FAIR VALUE MEASUREMENTS

As discussed in Note 1 “Significant Accounting Policies,” to the Company’s audited Consolidated Financial Statements in the Annual Report on Form 10-K for the year ended December 31, 2014, the Company measures or monitors many of its assets and liabilities on a fair value basis. Fair value is used on a recurring basis for assets and liabilities for which fair value is the required or elected measurement basis of accounting. Additionally, fair value is used on a nonrecurring basis to evaluate assets for impairment or for disclosure purposes. Nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets. The Company also applies the fair value measurement guidance to determine amounts reported for certain disclosures in this Note for assets and liabilities not required to be reported at fair value in the financial statements.

The Company elected to account for residential mortgage loans held for sale and certain commercial and commercial real estate loans held for sale at fair value. Applying fair value accounting to the residential mortgage loans held for sale better aligns the reported results of the economic changes in the value of these loans and their related hedge instruments. Certain commercial and commercial real estate held for sale loans are managed by a commercial secondary loan desk that provides liquidity to banks, finance companies and institutional investors. Applying fair value accounting to this portfolio is appropriate because the Company holds these loans with the intent to sell within short term periods.

Fair Value Option, Residential Mortgage Loans Held for Sale

The fair value of residential loans held for sale is derived from observable mortgage security prices and includes adjustments for loan servicing value, agency guarantee fees, and other loan level attributes which are mostly observable in the marketplace. Credit risk does not significantly impact the valuation since these loans are sold shortly after origination. Therefore, the Company classifies the residential mortgage loans held for sale in Level 2 of the fair value hierarchy.

The election of the fair value option for financial assets and financial liabilities is optional and irrevocable. The loans accounted for under the fair value option are initially measured at fair value (i.e., acquisition cost) when the financial asset is acquired. Subsequent changes in fair value are recognized in mortgage banking fees on the Consolidated Statements of Operations. The Company recognized mortgage banking income (expense) of $4 million and $(2) million for the three months ended September 30, 2015 and 2014, respectively. The Company recognized mortgage banking income of $2 million and $3 million for the nine months ended September 30, 2015 and 2014, respectively.

Interest income on residential mortgage loans held for sale is calculated based on the contractual interest rate of the loan and is recorded in interest income.

Fair Value Option, Commercial and Commercial Real Estate Loans Held for Sale

The fair value of commercial and commercial real estate loans held for sale is estimated using observable prices of identical or similar loans that transact in the marketplace. In addition, the Company uses external pricing services that provide estimates of fair values based on quotes from various dealers transacting in the market, sector curves or benchmarking techniques. Therefore, the Company classifies the commercial and commercial real estate loans managed by the commercial secondary loan desk in Level 2 of the fair value hierarchy given the observable market inputs.

There were no loans in this portfolio that were 90 days or more past due or nonaccruing as of September 30, 2015. The loans accounted for under the fair value option are initially measured at fair value when the financial asset is recognized. Subsequent changes in fair value are recognized in current earnings. Since all loans in the Company’s commercial trading portfolio consist of floating rate obligations, all changes in fair value are due to changes in credit risk. Such credit-related fair value changes may include observed changes in overall credit spreads and/or changes to the creditworthiness of an individual borrower. Unsettled trades within the commercial trading portfolio are not recognized on the Consolidated Balance Sheets and represent off-balance sheet commitments. Refer to Note 13 “Commitments and Contingencies” for further information.

Interest income on commercial and commercial real estate loans held for sale is calculated based on the contractual interest rate of the loan and is recorded in interest income. Additionally, the Company recognized $1 million and $3 million for the three and nine months ended September 30, 2015, respectively, in other noninterest income related to its commercial trading portfolio. There was no interest income or noninterest income recorded in the three and nine months ended September 30, 2014.

The following table summarizes the difference between the aggregate fair value and the aggregate unpaid principal balance loans held for sale measured at fair value:



	September 30, 2015						December 31, 2014
(in millions)	Aggregate Fair Value		Aggregate Unpaid Principal		Aggregate Fair Value Less Aggregate Unpaid Principal		Aggregate Fair Value		Aggregate Unpaid Principal		Aggregate Fair Value Less Aggregate Unpaid Principal
Residential mortgage loans held for sale, at fair value		$269		$261		$8		$213		$206		$7
Commercial and commercial real estate loans held for sale, at fair value	100		100		—		43		43		—

Recurring Fair Value Measurements

The Company utilizes a variety of valuation techniques to measure its assets and liabilities at fair value. Following is a description of valuation methodologies used for significant assets and liabilities carried on the balance sheet at fair value on a recurring basis:

Securities available for sale

The fair value of securities classified as AFS is based upon quoted prices, if available. Where observable quoted prices are available in an active market, securities are classified as Level 1 in the fair value hierarchy. Classes of instruments that are valued using this market approach include debt securities issued by the U.S. Treasury. If quoted market prices are not available, the fair value for the security is estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. These instruments are classified as Level 2 because they currently trade in active markets and the inputs to the valuations are observable. The pricing models used to value securities generally begin with market prices (or rates) for similar instruments and make adjustments based on the unique characteristics of the instrument being valued. These adjustments reflect assumptions made regarding the sensitivity of each security’s value to changes in interest rates and prepayment speeds. Classes of instruments that are valued using this market approach include residential and commercial CMOs, specified pool mortgage “pass-through” securities and other debt securities issued by U.S. government-sponsored entities and state and political subdivisions.

A significant majority of the Company’s Level 1 and 2 securities are priced using an external pricing service. The Company verifies the accuracy of the pricing provided by its primary outside pricing service on a quarterly basis. This process involves using a secondary external vendor to provide valuations for the Company’s securities portfolio for comparison purposes. Any securities with discrepancies beyond a certain threshold are researched and, if necessary, valued by an independent outside broker.

In certain cases where there is limited activity or less transparency around inputs to the valuation model, securities are classified as Level 3.

Residential loans held for sale

See the “Fair Value Option, Residential Mortgage Loans Held for Sale” discussion above.

Commercial loans held for sale

See the “Fair Value Option, Commercial and Commercial Real Estate Loans Held for Sale” discussion above.

Derivatives

The vast majority of the Company’s derivatives portfolio is composed of “plain vanilla” interest rate swaps, which are traded in over-the-counter markets where quoted market prices are not readily available. For these interest rate derivatives, fair value is determined utilizing models that use primarily market observable inputs, such as swap rates and yield curves. The pricing models used to value interest rate swaps calculate the sum of each instrument’s fixed and variable cash flows, which are then discounted using an appropriate yield curve (i.e., LIBOR or OIS curve) to arrive at the fair value of each swap. The pricing models do not contain a high level of subjectivity as the methodologies used do not require significant judgment. The Company also considers certain adjustments to the modeled price which market participants would make when pricing each instrument, including a credit valuation adjustment that reflects the credit quality of the swap counterparty. The Company incorporates the effect of exposure to a particular counterparty’s credit by netting its derivative contracts with the collateral available and calculating a credit valuation adjustment on the basis of the net position with the counterparty where permitted. The determination of this adjustment requires judgment on behalf of Company management; however, the total amount of this portfolio-level adjustment is not material to the total fair value of the interest rate swaps in their entirety. Therefore, interest rate swaps are classified as Level 2 in the valuation hierarchy.

The Company’s other derivatives include foreign exchange contracts. Fair value of foreign exchange derivatives uses the mid-point of daily quoted currency spot prices. A valuation model estimates fair value based on the quoted spot rates together with interest rate yield curves and forward currency rates. Since all of these inputs are observable in the market, foreign exchange derivatives are classified as Level 2 in the fair value hierarchy.

Money Market Mutual Fund

Fair value is determined based upon unadjusted quoted market prices and is considered a Level 1 fair value measurement.

Venture capital investments and other investments

The fair values of the Company’s venture capital investments and other investments are based on security prices in the market that are not active; therefore, these investments are classified as Level 2 in the fair value hierarchy.

The following table presents assets and liabilities measured at fair value, including gross derivative assets and liabilities on a recurring basis at September 30, 2015:



(in millions)	Total		Level 1		Level 2		Level 3
Securities available for sale:
Mortgage-backed securities		$18,156		$—		$18,156		$—
State and political subdivisions	9		—		9		—
Equity securities	17		—		17		—
U.S. Treasury	15		15		—		—
Total securities available for sale	18,197		15		18,182		—
Loans held for sale:
Residential loans held for sale	269		—		269		—
Commercial loans held for sale	100		—		100		—
Total loans held for sale	369		—		369		—
Derivative assets:
Interest rate swaps	837		—		837		—
Foreign exchange contracts	163		—		163		—
Other contracts	10		—		10		—
Total derivative assets	1,010		—		1,010		—
Other investment securities, at fair value:
Money market mutual fund	45		45		—		—
Venture capital investments and other investments	5		—		5		—
Total other investment securities, at fair value	50		45		5		—
Total assets		$19,626		$60		$19,566		$—
Derivative liabilities:
Interest rate swaps		$648		$—		$648		$—
Foreign exchange contracts	158		—		158		—
Other contracts	10		—		10		—
Total derivative liabilities	816		—		816		—
Total liabilities		$816		$—		$816		$—

The following table presents assets and liabilities measured at fair value including gross derivative assets and liabilities on a recurring basis at December 31, 2014:



(in millions)	Total		Level 1		Level 2		Level 3
Securities available for sale:
Mortgage-backed securities		$18,606		$—		$18,606		$—
State and political subdivisions	10		—		10		—
Equity securities	25		8		17		—
U.S. Treasury	15		15		—		—
Total securities available for sale	18,656		23		18,633		—
Loans held for sale:
Residential loans held for sale	213		—		213		—
Commercial loans held for sale	43		—		43		—
Total loans held for sale	256		—		256		—
Derivative assets:
Interest rate swaps	613		—		613		—
Foreign exchange contracts	170		—		170		—
Other contracts	7		—		7		—
Total derivative assets	790		—		790		—
Other investment securities, at fair value:
Money market mutual fund	28		28		—		—
Venture capital investments and other investments	5		—		—		5
Total other investment securities, at fair value	33		28		—		5
Total assets		$19,735		$51		$19,679		$5
Derivative liabilities:
Interest rate swaps		$600		$—		$600		$—
Foreign exchange contracts	164		—		164		—
Other contracts	9		—		9		—
Total derivative liabilities	773		—		773		—
Total liabilities		$773		$—		$773		$—

The changes in Level 3 assets measured at fair value on a recurring basis are summarized as follows:



	Three Months Ended September 30,					Nine Months Ended September 30,
(in millions)	2015			2014		2015			2014
Beginning of period balance		$1			$6		$5			$5
Purchases, issuances, sales and settlements:
Purchases	—			—		1			—
Sales	—			—		—			—
Settlements	—			—		—			—
Net (losses) gains	(1		)	—		(1		)	1
Transfers from Level 3 to Level 2	—			—		(5		)	—
Balance as of period end		$—			$6		$—			$6
Net unrealized gain included in net income for the year relating to assets held at period end		$—			$—		$—			$—

In March 2015, the Company transferred $5 million of securities from Level 3 to Level 2. The fair values of these securities are based on security prices in the market that are not active.

Nonrecurring Fair Value Measurements

The following valuation techniques are utilized to measure significant assets for which the Company utilizes fair value on a nonrecurring basis:

Impaired Loans

The carrying amount of collateral-dependent impaired loans is compared to the appraised value of the collateral less costs to dispose and is classified as Level 2. Any excess of carrying amount over the appraised value is charged to the ALLL.

Mortgage Servicing Rights

MSRs do not trade in an active market with readily observable prices. MSRs are classified as Level 3 since the valuation methodology utilizes significant unobservable inputs. At September 30, 2015, the fair value was calculated using a discounted cash flow model, which used assumptions, including weighted-average life of 5.2 years (range of 2.7 - 5.8 years), weighted-average constant prepayment rate of 12.3% (range of 11.6% - 22.47%) and weighted-average discount rate of 9.7% (range of 9.11% - 12.07%). At December 31, 2014, the fair value was calculated using a discounted cash flow model, which used assumptions, including weighted-average life of 5.2 years (range of 2.8 - 6.6 years), weighted-average constant prepayment rate of 12.4% (range of 10.4% - 22.6%) and weighted-average discount rate of 9.8% (range of 9.1% - 12.1%). Refer to Note 1 “Significant Accounting Policies” to the Company’s audited Consolidated Financial Statements in the Annual Report on Form 10-K for the year ended December 31, 2014 and Note 7 “Mortgage Banking” for more information.

Foreclosed assets

Foreclosed assets consist primarily of residential properties. Foreclosed assets are carried at the lower of carrying value or fair value less costs to dispose. Fair value is based upon independent market prices or appraised values of the collateral and is classified as Level 2.

The following table presents gains (losses) on assets and liabilities measured at fair value on a nonrecurring basis and recorded in earnings:



	Three Months Ended September 30,						Nine Months Ended September 30,
(in millions)	2015			2014			2015			2014
Impaired collateral-dependent loans		($9	)		($5	)		($22	)		($99	)
MSRs	(1		)	5			6			8
Foreclosed assets	—			(1		)	(2		)	(2		)

The following tables present assets and liabilities measured at fair value on a nonrecurring basis:



	September 30, 2015								December 31, 2014
(in millions)	Total		Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3
Impaired collateral-dependent loans		$107		$—		$107		$—		$102		$—		$102		$—
MSRs	177		—		—		177		166		—		—		166
Foreclosed assets	36		—		36		—		40		—		40		—

Disclosures about Fair Value of Financial Instruments

Following is a description of valuation methodologies used to estimate the fair value of financial instruments for disclosure purposes (these instruments are not recorded in the financial statements at fair value):

Loans and leases

For loans and leases not recorded at fair value on a recurring basis that are not accounted for as collateral-dependent impaired loans, fair value is estimated by using one of two methods: a discounted cash flow method or a securitization method. The discounted cash flow method involves discounting the expected future cash flows using current rates which a market participant would likely use to value similar pools of loans. Inputs used in this method include observable information such as contractual cash flows (net of servicing cost) and unobservable information such as estimated prepayment speeds, credit loss exposures, and discount rates. The securitization method involves utilizing market securitization data to value the assets as if a securitization transaction had been executed. Inputs used include observable market-based MBS data and pricing adjustments based on unobservable data reflecting the liquidity risk, credit loss exposure and other characteristics of the underlying loans. The internal risk-weighted balances of loans are grouped by product type for purposes of these estimated valuations. For nonaccruing loans, fair value is estimated by discounting management’s estimate of future cash flows with a discount rate commensurate with the risk associated with such assets. Fair value of collateral-dependent loans is primarily based on the appraised value of the collateral.

Other loans held for sale

Balances are loans that were transferred to loans held for sale that are reported at book value.

Securities held to maturity

The fair value of securities classified as HTM is estimated using pricing models, quoted prices of securities with similar characteristics or discounted cash flow. The pricing models used to value these securities generally begin with market prices (or rates) for similar instruments and make adjustments based on the unique characteristics of the instrument being valued. These adjustments reflect assumptions made regarding the sensitivity of each security’s value to changes in interest rates and prepayment speeds.

Other investment securities

The fair value of other investment securities, such as FHLB stock and FRB stock, is assumed to approximate the cost basis of the securities. As a member of the FHLB and FRB, the Company is required to hold FHLB and FRB stock. The stock can be sold only to the FHLB and FRB upon termination of membership, or redeemed at the FHLB’s or FRB’s sole discretion.

Deposits

The fair value of demand deposits, checking with interest accounts, regular savings and money market accounts is the amount payable on demand at the balance sheet date. The fair value of term deposits is estimated by discounting the expected future cash flows using rates currently offered for deposits of similar remaining maturities.

Federal funds purchased and securities sold under agreements to repurchase, other short-term borrowed funds, and long-term borrowed funds

Rates currently available to the Company for debt of similar terms and remaining maturities are used to discount the expected cash flows of existing debt.

The following table is a summary of fair value for financial instruments not recorded at fair value in the unaudited interim Consolidated Financial Statements. The carrying amounts in the following table are recorded in the Consolidated Balance Sheets under the indicated captions:



	September 30, 2015
	Total				Level 1				Level 2				Level 3
(in millions)	Carrying Value		Fair Value		Carrying Value		Fair Value		Carrying Value		Fair Value		Carrying Value		Fair Value
Financial Assets:
Securities held to maturity		$5,285		$5,386		$—		$—		$5,285		$5,386		$—		$—
Other investment securities, at cost	822		822		—		—		822		822		—		—
Other loans held for sale	51		51		—		—		—		—		51		51
Loans and leases	97,431		97,314		—		—		107		107		97,324		97,207
Financial Liabilities:
Deposits	101,866		101,869		—		—		101,866		101,869		—		—
Federal funds purchased and securities sold under agreements to repurchase	1,293		1,294		—		—		1,293		1,294		—		—
Other short-term borrowed funds	5,861		5,861		—		—		5,861		5,861		—		—
Long-term borrowed funds	4,153		4,261		—		—		4,153		4,261		—		—



	December 31, 2014
	Total				Level 1				Level 2				Level 3
(in millions)	Carrying Value		Fair Value		Carrying Value		Fair Value		Carrying Value		Fair Value		Carrying Value		Fair Value
Financial Assets:
Securities held to maturity		$5,148		$5,193		$—		$—		$5,148		$5,193		$—		$—
Other investment securities, at cost	867		867		—		—		867		867		—		—
Other loans held for sale	25		25		—		—		—		—		25		25
Loans and leases	93,410		93,674		—		—		102		102		93,308		93,572
Financial Liabilities:
Deposits	95,707		95,710		—		—		95,707		95,710		—		—
Federal funds purchased and securities sold under agreements to repurchase	4,276		4,276		—		—		4,276		4,276		—		—
Other short-term borrowed funds	6,253		6,253		—		—		6,253		6,253		—		—
Long-term borrowed funds	4,642		4,706		—		—		4,642		4,706		—		—