The document discusses hedge accounting strategies for credit unions, presenting case studies of two credit unions - ABC Credit Union and 123 Credit Union - that were seeking to hedge their portfolios of CDs against interest rate risk using cash flow hedges, and the different solutions for qualifying for hedge accounting based on the historical correlation of their balances to the hedge instrument benchmark rate. Key takeaways include using an advisor to properly plan and execute hedging strategies that qualify for hedge accounting, obtaining auditor approval, and ensuring hedge effectiveness is quantitatively assessed.

1. John Trefethen
Director, Sales
Travis Quast
Director, Hedge Accounting

2. 1www.DerivActiv.com Demystifying Hedge Accounting
• Founded 2004
• Leading, independent
provider of valuations and
hedge accounting
• Over 400 institutional
clients globally
• 10+ years of hedge
accounting experience
• Joined DerivActiv in
2006
• Previously worked for a
MN-based Fortune 500
company
Travis Quast
Director
Hedge Accounting

3. 2www.DerivActiv.com Demystifying Hedge Accounting
• What is Hedge Accounting?
• A Tale of Two Case Studies
• “ABC Credit Union”
• “123 Credit Union”
• Top 3 Takeaways

4. 3www.DerivActiv.com Demystifying Hedge Accounting
A textbook definition A practical definition
A method of accounting where
entries for the ownership of a
security and the opposing
hedge are treated as one.
Hedge accounting attempts to
reduce the volatility created by
the repeated adjustment of a
financial instrument's value,
known as marking-to-market.
A way to avoid
“lumpiness” in
your income
statement

5. 4www.DerivActiv.com Demystifying Hedge Accounting
Change in Fair Value
recorded in OCI
(equity)
Change in Fair Value
of Derivative offsets
hedged item
(Runs through P&L)
Fair Value Cash Flow
Change in Fair Value
through P&L
LUMPINESS
Qualifies
Does Not Qualify
ASC 815 (FAS 133) Accounting Summary

6. 5www.DerivActiv.com Demystifying Hedge Accounting
MUST-HAVES
• Formal documentation at hedge inception
• Use an advisor like ALM First to plan and execute a
hedging strategy that qualifies for hedge
accounting
• Obtain pre‐approval from your auditor
• Hedging relationship expected to be highly effective
• Changes in cash flows that could affect earnings

7. 6www.DerivActiv.com Demystifying Hedge Accounting
INITIAL
• Hedge Designation Memorandum and
effectiveness analysis
ONGOING
• Periodic hedge effectiveness testing
• Monthly: credit unions and other financial institutions
• Quarterly: regulatory requirement
• Required journal entries
Hedge Memo
(6-10 pages)

8. 7www.DerivActiv.com Demystifying Hedge Accounting
1 Fair Value Hedge 2 Cash Flow Hedge
Purpose: Unlock an interest rate
Hedge: Mortgage portfolio
Purpose: Lock-in an interest rate
Hedge: CDs or NMDs
Swap
Counterparty
Credit Union
Borrower
Fixed
%
Fixed
%
Variable
%
Swap
Counterparty
Credit Union
Portfolio of
CDs/NMDs
Variable
%
Fixed
%
Variable
%

9. 8www.DerivActiv.com Demystifying Hedge Accounting
1 Fair Value Hedge 2 Cash Flow Hedge
Purpose: Unlock an interest rate
Hedge: Mortgage portfolio
Purpose: Lock-in an interest rate
Hedge: CDs or NMDs
Swap
Counterparty
Credit Union
Borrower
Fixed
%
Fixed
%
Variable
%
Swap
Counterparty
Credit Union
Portfolio of
CDs/NMDs
Variable
%
Fixed
%
Variable
%
The requirement
that each loan in
the portfolio be
very similar is so
restrictive that
most credit unions
do not attempt

10. 9www.DerivActiv.com Demystifying Hedge Accounting
$4.1B in assets
260,000 members
THE SITUATION
• “ABC Credit Union” desires to
hedge its portfolio of CDs by
entering into a pay-fixed,
receive-floating cash flow
hedge.
$3.9B in assets
240,000 members
THE SITUATION
• “123 Credit Union” desires to
hedge its portfolio of CDs by
entering into a pay-fixed,
receive-floating cash flow
hedge.

11. 10www.DerivActiv.com Demystifying Hedge Accounting
$4.1B in assets
260,000 members
THE PROBLEM
• Management would like to
apply hedge accounting,
BUT…
• Balances are small relative to
the desired hedging notional
amount.
$3.9B in assets
240,000 members
THE PROBLEM
• Management would like to
apply hedge accounting,
BUT…
• Balances are small relative to
the desired hedging notional
amount.

12. 11www.DerivActiv.com Demystifying Hedge Accounting
$4.1B in assets
260,000 members
THE SOLUTION
• Tier 4 money market rates
have historically been
correlated with LIBOR.
• Thus tier 4 floating-rate
interest payments can be the
hedged forecasted
transactions.
$3.9B in assets
240,000 members
NOT THE SOLUTION
• Tier 4 money market rates
have historically been not
correlated with LIBOR.
• Thus tier 4 floating-rate
interest payments cannot be
the hedged forecasted
transactions.

13. 12www.DerivActiv.com Demystifying Hedge Accounting
$4.1B in assets
260,000 members
THE SOLUTION
• Tier 4 money market rates
have historically been
correlated with LIBOR.
• Thus tier 4 floating-rate
interest payments can be the
hedged forecasted
transactions.
$3.9B in assets
240,000 members
THE SOLUTION
• Designate a portion of the
derivative as the hedge, thus
reducing lumpiness by that
percentage
• OR index tier 4 money market
rates to LIBOR.

14. 13www.DerivActiv.com Demystifying Hedge Accounting
1) GET RID OF LUMPINESS
• Take advantage of hedge accounting!
2) PLAN AHEAD
• Use an advisor like ALM First to plan and execute a hedging strategy to
get terms that will qualify for hedge accounting.
• Obtain pre‐approval from your auditor for any new hedging strategy.
3) DO IT RIGHT
• Beware of widely publicized “shortcut” and “critical terms match”
methods, which have led to numerous restatements.
• Quantitative methods in which hedge effectiveness is assessed and
measured are much safer.

15. 14www.DerivActiv.com Demystifying Hedge Accounting
John Trefethen
Director, Sales
952-746-6040
jtrefethen@derivactiv.com
Minneapolis || New York || Panama City
www.DerivActiv.com
866-200-9012
Travis Quast
Director, Hedge Accounting
952-746-6174
tquast@derivactiv.com