Wells Fargo 2013 Annual Report Download - page 213

Cash Flow Hedges
We hedge floating-rate debt against future interest rate increases
by using interest rate swaps, caps, floors and futures to limit
variability of cash flows due to changes in the benchmark
interest rate. We also use interest rate swaps and floors to hedge
the variability in interest payments received on certain floating-
rate commercial loans, due to changes in the benchmark interest
rate. Gains and losses on derivatives that are reclassified from
OCI to interest income, interest expense, noninterest income
and noninterest expense in the current period are included in
the line item in which the hedged item’s effect on earnings is
recorded. All parts of gain or loss on these derivatives are
included in the assessment of hedge effectiveness. We assess
hedge effectiveness using regression analysis, both at inception
of the hedging relationship and on an ongoing basis. The
regression analysis involves regressing the periodic changes in
cash flows of the hedging instrument against the periodic
changes in cash flows of the forecasted transaction being hedged
due to changes in the hedged risk(s). The assessment includes an
evaluation of the quantitative measures of the regression results
used to validate the conclusion of high effectiveness.
Based upon current interest rates, we estimate that
$212 million (pre tax) of deferred net gains on derivatives in OCI
at December 31, 2013, will be reclassified into net interest
income during the next twelve months. Future changes to
interest rates may significantly change actual amounts
reclassified to earnings. We are hedging our exposure to the
variability of future cash flows for all forecasted transactions for
a maximum of 7 years for both hedges of floating-rate debt and
floating-rate commercial loans.
The following table shows the net gains (losses) recognized
related to derivatives in cash flow hedging relationships.
$
Year ended December 31,
(in millions) 2013 2012 2011
Gains (losses) (pre tax) recognized in OCI on derivatives (32) 52 190
Gains (pre tax) reclassified from cumulative OCI into net income (1) 296 388 571
Gains (losses) (pre tax) recognized in noninterest income for hedge ineffectiveness (2) 1 (1) (5)
(1) See Note 23 for detail on components of net income.
(2) None of the change in value of the derivatives was excluded from the assessment of hedge effectiveness.
Free-Standing Derivatives
We use free-standing derivatives (economic hedges) to hedge the
risk of changes in the fair value of certain residential MHFS,
certain loans held for investment, residential MSRs measured at
fair value, derivative loan commitments and other interests held.
The resulting gain or loss on these economic hedges is reflected
in mortgage banking noninterest income, net gains (losses) from
equity investments and other noninterest income.
The derivatives used to hedge MSRs measured at fair value,
which include swaps, swaptions, constant maturity mortgages,
forwards, Eurodollar and Treasury futures and options
contracts, resulted in net derivative losses of $2.9 billion in 2013
and net derivative gains of $3.6 billion and $5.2 billion in 2012
and 2011, respectively which are included in mortgage banking
noninterest income. The aggregate fair value of these derivatives
was a net liability of $531 million at December 31, 2013 and a net
asset of $87 million at December 31, 2012. The change in fair
value of these derivatives for each period end is due to changes
in the underlying market indices and interest rates as well as the
purchase and sale of derivative financial instruments throughout
the period as part of our dynamic MSR risk management
process.
Interest rate lock commitments for residential mortgage
loans that we intend to sell are considered free-standing
derivatives. Our interest rate exposure on these derivative loan
commitments, as well as substantially all residential MHFS, is
hedged with free-standing derivatives (economic hedges) such as
swaps, forwards and options, Eurodollar futures and options,
and Treasury futures, forwards and options contracts. The
commitments, free-standing derivatives and residential MHFS
are carried at fair value with changes in fair value included in
mortgage banking noninterest income. For the fair value
measurement of interest rate lock commitments we include, at
inception and during the life of the loan commitment, the
expected net future cash flows related to the associated servicing
of the loan. Fair value changes subsequent to inception are based
on changes in fair value of the underlying loan resulting from the
exercise of the commitment and changes in the probability that
the loan will not fund within the terms of the commitment
(referred to as a fall-out factor). The value of the underlying loan
is affected primarily by changes in interest rates and the passage
of time. However, changes in investor demand can also cause
changes in the value of the underlying loan value that cannot be
hedged. The aggregate fair value of derivative loan commitments
on the balance sheet was a net liability of $26 million and a net
asset of $497 million at December 31, 2013 and
December 31, 2012, respectively, and is included in the caption
“Interest rate contracts” under “Customer accommodation,
trading and other free-standing derivatives” in the first table in
this Note.
We also enter into various derivatives primarily to provide
derivative products to customers. To a lesser extent, we take
positions based on market expectations or to benefit from price
differentials between financial instruments and markets. These
derivatives are not linked to specific assets and liabilities on the
balance sheet or to forecasted transactions in an accounting
hedge relationship and, therefore, do not qualify for hedge
accounting. We also enter into free-standing derivatives for risk
management that do not otherwise qualify for hedge accounting.
They are carried at fair value with changes in fair value recorded
as other noninterest income.
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