US Bank 2006 Annual Report Download - page 49

fair value hedges is recorded in noninterest income. Changes various counterparties, requiring collateral agreements with
in the fair value of derivatives designated as fair value credit-rating thresholds, entering into master netting
hedges, and changes in the fair value of the hedged items, agreements in certain cases and entering into interest rate
are recorded in earnings. Changes in the fair value of swap risk participation agreements. These agreements
derivatives designated as cash flow hedges are recorded in transfer the credit risk related to interest rate swaps from
other comprehensive income until income from the cash the Company to an unaffiliated third-party. The Company
flows of the hedged items is realized. Customer-related also provides credit protection to third-parties with risk
interest rate swaps, foreign exchange rate contracts, and all participation agreements, for a fee, as part of a loan
other derivative contracts that do not qualify for hedge syndication transaction.
accounting are recorded at fair value and resulting gains or At December 31, 2006, the Company had $83 million
losses are recorded in trading account gains or losses or in accumulated other comprehensive income related to
mortgage banking revenue. Gains or losses on customer- realized and unrealized losses on derivatives classified as
related derivative positions were not material in 2006. cash flow hedges. Unrealized gains and losses are reflected
By their nature, derivative instruments are subject to in earnings when the related cash flows or hedged
market risk. The Company does not utilize derivative transactions occur and offset the related performance of the
instruments for speculative purposes. Of the Company’s hedged items. The estimated amount to be reclassified from
$32.9 billion of total notional amount of asset and liability accumulated other comprehensive income into earnings
management derivative positions at December 31, 2006, during the next 12 months is a loss of $29 million.
$24.1 billion was designated as either fair value or cash The change in fair value of forward commitments
flow hedges, or net investment hedges of foreign operations. attributed to hedge ineffectiveness recorded in noninterest
The cash flow hedge derivative positions are interest rate income was a decrease of $3 million and $4 million in 2006
swaps that hedge the forecasted cash flows from the and 2005, respectively. The change in the fair value of all
underlying variable-rate debt. The fair value hedges are other asset and liability management derivative positions
primarily interest rate swaps that hedge the change in fair attributed to hedge ineffectiveness was not material for
value related to interest rate changes of underlying fixed- 2006.
rate debt and subordinated obligations. The Company enters into derivatives to protect its net
In addition, the Company uses forward commitments investment in certain foreign operations. The Company uses
to sell residential mortgage loans to hedge its interest rate forward commitments to sell specified amounts of certain
risk related to residential mortgage loans held for sale. The foreign currencies to hedge its capital volatility risk
Company commits to sell the loans at specified prices in a associated with fluctuations in foreign currency exchange
future period, typically within 90 days. The Company is rates. The net amount of gains or losses included in the
exposed to interest rate risk during the period between cumulative translation adjustment for 2006 was not
issuing a loan commitment and the sale of the loan into the material.
secondary market. Related to its mortgage banking Table 18 summarizes information on the Company’s
operations, the Company held $1.4 billion of forward derivative positions at December 31, 2006. Refer to Notes 1
commitments to sell mortgage loans and $1.3 billion of and 19 of the Notes to Consolidated Financial Statements
unfunded mortgage loan commitments that were derivatives for significant accounting policies and additional
in accordance with the provisions of the Statement of information regarding the Company’s use of derivatives.
Financial Accounting Standards No. 133, ‘‘Accounting for Market Risk Management In addition to interest rate risk,
Derivative Instruments and Hedge Activities.’’ The unfunded the Company is exposed to other forms of market risk as a
mortgage loan commitments are reported at fair value as consequence of conducting normal trading activities. These
options in Table 18. Beginning in March 2006, the trading activities principally support the risk management
Company entered into U.S. Treasury futures and options on processes of the Company’s customers including their
U.S. Treasury futures contracts to economically hedge the management of foreign currency and interest rate risks. The
change in fair value related to the election of fair value Company also manages market risk of non-trading business
measurement for its residential MSRs. activities including its MSRs and loans held-for-sale. Value
Derivative instruments are also subject to credit risk at Risk (‘‘VaR’’) is a key measure of market risk for the
associated with counterparties to the derivative contracts. Company. Theoretically, VaR represents the maximum
Credit risk associated with derivatives is measured based on amount that the Company has placed at risk of loss, with a
the replacement cost should the counterparties with ninety-ninth percentile degree of confidence, to adverse
contracts in a gain position to the Company fail to perform market movements in the course of its risk taking activities.
under the terms of the contract. The Company manages this
risk through diversification of its derivative positions among
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