Note 12

Derivative Instruments

In the ordinary course of business, the Company enters into derivative transactions to manage various risks and to accommodate the business requirements of its customers. The Company recognizes all derivatives on the Consolidated Balance Sheet at fair value in other assets or in other liabilities. On the date the Company enters into a derivative contract, the derivative is designated as either a fair value hedge, cash flow hedge, net investment hedge, or a designation is not made as it is a customer-related transaction, an economic hedge for asset/liability risk management purposes or another stand-alone derivative created through the Company’s operations (“free-standing derivative”). When a derivative is designated as a fair value, cash flow or net investment hedge, the Company performs an assessment, at inception and, at a minimum, quarterly thereafter, to determine the effectiveness of the derivative in offsetting changes in the value or cash flows of the hedged item(s).

Fair Value Hedges These derivatives are interest rate swaps the Company uses to hedge the change in fair value related to interest rate changes of its underlying fixed-rate debt. Changes in the fair value of derivatives designated as fair value hedges, and changes in the fair value of the hedged items, are recorded in earnings. All fair value hedges were highly effective for the three and nine months ended September 30, 2016, and the change in fair value attributed to hedge ineffectiveness was not material.

Cash Flow Hedges These derivatives are interest rate swaps the Company uses to hedge the forecasted cash flows from its underlying variable-rate debt. Changes in the fair value of derivatives designated as cash flow hedges are recorded in other comprehensive income (loss) until the cash flows of the hedged items are realized. If a derivative designated as a cash flow hedge is terminated or ceases to be highly effective, the gain or loss in other comprehensive income (loss) is amortized to earnings over the period the forecasted hedged transactions impact earnings. If a hedged forecasted transaction is no longer probable, hedge accounting is ceased and any gain or loss included in other comprehensive income (loss) is reported in earnings immediately, unless the forecasted transaction is at least reasonably possible of occurring, whereby the amounts remain within other comprehensive income (loss). At September 30, 2016, the Company had $96 million (net-of-tax) of realized and unrealized losses on derivatives classified as cash flow hedges recorded in other comprehensive income (loss), compared with $67 million (net-of-tax) of realized and unrealized losses at December 31, 2015. The estimated amount to be reclassified from other comprehensive income (loss) into earnings during the remainder of 2016 and the next 12 months are losses of $12 million (net-of-tax) and $34 million (net-of-tax), respectively. This amount includes gains and losses related to hedges that were terminated early for which the forecasted transactions are still probable. All cash flow hedges were highly effective for the three and nine months ended September 30, 2016, and the change in fair value attributed to hedge ineffectiveness was not material.

Net Investment Hedges The Company uses forward commitments to sell specified amounts of certain foreign currencies, and occasionally non-derivative debt instruments, to hedge the volatility of its investment in foreign businesses driven by fluctuations in foreign currency exchange rates. The ineffectiveness on all net investment hedges was not material for the three and nine months ended September 30, 2016. There were no non-derivative debt instruments designated as net investment hedges at September 30, 2016 or December 31, 2015.

Other Derivative Positions The Company enters into free-standing derivatives to mitigate interest rate risk and for other risk management purposes. These derivatives include forward commitments to sell to-be-announced securities (“TBAs”) and other commitments to sell residential mortgage loans, which are used to economically hedge the interest rate risk related to residential mortgage loans held for sale (“MLHFS”) and unfunded mortgage loan commitments. The Company also enters into interest rate swaps, forward commitments to buy TBAs, U.S. Treasury and Eurodollar futures and options on U.S. Treasury futures to economically hedge the change in the fair value of the Company’s MSRs. The Company also enters into foreign currency forwards to economically hedge remeasurement gains and losses the Company recognizes on foreign currency denominated assets and liabilities. In addition, the Company acts as a seller and buyer of interest rate derivatives and foreign exchange contracts for its customers. The Company mitigates the market and liquidity risk associated with these customer derivatives by entering into similar offsetting positions with broker-dealers, or on a portfolio basis by entering into other derivative or non-derivative financial instruments that partially or fully offset the exposure from these customer-related positions. The Company’s customer derivatives and related hedges are monitored and reviewed by the Company’s Market Risk Committee, which establishes policies for market risk management, including exposure limits for each portfolio. The Company also has derivative contracts that are created through its operations, including commitments to originate MLHFS and swap agreements related to the sale of a portion of its Class B common shares of Visa Inc. Refer to Note 14 for further information on these swap agreements.

For additional information on the Company’s purpose for entering into derivative transactions and its overall risk management strategies, refer to “Management Discussion and Analysis — Use of Derivatives to Manage Interest Rate and Other Risks”, which is incorporated by reference into these Notes to Consolidated Financial Statements.

The following table summarizes the asset and liability management derivative positions of the Company:


	Asset Derivatives						Liability Derivatives
(Dollars in Millions)	Notional Value		Fair Value		Weighted- Average Remaining Maturity In Years		Notional Value		Fair Value		Weighted- Average Remaining Maturity In Years
September 30, 2016
Fair value hedges
Interest rate contracts
Receive fixed/pay floating swaps	$	3,800	$	133		3.89	$	–	$	–		–
Cash flow hedges
Interest rate contracts
Pay fixed/receive floating swaps		500		–		1.33		6,625		176		4.78
Net investment hedges
Foreign exchange forward contracts		1,222		8		.05		152		–		.05
Other economic hedges
Interest rate contracts
Futures and forwards
Buy		6,723		52		.07		156		1		.12
Sell		1,071		12		.15		8,048		43		.09
Options
Purchased		2,200		–		.06		–		–		–
Written		3,277		67		.10		20		1		.09
Receive fixed/pay floating swaps		6,952		355		9.59		2,475		10		10.22
Pay fixed/receive floating swaps		47		–		7.95		4,333		341		9.22
Foreign exchange forward contracts		372		4		.04		3,426		25		.01
Equity contracts		64		1		.72		35		–		.26
Credit contracts		1,413		1		3.05		3,302		3		3.06
Other (a)		285		2		.01		997		100		2.68
Total	$	27,926	$	635			$	29,569	$	700
December 31, 2015
Fair value hedges
Interest rate contracts
Receive fixed/pay floating swaps	$	3,050	$	73		4.43	$	–	$	–		–
Cash flow hedges
Interest rate contracts
Pay fixed/receive floating swaps		1,772		7		9.22		5,009		146		1.13
Net investment hedges
Foreign exchange forward contracts		1,140		4		.04		–		–		–
Other economic hedges
Interest rate contracts
Futures and forwards
Buy		3,812		17		.07		452		1		.06
Sell		3,201		12		.09		2,559		7		.12
Options
Purchased		2,935		–		.06		–		–		–
Written		3,199		29		.10		5		1		.08
Receive fixed/pay floating swaps		3,733		42		9.98		4,748		18		10.18
Pay fixed/receive floating swaps		287		2		9.82		4,158		35		9.97
Foreign exchange forward contracts		3,023		13		.01		2,380		10		.03
Equity contracts		62		–		.47		24		1		.82
Credit contracts		1,192		2		2.58		2,821		3		2.99
Other (a)		36		–		.04		662		64		2.60
Total	$	27,442	$	201			$	22,818	$	286

(a)

Includes short-term underwriting purchase and sale commitments with total asset and liability notional values of $285 million and $36 million at September 30, 2016 and December 31, 2015, respectively, and derivative liability swap agreements related to the sale of a portion of the Company’s Class B common shares of Visa Inc. The Visa swap agreements had a total notional value, fair value and weighted average remaining maturity of $712 million, $98 million and 3.75 years at September 30, 2016, respectively, compared to $626 million, $64 million and 2.75 years at December 31, 2015, respectively.

The following table summarizes the customer-related derivative positions of the Company:


	Asset Derivatives						Liability Derivatives
(Dollars in Millions)	Notional Value		Fair Value		Weighted- Average Remaining Maturity In Years		Notional Value		Fair Value		Weighted- Average Remaining Maturity In Years
September 30, 2016
Interest rate contracts
Receive fixed/pay floating swaps	$	56,962	$	2,249		5.04	$	14,464	$	29		3.17
Pay fixed/receive floating swaps		11,835		29		2.81		59,866		2,385		5.01
Options
Purchased		10,127		7		2.11		356		26		.89
Written		449		27		5.47		8,987		3		1.67
Futures
Buy		3,540		1		1.41		4,701		–		.82
Foreign exchange rate contracts
Forwards, spots and swaps		24,249		690		.52		18,252		663		.65
Options
Purchased		1,771		47		1.23		–		–		–
Written		–		–		–		1,771		47		1.23
Total	$	108,933	$	3,050			$	108,397	$	3,153
December 31, 2015
Interest rate contracts
Receive fixed/pay floating swaps	$	32,647	$	1,097		5.69	$	14,068	$	54		4.71
Pay fixed/receive floating swaps		10,685		43		4.55		35,045		1,160		5.74
Options
Purchased		8,705		10		2.61		146		1		2.23
Written		146		2		2.23		8,482		9		2.57
Futures
Buy		–		–		–		2,859		2		.84
Sell		45		–		.97		–		–		–
Foreign exchange rate contracts
Forwards, spots and swaps		18,399		851		.59		17,959		830		.58
Options
Purchased		1,485		43		1.19		–		–		–
Written		–		–		–		1,485		43		1.19
Total	$	72,112	$	2,046			$	80,044	$	2,099

The table below shows the effective portion of the gains (losses) recognized in other comprehensive income (loss) and the gains (losses) reclassified from other comprehensive income (loss) into earnings (net-of-tax):


	Three Months Ended September 30,											Nine Months Ended September 30,
	Gains (Losses) Recognized in Other Comprehensive Income (Loss)					Gains (Losses) Reclassified from Other Comprehensive Income (Loss) into Earnings						Gains (Losses) Recognized in Other Comprehensive Income (Loss)						Gains (Losses) Reclassified from Other Comprehensive Income (Loss) into Earnings
(Dollars in Millions)	2016		2015			2016			2015			2016			2015			2016			2015
Asset and Liability Management Positions
Cash flow hedges
Interest rate contracts (a)	$	20	$	(24	)	$	(17	)	$	(30	)	$	(93	)	$	(38	)	$	(64	)	$	(91	)
Net investment hedges
Foreign exchange forward contracts		–		(1	)		–			–			(15	)		79			–			–

Note:

Ineffectiveness on cash flow and net investment hedges was not material for the three and nine months ended September 30, 2016 and 2015.

(a)

Gains (Losses) reclassified from other comprehensive income (loss) into interest expense.

The table below shows the gains (losses) recognized in earnings for fair value hedges, other economic hedges and the customer-related positions:


(Dollars in Millions)	Location of Gains (Losses) Recognized in Earnings		Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in Millions)	Location of Gains (Losses) Recognized in Earnings		2016			2015			2016			2015
Asset and Liability Management Positions
Fair value hedges (a)
Interest rate contracts		Other noninterest income	$	(31	)	$	52		$	63		$	44
Other economic hedges
Interest rate contracts
Futures and forwards		Mortgage banking revenue		21			(55	)		(34	)		133
Purchased and written options		Mortgage banking revenue		102			99			315			181
Receive fixed/pay floating swaps		Mortgage banking revenue		(134	)		173			268			152
Pay fixed/receive floating swaps		Mortgage banking revenue		113			(4	)		111			(3	)
Foreign exchange forward contracts		Commercial products revenue		9			17			(46	)		103
Equity contracts		Compensation expense		1			(1	)		–			(2	)
Credit contracts		Other noninterest income		1			–			–			1
Other		Other noninterest income		–			–			(38	)		–
Customer-Related Positions
Interest rate contracts
Receive fixed/pay floating swaps		Other noninterest income		(397	)		540			1,326			640
Pay fixed/receive floating swaps		Other noninterest income		417			(534	)		(1,289	)		(615	)
Purchased and written options		Other noninterest income		(4	)		1			(3	)		2
Futures		Other noninterest income		(4	)		2			3			3
Foreign exchange rate contracts
Forwards, spots and swaps		Commercial products revenue		21			19			61			56
Purchased and written options		Commercial products revenue		1			–			3			1

(a)

Gains (Losses) on items hedged by interest rate contracts included in noninterest income (expense), were $31 million and $(50) million for the three months ended September 30, 2016 and 2015, respectively, and $(61) million and $(43) million for the nine months ended September 30, 2016 and 2015, respectively. The ineffective portion was immaterial for the three and nine months ended September 30, 2016 and 2015.

Derivatives are subject to credit risk associated with counterparties to the derivative contracts. The Company measures that credit risk using a credit valuation adjustment and includes it within the fair value of the derivative. The Company manages counterparty credit risk through diversification of its derivative positions among various counterparties, by entering into master netting arrangements and, where possible, by requiring collateral arrangements. A master netting arrangement allows two counterparties, who have multiple derivative contracts with each other, the ability to net settle amounts under all contracts, including any related collateral, through a single payment and in a single currency. Collateral arrangements require the counterparty to deliver collateral (typically cash or U.S. Treasury and agency securities) equal to the Company’s net derivative receivable, subject to minimum transfer and credit rating requirements.

The Company’s collateral arrangements are predominately bilateral and, therefore, contain provisions that require collateralization of the Company’s net liability derivative positions. Required collateral coverage is based on certain net liability thresholds and contingent upon the Company’s credit rating from two of the nationally recognized statistical rating organizations. If the Company’s credit rating were to fall below credit ratings thresholds established in the collateral arrangements, the counterparties to the derivatives could request immediate additional collateral coverage up to and including full collateral coverage for derivatives in a net liability position. The aggregate fair value of all derivatives under collateral arrangements that were in a net liability position at September 30, 2016, was $1.6 billion. At September 30, 2016, the Company had $1.5 billion of cash posted as collateral against this net liability position.