Fair Value Measurement and Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2012

Fair Value Measurement and Fair Value of Financial Instruments

Note 8—Fair Value Measurement and Fair Value of Financial Instruments

Valuation Methodologies

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., an exit price) in an orderly transaction between willing market participants at the measurement date. The Company has an established and documented process for determining fair value for financial assets and financial liabilities that are measured at fair value on either a recurring or nonrecurring basis. When available, quoted market prices are used to determine fair value. If quoted market prices are not available, fair value is based upon valuation techniques that use, where possible, current market-based or independently sourced parameters, such as yield curves, foreign exchange rates, credit spreads, commodity prices, and implied volatilities. Valuation adjustments may be made to ensure the financial instruments are recorded at fair value. These adjustments include amounts that reflect counterparty credit quality and that consider the Company’s creditworthiness in determining the fair value of its trading liabilities. For further information related to the valuation methodologies used for certain financial assets and financial liabilities measured at fair value, see Note 15 to the consolidated financial statements in the Company’s 2011 Form 10-K.

Fair Value Hierarchy

In determining fair value, the Company maximizes the use of observable market inputs and minimizes the use of unobservable inputs. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect the Company’s estimate about market data. Based on the observability of the significant inputs used, the Company classifies its fair value measurements in accordance with the three-level hierarchy as defined by US GAAP. This hierarchy is based on the quality, observability, and reliability of the information used to determine fair value. For further information related to the fair value hierarchy, see Note 15 to the consolidated financial statements in the Company’s 2011 Form 10-K.

Valuation Processes

The Company has established a Valuation Committee (VC) to oversee its valuation framework for measuring fair value and to establish valuation policies and procedures. The VC’s responsibilities include reviewing and approving all fair value measurements and categorizations within the fair value hierarchy and monitoring the use of pricing sources, mark-to-model valuations, dealer quotes, and other valuation processes. The VC reports to the Company’s Risk & Capital Committee and meets at least quarterly.

Fair Value Measurements on a Recurring Basis

The following tables present financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011, by major category and by valuation hierarchy level:

	September 30, 2012
(Dollars in millions)	Level 1			Level 2			Level 3			Netting Adjustment(1)			Fair Value
Assets
Trading account assets:
U.S. Treasury	$	—		$	9		$	—		$	—		$	9
U.S. government sponsored agencies		—			97			—			—			97
State and municipal		—			10			—			—			10
Commercial paper		—			20			—			—			20
Interest rate derivative contracts		—			1,084			—			(91	)		993
Commodity derivative contracts		—			165			36			(158	)		43
Foreign exchange derivative contracts		2			88			4			(33	)		61
Equity derivative contracts		—			—			115			(112	)		3
Other derivative contracts		—			1			—			(1	)		—
Total trading account assets		2			1,474			155			(395	)		1,236
Securities available for sale:
U.S. government sponsored agencies		—			2,629			—			—			2,629
Residential mortgage-backed securities:
U.S. government and government sponsored agencies		—			11,970			—			—			11,970
Privately issued		—			498			—			—			498
Commercial mortgage-backed securities		—			2,361			—			—			2,361
CLOs		—			1,590			—			—			1,590
Other debt securities		—			329			1,426			—			1,755
Equity securities		104			—			—			—			104
Total securities available for sale		104			19,377			1,426			—			20,907
Other assets:
Interest rate hedging contracts		—			53			—			(43	)		10
Total other assets		—			53			—			(43	)		10
Total assets	$	106		$	20,904		$	1,581		$	(438	)	$	22,153
Percentage of Total		1	%		94	%		7	%		(2	)%		100	%
Percentage of Total Company Assets		—			24	%		2	%		—			26	%
Liabilities
Trading account liabilities:
Interest rate derivative contracts	$	6		$	1,021		$	—		$	(433	)	$	594
Commodity derivative contracts		—			134			36			(49	)		121
Foreign exchange derivative contracts		1			90			4			(3	)		92
Equity derivative contracts		—			—			115			—			115
Securities sold, not yet purchased		—			30			—			—			30
Total trading account liabilities		7			1,275			155			(485	)		952
Other liabilities		—			—			77			—			77
Total liabilities	$	7		$	1,275		$	232		$	(485	)	$	1,029
Percentage of Total		1	%		124	%		22	%		(47	)%		100	%
Percentage of Total Company Liabilities		—			2	%		—			(1	)%		1	%

⁽¹⁾  Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.

	December 31, 2011
(Dollars in millions)	Level 1			Level 2			Level 3			Netting Adjustment(1)			Fair Value
Assets
Trading account assets:
U.S. Treasury	$	14		$	—		$	—		$	—		$	14
U.S. government sponsored agencies		17			—			—			—			17
State and municipal		—			17			—			—			17
Commercial paper		—			30			—			—			30
Interest rate derivative contracts		1			921			—			(85	)		837
Commodity derivative contracts		—			250			—			(165	)		85
Foreign exchange derivative contracts		1			87			—			(40	)		48
Equity derivative contracts		—			87			—			—			87
Total trading account assets		33			1,392			—			(290	)		1,135
Securities available for sale:
U.S. government sponsored agencies		6,997			—			—			—			6,997
Residential mortgage-backed securities:
U.S government and government sponsored agencies		—			13,485			—			—			13,485
Privately issued		—			738			—			—			738
Commercial mortgage-backed securities		—			1,060			—			—			1,060
Other debt securities		—			425			47			—			472
Equity securities		80			—			1			—			81
Total securities available for sale		7,077			15,708			48			—			22,833
Other assets:
Interest rate hedging contracts		—			3			—			(3	)		—
Total other assets		—			3			—			(3	)		—
Total assets	$	7,110		$	17,103		$	48		$	(293	)	$	23,968
Percentage of Total		30	%		71	%		—			(1	)%		100	%
Percentage of Total Company Assets		8	%		19	%		—			—			27	%
Liabilities
Trading account liabilities:
Interest rate derivative contracts	$	4		$	865		$	—		$	(228	)	$	641
Commodity derivative contracts		—			247			—			(43	)		204
Foreign exchange derivative contracts		1			94			—			(7	)		88
Equity derivative contracts		—			87			—			—			87
Securities sold, not yet purchased		20			—			—			—			20
Total trading account liabilities		25			1,293			—			(278	)		1,040
Other liabilities		—			10			51			—			61
Total liabilities	$	25		$	1,303		$	51		$	(278	)	$	1,101
Percentage of Total		2	%		119	%		5	%		(25	)%		100	%
Percentage of Total Company Liabilities		—			1	%		—			—			1	%

⁽¹⁾ Amounts represent the impact of legally enforceable master netting agreements between the same counterparties that allow the Company to net settle all contracts.

The following tables present a reconciliation of the assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2012 and 2011. Level 3 available for sale securities at September 30, 2012 and 2011 primarily consisted of tax-exempt conduit debt bonds. The Company’s policy is to recognize transfers in and out of Level 1, 2 and 3 as of the end of a reporting period. In the first quarter of 2012, the Company, based on its analysis, transferred its U.S. Treasury and U.S. government sponsored agency securities from Level 1 to Level 2 and certain of its derivative contracts from Level 2 to Level 3.

	For the Three Months Ended
	September 30, 2012												September 30, 2011
(Dollars in millions)	Trading Assets			Securities Available for Sale			Trading Liabilities			Other Liabilities			Securities Available for Sale		Trading Liabilities			Other Liabilities
Asset (liability) balance, beginning of period	$	118		$	1,134		$	(118	)	$	(72	)	$	48	$	(8	)	$	(41	)
Total gains (losses) (realized/unrealized):
Included in income before taxes		37			—			(37	)		(5	)		—		(1	)		(4	)
Included in other comprehensive income		—			(43	)		—			—			—		—			—
Purchases/additions		3			383			(3	)		—			—		—			—
Sales		(3	)		—			3			—			—		—			—
Settlements		—			(48	)		—			—			—		—			—
Transfers into Level 3		—			—			—			—			—		—			—
Asset (liability) balance, end of period	$	155		$	1,426		$	(155	)	$	(77	)	$	48	$	(9	)	$	(45	)
Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at end of period	$	37		$	—		$	(37	)	$	(5	)	$	—	$	(1	)	$	(4	)

	For the Nine Months Ended
	September 30, 2012												September 30, 2011
(Dollars in millions)	Trading Assets			Securities Available for Sale			Trading Liabilities			Other Liabilities			Securities Available for Sale			Trading Liabilities			Other Liabilities
Asset (liability) balance, beginning of period	$	—		$	48		$	—		$	(51	)	$	8		$	(14	)	$	(36	)
Total gains (losses) (realized/unrealized):
Included in income before taxes		3			—			(3	)		(26	)		—			5			(9	)
Included in other comprehensive income		—			(47	)		—			—			(1	)		—			—
Purchases/additions		5			1,473			(5	)		—			42			—			—
Sales		(6	)		—			6			—			(1	)		—			—
Settlements		—			(48	)		—			—			—			—			—
Transfers into Level 3		153			—			(153)			—			—			—			—
Asset (liability) balance, end of period	$	155		$	1,426		$	(155	)	$	(77	)	$	48		$	(9	)	$	(45	)
Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at end of period	$	3		$	—		$	(3	)	$	(26	)	$	—		$	5		$	(9	)

Other debt securities classified within the Level 3 fair value hierarchy consist of tax-exempt conduit debt bonds. A return on equity methodology was the principal technique used to estimate the fair value of these securities. The significant unobservable inputs used in this approach include a market-required return on capital, probability of default and loss severity. As of September 30, 2012, the market required return on capital ranged from 15.0 percent to 17.0 percent with a weighted average of 16.2 percent; probability of default ranged from 0.03 percent to 8.0 percent with a weighted average of 0.6 percent; and loss severity amounts ranged from 10.0 percent to 60.0 percent with a weighted average of 35.7 percent. Increases (decreases) in any of these inputs in isolation would result in a lower (higher) fair value measurement.

Fair Value Measurement on a Nonrecurring Basis

Certain assets may be measured at fair value on a nonrecurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis during the nine months ended September 30, 2012 and 2011 that were still held on the consolidated balance sheet as of the respective periods ended, the following tables present the fair value of such financial instruments by the level of valuation assumptions used to determine each fair value adjustment:

	September 30, 2012								Loss for the Three Months Ended September 30, 2012			Loss for the Nine Months Ended September 30, 2012
(Dollars in millions)	Carrying Amount		Level 1		Level 2		Level 3
Loans:
Impaired loans	$	111	$	—	$	—	$	111	$	(34	)	$	(70	)
Other assets:
OREO		47		—		—		47		(3	)		(20	)
Private equity investments		—		—		—		—		—			(2	)
Total	$	158	$	—	$	—	$	158	$	(37	)	$	(92	)

	September 30, 2011								Loss for the Three Months Ended September 30, 2011			Loss for the Nine Months Ended September 30, 2011
(Dollars in millions)	Carrying Amount		Level 1		Level 2		Level 3
Loans:
Loans Held for Sale	$	2	$	—	$	—	$	2	$	—		$	—
Impaired loans		199		—		—		199		(28	)		(79	)
Other assets:
OREO		123		—		—		123		(8	)		(27	)
Total	$	324	$	—	$	—	$	324	$	(36	)	$	(106	)

Loans include individually impaired loans that are measured based on the fair value of the underlying collateral or the fair value of the loan. The fair value of impaired loans was determined based on appraised values of the underlying collateral or market pricing for the loan, adjusted for management judgment, as of the measurement date. The fair value of OREO was primarily based on independent appraisals.

Fair Value of Financial Instruments Disclosures

The tables below present the carrying amount and estimated fair value of certain financial instruments by the level of valuation assumptions held by the Company as of September 30, 2012, and the carrying amount and the estimated fair value at December 31, 2011:

	September 30, 2012
(Dollars in millions)	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	2,972	$	2,972	$	2,972	$	—	$	—
Securities held to maturity		1,182		1,224		—		1,224		—
Loans held for investment, net of allowance for loan losses(1)		53,785		55,057		—		—		55,057
FDIC indemnification asset		401		249		—		—		249
Liabilities
Deposits	$	65,143	$	65,393	$	—	$	65,393	$	—
Commercial paper and other short-term borrowings		2,091		2,091		—		2,091		—
Long-term debt		5,540		5,774		—		5,774		—
Off-Balance Sheet Instruments
Commitments to extend credit and standby and commercial letters of credit	$	278	$	278	$	—	$	—	$	278

⁽¹⁾  Excludes lease financing, net of related allowance.

	December 31, 2011
(Dollars in millions)	Carrying Amount		Fair Value
Assets
Cash and cash equivalents	$	4,195	$	4,195
Securities held to maturity		1,273		1,429
Loans held for investment, net of allowance for loan losses(1)		51,823		52,423
FDIC indemnification asset		598		409
Liabilities
Deposits	$	64,420	$	64,420
Commercial paper and other short-term borrowings		3,683		3,684
Long-term debt		6,684		6,798
Off-Balance Sheet Instruments
Commitments to extend credit and standby and commercial letters of credit	$	287	$	287

⁽¹⁾  Excludes lease financing, net of related allowance.

For further information on methodologies for approximating fair values, see Note 15 to the consolidated financial statements in the Company’s 2011 Form 10-K.