Derivatives and Hedging Activities

Nature of Business Activity

The FHLB is exposed to interest rate risk primarily from the effect of interest rate changes on its interest-earning assets and on the interest-bearing liabilities that finance these assets. The goal of the FHLB'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 FHLB 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 FHLB monitors the risk to its interest income, net interest margin and average maturity of interest-earning assets and interest-bearing liabilities. See Note 11 - Derivatives and Hedging Activities in the FHLB's 2016 Annual Report on Form 10-K for additional information on the FHLB's derivative transactions.

The FHLB uses derivatives when they are considered to be the most cost-effective alternative to achieve the FHLB's financial and risk management objectives. The FHLB re-evaluates its hedging strategies from time to time and may change the hedging techniques it uses or adopt new strategies.

The FHLB transacts 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. Derivative transactions may be either executed with a counterparty (uncleared derivatives) or cleared through a Futures Commission Merchant (i.e., clearing agent) with a Derivative Clearing Organization (cleared derivatives).

Once a derivative transaction has been accepted for clearing by a Derivative Clearing Organization (Clearinghouse), the executing counterparty is replaced with the Clearinghouse. The FHLB is not a derivative dealer and does not trade derivatives for short-term profit.

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 reflects the FHLB's involvement in the various classes of financial instruments and represents neither the actual amounts exchanged nor the overall exposure of the FHLB to credit and market risk; the overall risk is much smaller. The risks of derivatives only 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.

Table 10.1 summarizes the notional amount, fair value of derivative instruments (excluding fair value adjustments related to variation margin on settled daily contracts), and total derivative assets and liabilities. Total derivative assets and liabilities include the effect of netting adjustments, cash collateral and variation margin for daily settled contracts. 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)



	June 30, 2017
	Notional Amount of Derivatives		Derivative Assets		Derivative Liabilities
Derivatives designated as fair value hedging instruments:
Interest rate swaps	$	5,537,149	$	31,133	$	19,832
Derivatives not designated as hedging instruments:
Interest rate swaps	5,902,265		1,148		54,834
Interest rate swaptions	2,255,000		6,774		—
Forward rate agreements	280,000		237		566
Mortgage delivery commitments	264,427		374		572
Total derivatives not designated as hedging instruments	8,701,692		8,533		55,972
Total derivatives before adjustments	$	14,238,841	39,666		75,804
Netting adjustments, cash collateral and variation margin for daily settled contracts ⁽¹⁾			38,483		(69,862		)
Total derivative assets and total derivative liabilities			$	78,149	$	5,942

	December 31, 2016
	Notional Amount of Derivatives		Derivative Assets		Derivative Liabilities
Derivatives designated as fair value hedging instruments:
Interest rate swaps	$	5,660,420	$	37,379	$	26,610
Derivatives not designated as hedging instruments:
Interest rate swaps	8,199,000		2,135		64,661
Interest rate swaptions	2,346,000		13,335		—
Forward rate agreements	511,000		681		166
Mortgage delivery commitments	440,849		319		10,628
Total derivatives not designated as hedging instruments	11,496,849		16,470		75,455
Total derivatives before adjustments	$	17,157,269	53,849		102,065
Netting adjustments and cash collateral ⁽¹⁾			50,904		(84,191		)
Total derivative assets and total derivative liabilities			$	104,753	$	17,874

(1)

Amounts represent the application of the netting requirements that allow the FHLB to settle positive and negative positions, cash collateral and related accrued interest held or placed by the FHLB with the same clearing agent and/or counterparty, and effective January 3, 2017, includes fair value adjustments on derivatives for which variation margin is characterized as a daily settled contract. Cash collateral posted and related accrued interest was (in thousands) $79,634 and $180,169 at June 30, 2017 and December 31, 2016. Cash collateral received and related accrued interest was (in thousands) $25,919 and $45,074 at June 30, 2017 and December 31, 2016. Variation margin for daily settled contracts was (in thousands) $54,630 at June 30, 2017 and $0 at December 31, 2016.

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 June 30,
	2017			2016
Derivatives and hedged items in fair value hedging relationships:
Interest rate swaps	$	(205	)	$	(1,142	)
Derivatives not designated as hedging instruments:
Economic hedges:
Interest rate swaps	16,380			19,370
Interest rate swaptions	(2,053		)	(469		)
Forward rate agreements	(3,136		)	(9,761		)
Net interest settlements	(1,451		)	4,026
Mortgage delivery commitments	3,582			10,361
Total net gains related to derivatives not designated as hedging instruments	13,322			23,527
Other ⁽¹⁾	143			—
Net gains on derivatives and hedging activities	$	13,260		$	22,385

	Six Months Ended June 30,
	2017			2016
Derivatives and hedged items in fair value hedging relationships:
Interest rate swaps	$	140		$	(2,870	)
Derivatives not designated as hedging instruments:
Economic hedges:
Interest rate swaps	12,833			24,473
Interest rate swaptions	(10,369		)	(1,283		)
Forward rate agreements	(3,513		)	(19,032		)
Net interest settlements	(1,083		)	5,815
Mortgage delivery commitments	6,877			20,927
Total net gains related to derivatives not designated as hedging instruments	4,745			30,900
Other ⁽¹⁾	259			—
Net gains on derivatives and hedging activities	$	5,144		$	28,030


(1)	Consists of price alignment amount on derivatives for which variation margin is characterized as a daily settled contract.

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 FHLB's net interest income.

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



	Three Months Ended June 30,
2017	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	$	(9,666	)	$	9,279		$	(387	)	$	(4,744	)
Consolidated Bonds	806			(624		)	182			(157		)
Total	$	(8,860	)	$	8,655		$	(205	)	$	(4,901	)
2016
Hedged Item Type:
Advances	$	(10,587	)	$	9,346		$	(1,241	)	$	(16,109	)
Consolidated Bonds	(551		)	650			99			2,127
Total	$	(11,138	)	$	9,996		$	(1,142	)	$	(13,982	)

	Six Months Ended June 30,
2017	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	$	(299	)	$	110		$	(189	)	$	(11,445	)
Consolidated Bonds	(264		)	593			329			266
Total	$	(563	)	$	703		$	140		$	(11,179	)
2016
Hedged Item Type:
Advances	$	(54,225	)	$	51,471		$	(2,754	)	$	(33,396	)
Consolidated Bonds	2,254			(2,370		)	(116		)	5,438
Total	$	(51,971	)	$	49,101		$	(2,870	)	$	(27,958	)

(1)

For fair value hedge relationships, the net effect of derivatives on net interest income is included in the interest income or interest expense line item of the respective hedged item type. These amounts include the effect of net interest settlements attributable to designated fair value hedges but do not include (in thousands) $(683) and $(804) of (amortization)/accretion related to fair value hedging activities for the three months ended June 30, 2017 and 2016 and (in thousands) $(1,287) and $(1,682) for the six months ended June 30, 2017 and 2016.

Credit Risk on Derivatives

The FHLB is subject to credit risk due to the risk of non-performance by counterparties to its derivative transactions, and manages credit risk through credit analysis, collateral requirements and adherence to the requirements set forth in its policies, U.S. Commodity Futures Trading Commission regulations, and Finance Agency regulations.

For uncleared derivatives, the degree of credit risk depends on the extent to which master netting arrangements are included in these contracts to mitigate the risk. The FHLB requires collateral agreements with collateral delivery thresholds on the majority of its uncleared derivatives.

For cleared derivatives, the Clearinghouse is the FHLB's counterparty. The Clearinghouse notifies the clearing agent of the required initial and variation margin and the clearing agent in turn notifies the FHLB. The FHLB utilizes two Clearinghouses for all cleared derivative transactions, LCH.Clearnet LLC and CME Clearing. Effective January 3, 2017, CME Clearing made certain amendments to its rulebook changing the legal characterization of variation margin payments to be daily settlement payments, rather than collateral. Variation margin related to LCH.Clearnet LLC contracts continues to be presented as cash collateral. At both Clearinghouses, initial margin continues to be considered collateral. The requirement that the FHLB post initial and variation margin through the clearing agent, to the Clearinghouse, exposes the FHLB to 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 value of cleared derivatives is posted daily through a clearing agent.

The FHLB has analyzed the enforceability of offsetting rights incorporated in its cleared derivative transactions and 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 bankruptcy, insolvency, or similar proceeding involving the Clearinghouse or the FHLB's clearing agent, or both. Based on this analysis, the FHLB presents a net derivative receivable or payable for all of its transactions through a particular clearing agent with a particular Clearinghouse.

Certain of the FHLB's uncleared derivative contracts contain provisions that require the FHLB to post additional collateral with its counterparties if there is deterioration in the FHLB's credit ratings. At June 30, 2017, the FHLB would not have been required to deliver any additional collateral if the FHLB's credit ratings had been lowered to the next lower rating. The aggregate fair value of all uncleared derivatives with credit-risk-related contingent features that were in a net liability position (before cash collateral and related accrued interest) at June 30, 2017 was (in thousands) $7,061, for which the FHLB had posted collateral with a fair value of (in thousands) $2,683 in the normal course of business.

For cleared derivatives, the Clearinghouse determines initial margin requirements and 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. At June 30, 2017, the FHLB was not required to post additional initial margin by its clearing agents based on credit considerations.

Offsetting of Derivative Assets and Derivative Liabilities

The FHLB presents derivative instruments, related cash collateral, including any initial and certain variation margin, 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.

Table 10.4 presents separately the fair value of derivative instruments meeting or not meeting netting requirements, including the related collateral received from or pledged to counterparties and variation margin for daily settled contracts. At June 30, 2017 and December 31, 2016, the FHLB did not receive or pledge any non-cash collateral. Any overcollateralization under an individual clearing agent and/or counterparty level is not included in the determination of the net unsecured amount.

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



	June 30, 2017						December 31, 2016
	Derivative Assets			Derivative Liabilities			Derivative Assets			Derivative Liabilities
Derivative instruments meeting netting requirements:
Gross recognized amount:
Uncleared derivatives	$	7,525		$	13,871		$	15,506		$	21,378
Cleared derivatives	31,530			60,795			37,343			69,893
Total gross recognized amount	39,055			74,666			52,849			91,271
Gross amounts of netting adjustments, cash collateral and variation margin for daily settled contracts ⁽¹⁾:
Uncleared derivatives	(7,324		)	(9,067		)	(14,737		)	(14,298		)
Cleared derivatives	45,807			(60,795		)	65,641			(69,893		)
Total gross amounts of netting adjustments, cash collateral and variation margin for daily settled contracts ⁽¹⁾	38,483			(69,862		)	50,904			(84,191		)
Net amounts after netting adjustments, cash collateral and variation margin for daily settled contracts:
Uncleared derivatives	201			4,804			769			7,080
Cleared derivatives	77,337			—			102,984			—
Total net amounts after netting adjustments, cash collateral and variation margin for daily settled contracts	77,538			4,804			103,753			7,080
Derivative instruments not meeting netting requirements ⁽²⁾:
Uncleared derivatives	611			1,138			1,000			10,794
Total derivative instruments not meeting netting requirements ⁽²⁾	611			1,138			1,000			10,794
Total derivative assets and total derivative liabilities:
Uncleared derivatives	812			5,942			1,769			17,874
Cleared derivatives	77,337			—			102,984			—
Total derivative assets and total derivative liabilities	$	78,149		$	5,942		$	104,753		$	17,874


(1)	Variation margin for daily settled contracts was (in thousands) $54,630 at June 30, 2017.


(2)	Represents mortgage delivery commitments and forward rate agreements that are not subject to an enforceable netting agreement.