Financial Derivatives

12 Months Ended

Dec. 31, 2011

Notes to Financial Statements [Abstract]

Financial Derivatives

FINANCIAL DERIVATIVES

Farmer Mac is required to recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative.  Farmer Mac enters into financial derivative transactions principally to protect against risk from the effects of market price or interest rate movements on the value of certain assets, future cash flows or debt issuance, not for trading or speculative purposes.  Farmer Mac enters into interest rate swap contracts to adjust the characteristics of its short-term debt to match more closely the cash flow and duration characteristics of its longer-term loans and other assets, and also to adjust the characteristics of its long-term debt to match more closely the cash flow and duration characteristics of its short-term assets, thereby reducing interest rate risk and often times deriving an overall lower effective cost of borrowing than would otherwise be available to Farmer Mac in the conventional debt market.  

Farmer Mac manages the interest rate risk related to loans it has committed to acquire, but has not yet purchased and permanently funded, through the use of forward sale contracts on the debt of other GSEs, futures contracts involving U.S. Treasury securities and interest rate swaps.  Farmer Mac uses forward sale contracts on GSE securities to reduce its interest rate exposure to changes in both Treasury rates and spreads on Farmer Mac debt and Farmer Mac Guaranteed Securities.  The notional amounts of these contracts are determined based on a duration-matched hedge ratio between the hedged item and the hedge instrument.  Gains or losses generated by these hedge transactions should offset any changes in funding costs or Farmer Mac Guaranteed Securities sale prices that occur during the hedge period.

Market Risk:

Market risk is the risk of an adverse effect resulting from changes in interest rates or spreads on the value of a financial instrument.  Farmer Mac manages market risk associated with financial derivatives by establishing and monitoring limits as to the degree of risk that may be undertaken.  This risk is periodically measured as part of Farmer Mac's overall risk monitoring processes, which include market value of equity measurements, net interest income modeling and other measures.

Credit Risk:

Credit risk is the risk that a counterparty will fail to perform according to the terms of a financial contract in which Farmer Mac has an unrealized gain.  Credit losses could occur in the event of non-performance by counterparties to the financial derivative contracts.  Farmer Mac mitigates this counterparty credit risk by contracting only with counterparties that have investment grade credit ratings (i.e., at least BBB), establishing and maintaining collateral requirements based upon credit ratings and entering into netting agreements.  Netting agreements provide for the calculation of the net amount of all receivables and payables under all transactions covered by the netting agreement between Farmer Mac and a single counterparty.  Farmer Mac's exposure to credit risk related to its financial derivatives is represented by those counterparties for which Farmer Mac has a net receivable, including the effect of any netting arrangements.  As of December 31, 2011 and 2010, Farmer Mac's credit exposure to interest rate swap counterparties, excluding netting arrangements, was $46.6 million and $48.0 million, respectively; however, including netting arrangements, Farmer Mac's credit exposure was $4.6 million and $12.4 million as of December 31, 2011 and 2010, respectively.  As of December 31, 2011 and 2010, there were no financial derivatives in a net payable position where Farmer Mac was required to pledge collateral which the counterparty had the right to sell or repledge.

Interest Rate Risk:

Farmer Mac uses financial derivatives to manage its interest rate risk exposure by effectively modifying the interest rate reset or maturity characteristics of certain assets and liabilities and by locking in the rates for certain forecasted issuances of liabilities.  The primary financial derivatives Farmer Mac uses include interest rate swaps and forward sale contracts.  Farmer Mac uses interest-rate swaps to assume fixed rate interest payments in exchange for floating rate interest payments and vice versa.  Depending on the economic hedging relationship, the effects of these agreements are (a) the conversion of variable rate liabilities to longer-term fixed rate liabilities, (b) the conversion of long-term fixed rate assets to shorter-term floating rate assets, or (c) the reduction of the variability of future changes in interest rates on forecasted issuances of liabilities.  The net payments on these agreements are recorded as gains and losses on financial derivatives in the consolidated statements of operations.

The following tables summarize information related to Farmer Mac's financial derivatives as of December 31, 2011 and 2010:

	December 31, 2011
			Fair Value						Weighted- Average Pay Rate	Weighted- Average Receive Rate	Weighted- Average Remaining Life (in years)
	Notional Amount		Asset			(Liability)
	(dollars in thousands)
Interest rate swaps:
Pay fixed non-callable	$	1,906,123	$	—		$	(157,520	)	3.65%	0.46%	4.48
Receive fixed non-callable	4,212,713		41,006			(1,302		)	0.41%	0.96%	0.97
Basis swaps	457,694		—			(2,137		)	0.80%	0.38%	1.30
Credit default swaps	10,000		17			—			1.00%	—	0.72
Credit valuation adjustment	—		(773		)	935
Total financial derivatives	$	6,586,530	$	40,250		$	(160,024	)

	December 31, 2010
			Fair Value						Weighted- Average Pay Rate	Weighted- Average Receive Rate	Weighted- Average Forward Price	Weighted- Average Remaining Life (in years)
	Notional Amount		Asset			(Liability)
	(dollars in thousands)
Interest rate swaps:
Pay fixed callable	$	13,144	$	—		$	(69	)	5.11%	0.29%		7.12
Pay fixed non-callable	1,275,108		2,814			(108,503		)	4.69%	0.30%		3.93
Receive fixed non-callable	2,874,534		39,551			(1,828		)	0.44%	1.40%		1.70
Basis swaps	254,991		52			(3,411		)	1.34%	0.38%		1.71
Credit default swaps	30,000		—			(216		)	1.00%	—		1.05
Agency forwards	37,336		—			(174		)			101.03
Treasury futures	1,300		—			(6		)			119.95
Credit valuation adjustment	—		(925		)	520
Total financial derivatives	$	4,486,413	$	41,492		$	(113,687	)

In the normal course of business, collateral requirements contained in Farmer Mac's derivative contracts are enforced by Farmer Mac and its counterparties.  Upon enforcement of the collateral requirements, the amount of collateral posted is typically based on the net fair value of all derivative contracts with the counterparty, i.e., derivative assets net of derivative liabilities at the counterparty level.  If Farmer Mac were to be in violation of certain provisions of the derivative contracts, the related counterparty could request payment or full collateralization on the derivative contracts.  As of December 31, 2011, the fair value of Farmer Mac's derivatives in a net liability position at the counterparty level, which includes accrued interest but excludes any adjustment for nonperformance risk, was $140.5 million.  As of December 31, 2011, Farmer Mac posted cash of $12.8 million and investment securities that the counterparty does not have the ability to sell or repledge with a fair value of $26.1 million as collateral for its derivatives in net liability positions.  Farmer Mac records posted cash as a reduction in the outstanding balance of cash and cash equivalents and an increase in the balance of prepaid expenses and other assets.  The investment securities posted as collateral are included in the investment securities balances on the consolidated balance sheets. If Farmer Mac had breached certain provisions of the derivative contracts as of December 31, 2011, it could have been required to settle its obligations under the agreements or post additional collateral of $101.7 million.

The following table summarizes the effects of Farmer Mac's financial derivatives on the consolidated statements of operations for the years ended December 31, 2011, 2010 and 2009:

	(Losses)/Gains on Financial Derivatives
	For the Year Ended December 31,
	2011			2010			2009
	(in thousands)
Interest rate swaps	$	(86,402	)	$	(13,071	)	$	24,377
Agency forwards	(5,710		)	(3,246		)	(2,359		)
Treasury futures	(513		)	(465		)	(71		)
Credit default swaps	(20		)	(307		)	(416		)
Subtotal	(92,645		)	(17,089		)	21,531
Amortization of derivatives transition adjustment	—			(70		)	(234		)
Total	$	(92,645	)	$	(17,159	)	$	21,297

As of December 31, 2010, Farmer Mac had reclassified all of the net after-tax unrealized gains and losses on financial derivatives included in accumulated other comprehensive income related to the financial derivatives transition adjustment into earnings.

As of December 31, 2011, Farmer Mac had outstanding basis swaps with Zions First National Bank, a related party, with a total notional amount of $72.7 million and a fair value of $(1.3) million, compared to $85.0 million and $(3.4) million, respectively as of December 31, 2010.  Under the terms of those basis swaps, Farmer Mac pays Constant Maturity Treasury-based rates and receives LIBOR.  Those swaps hedge most of the interest rate basis risk related to loans Farmer Mac purchases that pay a Constant Maturity Treasury based-rate and the discount notes Farmer Mac issues to fund the loan purchases.  The pricing of discount notes is closely correlated to LIBOR rates.  Accordingly, Farmer Mac recorded unrealized gains on those outstanding basis swaps of $2.1 million, $0.3 million and $0.1 million for 2011, 2010 and 2009, respectively.  See Note 3 for additional information on these related party transactions.