Quarterly report pursuant to Section 13 or 15(d)

Derivatives

v2.3.0.15
Derivatives
 9 Months Ended
Sep. 30, 2011
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivatives
NOTE 4 – Derivatives
 
Derivative Balances

Derivatives are entered into on behalf of customers, for trading, as economic hedges or as qualifying accounting hedges. For additional information on the Corporation’s derivatives and hedging activities, see Note 1 – Summary of Significant Accounting Principles to the Consolidated Financial Statements of the Corporation's 2010 Annual Report on Form 10-K. The tables below identify derivative instruments included on the Corporation’s Consolidated Balance Sheet in derivative assets and liabilities at September 30, 2011 and December 31, 2010. Balances are presented on a gross basis, prior to the application of counterparty and collateral netting. Total derivative assets and liabilities are adjusted on an aggregate basis to take into consideration the effects of legally enforceable master netting agreements and have been reduced by the cash collateral applied.

 
September 30, 2011
 
 
 
Gross Derivative Assets
 
Gross Derivative Liabilities
(Dollars in billions)
Contract/
Notional (1)
 
Trading
Derivatives
and
Economic
Hedges
 
Qualifying
Accounting
Hedges
 
Total
 
Trading
Derivatives
and
Economic
Hedges
 
Qualifying
Accounting
Hedges (2)
 
Total
Interest rate contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
Swaps
$
44,392.2

 
$
1,713.0

 
$
16.1

 
$
1,729.1

 
$
1,690.8

 
$
15.1

 
$
1,705.9

Futures and forwards
12,062.5

 
3.7

 
—

 
3.7

 
4.3

 
—

 
4.3

Written options
2,803.1

 
—

 
—

 
—

 
116.0

 
—

 
116.0

Purchased options
2,834.3

 
120.8

 
—

 
120.8

 
—

 
—

 
—

Foreign exchange contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
Swaps
2,326.5

 
65.6

 
3.0

 
68.6

 
75.4

 
2.0

 
77.4

Spot, futures and forwards
2,938.4

 
55.6

 
2.2

 
57.8

 
56.1

 
0.4

 
56.5

Written options
479.7

 
—

 
—

 
—

 
13.5

 
—

 
13.5

Purchased options
442.5

 
13.1

 
—

 
13.1

 
—

 
—

 
—

Equity contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
Swaps
52.0

 
1.9

 
—

 
1.9

 
2.1

 
—

 
2.1

Futures and forwards
102.4

 
2.5

 
—

 
2.5

 
2.3

 
—

 
2.3

Written options
364.4

 
—

 
—

 
—

 
24.3

 
—

 
24.3

Purchased options
362.3

 
26.0

 
—

 
26.0

 
—

 
—

 
—

Commodity contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
Swaps
78.4

 
6.0

 
0.1

 
6.1

 
6.2

 
—

 
6.2

Futures and forwards
554.0

 
3.8

 
—

 
3.8

 
2.6

 
—

 
2.6

Written options
137.8

 
—

 
—

 
—

 
8.3

 
—

 
8.3

Purchased options
138.3

 
8.3

 
—

 
8.3

 
—

 
—

 
—

Credit derivatives
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased credit derivatives:
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit default swaps
2,085.3

 
116.6

 
—

 
116.6

 
11.6

 
—

 
11.6

Total return swaps/other
27.5

 
0.8

 
—

 
0.8

 
0.3

 
—

 
0.3

Written credit derivatives:
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit default swaps
2,005.0

 
12.3

 
—

 
12.3

 
111.9

 
—

 
111.9

Total return swaps/other
24.8

 
0.6

 
—

 
0.6

 
0.9

 
—

 
0.9

Gross derivative assets/liabilities
 
 
$
2,150.6

 
$
21.4

 
$
2,172.0

 
$
2,126.6

 
$
17.5

 
$
2,144.1

Less: Legally enforceable master netting agreements
 
 
 
 
 
 
(2,027.4
)
 
 
 
 
 
(2,027.4
)
Less: Cash collateral applied
 
 
 
 
 
 
(65.6
)
 
 
 
 
 
(57.4
)
Total derivative assets/liabilities
 
 
 
 
 
 
$
79.0

 
 
 
 
 
$
59.3

(1) 
Represents the total contract/notional amount of derivative assets and liabilities outstanding.
(2) 
Excludes $3.0 billion of long-term debt designated as a hedge of foreign currency risk.

 
December 31, 2010
 
 
 
Gross Derivative Assets
 
Gross Derivative Liabilities
(Dollars in billions)
Contract/
Notional (1)
 
Trading
Derivatives
and
Economic
Hedges
 
Qualifying
Accounting
Hedges
 
Total
 
Trading
Derivatives
and
Economic
Hedges
 
Qualifying
Accounting
Hedges (2)
 
Total
Interest rate contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
Swaps
$
42,719.2

 
$
1,193.9

 
$
14.9

 
$
1,208.8

 
$
1,187.9

 
$
2.2

 
$
1,190.1

Futures and forwards
9,939.2

 
6.0

 
—

 
6.0

 
4.7

 
—

 
4.7

Written options
2,887.7

 
—

 
—

 
—

 
82.8

 
—

 
82.8

Purchased options
3,026.2

 
88.0

 
—

 
88.0

 
—

 
—

 
—

Foreign exchange contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
Swaps
630.1

 
26.5

 
3.7

 
30.2

 
28.5

 
2.1

 
30.6

Spot, futures and forwards
2,652.9

 
41.3

 
—

 
41.3

 
44.2

 
—

 
44.2

Written options
439.6

 
—

 
—

 
—

 
13.2

 
—

 
13.2

Purchased options
417.1

 
13.0

 
—

 
13.0

 
—

 
—

 
—

Equity contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
Swaps
42.4

 
1.7

 
—

 
1.7

 
2.0

 
—

 
2.0

Futures and forwards
78.8

 
2.9

 
—

 
2.9

 
2.1

 
—

 
2.1

Written options
242.7

 
—

 
—

 
—

 
19.4

 
—

 
19.4

Purchased options
193.5

 
21.5

 
—

 
21.5

 
—

 
—

 
—

Commodity contracts
 
 
 
 
 
 
 
 
 
 
 
 
 
Swaps
90.2

 
8.8

 
0.2

 
9.0

 
9.3

 
—

 
9.3

Futures and forwards
413.7

 
4.1

 
—

 
4.1

 
2.8

 
—

 
2.8

Written options
86.3

 
—

 
—

 
—

 
6.7

 
—

 
6.7

Purchased options
84.6

 
6.6

 
—

 
6.6

 
—

 
—

 
—

Credit derivatives
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased credit derivatives:
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit default swaps
2,184.7

 
69.8

 
—

 
69.8

 
34.0

 
—

 
34.0

Total return swaps/other
26.0

 
0.9

 
—

 
0.9

 
0.2

 
—

 
0.2

Written credit derivatives:
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit default swaps
2,133.5

 
33.3

 
—

 
33.3

 
63.2

 
—

 
63.2

Total return swaps/other
22.5

 
0.5

 
—

 
0.5

 
0.5

 
—

 
0.5

Gross derivative assets/liabilities
 
 
$
1,518.8

 
$
18.8

 
$
1,537.6

 
$
1,501.5

 
$
4.3

 
$
1,505.8

Less: Legally enforceable master netting agreements
 
 
 
 
 
 
(1,406.3
)
 
 
 
 
 
(1,406.3
)
Less: Cash collateral applied
 
 
 
 
 
 
(58.3
)
 
 
 
 
 
(43.6
)
Total derivative assets/liabilities
 
 
 
 
 
 
$
73.0

 
 
 
 
 
$
55.9

(1) 
Represents the total contract/notional amount of derivative assets and liabilities outstanding.
(2) 
Excludes $4.1 billion of long-term debt designated as a hedge of foreign currency risk.

ALM and Risk Management Derivatives

The Corporation’s asset and liability management (ALM) and risk management activities include the use of derivatives to mitigate risk to the Corporation including both derivatives that are designated as qualifying accounting hedges and economic hedges. Interest rate, commodity, credit and foreign exchange contracts are utilized in the Corporation’s ALM and risk management activities.

The Corporation maintains an overall interest rate risk management strategy that incorporates the use of interest rate contracts, which are generally non-leveraged generic interest rate and basis swaps, options, futures and forwards, to minimize significant fluctuations in earnings that are caused by interest rate volatility. The Corporation’s goal is to manage interest rate sensitivity and volatility so that movements in interest rates do not significantly adversely affect earnings or capital. As a result of interest rate fluctuations, hedged fixed-rate assets and liabilities appreciate or depreciate in fair value. Gains or losses on the derivative instruments that are linked to the hedged fixed-rate assets and liabilities are expected to substantially offset this unrealized appreciation or depreciation.

Interest rate and market risk can be substantial in the mortgage business. Market risk is the risk that values of mortgage assets or revenues will be adversely affected by changes in market conditions such as interest rate movements. To hedge interest rate risk in mortgage banking production income, the Corporation utilizes forward loan sale commitments and other derivative instruments including purchased options. The Corporation also utilizes derivatives such as interest rate options, interest rate swaps, forward settlement contracts and Eurodollar futures as economic hedges of the fair value of mortgage servicing rights (MSRs). For additional information on MSRs, see Note 19 – Mortgage Servicing Rights.

The Corporation uses foreign currency contracts to manage the foreign exchange risk associated with certain foreign currency-denominated assets and liabilities, as well as the Corporation’s investments in non-U.S. subsidiaries. Foreign exchange contracts, which include spot and forward contracts, represent agreements to exchange the currency of one country for the currency of another country at an agreed-upon price on an agreed-upon settlement date. Exposure to loss on these contracts will increase or decrease over their respective lives as currency exchange and interest rates fluctuate.

The Corporation enters into derivative commodity contracts such as futures, swaps, options and forwards as well as non-derivative commodity contracts to provide price risk management services to customers or to manage price risk associated with its physical and financial commodity positions. The non-derivative commodity contracts and physical inventories of commodities expose the Corporation to earnings volatility. Cash flow and fair value accounting hedges provide a method to mitigate a portion of this earnings volatility.

The Corporation purchases credit derivatives to manage credit risk related to certain funded and unfunded credit exposures. Credit derivatives include credit default swaps, total return swaps and swaptions. These derivatives are accounted for as economic hedges and changes in fair value are recorded in other income.

Derivatives Designated as Accounting Hedges

The Corporation uses various types of interest rate, commodity and foreign exchange derivative contracts to protect against changes in the fair value of its assets and liabilities due to fluctuations in interest rates, exchange rates and commodity prices (fair value hedges). The Corporation also uses these types of contracts and equity derivatives to protect against changes in the cash flows of its assets and liabilities, and other forecasted transactions (cash flow hedges). The Corporation hedges its net investment in consolidated non-U.S. operations determined to have functional currencies other than the U.S. dollar using forward exchange contracts, cross-currency basis swaps, and by issuing foreign currency-denominated debt (net investment hedges).

Fair Value Hedges

The table below summarizes amounts recognized in revenue related to the Corporation’s derivatives designated as fair value hedges for the three and nine months ended September 30, 2011 and 2010.

 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2011
 
2011
(Dollars in millions)
Derivative
 
Hedged
Item
 
Hedge
Ineffectiveness
 
Derivative
 
Hedged
Item
 
Hedge
Ineffectiveness
Derivatives designated as fair value hedges
 
 
 
 
 
 
 
 
 
 
 
Interest rate risk on long-term debt (1)
$
4,055

 
$
(4,233
)
 
$
(178
)
 
$
4,494

 
$
(4,938
)
 
$
(444
)
Interest rate and foreign currency risk on long-term debt (1)
(870
)
 
759

 
(111
)
 
1,317

 
(1,534
)
 
(217
)
Interest rate risk on AFS securities (2)
(10,420
)
 
9,810

 
(610
)
 
(11,141
)
 
10,356

 
(785
)
Price risk on commodity inventory (3)
16

 
(16
)
 
—

 
32

 
(32
)
 
—

Total
$
(7,219
)
 
$
6,320

 
$
(899
)
 
$
(5,298
)
 
$
3,852

 
$
(1,446
)
 
 
2010
 
2010
Derivatives designated as fair value hedges
 
 
 
 
 
 
 
 
 
 
 
Interest rate risk on long-term debt (1)
$
2,128

 
$
(2,268
)
 
$
(140
)
 
$
6,214

 
$
(6,598
)
 
$
(384
)
Interest rate and foreign currency risk on long-term debt (1)
3,913

 
(3,867
)
 
46

 
630

 
(911
)
 
(281
)
Interest rate risk on AFS securities (2)
(3,073
)
 
2,842

 
(231
)
 
(8,342
)
 
8,024

 
(318
)
Price risk on commodity inventory (3)
25

 
(23
)
 
2

 
66

 
(69
)
 
(3
)
Total
$
2,993

 
$
(3,316
)
 
$
(323
)
 
$
(1,432
)
 
$
446

 
$
(986
)
(1) 
Amounts are recorded in interest expense on long-term debt and in other income.
(2) 
Amounts are recorded in interest income on AFS securities.
(3) 
Amounts relating to commodity inventory are recorded in trading account profits.
Cash Flow Hedges

The table below summarizes certain information related to the Corporation’s derivatives designated as cash flow hedges and net investment hedges for the three and nine months ended September 30, 2011 and 2010. During the next 12 months, net losses in accumulated other comprehensive income (OCI) of approximately $1.7 billion ($1.1 billion after-tax) on derivative instruments that qualify as cash flow hedges are expected to be reclassified into earnings. These net losses reclassified into earnings are expected to primarily reduce net interest income related to the respective hedged items.

Amounts related to commodity price risk reclassified from accumulated OCI are recorded in trading account profits with the underlying hedged item. Amounts related to price risk on restricted stock awards reclassified from accumulated OCI are recorded in personnel expense. Amounts related to price risk on equity investments included in available-for-sale (AFS) securities reclassified from accumulated OCI are recorded in equity investment income with the underlying hedged item.

Amounts related to foreign exchange risk recognized in accumulated OCI on derivatives exclude gains (losses) of $145 million and $(33) million related to long-term debt designated as a net investment hedge for the three and nine months ended September 30, 2011 compared to $(241) million and $135 million for the same periods in 2010.

 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2011
 
2011
(Dollars in millions, amounts pre-tax)
Gains (Losses)
Recognized in
Accumulated OCI
on Derivatives
 
Gains (Losses)
in Income
Reclassified from
Accumulated OCI
 
Hedge
Ineffectiveness and
Amounts Excluded
from Effectiveness
Testing (1)
 
Gains (Losses)
Recognized in
Accumulated OCI
on Derivatives
 
Gains (Losses)
in Income
Reclassified from
Accumulated OCI
 
Hedge
Ineffectiveness and
Amounts Excluded
from Effectiveness
Testing (1)
Derivatives designated as cash flow hedges
 
 
 
 
 
 
 
 
 
 
 
Interest rate risk on variable rate portfolios (2)
$
(1,550
)
 
$
(464
)
 
$
26

 
$
(2,272
)
 
$
(1,212
)
 
$
(8
)
Commodity price risk on forecasted purchases and sales
5

 
2

 
2

 
(4
)
 
5

 
—

Price risk on restricted stock awards
(204
)
 
(75
)
 
—

 
(395
)
 
(145
)
 
—

Total
$
(1,749
)
 
$
(537
)
 
$
28

 
$
(2,671
)
 
$
(1,352
)
 
$
(8
)
Net investment hedges
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange risk
$
2,212

 
$
(16
)
 
$
(175
)
 
$
597

 
$
407

 
$
(425
)
 
 
 
 
 
 
 
 
 
 
 
 
 
2010
 
2010
Derivatives designated as cash flow hedges
 
 
 
 
 
 
 
 
 
 
 
Interest rate risk on variable rate portfolios
$
(1,577
)
 
$
(116
)
 
$
(9
)
 
$
(2,935
)
 
$
(302
)
 
$
(29
)
Commodity price risk on forecasted purchases and sales
20

 
3

 
4

 
47

 
16

 
6

Price risk on restricted stock awards
(58
)
 
(21
)
 
—

 
(96
)
 
(4
)
 
—

Price risk on equity investments included in AFS securities
—

 
—

 
—

 
186

 
(226
)
 
—

Total
$
(1,615
)
 
$
(134
)
 
$
(5
)
 
$
(2,798
)
 
$
(516
)
 
$
(23
)
Net investment hedges
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange risk
$
(2,162
)
 
$
—

 
$
(63
)
 
$
(278
)
 
$
—

 
$
(196
)
(1) 
Amounts related to derivatives designated as cash flow hedges represent hedge ineffectiveness and amounts related to net investment hedges represent amounts excluded from effectiveness testing.
(2) 
Gains reclassified from accumulated OCI to income include $38 million related to the discontinuance of certain cash flow hedges because it was no longer probable that the original forecasted transaction would occur.

The Corporation entered into equity total return swaps to hedge a portion of restricted stock units (RSUs) granted to certain employees as part of their compensation in prior periods. Certain awards contain clawback provisions which permit the Corporation to cancel all or a portion of the award under specified circumstances, and certain awards may be settled in cash. These RSUs are accrued as liabilities over the vesting period and adjusted to fair value based on changes in the share price of the Corporation’s common stock. From time to time, the Corporation may enter into equity derivatives to minimize the change in the expense to the Corporation driven by fluctuations in the share price of the Corporation’s common stock during the vesting period of any RSUs that may be granted, if any, subject to similar or other terms and conditions. Certain of these derivatives are designated as cash flow hedges of unrecognized unvested awards with the changes in fair value of the hedge recorded in accumulated OCI and reclassified into earnings in the same period as the RSUs affect earnings. The remaining derivatives are accounted for as economic hedges and changes in fair value are recorded in personnel expense. For more information on RSUs and related hedges, see Note 12 – Shareholders' Equity.

Economic Hedges

Derivatives accounted for as economic hedges, because either they did not qualify for or were not designated as accounting hedges, are used by the Corporation to reduce certain risk exposures. The table below presents gains (losses) on these derivatives for the three and nine months ended September 30, 2011 and 2010. These gains (losses) are largely offset by the income or expense that is recorded on the economically hedged item.

 
Three Months Ended September 30
 
Nine Months Ended September 30
(Dollars in millions)
2011
 
2010
 
2011
 
2010
Price risk on mortgage banking production income (1, 2)
$
1,158

 
$
3,577

 
$
2,324

 
$
6,974

Interest rate risk on mortgage banking servicing income (1)
2,678

 
1,736

 
3,063

 
5,048

Credit risk on loans (3)
66

 
(44
)
 
38

 
(72
)
Interest rate and foreign currency risk on long-term debt and other foreign exchange transactions (4)
(3,616
)
 
7,613

 
1,604

 
(1,596
)
Other (5)
(288
)
 
(35
)
 
(384
)
 
(134
)
Total
$
(2
)
 
$
12,847

 
$
6,645

 
$
10,220

(1) 
Gains (losses) on these derivatives are recorded in mortgage banking income.
(2) 
Includes gains on interest rate lock commitments related to the origination of mortgage loans that are held-for-sale, which are considered derivative instruments, of $1.2 billion and $3.4 billion for the three and nine months ended September 30, 2011 compared to $2.9 billion and $7.6 billion for the same periods in 2010.
(3) 
Gains (losses) on these derivatives are recorded in other income.
(4) 
The majority of the balance is related to the revaluation of economic hedges of foreign currency-denominated debt which is offset with the revaluation of the debt in other income.
(5) 
Gains (losses) on these derivatives are recorded in other income or in personnel expense for hedges of certain RSUs.

Sales and Trading Revenue

The Corporation enters into trading derivatives to facilitate client transactions, for principal trading purposes, and to manage risk exposures arising from trading account assets and liabilities. It is the Corporation’s policy to include these derivative instruments in its trading activities which include derivatives and non-derivative cash instruments. The resulting risk from these derivatives is managed on a portfolio basis as part of the Corporation’s Global Banking & Markets (GBAM) business segment. The related sales and trading revenue generated within GBAM is recorded in various income statement line items including trading account profits and net interest income as well as other revenue categories. However, the vast majority of income related to derivative instruments is recorded in trading account profits.

Sales and trading revenue includes changes in the fair value and realized gains and losses on the sales of trading and other assets, net interest income and fees primarily from commissions on equity securities. Revenue is generated by the difference in the client price for an instrument and the price at which the trading desk can execute the trade in the dealer market. For equity securities, commissions related to purchases and sales are recorded in other income on the Consolidated Statement of Income. Changes in the fair value of these securities are included in trading account profits. For debt securities, revenue, with the exception of interest associated with the debt securities, is typically included in trading account profits. Unlike commissions for equity securities, the initial revenue related to broker/dealer services for debt securities is included in the pricing of the instrument rather than being charged through separate fee arrangements. Therefore, this revenue is recorded in trading account profits as part of the initial mark to fair value. For derivatives, all revenue is included in trading account profits. In transactions where the Corporation acts as agent, which includes exchange-traded futures and options, fees are recorded in other income.

Certain instruments, primarily loans, held in the GBAM business segment are not considered trading instruments. Gains (losses) on sales and changes in fair value of these instruments, where applicable (e.g., where the fair value option has been elected), are reflected in other income. Interest revenue for debt securities and loans is included in net interest income.

The table below, which includes both derivatives and non-derivative cash instruments, identifies the amounts in the respective income statement line items attributable to the Corporation’s sales and trading revenue in GBAM, categorized by primary risk, for the three and nine months ended September 30, 2011 and 2010. The difference between total trading account profits in the table below and in the Consolidated Statement of Income relates to trading activities in business segments other than GBAM.

 
Three Months Ended September 30
 
2011
 
2010
(Dollars in millions)
Trading
Account
Profits
 
Other
Income (1, 2)
 
Net Interest
Income
 
Total
 
Trading
Account
Profits
 
Other
Income (1, 2)
 
Net Interest
Income
 
Total
Interest rate risk
$
1,241

 
$
8

 
$
256

 
$
1,505

 
$
471

 
$
25

 
$
134

 
$
630

Foreign exchange risk
333

 
(17
)
 
2

 
318

 
207

 
(28
)
 
(1
)
 
178

Equity risk
267

 
646

 
48

 
961

 
418

 
562

 
(15
)
 
965

Credit risk
(461
)
 
(408
)
 
687

 
(182
)
 
1,179

 
340

 
952

 
2,471

Other risk
201

 
(4
)
 
(63
)
 
134

 
151

 
27

 
(43
)
 
135

Total sales and trading revenue
$
1,581

 
$
225

 
$
930

 
$
2,736

 
$
2,426

 
$
926

 
$
1,027

 
$
4,379

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30
 
2011
 
2010
Interest rate risk
$
2,028

 
$
(5
)
 
$
672

 
$
2,695

 
$
1,958

 
$
65

 
$
460

 
$
2,483

Foreign exchange risk
825

 
(48
)
 
8

 
785

 
722

 
(46
)
 
—

 
676

Equity risk
1,326

 
1,904

 
77

 
3,307

 
1,494

 
1,892

 
(17
)
 
3,369

Credit risk
1,532

 
390

 
2,239

 
4,161

 
4,294

 
446

 
2,905

 
7,645

Other risk
486

 
(2
)
 
(126
)
 
358

 
201

 
111

 
(141
)
 
171

Total sales and trading revenue
$
6,197

 
$
2,239

 
$
2,870

 
$
11,306

 
$
8,669

 
$
2,468

 
$
3,207

 
$
14,344

(1) 
Represents investment and brokerage services and other income recorded in GBAM that the Corporation includes in its definition of sales and trading revenue.
(2) 
Other income includes commissions and brokerage fee revenue of $610 million and $1.9 billion for the three and nine months ended September 30, 2011 and $560 million and $1.8 billion for the same periods in 2010.

Credit Derivatives

The Corporation enters into credit derivatives primarily to facilitate client transactions and to manage credit risk exposures. Credit derivatives derive value based on an underlying third party-referenced obligation or a portfolio of referenced obligations and generally require the Corporation, as the seller of credit protection, to make payments to a buyer upon the occurrence of a pre-defined credit event. Such credit events generally include bankruptcy of the referenced credit entity and failure to pay under the obligation, as well as acceleration of indebtedness and payment repudiation or moratorium. For credit derivatives based on a portfolio of referenced credits or credit indices, the Corporation may not be required to make payment until a specified amount of loss has occurred and/or may only be required to make payment up to a specified amount.

Credit derivative instruments where the Corporation is the seller of credit protection and their expiration at September 30, 2011 and December 31, 2010 are summarized below. These instruments are classified as investment and non-investment grade based on the credit quality of the underlying reference obligation. The Corporation considers ratings of BBB- or higher as investment grade. Non-investment grade includes non-rated credit derivative instruments.
 
September 30, 2011
 
Carrying Value
(Dollars in millions)
Less than
One Year
 
One to Three
Years
 
Three to
Five Years
 
Over Five
Years
 
Total
Credit default swaps:
 
 
 
 
 
 
 
 
 
Investment grade
$
640

 
$
5,991

 
$
19,676

 
$
12,475

 
$
38,782

Non-investment grade
3,092

 
15,416

 
21,595

 
33,055

 
73,158

Total
3,732

 
21,407

 
41,271

 
45,530

 
111,940

Total return swaps/other:
 
 
 
 
 
 
 
 
 
Investment grade
—

 
1

 
392

 
238

 
631

Non-investment grade
3

 
—

 
48

 
199

 
250

Total
3

 
1

 
440

 
437

 
881

Total credit derivatives
$
3,735

 
$
21,408

 
$
41,711

 
$
45,967

 
$
112,821

Credit-related notes: (1)
 
 
 
 
 
 
 
 
 
Investment grade
$
138

 
$
10

 
$
214

 
$
1,975

 
$
2,337

Non-investment grade
—

 
80

 
217

 
1,339

 
1,636

Total credit-related notes
$
138

 
$
90

 
$
431

 
$
3,314

 
$
3,973

 
Maximum Payout/Notional
Credit default swaps:
 
 
 
 
 
 
 
 
 
Investment grade
$
140,443

 
$
404,540

 
$
465,308

 
$
204,044

 
$
1,214,335

Non-investment grade
106,067

 
283,738

 
215,745

 
185,143

 
790,693

Total
246,510

 
688,278

 
681,053

 
389,187

 
2,005,028

Total return swaps/other:
 
 
 
 
 
 
 
 
 
Investment grade
13

 
130

 
18,781

 
2,942

 
21,866

Non-investment grade
197

 
629

 
1,438

 
686

 
2,950

Total
210

 
759

 
20,219

 
3,628

 
24,816

Total credit derivatives
$
246,720

 
$
689,037

 
$
701,272

 
$
392,815

 
$
2,029,844

 
 
 
 
 
 
 
 
 
 
 
December 31, 2010
 
Carrying Value
(Dollars in millions)
Less than
One Year
 
One to Three
Years
 
Three to
Five Years
 
Over Five
Years
 
Total
Credit default swaps:
 
 
 
 
 
 
 
 
 
Investment grade
$
158

 
$
2,607

 
$
7,331

 
$
14,880

 
$
24,976

Non-investment grade
598

 
6,630

 
7,854

 
23,106

 
38,188

Total
756

 
9,237

 
15,185

 
37,986

 
63,164

Total return swaps/other:
 
 
 
 
 
 
 
 
 
Investment grade
—

 
—

 
38

 
60

 
98

Non-investment grade
1

 
2

 
2

 
415

 
420

Total
1

 
2

 
40

 
475

 
518

Total credit derivatives
$
757

 
$
9,239

 
$
15,225

 
$
38,461

 
$
63,682

Credit-related notes: (1, 2)
 
 
 
 
 
 
 
 
 
Investment grade
$
—

 
$
136

 
$
—

 
$
3,525

 
$
3,661

Non-investment grade
9

 
33

 
174

 
2,423

 
2,639

Total credit-related notes
$
9

 
$
169

 
$
174

 
$
5,948

 
$
6,300

 
Maximum Payout/Notional
Credit default swaps:
 
 
 
 
 
 
 
 
 
Investment grade
$
133,691

 
$
466,565

 
$
475,715

 
$
275,434

 
$
1,351,405

Non-investment grade
84,851

 
314,422

 
178,880

 
203,930

 
782,083

Total
218,542

 
780,987

 
654,595

 
479,364

 
2,133,488

Total return swaps/other:
 
 
 
 
 
 
 
 
 
Investment grade
—

 
10

 
15,413

 
4,012

 
19,435

Non-investment grade
113

 
78

 
951

 
1,897

 
3,039

Total
113

 
88

 
16,364

 
5,909

 
22,474

Total credit derivatives
$
218,655

 
$
781,075

 
$
670,959

 
$
485,273

 
$
2,155,962

(1) 
For credit-related notes, maximum payout/notional is the same.
(2) 
For December 31, 2010, total credit-related note amounts have been revised from $3.6 billion (as previously reported) to $6.3 billion to reflect collateralized debt obligations and collateralized loan obligations held by certain consolidated VIEs.
The notional amount represents the maximum amount payable by the Corporation for most credit derivatives. However, the Corporation does not solely monitor its exposure to credit derivatives based on notional amount because this measure does not take into consideration the probability of occurrence. As such, the notional amount is not a reliable indicator of the Corporation’s exposure to these contracts. Instead, a risk framework is used to define risk tolerances and establish limits to help ensure that certain credit risk-related losses occur within acceptable, pre-defined limits.

The Corporation economically hedges its market risk exposure to credit derivatives by entering into a variety of offsetting derivative contracts and security positions. For example, in certain instances, the Corporation may purchase credit protection with identical underlying referenced names to offset its exposure. The carrying amount and notional amount of written credit derivatives for which the Corporation held purchased credit derivatives with identical underlying referenced names and terms at September 30, 2011 was $63.7 billion and $1.1 trillion compared to $43.7 billion and $1.4 trillion at December 31, 2010.

Credit-related notes in the table on page 159 include investments in securities issued by collateralized debt obligations (CDOs), collateralized loan obligations (CLOs) and credit-linked note vehicles. These instruments are primarily classified as trading securities. The carrying value of these instruments equals the Corporation’s maximum exposure to loss. The Corporation is not obligated to make any payments to the entities under the terms of the securities owned. The Corporation discloses internal categorizations (i.e., investment grade, non-investment grade) consistent with how risk is managed for these instruments.

Credit-related Contingent Features and Collateral

The Corporation executes the majority of its derivative contracts in the over-the-counter (OTC) market with large, international financial institutions, including broker/dealers and, to a lesser degree, with a variety of non-financial companies. Substantially all of the derivative transactions are executed on a daily margin basis. Therefore, events such as a credit ratings downgrade (depending on the ultimate rating level) or a breach of credit covenants would typically require an increase in the amount of collateral required of the counterparty, where applicable, and/or allow the Corporation to take additional protective measures such as early termination of all trades. Further, as previously discussed on page 153, the Corporation enters into legally enforceable master netting agreements which reduce risk by permitting the closeout and netting of transactions with the same counterparty upon the occurrence of certain events.

A majority of the Corporation’s derivative contracts contain credit risk related contingent features, primarily in the form of International Swaps and Derivatives Association, Inc. (ISDA) master netting agreements and credit support documentation that enhance the creditworthiness of these instruments compared to other obligations of the respective counterparty with whom the Corporation has transacted (e.g., other debt or equity). These contingent features may be for the benefit of the Corporation as well as its counterparties with respect to changes in the Corporation’s creditworthiness and the mark-to-market exposure under the derivative transactions. At September 30, 2011 and December 31, 2010, the Corporation held cash and securities collateral of $93.0 billion and $86.1 billion, and posted cash and securities collateral of $87.8 billion and $66.9 billion in the normal course of business under derivative agreements.

In connection with certain OTC derivative contracts and other trading agreements, the Corporation can be required to provide additional collateral or to terminate transactions with certain counterparties in the event of a downgrade of the senior debt ratings of the Corporation and its subsidiaries. The amount of additional collateral required depends on the contract and is usually a fixed incremental amount and/or the market value of the exposure.

At September 30, 2011, the amount of collateral, calculated based on the terms of the contracts that the Corporation and its subsidiaries could be required to post to counterparties but had not yet posted to counterparties was approximately $4.9 billion. That amount included $3.2 billion in collateral that could be required to be posted as a result of the downgrade by Moody's Investors Service, Inc. on September 21, 2011.

Some counterparties are able to unilaterally terminate certain contracts, or the Corporation may be required to take other action such as find a suitable replacement or obtain a guarantee. At September 30, 2011, the current liability recorded for these derivative contracts was $3.5 billion, against which the Corporation had posted $1.6 billion of collateral for these contracts, resulting in a net uncollateralized liability of $1.9 billion. The amount of additional collateral calculated based on the terms of the contracts the Corporation could be required to post is approximately $2.3 billion, all of which is included in the $4.9 billion figure discussed above.

In addition, if at September 30, 2011, the ratings agencies had downgraded their long-term senior debt ratings for the Corporation by one incremental notch, the amount of additional collateral and termination payments contractually required by such derivative contracts and other trading agreements would have been up to approximately $5.1 billion comprised of $3.4 billion for BANA and $1.7 billion for Merrill Lynch. If the agencies had downgraded their long-term senior debt ratings for the Corporation by a second incremental notch, approximately $1.5 billion comprised of approximately $1.0 billion for BANA and $500 million for Merrill Lynch, in additional collateral and termination payments would have been required.

Derivative Valuation Adjustments

The Corporation records counterparty credit risk valuation adjustments on derivative assets in order to properly reflect the credit quality of the counterparty. These adjustments are necessary as the market quotes on derivatives do not fully reflect the credit risk of the counterparties to the derivative assets. The Corporation considers collateral and legally enforceable master netting agreements that mitigate its credit exposure to each counterparty in determining the counterparty credit risk valuation adjustment. All or a portion of these counterparty credit valuation adjustments are subsequently adjusted due to changes in the value of the derivative contract, collateral and creditworthiness of the counterparty. During the three and nine months ended September 30, 2011, credit valuation gains (losses) of $(1.6) billion and $(2.0) billion ($(81) million and $(704) million, net of hedges) compared to $400 million and $(27) million ($183 million and $(188) million, net of hedges) for the same periods in 2010 for counterparty credit risk related to derivative assets were recognized in trading account profits. These credit valuation adjustments were primarily related to the Corporation’s monoline exposure. At September 30, 2011 and December 31, 2010, the cumulative counterparty credit risk valuation adjustment reduced the derivative assets balance by $3.0 billion and $6.8 billion.

In addition, the fair value of the Corporation’s or its subsidiaries’ derivative liabilities is adjusted to reflect the impact of the Corporation’s credit quality. During the three and nine months ended September 30, 2011, the Corporation recorded DVA gains (losses) of $1.8 billion and $1.7 billion ($1.7 billion and $1.5 billion, net of hedges) compared to $(55) million and $307 million ($(34) million and $212 million, net of hedges) for the same periods in 2010 in trading account profits for changes in the Corporation’s or its subsidiaries’ credit risk. At September 30, 2011 and December 31, 2010, the Corporation’s cumulative DVA reduced the derivative liabilities balance by $2.7 billion and $1.1 billion.