Loans Held for Sale

Loans held for sale consisted of the following:



	September 30, 2013		December 31, 2012
	(in millions)
Commercial loans	$	42	$	481
Consumer loans:
Residential mortgages	130		472
Other consumer	64		65
Total consumer	194		537
Total loans held for sale	$	236	$	1,018

We originate commercial loans in connection with our participation in a number of leveraged acquisition finance syndicates. A substantial majority of these loans were originated with the intent of selling them to unaffiliated third parties and are classified as commercial loans held for sale at September 30, 2013 and December 31, 2012. The fair value of commercial loans held for sale under this program was $1 million and $465 million at September 30, 2013 and December 31, 2012, respectively. We have elected to designate all of the leveraged acquisition finance syndicated loans classified as held for sale at fair value under fair value option. See Note 11, “Fair Value Option,” for additional information.

Commercial loans held for sale also includes commercial real estate loans totaling $41 million and $16 million at September 30, 2013 and December 31, 2012, respectively.

Gains and losses from the sale of residential mortgage loans are reflected as a component of residential mortgage banking revenue in the accompanying consolidated statement of income (loss). Upon conversion of our mortgage processing and servicing operations to PHH Mortgage in the second quarter of 2013, we no longer retain the servicing rights in relation to new mortgage loans and new agency eligible loan originations are sold servicing released directly to PHH Mortgage beginning with May 2013 applications. Also included in residential mortgage loans held for sale are subprime residential mortgage loans with a fair value of $48 million and $52 million at September 30, 2013 and December 31, 2012, respectively, which were acquired from unaffiliated third parties and from HSBC Finance with the intent of securitizing or selling the loans to third parties.

Excluding the commercial loans designated under fair value option discussed above, loans held for sale are recorded at the lower of amortized cost or fair value. While the initial carrying amount of loans held for sale continued to exceed fair value at September 30, 2013, we experienced a decrease in the valuation allowance for consumer loans held for sale during 2013 due primarily to loan sales. The valuation allowance on consumer loans held for sale was $81 million and $114 million at September 30, 2013 and December 31, 2012, respectively.

Loans held for sale are subject to market risk, liquidity risk and interest rate risk, in that their value will fluctuate as a result of changes in market conditions, as well as the credit environment. Interest rate risk for residential mortgage loans held for sale was partially mitigated through an economic hedging program to offset changes in the fair value of the mortgage loans held for sale attributable to changes in market interest rates. Trading related revenue associated with this economic hedging program, which is included in residential mortgage banking revenue in the consolidated statement of income (loss), were losses of $9 million and $5 million during the three and nine months ended September 30, 2013, respectively, compared with losses of $4 million and gains of $0 million during the three and nine months ended September 30, 2012, respectively. With the conversion of our mortgage processing and servicing operations to PHH Mortgage in the second quarter of 2013, PHH Mortgage is obligated to purchase agency eligible loans from us as of the earlier of when the customer locks the mortgage loan pricing or when the mortgage loan application is approved beginning with May 2013 applications. As a result, we retain none of the risk of market changes in mortgage rates and, therefore, an economic hedging program is no longer required for these loans.