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Derivative Instruments and Hedging Activities

6 Months Ended

Jun. 30, 2020

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities

NOTE 8—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Use of Derivatives and Accounting for Derivatives

We regularly enter into derivative transactions to support our overall risk management activities. Our primary market risks stem from the impact on our earnings and economic value of equity due to changes in interest rates and, to a lesser extent, changes in foreign exchange rates. We manage our interest rate sensitivity by employing several techniques, which include changing the duration and re-pricing characteristics of various assets and liabilities by using interest rate derivatives. We also use foreign currency derivatives to limit our earnings and capital exposures to foreign exchange risk by hedging exposures denominated in foreign currencies. We primarily use interest rate and foreign currency derivatives to hedge, but we may also use a variety of other derivative instruments, including caps, floors, options, futures and forward contracts, to manage our interest rate and foreign exchange risks. We designate these risk management derivatives as either qualifying accounting hedges or free-standing derivatives. Qualifying accounting hedges are further designated as fair value hedges, cash flow hedges or net investment hedges. Free-standing derivatives are economic hedges that do not qualify for hedge accounting.

We also offer interest rate, commodity, foreign currency derivatives and other contracts as an accommodation to our customers within our Commercial Banking business. We enter into these derivatives with our customers primarily to help them manage their interest rate risks, hedge their energy and other commodities exposures, and manage foreign currency fluctuations. We then enter into derivative contracts with counterparties to economically hedge substantially all of our subsequent exposures.

See below for additional information on our use of derivatives and how we account for them:

•

Fair Value Hedges: We designate derivatives as fair value hedges when they are used to manage our exposure to changes in the fair value of certain financial assets and liabilities, which fluctuate in value as a result of movements in interest rates. Changes in the fair value of derivatives designated as fair value hedges are presented in the same line item on our consolidated statements of income as the earnings effect of the hedged items. Our fair value hedges primarily consist of interest rate swaps that are intended to modify our exposure to interest rate risk on various fixed-rate financial assets and liabilities.

•

Cash Flow Hedges: We designate derivatives as cash flow hedges when they are used to manage our exposure to variability in cash flows related to forecasted transactions. Changes in the fair value of derivatives designated as cash flow hedges are recorded as a component of AOCI. Those amounts are reclassified into earnings in the same period during which the forecasted transactions impact earnings and presented in the same line item on our consolidated statements of income as the earnings effect of the hedged items. Our cash flow hedges use interest rate swaps and floors that are intended to hedge the variability in interest receipts or interest payments on some of our variable-rate financial assets or liabilities. We also enter into foreign currency forward contracts to hedge our exposure to variability in cash flows related to intercompany borrowings denominated in foreign currencies.

•

Net Investment Hedges: We use net investment hedges to manage the foreign currency exposure related to our net investments in foreign operations that have functional currencies other than the U.S. dollar. Changes in the fair value of net investment hedges are recorded in the translation adjustment component of AOCI, offsetting the translation gain or loss from those foreign operations. We execute net investment hedges using foreign currency forward contracts to hedge the translation exposure of the net investment in our foreign operations under the forward method.

•

Free-Standing Derivatives: Our free-standing derivatives primarily consist of our customer accommodation derivatives and other economic hedges. The customer accommodation derivatives and the related offsetting contracts are mainly interest rate, commodity and foreign currency contracts. The other free-standing derivatives are primarily used to economically hedge the risk of changes in the fair value of our commercial mortgage loan origination and purchase commitments as well as other interests held. Changes in the fair value of free-standing derivatives are recorded in earnings as a component of other non-interest income.

Derivatives Counterparty Credit Risk

Counterparty Types

Derivative instruments contain an element of credit risk that arises from the potential failure of a counterparty to perform according to the terms of the contract, including making payments due upon maturity of certain derivative instruments. We execute our derivative contracts primarily in over-the-counter (“OTC”) markets. We also execute interest rate and commodity futures in the exchange-traded derivative markets. Our OTC derivatives consist of both trades cleared through central counterparty clearinghouses (“CCPs”) and uncleared bilateral contracts. The Chicago Mercantile Exchange (“CME”) and the LCH Group (“LCH”) are our CCPs in our centrally cleared contracts. In our uncleared bilateral contracts, we enter into agreements directly with our derivative counterparties.

Counterparty Credit Risk Management

We manage the counterparty credit risk associated with derivative instruments by entering into legally enforceable master netting arrangements, where possible, and exchanging collateral with our counterparties, typically in the form of cash or high-quality liquid securities. The amount of collateral exchanged is dependent upon the fair value of the derivative instruments as well as the fair value of the pledged collateral. When valuing collateral, an estimate of the variation in price and liquidity over time is subtracted in the form of a “haircut” to discount the value of the collateral pledged. Our exposure to derivative counterparty credit risk, at any point in time, is equal to the amount reported as a derivative asset on our balance sheet. The fair value of our derivatives is adjusted on an aggregate basis to take into consideration the effects of legally enforceable master netting agreements and any associated cash collateral received or pledged. See Table 8.3 for our net exposure associated with derivatives.

The terms under which we collateralize our exposures differ between cleared exposures and uncleared bilateral exposures.

•

CCPs: We clear eligible OTC derivatives with CCPs as part of our regulatory requirements. Futures commission merchants (“FCMs”) serve as the intermediary between CCPs and us. CCPs require that we post initial and variation margin through our FCMs to mitigate the risk of non-payment or default. Initial margin is required upfront by CCPs as collateral against potential losses on our cleared derivative contracts and variation margin is exchanged on a daily basis to account for mark-to-market changes in those derivative contracts. For CME and LCH-cleared OTC derivatives, we characterize variation margin cash payments as settlements. Our FCM agreements governing these derivative transactions include provisions that may require us to post additional collateral under certain circumstances.

•

Bilateral Counterparties: We enter into legally enforceable master netting agreements and collateral agreements, where possible, with bilateral derivative counterparties to mitigate the risk of default. We review our collateral positions on a daily basis and exchange collateral with our counterparties in accordance with these agreements. These bilateral agreements typically provide the right to offset exposure with the same counterparty and require the party in a net liability position to post collateral. Agreements with certain bilateral counterparties require both parties to maintain collateral in the event the fair values of derivative instruments exceed established exposure thresholds. Certain of these bilateral agreements include provisions requiring that our debt maintain a credit rating of investment grade or above by each of the major credit rating agencies. In the event of a downgrade of our debt credit rating below investment grade, some of our counterparties would have the right to terminate their derivative contract and close out existing positions.

Credit Risk Valuation Adjustments

We record counterparty credit valuation adjustments (“CVAs”) on our derivative assets to reflect the credit quality of our counterparties. We consider collateral and legally enforceable master netting agreements that mitigate our credit exposure to each counterparty in determining CVAs, which may be adjusted due to changes in the fair values of the derivative contracts, collateral, and creditworthiness of the counterparty. We also record debit valuation adjustments (“DVAs”) to adjust the fair values of our derivative liabilities to reflect the impact of our own credit quality.

Balance Sheet Presentation

The following table summarizes the notional amounts and fair values of our derivative instruments as of June 30, 2020 and December 31, 2019, which are segregated by derivatives that are designated as accounting hedges and those that are not, and are further segregated by type of contract within those two categories. The total derivative assets and liabilities are adjusted on an aggregate basis to take into consideration the effects of legally enforceable master netting agreements and any associated cash collateral received or pledged. Derivative assets and liabilities are included in other assets and other liabilities, respectively, on our consolidated balance sheets, and their related gains or losses are included in operating activities as changes in other assets and other liabilities in the consolidated statements of cash flows.

Table 8.1: Derivative Assets and Liabilities at Fair Value



	June 30, 2020								December 31, 2019
	Notional or Contractual Amount		Derivative⁽¹⁾						Notional or Contractual Amount		Derivative⁽¹⁾
(Dollars in millions)	Notional or Contractual Amount		Assets			Liabilities			Notional or Contractual Amount		Assets			Liabilities
Derivatives designated as accounting hedges:
Interest rate contracts:
Fair value hedges	$	48,761	$	3		$	20		$	57,587	$	11		$	55
Cash flow hedges	114,600		1,002			13			96,900		321			29
Total interest rate contracts	163,361		1,005			33			154,487		332			84
Foreign exchange contracts:
Fair value hedges	1,404		20			0			1,402		0			6
Cash flow hedges	4,639		50			63			6,103		0			113
Net investment hedges	2,596		27			14			2,829		0			102
Total foreign exchange contracts	8,639		97			77			10,334		0			221
Total derivatives designated as accounting hedges	172,000		1,102			110			164,821		332			305
Derivatives not designated as accounting hedges:
Customer accommodation:
Interest rate contracts	68,707		1,721			224			62,268		552			117
Commodity contracts	17,384		1,876			1,739			15,492		758			694
Foreign exchange and other contracts	3,816		48			52			4,674		39			42
Total customer accommodation	89,907		3,645			2,015			82,434		1,349			853
Other interest rate exposures⁽²⁾	6,263		87			81			6,729		48			30
Other contracts	1,614		1			8			1,562		0			9
Total derivatives not designated as accounting hedges	97,784		3,733			2,104			90,725		1,397			892
Total derivatives	$	269,784	$	4,835		$	2,214		$	255,546	$	1,729		$	1,197
Less: netting adjustment⁽³⁾			(2,226		)	(754		)			(633		)	(523		)
Total derivative assets/liabilities			$	2,609		$	1,460				$	1,096		$	674

__________

⁽¹⁾

Does not reflect $33 million and $12 million recognized as a net valuation allowance on derivative assets and liabilities for non-performance risk as of June 30, 2020 and December 31, 2019, respectively. Non-performance risk is included in derivative assets and liabilities, which are part of other assets and other liabilities on the consolidated balance sheets, and is offset through non-interest income in the consolidated statements of income.


⁽²⁾	Other interest rate exposures include commercial mortgage-related derivatives and interest rate swaps.


⁽³⁾	Represents balance sheet netting of derivative assets and liabilities, and related payables and receivables for cash collateral held or placed with the same counterparty.

The following table summarizes the carrying value of our hedged assets and liabilities in fair value hedges and the associated cumulative basis adjustments included in those carrying values, excluding basis adjustments related to foreign currency risk, as of June 30, 2020 and December 31, 2019.

Table 8.2: Hedged Items in Fair Value Hedging Relationships



	June 30, 2020									December 31, 2019
	Carrying Amount Assets/(Liabilities)			Cumulative Amount of Basis Adjustments Included in the Carrying Amount						Carrying Amount Assets/(Liabilities)			Cumulative Amount of Basis Adjustments Included in the Carrying Amount
(Dollars in millions)	Carrying Amount Assets/(Liabilities)			Total Assets/(Liabilities)			Discontinued-Hedging Relationships			Carrying Amount Assets/(Liabilities)			Total Assets/(Liabilities)			Discontinued-Hedging Relationships
Line item on our consolidated balance sheets in which the hedged item is included:
Investment securities available for sale⁽¹⁾⁽²⁾	$	4,858		$	660		$	212		$	10,825		$	300		$	52
Interest-bearing deposits	(14,851		)	(306		)	0			(14,310		)	(12		)	0
Securitized debt obligations	(10,011		)	(248		)	42			(9,403		)	44			64
Senior and subordinated notes	(22,620		)	(1,533		)	(732		)	(27,777		)	(458		)	324

__________

⁽¹⁾

These amounts include the amortized cost basis of our investment securities designated in hedging relationships for which the hedged item is the last layer expected to be remaining at the end of the hedging relationship. In the second quarter of 2020, we terminated all last of layer hedging relationships with cumulative basis adjustment totaling $212 million as of June 30, 2020. As of December 31, 2019, the amortized cost basis of this portfolio was $5.9 billion, the amount of the designated hedged items was $3.1 billion, and the cumulative basis adjustment associated with these hedges was $75 million.


⁽²⁾	Carrying value represents amortized cost.

Balance Sheet Offsetting of Financial Assets and Liabilities

Derivative contracts and repurchase agreements that we execute bilaterally in the OTC market are generally governed by enforceable master netting arrangements where we generally have the right to offset exposure with the same counterparty. Either counterparty can generally request to net settle all contracts through a single payment upon default on, or termination of, any one contract. We elect to offset the derivative assets and liabilities under master netting arrangements for balance sheet presentation where a right of setoff exists. For derivative contracts entered into under master netting arrangements for which we have not been able to confirm the enforceability of the setoff rights, or those not subject to master netting arrangements, we do not offset our derivative positions for balance sheet presentation.

The following table presents the gross and net fair values of our derivative assets, derivative liabilities, resale and repurchase agreements and the related offsetting amounts permitted under U.S. GAAP as of June 30, 2020 and December 31, 2019. The table also includes cash and non-cash collateral received or pledged in accordance with such arrangements. The amount of collateral presented, however, is limited to the amount of the related net derivative fair values or outstanding balances; therefore, instances of over-collateralization are excluded.

Table 8.3: Offsetting of Financial Assets and Financial Liabilities



	Gross Amounts		Gross Amounts Offset in the Balance Sheet						Net Amounts as Recognized		Securities Collateral Held Under Master Netting Agreements
(Dollars in millions)	Gross Amounts		Financial Instruments			Cash Collateral Received			Net Amounts as Recognized		Securities Collateral Held Under Master Netting Agreements		Net Exposure
As of June 30, 2020
Derivative assets⁽¹⁾	$	4,835	$	(702	)	$	(1,524	)	$	2,609	$	0	$	2,609
As of December 31, 2019
Derivative assets⁽¹⁾	1,729		(347		)	(286		)	1,096		0		1,096



	Gross Amounts		Gross Amounts Offset in the Balance Sheet						Net Amounts as Recognized		Securities Collateral Pledged Under Master Netting Agreements
(Dollars in millions)	Gross Amounts		Financial Instruments			Cash Collateral Pledged			Net Amounts as Recognized					Net Exposure
As of June 30, 2020
Derivative liabilities⁽¹⁾	$	2,214	$	(702	)	$	(52	)	$	1,460	$	0		$	1,460
Repurchase agreements⁽²⁾	573		0			0			573		(573		)	0
As of December 31, 2019
Derivative liabilities⁽¹⁾	1,197		(347		)	(176		)	674		0			674
Repurchase agreements⁽²⁾	314		0			0			314		(314		)	0

__________

⁽¹⁾

We received cash collateral from derivative counterparties totaling $1.7 billion and $347 million as of June 30, 2020 and December 31, 2019, respectively. We also received securities from derivative counterparties with a fair value of approximately $1 million as of both June 30, 2020 and December 31, 2019, which we have the ability to re-pledge. We posted $1.3 billion and $954 million of cash collateral as of June 30, 2020 and December 31, 2019, respectively.


⁽²⁾	Under our customer repurchase agreements, which mature the next business day, we pledged collateral with a fair value of $584 million and $320 million as of June 30, 2020 and December 31, 2019, respectively, primarily consisting of agency RMBS securities.

Income Statement and AOCI Presentation

Fair Value and Cash Flow Hedges

The net gains (losses) recognized in our consolidated statements of income related to derivatives in fair value and cash flow hedging relationships are presented below for the three and six months ended June 30, 2020 and 2019.

Table 8.4: Effects of Fair Value and Cash Flow Hedge Accounting



	Three Months Ended June 30, 2020
	Net Interest Income																Non-Interest Income
(Dollars in millions)	Investment Securities			Loans, Including Loans Held for Sale		Other		Interest-bearing Deposits			Securitized Debt Obligations			Senior and Subordinated Notes			Other
Total amounts presented in our consolidated statements of income	$	482		$	5,820	$	16	$	(611	)	$	(56	)	$	(180	)	$	166
Fair value hedging relationships:
Interest rate and foreign exchange contracts:
Interest recognized on derivatives	$	(17	)	$	0	$	0	$	27		$	40		$	71		$	0
Gains (losses) recognized on derivatives	(26		)	0		0		9			(13		)	61			26
Gains (losses) recognized on hedged items⁽¹⁾	22			0		0		(10		)	0			(68		)	(26		)
Excluded component of fair value hedges⁽²⁾	0			0		0		0			0			0			0
Net expense recognized on fair value hedges	$	(21	)	$	0	$	0	$	26		$	27		$	64		$	0
Cash flow hedging relationships:⁽³⁾
Interest rate contracts:
Realized losses reclassified from AOCI into net income	$	7		$	135	$	0	$	0		$	0		$	0		$	0
Foreign exchange contracts:
Realized gains reclassified from AOCI into net income⁽⁴⁾	0			0		2		0			0			0			(2		)
Net income (expense) recognized on cash flow hedges	$	7		$	135	$	2	$	0		$	0		$	0		$	(2	)



	Six Months Ended June 30, 2020
	Net Interest Income																Non-Interest Income
(Dollars in millions)	Investment Securities			Loans, Including Loans Held for Sale		Other		Interest-bearing Deposits			Securitized Debt Obligations			Senior and Subordinated Notes			Other
Total amounts presented in our consolidated statements of income	$	1,012		$	12,362	$	53	$	(1,342	)	$	(155	)	$	(419	)	$	311
Fair value hedging relationships:
Interest rate and foreign exchange contracts:
Interest recognized on derivatives	$	(28	)	$	0	$	0	$	25		$	52		$	110		$	0
Gains (losses) recognized on derivatives	(364		)	0		0		296			269			1,129			3
Gains (losses) recognized on hedged items⁽¹⁾	360			0		0		(296		)	(292		)	(1,159		)	(3		)
Excluded component of fair value hedges⁽²⁾	0			0		0		0			0			(1		)	0
Net income (expense) recognized on fair value hedges	$	(32	)	$	0	$	0	$	25		$	29		$	79		$	0
Cash flow hedging relationships:⁽³⁾
Interest rate contracts:
Realized gains reclassified from AOCI into net income	$	9		$	159	$	0	$	0		$	0		$	0		$	0
Foreign exchange contracts:
Realized gains reclassified from AOCI into net income⁽⁴⁾	0			0		9		0			0			0			(2		)
Net income recognized on cash flow hedges	$	9		$	159	$	9	$	0		$	0		$	0		$	(2	)



	Three Months Ended June 30, 2019
	Net Interest Income																	Non-Interest Income
(Dollars in millions)	Investment Securities			Loans, Including Loans Held for Sale			Other		Interest-bearing Deposits			Securitized Debt Obligations			Senior and Subordinated Notes			Other
Total amounts presented in our consolidated statements of income	$	629		$	6,383		$	64	$	(870	)	$	(139	)	$	(310	)	$	191
Fair value hedging relationships:
Interest rate contracts:
Interest recognized on derivatives	$	(1	)	$	0		$	0	$	(33	)	$	(6	)	$	(10	)	$	0
Gains (losses) recognized on derivatives	(175		)	0			0		154			79			471			11
Gains (losses) recognized on hedged items⁽¹⁾	174			0			0		(151		)	(102		)	(511		)	(10		)
Net income (expense) recognized on fair value hedges	$	(2	)	$	0		$	0	$	(30	)	$	(29	)	$	(50	)	$	1
Cash flow hedging relationships:⁽³⁾
Interest rate contracts:
Realized losses reclassified from AOCI into net income	$	(3	)	$	(59	)	$	0	$	0		$	0		$	0		$	0
Foreign exchange contracts:
Realized gains (losses) reclassified from AOCI into net income⁽⁴⁾	0			0			13		0			0			0			(1		)
Net income (expense) recognized on cash flow hedges	$	(3	)	$	(59	)	$	13	$	0		$	0		$	0		$	(1	)



	Six Months Ended June 30, 2019
	Net Interest Income																	Non-Interest Income
(Dollars in millions)	Investment Securities			Loans, Including Loans Held for Sale			Other		Interest-bearing Deposits			Securitized Debt Obligations			Senior and Subordinated Notes			Other
Total amounts presented in our consolidated statements of income	$	1,284		$	12,751		$	133	$	(1,687	)	$	(282	)	$	(624	)	$	348
Fair value hedging relationships:
Interest rate contracts:
Interest recognized on derivatives	$	1		$	0		$	0	$	(69	)	$	(12	)	$	(21	)	$	0
Gains (losses) recognized on derivatives	(286		)	0			0		249			112			752			11
Gains (losses) recognized on hedged items⁽¹⁾	284			0			0		(243		)	(159		)	(831		)	(10		)
Net income (expense) recognized on fair value hedges	$	(1	)	$	0		$	0	$	(63	)	$	(59	)	$	(100	)	$	1
Cash flow hedging relationships:⁽³⁾
Interest rate contracts:
Realized losses reclassified from AOCI into net income	$	(7	)	$	(115	)	$	0	$	0		$	0		$	0		$	0
Foreign exchange contracts:
Realized gains (losses) reclassified from AOCI into net income⁽⁴⁾	0			0			25		0			0			0			(1		)
Net income (expense) recognized on cash flow hedges	$	(7	)	$	(115	)	$	25	$	0		$	0		$	0		$	(1	)

__________


⁽¹⁾	Includes amortization expense of $17 million and $53 million for the three and six months ended June 30, 2020, respectively, and amortization expense of $56 million and $117 million for the three and six months ended June 30, 2019, respectively, related to basis adjustments on discontinued hedges.


⁽²⁾	Changes in fair values of cross-currency swaps attributable to changes in cross-currency basis spreads are excluded from the assessment of hedge effectiveness and recorded in other comprehensive income. The initial value of the excluded component is recognized in earnings over the life of the swap under the amortization approach.


⁽³⁾	See “Note 9—Stockholders’ Equity” for the effects of cash flow and net investment hedges on AOCI and amounts reclassified to net income, net of tax.

⁽⁴⁾

We recognized a loss of $299 million and a gain of $93 million for the three and six months ended June 30, 2020, respectively, and a loss of $123 million and $295 million for the three and six months ended June 30, 2019, respectively, on foreign exchange contracts reclassified from AOCI. These amounts were largely offset by the foreign currency transaction gains (losses) on our foreign currency denominated intercompany funding included other non-interest income.

In the next 12 months, we expect to reclassify to earnings net after-tax gains of $649 million recorded in AOCI as of June 30, 2020. These amounts will offset the cash flows associated with the hedged forecasted transactions. The maximum length of time over which forecasted transactions were hedged was approximately 7 years as of June 30, 2020. The amount we expect to reclassify into earnings may change as a result of changes in market conditions and ongoing actions taken as part of our overall risk management strategy.

Free-Standing Derivatives

The net impacts to our consolidated statements of income related to free-standing derivatives are presented below for the three and six months ended June 30, 2020 and 2019. These gains or losses are recognized in other non-interest income in our consolidated statements of income.

Table 8.5: Gains (Losses) on Free-Standing Derivatives



	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in millions)	2020			2019			2020			2019
Gains (losses) recognized in other non-interest income:
Customer accommodation:
Interest rate contracts	$	(1	)	$	4		$	12		$	10
Commodity contracts	(1		)	7			16			9
Foreign exchange and other contracts	1			4			4			7
Total customer accommodation	(1		)	15			32			26
Other interest rate exposures	(34		)	(14		)	(16		)	(14		)
Other contracts	1			0			0			(2		)
Total	$	(34	)	$	1		$	16		$	10