NOTE 9 - DERIVATIVES

In the normal course of business, Citizens 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. These transactions include interest rate swap contracts, interest rate options, foreign exchange contracts, residential loan commitment rate locks, interest rate future contracts, swaptions, forward commitments to sell to-be-announced mortgage securities (“TBAs”), forward sale contracts and purchase options. The Company monitors the results of each transaction to ensure that management’s intent is satisfied. 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 13 "Fair Value Measurements."

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



	March 31, 2019								December 31, 2018
(in millions)	Notional Amount⁽¹⁾		Derivative Assets			Derivative Liabilities			Notional Amount⁽¹⁾		Derivative Assets			Derivative Liabilities
Derivatives designated as hedging instruments:
Interest rate contracts		$14,500		$—			$15			$12,050		$5			$—
Derivatives not designated as hedging instruments:
Interest rate contracts	126,525		443			145			117,076		301			277
Foreign exchange contracts	11,858		135			113			9,866		129			113
Other contracts	5,221		19			21			3,555		14			25
Total derivatives not designated as hedging instruments			597			279					444			415
Gross derivative fair values			597			294					449			415
Less: Gross amounts offset in the Consolidated Balance Sheets ⁽²⁾			(78		)	(78		)			(87		)	(87		)
Less: Cash collateral applied ⁽²⁾			(54		)	(43		)			(45		)	(36		)
Total net derivative fair values presented in the Consolidated Balance Sheets				$465			$173					$317			$292

⁽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 contracts, the notional amount is typically not exchanged. Therefore, notional amounts should not be taken as the measure of credit or market risk, as they do not measure the true economic risk of these contracts.

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

The Company’s derivative transactions are internally divided into three sub-groups: institutional, customer and residential loan. Citizens has certain derivative transactions which are designated as fair value or cash flow hedges, described as follows:

Derivatives Designated As Hedging Instruments

The Company’s institutional derivatives portfolio qualifies for hedge accounting treatment. This includes interest rate swaps that are designated as highly effective fair value and 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, Citizens monitors the effectiveness of its hedge relationships during the duration of the hedge relationship. The methods utilized to assess hedge effectiveness vary based on the type of item being hedged. The Company discontinues hedge accounting treatment 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

Citizens has outstanding interest rate swap agreements to manage the interest rate exposure on its medium-term borrowings. The changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability attributable to the hedged risk are recorded in the same income statement line in the Consolidated Statements of Operations.

The following table reflects the change in fair value of interest rate contracts, designated as fair value hedges, as well as the change in fair value of the related hedged items attributable to the risk being hedged, included in the Consolidated Statements of Operations:



	Three Months Ended March 31,
(in millions)	2019			2018			Affected Line Item in the Consolidated Statements of Operations
Change in fair value of interest rate swaps hedging borrowed funds		$39			($39	)	Interest expense - borrowed funds
Change in fair value of hedged long-term debt attributable to the risk being hedged	(39		)	37			Interest expense - borrowed funds

The following table reflects amounts recorded on the Consolidated Balance Sheets related to cumulative basis adjustments for fair value hedges:



	March 31, 2019
(in millions)	Long-term borrowed funds
Carrying amount of the hedged liabilities		$5,362
Cumulative amount of fair value hedging adjustments included in the carrying amount of the hedged items⁽¹⁾	(23		)

⁽¹⁾The balance reported includes ($4) million of cumulative hedging adjustments recorded on discontinued fair value hedging relationships.

Cash Flow Hedges

Citizens has outstanding interest rate swap agreements designed to hedge a portion of the Company’s floating rate assets. All of these swaps have been deemed as highly effective cash flow hedges. The entire change in the fair value of the interest rate swap included in the assessment of hedge effectiveness is recorded in OCI and reclassified from OCI to current period earnings (interest income or interest expense) in the same period that the hedged item affects earnings. During the next 12 months, there are $12 million in pre-tax net losses on derivative instruments included in OCI expected to be reclassified to net interest income in the Consolidated Statements of Operations. This amount could differ from amounts actually recognized due to changes in interest rates, hedge de-designations, and the addition of other hedges subsequent to March 31, 2019.

During the three months ended March 31, 2019 and 2018, there were no gains or losses reclassified from OCI to current period earnings (other income) associated with the discontinuance of the Company’s cash flow hedges because it was probable that the original forecasted transaction would no longer occur by the end of the originally specified time period.

The following table presents the pretax net gains (losses) recorded in the Consolidated Statements of Operations and in the Consolidated Statements of Comprehensive Income relating to derivative instruments designated as cash flow hedges:



	Three Months Ended March 31,
(in millions)	2019			2018⁽¹⁾
Amount of pretax net gains (losses) recognized in OCI		$51			($70	)
Amount of pretax net losses reclassified from OCI into interest income	(20		)	(6		)
Amount of pretax net gains reclassified from OCI into interest expense	—			4

⁽¹⁾For the three months ended March 31, 2018, the amount of pretax net losses recognized in OCI represented the effective portion of the cumulative gains or losses on cash flow hedges and ineffectiveness was reported within noninterest income.

Derivatives Not Designated As Hedging Instruments

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 designed to meet the hedging and financing needs of the Company’s customers. The mark-to-market gains and losses associated with the customer derivatives are mitigated by mark-to-market gains and losses on interest rate and foreign exchange derivative contracts transacted. Citizens also purchases interest rate floors primarily to hedge the exposure related to customer deposit products that have embedded minimum interest rate guarantees. Citizens utilizes interest rate floors in non-qualifying hedging relationships.

The Company’s residential loan derivatives (including residential loan commitments and forward sales contracts) are recorded on the Consolidated Balance Sheets at fair value. Citizens also uses derivatives to hedge the risk of changes in the fair value of its residential MSR portfolio measured at fair value. Certain residential MSRs are accounted for at fair value with changes in the fair value influenced primarily by changes in interest rates. Derivatives used to hedge the fair value of residential MSRs include TBAs, interest rate swaptions, interest rate futures and interest rate swaps.

The following table presents the effect of economic hedges on noninterest income:



	Amounts Recognized in Noninterest Income for the
	Three Months Ended March 31,						Affected Line Item in the Consolidated Statements of Operations
(in millions)	2019			2018
Economic hedge type:
Customer interest rate contracts		$229			($204	)	Foreign exchange and interest rate products
Customer foreign exchange contracts	(34		)	11			Foreign exchange and interest rate products
Derivatives transactions to hedge interest rate risk	(217		)	216			Foreign exchange and interest rate products
Derivatives transactions to hedge foreign exchange risk	40			(17		)	Foreign exchange and interest rate products
Residential loan commitments	5			(1		)	Mortgage banking fees
Forward sale contracts	4			—			Mortgage banking fees
Interest rate derivative contracts used to hedge residential MSRs	45			—			Mortgage banking fees
Total		$72			$5