Derivative Financial Instruments

We maintain an overall interest rate risk management strategy that incorporates the use of derivative instruments to reduce the economic effect of interest rate changes. Our goal is to manage interest rate sensitivity by modifying the repricing frequency and underlying index characteristics of certain balance sheet assets or liabilities so any adverse impacts related to movements in interest rates are managed within low to moderate limits. As a result of interest rate fluctuations, hedged balance sheet positions will appreciate or depreciate in market value or create variability in cash flows. Income or loss on the derivative instruments linked to the hedged item will generally offset the effect of this unrealized appreciation or depreciation or volatility in cash flows for the period the item is being hedged. We view this strategy as a prudent management of interest rate risk. Please refer to Note 11, “Derivative Financial Instruments” in our 2017 Form 10-K for a full discussion of our risk management strategy.

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) requires all standardized derivatives, including most interest rate swaps, to be submitted for clearing to central counterparties to reduce counterparty risk. Two of the central counterparties we use are the Chicago Mercantile Exchange (“CME”) and the London Clearing House (“LCH”). The CME and the LCH made amendments to their respective rules that resulted in the prospective accounting treatment of certain daily variation margin payments being considered as the legal settlement of the outstanding exposure of the derivative instead of the posting of collateral. The CME rule changes, which became effective in January 2017, and the LCH rule changes, which became effective in January 2018, result in all variation margin payments on derivatives cleared through the CME and LCH being accounted for as legal settlement. As of March 31, 2018, $5.7 billion notional of our derivative contracts were cleared on the CME and $0.7 billion were cleared on the LCH. The derivative contracts cleared through the CME and LCH represent 89.8 percent and 10.2 percent, respectively, of our total notional derivative contracts of $6.4 billion at March 31, 2018.

For derivatives cleared through the CME and LCH, the net gain (loss) position includes the variation margin amounts as settlement of the derivative and not collateral against the fair value of the derivative. Interest income (expense) related to variation margin on derivatives that are not designated as hedging instruments or are designated as fair value relationships is recognized as a gain (loss) rather than as interest income (expense). Changes in fair value for derivatives not designated as hedging instruments will be presented as realized gains (losses).

Our exposure is limited to the value of the derivative contracts in a gain position less any collateral held and plus any collateral posted. When there is a net negative exposure, we consider our exposure to the counterparty to be zero. At March 31, 2018 and December 31, 2017, we had a net positive exposure (derivative gain positions to us, less collateral held by us and plus collateral posted with counterparties) related to derivatives of $31.3 million and $19.6 million, respectively.

Summary of Derivative Financial Statement Impact

The following tables summarize the fair values and notional amounts of all derivative instruments at March 31, 2018 and December 31, 2017, and their impact on earnings and other comprehensive income for the three months ended March 31, 2018 and 2017. Please refer to Note 11, “Derivative Financial Instruments” in our 2017 Form 10-K for a full discussion of cash flow hedges, fair value hedges, and trading activities.

Impact of Derivatives on the Consolidated Balance Sheet



		Cash Flow Hedges						Fair Value Hedges				Trading					Total
		March 31,			December 31,			March 31,		December 31,		March 31,			December 31,		March 31,			December 31,
		2018			2017			2018		2017		2018			2017		2018			2017
Fair Values⁽¹⁾	Hedged Risk Exposure

Derivative Assets:⁽²⁾
Interest rate swaps	Interest rate	$	—		$	—		$	794	$	630	$	—		$	182	$	794		$	812
Derivative Liabilities:⁽²⁾
Interest rate swaps	Interest rate	(1,053		)	(2,584		)	—		—		(36		)	—		(1,089		)	(2,584		)
Total net derivatives		$	(1,053	)	$	(2,584	)	$	794	$	630	$	(36	)	$	182	$	(295	)	$	(1,772	)

___________

(1)

Fair values reported include variation margin as legal settlement of the derivative contract and accrued interest. Assets and liabilities are presented without consideration of master netting agreements. Derivatives are carried on the balance sheet based on net position by counterparty under master netting agreements, and classified in other assets or other liabilities depending on whether in a net positive or negative position.


(2)	The following table reconciles gross positions with the impact of master netting agreements to the balance sheet classification:



	Other Assets						Other Liabilities
	March 31,			December 31,			March 31,			December 31,
	2018			2017			2018			2017
Gross position⁽¹⁾	$	794		$	812		$	(1,089	)	$	(2,584	)
Impact of master netting agreement	(794		)	(812		)	794			812
Derivative values with impact of master netting agreements (as carried on balance sheet)	—			—			(295		)	(1,772		)
Cash collateral pledged⁽²⁾	—			—			31,637			21,586
Net position	$	—		$	—		$	31,342		$	19,814

__________


(1)	Gross position amounts include accrued interest and variation margin as legal settlement of the derivative contract.


(2)	Cash collateral pledged excludes amounts that represent legal settlement of the derivative contracts.



	Cash Flow				Fair Value				Derivatives Not Designated as Hedges				Total
	March 31,		December 31,		March 31,		December 31,		March 31,		December 31,		March 31,		December 31,
	2018		2017		2018		2017		2018		2017		2018		2017
Notional Values

Interest rate swaps	$	1,376,816	$	1,408,649	$	3,867,204	$	3,062,849	$	1,161,000	$	987,577	$	6,405,020	$	5,459,075
Other⁽¹⁾	$	—	$	—	$	—	$	—	$	5,476	$	3,245	$	5,476	$	3,245

________

(1) “Other” includes embedded derivatives included in forward purchase contracts.

Impact of Derivatives on the Consolidated Statements of Income



	Three Months Ended March 31,
	2018			2017

Fair Value Hedges
Interest rate swaps:
Hedge ineffectiveness realized gains (losses) recorded in earnings⁽¹⁾	$	5,853		$	(4,167	)
Realized gains (losses) recorded in interest expense	(514		)	4,547
Total	$	5,339		$	380

Cash Flow Hedges
Interest rate swaps:
Hedge ineffectiveness gains (losses) recorded in earnings⁽¹⁾	$	2,684		$	(72	)
Realized losses recorded in interest expense	(1,562		)	(3,339		)
Total	$	1,122		$	(3,411	)

Trading
Interest rate swaps:
Interest reclassification	$	110		$	80
Realized losses recorded in earnings	(4,755		)	(1,219		)
Total⁽¹⁾	(4,645		)	(1,139		)
Total	$	1,816		$	(4,170	)

________


(1)	Amounts included in “gains (losses) on derivatives and hedging activities, net” in the consolidated statements of income.

Impact of Derivatives on the Statements of Changes in Stockholders’ Equity



	Three Months Ended
	March 31,
	2018			2017

Amount of gain recognized in other comprehensive income (loss)	$	18,728		$	1,440
Less: amount of loss reclassified in interest expense⁽¹⁾	(1,562		)	(3,339		)
Total change in other comprehensive income (loss) for unrealized gains on derivatives, before income tax (expense) benefit	$	20,290		$	4,779

___________

⁽¹⁾ Amounts included in “realized losses recorded in interest expense” in the “Impact of Derivatives on the Consolidated Statements of Income” table.

Cash Collateral

As of March 31, 2018, cash collateral held and pledged excludes amounts that represent legal settlement of the derivative contracts held with CME and LCH. Cash collateral held related to derivative exposure between us and our derivatives counterparties was zero at both March 31, 2018 and December 31, 2017. Collateral held is recorded in “Other Liabilities” on the consolidated balance sheets. Cash collateral pledged related to derivative exposure between us and our derivatives counterparties was $31.6 million and $21.6 million at March 31, 2018 and December 31, 2017, respectively. Collateral pledged is recorded in “Other interest-earning assets” on the consolidated balance sheets.