Derivatives and Hedging Activities

3 Months Ended

Mar. 31, 2013

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivatives and Hedging Activities [Text Block]

Derivatives and Hedging Activities

Nature of Business Activity

The FHLBank is exposed to interest rate risk primarily from the effect of interest rate changes on its interest-earning assets and on the funding sources that finance these assets. The goal of the FHLBank'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 FHLBank has established policies and procedures, which include guidelines on the amount of exposure to interest rate changes it is willing to accept. In addition, the FHLBank monitors the risk to its interest income, net interest margin and average maturity of interest-earning assets and funding sources.

Consistent with Finance Agency Regulations, the FHLBank enters into derivatives to manage the interest rate risk exposures inherent in otherwise unhedged assets and funding positions, to achieve the FHLBank's risk management objectives and to act as an intermediary between its members and counterparties. The use of derivatives is an integral part of the FHLBank's financial management strategy. However, Finance Agency Regulations and the FHLBank's financial management policy prohibit trading in or the speculative use of derivative instruments and limit credit risk arising from them.

The most common ways in which the FHLBank uses derivatives are to:

▪ reduce the interest rate sensitivity and repricing gaps of assets and liabilities;

▪ manage embedded options in assets and liabilities;

▪ reduce funding costs by combining a derivative with a Consolidated Obligation Bond, as the cost of a combined funding structure can be lower than the cost of a comparable Consolidated Obligation Bond;

▪ preserve a favorable interest rate spread between the yield of an asset (e.g., an Advance) and the cost of the related liability (e.g., the Consolidated Obligation Bond used to fund the Advance); without the use of derivatives, this interest rate spread could be reduced or eliminated when a change in the interest rate on the Advance does not match a change in the interest rate on the Bond; and

▪ protect the value of existing asset or liability positions.

Types of Derivatives

The FHLBank may enter into interest rate swaps (including callable and putable swaps), swaptions, interest rate cap and floor agreements, calls, puts, futures, and forward contracts to manage its exposure to changes in interest rates.

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 paid 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 principal 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 principal amount at a variable-rate index for the same period of time. The variable-rate transacted by the FHLBank in its derivatives is the London Interbank Offered Rate (LIBOR).

Application of Interest Rate Swaps

The FHLBank generally uses derivatives as fair value hedges of underlying financial instruments. However, because the FHLBank uses interest rate swaps when they are considered to be the most cost-effective alternative to achieve the FHLBank's financial and risk management objectives, it may enter into interest rate swaps that do not necessarily qualify for hedge accounting (economic hedges). The FHLBank re-evaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new strategies.

The FHLBank transacts most of its derivatives with large banks and major broker-dealers. Some of these banks and broker-dealers or their affiliates buy, sell, and distribute Consolidated Obligations. The FHLBank is not a derivatives dealer and does not trade derivatives for short-term profit.

Types of Hedged Items

The FHLBank documents at inception all relationships between derivatives designated as hedging instruments and the hedged items, its risk management objectives and strategies for undertaking various hedge transactions, and its method of assessing effectiveness. This process includes linking all derivatives that are designated as fair value hedges to assets and liabilities on the Statements of Condition. The FHLBank also formally assesses (both at the hedge's inception and at least quarterly) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value of the hedged items and whether those derivatives may be expected to remain effective in future periods. The FHLBank currently uses regression analyses to assess the effectiveness of its hedges.The types of assets and liabilities currently hedged with derivatives are:

▪ Consolidated Obligations

▪ Advances

▪ Firm Commitments

Financial Statement Effect and Additional Financial Information

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

Table 10.1 summarizes the fair value of derivative instruments. For purposes of this disclosure, the derivative values include the fair value of derivatives and the related accrued interest.

Table 10.1 - Fair Value of Derivative Instruments (in thousands)

	March 31, 2013
	Notional Amount of Derivatives		Derivative Assets			Derivative Liabilities
Derivatives designated as fair value hedging instruments:
Interest rate swaps	$	6,427,875	$	56,824		$	331,939
Derivatives not designated as hedging instruments:
Interest rate swaps	2,433,000		2,289			10,698
Mortgage delivery commitments	111,546		123			359
Total derivatives not designated as hedging instruments	2,544,546		2,412			11,057
Total derivatives before netting and collateral adjustments	$	8,972,421	59,236			342,996
Netting adjustments			(52,802		)	(52,802		)
Cash collateral and related accrued interest			(1,600		)	(181,264		)
Total collateral and netting adjustments (1)			(54,402		)	(234,066		)
Total derivative assets and total derivative liabilities			$	4,834		$	108,930
	December 31, 2012
	Notional Amount of Derivatives		Derivative Assets			Derivative Liabilities
Derivatives designated as fair value hedging instruments:
Interest rate swaps	$	8,262,375	$	66,836		$	372,959
Derivatives not designated as hedging instruments:
Interest rate swaps	3,774,000		2,686			15,930
Mortgage delivery commitments	123,588		155			584
Total derivatives not designated as hedging instruments	3,897,588		2,841			16,514
Total derivatives before netting and collateral adjustments	$	12,159,963	69,677			389,473
Netting adjustments			(61,900		)	(61,900		)
Cash collateral and related accrued interest			(1,900		)	(212,685		)
Total collateral and netting adjustments (1)			(63,800		)	(274,585		)
Total derivative assets and total derivative liabilities			$	5,877		$	114,888

(1) Amounts represent the effects of legally enforceable master netting agreements that allow the FHLBank to settle positive and negative positions and of cash collateral held or placed with the same counterparties.

Table 10.2 presents the components of net gains on derivatives and hedging activities as presented in the Statements of Income.

Table 10.2 - Net Gains on Derivatives and Hedging Activities (in thousands)

	Three Months Ended March 31,
	2013			2012
Derivatives and hedged items in fair value hedging relationships:
Interest rate swaps	$	2,922		$	3,454
Derivatives not designated as hedging instruments:
Economic hedges:
Interest rate swaps	4,231			4,586
Forward rate agreements	—			(3,049		)
Net interest settlements	413			(1,223		)
Mortgage delivery commitments	(3,221		)	(14		)
Total net gains related to derivatives not designated as hedging instruments	1,423			300
Net gains on derivatives and hedging activities	$	4,345		$	3,754

Table 10.3 presents by type of hedged item, the gains (losses) on derivatives and the related hedged items in fair value hedging relationships and the impact of those derivatives on the FHLBank's net interest income.

Table 10.3 - Effect of Fair Value Hedge Related Derivative Instruments (in thousands)

	Three Months Ended March 31,
2013	Gain/(Loss) on Derivative			Gain/(Loss) on Hedged Item			Net Fair Value Hedge Ineffectiveness			Effect of Derivatives on Net Interest Income(1)
Hedged Item Type:
Advances	$	40,420		$	(37,783	)	$	2,637		$	(28,752	)
Consolidated Bonds	(8,647		)	8,932			285			8,488
Total	$	31,773		$	(28,851	)	$	2,922		$	(20,264	)
2012
Hedged Item Type:
Advances	$	76,502		$	(72,716	)	$	3,786		$	(81,105	)
Consolidated Bonds	1,279			(1,611		)	(332		)	8,881
Total	$	77,781		$	(74,327	)	$	3,454		$	(72,224	)

(1) The net interest on derivatives in fair value hedge relationships is included in the interest income/expense line item of the respective hedged item.

Offsetting of Derivative Assets and Derivative Liabilities

The FHLBank enters into enforceable master netting arrangements for derivative instruments that contain provisions allowing the legal right of offset. When the FHLBank has the legal right of offset under these agreements, the FHLBank has elected to offset at the individual master agreement the gross derivative assets and gross derivative liabilities, and the related received or pledged cash collateral and associated accrued interest.

Table 10.4 presents separately the fair value of derivative instruments with and without the legal right of offset, including the related collateral received from or pledged to counterparties, based on the terms of the FHLBank's master netting arrangements or similar agreements. At March 31, 2013 and December 31, 2012, the FHLBank did not receive or pledge any non-cash collateral. Any overcollateralization at an individual master agreement is not included in the determination of the net unsecured amount.

Table 10.4 - Offsetting of Derivative Assets and Derivative Liabilities (in thousands)

	March 31, 2013
	Derivative Assets			Derivative Liabilities
Derivative instruments with legal right of offset:
Gross recognized amount	$	59,113		$	342,637
Gross amounts of offsetting adjustments	(54,402		)	(234,066		)
Net amounts after offsetting adjustments	4,711			108,571
Derivative instruments without legal right of offset	123			359
Net unsecured amount	$	4,834		$	108,930
	December 31, 2012
	Derivative Assets			Derivative Liabilities
Derivative instruments with legal right of offset:
Gross recognized amount	$	69,522		$	388,889
Gross amounts of offsetting adjustments	(63,800		)	(274,585		)
Net amounts after offsetting adjustments	5,722			114,304
Derivative instruments without legal right of offset	155			584
Net unsecured amount	$	5,877		$	114,888

Managing Credit Risk on Derivatives

The FHLBank is subject to credit risk due to nonperformance by counterparties to its derivative agreements. The degree of counterparty risk depends on the extent to which master netting arrangements are included in the contracts to mitigate the risk. The FHLBank manages counterparty credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in FHLBank policies and Finance Agency Regulations. The FHLBank requires collateral agreements on all derivatives that establish collateral delivery thresholds. Based on credit analyses and collateral requirements at March 31, 2013 andDecember 31, 2012, the FHLBank management did not anticipate any credit losses on its derivative agreements. See Note 18 for discussion regarding the FHLBank's fair value methodology for derivative assets/liabilities, including the evaluation of the potential for the fair value of these instruments to be affected by counterparty credit risk and Note 19 for a discussion of a dispute with a past counterparty.

Certain of the FHLBank's interest rate swap contracts contain provisions that require the FHLBank to post additional collateral with its counterparties if there is deterioration in the FHLBank's credit ratings. The aggregate fair value of all interest rate swaps with credit-risk-related contingent features that were in a liability position at March 31, 2013 was (in thousands) $289,835, for which the FHLBank had posted collateral with a fair value of (in thousands) $181,264 in the normal course of business.

If one of the FHLBank's credit ratings had been lowered to the next lower rating that would have triggered additional collateral to be delivered, the FHLBank would have been required to deliver up to an additional (in thousands) $27,081 of collateral at fair value to its derivatives counterparties at March 31, 2013.