Annual Report - CoBank

The previous table excludes $2.8 billion of cash as ofDecember 31, 2011. While cash is not considered an interestearningasset, we include our cash balance in the sensitivityanalysis discussed below, as we would invest such funds inovernight or other highly-liquid investments if market ratesincreased as depicted in such scenarios. Our interest ratesensitivity position at December 31, 2011 may becharacterized as slightly “liability sensitive.” Typically, whenour position is liability-sensitive, our net interest income willbe favorably impacted in a stable or declining interest rateenvironment and when the slope of the yield curve isrelatively steep. This position will be unfavorably impacted ina rising interest rate environment or when the slope of theyield curve is flatter. We have adjusted our position to beslightly liability-sensitive in anticipation of stable short-termrates over the next few years.We continually monitor interest rates and have the abilityto reposition our balance sheet as a result of anticipatedinterest rate changes. For example, if we expected a moreimmediate and meaningful increase in short-term interestrates, we can shift our position to an asset-sensitive position.Duration Gap AnalysisThe duration gap is the difference between the estimateddurations of assets and liabilities, which is calculated using anasset/liability model. The duration gap summarizes the extentto which estimated cash flows for assets and liabilities arematched, on average, over time. A positive duration gapmeans there is increased market value exposure to risinginterest rates over the long-term because it indicates that theduration of our assets exceeds the duration of our liabilities. Anegative duration gap indicates increased exposure todeclining interest rates over the long-term because theduration of our assets is less than the duration of our liabilities.We apply the same interest rate process, prepayment models,and volatility assumptions to generate the portfolio durationgap that we use in our sensitivity analysis, which is discussedbelow. The duration gap provides a relatively concise andsimple measure of the interest rate risk inherent in our balancesheet, but it is not directly linked to expected future earningsperformance. Our aggregate positive duration gap was2.1 months at both December 31, 2011 and 2010.Sensitivity AnalysisWe use asset/liability models to evaluate the dynamics ofthe balance sheet and to estimate earnings volatility underdifferent interest rate scenarios. Our analysis includescalculating the impact of significant increases or decreases ininterest rates on net interest income, over a twelve monthperiod, and the estimated market value of equity.Our analysis estimates the effect of immediate andsustained parallel shifts in the yield curve (called “shocks”) of100, 200 and 300 basis points. Pursuant to regulation and ourBoard policy, when the three-month Treasury rate is below4 percent, as it was for each of the periods presented, weperform a shock equal to one-half the three-month Treasuryrate. This resulted in downward shocks of -1 basis point,-6 basis points, and -3 basis points at December 31, 2011,2010, and 2009, respectively. Due to extremely low short-terminterest rates, these downward shock scenarios, while requiredby policy, are not considered meaningful. When analyzing netinterest income at risk, we also estimate the effect of gradualupward or downward changes in market rates (called “ramps”)over a one year period of 100, 200 and 300 basis points, wherepossible.The following table summarizes the impact of interest ratechanges on net interest income and the market value of equity.Market value of equity is the net present value of all futurecash flows discounted to a valuation date, using discountingfactors derived from observed market rates on the samevaluation date. In all cases, the underlying assumptions andhedging strategies are held constant so that results arecomparable from scenario to scenario. However, actual resultswould differ to the extent changes in strategy were undertakento mitigate the unfavorable impact of interest rate changes.Net Interest Income at RiskDecember 31,Scenario:201120102009- 300 bp shockn/a n/a n/a- 200 bp shockn/a n/a n/a- 100 bp shockn/a n/a n/a- 6 bp shockn/a - n/a- 3 bp shockn/a n/a -- 1 bp shock- n/a n/a+ 100 bp shock- 0.2 % (3.5) %+ 200 bp shock(0.3) % 0.7 (7.1)+ 300 bp shock(0.9) 1.1 (10.9)- 300 bp rampn/a n/a n/a- 200 bp rampn/a n/a n/a- 100 bp rampn/a n/a n/a+ 100 bp ramp0.6 0.1 (1.2)+ 200 bp ramp1.3 0.7 (2.4)+ 300 bp ramp1.9 1.4 (3.7)Market Value of Equity at RiskDecember 31,2011 2010 2009Scenario:- 300 bp shockn/a n/a n/a- 200 bp shockn/a n/a n/a- 100 bp shockn/a n/a n/a- 6 bp shockn/a 0.2 % n/a- 3 bp shockn/a n/a 0.1 %- 1 bp shock- n/a n/a+ 100 bp shock(4.1) % (3.7) (4.6)+ 200 bp shock(8.8) (7.2) (9.3)+ 300 bp shock(13.3) (10.7) (13.9)CoBank 2011 Annual Report49