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FEDERAL HOME LOAN BANK OF DALLAS - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 12, 2014

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the financial statements and notes thereto included in "Item 1. Financial Statements." Forward-Looking Information This quarterly report contains forward-looking statements that reflect current beliefs and expectations of the Federal Home Loan Bank of Dallas (the "Bank") about its future results, performance, liquidity, financial condition, prospects and opportunities. These statements are identified by the use of forward-looking terminology, such as "anticipates," "plans," "believes," "could," "estimates," "may," "should," "would," "will," "might," "expects," "intends" or their negatives or other similar terms. The Bank cautions that forward-looking statements involve risks or uncertainties that could cause the Bank's actual results to differ materially from those expressed or implied in these forward-looking statements, or could affect the extent to which a particular objective, projection, estimate, or prediction is realized. As a result, undue reliance should not be placed on these statements. These risks and uncertainties include, without limitation, evolving economic and market conditions, political events, and the impact of competitive business forces. The risks and uncertainties related to evolving economic and market conditions include, but are not limited to, changes in interest rates, changes in the Bank's access to the capital markets, changes in the cost of the Bank's debt, changes in the ratings on the Bank's debt, adverse consequences resulting from a significant regional, national or global economic downturn (including, but not limited to, reduced demand for the Bank's products and services), credit and prepayment risks, or changes in the financial health of the Bank's members or non-member borrowers. Among other things, political events could possibly lead to changes in the Bank's regulatory environment or its status as a government-sponsored enterprise ("GSE"), or to changes in the regulatory environment for the Bank's members or non-member borrowers. Risks and uncertainties related to competitive business forces include, but are not limited to, the potential loss of a significant amount of member borrowings through acquisitions or other means or changes in the relative competitiveness of the Bank's products and services for member institutions. For a more detailed discussion of the risk factors applicable to the Bank, see "Item 1A - Risk Factors" in the Bank's Annual Report on Form 10-K for the year ended December 31, 2013, which was filed with the Securities and Exchange Commission ("SEC") on March 24, 2014 (the "2013 10-K"). The Bank undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances, or any other reason. Overview Business The Bank is one of 12 district Federal Home Loan Banks (each individually a "FHLBank" and collectively the "FHLBanks" and, together with the Federal Home Loan Banks Office of Finance ("Office of Finance"), a joint office of the FHLBanks, the "FHLBank System") that were created by the Federal Home Loan Bank Act of 1932. The FHLBanks serve the public by enhancing the availability of credit for residential mortgages, community lending, and targeted community development. As independent, member-owned cooperatives, the FHLBanks seek to maintain a balance between their public purpose and their ability to provide adequate returns on the capital supplied by their members. The Federal Housing Finance Agency ("Finance Agency"), an independent agency in the executive branch of the U.S. government, is responsible for supervising and regulating the FHLBanks and the Office of Finance. The Finance Agency's stated mission is to ensure that the housing GSEs, including the FHLBanks, operate in a safe and sound manner so that they serve as a reliable source of liquidity and funding for housing finance and community investment. Consistent with this mission, the Finance Agency establishes policies and regulations covering the operations of the FHLBanks. The Bank serves eligible financial institutions in Arkansas, Louisiana, Mississippi, New Mexico and Texas (collectively, the Ninth District of the FHLBank System). The Bank's primary business is lending relatively low cost funds (known as advances) to its member institutions, which include commercial banks, thrifts, insurance companies, credit unions, and Community Development Financial Institutions that are certified under the Community Development Banking and Financial Institutions Act of 1994. While not members of the Bank, housing associates, including state and local housing authorities, that meet certain statutory criteria may also borrow from the Bank. The Bank also maintains a portfolio of investments, the vast majority of which are highly rated, for liquidity purposes and to provide additional earnings. Additionally, the Bank holds interests in a small and declining portfolio of government-guaranteed/insured and conventional mortgage loans that were acquired during the period from 1998 to mid-2003 through the Mortgage Partnership Finance® ("MPF"®) Program offered by the FHLBank of Chicago. Shareholders' return on their investment includes dividends (which are typically paid quarterly in the form of capital stock) and the value derived from access to the Bank's products and services. Historically, the Bank has balanced the financial rewards to shareholders by seeking to pay a dividend that meets or exceeds the return on alternative short-term money market investments available to shareholders, while lending funds at the lowest rates expected to be compatible with that objective and its objective to build retained earnings over time. 39



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The Bank's capital stock is not publicly traded and can be held only by members of the Bank, by non-member institutions that acquire stock by virtue of acquiring member institutions, by a federal or state agency or insurer acting as a receiver of a closed institution, or by former members of the Bank that retain capital stock to support advances or other obligations that remain outstanding or until any applicable stock redemption or withdrawal notice period expires. All members must hold stock in the Bank. The Bank's capital stock has a par value of $100 per share and is purchased, redeemed, repurchased and transferred only at its par value. By regulation, the parties to a transaction involving the Bank's stock can include only the Bank and its member institutions (or non-member institutions or former members, as described above). While a member could transfer stock to another member of the Bank, that transfer could occur only upon approval of the Bank and then only at par value. Members may redeem excess stock, or withdraw from membership and redeem all outstanding capital stock, with five years' written notice to the Bank. The FHLBanks' debt instruments (known as consolidated obligations) are their primary source of funds and are the joint and several obligations of all 12 FHLBanks. Consolidated obligations are issued through the Office of Finance (acting as agent for the FHLBanks) and generally are publicly traded in the over-the-counter market. The Bank records on its statements of condition only those consolidated obligations for which it receives the proceeds. Consolidated obligations are not obligations of the U.S. government and the U.S. government does not guarantee them. Consolidated obligations are currently rated Aaa/P-1 by Moody's Investors Service ("Moody's") and AA+/A-1+ by Standard & Poor's ("S&P"). These ratings indicate that each of these nationally recognized statistical rating organizations ("NRSROs") has concluded that the FHLBanks have a very strong capacity to meet their commitments to pay principal and interest on consolidated obligations. The ratings also reflect the FHLBank System's status as a GSE. Historically, the FHLBanks' GSE status and very high credit ratings on consolidated obligations have provided the FHLBanks with excellent capital markets access. Deposits, other borrowings and the proceeds from capital stock issued to members are also sources of funds for the Bank. In addition to ratings on the FHLBanks' consolidated obligations, each FHLBank is rated individually by both S&P and Moody's. These individual FHLBank ratings apply to the individual obligations of the respective FHLBanks, such as interest rate derivatives, deposits, and letters of credit. As of June 30, 2014, Moody's had assigned a deposit rating of Aaa/P-1 to each of the FHLBanks. At that same date, S&P had rated 11 of the FHLBanks AA+/A-1+ and the FHLBank of Seattle AA/A-1+. Shareholders, bondholders and prospective shareholders and bondholders should understand that these credit ratings are not a recommendation to buy, hold or sell securities and they may be subject to revision or withdrawal at any time by the NRSRO. The ratings from each of the NRSROs should be evaluated independently. The Bank conducts its business and fulfills its public purpose primarily by acting as a financial intermediary between its members and the capital markets. The intermediation of the timing, structure, and amount of its members' credit needs with the investment requirements of the Bank's creditors is made possible by the extensive use of interest rate exchange agreements, including interest rate swaps and caps. The Bank's interest rate exchange agreements are accounted for in accordance with the provisions of Topic 815 of the Financial Accounting Standards Board Accounting Standards Codification entitled "Derivatives and Hedging." The Bank defines "adjusted earnings" as net earnings exclusive of: (1) gains or losses on the sales of investment securities, if any; (2) gains or losses on the retirement or transfer of debt, if any; (3) prepayment fees on advances; (4) fair value adjustments (except for net interest settlements) associated with derivatives and hedging activities and assets and liabilities carried at fair value; and (5) realized gains and losses associated with early terminations of derivative transactions. The Bank's adjusted earnings are generated primarily from net interest income and typically tend to rise and fall with the overall level of interest rates, particularly short-term money market rates. Because the Bank is a cooperatively owned wholesale institution, the spread component of its net interest income is much smaller than a typical commercial bank. The Bank endeavors to maintain a fairly neutral interest rate risk profile. As a result, the Bank's capital is effectively invested in shorter-term assets or assets with short repricing intervals, and its adjusted earnings and returns on capital stock (based on adjusted earnings) generally tend to track short-term interest rates. The Bank's profitability objective is to achieve a rate of return on members' capital stock investment sufficient to allow the Bank to continue to increase its retained earnings and pay dividends on capital stock at rates that equal or exceed the average federal funds rate. The Bank's quarterly dividends are based upon its operating results, shareholders' average capital stock holdings and, currently, the upper end of the targeted range for the federal funds rate for the immediately preceding quarter. While the Bank has had a long-standing practice of paying quarterly dividends, future dividend payments cannot be assured. The Bank operates in only one reportable segment. All of the Bank's revenues are derived from U.S. operations. 40



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The following table summarizes the Bank's membership, by type of institution, as of June 30, 2014 and December 31, 2013.

MEMBERSHIP SUMMARY June 30, 2014 December 31, 2013 Commercial banks 665 679 Thrifts 71 71 Credit unions 98 96 Insurance companies 29 26 Community Development Financial Institutions 4 3 Total members 867 875 Housing associates 8 8 Non-member borrowers 10 10 Total 885 893 Community Financial Institutions ("CFIs") (1) 681 696



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(1) The figures presented above reflect the number of members that were

Community Financial Institutions as of June 30, 2014 and December 31, 2013 based upon the definitions of Community Financial Institutions that applied as of those dates. For 2014, Community Financial Institutions ("CFIs") are defined to include all institutions insured by the Federal Deposit Insurance Corporation ("FDIC") with average total assets as of December 31, 2013, 2012 and 2011 of less than $1.108 billion. For 2013, CFIs were defined as FDIC-insured institutions with average total assets as of December 31, 2012, 2011 and 2010 of less than $1.095 billion. Financial Market Conditions Economic growth in the United States slowed during the first quarter of 2014 and then improved during the second quarter. The gross domestic product increased at an annual rate of 4.0 percent during the second quarter of 2014, after decreasing at an annual rate of 2.1 percent during the first quarter of 2014. The nationwide unemployment rate fell from 6.7 percent at both March 31, 2014 and December 31, 2013 to 6.1 percent at June 30, 2014. Housing prices continued to improve in most major metropolitan areas. Credit market conditions also remained relatively stable during the first six months of 2014. In February 2014, in order to avoid the possible financial market impacts of an ongoing debt ceiling debate, the U.S. Congress passed a suspension of the debt ceiling until March 2015. During 2013, the Federal Reserve purchased agency mortgage-backed securities ("MBS") at a pace of $40 billion per month and longer-term U.S. Treasury securities at a pace of $45 billion per month. During the first six months of 2014, these purchases were reduced in measured steps. At its July 2014 Federal Open Market Committee ("FOMC") meeting, the Federal Reserve announced that it would further reduce its purchases of agency MBS and longer-term U.S. Treasury securities to $10 billion and $15 billion, respectively, in August 2014. The Federal Reserve is also maintaining its existing policy of reinvesting the principal payments from its holdings of agency debt and agency MBS in agency MBS and of rolling over maturing treasury securities at auction. The Federal Reserve stated that it will closely monitor incoming information on economic and financial developments in coming months. If the incoming information broadly supports the FOMC's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the FOMC will likely reduce the pace of its purchases of U.S. Treasury securities and agency MBS in further measured steps. The FOMC maintained its target for the federal funds rate at a range between 0 and 0.25 percent throughout the first six months of 2014. The Federal Reserve stated at its July 2014 FOMC meeting that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the FOMC's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. During the first six months of 2014, the Federal Reserve continued to pay interest on required and excess reserves held by depository institutions at a rate of 0.25 percent, equivalent to the upper boundary of the target range for federal funds. The sustained increase in bank reserves combined with the rate of interest being paid on those reserves has contributed to a decline in the volume of transactions taking place in the overnight federal funds market and an effective federal funds rate that has generally been below the upper end of the targeted range. 41



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One-month and three-month LIBOR rates decreased slightly during the first six months of 2014, with one-month and three-month LIBOR ending the second quarter at 0.16 percent and 0.23 percent, respectively, as compared to 0.17 percent and 0.25 percent, respectively, at the end of 2013. The following table presents information on various market interest rates at June 30, 2014 and December 31, 2013 and various average market interest rates for the three and six-month periods ended June 30, 2014 and 2013.

Ending Rate Average Rate Average Rate Second Second Six Months Six Months Quarter Quarter Ended June Ended June June 30, 2014 December 31, 2013 2014 2013 30, 2014 30, 2013 Federal Funds Target (1) 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% Average Effective Federal Funds Rate (2) 0.09% 0.07% 0.09% 0.12% 0.08% 0.13% 1-month LIBOR (1) 0.16% 0.17% 0.15% 0.20% 0.15% 0.20% 3-month LIBOR (1) 0.23% 0.25% 0.23% 0.28% 0.23% 0.28% 2-year LIBOR (1) 0.58% 0.49% 0.54% 0.41% 0.52% 0.41% 5-year LIBOR (1) 1.70% 1.79% 1.74% 1.08% 1.71% 1.02% 10-year LIBOR (1) 2.63% 3.09% 2.72% 2.15% 2.79% 2.08% 3-month U.S. Treasury (1) 0.04% 0.07% 0.03% 0.05% 0.04% 0.07% 2-year U.S. Treasury (1) 0.47% 0.38% 0.42% 0.27% 0.40% 0.27% 5-year U.S. Treasury (1) 1.62% 1.75% 1.66% 0.91% 1.63% 0.87% 10-year U.S. Treasury (1) 2.53% 3.04% 2.62% 1.99% 2.69% 1.97% _____________________________ (1) Source: Bloomberg (2) Source: Federal Reserve Statistical Release Year-to-Date 2014 Summary • The Bank ended the second quarter of 2014 with total assets of $33.6 billion compared with $30.2 billion at the end of 2013. The $3.4 billion increase in total assets during the six-month period was attributable to a $2.2 billion increase in advances and a $1.2 billion increase in the Bank's short-term liquidity portfolio. • Total advances increased from $16.0 billion at December 31, 2013 to $18.2 billion at June 30, 2014. During the second quarter of 2014, the Bank's lending activities expanded due to increased demand for loans at member institutions which the Bank attributes to improving economic conditions and more robust activity in the housing markets served by its members. • The Bank's net income for the three and six months ended June 30, 2014 was $14.0 million and $26.9 million, respectively, as compared to $22.1 million and $40.2 million, respectively, during the corresponding periods in 2013. • Unrealized losses on the Bank's holdings of non-agency residential MBS ("RMBS"), all of which are classified as held-to-maturity, totaled $10.5 million (6 percent of amortized cost) at June 30, 2014, as compared to $16.1 million (8 percent of amortized cost) at December 31, 2013. Based on its quarter-end analysis of the 28 securities in this portfolio, the Bank believes that the unrealized losses were principally the result of liquidity risk related discounts in the non-agency RMBS market and do not accurately reflect the currently likely future credit performance of the securities. Accordingly, no credit-related other-than-temporary impairment charges were recorded during the three months ended June 30, 2014. For a discussion of the Bank's analysis, see "Item 1. Financial Statements" (specifically, Note 5 beginning on page 11 of this report). If the actual and/or projected performance of the loans underlying the Bank's holdings of non-agency RMBS deteriorates beyond management's current expectations, the Bank could recognize further losses on the securities that it has already determined to be other-than-temporarily impaired in prior periods and/or losses on its other investments in non-agency RMBS. • At all times during the first six months of 2014, the Bank was in compliance with all of its regulatory capital requirements. In addition, the Bank's retained earnings increased to $680.4 million at June 30, 2014 from $655.5 million at December 31, 2013. Retained earnings approximated 2 percent of total assets at each of these dates. • During the first six months of 2014, the Bank paid dividends totaling $2.0 million; the Bank's first and second quarter dividends were each paid at an annualized rate of 0.375 percent, which exceeded the upper end of the Federal Reserve's target range for the federal funds rate of 0.25 percent for each of the preceding quarters by 12.5 basis points. 42



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• While the Bank cannot predict future economic conditions or future levels of advances demand from its members, based on its current expectations the Bank anticipates that its earnings will be sufficient both to continue paying quarterly dividends at a rate at least equal to or slightly above the upper end of the Federal Reserve's target range for the federal funds rate and to continue building retained earnings for the foreseeable future. In addition, the Bank currently expects to continue its quarterly repurchases of surplus stock. 43



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