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DERIVATIVES
 9 Months Ended
Sep. 30, 2019
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
DERIVATIVES
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. During the three months ended September 30, 2019, Citizens executed a last-of-layer hedge utilizing pay-fixed interest rate swap agreements to manage the interest rate exposure on mortgage-backed securities held in its available for sale debt securities. 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 in the Company’s Form 10-Q for the period ended March 31, 2019 and Note 19 in the Company’s 2018 Form 10-K.
The following table presents derivative instruments included on the Consolidated Balance Sheets in derivative assets and derivative liabilities:
 
September 30, 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

$31,596


$—


$3

 

$12,050


$5


$—

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
Interest rate contracts
140,652

993

172

 
117,076

301

277

Foreign exchange contracts
12,905

224

195

 
9,866

129

113

Other contracts
9,382

49

24

 
3,555

14

25

Total derivatives not designated as hedging instruments
 
1,266

391

 
 
444

415

Gross derivative fair values
 
1,266

394

 
 
449

415

Less: Gross amounts offset in the Consolidated Balance Sheets (2)
 
(122
)
(122
)
 
 
(87
)
(87
)
Less: Cash collateral applied (2)
 
(117
)
(111
)
 
 
(45
)
(36
)
Total net derivative fair values presented in the Consolidated Balance Sheets
 

$1,027


$161

 
 

$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 period. 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, certain fixed rate residential mortgages and debt securities available for sale. 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 September 30,
 
Nine Months Ended September 30,
 
(in millions)
2019

 
2018

 
2019

 
2018

Affected Line Item in the Consolidated Statements of Operations
Change in fair value of interest rate swaps hedging borrowed funds

$18

 

($6
)
 

$122

 

($32
)
Interest expense - borrowed funds
Change in fair value of hedged long-term debt attributable to the risk being hedged
(18
)
 
7

 
(121
)
 
31

Interest expense - borrowed funds
Change in fair value of interest rate swaps hedging fixed rate loans
(10
)
 
—

 
(26
)
 
—

Interest and fees on loans and leases
Change in fair value of hedged fixed rate loans attributable to the risk being hedged
10

 
—

 
26

 
—

Interest and fees on loans and leases
Change in fair value of interest rate swaps hedging debt securities available for sale
(13
)
 
—

 
(13
)
 
—

Interest income - investment securities
Change in fair value of hedged debt securities available for sale attributable to risk being hedged
13

 
—

 
13

 
—

Interest income - investment securities

The following table reflects amounts recorded on the Consolidated Balance Sheets related to cumulative basis adjustments for fair value hedges:    
 
September 30, 2019
(in millions)
Debt securities available for sale(2)
Residential mortgages
Long-term borrowed funds
Carrying amount of the hedged assets

$19,872


$985


$—

Carrying amount of the hedged liabilities(1)
—

—

5,450

Cumulative amount of fair value hedging adjustments included in the carrying amount of the hedged items
13

26

62

(1)The balance reported for long-term borrowed funds includes ($1) million of cumulative hedging adjustments recorded on discontinued fair value hedging relationships.
(2)The Company designated $2.0 billion as the hedged amount (from a closed portfolio of prepayable financial assets with a carrying value of $20 billion as of September 30, 2019) in a last-of-layer hedging relationship, which commenced in the third quarter of 2019.
Cash Flow Hedges
Citizens has outstanding interest rate swap agreements designed to hedge a portion of the Company’s floating rate assets and liabilities. 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 $10 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 September 30, 2019.
During the three and nine months ended September 30, 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 pre-tax 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 September 30,
 
Nine Months Ended September 30,
(in millions)
2019
 
2018(1)
 
2019
 
2018(1)
Amount of pre-tax net (losses) gains recognized in OCI

($5
)
 

($35
)
 

$138

 

($122
)
Amount of pre-tax net losses reclassified from OCI into interest income
(22
)
 
(17
)
 
(62
)
 
(36
)
Amount of pre-tax net gains reclassified from OCI into interest expense
8

 
3

 
9

 
11

(1) For the three and nine months ended September 30, 2018, the amount of pre-tax net gains (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.
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. 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 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 September 30,
 
Nine Months Ended September 30,
Affected Line Item in the Consolidated Statements of Operations
(in millions)
2019

 
2018

 
2019

 
2018

Economic hedge type:
 
 
 
 
 
 
 
 
Customer interest rate contracts

$196

 

($84
)
 

$850

 

($363
)
Foreign exchange and interest rate products
Customer foreign exchange contracts
(81
)
 
30

 
(162
)
 
(27
)
Foreign exchange and interest rate products
Derivatives transactions to hedge interest rate risk
(182
)
 
97

 
(809
)
 
403

Foreign exchange and interest rate products
Derivatives transactions to hedge foreign exchange risk
130

 
24

 
224

 
99

Foreign exchange and interest rate products
Residential loan commitments
6

 
6

 
22

 
6

Mortgage banking fees
Forward sale contracts
29

 
(13
)
 
24

 
(15
)
Mortgage banking fees
Interest rate derivative contracts used to hedge residential MSRs
92

 
(3
)
 
208

 
(3
)
Mortgage banking fees
Total

$190

 

$57

 

$357

 

$100