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. There were no fair value hedges at June 30, 2018.

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 June 30, 2018, the Company had $176 million (net-of-tax) of realized and unrealized gains on derivatives classified as cash flow hedges recorded in other comprehensive income (loss), compared with $71 million (net-of-tax) of realized and unrealized gains at December 31, 2017. The estimated amount to be reclassified from other comprehensive income (loss) into earnings during the remainder of 2018 and the next 12 months are gains of $35 million (net-of-tax) and $69 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 six months ended June 30, 2018.

Net Investment Hedges The Company uses forward commitments to sell specified amounts of certain foreign currencies, and non-derivative debt instruments, to hedge the volatility of its net investment in foreign operations driven by fluctuations in foreign currency exchange rates. The carrying amount of non-derivative debt instruments designated as net investment hedges was $1.2 billion at June 30, 2018 and December 31, 2017.

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, swaptions, 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 certain unfunded mortgage loan commitments 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
June 30, 2018
Cash flow hedges
Interest rate contracts
Pay fixed/receive floating swaps	$	8,872	$	14		3.28	$	1,720	$	–		2.35
Net investment hedges
Foreign exchange forward contracts		298		4		.05		–		–		–
Other economic hedges
Interest rate contracts
Futures and forwards
Buy		2,363		12		.09		602		2		.10
Sell		13,904		9		1.10		5,718		23		.03
Options
Purchased		6,255		85		8.18		–		–		–
Written		1,060		25		.09		8		–		.12
Receive fixed/pay floating swaps		2,822		–		12.76		4,911		–		9.07
Pay fixed/receive floating swaps		4,530		–		7.37		430		–		11.30
Foreign exchange forward contracts		579		8		.05		141		1		.05
Equity contracts		–		–		—		143		4		.84
Credit contracts		1,820		–		2.83		4,265		1		3.46
Other (a)		147		1		.01		1,420		120		1.80
Total	$	42,650	$	158			$	19,358	$	151
December 31, 2017
Fair value hedges
Interest rate contracts
Receive fixed/pay floating swaps	$	1,000	$	28		6.70	$	3,600	$	16		1.55
Cash flow hedges
Interest rate contracts
Pay fixed/receive floating swaps		3,772		5		6.73		–		–		–
Net investment hedges
Foreign exchange forward contracts		–		–		—		373		8		.05
Other economic hedges
Interest rate contracts
Futures and forwards
Buy		1,632		7		.10		1,326		2		.04
Sell		15,291		10		.89		4,511		10		.03
Options
Purchased		4,985		65		7.57		–		–		–
Written		1,285		21		.10		5		–		.05
Receive fixed/pay floating swaps		2,019		5		16.49		5,469		–		8.43
Pay fixed/receive floating swaps		4,844		21		7.69		46		1		6.70
Foreign exchange forward contracts		147		1		.02		669		8		.04
Equity contracts		45		–		1.10		88		1		.58
Credit contracts		1,559		–		3.41		3,779		1		3.16
Other (a)		–		–		–		1,164		125		2.50
Total	$	36,579	$	163			$	21,030	$	172

(a)

Includes 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 $1.3 billion, $119 million and 2.01 years at June 30, 2018, respectively, compared to $1.2 billion, $125 million and 2.50 years at December 31, 2017, respectively. In addition, includes short-term underwriting purchase and sale commitments with total asset and liability notional values of $147 million at June 30, 2018.

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
June 30, 2018
Interest rate contracts
Receive fixed/pay floating swaps	$	24,816	$	470		5.93	$	76,059	$	733		4.55
Pay fixed/receive floating swaps		72,131		464		4.50		24,623		353		6.11
Options
Purchased		37,827		65		1.63		1,360		9		3.03
Written		1,360		11		3.03		34,942		61		1.47
Futures
Buy		40		–		1.72		–		–		–
Sell		7,588		10		.98		800		–		.22
Foreign exchange rate contracts
Forwards, spots and swaps		24,755		621		.88		24,056		601		.91
Options
Purchased		5,132		85		.76		–		–		–
Written		–		–		–		5,132		85		.76
Total	$	173,649	$	1,726			$	166,972	$	1,842
December 31, 2017
Interest rate contracts
Receive fixed/pay floating swaps	$	28,681	$	679		5.71	$	59,990	$	840		4.27
Pay fixed/receive floating swaps		63,038		860		4.20		25,093		602		5.76
Options
Purchased		29,091		22		1.61		880		14		4.24
Written		880		15		4.24		27,056		20		1.50
Futures
Sell		7,007		4		1.21		–		–		–
Foreign exchange rate contracts
Forwards, spots and swaps		24,099		656		.81		23,440		636		.83
Options
Purchased		4,026		83		1.20		–		–		–
Written		–		–		–		4,026		83		1.20
Total	$	156,822	$	2,319			$	140,485	$	2,195

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 June 30										Six Months Ended June 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)	2018		2017			2018		2017			2018		2017			2018			2017
Asset and Liability Management Positions
Cash flow hedges
Interest rate contracts	$	25	$	(23	)	$	1	$	(6	)	$	89	$	(19	)	$	(1	)	$	(15	)
Net investment hedges
Foreign exchange forward contracts		12		(41	)		–		–			28		(48	)		–			–
Non-derivative debt instruments		50		(11	)		–		–			16		(11	)		–			–

Note:

The Company does not exclude components from effectiveness testing for cash flow and net investment hedges.

The table below shows the effect of fair value and cash flow hedge accounting on the Consolidated Statement of Income:


	Three Months Ended June 30										Six Months Ended June 30
	Other Noninterest Income					Interest Expense					Other Noninterest Income					Interest Expense
(Dollars in Millions)	2018		2017			2018			2017		2018		2017			2018			2017
Total amount of income and expense line items presented in the Consolidated Statement of Income in which the effects of fair value or cash flow hedges are recorded	$	207	$	195		$	751		$	470	$	374	$	375		$	1,374		$	883

Asset and Liability Management Positions
Fair value hedges
Interest rate contract derivatives		–		14			48			–		–		4			5			–
Hedged items		–		(14	)		(48	)		–		–		(4	)		(5	)		–
Cash Flow hedges
Interest rate contract derivatives		–		–			(2	)		10		–		–			1			24

Note:

The Company does not exclude components from effectiveness testing for fair value and cash flow hedges. The Company did not reclassify gains or losses into earnings as a result of the discontinuance of cash flow hedges during the three and six months ended June 30, 2018 and 2017.

The table below shows cumulative hedging adjustments and the carrying amount of assets (liabilities) designated in fair value hedges:


	Carrying Amount of the Hedged Assets (Liabilities)				Cumulative Hedging Adjustment (a)
(Dollars in Millions)	June 30, 2018		December 31, 2017		June 30, 2018			December 31, 2017
Line Item in the Consolidated Balance Sheet
Long-term Debt	$	–	$	4,584	$	(45	)	$	(8	)

(a)

The cumulative hedging adjustment at June 30, 2018 relates to discontinued hedging relationships. The Company did not have any hedging adjustments for discontinued fair value hedges at December 31, 2017.

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


		Three Months Ended June 30						Six Months Ended June 30
(Dollars in Millions)	Location of Gains (Losses) Recognized in Earnings	2018			2017			2018			2017
Asset and Liability Management Positions
Other economic hedges
Interest rate contracts
Futures and forwards	Mortgage banking revenue	$	15		$	(1	)		73		$	5
Purchased and written options	Mortgage banking revenue		56			77			98			117
Receive fixed/pay floating swaps	Mortgage banking revenue		(61	)		117			(140	)		148
Pay fixed/receive floating swaps	Mortgage banking revenue		15			(71	)		(16	)		(111	)
Foreign exchange forward contracts	Other noninterest income		15			(30	)		27			(37	)
Equity contracts	Compensation expense		–			(1	)		(1	)		–
Credit contracts	Other noninterest income		2			–			2			1
Other	Other noninterest income		1			(1	)		1			(1	)
Customer-Related Positions
Interest rate contracts
Receive fixed/pay floating swaps	Commercial products revenue		(351	)		(323	)		(1,515	)		(573	)
Pay fixed/receive floating swaps	Commercial products revenue		365			333			1,532			602
Purchased and written options	Commercial products revenue		2			(2	)		2			(8	)
Futures	Commercial products revenue		3			–			11			(2	)
Foreign exchange rate contracts
Forwards, spots and swaps	Commercial products revenue		22			24			45			46
Purchased and written options	Commercial products revenue		–			–			–			1

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 derivative positions that are centrally cleared through clearinghouses, 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 generally 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 net liability thresholds and may be 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 June 30, 2018, was $431 million. At June 30, 2018, the Company had $345 million of cash posted as collateral against this net liability position.