Note 16—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 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.

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.

Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities. Since the valuations are based on quoted prices that are readily available in an active market, they do not entail a significant degree of judgment.

Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.

Level 3: Valuations are based on at least one significant unobservable input that is supported by little or no market activity and is significant to the fair value measurement. Values are determined using pricing models and discounted cash flow models that include management judgment and estimation, which may be significant.

In assigning the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are measured at fair value. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. The level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Therefore, an item may be classified in Level 3 even though there may be many significant inputs that are readily observable.

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.

Independent price verification (IPV) is performed periodically by the Company to test the market data and valuations of substantially all instruments measured at fair value on a recurring basis. As part of its IPV procedures, the Company compares pricing sources, tests data variance within certain thresholds and performs variance analysis, utilizing third party valuations and both internal and external models. Results are formally reported on a quarterly basis to the VC.

A description of the valuation methodologies used for certain financial assets and liabilities measured at fair value is as follows:

Recurring Fair Value Measurements:

Trading Account Assets: Trading account assets are recorded at fair value and primarily consist of securities and derivatives held for trading purposes. See discussion below on securities available for sale, which utilize the same valuation methodology as trading account securities. See also discussion below on derivatives valuation.

Securities Available for Sale: Securities available for sale are recorded at fair value based on readily available quoted market prices, if available. These securities are classified as Level 1 and include exchange traded equities. If such quoted market prices are not available, management utilizes third-party pricing services and broker quotations from dealers in the specific instruments. If no market prices or broker quotes are available, internal pricing models are used. To the extent possible, these pricing model valuations utilize observable market inputs obtained for similar securities. Typical inputs include LIBOR and U.S. Treasury yield curves, benchmark yields, consensus prepayment estimates and credit spreads. These securities are classified as Level 2 and include U.S. government sponsored agencies, residential and commercial mortgage-backed securities, collateralized loan obligations, and certain other debt securities. When pricing model valuations use significant unobservable inputs, the securities are classified as Level 3. These other debt securities primarily include tax-exempt conduit debt bonds. The valuation of these securities are based upon a return on equity method which incorporates a market-required return on capital, probability of default and loss severity.

Derivatives: The Company’s derivatives are primarily traded in over-the-counter markets where quoted market prices are not readily available. The Company values its derivatives using pricing models that are widely accepted in the financial services industry with inputs that are observable in the market or can be derived from or corroborated by observable market data. These models reflect the contractual terms of the derivatives including the period to maturity and market observable inputs such as yield curves and option volatility. Valuation adjustments are made to reflect counterparty credit quality and to consider the creditworthiness of the Company. These derivatives, which are included in trading account assets, trading account liabilities, other assets and other liabilities are generally classified as Level 2. Trading account assets and trading account liabilities include Level 3 derivatives comprised of embedded derivatives contained in market-linked CDs and perfectly matched over-the-counter options, whose fair value is obtained through unadjusted third party broker quotes which incorporate significant unobservable inputs.

Trading Account Liabilities: Trading account liabilities are recorded at fair value and primarily consist of derivatives and securities sold, not yet purchased. See discussion above on derivatives valuation. Securities sold, not yet purchased consist of U.S. Government securities and are classified as Level 2, which utilize the same valuation methodology as trading account securities.

Other Liabilities: The fair value of the Company’s FDIC clawback liability is determined using a discounted cash flow model with significant unobservable inputs which include probability of default and loss severity. The FDIC clawback liability is classified as Level 3.

Nonrecurring Fair Value Measurements:

Individually Impaired Loans: Individually impaired loans are valued at the time the loan is identified as impaired based on the present value of the remaining expected cash flows. Because the discount factor applied is based on the loan’s original effective yield rather than a current market rate, that present value does not represent fair value. However, as a practical expedient, an impaired loan may be measured based on a loan’s observable market price or the underlying collateral securing the loan (provided the loan is collateral dependent), which does approximate fair value. Collateral may be real estate or business assets, including equipment. The value of collateral is determined based on independent appraisals. Appraised values may be adjusted based on management’s historical knowledge, changes in market conditions from the time of valuation, and management’s knowledge of the client and the client’s business. The loan’s market price is determined using market pricing for similar assets, adjusted for management judgment. Impaired loans are reviewed and evaluated at least quarterly for additional impairment and adjusted accordingly. Impaired loans that are adjusted to fair value based on underlying collateral or the loan’s market price are classified as Level 3.

Loans Held for Sale: Residential mortgage and commercial loans held for sale are recorded at the lower of cost or fair value. The fair value of fixed-rate residential loans is based on whole loan forward prices obtained from GSEs. These loans are classified as Level 2. The fair value of commercial loans held for sale may be based on secondary market offerings for loans with similar characteristics or a valuation methodology utilizing the appraised value to outstanding loan balance ratio. These loan values are classified as Level 3.

Private Equity Investments: Private equity investments are recorded either at cost or using the equity method and are evaluated for impairment. The valuation of these investments requires significant management judgment due to the absence of quoted market prices, lack of liquidity and the long-term nature of these assets. When required, the fair value of the investments was estimated using the NAV of the fund or based on the investee’s business model, current and projected financial performance, liquidity and overall economic and market conditions. Private equity investments are generally classified as Level 3.

OREO: OREO represents collateral acquired through foreclosure and is initially recorded at fair value as established by a current appraisal, adjusted for disposition costs. Subsequently, OREO is measured at lower of cost or fair value. OREO values are reviewed on an ongoing basis and any subsequent decline in fair value is recorded as a foreclosed asset expense in the current period. The value of OREO is determined based on independent appraisals and is generally classified as Level 3.

LIHC Investments: LIHC investments represent guaranteed and unguaranteed funds that are recorded using the effective yield or equity method of accounting, with the investment amortized over the period the tax credits are allocated. These investments are evaluated for impairment based on the realizability of the tax credits and benefits from operating losses. Realizability of the tax credits is based on the qualification of low-income status for the underlying properties. These investments are generally classified as Level 3.

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 December 31, 2012 and 2011, by major category and by valuation hierarchy level.


	December 31, 2012
(Dollars in millions)	Level 1			Level 2			Level 3			Netting Adjustment⁽¹⁾			Fair Value
Assets
Trading account assets:
U.S. Treasury	$	—		$	1		$	—		$	—		$	1
U.S. government sponsored agencies		—			113			—			—			113
State and municipal		—			15			—			—			15
Commercial paper		—			10			—			—			10
Interest rate derivative contracts		—			1,075			—			(87	)		988
Commodity derivative contracts		—			137			30			(127	)		40
Foreign exchange derivative contracts		1			65			3			(28	)		41
Equity derivative contracts		—			—			103			(103	)		—

Total trading account assets		1			1,416			136			(345	)		1,208
Securities available for sale:
U.S. government sponsored agencies		—			885			—			—			885
Residential mortgage-backed securities:
U.S. government and government sponsored agencies		—			13,333			—			—			13,333
Privately issued		—			443			—			—			443
Commercial mortgage-backed securities		—			2,971			—			—			2,971
CLOs		—			1,959			—			—			1,959
Other debt securities		—			243			1,499			—			1,742
Equity securities		19			—			—			—			19

Total securities available for sale		19			19,834			1,499			—			21,352

Other assets:
Interest rate hedging contracts		—			28			—			(24	)		4
Other derivative contracts		—			1			—			(1	)		—

Total other assets		—			29			—			(25	)		4

Total assets	$	20		$	21,279		$	1,635		$	(370	)	$	22,564

Percentage of Total		—	%		94	%		7	%		(1	)%		100	%
Percentage of Total Company Assets		—	%		22	%		1	%		—	%		23	%
Liabilities
Trading account liabilities:
Interest rate derivative contracts	$	5		$	1,004		$	—		$	(407	)	$	602
Commodity derivative contracts		—			110			30			(42	)		98
Foreign exchange derivative contracts		1			61			3			—			65
Equity derivative contracts		—			—			103			—			103
Credit derivative contracts		—			—			—			—			—
Securities sold, not yet purchased		—			27			—			—			27

Total trading account liabilities		6			1,202			136			(449	)		895
Other liabilities
FDIC clawback liability		—			—			92			—			92
Other derivative contracts		—			—			3			—			3

Total other liabilities		—			—			95			—			95

Total liabilities	$	6		$	1,202		$	231		$	(449	)	$	990

Percentage of Total		1	%		121	%		23	%		(45	)%		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
Foreign exchange derivative contracts		1			87			—			(40	)		48
Commodity derivative contracts		—			250			—			(165	)		85
Interest rate derivative contracts		1			921			—			(85	)		837
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
Asset-backed securities		—			284			—			—			284
Other debt securities		—			141			47			—			188
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:
Foreign exchange derivative contracts	$	1		$	94		$	—		$	(7	)	$	88
Commodity derivative contracts		—			247			—			(43	)		204
Interest rate derivative contracts		4			865			—			(228	)		641
Equity derivative contracts		—			87			—			—			87
Other derivative contracts		—			—			—			—			—
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 years ended December 31, 2012 and 2011. Level 3 available for sale securities at December 31, 2012 primarily consist 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 Year Ended
	December 31, 2012												December 31, 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		(18	)		—			18			(41	)		—			14			(15	)
Included in other comprehensive income		—			(35	)		—			—			(1	)		—			—
Purchases/additions		8			1,619			—			(3	)		42			—			—
Sales		—			—			(8	)		—			(1	)		—			—
Settlements		(7	)		(133	)		7			—			—			—			—
Transfers into Level 3		153			—			(153	)		—			—			—			—

Asset (liability) balance, end of period	$	136		$	1,499		$	(136	)	$	(95	)	$	48		$	—		$	(51	)

Changes in unrealized gains (losses) included in income before taxes for assets and liabilities still held at end of period	$	(18	)	$	—		$	18		$	(41	)	$	—		$	14		$	(15	)

The following table presents information about significant unobservable inputs related to the Company’s significant Level 3 assets and liabilities at December 31, 2012.


	December 31, 2012
(Dollars in millions)	Level 3 Fair Value		Valuation Technique(s)	Significant Unobservable Input(s)	Range of Inputs			Weighted Average
Securities available for sale:
Tax-exempt conduit debt bonds	$	1,440	Return on equity	Market-required return on capital		15.0 - 17.0	%		16.0	%
				Probability of default		0.0 - 8.0	%		0.6	%
				Loss severity		10.0 - 75.0	%		36.2	%
Other liabilities
FDIC clawback liability		92	Discounted cash flow	Probability of default		0.4 - 100.0	%		54.6	%
				Loss severity		20.0 - 100.0	%		49.9	%

The tax-exempt conduit debt bonds use a return on equity valuation technique. This technique uses significant unobservable inputs such as market-required return on capital, probability of default, and loss severity. Increases (decreases) in any of these inputs in isolation would result in a lower (higher) fair value measurement.

The FDIC clawback liability uses a discounted cash flow valuation technique. This technique uses significant unobservable inputs such as probability of default and loss severity. Increases (decreases) in probability of default and loss severity would result in a lower (higher) liability.

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 years ended December 31, 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.


	December 31, 2012								Loss for the Year Ended December 31, 2012
(Dollars in millions)	Carrying Amount		Level 1		Level 2		Level 3		Loss for the Year Ended December 31, 2012
Loans:
Impaired loans	$	119	$	—	$	—	$	119	$	(88	)
Other assets:
OREO		53		—		—		53		(27	)
Private equity investments		—		—		—		—		(2	)

Total	$	172	$	—	$	—	$	172	$	(117	)


	December 31, 2011								Loss for the Year Ended December 31, 2011
(Dollars in millions)	Carrying Amount		Level 1		Level 2		Level 3		Loss for the Year Ended December 31, 2011
Loans:
Loans Held for Sale	$	1	$	—	$	—	$	1	$	(1	)
Impaired loans		144		—		—		144		(91	)
Other assets:
OREO		70		—		—		70		(40	)
Private equity investments		28		—		—		28		(4	)

Total	$	243	$	—	$	—	$	243	$	(136	)

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

In addition to financial instruments recorded at fair value in the Company’s financial statements, the disclosure of the estimated fair value of financial instruments that are not carried at fair value is also required. Excluded from this disclosure requirement are lease financing arrangements, investments accounted for under the equity method, employee pension and other postretirement obligations and all nonfinancial assets and liabilities, including goodwill and other intangible assets such as long-term customer relationships. The fair values presented are estimates for certain individual financial instruments and do not represent an estimate of the fair value of the Company as a whole.

Certain financial instruments that are not recognized at fair value on the consolidated balance sheet are carried at amounts that approximate fair value due to their short-term nature. These financial instruments include cash and due from banks, interest bearing deposits in banks, federal funds sold and purchased, securities purchased under resale agreements, securities sold under repurchase agreements and commercial paper. In addition, the fair value of deposits with no stated maturity, such as noninterest bearing demand deposits, interest bearing checking, and market rate and other savings are deemed to equal their carrying amounts.

Financial instruments for which their carrying amounts do not approximate fair value include securities held to maturity, loans, FDIC indemnification asset, interest bearing deposits with stated maturities, commercial paper and other short-term borrowings, long-term debt and off-balance sheet instruments.

Securities held to maturity: The fair value of U.S. government agency and government sponsored agencies—residential mortgage backed securities and CLOs classified as held to maturity are based on unadjusted third party pricing service prices.

Loans: The fair value of purchased credit-impaired loans was estimated using a discounted cash flow methodology that considered factors including the type of loan and related collateral, risk classification, term of loan, performance status and current discount rates. The fair values of mortgage loans were estimated based on quoted market prices for loans with similar credit and interest rate risk characteristics. The fair values of other loans were estimated based upon the type of loan and maturity and was determined by discounting the future expected cash flows using the current origination rates for similar loans made to borrowers with similar credit ratings and include adjustments for liquidity premiums.

FDIC indemnification asset: The fair value of the FDIC indemnification asset was estimated using the present value of the cash flows that the Company expects to collect from the FDIC under the loss share agreements.

Interest bearing deposits: The fair values of savings accounts and certain money market accounts were based on the amounts payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit was estimated using a discounted cash flow calculation that applies current interest rates being offered on certificates with similar maturities.

Commercial paper and other short-term borrowings: The fair values of Federal Reserve Bank term borrowings, FHLB borrowings and term federal funds purchased were estimated using a discounted cash flow calculation that applies current market rates for applicable maturities. The carrying amounts of other short-term borrowed funds were assumed to approximate their fair value due to their limited duration.

Long-term debt: The fair value of senior and subordinated debt was estimated using either a discounted cash flow analysis based on current market interest rates for debt with similar maturities and credit quality or estimated using market quotes. The fair value of junior subordinated debt payable to subsidiary grant trust was estimated using market quotes of similar securities.

Off-balance sheet instruments: Commitments to extend credit and standby and commercial letters of credit are instruments that generate ongoing fees, which are recognized over the term of the commitment period. In situations where the credit quality of the counterparty to a commitment has declined, the Company records a reserve. A reasonable estimate of the fair value of these instruments is the carrying amount of deferred fees plus the related reserve.

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 December 31, 2012, and the carrying amount and the estimated fair value at December 31, 2011.


	December 31, 2012
(Dollars in millions)	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	5,491	$	5,491	$	5,491	$	—	$	—
Securities held to maturity		1,103		1,135		—		1,135		—
Loans held for investment, net of allowance for loan losses⁽¹⁾		58,284		59,613		—		—		59,613
FDIC indemnification asset		338		151		—		—		151
Other assets		3		3		—		—		3
Liabilities
Deposits	$	74,255	$	74,524	$	—	$	74,524	$	—
Commercial paper and other short-term borrowings		1,363		1,363		—		1,363		—
Long-term debt		5,622		5,861		—		5,861		—
Off-Balance Sheet Instruments
Commitments to extend credit and standby and commercial letters of credit	$	262	$	262	$	—	$	—	$	262

⁽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.