NOTE 9—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Use of Derivatives

We manage our asset and liability positions and market risk exposure and limits in accordance with our market risk management policies that are approved by our Board of Directors. Our primary market risks stem from the impact on our earnings and economic value of equity from changes in interest rates and, to a lesser extent, changes in foreign exchange rates. We employ several techniques to manage our interest rate sensitivity which include changing the duration and re-pricing characteristics of various assets and liabilities by using interest rate derivatives. Our current policies also include the use of derivatives to hedge exposures denominated in foreign currency so we may limit our earnings and capital ratio exposures to foreign exchange risk. We execute our derivative contracts in both the over-the-counter (“OTC”) and exchange-traded derivative markets, and clear eligible derivative transactions through a central clearinghouse as required under the Dodd-Frank Act. The majority of our derivatives are interest rate swaps. In addition, we may use a variety of other derivative instruments, including caps, floors, options, futures and forward contracts, to manage our interest rate and foreign exchange risks. We offer various interest rate, foreign exchange rate and commodity derivatives as an accommodation to our customers within our Commercial Banking business, and usually offset our exposure through derivative transactions with other counterparties.

Accounting for Derivatives

Our derivatives are designated as either qualifying accounting hedges or free-standing derivatives. Qualifying accounting hedges are designated as fair value hedges, cash flow hedges or net investment hedges. Free-standing derivatives primarily consist of customer-accommodation derivatives and economic hedges that do not qualify for hedge accounting.

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Fair Value Hedges: We designate derivatives as fair value hedges when they are used to manage our exposure to changes in the fair value of certain financial assets and liabilities, which fluctuate in value as a result of movements in interest rates. Changes in the fair value of derivatives designated as fair value hedges are recorded in earnings together with offsetting changes in the fair value of the hedged item and any resulting ineffectiveness. Our fair value hedges consist of interest rate swaps that are intended to modify our exposure to interest rate risk on various fixed-rate assets and liabilities.

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Cash Flow Hedges: We designate derivatives as cash flow hedges when they are used to manage our exposure to variability in cash flows related to forecasted transactions. Changes in the fair value of derivatives designated as cash flow hedges are recorded as a component of AOCI, to the extent that the hedge relationships are effective, and amounts are reclassified from AOCI to earnings as the forecasted transactions impact earnings. To the extent that any ineffectiveness exists in the hedge relationships, the amounts are recorded in current period earnings. Our cash flow hedges use interest rate swaps and floors that are intended to hedge the variability in interest payments or interest receipts on some of our variable-rate assets or liabilities. We have also entered into forward foreign currency derivative contracts to hedge our exposure to variability in cash flows related to intercompany borrowings denominated in foreign currency.

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Net Investment Hedges: We use net investment hedges to manage the foreign currency exposure related to our net investments in foreign operations that have functional currencies other than the U.S. dollar. Changes in the fair value of net investment hedges are recorded in the translation adjustment component of AOCI, offsetting the translation gain or loss from those foreign operations. We execute net investment hedges using foreign exchange forward contracts to hedge the translation exposure of the net investment in our foreign operations.

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Free-Standing Derivatives: We use free-standing derivatives to hedge the risk of changes in the fair value of residential MSRs, mortgage loan origination and purchase commitments and other interests held. We also categorize our customer accommodation derivatives and the related offsetting contracts as free-standing derivatives. Changes in the fair value of free-standing derivatives are recorded in earnings as a component of other non-interest income.

Balance Sheet Presentation

The following table summarizes the notional and fair values of our derivative instruments on a gross basis as of March 31, 2016 and December 31, 2015, which are segregated by derivatives that are designated as accounting hedges and those that are not, and are further segregated by type of contract within those two categories. The total derivative assets and liabilities are adjusted on an aggregate basis to take into consideration the effects of legally enforceable master netting agreements and any associated cash collateral received or paid.

Table 9.1: Derivative Assets and Liabilities at Fair Value



	March 31, 2016								December 31, 2015
	Notional or Contractual Amount		Derivative⁽¹⁾						Notional or Contractual Amount		Derivative⁽¹⁾
(Dollars in millions)	Notional or Contractual Amount		Assets			Liabilities			Notional or Contractual Amount		Assets			Liabilities
Derivatives designated as accounting hedges:
Interest rate contracts:
Fair value hedges	$	33,767	$	556		$	78		$	34,417	$	550		$	146
Cash flow hedges	37,535		677			18			30,450		167			61
Total interest rate contracts	71,302		1,233			96			64,867		717			207
Foreign exchange contracts:
Cash flow hedges	5,395		42			154			5,580		239			2
Net investment hedges	2,545		50			0			2,562		87			0
Total foreign exchange contracts	7,940		92			154			8,142		326			2
Total derivatives designated as accounting hedges	79,242		1,325			250			73,009		1,043			209
Derivatives not designated as accounting hedges:
Interest rate contracts covering:
MSRs⁽²⁾	1,180		25			13			1,665		11			7
Customer accommodation	30,811		636			511			28,841		431			290
Other interest rate exposures⁽³⁾	1,873		37			19			1,519		33			10
Total interest rate contracts	33,864		698			543			32,025		475			307
Other contracts	864		0			2			882		0			4
Total derivatives not designated as accounting hedges	34,728		698			545			32,907		475			311
Total derivatives	$	113,970	$	2,023		$	795		$	105,916	$	1,518		$	520
Less: netting adjustment⁽⁴⁾			(334		)	(350		)			(532		)	(143		)
Total derivative assets/liabilities			$	1,689		$	445				$	986		$	377

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⁽¹⁾	Derivative assets and liabilities include interest accruals.


⁽²⁾	Includes interest rate swaps and to-be-announced contracts.


⁽³⁾	Other interest rate exposures include mortgage-related derivatives.


⁽⁴⁾	Represents balance sheet netting of derivative assets and liabilities, and related payables and receivables for cash collateral held or placed with the same counterparty. See Table 9.2 for further information.

Offsetting of Financial Assets and Liabilities

We execute the majority of our derivative transactions and repurchase agreements under master netting arrangements. Under our existing enforceable master netting arrangements, we generally have the right to offset exposure with the same counterparty. In addition, either counterparty can generally request the net settlement of all contracts through a single payment upon default on, or termination of, any one contract. The Company offsets derivative assets and liabilities for purposes of balance sheet presentation where a right of setoff exists. As of March 31, 2016 and December 31, 2015, derivative contracts that are executed bilaterally with a counterparty in the OTC market and then novated to and cleared through a central clearinghouse are not subject to offsetting due to the uncertainty existing around an end-user’s ability to setoff derivative contracts that have been novated to a clearinghouse.

The following table presents as of March 31, 2016 and December 31, 2015 the gross and net fair values of our derivative assets and liabilities and repurchase agreements, as well as the related offsetting amounts permitted under U.S. GAAP. The table also includes cash and non-cash collateral received or pledged associated with such arrangements. The collateral amounts shown are limited to the extent of the related net derivative fair values or outstanding balances, thus instances of over-collateralization are not shown.

Table 9.2: Offsetting of Financial Assets and Financial Liabilities



	Gross Amounts		Gross Amounts Offset in the Balance Sheet						Net Amounts as Recognized		Securities Collateral Held Under Master Netting Agreements
(Dollars in millions)	Gross Amounts		Financial Instruments			Cash Collateral Received			Net Amounts as Recognized		Securities Collateral Held Under Master Netting Agreements			Net Exposure
As of March 31, 2016
Derivatives assets⁽¹⁾	$	2,023	$	(200	)	$	(134	)	$	1,689	$	(5	)	$	1,684
As of December 31, 2015
Derivatives assets⁽¹⁾	1,518		(86		)	(446		)	986		(156		)	830



	Gross Amounts		Gross Amounts Offset in the Balance Sheet						Net Amounts as Recognized		Securities Collateral Pledged Under Master Netting Agreements
(Dollars in millions)	Gross Amounts		Financial Instruments			Cash Collateral Pledged			Net Amounts as Recognized					Net Exposure
As of March 31, 2016
Derivatives liabilities⁽¹⁾	$	795	$	(200	)	$	(150	)	$	445	$	0		$	445
Repurchase agreements⁽²⁾⁽³⁾	917		0			0			917		(917		)	0
As of December 31, 2015
Derivatives liabilities⁽¹⁾	520		(86		)	(57		)	377		0			377
Repurchase agreements⁽²⁾	969		0			0			969		(969		)	0

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⁽¹⁾	The gross balances include derivative assets and derivative liabilities as of March 31, 2016 totaling $1.1 billion and $364 million, respectively, related to the centrally cleared derivative contracts. The comparable amounts as of December 31, 2015 totaled $429 million and $314 million, respectively. These contracts were not subject to offsetting as of March 31, 2016 and December 31, 2015.


⁽²⁾	As of March 31, 2016 and December 31, 2015, the Company only had repurchase obligations outstanding and did not have any reverse repurchase receivables.


⁽³⁾	Represents customer repurchase agreements that mature the next business day. As of March 31, 2016, we pledged collateral with a fair value of $936 million under these customer repurchase agreements, which were primarily agency RMBS securities.

Credit Risk-Related Contingency Features and Collateral

Certain of our derivatives contracts include provisions requiring that our debt maintain a credit rating of investment grade or above by each of the major credit rating agencies. In the event of a downgrade of our debt credit rating below investment grade, some of our derivatives counterparties would have the right to terminate the derivative contract and close out the existing positions, or demand immediate and ongoing full overnight collateralization on derivative instruments in a net liability position. Certain of our derivatives contracts may also allow, in the event of a downgrade of our debt credit rating of any kind, our derivatives counterparties to demand additional collateralization on such derivatives instruments in a net liability position. We posted $215 million and $304 million of cash collateral as of March 31, 2016 and December 31, 2015, respectively. If our debt credit rating had fallen below investment grade, we would have been required to post $60 million and $55 million of additional collateral as of March 31, 2016 and December 31, 2015, respectively. The fair value of derivatives instruments with credit risk-related contingent features in a net liability position was less than $1 million as of both March 31, 2016 and December 31, 2015.

Derivatives Counterparty Credit Risk

Derivatives instruments contain an element of credit risk that arises from the potential failure of a counterparty to perform according to the contractual terms of the contract. Our exposure to derivatives counterparty credit risk, at any point in time, is represented by the fair value of derivatives in a gain position, or derivatives assets position, assuming no recoveries of underlying collateral. To mitigate the risk of counterparty default, we enter into legally enforceable master netting agreements and maintain collateral agreements with certain derivative counterparties. We generally enter into these agreements on a bilateral basis with our counterparties; however, since June 2013 we have begun to clear eligible OTC derivatives through a central clearinghouse in accordance with the requirements under Title VII of the Dodd-Frank Act. These agreements typically provide for the right to offset exposures and require both parties to maintain collateral in the event the fair values of derivative financial instruments exceed established thresholds. We received cash collateral from derivatives counterparties totaling $502 million and $544 million as of March 31, 2016 and December 31, 2015, respectively. We also received securities from derivatives counterparties with a fair value of $7 million and $172 million as of March 31, 2016 and December 31, 2015, respectively, which we have the ability to re-pledge.

We record counterparty credit risk valuation adjustments on our derivative assets to properly reflect the credit quality of the counterparty. We consider collateral and legally enforceable master netting agreements that mitigate our credit exposure to each counterparty in determining the counterparty credit risk valuation adjustment, which may be adjusted in future periods due to changes in the fair value of the derivatives contracts, collateral and creditworthiness of the counterparty. The cumulative counterparty credit risk valuation adjustment recorded on our consolidated balance sheets as a reduction to the derivatives asset balance was $5 million and $4 million as of March 31, 2016 and December 31, 2015, respectively. We also adjust the fair value of our derivatives liabilities to reflect the impact of our own credit quality. We calculate this adjustment by comparing the spreads on our credit default swaps to the discount benchmark curve. The cumulative credit risk valuation adjustment related to our credit quality recorded on our consolidated balance sheets as a reduction in the derivative liability balance was less than $1 million as of both March 31, 2016 and December 31, 2015.

Income Statement Presentation and AOCI

The following tables summarize the impact of derivatives and the related hedged items in our consolidated statements of income and AOCI.

Fair Value Hedges and Free-Standing Derivatives

The net gains (losses) recognized in earnings related to derivatives in fair value hedging relationships and free-standing derivatives are presented below for the three months ended March 31, 2016 and 2015.

Table 9.3: Gains and Losses on Fair Value Hedges and Free-Standing Derivatives



	Three Months Ended March 31,
(Dollars in millions)	2016			2015
Derivatives designated as accounting hedges:⁽¹⁾
Fair value interest rate contracts:
Gains (losses) recognized in earnings on derivatives	$	208		$	153
Gains (losses) recognized in earnings on hedged items	(192		)	(148		)
Net fair value hedge ineffectiveness gains (losses)	16			5
Derivatives not designated as accounting hedges:⁽¹⁾
Interest rate contracts covering:
MSRs	10			6
Customer accommodation	5			4
Other interest rate exposures	15			2
Total interest rate contracts	30			12
Other contracts	0			(2		)
Total gains on derivatives not designated as accounting hedges	30			10
Net derivative gains (losses) recognized in earnings	$	46		$	15

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⁽¹⁾	Amounts are recorded in our consolidated statements of income in other non-interest income.

Cash Flow and Net Investment Hedges

The table below shows the net gains (losses) related to derivatives designated as cash flow hedges and net investment hedges for the three months ended March 31, 2016 and 2015.

Table 9.4: Gains and Losses on Derivatives Designated as Cash Flow Hedges and Net Investment Hedges



	Three Months Ended March 31,
(Dollars in millions)	2016			2015
Gains (losses) recorded in AOCI:
Cash flow hedges:
Interest rate contracts	$	426		$	210
Foreign exchange contracts	0			(5		)
Subtotal	426			205
Net investment hedges:
Foreign exchange contracts	41			75
Net derivatives gains (losses) recognized in AOCI	$	467		$	280
Gains (losses) recorded in earnings:
Cash flow hedges:
Gains (losses) reclassified from AOCI into earnings:
Interest rate contracts⁽¹⁾	$	50		$	47
Foreign exchange contracts⁽²⁾	(1		)	(4		)
Subtotal	49			43
Gains (losses) recognized in earnings due to ineffectiveness:
Interest rate contracts⁽²⁾	3			2
Net derivative gains (losses) recognized in earnings	$	52		$	45

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⁽¹⁾	Amounts reclassified are recorded in our consolidated statements of income in interest income or interest expense.


⁽²⁾	Amounts are recorded in our consolidated statements of income in other non-interest income or other interest income.

In the next 12 months, we expect to reclassify to earnings net after-tax gains of $173 million currently recorded in AOCI as of March 31, 2016. These amounts will offset the cash flows associated with the hedged forecasted transactions. The maximum length of time over which forecasted transactions were hedged was approximately six years as of March 31, 2016. The amount we expect to reclassify into earnings may change as a result of changes in market conditions and ongoing actions taken as part of our overall risk management strategy.