"Settled" here has its usual meaning in relation to securities. A trade in securities is a commitment to buy/sell. From the moment the agreement is made the buyer notionally holds the security, but does not actually have it yet. Subsequently (commonly within three days, though in some cases within a day) the trade is completed by the actual security being delivered to the buyer and payment being made. This is called settlement.

"Settlement of securities is a business process whereby securities or interests in securities are delivered, usually against (in simultaneous exchange for) payment of money, to fulfill contractual obligations, such as those arising under securities trades."
http://en.wikipedia.org/wiki/Settlement_(finance)

(In the old days pieces of paper were physically handed over; nowadays settlement is electronic.)

Since 2008 the Federal Reserve has been buying huge amounts of Mortgage Backed Securities (MBS), whose value had plummeted because the mortgages on which they were based had become largely worthless. In doing so they sought to bale out the banks by taking toxic debt off their books and also rescue the housing market.

On its balance sheet the Fed distinguishes between settled and non-settled securities. If you look at the graph of "Securities Held Outright" in its March 2014 balance sheet report, you'll see there's a note that says "On a settlement basis rather than a commitment basis".
http://www.federalreserve.gov/monetarypolicy/files/quarterly...

And this comment clarifies it further:

"The Fed H.4.1 reports MBS that have settled on the balance sheet ($1025 billion as of feb 17th) and the ones not settled as a memo item: ($108 billion as of feb 17th)."
http://econbrowser.com/archives/2010/02/treasury_supple

This reading is confirmed by the context of the sentence you have given (I quote here from what appears to be the same document; I won't give the source):

"Additionally, unlike with Treasuries, the Fed will not lend agency MBS that have settled on its balance sheet. Within the Treasury market, if an issue is in short supply and it is financing special in the repo market, the Fed will lend its Treasuries to ease the squeeze. This is not the case with agency MBS; once the Fed has taken delivery of a security, that bond is gone forever."

So what it means is that the Fed has decided, once its purchases of MBSs have settled on its balance sheet — once the deals are completed and it has taken delivery of these securities — that it will not lend them in repos (repurchase agreements), in other words, sell them short term with a commitment to buy them back, in order to correct market shortages in this type of security. It has taken them permanently out of circulation and for trading purposes they have effectively ceased to exist.

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Note added at 5 hrs (2014-10-13 06:06:48 GMT)
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The graph I mentioned is on p. 6 (top right) of the March 2014 Fed balance sheet report.

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Note added at 6 hrs (2014-10-13 06:07:21 GMT)
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"Treasuries", of course, are Treasury securities.

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Note added at 6 hrs (2014-10-13 06:11:59 GMT)
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So "to settle" is being used here as an intransitive verb meaning "to be settled".