Note 7 – Hedge accounting

There are three types of hedge relations: Fair value hedge, Cash flow hedge, and Hedge of net investment in foreign operations.

In hedge accounting, the groups of risk factors measured by ITAÚ UNIBANCO HOLDING are:

•

Interest Rate: Risk of loss in transactions subject to interest rate variations;

•

Currency: Risk of loss in transactions subject to exchange variation.

The structure of risk limits is extended to the risk factor level, with specific limits that aim at improving the monitoring and understanding process, as well as avoiding concentration of these risks.

The structures designed for categories of interest rate and exchange rate are realized considering aggregate risks when there are compatible hedge instruments. Due to a management’s decision, in certain cases risks are hedged for the term and limit of the hedge instrument risk factor.

The other risk factors hedged by the institution are presented in Note 32.

To protect cash flows and fair value of instruments designated as hedged items, ITAÚ UNIBANCO HOLDING uses derivative financial instruments and financial assets. Currently, Futures Contracts, Options, NDF (non-deliverable forward), Forward, Swap and Financial Assets are used.

ITAÚ UNIBANCO HOLDING manages risks through the economic relationship between hedge instruments and hedged items, where the expectation is that these instruments move in opposite directions and in the same proportion, with the purpose of neutralizing risk factors.

The designated coverage ratio is always 100% of the risk factor eligible for coverage. The sources of ineffectiveness are in general related to the counterparty’s credit risk and possible mismatches of terms between the hedge instrument and the hedged item.

a)	Cash flow hedge

The cash flow hedge strategies of ITAÚ UNIBANCO HOLDING consist of a hedge of exposure to variations in cash flows, payment of interest and exposure to interest rate, which are attributable to changes in interest rates related to assets and liabilities recognized and changes in interest rates of unrecognized assets and liabilities.

ITAÚ UNIBANCO HOLDING has applied cash flow hedge strategies as follows:

Interest rate risks

•

Hedge of time deposits and repurchase agreements: to hedge of the variability in cash flows of interest payments resulting from changes in the DI interest rate, through futures contracts;

•

Hedge of Syndicated Loan: to hedge the variability in cash flow of interest payments resulting from changes in the LIBOR interest rate, through futures contracts;

•

Hedge of asset transactions: to hedge the variations in cash flows of interest receipts resulting from changes in the DI rate, through futures contracts;

•

Hedge of assets denominated in UF*: to hedge the variations in cash flows of interest receipts resulting from changes in the UF*, through swap contracts;

•

Hedge of Funding: to hedge the variations in cash flows of interest payments resulting from changes in the TPM* rate and foreign exchange, through swap contracts;

•

Hedge of loan operations: to hedge the variations in cash flows of interest receipts resulting from changes in the TPM* rate, through swap contracts;

•

Hedge of asset-backed securities under repurchase agreements: to hedge changes in cash flows from interest received on changes in Selic (benchmark interest rate), through futures contracts.

*	UF – Chilean unit of account / TPM – Monetary policy rate

ITAÚ UNIBANCO HOLDING does not use the qualitative method to evaluate the effectiveness and to measure the ineffectiveness of such strategies.

In such strategies of cash flow hedge, ITAÚ UNIBANCO HOLDING uses the hypothetical derivative method. The hypothetical derivative method is based on a comparison of the change in the fair value of a hypothetical derivative with terms identical to the critical terms of the variable-rate liability, and this change in the fair value of a hypothetical derivative is considered a proxy of the present value of the cumulative change in the future cash flow expected for the hedged liability.

a)	*Hedge* Cash flow


Strategies	Heading	12/31/2018
		Hedged item										Hedge instrument
		Book Value				Variation in value recognized in Other comprehensive income			Cash flow hedge reserve			Nominal Value		Variation in the amounts used to calculate hedge ineffectiveness
		Assets		Liabilities		Variation in value recognized in Other comprehensive income			Cash flow hedge reserve			Nominal Value
Interest rate risk
Hedge of deposits and repurchase agreements	Securities purchased under agreements to resell		0		29,727		(1,682	)		(2,946	)		29,727		(1,800	)
Hedge of assets transactions	Loan operations and lease operations and Securities		7,866		0		136			136			8,003		136
Hedge of Asset-backed securities under repurchase agreements	Securities purchased under agreements to resell		36,668		0		353			353			38,013		359
Hedge of loan operations	Loan operations and lease operations		274		0		6			6			268		7
Hedge of funding	Deposits		0		3,200		78			86			3,105		82
Hedge of assets denominated in UF	Securities		13,247		0		26			26			13,221		23
Foreign exchange risk
Hedge of highly probable forecast transactions			71		0		6			6			71		6

Total			58,126		32,927		(1,077	)		(2,333	)		92,408		(1,187	)

Strategies	Heading	12/31/2017
		Hedged item										Hedge instrument
		Book Value				Variation in value recognized in Other comprehensive income			Cash flow hedge reserve			Nominal Value		Variation in the amounts used to calculate hedge ineffectiveness
		Assets		Liabilities		Variation in value recognized in Other comprehensive income			Cash flow hedge reserve			Nominal Value
Interest rate risk
Hedge of deposits and repurchase agreements	Securities purchased under agreements to resell		—		62,667		(3,227	)		(3,227	)		62,667		(3,377	)
Hedge of assets transactions	Loan operations and lease operations and Securities		23,490		—		429			429			23,919		429
Hedge of Asset-backed securities under repurchase agreements	Securities purchased under agreements to resell		31,099		—		672			672			31,855		670
Hedge of loan operations	Loan operations and lease operations		1,124		—		14			14			1,124		13
Hedge of funding	Deposits		—		6,444		(16	)		(16	)		6,444		(17	)
Hedge of assets denominated in UF	Securities		15,227		—		(29	)		(29	)		15,227		(34	)
Foreign exchange risk
Hedge of highly probable forecast transactions			219		—		(5	)		(5	)		232		(5	)

Total			71,159		69,111		(2,162	)		(2,162	)		141,468		(2,321	)

For strategies of deposits and repurchase agreements to resell, asset transactions and asset-backed securities under repurchase agreements, the entity frequently reestablishes the coverage relationship, since both the hedged item and instruments change over time. This is so because they are portfolio strategies, reflecting guidelines for risk management strategy approved in the proper approval level.

The amount of R$ (1,615) in Reserve of Cash Flow Hedge will be recognized in result for the maturity term of the hedged item. In the period ended December 31, 2018, the amount of R$ (499) was recognized in Result related to this deferral.


Hedge Instruments	12/31/2018
	Nominal Value		*Book Value ^()**					Variations in fair value used to calculate hedge ineffectiveness			Variation in value recognized in Other comprehensive income			Hedge ineffectiveness recognized in income			Amount reclassified from Cash flow hedge reserve to income
	Nominal Value		Assets		Liabilities						Variation in value recognized in Other comprehensive income			Hedge ineffectiveness recognized in income			Amount reclassified from Cash flow hedge reserve to income
Interest rate risk
Interest rate futures		75,743		256		21			(1,305	)		(1,193	)		(112	)		0
Interest rate Swap		16,594		3,023		13,519			112			110			2			0
Foreign currency risk
DDI futures		6		5		0			1			1			0
Option		65		9		0			5			5			0			0

Total		92,408		3,293		13,540			(1,187	)		(1,077	)		(110	)		0

Hedge Instruments	12/31/2017
	Nominal Value		*Book Value ()**					Variations in fair value used to calculate hedge ineffectiveness			Variation in value recognized in Other comprehensive income			Hedge ineffectiveness recognized in income			Amount reclassified from Cash flow hedge reserve to income
	Nominal Value		Assets		Liabilities						Variation in value recognized in Other comprehensive income			Hedge ineffectiveness recognized in income			Amount reclassified from Cash flow hedge reserve to income
Interest rate risk
Interest rate futures		118,441		13		(32	)		(2,278	)		(2,126	)		(152	)		—
Interest rate Swap		22,795		14		(44	)		(38	)		(31	)		(7	)		—
Foreign currency risk
DDI futures		78		—		—			1			1			—			—
Option		154		9		—			(6	)		(6	)		—			—

Total		141,468		36		(76	)		(2,321	)		(2,162	)		(159	)		—

(*)

Amounts recorded in the Derivatives.

b)	Hedge of net investment in foreign operations

ITAÚ UNIBANCO HOLDING strategies of net investments in foreign operations consist of a hedge of the exposure in foreign currency arising from the functional currency of the foreign operation, with respect to the functional currency of the head office, by contracting futures, DDI, NDF and financial assets.

The risk hedged in this type of strategy is the foreign exchange risk.

ITAÚ UNIBANCO HOLDING does not use the qualitative method to assess the effectiveness and measure the ineffectiveness of these strategies.

To evaluate the effectiveness and to measure the ineffectiveness of such strategies, ITAÚ UNIBANCO HOLDING uses the Dollar Offset Method. The Dollar Offset Method is based on a comparison of the change in fair value (cash flow) of the hedge instrument, attributable to changes in exchange rate and gain (loss) arising from the variation in exchange rates, on the amount of investment abroad designated as a hedged item.

Strategies

12/31/2018

Hedged item

Hedge instrument

Book Value ⁽²⁾

Variation in value
recognized in Other
comprehensive income

Foreign
currency
convertion

Nominal
Value

Variation in the
amounts used to
calculate hedge
ineffectiveness

Assets

Liabilities

Foreign exchange risk

Hedge of net investment in foreign operations ⁽¹⁾

14,820

(7,300

)

(7,300

)

12,550

(7,296

)

Total

14,820

(7,300

)

(7,300

)

12,550

(7,296

)

Strategies

12/31/2017

Hedged item

Hedge instrument

Book Value ⁽²⁾

Variation in
value
recognized in
Other
comprehensive
income

Foreign
currency
convertion

Nominal
Value

Variation in
the amounts
used to
calculate
hedge
ineffectiveness

Assets

Liabilities

Foreign exchange risk

Hedge of net investment in foreign operations ⁽¹⁾

—

13,074

(5,507

)

(5,507

)

10,561

(5,503

)

Total

—

13,074

(5,507

)

(5,507

)

10,561

(5,503

)

(1)

Hedge instruments include the overhedge rate of 44.65% regarding taxes.

(2)

Amounts recorded in the Hedge of net investment in foreign operation.


Hedge instruments	12/31/2018
	Nominal Value			*Book Value ^()**				Variations in fair value used to calculate hedge ineffectiveness			Variation in value recognized in Other comprehensive income			Hedge ineffectiveness recognized in income			Amount reclassified from foreign currency convertion into income
	Nominal Value			Assets		Liabilities					Variation in value recognized in Other comprehensive income			Hedge ineffectiveness recognized in income
Foreign exchange risk
DDI futures		27,990			0		113		(11,394	)		(11,353	)		(41	)		0
Forward		(1,470	)		1,059		0		764			726			38			0
NDF		(13,167	)		255		0		3,198			3,189			9			0
Financial Assets		(803	)		803		0		136			138			(2	)		0

Total		12,550			2,117		113		(7,296	)		(7,300	)		4			0


Hedge instruments	12/31/2017
	Nominal Value			*Book Value ^()**				Variations in fair value used to calculate hedge ineffectiveness			Variation in value recognized in Other comprehensive income			Hedge ineffectiveness recognized in income			Amount reclassified from foreign currency convertion into income
	Nominal Value			Assets		Liabilities					Variation in value recognized in Other comprehensive income			Hedge ineffectiveness recognized in income
Foreign exchange risk
DDI futures		23,641			49		—		(7,646	)		(7,605	)		(41	)		—
Forward		(1,065	)		1,050		—		661			623			38			—
NDF		(11,474	)		—		357		1,525			1,516			9			—
Financial Assets		(541	)		541		—		(43	)		(41	)		(2	)		—

Total		10,561			1,640		357		(5,503	)		(5,507	)		4			—

(*)

Amounts recorded in the Derivatives.

c)	Fair value hedge

The fair value hedge strategy of ITAÚ UNIBANCO HOLDING consists in hedging the exposure to variation in fair value, in the receipt and payment of interest related to recognized assets and liabilities.

ITAÚ UNIBANCO HOLDING has applied fair value hedge as follows:

Interest rate risk:

•

To protect the risk of variation in the fair value of receipt and payment of interest resulting from variations in the fair value of variable rates involved, by contracting swaps and futures.

ITAÚ UNIBANCO HOLDING does not use the qualitative method to assess effectiveness and to measure ineffectiveness of these strategies.

To evaluate the effectiveness and to measure the ineffectiveness of such strategy, ITAÚ UNIBANCO HOLDING uses the percentage approach and dollar offset method:

•

The percentage approach is based on the calculation of change in the fair value of the reviewed estimate for the hedged position (hedge item) attributable to the protected risk versus the change in the fair value of the hedged derivative instrument.

•

The dollar offset method is calculated based on the difference between the variation of the fair value of the hedging instrument and the variation in the fair value of the hedged item attributed to changes in the interest rate.

The effects of hedge accounting on the financial position and performance of ITAÚ UNIBANCO HOLDING are presented below:


Strategies	12/31/2018
	Hedged Item											Hedge Instruments
	*Book Value ()**				Fair value				Variation in the amounts used to calculate hedge ineffectiveness			Nominal Value		Variation in value recognized in income
	Assets		Liabilities		Assets		Liabilities					Nominal Value		Variation in value recognized in income
Interest rate risk
Hedge of loan operations		7,066		0		7,119		0		53			7,066		(54	)
Hedge of funding		0		9,124		0		9,081		(43	)		9,124		43
Hedge of fair value through other comprehensive income		5,391		0		5,483		0		93			5,401		(82	)

Total		12,457		9,124		12,602		9,081		103			21,591		(93	)


Strategies	12/31/2017
	Hedged Item											Hedge Instruments
	*Book Value ()**				Fair value				Variation in the amounts used to calculate hedge ineffectiveness			Nominal Value		Variation in value recognized in income
	Assets		Liabilities		Assets		Liabilities					Nominal Value		Variation in value recognized in income
Interest rate risk
Hedge of loan operations		5,977		—		5,978		—		(50	)		5,977		52
Hedge of funding		—		12,157		—		9,562		108			12,157		(113	)
Hedge of syndicated loan		—		794		—		779		—			794		—
Hedge of fair value through other comprehensive income		482		—		450		—		(33	)		482		34

Total		6,459		12,951		6,428		10,341		25			19,410		(27	)

(*)

Amounts recorded in the heading Deposits, Securities, Funds from Interbank Markets and Loan and Lease Operation.

For loan operations strategies, the entity reestablishes the coverage ratio, since both the hedged item and the instruments change over time. This occurs because they are portfolio strategies that reflect the risk management strategy guidelines approved in the proper authority level.

Hedge Instruments

12/31/2018

Nominal
Value

Book value ^(*)

Variation in the amount
used to calculate hedge
ineffectiveness

Hedge ineffectiveness
recognized in income

Assets

Liabilities

Interest rate risk

Interest rate Swap

21,591

1,078

(93

)

Total

21,591

1,078

(93

)

Hedge Instruments

12/31/2017

Nominal
Value

Book value ^(*)

Variation in the amount
used to calculate hedge
ineffectiveness

Hedge ineffectiveness
recognized in income

Assets

Liabilities

Interest rate risk

Interest rate Swap

19,410

114

(27

)

Total

19,410

114

(27

)

(*)

Amounts recorded in the Derivatives.

The tables below present, for each strategy, the nominal value and the fair value adjustments of hedge instruments and the book value of the hedged item:


Strategies	12/31/2018							12/31/2017
	Hedge instruments					Hedged item		Hedge instruments					Hedged item
	Nominal Value		Fair value adjustments			Book Value		Nominal Value		Fair value adjustments			Book Value
Hedge of deposits and repurchase agreements		29,727		(21	)		29,727		62,667		(32	)		62,667
Hedge of highly probable forecast transactions		71		6			71		232		9			219
Hedge of net investment in foreign operations ^(*)		12,550		2,230			14,820		10,561		1,283			13,074
Hedge of loan operations (Fair value)		7,066		(54	)		7,066		5,977		52			5,977
Hedge of loan operations (Cash flow)		268		7			274		1,124		14			1,124
Hedge of funding (Fair value)		9,124		43			9,124		12,157		(114	)		12,157
Hedge of funding (Cash flow)		3,105		82			3,200		6,444		(16	)		6,444
Hedge of syndicated loan (Fair value)		0		0			0		794					794
Hedge of assets transactions		8,003		136			7,866		23,919		2			23,490
Hedge of Asset-backed securities under repurchase agreements		38,013		8			36,668		31,855		11			31,099
Hedge of assets denominated in UF		13,221		23			13,247		15,227		(28	)		15,227
Hedge of fair value through other comprehensive income		5,401		(82	)		5,391		482		34			482

Total		0		2,378			0				1,215

(*)

Hedge instruments include the overhedge rate of 44.65% regarding taxes.

The table below shows the breakdown by maturity of the hedging strategies:


Strategies	12/31/2018
Strategies	0-1 year		1-2 years		2-3 years		3-4 years		4-5 years		5-10 years		over 10 years		Total
Hedge of deposits and repurchase agreements		11,925		4,729		3,519		0		5,737		3,817		0		29,727
Hedge of highly probable forecast transactions		71		0		0		0		0		0		0		71
Hedge of net investment in foreign operations ^(*)		12,550		0		0		0		0		0		0		12,550
Hedge of loan operations (Fair value)		293		1,416		1,793		1,379		375		822		988		7,066
Hedge of loan operations (Cash flow)		0		28		162		78		0		0		0		268
Hedge of funding (Fair value)		1,590		297		154		391		377		3,972		2,343		9,124
Hedge of funding (Cash flow)		2,874		0		0		0		0		231		0		3,105
Hedge of assets transactions		6,346		0		1,657		0		0		0		0		8,003
Hedge of Asset-backed securities under repurchase agreements		26,943		5,838		1,517		0		3,715		0		0		38,013
Hedge of assets denominated in UF		12,241		924		56		0		0		0		0		13,221
Hedge of fair value through other comprehensive income		4,223		0		0		0		0		1,178		0		5,401

Total		79,056		13,232		8,858		1,848		10,204		10,020		3,331		126,549


Strategies	12/31/2017
Strategies	0-1 year		1-2 years		2-3 years		3-4 years		4-5 years		5-10 years		over de 10 years		Total
Hedge of deposits and repurchase agreements		31,471		11,205		6,210		12,125		—		1,656		—		62,667
Hedge of highly probable forecast transactions		162		70		—		—		—		—		—		232
Hedge of net investment in foreign operations ^(*)		10,561		—		—		—		—		—		—		10,561
Hedge of loan operations (Fair value)		268		143		628		1,502		1,335		642		1,459		5,977
Hedge of loan operations (Cash flow)		—		—		27		157		75		865		—		1,124
Hedge of funding (Fair value)		2,399		3,669		799		218		348		2,099		2,625		12,157
Hedge of funding (Cash flow)		1,646		749		1,026		884		525		1,614		—		6,444
Hedge of syndicated loan (Fair value)		794		—		—		—		—		—		—		794
Hedge of assets transactions		16,726		5,940		—		1,253		—		—		—		23,919
Hedge of Asset-backed securities under repurchase agreements		251		25,209		3,956		1,349		—		1,090		—		31,855
Hedge of assets denominated in UF		12,352		2,822		—		53		—		—		—		15,227
Hedge of fair value through other comprehensive income		—		—		223		—		—		259		—		482

Total		76,630		49,807		12,869		17,541		2,283		8,225		4,084		171,439

(*)

Classified as current, since instruments are frequently renewed.