XML 93 R18.htm IDEA: XBRL DOCUMENT v2.4.0.6
Derivative Financial Instruments
 3 Months Ended
Mar. 31, 2012
Derivative Financial Instruments

10. Derivative Financial Instruments

The Bancorp maintains an overall risk management strategy that incorporates the use of derivative instruments to reduce certain risks related to interest rate, prepayment and foreign currency volatility. Additionally, the Bancorp holds derivative instruments for the benefit of its commercial customers and for other business purposes. The Bancorp does not enter into unhedged speculative derivative positions.

 

The Bancorp's interest rate risk management strategy involves modifying the repricing characteristics of certain financial instruments so that changes in interest rates do not adversely affect the Bancorp's net interest margin and cash flows. Derivative instruments that the Bancorp may use as part of its interest rate risk management strategy include interest rate swaps, interest rate floors, interest rate caps, forward contracts, options and swaptions. Interest rate swap contracts are exchanges of interest payments, such as fixed-rate payments for floating-rate payments, based on a stated notional amount and maturity date. Interest rate floors protect against declining rates, while interest rate caps protect against rising interest rates. Forward contracts are contracts in which the buyer agrees to purchase, and the seller agrees to make delivery of, a specific financial instrument at a predetermined price or yield. Options provide the purchaser with the right, but not the obligation, to purchase or sell a contracted item during a specified period at an agreed upon price. Swaptions are financial instruments granting the owner the right, but not the obligation, to enter into or cancel a swap.

 

Prepayment volatility arises mostly from changes in fair value of the largely fixed-rate MSR portfolio, mortgage loans and mortgage-backed securities. The Bancorp may enter into various free-standing derivatives (principal-only swaps, interest rate swaptions, interest rate floors, mortgage options, TBAs and interest rate swaps) to economically hedge prepayment volatility. Principal-only swaps are total return swaps based on changes in the value of the underlying mortgage principal-only trust. TBAs are a forward purchase agreement for a mortgage-backed securities trade whereby the terms of the security are undefined at the time the trade is made.

 

Foreign currency volatility occurs as the Bancorp enters into certain loans denominated in foreign currencies. Derivative instruments that the Bancorp may use to economically hedge these foreign denominated loans include foreign exchange swaps and forward contracts.

 

The Bancorp also enters into derivative contracts (including foreign exchange contracts, commodity contracts and interest rate contracts) for the benefit of commercial customers and other business purposes. The Bancorp may economically hedge significant exposures related to these free-standing derivatives by entering into offsetting third-party contracts with approved, reputable counterparties with substantially matching terms and currencies. Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. The Bancorp's exposure is limited to the replacement value of the contracts rather than the notional, principal or contract amounts. Credit risk is minimized through credit approvals, limits, counterparty collateral and monitoring procedures.

 

The Bancorp's derivative assets contain certain contracts in which the Bancorp requires the counterparties to provide collateral in the form of cash and securities to offset changes in the fair value of the derivatives, including changes in the fair value due to credit risk of the counterparty. As of March 31, 2012, December 31, 2011 and March 31, 2011, the balance of collateral held by the Bancorp for derivative assets was $1.1 billion, $1.2 billion and $837 million, respectively. The credit component negatively impacting the fair value of derivative assets associated with customer accommodation contracts as of March 31, 2012, December 31, 2011 and March 31, 2011 was $24 million, $28 million and $39 million, respectively.

 

In measuring the fair value of derivative liabilities, the Bancorp considers its own credit risk, taking into consideration collateral maintenance requirements of certain derivative counterparties and the duration of instruments with counterparties that do not require collateral maintenance. When necessary, the Bancorp primarily posts collateral in the form of cash and securities to offset changes in fair value of the derivatives, including changes in fair value due to the Bancorp's credit risk. As of March 31, 2012, December 31, 2011 and March 31, 2011, the balance of collateral posted by the Bancorp for derivative liabilities was $720 million, $788 million and $603 million, respectively. Certain of the Bancorp's derivative liabilities contain credit-risk related contingent features that could result in the requirement to post additional collateral upon the occurrence of specified events. As of March 31, 2012, the fair value of the additional collateral that could be required to be posted as a result of the credit-risk related contingent features being triggered was not material to the Bancorp's Condensed Consolidated Financial Statements. The posting of collateral has been determined to remove the need for consideration of credit risk. As a result, the Bancorp determined that the impact of the Bancorp's credit risk to the valuation of its derivative liabilities was immaterial to the Bancorp's Condensed Consolidated Financial Statements.

 

The Bancorp holds certain derivative instruments that qualify for hedge accounting treatment and are designated as either fair value hedges or cash flow hedges. Derivative instruments that do not qualify for hedge accounting treatment, or for which hedge accounting is not established, are held as free-standing derivatives. All customer accommodation derivatives are held as free-standing derivatives.

 

The fair value of derivative instruments is presented on a gross basis, even when the derivative instruments are subject to master netting arrangements. Derivative instruments with a positive fair value are reported in other assets in the Condensed Consolidated Balance Sheets while derivative instruments with a negative fair value are reported in other liabilities in the Condensed Consolidated Balance Sheets. Cash collateral payables and receivables associated with the derivative instruments are not added to or netted against the fair value amounts. The following tables reflect the notional amounts and fair values for all derivative instruments included in the Condensed Consolidated Balance Sheets as of:

 

      
    Fair Value
  Notional DerivativeDerivative
March 31, 2012 ($ in millions) Amount AssetsLiabilities
Qualifying hedging instruments     
Fair value hedges:     
Interest rate swaps related to long-term debt$ 4,080  562 -
Total fair value hedges    562 -
Cash flow hedges:     
Interest rate floors related to C&I loans  1,500  77 -
Interest rate swaps related to C&I loans  1,000  58 -
Interest rate caps related to long-term debt  500  - -
Interest rate swaps related to long-term debt  250  - 4
Total cash flow hedges    135 4
Total derivatives designated as qualifying hedging instruments    697 4
Derivatives not designated as qualifying hedging instruments     
Free-standing derivatives - risk management and other business purposes     
Interest rate contracts related to MSRs  8,077  201 -
Forward contracts related to held for sale mortgage loans  8,769  21 10
Interest rate swaps related to long-term debt  195  1 2
Stock warrants associated with sale of the processing business  228  157 -
Swap associated with the sale of Visa, Inc. Class B shares  507  - 22
Total free-standing derivatives - risk management and other business purposes    380 34
Free-standing derivatives - customer accommodation:     
Interest rate contracts for customers  26,185  655 674
Interest rate lock commitments  4,307  20 3
Commodity contracts  2,110  156 151
Foreign exchange contracts  17,473  191 178
Derivative instruments related to equity linked CDs  33  2 2
Total free-standing derivatives - customer accommodation    1,024 1,008
Total derivatives not designated as qualifying hedging instruments    1,404 1,042
Total  $ 2,101 1,046

      
    Fair Value
  NotionalDerivativeDerivative
December 31, 2011 ($ in millions) AmountAssetsLiabilities
Qualifying hedging instruments     
Fair value hedges:     
Interest rate swaps related to long-term debt$ 4,080  662 -
Total fair value hedges    662 -
Cash flow hedges:     
Interest rate floors related to C&I loans  1,500  91 -
Interest rate swaps related to C&I loans  1,500  59 -
Interest rate caps related to long-term debt  500  - -
Interest rate swaps related to long-term debt  250  - 5
Total cash flow hedges    150 5
Total derivatives designated as qualifying hedging instruments    812 5
Derivatives not designated as qualifying hedging instruments     
Free-standing derivatives - risk management and other business purposes     
Interest rate contracts related to MSRs  3,077  187 -
Forward contracts related to held for sale mortgage loans  5,705  8 54
Interest rate swaps related to long-term debt  311  1 3
Put options associated with sale of the processing business  978  - 1
Stock warrants associated with sale of the processing business  223  111 -
Swap associated with the sale of Visa, Inc. Class B shares  436  - 78
Total free-standing derivatives - risk management and other business purposes    307 136
Free-standing derivatives - customer accommodation:     
Interest rate contracts for customers  30,000  774 795
Interest rate lock commitments  3,835  33 1
Commodity contracts  2,074  134 130
Foreign exchange contracts  17,909  294 275
Derivative instruments related to equity linked CDs  34  2 2
Total free-standing derivatives - customer accommodation    1,237 1,203
Total derivatives not designated as qualifying hedging instruments    1,544 1,339
Total  $ 2,356 1,344

    Fair Value
  NotionalDerivativeDerivative
March 31, 2011 ($ in millions) AmountAssetsLiabilities
Qualifying hedging instruments     
Fair value hedges:     
Interest rate swaps related to long-term debt$ 4,355  376 -
Total fair value hedges    376 -
Cash flow hedges:     
Interest rate floors related to C&I loans  1,500  135 -
Interest rate swaps related to C&I loans  2,000  13 15
Interest rate caps related to long-term debt  1,500  4 -
Interest rate swaps related to long-term debt  302  - 8
Total cash flow hedges    152 23
Total derivatives designated as qualifying hedging instruments    528 23
Derivatives not designated as qualifying hedging instruments     
Free-standing derivatives - risk management and other business purposes     
Interest rate contracts related to MSRs  21,677  138 25
Forward contracts related to held for sale mortgage loans  2,529  3 10
Interest rate swaps related to long-term debt  457  3 7
Foreign exchange contracts for trading purposes  2,202  7 6
Put options associated with sale of the processing business  769  - 8
Stock warrants associated with sale of the processing business  175  76 -
Swap associated with the sale of Visa, Inc. Class B shares  363  - 28
Total free-standing derivatives - risk management and other business purposes    227 84
Free-standing derivatives - customer accommodation:     
Interest rate contracts for customers  28,748  629 656
Interest rate lock commitments  1,523  9 1
Commodity contracts  1,949  123 116
Foreign exchange contracts  17,928  308 301
Derivative instruments related to equity linked CDs  54  2 2
Total free-standing derivatives - customer accommodation    1,071 1,076
Total derivatives not designated as qualifying hedging instruments    1,298 1,160
Total  $ 1,826 1,183

Fair Value Hedges

The Bancorp may enter into interest rate swaps to convert its fixed-rate funding to floating-rate. Decisions to convert fixed-rate funding to floating are made primarily through consideration of the asset/liability mix of the Bancorp, the desired asset/liability sensitivity and interest rate levels. As of March 31, 2012, December 31, 2011 and March 31, 2011, certain interest rate swaps met the criteria required to qualify for the “shortcut” method of accounting. Based on this shortcut method of accounting treatment, no ineffectiveness is assumed. For interest rate swaps that do not meet the shortcut requirements, an assessment of hedge effectiveness using regression analysis was performed and such swaps were accounted for using the “long-haul” method. The long-haul method requires a quarterly assessment of hedge effectiveness and measurement of ineffectiveness. For interest rate swaps accounted for as a fair value hedge using the long-haul method, ineffectiveness is the difference between the changes in the fair value of the interest rate swap and changes in fair value of the related hedged item attributable to the risk being hedged. The ineffectiveness on interest rate swaps hedging fixed-rate funding is reported within interest expense in the Condensed Consolidated Statements of Income. The following table reflects the change in fair value of interest rate contracts, designated as fair value hedges, as well as the change in fair value of the related hedged items attributable to the risk being hedged, included in the Condensed Consolidated Statements of Income:

  Condensed Consolidated March 31,
For the three months ended ($ in millions)  Statements of Income Caption 20122011
Interest rate contracts:       
Change in fair value of interest rate swaps hedging long-term debt  Interest on long-term debt$ (100)  (66) 
Change in fair value of hedged long-term debt  Interest on long-term debt  92  65 
        

Cash Flow Hedges

The Bancorp may enter into interest rate swaps to convert floating-rate assets and liabilities to fixed rates or to hedge certain forecasted transactions. The assets or liabilities may be grouped in circumstances where they share the same risk exposure for which the Bancorp desired to hedge. The Bancorp may also enter into interest rate caps and floors to limit cash flow variability of floating rate assets and liabilities. As of March 31, 2012, all hedges designated as cash flow hedges are assessed for effectiveness using regression analysis. Ineffectiveness is generally measured as the amount by which the cumulative change in the fair value of the hedging instrument exceeds the present value of the cumulative change in the hedged item's expected cash flows attributable to the risk being hedged. Ineffectiveness is reported within other noninterest income in the Condensed Consolidated Statements of Income. The effective portion of the cumulative gains or losses on cash flow hedges are reported within accumulated other comprehensive income and are reclassified from accumulated other comprehensive income to current period earnings when the forecasted transaction affects earnings.

 

Reclassified gains and losses on interest rate contracts related to commercial and industrial loans are recorded within interest income while reclassified gains and losses on interest rate contracts related to debt are recorded within interest expense in the Condensed Consolidated Statements of Income. As of March 31, 2012, December 31, 2011 and March 31, 2011, $73 million, $80 million and $58 million, respectively, of deferred gains, net of tax, on cash flow hedges were recorded in accumulated other comprehensive income in the Condensed Consolidated Balance Sheets. As of March 31, 2012, $73 million in net deferred gains, net of tax, recorded in accumulated other comprehensive income are expected to be reclassified into earnings during the next twelve months. During the three months ended March 31, 2012 and March 31, 2011, there were no gains or losses reclassified into earnings associated with the discontinuance of cash flow hedges because it was probable that the original forecasted transaction would not occur.

 

The following table presents the net gains recorded in the Condensed Consolidated Statements of Income and accumulated other comprehensive income in the Condensed Consolidated Statements of Comprehensive Income relating to derivative instruments designated as cash flow hedges.

      
For the three months ended March 31: ($ in millions) 20122011
Amount of net gain recognized in OCI$ 9  - 
Amount of net gain reclassified from OCI into net income  20  15 
Amount of ineffectiveness recognized in other noninterest income  -  - 
      

Free-Standing Derivative Instruments – Risk Management and Other Business Purposes

As part of its overall risk management strategy relative to its mortgage banking activity, the Bancorp may enter into various free-standing derivatives (principal-only swaps, interest rate swaptions, interest rate floors, mortgage options, TBAs and interest rate swaps) to economically hedge changes in fair value of its largely fixed-rate MSR portfolio. Principal-only swaps hedge the mortgage-LIBOR spread because these swaps appreciate in value as a result of tightening spreads. Principal-only swaps also provide prepayment protection by increasing in value when prepayment speeds increase, as opposed to MSRs that lose value in a faster prepayment environment. Receive fixed/pay floating interest rate swaps and swaptions increase in value when interest rates do not increase as quickly as expected.

 

The Bancorp enters into forward contracts and mortgage options to economically hedge the change in fair value of certain residential mortgage loans held for sale due to changes in interest rates. Interest rate lock commitments issued on residential mortgage loan commitments that will be held for sale are also considered free-standing derivative instruments and the interest rate exposure on these commitments is economically hedged primarily with forward contracts. Revaluation gains and losses from free-standing derivatives related to mortgage banking activity are recorded as a component of mortgage banking net revenue in the Condensed Consolidated Statements of Income.

 

Additionally, the Bancorp may enter into free-standing derivative instruments (options, swaptions and interest rate swaps) in order to minimize significant fluctuations in earnings and cash flows caused by interest rate and prepayment volatility. The gains and losses on these derivative contracts are recorded within other noninterest income in the Condensed Consolidated Statements of Income.

 

In conjunction with the sale of the processing business in 2009, the Bancorp received warrants and issued put options, which are accounted for as free-standing derivatives. The put options expired as a result of the Vantiv, Inc. initial public offering in March of 2012. Refer to Note 18 for further discussion of significant inputs and assumptions used in the valuation of the warrants.

 

In conjunction with the sale of Visa, Inc. Class B shares in 2009, the Bancorp entered into a total return swap in which the Bancorp will make or receive payments based on subsequent changes in the conversion rate of the Class B shares into Class A shares. This total return swap is accounted for as a free-standing derivative. See Note 18 for further discussion of significant inputs and assumptions used in the valuation of this instrument.

 

The Bancorp entered into certain derivatives (forwards, futures and options) related to its foreign exchange business. These derivative contracts were not designated against specific assets or liabilities or to forecasted transactions. Therefore, these instruments did not qualify for hedge accounting. The Bancorp economically hedged the exposures related to these derivative contracts by entering into offsetting contracts with approved, reputable, independent counterparties with substantially similar terms. Revaluation gains and losses on these foreign currency derivative contracts were recorded within other noninterest income in the Condensed Consolidated Statements of Income. The net gains (losses) recorded in the Condensed Consolidated Statements of Income relating to free-standing derivative instruments used for risk management and other business purposes are summarized in the following table:

        
  Condensed Consolidated March 31,
For the three months ended ($ in millions)  Statements of Income Caption 20122011
Interest rate contracts:       
Forward contracts related to residential mortgage loans held for sale Mortgage banking net revenue$ 57  (83) 
Interest rate swaps and swaptions related to MSR portfolio Mortgage banking net revenue  4  (27) 
Interest rate swaps related to long-term debt Other noninterest income  1  2 
Foreign exchange contracts:       
Foreign exchange contracts for trading purposes Other noninterest income  -  (1) 
Equity contracts:       
Warrants associated with sale of the processing business Other noninterest income  45  (2) 
Put options associated with sale of the processing business Other noninterest income  1  - 
Swap associated with sale of Visa, Inc. Class B shares Other noninterest income  (19)  (9) 
        

Free-Standing Derivative Instruments – Customer Accommodation

The majority of the free-standing derivative instruments the Bancorp enters into are for the benefit of its commercial customers. These derivative contracts are not designated against specific assets or liabilities on the Bancorp's Condensed Consolidated Balance Sheets or to forecasted transactions and, therefore, do not qualify for hedge accounting. These instruments include foreign exchange derivative contracts entered into for the benefit of commercial customers involved in international trade to hedge their exposure to foreign currency fluctuations and commodity contracts to hedge such items as natural gas and various other derivative contracts. The Bancorp may economically hedge significant exposures related to these derivative contracts entered into for the benefit of customers by entering into offsetting contracts with approved, reputable, independent counterparties with substantially matching terms. The Bancorp hedges its interest rate exposure on commercial customer transactions by executing offsetting swap agreements with primary dealers. Revaluation gains and losses on interest rate, foreign exchange, commodity and other commercial customer derivative contracts are recorded as a component of corporate banking revenue in the Condensed Consolidated Statements of Income.

 

The Bancorp enters into risk participation agreements, under which the Bancorp assumes credit exposure relating to certain underlying interest rate derivative contracts. The Bancorp only enters into these risk participation agreements in instances in which the Bancorp has participated in the loan that the underlying interest rate derivative contract was designed to hedge. The Bancorp will make payments under these agreements if a customer defaults on its obligation to perform under the terms of the underlying interest rate derivative contract. As of March 31, 2012, December 31, 2011 and March 31, 2011, the total notional amount of the risk participation agreements was $824 million, $808 million and $834 million, respectively, and the fair value was a liability of $2 million at March 31, 2012 and December 31, 2011, and $1 million at March 31, 2011, which is included in interest rate contracts for customers. As of March 31, 2012, the risk participation agreements had an average life of 2.4 years.

 

The Bancorp's maximum exposure in the risk participation agreements is contingent on the fair value of the underlying interest rate derivative contracts in an asset position at the time of default. The Bancorp monitors the credit risk associated with the underlying customers in the risk participation agreements through the same risk grading system currently utilized for establishing loss reserves in its loan and lease portfolio. Risk ratings of the notional amount of risk participation agreements under this risk rating system are summarized in the following table:

 

        
  March 31,December 31,March 31,
As of ($ in millions) 201220112011 
Pass$ 781  772  756 
Special mention  14  14  21 
Substandard  29  18  56 
Doubtful  -  4  1 
Loss  -  -  - 
Total$ 824  808  834 

The net gains (losses) recorded in the Condensed Consolidated Statements of Income relating to free-standing derivative instruments used for customer accommodation are summarized in the following table:

 

  Condensed Consolidated  March 31,
For the three months ended ($ in millions)Statements of Income Caption 20122011
Interest rate contracts:      
Interest rate contracts for customers (contract revenue)Corporate banking revenue$ 6  7 
Interest rate contracts for customers (credit losses)Other noninterest expense  -  (2) 
Interest rate contracts for customers (credit portion of fair value adjustment)Other noninterest expense  3  7 
Interest rate lock commitmentsMortgage banking net revenue  50  24 
Commodity contracts:      
Commodity contracts for customers (contract revenue)Corporate banking revenue  2  1 
Foreign exchange contracts:      
Foreign exchange contracts - customers (contract revenue)Corporate banking revenue  15  16 
Foreign exchange contracts - customers (credit portion of fair value adjustment)Other noninterest expense  2  (5)