PART I

responsibility and corresponding authority to ensure that the FHLBanks operate in a safe and sound manner. Consistent with that duty, the Finance Board has an additional responsibility to ensure the FHLBanks are able to raise funds in the capital markets and carry out their housing and community development finance mission. In order to carry out those responsibilities, the Finance Board establishes regulations governing the operations of the FHLBanks, conducts ongoing off-site supervision and monitoring of the FHLBanks, and performs annual on-site examinations of each FHLBank.

The Bank’s debt and equity securities are exempt from registration under the Securities Act of 1933 and are “exempted securities” under the Securities Exchange Act of 1934 (the “Exchange Act”). On June 23, 2004, the Finance Board adopted a rule requiring each FHLBank to voluntarily register a class of its equity securities with the Securities and Exchange Commission (“SEC”) under Section 12(g) of the Exchange Act. The Bank’s registration with the SEC became effective on April 17, 2006. As a registrant, the Bank is subject to the periodic disclosure regime as administered and interpreted by the SEC. Materials that the Bank files with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site (http://www.sec.gov) that contains reports and other information filed with the SEC. Reports and other information that the Bank files with the SEC are also available free of charge through the Bank’s website at www.fhlb.com. To access reports and other information through the Bank’s website, click on “About FHLB Dallas,” then “Financial Reports” and then “SEC Filings.”

Membership

The Bank’s members are financial institutions with their principal place of business in the Ninth Federal Home Loan Bank District, which includes Arkansas, Louisiana, Mississippi, New Mexico and Texas. The following table summarizes the Bank’s membership, by type of institution, as of December 31, 2007, 2006 and 2005.

As of December 31, 2007, 2006 and 2005, approximately 64.9 percent, 63.1 percent and 66.5 percent, respectively, of the Bank’s members had outstanding advances from the Bank. These usage rates are calculated excluding housing associates and non-member borrowers. While eligible to borrow, housing associates are not members of the Bank and, as such, are not required to hold capital stock. Non-member borrowers consist of institutions that have acquired former members and assumed the advances held by those former members. Non-member borrowers are required to hold capital stock to support outstanding advances until the later of the time when those advances have been repaid or the applicable stock redemption period has expired, at which time the non-member borrower’s

affiliation with the Bank is terminated. During the period that the advances remain outstanding, non-member borrowers may not request new advances, nor are they permitted to extend or renew the assumed advances.

Approximately 85 percent of the Bank’s members are Community Financial Institutions (“CFIs”), which are defined by the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) to include all FDIC-insured institutions with average total assets over the three prior years equal to or less than $500 million, as adjusted annually for inflation since 1999. For 2008, CFIs are FDIC-insured institutions with average total assets as of December 31, 2007, 2006, and 2005 equal to or less than $625 million. In 2007, 2006 and 2005, the average total asset ceiling for CFI designation was $599 million, $587 million and $567 million, respectively. The GLB Act expanded the eligibility for membership of CFIs in the FHLBanks and authorized the FHLBanks to accept expanded types of assets as collateral for advances to CFIs.

The Bank’s membership currently includes the majority of institutions in its district that are eligible to become members. Eligible non-members are primarily smaller institutions that have thus far elected not to join the Bank. For this reason, the Bank does not currently anticipate that a substantial number of additional institutions will become members. In February 2008, Comerica Bank, which recently relocated its charter to the Ninth District, became a member of the Bank. As of February 29, 2008, Comerica Bank had outstanding advances of $2.0 billion and was the Bank’s fourth largest borrower at that date.

As a cooperative, the Bank is managed with the primary objectives of enhancing the value of membership for member institutions and fulfilling its public purpose. The value of membership includes access to readily available credit and other services from the Bank, the value of the cost differential between Bank advances and other potential sources of funds, and the dividends paid on members’ investment in the Bank’s capital stock.

Business Segments

The Bank manages its operations as one business segment. Management and the Bank’s Board of Directors review enterprise-wide financial information in order to make operating decisions and assess performance. All of the Bank’s revenues are derived from U.S. operations.

Interest Income

The Bank’s interest income is derived from advances, investment activities and, to a far lesser extent, mortgage loans held for portfolio. Each of these revenue sources is more fully described below. During the years ended December 31, 2007, 2006 and 2005, interest income derived from each of these sources (expressed as a percentage of the Bank’s total interest income) was as follows:

		Year Ended December 31,
		2007				2006				2005
Advances (including prepayment fees)			73.2	%			75.6	%			71.7	%
Investment activities			25.7				22.8				26.1
Mortgage loans held for portfolio			0.8				1.0				1.5
Other			0.3				0.6				0.7
Total			100.0	%			100.0	%			100.0	%
Total interest income (in thousands)		$	2,886,482			$	2,889,202			$	2,292,736

With the exception of interest earned on advances to Capital One, National Association and Washington Mutual Bank, non-member borrowers, substantially all of the Bank’s interest income from advances is derived from financial institutions domiciled in the Bank’s five-state district. Advances to Capital One, National Association and Washington Mutual Bank (and the related interest income) are described below in the “Products and Services” section.

Products and Services

Advances. The Bank’s primary function is to provide its members with a reliable source of secured credit in the form of loans known as advances. The Bank offers advances to its members with a wide variety of terms designed to meet members’ business and risk management needs. Standard offerings include the following types of advances:

Fixed rate, fixed term advances . The Bank offers fixed rate, fixed term advances with maturities ranging from overnight to 20 years, and with maturities as long as 30 years for Community Investment Program advances. Interest is generally collected monthly and principal repaid at maturity for fixed rate, fixed term advances.

Fixed rate, amortizing advances . The Bank offers fixed rate advances with a variety of final maturities and fixed amortization schedules. Standard advances offerings include fully amortizing advances with final maturities of 5, 7, 10, 15 or 20 years, and advances with amortization schedules based on those maturities but with shorter final maturities accompanied by balloon payments of the remaining outstanding principal balance. Borrowers may also request alternative amortization schedules and maturities. Interest is generally paid monthly and principal is repaid in accordance with the specified amortization schedule. Although these advances have fixed amortization schedules, borrowers may elect to pay a higher interest rate and have an option to prepay the advance without a fee after a specified lockout period (typically five years). Otherwise, early repayments are subject to the Bank’s standard prepayment fees.

Floating rate advances. The Bank’s standard advances offerings include term floating rate advances with maturities between one and five years. Borrowers may also request floating rate advances with maturities up to 10 years. Floating rate advances are typically indexed to either one-month LIBOR or three-month LIBOR, and are priced at a constant spread to the relevant index. In addition to longer term floating rate advances, the Bank offers short term floating rate advances (maturities of 30 days or less) indexed to the daily federal funds rate. Floating rate advances may also include embedded features such as caps, floors, provisions for the conversion of the advances to a fixed rate, or non-LIBOR indices.

Putable advances. The Bank also makes advances that include a put feature that allows the Bank to terminate the advance at specified points in time. If the Bank exercises its option to terminate the putable advance, the Bank offers replacement funding to the member for a period selected by the member up to the remaining term to maturity of the putable advance, provided the Bank determines that the member is able to satisfy the normal credit and collateral requirements of the Bank for the replacement funding requested.

The Bank manages the interest rate and option risk of advances through the use of a variety of debt and derivative instruments. Members are required by statute and regulation to use the proceeds of advances with an original term to maturity of greater than five years to purchase or fund new or existing residential housing finance assets which, for CFIs, are defined by regulation to include small business, small farm and small agribusiness loans and securities representing a whole interest in such loans.

The Bank prices its credit products with the objective of providing benefits of membership that are greatest for those members that use the Bank’s products most actively, while maintaining sufficient profitability to pay dividends at a rate that makes members financially indifferent to holding the Bank’s capital stock and which will allow the Bank to increase its retained earnings over time. That set of objectives results in relatively small mark-ups over the Bank’s cost of funds for its advances and dividends on capital stock at rates that are at or slightly above the periodic average effective federal funds rate. In keeping with its cooperative philosophy, the Bank provides equal pricing for advances to all members regardless of asset or transaction size, charter type, or geographic location.

The Bank is required by the FHLB Act to obtain collateral that is sufficient, in the judgment of the Bank, to fully secure members’ advances and other extensions of credit. The Bank has not suffered any credit losses on advances in its 75-year history. In accordance with the Bank’s capital plan, members must purchase capital stock in proportion to their outstanding advances. Pursuant to the FHLB Act, the Bank has a lien upon and holds the Bank’s Class B capital stock owned by each of its shareholders as additional collateral for all of the respective shareholder’s obligations to the Bank.

In order to comply with the requirement to fully secure advances and other extensions of credit to its members, the Bank and its members execute a written security agreement that establishes the Bank’s security interest in a variety of its members’ assets. The Bank, pursuant to the FHLB Act and the regulations issued by the Finance Board, originates, renews, or extends advances to its members only if it has obtained and is maintaining a security interest in eligible collateral at the time such advance is made, renewed, or extended. Eligible collateral includes whole first mortgages on improved residential real property or securities representing a whole interest in such mortgages; securities issued, insured, or guaranteed by the United States Government or any of its agencies, including mortgage-backed and other debt securities issued or guaranteed by the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”), or the Government National Mortgage Association; term deposits in the Bank; and other real estate-related collateral acceptable to the Bank, provided that such collateral has a readily ascertainable value and the Bank can perfect a security interest in such property.

In the case of CFIs, the Bank may also accept as eligible collateral secured small business, small farm, and small agribusiness loans and securities representing a whole interest in such loans, provided the collateral has a readily ascertainable value and the Bank can perfect a security interest in such collateral. At December 31, 2007, 2006 and 2005, total CFI obligations secured by these types of collateral, including commercial real estate, totaled approximately $1.4 billion, $1.0 billion and $1.8 billion, respectively, which represented approximately 2.7 percent, 2.2 percent and 3.6 percent, respectively, of the total advances and letters of credit outstanding as of those dates.

The FHLB Act affords any security interest granted to the Bank by any member/borrower of the Bank, or any affiliate of any such member/borrower, priority over the claims and rights of any party, including any receiver, conservator, trustee, or similar party having rights of a lien creditor. However, the Bank’s security interest is not entitled to priority over the claims and rights of a party that (i) would be entitled to priority under otherwise applicable law or (ii) is an actual bona fide purchaser for value or is a secured party who has a perfected security interest in such collateral in accordance with applicable law (e.g., a prior perfected security interest under the Uniform Commercial Code or other applicable law).

As stated above, each member/borrower of the Bank executes a security agreement pursuant to which such member/borrower grants a security interest in favor of the Bank in certain assets of such member/borrower. The assets in which a member grants a security interest fall into one of two general structures. In the first structure, the member grants a security interest in all of its assets that are included in one of the eligible collateral categories, as described above, which the Bank refers to as a “blanket lien.” If a member has an investment grade credit rating from an NRSRO, the member may request that its blanket lien be modified, such that the member grants in favor of the Bank a security interest limited to certain of the eligible collateral categories (i.e., whole first residential mortgages, securities, term deposits in the Bank and other real estate-related collateral). In the second structure, the member grants a security interest in specifically identified assets rather than in the broad categories of eligible collateral covered by the blanket lien and the Bank identifies such members as being on “specific collateral only status.”

The basis upon which the Bank will lend to a member that has granted the Bank a blanket lien depends on numerous factors, including, among others, that member’s financial condition and general creditworthiness. Generally, and subject to certain limitations, a member that has granted the Bank a blanket lien may borrow up to a specified percentage of the value of eligible collateral categories, as determined from such member’s financial statements filed with its federal regulator, without specifically identifying each item of collateral or delivering the collateral to the Bank. Under certain circumstances, including, among others, a deterioration of a member’s financial condition or general creditworthiness, the amount a member may borrow is determined on the basis of only that portion of the collateral subject to the blanket lien that such member delivers to the Bank. Under these circumstances, the Bank places the member on “custody status.” In addition, members on blanket lien status may choose to deliver some or all of the collateral to the Bank.

The members/borrowers that are granted specific collateral only status by the Bank are generally either insurance companies or members/borrowers with an investment grade credit rating from an NRSRO that have requested this type of structure. Insurance companies grant a security interest in, and are only permitted to borrow against, the eligible collateral that is delivered to the Bank. Members/borrowers with an investment grade credit rating from an NRSRO may grant a security interest in, and would only be permitted to borrow against, delivered eligible securities

and specifically identified, eligible first-lien mortgage loans. Such loans must be delivered to the Bank or a third-party custodian approved by the Bank, or the Bank and such member/borrower must otherwise agree on an arrangement to assure the priority of the Bank’s security interest in such loans. Investment grade rated members/borrowers that choose this option are subject to fewer provisions that allow the Bank to demand additional collateral or exercise other remedies based on the Bank’s discretion.

As of December 31, 2007, 731 of the Bank’s borrowers/potential borrowers with a total of $26.3 billion in outstanding advances were on blanket lien status, 22 borrowers/potential borrowers with $18.8 billion in outstanding advances were on specific collateral only status and 156 borrowers/potential borrowers with $1.0 billion in outstanding advances were on custody status.

The Bank perfects its security interests in borrowers’ collateral in a number of ways. The Bank usually perfects its security interest in collateral by filing a uniform commercial code financing statement against the borrower. In the case of certain borrowers, the Bank perfects its security interest by taking possession or control of the collateral, which may be in addition to the filing of a financing statement. In these cases, the Bank also generally takes assignments of most of the mortgages and deeds of trust that are designated as collateral. Instead of requiring delivery of the collateral to the Bank, the Bank may allow certain borrowers to deliver specific collateral to a third-party custodian approved by the Bank.

On a quarterly basis, the Bank obtains updated information relating to collateral pledged to the Bank by members on blanket lien status. This information is accessed by the Bank from appropriate regulatory filings. On a monthly basis or as otherwise requested by the Bank, members on custody status and members on specific collateral only status must update information relating to collateral pledged to the Bank. In accordance with written procedures similar to those established by the Auditing Standards Board of the American Institute of Certified Public Accountants, Bank personnel regularly verify the existence of collateral securing advances to members on blanket lien status and members on specific collateral only status with respect to any collateral not delivered to the Bank. The frequency and the extent of these collateral verifications depend on the average amount by which a member’s outstanding obligations to the Bank during the year exceed the collateral value of its securities, loans and term deposits held by the Bank. Collateral verifications are not required for members that have had no outstanding obligations to the Bank secured by a blanket lien during the prior calendar year, are on custody status, or are on blanket lien status but at all times have delivered to the Bank eligible loans, securities and term deposits with a collateral value in excess of the member’s advances and other extensions of credit.

Finance Board regulations require the Bank to establish a formula for and to charge a prepayment fee on an advance that is repaid prior to maturity in an amount sufficient to make the Bank financially indifferent to the borrower’s decision to repay the advance prior to its scheduled maturity date. These fees are generally calculated as the present value of the difference (if positive) between the interest rate on the prepaid advance and the current rate on a permissible investment for the remaining term to maturity of the repaid advance. During the years ended December 31, 2007, 2006 and 2005, the Bank collected net prepayment fees of $2.3 million, $2.2 million and $2.7 million, respectively.

As of December 31, 2007, the Bank’s outstanding advances (at par value) totaled $46.1 billion. As of that date, advances outstanding to the Bank’s ten largest borrowers represented 65.3 percent of the Bank’s total outstanding advances. Advances to the Bank’s three largest borrowers represented 54.4 percent of the Bank’s total outstanding advances. Individually, advances to the Bank’s three largest borrowers represented 37.4 percent (Wachovia Bank, FSB), 12.4 percent (Guaranty Bank) and 4.6 percent (Franklin Bank, SSB) of the total advances outstanding as of December 31, 2007.

As of December 31, 2007, the Bank’s fifth largest borrower was Capital One, National Association, a Virginia-domiciled institution with approximately $841 million of advances outstanding. In November, 2005, Capital One Financial Corp. (domiciled in the Fourth District of the FHLBank system) acquired Hibernia National Bank (now known as Capital One, National Association). Effective July 1, 2007, Capital One, National Association relocated its charter to the Fourth District of the FHLBank System and is no longer eligible for membership in the Bank. Capital One, National Association’s remaining advances are scheduled to mature as follows: $201 million in 2008, $602 million in 2009, and the remaining $38 million during the period from 2010 through 2034. During the years

ended December 31, 2007, 2006 and 2005, Capital One, National Association accounted for 3.2 percent, 3.2 percent and 3.4 percent, respectively, of the Bank’s total interest income from advances.

As of December 31, 2007, the Bank’s fifteenth largest borrower was Washington Mutual Bank, a California-based institution with approximately $368 million of advances outstanding. On February 13, 2001, Washington Mutual Bank acquired Bank United, then the Bank’s largest shareholder and borrower, and dissolved Bank United’s Ninth District charter. Washington Mutual Bank assumed Bank United’s advances, which at the time totaled $7.6 billion, and in so doing became a non-member borrower. In 2006 and 2007, $4.0 billion and $3.1 billion, respectively, of these advances matured and were repaid. Washington Mutual’s remaining advances mature in the third quarter of 2008. During the years ended December 31, 2007, 2006 and 2005, Washington Mutual Bank accounted for 4.0 percent, 11.1 percent and 14.9 percent, respectively, of the Bank’s total interest income from advances.

For additional information regarding the composition and concentration of the Bank’s advances, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Community Investment Cash Advances. The Bank also offers a Community Investment Cash Advances (“CICA”) program as authorized by Finance Board regulations. Advances made under the CICA program benefit low- to moderate-income households by providing funds for housing or economic development projects. CICA advances are made at rates below the rates the Bank charges on standard advances, and may be made at the Bank’s cost of funds or, in certain circumstances for specified purposes, below its cost of funds. The Bank currently prices CICA advances at interest rates that are approximately 15 basis points lower than rates on comparable advances made outside the program. CICA advances are provided separately from and do not count toward the Bank’s statutory obligations under the Affordable Housing Program (“AHP”), through which the Bank provides grants to support projects that benefit low-income households (see the “Affordable Housing Program” section below). As of December 31, 2007, advances outstanding under the CICA program totaled approximately $685 million, representing approximately 1.5 percent of the Bank’s total advances outstanding as of that date.

Letters of Credit. The Bank’s credit services also include letters of credit issued or confirmed on behalf of members to facilitate business transactions with third parties that support residential housing finance, community lending, or asset/liability management or to provide liquidity to members. Letters of credit are also issued on behalf of members to secure the deposits of public entities that are held by such members. Letters of credit must be fully collateralized as though they were funded advances. During the years ended December 31, 2007, 2006 and 2005, letter of credit fees earned by the Bank totaled approximately $4.1 million, $2.8 million and $2.0 million, respectively.

Acquired Member Assets (“AMA”) . The Bank offers its members the ability to participate in the Mortgage Partnership Finance ^® (MPF ^® ) Program developed and managed by the Federal Home Loan Bank of Chicago (the “FHLBank of Chicago”). “Mortgage Partnership Finance” and “MPF” are registered trademarks of the FHLBank of Chicago. Under the MPF Program, one or more FHLBanks acquire fixed rate, conforming mortgage loans originated by their member institutions that participate in the MPF Program (“Participating Financial Institutions” or “PFIs”). PFIs are paid a fee by the purchasing FHLBank for assuming a portion of the credit risk of the mortgages delivered to the FHLBank, while the FHLBank assumes the interest rate risk of holding the mortgages in its portfolio as well as a portion of the credit risk. PFIs deliver loans pursuant to the terms of master commitment agreements (“MCs”) entered into by the FHLBank and the PFI and acknowledged and approved by the FHLBank of Chicago. Under the terms of the MCs, a PFI may either deliver loans that the PFI has already closed in its own name and transfers to the FHLBank or, as agent for the FHLBank, close loans directly in the name of the FHLBank (collectively, “Program Loans”). Program Loans are owned directly by the FHLBank and are not held through a trust or any other conduit entity. Title to Program Loans is in the name of the purchasing FHLBank, subject to the participation interests in such loans that the FHLBank may have sold to the FHLBank of Chicago.

From 1998 to mid-2003, the Bank generally retained an interest in the Program Loans it acquired from its PFIs under the MPF Program pursuant to the terms of an investment and services agreement between the FHLBank of Chicago and the Bank (the “First MPF Agreement”). Under the First MPF Agreement, the Bank retained title to the Program Loans, subject to any participation interest in such loans that was sold to the FHLBank of Chicago. The FHLBank of Chicago’s participation interest in Program Loans reduced the Bank’s beneficial interest in such loans. The First MPF Agreement permitted the Bank to retain a beneficial interest in Program Loans ranging from 1

percent to 49 percent, as the Bank in its discretion determined, and required the FHLBank of Chicago to purchase a participation interest in the Program Loans equal to the amount of interest in such loans that the Bank chose not to retain. In any case where the FHLBank of Chicago’s participation interest was less than 51 percent, the Bank would have been required to pay a transaction services fee to the FHLBank of Chicago. The interest in the Program Loans retained by the Bank during this period ranged from a low of 1 percent to a maximum of 49 percent. Because the FHLBank of Chicago’s interest in the Program Loans was always equal to or greater than 51 percent, the Bank was never required to pay a transaction services fee to the FHLBank of Chicago. During the period from 1998 to 2000, the Bank also acquired from the FHLBank of Chicago a percentage interest (ranging up to 75 percent) in certain MPF loans originated by PFIs of other FHLBanks. The Bank’s purchase of Program Loans from PFIs and its sale of participation interests to the FHLBank of Chicago occurred simultaneously and at the same price.

On December 5, 2002, the Bank and the FHLBank of Chicago entered into a new investment and services agreement (the “Second MPF Agreement”) to replace the First MPF Agreement with respect to Program Loans delivered under MCs entered into on or after December 5, 2002. Following an initial term of three years, the agreement now continues indefinitely unless terminated by either party upon 90 days’ prior notice. The Second MPF Agreement provides that the FHLBank of Chicago will assume all rights and obligations of the Bank under each MC with the Bank’s PFIs and will acquire directly from such PFIs the Program Loans. The FHLBank of Chicago, the Bank, and the applicable PFI execute a written assignment and assumption agreement with respect to each MC that documents the rights and obligations of the FHLBank of Chicago as the assignee of the Bank’s rights and obligations under such MC. The Bank has no obligation to its PFIs to purchase Program Loans or perform any other obligation under an MC that has been assumed by the FHLBank of Chicago. Under such MCs, the FHLBank of Chicago purchases Program Loans directly from the Bank’s PFIs. All substantive terms of the MCs issued under the Second MPF Agreement are unchanged from the terms of MCs issued under the First MPF Agreement. Under the Second MPF Agreement, the FHLBank of Chicago is obligated to pay to the Bank a participation fee equal to a percentage of the dollar volume of Program Loans delivered by the Bank’s PFIs.

Under the terms of the Second MPF Agreement, the Bank retains the option to purchase up to a 50 percent interest in Program Loans delivered by its PFIs in lieu of receiving participation fees and provided that the Bank pays to the FHLBank of Chicago a monthly transaction service fee. Pursuant to an amendment to the First MPF Agreement entered into on June 23, 2003, the Bank and the FHLBank of Chicago agreed to extend the terms of the Second MPF Agreement to Program Loans delivered pursuant to MCs entered into prior to December 5, 2002. The Bank has not exercised its option under the Second MPF Agreement to purchase any interest in Program Loans and currently anticipates that all future Program Loans delivered by its PFIs will be subject to the fee arrangement and will not be held on the Bank’s balance sheet.

As of December 31, 2007, MPF loans held for portfolio (net of allowance for credit losses) were $381 million, representing approximately 0.6 percent of the Bank’s total assets. As of both December 31, 2006 and 2005, MPF loans held for portfolio (net of allowance for credit losses) represented approximately 0.8 percent of the Bank’s total assets. Because the Bank does not expect to exercise its option to purchase interests in MPF loans in the future, the Bank currently anticipates that (in the absence of a merger with the FHLBank of Chicago, as discussed below in the section entitled “Merger Discussions”) its balance of retained MPF loans will continue to decline over time. For more information regarding the Bank’s MPF loans, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Affordable Housing Program (“AHP”) . The Bank offers an AHP as required by the FHLB Act and in accordance with Finance Board regulations. The Bank sets aside 10 percent of each year’s earnings (as adjusted for interest expense on mandatorily redeemable capital stock) for its AHP, which provides grants for projects that facilitate development of rental and owner-occupied housing for low-income households. The calculation of the amount to be set aside is further discussed below in the section entitled “Taxation.” Each year, the Bank conducts two competitive application processes to allocate the AHP funds set aside from the prior year’s earnings. Applications submitted by Bank members and their community partners during these funding rounds are scored in accordance with Finance Board regulations and the Bank’s AHP Implementation Plan. The highest scoring proposals are approved to receive funds, which are disbursed upon receipt of documentation that the projects are progressing as specified in the original applications.

Correspondent Banking Services . The Bank provides its members with a variety of correspondent banking services. These services include overnight and term deposit accounts, wire transfer services, reserve pass-through and settlement services, securities safekeeping and securities pledging services. In the aggregate, correspondent banking services generated fee income for the Bank of $3.7 million, $3.4 million and $2.8 million during the years ended December 31, 2007, 2006 and 2005, respectively.

SecureConnect . The Bank provides secure on-line access to many of its products, services and reports through SecureConnect, a secure on-line product delivery system. A substantial portion of the Bank’s advances and wire transfers are initiated by members through SecureConnect. In addition, a large proportion of account statements and other reports are made available through SecureConnect. Further, members may manage securities held in safekeeping by the Bank and participate in auctions for Bank advances and deposits through SecureConnect.

AssetConnection ^® . The Bank has an electronic communications system, known as AssetConnection ^® , that was developed to facilitate the transfer of financial and other assets among member institutions. “AssetConnection” is a registered trademark of the Bank. Types of assets that may be transferred include mortgage and other secured loans or loan participations. The purpose of this system is to enhance the liquidity of mortgage loans and other assets by providing a mechanism to balance the needs of those member institutions with excess loan capacity and those with more asset demand than capacity.

AssetConnection is a listing service that allows member institutions to list assets available for sale or interests in assets to purchase. In this form, the Bank does not take a position in any of the assets listed, nor does the Bank offer any form of endorsement or guarantee related to the assets being listed. All transactions must be negotiated and consummated between principals. To date, a limited number of assets have been listed for sale through AssetConnection and several members have accessed the system in search of assets to purchase. If members ultimately find the services available through AssetConnection to be of value to their institutions, it could provide an additional source of fee income for the Bank.

Investment Activities

The Bank maintains a portfolio of investments to enhance interest income and meet liquidity needs. To ensure the availability of funds to meet members’ credit needs and its other general liquidity requirements, the Bank maintains a portfolio of short-term, unsecured investments issued by highly rated institutions, including overnight federal funds and short-term commercial paper. At December 31, 2007, the Bank’s short-term investments were comprised of overnight federal funds sold to domestic counterparties (including a loan to another FHLBank) and short-term commercial paper of $7.5 billion and $1.0 billion, respectively.

To enhance interest income, the Bank maintains a long-term investment portfolio, which includes securities issued by United States Government agencies or government-sponsored agencies (e.g., Fannie Mae and Freddie Mac), mortgage-backed securities (“MBS”) issued by government-sponsored agencies, and non-agency residential and commercial MBS that carry the highest ratings from Moody’s or S&P. The interest rate and prepayment risk inherent in the MBS is managed though a variety of debt and interest rate derivative instruments. As of December 31, 2007, the Bank’s long-term investment portfolio was comprised of approximately $7.7 billion of MBS and $0.2 billion of United States Government and government-sponsored agency securities. As further described in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Bank sold $0.017 billion of MBS during the year ended December 31, 2007 and $4.1 billion (par value) of government-sponsored agency securities during the year ended December 31, 2005. No long-term investments were sold during the year ended December 31, 2006.

The Bank’s non-agency residential MBS (“RMBS”) are collateralized by whole mortgage loans that generally do not conform to government agency pooling requirements and its non-agency commercial MBS (“CMBS”) are collateralized by loans secured by commercial real estate. The Bank’s non-agency MBS investments are self-insured by a senior/subordinate structure in which the subordinate classes of securities provide credit support for the most senior class of securities, an interest in which is owned by the Bank. Losses in the underlying loan pool would generally have to exceed the credit support provided by the subordinate classes of securities before the most senior class of securities would experience any credit losses. The credit support provided by the subordinate securities is typically expressed as a percentage equal to the quotient of the sum of the proportionate principal amount of securities that are subordinate to all triple-A securities plus the principal amount of any triple-A securities that are subordinate solely to the Bank’s security,

divided by the principal amount of the Bank’s security. As of December 31, 2007, the credit support for the Bank’s non-agency securities ranged from 25 percent to 62 percent (in the case of the CMBS) and from 5 percent to 65 percent (in the case of the RMBS).

The Bank further reduces the credit risk of its non-agency MBS by purchasing securities with other risk-reducing attributes. For instance, the Bank purchases RMBS backed by loan pools that feature a high percentage of relatively small and geographically dispersed loans, a high percentage of owner-occupied properties, and low loan-to-value ratios. When purchasing CMBS, the Bank has generally acquired securities backed by relatively small and geographically diverse loans, diverse loan types and high debt service coverage ratios. At December 31, 2007 (and as of March 21, 2008), all of the Bank’s holdings of privately issued mortgage-backed securities retained the highest investment grade rating.

Finance Board policy and regulations limit the Bank’s MBS investments to 300 percent of its total capital, as of the prior month end at the time new investments are made, and non-MBS obligations of a single government-sponsored agency to 100 percent of the Bank’s total capital as of the prior month end at the time new investments are made. In accordance with Finance Board regulations, total capital for these purposes excludes accumulated other comprehensive income (loss) and includes all amounts paid in for the Bank’s capital stock regardless of accounting classification (see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations). The Bank is not required to sell or otherwise reduce any investments that exceed these regulatory limits due to reductions in capital or changes in value after the investments are made, but it is precluded from making additional investments that exceed these limits. To the extent the Bank’s total capital grows through additional capital stock investments, distributions of earnings in the form of stock dividends, and increases in retained earnings, the Bank may increase its MBS investments if opportunities to purchase securities at favorable spreads exist in the marketplace.

The Bank attempts to maintain its investments in MBS close to the regulatory limit of 300 percent of total capital. While the Finance Board sets limits on the risks that may be taken with MBS investments, the Bank has generally adopted a more conservative approach. In certain cases, the Bank uses interest rate derivatives to manage prepayment risks and other options embedded in the MBS that it acquires.

On March 24, 2008, the Board of Directors of the Finance Board passed a resolution that authorizes the FHLBanks to temporarily invest up to an additional 300 percent of their total capital in agency mortgage securities. For additional information regarding this expanded investment authority, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Regulatory Developments.

Finance Board regulations include a variety of restrictions and limitations on the FHLBanks’ investment activities, including limits on the types, amounts, and maturities of unsecured investments in private issuers. Finance Board rules and regulations also prohibit the Bank from investing in certain types of securities, including:

	•		instruments, such as common stock, that represent an ownership interest in an entity, other than stock in small business investment companies, or certain investments targeted to low-income persons or communities;
	•		instruments issued by non-United States entities, other than those issued by United States branches and agency offices of foreign commercial banks;
	•		non-investment grade debt instruments, other than certain investments targeted to low-income persons or communities and instruments that were downgraded after purchase by the Bank;
	•		whole mortgages or other whole loans, other than 1) those acquired by the Bank through a duly authorized AMA program such as the MPF Program; 2) certain investments targeted to low-income persons or communities; 3) certain marketable direct obligations of State, local, or tribal government units or agencies, having at least the second highest credit rating from an NRSRO; 4) MBS or asset-backed securities backed by manufactured housing loans or home equity loans; and 5) certain foreign housing loans authorized under Section 12(b) of the FHLB Act;

	•		non-U.S. dollar denominated securities;
	•		interest-only or principal-only stripped MBS;
	•		residual-interest or interest-accrual classes of collateralized mortgage obligations and real estate mortgage investment conduits; and
	•		fixed rate MBS or floating rate MBS that, on trade date, are at rates equal to their contractual cap and that have average lives that vary by more than 6 years under an assumed instantaneous interest rate change of 300 basis points.

Funding Sources

General . The principal funding source for the Bank is consolidated obligations issued in the capital markets through the Office of Finance. Member deposits and the proceeds from the issuance of capital stock are also funding sources for the Bank. Consolidated obligations consist of consolidated bonds and consolidated discount notes. Generally, discount notes are consolidated obligations with maturities of one year or less, and consolidated bonds have maturities in excess of one year.

The Bank determines its participation in the issuance of consolidated obligations based upon, among other things, its own funding and operating requirements and the amounts, maturities, rates of interest and other terms available in the marketplace. The issuance terms for consolidated obligations are established by the Office of Finance, subject to policies established by its Board of Directors and the regulations of the Finance Board. In addition, the Government Corporation Control Act provides that, before a government corporation issues and offers obligations to the public, the U.S. Secretary of the Treasury shall prescribe the form, denomination, maturity, interest rate, and conditions of the obligations, the way and time issued, and the selling price.

Consolidated bonds satisfy long-term funding needs. Typically, the maturities of these securities range from 1 to 20 years, but their maturities are not subject to any statutory or regulatory limit. Consolidated bonds can be fixed or adjustable rate and may be callable or non-callable.

Consolidated bonds are issued and distributed daily through negotiated or competitively bid transactions with approved underwriters or selling group members. The Bank receives 100 percent of the proceeds of bonds issued through direct negotiation with underwriters of System debt when it is the only FHLBank involved in the issuance and is the sole FHLBank that is the primary obligor on consolidated obligation bonds issued under those circumstances. When the Bank and one or more other FHLBanks jointly agree to the issuance of bonds directly negotiated with underwriters, the Bank receives the portion of the proceeds of the bonds agreed upon with the other FHLBanks; in those cases, the Bank is the primary obligor for a pro rata portion of the bonds based on the proceeds it receives. In these cases, the Bank records on its balance sheet only that portion of the bonds for which it is the primary obligor. The majority of the Bank’s consolidated obligation bond issuance is conducted through direct negotiation with underwriters of System debt, and a majority of that issuance is without participation by the other FHLBanks.

The Bank may also request that specific amounts of specific bonds be offered by the Office of Finance for sale through competitive auction conducted with underwriters in a bond selling group. One or more other FHLBanks may also request that amounts of these same bonds be offered for sale for their benefit through the same auction. The Bank may receive from zero to 100 percent of the proceeds of the bonds issued through competitive auction depending on the amounts and costs for the bonds bid by underwriters, the maximum costs the Bank or other FHLBanks, if any, participating in the same issue are willing to pay for the bonds, and Office of Finance guidelines for allocation of bond proceeds among multiple participating FHLBanks.

Consolidated discount notes are a significant funding source for money market instruments and for advances with short-term maturities or repricing frequencies of less than one year. Discount notes are sold at a discount and mature at par, and are offered daily through a consolidated discount notes selling group and through other authorized underwriters.

On a daily basis, the Bank may request that specific amounts of discount notes with specific maturity dates be offered by the Office of Finance at a specific cost for sale to underwriters in the discount note selling group. One or more other FHLBanks may also request that amounts of discount notes with the same maturities be offered for sale for their benefit on the same day. The Office of Finance commits to issue discount notes on behalf of the participating FHLBanks when underwriters in the selling group submit orders for the specific discount notes offered for sale. The Bank may receive from zero to 100 percent of the proceeds of the discount notes issued through this sales process depending on the maximum costs the Bank or other FHLBanks, if any, participating in the same discount notes are willing to pay for the discount notes, the amounts of orders for the discount notes submitted by underwriters, and Office of Finance guidelines for allocation of discount notes proceeds among multiple participating FHLBanks. Under the Office of Finance guidelines, FHLBanks generally receive funding on a first-come-first-serve basis subject to threshold limits within each category of discount notes. For overnight discount notes, sales are allocated to the FHLBanks in lots of $250 million. For all other discount note maturities, sales are allocated in lots of $50 million. Within each category of discount notes, the allocation process is repeated until all orders are filled or canceled.

Twice weekly, the Bank may also request that specific amounts of discount notes with fixed maturity dates ranging from 4 to 26 weeks be offered by the Office of Finance through competitive auctions conducted with underwriters in the discount note selling group. One or more other FHLBanks may also request that amounts of those same discount notes be offered for sale for their benefit through the same auction. The discount notes offered for sale through competitive auction are not subject to a limit on the maximum costs the FHLBanks are willing to pay. The FHLBanks receive funding based on their requests at a weighted average rate of the winning bids from the dealers. If the bids submitted are less than the total of the FHLBanks’ requests, the Bank receives funding based on the ratio of the Bank’s capital relative to the capital of the other FHLBanks offering discount notes. The majority of the Bank’s discount note issuance in maturities of four weeks or longer is conducted through the auction process. Regardless of the method of issuance, as with consolidated bonds, the Bank is the primary obligor for the portion of discount notes issued for which it has received the proceeds.

On occasion, and as an alternative to issuing new debt, the Bank may assume the outstanding consolidated obligations for which other FHLBanks are the original primary obligors. This occurs in cases where the original primary obligor may have participated in a large consolidated obligation issue to an extent that exceeded its immediate funding needs in order to facilitate better market execution for the issue. The original primary obligor might then warehouse the funds until they were needed, or make the funds available to other FHLBanks. Transfers may also occur when the original primary obligor’s funding needs change, and that FHLBank offers to transfer debt that is no longer needed to other FHLBanks. Transferred debt is typically fixed rate, fixed term, non-callable debt, and may be in the form of discount notes or bonds. In connection with these transactions, the Bank becomes the primary obligor for the transferred debt.

The Bank participates in such transfers of funding from other FHLBanks when the transfer represents favorable pricing relative to a new issue of consolidated obligations with similar features. During the years ended December 31, 2007 and 2005, the Bank assumed consolidated obligations from other FHLBanks with par amounts of $323 million and $425 million, respectively. The Bank did not assume any consolidated obligations from other FHLBanks during the year ended December 31, 2006.

In addition, the Bank occasionally transfers debt that it no longer needs to other FHLBanks. During the year ended December 31, 2007, the Bank transferred consolidated obligations with an aggregate par amount of $461 million to other FHLBanks. The Bank did not transfer any consolidated obligations to other FHLBanks during the years ended December 31, 2006 and 2005.

At December 31, 2007, the Bank was primary obligor on $56.9 billion of consolidated obligations (at par value), of which $32.7 billion were consolidated bonds and $24.2 billion were consolidated discount notes.

Joint and Several Liability . Although the Bank is primarily liable only for its portion of consolidated obligations (i.e., those consolidated obligations issued on its behalf and those that have been transferred/assumed from other FHLBanks), it is also jointly and severally liable with the other FHLBanks for the payment of principal and interest on all of the consolidated obligations issued by the FHLBanks. The Finance Board, in its discretion, may require

any FHLBank to make principal or interest payments due on any consolidated obligation, regardless of whether there has been a default by a FHLBank having primary liability. To the extent that a FHLBank makes any payment on a consolidated obligation on behalf of another FHLBank, the paying FHLBank shall be entitled to reimbursement from the FHLBank with primary liability. The FHLBank with primary liability would have a corresponding liability to reimburse the FHLBank providing assistance to the extent of such payment and other associated costs (including interest to be determined by the Finance Board). However, if the Finance Board determines that the primarily liable FHLBank is unable to satisfy its obligations, then the Finance Board may allocate the outstanding liability among the remaining FHLBanks on a pro rata basis in proportion to each FHLBank’s participation in all consolidated obligations outstanding, or on any other basis that the Finance Board may determine. No FHLBank has ever failed to make any payment on a consolidated obligation for which it was the primary obligor; as a result, the regulatory provisions for directing other FHLBanks to make payments on behalf of another FHLBank or allocating the liability among other FHLBanks have never been invoked. Consequently, the Bank has no means to determine how the Finance Board might allocate among the other FHLBanks the obligations of a FHLBank that is unable to pay consolidated obligations for which such FHLBank is primarily liable. In the unlikely event the Bank is holding a consolidated obligation as an investment for which the Finance Board would allocate liability among the 12 FHLBanks, the Bank might be exposed to a credit loss to the extent of its share of the assigned liability for that particular consolidated obligation. If principal or interest on any consolidated obligation issued by the FHLBank System is not paid in full when due, the Bank may not pay dividends to, or repurchase shares of stock from, any shareholder of the Bank.

To facilitate the timely funding of principal and interest payments on FHLBank System consolidated obligations in the event that a FHLBank is not able to meet its funding obligations in a timely manner, the FHLBanks and the Office of Finance entered into the Federal Home Loan Banks P&I Funding and Contingency Plan Agreement on June 23, 2006. For additional information regarding this agreement, see the section entitled “Liquidity and Capital Resources” in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

According to the Office of Finance, the 12 FHLBanks had (at par value) approximately $1.190 trillion, $0.952 trillion and $0.937 trillion in consolidated obligations outstanding at December 31, 2007, 2006 and 2005, respectively. The Bank was the primary obligor on $56.9 billion, $50.2 billion and $57.8 billion (at par value), respectively, of these consolidated obligations.

Certification and Reporting Obligations . Under Finance Board regulations, before the end of each calendar quarter and before paying any dividends for that quarter, the President and Chief Executive Officer of the Bank must certify to the Finance Board that, based upon known current facts and financial information, the Bank will remain in compliance with applicable liquidity requirements and will remain capable of making full and timely payment of all current obligations (which includes the Bank’s obligation to pay principal and interest on consolidated obligations) coming due during the next quarter. The Bank is required to provide notice to the Finance Board if it (i) is unable to provide the required certification, (ii) projects at any time that it will fail to comply with its liquidity requirements or will be unable to meet all of its current obligations due during the quarter, (iii) actually fails to comply with its liquidity requirements or to meet all of its current obligations due during the quarter, or (iv) negotiates to enter into or enters into an agreement with one or more other FHLBanks to obtain financial assistance to meet its current obligations due during the quarter. The Bank has been in compliance with the applicable reporting requirements at all times since they became effective in 1999.

A FHLBank must file a consolidated obligation payment plan for Finance Board approval if (i) the FHLBank becomes a non-complying FHLBank as a result of failing to provide the required certification, (ii) the FHLBank becomes a non-complying FHLBank as a result of being required to provide the notice described above to the Finance Board, except in the case of a failure to make a payment on a consolidated obligation caused solely by an external event such as a power failure, or (iii) the Finance Board determines that the FHLBank will cease to be in compliance with its liquidity requirements or will lack the capacity to meet all of its current obligations due during the quarter.

A non-complying FHLBank is permitted to continue to incur and pay normal operating expenses in the regular course of business, but may not incur or pay any extraordinary expenses, or declare or pay dividends, or redeem any capital stock, until such time as the Finance Board has approved the FHLBank’s consolidated obligation payment

plan or inter-FHLBank assistance agreement, or ordered another remedy, and all of the non-complying FHLBank’s direct obligations have been paid.

Negative Pledge Requirements . Each FHLBank must maintain specified assets free from any lien or pledge in an amount at least equal to its participation in outstanding consolidated obligations. Eligible assets for this purpose include (i) cash; (ii) obligations of, or fully guaranteed by, the United States Government; (iii) secured advances; (iv) mortgages having any guaranty, insurance, or commitment from the United States Government or any related agency; (v) investments described in Section 16(a) of the FHLB Act, which, among other items, include securities that a fiduciary or trust fund may purchase under the laws of the state in which the FHLBank is located; and (vi) other securities that are assigned a rating or assessment by an NRSRO that is equivalent to or higher than the rating on the FHLBanks’ consolidated obligations. At December 31, 2007, 2006 and 2005, the Bank had eligible assets free from pledge of $62.9 billion, $55.3 billion and $64.4 billion, respectively, compared to its participation in outstanding consolidated obligations of $56.9 billion, $50.2 billion and $57.8 billion, respectively. In addition, the Bank was in compliance with its negative pledge requirements at all times during the years ended December 31, 2007, 2006 and 2005.

Office of Finance . The Office of Finance is a joint office of the 12 FHLBanks that executes the issuance of consolidated obligations, as agent, on behalf of the FHLBanks. Established by the Finance Board, the Office of Finance also services all outstanding consolidated obligation debt, serves as a source of information for the FHLBanks on capital market developments, manages the FHLBank System’s relationship with rating agencies as it pertains to the consolidated obligations, and prepares and distributes the annual and quarterly combined financial reports for the FHLBanks.

The Office of Finance is managed by a board of directors that consists of three part-time members appointed by the Finance Board. Under current Finance Board regulations, two of these members are presidents of FHLBanks and the third is a private citizen of the United States with a demonstrated expertise in financial markets. The private citizen member of the board also serves as its Chairman. The Bank’s President and Chief Executive Officer has served as a director of the Office of Finance since April 1, 2003 and is currently serving a second three-year term that will expire on March 31, 2009.

One of the responsibilities of the Board of Directors of the Office of Finance is to establish policies regarding consolidated obligations to ensure that, among other things, such obligations are issued efficiently and at the lowest all-in funding costs for the FHLBanks over time consistent with prudent risk management practices and other market and regulatory factors.

The Finance Board has regulatory oversight and enforcement authority over the Office of Finance and its directors and officers to the same extent as it has such authority over a FHLBank and its respective directors and officers. The FHLBanks are responsible for jointly funding the expenses of the Office of Finance, which are shared on a pro rata basis with one-third based on each FHLBank’s total outstanding capital stock (as of the prior month-end, excluding those amounts classified as mandatorily redeemable), one-third based on each FHLBank’s total debt issuance (during the current month), and one-third based on each FHLBank’s total consolidated obligations outstanding (as of the current month-end).

Through December 31, 2000, consolidated obligations were issued by the Finance Board through the Office of Finance under the authority of Section 11(c) of the FHLB Act, which provides that debt so issued is the joint and several obligation of the FHLBanks. Since January 2, 2001, the FHLBanks have issued consolidated obligations in the name of the FHLBanks through the Office of Finance under Section 11(a) of the FHLB Act. While the FHLB Act does not impose joint and several liability on the FHLBanks for debt issued under Section 11(a), the Finance Board has determined that the same rules governing joint and several liability should apply whether consolidated obligations are issued by the Finance Board under Section 11(c) or by the FHLBanks under Section 11(a). No FHLBank is currently permitted to issue individual debt under Section 11(a) of the FHLB Act without Finance Board approval.

Use of Interest Rate Exchange Agreements

Finance Board regulations authorize and establish general guidelines for the FHLBanks’ use of derivative instruments, and the Bank’s Risk Management Policy establishes specific guidelines for their use. The Bank can use interest rate swaps, swaptions, cap and floor agreements, calls, puts, and futures and forward contracts as part of its interest rate risk management and funding strategies. Regulations prohibit derivative instruments that do not qualify as hedging instruments pursuant to generally accepted accounting principles unless a non-speculative use is documented.

In general, the Bank uses interest rate exchange agreements in two ways: either by designating them as a fair value hedge of an underlying financial instrument or by designating them as a hedge of some defined risk in the course of its balance sheet management. For example, the Bank uses interest rate exchange agreements in its overall interest rate risk management activities to adjust the interest rate sensitivity of consolidated obligations to approximate more closely the interest rate sensitivity of its assets, including advances and investments, and/or to adjust the interest rate sensitivity of advances and investments to approximate more closely the interest rate sensitivity of its liabilities. In addition to using interest rate exchange agreements to manage mismatches between the coupon features of its assets and liabilities, the Bank also uses interest rate exchange agreements to manage embedded options in assets and liabilities, to preserve the market value of existing assets and liabilities and to reduce funding costs.

To reduce funding costs, the Bank may enter into interest rate exchange agreements concurrently with the issuance of consolidated obligations. This strategy of issuing bonds while simultaneously entering into interest rate exchange agreements enables the Bank to offer a wider range of attractively priced advances to its members. The continued attractiveness of such debt depends on yield relationships between the bond and interest rate exchange markets. If conditions in these markets change, the Bank may alter the types or terms of the bonds that it issues.

For further discussion of interest rate exchange agreements, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Competition

Demand for the Bank’s advances is affected by, among other things, the cost of other available sources of funds for its members, including deposits. The Bank competes with other suppliers of wholesale funding, both secured and unsecured, including investment banking concerns, commercial banks and, in certain circumstances, other FHLBanks. Sources of wholesale funds for its members include unsecured long-term debt, unsecured short-term debt such as federal funds, repurchase agreements, and deposits issued into the brokered certificate of deposits market. The availability to members of alternative funding sources, including covered bonds, could significantly influence the demand for the Bank’s advances and can vary as a result of a variety of factors including, among others, market conditions, members’ creditworthiness and availability of collateral. The Bank competes against these other financing sources on the basis of cost, the relative ease by which the members can access the various sources of funds, and the flexibility desired by the member when structuring the liability.

The MPF Program competes primarily with Fannie Mae and Freddie Mac. While the Bank no longer expects to acquire interests in mortgage loans through this program, its ability to generate fee income from loans that are sold by its members to the FHLBank of Chicago is affected by competitive factors. These competitive factors include price, products, structures, and services offered, all of which are established by the FHLBank of Chicago.

The Bank also competes with Fannie Mae, Freddie Mac and other GSEs, as well as corporate, sovereign and supranational entities for funds raised in the national and global debt markets. Increases in the supply of competing debt products may, in the absence of increases in demand, result in higher debt costs. Although the available supply of funds has kept pace with the Bank’s funding needs, there can be no assurance that this will continue to be the case indefinitely.

In addition, the sale of callable debt and the simultaneous execution of callable interest rate exchange agreements that mirror the debt has been an important source of competitive funding for the Bank. As such, the Bank’s access to interest rate exchange agreements has been, and will continue to be, an important determinant of the Bank’s relative cost of funds. Given that the trend has been towards increased concentration in the number of providers of

interest rate exchange agreements, there can be no assurance that the current breadth and depth of these markets will be sustained.

Capital

The Bank’s capital consists of capital stock owned by its members (and, in some cases, non-member borrowers or former members as described below), plus retained earnings and accumulated other comprehensive income (loss). From its enactment in 1932, the FHLB Act provided for a subscription-based capital structure for the FHLBanks that required every member of a FHLBank to own that FHLBank’s capital stock in an amount in proportion to the member’s mortgage assets and its borrowing activity with the FHLBank pursuant to a statutory formula. In 1999, the GLB Act replaced the former subscription capital structure with requirements for total capital, leverage capital and risk-based capital for the FHLBanks, authorized the issuance of two new classes of capital stock redeemable with six months’ notice (Class A stock) or five years’ notice (Class B stock), and required each FHLBank to develop a new capital plan to replace the previous statutory capital structure.

On January 30, 2001, the Finance Board published a final rule implementing the required new capital structure for the FHLBanks. As required by the new capital regulations, the Bank submitted its proposed capital plan to the Finance Board on October 29, 2001 for review and approval. The Finance Board approved the Bank’s capital plan on June 12, 2002 and the Bank converted to its new capital structure on September 2, 2003.

In general, the Bank’s capital plan requires each member to own Class B stock (redeemable with five years’ written notice subject to certain restrictions) in an amount equal to the sum of a membership stock requirement and an activity-based stock requirement. Specifically, the Bank’s capital plan requires members to hold capital stock in proportion to their total asset size and borrowing activity with the Bank.

The Bank’s capital stock is not publicly traded and it may be issued, repurchased, redeemed or transferred (with the prior approval of the Bank) only at its par value. In addition, the Bank’s capital stock may only be issued to and held by members of the Bank or by former members of the Bank or institutions that acquire members of the Bank and that retain stock in accordance with the Bank’s capital plan. For more information about the Bank’s capital stock, see Item 11 - Description of Registrant’s Securities to be Registered in the Bank’s Amended Registration Statement on Form 10 filed with the SEC on April 14, 2006 (the “Amended Form 10”). For more information about the Bank’s minimum capital requirements, see Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Retained Earnings. In August 2003, the Finance Board encouraged all 12 FHLBanks to establish retained earnings targets and to specify the priority for increasing retained earnings relative to paying dividends. On February 27, 2004, the Bank’s Board of Directors adopted a retained earnings policy. Currently, the policy calls for the Bank to maintain retained earnings in an amount sufficient to protect the par value of members’ capital stock investments from potential economic losses and fluctuations in earnings. The Bank’s Board of Directors reviews the Bank’s retained earnings targets at least annually under an analytic framework that takes into account sources of potential realized and unrealized losses, including potential loss distributions for each, and revises the targets as appropriate. The Bank’s current retained earnings policy target is described in the section entitled “Financial Condition – Retained Earnings and Dividends” in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Dividends. Subject to the FHLB Act, Finance Board regulations and other Finance Board directives, the Bank pays dividends to holders of its capital stock quarterly or as otherwise determined by its Board of Directors. Dividends may be paid in the form of cash or capital stock as authorized by the Bank’s Board of Directors, and are paid at the same rate on all shares of the Bank’s capital stock regardless of their classification for accounting purposes. The Bank is permitted by statute and regulation to pay dividends only from previously retained earnings or current net earnings.

During the period from January 1, 2001 through June 30, 2005, the Bank paid quarterly dividends which it believed in good faith fully complied with the requirements of the statute and regulation, based upon the Bank’s retained earnings and current net earnings for those periods. However, as discussed in its Amended Form 10, the Bank determined in August 2005 that it was necessary to restate its previously issued financial statements for the three

months ended March 31, 2005 and the years ended December 31, 2004, 2003, 2002 and 2001 in order to correct certain errors with respect to the application of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“SFAS 133”). On a restated basis, the Bank’s retained earnings were negative at various times in 2002, 2003, 2004 and 2005 (including June 30, 2005). These negative retained earnings balances would suggest retrospectively that the requirement to pay dividends only from previously retained earnings or current net earnings was not met at all times during the subject period.

In August 2005 (immediately after discovering the errors that gave rise to the restatement and determining the required accounting corrections), the Bank sold/terminated substantially all of the financial instruments to which the errors related which restored the Bank’s retained earnings to a positive balance. Therefore, the Bank was in compliance with these regulatory requirements with regard to the payment of its third quarter 2005 dividend on September 30, 2005 and has been in complete compliance ever since. While there can be no assurances, the Bank believes that it will not be subject to any regulatory sanctions as a result of having paid dividends that, when viewed retrospectively, at times exceeded its accumulated restated retained earnings.

Prior to the third quarter of 2006, dividends had been declared during a calendar quarter prior to the date on which the Bank’s actual earnings for that quarter were known. On June 25, 2006, the Board of Directors approved a change to the Bank’s dividend declaration and payment process. Effective with the third quarter 2006 dividend, the Bank changed its dividend declaration and payment process such that the Bank now declares and pays dividends only after the close of the calendar quarter to which the dividend pertains and the earnings for that quarter have been calculated.

Because the Bank’s returns (exclusive of gains on the sales of investment securities, if any, and fair value adjustments required by SFAS 133) generally track short-term interest rates, the Bank has had a long-standing practice of benchmarking the dividend rate that it pays on capital stock to the average effective federal funds rate. The Bank generally pays dividends in the form of capital stock. When dividends are paid, capital stock is issued in full shares and any fractional shares are paid in cash. For a more detailed discussion of the Bank’s dividend policy and the restrictions relating to its payment of dividends, see Item 5 – Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities and Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Regulatory Oversight and Corporate Governance

The Bank is supervised and regulated by the Finance Board. The Finance Board has a statutory responsibility and corresponding authority to ensure that the FHLBanks operate in a safe and sound manner. Consistent with that duty, the Finance Board has an additional responsibility to ensure the FHLBanks are able to raise funds in the capital markets and carry out their housing and community development finance mission. To fulfill those responsibilities, the Finance Board establishes regulations governing the entire range of operations of the FHLBanks, assesses the safety and soundness of the FHLBanks through annual on-site examinations and periodic interim on-site reviews, conducts ongoing off-site monitoring and supervisory reviews, and requires the FHLBanks to submit monthly information regarding their financial condition and results of operations.

The Finance Board is comprised of a five-member board. Four board members are appointed by the President of the United States, with the advice and consent of the Senate, to serve seven-year terms, and the President designates one of those appointees as Chairman. The fifth member of the board is the Secretary of the Department of Housing and Urban Development, or the Secretary’s designee. The Finance Board is funded entirely by assessments from the 12 FHLBanks; no tax dollars or other appropriations support the operations of the Finance Board or the FHLBanks. The Finance Board assessments are shared by the FHLBanks on a pro rata basis based on a percentage that is derived by dividing each FHLBank’s total outstanding capital stock as of August 31 of each year (including those amounts classified as mandatorily redeemable) by the total outstanding capital stock of all FHLBanks as of that date.

The Government Corporation Control Act provides that, before a government corporation issues and offers obligations to the public, the Secretary of the Treasury shall prescribe the form, denomination, maturity, interest rate, and conditions of the obligations, the way and time issued, and the selling price. The FHLB Act also authorizes the Secretary of the Treasury, at his or her discretion, to purchase consolidated obligations up to an aggregate principal amount of $4 billion. Since 1977, the U. S. Department of the Treasury has not owned any consolidated

obligations under this authority. The U.S. Department of the Treasury receives the Finance Board’s annual report to the United States Congress (“Congress”), weekly reports reflecting securities transactions of the FHLBanks, and other reports reflecting the operations of the FHLBanks.

In accordance with the FHLB Act, the Bank’s Board of Directors is comprised of a combination of directors elected by the Bank’s member institutions and directors appointed by the Finance Board. No members of the Bank’s management may serve as directors of a FHLBank. The Bank’s Board of Directors currently includes 11 elected directors and 8 appointed directors. For additional information regarding the Bank’s Board of Directors, see Item 10 – Directors, Executive Officers and Corporate Governance.

The Bank’s Board of Directors has an Audit Committee, which is currently comprised of eight directors, three of whom are appointed directors and five of whom are elected directors. The Audit Committee oversees the Bank’s financial reporting processes; reviews compliance with laws, regulations, policies and procedures; and evaluates the adequacy of administrative, operating, and internal accounting controls. All Audit Committee members are independent, as defined by the Finance Board. The elected directors serving on the committee, however, do not meet the SEC’s criteria for independence as a result of their affiliation with members of the Bank. The Bank's Board of Directors affirmatively determined that each of its appointed directors who serves on the Audit Committee is independent under the SEC's criteria for independence, with the exception of Clarence G. Simmons, III, for whom the Board of Directors did not have sufficient information to make a conclusive affirmative determination. For more information regarding director independence, see Item 13 – Certain Relationships and Related Transactions, and Director Independence. The Bank also has an internal audit department that independently assesses the effectiveness of internal controls and recommends possible improvements thereto. The Bank’s Director of Internal Audit reports directly to the Audit Committee.

An independent registered public accounting firm audits the annual financial statements of the Bank. Beginning in 2007, the independent registered public accounting firm also audits the Bank’s internal control over financial reporting as of the end of each fiscal year. The independent registered public accounting firm conducts these audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Bank must submit annual management reports to Congress, the President of the United States, the Office of Management and Budget, and the Comptroller General. These reports include a statement of financial condition, a statement of operations, a statement of cash flows, a statement of internal accounting and administrative control systems, and the report of the independent auditor on the financial statements. The Comptroller General has authority under the FHLB Act to audit or examine the Finance Board and the Bank and to decide the extent to which they fairly and effectively fulfill the purposes of the FHLB Act. Furthermore, the Government Corporation Control Act provides that the Comptroller General may review any audit of the financial statements conducted by an independent registered public accounting firm. If the Comptroller General conducts such a review, then he or she must report the results and provide his or her recommendations to Congress, the Office of Management and Budget, and the FHLBank in question. The Comptroller General may also conduct his or her own audit of any financial statements of the Bank.

Over the last few years, both chambers of Congress have considered legislative proposals that would modify the structure of the regulatory oversight of the housing GSEs, including the FHLBanks. In October 2005, the House of Representatives passed the Federal Housing Finance Reform Act of 2005. In July of that same year, the Senate Banking Committee passed the Federal Housing Enterprise Regulatory Reform Act of 2005; however, no action was taken by the full Senate on the bill before the adjournment of the 109 ^th Congress in December 2006. In 2007, the House Financial Services Committee approved a GSE regulatory reform bill (H.R. 1427) which would, among other things, establish a new regulator for the housing GSEs. On May 22, 2007, the House of Representatives passed H.R. 1427. The Senate Banking Committee has not held a hearing or passed GSE reform legislation at this time. Although it does not appear that the current legislative proposals would alter the charter of the FHLBanks, the content of any legislation that might be enacted into law cannot be predicted at this time. Since neither the timing nor outcome of the legislative debate, nor the structure for a new regulatory body that might be created, is known at this time, the effect on the Bank’s operations, if any, cannot be determined.

Employees

As of December 31, 2007, the Bank employed 176 people, all of whom were located in one office in Irving, Texas. None of the Bank’s employees are subject to a collective bargaining agreement and the Bank believes its relationship with its employees is good.

Taxation

Although the Bank is exempt from all Federal, State, and local taxation (except for real property taxes), all FHLBanks are obligated to make contributions to the Resolution Funding Corporation (“REFCORP”) in the amount of 20 percent of their net earnings (after deducting the AHP assessment). REFCORP was created by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) solely for the purpose of issuing $30 billion of long-term bonds to provide funds for the resolution of insolvent thrift institutions. The FHLBanks were initially required to contribute approximately $2.5 billion to defease the principal repayments of those bonds in 2030, and thereafter to contribute $300 million per year toward the interest payments on those bonds.

As part of the GLB Act of 1999, the FHLBanks’ $300 million annual obligation to REFCORP was modified to 20 percent of their annual net earnings before charges for REFCORP (but after expenses for AHP). The FHLBanks will have this obligation until the aggregate amounts actually paid by all 12 FHLBanks are equivalent to a $300 million annual annuity whose final maturity date is April 15, 2030, at which point the required payment of each FHLBank to REFCORP will be fully satisfied. As specified in the Finance Board regulation that implements section 607 of the GLB Act, the amount by which the combined REFCORP payments of all of the FHLBanks for any quarter exceeds the $75 million benchmark payment is used to simulate the purchase of zero-coupon Treasury bonds to “defease” all or a portion of the most-distant remaining quarterly benchmark payment. Because the FHLBanks’ recent REFCORP payments have exceeded $300 million per year, those extra payments have defeased $24 million of the $75 million benchmark payment due on October 15, 2013 and all scheduled payments thereafter. The defeased benchmark payments (or portions thereof) can be reinstated if future actual REFCORP payments fall short of the $75 million benchmark in any quarter. Cumulative amounts to be paid by the Bank to REFCORP cannot be determined at this time because the amount is dependent upon the future earnings of each FHLBank and interest rates.

In addition, the FHLB Act requires each FHLBank to establish and fund an AHP. Annually, the FHLBanks must collectively set aside for the AHP the greater of $100 million or 10 percent of their current year’s income before charges for AHP and before declaring any dividend payments (but after expenses for REFCORP). Interest expense on capital stock that is classified as a liability (i.e., mandatorily redeemable capital stock) is added back to income for purposes of computing the Bank’s AHP assessment. The Bank’s AHP funds are made available to members in the form of direct grants to assist in the purchase, construction, or rehabilitation of housing for very low-, low- and moderate-income households.

The combined assessments for REFCORP and AHP are the equivalent of a minimum 26.5 percent effective income tax rate for the Bank. This rate is increased by the impact of non-deductible interest on mandatorily redeemable capital stock.

Business Strategy and Outlook

The Bank maintains a Strategic Business Plan that provides the framework for its future business direction. The goals and strategies for the Bank’s major business activities are encompassed in this plan, which is updated and approved by the Board of Directors at least annually and at any other time that revisions are deemed necessary.

The Bank intends to continue to operate under its cooperative business model for the foreseeable future. Under this model, the Bank’s net income (exclusive of gains on the sales of investment securities, if any, and fair value adjustments required by SFAS 133) is expected to rise and fall with the general level of market interest rates, particularly short-term money market rates. Under that scenario, the Bank’s return on average capital stock (exclusive of gains on the sales of investment securities, if any, and fair value adjustments required by SFAS 133) is expected to continue to track changes in the federal funds rate.

In addition to changes in the general economic and business environment, developments that are expected to have an effect on the extent to which the Bank’s return on average capital stock (exclusive of gains on the sales of investment securities, if any, and fair value adjustments required by SFAS 133) exceeds the federal funds rate benchmark include the future cost of the Bank’s long-term debt relative to the LIBOR index, the availability of interest rate exchange agreements at competitive prices, whether the Bank’s larger borrowers continue to be

members of the Bank and whether they maintain or increase their borrowing activity, and the extent to which the Bank’s smaller and mid-sized members continue to increase their utilization of Bank advances.

The Bank believes that there remains potential for advances growth from among its CFIs and other small and intermediate-sized institutions. There remains uncertainty about whether the Bank’s future membership base will continue to include larger institutions that will borrow in sufficient quantity to provide economies of scale that will sustain the current economics of the Bank’s business model.

In light of these factors, and in order to become a more valuable resource to its members, the Bank intends to continue to evaluate opportunities to diversify its product offerings and its income stream. In particular, the Bank intends to expand the services that it can provide electronically through the secure electronic delivery channel currently used extensively by members to execute advances, initiate wire transfers, provide securities safekeeping instructions, and obtain a wide variety of reports and information about their business relationship with the Bank. The Bank is, however, limited by the FHLB Act and Finance Board regulations as to the products and services that it can offer to its members. The FHLB Act and Finance Board regulations also govern many of the terms of the products and services that the Bank offers to its members. Therefore, the Bank will have to assess any potential new products or services offerings in light of these restrictions.

Merger Discussions

On August 8, 2007, the Bank and the FHLBank of Chicago jointly announced that the two FHLBanks are engaged in discussions to determine the possible benefits and feasibility of combining their business operations. These discussions have been focused on identifying whether and how a merger could produce advantageous results and improved value for members of both organizations, while providing increased resources for affordable housing and economic development initiatives in the communities served by the two institutions. The FHLBank of Chicago has over 840 member institutions in Illinois and Wisconsin. While the discussions between the Bank and the FHLBank of Chicago are continuing, there can be no assurance that a definitive agreement will be reached between the two organizations. Any agreement that is reached would be subject to regulatory approval and conditions that would be set forth in such agreement.