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Derivative Instruments and Hedging Activities

3 Months Ended

Mar. 31, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities

NOTE 9—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Use of Derivatives and Accounting for Derivatives

We regularly enter into derivative transactions to support our overall risk management activities. Our primary market risks stem from the impact on our earnings and economic value of equity due to changes in interest rates and, to a lesser extent, changes in foreign exchange rates. We manage our interest rate sensitivity by employing several techniques, which include changing the duration and re-pricing characteristics of various assets and liabilities by using interest rate derivatives. We also use foreign currency derivatives to limit our earnings and capital exposures to foreign exchange risk by hedging exposures denominated in foreign currencies. In addition to interest rate and foreign currency derivatives, we may also 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 designate these risk management derivatives as either qualifying accounting hedges or free-standing derivatives. Qualifying accounting hedges are further designated as fair value hedges, cash flow hedges or net investment hedges, and free-standing derivatives are economic hedges that do not qualify for hedge accounting.

We also offer various interest rate, commodity and foreign currency derivatives as accommodation to our customers within our Commercial Banking business. We enter into these derivatives with our customers primarily to help them manage interest rate risks, hedge their energy and other commodities exposures, and manage foreign currency fluctuations. We then enter into offsetting derivative contracts with counterparties to economically hedge the majority of our subsequent exposures.

See below for additional information on our use of derivatives and how we account for them:

•

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 presented in the same line item on our consolidated statements of income as the earnings effect of the hedged items. Our fair value hedges consist of interest rate swaps that are intended to modify our exposure to interest rate risk on various fixed-rate financial assets and liabilities.

•

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. Those amounts are reclassified into earnings in the same period during which the forecasted transactions impact earnings and presented in the same line item on our consolidated statements of income as the earnings effect of the hedged items. Our cash flow hedges use interest rate swaps and floors that are intended to hedge the variability in interest receipts or interest payments on some of our variable-rate financial assets or liabilities. We also enter into foreign currency forward contracts to hedge our exposure to variability in cash flows related to intercompany borrowings denominated in a foreign currency.

•

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 currency forward contracts to hedge the translation exposure of the net investment in our foreign operations under the forward method.

•

Free-Standing Derivatives: Our free-standing derivatives primarily consist of our customer accommodation derivatives and other economic hedges. The customer accommodation derivatives and the related offsetting contracts are mainly interest rate, commodity and foreign currency contracts. The other free-standing derivatives are primarily used to economically hedge the risk of changes in the fair value of our commercial mortgage loan origination and purchase commitments as well as other interests held. Changes in the fair value of free-standing derivatives are recorded in earnings as a component of other non-interest income.

Derivatives Counterparty Credit Risk

Counterparty Types

Derivative instruments contain an element of credit risk that arises from the potential failure of a counterparty to perform according to the terms of the contract. We execute our derivative contracts primarily in over-the-counter (“OTC”) markets. We also execute minimal amounts of interest rate and commodity futures in the exchange-traded derivative markets. Our OTC derivatives consist of both centrally cleared and uncleared bilateral contracts. In our centrally cleared contracts, our counterparties are central counterparty clearinghouses (“CCPs”), such as the Chicago Mercantile Exchange (“CME”) and the LCH Group (“LCH”). In our uncleared bilateral contracts, we enter into agreements directly with our derivative counterparties.

Counterparty Credit Risk Management

We generally manage our counterparty credit risk associated with derivative instruments by entering into legally enforceable master netting arrangements, where possible, and exchanging margin and collateral with our counterparties, typically in the form of cash or high-quality liquid securities. The amount of collateral exchanged is dependent upon the fair value of the derivative instruments as well as the fair value of the pledged collateral. When valuing collateral, an estimate of the variation in price and liquidity over time is subtracted in the form of a “haircut” to discount the value of the collateral pledged. Our exposure to derivative counterparty credit risk, at any point in time, is equal to the amount reported as a derivative asset on our balance sheet. The fair value of derivatives is adjusted on an aggregate basis to take into consideration the effects of legally enforceable master netting agreements and any associated cash collateral received or pledged. See Table 9.3 for our net exposure associated with derivatives.

The terms under which we collateralize our exposures differ between cleared exposures and uncleared bilateral exposures.

•

CCPs: We clear eligible OTC derivatives with CCPs as part of our regulatory requirements. Futures commission merchants (“FCMs”) serve as the intermediary between CCPs and us. CCPs require that we post initial and variation margin through our FCMs to mitigate the risk of non-payment or default. Initial margin is required upfront by CCPs as collateral against potential losses on our cleared derivative contracts. Variation margin is exchanged on a daily basis to account for mark-to-market changes in the derivative contracts. For CME and LCH-cleared OTC derivatives, we characterize variation margin cash payments as settlements. Our FCM agreements governing these derivative transactions include provisions that may require us to post additional collateral under certain circumstances.

•

Bilateral Counterparties: We generally enter into legally enforceable master netting agreements and collateral agreements, where possible, with bilateral derivative counterparties to mitigate the risk of default. We review our collateral positions on a daily basis and exchange collateral with our counterparties in accordance with these agreements. These bilateral agreements typically provide the right to offset exposure with the same counterparty and require the party in a net liability position to post collateral. Agreements with certain bilateral counterparties require both parties to maintain collateral in the event the fair values of derivative instruments exceed established exposure thresholds. Certain of these bilateral agreements 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 counterparties would have the right to terminate the derivative contract and close out the existing positions.

Credit Risk Valuation Adjustments

We record counterparty credit valuation adjustments (“CVAs”) 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 CVA, which may be adjusted in future periods due to changes in the fair values of the derivative contracts, collateral and creditworthiness of the counterparty. We also record debit valuation adjustments (“DVAs”) to adjust the fair values of our derivative 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.

Balance Sheet Presentation

The following table summarizes the notional and fair values of our derivative instruments as of March 31, 2019 and December 31, 2018, 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 pledged. Derivative assets and liabilities are included in other assets and other liabilities, respectively, on our consolidated balance sheets.

Table 9.1: Derivative Assets and Liabilities at Fair Value



	March 31, 2019								December 31, 2018
	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	$	52,735	$	24		$	67		$	53,413	$	64		$	28
Cash flow hedges	84,600		138			44			81,200		83			70
Total interest rate contracts	137,335		162			111			134,613		147			98
Foreign exchange contracts:
Cash flow hedges	5,523		42			21			5,745		184			2
Net investment hedges	2,648		32			6			2,607		178			0
Total foreign exchange contracts	8,171		74			27			8,352		362			2
Total derivatives designated as accounting hedges	145,506		236			138			142,965		509			100
Derivatives not designated as accounting hedges:
Customer accommodation:
Interest rate contracts	50,554		295			160			49,386		190			256
Commodity contracts	11,529		553			527			10,673		797			786
Foreign exchange and other contracts	1,698		18			15			1,418		12			11
Total customer accommodation	63,781		866			702			61,477		999			1,053
Other interest rate exposures⁽²⁾	6,065		30			24			6,427		29			36
Other contracts	3,621		89			11			1,636		2			12
Total derivatives not designated as accounting hedges	73,467		985			737			69,540		1,030			1,101
Total derivatives	$	218,973	$	1,221		$	875		$	212,505	$	1,539		$	1,201
Less: netting adjustment⁽³⁾			(512		)	(421		)			(1,079		)	(287		)
Total derivative assets/liabilities			$	709		$	454				$	460		$	914

__________


⁽¹⁾	Derivative assets and liabilities presented above exclude valuation adjustments related to non-performance risk. As of March 31, 2019 and December 31, 2018, the cumulative CVA balances were $7 million and $3 million, respectively. The cumulative DVA balance was approximately $1 million as of both March 31, 2019 and December 31, 2018.


⁽²⁾	Other interest rate exposures include commercial mortgage-related derivatives and interest rate swaps.


⁽³⁾	Represents balance sheet netting of derivative assets and liabilities, and related payables and receivables for cash collateral held or placed with the same counterparty.

The following table summarizes the carrying value of our hedged assets and liabilities in fair value hedges and the associated cumulative basis adjustments included in those carrying values as of March 31, 2019 and December 31, 2018.

Table 9.2: Hedged Items in Fair Value Hedging Relationships



	March 31, 2019								December 31, 2018
	Carrying Amount Assets/(Liabilities)			Cumulative Amount of Basis Adjustments Included in the Carrying Amount					Carrying Amount Assets/(Liabilities)			Cumulative Amount of Basis Adjustments Included in the Carrying Amount
(Dollars in millions)	Carrying Amount Assets/(Liabilities)			Total Assets/(Liabilities)			Discontinued-Hedging Relationships		Carrying Amount Assets/(Liabilities)			Total Assets/(Liabilities)			Discontinued-Hedging Relationships
Line item on our consolidated balance sheets in which the hedged item is included:
Investment securities available for sale⁽¹⁾⁽²⁾	$	12,519		$	145		$	1	$	14,067		$	(6	)	$	(2	)
Interest-bearing deposits	(13,136		)	155			0		(13,101		)	247			0
Securitized debt obligations	(5,928		)	111			118		(5,887		)	168			143
Senior and subordinated notes	(25,128		)	(5		)	355		(23,572		)	315			392

__________

⁽¹⁾

These amounts include the amortized cost basis of our investment securities designated in hedging relationships for which the hedged item is the last layer expected to be remaining at the end of the hedging relationship. The amortized cost basis of this portfolio was $8.7 billion and $8.3 billion, the amount of the designated hedged items was $4.2 billion and $4.0 billion, and the cumulative basis adjustment associated with these hedges was $71 million and $26 million as of March 31, 2019 and December 31, 2018, respectively.


⁽²⁾	Carrying value represents amortized cost.

Balance Sheet Offsetting of Financial Assets and Liabilities

Derivative contracts and repurchase agreements that we execute bilaterally in the OTC market are generally governed by enforceable master netting arrangements where we generally have the right to offset exposure with the same counterparty. Either counterparty can generally request to net settle all contracts through a single payment upon default on, or termination of, any one contract. We elect to offset the derivative assets and liabilities under netting arrangements for balance sheet presentation where a right of setoff exists. For derivative contracts entered into under master netting arrangements for which we have not been able to confirm the enforceability of the setoff rights, or those not subject to master netting arrangements, we do not offset our derivative positions for balance sheet presentation.

The following table presents as of March 31, 2019 and December 31, 2018 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 in accordance with such arrangements. The amount of collateral presented, however, is limited to the amount of the related net derivative fair values or outstanding balances; therefore, instances of over-collateralization are excluded.

Table 9.3: 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, 2019
Derivative assets⁽¹⁾	$	1,221	$	(265	)	$	(247	)	$	709	$	0	$	709
As of December 31, 2018
Derivative assets⁽¹⁾	1,539		(205		)	(874		)	460		0		460



	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, 2019
Derivative liabilities⁽¹⁾	$	875	$	(265	)	$	(156	)	$	454	$	0		$	454
Repurchase agreements⁽²⁾	335		0			0			335		(335		)	0
As of December 31, 2018
Derivative liabilities⁽¹⁾	1,201		(205		)	(82		)	914		0			914
Repurchase agreements⁽²⁾	352		0			0			352		(352		)	0

__________

⁽¹⁾

We received cash collateral from derivative counterparties totaling $440 million and $925 million as of March 31, 2019 and December 31, 2018, respectively. We also received securities from derivative counterparties with a fair value of $1 million as of both March 31, 2019 and December 31, 2018, which we have the ability to re-pledge. We posted $695 million and $633 million of cash collateral as of March 31, 2019 and December 31, 2018, respectively.


⁽²⁾	Represents customer repurchase agreements that mature the next business day. As of March 31, 2019 and December 31, 2018, we pledged collateral with a fair value of $342 million and $359 million, respectively, under these customer repurchase agreements, which were primarily agency RMBS securities.

Income Statement and AOCI Presentation

Fair Value and Cash Flow Hedges

The net gains (losses) recognized in our consolidated statements of income related to derivatives in fair value and cash flow hedging relationships are presented below for the three months ended March 31, 2019 and 2018.

Table 9.4: Effects of Fair Value and Cash Flow Hedge Accounting



	Three Months Ended March 31, 2019
	Net Interest Income
(Dollars in millions)	Investment Securities			Loans, Including Loans Held for Sale			Other		Interest-bearing Deposits			Securitized Debt Obligations			Senior and Subordinated Notes
Total amounts presented in our consolidated statements of income	$	655		$	6,368		$	69	$	(817	)	$	(143	)	$	(314	)
Fair value hedging relationships:
Interest rate contracts:
Interest recognized on derivatives	2			0			0		(36		)	(6		)	(11		)
Gains (losses) recognized on derivatives	(111		)	0			0		95			33			281
Gains (losses) recognized on hedged items⁽¹⁾	110			0			0		(92		)	(57		)	(320		)
Net income (expense) recognized on fair value hedges	1			0			0		(33		)	(30		)	(50		)
Cash flow hedging relationships:⁽²⁾
Interest rate contracts:
Realized losses reclassified from AOCI into net income	(4		)	(56		)	0		0			0			0
Foreign exchange contracts:
Realized gains reclassified from AOCI into net income⁽³⁾	0			0			12		0			0			0
Net income (expense) recognized on cash flow hedges	$	(4	)	$	(56	)	$	12	$	0		$	0		$	0



	Three Months Ended March 31, 2018
	Net Interest Income
(Dollars in millions)	Investment Securities			Loans, Including Loans Held for Sale		Other		Interest-bearing Deposits			Securitized Debt Obligations			Senior and Subordinated Notes
Total amounts presented in our consolidated statements of income	$	452		$	6,134	$	51	$	(539	)	$	(107	)	$	(251	)
Fair value hedging relationships:
Interest rate contracts:
Interest recognized on derivatives	(8		)	0		0		(2		)	(5		)	10
Gains (losses) recognized on derivatives	100			0		0		(160		)	(101		)	(357		)
Gains (losses) recognized on hedged items⁽¹⁾	(99		)	0		0		155			98			325
Net income (expense) recognized on fair value hedges	$	(7	)	$	0	$	0	$	(7	)	$	(8	)	$	(22	)
Cash flow hedging relationships:⁽²⁾
Interest rate contracts:
Realized gains (losses) reclassified from AOCI into net income	$	(2	)	$	8	$	0	$	0		$	0		$	0
Foreign exchange contracts:
Realized gains reclassified from AOCI into net income⁽³⁾	0			0		8		0			0			0
Net income (expense) recognized on cash flow hedges	$	(2	)	$	8	$	8	$	0		$	0		$	0

__________


⁽¹⁾	Includes amortization of $61 million and $10 million for the three months ended March 31, 2019 and 2018, respectively, related to basis adjustments on discontinued hedges.


⁽²⁾	See “Note 10—Stockholders’ Equity” for the effects of cash flow and net investment hedges on AOCI and amounts reclassified to net income, net of tax.


⁽³⁾	We recognized a loss of $172 million and a gain of $75 million on foreign exchange contracts reclassified from AOCI for the three months ended March 31, 2019 and 2018, respectively. These amounts were entirely offset by the foreign currency transaction gains (losses) on our foreign currency denominated inter-company borrowings included non-interest income.

In the next 12 months, we expect to reclassify to earnings net after-tax losses of $113 million recorded in AOCI as of March 31, 2019. 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 seven years as of March 31, 2019. 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.

Free-Standing Derivatives

The net impacts to our consolidated statements of income related to free-standing derivatives are presented below for the three months ended March 31, 2019 and 2018. These gains or losses are recognized in other non-interest income on our consolidated statements of income.

Table 9.5: Gains (Losses) on Free-Standing Derivatives



	Three Months Ended March 31,
(Dollars in millions)	2019			2018
Gains (losses) recognized in other non-interest income:
Customer accommodation:
Interest rate contracts	$	6		$	4
Commodity contracts	2			4
Foreign exchange and other contracts	3			2
Total customer accommodation	11			10
Other interest rate exposures	0			12
Other contracts	(2		)	(20		)
Total	$	9		$	2