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Derivatives and Hedging Activities
 12 Months Ended
Dec. 31, 2019
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivatives and Hedging Activities [Text Block] Derivatives and Hedging Activities

NATURE OF BUSINESS ACTIVITY

The Bank is exposed to interest rate risk primarily from the effect of interest rate changes on its interest-earning assets and its related funding sources. The goal of the Bank’s interest rate risk management strategy is not to eliminate interest rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, the Bank has established policies and procedures, which include guidelines on the amount of exposure to interest rate changes it is willing to accept.

The Bank enters into derivative contracts to manage the interest rate risk exposures inherent in its otherwise unhedged assets and funding positions. Finance Agency regulations and the Bank’s risk management policies establish guidelines for derivatives, prohibit trading in or the speculative use of derivatives, and limit credit risk arising from derivatives.

Derivative financial instruments are used by the Bank to achieve its financial and risk management objectives. The Bank reevaluates its hedging strategies periodically and may change the hedging techniques it uses or may adopt new strategies. The most common ways in which the Bank uses derivatives are to:
 
•
reduce the interest rate sensitivity and repricing gaps of assets and liabilities;

•
preserve an interest rate spread between the yield of an asset and the cost of the related liability. Without the use of derivatives, this interest rate spread could be reduced or eliminated when a change in the interest rate on the asset does not match a change in the interest rate on the liability;

•
mitigate the adverse earnings effects of the shortening or extension of certain assets and liabilities;

•
manage embedded options in assets and liabilities; and

•
reduce funding costs by combining a derivative with a consolidated obligation, as the cost of a combined funding structure can be lower than the cost of a comparable consolidated obligation.

TYPES OF DERIVATIVES

The Bank may use the following derivative instruments:

•
Interest Rate Swaps. An interest rate swap is an agreement between two entities to exchange cash flows in the future. The agreement sets the dates on which the cash flows will be exchanged and the manner in which the cash flows will be calculated. One of the simplest forms of an interest rate swap involves the promise by one party to pay cash flows equivalent to the interest on a notional amount at a predetermined fixed rate for a given period of time. In return for this promise, this party receives cash flows equivalent to the interest on the same notional amount at a variable interest rate index for the same period of time. The variable interest rate received or paid by the Bank in derivative transactions is LIBOR.

•
Options. An option is an agreement between two entities that conveys the right, but not the obligation, to engage in a future transaction on some underlying security or other financial asset at an agreed upon price during a certain period of time or on a specific date. Premiums or swap fees paid to acquire options are considered the fair value of the option at inception of the hedge and are reported as derivative assets on the Statements of Condition.

•
Swaptions. A swaption is an option on a swap that gives the buyer the right to enter into a specified interest rate swap at a certain time in the future. When used as a hedge, a swaption can protect the Bank against future interest rate changes. The Bank may enter into both payer and receiver swaptions. A payer swaption is the option to make fixed interest payments at a later date and a receiver swaption is the option to receive fixed interest payments at a later date.

•
Interest Rate Caps and Floors. In an interest rate cap agreement, a cash flow is generated if the price or interest rate of an underlying variable rises above a certain threshold (or “cap”) price. In an interest rate floor agreement, a cash flow is generated if the price or interest rate of an underlying variable falls below a certain threshold (or “floor”) price. Interest rate caps and floors are designed as protection against the interest rate on a variable rate asset or liability rising above or falling below a certain level.

•
Futures/Forwards Contracts. Futures and forwards contracts give the buyer the right to buy or sell a specific type of asset at a specific time at a given price. For example, certain mortgage purchase commitments entered into by the Bank are considered derivatives. The Bank may hedge these commitments by selling “to-be-announced” (TBA) MBS for forward settlement. A TBA represents a forward contract for the sale of MBS at a future agreed upon date for an established price.

TYPES OF HEDGED ITEMS

The Bank may have the following types of hedged items:

•
Investment Securities. The Bank primarily invests in other U.S. obligations, GSE and Tennessee Valley Authority obligations, state or local housing agency obligations, and MBS, and classifies them as either trading, AFS, or HTM. The interest rate and prepayment risk associated with these investment securities is managed through a combination of debt issuance and derivatives. To manage interest rate risk, the Bank may fund investment securities with callable consolidated obligations or utilize interest rate swaps, caps, floors, or swaptions. Derivatives held by the Bank that are associated with trading and HTM securities, if applicable, are designated as economic hedges and derivatives held by the Bank associated with AFS securities may be designated as either a fair value or economic hedge.

•
Advances. The Bank offers a wide range of fixed and variable rate advance products with different maturities, interest rates, payment characteristics, and optionality. The Bank may use derivatives to adjust the repricing and/or option characteristics of advances in order to more closely match the characteristics of its funding liabilities. In general, whenever a borrower executes a fixed rate advance or a variable rate advance with embedded options, the Bank may simultaneously execute a derivative with terms that offset the terms and embedded options, if any, in the advance. For example, the Bank may hedge a fixed rate advance with an interest rate swap where the Bank pays a fixed rate coupon and receives a variable rate coupon, effectively converting the fixed rate advance to a variable rate advance. This type of hedge is typically treated as a fair value hedge. In addition, the Bank may hedge a callable advance, which gives the borrower the option to extinguish the fixed rate advance, by entering into a cancelable interest rate swap.
•
Mortgage Loans. The Bank invests in fixed rate mortgage loans. The prepayment options embedded in mortgage loans can result in extensions or contractions in the expected repayment of these investments, depending on changes in actual and estimated prepayment speeds. The Bank manages the interest rate risk associated with mortgage loans through a combination of debt issuance and derivatives. The Bank may issue both callable and noncallable debt and prepayment-linked consolidated obligations to achieve cash flow patterns and liability durations similar to those expected on the mortgage loans. The Bank may also purchase interest rate caps, floors, or swaptions to minimize the interest rate risk embedded in mortgage assets. Although these derivatives are valid economic hedges, they are not specifically linked to individual mortgage assets and, therefore, do not receive fair value hedge accounting.

•
Consolidated Obligations. The Bank may enter into derivatives to hedge the interest rate risk associated with its consolidated obligations. For example, the Bank may issue and hedge a fixed rate consolidated obligation with an interest rate swap where the Bank receives a fixed rate coupon and pays a variable rate coupon, effectively converting the fixed rate consolidated obligation to a variable rate consolidated obligation. This type of hedge is typically treated as a fair value hedge. The Bank may also issue variable interest rate consolidated obligations indexed to LIBOR, or other specified index and simultaneously execute interest rate swaps to hedge the basis risk of the variable interest rate debt. Interest rate swaps used to hedge the basis risk of variable interest rate debt do not qualify for hedge accounting. As a result, this type of hedge is treated as an economic hedge. This strategy of issuing consolidated obligations while simultaneously entering into derivatives enables the Bank to offer a wider range of attractively priced advances to its borrowers and may allow the Bank to reduce its funding costs.
  
•
Firm Commitments. Certain mortgage loan purchase commitments are considered derivatives. The Bank normally hedges these commitments by selling TBA MBS for forward settlement. A TBA represents a forward contract for the sale of MBS at a future agreed upon date for an established price. The mortgage loan purchase commitment and the TBA used in the firm commitment hedging strategy are considered economic hedges. When the mortgage loan purchase commitment derivative settles, the current market value of the commitment is included with the basis of the mortgage loan and amortized over the contractual life of the mortgage loan using the level-yield method. The Bank may also hedge a firm commitment for a forward-starting advance through the use of an interest-rate swap (fair value hedge). In this case, the interest rate swap will function as the hedging instrument for both the firm commitment and the subsequent advance and is treated as a fair value hedge.

For additional information on the Bank’s derivative and hedging accounting policy, see “Note 1 — Summary of Significant Account Policies.”

FINANCIAL STATEMENT EFFECT AND ADDITIONAL FINANCIAL INFORMATION

The notional amount of derivatives serves as a factor in determining periodic interest payments and cash flows received and paid. However, the notional amount of derivatives represents neither the actual amounts exchanged nor the overall exposure of the Bank to credit and market risk. The risks of derivatives can be measured meaningfully on a portfolio basis that takes into account the counterparties, the types of derivatives, the items being hedged, and any offsets between the derivatives and the items being hedged.

The following table summarizes the Bank’s notional amount and fair value of derivative instruments and total derivative assets and liabilities. Total derivative assets and liabilities include the effect of netting adjustments and cash collateral. For purposes of this disclosure, the derivative values include the fair value of derivatives and the related accrued interest (dollars in millions):
 
 
December 31, 2019
 
December 31, 2018
 
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
 
Notional
Amount
 
Derivative
Assets
 
Derivative
 Liabilities
Derivatives designated as hedging instruments (fair value hedges)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
37,684

 
$
31

 
$
159

 
$
47,316

 
$
83

 
$
115

Derivatives not designated as hedging instruments (economic hedges)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
1,038

 
8

 
43

 
1,321

 
20

 
24

Forward settlement agreements (TBAs)
 
122

 
—

 
—

 
98

 
—

 
—

Mortgage loan purchase commitments
 
127

 
—

 
—

 
101

 
1

 
—

Total derivatives not designated as hedging instruments
 
1,287

 
8

 
43

 
1,520

 
21

 
24

Total derivatives before netting and collateral adjustments
 
$
38,971

 
39

 
202

 
$
48,836

 
104

 
139

Netting adjustments and cash collateral1
 
 
 
63

 
(201
)
 
 
 
(46
)
 
(130
)
Total derivative assets and derivative liabilities
 
 
 
$
102

 
$
1

 
 
 
$
58

 
$
9


1
Amounts represent the application of the netting requirements that allow the Bank to net settle positive and negative positions and also cash collateral and the related accrued interest held or placed with the same clearing agent and/or counterparty. At December 31, 2019 and 2018, cash collateral posted by the Bank and related accrued interest was $264 million and $121 million. At December 31, 2019, the Bank held no cash collateral and related accrued interest from clearing agents and/or counterparties. At December 31, 2018, the Bank held cash collateral and related accrued interest from clearing agents and/or counterparties of $37 million.

Beginning on January 1, 2019, as a result of the adoption of ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, changes in the fair value of a derivative that is designated and qualifies as a fair value hedge, along with changes in the fair value of the hedged asset or liability that is attributable to the hedged risk, are recorded in net interest income in the same line as the earnings effect of the hedged item. Prior to January 1, 2019, any hedge ineffectiveness, or the amount by which the change in the fair value of the derivative differed from the change in the fair value of the hedge item, was recorded in other income (loss) in “Net gains (losses) on derivative and hedging activities.” For additional information, refer to “Note 2 — Recently Adopted and Issued Accounting Guidance — Targeted Improvements to Accounting for Hedging Activities.”

The following tables summarize the income effect from fair value hedging relationships recorded in either net interest income or other income as well as total income (expense) by product recorded on the Statements of Income (dollars in millions):
 
 
For the Year Ended December 31, 2019
 
 
Interest Income (Expense)
 
 
Advances
 
Available-for-Sale Securities
 
Consolidated Obligation Bonds
Total interest income (expense) recorded on the Statements of Income1
 
$
2,466

 
$
506

 
$
(2,289
)
Net interest income effect from fair value hedging relationships
 
 
 
 
 
 
Interest rate contracts
 
 
 
 
 
 
Derivatives2
 
(223
)
 
(233
)
 
188

Hedged items3
 
276

 
224

 
(357
)
Total net interest income effect from fair value hedging relationships
 
$
53

 
$
(9
)
 
$
(169
)
 
 
For the Year Ended December 31, 2018
 
 
Interest Income (Expense)
 
Other Income
 
 
Advances
 
Available-for-Sale Securities
 
Consolidated Obligation Bonds
 
Net Gains (Losses) on Derivatives and Hedging Activities
Total income (expense) recorded on the Statements of Income1
 
$
2,443

 
$
504

 
$
(2,095
)
 
$
19

Net income effect from fair value hedging relationships
 
 
 
 
 
 
 
 
Interest rate contracts
 
 
 
 
 
 
 
 
Derivatives4
 
47

 
(22
)
 
(217
)
 
203

Hedged items5
 
7

 
4

 
(2
)
 
(200
)
Total net income effect from fair value hedging relationships
 
$
54

 
$
(18
)
 
$
(219
)
 
$
3

 
 
For the Year Ended December 31, 2017
 
 
Interest Income (Expense)
 
Other Income
 
 
Advances
 
Available-for-Sale Securities
 
Consolidated Obligation Bonds
 
Net Gains (Losses) on Derivatives and Hedging Activities
Total income (expense) recorded on the Statements of Income1
 
$
1,589

 
$
368

 
$
(1,239
)
 
$
12

Net income effect from fair value hedging relationships
 
 
 
 
 
 
 
 
Interest rate contracts
 
 
 
 
 
 
 
 
Derivatives4
 
(70
)
 
(93
)
 
6

 
85

Hedged items5
 
(3
)
 
(2
)
 
5

 
(74
)
Total net income effect from fair value hedging relationships
 
$
(73
)
 
$
(95
)
 
$
11

 
$
11


1    Amounts shown to give context to the disclosure and include total interest income (expense) of the products indicated, including coupon, prepayment fees, amortization, and
derivative net interest settlements. In 2019, interest income (expense) amounts also include gains and losses on derivatives and hedged items in fair value hedging relationships.
In 2018, gains and losses on derivatives and hedged items in fair value hedging relationships were recorded in other income in “net gains (losses) on derivatives and hedging
activities” along with gains and losses on economic derivatives.

2    Includes changes in fair value, net interest settlements on derivatives, and amortization of the financing element of off-market derivatives.

3    Includes changes in fair value and amortization/accretion of basis adjustments on closed hedge relationships.

4    Interest income (expense) amounts include net interest settlements on derivatives and amortization of the financing element of off-market derivatives. Other income amounts
include changes in fair value.

5    Interest income (expense) amounts include amortization/accretion of basis adjustments on closed hedge relationships. Other income amounts include changes in fair value.

The following table summarizes cumulative fair value hedging adjustments and the related amortized cost of the hedged items (dollars in millions):
 
 
December 31, 2019
Line Item on Statements of Condition
 
Amortized Cost of Hedged Asset/ Liability1
 
Changes in Fair Value for Active Hedging Relationships Included in Amortized Cost
 
Basis Adjustments for Discontinued Hedging Relationships Included in Amortized Cost
 
Cumulative Amount of Fair Value Hedging Adjustments
Advances
 
$
14,806

 
$
146

 
$
10

 
$
156

Available-for-sale securities
 
6,221

 
167

 
—

 
167

Consolidated obligation bonds
 
20,256

 
16

 
(15
)
 
1


1    Includes only the portion of amortized cost representing the hedged items in fair value hedging relationships.

The following table summarizes the components of “Net gains (losses) on derivatives and hedging activities” as presented on the Statements of Income (dollars in millions). For periods prior to January 1, 2019, net gains (losses) representing hedge ineffectiveness for fair value hedging relationships were recorded in “Net gains (losses) on derivatives and hedging activities.” Beginning on January 1, 2019, changes in the fair value of the derivative and the hedged item in a fair value hedge relationship are recorded in net interest income.
 
For the Years Ended December 31,
 
2019
 
2018
 
2017
Derivatives designated as hedging instruments (fair value hedges)
 
 
 
 
 
Interest rate swaps
 
 
$
3

 
$
11

Derivatives not designated as hedging instruments (economic hedges)
 
 
 
 
 
Interest rate swaps
$
(34
)
 
$
16

 
$
10

Forward settlement agreements (TBAs)
(5
)
 
2

 
(2
)
Mortgage loan purchase commitments
5

 
(2
)
 
2

Net interest settlements
(1
)
 
(3
)
 
(12
)
Total net gains (losses) related to derivatives not designated as hedging instruments
(35
)
 
13

 
(2
)
Price alignment amount1
—

 
3

 
3

Net gains (losses) on derivatives and hedging activities
$
(35
)
 
$
19

 
$
12



1
This amount represents interest on variation margin which is a component of the derivative fair value for cleared transactions. The amounts reported for the year ended December 31, 2019 reflect the price alignment amounts on variation margin for daily settled derivative contracts not designated as hedging instruments. The amounts recorded for the year ended December 31, 2019 were less than $1 million. The price alignment amounts on variation margin for daily settled derivative contracts designated as hedging instruments are recorded in the same line item as the earnings effect of the hedged item. The amounts reported for the year ended December 31, 2018 and 2017 reflect the price alignment amounts on variation margin for all daily settled derivative contracts.

MANAGING CREDIT RISK ON DERIVATIVES

The Bank is subject to credit risk due to the risk of nonperformance by counterparties to its derivative contracts. The Bank manages credit risk through credit analyses, collateral requirements, and adherence to the requirements set forth in the Bank’s policies, U.S. Commodity Futures Trading Commission regulations, and Finance Agency regulations.

The Bank transacts most of its derivative transactions with large banks and major broker-dealers. Over-the-counter derivative transactions may be either executed directly with a counterparty (uncleared derivatives) or cleared through a Futures Commission Merchant (i.e., clearings agent) with a Derivative Clearing Organization (cleared derivatives). Once a derivative transaction has been accepted for clearing by a Derivative Clearing Organization (Clearinghouse), the derivative transaction is novated and the executing counterparty is replaced with the Clearinghouse. The Bank is not a derivative dealer and does not trade derivatives for short-term profit.

For uncleared derivatives, the degree of credit risk depends on the extent to which master netting arrangements are included in the derivative contracts to mitigate the risk. The Bank requires collateral agreements on its uncleared derivatives.
Certain of the Bank’s uncleared derivative instruments contain provisions that require the Bank to post additional collateral with its counterparties if there is deterioration in the Bank’s credit rating. If the Bank’s credit rating is lowered by a nationally recognized statistical rating organization, the Bank may be required to deliver additional collateral on uncleared derivative instruments in net liability positions, unless the collateral delivery threshold is set to zero. The aggregate fair value of all uncleared derivative instruments with credit-risk-related contingent features that were in a net liability position (before cash collateral and related accrued interest) at December 31, 2019 was $1 million, for which the Bank was not required to post collateral in the normal course of business. If the Bank’s credit rating had been lowered from its current rating to the next lower rating, the Bank would not have been required to deliver additional collateral to its uncleared derivatives counterparties at December 31, 2019.

For cleared derivatives, the Clearinghouse is the Bank’s counterparty. The Bank utilizes one Clearinghouse, CME Clearing, for all cleared derivative transactions. CME Clearing notifies the clearing agent of the required initial margin and daily variation margin requirements, and the clearing agent in turn notifies the Bank.

The Clearinghouse determines initial margin requirements which are considered cash collateral. Generally credit ratings are not factored into the initial margin. However, clearing agents may require additional initial margin to be posted based on credit considerations, including, but not limited to, credit rating downgrades. The Bank was not required to post additional initial margin by its clearing agent, based on credit considerations, at December 31, 2019. Variation margin requirements with CME Clearing are based on changes in the fair value of cleared derivatives and are legally characterized as daily settlement payments, rather than cash collateral.

The requirement that the Bank post initial and variation margin through the clearing agent, to the Clearinghouse, exposes the Bank to institutional credit risk if the clearing agent or the Clearinghouse fails to meet its obligations. The use of cleared derivatives is intended to mitigate credit risk exposure because a central counterparty is substituted for individual counterparties and collateral/payments for changes in the fair value of cleared derivatives is posted daily through a clearing agent.

OFFSETTING OF DERIVATIVE ASSETS AND DERIVATIVE LIABILITIES

The Bank presents derivative instruments, related cash collateral received or pledged, and associated accrued interest on a net basis by clearing agent and/or by counterparty when it has met the netting requirements. Additional information regarding these agreements is provided in “Note 1 — Summary of Significant Accounting Policies.”

The Bank has analyzed the enforceability of offsetting rights incorporated in its cleared derivative transactions and has determined that the exercise of those offsetting rights by a non-defaulting party under these transactions should be upheld under applicable law upon an event of default, including a bankruptcy, insolvency, or similar proceeding involving the Clearinghouse or the clearing agent, or both. Based on this analysis, the Bank presents a net derivative receivable or payable for all of its transactions through a particular clearing agent with a particular Clearinghouse.

The following tables present the fair value of derivative instruments meeting or not meeting the netting requirements and the related collateral received from or pledged to counterparties (dollars in millions):
 
 
December 31, 2019
 
 
Derivative Instruments Meeting Netting Requirements
 
 
 
 
 
 
Gross Amount Recognized1
 
Gross Amounts of Netting Adjustments and Cash Collateral
 
Derivative Instruments Not Meeting Netting Requirements2
 
Total Derivative Assets and Total Derivative Liabilities
Derivative Assets
 
 
 
 
 
 
 
 
  Uncleared derivatives
 
$
34

 
$
(28
)
 
$
—

 
$
6

  Cleared derivatives
 
5

 
91

 
—

 
96

Total
 
$
39

 
$
63

 
$
—

 
$
102

Derivative Liabilities
 
 
 
 
 
 
 
 
  Uncleared derivatives
 
$
199

 
$
(198
)
 
$
—

 
$
1

  Cleared derivatives
 
3

 
(3
)
 
—

 
—

Total
 
$
202

 
$
(201
)
 
$
—

 
$
1


 
 
December 31, 2018
 
 
Derivative Instruments Meeting Netting Requirements
 
 
 
 
 
 
Gross Amount Recognized1
 
Gross Amounts of Netting Adjustments and Cash Collateral
 
Derivative Instruments Not Meeting Netting Requirements2
 
Total Derivative Assets and Total Derivative Liabilities
Derivative Assets
 
 
 
 
 
 
 
 
  Uncleared derivatives
 
$
96

 
$
(96
)
 
$
1

 
$
1

  Cleared derivatives
 
7

 
50

 
—

 
57

Total
 
$
103

 
$
(46
)
 
$
1

 
$
58

Derivative Liabilities
 
 
 
 
 
 
 
 
  Uncleared derivatives
 
$
119

 
$
(110
)
 
$
—

 
$
9

  Cleared derivatives
 
20

 
(20
)
 
—

 
—

Total
 
$
139

 
$
(130
)
 
$
—

 
$
9



1    Represents derivative assets and derivative liabilities prior to netting adjustments and cash collateral.

2     Represents mortgage loan purchase commitments not subject to enforceable netting requirements.