FINANCIAL DERIVATIVES

Farmer Mac enters into financial derivative transactions principally to protect against risk from the effects of market price or interest rate movements on the value of certain assets, future cash flows, or debt issuance, and not for trading or speculative purposes. Certain financial derivatives are designated as fair value hedges of fixed rate assets, primarily classified as available-for-sale, to protect against fair value changes in the assets related to a benchmark interest rate (e.g., LIBOR). Other financial derivatives are designated as cash flow hedges to mitigate the volatility of future interest rate payments on floating rate debt. Farmer Mac manages the interest rate risk related to loans it has committed to acquire, but has not yet permanently funded, through the use of forward sale contracts on the debt of other GSEs and futures contracts involving U.S. Treasury securities. Farmer Mac uses forward sale contracts on GSE securities to reduce its interest rate exposure to changes in both U.S. Treasury rates and spreads on Farmer Mac debt. The notional amounts of these contracts are determined based on a duration-matched hedge ratio between the hedged item and the hedge instrument. Gains or losses generated by these hedge transactions are expected to offset changes in funding costs. All financial derivatives are recorded on the balance sheet at fair value as a freestanding asset or liability.

Effective first quarter 2018, Farmer Mac adopted ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." This ASU reduces the complexity of hedge accounting by eliminating the requirement to separately measure and report hedge ineffectiveness and by requiring the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the income or expense effect from the hedged item. Upon the adoption of the ASU, Farmer Mac elected to retrospectively designate the hedged risk of its fair value hedges as the risk of changes in fair value resulting from changes in the benchmark interest rate component of the contractual coupon cash flows. Farmer Mac made this election for its fair value hedges designated upon the inception of the hedging instruments. For fair value hedges designated subsequent to the inception of the hedging instruments, Farmer Mac continues to designate the hedged risk as the risk of changes in fair value based on total contractual coupon cash flows. The adoption of the new guidance did not have a material effect on Farmer Mac's financial position, results of operations, or cash flows.

The following tables summarize information related to Farmer Mac's financial derivatives on a gross basis without giving consideration to master netting arrangements as of September 30, 2018 and December 31, 2017:

Table 4.1



	As of September 30, 2018
			Fair Value						Weighted- Average Pay Rate	Weighted- Average Receive Rate	Weighted- Average Forward Price	Weighted- Average Remaining Term (in years)
	Notional Amount		Asset			(Liability)			Weighted- Average Pay Rate	Weighted- Average Receive Rate	Weighted- Average Forward Price	Weighted- Average Remaining Term (in years)
	(dollars in thousands)
Fair value hedges:
Interest rate swaps:
Pay fixed non-callable	$	2,801,164	$	860		$	(4,493	)	2.04%	2.13%		10.39
Receive fixed non-callable	2,131,200		682			(4,796		)	2.20%	1.78%		1.74
Cash flow hedges:
Interest rate swaps:
Pay fixed non-callable	389,500		4,429			(276		)	2.36%	2.57%		6.10
No hedge designation:
Interest rate swaps:
Pay fixed non-callable	317,586		1,966			(8,065		)	3.69%	2.33%		6.48
Receive fixed non-callable	2,521,965		—			—			2.16%	1.99%		0.84
Basis swaps	1,529,000		233			(206		)	2.01%	2.07%		1.41
Treasury futures	12,700		—			(11		)			118.70
Credit valuation adjustment			(163		)	6
Total financial derivatives	$	9,703,115	$	8,007		$	(17,841	)
Collateral pledged			—			46,841
Net amount			$	8,007		$	29,000



	As of December 31, 2017
			Fair Value						Weighted- Average Pay Rate	Weighted- Average Receive Rate	Weighted- Average Forward Price	Weighted- Average Remaining Term (in years)
	Notional Amount		Asset			(Liability)			Weighted- Average Pay Rate	Weighted- Average Receive Rate	Weighted- Average Forward Price	Weighted- Average Remaining Term (in years)
	(dollars in thousands)
Fair value hedges:
Interest rate swaps:
Pay fixed non-callable	$	2,086,347	$	5,240		$	(5,990	)	1.88%	1.40%		5.46
Receive fixed non-callable	1,559,700		110			(4,033		)	1.38%	1.45%		1.68
Cash flow hedges:
Interest rate swaps:
Pay fixed non-callable	365,500		1,402			(138		)	2.16%	1.74%		5.84
No hedge designation:
Interest rate swaps:
Pay fixed non-callable	345,333		339			(16,352		)	3.79%	1.40%		6.68
Receive fixed non-callable	3,409,916		—			—			1.25%	1.24%		0.92
Basis swaps	1,053,500		18			(106		)	1.33%	1.42%		0.91
Treasury futures	40,000		—			(36		)			123.96
Credit valuation adjustment			(16		)	56
Total financial derivatives	$	8,860,296	$	7,093		$	(26,599	)
Collateral pledged			—			24,926
Net amount			$	7,093		$	(1,673	)

Changes in the fair values of financial derivatives not designated as cash flow or fair value hedges are reported in "Gains/(losses) on financial derivatives and hedging activities" in the consolidated statements of operations. For financial derivatives designated in fair value hedge relationships, changes in the fair values of the hedged items, which are primarily fixed rate AgVantage securities and fixed rate medium-term notes, related to the risk being hedged are reported in "Net interest income" in the consolidated statements of operations. Interest accruals on derivatives designated in fair value hedge relationships are also recorded in "Net interest income" in the consolidated statements of operations. For financial derivatives designated in cash flow hedge relationships, the unrealized gain or loss on the derivative is recorded in other comprehensive income. Because the hedging instrument is an interest rate swap and the hedged forecasted transactions are future interest payments on variable rate debt, amounts recorded in accumulated other comprehensive income are reclassified to "Total interest expense" in conjunction with the recognition of interest expense on the debt. As of September 30, 2018, Farmer Mac expects to reclassify $1.9 million after tax from accumulated other comprehensive income to earnings over the next twelve months. This amount could differ from amounts actually recognized due to changes in interest rates, hedge de-designations, and the addition of other hedges subsequent to September 30, 2018. During the three and nine months ended September 30, 2018 and 2017, there were no gains or losses from interest rate swaps designated as cash flow hedges reclassified to earnings because it became probable that the original forecasted transaction would not occur.

The following table summarizes the net income/(expense) recognized in the consolidated statements of operations related to derivatives for the three and nine months ended September 30, 2018 and 2017:

Table 4.2



	For the Three Months Ended September 30, 2018
	Net Income/(Expense) Recognized in Consolidated Statement of Operations on Derivatives
	Net Interest Income									Non-Interest Income			Total
	Interest Income Farmer Mac Guaranteed Securities and USDA Securities			Interest Income Loans			Total Interest Expense			Gains/(losses) on financial derivatives and hedging activities			Total
	(in thousands)
Total amounts presented in the consolidated statement of operations:	$	76,870		$	50,622		$	(97,557	)	$	628		$	30,563
Income/(expense) related to interest settlements on fair value hedging relationships:
Recognized on derivatives	1,272			(98		)	(2,702		)	—			(1,528		)
Recognized on hedged items	16,769			1,660			(9,821		)	—			8,608
Discount amortization recognized on hedged items	—			—			(177		)	—			(177		)
Income/(expense) related to interest settlements on fair value hedging relationships	$	18,041		$	1,562		$	(12,700	)	$	—		$	6,903

(Losses)/gains on fair value hedging relationships:
Recognized on derivatives	13,420			3,909			(1,188		)	—			16,141
Recognized on hedged items	(13,432		)	(4,062		)	2,404			—			(15,090		)
(Losses)/gains on fair value hedging relationships	$	(12	)	$	(153	)	$	1,216		$	—		$	1,051

Expense related to interest settlements on cash flow hedging relationships:
Interest settlements reclassified from AOCI into net income on derivatives	—			—			189			—			189
Recognized on hedged items	—			—			(2,501		)	—			(2,501		)
Discount amortization recognized on hedged items	—			—			(2		)	—			(2		)
Expense recognized on cash flow hedges	$	—		$	—		$	(2,314	)	$	—		$	(2,314	)

Gains on financial derivatives not designated in hedge relationships:
Gains on interest rate swaps	—			—			—			3,267			3,267
Interest expense on interest rate swaps	—			—			—			(3,048		)	(3,048		)
Treasury futures	—			—			—			409			409
Gains on financial derivatives not designated in hedge relationships	$	—		$	—		$	—		$	628		$	628



	For the Three Months Ended September 30, 2017
	Net Income/(Expense) Recognized in Consolidated Statement of Operations on Derivatives
	Net Interest Income									Non-Interest Income			Total
	Interest Income Farmer Mac Guaranteed Securities and USDA Securities			Interest Income Loans			Total Interest Expense			Gains/(losses) on financial derivatives and hedging activities			Total
	(in thousands)
Total amounts presented in the consolidated statement of operations	$	54,350		$	40,924		$	(64,935	)	$	661		$	31,000
Income/(expense) related to interest settlements on fair value hedging relationships:
Recognized on derivatives	(2,267		)	(342		)	717			—			(1,892		)
Recognized on hedged items	11,986			947			(5,069		)	—			7,864
Discount amortization recognized on hedged items	—			—			(121		)	—			(121		)
Income/(expense) related to interest settlements on fair value hedging relationships	$	9,719		$	605		$	(4,473	)	$	—		$	5,851

Gains on fair value hedging relationships:
Recognized on derivatives⁽¹⁾	—			—			—			1,576			1,576
Recognized on hedged items	—			—			—			166			166
Gains on fair value hedging relationships	$	—		$	—		$	—		$	1,742		$	1,742

Expense related to interest settlements on cash flow hedging relationships:
Interest settlements reclassified from AOCI into net income on derivatives	$	—		$	—		$	(454	)	$	—		$	(454	)
Recognized on hedged items	—			—			(1,169		)	—			(1,169		)
Discount amortization recognized on hedged items	—			—			(1		)	—			(1		)
Losses recognized in income for hedge ineffectiveness	—			—			—			(191		)	(191		)
Expense recognized on cash flow hedges	$	—		$	—		$	(1,624	)	$	(191	)	$	(1,815	)

Losses on financial derivatives not designated in hedging relationships:
Gains on interest rate swaps	$	—		$	—		$	—		$	1,645		$	1,645
Interest expense on interest rate swaps	—			—			—			(2,676		)	(2,676		)
Agency forwards	—			—			—			—			—
Treasury futures	—			—			—			141			141
Losses on financial derivatives not designated in hedge relationships	$	—		$	—		$	—		$	(890	)	$	(890	)

⁽¹⁾

Included in the assessment of hedge effectiveness as of September 30, 2017, but excluded from the amounts in the table, were losses of $1.6 million for the three months ended September 30, 2017, attributable to the fair value of the swaps at the inception of the hedging relationship. Accordingly, the amount recognized as hedge ineffectiveness for the three months ended September 30, 2017 were gains of $0.1 million.



	For the Nine Months Ended September 30, 2018
	Net Income/(Expense) Recognized in Consolidated Statement of Operations on Derivatives
	Net Interest Income									Non-Interest Income			Total
	Interest Income Farmer Mac Guaranteed Securities and USDA Securities			Interest Income Loans			Total Interest Expense			Gains/(losses) on financial derivatives and hedging activities			Total
	(in thousands)
Total amounts presented in the consolidated statement of operations:	$	213,479		$	145,671		$	(265,611	)	$	(688	)	$	92,851
Income/(expense) related to interest settlements on fair value hedging relationships:
Recognized on derivatives	465			(560		)	(5,315		)	—			(5,410		)
Recognized on hedged items	46,289			4,619			(28,633		)	—			22,275
Discount amortization recognized on hedged items	—			—			(534		)	—			(534		)
Income/(expense) related to interest settlements on fair value hedging relationships	$	46,754		$	4,059		$	(34,482	)	$	—		$	16,331

Gains/(losses) on fair value hedging relationships:
Recognized on derivatives	46,354			12,564			(13,565		)	—			45,353
Recognized on hedged items	(43,229		)	(13,106		)	16,733			—			(39,602		)
Gains/(losses) on fair value hedging relationships	$	3,125		$	(542	)	$	3,168		$	—		$	5,751

Expense related to interest settlements on cash flow hedging relationships:
Interest settlements reclassified from AOCI into net income on derivatives	—			—			(21		)	—			(21		)
Recognized on hedged items	—			—			(6,611		)	—			(6,611		)
Discount amortization recognized on hedged items	—			—			(5		)	—			(5		)
Expense recognized on cash flow hedges	$	—		$	—		$	(6,637	)	$	—		$	(6,637	)

Losses on financial derivatives not designated in hedge relationships:
Gains on interest rate swaps	—			—			—			7,443			7,443
Interest expense on interest rate swaps	—			—			—			(8,903		)	(8,903		)
Treasury futures	—			—			—			772			772
Losses on financial derivatives not designated in hedge relationships	$	—		$	—		$	—		$	(688	)	$	(688	)



	For the Nine Months Ended September 30, 2017
	Net Income/(Expense) Recognized in Consolidated Statement of Operations on Derivatives
	Net Interest Income									Non-Interest Income			Total
	Interest Income Farmer Mac Guaranteed Securities and USDA Securities			Interest Income Loans			Total Interest Expense			Gains/(losses) on financial derivatives and hedging activities			Total
	(in thousands)
Total amounts presented in the consolidated statement of operations	$	146,978		$	117,349		$	(172,797	)	$	2,530		$	94,060
Income/(expense) related to interest settlements on fair value hedging relationships:
Recognized on derivatives	(8,251		)	(767		)	2,157			—			(6,861		)
Recognized on hedged items	34,212			2,045			(12,832		)	—			23,425
Discount amortization recognized on hedged items	—			—			(311		)	—			(311		)
Income/(expense) related to interest settlements on fair value hedging relationships	$	25,961		$	1,278		$	(10,986	)	$	—		$	16,253

Losses on fair value hedging relationships:
Recognized on derivatives⁽¹⁾	—			—			—			(5,466		)	(5,466		)
Recognized on hedged items	—			—			—			4,750			4,750
Losses on fair value hedging relationships	$	—		$	—		$	—		$	(716	)	$	(716	)

Expense related to interest settlements on cash flow hedging relationships:
Interest settlements reclassified from AOCI into net income on derivatives	$	—		$	—		$	(1,494	)	$	—		$	(1,494	)
Recognized on hedged items	—			—			(2,665		)	—			(2,665		)
Discount amortization recognized on hedged items	—			—			(3		)	—			(3		)
Losses recognized in income for hedge ineffectiveness	—			—			—			(365		)	(365		)
Expense recognized on cash flow hedges	$	—		$	—		$	(4,162	)	$	(365	)	$	(4,527	)

Gains on financial derivatives not designated in hedging relationships:
Gains on interest rate swaps	$	—		$	—		$	—		$	12,324		$	12,324
Interest expense on interest rate swaps	—			—			—			(8,318		)	(8,318		)
Agency forwards	—			—			—			(588		)	(588		)
Treasury futures	—			—			—			193			193
Gains on financial derivatives not designated in hedge relationships	$	—		$	—		$	—		$	3,611		$	3,611


⁽¹⁾	Included in the assessment of hedge effectiveness as of September 30, 2017, but excluded from the amounts in the table, were gains of $0.7 million for the nine months ended September 30, 2017, attributable to the fair value of the swaps at the inception of the hedging relationship. Accordingly, the amounts recognized as hedge ineffectiveness for the nine months ended September 30, 2017 were zero.

The following table shows the carrying amount and associated cumulative basis adjustment related to the application of hedge accounting that is included in the carrying amount of hedged assets and liabilities in fair value hedging relationships as of September 30, 2018 and December 31, 2017:

Table 4.3



	Hedged Items in Fair Value Relationship
	Carrying Amount of Hedged Assets/(Liabilities)						Cumulative Amount of Fair Value Hedging Adjustments included in the Carrying Amount of the Hedged Assets/(Liabilities)
	September 30, 2018			December 31, 2017			September 30, 2018			December 31, 2017
	(in thousands)
Farmer Mac Guaranteed Securities, Available-for-Sale, at fair value	$	2,514,978		$	1,928,220		$	(65,596	)	$	(22,853	)
Loans held for investment, at amortized cost	166,754			149,304			(13,150		)	(189		)
Notes Payable, due after one year⁽¹⁾⁽²⁾	(2,057,594		)	(1,552,935		)	22,428			5,836


⁽¹⁾	Carrying amount represents amortized cost.


⁽²⁾	Includes $0.4 million of hedging adjustments on a discontinued hedging relationship.

As of September 30, 2018 and December 31, 2017, Farmer Mac's credit exposure to interest rate swap counterparties, excluding netting arrangements and any adjustment for nonperformance risk, but including accrued interest, was $94.6 million and $28.5 million, respectively; however, including netting arrangements and accrued interest, Farmer Mac's credit exposure was $4.4 million and $0.5 million as of September 30, 2018 and December 31, 2017, respectively. As of September 30, 2018, Farmer Mac held no cash as collateral for its derivatives in net asset positions resulting in uncollateralized net asset positions of $4.4 million. As of December 31, 2017, Farmer Mac held no cash collateral for its derivatives in net asset positions, resulting in uncollateralized net asset positions of $0.5 million.

As of September 30, 2018 and December 31, 2017, the fair value of Farmer Mac's derivatives in a net liability position including accrued interest but excluding netting arrangements and any adjustment for nonperformance risk, was $50.1 million and $58.2 million, respectively; however, including netting arrangements and accrued interest, the fair value of Farmer Mac's derivatives in a net liability position at the counterparty level was $6.4 million and $28.0 million as of September 30, 2018 and December 31, 2017, respectively. Farmer Mac posted cash of $0 and $46.8 million of investment securities as of September 30, 2018 and posted cash of $0.1 million and $24.8 million investment securities as of December 31, 2017. Farmer Mac records posted cash as a reduction in the outstanding balance of cash and cash equivalents and an increase in the balance of prepaid expenses and other assets. Any investment securities posted as collateral are included in the investment securities balances on the consolidated balance sheets. If Farmer Mac had breached certain provisions of the derivative contracts as of September 30, 2018 and December 31, 2017, it could have been required to settle its obligations under the agreements or post additional collateral of none and $3.1 million, respectively. As of September 30, 2018 and December 31, 2017, there were no financial derivatives in a net payable position where Farmer Mac was required to pledge collateral which the counterparty had the right to sell or repledge.

For certain derivatives, Farmer Mac clears interest rate swaps through a clearinghouse, the Chicago Mercantile Exchange ("CME"). Farmer Mac posts initial and variation margin to this clearinghouse through which centrally-cleared derivatives and futures contracts are traded. These collateral postings expose Farmer Mac to institutional credit risk in the event that either the clearinghouse or the futures commission merchant that Farmer Mac uses to post collateral to the clearinghouse fails to meet its obligations. Conversely, the use of centrally-cleared derivatives mitigates Farmer Mac's credit risk to individual counterparties because clearinghouses assume the credit risk among counterparties in centrally-cleared derivatives transactions. Of Farmer Mac's $9.7 billion notional amount of interest rate swaps outstanding as of September 30, 2018, $8.3 billion were cleared through the swap clearinghouse. Of Farmer Mac's $8.8 billion notional amount of interest rate swaps outstanding as of December 31, 2017, $7.9 billion were cleared through the swap clearinghouse.