DERIVATIVES

In the normal course of business, the Company enters into a variety of derivative transactions in order to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates and foreign currency exchange rates. The Company does not use derivatives for speculative purposes.

The Company’s derivative instruments are recognized on the Consolidated Balance Sheets at fair value. Information regarding the valuation methodology and inputs used to estimate the fair value of the Company’s derivative instruments is described in Note 15 “Fair Value Measurements.”

The following table identifies derivative instruments included on the Consolidated Balance Sheets in derivative assets and derivative liabilities:



	March 31, 2015								December 31, 2014
(in millions)	Notional Amount ⁽¹⁾		Derivative Assets			Derivative Liabilities			Notional Amount ⁽¹⁾		Derivative Assets			Derivative Liabilities
Derivatives designated as hedging instruments:
Interest rate swaps		$7,500		$89			$55			$5,750		$24			$99
Derivatives not designated as hedging instruments:
Interest rate swaps	32,632		655			569			31,848		589			501
Foreign exchange contracts	8,046		253			247			8,359		170			164
Other contracts	1,144		9			9			730		7			9
Total derivatives not designated as hedging instruments			917			825					766			674
Gross derivative fair values			1,006			880					790			773
Less: Gross amounts offset in the Consolidated Balance Sheets ⁽²⁾			(264		)	(264		)			(161		)	(161		)
Total net derivative fair values presented in the Consolidated Balance Sheets ⁽³⁾				$742			$616					$629			$612

⁽¹⁾The notional or contractual amount of interest rate derivatives and foreign exchange contracts is the amount upon which interest and other payments under the contract are based. For interest rate derivatives, the notional amount is typically not exchanged. Therefore, notional amounts should not be taken as the measure of credit or market risk, as they tend to greatly overstate the true economic risk of these contracts.

⁽²⁾Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle positive and negative positions.

⁽³⁾The Company also offsets assets and liabilities associated with repurchase agreements on the Consolidated Balance Sheets. See Note 2 “Securities” for further information.

The Company’s derivative transactions are internally divided into three sub-groups: institutional, customer and residential loan.

Institutional derivatives

The institutional derivatives portfolio primarily consists of interest rate swap agreements that are used to hedge the interest rate risk associated with the Company’s loans and financing liabilities (i.e., borrowed funds, deposits, etc.). The goal of the Company’s interest rate hedging activities is to manage interest rate sensitivity so that movements in interest rates do not significantly adversely affect net interest income.

The Company enters into certain interest rate swap agreements to hedge the risk associated with floating rate loans. By entering into pay-floating/receive-fixed interest rate swaps, the Company was able to minimize the variability in the cash flows of these assets due to changes in interest rates. The Company has outstanding interest rate swap agreements designed to hedge a portion of the Company’s borrowed funds and deposits. By entering into a pay-fixed/receive-floating interest rate swap, a portion of these liabilities has been effectively converted to a fixed rate liability for the term of the interest rate swap agreement.

Customer derivatives

The customer derivatives portfolio consists of interest rate swap agreements and option contracts that are transacted to meet the financing needs of the Company’s customers. Offsetting swap and cap agreements are simultaneously transacted to effectively eliminate the Company’s market risk associated with the customer derivative products. The customer derivatives portfolio also includes foreign exchange contracts that are entered into on behalf of customers for the purpose of hedging exposure related to cash orders and loans and deposits denominated in foreign currency. The primary risks associated with these transactions arise from exposure to changes in foreign currency exchange rates and the ability of the counterparties to meet the terms of the contract. To manage this market risk, the Company simultaneously enters into offsetting foreign exchange contracts.

Residential loan derivatives

The Company enters into residential loan commitments that allow residential mortgage customers to lock in the interest rate on a residential mortgage while the loan undergoes the underwriting process. The Company also uses forward sales contracts to protect the value of residential mortgage loans and loan commitments that are being underwritten for future sale to investors in the secondary market.

The Company has certain derivative transactions that are designated as hedging instruments described as follows:

Derivatives designated as hedging instruments

The Company’s total institutional hedging portfolio qualifies for hedge accounting. This includes interest rate swaps that are designated in highly effective cash flow hedging relationships. The Company formally documents at inception all hedging relationships, as well as risk management objectives and strategies for undertaking various accounting hedges. Additionally, the Company uses dollar offset or regression analysis at the hedge’s inception, and monthly thereafter to assess whether the derivatives are expected to be, or have been, highly effective in offsetting changes in the hedged item’s expected cash flows. The Company discontinues hedge accounting when it is determined that a derivative is not expected to be or has ceased to be effective as a hedge, and then reflects changes in fair value in earnings after termination of the hedge relationship.

Fair value hedges

The Company has entered into an interest rate swap agreement to manage the interest rate exposure on its medium term fixed-rate borrowing. This agreement involves the receipt of fixed-rate amounts in exchange for floating-rate interest payments over the life of the agreement. The changes in fair value of the fair value hedges, to the extent that the hedging relationship is effective, are recorded through earnings and offset against changes in the fair value of the hedged item.

The following table summarizes certain information related to the Company’s fair value hedges:



	The Effect of Fair Value Hedges on Net Income
	Amounts Recognized in Other Income for the Three Months Ended March 31, 2015
(in millions)	Derivative		Hedged Item			Hedge Ineffectiveness
Hedges of interest rate risk on borrowing using interest rate swaps		$9		($9	)		$—

There was no impact on net income for the three months ended March 31, 2014.

Cash flow hedges

The Company has outstanding interest rate swap agreements designed to hedge a portion of the Company’s floating rate assets and financing liabilities (including its borrowed funds and deposits). All of these swaps have been deemed as highly effective cash flow hedges. The effective portion of the hedging gains and losses associated with these hedges are recorded in OCI; the ineffective portion of the hedging gains and losses is recorded in earnings (other income). Hedging gains and losses on derivative contracts reclassified from OCI to current period earnings are included in the line item in the accompanying Consolidated Statements of Operations in which the hedged item is recorded, and in the same period that the hedged item affects earnings. During the next 12 months, approximately $16 million of net loss (pre-tax) on derivative instruments included in OCI is expected to be reclassified to net interest expense in the Consolidated Statements of Operations.

Hedging gains and losses associated with the Company’s cash flow hedges are immediately reclassified from OCI to current period earnings (other income) if it becomes probable that the hedged forecasted transactions will not occur during the originally specified time period.

The following table summarizes certain information related to the Company’s cash flow hedges:



The Effect of Cash Flow Hedges on Net Income and Stockholders' Equity
	Amounts Recognized for the Three Months Ended March 31,
(in millions)	2015			2014
Effective portion of gain (loss) recognized in OCI ⁽¹⁾		$104			($92	)
Amounts reclassified from OCI to interest income ⁽²⁾	18			18
Amounts reclassified from OCI to interest expense ⁽²⁾	(15		)	(29		)
Ineffective portion of gain recognized in other income ⁽³⁾	1			—

⁽¹⁾The cumulative effective gains and losses on the Company’s cash flow hedging activities are included on the accumulated other comprehensive loss line item on the Consolidated Balance Sheets.

⁽²⁾This amount includes both (a) the amortization of effective gains and losses associated with the Company’s terminated cash flow hedges and (b) the current reporting period’s interest settlements realized on the Company’s active cash flow hedges. Both (a) and (b) were previously included on the accumulated other comprehensive loss line item on the Consolidated Balance Sheets and were subsequently recorded as adjustments to the interest expense of the underlying hedged item.

⁽³⁾This amount represents the net ineffectiveness recorded during the reporting periods presented plus any amounts excluded from effectiveness testing. These amounts are reflected in the other income line item on the Consolidated Statements of Operations.

Economic hedges

The Company’s customer derivatives are recorded on the Consolidated Balance Sheets at fair value. These include interest rate and foreign exchange derivative contracts that are transacted to meet the hedging and financing needs of the Company’s customers. Mark-to-market adjustments to the fair value of customer related interest rate contracts are included in other income in the accompanying Consolidated Statements of Operations. Mark-to-market adjustments to the fair value of foreign exchange contracts relating to foreign currency loans are included in interest and fees on loans and leases in the accompanying Consolidated Statements of Operations, while all other foreign currency contract fair value changes are included in foreign exchange and trade finance fees. In both cases, the mark-to-market gains and losses associated with the customer derivatives are mitigated by the mark-to-market gains and losses on the offsetting interest rate and foreign exchange derivative contracts transacted.

The Company’s residential loan derivatives (including residential loan commitments and forward sales contracts) are recorded on the Consolidated Balance Sheets at fair value. Mark-to-market adjustments to the fair value of residential loan commitments and forward sale contracts are included in noninterest income under mortgage banking fees.

The following table summarizes certain information related to the Company’s economic hedges:



The Effect of Customer Derivatives and Economic Hedges on Net Income
	Amounts Recognized in Noninterest Income for the Three Months Ended March 31,
(in millions)	2015			2014
Customer derivative contracts
Customer interest rate contracts ⁽¹⁾		$73			$61
Customer foreign exchange contracts ⁽¹⁾	(35		)	4
Residential loan commitments ⁽³⁾	—			3
Economic hedges
Offsetting derivatives transactions to hedge interest rate risk on customer interest rate contracts ⁽¹⁾	(68		)	(53		)
Offsetting derivatives transactions to hedge foreign exchange risk on customer foreign exchange contracts ⁽²⁾	35			(6		)
Forward sale contracts ⁽³⁾	(1		)	(1		)
Total		$4			$8

⁽¹⁾Reported in other income on the Consolidated Statements of Operations.

⁽²⁾Reported in foreign exchange and trade finance fees on the Consolidated Statements of Operations.

⁽³⁾Reported in mortgage banking fees on the Consolidated Statements of Operations.