US Bank 2014 Annual Report Download - page 60

projected interest rates compared with underlying contractual
rates, the time since origination and period to next reset date if
floating rate loans, and other factors including housing price
indices and geography, which are updated regularly based on
historical experience and forward market expectations. The
balance and pricing assumptions of deposits that have no
stated maturity are based on historical performance, the
competitive environment, customer behavior, and product mix.
These assumptions are validated on a periodic basis. A
sensitivity analysis of key variables of the valuation analysis is
provided to the ALCO monthly and is used to guide asset/
liability management strategies.
Management measures the impact of changes in
market interest rates under a number of scenarios, including
immediate and sustained parallel shifts, and flattening or
steepening of the yield curve. The ALCO policy limits the
change in the market value of equity in a 200 bps parallel
rate shock to a 15.0 percent decline. A 200 bps increase
would have resulted in a 6.7 percent decrease in the market
value of equity at December 31, 2014, compared with a
5.1 percent decrease at December 31, 2013. A 200 bps
decrease, where possible given current rates, would have
resulted in a 7.1 percent decrease in the market value of
equity at December 31, 2014, compared with a .8 percent
decrease at December 31, 2013. The change in the market
value of equity to an immediate 200 bps increase in the yield
curve at December 31, 2014, as compared with December 31,
2013, was primarily due to enhancements to improve the
modeling of balance sheet products with optionality. The
change in the market value of equity to an immediate 200 bps
decrease in the yield curve at December 31, 2014, as
compared with December 31, 2013, was due to lower rates
on the long end of the yield curve, as well as enhancements
to improve the modeling of balance sheet products with
optionality. At December 31, 2014 and 2013, the Company
was within policy.
Use of Derivatives to Manage Interest Rate and Other Risks
To manage the sensitivity of earnings and capital to interest
rate, prepayment, credit, price and foreign currency
fluctuations (asset and liability management positions), the
Company enters into derivative transactions. The Company
uses derivatives for asset and liability management purposes
primarily in the following ways:
– To convert fixed-rate debt from fixed-rate payments to
floating-rate payments;
– 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, 2014, to an immediate 25, 50 and 100 bps
downward movement in interest rates would be a decrease
of approximately $5 million, $19 million and $99 million,
respectively. An immediate upward movement in interest
rates at December 31, 2014 of 25, 50 and 100 bps would
decrease the fair value of the MSRs and related derivative
instruments by $2 million, $12 million and $29 million,
respectively. Refer to Note 10 of the Notes to Consolidated
Financial Statements for additional information regarding
MSRs.
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