Dear Seattle Bank Members,

The past two years have been among the most challenging in the 75-year history of the Federal Home Loan Bank System, as the FHLBanks—along with our member financial institutions and the communities we all serve—have worked to manage through the most difficult economy that most of us can remember. The challenge has been one of global proportion and personally devastating for those who have lost their jobs, their businesses, and their homes.

Throughout this difficult time, the Federal Home Loan Bank of Seattle—and all of the FHLBanks—have continued to fulfill their mission of providing liquidity and funding to support their members and, in turn, their customers and communities.

The Seattle Bank’s challenges were most vividly portrayed by our net loss of $161.6 million in 2009—a particularly disappointing result considering this was the year we had expected to substantially complete the business turnaround we began five years ago. In fact, our net interest income—the primary gauge of our core business performance—had been exceeding our turnaround plan, increasing from $77.0 million in 2006 to $215.2 million for 2009.

By now, through our public announcements, Securities and Exchange Commission filings, and presentations at state and regional trade conferences, you are well aware of the primary reason for our 2009 loss: our investments in certain private-label, mortgage-backed securities (MBS) and the accounting treatment they require. Ironically, these investments were a part of our turnaround strategy. We knew that they carried some credit and interest-rate risk, and we mitigated those risks. We also believed that we had addressed any accounting risk by classifying the securities as held to maturity. Unfortunately, the effects of mark-to-market accounting and changes to the impairment rules have brought us to where we are today.

We were pleased to have returned to profitability in the first quarter of 2010, reporting $6.1 million of earnings, compared to a net loss of $16.2 million for the same period in 2009. Regardless, we know that many of the conditions that precipitated our 2009 net loss persist, and we expect that it will take some time for our earnings to fully recover.

A Declining Mortgage Market and New Accounting Rules

The challenges surrounding our investments in private-label MBS stem, of course, from the troubled U.S. mortgage market. Throughout 2009, increasing mortgage delinquencies, defaults, and foreclosures—and forecasts of further deterioration—required that a number of our investments in private-label MBS be classified as other-than-temporarily impaired (OTTI).

Further, our adoption of new accounting guidance from the Financial Accounting Standards Board, effective January 1, 2009, changed the way we account for OTTI securities, requiring that we recognize the amount of any expected credit loss in current earnings and record the noncredit-related portion of an impairment in accumulated other comprehensive income or loss (AOCI/L).

While it reduced the amount of an OTTI loss attributable to earnings, implementation of the new guidance also introduced a more stringent standard for determining when a security should be classified as OTTI. This, in turn, resulted in our need to impair a greater number of securities than would have been required under the previous guidance.

The net effect: as of December 31, 2009, the Seattle Bank had realized $311.2 million of credit losses on its private-label MBS and recorded an AOCL of $908.8 million. Through that date, we had received all cash flows due from those securities.

At the time of purchase, all of our private-label MBS were AAA-rated or credit-enhanced to that level. Our policy required the purchase of additional credit enhancements to achieve the AAA rating, even though we sacrificed some yield to do that—in many cases several times the amount required to achieve the AAA rating.

Unfortunately, many of the loans underlying these securities do not appear to have the characteristics described in the sales prospectuses, and in December 2009, we filed a number of lawsuits against the dealers that sold the securities. It will take some time before we know the outcome of this litigation, which seeks to rescind the purchases, but we are working to protect our members’ rights with respect to these investments.

The Impact on Our Earnings and Capital

The need to realize in current earnings losses projected to occur over the life of an OTTI security—an average of 19 years in the case of the Seattle Bank’s private-label MBS—has had a very different effect on our earnings and capital than if we were to recognize those losses when they are projected to occur.

In terms of our 2009 earnings, the $311.2 million of credit losses on our private-label MBS reduced what would have been a $149.6 million profit before assessments to a $161.6 million loss. To be clear, these losses represent our current expectations. They are based on assumptions shared by all of the FHLBanks, which project continued deterioration in the housing market and a slow rebound relative to prior economic recoveries, once the bottom has been reached. If we were to realize these losses over time, as we expect they will occur, our projected income would be more than sufficient to absorb them. That is to say, the losses would still impact our profitability, but they would not eliminate it.

Our total GAAP capital, including $1.9 billion of capital stock, $52.9 million of retained earnings, and an AOCL of $908.8 million, stood at $993.7 million as of December 31, 2009. Fortunately, our AOCL does not reflect expected economic losses, and barring a substantial increase in additional other than temporary impairments, it will decline over the remaining life of the affected securities. We began to see some improvement in the first quarter of 2010, but it will take time to work through this noncredit-related loss.

The Seattle Bank met all of its regulatory capital requirements as of December 31, 2009, and continues to do so. During the first half of 2009, however, the severely depressed prices on certain of our MBS investments adversely affected our risk-based capital, and we failed to meet this requirement as of March 31 and June 30, 2009. As a result, the Federal Housing Finance Agency (Finance Agency) classified the bank as “undercapitalized” in August 2009. Although we returned to risk-based capital compliance on September 30, 2009, we remain classified as undercapitalized. As such, we are prohibited from redeeming or repurchasing capital stock and have been required to prepare a capital restoration plan.

We submitted a capital restoration plan on December 5, 2009, which the Finance Agency deemed complete, and on March 24, 2010, we received permission to provide the Finance Agency with supplemental information. Following our submission, the Finance Agency requested additional information in the form of a business plan, specifying the steps we will take to resume repurchases and redemptions of capital stock. We expect to submit this information on or before August 16, 2010, and we are working closely with our regulator to ensure that our plan will protect the interests of our membership.

Advances: Reflecting Industry Challenges and Member Funding Needs

After reaching a record $46.3 billion in September 2008 in response to a record demand for liquidity by our members, our advances outstanding declined to $36.9 billion as of December 31, 2008, and $22.3 billion as of December 31, 2009. The decline reflects the impact of the challenging economy on our members and the cyclical nature of our business.

As is the case with other FHLBanks, our members have had less need for liquidity in recent months, as many have experienced reduced loan demand and increases in retail deposits, reduced their asset balances, and focused on building their capital reserves and improving their capital ratios. Industry consolidation and the failure of certain members in our district have certainly played a role and will likely continue to have an impact for the next couple of years.

As a provider of liquidity and funding, we encourage member borrowing, but the variance in our advance business over the past two years demonstrates one of the core strengths of the FHLBank business model: our ability to expand and contract our advances portfolio based on our members’ needs for funding through all economic cycles.

Our Contribution to Affordable Housing and Economic Development

In 2009, we awarded $2.8 million in Affordable Housing Program (AHP) subsidies and provided $3.9 million of downpayment assistance to first-time homebuyers through our Home$tart Program. These funds will serve more than 1,000 households earning up to 80 percent of area median income.

Because these programs are funded with 10 percent of our annual profits, however, we do not expect to conduct an AHP funding round in 2010. That said, funds are occasionally returned from previous awards for projects that did not move forward, and if this occurs, we will make those funds available through our Home$tart Program.

Our Community Investment Program and Economic Development Fund (CIP/EDF) remain very viable options for community investment funding, and we encourage you to use them. These programs offer reduced-rate advances for funding qualifying assets, and with rates currently approaching 2003 levels, they are a particularly good option at this time.

First Quarter 2010 Results

Now more than a quarter into 2010, we are starting to see some early signs of recovery. Housing prices have shown some signs of stabilization, and prices in the secondary private-label MBS market have recovered somewhat from their lows in 2007 and 2008. At the same time, foreclosures continue to mount. This good news/bad news scenario is reflected in our OTTI securities portfolio.

Although we continued to experience additional credit losses on our private-label MBS, the amounts of those additional credit losses have moderated over the past two quarters, from $130.1 million in the third quarter of 2009 to $47.7 million in the fourth quarter of 2009 to $19.6 million in the first quarter of 2010. Our AOCL declined, to $855.8 million as of March 31, 2010, from $908.8 million as of December 31, 2009.

As a result, we reported net income of $6.1 million for the first quarter of 2010, as well as improvement in our regulatory and total capital positions. The Seattle Bank held $2.9 billion of regulatory capital and $1.1 billion of total GAAP capital as of March 31, 2010, compared to $2.8 billion and $993.7 million as of December 31, 2009.

Addressing the Challenge/Fulfilling Our Mission

The events of the past two years have delivered an undeniable blow to the turnaround we began in 2005, and we know that there are challenges ahead. Our economy remains uncertain, as does the financial services regulatory environment.

These challenges, however, have only strengthened our resolve.

Although it can be difficult to maintain perspective in these uncertain times, we are managing our cooperative for the long term. We are addressing our risks, increasing our operational efficiencies, and growing our profitability and our capital. We look forward to the completion and successful implementation of our capital restoration plan and to once again redeeming your capital stock and paying dividends.

First and foremost, we remain focused on our mission: providing liquidity, funding, and affordable housing and economic development assistance to support your businesses and the communities you serve.

We thank you for your continued support of the Seattle Bank cooperative.