BANKING
AUGUST 1, 2013
Federal Home Loan Bank System:
Frequently Asked Questions
CREDIT FOCUS
Credit risks balanced by System’s strategic importance, strong asset quality along with adequate
profitability and capital levels.
Summary
RATINGS
Federal Home Loan Banks
Senior Unsecured
ST Issuer Rating
Aaa
P-1
»
The Federal Home Loan Bank System (FHLBank System or System) is the third-largest
Government-Sponsored Entity (GSE) in the US, after Fannie Mae and Freddie Mac,
with total assets as of March 31, 2013 of $739 billion. The FHLBank System is
comprised of twelve independent regional Federal Home Loan Banks (FHLBanks), each
of whose capital stock is held by member financial institutions (banks, insurance
companies and credit unions) in their district. The System was created by the U.S.
Congress in 1932 to provide member financial institutions with a stable source of
funding to extend credit for residential mortgages and targeted community
development. As such, the FHLBanks' primary business is extending “secured advances”
(i.e., loans) to members, which the members use to finance mortgages held in their
portfolios, along with purchasing mortgages from members1.
»
This report answers some common questions we are asked with respect to the key credit
concerns for the FHLBank System and the twelve individual FHLBanks, especially as
they relate to the health of the economy and housing markets and the potential impact
of GSE reform and other regulatory initiatives. Key takeaways from this discussion
include:
KEY INDICATORS
Total Assets
ROA
Private Label
RMBS/Total Assets
Total Regulatory
Capital Ratio
12-12
12-11
12-10
762
0.3
3.3
766
0.2
3.8
878
0.2
4.2
6.7
6.9
6.5
Analyst Contacts:
NEW YORK
+1.212.553.1653
Warren Kornfeld
+1.212.553.1932
Senior Vice President
warren.kornfeld@moodys.com
Brian L. Harris
Senior Vice President
brian.harris@moodys.com
+1.212.553.4705
Robert Young
+1.212.553.4122
Managing Director - Financial Institutions
robert.young@moodys.com
1
–
The FHLBanks’ Aaa-rated debt securities are not guaranteed by the US
Government (Aaa stable). Although there is no explicit US Government guarantee,
housing remains a key economic issue in the United States. The FHLBanks’ core
mission is to provide liquidity to the US housing market and their member financial
institutions. Therefore, we believe it is very likely that the US Government would
support the FHLBank System in the event of financial distress, thereby lifting the
System’s debt rating from its a1 standalone baseline credit assessment (BCA) to the
level of the US Government’s Aaa bond rating with a stable outlook.
Other businesses of the FHLBanks include: providing credit products such as interest rate swaps and letters of credit, as well as offering safekeeping and settlement
services. Each FHLBank also maintains an investment portfolio, primarily for liquidity.
BANKING
–
The FHLBanks have identical deposit ratings, but there are material differences in their
standalone credit strength. In addition to rating the System’s consolidated debt obligations,
we also evaluate the creditworthiness of each of the twelve FHLBanks. Although all the
FHLBanks have identical long- and short-term deposit ratings owing to assumed US
Government support (Aaa stable and P-1), their standalone baseline credit assessments
(BCAs) range from aa3 to baa2, reflecting material differences in their credit strength. These
differences particularly relate to their advance business, business mix and levels of privatelabel RMBS exposure.
–
The asset quality of the FHLBanks is sound. In their more than 80-year history, no
FHLBank has ever experienced a loss on an advance. Delinquencies and losses on the
FHLBanks’ residential mortgage portfolios have been very low, especially compared with
industry averages. Except for their private-label RMBS portfolios, the FHLBanks’ investment
portfolios primarily comprise Aaa-rated securities, primarily US Government and agency
bonds and US agency MBS.
1. What are the key credit risks of the FHLBanks?
The standalone baseline credit assessments (BCAs) of the twelve FHLBanks range from aa3 to
baa2, with the BCA of the entire System at a1, among the highest standalone assessments achieved
for financial institutions either domestically or globally.
We believe that the FHLBanks’ key credit risks are:
1) interest rate/asset liability management risk of their mortgage and MBS investment portfolios
(see question 2),
2) the credit risk of their private-label RMBS investment portfolios, which as of year-end 2012
totaled $25 billion or approximately 3.3% of total assets and 50% of total shareholders’
equity (see question 4), and
3) their uncertain future role in the US mortgage finance market (see question 7).
2. Can you further describe the interest rate and asset liability management risk?
The FHLBanks’ interest rate risk primarily arises from the difficulty of match funding mortgages
and MBS held in the banks’ investment portfolios. Most US residential mortgages allow
homeowners to refinance or repay their mortgage at any time, typically without any prepayment
penalty. As a result, when interest rates decline, many homeowners opt to refinance their
mortgage at a lower rate. Low interest rates also encourage greater home sale activity, which also
increases prepayment rates. In a rising interest rate environment, on the other hand, mortgage
prepayments typically decrease. As a result, the effective life or duration of a mortgage shortens as
interest rates decline and lengthens as interest rates increase.
In a rising interest rate environment, when the duration of a mortgage investor’s portfolio
increases, funding costs will typically increase. The difficulty of predicting precise borrower
prepayment behavior thus exposes mortgage investors to potentially unhedged declining
investment income or increased funding costs. The FHLBanks’ history of asset liability
management is mixed, particularly for their mortgage loan portfolio. FHLBank Seattle and
FHLBank Chicago both incurred financial stress during the mid 2000s due to asset liability
mismatches in funding their mortgage loan portfolios. Currently, many of the FHLBanks use
callable fixed-rate debt to mitigate the prepayment risk associated with long-term fixed-rate
mortgage assets.
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CREDIT FOCUS: FEDERAL HOME LOAN BANK SYSTEM: FREQUENTLY ASKED QUESTIONS
BANKING
Since it is easier and cheaper for the FHLBanks to match fund their advance/loan book, the level
of interest rate and asset liability management risk in this business is lower than in their mortgage
portfolios. Many of the FHLBanks’ advances to member institutions require the borrower to pay
a prepayment penalty, typically in the form of a “make-whole amount” reimbursing the FHLBank
for any interest rate loss. Advances without a pre-payment penalty are typically funded with
callable debt that mirrors the provisions of the advance loan.
Given their modest profitability as cooperative banks, the FHLBanks’ have limited ability to offset
asset-liability losses with other earnings. The FHLBanks have been consistently profitable, but at
low levels, with net income as a percent of average assets (ROAA) averaging just 0.22% over the
last ten years.
EXHIBIT 1
FHLBank Profitability
System Net Income
$Millions
System Net Income (L - Axis)
ROAA (R - Axis)
Average ROAA (Last 10 Years) (R - Axis)
$3,000
0.60%
$2,500
0.50%
$2,000
0.40%
$1,500
0.30%
$1,000
0.20%
$500
0.10%
$0
0.00%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: Federal Housing Finance Agency’s 2012 Report to Congress, June 13, 2013
3. What is the FHLBanks’ mortgage exposure and how has it changed over time?
As of year-end 2012, the FHLBanks’ mortgage exposures ranged widely from a low of 14% for
FHLBank New York to a high of 47% for FHLBank Chicago (see Exhibit 2) with an average of
just under 25% for the entire FHLBank System.
EXHIBIT 2
2012 Year-End Mortgage Exposure by FHLBank
50%
Mortgage Loans / Total Assets
Mortgage Investments / Total Assets
System Average
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Source: Company Disclosures
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CREDIT FOCUS: FEDERAL HOME LOAN BANK SYSTEM: FREQUENTLY ASKED QUESTIONS
BANKING
The FHLBanks’ mortgage exposure has increased over the years (see Exhibit 3) from 14% of total
assets in 2000 to 25% as of year-end 2012.
EXHIBIT 3
FHLBank System Mortgage Exposure as a Percent of Total Assets
30%
25%
20%
15%
10%
5%
0%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: Federal Housing Finance Agency’s 2012 Report to Congress, June 13, 2013
4. What is the impact on the FHLBanks private-label RMBS portfolio in a stressed economic
environment?
The FHLBanks recognized $4.1 billion of credit related other than temporary impairments
(OTTI) on their existing private-label RMBS portfolio from 2008-12. As the housing market
improves the risk of further credit impairments decreases markedly. At only $112 million,
impairments in 2012 were a fraction of the $856 million recognized in 2011 and $1,071 million
recognized in 2010.
Exhibit 4 analyzes the potential impact on capital of further credit deterioration in the FHLBanks’
private-label RMBS portfolios as of year-end 2012. The analysis assumes that cumulative
impairments increase an additional 50%, or $2.1 billion, for the System as a whole, which is
almost twenty times impairments incurred in 2012 or 8% of the $25 billion private-label
investment portfolio currently outstanding. In such a scenario, shareholders’ equity to total assets
of the System would only decline by 0.3% to 6.2% from 6.5%, still well above the 4% level of
regulatory capital to assets that each FHLBank is required to maintain.
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CREDIT FOCUS: FEDERAL HOME LOAN BANK SYSTEM: FREQUENTLY ASKED QUESTIONS
BANKING
EXHIBIT 4
Private-Label Credit Loss Stress Analysis
Row #
Notes
Atlanta
Boston
123,705 40,209
Cin
Des
Dallas Moines
69,584 81,562
35,755 47,367
Chicago
Indianapolis
Total Assets
1
Dec 31, 2012
Financials
Shareholders' Equity
2
Dec 31, 2012
Financials
6,315
3,782
3,454 4,748
1,775
2,844
2,667
Shareholders' Equity
/ Total Assets
3
Row 2 /
Row 1
5.1%
9.4%
5.0% 5.8%
5.0%
6.0%
2008 to 2012 Credit
Related OTTI
4
2008 to 2012
Financials
586
497
717
-
13
Stressed Additional
OTTI
5
50% of Row 4
293
249
359
-
Shareholders Equity
Minus Stressed
Additional OTTI
6
Row 2 minus
Row 5
6,022
3,533
Shareholders Equity
Minus Stressed
Additional OTTI /
Total Assets
7
Row 6 /
Row 1
4.9%
Decrease In
Shareholders' Equity
/ Total Assets
8
Row 3
minus
Row 7
0.2%
NY
41,228 102,989
Pitts San Fran
Seattle Topeka
System
35,421 33,819
762,454
64,616
86,421
5,515
3,861
9,956
2,760
1,726
49,478
6.5%
5.4%
6.0%
11.5%
7.8%
5.1%
6.5%
-
109
37
326
1,397
430
11
4,123
7
-
55
18
163
699
215
5
2,062
3,096 4,748
1,769
2,844
2,612
5,497
3,697
9,258
2,545
1,721
47,417
8.8%
4.4% 5.8%
4.9%
6.0%
6.3%
5.3%
5.7%
10.7%
7.2%
5.1%
6.2%
0.6%
0.5% 0.0%
0.0%
0.0%
0.1%
0.0%
0.3%
0.8%
0.6%
0.0%
0.3%
Note: Shareholders’ Equity includes mandatorily redeemable capital stock
Source: Moodys, Company Disclosures
5. If the obligations of the FHLBanks are not guaranteed by the US Government, how do you
arrive at a Aaa bond rating for the Federal Home Loan Bank System?
Our standalone BCA for the FHLBank System is a1. In arriving at the FHLBank System’s BCA,
we consider the individual BCA of each of the FHLBanks as well as the profile of the FHLBank
System as if it were one combined entity given the joint and several liability of all FHLBank
consolidated obligations.
The FHLBank System’s core mission is to provide liquidity to the US housing market through
their member financial institutions. With more than $600 billion combined of advances to
members (which are secured primarily by residential mortgages), residential mortgage loans held,
and residential mortgage-related security investments, the FHLBank System provides residential
mortgage funding for approximately 6% of the $10 trillion US residential mortgage market (see
Exhibit 5). During the financial crisis, these figures were even higher, with the FHLBank System’s
total funding peaking at almost $1.3 trillion in 2008.
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AUGUST 1, 2013
CREDIT FOCUS: FEDERAL HOME LOAN BANK SYSTEM: FREQUENTLY ASKED QUESTIONS
BANKING
EXHIBIT 5
FHLBanks’ Mortgage Funding 1992 to 2012
Advances
Mortgage Loans Held
Mortgage Related Securities
1,200,000
1,100,000
1,000,000
$ Millions
900,000
800,000
700,000
600,000
500,000
400,000
300,000
200,000
100,000
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: Federal Housing Finance Agency’s 2012 Report to Congress, June 13, 2013
EXHIBIT 6
FHLBanks’ Mortgage Funding During the Financial Crisis
Advances
Mortgage Loans Held
Mortgage Related Securities
1,400,000
1,200,000
$ Millions
1,000,000
800,000
600,000
400,000
200,000
Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009
Source: Quarterly - Company Disclosures; Annual - Federal Housing Finance Agency’s 2012 Report to Congress, June 13, 2013
Given the significant role of the FHLBank System in providing relatively inexpensive mortgage
funding and liquidity to the economically important US housing market, we believe it is very
likely that the US Government would support the FHLBank System in the event of financial
distress, thereby lifting the FHLBank System’s debt rating from its a1 BCA to the level of the US
Government’s Aaa bond rating with a stable outlook.
6. The standalone baseline credit assessments of the twelve FHLBanks range from aa3 for
FHLBank New York to baa2 for FHLBank Seattle. What accounts for these generally high
assessments? Can you comment on the primary drivers of any differences?
With BCAs mostly concentrated around a1, the FHLBanks rank among the strongest of any
financial institution on a standalone basis, either domestically or globally. This is primarily based
upon the strength of the FHLBanks’ business activities that consist primarily of: 1) providing
secured loans (advances) or letters of credit to members, 2) purchasing mortgage loans from
member financial institutions, and 3) managing an investment portfolio.
The FHLBank System has never incurred a loss on an advance in its 80-year history. The
FHLBanks' collateral requirements on advances, and their preferred creditor status, support asset
quality in the event a member defaults on its advances.
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CREDIT FOCUS: FEDERAL HOME LOAN BANK SYSTEM: FREQUENTLY ASKED QUESTIONS
BANKING
The FHLBanks' conforming mortgage loan purchase programs, MPF® and MPP, provide
members with an alternative to Fannie Mae and Freddie Mac. The FHLBanks' mortgage assets are
more susceptible to asset liability management risk and credit loss than the advance business, and
also carry heightened operational complexity. Nonetheless, the credit performance of the MPF®
and MPP programs has been very good, with delinquencies far lower than that of Fannie Mae and
Freddie Mac.
Aside from their private-label RMBS portfolios, the credit risk within the FHLBanks’ investment
portfolios is very low. Holdings consist primarily of US agency MBS securities, as well as US
Treasury securities, commercial paper, federal funds, and resale agreements.
Beyond these shared strengths, there are several points of differentiation in the FHLBanks’
performance that are reflected in their individual BCAs, including: 1) the strength of each
FHLBanks’ advance business, 2) their exposure to private-label RMBS investments, and 3) the
level of interest rate risk from their exposure to mortgage-related assets (mortgage loan portfolio
and MBS investments).
For example, as shown in Exhibit 7, we have assigned FHLBank New York the highest BCA at
aa3 because it has a large concentration in the lowest risk business of the FHLBanks – its advance
portfolio of $72 billion is also 70% of total assets – and it has the lowest level of mortgage-related
assets to total assets (14.1%); i.e., it has the lowest level of interest rate risk among the FHLBanks.
At the other end of the spectrum is FHLBank Seattle, with a baa2 BCA, two notches below its
next-lowest peer. FHLBank Seattle has by far the fewest advances ($8.9 billion), has the secondlowest ratio of advances to total assets (25.1%), and has the second-highest percent of private-label
RMBS to total assets (5.3%).
EXHIBIT 7
Summary of Key Indicators as of Year-End 2012
NY
Atlanta
Cin
Dallas
Des
Moines
Indianapolis
Topeka
San Fran
Boston
Chicago
Pitts
Seattle
System
aa3
a1
a1
a1
a1
a1
a1
a2
a3
a3
a3
baa2
a1
Total assets
102,989
123,705
81,562
35,755
47,367
41,228
33,819
86,421
40,209
69,584
64,616
35,421 762,454
Total Advances
72,292
83,870
53,621
17,928
26,055
17,382
16,109
43,180
20,270
14,340
39,671
8,881
413,600
Advances / Total Assets
70.2%
67.8%
65.7%
50.1%
55.0%
42.2%
47.6%
50.0%
50.4%
20.6%
61.4%
25.1%
54.2%
Stand-alone credit assessment
Private Label RMBS / Total Assets
0.1%
4.4%
0.0%
0.6%
0.1%
2.1%
1.5%
12.2%
3.2%
2.2%
4.1%
5.3%
3.3%
Total Mortgage Related Assets /
Total Assets
14.1%
14.1%
24.9%
14.7%
29.1%
33.6%
33.1%
27.4%
28.0%
47.3%
20.5%
26.3%
24.6%
Source: Moodys, Company Disclosures
7. Can you comment on the potential impact of GSE reform, Basel III and other regulatory
initiatives?
GSE Reform
We continue to believe that GSE reform is several years away. To date, the debate has primarily
focused on the roles of Fannie Mae and Freddie Mac, but the FHLBanks are likely to be included
in any reform. In a May speech, Ed DeMarco, the acting director of the Federal Housing Finance
Agency (FHFA), the regulator of the FHLBanks, stated “Clearly, resolving the conservatorships of
Fannie Mae and Freddie Mac are central to the future of the secondary mortgage market. But the
FHLBanks can and should be a part of the larger discussion of our housing finance reform.”
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CREDIT FOCUS: FEDERAL HOME LOAN BANK SYSTEM: FREQUENTLY ASKED QUESTIONS
BANKING
DeMarco noted that, in addition to their traditional role of providing mortgage funding for
financial institutions, the FHLBanks could become mortgage aggregators, assisting smaller
institutions without the necessary scale to gain access to the securitization markets or, less likely,
act as guarantors of mortgage-backed securities.
We would view the expansion of the FHLBanks beyond their current core businesses as credit
negative, and depending on the extent and risk of these activities, could negatively affect the
FHLBanks’ standalone BCAs.
Basel III
The proposed Basel III bank regulatory capital framework introduces, among other things, two
new liquidity requirements: the liquidity coverage ratio (a 30-day test) and net-stable funding
ratio (a one-year test). Neither the Basel III framework nor the proposed US rules give banks
credit for undrawn FHLBank commitments as a source of funding in calculating these two new
metrics, a potential credit negative for the FHLBanks. If banks reduce their reliance on
FHLBanks’ funding in response to the new requirements, this could reduce the size and
importance of the FHLBank System. If, on the other hand, banks elected to fund their increased
Basel III liquidity requirements by increasing the amount they borrow from the FHLBanks (as
opposed to maintaining undrawn commitments), this would increase the FHLBanks’ revenues
and profitability with limited incremental risk, a credit positive.
Other Regulatory Initiatives
The Federal Housing Finance Agency and the US Treasury have expressed support for several
regulatory initiatives that could affect the FHLBanks:
1) limiting all of the bank subsidiaries of an individual bank holding company to membership in one
FHLBank. Currently, each bank subsidiary of a bank holding company may be a member of
the FHLBank where such bank subsidiary is chartered. As a result, many bank families obtain
FHLBank advances from more than one FHLBank. Since bank funding is partly fungible
across different bank subsidiaries of a bank holding company, this creates competition among
FHLBanks to provide advances to members. If such competition were reduced by the
proposed regulation, it would be credit positive for the FHLBanks. Prior to full
implementation, however, the measure would likely increase competition in the short-term, a
credit negative, as the FHLBanks competed to provide all advance funding for individual
bank holding companies.
2) setting a maximum amount that an individual member can borrow from the FHLBank System.
Although a regulatory limit on the amount of low-cost FHLBank funding that a single
financial institution can receive would decrease the level of member concentration, in our
opinion it would be credit negative. We believe that the reduced importance of the FHLBank
System would offset any credit benefit gained from reduced concentration.
3) limiting the size of the FHLBanks’ investment portfolio. While investment portfolios have helped
restore the financial health of the FHLBanks, by leveraging their low funding costs, some have
questioned whether an investment portfolio beyond liquidity needs is a core mission of the
FHLBanks. We believe that a limitation on the size of the investment portfolio would be
modestly credit positive. A smaller investment portfolio reduces risk and further simplifies their
business model. This would likely more than offset the resulting reduction in profitability.
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CREDIT FOCUS: FEDERAL HOME LOAN BANK SYSTEM: FREQUENTLY ASKED QUESTIONS
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Moody’s Related Research
Credit Opinions for the System and the twelve FHLBanks:
»
Federal Home Loan Banks, July 2013
»
Federal Home Loan Bank of Chicago, July 2013
»
Federal Home Loan Bank of Atlanta, July 2013
»
Federal Home Loan Bank of New York, July 2013
»
Federal Home Loan Bank of Boston, July 2013
»
Federal Home Loan Bank of Seattle, July 2013
»
Federal Home Loan Bank of Topeka, July 2013
»
Federal Home Loan Bank of Indianapolis, July 2013
»
Federal Home Loan Bank of San Francisco, July 2013
»
Federal Home Loan Bank of Cincinnati, July 2013
»
Federal Home Loan Bank of Pittsburgh, July 2013
»
Federal Home Loan Bank of Dallas, July 2013
»
Federal Home Loan Bank of Des Moines, July 2013
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of
this report and that more recent reports may be available. All research may not be available to all clients.
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CREDIT FOCUS: FEDERAL HOME LOAN BANK SYSTEM: FREQUENTLY ASKED QUESTIONS
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Report Number: 156745
Author
Warren Kornfeld
Production Associate
Prabhakaran Elumalai
© 2013 Moody’s Investors Service, Inc. and/or its licensors and affiliates (collectively, “MOODY’S”). All rights reserved.
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prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to
approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS’s ratings and
rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between
entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is
posted annually at www.moodys.com under the heading “Shareholder Relations — Corporate Governance — Director and
Shareholder Affiliation Policy.”
For Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of
MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody’s Analytics Australia Pty
Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to “wholesale clients” within
the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you
represent to MOODY’S that you are, or are accessing the document as a representative of, a “wholesale client” and that neither you
nor the entity you represent will directly or indirectly disseminate this document or its contents to “retail clients” within the meaning
of section 761G of the Corporations Act 2001. MOODY’S credit rating is an opinion as to the creditworthiness of a debt obligation of
the issuer, not on the equity securities of the issuer or any form of security that is available to retail clients. It would be dangerous for
retail clients to make any investment decision based on MOODY’S credit rating. If in doubt you should contact your financial or other
professional adviser.
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CREDIT FOCUS: FEDERAL HOME LOAN BANK SYSTEM: FREQUENTLY ASKED QUESTIONS