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Derivative Instruments and Hedging Activities
 9 Months Ended
Sep. 30, 2015
Derivative Instruments and Hedging Activities Disclosure  
Derivative Instruments and Hedging Activities

4.    Derivative Instruments and Hedging Activities.

The Company trades and makes markets globally in listed futures, over-the-counter (“OTC”) swaps, forwards, options and other derivatives referencing, among other things, interest rates, currencies, investment grade and non-investment grade corporate credits, loans, bonds, U.S. and other sovereign securities, emerging market bonds and loans, credit indices, asset-backed security indices, property indices, mortgage-related and other asset-backed securities, and real estate loan products. The Company uses these instruments for trading, foreign currency exposure management, and asset and liability management.

The Company manages its trading positions by employing a variety of risk mitigation strategies. These strategies include diversification of risk exposures and hedging. Hedging activities consist of the purchase or sale of positions in related securities and financial instruments, including a variety of derivative products (e.g., futures, forwards, swaps and options). The Company manages the market risk associated with its trading activities on a Company-wide basis, on a worldwide trading division level and on an individual product basis.

Offsetting of Derivative Instruments.

In connection with its derivative activities, the Company generally enters into master netting agreements and collateral agreements with its counterparties. For a further discussion of these agreements, see Note 12 to the consolidated financial statements in the 2014 Form 10-K. The following tables present information about the offsetting of derivative instruments and related collateral amounts. See information related to offsetting of certain collateralized transactions in Note 6.

At September 30, 2015
Gross Amounts(1)Amounts Offset in the Condensed Consolidated Statements of Financial ConditionNet Amounts Presented in the Condensed Consolidated Statements of Financial ConditionAmounts Not Offset in the Condensed Consolidated Statements of Financial Condition(2)Net Exposure
Financial Instruments CollateralOther Cash Collateral
(dollars in millions)
Derivative assets
Bilateral OTC $ 379,609 $ (351,265)$ 28,344 $ (9,967)$ (8)$ 18,369
Cleared OTC(3) 129,262 (127,987) 1,275 — — 1,275
Exchange traded 31,948 (28,273) 3,675 — — 3,675
Total derivative assets$ 540,819 $ (507,525)$ 33,294 $ (9,967)$ (8)$ 23,319
Derivative liabilities
Bilateral OTC $ 361,467 $ (332,549)$ 28,918 $ (6,967)$ — $ 21,951
Cleared OTC(3) 128,153 (127,267) 886 — (2) 884
Exchange traded 34,242 (28,273) 5,969 (735) — 5,234
Total derivative liabilities$ 523,862 $ (488,089)$ 35,773 $ (7,702)$ (2)$ 28,069

At December 31, 2014
Gross Amounts(4)Amounts Offset in the Condensed Consolidated Statements of Financial ConditionNet Amounts Presented in the Condensed Consolidated Statements of Financial ConditionAmounts Not Offset in the Condensed Consolidated Statements of Financial Condition(2)Net Exposure
Financial Instruments CollateralOther Cash Collateral
(dollars in millions)
Derivative assets
Bilateral OTC $ 427,079 $ (396,582)$ 30,497 $ (9,844)$ (19)$ 20,634
Cleared OTC(3) 217,169 (215,576) 1,593 — — 1,593
Exchange traded 32,123 (27,819) 4,304 — — 4,304
Total derivative assets$ 676,371 $ (639,977)$ 36,394 $ (9,844)$ (19)$ 26,531
Derivative liabilities
Bilateral OTC $ 410,003 $ (375,095)$ 34,908 $ (11,192)$ (179)$ 23,537
Cleared OTC(3) 211,695 (211,180) 515 — (6) 509
Exchange traded 32,608 (27,819) 4,789 (726) — 4,063
Total derivative liabilities$ 654,306 $ (614,094)$ 40,212 $ (11,918)$ (185)$ 28,109

(1) Amounts include $6.2 billion of derivative assets and $6.9 billion of derivative liabilities, which are either not subject to master netting agreements or collateral agreements or are subject to such agreements but the Company has not determined the agreements to be legally enforceable. See also “Fair Value and Notional of Derivative Instruments” herein, for additional disclosure about gross fair values and notionals for derivative instruments by risk type.

(2) Amounts relate to master netting agreements and collateral agreements, which have been determined by the Company to be legally enforceable in the event of default but where certain other criteria are not met in accordance with applicable offsetting accounting guidance.

(3) Amounts include OTC derivatives that are centrally cleared in accordance with certain regulatory requirements.

(4) Amounts include $6.5 billion of derivative assets and $6.9 billion of derivative liabilities, which are either not subject to master netting agreements or collateral agreements or are subject to such agreements but the Company has not determined the agreements to be legally enforceable. See also “Fair Value and Notional of Derivative Instruments” herein, for additional disclosure about gross fair values and notionals for derivative instruments by risk type.

The Company incurs credit risk as a dealer in OTC derivatives. Credit risk with respect to derivative instruments arises from the failure of a counterparty to perform according to the terms of the contract. The Company’s exposure to credit risk at any point in time is represented by the fair value of the derivative contracts reported as assets. The fair value of a derivative represents the amount at which the derivative could be exchanged in an orderly transaction between market participants and is further described in Note 2 to the consolidated financial statements in the 2014 Form 10-K and Note 3.

OTC Derivative Products—Trading Assets.

The tables below present a summary by counterparty credit rating and remaining contract maturity of the fair value of OTC derivatives in a gain position at September 30, 2015 and December 31, 2014. Fair value is presented in the final column, net of collateral received (principally cash and U.S. government and agency securities):

At September 30, 2015(1)
Years to MaturityCross-Maturityand Cash Collateral Netting(3)Net Exposure Post-cash CollateralNet Exposure Post-collateral
Credit Rating(2)Less than 11 - 33 - 5Over 5
(dollars in millions)
AAA $ 260 $ 289 $ 895 $ 4,174 $ (4,514)$ 1,104 $ 924
AA 2,599 2,493 1,848 11,978 (13,432) 5,486 2,887
A 10,807 9,428 5,885 22,520 (38,543) 10,097 6,606
BBB 4,202 4,711 2,414 12,306 (15,682) 7,951 5,654
Non-investment grade 4,502 3,339 1,521 3,755 (8,144) 4,973 3,573
Total $ 22,370 $ 20,260 $ 12,563 $ 54,733 $ (80,315)$ 29,611 $ 19,644

At December 31, 2014(1)
Years to MaturityCross-Maturity and Cash Collateral Netting(3)Net Exposure Post-cash CollateralNet Exposure Post-collateral
Credit Rating(2)Less than 11-33-5Over 5
(dollars in millions)
AAA $ 499 $ 246 $ 1,313 $ 4,281 $ (5,009)$ 1,330 $ 1,035
AA 2,679 2,811 2,704 14,137 (15,415) 6,916 4,719
A 11,733 10,833 7,585 23,968 (43,644) 10,475 6,520
BBB 5,119 3,753 2,592 13,132 (15,844) 8,752 6,035
Non-investment grade 3,196 3,089 1,541 2,499 (5,727) 4,598 3,918
Total $ 23,226 $ 20,732 $ 15,735 $ 58,017 $ (85,639)$ 32,071 $ 22,227

_____________

(1) Fair values shown represent the Company’s net exposure to counterparties related to the Company’s OTC derivative products. Amounts include centrally cleared OTC derivatives. The tables do not include exchange-traded derivatives and the effect of any related hedges utilized by the Company.

(2) Obligor credit ratings are determined by the Company’s Credit Risk Management Department.

(3) Amounts represent the netting of receivable balances with payable balances for the same counterparty across maturity categories. Receivable and payable balances with the same counterparty in the same maturity category are netted within such maturity category, where appropriate. Cash collateral received is netted on a counterparty basis, provided legal right of offset exists.

For a discussion of hedge accounting, fair value hedges—interest rate risk and net investment hedges, see Note 12 to the consolidated financial statements in the 2014 Form 10-K.

Fair Value and Notional of Derivative Instruments.

The following tables summarize the fair value of derivative instruments designated as accounting hedges and the fair value of derivative instruments not designated as accounting hedges by type of derivative contract and the platform on which these instruments are traded or cleared on a gross basis. Fair values of derivative contracts in an asset position are included in Trading assets, and fair values of derivative contracts in a liability position are reflected in Trading liabilities in the Company’s condensed consolidated statements of financial condition (see Note 3):

Derivative Assets
at September 30, 2015
Fair ValueNotional
Bilateral OTCCleared OTC(1)Exchange TradedTotalBilateral OTCCleared OTC(1)Exchange TradedTotal
(dollars in millions)
Derivatives designated as accounting
hedges:
Interest rate contracts $ 3,565 $ 1,828 $ — $ 5,393 $ 38,389 $ 43,193 $ — $ 81,582
Foreign exchange contracts 210 5 — 215 6,533 438 — 6,971
Total derivatives designated as
accounting hedges 3,775 1,833 — 5,608 44,922 43,631 — 88,553
Derivatives not designated as accounting
hedges(2):
Interest rate contracts 242,212 123,482 436 366,130 4,570,771 6,416,792 1,231,155 12,218,718
Credit contracts 21,246 3,535 — 24,781 684,536 171,985 — 856,521
Foreign exchange contracts 70,521 412 102 71,035 1,964,784 13,908 42,417 2,021,109
Equity contracts 25,261 — 26,399 51,660 356,509 — 294,745 651,254
Commodity contracts 16,230 — 5,011 21,241 87,566 — 103,188 190,754
Other 364 — — 364 7,568 — — 7,568
Total derivatives not designated
as accounting hedges 375,834 127,429 31,948 535,211 7,671,734 6,602,685 1,671,505 15,945,924
Total derivatives $ 379,609 $ 129,262 $ 31,948 $ 540,819 $ 7,716,656 $ 6,646,316 $ 1,671,505 $ 16,034,477
Cash collateral netting (54,391) (2,480) — (56,871) — — — —
Counterparty netting (296,874) (125,507) (28,273) (450,654) — — — —
Total derivative assets$ 28,344 $ 1,275 $ 3,675 $ 33,294 $ 7,716,656 $ 6,646,316 $ 1,671,505 $ 16,034,477

Derivative Liabilities
at September 30, 2015
Fair ValueNotional
Bilateral OTCCleared OTC(1)Exchange TradedTotalBilateral OTCCleared OTC(1)Exchange TradedTotal
(dollars in millions)
Derivatives designated as accounting
hedges:
Interest rate contracts $ 61 $ 98 $ — $ 159 $ 2,000 $ 4,519 $ — $ 6,519
Foreign exchange contracts 37 2 — 39 4,155 153 — 4,308
Total derivatives designated as .
accounting hedges 98 100 — 198 6,155 4,672 — 10,827
Derivatives not designated as accounting
hedges(2):
Interest rate contracts 224,805 124,372 321 349,498 4,259,745 6,013,571 1,189,701 11,463,017
Credit contracts 21,224 3,418 — 24,642 617,011 165,496 — 782,507
Foreign exchange contracts 72,572 263 60 72,895 1,968,292 12,137 9,274 1,989,703
Equity contracts 28,858 — 28,553 57,411 351,276 — 293,615 644,891
Commodity contracts 13,859 — 5,308 19,167 79,641 — 89,147 168,788
Other 51 — — 51 4,170 — — 4,170
Total derivatives not designated
as accounting hedges 361,369 128,053 34,242 523,664 7,280,135 6,191,204 1,581,737 15,053,076
Total derivatives $ 361,467 $ 128,153 $ 34,242 $ 523,862 $ 7,286,290 $ 6,195,876 $ 1,581,737 $ 15,063,903
Cash collateral netting (35,675) (1,760) — (37,435) — — — —
Counterparty netting (296,874) (125,507) (28,273) (450,654) — — — —
Total derivative liabilities$ 28,918 $ 886 $ 5,969 $ 35,773 $ 7,286,290 $ 6,195,876 $ 1,581,737 $ 15,063,903

Derivative Assets
at December 31, 2014
Fair ValueNotional
Bilateral OTCCleared OTC(1)Exchange TradedTotalBilateral OTCCleared OTC(1)Exchange TradedTotal
(dollars in millions)
Derivatives designated as accounting
hedges:
Interest rate contracts $ 3,947 $ 1,053 $ — $ 5,000 $ 44,324 $ 27,692 $ — $ 72,016
Foreign exchange contracts 498 6 — 504 9,362 261 — 9,623
Total derivatives designated as
accounting hedges 4,445 1,059 — 5,504 53,686 27,953 — 81,639
Derivatives not designated as accounting
hedges(3):
Interest rate contracts 281,214 211,552 407 493,173 4,854,953 9,187,454 1,467,056 15,509,463
Credit contracts 27,776 4,406 — 32,182 806,441 167,390 — 973,831
Foreign exchange contracts 72,362 152 83 72,597 1,955,343 11,538 9,663 1,976,544
Equity contracts 23,208 — 24,916 48,124 299,363 — 271,164 570,527
Commodity contracts 17,698 — 6,717 24,415 115,792 — 156,440 272,232
Other 376 — — 376 5,179 — — 5,179
Total derivatives not designated
as accounting hedges 422,634 216,110 32,123 670,867 8,037,071 9,366,382 1,904,323 19,307,776
Total derivatives $ 427,079 $ 217,169 $ 32,123 $ 676,371 $ 8,090,757 $ 9,394,335 $ 1,904,323 $ 19,389,415
Cash collateral netting (58,541) (4,654) — (63,195) — — — —
Counterparty netting (338,041) (210,922) (27,819) (576,782) — — — —
Total derivative assets$ 30,497 $ 1,593 $ 4,304 $ 36,394 $ 8,090,757 $ 9,394,335 $ 1,904,323 $ 19,389,415

Derivative Liabilities
at December 31, 2014
Fair ValueNotional
Bilateral OTCCleared OTC(1)Exchange TradedTotalBilateral OTCCleared OTC(1)Exchange TradedTotal
(dollars in millions)
Derivatives designated as accounting
hedges:
Interest rate contracts $ 125 $ 99 $ — $ 224 $ 2,024 $ 7,588 $ — $ 9,612
Foreign exchange contracts 5 1 — 6 1,491 121 — 1,612
Total derivatives designated as
accounting hedges 130 100 — 230 3,515 7,709 — 11,224
Derivatives not designated as accounting
hedges(3):
Interest rate contracts 264,579 207,482 293 472,354 4,615,886 9,138,417 1,714,021 15,468,324
Credit contracts 28,165 3,944 — 32,109 714,181 154,054 — 868,235
Foreign exchange contracts 72,156 169 21 72,346 1,947,178 11,477 1,761 1,960,416
Equity contracts 30,061 — 25,511 55,572 339,884 — 302,205 642,089
Commodity contracts 14,740 — 6,783 21,523 93,019 — 132,136 225,155
Other 172 — — 172 5,478 — — 5,478
Total derivatives not designated
as accounting hedges 409,873 211,595 32,608 654,076 7,715,626 9,303,948 2,150,123 19,169,697
Total derivatives $ 410,003 $ 211,695 $ 32,608 $ 654,306 $ 7,719,141 $ 9,311,657 $ 2,150,123 $ 19,180,921
Cash collateral netting (37,054) (258) — (37,312) — — — —
Counterparty netting (338,041) (210,922) (27,819) (576,782) — — — —
Total derivative liabilities$ 34,908 $ 515 $ 4,789 $ 40,212 $ 7,719,141 $ 9,311,657 $ 2,150,123 $ 19,180,921

_____________

(1) Amounts include OTC derivatives that are centrally cleared in accordance with certain regulatory requirements.

(2) Notional amounts include gross notionals related to open long and short futures contracts of $886 billion and $950 billion, respectively. The unsettled fair value on these futures contracts (excluded from the table above) of $432 million and $9 million is included in Customer and other receivables and Customer and other payables, respectively, in the Company’s condensed consolidated statements of financial condition.

(3) Notional amounts include gross notionals related to open long and short futures contracts of $685 billion and $1,122 billion, respectively. The unsettled fair value on these futures contracts (excluded from the table above) of $472 million and $21 million is included in Customer and other receivables and Customer and other payables, respectively, in the Company’s condensed consolidated statements of financial condition.

 

At September 30, 2015, cash collateral payables of $3 million and at December 31, 2014, cash collateral receivables and payables of $21 million and $30 million, respectively, were not offset against certain contracts that did not meet the definition of a derivative. The Company had no cash collateral receivable at September 30, 2015 that was not offset against certain contracts that did not meet the definition of a derivative.

Derivatives Designated as Fair Value Hedges.

The following table presents gains (losses) reported on interest rate derivative instruments designated and qualifying as accounting hedges and the related hedged item as well as the hedge ineffectiveness included in Interest expense in the Company’s condensed consolidated statements of income:

Gains (Losses) Recognized in Interest Expense
Three Months EndedNine Months Ended
September 30,September 30,
Product Type2015201420152014
(dollars in millions)
Derivatives$ 1,531 $ (384)$ 390 $ 547
Borrowings (1,334) 757 386 429
Total $ 197 $ 373 $ 776 $ 976

Derivatives Designated as Net Investment Hedges.

The following table presents gains (losses) reported on derivative instruments designated and qualifying as accounting hedges:

Gains (Losses) Recognized in OCI (effective portion)
Three Months EndedNine Months Ended
September 30,September 30,
Product Type2015201420152014
(dollars in millions)
Foreign exchange contracts(1)$ 210 $ 438 $ 391 $ 262
Total $ 210 $ 438 $ 391 $ 262

____________

(1) Losses of $37 million and $117 million related to the forward points on the hedging instruments were excluded from hedge effectiveness testing and recognized in interest income during the quarter and nine months ended September 30, 2015, respectively. Losses of $46 million and $143 million related to the forward points on the hedging instruments were excluded from hedge effectiveness testing and recognized in interest income during the quarter and nine months ended September 30, 2014, respectively.

Derivatives Not Designated as Accounting Hedges.

The following table summarizes gains (losses) on derivative instruments not designated as accounting hedges:

Gains (Losses) Recognized in Income(1)
Three Months EndedNine Months Ended
September 30,September 30,
Product Type2015201420152014
(dollars in millions)
Interest rate contracts$ 103 $ (37)$ 579 $ (1,847)
Credit contracts 99 407 (110) 258
Foreign exchange contracts 3,570 191 (1,224) 1,795
Equity contracts 3,678 114 1,658 (2,212)
Commodity contracts 787 60 1,435 531
Other contracts 35 22 (30) 133
Total derivative instruments$ 8,272 $ 757 $ 2,308 $ (1,342)

____________

(1) Gains (losses) on derivative contracts not designated as hedges are primarily included in Trading revenues in the Company’s condensed consolidated statements of income. Gains (losses) associated with certain derivative contracts that have physically settled are excluded from the table above. Gains (losses) on these contracts are reflected with the associated cash instruments, which are also included in Trading revenues in the Company’s condensed consolidated statements of income.

 

The Company also has certain embedded derivatives that have been bifurcated from the related structured borrowings. Such derivatives are classified in Long-term borrowings and had a net fair value of $19 million and $10 million at September 30, 2015 and December 31, 2014, respectively, and a notional value of $2,069 million at both September 30, 2015 and December 31, 2014. The Company recognized a loss of $6 million and a gain of $10 million related to changes in the fair value of its bifurcated embedded derivatives for the quarter and nine months ended September 30, 2015, respectively. The Company recognized a gain of $5 million and a loss of $23 million related to changes in the fair value of its bifurcated embedded derivatives for the quarter and nine months ended September 30, 2014, respectively.

Credit Risk-Related Contingencies.

In connection with certain OTC trading agreements, the Company may be required to provide additional collateral or immediately settle any outstanding liability balances with certain counterparties in the event of a credit rating downgrade of the Company. The following table presents the aggregate fair value of certain derivative contracts that contain credit risk-related contingent features that are in a net liability position for which the Company has posted collateral in the normal course of business.

At September 30, 2015
(dollars in millions)
Net derivative liabilities$ 26,700
Collateral posted 22,247

The additional collateral or termination payments which may be called in the event of a future credit rating downgrade vary by contract and can be based on ratings by either or both of Moody’s Investors Service, Inc. (“Moody’s”) and Standard & Poor’s Ratings Services (“S&P”). At September 30, 2015, for such OTC trading agreements, the future potential collateral amounts and termination payments that could be called or required by counterparties or exchange and clearing organizations in the event of one-notch or two-notch downgrade scenarios based on the relevant contractual downgrade triggers were as follows:

At September 30, 2015
(dollars in millions)
Incremental collateral or termination payments upon potential future ratings downgrade(1):
One-notch downgrade$ 1,111
Two-notch downgrade 1,251

________

(1) Amounts include $1,879 million related to bilateral arrangements between the Company and other parties where upon the downgrade of one party, the downgraded party must deliver collateral to the other party. These bilateral downgrade arrangements are a risk management tool used extensively by the Company as credit exposures are reduced if counterparties are downgraded.

Credit Derivatives and Other Credit Contracts.

The Company enters into credit derivatives, principally through credit default swaps, under which it receives or provides protection against the risk of default on a set of debt obligations issued by a specified reference entity or entities. A majority of the Company’s counterparties are banks, broker-dealers, insurance and other financial institutions, and monoline insurers.

The tables below summarize the notional and fair value of protection sold and protection purchased through credit default swaps:

At September 30, 2015
Maximum Potential Payout/Notional
Protection SoldProtection Purchased
NotionalFair Value (Asset)/LiabilityNotionalFair Value (Asset)/Liability
(dollars in millions)
Single name credit default swaps$ 458,768 $ 1,241 $ 439,328 $ (593)
Index and basket credit default swaps 264,416 (148) 231,528 (68)
Tranched index and basket credit default swaps 74,353 (1,394) 170,635 823
Total$ 797,537 $ (301)$ 841,491 $ 162

At December 31, 2014
Maximum Potential Payout/Notional
Protection SoldProtection Purchased
NotionalFair Value (Asset)/LiabilityNotionalFair Value (Asset)/Liability
(dollars in millions)
Single name credit default swaps$ 535,415 $ (2,479)$ 509,872 $ 1,641
Index and basket credit default swaps 276,465 (1,777) 229,789 1,563
Tranched index and basket credit default swaps 96,182 (2,355) 194,343 3,334
Total$ 908,062 $ (6,611)$ 934,004 $ 6,538

The tables below summarize the credit ratings of the reference obligation and maturities of protection sold through credit default swaps and other credit contracts:

At September 30, 2015
Maximum Potential Payout/NotionalFair Value(Asset)/Liability(1)(2)
Years to Maturity
Credit Ratings of the Reference ObligationLess than 11-33-5Over 5Total
(dollars in millions)
Single name credit default swaps:
AAA $ 4,247 $ 13,475 $ 5,252 $ 1,587 $ 24,561 $ (253)
AA 9,247 18,450 10,605 2,689 40,991 (433)
A 18,861 36,875 11,145 1,825 68,706 (803)
BBB 43,071 92,864 41,808 11,883 189,626 (325)
Non-investment grade 35,030 66,058 28,914 4,882 134,884 3,055
Total 110,456 227,722 97,724 22,866 458,768 1,241
Index and basket credit default swaps:
AAA 14,890 41,296 1,663 — 57,849 (1,006)
A 4,700 4,668 6,271 12 15,651 (197)
BBB 9,904 27,045 49,952 34,893 121,794 (818)
Non-investment grade 24,331 82,978 16,048 20,118 143,475 479
Total 53,825 155,987 73,934 55,023 338,769 (1,542)
Total credit default swaps sold $ 164,281 $ 383,709 $ 171,658 $ 77,889 $ 797,537 $ (301)
Other credit contracts(3) $ 1 $ 806 $ 340 $ 49 $ 1,196 $ (1,042)
Total credit derivatives and other credit
contracts $ 164,282 $ 384,515 $ 171,998 $ 77,938 $ 798,733 $ (1,343)

At December 31, 2014
Maximum Potential Payout/NotionalFair Value(Asset)/Liability(1)(2)
Years to Maturity
Credit Ratings of the Reference ObligationLess than 11-33-5Over 5Total
(dollars in millions)
Single name credit default swaps:
AAA$ 2,385 $ 9,400 $ 6,147 $ 692 $ 18,624 $ (113)
AA 9,080 23,701 14,769 3,318 50,868 (688)
A 22,861 52,291 22,083 2,944 100,179 (1,962)
BBB 48,547 114,384 60,629 13,536 237,096 (1,489)
Non-investment grade 29,857 66,066 29,011 3,714 128,648 1,773
Total 112,730 265,842 132,639 24,204 535,415 (2,479)
Index and basket credit default swaps:
AAA 17,625 31,124 7,265 1,883 57,897 (985)
AA 704 6,512 716 2,864 10,796 (270)
A 1,283 6,841 10,154 30 18,308 (465)
BBB 30,265 40,575 60,141 7,730 138,711 (2,904)
Non-investment grade 25,750 88,105 22,971 10,109 146,935 492
Total 75,627 173,157 101,247 22,616 372,647 (4,132)
Total credit default swaps sold$ 188,357 $ 438,999 $ 233,886 $ 46,820 $ 908,062 $ (6,611)
Other credit contracts(3)$ 51 $ 539 $ 1 $ 620 $ 1,211 $ (500)
Total credit derivatives and other credit
contracts$ 188,408 $ 439,538 $ 233,887 $ 47,440 $ 909,273 $ (7,111)

_____________

(1) Fair value amounts are shown on a gross basis prior to cash collateral or counterparty netting.

(2) Fair value amounts of certain credit default swaps where the Company sold protection have an asset carrying value because credit spreads of the underlying reference entity or entities tightened during the term of the contracts.

(3) Other credit contracts include credit-linked notes (“CLNs”), collateralized debt obligations (“CDOs”) and credit default swaps that are considered hybrid instruments. Fair value amounts shown represent the fair value of the hybrid instruments.

 

Single Name Credit Default Swaps.    

A credit default swap protects the buyer against the loss of principal on a bond or loan in case of a default by the issuer. The protection buyer pays a periodic premium (generally quarterly) over the life of the contract and is protected for the period. The Company in turn will have to perform under a credit default swap if a credit event as defined under the contract occurs. Typical credit events include bankruptcy, dissolution or insolvency of the referenced entity, failure to pay and restructuring of the obligations of the referenced entity. In order to provide an indication of the current payment status or performance risk of the credit default swaps, a breakdown by credit ratings is provided. Agency ratings, if available, are used for this purpose; otherwise the Company’s internal ratings are used.

Index and Basket Credit Default Swaps.    

Index and basket credit default swaps are products where credit protection is provided on a portfolio of single name credit default swaps. Generally, in the event of a default on one of the underlying names, the Company will have to pay a pro rata portion of the total notional amount of the credit default swap.

The Company also enters into tranched index and basket credit default swaps where credit protection is provided on a particular portion of the portfolio loss distribution. The most junior tranches cover initial defaults, and once losses exceed the notional of the tranche, they are passed on to the next most senior tranche in the capital structure.

In order to provide an indication of the current payment status or performance risk of the credit default swaps, a breakdown by the Company’s internal credit ratings is provided. Effective January 1, 2015, the Company utilized its internal credit ratings as compared with December 31, 2014 where external agency ratings, if available, were utilized. The change in the rating methodology did not have a significant impact on investment grade versus non-investment grade classifications or the fair values of tranched and non-tranched index and basket products in the above table.

Credit Protection Sold through CLNs and CDOs.    

The Company has invested in CLNs and CDOs, which are hybrid instruments containing embedded derivatives, in which credit protection has been sold to the issuer of the note. If there is a credit event of a reference entity underlying the instrument, the principal balance of the note may not be repaid in full to the Company.

Purchased Credit Protection with Identical Underlying Reference Obligations.    

For single name credit default swaps and non-tranched index and basket credit default swaps, the Company has purchased protection with a notional amount of approximately $668 billion and $731 billion at September 30, 2015 and December 31, 2014, respectively, compared with a notional amount of approximately $721 billion and $805 billion at September 30, 2015 and December 31, 2014, respectively, of credit protection sold with identical underlying reference obligations. In order to identify purchased protection with the same underlying reference obligations, the notional amount for individual reference obligations within non-tranched indices and baskets was determined on a pro rata basis and matched off against single name and non-tranched index and basket credit default swaps where credit protection was sold with identical underlying reference obligations.

The purchase of credit protection does not represent the sole manner in which the Company risk manages its exposure to credit derivatives. The Company manages its exposure to these derivative contracts through a variety of risk mitigation strategies, which include managing the credit and correlation risk across single name, non-tranched indices and baskets, tranched indices and baskets, and cash positions. Aggregate market risk limits have been established for credit derivatives, and market risk measures are routinely monitored against these limits. The Company may also recover amounts on the underlying reference obligation delivered to the Company under credit default swaps where credit protection was sold.