Commitments, Contingent Liabilities and Guarantees

9 Months Ended

Sep. 30, 2017

Commitments, Contingent Liabilities and Guarantees

Commitments, Contingent Liabilities and Guarantees

18. Commitments, Contingent Liabilities and Guarantees

The Bancorp, in the normal course of business, enters into financial instruments and various agreements to meet the financing needs of its customers. The Bancorp also enters into certain transactions and agreements to manage its interest rate and prepayment risks, provide funding, equipment and locations for its operations and invest in its communities. These instruments and agreements involve, to varying degrees, elements of credit risk, counterparty risk and market risk in excess of the amounts recognized in the Condensed Consolidated Balance Sheets. The creditworthiness of counterparties for all instruments and agreements is evaluated on a case-by-case basis in accordance with the Bancorp’s credit policies. The Bancorp’s significant commitments, contingent liabilities and guarantees in excess of the amounts recognized in the Condensed Consolidated Balance Sheets are discussed in the following sections.

Commitments
The Bancorp has certain commitments to make future payments under contracts. The following table reflects a summary of significant commitments as of:
		September 30,	December 31,
($ in millions)		2017	2016
Commitments to extend credit	$	66,606	67,909
Letters of credit		2,401	2,583
Forward contracts related to residential mortgage loans held for sale		2,297	1,823
Noncancelable operating lease obligations		580	576
Purchase obligations		103	57
Capital commitments for private equity investments		52	59
Capital expenditures		35	29
Capital lease obligations		15	19

Commitments to extend credit

Commitments to extend credit are agreements to lend, typically having fixed expiration dates or other termination clauses that may require payment of a fee. Since many of the commitments to extend credit may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements. The Bancorp is exposed to credit risk in the event of nonperformance by the counterparty for the amount of the contract. Fixed-rate commitments are also subject to market risk resulting from fluctuations in interest rates and the Bancorp’s exposure is limited to the replacement value of those commitments. As of September 30, 2017 and December 31, 2016, the Bancorp had a reserve for unfunded commitments, including letters of credit, totaling $157 million and $161 million, respectively, included in other liabilities in the Condensed Consolidated Balance Sheets. The Bancorp monitors the credit risk associated with commitments to extend credit using the same risk rating system utilized within its loan and lease portfolio.

Risk ratings under this risk rating system are summarized in the following table as of:
		September 30,	December 31,
($ in millions)		2017	2016
Pass	$	65,638	66,802
Special mention		331	338
Substandard		637	753
Doubtful		-	16
Total commitments to extend credit	$	66,606	67,909

Letters of credit

Standby and commercial letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party and expire as summarized in the following table as of September 30, 2017:
($ in millions)
Less than 1 year(a)	$	1,198
1 - 5 years(a)		1,155
Over 5 years		48
Total letters of credit	$	2,401

(a) Includes $12 and $2 issued on behalf of commercial customers to facilitate trade payments in U.S. dollars and foreign currencies which expire less than 1 year and between 1 - 5 years, respectively.

Standby letters of credit accounted for 99% of total letters of credit at both September 30, 2017 and December 31, 2016, and are considered guarantees in accordance with U.S. GAAP. Approximately 62% of the total standby letters of credit were collateralized as of both September 30, 2017 and December 31, 2016. In the event of nonperformance by the customers, the Bancorp has rights to the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities. The reserve related to these standby letters of credit, which was included in the total reserve for unfunded commitments, was $6 million and$3 million at September 30, 2017 and December 31, 2016, respectively. The Bancorp monitors the credit risk associated with letters of credit using the same risk rating system utilized within its loan and lease portfolio.

Risk ratings under this risk rating system are summarized in the following table as of:
		September 30,	December 31,
($ in millions)		2017	2016
Pass	$	2,044	2,134
Special mention		89	98
Substandard		162	290
Doubtful		106	61
Total letters of credit	$	2,401	2,583

At September 30, 2017 and December 31, 2016, the Bancorp had outstanding letters of credit that were supporting certain securities issued as VRDNs. The Bancorp facilitates financing for its commercial customers, which consist of companies and municipalities, by marketing the VRDNs to investors. The VRDNs pay interest to holders at a rate of interest that fluctuates based upon market demand. The VRDNs generally have long-term maturity dates, but can be tendered by the holder for purchase at par value upon proper advance notice. When the VRDNs are tendered, a remarketing agent generally finds another investor to purchase the VRDNs to keep the securities outstanding in the market. As of September 30, 2017 and December 31, 2016, total VRDNs in which the Bancorp was the remarketing agent or were supported by a Bancorp letter of credit were $718 million and $929 million, respectively, of which FTS acted as the remarketing agent to issuers on $615 million and $784 million, respectively. As remarketing agent, FTS is responsible for finding purchasers for VRDNs that are put by investors. The Bancorp issued letters of credit, as a credit enhancement, to $436 million and $609 million of the VRDNs remarketed by FTS, in addition to $103 million and $145million in VRDNs remarketed by third parties at September 30, 2017 and December 31, 2016, respectively. These letters of credit are included in the total letters of credit balance provided in the previous table. The Bancorp held $9 million and $6 million of these VRDNs in its portfolio and classified them as trading securities at September 30, 2017 and December 31, 2016, respectively.

Forward contracts related to residential mortgage loans held for sale

The Bancorp enters into forward contracts to economically hedge the change in fair value of certain residential mortgage loans held for sale due to changes in interest rates. The outstanding notional amounts of these forward contracts are included in the summary of significant commitments table for all periods presented.

Noncancelable operating lease obligations and other commitments

The Bancorp’s subsidiaries have entered into a number of noncancelable lease agreements. The minimum rental commitments under noncancelable lease agreements are shown in the summary of significant commitments table. The Bancorp has also entered into a limited number of agreements for work related to banking center construction and to purchase goods or services.

Contingent Liabilities

Legal claims

There are legal claims pending against the Bancorp and its subsidiaries that have arisen in the normal course of business. Refer to Note 18 for additional information regarding these proceedings.

Guarantees

The Bancorp has performance obligations upon the occurrence of certain events under financial guarantees provided in certain contractual arrangements as discussed in the following sections.

Residential mortgage loans sold with representation and warranty provisions

Conforming residential mortgage loans sold to unrelated third parties are generally sold with representation and warranty provisions. A contractual liability arises only in the event of a breach of these representations and warranties and, in general, only when a loss results from the breach. The Bancorp may be required to repurchase any previously sold loan, indemnify or make whole the investor or insurer for which the representation or warranty of the Bancorp proves to be inaccurate, incomplete or misleading. For more information on how the Bancorp establishes the residential mortgage repurchase reserve, refer to Note 1 of the Notes to Consolidated Financial Statements included in the Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2016.

As of September 30, 2017 and December 31, 2016, the Bancorp maintained reserves related to loans sold with representation and warranty provisions totaling $10 million and $13 million, respectively, included in other liabilities in the Condensed Consolidated Balance Sheets.

The Bancorp uses the best information available when estimating its mortgage representation and warranty reserve; however, the estimation process is inherently uncertain and imprecise and, accordingly, losses in excess of the amounts reserved as of September 30, 2017 are reasonably possible. The Bancorp currently estimates that it is reasonably possible that it could incur losses related to mortgage representation and warranty provisions in an amount up to approximately $11 million in excess of amounts reserved. This estimate was derived by modifying the key assumptions to reflect management's judgment regarding reasonably possible adverse changes to those assumptions. The actual repurchase losses could vary significantly from the recorded mortgage representation and warranty reserve or this estimate of reasonably possible losses, depending on the outcome of various factors, including those previously discussed.

For both the three months ended September 30, 2017 and 2016, the Bancorp paid an immaterial amount in the form of make whole payments andrepurchased $4million in outstanding principal of loans to satisfy investor demands. For both the nine months ended September 30, 2017 and 2016, the Bancorp paid an immaterial amount in the form of make whole payments and repurchased $9 million and $10 million, respectively, in outstanding principal of loans to satisfy investor demands. Total repurchase demand requests during the three months ended September 30, 2017 and 2016 were $4 million and $8 million, respectively. Total repurchase demand requests during the nine months ended September 30, 2017 and 2016were $12 million and $18 million, respectively. Total outstanding repurchase demand inventory was$1million and $2million at September 30, 2017 and December 31, 2016, respectively.

The following table summarizes activity in the reserve for representation and warranty provisions:
		For the three months ended		For the nine months ended
		September 30,		September 30,
($ in millions)		2017	2016	2017	2016
Balance, beginning of period	$	11	21	13	25
Net reductions to the reserve		(1)	(3)	(3)	(7)
Losses charged against the reserve		-	-	-	-
Balance, end of period	$	10	18	10	18

The following tables provide a rollforward of unresolved claims by claimant type for the nine months ended:
	GSE			Private Label
September 30, 2017 ($ in millions)	Units		Dollars	Units		Dollars
Balance, beginning of period	13	$	2	-	$	-
New demands	86		12	-		-
Loan paydowns/payoffs	(2)		-	-		-
Resolved demands	(90)		(13)	-		-
Balance, end of period	7	$	1	-	$	-

	GSE			Private Label
September 30, 2016 ($ in millions)	Units		Dollars	Units		Dollars
Balance, beginning of period	16	$	4	2	$	-
New demands	253		18	4		-
Loan paydowns/payoffs	(8)		(1)	-		-
Resolved demands	(203)		(14)	(6)		-
Balance, end of period	58	$	7	-	$	-

Residential mortgage loans sold with credit recourse

The Bancorp sold certain residential mortgage loans in the secondary market with credit recourse. In the event of any customer default, pursuant to the credit recourse provided, the Bancorp is required to reimburse the third party. The maximum amount of credit risk in the event of nonperformance by the underlying borrowers is equivalent to the total outstanding balance. In the event of nonperformance, the Bancorp has rights to the underlying collateral value securing the loan. The outstanding balances on these loans sold with credit recourse were $327 million and $374 million at September 30, 2017 and December 31, 2016, respectively, and the delinquency rates were 3.0% and3.2% at September 30, 2017 and December 31, 2016, respectively. The Bancorp maintained an estimated credit loss reserve on these loans sold with credit recourse of $5 million and $7 million at September 30, 2017 and December 31, 2016, respectively, recorded in other liabilities in the Condensed Consolidated Balance Sheets. To determine the credit loss reserve, the Bancorp used an approach that is consistent with its overall approach in estimating credit losses for various categories of residential mortgage loans held in its loan portfolio.

Margin accounts

FTS, an indirect wholly-owned subsidiary of the Bancorp, guarantees the collection of all margin account balances held by its brokerage clearing agent for the benefit of its customers. FTS is responsible for payment to its brokerage clearing agent for any loss, liability, damage, cost or expense incurred as a result of customers failing to comply with margin or margin maintenance calls on all margin accounts. The margin account balances held by the brokerage clearing agent were$15million at bothSeptember 30, 2017 and December 31, 2016. In the event of any customer default, FTS has rights to the underlying collateral provided. Given the existence of the underlying collateral provided and negligible historical credit losses, the Bancorp does not maintain a loss reserve related to the margin accounts.

Long-term borrowing obligations

The Bancorp had certain fully and unconditionally guaranteed long-term borrowing obligations issued by wholly-owned issuing trust entities of $62 million at both September 30, 2017 and December 31, 2016.

Visa litigation

The Bancorp, as a member bank of Visa prior to Visa’s reorganization and IPO (the “IPO”) of its Class A common shares (the “Class A Shares”) in 2008, had certain indemnification obligations pursuant to Visa’s certificate of incorporation and by-laws and in accordance with their membership agreements. In accordance with Visa’s by-laws prior to the IPO, the Bancorp could have been required to indemnify Visa for the Bancorp’s proportional share of losses based on the pre-IPO membership interests. As part of its reorganization and IPO, the Bancorp’s indemnification obligation was modified to include only certain known or anticipated litigation (the “Covered Litigation”) as of the date of the restructuring. This modification triggered a requirement for the Bancorp to recognize a liability equal to the fair value of the indemnification liability.

In conjunction with the IPO, the Bancorp received 10.1 million of Visa’s Class B common shares (the “Class B Shares”) based on the Bancorp’s membership percentage in Visa prior to the IPO. The Class B Shares are not transferable (other than to another member bank) until the later of the third anniversary of the IPO closing or the date which the Covered Litigation has been resolved; therefore, the Bancorp’s Class B Shares were classified in other assets and accounted for at their carryover basis of $0. Visa deposited $3 billion of the proceeds from the IPO into a litigation escrow account, established for the purpose of funding judgments in, or settlements of, the Covered Litigation. Since then, when Visa’s litigation committee determined that the escrow account was insufficient; Visa issued additional Class A Shares and deposited the proceeds from the sale of the Class A Shares into the litigation escrow account. When Visa funded the litigation escrow account, the Class B Shares were subjected to dilution through an adjustment in the conversion rate of Class B Shares into Class A Shares.

In 2009, the Bancorp completed the sale of Visa, Inc. Class B Shares and 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. The swap terminates on the later of the third anniversary of Visa’s IPO or the date on which the Covered Litigation is settled. Refer to Note 23 for additional information on the valuation of the swap. The counterparty to the swap as a result of its ownership of the Class B Shares will be impacted by dilutive adjustments to the conversion rate of the Class B Shares into Class A Shares caused by any Covered Litigation losses in excess of the litigation escrow account. If actual judgments in, or settlements of, the Covered Litigation significantly exceed current expectations, then additional funding by Visa of the litigation escrow account and the resulting dilution of the Class B Shares could result in a scenario where the Bancorp’s ultimate exposure associated with the Covered Litigation (the “Visa Litigation Exposure”) exceeds the value of the Class B Shares owned by the swap counterparty (the “Class B Value”). In the event the Bancorp concludes that it is probable that the Visa Litigation Exposure exceeds the Class B Value, the Bancorp would record a litigation reserve liability and a corresponding amount of other noninterest expense for the amount of the excess. Any such litigation reserve liability would be separate and distinct from the fair value derivative liability associated with the total return swap.

As of the date of the Bancorp’s sale of the Visa Class B Shares and through September 30, 2017, the Bancorp has concluded that it is not probable that the Visa Litigation Exposure will exceed the Class B value. Based on this determination, upon the sale of Class B Shares, the Bancorp reversed its net Visa litigation reserve liability and recognized a free-standing derivative liability associated with the total return swap. The fair value of the swap liability was $136million at September 30, 2017 and $91 million at December 31, 2016. Refer to Note 13 and Note 23 for further information.

After the Bancorp’s sale of the Class B Shares, Visa has funded additional amounts into the litigation escrow account which have resulted in further dilutive adjustments to the conversion of Class B Shares into Class A Shares, and along with other terms of the total return swap, required the Bancorp to make cash payments in varying amounts to the swap counterparty as follows:

		Visa	Bancorp Cash
Period ($ in millions)		Funding Amount	Payment Amount
Q2 2010	$	500	20
Q4 2010		800	35
Q2 2011		400	19
Q1 2012		1,565	75
Q3 2012		150	6
Q3 2014		450	18	i