Loans Held for Sale

Loans held for sale consisted of the following:



	September 30, 2016		December 31, 2015
	(in millions)
Commercial loans:
Construction and other real estate	$	—	$	1,895
Global banking	741		200
Total commercial	741		2,095
Consumer loans:
Residential mortgages	971		11
Home equity mortgages	4		—
Other consumer	75		79
Total consumer	1,050		90
Total loans held for sale	$	1,791	$	2,185

Commercial Loans During the second quarter of 2016, we sold $1,161 million of commercial real estate loans to a third party and recognized a loss on sale of approximately $3 million, including transaction costs. Upon completion of the sale, the remaining loans that were not sold, which had a carrying value of $612 million at June 30, 2016, were transferred back to held for investment as we now intend to hold these loans for the foreseeable future.

Global banking loans held for sale includes commercial loans that we originate in connection with our participation in a number of syndicated credit facilities with the intent of selling them to unaffiliated third parties as well as commercial loans that we purchase from the secondary market and hold as hedges against our exposure to certain total return swaps. The fair value of these loans, which we have elected to designate under the fair value option, totaled $649 million and $151 million at September 30, 2016 and December 31, 2015, respectively. See Note 11, "Fair Value Option," for additional information.

Global banking loans held for sale also includes certain loans that we no longer intend to hold for investment and transferred to held for sale which totaled $92 million and $49 million at September 30, 2016 and December 31, 2015, respectively.

We recorded lower of amortized cost or fair value adjustments associated with the write-down of commercial loans held for sale of $7 million and $37 million during the three and nine months ended September 30, 2016, respectively, compared with $2 million and $16 million during the three and nine months ended September 30, 2015, respectively, as a component of other income (loss) in the consolidated statement of income. The $7 million lower of amortized cost or fair value adjustment recorded during the three months ended September 30, 2016 reflects an immaterial out of period adjustment related to certain commercial real estate loans which were transferred back to held for investment in the second quarter of 2016 as discussed above.

Consumer Loans As previously disclosed, we continue to evaluate our overall operations as we seek to optimize our risk profile and cost efficiencies, as well as our liquidity, capital and funding requirements. As part of this on-going evaluation, as well as continued market demand for non-performing residential mortgage loans, during the first quarter of 2016 we decided we no longer have the intent to hold for investment certain residential mortgage loans and adopted a formal program to initiate sale activities for these residential mortgage loans when a loan meeting pre-determined criteria is written down to the lower of amortized cost or fair value of the collateral less cost to sell (generally 180 days past due) in accordance with our existing charge-off policies. These loans were largely originated by us prior to the implementation of our Premier strategy.

Under this program, during the three and nine months ended September 30, 2016, we transferred residential mortgage loans to held for sale with a total unpaid principal balance of approximately $25 million and $549 million, respectively, at the time of transfer. The carrying value of these loans prior to transfer, after considering the fair value of the property less costs to sell, was approximately $23 million and $456 million, respectively, including related escrow advances. During the three and nine months ended September 30, 2016, we recorded an initial lower of amortized cost or fair value adjustment of $4 million and $42 million, respectively, associated with newly transferred loans, all of which was attributed to non-credit factors and recorded as a component of other income (loss) in the consolidated statement of income. During the three and nine months ended September 30, 2016, we recorded $2 million and $8 million, respectively, of additional lower of amortized cost or fair value adjustment on these loans held for sale as a component of other income (loss) in the consolidated statement of income as a result of a change in the estimated pricing on specific pools of loans. As we plan to sell these loans to third party investors, fair value represents the price we believe a third party investor would pay to acquire the loan portfolios.

In addition to the residential mortgage sales program discussed above, during the third quarter of 2016, we decided we no longer have the intent to hold for investment a portfolio of residential mortgage loans that we previously purchased from HSBC Finance Corporation ("HSBC Finance"), along with any home equity mortgage balances associated with these loans. As a result of this decision, during the third quarter of 2016, we transferred residential mortgage and home equity mortgage loans to held for sale with a total unpaid principal balance of approximately $648 million at the time of transfer. The carrying value of these loans prior to transfer, after considering the fair value of the property less costs to sell, as applicable, was approximately $628 million, including accrued interest. During the third quarter of 2016, we recorded an initial lower of cost or fair value adjustment of $11 million associated with the newly transferred loans, all of which was attributed to credit factors and recorded as a component of the provision for credit losses in the consolidated statement of income. As we plan to sell these loans to third party investors, fair value represents the price we believe a third party investor would pay to acquire the loans.

We also continue to sell all our agency eligible residential mortgage loan originations servicing released directly to PHH Mortgage Corporation ("PHH Mortgage"). Gains and losses from the sale of these residential mortgage loans are reflected as a component of residential mortgage banking revenue (expense) in the accompanying consolidated statement of income. Residential mortgage loans held for sale also includes subprime residential mortgage loans with a fair value of $3 million at both September 30, 2016 and December 31, 2015 which were previously acquired from unaffiliated third parties and from HSBC Finance with the intent of securitizing or selling the loans to third parties.

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. 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. As such, we retain none of the risk of market changes in mortgage rates for these loans purchased by PHH Mortgage.

Other consumer loans held for sale reflects student loans which we no longer originate.

Valuation Allowances 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, with adjustments to fair value being recorded as a valuation allowance. The valuation allowance on consumer loans held for sale was $60 million and $13 million at September 30, 2016 and December 31, 2015, respectively. The valuation allowance on commercial loans held for sale was $54 million and $21 million at September 30, 2016 and December 31, 2015, respectively.