Citibank 2015 Annual Report Download - page 259

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For asset/liability management hedging, fixed-rate long-term debt is
recorded at amortized cost under GAAP. However, by designating an interest
rate swap contract as a hedging instrument and electing to apply ASC 815
fair value hedge accounting, the carrying value of the debt is adjusted for
changes in the benchmark interest rate, with such changes in value recorded
in current earnings. The related interest-rate swap also is recorded on the
balance sheet at fair value, with any changes in fair value also reflected in
earnings. Thus, any ineffectiveness resulting from the hedging relationship is
captured in current earnings.
Alternatively, for management hedges that do not meet the ASC 815
hedging criteria, the derivative is recorded at fair value on the balance sheet,
with the associated changes in fair value recorded in earnings, while the
debt continues to be carried at amortized cost. Therefore, current earnings
are affected only by the interest rate shifts and other factors that cause a
change in the swap’s value. This type of hedge is undertaken when hedging
requirements cannot be achieved or management decides not to apply ASC
815 hedge accounting.
Another alternative is to elect to carry the debt at fair value under the
fair value option. Once the irrevocable election is made upon issuance of
the debt, the full change in fair value of the debt is reported in earnings.
The related interest rate swap, with changes in fair value, is also reflected in
earnings, which provides a natural offset to the debt’s fair value change. To
the extent the two offsets are not exactly equal because the full change in the
fair value of the debt includes risks not offset by the interest rate swap, the
difference is captured in current earnings.
The key requirements to achieve ASC 815 hedge accounting are
documentation of a hedging strategy and specific hedge relationships at
hedge inception and substantiating hedge effectiveness on an ongoing basis.
A derivative must be highly effective in accomplishing the hedge objective of
offsetting either changes in the fair value or cash flows of the hedged item
for the risk being hedged. Any ineffectiveness in the hedge relationship is
recognized in current earnings. The assessment of effectiveness may exclude
changes in the value of the hedged item that are unrelated to the risks being
hedged. Similarly, the assessment of effectiveness may exclude changes
in the fair value of a derivative related to time value that, if excluded, are
recognized in current earnings.
Fair Value Hedges
Hedging of Benchmark Interest Rate Risk
Citigroup hedges exposure to changes in the fair value of outstanding
fixed-rate issued debt. These hedges are designated as fair value hedges
of the benchmark interest rate risk associated with the currency of the
hedged liability. The fixed cash flows of the hedged items are converted to
benchmark variable-rate cash flows by entering into receive-fixed, pay-
variable interest rate swaps. These fair value hedge relationships use either
regression or dollar-offset ratio analysis to assess whether the hedging
relationships are highly effective at inception and on an ongoing basis.
Citigroup also hedges exposure to changes in the fair value of fixed-rate
assets due to changes in benchmark interest rates, including available-
for-sale debt securities and loans. The hedging instruments used are
receive-variable, pay-fixed interest rate swaps. These fair value hedging
relationships use either regression or dollar-offset ratio analysis to assess
whether the hedging relationships are highly effective at inception and on
an ongoing basis.