NOTE 6 – DERIVATIVE AND CREDIT-RELATED FINANCIAL INSTRUMENTS

In the normal course of business, the Corporation enters into various transactions involving derivative and credit-related financial instruments to manage exposure to fluctuations in interest rate, foreign currency and other market risks and to meet the financing needs of customers. These financial instruments involve, to varying degrees, elements of market and credit risk. Derivatives are carried at fair value in the consolidated financial statements. Market and credit risk are included in the determination of fair value.

Market risk is the potential loss that may result from movements in interest rates, foreign currency exchange rates or energy commodity prices that cause an unfavorable change in the value of a financial instrument. The Corporation manages this risk by establishing monetary exposure limits and monitoring compliance with those limits. Market risk inherent in interest rate and energy contracts entered into on behalf of customers is mitigated by taking offsetting positions, except in those circumstances when the amount, tenor and/or contract rate level results in negligible economic risk, whereby the cost of purchasing an offsetting contract is not economically justifiable. The Corporation mitigates most of the inherent market risk in foreign exchange contracts entered into on behalf of customers by taking offsetting positions and manages the remainder through individual foreign currency position limits and aggregate value-at-risk limits. These limits are established annually and reviewed quarterly. Market risk inherent in derivative instruments held or issued for risk management purposes is typically offset by changes in the fair value of the assets or liabilities being hedged.

Credit risk is the possible loss that may occur in the event of nonperformance by the counterparty to a financial instrument. For customer-initiated derivatives, the Corporation attempts to minimize credit risk arising from financial instruments by evaluating the creditworthiness of each counterparty, adhering to the same credit approval process used for traditional lending activities and obtaining collateral as deemed necessary.

For derivatives with dealer counterparties, the Corporation utilizes both counterparty risk limits and monitoring procedures as well as master netting arrangements and bilateral collateral agreements to facilitate the management of credit risk. Master netting arrangements effectively reduce credit risk by permitting settlement, on a net basis, of contracts entered into with the same counterparty. Bilateral collateral agreements require daily exchange of cash or highly rated securities issued by the U.S. Treasury or other U.S. government agencies to collateralize amounts due to either party beyond certain risk limits. At June 30, 2011, counterparties had pledged marketable investment securities to secure approximately 85 percent of the fair value of contracts with bilateral collateral agreements in an unrealized gain position. For those counterparties not covered under bilateral collateral agreements, collateral is obtained, if deemed necessary, based on the results of management's credit evaluation of the counterparty. Collateral varies, but may include cash, investment securities, accounts receivable, equipment or real estate. Included in the fair value of derivative instruments are credit valuation adjustments reflecting counterparty credit risk. These adjustments are determined by applying a credit spread for the counterparty or the Corporation, as appropriate, to the total expected exposure of the derivative.

The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on June 30, 2011 was $114 million, for which the Corporation had pledged collateral of $99 million in the normal course of business. The credit-risk-related contingent features require the Corporation's debt to maintain an investment grade credit rating from each of the major credit rating agencies. If the Corporation's debt were to fall below investment grade, the counterparties to the derivative instruments could require additional overnight collateral on derivative instruments in net liability positions. If the credit-risk-related contingent features underlying these agreements had been triggered on June 30, 2011, the Corporation would have been required to assign an additional $15 million of collateral to its counterparties.

Derivative Instruments

The following table presents the composition of the Corporation's derivative instruments held or issued for risk management purposes or in connection with customer-initiated and other activities at June 30, 2011 and December 31, 2010. The table excludes commitments, warrants accounted for as derivatives and a derivative related to the Corporation's 2008 sale of its remaining ownership of Visa shares.


	June 30, 2011						December 31, 2010
	Notional/ Contract Amount (b)		Fair Value (a)				Notional/ Contract Amount (b)		Fair Value (a)
			Asset Derivatives		Liability Derivatives				Asset Derivatives		Liability Derivatives
(in millions)			Asset Derivatives		Liability Derivatives				Asset Derivatives		Liability Derivatives
Risk management purposes
Derivatives designated as hedging instruments
Interest rate contracts:
Swaps - cash flow - receive fixed/pay floating	$	—	$	—	$	—	$	800	$	3	$	—
Swaps - fair value - receive fixed/pay floating		1,450		261		—		1,600		263		—

Total risk management interest rate swaps designated as hedging instruments		1,450		261		—		2,400		266		—

Derivatives used as economic hedges
Foreign exchange contracts:
Spot, forwards and swaps		386		2		1		220		2		—

Total risk management purposes	$	1,836	$	263	$	1	$	2,620	$	268	$	—

Customer-initiated and other activities
Interest rate contracts:
Caps and floors written	$	553	$	—	$	5	$	697	$	—	$	7
Caps and floors purchased		553		5		—		697		7		—
Swaps		9,231		247		218		9,126		269		242

Total interest rate contracts		10,337		252		223		10,520		276		249

Energy derivative contracts:
Caps and floors written		1,254		—		71		1,106		—		62
Caps and floors purchased		1,254		71		—		1,106		62		—
Swaps		413		29		29		411		41		41

Total energy derivative contracts		2,921		100		100		2,623		103		103

Foreign exchange contracts:
Spot, forwards, futures, options and swaps		2,621		45		39		2,497		49		48

Total customer-initiated and other activities	$	15,879	$	397	$	362	$	15,640	$	428	$	400

Total derivatives	$	17,715	$	660	$	363	$	18,260	$	696	$	400

(a)

Asset derivatives are included in "accrued income and other assets" and liability derivatives are included in "accrued expenses and other liabilities" on the consolidated balance sheets. Included in the fair value of derivative assets and liabilities are credit valuation adjustments reflecting counterparty credit risk and credit risk of the Corporation. The fair value of derivative assets included credit valuation adjustments for counterparty credit risk totaling $4 million and $5 million at June 30, 2011 and December 31, 2010, respectively.

(b)

Notional or contract amounts, which represent the extent of involvement in the derivatives market, are used to determine the contractual cash flows required in accordance with the terms of the agreement. These amounts are typically not exchanged, significantly exceed amounts subject to credit or market risk and are not reflected in the consolidated balance sheets.

Risk Management

As an end-user, the Corporation employs a variety of financial instruments for risk management purposes, including cash instruments, such as investment securities, as well as derivative instruments. Activity related to these instruments is centered predominantly in the interest rate markets and mainly involves interest rate swaps. Various other types of instruments also may be used to manage exposures to market risks, including interest rate caps and floors, total return swaps, foreign exchange forward contracts and foreign exchange swap agreements.

As part of a fair value hedging strategy, the Corporation entered into interest rate swap agreements for interest rate risk management purposes. These interest rate swap agreements effectively modify the Corporation's exposure to interest rate risk by converting fixed-rate debt to a floating rate. These agreements involve the receipt of fixed-rate interest amounts in exchange for floating-rate interest payments over the life of the agreement, without an exchange of the underlying principal amount.

Risk management fair value interest rate swaps generated net interest income of $18 million and $36 million for the three- and six-month periods ended June 30, 2011, respectively, compared to net interest income of $20 million and $39 million for the three- and six-month periods ended June 30, 2010, respectively.

The net gains (losses) recognized in other noninterest income (i.e., the ineffective portion) in the consolidated statements of income on risk management derivatives designated as fair value hedges of fixed-rate debt was as follows.


	Three Months Ended June 30,					Six Months Ended June 30,
(in millions)	2011		2010			2011		2010
Interest rate swaps	$	—	$	(1	)	$	1	$	(2	)

As part of a cash flow hedging strategy, the Corporation had entered into interest rate swap agreements that effectively converted a portion of existing and forecasted floating-rate loans to a fixed-rate basis, thus reducing the impact of interest rate changes on future interest income over the life of the agreements. In the first quarter 2011, the remaining $800 million notional amount of interest rate swap agreements outstanding at December 31, 2010 matured. As of June 30, 2011 the Corporation had no interest rate swap agreements designated as cash flow hedges of loans outstanding.

The net gains (losses) recognized in income and OCI on risk management derivatives designated as cash flow hedges of loans for the three- and six-month periods ended June 30, 2011 and 2010 are displayed in the table below.


	Three Months Ended June 30,				Six Months Ended June 30,
(in millions)	2011		2010		2011			2010
Interest rate swaps
Gain (loss) recognized in OCI (effective portion)	$	—	$	1	$	(2	)	$	7
Gain (loss) recognized in other noninterest income (ineffective portion)		—		—		1			(3	)
Gain reclassified from accumulated OCI into interest and fees on loans (effective portion)		—		9		1			17

Foreign exchange rate risk arises from changes in the value of certain assets and liabilities denominated in foreign currencies. The Corporation employs spot and forward contracts in addition to swap contracts to manage exposure to these and other risks.

The Corporation recognized an insignificant amount of net gains (losses) on risk management derivative instruments used as economic hedges in other noninterest income in the consolidated statements of income in the three- and six-month periods ended June 30, 2011 and 2010.

The following table summarizes the expected weighted average remaining maturity of the notional amount of risk management interest rate swaps and the weighted average interest rates associated with amounts expected to be received or paid on interest rate swap agreements as of June 30, 2011 and December 31, 2010.


			Weighted Average
(dollar amounts in millions)	Notional Amount		Remaining Maturity (in years)		Receive Rate			Pay Rate (a)
June 30, 2011
Swaps - fair value - receive fixed/pay floating rate
Medium- and long-term debt designation	$	1,450		5.9		5.45	%		0.45	%

Total risk management interest rate swaps	$	1,450

December 31, 2010
Swaps - cash flow - receive fixed/pay floating rate
Variable rate loan designation	$	800		0.1		4.75	%		3.25	%
Swaps - fair value - receive fixed/pay floating rate
Medium- and long-term debt designation		1,600		7.1		5.73			0.85

Total risk management interest rate swaps	$	2,400

(a)	Variable rates paid on receive fixed swaps are based on prime and six-month LIBOR rates in effect at June 30, 2011 and December 31, 2010.

Management believes these hedging strategies achieve the desired relationship between the rate maturities of assets and funding sources which, in turn, reduce the overall exposure of net interest income to interest rate risk, although there can be no assurance that such strategies will be successful.

Customer-Initiated and Other

Fee income is earned from entering into various transactions at the request of customers (customer-initiated contracts), principally foreign exchange contracts, interest rate contracts and energy derivative contracts. For customer-initiated foreign exchange contracts, the Corporation mitigates most of the inherent market risk by taking offsetting positions and manages the remainder through individual foreign currency position limits and aggregate value-at-risk limits. These limits are established annually and reviewed quarterly.

For those customer-initiated derivative contracts which were not offset or where the Corporation holds a speculative position within the limits described above, the Corporation recognized an insignificant amount of net gains in "other noninterest income" in the consolidated statements of income in both the three-month periods ended June 30, 2011 and 2010, and an insignificant amount and $1 million of net gains in the six-month periods ended June 30, 2011 and 2010, respectively.

Fair values of customer-initiated and other derivative instruments represent the net unrealized gains or losses on such contracts and are recorded in the consolidated balance sheets. Changes in fair value are recognized in the consolidated statements of income. The net gains recognized in income on customer-initiated derivative instruments, net of the impact of offsetting positions, were as follows.


		Three Months Ended June 30,				Six Months Ended June 30,
(in millions)	Location of Gain	2011		2010		2011		2010
Interest rate contracts	Other noninterest income	$	2	$	4	$	8	$	7
Energy derivative contracts	Other noninterest income		1		1		1		1
Foreign exchange contracts	Foreign exchange income		9		10		17		19

Total		$	12	$	15	$	26	$	27

Additional information regarding the nature, terms and associated risks of derivative instruments can be found in the Corporation's 2010 Annual Report on page 55 and in Notes 1 and 9 to the consolidated financial statements.

Credit-Related Financial Instruments

The Corporation issues off-balance sheet financial instruments in connection with commercial and consumer lending activities. The Corporation's credit risk associated with these instruments is represented by the contractual amounts indicated in the following table.


(in millions)	June 30, 2011		December 31, 2010
Unused commitments to extend credit:
Commercial and other	$	23,612	$	23,578
Bankcard, revolving check credit and home equity loan commitments		1,565		1,568

Total unused commitments to extend credit	$	25,177	$	25,146

Standby letters of credit	$	5,282	$	5,453
Commercial letters of credit		132		93
Other credit-related financial instruments		1		1

The Corporation maintains an allowance to cover probable credit losses inherent in lending-related commitments, including unused commitments to extend credit, letters of credit and financial guarantees. At June 30, 2011 and December 31, 2010, the allowance for credit losses on lending-related commitments, included in "accrued expenses and other liabilities" on the consolidated balance sheets, was $30 million and $35 million, respectively.

Unused Commitments to Extend Credit

Commitments to extend credit are legally binding agreements to lend to a customer, provided there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments expire without being drawn upon, the total contractual amount of commitments does not necessarily represent future cash requirements of the Corporation. Commercial and other unused commitments are primarily variable rate commitments. The allowance for credit losses on lending-related commitments included $13 million and $16 million, at June 30, 2011 and December 31, 2010, respectively, for probable credit losses inherent in the Corporation's unused commitments to extend credit.

At June 30, 2011 and December 31, 2010, commitments to lend additional funds to borrowers whose terms have been modified in troubled debt restructurings totaled $10 million and $7 million, respectively.

Standby and Commercial Letters of Credit

Standby letters of credit represent conditional obligations of the Corporation which guarantee the performance of a customer to a third party. Standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Commercial letters of credit are issued to finance foreign or domestic trade transactions. These contracts expire in decreasing amounts through the year 2019. The Corporation may enter into participation arrangements with third parties that effectively reduce the maximum amount of future payments which may be required under standby and commercial letters of credit. These risk participations covered $257 million and $298 million of the $5.4 billion and $5.5 billion standby and commercial letters of credit outstanding at June 30, 2011 and December 31, 2010, respectively.

The carrying value of the Corporation's standby and commercial letters of credit, included in "accrued expenses and other liabilities" on the consolidated balance sheet, totaled $80 million at June 30, 2011, including $63 million of deferred fees and $17 million in the allowance for credit losses on lending-related commitments. At December 31, 2010, the comparable amounts were $83 million, $64 million and $19 million, respectively.

The following table presents a summary of internally classified watch list standby and commercial letters of credit at June 30, 2011 and December 31, 2010. The Corporation's internal watch list is generally consistent with loans in the Special Mention, Substandard and Doubtful (nonaccrual) categories defined by regulatory authorities. The Corporation manages credit risk through underwriting, periodically reviewing and approving its credit exposures using Board committee approved credit policies and guidelines.


(dollar amounts in millions)	June 30, 2011			December 31, 2010
Total watch list standby and commercial letters of credit	$	233		$	243
As a percentage of total outstanding standby and commercial letters of credit		4.3	%		4.4	%

Other credit-related financial instruments

The Corporation enters into credit risk participation agreements, under which the Corporation assumes credit exposure associated with a borrower's performance related to certain interest rate derivative contracts. The Corporation is not a party to the interest rate derivative contracts and only enters into these credit risk participation agreements in instances in which the Corporation is also a party to the related loan participation agreement for such borrowers. The Corporation manages its credit risk on the credit risk participation agreements by monitoring the creditworthiness of the borrowers, which is based on the normal credit review process had it entered into the derivative instruments directly with the borrower. The notional amount of such credit risk participation agreement reflects the pro-rata share of the derivative instrument, consistent with its share of the related participated loan. As of June 30, 2011 and December 31, 2010, the total notional amount of the credit risk participation agreements was approximately $305 million and $316 million, respectively, and the fair value, included in customer-initiated interest rate contracts recorded in "accrued expenses and other liabilities" on the consolidated balance sheets, was insignificant for each period. The maximum estimated exposure to these agreements, as measured by projecting a maximum value of the guaranteed derivative instruments, assuming 100 percent default by all obligors on the maximum values, was approximately $12 million at both June 30, 2011 and December 31, 2010. In the event of default, the lead bank has the ability to liquidate the assets of the borrower, in which case the lead bank would be required to return a percentage of the recouped assets to the participating banks. As of June 30, 2011, the credit risk participation agreements had a weighted average remaining maturity for outstanding agreements of 2.5 years.

In 2008, the Corporation sold its remaining ownership of Visa Class B shares and entered into a derivative contract. Under the terms of the derivative contract, the Corporation will compensate the counterparty primarily for dilutive adjustments made to the conversion factor of the Visa Class B shares to Class A shares based on the ultimate outcome of litigation involving Visa. Conversely, the Corporation will be compensated by the counterparty for any increase in the conversion factor from anti-dilutive adjustments. The notional amount of the derivative contract was equivalent to approximately 780 thousand Visa Class B shares. The fair value of the derivative liability, included in "accrued expenses and other liabilities" on the consolidated balance sheets, was $1 million at both June 30, 2011 and December 31, 2010.