Loans Held for Sale

Loans held for sale consisted of the following:



	March 31, 2018		December 31, 2017
	(in millions)
Commercial loans:
Real estate, including construction	$	31	$	115
Business and corporate banking	15		—
Global banking	360		533
Total commercial	406		648
Consumer loans:
Residential mortgages	6		6
Other consumer	58		61
Total consumer	64		67
Total loans held for sale	$	470	$	715

Commercial Loans Commercial loans held for sale primarily consists of certain loans that we have elected to designate under the fair value option which include 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 loans that we purchase from the secondary market and hold as hedges against our exposure to certain total return swaps. During the first quarter of 2018, we elected to apply fair value option accounting to syndicated loans in commercial real estate which are originated with the intent to sell. The fair value of commercial loans designated under the fair value option totaled $338 million and $471 million at March 31, 2018 and December 31, 2017, respectively. See Note 10, "Fair Value Option," for additional information.

Commercial 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 $68 million and $62 million at March 31, 2018 and December 31, 2017, respectively. During the three months ended March 31, 2018, we reversed $3 million of the lower of amortized cost or fair value adjustment previously recorded on commercial loans held for sale as a component of other income in the consolidated statement of income (loss) as a result of an increase in fair value due to improved pricing compared with recording $1 million of lower of amortized cost or fair value adjustment associated with the write-down of commercial loans held for sale during the three months ended March 31, 2017.

Consumer Loans Prior to 2018 applications, we sold agency eligible residential mortgage loan originations on a servicing released basis directly to PHH Mortgage Corporation ("PHH Mortgage"). Beginning with 2018 applications, PHH Mortgage is no longer obligated to purchase these loans from us directly upon origination and instead we now market these loans for sale to other third parties. 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 (loss). Residential mortgage loans held for sale also includes subprime residential mortgage loans with a fair value of $2 million at both March 31, 2018 and December 31, 2017 which were previously acquired from unaffiliated third parties and from HSBC Finance Corporation ("HSBC Finance") with the intent of securitizing or selling the loans to third parties.

In addition to the residential mortgages discussed above, during 2017, we competed the sale of the portfolio of residential mortgage loans that we previously purchased from HSBC Finance and transferred to held for sale during 2016 to third parties. The portion of these residential mortgage loans sold during the three months ended March 31, 2017 had an unpaid principal balance of $471 million (aggregate carrying value of $445 million) at the time of sale and we recognized a gain on sale of approximately $43 million, including transaction costs. During the three months ended March 31, 2017, we recorded $1 million of additional lower of amortized cost or fair value adjustment on this portfolio of loans as a component of other income in the consolidated statement of income (loss) as a result of a reduction in the estimated pricing on specific pools of loans.

In March 2017, we also completed the sale of certain residential mortgage loans which previously had been 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 and were transferred to held for sale during 2016 to a third party. These residential mortgage loans had an unpaid principal balance of $364 million (aggregate carrying value of $276 million) at the time of sale and we recognized a loss on sale of approximately $2 million, largely reflecting transaction costs. During the first quarter of 2017, we reversed $5 million of the lower of amortized cost or fair value adjustment previously recorded on these loans as a component of other income in the consolidated statement of income (loss) as a result of an increase in fair value due to improved pricing.

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

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. As discussed above, prior to 2018 applications, PHH Mortgage was obligated to purchase agency eligible loans from us directly upon origination and, as such, we retained none of the risk of market changes in mortgage rates for these loans purchased by PHH Mortgage. Beginning with 2018 applications, we now market these loans for sale to other third parties. As a result, in 2018, we have reinstated an economic hedging program to offset changes in the fair value of these mortgage loans held for sale attributable to changes in market interest rates, partially mitigating the interest rate risk for these mortgage loans held for sale. Revenue associated with this economic hedging program, which is included in residential mortgage banking revenue (expense) in the consolidated statement of income (loss), was less than $1 million during the three months ended March 31, 2018.

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 through other revenues. The valuation allowance on consumer loans held for sale was $4 million and $5 million at March 31, 2018 and December 31, 2017, respectively. The valuation allowance on commercial loans held for sale was $5 million and $10 million at March 31, 2018 and December 31, 2017, respectively.