement Contingency liquidity risk is the potential inability to meet liquidity needs because our access to the capital markets to issue Consolidated Obligations is restricted or suspended for a period of time due to a market disruption, operational failure, or real or perceived credit quality problems. In 2012, we continued to hold an ample amount of liquidity reserves to protect against contingency liquidity risk. Contingency Liquidity Requirement (in millions)         December 31, 2012       December 31, 2011 Total Contingency Liquidity Reserves (1)               $          23,199       $          23,599 Total Requirement (2)                                            (10,942 )                (6,669 ) Excess Contingency Liquidity Available                 $          12,257       $          16,930   
(1)    Includes, among others, cash, overnight Federal funds, overnight deposits,
       self-liquidating term Federal funds, 95 percent of the market value of
       available-for-sale negotiable securities, and 75 percent of the market
       value of certain held-to-maturity obligations, including obligations of
the United States, U.S. government agency obligations and mortgage-backed
       securities.   
(2)    Includes net liabilities maturing in the next seven business days, assets
       traded not yet settled, Advance commitments outstanding, Advances maturing
       in the next seven business days, and a three percent hypothetical increase
        in Advances.    Deposit Reserve Requirement To support our member deposits, we also must meet a statutory deposit reserve requirement. The sum of our investments in obligations of the United States, deposits in eligible banks or trust companies, and Advances with a final maturity not exceeding five years must equal or exceed the current amount of member deposits. The following table presents the components of this liquidity requirement. Deposit Reserve Requirement (in millions)  December 31, 2012     December 31, 2011 Total Eligible Deposit Reserves           $          54,943     $          33,733 Total Member Deposits                                (1,158 )              (1,067 ) Excess Deposit Reserves                   $          53,785     $          32,666    Contractual Obligations The following table summarizes our contractual obligations at December 31, 2012. The allocations according to the expiration terms and payment due dates of these obligations were not materially different from those at the end of 2011. Changes reflected normal business variations. We believe that, as in the past, we will continue to have sufficient liquidity, including from access to the debt markets to issue Consolidated Obligations, to satisfy these obligations timely. (In millions)                         < 1 year       1<3 years       3<5 years       > 5 years       Total Contractual Obligations Long-term debt (Bonds) - par (1)     $  18,660     $    13,987     $     5,207     $     6,369     $ 44,223 Operating leases (include premises and equipment)                               1               1               2               7           11 Mandatorily redeemable capital stock         3             208               -               -          211 Commitments to fund mortgage loans         124               -               -               -          124 Pension and other postretirement benefit obligations                          3               5               5              19           32 
Total Contractual Obligations        $  18,791$    14,201$     5,214$     6,395$ 44,601
(1)    Does not include Discount Notes and contractual interest payments related
       to Bonds. Total is based on contractual maturities; the actual timing of
       payments could be affected by factors affecting redemptions.                                            71
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  Off-Balance Sheet Arrangements The following table summarizes our off-balance sheet items at December 31, 2012. The allocations according to the expiration terms and payment due dates of these items were not materially different from those at the end of 2011, and changes reflected normal business variations. (In millions)                         < 1 year       1<3 years      3<5 years      > 5 years       Total Off-balance sheet items (1) Standby Letters of Credit            $   9,959     $       102     $       37     $       54     $ 10,152 Standby bond purchase agreements           313              67              -              -          380 Consolidated Obligations traded, not yet settled                                750              40             50             20          860 
Total off-balance sheet items        $  11,022     $       209     $       87     $       74     $ 11,392
(1) Represents notional amount of off-balance sheet obligations.
Operational Risk
  Operational risk is defined as the risk of an unexpected loss resulting from human error, fraud, unenforceability of legal contracts, or deficiencies in internal controls or information systems. We mitigate operational risk through adherence to internal policies, conformance with entity level controls, department procedures and controls, use of tested information systems, disaster recovery provisions for those systems, acquisition of insurance coverage to help protect us from financial exposure relating to errors or fraud by our personnel, and comprehensive policies and procedures related to Human Resources. In addition, the Internal Audit Department, which reports directly to the Audit Committee of the Board of Directors, regularly monitors and tests compliance with our policies, procedures, applicable regulatory requirements and best practices. In 2013, we will implement an integrated and comprehensive framework for operational risk management and document our activities regarding a regulation on prudential management and operating standards.  
A development related to operational risk exposure is discussed in Item 1A's "Risk Factors."
  Internal Department Procedures and Controls Each of our departments maintains and regularly reviews and enhances, as needed, a system of internal procedures and controls, including those that address proper segregation of duties. Each system is designed to prevent any one individual from processing the entirety of a transaction that affects member accounts, correspondent FHLBank accounts or third-party servicers providing support to us. We review daily and periodic transaction activity reports in a timely manner to detect erroneous or fraudulent activity. Procedures and controls also are assessed on an enterprise-wide basis, independently from the business unit departments. We also are in compliance with Sarbanes-Oxley Sections 302 and 404, which focus on the control environment over financial reporting.  Information Systems We rely heavily upon internal and third-party information systems and other technology to conduct and manage our business. Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Our computer systems, software and networks may be subjected to "cyberattacks" (e.g., breaches, unauthorized access, misuse, computer viruses or other malicious code and other events) that could jeopardize the confidentiality or integrity of such information, or otherwise cause interruptions or malfunctions in our operations. We seek to mitigate the risk associated with "cyberattacks" through the implementation of multiple layers of security controls. Administrative, physical, and logical controls are in place for establishing, administering and actively monitoring system access, sensitive data, and system change. Additionally, separate groups within our organization and/or third parties validate the strength of our security and confirm that established policies and procedures are being followed. We also have a committee of the Board of Directors that has oversight responsibility to ensure our investment in and utilization of information technology supports our strategic business plan and associated mission and goals. A related management committee reports to the Board Committee, approves short- and long-range information technology initiatives and annual disaster recovery test plans, and reviews data security policy and related standards and safeguards. We employ a systems development life cycle methodology to implement business solutions via significant software changes, new applications, or system upgrades as well as a business resumption and contingency plan to mitigate solution availability risk. The testing and validation of this plan, which includes documented test plans, cases and evaluations, is designed to ensure continuity of business processing.                                         72
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  Disaster Recovery Provisions We have a Business Resumption Contingency Plan that provides us with the ability to maintain operations in various scenarios of business disruption. A committee of staff reviews and updates this plan periodically to ensure that it serves our changing operational needs and those of our members. We have an off-site facility in a suburb of Cincinnati, Ohio, which is tested at least annually. We also have a back-up agreement in place with the FHLBank of Indianapolis in the event that both of our Cincinnati-based facilities are inoperable.  Insurance Coverage We have insurance coverage for employee fraud, forgery and wrongdoing, as well as Directors' and Officers' liability coverage that provides protection for claims alleging breach of duty, misappropriation of funds, neglect, acts of omission, employment practices, and fiduciary liability. We also have property, casualty, computer equipment, automobile, and various types of other coverage as well.  Human Resources Policies and Procedures The risks associated with our Human Resources function are categorized as either Employment Practices Risk or Human Capital Risk. Employment Practices Risk is the potential failure to properly administer our policies regarding employment practices and compensation and benefit programs for eligible staff and retirees, and the potential failure to observe and properly comply with federal, state and municipal laws and regulations. Human Capital Risk is the potential inability to attract and retain appropriate levels of qualified human resources to maintain efficient operations.  Comprehensive policies and procedures are in place to limit Employment Practices Risk. These are supported by an established internal control system that is routinely monitored and audited. With respect to Human Capital Risk, we strive to maintain a competitive salary and benefit structure, which is regularly reviewed and updated as appropriate to attract and retain qualified staff. In addition, we have a management succession plan that is reviewed and approved by our Board of Directors.   
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Introduction
  The preparation of financial statements in accordance with GAAP requires management to make a number of significant judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities (if applicable), and the reported amounts of income and expenses during the reported periods. Although management believes its judgments, estimates, and assumptions are reasonable, actual results may differ and other parties could arrive at different conclusions.  We have identified the following critical accounting policies that require management to make subjective or complex judgments about inherently uncertain matters. Our financial condition and results of operations could be materially affected under different conditions or different assumptions related to these accounting policies.  
Accounting for Derivatives and Hedging Activity
  In accordance with Finance Agency Regulations, we execute all derivatives to reduce market risk exposure, not for speculation or solely for earnings enhancement. As in past years, in 2012 all outstanding derivatives hedged specific assets, liabilities, or Mandatory Delivery Contracts. We record derivative instruments at their fair values on the Statements of Condition, and we record changes in these fair values in current period earnings. We generally plan our use of derivatives to maximize the probability that they are highly effective in offsetting changes in the market values of the designated balance sheet instruments.  Fair Value Hedges As indicated in the "Use of Derivatives in Market Risk Management" section of "Quantitative and Qualitative Disclosures About Risk Management," we designate the majority of our derivatives as fair value hedges. Fair value hedge accounting permits the changes in fair values of the hedged risk in the hedged instruments to be recorded in the current period, thus offsetting, partially or fully, the change in fair value of the derivatives. For derivatives accounted as fair value hedges, the hedged risk is designated to be changes in LIBOR benchmark interest rates. The result is that there has been a relatively small amount of unrealized earnings volatility from hedging market risk with derivatives.  In order to determine if a derivative qualifies for fair value hedge accounting, we must assess how effective the derivative has been, and is expected to be, in hedging changes in the fair values of the risk being hedged. To do this, each month we perform                                         73
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  effectiveness testing using a consistently applied standard statistical methodology, regression analysis, that measures the degree of correlation and relationship between the fair values of the derivative and hedged instrument. The results of the statistical measures must pass pre-defined threshold values to enable us to conclude that the fair values of the derivative transaction have a close correlation and strong relationship with the fair values of the hedged instrument. If any measure is outside of its respective tolerance, the hedge no longer qualifies for hedge accounting. This then means we must record the fair value change of the derivative in current earnings without any offset in the fair value change of the related hedged instrument. Due to the intentional matching of terms between the derivative and the hedged instrument, we expect that failing an effectiveness test will be infrequent, which has been the case historically.  Each month, we compute fair values on all derivatives and related hedged instruments across a range of interest rate scenarios. As of year-end 2012, for derivatives receiving long-haul fair value hedge accounting, the total net difference between the fair values of the derivatives and related hedged instruments under an assumption of stressed interest rate environments was in a range of negative $1 million to positive $2 million. This range is minimal compared to the amount of notional principal amount.  As noted previously, each derivative/hedged instrument transaction had very closely related, or exactly matched, characteristics such as notional amount, final maturity, options, interest payment frequencies, reset dates, etc. Fair value differences that have actually occurred have historically resulted in a relatively small amount of earnings volatility. These differences are primarily because of the following factors:  
?      Our interest rate swaps have an adjustable-rate LIBOR leg (which is
       referenced to 1- or 3-month LIBOR), whereas the hedged instruments do not.
  ?      Option values of the swaps versus those of hedged instruments may have        different changes in values.   ?      Use of overnight indexed swap curves to value interest rate swaps may        result in differences in fair values between derivatives and hedged items        or less measured effectiveness of swap transactions.    An important element of effectiveness testing is the duration of the derivative and the hedged instrument. The effective duration is affected primarily by the final maturity and any option characteristics. In general, the shorter the effective duration the more likely it is that effectiveness testing will fail. This is because, given a relatively short duration, the LIBOR leg of the swap is a relatively important component (i.e., very small dollar changes may result in relatively large statistical movements) of the monthly change in the derivative's fair value, and there is no offsetting LIBOR leg on the hedged instrument.  If a derivative/hedged instrument transaction fails effectiveness testing, it does not mean that the hedge relationship is no longer successful in achieving its intended economic purpose. For example, an Obligation hedged with an interest rate swap creates adjustable-rate LIBOR funding, which is used to match fund adjustable-rate LIBOR and other short-term Advances. The hedge achieves the desired result (matching the net funding with the asset) because, economically, the Advance is part of the overall hedging strategy and the reason for engaging in the derivative transaction.  Fair Value Option--Economic Hedge We account for certain Bond-related derivatives using an accounting election called "fair value option," which is included in the economic hedge category. An economic hedge under the fair value option does not require passing effectiveness testing to permit the derivatives' fair market value to be offset with the market value of the hedged instrument, as is required under a fair value hedge. However, it records the fair market value of the hedged instrument at its full fair value instead of only the value of hedging the benchmark interest rate (LIBOR). The effect of electing full fair value is that the hedged instruments' market value includes the impact of changes in spreads between LIBOR and the interest rate index related to the hedged instrument. Therefore, full fair value results in a different kind of unrealized earnings volatility (which could be higher or lower) compared to accounting under fair value hedge treatment. The magnitude and direction depends on changes in interest rates, changes in LIBOR versus Consolidated Obligation debt costs, and the dollar amount of hedges that may fail effectiveness testing under the fail value hedging treatment.  
Accounting for Premiums and Discounts on Mortgage Loans and Mortgage-Backed Securities
  The accounting for amortization/accretion of premiums/discounts can result in substantial earnings volatility, most of which relates to our MPP, mortgage-backed securities, and Consolidated Obligations. Normally, earnings volatility associated with amortization/accretion of premiums/discounts for Obligations is less pronounced than that for mortgage assets.                                          74
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  When we purchase or invest in mortgages, we normally pay an amount that differs from the principal balance. A premium price is paid if the purchase price exceeds the principal amount. A discount price is paid if the purchase price is less than the principal amount. Premiums/discounts are required to be deferred and amortized/accreted to net interest income in a manner such that the yield recognized each month on the underlying asset is constant over the asset's historical life and estimated future life. This is called the constant effective (level) yield method.  We typically pay more than the principal balance when the interest rate on a purchased mortgage is greater than the prevailing market rate for similar mortgages. The net purchase premium is amortized as a reduction in the mortgage's book yield. Similarly, if we pay less than the principal balance, the net discount is accreted in the same manner as the premium, resulting in an increase in the mortgage's book yield.  We have historically purchased most of the loans in the MPP at premiums. Overall, mortgage-backed securities have been purchased at net premium prices close to par. At the end of 2012, the MPP had a net premium balance of $182 million and mortgage-backed securities had a net premium balance of $17 million, resulting in a total mortgage net premium balance of $199 million.  When mortgage principal cash flows are volatile, there can be substantial fluctuation in the accounting recognition of premiums and discounts. We update the constant effective yield method monthly using actual historical and projected principal cash flows. Projected principal cash flows requires us to estimate prepayment speeds, which are driven primarily by changes in interest rates. When interest rates decline, actual and projected prepayment speeds are likely to increase. This accelerates the amortization/accretion, resulting in a reduction in the mortgages' book yields on premium balances and an increase in book yields on discount balances. The opposite effect tends to occur when interest rates rise. The immediate adjustment and the schedules for future amortization/accretion are based on applying the new constant effective yield as if it had been in effect since the purchase of the assets. See Note 1 of the Notes to Financial Statements for additional information.  Our mortgages under the MPP are stratified for amortization purposes into multiple portfolios according to common characteristics such as coupon interest rate, state of origination, final original maturity (mostly 15, 20, and 30 years), loan age, and type of mortgage (i.e., conventional and FHA). We compute amortization/accretion for each mortgage-backed security separately. Projected prepayment speeds are derived using a market-tested third-party prepayment model. We estimate prepayment speeds using a single interest rate scenario of implied forward interest rates for LIBOR and residential mortgages computed from the daily average market interest rate environment from the previous month. We use implied forward interest rates because they underlie many market practices, both from a theoretical and operational perspective. We regularly test the reasonableness and accuracy of the prepayment model by comparing its projections to actual prepayment results experienced over time and to dealer prepayment indications.  It is difficult to calculate how much amortization/accretion is likely to change over time because prepayment projections are inherently subject to uncertainty. Exact trends depend on the relationship between market interest rates and coupon rates on outstanding mortgage assets, the historical evolution of mortgage interest rates, the age of the mortgage loans, demographic and population trends, and other market factors. Changes in amortization/accretion also depend on 1) the accuracy of prepayment projections compared to actual realized prepayments and 2) term structure models used to simulate possible future evolution of various interest rates. The term structure models depend heavily on theories and assumptions related to future interest rates and interest rate volatility. We strive to maintain consistency in our use of prepayment and term structure models, although we do enhance these models based on developments in theories, technologies, best practices, and market conditions.  We regularly perform analyses that test the sensitivity of premium/discount recognition for mortgage assets to changes in prepayment speeds. The following table shows, as of year-end 2012, the estimated adjustments to the immediate recognition of premium amortization/discount accretion for various interest rate shocks (with interest rates not permitted to fall below zero percent). Although some of the changes shown below would result in a substantial change in ROE in the quarter in which the rate change occurred, it currently would not materially threaten the competitiveness of profitability.  (In millions)    -200      -100       -50      Base     +50     +100     +200                 $ (32 )   $ (21 )   $ (13 )   $ (2 )   $  9    $  16    $  23    Provision for Credit Losses  
We evaluate Advances and the MPP to assure an adequate reserve is maintained to absorb probable losses inherent in these portfolios.
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Advances
 We evaluate probable credit losses inherent in Advances due to borrower default or delayed receipt of interest and principal, taking into consideration the amount recoverable from the collateral pledged. This analysis is performed for each member separately on at least a quarterly basis. We believe we have adequate policies and procedures in place to effectively manage credit risk exposure on Advances. These include monitoring the creditworthiness and financial condition of the institutions to which we lend funds, reviewing the quality and value of collateral pledged by members to secure Advances, estimating borrowing capacity based on collateral value and type for each member, and evaluating historical loss experience. At December 31, 2012, we had rights to collateral (either loans or securities), on a member-by-member basis, with an estimated fair value that exceeds the amount of outstanding Advances. At the end of 2012, the aggregate estimated value of this collateral was $198.0 billion. Although some of this overcollateralization may reflect a desire to maintain excess borrowing capacity, all of a member's pledged collateral would be available as necessary to cover any of that member's credit obligations to the FHLBank.  Based on the nature and quality of the collateral held as security for Advances, including overcollateralization, our credit analyses of members and collateral, and members' prior repayment history (i.e., we have never recorded a loss from an Advance), we believe that no allowance for losses was necessary at December 31, 2012. See Notes 1 and 10 of the Notes to Financial Statements for additional information.  Mortgage Loans Acquired Under the MPP We analyze loans in the MPP on at least a quarterly basis by 1) estimating the incurred credit losses inherent in the portfolio and comparing these to credit enhancements, including the recoverability of insurance, and 2) establishing reserves based on the results. We apply a consistent methodology to determine our estimates.  We acquire both FHA and conventional fixed-rate mortgage loans under the MPP. Because FHA mortgage loans are U.S. government insured, we have determined that they do not require a loan loss allowance. We are protected against credit losses on conventional mortgage loans from several sources, in order of priority:  
?      having the related real estate as collateral, which effectively includes
       the borrower's equity,   ?      by credit enhancements including 1) primary mortgage insurance, if        applicable, 2) the member's available funds remaining in the Lender Risk
       Account, and 3) if applicable, Supplemental Mortgage Insurance coverage up
       to the policy limit, applied on a loan-by-loan basis.
    We assume any credit exposure if losses exceed the related real estate value and credit enhancements. The key estimates and assumptions that affect our allowance for credit losses generally include: ? the characteristics of specific conventional loans outstanding under the MPP;   ?      evaluations of the overall delinquent loan portfolio through the use of        migration analysis;   ? loss severity estimates;   
? historical claims and default experience;
? expected proceeds from credit enhancements;
  ?      evaluation of exposure to Supplemental Mortgage Insurance providers and        their ability to pay claims;  
? comparisons to industry reported data; and
? current economic trends and conditions.
These estimates require significant judgments, especially considering the current national housing market, the inability to readily determine the fair value of all underlying properties, the application of pool level credit enhancements, and the uncertainty in other macroeconomic factors that make estimating defaults and severity imprecise.
  Based on our analysis, as of December 31, 2012, we determined that an allowance for credit losses of $18 million was required for our conventional mortgage loans in the MPP. Further substantial reductions in home prices or other economic variables that affect mortgage defaults could increase credit losses experienced in the portfolio.                                          76
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Other-Than-Temporary Impairment Analysis for Investment Securities
  Due to the decline in value of residential U.S. real estate and difficult conditions in the credit and mortgage markets, we closely monitor the performance of our investment securities to evaluate our exposure to the risk of loss of principal or interest on these investments and to determine on a quarterly basis whether this risk of loss represents an other-than-temporary impairment.  An investment security is deemed impaired if the fair value of the security is less than its amortized cost. To determine whether an impairment is other-than-temporary, we assess whether the amortized cost basis of the security will be recovered by considering numerous factors, as described in Notes 1 and 7 of the Notes to Financial Statements. We must recognize impairment losses if we intend to sell the security or if available evidence indicates it is more likely than not we will be required to sell the security before the recovery of its amortized cost basis. We also must recognize impairment losses when any credit losses are expected for the security. This includes consideration of market conditions and projections of future results which requires significant judgments, estimates and assumptions, especially considering the unprecedented deterioration in the national housing market and the uncertainty in other macroeconomic factors that make estimating future results imprecise.  If we were to determine that an other-than-temporary impairment existed, the security would initially be written down to current market value, with the loss recognized in non-interest income if we intend to sell the security or it is more likely than not we will be required to sell the security before recovery of the amortized cost basis. If we do not intend to sell the security and it is not more likely than not we will be required to sell the security before recovery, the security would be written down to current market value with a separate display of losses related to credit deterioration and losses related to all other factors on the income statement. Any non-credit loss related amounts would then be reclassified and recorded in other comprehensive income, resulting in only net credit-related losses recorded on the income statement. As of December 31, 2012 we did not consider any of our investment securities to be other-than-temporarily impaired.  
Fair Values
  Fair values play an important role in the valuation of certain assets, liabilities and derivative transactions, which may be presented in the Statements of Condition or related Notes to the Financial Statements at fair value. We carry investments classified as available-for-sale and trading, and all derivatives, on the Statements of Condition at fair value. Additionally, any financial instruments where the fair value option election has been made are carried at fair value on the Statements of Condition.  Fair value is defined as the price - the "exit price" - that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Because our investments currently do not have available quoted market prices, we determine fair values based on 1) our valuation models or 2) dealer indications, which may be based on the dealers' own valuation models and/or prices of similar instruments.  Valuation models and their underlying assumptions are based on the best estimates of management with respect to discount rates, prepayments, market volatility, and other factors. These assumptions may have a significant effect on the reported fair values of assets and liabilities, including derivatives, and the income and expense related thereto. The use of different assumptions or changes in the models and assumptions, as well as changes in market conditions, could result in materially different net income and retained earnings.  We have control processes designed to ensure that fair value measurements are appropriate and reliable, that they are based on observable inputs wherever possible and that our valuation approaches and assumptions are reasonable and consistently applied. Where applicable, valuations are also compared to alternative external market data (e.g., quoted market prices, broker or dealer indications, pricing services and comparative analyses to similar instruments). For further discussion regarding how we measure financial assets and financial liabilities at fair value, see Note 20 of the Notes to Financial Statements.  We categorize each of our financial instruments carried at fair value into one of three levels in accordance with the fair value hierarchy. The hierarchy is based upon the transparency (observable or unobservable) of inputs to the valuation of an asset or liability as of the measurement date. Observable inputs reflect market data obtained from independent sources (Levels 1 and 2), while unobservable inputs reflect our assumptions of market variables (Level 3). Management utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Because items classified as Level 3 are valued using significant unobservable inputs, the process for determining the fair value of these items is generally more subjective and involves a high degree of management judgment and use of assumptions.                                          77
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  The following table summarizes our assets and liabilities measured at fair value on a recurring basis by level of valuation hierarchy. (Dollars in millions)                                                       December 31, 2012                                                   Assets                                                        Liabilities                                                                                              Derivative             Consolidated                        Trading Securities      Derivative Assets(1)        Total           Liabilities(1)       Obligation Bonds (2)       Total Level 1                            - %                      - %                  - %                  - %                     - %               - % Level 2                          100                      100                  100                  100                     100               100 Level 3                            -                        -                    -                    -                       -                 - Total                            100 %                    100 %                100 %                100 %                   100 %             100 % Total GAAP Fair Value $            2          $             6           $        8      $           115         $         3,402         $   3,517   (Dollars in millions)                                                                   December 31, 2011                                                                Assets                                                                    Liabilities                                                  Available-for-sale                                                   Derivative             Consolidated                        Trading Securities            Securities            Derivative Assets(1)       Total         Liabilities(1)       Obligation Bonds (2)       Total Level 1                               - %                       - %                     - %                - %                 - %                     - %               - % Level 2                             100                       100                     100                100                 100                     100               100 Level 3                               -                         -                       -                  -                   -                       -                 - Total                               100 %                     100 %                   100 %              100 %               100 %                   100 %             100 % Total GAAP Fair Value $           2,863       $             4,171         $             5           $  7,039     $           105         $         
4,900         $   5,005
(1)   Based on total fair value of derivative assets and liabilities after effect of counterparty netting and cash collateral netting. (2)  Represents Consolidated Obligation Bonds recorded under the fair value option.
RECENTLY ISSUED ACCOUNTING STANDARDS AND INTERPRETATIONS
See Note 2 of the Notes to Financial Statements for a discussion of recently issued accounting standards and interpretations.
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  Table of Contents  OTHER FINANCIAL INFORMATION  Income Statements 
Summary income statements for each quarter within the two years ended December 31, 2012 are provided in the tables below.
                                                                    2012 (In millions)                 1st Quarter       2nd Quarter       3rd Quarter      4th Quarter        Total Interest income              $       246      $         212      $       232      $       231      $      921 Interest expense                     165                159              149              140             613 Net interest income                   81                 53               83               91             308 Provision for credit loss              1                  -                -                -               1 Non-interest (loss) income            (1 )               22               (4 )             (4 )            13 Non-interest expense                  21                 20               22               22              85 Net income                   $        58      $          55      $        57      $        65      $      235                                                                       2011 (In millions)                  1st Quarter        2nd Quarter       3rd Quarter      4th Quarter        Total Interest income              $         277      $         263      $       231      $       240      $   1,011 Interest expense                       207                196              187              172            762 Net interest income                     70                 67               44               68            249 Provision for credit loss                2                  1                2                7             12 Non-interest income (loss)               4                  -               (7 )             (2 )           (5 ) Non-interest expense                    30                 28               17               19             94 Net income                   $          42      $          38      $        18      $        40      $     138                                            79
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Investment Securities
  Data on investments for the years ended December 31, 2012, 2011 and 2010 are provided in the tables below. (In millions)                                            Carrying Value at December 31,                                                         2012           2011          2010 Trading securities: U.S. Treasury obligations                           $         -     $     331     $   1,905 Government-sponsored enterprises                              -         2,530         4,496 Mortgage-backed securities: Other U.S. obligation residential mortgage-backed securities                                                    2             2             2 Total trading securities                                      2         2,863         6,403  Available-for-sale securities: Certificates of deposit                                       -         3,954         5,790 Other *                                                       -           217             - Total available-for-sale securities                           -         
4,171         5,790
  Held-to-maturity securities: Government-sponsored enterprises                             26            24            22 States and local housing agency obligations                   -             -             3 TLGP                                                          -         1,411         1,011 Mortgage-backed securities: Other U.S. obligation residential mortgage-backed securities                                                1,411         1,501           910 
Government-sponsored enterprise residential
   mortgage-backed securities                             11,361         9,684        10,657 Private-label residential mortgage-backed securities                                                    -            17            88 Total held-to-maturity securities                        12,798        12,637        12,691  Total securities                                         12,800        19,671        24,884  Securities purchased under agreements to resell           3,800             -         2,950 Federal funds sold                                        3,350         2,270         5,480 Total investments                                   $    19,950     $  21,941     $  33,314    *      Consists of debt securities issued by International Bank for        Reconstruction and Development.                                            80
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  As of December 31, 2012, investments had the following maturity and yield characteristics.                                                     Due after one                                    Due in one year  year through     Due after five    Due after 10 (Dollars in millions)                  or less       five years     through 10 years       years      Carrying Value Trading securities: Mortgage-backed securities*: Other U.S. obligation residential   mortgage-backed securities      $          -      $         -   $            -       $         2   $             2 Total trading securities                     -                -                -                 2                 2 Yield on trading securities                  - %              - %              - %            2.44 %  Held-to-maturity securities: Government-sponsored enterprises            26                -                -                 -                26 Mortgage-backed securities*: Other U.S. obligation residential   mortgage-backed securities                 -              309            1,102                 -             1,411 
Government-sponsored enterprise
   residential mortgage-backed securities                                   -                -              659            10,702            11,361 Total held-to-maturity securities           26              309            1,761            10,702            12,798 Yield on held-to-maturity securities                                0.12 %           0.57 %           2.20 %            2.32 %  Total securities                            26              309            1,761            10,704            12,800  Securities purchased under agreements to resell                     3,800                -                -                 -             3,800 Federal funds sold                       3,350                -                -                 -             3,350 Total investments                 $      7,176      $       309   $        1,761       $    10,704   $        19,950    *      Mortgage-backed securities allocated based on contractual principal        maturities assuming no prepayments.    As of December 31, 2012, the FHLBank held securities of the following issuers with a book value greater than 10 percent of FHLBank capital. The table includes government-sponsored enterprises, securities of the U.S. government, and government agencies and corporations. (In millions)                                     Total             Total Name of Issuer                                Carrying Value     Fair Value Freddie Mac                                  $         4,127    $      4,246 Fannie Mae                                             7,260           7,516 National Credit Union Administration Trust             1,411           
1,415
 Government National Mortgage Association                   2               2 Total investment securities                  $        12,800    $     13,179                                            81
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Loan Portfolio Analysis
  The FHLBank's outstanding loans, loans 90 days or more past due and accruing interest, and allowance for credit loss information for the five years ended December 31 are shown below. The FHLBank's interest and related shortfall on non-accrual loans and loans modified in troubled debt restructurings was not material during the years presented below. (Dollars in millions)                    2012         2011         2010         2009         2008 Domestic: Advances                              $ 53,944     $ 28,424     $ 30,181     $ 35,818     $ 53,916 Real estate mortgages                 $  7,548     $  7,871     $  7,782     $  9,366     $  8,632 Real estate mortgages past due 90 days   or more (including those in process of foreclosure) 
  and still accruing interest         $    113$    145$    133
  $    135     $     73 Non-accrual loans, unpaid principal balance (1)                           $      3     $      2     $      -     $      -     $      - Troubled debt restructurings (not included above)                       $      3     $      1     $      -     $      -     $      - Allowance for credit losses on mortgage loans,   beginning of year                   $     21     $     12     $      -     $      -     $      - Charge-offs                                 (4 )         (3 )         (1 )          -            - Provision for credit losses                  1           12           13            -            - Allowance for credit losses on mortgage loans,   end of year                         $     18     $     21     $     12     $      -     $      - Ratio of net charge-offs during the period to   average loans outstanding during the period                                0.06 %       0.05 %       0.02 %  
        - %          - %
(1)    See Note 1 of the Notes to Financial Statements for an explanation of the
       FHLBank's non-accrual policy.
Other Borrowings
Borrowings with original maturities of one year or less are classified as short-term. The following is a summary of short-term borrowings exceeding 30 percent of total capital for the years ended December 31: (Dollars in millions)
                                    2012         2011  
       2010
 Discount Notes Outstanding at year-end (book value)                  $ 30,840     $ 26,136     $ 35,003 Weighted average rate at year-end (1) (2)                 0.13 %       0.03 %       0.11 % Daily average outstanding for the year (book value)   $ 29,499     $ 32,292     $ 27,914 Weighted average rate for the year (2)                    0.10 %       0.09 %       0.15 % Highest outstanding at any month-end (book value)     $ 32,556     $ 37,902     $ 36,101 Bonds (short-term) Outstanding at year-end (par value)                   $  9,140     $  2,725     $  2,350 Weighted average rate at year-end (2) (3)                 0.17 %       0.20 %       0.43 % Daily average outstanding for the year (par value)    $  3,527     $  2,635     $  3,187 Weighted average rate for the year (2) (3)                0.19 %       0.29 %       0.56 % Highest outstanding at any month-end (par value)      $  9,140     $  3,200 
$  5,859
(1) Represents an implied rate without consideration of concessions.
(2)    Amounts used to calculate weighted average rates for the year are based on
       dollars in thousands. Accordingly, recalculations based upon amounts in
       millions may not produce the same results.
(3) Represents the effective coupon rate.
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Term Deposits
At December 31, 2012, term deposits in denominations of $100,000 or more totaled $118,350,000. The table below presents the maturities for term deposits in denominations of $100,000 or more:
                                                              Over 3         
Over 6        Over 12
                                                            months but     months but     months but By remaining maturity at December                           within 6      within 12      within 24 31, 2012                             3 months or less        months         months         months         Total (In millions) Time certificates of deposit ($1 or more)                       $               41     $       26     $       36     $       15     $     118    Ratios                                     2012      2011      2010 Return on average assets            0.35 %    0.21 %    0.24 % Return on average equity            6.20      3.89      4.67
Average equity to average assets    5.68      5.29      5.08 Dividend payout ratio
              60.09 %   95.42 %   84.13 %     
Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.
Information required under this Item is set forth in the "Quantitative and Qualitative Disclosures About Risk Management" caption at Part II, Item 7, of this filing.
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