Annual Report - CoBank

Our net interest income is lower in the rising interest ratescenarios due to our liability-sensitive position. Our Boardlimits the amount of adverse change to net interest income andmarket value of equity under a 200 basis point rate shock. Thelimit for market value of equity was 15 percent and the limitfor net interest income was 10 percent for all three yearspresented. At December 31, 2011, 2010 and 2009, we werewithin our policy limits as detailed in the table above.ForecastingWe update our asset/liability model monthly withinformation on loans, investment securities, borrowings andderivatives. This “current position” is the starting point for allanalysis. The current position data is then combined with basecase business plan assumptions and independent, third-partyeconomic forecasts to derive our estimates of future netinterest income. Generally, we set assumptions on pricing,maturity characteristics and funding mix using trend analysisof actual asset and liability data.Net interest income forecasts are derived utilizingdifferent interest rate scenarios. As noted previously, weobtain independent market interest rate projections whenpreparing our forecasts. These interest rate projections aredesigned around economic forecasts that are meant to estimatethe most likely path of interest rates for the planning horizonand alternate views of a rapidly expanding economy, and adramatically slowing economy. In addition, we reviewscenarios based on the market’s implied forward rates andunchanged rates. We also review the impact on net interestincome of parallel and nonparallel shifts in the yield curveover different time horizons using stochastic processes, orthose involving a randomly determined sequence ofobservations.Use of DerivativesWe use derivatives as an integral part of our interest raterisk management activities. To achieve risk managementobjectives and satisfy the financing needs of our borrowers,we execute various derivative transactions with other financialinstitutions. Derivatives (primarily interest rate swaps) areused to manage liquidity and the interest rate risk arising frommaturity and repricing mismatches between assets andliabilities. In addition, we execute foreign exchange spot andforward contracts to manage currency risk on our relativelynominal amount of loans denominated in foreign currencies.The notional amounts of derivatives, weighted average interestrates to be received and paid, and fair values at December 31,2011, are shown in the following table. We also discussderivatives in Note 11 to the accompanying consolidatedfinancial statements.Derivative Financial Instruments atDecember 31, 2011 ($ in Millions)Derivative ProductNotionalAmountWeightedAverageReceiveRateWeightedAveragePayRateFairValueReceive Fixed Swaps $ 19,230 2.57 % 0.32 % $ 956Receive FixedAmortizing Swaps1,031 2.86 0.51 78Pay Fixed Swaps 1,963 0.55 1.80 (62)Pay FixedAmortizing Swaps1,031 0.51 2.64 (66)Interest Rate Options 1,999 - - 2Foreign CurrencySpots and Forwards299 - - 4Total $ 25,553 2.32 % 0.55 % $ 912We have included a summary of our derivatives portfolioby strategy with further explanation of each strategy in thefollowing section.Notional Amounts of DerivativeFinancial Instruments by Strategy ($ in Millions)December 31,2011 2010 2009Liquidity Management $ 14,364 $ 21,474 $ 24,325Equity Positioning 2,903 3,088 2,928Options Risk Management (1) 1,850 1,850 1,500Customer Transactions 6,193 4,411 3,685Foreign Currency RiskManagement (2) 243 131 128Total $ 25,553 $ 30,954 $ 32,566(1) Excludes $149.0 million, $206.0 million and $100.0 million of interestrate options at December 31, 2011, 2010 and 2009, respectively, whichare classified as customer transactions.(2) Excludes $56.0 million, $68.0 million and $90.0 million of foreign currency spotsand forwards at December 31, 2011, 2010 and 2009, respectively, whichare classified as customer transactions.The total notional amount of our derivatives portfoliodecreased by $5.4 billion in 2011. The decrease was largelydue to a lower level of liquidity management derivatives, as aportion of our liquidity objectives were met through theincrease of floating-rate term debt instead of the use ofderivatives that convert fixed-rate term debt to floating-rate.This was partially offset by a higher level of customerderivative activity in 2011, as customers took advantage of thelow rate environment to lock-in or protect their term fundingcosts.CoBank 2011 Annual Report50