10-Q 1 d10q.htm FORM 10-Q Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[ü] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2007

or

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

Commission file number:

1-6523

Exact name of registrant as specified in its charter:

Bank of America Corporation

State of incorporation:

Delaware

IRS Employer Identification Number:

56-0906609

Address of principal executive offices:

Bank of America Corporate Center

100 N. Tryon Street

Charlotte, North Carolina 28255

Registrant’s telephone number, including area code:

(704) 386-5681

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ü    No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ü    Accelerated filer    Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).

Yes    No ü

On October 31, 2007, there were 4,438,318,140 shares of Bank of America Corporation Common Stock outstanding.

 


 

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Table of Contents

   Bank of America Corporation

 

  September 30, 2007 Form 10-Q

INDEX

 

                   Page
Part I.      Item 1.     

Financial Statements:

  
Financial

Information

         

Consolidated Statement of Income for the Three and Nine Months Ended September 30, 2007 and 2006

   3
         

Consolidated Balance Sheet at September 30, 2007 and December 31, 2006

   4
         

Consolidated Statement of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2007 and 2006

   5
         

Consolidated Statement of Cash Flows for the Nine Months Ended September 30, 2007 and 2006

   6
         

Notes to Consolidated Financial Statements

   7
     Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations   
         

Table of Contents

   46
         

Discussion and Analysis

   47
     Item 3.      Quantitative and Qualitative Disclosures about Market Risk    134
     Item 4.      Controls and Procedures    134
                    
Part II.             
Other

Information

            
     Item 1.     

Legal Proceedings

   134
     Item 1A.     

Risk Factors

   134
     Item 2.     

Unregistered Sales of Equity Securities and the Use of Proceeds

   135
     Item 6.     

Exhibits

   135
     Signature    136
     Index to Exhibits    137

 

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Table of Contents

Bank of America Corporation and Subsidiaries

Consolidated Statement of Income

     Three Months Ended
September 30
       Nine Months Ended
September 30
 

  (Dollars in millions, except per share information)

   2007        2006        2007      2006  

Interest income

                 

Interest and fees on loans and leases

   $ 14,111        $ 12,638        $ 40,318      $ 35,569   

Interest on debt securities

     2,334          3,080          7,046        9,215  

Federal funds sold and securities purchased under agreements to resell

     1,839          2,146          5,974        5,755  

Trading account assets

     2,519          1,856          7,059        5,031  

Other interest income

     1,230          952          3,428        2,524  

Total interest income

     22,033          20,672          63,825        58,094  

Interest expense

                 

Deposits

     4,545          3,976          12,840        10,491  

Short-term borrowings

     5,521          5,467          16,376        14,618  

Trading account liabilities

     906          727          2,619        1,840  

Long-term debt

     2,446          1,916          6,721        5,153  

Total interest expense

     13,418          12,086          38,556        32,102  

Net interest income

     8,615          8,586          25,269        25,992  

Noninterest income

                 

Card income

     3,595          3,473          10,486        10,571  

Service charges

     2,221          2,147          6,493        6,125  

Investment and brokerage services

     1,378          1,085          3,720        3,334  

Investment banking income

     389          510          1,801        1,623  

Equity investment income

     904          705          3,747        2,122  

Trading account profits (losses)

     (1,457 )        731          305        2,706  

Mortgage banking income

     155          189          516        415  

Gains (losses) on sales of debt securities (1)

     7          (469 )        71        (464 )

Other income

     122          1,227          1,239        1,670  

Total noninterest income

     7,314          9,598          28,378        28,102  

Total revenue, net of interest expense

     15,929          18,184          53,647        54,094  

Provision for credit losses

     2,030          1,165          5,075        3,440  

Noninterest expense

                 

Personnel

     4,169          4,474          13,931        13,767  

Occupancy

     754          696          2,211        2,100  

Equipment

     336          318          1,018        978  

Marketing

     552          587          1,644        1,713  

Professional fees

     258          259          770        710  

Amortization of intangibles

     429          441          1,209        1,322  

Data processing

     463          426          1,372        1,245  

Telecommunications

     255          237          750        685  

Other general operating

     1,243          1,156          3,558        3,423  

Merger and restructuring charges

     84          269          270        561  

Total noninterest expense

     8,543          8,863          26,733        26,504  

Income before income taxes

     5,356          8,156          21,839        24,150  

Income tax expense

     1,658          2,740          7,125        8,273  

Net income

   $ 3,698        $ 5,416        $ 14,714      $ 15,877  

Preferred stock dividends

     43          -          129        9  

Net income available to common shareholders

   $ 3,655        $ 5,416        $ 14,585      $ 15,868  

Per common share information

                 

Earnings

   $ 0.83        $ 1.20        $ 3.30      $ 3.49  

Diluted earnings

     0.82          1.18          3.25        3.44  

Dividends paid

     0.64          0.56          1.76        1.56  

Average common shares issued and outstanding (in thousands)

     4,420,616          4,499,704          4,424,269        4,547,693  

Average diluted common shares issued and outstanding (in thousands)

     4,475,917          4,570,558          4,483,465        4,614,599  

 

 

(1)

Effective April 1, 2007, the Corporation changed its income statement presentation to reflect gains (losses) on sales of debt securities as a component of noninterest income.

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

  Bank of America Corporation and Subsidiaries

  Consolidated Balance Sheet

  (Dollars in millions)    September 30
2007
       December 31
2006
 

Assets

       

Cash and cash equivalents

   $ 34,956        $ 36,429   

Time deposits placed and other short-term investments

     8,829          13,952  

Federal funds sold and securities purchased under agreements to resell (includes $2,561 measured at fair value at September 30, 2007 and $135,110 and $135,409 pledged as collateral)

     135,150          135,478  

Trading account assets (includes $72,704 and $92,274 pledged as collateral)

     179,365          153,052  

Derivative assets

     30,843          23,439  

Debt securities:

       

Available-for-sale (includes $99,048 and $83,785 pledged as collateral)

     176,778          192,806  

Held-to-maturity, at cost (fair value – $518 and $40)

     518          40  

Total debt securities

     177,296          192,846  

Loans and leases (includes $4,525 measured at fair value at September 30, 2007 and $119,371 and $14,290 pledged as collateral)

     793,537          706,490  

Allowance for loan and lease losses

     (9,535 )        (9,016 )

Loans and leases, net of allowance

     784,002          697,474  

Premises and equipment, net

     9,762          9,255  

Mortgage servicing rights (includes $3,179 and $2,869 measured at fair value)

     3,417          3,045  

Goodwill

     67,433          65,662  

Intangible assets

     9,635          9,422  

Other assets (includes $26,285 measured at fair value at September 30, 2007)

     138,075          119,683  

Total assets

   $ 1,578,763        $ 1,459,737  

Liabilities

       

Deposits in domestic offices:

       

Noninterest-bearing

   $ 165,343        $ 180,231  

Interest-bearing (includes $521 measured at fair value at September 30, 2007)

     434,728          418,100  

Deposits in foreign offices:

       

Noninterest-bearing

     3,950          4,577  

Interest-bearing

     95,201          90,589  

Total deposits

     699,222          693,497  

Federal funds purchased and securities sold under agreements to repurchase

     199,293          217,527  

Trading account liabilities

     87,155          67,670  

Derivative liabilities

     19,012          16,339  

Commercial paper and other short-term borrowings

     201,155          141,300  

Accrued expenses and other liabilities (includes $454 measured at fair value at September 30, 2007 and $392 and $397 of reserve for unfunded lending commitments)

     48,932          42,132  

Long-term debt

     185,484          146,000  

Total liabilities

     1,440,253          1,324,465  

Commitments and contingencies (Note 9 – Variable Interest Entities and Note 11 – Commitments and Contingencies)

       

Shareholders’ equity

       

Preferred stock, $0.01 par value; authorized - 100,000,000 shares; issued and outstanding – 143,739 and 121,739 shares

     3,401          2,851  

Common stock and additional paid-in capital, $0.01 par value; authorized – 7,500,000,000 shares; issued and outstanding – 4,436,855,341 and 4,458,151,391 shares

     60,276          61,574  

Retained earnings

     84,027          79,024  

Accumulated other comprehensive income (loss)

     (8,615 )        (7,711 )

Other

     (579 )        (466 )

Total shareholders’ equity

     138,510          135,272  

Total liabilities and shareholders’ equity

   $ 1,578,763        $ 1,459,737  

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

  Bank of America Corporation and Subsidiaries

  Consolidated Statement of Changes in Shareholders’ Equity

  (Dollars in millions, shares in thousands)   Preferred
Stock
   

Common Stock

and Additional

Paid-in Capital

    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss) (1)
    Other     Total
Shareholders’
Equity
    Comprehensive
Income
 
    Shares     Amount            
                                                               

Balance, December 31, 2005

  $ 271     3,999,688     $ 41,693     $ 67,552     $ (7,556 )   $ (427 )   $ 101,533    

Net income

          15,877           15,877     $ 15,877   

Net changes in available-for-sale debt and marketable equity securities

            (106 )       (106 )     (106 )

Net changes in foreign currency translation adjustments

            177         177       177  

Net changes in derivatives

            618         618       618  

Cash dividends paid:

               

Common

          (7,149 )         (7,149 )  

Preferred

          (9 )         (9 )  

Issuance of preferred stock

    825                 825    

Redemption of preferred stock

    (270 )               (270 )  

Common stock issued under employee plans and related tax benefits

    98,312       3,988           (135 )     3,853    

Stock issued in acquisition (2)

    631,145       29,377             29,377    

Common stock repurchased

          (231,000 )     (11,129 )                             (11,129 )        

Balance, September 30, 2006

  $ 826     4,498,145     $ 63,929     $ 76,271     $ (6,867 )   $ (562 )   $ 133,597     $ 16,566  

Balance, December 31, 2006

  $ 2,851     4,458,151     $ 61,574     $ 79,024     $ (7,711 )   $ (466 )   $ 135,272    

Cumulative adjustment for accounting changes (3):

               

Leveraged leases

          (1,381 )         (1,381 )  

Fair value option and measurement

          (208 )         (208 )  

Income tax uncertainties

          (146 )         (146 )  

Net income

          14,714           14,714     $ 14,714  

Net changes in available-for-sale debt and marketable equity securities

            (1,130 )       (1,130 )     (1,130 )

Net changes in foreign currency translation adjustments

            156         156       156  

Net changes in derivatives

            (22 )       (22 )     (22 )

Amortization of costs included in net periodic benefit costs

            92         92       92  

Cash dividends paid:

               

Common

          (7,847 )         (7,847 )  

Preferred

          (129 )         (129 )  

Issuance of preferred stock

    550                 550    

Common stock issued under employee plans and related tax benefits

    49,734       2,366           (113 )     2,253    

Common stock repurchased

          (71,030 )     (3,664 )                             (3,664 )        

Balance, September 30, 2007

  $ 3,401     4,436,855     $ 60,276     $ 84,027     $ (8,615 )   $ (579 )   $ 138,510     $ 13,810  

 

 

(1)

Amounts shown are net of tax. For additional information on accumulated OCI, see Note 12 – Shareholders’ Equity and Earnings Per Common Share to the Consolidated Financial Statements.

 

 

(2)

Includes adjustment for the fair value of outstanding MBNA Corporation (MBNA) stock options of $435 million.

 

 

(3)

Effective January 1, 2007, the Corporation adopted FSP 13-2, SFAS 157, SFAS 159 and FIN 48. For additional information on the adoption of these accounting pronouncements, see Note 1 – Summary of Significant Accounting Principles to the Consolidated Financial Statements.

See accompanying Notes to Consolidated Financial Statements

 

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Table of Contents

  Bank of America Corporation and Subsidiaries

  Consolidated Statement of Cash Flows

     Nine Months Ended September 30  

  (Dollars in millions)

   2007        2006  

Operating activities

       

Net income

   $ 14,714        $ 15,877   

Reconciliation of net income to net cash provided by (used in) operating activities:

       

Provision for credit losses

     5,075          3,440  

(Gains) losses on sales of debt securities

     (71 )        464  

Depreciation and premises improvements amortization

     836          835  

Amortization of intangibles

     1,209          1,322  

Deferred income tax (benefit) expense

     (213 )        1,322  

Net (increase) decrease in trading and derivative instruments

     (14,252 )        7,830  

Net increase in other assets

     (19,157 )        (26,704 )

Net increase in accrued expenses and other liabilities

     7,238          648  

Other operating activities, net

     3,429          (2,192 )

Net cash provided by (used in) operating activities

     (1,192 )        2,842  

Investing activities

       

Net (increase) decrease in time deposits placed and other short-term investments

     5,135          (295 )

Net decrease in federal funds sold and securities purchased under agreements to resell

     148          13,903  

Proceeds from sales of available-for-sale debt securities

     10,956          17,122  

Proceeds from paydowns and maturities of available-for-sale debt securities

     15,231          17,708  

Purchases of available-for-sale debt securities

     (7,217 )        (38,270 )

Proceeds from maturities of held-to-maturity debt securities

     547          -  

Purchases of held-to-maturity debt securities

     (116 )        -  

Proceeds from sales of loans and leases

     45,058          29,902  

Other changes in loans and leases, net

     (138,371 )        (96,643 )

Net purchases of premises and equipment

     (1,318 )        (398 )

Proceeds from sales of foreclosed properties

     60          86  

(Acquisition) divestiture of business activities, net

     (3,694 )        (3,615 )

Other investing activities, net

     2,078          (222 )

Net cash used in investing activities

     (71,503 )        (60,722 )

Financing activities

       

Net increase in deposits

     2,318          7,249  

Net increase (decrease) in federal funds purchased and securities sold under agreements to repurchase

     (18,809 )        18,109  

Net increase in commercial paper and other short-term borrowings

     59,928          17,454  

Proceeds from issuance of long-term debt

     60,580          37,403  

Retirement of long-term debt

     (23,018 )        (13,507 )

Issuance of preferred stock

     550          825  

Redemption of preferred stock

     -          (270 )

Proceeds from issuance of common stock

     1,022          2,587  

Common stock repurchased

     (3,664 )        (11,129 )

Cash dividends paid

     (7,976 )        (7,158 )

Excess tax benefits related to share-based payments

     233          342  

Other financing activities, net

     (52 )        121  

Net cash provided by financing activities

     71,112          52,026  

Effect of exchange rate changes on cash and cash equivalents

     110          94  

Net decrease in cash and cash equivalents

     (1,473 )        (5,760 )

Cash and cash equivalents at January 1

     36,429          36,999  

Cash and cash equivalents at September 30

   $ 34,956        $ 31,239  

The fair values of noncash assets acquired and liabilities assumed in the U.S. Trust Corporation merger were $12.9 billion and $9.8 billion at July 1, 2007.

During the nine months ended September 30, 2007, the Corporation sold its operations in Chile and Uruguay for approximately $750 million in equity in Banco Itaú Holding Financeira S.A., and its assets in BankBoston Argentina for the assumption of its liabilities. The total assets and liabilities in these divestitures were $6.1 billion and $5.6 billion.

During the nine months ended September 30, 2007, the Corporation transferred $1.7 billion of trading account assets to AFS debt securities.

On January 1, 2007, the Corporation transferred $3.7 billion of AFS debt securities to trading account assets following the adoption of SFAS 159.

The fair values of noncash assets acquired and liabilities assumed in the MBNA merger were $83.3 billion and $50.4 billion at January 1, 2006.

Approximately 631 million shares of common stock, valued at approximately $28.9 billion, were issued in connection with the MBNA merger at January 1, 2006.

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

  Bank of America Corporation and Subsidiaries

   Notes to Consolidated Financial Statements

Bank of America Corporation and its subsidiaries (the Corporation), through its banking and nonbanking subsidiaries, provides a diverse range of financial services and products throughout the U.S. and in selected international markets. At September 30, 2007, the Corporation operated its banking activities primarily under two charters: Bank of America, National Association (Bank of America, N.A.) and FIA Card Services, N.A.

 

  NOTE 1 – Summary of Significant Accounting Principles

 

Principles of Consolidation and Basis of Presentation

The Consolidated Financial Statements include the accounts of the Corporation and its majority-owned subsidiaries, and those variable interest entities (VIEs) where the Corporation is the primary beneficiary. All significant intercompany accounts and transactions have been eliminated.

The information contained in the Consolidated Financial Statements is unaudited. In the opinion of management, normal recurring adjustments necessary for a fair statement of the interim period results have been made. Results of operations of companies purchased are included from the dates of acquisition.

Effective January 1, 2007, the Corporation changed its basis of presentation for its business segments. For additional information, see Note 17 – Business Segment Information to the Consolidated Financial Statements.

Effective April 1, 2007, the Corporation changed the current and historical presentation of its Consolidated Statement of Income to present gains (losses) on sales of debt securities as a component of noninterest income.

Prior period amounts have been reclassified to conform to current period presentation.

 

Recently Issued Accounting Pronouncements

On June 27, 2007, the Financial Accounting Standards Board (FASB) ratified the Emerging Issues Task Force (EITF) consensus on Issue No. 06–11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards” (EITF 06-11). EITF 06–11 requires that the tax benefit related to dividend equivalents paid on restricted stock and restricted stock units which are expected to vest be recorded as an increase to additional paid-in capital. The Corporation currently accounts for this tax benefit as a reduction to income tax expense. EITF 06–11 is to be applied prospectively for tax benefits on dividends declared by the Corporation on or after January 1, 2008. The Corporation expects to adopt the provisions of EITF 06–11 on January 1, 2008. The adoption of EITF 06–11 will not have a material impact on the Corporation’s financial condition and results of operations.

Effective January 1, 2007, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” (SFAS 157) and SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). SFAS 157 defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States (GAAP) and enhances disclosures about fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The impact of adopting both SFAS 157 and SFAS 159 reduced the beginning balance of retained earnings as of January 1, 2007 by $208 million, net of tax. Subsequent changes in fair value of these financial assets and liabilities are recognized in earnings when they occur. For additional information on the fair value of certain financial assets and liabilities, see Note 15 – Fair Value Disclosures to the Consolidated Financial Statements.

 

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Effective January 1, 2007, the Corporation adopted FASB Staff Position (FSP) No. FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (FSP 13-2). The principal provision of FSP 13-2 is the requirement that a lessor recalculate the recognition of lease income when there is a change in the estimated timing of the cash flows relating to income taxes generated by such leveraged lease. The adoption of FSP 13-2 reduced the beginning balance of retained earnings as of January 1, 2007 by $1.4 billion, net of tax, with a corresponding offset decreasing the net investment in leveraged leases recorded as part of loans and leases. Following the adoption, if during the remainder of the lease term the timing of the income tax cash flows generated by the leveraged leases are revised as a result of final determination by the Internal Revenue Service on certain leveraged leases or management changes its assumption about the timing of the tax cash flows, the rate of return shall be recalculated from the inception of the lease using the revised assumption and the change in the net investment shall be recognized as a gain or loss in the year in which the assumption is changed.

Effective January 1, 2007, the Corporation adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting and reporting for income taxes where interpretation of the tax law may be uncertain. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. The adoption of FIN 48 reduced the beginning balance of retained earnings as of January 1, 2007 by $146 million and increased goodwill by $52 million. For additional information on income taxes, see Note 14 – Income Taxes to the Consolidated Financial Statements.

For additional information on recently issued accounting pronouncements and other significant accounting principles, see Note 1 – Summary of Significant Accounting Principles to the Consolidated Financial Statements filed as Exhibit 99.2 to the Corporation’s Current Report on Form 8-K filed on May 23, 2007.

 

  NOTE 2 – Merger and Restructuring Activity

On October 1, 2007, the Corporation acquired all the outstanding shares of ABN Amro North America Holding Company, parent of LaSalle Bank Corporation (LaSalle), for $21.0 billion in cash. With this acquisition, the Corporation significantly expanded its metropolitan Chicago and Michigan presence by adding LaSalle’s commercial banking clients, retail customers, and banking centers. LaSalle’s results of operations will be included in the Corporation’s results beginning October 1, 2007.

On July 1, 2007, the Corporation acquired all the outstanding shares of U.S. Trust Corporation for $3.3 billion in cash. The Corporation allocated $1.6 billion to goodwill and $1.3 billion to intangible assets as part of the preliminary purchase price allocation. U.S. Trust Corporation’s results of operations were included in the Corporation’s results beginning July 1, 2007.

On January 1, 2006, the Corporation acquired 100 percent of the outstanding stock of MBNA. MBNA’s results of operations were included in the Corporation’s results beginning January 1, 2006.

 

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Merger and Restructuring Charges

Merger and restructuring charges are recorded in the Consolidated Statement of Income and include incremental costs to integrate the operations of the Corporation and those of acquired entities. These charges represent costs associated with these one-time activities and do not represent ongoing costs of the fully integrated combined organization. The following table presents severance and employee-related charges, systems integrations and related charges, and other merger-related charges for the three and nine months ended September 30, 2007 and 2006.

 

     Three Months Ended September 30      Nine Months Ended September 30  

  (Dollars in millions)

   2007      2006      2007      2006  

Severance and employee-related charges

   $ 21      $ 40      $ 39      $ 74   

Systems integrations and related charges

     47        183        183        363  

Other

     16        46        48        124  
   

Total merger and restructuring charges (1)

   $ 84      $ 269      $ 270      $ 561  

 

 

(1)

Included for the three and nine months ended September 30, 2007 are merger-related charges of $46 million and $61 million related to the U.S. Trust Corporation acquisition and $38 million and $209 million related to the MBNA acquisition.

 

Merger-related Exit Cost and Restructuring Reserves

As of December 31, 2006, there were $125 million of exit cost reserves related to the MBNA acquisition, including $121 million for severance, relocation and other employee-related expenses and $4 million for contract terminations. During both the three and nine months ended September 30, 2007, $35 million was added to the exit cost reserves related to the U.S. Trust Corporation acquisition. Included in the $35 million were $30 million for severance and other employee-related expenses and $5 million for contract terminations. Cash payments of $12 million and $57 million during the three and nine months ended September 30, 2007, consisted of $12 million and $55 million of severance, relocation and other employee-related costs. In addition, cash payments of $2 million for contract terminations were recorded during the nine months ended September 30, 2007.

As of December 31, 2006, there were $67 million of restructuring reserves related to the MBNA acquisition, including $58 million related to severance and other employee-related expenses and $9 million related to contract terminations. During the three and nine months ended September 30, 2007, $21 million and $37 million were added to the restructuring reserve consisting of severance and other employee-related expenses associated with the MBNA and U.S. Trust Corporation acquisitions. Cash payments of $7 million and $54 million during the three and nine months ended September 30, 2007 consisted of $7 million and $49 million of severance and other employee-related costs. In addition, cash payments of $5 million for contract terminations have reduced this liability during the nine months ended September 30, 2007.

 

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Payments under exit cost and restructuring reserves associated with the MBNA merger are expected to be substantially completed in 2007 while payments associated with the U.S. Trust Corporation acquisition will continue through 2008. The following table presents the changes in exit cost and restructuring reserves for the three and nine months ended September 30, 2007 and 2006.

 

     Exit Cost Reserves (1, 2)        Restructuring Reserves (2, 3)  

  (Dollars in millions)

   2007        2006        2007        2006  

Balance, January 1

   $ 125        $ -        $ 67        $ -   

MBNA exit costs and restructuring charges

     -          368          16          74  

Cash payments

     (45 )        (67 )        (47 )        (4 )

Balance, June 30

     80          301          36          70  

MBNA exit costs and restructuring charges

     -          (69 )        2          59  

U.S. Trust Corporation exit costs and restructuring charges

     35          -          19          -  

Cash payments

     (12 )        (41 )        (7 )        (7 )

Balance, September 30

   $ 103        $ 191        $ 50        $ 122  

 

 

(1)

Exit cost reserves were established in purchase accounting resulting in an increase in goodwill.

 

 

(2)

At September 30, 2007, there were no exit cost and restructuring reserves related to the LaSalle acquisition. The Corporation will record exit cost and restructuring reserves related to the LaSalle acquisition beginning in the fourth quarter of 2007.

 

 

(3)

Restructuring reserves were established by a charge to merger and restructuring charges.

 

  NOTE 3 – Trading Account Assets and Liabilities

The following table presents the fair values of the components of trading account assets and liabilities at September 30, 2007 and December 31, 2006.

 

  (Dollars in millions)

   September 30
2007
     December 31
2006
 

Trading account assets

       

Corporate securities, trading loans and other

   $ 60,848      $ 53,923   

U.S. Government and agency securities (1)

     46,327        36,656  

Equity securities

     32,022        27,103  

Mortgage trading loans and asset-backed securities

     21,324        15,449  

Foreign sovereign debt

     18,844        19,921  

Total trading account assets

   $ 179,365      $ 153,052  

Trading account liabilities

       

U.S. Government and agency securities

   $ 38,650      $ 26,760  

Equity securities

     31,995        23,908  

Foreign sovereign debt

     8,532        9,261  

Corporate securities and other

     7,978        7,741  

Total trading account liabilities

   $ 87,155      $ 67,670  

 

 

(1)

Includes $18.8 billion and $22.7 billion at September 30, 2007 and December 31, 2006 of government-sponsored enterprise obligations that are not backed by the full faith and credit of the U.S. government.

 

  NOTE 4 – Derivatives

All derivatives are recognized on the Consolidated Balance Sheet at fair value taking into consideration the effects of legally enforceable master netting agreements that allow the Corporation to settle positive and negative positions and offset cash collateral held with the same counterparty on a net basis. For exchange-traded contracts, fair value is based on quoted market prices. For non-exchange traded contracts, fair value is based on dealer quotes, pricing models or quoted prices for

 

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instruments with similar characteristics. The Corporation designates at inception whether the derivative contract is considered hedging or non-hedging for SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133) accounting purposes. Derivatives designated as hedges for SFAS 133 purposes are either accounted for as cash flow, fair value or net investment hedges. Derivatives held for trading purposes are included in derivative assets or derivative liabilities with changes in fair value reflected in trading account profits (losses). Other derivatives that are used as economic hedges, but not designated in a hedging relationship for accounting purposes, are also included in derivative assets or derivative liabilities with changes in fair value recorded in mortgage banking income or other income. A detailed discussion of derivative trading activities and asset and liability management (ALM) activities are presented in Note 1 – Summary of Significant Accounting Principles and Note 4—Derivatives to the Consolidated Financial Statements filed as Exhibit 99.2 to the Corporation’s Current Report on Form 8-K filed on May 23, 2007.

The following table presents the contract/notional amounts and credit risk amounts at September 30, 2007 and December 31, 2006 of all the Corporation’s derivative positions. These derivative positions are primarily executed in the over-the-counter market. Credit risk associated with derivatives is measured as the net replacement cost in the event the counterparties with contracts in a gain position to the Corporation completely fail to perform under the terms of those contracts. The credit risk amounts take into consideration the effects of legally enforceable master netting agreements and on an aggregate basis have been reduced by the cash collateral applied against derivative assets. At September 30, 2007 and December 31, 2006, the cash collateral applied against derivative assets on the Consolidated Balance Sheet was $9.6 billion and $7.3 billion. In addition, at September 30, 2007 and December 31, 2006, the cash collateral placed against derivative liabilities was $7.4 billion and $6.5 billion.

 

     September 30, 2007      December 31, 2006  

  (Dollars in millions)

   Contract/
Notional (1)
     Credit
Risk
     Contract/
Notional (1)
     Credit
Risk
 

Interest rate contracts

                 

Swaps

   $ 22,339,658      $ 10,332      $ 18,185,655      $ 9,601   

Futures and forwards

     2,385,605        87        2,283,579        103  

Written options

     1,503,936        -        1,043,933        -  

Purchased options

     1,590,442        2,245        1,308,888        2,212  

Foreign exchange contracts

                 

Swaps

     535,712        6,871        451,462        4,241  

Spot, futures and forwards

     1,651,657        4,602        1,234,009        2,995  

Written options

     388,337        -        464,420        -  

Purchased options

     381,459        1,487        414,004        1,391  

Equity contracts

                 

Swaps

     57,808        1,742        32,247        577  

Futures and forwards

     19,427        87        19,947        24  

Written options

     214,339        -        102,902        -  

Purchased options

     236,880        6,937        104,958        7,513  

Commodity contracts

                 

Swaps

     13,242        726        4,868        1,129  

Futures and forwards

     21,300        39        13,513        2  

Written options

     17,364        -        9,947        -  

Purchased options

     16,764        227        6,796        184  

Credit derivatives

     2,959,027        5,050        1,497,869        756  
                           

Credit risk before cash collateral

          40,432             30,728  

Less: Cash collateral applied

              9,589                 7,289  

Total derivative assets

            $ 30,843               $ 23,439  

 

 

(1)

Represents the total contract/notional amount of the derivatives outstanding and includes both short and long positions.

 

The average fair value of derivative assets, less cash collateral, for the three months ended September 30, 2007 and December 31, 2006 was $30.9 billion and $24.3 billion. The average fair value of derivative liabilities for the three months ended September 30, 2007 and December 31, 2006 was $21.5 billion and $17.1 billion.

 

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Fair Value and Cash Flow Hedges

The Corporation uses various types of interest rate and foreign exchange derivative contracts to protect against changes in the fair value of its assets and liabilities due to fluctuations in interest rates and exchange rates (fair value hedges). The Corporation also uses these types of contracts to protect against changes in the cash flows of its assets and liabilities, and other forecasted transactions (cash flow hedges). During the next 12 months, net losses on derivative instruments included in accumulated other comprehensive income (OCI) of approximately $1.3 billion ($800 million after-tax) are expected to be reclassified into earnings. These net losses reclassified into earnings are expected to impact net interest income related to the respective hedged items.

The following table summarizes certain information related to the Corporation’s derivative hedges accounted for under SFAS 133 for the three and nine months ended September 30, 2007 and 2006.

 

     Three Months Ended September 30      Nine Months Ended September 30  

  (Dollars in millions)

   2007      2006      2007      2006  

Fair value hedges

                 

Hedge ineffectiveness recognized in net interest income

   $ 35      $ 6      $ (1)      $ 5   

Cash flow hedges

                 

Hedge ineffectiveness recognized in net interest income

     (8)        7        (1)        10  

Net gains on transactions which are probable of not occurring recognized in other income

     32        -        18        -  

The Corporation hedges its net investment in consolidated foreign operations determined to have functional currencies other than the U.S. dollar using forward foreign exchange contracts that typically settle in 90 days. The Corporation recorded net derivative losses in accumulated OCI associated with net investment hedges of $266 million and $568 million for the three and nine months ended September 30, 2007 as compared to losses of $94 million and $296 million for the same periods in the prior year.

 

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  NOTE 5 – Securities

The amortized cost, gross unrealized gains and losses, and fair value of available-for-sale (AFS) debt and marketable equity securities at September 30, 2007 and December 31, 2006 were:

 

  (Dollars in millions)

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

Available-for-sale debt securities, September 30, 2007

                 

U.S. Treasury securities and agency debentures

   $ 763      $ 2      $ (4)      $ 761   

Mortgage-backed securities (1)

     150,632        7        (5,719)        144,920  

Foreign securities

     7,739        4        (180)        7,563  

Corporate/Agency bonds

     3,799        6        (97)        3,708  

Other taxable securities (2)

     13,215        7        (52)        13,170  

Total taxable securities

     176,148        26        (6,052)        170,122  

Tax-exempt securities

     6,721        7        (72)        6,656  

Total available-for-sale debt securities

   $ 182,869      $ 33      $ (6,124)      $ 176,778  

Available-for-sale marketable equity securities (3)

   $ 3,313      $ 176      $ (195)      $ 3,294  

Available-for-sale debt securities, December 31, 2006

                 

U.S. Treasury securities and agency debentures

   $ 697      $ -      $ (9)      $ 688  

Mortgage-backed securities (1)

     161,693        4        (4,804)        156,893  

Foreign securities

     12,126        2        (78)        12,050  

Corporate/Agency bonds

     4,699        -        (96)        4,603  

Other taxable securities (2)

     12,077        10        (38)        12,049  

Total taxable securities

     191,292        16        (5,025)        186,283  

Tax-exempt securities

     6,493        64        (34)        6,523  

Total available-for-sale debt securities

   $ 197,785      $ 80      $ (5,059)      $ 192,806  

Available-for-sale marketable equity securities (3)

   $ 2,799      $ 408      $ (10)      $ 3,197  

 

 

(1)

Substantially all securities were issued by U.S. government-backed or government-sponsored enterprises.

 

 

(2)

Includes asset-backed securities.

 

 

(3)

Represents those AFS marketable equity securities that are recorded in other assets on the Consolidated Balance Sheet.

 

At September 30, 2007, the amortized cost and fair value of both taxable and tax-exempt held-to-maturity debt securities were $518 million. At December 31, 2006, the amortized cost and fair value of both taxable and tax-exempt held-to-maturity debt securities were $40 million. Effective January 1, 2007, the Corporation redesignated $909 million of debt securities at amortized cost from AFS to held-to-maturity.

At September 30, 2007 and December 31, 2006, accumulated net unrealized losses on AFS debt and marketable equity securities included in accumulated OCI were $3.9 billion and $2.9 billion, net of the related income tax benefit of $2.2 billion and $1.7 billion, respectively.

For all AFS debt and marketable equity securities that are in an unrealized loss position, we have the intent and ability to hold these securities to recovery.

 

Certain Corporate and Strategic Investments

In August 2007, the Corporation made a $2.0 billion investment in Countrywide Financial Corporation (Countrywide), the largest mortgage lender in the U.S., in the form of a Series B non-voting convertible preferred security yielding 7.25 percent, which is recorded in other assets. The security is convertible into common stock of Countrywide at $18 per share,

 

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which would result in an ownership interest of approximately 16 percent in Countrywide if converted. This investment is accounted for under the cost method of accounting.

The Corporation owns approximately eight percent, or 19.1 billion shares, of the stock of China Construction Bank (CCB) which is recorded in other assets. These shares are accounted for at cost as they are non-transferable until October 2008. The Corporation also holds an option to increase its ownership interest in CCB to 19.1 percent. This option expires in February 2011. The strike price of the option is based on the initial public offering price that steps up on an annual basis beginning at 103 percent and is capped at 118 percent depending on when the option is exercised.

Additionally, the Corporation owns approximately 137.0 million and 41.1 million of preferred and common shares, respectively, of Banco Itaú Holding Financeira S.A. (Banco Itaú) at September 30, 2007 which are recorded in other assets. These shares are accounted for at cost as they are non-transferable until May 2009.

The shares of CCB and Banco Itaú are currently carried at cost but, in accordance with GAAP, will be accounted for as AFS marketable equity securities and carried at fair value with an offset to accumulated OCI beginning in the fourth quarter of 2007 and second quarter of 2008. Dividend income on these investments is accounted for as part of equity investment income. The cost of the CCB and Banco Itaú investments was $3.0 billion and $2.6 billion. The fair values of the CCB shares and Banco Itaú shares were approximately $17.5 billion and $4.5 billion at September 30, 2007.

The Corporation has a 24.9 percent, or $2.7 billion, investment in Grupo Financiero Santander Serfin (Santander) which is recorded in other assets. This investment is accounted for under the equity method of accounting and income is recorded in equity investment income.

For additional information on securities, see Note 1 – Summary of Significant Accounting Principles and Note 5 – Securities to the Consolidated Financial Statements filed as Exhibit 99.2 to the Corporation’s Current Report on Form 8-K filed on May 23, 2007.

 

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  NOTE 6 – Outstanding Loans and Leases

Outstanding loans and leases at September 30, 2007 and December 31, 2006 were:

 

  (Dollars in millions)

   September 30
2007
     December 31
2006
 

Consumer

       

Residential mortgage

   $ 271,753      $ 241,181   

Credit card – domestic

     58,716        61,195  

Credit card – foreign

     12,986        10,999  

Home equity (1)

     101,046        87,893  

Direct/Indirect consumer (1)

     70,424        55,504  

Other consumer (1, 2)

     7,780        8,933  

Total consumer

     522,705        465,705  

Commercial

       

Commercial – domestic (3)

     177,251        161,982  

Commercial real estate (4)

     40,374        36,258  

Commercial lease financing

     20,357        21,864  

Commercial – foreign

     28,325        20,681  

Total commercial loans measured at historical cost

     266,307        240,785  

Commercial loans measured at fair value (5)

     4,525        n/a  

Total commercial

     270,832        240,785  

Total loans and leases

   $ 793,537      $ 706,490  

 

 

(1)

Home equity loans of $13.0 billion at December 31, 2006 have been reclassified to home equity from direct/indirect consumer and other consumer to conform to the current period presentation.

 

 

(2)

Includes foreign consumer loans of $4.6 billion and $6.2 billion, and consumer finance loans of $3.1 billion and $2.8 billion at September 30, 2007 and December 31, 2006.

 

 

(3)

Includes small business commercial – domestic loans of $16.4 billion and $13.7 billion at September 30, 2007 and December 31, 2006.

 

 

(4)

Includes domestic commercial real estate loans of $39.1 billion and $35.7 billion, and foreign commercial real estate loans of $1.2 billion and $578 million at September 30, 2007 and December 31, 2006.

 

 

(5)

Certain commercial loans are measured at fair value in accordance with SFAS 159 and include commercial – domestic loans of $3.63 billion, commercial – foreign loans of $672 million and commercial real estate loans of $224 million at September 30, 2007. See Note 15 – Fair Value Disclosures to the Consolidated Financial Statements for additional discussion of fair value for certain financial instruments.

n/a = not applicable

The following table presents the recorded loan amounts, without consideration for the specific component of the allowance for loan and lease losses, that were considered individually impaired in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” (SFAS 114) at September 30, 2007 and December 31, 2006. SFAS 114 impairment includes performing troubled debt restructurings and excludes all commercial leases.

 

  (Dollars in millions)

   September 30
2007
     December 31
2006
 

Commercial – domestic (1)

   $ 766      $ 586   

Commercial real estate

     352        118  

Commercial – foreign

     16        13  

Total impaired loans

   $ 1,134      $ 717  

 

 

(1)

Includes small business commercial – domestic loans of $97 million and $79 million at September 30, 2007 and December 31, 2006.

 

At September 30, 2007 and December 31, 2006, nonperforming loans and leases, including impaired and nonaccrual consumer loans, totaled $3.2 billion and $1.8 billion. In addition, included in other assets were consumer and commercial nonperforming loans held-for-sale of $93 million and $80 million at September 30, 2007 and December 31, 2006.

 

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  NOTE 7 – Allowance for Credit Losses

The following table summarizes the changes in the allowance for credit losses for the three and nine months ended September 30, 2007 and 2006.

 

    

Three Months Ended

September 30

      

Nine Months Ended

September 30

 

  (Dollars in millions)

   2007        2006        2007        2006  

Allowance for loan and lease losses, beginning of period

   $ 9,060        $ 9,080        $ 9,016        $ 8,045   

Transition adjustment due to the adoption of SFAS 159

     -          -          (32 )        -  

MBNA balance, January 1, 2006

     -          -          -          577  

Loans and leases charged off

     (1,897 )        (1,637 )        (5,445 )        (4,161 )

Recoveries of loans and leases previously charged off

     324          360          950          1,039  

Net charge-offs

     (1,573 )        (1,277 )        (4,495 )        (3,122 )

Provision for loan and lease losses

     2,014          1,165          5,050          3,440  

Other (1)

     34          (96 )        (4 )        (68 )

Allowance for loan and lease losses, September 30

     9,535          8,872          9,535          8,872  

Reserve for unfunded lending commitments, beginning of period

     376          395          397          395  

Transition adjustment due to the adoption of SFAS 159

     -          -          (28 )        -  

Provision for unfunded lending commitments

     16          -          25          -  

Other

     -          (7 )        (2 )        (7 )

Reserve for unfunded lending commitments, September 30

     392          388          392          388  

Allowance for credit losses, September 30

   $ 9,927        $ 9,260        $ 9,927        $ 9,260  

 

 

(1)

Includes $25 million as of July 1, 2007 related to the acquisition of U.S. Trust Corporation.

 

  NOTE 8 – Securitizations

The Corporation securitizes loans which may be serviced by the Corporation or by third parties. With each securitization the Corporation may retain all or a portion of the securities, subordinated tranches, interest-only strips, subordinated interests in accrued interest and fees on the securitized receivables, and, in some cases, cash reserve accounts, all of which are known as retained interests. These retained interests are recorded in other assets and/or AFS debt securities and are carried at fair value or amounts that approximate fair value with changes recorded in income or accumulated OCI. Changes in the fair value for credit card related interest-only strips are recorded in card income.

 

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As of September 30, 2007 and December 31, 2006 the aggregate debt securities outstanding for the Corporation’s credit card securitization trusts were $100.4 billion and $96.8 billion. Key assumptions used in measuring the fair value of certain interests that continue to be held by the Corporation (included in other assets) from credit card securitizations and the sensitivity of the current fair value of residual cash flows to changes in those assumptions are as follows:

 

  (Dollars in millions)

   September 30
2007
       December 31
2006
 

Carrying amount of residual interests (at fair value) (1)

   $ 3,040        $ 2,929  

Balance of unamortized securitized loans

     102,068          98,295  

Weighted average life to call or maturity (in years)

     0.3          0.3  

Monthly payment rate

     11.7-16.6   %        11.2-19.8   %  

Impact on fair value of 10% favorable change

   $ 48        $ 43  

Impact on fair value of 25% favorable change

     140          133  

Impact on fair value of 10% adverse change

     (35 )        (38 )

Impact on fair value of 25% adverse change

     (83 )        (82 )

Expected credit losses (annual rate)

     3.4-5.7   %        3.8-5.8   %

Impact on fair value of 10% favorable change

   $ 121        $ 86  

Impact on fair value of 25% favorable change

     306          218  

Impact on fair value of 10% adverse change

     (121 )        (85 )

Impact on fair value of 25% adverse change

     (302 )        (211 )

Residual cash flows discount rate (annual rate)

     11.5   %        12.5   %

Impact on fair value of 100 bps favorable change

   $ 11        $ 12  

Impact on fair value of 200 bps favorable change

     15          17  

Impact on fair value of 100 bps adverse change

     (13 )        (14 )

Impact on fair value of 200 bps adverse change

     (26 )        (27 )

 

 

(1)

Residual interests include interest-only strips, subordinated tranches, subordinated interests in accrued interest and fees on the securitized receivables and cash reserve accounts which are carried at fair value or amounts that approximate fair value.

The sensitivities in the preceding table are hypothetical and should be used with caution. As the amounts indicate, changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of an interest that continues to be held by the Corporation is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Additionally, the Corporation has the ability to hedge interest rate risk associated with retained residual positions. The above sensitivities do not reflect any hedge strategies that may be undertaken to mitigate such risk.

Principal proceeds from collections reinvested in revolving credit card securitizations were $45.7 billion and $135.0 billion for the three and nine months ended September 30, 2007, and $41.6 billion and $120.8 billion for the three and nine months ended September 30, 2006. Contractual credit card servicing fee income totaled $526 million and $1.5 billion for the three and nine months ended September 30, 2007, and $472 million and $1.4 billion for the three and nine months ended September 30, 2006. Other cash flows received on credit card securitization interests that continued to be held by the Corporation were $1.7 billion and $4.9 billion for the three and nine months ended September 30, 2007, and $1.7 billion and $5.1 billion for the three and nine months ended September 30, 2006.

 

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  NOTE 9 – Variable Interest Entities

The following table presents total assets of those VIEs in which the Corporation holds a significant variable interest and, in the unlikely event that all of the assets in the VIEs become worthless, the Corporation’s maximum exposure to loss. The Corporation’s maximum exposure to loss incorporates not only potential losses associated with assets recorded on the Corporation’s balance sheet but also off-balance sheet commitments, such as unfunded liquidity and lending commitments and other contractual arrangements.

 

     Consolidated (1)      Unconsolidated  

  (Dollars in millions)

   Total
Assets
     Loss
Exposure
     Total
Assets
     Loss
Exposure
 

Variable interest entities, September 30, 2007

                 

Corporation-sponsored multi-seller conduits

   $ 9,191      $ 12,603      $ 28,674      $ 50,024   

Collateralized debt obligations

     3,415        3,415        13,573        12,281  

Leveraged lease trusts

     6,187        6,187        -        -  

Other

     6,354        4,965        20,820        8,583  

Total variable interest entities

   $ 25,147      $ 27,170      $ 63,067      $ 70,888  

Variable interest entities, December 31, 2006

                 

Corporation-sponsored multi-seller conduits

   $ 9,090      $ 11,515      $ 18,983      $ 29,836  

Collateralized debt obligations

     -        -        8,489        7,658  

Leveraged lease trusts

     8,575        8,575        -        -  

Other

     4,717        3,019        12,709        9,310  

Total variable interest entities

   $ 22,382      $ 23,109      $ 40,181      $ 46,804  

 

 

(1)

The Corporation consolidates VIEs when it is the primary beneficiary that will absorb the majority of the expected losses or expected residual returns of the VIEs or both.

Corporation-sponsored multi-seller conduits

The Corporation administers three multi-seller conduits which provide a low-cost funding alternative to its customers by facilitating their access to the commercial paper market. These customers sell or otherwise transfer assets to the conduits, which in turn issue high-grade, short-term commercial paper that is collateralized by the underlying assets. The Corporation receives fees for providing combinations of liquidity and standby letters of credit (SBLCs) or similar loss protection commitments to the conduits. The Corporation is the primary beneficiary of one conduit which is included in the Consolidated Financial Statements of the Corporation. The Corporation does not consolidate the other two conduits which issued capital notes to independent third parties as it does not expect to absorb a majority of the variability of the conduits. The assets of the consolidated conduit are recorded in AFS and held-to-maturity debt securities and other assets.

At September 30, 2007, the Corporation’s liquidity commitments to these conduits were collateralized by various classes of assets, including student loans of 24 percent, credit card loans of 13 percent, auto loans and trade receivables of eight percent each, and prime residential mortgages of four percent. Less than one percent of these commitments are collateralized by subprime residential mortgages. In addition, 27 percent of the Corporation’s commitments were collateralized by the conduits’ short-term lending obligations to investment funds (e.g., real estate limited partnerships, private equity or venture capital funds). Amounts advanced under these obligations are expected to be repaid when the investment funds issue capital calls to their qualified equity investors. Net revenues earned from fees associated with these commitments were $51 million and $135 million for the three and nine months ended September 30, 2007, and $34 million and $89 million for the three and nine months ended September 30, 2006.

 

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Collateralized debt obligations

Collateralized debt obligations (CDOs) are special purpose entities (SPEs) that hold diversified pools of fixed income securities. They issue multiple tranches of debt securities, including commercial paper, and equity securities. The Corporation receives fees for structuring the CDOs and/or placing debt securities with third party investors.

At September 30, 2007 and December 31, 2006, the Corporation provided liquidity support in the form of written put options on $10.0 billion and $2.1 billion of commercial paper issued by CDOs including $3.2 billion issued by the consolidated CDO at September 30, 2007. The commercial paper is the most senior class of securities issued by the CDOs and benefits from the subordination of all other securities, including AAA-rated securities, issued by the CDOs. The Corporation is obligated under the written put options to provide funding to the CDOs by purchasing the commercial paper at predetermined contractual yields in the event of a severe disruption in the short-term funding market. See Note 11 – Commitments and Contingencies to the Consolidated Financial Statements for more information on the written put options. These written put options are recorded as derivatives on the Consolidated Balance Sheet and are carried at fair value with changes in fair value recorded in trading account profits (losses). Derivative activity related to these entities is included in Note 4 – Derivatives to the Consolidated Financial Statements. The assets of the consolidated conduit are recorded in trading account assets.

The Corporation also administers a CDO conduit that obtains funds by issuing commercial paper to third party investors. The conduit held $5.5 billion of assets at both September 30, 2007 and December 31, 2006 consisting of super senior tranches of debt securities issued by other CDOs. These securities benefit from overcollateralization exceeding the amount that would be required for a AAA rating. The Corporation provides liquidity support equal to the amount of assets in this conduit which obligates it to purchase the commercial paper at a predetermined contractual yield in the event of a severe disruption in the short-term funding market.

Net revenues earned from fees associated with these liquidity commitments were $2 million and $5 million for the three and nine months ended September 30, 2007, and $1 million and $2 million for the three and nine months ended September 30, 2006.

Leveraged lease trusts

The Corporation’s net investment in leveraged lease trusts totaled $6.2 billion and $8.6 billion at September 30, 2007 and December 31, 2006. These amounts, which were recorded in loans and leases, represent the Corporation’s maximum loss exposure to these entities in the unlikely event that the leveraged lease investments become worthless. Debt issued by the leveraged lease trusts is nonrecourse to the Corporation. The Corporation has no liquidity exposure to these leveraged lease trusts.

Other

Other consolidated VIEs at September 30, 2007 and December 31, 2006 consisted primarily of securitization vehicles, including an asset acquisition conduit that holds securities on our behalf and term securitization vehicles that did not meet qualified special purpose entity (QSPE) status, as well as managed investment vehicles that invest in financial assets, primarily debt securities. The Corporation’s maximum exposure to loss of these VIEs included $1.3 billion and $1.1 billion of liquidity exposure to the consolidated asset acquisition conduit and $348 million and $272 million of liquidity exposure to consolidated trusts that hold municipal bonds at September 30, 2007 and December 31, 2006. The assets of these consolidated VIEs were recorded in trading account assets, AFS debt securities and other assets. Other unconsolidated VIEs at September 30, 2007 and December 31, 2006 consisted primarily of securitization vehicles, managed investment vehicles that invest in financial assets, primarily debt securities, and investments in affordable housing investment partnerships. Revenues associated with administration, asset management, liquidity, and other services were $4 million and $13 million for the three and nine months ended September 30, 2007 and $5 million and $17 million for the three and nine months ended September 30, 2006.

 

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  NOTE 10 – Goodwill and Intangible Assets

The following tables present goodwill and intangible assets at September 30, 2007 and December 31, 2006.

 

     September 30      December 31  

  (Dollars in millions)

   2007      2006  

Global Consumer and Small Business Banking

   $ 38,895      $ 38,760   

Global Corporate and Investment Banking

     21,438        21,420  

Global Wealth and Investment Management

     6,891        5,243  

All Other

     209        239  

Total goodwill

   $ 67,433      $ 65,662  

The gross carrying values and accumulated amortization related to intangible assets at September 30, 2007 and December 31, 2006 are presented below:

 

     September 30, 2007      December 31, 2006  

  (Dollars in millions)

   Gross Carrying
Value
     Accumulated
Amortization
    

Gross Carrying

Value

     Accumulated
Amortization
 

Purchased credit card relationships

   $ 6,971      $ 1,764      $ 6,790      $ 1,159   

Core deposit intangibles

     3,894        2,699        3,850        2,396  

Affinity relationships

     1,684        356        1,650        205  

Other intangibles

     2,675        770        1,525        633  

Total intangible assets

   $ 15,224      $ 5,589      $ 13,815      $ 4,393  

The above tables include $1.6 billion of goodwill recorded in Global Wealth and Investment Management and $1.3 billion of intangible assets related to the preliminary purchase price allocation of U.S. Trust Corporation.

Amortization of intangibles expense was $429 million and $441 million for the three months ended September 30, 2007 and 2006, and $1.2 billion and $1.3 billion for the nine months ended September 30, 2007 and 2006. The Corporation estimates aggregate amortization expense will be approximately $425 million for the fourth quarter of 2007. In addition, the Corporation estimates that aggregate amortization expense will be approximately $1.6 billion, $1.3 billion, $1.3 billion, $1.0 billion and $900 million for 2008 through 2012, respectively. These estimates exclude the impact of the LaSalle acquisition.

 

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  NOTE 11 – Commitments and Contingencies

In the normal course of business, the Corporation enters into a number of off-balance sheet commitments. These commitments expose the Corporation to varying degrees of credit and market risk and are subject to the same credit and market risk limitation reviews as those instruments recorded on the Corporation’s Consolidated Balance Sheet.

 

Credit Extension Commitments

The Corporation enters into commitments to extend credit such as loan commitments, SBLCs and commercial letters of credit to meet the financing needs of its customers. For additional information on commitments to extend credit, see Note 13 – Commitments and Contingencies to the Consolidated Financial Statements filed on Exhibit 99.2 to the Corporation’s Current Report on Form 8-K filed on May 23, 2007. The unfunded legally binding lending commitments shown in the following table are net of amounts distributed (e.g., syndicated) to other financial institutions of $35.4 billion and $30.5 billion at September 30, 2007 and December 31, 2006. The carrying amount of these commitments, excluding fair value adjustments as discussed below, was $422 million and $444 million at September 30, 2007 and December 31, 2006 and was recorded in accrued expenses and other liabilities. At September 30, 2007, the carrying amount included deferred revenue of $30 million and a reserve for unfunded legally binding lending commitments of $392 million. At December 31, 2006, the carrying amount included deferred revenue of $47 million and a reserve for unfunded legally binding lending commitments of $397 million.

The table below also includes the notional value of commitments of $20.2 billion which are measured at fair value in accordance with SFAS 159 at September 30, 2007. However, the table below excludes the fair value adjustment of $454 million on these commitments that was recorded in accrued expenses and other liabilities. See Note 15 – Fair Value Disclosures to the Consolidated Financial Statements for additional information on the adoption of SFAS 159.

 

  (Dollars in millions)

  

Expires in 1

year or less

  

Expires after 1

year through 3

years

  

Expires after 3

years through

5 years

  

Expires after

5 years

   Total  

Credit extension commitments,

  September 30, 2007

              

Loan commitments

   $ 173,480    $ 70,265    $ 97,550    $ 26,907    $ 368,202   

Home equity lines of credit

     1,614      1,805      2,706      104,845      110,970  

Standby letters of credit and financial guarantees

     28,280      11,057      6,302      8,326      53,965  

Commercial letters of credit

     4,019      33      41      962      5,055  

Legally binding commitments (1)

     207,393      83,160      106,599      141,040      538,192  

Credit card lines

     874,417      17,018      -      -      891,435  

Total credit extension commitments

   $ 1,081,810    $ 100,178    $ 106,599    $ 141,040    $ 1,429,627  

Credit extension commitments,

  December 31, 2006

              

Loan commitments

   $ 151,604    $ 60,637    $ 90,988    $ 32,133    $ 335,362  

Home equity lines of credit

     1,738      1,801      2,742      91,919      98,200  

Standby letters of credit and financial guarantees

     29,213      10,712      6,744      6,337      53,006  

Commercial letters of credit

     3,880      180      27      395      4,482  

Legally binding commitments (1)

     186,435      73,330      100,501      130,784      491,050  

Credit card lines

     840,215      13,377      -      -      853,592  

Total credit extension commitments

   $ 1,026,650    $ 86,707    $ 100,501    $ 130,784    $ 1,344,642  

 

 

(1)

Includes commitments to VIEs disclosed in Note 9 – Variable Interest Entities to the Consolidated Financial Statements, including $50.0 billion and $29.8 billion to corporation-sponsored multi-seller conduits and $5.5 billion for both periods to CDOs at September 30, 2007 and December 31, 2006. Also includes commitments to SPEs that are not disclosed in Note 9 – Variable Interest Entities to the Consolidated Financial Statements because the Corporation does not hold a significant variable interest or because they are QSPEs, including $4.3 billion and $2.3 billion to municipal bond trusts and $2.7 billion and $4.6 billion to customer-sponsored conduits at September 30, 2007 and December 31, 2006.

Legally binding commitments to extend credit generally have specified rates and maturities. Certain of these commitments have adverse change clauses that help to protect the Corporation against deterioration in the borrowers’ ability to pay.

 

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The Corporation also facilitates bridge financing (high grade debt, high yield debt and equity) to fund acquisitions, recapitalizations and other short-term needs as well as provide syndicated financing for clients. These concentrations are managed in part through our established “originate to distribute” strategy. These client transactions are sometimes large and leveraged. They can also have a higher degree of risk as we are providing offers or commitments for various components of the clients’ capital structures, including lower rated unsecured and subordinated debt tranches and/or equity. In many cases, these offers to finance will not be accepted. If accepted, these conditional commitments are often retired prior to or shortly following funding via the placement of securities, syndication or the client’s decision to terminate. Where we have a commitment and there is a market disruption or other unexpected event, there may be heightened exposure in the portfolios, and higher potential for loss, unless an orderly disposition of the exposure can be made. The Corporation does not believe these commitments are necessarily indicative of actual risk or funding requirements as the commitments may expire unused, the borrower may not be successful in completing the proposed transaction or may utilize multiple financing sources, including other investment and commercial banks, as well as accessing the general capital markets instead of drawing on the commitment. In addition, the Corporation may reduce its portion of the commitment through syndications to investors and/or lenders prior to funding. Therefore, these commitments are generally significantly greater than the amounts the Corporation will ultimately fund. Additionally, the borrower’s ability to draw on the commitment may be subject to there being no material adverse change in the borrower’s financial condition, among other factors. Commitments also generally contain certain flexible pricing features to adjust for changing market conditions prior to closing. The Corporation’s share of the leveraged finance forward calendar was $28.1 billion at September 30, 2007 compared to $33.5 billion at June 30, 2007 with the change being transactions that were syndicated of $700 million, those closed and not yet syndicated of $4.3 billion and client-terminated transactions of $8.4 billion, offset by new transactions of $8.1 billion.

During the three months ended September 30, 2007, there were extreme dislocations in the financial markets in which the Corporation operates and it was unable to distribute all of its funded commitments in excess of designated hold positions via the placement of securities or syndication. Much of the impact associated with corporate credit was centered in the leveraged finance space. At September 30, 2007, the Corporation’s funded exposure in excess of designated hold positions for the leveraged finance business was $4.3 billion. These positions are carried in other assets at the lower of cost or market.

The Corporation recorded a loss of $247 million ($97 million related to funded loans and $150 million related to unfunded commitments), net of fees of $528 million, in earnings related to funded exposures in excess of designated hold positions and the Corporation’s share of the forward calendar, principally leveraged loans and loan commitments.

 

Other Commitments

Principal Investments and Other Equity Investments

At September 30, 2007 and December 31, 2006, the Corporation had unfunded equity investment commitments of approximately $4.2 billion and $2.8 billion. These commitments primarily relate to bridge equity commitments and those equity commitments included in the Corporation’s Principal Investing business, which is comprised of a diversified portfolio of investments in privately-held and publicly-traded companies at all stages of their life cycle from start-up to buyout. These investments are made either directly in a company or held through a fund and are accounted for at fair value. The Corporation selectively provides equity bridge financing to facilitate its clients’ investment activities. These conditional commitments are often retired prior to or shortly following funding via syndication or the client’s decision to terminate. Where the Corporation has a binding equity bridge commitment and there is a market disruption or other unexpected event, there may be heightened exposure in the portfolio and higher potential for loss, unless an orderly disposition of the exposure can be made. Included in the Corporation’s unfunded equity investment commitments were unfunded bridge equity commitments of $1.8 billion and $1.2 billion at September 30, 2007 and December 31, 2006. At September 30, 2007, the Corporation had funded $197 million of equity bridges that it still intends to distribute. These equity instruments were recorded at fair value.

U.S. Government Guaranteed Charge Cards

At September 30, 2007 and December 31, 2006, the unfunded lending commitments related to charge cards (nonrevolving card lines) to individuals and government entities guaranteed by the U.S. government in the amount of $10.7 billion and $9.6 billion were not included in credit card line commitments in the previous table. The outstanding balances related to these charge cards were $265 million and $193 million at September 30, 2007 and December 31, 2006.

 

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Loan Purchases

At September 30, 2007, the Corporation had no whole mortgage loan purchase commitments related to our ALM activities. At December 31, 2006, the Corporation had whole mortgage loan purchase commitments related to our ALM activities of $8.5 billion, all of which settled in the first quarter of 2007.

In 2005, the Corporation entered into an agreement for the committed purchase of retail automotive loans over a five-year period, ending June 30, 2010. For the nine months ended September 30, 2007, the Corporation purchased $4.5 billion of loans under this agreement. In 2006, the Corporation purchased $7.5 billion of such loans. Under the agreement, the Corporation is committed to purchase up to $5.0 billion for the fiscal period July 1, 2007 to June 30, 2008 and $10.0 billion in each of the agreement’s following two fiscal years. As of September 30, 2007, the remaining commitment amount was $25.0 billion.

Operating Leases

The Corporation is a party to operating leases for certain of its premises and equipment. Commitments under these leases approximate $1.5 billion, $1.6 billion, $1.4 billion, $1.3 billion and $1.2 billion for 2007 through 2011, respectively, and $7.9 billion for all years thereafter.

Other Commitments

The Corporation provided support to a cash fund advised within its Global Wealth and Investment Management business segment by purchasing certain assets for cash at fair market value and by committing to provide a limited amount of capital to the fund. In addition, the Corporation may from time to time, but is under no obligation to, provide additional support to funds advised within the Global Wealth and Investment Management business segment. Future support, if any, may take the form of a commitment to provide capital to the funds or to purchase certain assets from the funds.

 

Other Guarantees

Written Put Options

At September 30, 2007 and December 31, 2006, the Corporation provided liquidity support in the form of written put options on $10.0 billion and $2.1 billion of commercial paper issued by CDOs, including $3.2 billion issued by a consolidated CDO at September 30, 2007. The commercial paper is the most senior class of securities issued by the CDOs and benefits from the subordination of all other securities, including AAA-rated securities, issued by the CDOs. The Corporation is obligated under the written put options to provide funding to the CDOs by purchasing the commercial paper at predetermined contractual yields in the event of a severe disruption in the short-term funding market. These agreements have various maturities ranging from two to five years. The underlying collateral in the CDOs includes mortgage-backed securities, asset-backed securities, and CDO securities issued by other vehicles. These written put options are recorded as derivatives on the Consolidated Balance Sheet and are carried at fair value with changes in fair value recorded in trading account profits (losses). Derivative activity related to these entities is included in Note 4 – Derivatives to the Consolidated Financial Statements.

 

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Merchant Services

The Corporation provides credit and debit card processing services to various merchants by processing credit and debit card transactions on their behalf. In connection with these services, a liability may arise in the event of a billing dispute between the merchant and a cardholder that is ultimately resolved in the cardholder’s favor and the merchant defaults upon its obligation to reimburse the cardholder. A cardholder, through its issuing bank, generally has until the later of up to six months after the date a transaction is processed or the delivery of the product or service to present a chargeback to the Corporation as the merchant processor. If the Corporation is unable to collect this amount from the merchant, it bears the loss for the amount paid to the cardholder. For the three months ended September 30, 2007 and 2006, the Corporation processed $90.1 billion and $97.0 billion of transactions and recorded losses as a result of these chargebacks of $2 million and $4 million. For the nine months ended September 30, 2007 and 2006, the Corporation processed $264.5 billion and $282.6 billion of transactions and recorded losses as a result of these chargebacks of $10 million and $13 million.

At September 30, 2007 and December 31, 2006, the Corporation held as collateral approximately $21 million and $32 million of merchant escrow deposits which the Corporation has the right to offset against amounts due from the individual merchants. The Corporation also has the right to offset any payments with cash flows otherwise due to the merchant. Accordingly, the Corporation believes that the maximum potential exposure is not representative of the actual potential loss exposure. The Corporation believes the maximum potential exposure for chargebacks would not exceed the total amount of merchant transactions processed through Visa and MasterCard for the last six months, which represents the claim period for the cardholder, plus any outstanding delayed-delivery transactions. As of September 30, 2007 and December 31, 2006, the maximum potential exposure totaled approximately $150.2 billion and $176.0 billion.

Other Guarantees

For additional information on other guarantees, see Note 13 – Commitments and Contingencies to the Consolidated Financial Statements filed on Exhibit 99.2 to the Corporation’s Current Report on Form 8-K filed on May 23, 2007. For additional information on recourse obligations related to residential mortgage loans sold and other guarantees related to securitizations, see Note 9 – Securitizations to the Consolidated Financial Statements filed on Exhibit 99.2 to the Corporation’s Current Report on Form 8-K filed on May 23, 2007.

 

Litigation and Regulatory Matters

The following supplements the disclosure in Note 13 – Commitments and Contingencies to the Consolidated Financial Statements filed as Exhibit 99.2 to the Corporation’s Current Report on Form 8-K filed on May 23, 2007 and the Corporation’s Quarterly Reports on Form 10-Q for the periods ended March 31, 2007 and June 30, 2007.

Adelphia Communications Corporation

On August 17, 2007, the U.S. Bankruptcy Court for the Southern District of New York (the Bankruptcy Court) dismissed the claims asserted by the Equity Committee against Bank of America, N.A., Banc of America Securities LLC (BAS) and Fleet Securities, Inc. (FSI) (in some cases with leave to amend and replead). On September 5, 2007, the U.S. District Court for the Southern District of New York granted Bank of America, N.A., BAS and FSI leave to appeal the Bankruptcy Court’s denial of motions to dismiss certain claims asserted by the Creditors’ Committee.

In re Initial Public Offering Securities Litigation

On September 27, 2007, the plaintiffs In re Initial Public Offering Securities Litigation filed new motions to certify as class actions six of the 309 cases, which the defendants will oppose.

IPO Underwriting Fee Litigation

BAS, Robertson Stephens, Inc., and other underwriters have been named as defendants in purported class actions, captioned In re Public Offering Fee Antitrust Litigation and In re Issuer Plaintiff Initial Public Offering Fee Antitrust Litigation, filed in the U.S. District Court for the Southern District of New York alleging that underwriters conspired to fix the underwriters’ discount at 7% of the offering price in certain initial public offerings (IPOs). The complaints, which have been filed by both purchasers and certain issuers in IPOs, seek treble damages and injunctive relief. On February 24, 2004,

 

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the district court granted the defendants’ motion to dismiss as to the purchasers’ damages claims. On April 18, 2006, the district court denied class certification with respect to the issuers’ damages claims. On September 11, 2007, the U.S. Court of Appeals for the Second Circuit reversed the order denying class certification as to the issuers’ damages claims.

Refco

On August 21, 2007, BAS was named as a defendant in a lawsuit, Kirschner v. Grant Thornton, et al., filed in the Circuit Court of Cook County, Illinois on behalf of the estate of Refco Inc. and certain of its affiliates (Refco). The lawsuit, which seeks unspecified damages, names as other defendants Refco’s outside auditors, certain officers and directors of Refco, other financial services companies, and others. The lawsuit includes claims against BAS for aiding and abetting breaches of fiduciary duty by Refco insiders in connection with Refco’s senior subordinated notes offering in August 2004 and Refco’s initial public offering in August 2005. Certain defendants have removed the lawsuit to the U.S. District Court for the Northern District of Illinois. Plaintiffs are seeking to have it remanded to state court.

Parmalat Finanziaria S.p.A.

On July 24, 2007, the U.S. District Court for the Southern District of New York granted the Corporation’s motion to dismiss for lack of subject matter jurisdiction the claims of foreign purchaser plaintiffs in In re Parmalat Securities Litigation (Southern Alaska Carpenters Pension Fund et al. v. Bonlat Financing Corporation et al.).

On August 8, 2007, the district court granted the Corporation’s motions to dismiss the actions entitled Gerald K. Smith, Litigation Trustee v. Bank of America Corporation, et al. (the Farmland Action) and G. Peter Pappas in his capacity as the Plan Administrator of the Plan of Liquidation of Parmalat-USA Corporation v. Bank of America Corporation, et al. (the Parmalat USA Action). The district court entered final judgment on September 5, 2007. On September 7, 2007, plaintiffs filed motions to amend the judgment and for leave to amend, which are pending. On September 24, 2007, plaintiffs filed notices of appeal to the U.S. Court of Appeals for the Second Circuit.

On October 1, 2007 the Public Prosecutors Office of Milan filed a criminal charge against three former employees for an alleged violation of Article 640 of the Italian Criminal Code. The charge alleges that these individuals committed fraud upon the Italian state in December 2001 in connection with the structuring of certain payments relating to a single financial transaction with Parmalat. Another former employee is noted as being under investigation but is not currently charged. The charge indicates potential damages of less than $1 million.

Richards

On September 20, 2007, the Corporation and the other named defendants agreed in principle with class counsel to settle all claims brought on behalf of the class. The agreement is subject to the execution of a definitive settlement agreement and court approval.

 

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  NOTE 12 – Shareholders’ Equity and Earnings Per Common Share

 

Common Stock

The following table presents share repurchase activity for the three and nine months ended September 30, 2007 and 2006, including total common shares repurchased under announced programs, weighted average per share price and the remaining buyback authority under announced programs.

 

  (Dollars in millions, except per share information; shares in thousands)

   Common Shares
Repurchased (1)
   Weighted Average
Per Share Price
   Remaining Buyback Authority (2)  
         Amounts    Shares  

July 1 – 31, 2007

   1,100    $ 47.88    $ 15,628    200,538   

August 1 – 31, 2007

   3,600      49.27      13,849    196,938  

September 1 – 30, 2007

   4,880      49.98      13,605    192,058  

Three months ended September 30, 2007

   9,580      49.47      

Nine months ended September 30, 2007

   71,030      51.61              

  (Dollars in millions, except per share information; shares in thousands)

   Common Shares
Repurchased (3)
   Weighted Average
Per Share Price
   Remaining Buyback Authority (2)  
         Amounts    Shares  

July 1 – 31, 2006

   11,500    $ 49.48    $ 10,600    171,188   

August 1 – 31, 2006

   24,000      52.03      9,352    147,188  

September 1 – 30, 2006

   24,000      51.98      8,104    123,188  

Three months ended September 30, 2006

   59,500      51.51      

Nine months ended September 30, 2006

   231,000      48.21              

 

 

(1)

Reduced shareholders’ equity by $3.7 billion and increased diluted earnings per common share by approximately $0.02 for the nine months ended September 30, 2007. These repurchases were partially offset by the issuance of approximately 49.7 million shares of common stock under employee plans, which increased shareholders’ equity by $2.3 billion, net of $113 million of deferred compensation related to restricted stock awards, and decreased diluted earnings per common share by approximately $0.01 for the nine months ended September 30, 2007.

 

 

(2)

On January 24, 2007, the Board of Directors (the Board) authorized a stock repurchase program of up to 200 million shares of the Corporation’s common stock at an aggregate cost not to exceed $14.0 billion and is limited to a period of 12 to 18 months. On April 26, 2006, the Board authorized a stock repurchase program of up to 200 million shares of the Corporation’s common stock at an aggregate cost not to exceed $12.0 billion and to be completed within a period of 12 to 18 months. This repurchase plan was completed during the third quarter of 2007.

 

 

(3)

Reduced shareholders’ equity by $11.1 billion and increased diluted earnings per common share by approximately $0.06 for the nine months ended September 30, 2006. These repurchases were partially offset by the issuance of approximately 98.3 million shares of common stock under employee plans, which increased shareholders’ equity by $3.9 billion, net of $135 million of deferred compensation related to restricted stock awards, and decreased diluted earnings per common share by approximately $0.03 for the nine months ended September 30, 2006.

The Corporation may repurchase shares, from time to time, in the open market or in private transactions through the Corporation’s approved repurchase program. The Corporation expects to continue to repurchase a number of shares of common stock comparable to any shares issued under the Corporation’s employee stock plans.

In October 2007, the Board declared a regular quarterly cash dividend on common stock of $0.64 per share, payable on December 28, 2007 to common shareholders of record on December 7, 2007.

In July 2007, the Board increased the regular quarterly cash dividend on common stock 14 percent from $0.56 to $0.64 per share, payable on September 28, 2007 to common shareholders of record on September 7, 2007.

In April 2007, the Board declared a regular quarterly cash dividend on common stock of $0.56 per share, payable on June 22, 2007 to common shareholders of record on June 1, 2007.

 

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Preferred Stock Issuance

In September 2007, the Corporation issued 22 thousand shares of Bank of America Corporation 6.625% Non-Cumulative Preferred Stock, Series I (Series I Preferred Stock) with a par value of $0.01 per share for $550 million. Ownership is held in the form of depositary shares, each representing a 1/1,000th interest in a share of Series I Preferred Stock, paying a quarterly cash dividend on the liquidation preference of $25,000 per share of Series I Preferred Stock at an annual rate of 6.625 percent. On any dividend date on or after October 1, 2017, the Corporation may redeem Series I Preferred Stock, in whole or in part, at its option, at $25,000 per share, plus accrued and unpaid dividends.

 

Accumulated OCI

The following table presents the changes in accumulated OCI for the nine months ended September 30, 2007 and 2006, net of tax:

 

  (Dollars in millions)

   Securities (1, 2)        Derivatives (3)        Employee
Benefit Plans
      

Foreign

Currency

       Total  

Balance, December 31, 2006

   $ (2,733 )      $ (3,697 )      $ (1,428 )      $ 147        $ (7,711 )  

Net change in fair value recorded in accumulated OCI

     (792 )        (409 )        -          149          (1,052 )

Net realized (gains) losses reclassified into earnings (4)

     (338 )        387          92          7          148  

Balance, September 30, 2007

   $ (3,863 )      $ (3,719 )      $ (1,336 )      $ 303        $ (8,615 )

Balance, December 31, 2005

   $ (2,978 )      $ (4,338 )      $ (118 )      $ (122 )      $ (7,556 )

Net change in fair value recorded in accumulated OCI

     (159 )        557          -          128          526  

Net realized (gains) losses reclassified into earnings (4)

     53          61          -          49          163  

Balance, September 30, 2006

   $ (3,084 )      $ (3,720 )      $ (118 )      $ 55        $ (6,867 )

 

 

(1)

For the nine months ended September 30, 2007 and 2006, the Corporation reclassified net realized (gains) losses into earnings on the sales of AFS debt securities of $(45) million and $292 million net of tax, and gains on the sales of AFS marketable equity securities of $(293) million and $(239) million net of tax.

 

 

(2)

Accumulated OCI includes fair value losses of $10 million and gains of $187 million net of tax on certain retained interests in the Corporation’s securitization transactions that were included in other assets at September 30, 2007 and 2006.

 

 

(3)

The amounts included in accumulated OCI for terminated derivative contracts were losses of $3.2 billion and $3.1 billion, net of tax, at September 30, 2007 and 2006.

 

 

(4)

Included in this line item are amounts related to derivatives used in cash flow hedge relationships. These amounts are reclassified into earnings in the same period or periods during which the hedged forecasted transactions affect earnings. This line item also includes gains (losses) on AFS debt and marketable equity securities. These amounts are reclassified into earnings upon sale of the related security.

 

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Earnings per Common Share

The calculation of earnings per common share and diluted earnings per common share for the three and nine months ended September 30, 2007 and 2006 is presented below:

 

     Three Months Ended September 30      Nine Months Ended September 30  

  (Dollars in millions, except per share information; shares in
thousands)

   2007        2006      2007        2006  

Earnings per common share

                 

Net income

   $ 3,698        $ 5,416      $ 14,714        $ 15,877   

Preferred stock dividends

     (43 )        -        (129 )        (9 )

Net income available to common shareholders

   $ 3,655        $ 5,416      $ 14,585        $ 15,868  

Average common shares issued and outstanding

     4,420,616          4,499,704        4,424,269          4,547,693  

Earnings per common share

   $ 0.83        $ 1.20      $ 3.30        $ 3.49  

Diluted earnings per common share

                 

Net income available to common shareholders

   $ 3,655        $ 5,416      $ 14,585        $ 15,868  

Average common shares issued and outstanding

     4,420,616          4,499,704        4,424,269          4,547,693  

Dilutive potential common shares (1, 2)

     55,301          70,854        59,196          66,906  

Total diluted average common shares issued and outstanding

     4,475,917          4,570,558        4,483,465          4,614,599  

Diluted earnings per common share

   $ 0.82        $ 1.18      $ 3.25        $ 3.44  

 

 

(1)

For the three and nine months ended September 30, 2007, average options to purchase 33 million and 27 million shares were outstanding but not included in the computation of earnings per common share because they were antidilutive. For the three and nine months ended September 30, 2006, average options to purchase 286 thousand and 28 million shares were outstanding but not included in the computation of earnings per common share because they were antidilutive.

 

 

(2)

Includes incremental shares from restricted stock units, restricted stock shares and stock options.

 

  NOTE 13 – Pension and Postretirement Plans

The Corporation sponsors noncontributory trusteed qualified pension plans that cover substantially all officers and employees, a number of noncontributory nonqualified pension plans, and postretirement health and life plans. The Bank of America Pension Plan (the Pension Plan) allows participants to select from various earnings measures, which are based on the returns of certain funds or common stock of the Corporation. The participant-selected earnings measures determine the earnings rate on the individual participant account balances in the Pension Plan. A detailed discussion of these plans is presented in Note 16 – Employee Benefit Plans to the Consolidated Financial Statements filed as Exhibit 99.2 to the Corporation’s Current Report on Form 8-K filed on May 23, 2007. In July 2007, the Corporation assumed the obligations related to the plans of the former U.S. Trust Corporation, which were not material.

 

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Net periodic benefit cost (income) for the three and nine months ended September 30, 2007 and 2006 included the following components:

 

     Three Months Ended September 30  
     Qualified Pension
Plans
       Nonqualified
Pension Plans
       Postretirement
Health and Life
Plans
 

  (Dollars in millions)

   2007        2006        2007        2006        2007        2006  

Components of net periodic benefit cost (income)

                           

Service cost

   $ 78        $ 77        $ 2        $ 4        $ 4        $ 3   

Interest cost

     186          169          18          19          21          18  

Expected return on plan assets

     (322 )        (259 )        -          -          (2 )        (4 )

Amortization of transition obligation

     -          -          -          -          8          8  

Amortization of prior service cost (credits)

     12          10          (2 )        (2 )        -          -  

Recognized net actuarial loss (gain)

     38          57          4          5          (16 )        (17 )

Net periodic benefit cost (income)

   $ (8 )      $ 54        $ 22        $ 26        $ 15        $ 8  
     Nine Months Ended September 30  
     Qualified Pension
Plans
       Nonqualified
Pension Plans
       Postretirement
Health and Life
Plans
 

  (Dollars in millions)

   2007        2006        2007        2006        2007        2006  

Components of net periodic benefit cost (income)

                           

Service cost

   $ 229        $ 230        $ 6        $ 10        $ 11        $ 10  

Interest cost

     546          507          52          59          62          64  

Expected return on plan assets

     (950 )        (776 )        -          -          (5 )        (8 )

Amortization of transition obligation

     -          -          -          -          24          24  

Amortization of prior service cost (credits)

     36          31          (6 )        (6 )        -          -  

Recognized net actuarial loss (gain)

     114          171          13          15          (47 )        9  

Recognized loss due to settlements and curtailments

     -          -          13          -          -          -  

Net periodic benefit cost (income)

   $ (25 )      $ 163        $ 78        $ 78        $ 45        $ 99  

The Corporation expects to contribute $147 million and $95 million in 2007 to its Nonqualified Pension Plans and Postretirement Health and Life Plans. For the nine months ended September 30, 2007, the Corporation contributed $138 million and $71 million to these plans.

 

  NOTE 14 – Income Taxes

Under FIN 48, income tax benefits are recognized and measured based upon a two-step model: 1) a tax position must be more-likely-than-not to be sustained based solely on its technical merits in order to be recognized, and 2) the benefit is measured as the largest dollar amount of that position that is more-likely-than-not to be sustained upon settlement. The difference between the benefit recognized for a position in accordance with this FIN 48 model and the tax benefit claimed on a tax return is referred to as an unrecognized tax benefit (UTB). As of January 1, 2007, the balance of the Corporation’s UTBs, excluding any related accrual for interest, was $2.7 billion, of which $1.5 billion would, if recognized, affect the Corporation’s effective tax rate. Included in the $2.7 billion UTB balance are some items the recognition of which would not affect the effective tax rate, such as the tax effect of certain temporary differences, the portion of gross state UTBs that would be offset by the tax benefit of the associated federal deduction and UTBs related to acquired entities that will impact goodwill if recognized.

During the second quarter of 2007, the Internal Revenue Service (IRS) completed the examination phase of the audit of the Corporation’s federal income tax returns for the years 2000 through 2002 and issued a Revenue Agent’s Report (RAR) to the Corporation. Included in this RAR were proposed adjustments to disallow certain tax deductions and include additional

 

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taxable income relating to certain leveraged leases referred to by the IRS as “SILOs.” The Corporation filed a protest of this proposed adjustment as well as certain other of the RAR adjustments with the Appeals office of the IRS. We believe our tax treatment of the SILO position as true leases for U.S. income tax purposes is supported by the relevant facts and tax authorities. Further, issuance of the RAR did not change management’s estimate of the ultimate resolution of positions included in the UTB balance. However, final determination of the audit or changes in the Corporation’s estimate may result in future income tax expense or benefit. The Corporation’s federal income tax returns for the years 2003 and 2004 remain under examination by the IRS. In addition, the federal income tax returns of FleetBoston Financial Corporation (FleetBoston) are currently under examination for the years 1997 through March 31, 2004. Upon the final determination of each of the above audits, the UTB balance will decrease, since resolved items would be removed from the balance whether their resolution resulted in payment or recognition. Management does not expect these matters to be concluded within the next 12 months. Finally, the audit of the federal income tax returns of MBNA for the tax years 2001 through 2004 was completed during the second quarter of 2007. The completion of the MBNA audit did not significantly impact the Corporation’s effective tax rate or UTB balance. All tax years subsequent to the above years remain open to examination.

As of September 30, 2007, the Corporation’s accrual for interest and penalties that relate to income taxes, net of taxes and net of payments and deposits, including applicable interest on certain leveraged lease positions, was $493 million. This amount represents a decrease from January 1, 2007, primarily as a result of payments to and deposits with the IRS of tax and interest to stop the potential accrual of interest on certain items relating to the examinations. Under FIN 48 the Corporation continues its policy of accruing income-tax-related interest and penalties (if applicable) within income tax expense.

 

  NOTE 15 – Fair Value Disclosures

Effective January 1, 2007, the Corporation adopted SFAS 157, which provides a framework for measuring fair value under GAAP. As described more fully below, SFAS 157 also eliminated the deferral of gains and losses at inception of certain derivative contracts whose fair value was not evidenced by market observable data. SFAS 157 requires that the impact of this change in accounting for derivative contracts be recorded as an adjustment to beginning retained earnings in the period of adoption.

The Corporation also adopted SFAS 159 on January 1, 2007. SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Corporation elected to adopt the fair value option for certain financial instruments on the adoption date. SFAS 159 requires that the difference between the carrying value before election of the fair value option and the fair value of these instruments be recorded as an adjustment to beginning retained earnings in the period of adoption.

 

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The following table summarizes the impact of the change in accounting for derivative contracts described above and the impact of adopting the fair value option for certain financial instruments on January 1, 2007. Amounts shown represent the carrying value of the affected instruments before and after the changes in accounting resulting from the adoption of SFAS 157 and SFAS 159.

 

  Transition Impact

  (Dollars in millions)

  

Ending Balance

Sheet

December 31, 2006

      

Adoption Net

Gain/(Loss)

      

Opening Balance

Sheet

January 1, 2007

 

Impact of adopting SFAS 157

            

Net derivative assets and liabilities (1)

   $ 7,100        $ 22        $ 7,122   

Impact of electing the fair value option under SFAS 159

            

Loans and leases (2)

     3,968          (21 )        3,947  

Accrued expenses and other liabilities (3)

     (28 )        (321 )        (349 )

Other assets (4)

     8,778          -          8,778  

Available-for-sale debt securities (5)

     3,692          -          3,692  

Federal funds sold and securities purchased under agreements to resell (6)

     1,401          (1 )        1,400  

Interest-bearing deposits liability in domestic offices (7)

     (548 )        1          (547 )

Cumulative-effect adjustment (pre-tax)

          (320 )     

Tax impact

                112             

Cumulative-effect adjustment (net of tax), decrease to retained earnings

              $ (208 )           

 

 

(1)

The transition adjustment reflects the impact of recognizing previously deferred gains and losses as a result of the rescission of certain requirements of Emerging Issues Task Force (EITF) Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (EITF 02-3) in accordance with SFAS 157.

 

 

(2)

Includes loans to certain large corporate clients. The ending balance at December 31, 2006 and the transition adjustment were net of a $32 million reduction in the allowance for loan and lease losses.

 

 

(3)

The January 1, 2007 balance after adoption represents the fair value of certain unfunded commercial loan commitments. The December 31, 2006 balance prior to adoption represents the reserve for unfunded lending commitments associated with these commitments.

 

 

(4)

Other assets include loans held-for-sale. No transition adjustment was recorded for the loans held-for-sale because they were already recorded at fair value pursuant to lower of cost or market accounting.

 

 

(5)

Changes in fair value of these AFS debt securities resulting from foreign currency exposure, which is the primary driver of fair value for these securities, had previously been hedged by derivatives that qualified for fair value hedge accounting in accordance with SFAS 133. As a result, there was no transition adjustment. Following the election of the fair value option, these AFS debt securities have been transferred to trading account assets.

 

 

(6)

Includes structured reverse repurchase agreements that were hedged with derivatives in accordance with SFAS 133.

 

 

(7)

Includes long-term fixed rate deposits that were economically hedged with derivatives.

 

Fair Value Option

Corporate Loans and Loan Commitments

The Corporation elected to account for certain large corporate loans and loan commitments which exceeded the Corporation’s single name credit risk concentration guidelines at fair value in accordance with SFAS 159. Lending commitments, both funded and unfunded, are actively managed and monitored, and, as appropriate, credit risk for these lending relationships may be mitigated through the use of credit derivatives, with our credit view and market perspectives determining the size and timing of the hedging activity. These credit derivatives do not meet the requirements for hedge accounting under SFAS 133 and are therefore carried at fair value with changes in fair value recorded in other income. Electing the fair value option allows the Corporation to account for these loans and loan commitments at fair value, which is more consistent with management’s view of the underlying economics and the manner in which they are managed. In addition, accounting for these loans and loan commitments at fair value reduces the accounting asymmetry that would otherwise result from carrying the loans at historical cost and the credit derivatives at fair value.

Fair values for the loans and loan commitments are based on market prices, where available, or discounted cash flows using market-based credit spreads of comparable debt instruments or credit derivatives of the specific borrower or

 

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comparable borrowers. Results of discounted cash flow calculations may be adjusted, as appropriate, to reflect other market conditions or the perceived credit risk of the borrower.

At September 30, 2007, funded loans which the Corporation has elected to fair value had an aggregate fair value of $4.53 billion recorded in loans and leases and an aggregate outstanding principal balance of $4.67 billion. At September 30, 2007, unfunded loan commitments that the Corporation has elected to fair value had an aggregate fair value of $454 million recorded in accrued expenses and other liabilities and an aggregate committed exposure of $20.2 billion. Interest income on these loans is recorded in interest and fees on loans and leases. At September 30, 2007, none of these loans were 90 days or more past due and still accruing interest or had been placed on nonaccrual status. Net losses resulting from changes in fair value of these loans and loan commitments of $140 million and $180 million were recorded in other income and $2 million and $3 million were recorded in trading account profits (losses) during the three and nine months ended September 30, 2007. These losses were significantly attributable to changes in instrument-specific credit risk. Following adoption of SFAS 159, an immaterial amount of direct loan origination fees and costs related to items for which the fair value option was elected were recognized in earnings. Previously, these items would have been capitalized and amortized to earnings over the life of the loans.

Loans Held-for-Sale

The Corporation also elected to account for certain loans held-for-sale at fair value. Electing to use fair value allows a better offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting under SFAS 133. The Corporation has not elected to fair value other loans held-for-sale primarily because these loans are floating rate loans that are not economically hedged using derivative instruments. Fair values for loans held-for-sale are based on quoted market prices, where available, or are determined by discounting estimated cash flows using interest rates approximating the Corporation’s current origination rates for similar loans and adjusted to reflect the inherent credit risk. At September 30, 2007, residential mortgage loans, commercial mortgage loans, and other loans held-for-sale for which the fair value option was elected had an aggregate fair value of $16.95 billion and an aggregate outstanding principal balance of $17.05 billion and were recorded in other assets. Interest income on these loans is recorded in interest and fees on loans and leases. Net gains (losses) resulting from changes in fair value of these loans, including realized gains (losses) on sale, of $81 million and $120 million were recorded in mortgage banking income, $59 million and $(186) million were recorded in trading account profits (losses), and $(46) million and $(53) million were recorded in other income during the three and nine months ended September 30, 2007. These changes in fair value are mostly offset by hedging activities. An immaterial portion of these amounts was attributable to changes in instrument-specific credit risk. The adoption of SFAS 159 resulted in an increase of $119 million and $180 million in mortgage banking income for the three and nine months ended September 30, 2007, and in an increase of $66 million and $131 million in noninterest expense for the three and nine months ended September 30, 2007. Subsequent to the adoption of SFAS 159, mortgage loan origination costs are recognized in noninterest expense when incurred. Previously, mortgage loan origination costs would have been capitalized as part of the carrying amount of the loans and recognized as a reduction of mortgage banking income upon the sale of such loans.

Debt Securities

Effective January 1, 2007, the Corporation elected to fair value $3.7 billion of AFS debt securities through earnings. Changes in fair value resulting from foreign currency exposure, which is the primary driver of fair value for these securities, had previously been hedged by derivatives that qualified for fair value hedge accounting in accordance with SFAS 133. Electing the fair value option allows the Corporation to eliminate the burden of complying with the requirements for hedge accounting under SFAS 133 without introducing accounting volatility. Following election of the fair value option, these securities were reclassified to trading account assets. The Corporation did not elect the fair value option for other AFS debt securities because they are not hedged by derivatives that qualified for hedge accounting in accordance with SFAS 133.

Structured Reverse Repurchase Agreements

The Corporation elected to fair value certain structured reverse repurchase agreements which were hedged with derivatives which qualified for fair value hedge accounting in accordance with SFAS 133. Election of the fair value option allows the Corporation to reduce the burden of complying with the requirements of hedge accounting under SFAS 133. At September 30, 2007, these instruments had an aggregate fair value of $2.56 billion and a principal balance of $2.53 billion recorded in federal funds sold and securities purchased under agreements to resell. Interest earned on these instruments continues to be recorded in interest income. Net gains resulting from changes in fair value of these instruments of $8 million and $16 million were recorded in other income for the three and nine months ended September 30, 2007. The Corporation

 

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did not elect to fair value other financial instruments within the same balance sheet category because they are not economically hedged using derivatives.

Long-term Deposits

The Corporation elected to fair value certain long-term fixed rate deposits which are economically hedged with derivatives. At September 30, 2007, these instruments had an aggregate fair value of $521 million and principal balance of $531 million recorded in interest-bearing deposits. Interest paid on these instruments continues to be recorded in interest expense. Net losses resulting from changes in fair value of these instruments of $25 million and $4 million were recorded in other income for the three and nine months ended September 30, 2007. Election of the fair value option will allow the Corporation to reduce the accounting volatility that would otherwise result from the accounting asymmetry created by accounting for the financial instruments at historical cost and the economic hedges at fair value. The Corporation did not elect to fair value other financial instruments within the same balance sheet category because they are not economically hedged using derivatives.

 

Fair Value Measurement

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1

Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as certain U.S. Treasury securities that are highly liquid and are actively traded in over-the-counter markets.

 

Level 2

Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes U.S. Government and agency mortgage-backed debt securities, corporate debt securities, derivative contracts and residential mortgage loans held-for-sale.

 

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights (MSRs), asset-backed securities, and highly structured or long-term derivative contracts.

Prior to the adoption of SFAS 157, EITF 02-3 prohibited the recognition of gains and losses at inception of a derivative contract unless the fair value of the contract was evidenced by a quoted price in an active market, an observable price or other market transaction, or other observable data. SFAS 157 rescinded this requirement, resulting in the recognition of previously deferred gains and losses as an increase to the beginning balance of retained earnings of $22 million (pre-tax).

Valuations of derivative assets and liabilities reflect the value of the instrument including the values associated with counterparty risk. With the issuance of SFAS 157, the accounting industry clarified that these values must also take into account the Corporation’s own credit standing, thus including in the valuation of the derivative instrument the value of the net credit differential between the counterparties to the derivative contract. Effective January 1, 2007, the Corporation updated its methodology to calculate the impact of both the counterparty and its own credit standing. The net impact for the three and nine months ended September 30, 2007 was not material.

 

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Assets and liabilities measured at fair value on a recurring basis, including financial instruments for which the Corporation has elected the fair value option, are summarized below:

 

     September 30, 2007  
     Fair Value Measurements Using      Netting
Adjustments (1)
       Assets/Liabilities
at Fair Value
 

  (Dollars in millions)

   Level 1      Level 2      Level 3          

Assets

                      

Federal funds sold and securities purchased under agreements to resell (2)

   $ -      $ 2,561      $ -      $ -        $ 2,561   

Trading account assets

     55,220        120,434        3,711        -          179,365  

Derivative assets

     530        309,936        9,004        (288,627 )        30,843  

Available-for-sale debt securities (3)

     2,109        174,141        528        -          176,778  

Loans and leases (2,4)

     -        -        4,525        -          4,525  

Mortgage servicing rights

     -        -        3,179        -          3,179  

Other assets (5)

     3,387        16,017        6,881        -          26,285  

Total assets

   $ 61,246      $ 623,089      $ 27,828      $ (288,627 )      $ 423,536  

Liabilities

                      

Interest-bearing deposits in domestic offices (2)

   $ -      $ 521      $ -      $ -        $ 521  

Trading account liabilities

     63,066        24,089        -        -          87,155  

Derivative liabilities

     425        295,378        9,626        (286,417 )        19,012  

Accrued expenses and other liabilities (2)

     -        -        454        -          454  

Total liabilities

   $ 63,491      $ 319,988      $ 10,080      $ (286,417 )      $ 107,142  

 

 

(1)

Amounts represent the impact of legally enforceable master netting agreements that allow the Corporation to settle positive and negative positions and also cash collateral held or placed with the same counterparties.

 

 

(2)

Amounts represent items for which the Corporation has elected the fair value option under SFAS 159.

 

 

(3)

Certain securities, primarily U.S. Government and agency mortgage-backed securities, had been classified as Level 1 measurements at March 31, 2007. We subsequently determined that these securities are more appropriately classified as Level 2 measurements. This change in classification did not impact the recorded fair value of the securities.

 

 

(4)

Loans and leases at September 30, 2007 included $20.4 billion of leases that were not eligible for the fair value option as they were specifically excluded from fair value option election in accordance with SFAS 159.

 

 

(5)

Other assets include equity investments held by Principal Investing, AFS equity investments and certain retained interests in securitization vehicles, including interest-only strips, all of which were carried at fair value prior to the adoption of SFAS 159; and loans held-for-sale for which the Corporation has elected the fair value option under SFAS 159. Substantially all of other assets are eligible for fair value accounting at September 30, 2007.

 

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The table below presents a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2007. Level 3 loans and loan commitments are carried at fair value due to adoption of the fair value option, as described on page 31. Other Level 3 instruments presented in the table, including derivatives, trading account assets, AFS debt securities, MSRs, certain equity investments and retained interests in securitizations, were carried at fair value prior to the adoption of SFAS 159. During the three months ended September 30, 2007, certain financial instruments, including certain asset-backed securities issued by CDOs and portfolios of loans held-for-sale, were transferred from Level 2 to Level 3 due to the lack of current observable market activity. These instruments were valued using pricing models and discounted cash flow methodologies incorporating assumptions that, in management’s judgment, reflect the assumptions a marketplace participant would use at September 30, 2007.

 

     Total Fair Value Measurements  
     Three Months Ended September 30, 2007  

 Level 3 Instruments Only

  (Dollars in millions)

  

Net

Derivatives (1)

     Trading
Account
Assets (2)
    

Available-

for-Sale
Debt
Securities (2)

     Loans and
Leases (3)
     Mortgage
Servicing
Rights (2)
     Other
Assets (4)
     Accrued
Expenses and
Other
Liabilities (3)
 

Balance, June 30, 2007

   $ (1,301 )    $ 289      $ 226      $ 3,606      $ 3,269      $ 6,670      $ (391 )  

Total gains or losses (realized/unrealized):

                    

Included in earnings

     411        (248 )      -        (79 )      (151 )      228        (63 )

Included in other comprehensive income

     -        -        (83 )      -        -        (10 )      -  

Purchases, issuances, and settlements

     207        412        385        998        61        (1,919 )      -  

Transfers in to/out of Level 3

     61        3,258        -        -        -        1,912        -  

Balance, September 30, 2007

   $ (622 )    $ 3,711      $ 528      $ 4,525      $ 3,179      $ 6,881      $ (454 )
     Total Fair Value Measurements  
     Nine Months Ended September 30, 2007  

 Level 3 Instruments Only

  (Dollars in millions)

   Net
Derivatives (1)
     Trading
Account
Assets (2)
     Available-
for-Sale
Debt
Securities (2)
     Loans and
Leases (3)
     Mortgage
Servicing
Rights (2)
     Other
Assets (4)
     Accrued
Expenses and
Other
Liabilities (3)
 

Balance, December 31, 2006

   $ 766      $ 303      $ -      $ 3,968      $ 2,869      $ 6,605      $ (28 )

Impact of SFAS 157 and SFAS 159 adoption

     22        -        -        (21 )      -        -        (321 )

Balance, January 1, 2007

   $ 788      $ 303      $ -      $ 3,947      $ 2,869      $ 6,605      $ (349 )

Total gains or losses (realized/unrealized):

                    

Included in earnings

     (172 )      (297 )      -        (78 )      388        2,169        (105 )

Included in other comprehensive income

     -        -        (79 )      -        -        (73 )      -  

Purchases, issuances, and settlements

     (252 )      436        376        656        (78 )      (4,069 )      -  

Transfers in to/out of Level 3

     (986 )      3,269        231        -        -        2,249        -  

Balance, September 30, 2007

   $ (622 )    $ 3,711      $ 528      $ 4,525      $ 3,179      $ 6,881      $ (454 )

 

 

(1)

Net derivatives at September 30, 2007 included derivative assets of $9.00 billion and derivative liabilities of $9.63 billion, all of which were carried at fair value prior to the adoption of SFAS 159.

 

 

(2)

Amounts represented items which were carried at fair value prior to the adoption of SFAS 159.

 

 

(3)

Amounts represented items for which the Corporation had elected the fair value option under SFAS 159 including commercial loan commitments recorded in accrued expenses and other liabilities.

 

 

(4)

Other assets included equity investments held by Principal Investing and certain retained interests in securitization vehicles, including interest-only strips, all of which were carried at fair value prior to the adoption of SFAS 159, and certain portfolios of loans held-for-sale, principally reverse mortgages, for which the Corporation has elected the fair value option under SFAS 159.

 

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The table below summarizes gains and losses due to changes in fair value, including both realized and unrealized gains and losses, recorded in earnings for Level 3 assets and liabilities for the three and nine months ended September 30, 2007. These amounts include gains and losses generated by loans, loans held-for-sale and loan commitments for which the fair value option was elected and by other instruments, including certain derivative contracts, trading account assets, MSRs, equity investments and retained interests in securitizations, which were carried at fair value prior to the adoption of SFAS 159. For the nine months ended September 30, 2007, more than 80 percent of the Level 3 gains were realized in cash.

 

     Total Gains and Losses  

 Level 3 Instruments Only

  (Dollars in millions)

   Net
Derivatives (1)
     Trading
Account
Assets (1)
     Loans and
Leases (2)
     Mortgage
Servicing
Rights (1)
     Other
Assets (3)
     Accrued
Expenses and
Other
Liabilities (2)
     Total  

Classification of gains and losses (realized/unrealized) included in earnings for the three months ended September 30, 2007:

                    

Card income

   $ -      $ -      $ -      $ -      $ (34 )    $ -      $ (34 )  

Equity investment income

     -        -        -        -        297        -        297  

Trading account profits (losses)

     332        (248 )      -        -        (39 )      (2 )      43  

Mortgage banking income

     79        -        -        (151 )      (6 )      -        (78 )

Other income

     -        -        (79 )      -        10        (61 )      (130 )

Total

   $ 411      $ (248 )    $ (79 )    $ (151 )    $ 228      $ (63 )    $ 98  

Classification of gains and losses (realized/unrealized) included in earnings for the nine months ended September 30, 2007:

                    

Card income

   $ -      $ -      $ -      $ -      $ 246      $ -      $ 246  

Equity investment income

     -        -        -        -        1,908        -        1,908  

Trading account profits (losses)

     (133 )      (297 )      -        -        (39 )      (3 )      (472 )

Mortgage banking income

     (39 )      -        -        388        (6 )      -        343  

Other income

     -        -        (78 )      -        60        (102 )      (120 )

Total

   $ (172 )    $ (297 )    $ (78 )    $ 388      $ 2,169      $ (105 )    $ 1,905  

 

 

(1)

Amounts represented items which were carried at fair value prior to the adoption of SFAS 159.

 

 

(2)

Amounts represented items for which the Corporation had elected the fair value option under SFAS 159.

 

 

(3)

Amounts represented items which were carried at fair value prior to the adoption of SFAS 159 and certain portfolios of loans held-for-sale for which the Corporation has elected the fair value option under SFAS 159.

 

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Table of Contents

The table below summarizes changes in unrealized gains or losses recorded in earnings for the three and nine months ended September 30, 2007 for Level 3 assets and liabilities that are still held at September 30, 2007. These amounts include changes in fair value of loans, loans held-for-sale and loan commitments for which the fair value option was elected and changes in fair value for other instruments, including certain derivative contracts, trading account assets, MSRs, equity investments and retained interests in securitizations, which were carried at fair value prior to the adoption of SFAS 159.

 

     Changes in Unrealized Gains or Losses  

 Level 3 Instruments Only

  (Dollars in millions)

   Net
Derivatives (1)
     Trading
Account
Assets (1)
     Loans and
Leases (2)
     Mortgage
Servicing
Rights (1)
     Other
Assets (3)
     Accrued
Expenses and
Other
Liabilities (2)
     Total  

Changes in unrealized gains or losses relating to assets still held at reporting date for the three months ended September 30, 2007:

                    

Card income

   $ -      $ -      $ -      $ -      $ (53 )    $ -      $ (53 )  

Equity investment income

     -        -        -        -        139        -        139  

Trading account profits (losses)

     475        (248 )      -        -        (39 )      -        188  

Mortgage banking income

     40        -        -        (229 )      (6 )      -        (195 )

Other income

     -        -        (88 )      -        -        (97 )      (185 )

Total

   $ 515      $ (248 )    $ (88 )    $ (229 )    $ 41      $ (97 )    $ (106 )

Changes in unrealized gains or losses relating to assets still held at reporting date for the nine months ended September 30, 2007:

                    

Card income

   $ -      $ -      $ -      $ -      $ 39      $ -      $ 39  

Equity investment income

     -        -        -        -        262        -        262  

Trading account profits (losses)

     (1 )      (297 )      -        -        (37 )      (1 )      (336 )

Mortgage banking income

     8        -        -        174        (6 )      -        176  

Other income

     -        -        (98 )      -        (2 )      (176 )      (276 )

Total

   $ 7      $ (297 )    $ (98 )    $ 174      $ 256      $ (177 )    $ (135 )

 

 

(1)

Amounts represented items which were carried at fair value prior to the adoption of SFAS 159.

 

 

(2)

Amounts represented items for which the Corporation had elected the fair value option under SFAS 159.

 

 

(3)

Amounts represented items which were carried at fair value prior to the adoption of SFAS 159 and certain portfolios of loans held-for-sale for which the Corporation has elected the fair value option under SFAS 159.

Certain assets and liabilities are measured at fair value on a non-recurring basis (e.g., loans held-for-sale, unfunded loan commitments held-for-sale and commercial and residential reverse mortgage MSRs all of which are carried at the lower of cost or fair value). At September 30, 2007, loans held-for-sale for which the Corporation had not elected the fair value option which had an aggregate cost of $12.13 billion had been written down to fair value of $11.69 billion (of which $3.99 billion and $7.70 billion were classified as Level 2 and Level 3 measures within the fair value hierarchy). In addition, unfunded loan commitments held-for-sale and the Corporation’s share of the forward calendar were written down by $150 million and were recorded in accrued expenses and other liabilities at September 30, 2007 all of which were classified as a Level 3 measure within the fair value hierarchy. For the three and nine months ended September 30, 2007, losses of $207 million and $233 million were recorded in other income (primarily leveraged loans and loan commitments held-for-sale), losses of $6 million and $10 million were recorded in mortgage banking income (primarily consumer mortgage loans held-for-sale), and losses of $44 million and $47 million were recorded in trading account profits (losses) (primarily commercial mortgage loans and loan commitments held-for-sale). During the nine months ended September 30, 2007, lease residuals for which the Corporation had not elected the fair value option, with an aggregate cost of $65 million had been written down to their then fair value of $52 million which was classified as a Level 2 measure within the fair value hierarchy. For the nine months ended September 30, 2007, other than temporary impairment charges of $13 million relating to lease residuals were recorded in other income to write the current carrying amount down to fair value. There were no other than temporary impairment charges relating to lease residuals recorded during the three months ended September 30, 2007.

 

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Table of Contents
  NOTE 16 – Mortgage Servicing Rights

The Corporation accounts for residential first mortgage MSRs at fair value with changes in fair value recorded in the Consolidated Statement of Income in mortgage banking income. The Corporation economically hedges these MSRs with certain derivatives such as options and interest rate swaps.

The following table presents activity for residential first mortgage MSRs for the three and nine months ended September 30, 2007 and 2006.

 

     Three Months Ended
September 30
           Nine Months Ended
September 30
 

  (Dollars in millions)

   2007        2006             2007        2006  

Balance, beginning of period

   $ 3,269        $ 3,083          $ 2,869        $ 2,658   

MBNA balance, January 1, 2006

     -          -            -          9  

Additions

     271          188            539          470  

Impact of customer payments

     (187 )        (177 )          (554 )        (515 )

Other changes in MSR market value

     (174 )        (162 )            325          310  

Balance, September 30

   $ 3,179        $ 2,932            $ 3,179        $ 2,932  

For the three and nine months ended September 30, 2007, other changes in MSR market value of $(174) million and $325 million reflect changes in discount rates and prepayment speed assumptions, mostly due to changes in interest rates. These amounts do not include $23 million and $63 million resulting from the actual cash received exceeding expected prepayments. The total of these amounts of $(151) million and $388 million is included in the line “Mortgage banking income” in the table “Total Fair Value Measurements” in Note 15 – Fair Value Disclosures to the Consolidated Financial Statements.

The key economic assumptions used in valuations of MSRs included modeled prepayment rates and resultant weighted average lives of the MSRs and the option adjusted spread levels. Commercial and residential reverse mortgage MSRs are accounted for using the amortization method (i.e., lower of cost or market). Commercial and residential reverse mortgage MSRs totaled $238 million at September 30, 2007, and commercial MSRs totaled $176 million at December 31, 2006 and are not included in the table above.

 

  NOTE 17 – Business Segment Information

The Corporation reports the results of its operations through three business segments: Global Consumer and Small Business Banking (GCSBB), Global Corporate and Investment Banking (GCIB) and Global Wealth and Investment Management (GWIM). The Corporation may periodically reclassify business segment results based on modifications to its management reporting methodologies and changes in organizational alignment.

 

Global Consumer and Small Business Banking

GCSBB provides a diversified range of products and services to individuals and small businesses. The Corporation reports GCSBB’s results, specifically credit card, business card and certain unsecured lending portfolios, on a managed basis. This basis of presentation excludes the Corporation’s securitized mortgage and home equity portfolios for which the Corporation retains servicing. Reporting on a managed basis is consistent with the way that management as well as analysts evaluate the results of GCSBB. Managed basis assumes that securitized loans were not sold and presents earnings on these loans in a manner similar to the way loans that have not been sold (i.e., held loans) are presented. Loan securitization is an alternative funding process that is used by the Corporation to diversify funding sources. Loan securitization removes loans from the Consolidated Balance Sheet through the sale of loans to an off-balance sheet QSPE which is excluded from the Corporation’s Consolidated Financial Statements in accordance with GAAP.

 

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Table of Contents

The performance of the managed portfolio is important in understanding GCSBB’s results as it demonstrates the results of the entire portfolio serviced by the business. Securitized loans continue to be serviced by the business and are subject to the same underwriting standards and ongoing monitoring as held loans. In addition, retained excess servicing income is exposed to similar credit risk and repricing of interest rates as held loans. GCSBB’s managed income statement line items differ from a held basis as follows:

 

   

Managed net interest income includes GCSBB’s net interest income on held loans and interest income on the securitized loans less the internal funds transfer pricing allocation related to securitized loans.

   

Managed noninterest income includes GCSBB’s noninterest income on a held basis less the reclassification of certain components of card income (e.g., excess servicing income) to record managed net interest income and provision for credit losses. Noninterest income, both on a held and managed basis, also includes the impact of adjustments to the interest-only strip that are recorded in card income as management continues to manage this impact within GCSBB.

   

Provision for credit losses represents the provision for credit losses on held loans combined with realized credit losses associated with the securitized loan portfolio.

 

Global Corporate and Investment Banking

GCIB provides a wide range of financial services to both the Corporation’s issuer and investor clients that range from business banking clients to large international corporate and institutional investor clients using a strategy to deliver value-added financial products and advisory solutions.

 

Global Wealth and Investment Management

GWIM offers investment and brokerage services, estate management, financial planning services, fiduciary management, credit and banking expertise, and diversified asset management products to institutional clients, as well as affluent and high net-worth individuals. GWIM also includes the impact of migrated qualifying affluent customers, including their related deposit balances, from GCSBB. After migration, the associated net interest income, service charges and noninterest expense on the deposit balances is recorded in GWIM.

 

All Other

All Other consists of equity investment activities including Principal Investing, Corporate Investments and Strategic Investments, the residual impact of the allowance for credit losses and the cost allocation processes, merger and restructuring charges, intersegment eliminations, and the results of certain businesses that are expected to be or have been sold or are in the process of being liquidated (e.g., the Corporation’s Brazilian operations, Asia Commercial Banking business and operations in Chile and Uruguay). All Other also includes certain amounts associated with ALM activities, including the residual impact of funds transfer pricing allocation methodologies, amounts associated with the change in the value of derivatives used as economic hedges of interest rate and foreign exchange rate fluctuations that did not qualify for SFAS 133 hedge accounting treatment, foreign exchange rate fluctuations related to SFAS No. 52, “Foreign Currency Translation” revaluation of foreign denominated debt issuances, certain gains (losses) on sales of whole mortgage loans, and gains (losses) on sales of debt securities. In addition, GCSBB is reported on a managed basis which includes a “securitization impact” adjustment which has the effect of assuming that loans that have been securitized were not sold and presenting these loans in a manner similar to the way loans that have not been sold are presented. All Other’s results include a corresponding “securitization offset” which removes the impact of these securitized loans in order to present the consolidated results of the Corporation on a GAAP basis (i.e., held basis).

 

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Table of Contents
Basis of Presentation

Total revenue, net of interest expense, includes net interest income on a fully taxable-equivalent (FTE) basis and noninterest income. The adjustment of net interest income to a FTE basis results in a corresponding increase in income tax expense. The net interest income of the businesses includes the results of a funds transfer pricing process that matches assets and liabilities with similar interest rate sensitivity and maturity characteristics. Net interest income of the business segments also includes an allocation of net interest income generated by the Corporation’s ALM activities.

Certain expenses not directly attributable to a specific business segment are allocated to the segments based on pre-determined means. The most significant of these expenses include data processing costs, item processing costs and certain centralized or shared functions. Data processing costs are allocated to the segments based on equipment usage. Item processing costs are allocated to the segments based on the volume of items processed for each segment. The costs of certain centralized or shared functions are allocated based on methodologies which reflect utilization.

 

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Table of Contents

The following tables present total revenue, net of interest expense, on a FTE basis and net income for the three and nine months ended September 30, 2007 and 2006, and total assets at September 30, 2007 and 2006 for each business segment, as well as All Other.

 

  Business Segments                                      
  Three Months Ended September 30  
     Total Corporation (1)      Global Consumer and Small
Business Banking (2, 3)
       Global Corporate and
Investment Banking (2)
 

  (Dollars in millions)

   2007        2006      2007        2006        2007      2006  

Net interest income (4)

   $ 8,990        $ 8,894      $ 7,265        $ 7,016        $ 2,747      $ 2,409   

Noninterest income

     7,314          9,598        4,720          4,268          138        2,759  

Total revenue, net of interest expense

     16,304          18,492        11,985          11,284          2,885        5,168  

Provision for credit losses (5)

     2,030          1,165        3,121          2,049          228        36  

Amortization of intangibles

     429          441        327          363          41        56  

Other noninterest expense

     8,114          8,422        4,644          4,256          2,445        2,805  

Income before income taxes

     5,731          8,464        3,893          4,616          171        2,271  

Income tax expense (4)

     2,033          3,048        1,441          1,697          71        838  

Net income

   $ 3,698        $ 5,416      $ 2,452        $ 2,919        $ 100      $ 1,433  

Period-end total assets

   $ 1,578,763        $ 1,449,211      $ 401,151        $ 399,385        $ 738,553      $ 667,345  
                               
     Global Wealth and Investment
Management (2)
     All Other (2, 3)                  

  (Dollars in millions)

   2007        2006      2007        2006                  

Net interest income (4)

   $ 1,009        $ 887      $ (2,031 )      $ (1,418 )            

Noninterest income

     1,191          891        1,265          1,680            

Total revenue, net of interest expense

     2,200          1,778        (766 )        262            

Provision for credit losses (5)

     (29 )        -        (1,290 )        (920 )          

Amortization of intangibles

     61          18        -          4            

Other noninterest expense

     1,213          947        (188 )        414            

Income before income taxes

     955          813        712          764            

Income tax expense (4)

     356          300        165          213            

Net income

   $ 599        $ 513      $ 547        $ 551            

Period-end total assets

   $ 139,955        $ 112,298      $ 299,104        $ 270,183            

 

 

(1)

There were no material intersegment revenues among the segments.

 

 

(2)

Total assets include asset allocations to match liabilities (i.e., deposits).

 

 

(3)

GCSBB is presented on a managed basis with a corresponding offset recorded in All Other.

 

 

(4)

FTE basis

 

 

(5)

Provision for credit losses represents: For GCSBB – Provision for credit losses on held loans combined with realized credit losses associated with the securitized loan portfolio and for All Other – Provision for credit losses combined with the GCSBB securitization offset.

 

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Table of Contents
 Business Segments                                        
 Nine Months Ended September 30  
     Total Corporation (1)        Global Consumer and Small
Business Banking (2, 3)
       Global Corporate and
Investment Banking (2)
 

  (Dollars in millions)

   2007        2006        2007        2006        2007      2006  

Net interest income (4)

   $ 26,368        $ 26,860        $ 21,409        $ 21,059        $ 7,809      $ 7,356   

Noninterest income

     28,378          28,102          13,759          12,196          6,389        8,652  

Total revenue, net of interest expense

     54,746          54,962          35,168          33,255          14,198        16,008  

Provision for credit losses (5)

     5,075          3,440          8,626          5,757          384        82  

Amortization of intangibles

     1,209          1,322          987          1,088          125        169  

Other noninterest expense

     25,524          25,182          13,580          12,503          8,441        8,403  

Income before income taxes

     22,938          25,018          11,975          13,907          5,248        7,354  

Income tax expense (4)

     8,224          9,141          4,416          5,123          1,948        2,720  

Net income

   $ 14,714        $ 15,877        $ 7,559        $ 8,784        $ 3,300      $ 4,634  

Period-end total assets

   $ 1,578,763        $ 1,449,211        $