US Bank 2013 Annual Report Download - page 55

• To convert the cash flows associated with floating-rate
loans and debt from floating-rate payments to fixed-rate
payments;
• To mitigate changes in value of the Company’s mortgage
origination pipeline, funded mortgage loans held for sale
and MSRs;
• To mitigate remeasurement volatility of foreign currency
denominated balances; and
• To mitigate the volatility of the Company’s investment in
foreign operations driven by fluctuations in foreign
currency exchange rates.
To manage these risks, the Company may enter into
exchange-traded, centrally cleared and over-the-counter
derivative contracts, including interest rate swaps, swaptions,
futures, forwards and options. In addition, the Company enters
into interest rate and foreign exchange derivative contracts to
support the business requirements of its customers (customer-
related positions). The Company historically has minimized the
market and liquidity risks of customer-related positions by
entering into similar offsetting positions with broker-dealers. In
2014, the Company began to instead actively manage the risks
from its exposure to these customer-related positions on a
portfolio basis by entering into other derivative or
non-derivative financial instruments that partially or fully offset
the exposure from these customer-related positions. The
Company does not utilize derivatives for speculative purposes.
The Company does not designate all of the derivatives
that it enters into for risk management purposes as accounting
hedges because of the inefficiency of applying the accounting
requirements and may instead elect fair value accounting for
the related hedged items. In particular, the Company enters
into interest rate swaps, forward commitments to buy to-be-
announced securities (“TBAs”), U.S. Treasury futures and
options on U.S. Treasury futures to mitigate fluctuations in the
value of its MSRs, but does not designate those derivatives as
accounting hedges. The estimated net sensitivity to changes
in interest rates of the fair value of the MSRs and the related
derivative instruments at December 31, 2013, to an immediate
25, 50 and 100 bps downward movement in interest rates
would be a decrease of approximately $2 million, $5 million
and $36 million, respectively. An upward movement in interest
rates at December 31, 2013, of 25 bps would result in no
change in the fair value of the MSRs and related derivative
instruments, while a 50 and 100 bps increase would decrease
the fair value of the MSRs and related derivative instruments
by $3 million and $14 million, respectively. Refer to Note 9 of
the Notes to Consolidated Financial Statements for additional
information regarding MSRs.
Additionally, the Company uses forward commitments to
sell TBAs and other commitments to sell residential mortgage
loans at specified prices to economically hedge the interest
rate risk in its residential mortgage loan production activities.
At December 31, 2013, the Company had $5.3 billion of
forward commitments to sell, hedging $2.8 billion of mortgage
loans held for sale and $3.1 billion of unfunded mortgage loan
commitments. The forward commitments to sell and the
unfunded mortgage loan commitments on loans intended to
be sold are considered derivatives under the accounting
guidance related to accounting for derivative instruments and
hedging activities. The Company has elected the fair value
option for the mortgage loans held for sale.
Derivatives are subject to credit risk associated with
counterparties to the contracts. Credit risk associated with
derivatives is measured by the Company based on the
probability of counterparty default. The Company manages the
credit risk of its derivative positions by diversifying its positions
among various counterparties, by entering into master netting
arrangements, and, where possible by requiring collateral
arrangements. The Company may also transfer counterparty
credit risk related to interest rate swaps to third parties through
the use of risk participation agreements. In addition, effective in
2013, certain interest rate swaps and credit contracts are
required to be centrally cleared through clearing houses to
further mitigate counterparty credit risk.
For additional information on derivatives and hedging
activities, refer to Notes 19 and 20 in the Notes to
Consolidated Financial Statements.
Market Risk Management In addition to interest rate risk,
the Company is exposed to other forms of market risk,
principally related to trading activities which support
customers’ strategies to manage their own foreign currency,
interest rate risk and funding activities. For purposes of its
internal capital adequacy assessment process, the
Company considers risk arising from its trading activities
employing methodologies consistent with the requirements
of regulatory rules for market risk. The Company’s Market
Risk Committee (“MRC”), within the framework of the ALCO,
oversees market risk management. The MRC monitors and
reviews the Company’s trading positions and establishes
policies for market risk management, including exposure
limits for each portfolio. The Company uses a Value at Risk
(“VaR”) approach to measure general market risk.
Theoretically, VaR represents the statistical risk of loss the
Company has to adverse market movements over a one-day
time horizon. The Company uses the Historical Simulation
method to calculate VaR for its trading businesses measured
at the ninety-ninth percentile using a one-year look-back
period for distributions derived from past market data. The
market factors used in the calculations include those
pertinent to market risks inherent in the underlying trading
portfolios, principally those that affect its corporate bond
trading business, foreign currency transaction business,
client derivatives business, loan trading business and
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