Quarterly report pursuant to Section 13 or 15(d)

Derivatives

 v2.3.0.11
Derivatives
 6 Months Ended
Jun. 30, 2011
Derivatives [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. The Corporation enters into derivatives to facilitate client transactions, for principal trading purposes and to manage risk exposures. 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 June 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.
                                                         
    June 30, 2011  
            Gross Derivative Assets     Gross Derivative Liabilities  
            Trading                     Trading              
            Derivatives                     Derivatives              
            and     Qualifying             and     Qualifying        
    Contract/     Economic     Accounting             Economic     Accounting        
(Dollars in billions)   Notional (1)     Hedges     Hedges     Total     Hedges     Hedges (2)     Total  
 
Interest rate contracts
                                                       
Swaps
  $ 45,518.3     $ 1,114.0     $ 9.8     $ 1,123.8     $ 1,106.3     $ 3.8     $ 1,110.1  
Futures and forwards
    12,471.9       3.5       -       3.5       4.1       -       4.1  
Written options
    3,089.1       -       -       -       78.4       -       78.4  
Purchased options
    3,132.4       84.0       -       84.0       -       -       -  
Foreign exchange contracts
                                                       
Swaps
    880.8       32.6       3.6       36.2       32.4       0.7       33.1  
Spot, futures and forwards
    3,109.3       36.7       0.5       37.2       37.3       0.9       38.2  
Written options
    545.7       -       -       -       12.4       -       12.4  
Purchased options
    542.2       11.1       -       11.1       -       -       -  
Equity contracts
                                                       
Swaps
    43.4       1.2       -       1.2       1.5       -       1.5  
Futures and forwards
    105.9       2.5       -       2.5       2.4       -       2.4  
Written options
    530.7       -       -       -       20.7       -       20.7  
Purchased options
    254.1       22.6       -       22.6       -       -       -  
Commodity contracts
                                                       
Swaps
    87.4       5.9       0.1       6.0       6.5       -       6.5  
Futures and forwards
    534.5       4.2       -       4.2       3.0       -       3.0  
Written options
    120.3       -       -       -       8.0       -       8.0  
Purchased options
    120.0       7.7       -       7.7       -       -       -  
Credit derivatives
                                                       
Purchased credit derivatives:
                                                       
Credit default swaps
    2,065.7       59.8       -       59.8       29.2       -       29.2  
Total return swaps/other
    41.4       0.4       -       0.4       0.3       -       0.3  
Written credit derivatives:
                                                       
Credit default swaps
    1,990.5       28.5       -       28.5       51.9       -       51.9  
Total return swaps/other
    40.8       0.5       -       0.5       0.6       -       0.6  
 
Gross derivative assets/liabilities
          $ 1,415.2     $ 14.0     $ 1,429.2     $ 1,395.0     $ 5.4     $ 1,400.4  
Less: Legally enforceable master netting agreements
                            (1,303.8 )                     (1,303.8 )
Less: Cash collateral applied
                            (58.8 )                     (42.2 )
 
Total derivative assets/liabilities
                          $ 66.6                     $ 54.4  
 
(1)  
Represents the total contract/notional amount of derivative assets and liabilities outstanding.
 
(2)  
Excludes $3.3 billion of long-term debt designated as a hedge of foreign currency risk.
                                                         
    December 31, 2010  
            Gross Derivative Assets     Gross Derivative Liabilities  
            Trading                     Trading              
            Derivatives                     Derivatives              
            and     Qualifying             and     Qualifying        
    Contract/     Economic     Accounting             Economic     Accounting        
(Dollars in billions)   Notional (1)     Hedges     Hedges     Total     Hedges     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 six months ended June 30, 2011 and 2010.
                                                 
    Three Months Ended June 30     Six Months Ended June 30  
    2011             2011        
            Hedged     Hedge             Hedged     Hedge  
(Dollars in millions)
  Derivative     Item     Ineffectiveness     Derivative     Item     Ineffectiveness  
 
Derivatives designated as fair value hedges
                                               
Interest rate risk on long-term debt (1)
  $ 1,373     $ (1,494 )   $ (121 )   $ 439     $ (705 )   $ (266 )
Interest rate and foreign currency risk on long-term debt (1)
    1,438       (1,487 )     (49 )     2,188       (2,293 )     (105 )
Interest rate risk on AFS securities (2)
    (1,873 )     1,630       (243 )     (721 )     546       (175 )
Price risk on commodity inventory (3)
    20       (20 )     -       16       (16 )     -  
 
Total
  $ 958     $ (1,371 )   $ (413 )   $ 1,922     $ (2,468 )   $ (546 )
 
 
    2010     2010  
         
Derivatives designated as fair value hedges
                                               
Interest rate risk on long-term debt (1)
  $ 3,202     $ (3,318 )   $ (116 )   $ 4,086     $ (4,330 )   $ (244 )
Interest rate and foreign currency risk on long-term debt (1)
    (1,907 )     1,704       (203 )     (3,282 )     2,955       (327 )
Interest rate risk on AFS securities (2)
    (5,240 )     5,165       (75 )     (5,270 )     5,184       (86 )
Price risk on commodity inventory (3)
    (16 )     15       (1 )     42       (46 )     (4 )
 
Total
  $ (3,961 )   $ 3,566     $ (395 )   $ (4,424 )   $ 3,763     $ (661 )
 
(1)  
Amounts are recorded in interest expense on long-term debt.
 
(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 six months ended June 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 losses of $17 million and $179 million related to long-term debt designated as a net investment hedge for the three and six months ended June 30, 2011 compared to gains of $114 million and $376 million for the same periods in 2010.
                                                  
    Three Months Ended June 30     Six Months Ended June 30  
    2011     2011  
                    Hedge                     Hedge  
    Gains (Losses)     Gains (Losses)     Ineffectiveness and     Gains (Losses)     Gains (Losses)     Ineffectiveness and  
    Recognized in     in Income     Amounts Excluded     Recognized in     in Income     Amounts Excluded  
    Accumulated OCI     Reclassified from     from Effectiveness     Accumulated OCI     Reclassified from     from Effectiveness  
(Dollars in millions, amounts pre-tax)   on Derivatives     Accumulated OCI     Testing (1)     on Derivatives     Accumulated OCI     Testing (1)  
 
Derivatives designated as cash flow hedges
                                               
Interest rate risk on variable rate portfolios
  $ (878 )   $ (444 )   $ (30 )   $ (722 )   $ (748 )   $ (34 )
Commodity price risk on forecasted purchases and sales
    (1 )     1       -       (9 )     3       (2 )
Price risk on restricted stock awards
    (136 )     (44 )     -       (191 )     (70 )     -  
 
Total
  $ (1,015 )   $ (487 )   $ (30 )   $ (922 )   $ (815 )   $ (36 )
 
Net investment hedges
                                               
Foreign exchange risk
  $ (653 )   $ -     $ (139 )   $ (1,615 )   $ 423     $ (250 )
 
 
    2010     2010  
 
Derivatives designated as cash flow hedges
                                               
Interest rate risk on variable rate portfolios
  $ (856 )   $ (105 )   $ (6 )   $ (1,358 )   $ (186 )   $ (20 )
Commodity price risk on forecasted purchases and sales
    (5 )     10       1       27       13       2  
Price risk on restricted stock awards
    (181 )     6       -       (37 )     17       -  
Price risk on equity investments included in AFS securities
    180       (226 )     -       186       (226 )     -  
 
Total
  $ (862 )   $ (315 )   $ (5 )   $ (1,182 )   $ (382 )   $ (18 )
 
Net investment hedges
                                               
Foreign exchange risk
  $ 906     $ -     $ (68 )   $ 1,885     $ -     $ (132 )
 
(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.
     The Corporation enters 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 from time to time, 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 six months ended June 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 June 30     Six Months Ended June 30  
(Dollars in millions)
  2011     2010     2011     2010  
 
Price risk on mortgage banking production income (1, 2)
  $ 1,221     $ 2,041     $ 1,166     $ 3,397  
Interest rate risk on mortgage banking servicing income (1)
    530       2,700       385       3,312  
Credit risk on loans (3)
    -       31       (30 )     (27 )
Interest rate and foreign currency risk on long-term debt and other foreign exchange transactions (4)
    1,826       (5,221 )     5,220       (9,209 )
Other (5)
    (166 )     (194 )     (176 )     (98 )
 
Total
  $ 3,411     $ (643 )   $ 6,565     $ (2,625 )
 
(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 $2.2 billion for the three and six months ended June 30, 2011 compared to $2.8 billion and $4.6 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 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 six months ended June 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 June 30  
    2011     2010  
    Trading                             Trading                    
    Account     Other     Net Interest             Account     Other     Net Interest        
(Dollars in millions)
  Profits     Income (1, 2)     Income (3)     Total     Profits     Income (1, 2)     Income (3)     Total  
 
Interest rate risk
  $ 488     $ 16     $ 199     $ 703     $ 434     $ 21     $ 138     $ 593  
Foreign exchange risk
    261       (16 )     4       249       234       (11 )     1       224  
Equity risk
    539       564       (22 )     1,081       202       727       (47 )     882  
Credit risk
    579       218       760       1,557       447       73       959       1,479  
Other risk
    164       12       (31 )     145       (129 )     30       (43 )     (142 )
 
Total sales and trading revenue
  $ 2,031     $ 794     $ 910     $ 3,735     $ 1,188     $ 840     $ 1,008     $ 3,036  
 
 
    Six Months Ended June 30  
    2011     2010  
Interest rate risk
  $ 791     $ (7 )   $ 415     $ 1,199     $ 1,493     $ 48     $ 327     $ 1,868  
Foreign exchange risk
    493       (31 )     7       469       515       (18 )     1       498  
Equity risk
    1,059       1,241       30       2,330       1,077       1,322       (3 )     2,396  
Credit risk
    1,983       769       1,552       4,304       3,109       121       1,953       5,183  
Other risk
    293       45       (65 )     273       50       68       (98 )     20  
 
Total sales and trading revenue
  $ 4,619     $ 2,017     $ 1,939     $ 8,575     $ 6,244     $ 1,541     $ 2,180     $ 9,965  
 
(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 $583 million and $1.3 billion for the three and six months ended June 30, 2011 and $657 million and $1.3 billion for the same periods in 2010.
 
(3)  
Net interest income excludes FTE adjustments of $43 million and $98 million for the three and six months ended June 30, 2011 compared to $75 million and $148 million 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 June 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.
                                         
    June 30, 2011  
    Carrying Value  
    Less than     One to Three     Three to     Over Five        
(Dollars in millions)
  One Year     Years     Five Years     Years     Total  
 
Credit default swaps:
                                       
Investment grade
  $ 113     $ 1,393     $ 5,263     $ 5,788     $ 12,557  
Non-investment grade
    758       5,380       8,334       24,864       39,336  
 
Total
    871       6,773       13,597       30,652       51,893  
 
Total return swaps/other:
                                       
Investment grade
    -       35       79       255       369  
Non-investment grade
    2       8       32       209       251  
 
Total
    2       43       111       464       620  
 
Total credit derivatives
  $ 873     $ 6,816     $ 13,708     $ 31,116     $ 52,513  
 
Credit-related notes: (1)
                                       
Investment grade
    1       17       415       2,952       3,385  
Non-investment grade
    9       26       208       1,722       1,965  
 
Total credit-related notes
  $ 10     $ 43     $ 623     $ 4,674     $ 5,350  
 
    Maximum Payout/Notional  
     
Credit default swaps:
                                       
Investment grade
  $ 133,694     $ 434,130     $ 456,682     $ 195,869     $ 1,220,375  
Non-investment grade
    97,824       273,164       201,725       197,442       770,155  
 
Total
    231,518       707,294       658,407       393,311       1,990,530  
 
Total return swaps/other:
                                       
Investment grade
    110       2,493       29,026       4,953       36,582  
Non-investment grade
    83       942       2,272       909       4,206  
 
Total
    193       3,435       31,298       5,862       40,788  
 
Total credit derivatives
  $ 231,711     $ 710,729     $ 689,705     $ 399,173     $ 2,031,318  
 
 
    December 31, 2010  
    Carrying Value  
    Less than     One to Three     Three to     Over Five        
(Dollars in millions)
  One Year     Years     Five Years     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 June 30, 2011 was $31.4 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 143 include investments in securities issued by collateralized debt obligations (CDOs), collateralized loan obligations (CLOs) and credit-linked note vehicles. These instruments are 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 Risk Management of Derivatives and Credit-related Contingent Features
     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 137, 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.
     Substantially all 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 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. At June 30, 2011 and December 31, 2010, the Corporation held cash and securities collateral of $74.4 billion and $76.0 billion, and posted cash and securities collateral of $58.5 billion and $61.2 billion in the normal course of business under derivative agreements.
     In connection with certain OTC derivative contracts and other trading agreements, the Corporation could 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. If the long-term credit rating of the Corporation was incrementally downgraded by one level by all ratings agencies, the amount of additional collateral and termination payments required for such derivatives and trading agreements would have been approximately $1.5 billion at June 30, 2011 and $1.2 billion at December 31, 2010. A second incremental one-level downgrade by the ratings agencies would have required approximately $1.8 billion and $1.1 billion in additional collateral and termination payments at June 30, 2011 and December 31, 2010. Excluded from these amounts are potential additional collateral requirements due to contingent triggers applicable in certain derivative contracts primarily with structured VIEs. The Corporation is in the process of evaluating these requirements in the contracts.
     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 six months ended June 30, 2011, credit valuation losses of $(592) million and $(450) million ($(151) million and $(624) million, net of hedges) compared to $(752) million and $(426) million ($(302) million and $(370) 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 June 30, 2011 and December 31, 2010, the cumulative counterparty credit risk valuation adjustment reduced the derivative assets balance by $7.1 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 six months ended June 30, 2011, the Corporation recorded DVA gains (losses) of $205 million and $(103) million ($121 million and $(236) million, net of hedges) compared to $206 million and $368 million ($77 million and $246 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 June 30, 2011 and December 31, 2010, the Corporation’s cumulative DVA reduced the derivative liabilities balance by $983 million and $1.1 billion.