Note 12: Derivatives

We use derivatives to manage exposure to market risk, interest rate risk, credit risk and foreign currency risk, to generate profits from proprietary trading and to assist customers with their risk management objectives. Derivative transactions are measured in terms of the notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the instruments. The notional amount is generally not exchanged, but is used only as the basis on which interest and other payments are determined.

Our asset/liability management approach to interest rate, foreign currency and certain other risks includes the use of derivatives. Such derivatives are typically designated as fair value or cash flow hedges, or economic hedge derivatives for those that do not qualify for hedge accounting. This helps minimize significant, unplanned fluctuations in earnings, fair values of assets and liabilities, and cash flows caused by interest rate, foreign currency and other market value volatility. This approach involves modifying the repricing characteristics of certain assets and liabilities so that changes in interest rates, foreign currency and other exposures do not have a significant adverse effect on the net interest margin, cash flows and earnings. As a result of fluctuations in these exposures, hedged assets and liabilities will gain or lose market value. In a fair value or economic hedge, the effect of this unrealized gain or loss will generally be offset by the gain or loss on the derivatives linked to the hedged assets and liabilities. In a cash flow hedge, where we manage the variability of cash payments due to interest rate fluctuations by the effective use of derivatives linked to hedged assets and liabilities, the unrealized gain or loss on the derivatives or the hedged asset or liability is generally not reflected in earnings.

We also offer various derivatives, including interest rate, commodity, equity, credit and foreign exchange contracts, to our customers but usually offset our exposure from such contracts by purchasing other financial contracts. The customer accommodations and any offsetting financial contracts are treated as free-standing derivatives. Free-standing derivatives also include derivatives we enter into for risk management that do not otherwise qualify for hedge accounting, including economic hedge derivatives. To a lesser extent, we take positions based on market expectations or to benefit from price differentials between financial instruments and markets. Additionally, free-standing derivatives include embedded derivatives that are required to be separately accounted for from their host contracts.

The following table presents the total notional or contractual amounts and fair values for derivatives, the fair values of derivatives designated as qualifying hedge contracts, which are used as asset/liability management hedges, and free-standing derivatives (economic hedges) not designated as hedging instruments that are recorded on the balance sheet in other assets or other liabilities. Customer accommodation, trading and other free-standing derivatives are recorded on the balance sheet at fair value in trading assets or other liabilities.


	June 30, 2011								December 31, 2010
	Notional or		Fair value						Notional or		Fair value
	contractual		Asset			Liability			contractual		Asset			Liability
(in millions)	amount		derivatives			derivatives			amount		derivatives			derivatives

Qualifying hedge contracts
Interest rate contracts (1)	$	96,071		6,495			1,556			110,314		7,126			1,614
Foreign exchange contracts		25,437		1,939			545			25,904		1,527			727

Total derivatives designated as qualifying hedging instruments				8,434			2,101					8,653			2,341

Derivatives not designated as hedging instruments
Free-standing derivatives (economic hedges):
Interest rate contracts (2)		292,787		1,076			1,050			408,563		2,898			2,625
Equity contracts		-		-			-			176		-			46
Foreign exchange contracts		6,045		35			83			5,528		23			53
Credit contracts — protection purchased		145		4			-			396		80			-
Other derivatives		2,524		1			34			2,538		-			35

Subtotal				1,116			1,167					3,001			2,759

Customer accommodation, trading and other
free-standing derivatives:
Interest rate contracts		2,859,012		55,599			56,975			2,809,387		58,225			59,329
Commodity contracts		91,410		4,808			3,974			83,114		4,133			3,918
Equity contracts		71,179		3,691			3,846			73,278		3,272			3,450
Foreign exchange contracts		146,093		3,035			2,596			110,889		2,800			2,682
Credit contracts — protection sold		44,536		569			5,257			47,699		605			5,826
Credit contracts — protection purchased		42,371		4,074			526			44,776		4,661			588
Other derivatives		-		-			-			190		8			-

Subtotal				71,776			73,174					73,704			75,793

Total derivatives not designated as hedging instruments				72,892			74,341					76,705			78,552

Total derivatives before netting				81,326			76,442					85,358			80,893

Netting (3)				(58,561	)		(65,082	)				(63,469	)		(70,009	)

Total			$	22,765			11,360					21,889			10,884


(1)		Notional amounts presented exclude $20.1 billion at June 30, 2011, and $20.9 billion at December 31, 2010, of basis swaps that are combined with receive fixed-rate/pay floating-rate swaps and designated as one hedging instrument.

(2)		Includes free-standing derivatives (economic hedges) used to hedge the risk of changes in the fair value of residential MSRs, MHFS and other interests held.

(3)		Represents netting of derivative asset and liability balances, and related cash collateral, with the same counterparty subject to master netting arrangements. The amount of cash collateral netted against derivative assets and liabilities was $6.1 billion and $12.6 billion, respectively, at June 30, 2011, and $5.5 billion and $12.1 billion, respectively, at December 31, 2010.

Fair Value Hedges

We use interest rate swaps to convert certain of our fixed-rate long-term debt and CDs to floating rates to hedge our exposure to interest rate risk. We also enter into cross-currency swaps, cross-currency interest rate swaps and forward contracts to hedge our exposure to foreign currency risk and interest rate risk associated with the issuance of non-U.S. dollar denominated long-term debt. In addition, we use interest rate swaps and forward contracts to hedge against changes in fair value of certain investments in available-for-sale debt securities due to changes in interest rates, foreign currency rates, or both. The entire derivative gain or loss is included in the assessment of hedge effectiveness for all fair value hedge relationships, except for those involving foreign-currency denominated securities available for sale and long-term debt hedged with foreign currency forward derivatives for which the component of the derivative gain or loss related to the changes in the difference between the spot and forward price is excluded from the assessment of hedge effectiveness.

We use statistical regression analysis to assess hedge effectiveness, both at inception of the hedging relationship and on an ongoing basis. The regression analysis involves regressing the periodic change in fair value of the hedging instrument against the periodic changes in fair value of the asset or liability being hedged due to changes in the hedged risk(s). The assessment includes an evaluation of the quantitative measures of the regression results used to validate the conclusion of high effectiveness.

The following table shows the net gains (losses) recognized in the income statement related to derivatives in fair value hedging relationships.


													Total net
	Interest rate						Foreign exchange						gains
	contracts hedging:						contracts hedging:						(losses)
	Securities						Securities						on fair
	available			Long-term			available			Long-term			value
(in millions)	for sale			debt			for sale			debt			hedges

Quarter ended June 30, 2011
Gains (losses) recorded in net interest income	$	(107	)		437			(3	)		105			432


Gains (losses) recorded in noninterest income
Recognized on derivatives		(280	)		736			11			515			982
Recognized on hedged item		279			(709	)		(18	)		(512	)		(960	)

Recognized on fair value hedges (ineffective portion) (1)	$	(1	)		27			(7	)		3			22


Quarter ended June 30, 2010
Gains (losses) recorded in net interest income	$	(94	)		527			(1	)		87			519


Gains (losses) recorded in noninterest income
Recognized on derivatives		(642	)		1,744			70			(1,769	)		(597	)
Recognized on hedged item		650			(1,626	)		(70	)		1,778			732

Recognized on fair value hedges (ineffective portion) (1)	$	8			118			-			9			135


Six months ended June 30, 2011
Gains (losses) recorded in net interest income	$	(213	)		851			(4	)		195			829


Gains (losses) recorded in noninterest income
Recognized on derivatives		(111	)		91			46			1,595			1,621
Recognized on hedged item		42			(87	)		(51	)		(1,629	)		(1,725	)

Recognized on fair value hedges (ineffective portion) (1)	$	(69	)		4			(5	)		(34	)		(104	)


Six months ended June 30, 2010
Gains (losses) recorded in net interest income	$	(188	)		1,058			(2	)		184			1,052


Gains (losses) recorded in noninterest income
Recognized on derivatives		(768	)		2,276			189			(2,905	)		(1,208	)
Recognized on hedged item		785			(2,143	)		(189	)		2,932			1,385

Recognized on fair value hedges (ineffective portion) (1)	$	17			133			-			27			177


(1)		The second quarter and first half of 2011 included $22 million and $30 million, respectively, and the second quarter and first half of 2010 included nil and $1 million, respectively, of gains (losses) on forward derivatives hedging foreign currency securities available for sale and long-term debt, representing the portion of derivatives gains (losses) excluded from the assessment of hedge effectiveness (time value).

Cash Flow Hedges

We hedge floating-rate debt against future interest rate increases by using interest rate swaps, caps, floors and futures to limit variability of cash flows due to changes in the benchmark interest rate. We also use interest rate swaps and floors to hedge the variability in interest payments received on certain floating-rate commercial loans, due to changes in the benchmark interest rate. Gains and losses on derivatives that are reclassified from cumulative OCI to current period earnings are included in the line item in which the hedged item’s effect on earnings is recorded. All parts of gain or loss on these derivatives are included in the assessment of hedge effectiveness. We assess hedge effectiveness using regression analysis, both at inception of the hedging relationship and on an ongoing basis. The regression analysis involves regressing the periodic changes in cash flows of the hedging instrument against the periodic changes in cash flows of the forecasted transaction being hedged due to changes in the hedged risk(s). The assessment includes an evaluation of the quantitative measures of the regression results used to validate the conclusion of high effectiveness.

Based upon current interest rates, we estimate that $323 million of deferred net gains on derivatives in OCI at June 30, 2011, will be reclassified as earnings during the next twelve months, compared with $367 million at December 31, 2010. Future changes to interest rates may significantly change actual amounts reclassified to earnings. We are hedging our exposure to the variability of future cash flows for all forecasted transactions for a maximum of 7 years for both hedges of floating-rate debt and floating-rate commercial loans.

The following table shows the net gains (losses) recognized related to derivatives in cash flow hedging relationships.



	Quarter ended June 30,						Six months ended June 30,
(in millions)	2011			2010			2011			2010

Gains (losses) (after tax) recognized in OCI on derivatives	$	(84	)		190			(83	)		349
Gains (pre tax) reclassified from cumulative OCI into net interest income		157			186			313			328
Gains (losses) (pre tax) recognized in noninterest income on derivatives (1)		-			(1	)		(2	)		6


(1)		None of the change in value of the derivatives was excluded from the assessment of hedge effectiveness.

Free-Standing Derivatives

We use free-standing derivatives (economic hedges), in addition to debt securities available for sale, to hedge the risk of changes in the fair value of residential MSRs measured at fair value, certain residential MHFS, derivative loan commitments and other interests held. The resulting gain or loss on these economic hedges is reflected in other income.

The derivatives used to hedge these MSRs measured at fair value, which include swaps, swaptions, forwards, Eurodollar and Treasury futures and options contracts, resulted in net derivative gains of $1.4 billion and $1.3 billion, respectively, in the second quarter and first half of 2011 and net derivative gains of $3.3 billion and $5.1 billion, respectively, in the same periods of 2010, which are included in mortgage banking noninterest income. The aggregate fair value of these derivatives was a net asset of $359 million at June 30, 2011, and a net liability of $943 million at December 31, 2010. Changes in fair value of debt securities available for sale (unrealized gains and losses) are not included in servicing income, but are reported in cumulative OCI (net of tax) or, upon sale, are reported in net gains (losses) on debt securities available for sale.

Interest rate lock commitments for residential mortgage loans that we intend to sell are considered free-standing derivatives. Our interest rate exposure on these derivative loan commitments, as well as substantially all residential MHFS, is hedged with free-standing derivatives (economic hedges) such as forwards and options, Eurodollar futures and options, and Treasury futures, forwards and options contracts. The commitments, free-standing derivatives and residential MHFS are carried at fair value with changes in fair value included in mortgage banking noninterest income. For the fair value measurement of interest rate lock commitments we include, at inception and during the life of the loan commitment, the expected net future cash flows related to the associated servicing of the loan. Fair value changes subsequent to inception are based on changes in fair value of the underlying loan resulting from the exercise of the commitment and changes in the probability that the loan will not fund within the terms of the commitment (referred to as a fall-out factor). The value of the underlying loan is affected primarily by changes in interest rates and the passage of time. However, changes in investor demand can also cause changes in the value of the underlying loan value that cannot be hedged. The aggregate fair value of derivative loan commitments in the balance sheet was a net liability of $48 million at June 30, 2011, and $271 million at December 31, 2010, and is included in the caption “Interest rate contracts” under “Customer accommodation, trading and other free-standing derivatives” in the first table in this Note.

We also enter into various derivatives primarily to provide derivative products to customers. To a lesser extent, we take positions based on market expectations or to benefit from price differentials between financial instruments and markets. These derivatives are not linked to specific assets and liabilities in the balance sheet or to forecasted transactions in an accounting hedge relationship and, therefore, do not qualify for hedge accounting. We also enter into free-standing derivatives for risk management that do not otherwise qualify for hedge accounting. They are carried at fair value with changes in fair value recorded as part of other noninterest income.

Free-standing derivatives also include embedded derivatives that are required to be accounted for separate from their host contract. We periodically issue hybrid long-term notes and CDs where the performance of the hybrid instrument notes is linked to an equity, commodity or currency index, or basket of such indices. These notes contain explicit terms that affect some or all of the cash flows or the value of the note in a manner similar to a derivative instrument and therefore are considered to contain an “embedded” derivative instrument. The indices on which the performance of the hybrid instrument is calculated are not clearly and closely related to the host debt instrument. The “embedded” derivative is separated from the host contract and accounted for as a free-standing derivative. Additionally, we may invest in hybrid instruments that contain embedded derivatives, such as credit derivatives, that are not clearly and closely related to the host contract. In such instances, we either elect fair value option for the hybrid instrument or separate the embedded derivative from the host contract and account for the host contract and derivative separately.

The following table shows the net gains recognized in the income statement related to derivatives not designated as hedging instruments.




	Quarter ended June 30,						Six months ended June 30,
(in millions)	2011			2010			2011			2010


Gains (losses) recognized on free-standing derivatives (economic hedges):
Interest rate contracts (1)
Recognized in noninterest income:
Mortgage banking	$	198			757			251			1,425
Other		(31	)		(30	)		(20	)		(36	)
Foreign exchange contracts (2)		(105	)		69			(369	)		145
Equity contracts (2)		(5	)		-			(5	)		-
Credit contracts (2)		(3	)		(36	)		(8	)		(125	)


Subtotal		54			760			(151	)		1,409

Gains (losses) recognized on customer accommodation, trading and other free-standing derivatives:
Interest rate contracts (3)
Recognized in noninterest income:
Mortgage banking		759			1,644			1,159			2,547
Other		94			(154	)		290			165
Commodity contracts (4)		116			13			101			33
Equity contracts (4)		639			495			477			449
Foreign exchange contracts (4)		125			148			307			266
Credit contracts (4)		91			(58	)		44			(488	)
Other (4)		(8	)		(12	)		(1	)		(19	)


Subtotal		1,816			2,076			2,377			2,953


Net gains recognized related to derivatives not designated as hedging instruments	$	1,870			2,836			2,226			4,362


(1)		Predominantly mortgage banking noninterest income including gains (losses) on the derivatives used as economic hedges of MSRs measured at fair value, interest rate lock commitments and mortgages held for sale.

(2)		Predominantly included in other noninterest income.

(3)		Predominantly mortgage banking noninterest income including gains (losses) on interest rate lock commitments.

(4)		Predominantly included in net gains from trading activities in noninterest income.

Credit Derivatives

We use credit derivatives to manage exposure to credit risk related to lending and investing activity and to assist customers with their risk management objectives. This may include protection sold to offset purchased protection in structured product transactions, as well as liquidity agreements written to special purpose vehicles. The maximum exposure of sold credit derivatives is managed through posted collateral, purchased credit derivatives and similar products in order to achieve our desired credit risk profile. This credit risk management provides an ability to recover a significant portion of any amounts that would be paid under the sold credit derivatives. We would be required to perform under the noted credit derivatives in the event of default by the referenced obligors. Events of default include events such as bankruptcy, capital restructuring or lack of principal and/or interest payment. In certain cases, other triggers may exist, such as the credit downgrade of the referenced obligors or the inability of the special purpose vehicle for which we have provided liquidity to obtain funding.

The following table provides details of sold and purchased credit derivatives.




			Notional amount
					Protection		Protection
					sold -		purchased		Net
					non-		with		protection		Other
	Fair value		Protection		investment		identical		sold		protection		Range of
(in millions)	liability		sold (A)		grade		underlyings (B)		(A) - (B)		purchased		maturities


June 30, 2011
Credit default swaps on:
Corporate bonds	$	676		28,736		16,501		15,775		12,961		10,194		2011-2021
Structured products		3,826		5,499		5,015		4,765		734		2,383		2016-2056
Credit protection on:
Default swap index		15		3,440		1,094		2,425		1,015		1,146		2011-2017
Commercial mortgage- backed securities index		641		1,564		499		750		814		678		2049-2052
Asset-backed securities index		89		99		99		10		89		130		2037-2046
Loan deliverable credit default swaps		1		491		467		379		112		266		2012-2016
Other		9		4,707		4,412		134		4,573		3,328		2011-2056


Total credit derivatives	$	5,257		44,536		28,087		24,238		20,298		18,125


December 31, 2010
Credit default swaps on:
Corporate bonds	$	810		30,445		16,360		17,978		12,467		9,440		2011-2020
Structured products		4,145		5,825		5,246		4,948		877		2,482		2016-2056
Credit protection on:
Default swap index		12		2,700		909		2,167		533		1,106		2011-2017
Commercial mortgage-backed securities index		717		1,977		612		924		1,053		779		2049-2052
Asset-backed securities index		128		144		144		46		98		142		2037-2046
Loan deliverable credit default swaps		2		481		456		391		90		261		2011-2014
Other		12		6,127		5,348		41		6,086		2,745		2011-2056


Total credit derivatives	$	5,826		47,699		29,075		26,495		21,204		16,955

Protection sold represents the estimated maximum exposure to loss that would be incurred under an assumed hypothetical circumstance, where the value of our interests and any associated collateral declines to zero, without any consideration of recovery or offset from any economic hedges. We believe this hypothetical circumstance to be an extremely remote possibility and accordingly, this required disclosure is not an indication of expected loss. The amounts under non-investment grade represent the notional amounts of those credit derivatives on which we have a higher risk of being required to perform under the terms of the credit derivative and are a function of the underlying assets.

We consider the risk of performance to be high if the underlying assets under the credit derivative have an external rating that is below investment grade or an internal credit default grade that is equivalent thereto. We believe the net protection sold, which is representative of the net notional amount of protection sold and purchased with identical underlyings, in combination with other protection purchased, is more representative of our exposure to loss than either non-investment grade or protection sold. Other protection purchased represents additional protection, which may offset the exposure to loss for protection sold, that was not purchased with an identical underlying of the protection sold.

Credit-Risk Contingent Features

Certain of our derivative contracts contain provisions whereby if the credit rating of our debt, based on certain major credit rating agencies indicated in the relevant contracts, were to fall below investment grade, the counterparty could demand additional collateral or require termination or replacement of derivative instruments in a net liability position. The aggregate fair value of all derivative instruments with such credit-risk-related contingent features that are in a net liability position was $13.9 billion at June 30, 2011, and $12.6 billion at December 31, 2010, respectively, for which we posted $12.8 billion and $12.0 billion, respectively, in collateral in the normal course of business. If the credit-risk-related contingent features underlying these agreements had been triggered on June 30, 2011, or December 31, 2010, we would have been required to post additional collateral of $1.5 billion or $1.0 billion, respectively, or potentially settle the contract in an amount equal to its fair value.

Counterparty Credit Risk

By using derivatives, we are exposed to counterparty credit risk if counterparties to the derivative contracts do not perform as expected. If a counterparty fails to perform, our counterparty credit risk is equal to the amount reported as a derivative asset on our balance sheet. The amounts reported as a derivative asset are derivative contracts in a gain position, and to the extent subject to master netting arrangements, net of derivatives in a loss position with the same counterparty and cash collateral received. We minimize counterparty credit risk through credit approvals, limits, monitoring procedures, executing master netting arrangements and obtaining collateral, where appropriate. To the extent the master netting arrangements and other criteria meet the applicable requirements, derivatives balances and related cash collateral amounts are shown net in the balance sheet. Counterparty credit risk related to derivatives is considered in determining fair value and our assessment of hedge effectiveness.