UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ü] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2009
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number:
1-6523
Exact Name of Registrant as Specified in its Charter:
Bank of America Corporation
State or Other Jurisdiction of Incorporation or Organization:
Delaware
IRS Employer Identification Number:
56-0906609
Address of Principal Executive Offices:
Bank of America Corporate Center
100 N. Tryon Street
Charlotte, North Carolina 28255
Registrants telephone number, including area code:
(704) 386-5681
Former name, former address and former fiscal year, if changed since last report:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ü No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer ü | Accelerated filer | Non-accelerated filer | Smaller reporting company | |||||||
(do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).
Yes No ü
On April 30, 2009, there were 6,402,966,457 shares of Bank of America Corporation Common Stock outstanding.
1
March 31, 2009 Form 10-Q
|
INDEX
Page | ||||||||
Part I. | Item 1. | Financial Statements: | ||||||
Financial Information |
Consolidated Statement of Income for the Three |
3 | ||||||
Consolidated Balance Sheet at March 31, 2009 and |
4 | |||||||
5 | ||||||||
Consolidated Statement of Cash Flows for the Three |
6 | |||||||
7 | ||||||||
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
|||||||
77 | ||||||||
78 | ||||||||
Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
181 | ||||||
Item 4. | Controls and Procedures | 181 | ||||||
Part II. | ||||||||
Other Information | Item 1. | Legal Proceedings | 181 | |||||
Item 1A. | Risk Factors | 181 | ||||||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
182 | ||||||
Item 6. | Exhibits | 183 | ||||||
Signature | 185 | |||||||
Index to Exhibits | 186 |
2
Part 1. FINANCIAL INFORMATION |
Bank of America Corporation and Subsidiaries Consolidated Statement of Income
|
Three Months Ended March 31 | |||||||
(Dollars in millions, except per share information) | 2009 | 2008 | |||||
Interest income |
|||||||
Interest and fees on loans and leases |
$ | 13,349 | $ | 14,415 | |||
Interest on debt securities |
3,830 | 2,774 | |||||
Federal funds sold and securities borrowed or purchased under agreements to resell |
1,155 | 1,208 | |||||
Trading account assets |
2,428 | 2,364 | |||||
Other interest income |
1,394 | 1,098 | |||||
Total interest income |
22,156 | 21,859 | |||||
Interest expense |
|||||||
Deposits |
2,543 | 4,588 | |||||
Short-term borrowings |
2,221 | 4,142 | |||||
Trading account liabilities |
579 | 840 | |||||
Long-term debt |
4,316 | 2,298 | |||||
Total interest expense |
9,659 | 11,868 | |||||
Net interest income |
12,497 | 9,991 | |||||
Noninterest income |
|||||||
Card income |
2,865 | 3,639 | |||||
Service charges |
2,533 | 2,397 | |||||
Investment and brokerage services |
2,963 | 1,340 | |||||
Investment banking income |
1,055 | 476 | |||||
Equity investment income |
1,202 | 1,054 | |||||
Trading account profits (losses) |
5,201 | (1,783 | ) | ||||
Mortgage banking income |
3,314 | 451 | |||||
Insurance income |
688 | 197 | |||||
Gains on sales of debt securities |
1,498 | 225 | |||||
Other income (loss) (includes $371 of debt other-than-temporary-impairment losses for 2009) |
1,942 | (916 | ) | ||||
Total noninterest income |
23,261 | 7,080 | |||||
Total revenue, net of interest expense |
35,758 | 17,071 | |||||
Provision for credit losses |
13,380 | 6,010 | |||||
Noninterest expense |
|||||||
Personnel |
8,768 | 4,726 | |||||
Occupancy |
1,128 | 849 | |||||
Equipment |
622 | 396 | |||||
Marketing |
521 | 637 | |||||
Professional fees |
405 | 285 | |||||
Amortization of intangibles |
520 | 446 | |||||
Data processing |
648 | 563 | |||||
Telecommunications |
327 | 260 | |||||
Other general operating |
3,298 | 931 | |||||
Merger and restructuring charges |
765 | 170 | |||||
Total noninterest expense |
17,002 | 9,263 | |||||
Income before income taxes |
5,376 | 1,798 | |||||
Income tax expense |
1,129 | 588 | |||||
Net income |
$ | 4,247 | $ | 1,210 | |||
Preferred stock dividends |
1,433 | 190 | |||||
Net income available to common shareholders |
$ | 2,814 | $ | 1,020 | |||
Per common share information |
|||||||
Earnings |
$ | 0.44 | $ | 0.23 | |||
Diluted earnings |
0.44 | 0.23 | |||||
Dividends paid |
0.01 | 0.64 | |||||
Average common shares issued and outstanding (in thousands) |
6,370,815 | 4,427,823 | |||||
Average diluted common shares issued and outstanding (in thousands) |
6,431,027 | 4,461,201 | |||||
See accompanying Notes to Consolidated Financial Statements.
3
Bank of America Corporation and Subsidiaries Consolidated Balance Sheet
|
(Dollars in millions) | March 31 2009 |
December 31 2008 |
||||||
Assets |
||||||||
Cash and cash equivalents |
$ | 173,460 | $ | 32,857 | ||||
Time deposits placed and other short-term investments |
23,947 | 9,570 | ||||||
Federal funds sold and securities borrowed or purchased under agreements to resell (includes $45,342 and $2,330 measured at fair value and $153,044 and $82,099 pledged as collateral) |
153,230 | 82,478 | ||||||
Trading account assets (includes $74,662 and $69,348 pledged as collateral) |
203,131 | 159,522 | ||||||
Derivative assets |
137,311 | 62,252 | ||||||
Debt securities: |
||||||||
Available-for-sale (includes $127,234 and $158,939 pledged as collateral) |
254,194 | 276,904 | ||||||
Held-to-maturity, at cost (fair value - $6,563 and $685) |
8,444 | 685 | ||||||
Total debt securities |
262,638 | 277,589 | ||||||
Loans and leases (includes $7,355 and $5,413 measured at fair value and $196,152 and $166,891 pledged as collateral) |
977,008 | 931,446 | ||||||
Allowance for loan and lease losses |
(29,048 | ) | (23,071 | ) | ||||
Loans and leases, net of allowance |
947,960 | 908,375 | ||||||
Premises and equipment, net |
15,549 | 13,161 | ||||||
Mortgage servicing rights (includes $14,096 and $12,733 measured at fair value) |
14,425 | 13,056 | ||||||
Goodwill |
86,910 | 81,934 | ||||||
Intangible assets |
13,703 | 8,535 | ||||||
Loans held-for-sale (includes $26,230 and $18,964 measured at fair value) |
40,214 | 31,454 | ||||||
Other assets (includes $40,926 and $29,906 measured at fair value) |
249,485 | 137,160 | ||||||
Total assets |
$ | 2,321,963 | $ | 1,817,943 | ||||
Liabilities |
||||||||
Deposits in domestic offices: |
||||||||
Noninterest-bearing |
$ | 233,902 | $ | 213,994 | ||||
Interest-bearing (includes $1,682 and $1,717 measured at fair value) |
639,616 | 576,938 | ||||||
Deposits in foreign offices: |
||||||||
Noninterest-bearing |
4,133 | 4,004 | ||||||
Interest-bearing |
75,857 | 88,061 | ||||||
Total deposits |
953,508 | 882,997 | ||||||
Federal funds purchased and securities loaned or sold under agreements to repurchase (includes $27,400 measured at fair value at March 31, 2009) |
246,734 | 206,598 | ||||||
Trading account liabilities |
52,993 | 57,287 | ||||||
Derivative liabilities |
76,582 | 30,709 | ||||||
Commercial paper and other short-term borrowings (includes $946 measured at fair value at March 31, 2009) |
185,816 | 158,056 | ||||||
Accrued expenses and other liabilities (includes $10,575 and $1,978 measured at fair value and $1,357 and $421 of reserve for unfunded lending commitments) |
126,030 | 36,952 | ||||||
Long-term debt (includes $36,169 measured at fair value at March 31, 2009) |
440,751 | 268,292 | ||||||
Total liabilities |
2,082,414 | 1,640,891 | ||||||
Commitments and contingencies (Note 9 - Variable Interest Entities and Note 12 Commitments and Contingencies) |
||||||||
Shareholders equity |
||||||||
Preferred stock, $0.01 par value; authorized - 100,000,000 shares; issued and outstanding 9,778,142 and 8,202,042 shares |
73,277 | 37,701 | ||||||
Common stock and additional paid-in capital, $0.01 par value; authorized 10,000,000,000 shares; issued and outstanding 6,400,949,995 and 5,017,435,592 shares |
100,864 | 76,766 | ||||||
Retained earnings |
76,877 | 73,823 | ||||||
Accumulated other comprehensive income (loss) |
(11,164 | ) | (10,825 | ) | ||||
Other |
(305 | ) | (413 | ) | ||||
Total shareholders equity |
239,549 | 177,052 | ||||||
Total liabilities and shareholders equity |
$ | 2,321,963 | $ | 1,817,943 | ||||
See accompanying Notes to Consolidated Financial Statements.
4
Bank of America Corporation and Subsidiaries Consolidated Statement of Changes in Shareholders Equity
|
Preferred Stock |
Common Stock and Additional Paid-in Capital |
Retained Earnings |
Accumulated Income (Loss) (1) |
Total Equity |
Comprehensive Income |
|||||||||||||||||||||||
(Dollars in millions, shares in thousands) | Shares | Amount | Other | |||||||||||||||||||||||||
Balance, December 31, 2007 |
$ | 4,409 | 4,437,885 | $ | 60,328 | $ | 81,393 | $ | 1,129 | $ | (456 | ) | $ | 146,803 | ||||||||||||||
Net income |
1,210 | 1,210 | $ | 1,210 | ||||||||||||||||||||||||
Net changes in available-for-sale debt and marketable equity securities |
(1,735 | ) | (1,735 | ) | (1,735 | ) | ||||||||||||||||||||||
Net changes in foreign currency translation adjustments |
20 | 20 | 20 | |||||||||||||||||||||||||
Net changes in derivatives |
(316 | ) | (316 | ) | (316 | ) | ||||||||||||||||||||||
Employee benefit plan adjustments |
18 | 18 | 18 | |||||||||||||||||||||||||
Dividends paid: |
||||||||||||||||||||||||||||
Common |
(2,859 | ) | (2,859 | ) | ||||||||||||||||||||||||
Preferred |
(190 | ) | (190 | ) | ||||||||||||||||||||||||
Issuance of preferred stock |
12,897 | 12,897 | ||||||||||||||||||||||||||
Common stock issued under employee plans and related tax effects |
14,925 | 752 | (291 | ) | 461 | |||||||||||||||||||||||
Balance, March 31, 2008 |
$ | 17,306 | 4,452,810 | $ | 61,080 | $ | 79,554 | $ | (884 | ) | $ | (747 | ) | $ | 156,309 | $ | (803 | ) | ||||||||||
Balance, December 31, 2008 |
$ | 37,701 | 5,017,436 | $ | 76,766 | $ | 73,823 | $ | (10,825 | ) | $ | (413 | ) | $ | 177,052 | |||||||||||||
Cumulative adjustment for accounting change Other-than-temporary impairments on debt securities (2) |
71 | (71 | ) | - | ||||||||||||||||||||||||
Net income |
4,247 | 4,247 | $ | 4,247 | ||||||||||||||||||||||||
Net changes in available-for-sale debt and marketable equity securities |
(811 | ) | (811 | ) | (811 | ) | ||||||||||||||||||||||
Net changes in foreign currency translation adjustments |
66 | 66 | 66 | |||||||||||||||||||||||||
Net changes in derivatives |
412 | 412 | 412 | |||||||||||||||||||||||||
Employee benefit plan adjustments |
65 | 65 | 65 | |||||||||||||||||||||||||
Dividends paid: |
||||||||||||||||||||||||||||
Common |
(64 | ) | (64 | ) | ||||||||||||||||||||||||
Preferred (3) |
(1,033 | ) | (1,033 | ) | ||||||||||||||||||||||||
Issuance of preferred stock and stock warrants (4) |
26,800 | 3,200 | 30,000 | |||||||||||||||||||||||||
Stock issued in acquisition |
8,605 | 1,375,476 | 20,504 | 29,109 | ||||||||||||||||||||||||
Common stock issued under employee plans and related tax effects |
8,038 | 394 | 108 | 502 | ||||||||||||||||||||||||
Other |
171 | (167 | ) | 4 | ||||||||||||||||||||||||
Balance, March 31, 2009 |
$ | 73,277 | 6,400,950 | $ | 100,864 | $ | 76,877 | $ | (11,164 | ) | $ | (305 | ) | $ | 239,549 | $ | 3,979 | |||||||||||
(1) |
Amounts shown are net-of-tax. For additional information on accumulated OCI, see Note 13 Shareholders Equity and Earnings Per Common Share to the Consolidated Financial Statements. |
(2) |
Effective January 1, 2009, the Corporation early adopted FSP No. FAS 115-2, FAS 124-2 and EITF 99-20-2. Amounts shown are net-of-tax. For additional information on the adoption of this accounting pronouncement, see Note 1 Summary of Significant Accounting Principles and Note 5 Securities to the Consolidated Financial Statements. |
(3) |
Excludes $233 million of first quarter 2009 cumulative preferred dividends not declared as of March 31, 2009 and $167 million of accretion of discounts on preferred stock issuances. |
(4) |
Proceeds from the issuance of Series Q and Series R Preferred Stock were allocated to the preferred stock and warrants on a relative fair value basis. For more information, see Note 13 Shareholders Equity and Earnings Per Common Share to the Consolidated Financial Statements. |
See accompanying Notes to Consolidated Financial Statements.
5
Bank of America Corporation and Subsidiaries Consolidated Statement of Cash Flows
|
Three Months Ended March 31 | ||||||||
(Dollars in millions) | 2009 | 2008 | ||||||
Operating activities |
||||||||
Net income |
$ | 4,247 | $ | 1,210 | ||||
Reconciliation of net income to net cash provided by (used in) operating activities: |
||||||||
Provision for credit losses |
13,380 | 6,010 | ||||||
Gains on sales of debt securities |
(1,498 | ) | (225 | ) | ||||
Depreciation and premises improvements amortization |
578 | 328 | ||||||
Amortization of intangibles |
520 | 446 | ||||||
Deferred income tax (benefit) expense |
486 | (1,041 | ) | |||||
Net decrease (increase) in trading and derivative instruments |
27,119 | (16,061 | ) | |||||
Net decrease (increase) in other assets |
28,304 | (13,350 | ) | |||||
Net (decrease) increase in accrued expenses and other liabilities |
(10,870 | ) | 12,606 | |||||
Other operating activities, net |
(7,469 | ) | 6,245 | |||||
Net cash provided by (used in) operating activities |
54,797 | (3,832 | ) | |||||
Investing activities |
||||||||
Net decrease in time deposits placed and other short-term investments |
19,336 | 2,966 | ||||||
Net decrease in federal funds sold and securities borrowed or purchased under agreements to resell |
68,072 | 9,263 | ||||||
Proceeds from sales of available-for-sale debt securities |
53,309 | 26,477 | ||||||
Proceeds from paydowns and maturities of available-for-sale debt securities |
13,871 | 5,194 | ||||||
Purchases of available-for-sale debt securities |
(6,576 | ) | (35,134 | ) | ||||
Proceeds from maturities of held-to-maturity debt securities |
280 | 46 | ||||||
Purchases of held-to-maturity debt securities |
(8 | ) | (460 | ) | ||||
Proceeds from sales of loans and leases |
565 | 16,245 | ||||||
Other changes in loans and leases, net |
(6,636 | ) | (21,443 | ) | ||||
Net purchases of premises and equipment |
(531 | ) | (431 | ) | ||||
Proceeds from sales of foreclosed properties |
417 | 33 | ||||||
Cash received upon acquisition, net |
31,804 | - | ||||||
Other investing activities, net |
2,708 | (953 | ) | |||||
Net cash provided by investing activities |
176,611 | 1,803 | ||||||
Financing activities |
||||||||
Net decrease in deposits |
(27,596 | ) | (8,108 | ) | ||||
Net decrease in federal funds purchased and securities loaned or sold under agreements to repurchase |
(71,444 | ) | (1,697 | ) | ||||
Net decrease in commercial paper and other short-term borrowings |
(10,135 | ) | (233 | ) | ||||
Proceeds from issuance of long-term debt |
24,246 | 7,774 | ||||||
Retirement of long-term debt |
(34,711 | ) | (7,618 | ) | ||||
Proceeds from issuance of preferred stock |
30,000 | 12,897 | ||||||
Proceeds from issuance of common stock |
- | 46 | ||||||
Cash dividends paid |
(1,097 | ) | (3,049 | ) | ||||
Excess tax benefits of share-based payments |
- | 16 | ||||||
Other financing activities, net |
11 | (6 | ) | |||||
Net cash (used in) provided by financing activities |
(90,726 | ) | 22 | |||||
Effect of exchange rate changes on cash and cash equivalents |
(79 | ) | (12 | ) | ||||
Net increase (decrease) in cash and cash equivalents |
140,603 | (2,019 | ) | |||||
Cash and cash equivalents at January 1 |
32,857 | 42,531 | ||||||
Cash and cash equivalents at March 31 |
$ | 173,460 | $ | 40,512 | ||||
During the three months ended March 31, 2009 the Corporation transferred credit card loans of $8.5 billion and the related allowance for loan and lease losses of $750 million in exchange for a $7.8 billion held-to-maturity debt security that was issued by the Corporations U.S. credit card securitization trust and retained by the Corporation.
During the three months ended March 31, 2009 the Corporation transferred $1.7 billion of auction rate securities from trading account assets to AFS debt securities.
The fair values of noncash assets acquired and liabilities assumed in the Merrill Lynch acquisition were $619.0 billion and $626.7 billion.
Approximately 1.4 billion shares of common stock valued at approximately $20.5 billion and 376 thousand shares of preferred stock valued at approximately $8.6 billion were issued in connection with the Merrill Lynch acquisition.
See accompanying Notes to Consolidated Financial Statements.
6
Bank of America Corporation and Subsidiaries Notes to Consolidated Financial Statements
|
On January 1, 2009, Bank of America Corporation and its subsidiaries (the Corporation) acquired all of the outstanding shares of Merrill Lynch & Co., Inc. (Merrill Lynch) through its merger with a subsidiary of the Corporation in exchange for common and preferred stock with a value of $29.1 billion. On July 1, 2008, the Corporation acquired all of the outstanding shares of Countrywide Financial Corporation (Countrywide) through its merger with a subsidiary of the Corporation in exchange for common stock with a value of $4.2 billion. Consequently, Merrill Lynchs and Countrywides results of operations were included in the Corporations results from their dates of acquisition. For more information related to the Merrill Lynch and Countrywide acquisitions, see Note 2 Merger and Restructuring Activity.
The Corporation, through its banking and nonbanking subsidiaries, provides a diverse range of financial services and products throughout the U.S. and in selected international markets. At March 31, 2009, the Corporation operated its banking activities primarily under three charters: Bank of America, National Association (Bank of America, N.A.), FIA Card Services, N.A. and Countrywide Bank, FSB. In addition with the acquisition of Merrill Lynch we acquired Merrill Lynch Bank USA and Merrill Lynch Bank & Trust Co., FSB. Effective April 27, 2009, Countrywide Bank, FSB merged into Bank of America, N.A. This merger had no impact on the Consolidated Financial Statements of the Corporation.
NOTE 1 Summary of Significant Accounting Principles
|
Principles of Consolidation and Basis of Presentation
The Consolidated Financial Statements include the accounts of the Corporation and its majority-owned subsidiaries, and those variable interest entities (VIEs) where the Corporation is the primary beneficiary. All significant intercompany accounts and transactions have been eliminated. Results of operations of companies purchased are included from the dates of acquisition and for VIEs, from the dates that the Corporation became the primary beneficiary. Assets held in an agency or fiduciary capacity are not included in the Consolidated Financial Statements. The Corporation accounts for investments in companies for which it owns a voting interest of 20 percent to 50 percent and for which it has the ability to exercise significant influence over operating and financing decisions using the equity method of accounting. These investments are included in other assets and are subject to impairment testing. The Corporations proportionate share of income or loss is included in equity investment income.
The preparation of the Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect reported amounts and disclosures. Actual results could differ from those estimates and assumptions.
These unaudited Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements included in the Corporations 2008 Annual Report on Form 10-K. The nature of the Corporations business is such that the results of any interim period are not necessarily indicative of results for a full year. In the opinion of management, normal recurring adjustments necessary for a fair statement of the interim period results have been made. Certain prior period amounts have been reclassified to conform to current period presentation.
Recently Proposed and Issued Accounting Pronouncements
On April 9, 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 157-4 Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (FSP FAS 157-4). FSP FAS 157-4 provides guidance for determining whether a market is inactive and a transaction is distressed in order to apply the existing fair value measurement guidance in FASB Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157). In addition, FSP FAS 157-4 requires enhanced disclosures regarding financial assets and liabilities that are recorded at fair value. The Corporation elected to early adopt FSP FAS 157-4 effective January 1, 2009 and the adoption did not have a material impact on the Corporations financial condition and results of operations. The enhanced disclosures related to FSP FAS 157-4 are included in Note 16 Fair Value Disclosures.
7
On April 9, 2009, the FASB issued FSP No. FAS 115-2, FAS 124-2 and EITF 99-20-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP FAS 115-2). This FSP requires an entity to recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the noncredit component in other comprehensive income (OCI) when the entity does not intend to sell the security and it is more likely than not that the entity will not be required to sell the security prior to recovery. FSP FAS 115-2 also requires expanded disclosures. The Corporation elected to early adopt FSP FAS 115-2 effective January 1, 2009, resulting in a reduction in other-than-temporary impairment charges recorded in earnings of $277 million, pre-tax, during the first quarter of 2009 and recorded a cumulative-effect adjustment to reclassify $71 million, net-of-tax, from retained earnings to accumulated OCI as of January 1, 2009. FSP FAS 115-2 does not change the recognition of other-than-temporary impairment for equity securities. The expanded disclosures related to FSP FAS 115-2 are included in Note 5 Securities.
On April 9, 2009, the FASB issued FSP No. FAS 107-1 and APB Opinion 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP FAS 107-1). FSP FAS 107-1 requires expanded disclosures for all financial instruments as defined by FAS 107 such as loans that are not measured at fair value through earnings. The expanded disclosure requirements for FSP FAS 107-1 are effective for the Corporations quarterly financial statements for the three months ended June 30, 2009. The adoption of FSP FAS 107-1 will not impact the Corporations financial condition and results of operations.
On April 1, 2009, the FASB issued FSP No. FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies (FSP FAS 141R-1) whereby assets acquired and liabilities assumed in a business combination that arise from contingencies should be recognized at fair value on the acquisition date if fair value can be determined during the measurement period. If fair value cannot be determined, companies should typically account for the acquired contingencies using existing accounting guidance. FSP FAS 141R-1 is effective for new acquisitions consummated on or after January 1, 2009. The Corporation applied FSP FAS 141R-1 to its January 1, 2009 acquisition of Merrill Lynch. See Note 2 Merger and Restructuring Activity for more information on FSP FAS 141R-1.
On September 15, 2008 the FASB released exposure drafts which would amend SFAS No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities a replacement of FASB Statement No. 125 (SFAS 140) and FASB Interpretation (FIN) No. 46 (revised December 2003) Consolidation of Variable Interest Entities an interpretation of ARB No. 51 (FIN 46R). As written, the proposed amendments would, among other things, eliminate the concept of a qualifying special purpose entity (QSPE) and change the standards for consolidation of VIEs. The changes would be effective for both existing and newly-created entities as of January 1, 2010. If adopted as written, the amendments would likely result in the consolidation of certain QSPEs and VIEs that are not currently recorded on the Consolidated Balance Sheet of the Corporation (e.g., credit card securitization trusts and certain mortgage securitizations). Management is continuing to evaluate the impact the exposure drafts would have on the Corporations financial condition and results of operations if adopted as written.
On January 1, 2009, the Corporation adopted FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (FSP EITF 03-6-1). FSP EITF 03-6-1 defines unvested share-based payment awards that contain nonforfeitable rights to dividends as participating securities that should be included in computing earnings per share (EPS) using the two-class method under SFAS No. 128, Earnings Per Share. Additionally, all prior-period EPS data was adjusted retrospectively. The adoption did not have a material impact on the Corporations financial condition and results of operations.
On January 1, 2009, the Corporation adopted SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161) which requires expanded qualitative, quantitative and credit-risk disclosures about derivatives and hedging activities and their effects on the Corporations financial position, financial performance and cash flows. The adoption of SFAS 161 did not impact the Corporations financial condition and results of operations. The expanded disclosures related to SFAS 161 are included in Note 4 Derivatives.
On January 1, 2009, the Corporation adopted FSP No. FAS 140-3, Accounting for Transfers of Financial Assets and Repurchase Financing Transactions (FSP 140-3). FSP 140-3 requires that an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously with, or in contemplation of, the initial transfer be evaluated together as a linked transaction under SFAS 140, unless certain criteria are met. The adoption of FSP 140-3 did not have a material impact on the Corporations financial condition and results of operations.
On January 1, 2009, the Corporation adopted SFAS No. 141 (revised 2007), Business Combinations (SFAS 141R). SFAS 141R modifies the accounting for business combinations and requires, with limited exceptions, the acquirer in a business combination to recognize 100 percent of the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition-date fair value. In addition, SFAS 141R requires the expensing of acquisition-related
8
transaction and restructuring costs, and certain contingent acquired assets and liabilities, as well as contingent consideration, to be recognized at fair value. SFAS 141R also modifies the accounting for certain acquired income tax assets and liabilities. The Corporation applied SFAS 141R to its January 1, 2009 acquisition of Merrill Lynch. See Note 2 Merger and Restructuring Activity for more information on SFAS 141R.
On January 1, 2009, the Corporation adopted SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements (SFAS 160). SFAS 160 requires all entities to report noncontrolling (i.e., minority) interests in subsidiaries as equity in the Consolidated Financial Statements and to account for transactions between an entity and noncontrolling owners as equity transactions if the parent retains its controlling financial interest in the subsidiary. SFAS 160 also requires expanded disclosure that distinguishes between the interests of the controlling owners and the interests of the noncontrolling owners of a subsidiary. The adoption of SFAS 160 did not have a material impact on the Corporations financial condition and results of operations.
NOTE 2 Merger and Restructuring Activity
|
Merrill Lynch
On January 1, 2009, the Corporation acquired Merrill Lynch through its merger with a subsidiary of the Corporation in exchange for common and preferred stock with a value of $29.1 billion, creating a financial services franchise with significantly enhanced wealth management, investment banking and international capabilities. Under the terms of the merger agreement, Merrill Lynch common shareholders received 0.8595 of a share of Bank of America Corporation common stock in exchange for each share of Merrill Lynch common stock. In addition, Merrill Lynch non-convertible preferred shareholders received Bank of America Corporation preferred stock having substantially similar terms. Merrill Lynch convertible preferred stock remains outstanding and is convertible into Bank of America common stock at an equivalent exchange ratio. With the acquisition, the Corporation has one of the largest wealth management businesses in the world with approximately 15,800 financial advisors and more than $1.7 trillion in client assets. Global investment management capabilities include an economic ownership of approximately 50 percent in BlackRock, Inc. (BlackRock), a publicly traded investment management company. In addition, the acquisition adds strengths in debt and equity underwriting, sales and trading, and merger and acquisition advice, creating significant opportunities to deepen relationships with corporate and institutional clients around the globe. Merrill Lynchs results of operations were included in the Corporations results beginning January 1, 2009.
9
The Merrill Lynch merger is being accounted for under the acquisition method of accounting in accordance with SFAS 141R. Accordingly, the purchase price was preliminarily allocated to the acquired assets and liabilities based on their estimated fair values at the Merrill Lynch acquisition date as summarized in the following table. Preliminary goodwill of $5.0 billion is calculated as the purchase premium after adjusting for the fair value of net assets acquired and represents the value expected from the synergies created from combining the Merrill Lynch wealth management and corporate and investment banking businesses with the Corporations capabilities in consumer and commercial banking as well as the economies of scale expected from combining the operations of the two companies. The allocation of the purchase price will be finalized upon completion of the analysis of the fair values of Merrill Lynchs assets and liabilities.
Merrill Lynch Preliminary Purchase Price Allocation | ||||
(Dollars in billions, except per share amounts) | ||||
Purchase price |
||||
Merrill Lynch common shares exchanged (in millions) |
1,600 | |||
Exchange ratio |
0.8595 | |||
The Corporations common shares issued (in millions) |
1,375 | |||
Purchase price per share of the Corporations common stock (1) |
$ | 14.08 | ||
Total value of the Corporations common stock and cash exchanged for fractional shares |
$ | 19.4 | ||
Merrill Lynch preferred stock (2) |
8.6 | |||
Fair value of outstanding employee stock awards |
1.1 | |||
Total purchase price |
29.1 | |||
Preliminary allocation of the purchase price |
||||
Merrill Lynch stockholders equity |
19.9 | |||
Merrill Lynch goodwill and intangible assets |
(2.6 | ) |
Pre-tax adjustments to reflect acquired assets and liabilities at fair value: |
||||
Derivatives and securities |
(1.1 | ) | ||
Loans |
(6.4 | ) | ||
Intangible assets (3) |
5.7 | |||
Other assets |
(1.4 | ) | ||
Long-term debt |
15.5 | |||
Pre-tax total adjustments |
12.3 | |||
Deferred income taxes |
(5.5 | ) | ||
After-tax total adjustments |
6.8 | |||
Fair value of net assets acquired |
24.1 | |||
Preliminary goodwill resulting from the Merrill Lynch merger (4) |
$ | 5.0 | ||
(1) |
The value of the shares of common stock exchanged with Merrill Lynch shareholders was based upon the closing price of the Corporations common stock at December 31, 2008, the last trading day prior to the date of acquisition. |
(2) |
Represents Merrill Lynchs preferred stock exchanged for Bank of America preferred stock having substantially similar terms and also includes $1.5 billion of convertible preferred stock. |
(3) |
Consists of trade name of $1.2 billion and customer relationship and core deposit intangibles of $4.5 billion. The amortization life is 10 years for the customer relationship and core deposit intangibles which will be primarily amortized on a straight-line basis. |
(4) |
No goodwill is expected to be deductible for federal income tax purposes. The goodwill was allocated to Global Wealth & Investment Management and Global Markets. |
10
Preliminary Condensed Statement of Net Assets Acquired
The following condensed statement of net assets acquired reflects the preliminary values assigned to Merrill Lynchs net assets as of the acquisition date.
(Dollars in billions) | January 1, 2009 | ||
Assets |
|||
Federal funds sold and securities borrowed or purchased under agreements to resell |
$ | 138.8 | |
Trading account assets |
87.9 | ||
Derivative assets |
97.1 | ||
Investment securities |
70.5 | ||
Loans and leases |
55.6 | ||
Intangible assets |
5.7 | ||
Other assets |
195.2 | ||
Total assets |
$ | 650.8 | |
Liabilities |
|||
Deposits |
$ | 98.1 | |
Federal funds purchased and securities loaned or sold under agreements to repurchase |
111.6 | ||
Trading account liabilities |
18.1 | ||
Derivative liabilities |
72.0 | ||
Commercial paper and other short-term borrowings |
37.9 | ||
Accrued expenses and other liabilities |
99.6 | ||
Long-term debt |
189.4 | ||
Total liabilities |
626.7 | ||
Fair value of net assets acquired (1) |
$ | 24.1 | |
(1) |
The fair value of net assets acquired excludes preliminary goodwill resulting from the Merrill Lynch merger of $5.0 billion. |
The fair value of net assets acquired includes preliminary fair value adjustments to certain receivables that were not considered impaired as of the acquisition date. These fair value adjustments were determined using incremental spread impacts for credit and liquidity risk which are part of the rate used to discount contractual cash flows. However, the Corporation believes that all contractual cash flows related to these financial instruments will be collected. As such, these receivables were not considered impaired at the acquisition date and were not subject to the requirements of SOP 03-3. Receivables acquired that were not subject to the requirements of SOP 03-3 include non-impaired loans and customer receivables with a preliminary fair value and gross contractual amounts receivable of $152.2 billion and $159.8 billion at the time of acquisition. For more information on the SOP 03-3 portfolio, see Note 6 Outstanding Loans and Leases.
Contingencies
The fair value of net assets acquired includes certain contingent liabilities that were recorded as of the acquisition date. Merrill Lynch has been named as a defendant in various pending legal actions and proceedings arising in connection with its activities as a global diversified financial services institution. Some of these legal actions and proceedings include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. Merrill Lynch is also involved in investigations and/or proceedings by governmental and self-regulatory agencies. Due to the number of variables and assumptions involved in assessing the possible outcome of these legal actions, sufficient information does not exist to reasonably estimate the fair value of these contingent liabilities. As such, these contingences have been measured in accordance with SFAS No. 5, Accounting for Contingencies. For further information, see Note 12 Commitments and Contingencies.
In connection with the Merrill Lynch acquisition, on January 1, 2009, the Corporation recorded certain guarantees, primarily standby liquidity facilities and letters of credit, with a fair value of approximately $1.0 billion. At the time of acquisition the maximum amount that could be drawn from these guarantees ranged from $0 to approximately $20.0 billion.
11
Countrywide
On July 1, 2008, the Corporation acquired Countrywide through its merger with a subsidiary of the Corporation. Under the terms of the agreement, Countrywide shareholders received 0.1822 of a share of Bank of America Corporation common stock in exchange for each share of Countrywide common stock. The acquisition of Countrywide significantly expanded the Corporations mortgage originating and servicing capabilities, making it a leading mortgage originator and servicer. As provided by the merger agreement, 583 million shares of Countrywide common stock were exchanged for 107 million shares of the Corporations common stock. Countrywides results of operations were included in the Corporations results beginning July 1, 2008.
LaSalle
On October 1, 2007, the Corporation acquired all the outstanding shares of ABN AMRO North America Holding Company, parent of LaSalle Bank Corporation (LaSalle), for $21.0 billion in cash. As part of the acquisition, ABN AMRO Bank N.V. (the seller) capitalized approximately $6.3 billion as equity of intercompany debt prior to the date of acquisition. With this acquisition, the Corporation significantly expanded its presence in metropolitan Chicago, Illinois and Michigan by adding LaSalles commercial banking clients, retail customers and banking centers. LaSalles results of operations were included in the Corporations results beginning October 1, 2007.
U.S. Trust Corporation
On July 1, 2007, the Corporation acquired all the outstanding shares of U.S. Trust Corporation for $3.3 billion in cash. The Corporation allocated $1.7 billion to goodwill and $1.2 billion to intangible assets as part of the purchase price allocation. U.S. Trust Corporations results of operations were included in the Corporations results beginning July 1, 2007. The acquisition significantly increased the size and capabilities of the Corporations wealth management business and positions it as one of the largest financial services companies managing private wealth in the U.S.
Unaudited Pro Forma Condensed Combined Financial Information
If the Merrill Lynch and Countrywide mergers had been completed on January 1, 2008, total revenue, net of interest expense would have been $21.4 billion, net income (loss) from continuing operations would have been $(1.4) billion, and basic and diluted earnings (loss) per common share would have been $(0.34) for the three months ended March 31, 2008. These results include the impact of amortizing certain purchase accounting adjustments such as intangible assets as well as fair value adjustments to loans, securities and issued debt. The pro forma financial information does not indicate the impact of possible business model changes nor does it consider any potential impacts of current market conditions or revenues, expense efficiencies, asset dispositions, share repurchases, or other factors. For the three months ended March 31, 2009, Merrill Lynch contributed $10.0 billion in revenue, net of interest expense, and $3.7 billion in net income before certain merger-related costs and revenue opportunities which were realized in legacy Bank of America legal entities.
12
Merger and Restructuring Charges
Merger and restructuring charges are recorded in the Consolidated Statement of Income and include incremental costs to integrate the operations of the Corporation, Merrill Lynch, Countrywide, LaSalle and U.S. Trust Corporation. These charges represent costs associated with these one-time activities and do not represent ongoing costs of the fully integrated combined organization. The following table presents severance and employee-related charges, systems integrations and related charges, and other merger-related charges.
Three Months Ended March 31 | ||||||
(Dollars in millions) | 2009 (1) | 2008 (2) | ||||
Severance and employee-related charges |
$ | 491 | $ | 45 | ||
Systems integrations and related charges |
192 | 90 | ||||
Other |
82 | 35 | ||||
Total merger and restructuring charges |
$ | 765 | $ | 170 | ||
(1) |
Included for the three months ended March 31, 2009 are merger-related charges of $513 million, $193 million and $59 million related to the Merrill Lynch, Countrywide and LaSalle mergers, respectively. |
(2) |
Included for the three months ended March 31, 2008 are merger-related charges of $129 million and $41 million related to the LaSalle and U.S. Trust Corporation mergers. |
During the three months ended March 31, 2009, the $513 million merger-related charges for the Merrill Lynch acquisition included $432 million for severance and other employee-related costs, $38 million of system integration costs and $43 million in other merger-related costs.
Merger-related Exit Cost and Restructuring Reserves
The following table presents the changes in exit cost and restructuring reserves for the three months ended March 31, 2009 and 2008.
Exit Cost Reserves (1) | Restructuring Reserves (2) | |||||||||||||||||
(Dollars in millions) | 2009 | 2008 | 2009 | 2008 | ||||||||||||||
Balance, January 1 |
$ | 523 | $ | 377 | $ | 86 | $ | 108 | ||||||||||
Exit costs and restructuring charges: |
||||||||||||||||||
Merrill Lynch |
n/a | n/a | 382 | - | ||||||||||||||
Countrywide |
- | - | 60 | - | ||||||||||||||
LaSalle |
- | 87 | (1 | ) | 31 | |||||||||||||
U.S. Trust Corporation |
- | - | - | 13 | ||||||||||||||
Cash payments |
(192 | ) | (59 | ) | (135 | ) | (55 | ) | ||||||||||
Balance, March 31 |
$ | 331 | $ | 405 | $ | 392 | $ | 97 | ||||||||||
(1) |
Exit cost reserves were established in purchase accounting resulting in an increase in goodwill. |
(2) |
Restructuring reserves were established by a charge to merger and restructuring charges. |
n/a = not applicable
As of December 31, 2008, there were $523 million of exit cost reserves related to the Countrywide, LaSalle and U.S. Trust Corporation acquisitions, including $347 million for severance, relocation and other employee-related costs and $176 million for contract terminations. During the three months ended March 31, 2009, there were no increases to the exit cost reserves. Cash payments of $192 million during the three months ended March 31, 2009 consisted of $122 million in severance, relocation and other employee-related costs and $70 million in contract terminations. Exit costs were not recorded in purchase accounting for the Merrill Lynch acquisition in accordance with SFAS 141R.
As of December 31, 2008, there were $86 million of restructuring reserves related to the Countrywide, LaSalle and U.S. Trust Corporation acquisitions related to severance and other employee-related costs. During the three months ended March 31, 2009, $441 million was added to the restructuring reserves related to severance and other employee-related costs
13
primarily associated with the Merrill Lynch acquisition. Cash payments of $135 million during the three months ended March 31, 2009 were all related to severance and other employee-related costs.
Payments under exit cost and restructuring reserves associated with the U.S. Trust Corporation acquisition will be substantially completed in 2009 while payments associated with the LaSalle, Countrywide and Merrill Lynch acquisitions will continue into 2010.
NOTE 3 Trading Account Assets and Liabilities
|
The following table presents the fair values of the components of trading account assets and liabilities at March 31, 2009 and December 31, 2008.
(Dollars in millions) | March 31 2009 |
December 31 2008 |
||||||
Trading account assets |
||||||||
U.S. government and agency securities (1) |
$ | 76,575 | $ | 84,660 | ||||
Corporate securities, trading loans and other |
59,721 | 34,056 | ||||||
Equity securities |
28,006 | 20,258 | ||||||
Foreign sovereign debt |
18,647 | 13,614 | ||||||
Mortgage trading loans and asset-backed securities |
20,182 | 6,934 | ||||||
Total trading account assets |
$ | 203,131 | $ | 159,522 | ||||
Trading account liabilities |
||||||||
U.S. government and agency securities |
$ | 23,643 | $ | 32,850 | ||||
Equity securities |
15,946 | 12,128 | ||||||
Foreign sovereign debt |
7,985 | 7,252 | ||||||
Corporate securities and other |
5,419 | 5,057 | ||||||
Total trading account liabilities |
$ | 52,993 | $ | 57,287 | ||||
(1) |
Includes $45.4 billion and $52.6 billion at March 31, 2009 and December 31, 2008 of government-sponsored enterprise obligations. |
14
NOTE 4 Derivatives
|
The Corporation designates derivatives as trading derivatives, economic hedges, or as derivatives used for SFAS 133 accounting purposes. For additional information on the Corporations derivatives and hedging activities, see Note 1 Summary of Significant Accounting Principles to the Consolidated Financial Statements of the Corporations 2008 Annual Report on Form 10-K.
Derivative Balances
The Corporation enters into derivatives to facilitate client transactions, for proprietary trading purposes and to manage risk exposures. The following table identifies derivative instruments included on the Consolidated Balance Sheet in derivative assets and liabilities at March 31, 2009 and December 31, 2008. Balances are provided on a gross basis, prior to the application of the impact 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.
March 31, 2009 | |||||||||||||||||||||||||
Gross Derivative Assets | Gross Derivative Liabilities | ||||||||||||||||||||||||
(Dollars in billions) | Contract/ Notional (1) |
Derivatives Used in Trading Activities and as Economic Hedges |
Derivatives Designated as SFAS 133 Hedging Instruments (2) |
Total | Derivatives Used in Trading Activities and as Economic Hedges |
Derivatives Designated as SFAS 133 Hedging Instruments (2) |
Total | ||||||||||||||||||
Interest rate contracts |
|||||||||||||||||||||||||
Swaps |
$ | 49,870.2 | $ | 1,815.4 | $ | 7.4 | $ | 1,822.8 | $ | 1,769.4 | $ | - | $ | 1,769.4 | |||||||||||
Futures and forwards |
8,961.3 | 10.2 | - | 10.2 | 10.3 | - | 10.3 | ||||||||||||||||||
Written options |
2,858.9 | 0.1 | - | 0.1 | 107.7 | - | 107.7 | ||||||||||||||||||
Purchased options |
2,818.2 | 112.4 | - | 112.4 | 0.7 | - | 0.7 | ||||||||||||||||||
Foreign exchange contracts |
|||||||||||||||||||||||||
Swaps |
647.2 | 28.2 | 4.1 | 32.3 | 38.0 | 1.1 | 39.1 | ||||||||||||||||||
Spot, futures and forwards |
2,042.6 | 50.5 | 0.2 | 50.7 | 50.3 | - | 50.3 | ||||||||||||||||||
Written options |
626.2 | - | - | - | 29.5 | - | 29.5 | ||||||||||||||||||
Purchased options |
612.6 | 30.9 | - | 30.9 | - | - | - | ||||||||||||||||||
Equity contracts |
|||||||||||||||||||||||||
Swaps |
58.3 | 4.1 | - | 4.1 | 2.5 | - | 2.5 | ||||||||||||||||||
Futures and forwards |
1,062.0 | 6.3 | - | 6.3 | 5.1 | - | 5.1 | ||||||||||||||||||
Written options |
602.6 | 4.8 | - | 4.8 | 69.4 | - | 69.4 | ||||||||||||||||||
Purchased options |
380.1 | 55.8 | - | 55.8 | 2.7 | 0.2 | 2.9 | ||||||||||||||||||
Commodity contracts |
|||||||||||||||||||||||||
Swaps |
122.0 | 37.8 | 0.1 | 37.9 | 34.7 | 0.1 | 34.8 | ||||||||||||||||||
Futures and forwards |
1,501.5 | 12.0 | 0.1 | 12.1 | 11.5 | - | 11.5 | ||||||||||||||||||
Written options |
68.6 | - | - | - | 14.3 | - | 14.3 | ||||||||||||||||||
Purchased options |
140.4 | 14.7 | - | 14.7 | - | - | - | ||||||||||||||||||
Credit derivatives |
|||||||||||||||||||||||||
Purchased protection: |
|||||||||||||||||||||||||
Credit default swaps |
2,825.1 | 356.0 | - | 356.0 | 9.3 | - | 9.3 | ||||||||||||||||||
Total return swaps/other |
22.9 | 3.0 | - | 3.0 | 0.1 | - | 0.1 | ||||||||||||||||||
Written protection: |
|||||||||||||||||||||||||
Credit default swaps |
2,773.4 | 10.6 | - | 10.6 | 351.0 | - | 351.0 | ||||||||||||||||||
Total return swaps/other |
42.4 | 0.4 | - | 0.4 | 11.2 | - | 11.2 | ||||||||||||||||||
Gross derivative assets/liabilities |
$ | 2,553.2 | $ | 11.9 | 2,565.1 | $ | 2,517.7 | $ | 1.4 | 2,519.1 | |||||||||||||||
Less: Legally enforceable master netting agreements |
(2,355.0 | ) | (2,355.0 | ) | |||||||||||||||||||||
Less: Cash collateral applied |
(72.8 | ) | (87.5 | ) | |||||||||||||||||||||
Total derivative assets/liabilities |
$ | 137.3 | $ | 76.6 | |||||||||||||||||||||
(1) Represents the total contract/notional amount of the derivatives outstanding and includes both written and purchased protection.
(2) Excludes $2.8 billion of long-term debt designated as a hedge of foreign currency risk.
15
December 31, 2008 | |||||||||||||||||||||||||
Gross Derivative Assets | Gross Derivative Liabilities | ||||||||||||||||||||||||
(Dollars in billions) | Contract/ Notional (1) |
Derivatives Used in Trading Activities and as Economic Hedges |
Derivatives Designated as SFAS 133 Hedging Instruments (2) |
Total | Derivatives Used in Trading Activities and as Economic Hedges |
Derivatives Designated as SFAS 133 Hedging Instruments (2) |
Total | ||||||||||||||||||
Interest rate contracts |
|||||||||||||||||||||||||
Swaps |
$ | 26,577.4 | $ | 1,213.2 | $ | 2.2 | $ | 1,215.4 | $ | 1,186.0 | $ | - | $ | 1,186.0 | |||||||||||
Futures and forwards |
4,432.1 | 5.1 | - | 5.1 | 7.9 | - | 7.9 | ||||||||||||||||||
Written options |
1,731.1 | 0.1 | - | 0.1 | 61.9 | - | 61.9 | ||||||||||||||||||
Purchased options |
1,656.6 | 60.2 | - | 60.2 | 0.8 | - | 0.8 | ||||||||||||||||||
Foreign exchange contracts |
|||||||||||||||||||||||||
Swaps |
438.9 | 17.5 | 3.6 | 21.1 | 20.5 | 1.3 | 21.8 | ||||||||||||||||||
Spot, futures and forwards |
1,376.5 | 52.3 | - | 52.3 | 51.3 | - | 51.3 | ||||||||||||||||||
Written options |
199.8 | - | - | - | 7.5 | - | 7.5 | ||||||||||||||||||
Purchased options |
175.7 | 8.0 | - | 8.0 | - | - | - | ||||||||||||||||||
Equity contracts |
|||||||||||||||||||||||||
Swaps |
34.7 | 1.8 | - | 1.8 | 1.0 | - | 1.0 | ||||||||||||||||||
Futures and forwards |
14.1 | 0.3 | - | 0.3 | 0.1 | - | 0.1 | ||||||||||||||||||
Written options |
214.1 | 5.2 | - | 5.2 | 28.7 | - | 28.7 | ||||||||||||||||||
Purchased options |
217.5 | 27.4 | - | 27.4 | 2.9 | 0.1 | 3.0 | ||||||||||||||||||
Commodity contracts |
|||||||||||||||||||||||||
Swaps |
2.1 | 2.4 | - | 2.4 | 2.1 | - | 2.1 | ||||||||||||||||||
Futures and forwards |
9.6 | 1.2 | - | 1.2 | 1.0 | - | 1.0 | ||||||||||||||||||
Written options |
17.6 | - | - | - | 3.8 | - | 3.8 | ||||||||||||||||||
Purchased options |
15.6 | 3.7 | - | 3.7 | - | - | - | ||||||||||||||||||
Credit derivatives |
|||||||||||||||||||||||||
Purchased protection: |
|||||||||||||||||||||||||
Credit default swaps |
1,025.9 | 125.7 | - | 125.7 | 3.4 | - | 3.4 | ||||||||||||||||||
Total return swaps |
6.6 | 1.8 | - | 1.8 | 0.2 | 0.2 | |||||||||||||||||||
Written protection: |
|||||||||||||||||||||||||
Credit default swaps |
1,000.0 | 3.4 | - | 3.4 | 118.8 | - | 118.8 | ||||||||||||||||||
Total return swaps |
6.2 | 0.4 | - | 0.4 | 0.1 | - | 0.1 | ||||||||||||||||||
Gross derivative assets/liabilities |
$ | 1,529.7 | $ | 5.8 | 1,535.5 | $ | 1,498.0 | $ | 1.4 | 1,499.4 | |||||||||||||||
Less: Legally enforceable master netting agreements |
(1,438.4 | ) | (1,438.4) | ||||||||||||||||||||||
Less: Cash collateral applied |
(34.8 | ) | (30.3) | ||||||||||||||||||||||
Total derivative assets/liabilities |
$ | 62.3 | $ | 30.7 | |||||||||||||||||||||
(1) Represents the total contract/notional amount of the derivatives outstanding and includes both written and purchased protection.
(2) Excludes $2.0 billion of long-term debt designated as a hedge of foreign currency risk.
ALM and Risk Management Derivatives
The Corporations ALM and risk management activities include the use of derivatives to mitigate risk to the Corporation including both derivatives that are designated as SFAS 133 accounting hedges and economic hedges. Interest rate, commodity, credit and foreign exchange contracts are utilized in the Corporations ALM and risk management activities.
The Corporation maintains an overall interest rate risk management strategy that incorporates the use of interest rate contracts to minimize significant fluctuations in earnings that are caused by interest rate volatility. The Corporations goal is to manage interest rate sensitivity so that movements in interest rates do not significantly adversely affect net interest income. As a result of interest rate fluctuations hedged fixed-rate assets and liabilities appreciate or depreciate in market 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 contracts, which are generally non-leveraged generic interest rate and basis swaps, options and futures, allow the Corporation to manage its interest rate risk position. Non-leveraged generic interest rate swaps involve the exchange of fixed-rate and variable-rate interest payments based on the contractual underlying notional amount. Basis
16
swaps involve the exchange of interest payments based on the contractual underlying notional amounts, where both the pay rate and the receive rate are floating rates based on different indices. Option products primarily consist of caps, floors and swaptions. Futures contracts used for the Corporations ALM activities are primarily index futures providing for cash payments based upon the movements of an underlying rate index.
Interest rate and market risk can be substantial in the mortgage business. 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 euro-dollar futures as economic hedges of the fair value of mortgage servicing rights. For additional information on mortgage servicing rights, see Note 17 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 Corporations investments in foreign 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 hedging 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 SFAS 133 Hedging Instruments
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 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 foreign operations determined to have functional currencies other than the U.S. dollar using forward exchange contracts that typically settle in 90 days as well as by issuing foreign-denominated debt.
The following table summarizes certain information related to the Corporations fair value derivative hedges accounted for under SFAS 133 for the three months ended March 31, 2009 and 2008.
Amounts Recognized in Income for the Three Months Ended | |||||||||||||||||||||||
March 31, 2009 | March 31, 2008 | ||||||||||||||||||||||
(Dollars in millions) | Derivative | Hedged Item |
Hedge Ineffectiveness |
Derivative | Hedged Item |
Hedge Ineffectiveness |
|||||||||||||||||
SFAS 133 fair value hedges |
|||||||||||||||||||||||
Interest rate risk on long-term borrowings (1) |
$ | (921 | ) | $ | 805 | $ | (116 | ) | $ | 1,360 | $ | (1,309 | ) | $ | 51 | ||||||||
Interest rate and foreign currency risk on long-term borrowings (1) |
(743 | ) | 759 | 16 | 2,253 | (2,243 | ) | 10 | |||||||||||||||
Commodity price risk on commodity inventory (2) |
56 | (58 | ) | (2 | ) | n/a | n/a | n/a | |||||||||||||||
Total |
$ | (1,608 | ) | $ | 1,506 | $ | (102 | ) | $ | 3,613 | $ | (3,552 | ) | $ | 61 | ||||||||
(1) |
Amounts are recorded in interest expense on long-term debt. |
(2) |
Amounts are recorded in trading account profits (losses). |
n/a = not applicable
17
The following table summarizes certain information related to the Corporations cash flow and net investment hedges accounted for under SFAS 133 for the three months ended March 31, 2009 and 2008. During the next 12 months, net losses in accumulated OCI of approximately $814 million ($514 million after-tax) on derivative instruments that qualified as cash flow hedges under SFAS 133 are expected to be reclassified into earnings. These net losses reclassified into earnings are expected to reduce net interest income related to the respective hedged items.
Three Months Ended March 31 | ||||||||||||||||||||||||||||
2009 | 2008 | |||||||||||||||||||||||||||
(Dollars in millions) | Amounts Recognized in OCI on Derivatives |
Amounts Reclassified from OCI into Income |
Hedge Ineffectiveness and Amount Excluded from |
Amounts Recognized in OCI on Derivatives |
Amounts Reclassified from OCI into Income |
Hedge Ineffectiveness and Amount Excluded from Effectiveness Testing (1) |
||||||||||||||||||||||
SFAS 133 cash flow hedges |
||||||||||||||||||||||||||||
Interest rate risk on variable rate portfolios (2, 3, 4) |
$ | 149 | $ | (409 | ) | $ | 4 | $ | (691 | ) | $ | (278 | ) | $ | (3 | ) | ||||||||||||
Commodity price risk on forecasted purchases and sales (5) |
48 | 3 | - | n/a | n/a | n/a | ||||||||||||||||||||||
Price risk on equity investments included in available-for-sale securities |
(44 | ) | - | - | (68 | ) | - | - | ||||||||||||||||||||
Total |
$ | 153 | $ | (406 | ) | $ | 4 | $ | (759 | ) | $ | (278 | ) | $ | (3 | ) | ||||||||||||
Net investment hedges |
||||||||||||||||||||||||||||
Foreign exchange risk (6) |
$ | 1,016 | $ | - | $ | (80 | ) | $ | 54 | $ | - | $ | (26 | ) | ||||||||||||||
(1) |
Amounts related to SFAS 133 cash flow hedges represent hedge ineffectiveness and amounts related to net investment hedges represent amounts excluded from effectiveness testing. |
(2) |
Losses reclassified from OCI reduced interest income on assets by $42 million and $101 million and increased interest expense $367 million and $177 million during the three months ended March 31, 2009 and 2008 respectively. |
(3) |
Hedge ineffectiveness of $4 million and $0 were recorded in interest income and $0 and $(3) million were recorded in interest expense during the three months ended March 31, 2009 and 2008, respectively. |
(4) |
Amounts recognized in OCI on derivatives excludes amounts related to terminated hedges of available-for-sale securities of $71 million and $39 million for the three months ended March 31, 2009 and 2008. |
(5) |
Gains (losses) reclassified from OCI into income were recorded in trading account profits (losses). |
(6) |
Amounts recognized in OCI on derivatives excludes $33 million related to long-term debt designated as a net investment hedge for the three months ended March 31, 2009. |
n/a = not applicable
18
Economic Hedges
Derivatives designated as economic hedges are used by the Corporation to reduce certain risk exposure but are not accounted for as qualifying SFAS 133 hedges. The following table presents gains (losses) on these derivatives for the three months ended March 31, 2009 and 2008. These gains (losses) are partially offset by the income or expense that is recorded on the economic hedged item.
Three Months Ended March 31 | ||||||||
(Dollars in millions) | 2009 | 2008 | ||||||
Price risk on mortgage banking production income (1, 2) |
$ | 2,255 | $ | 44 | ||||
Interest rate risk on mortgage banking servicing income (1) |
211 | 266 | ||||||
Credit risk on loans and leases (3) |
70 | 338 | ||||||
Interest rate and foreign currency risk on long-term borrowings and other foreign exchange transactions (3) |
(1,330 | ) | 2,208 | |||||
Other (3) |
15 | 62 | ||||||
Total |
$ | 1,221 | $ | 2,918 |
(1) |
Gains (losses) on these derivatives are recorded in mortgage banking income. |
(2) |
Includes gain on interest rate lock commitments related to the origination of mortgage loans that will be held for sale, which are considered derivative instruments, of $2.5 billion and $57 million for the three months ended March 31, 2009 and 2008. |
(3) |
Gains (losses) on these derivatives are recorded in other income. |
Sales and Trading Revenue
The Corporation enters into trading derivatives to facilitate client transactions, for proprietary trading purposes, and to manage risk exposures arising from trading assets and liabilities. It is the Corporations policy to include these derivative instruments in its trading activities which includes derivative and non-derivative cash instruments. The resulting risk from these derivatives is managed on a portfolio basis as part of our Global Markets business segment. The related sales and trading revenue generated within Global Markets is recorded on different income statement line items including trading account profits (losses) and net interest income as well as other revenue categories. The vast majority of income related to derivative instruments is recorded in trading account profits (losses). The following table identifies the amounts in the income statement line items attributable to trading activities including both derivative and non-derivative cash instruments categorized by primary risk for the three months ended March 31, 2009 and 2008.
Three Months Ended March 31 | ||||||||||||||||||||||||||||||||
2009 | 2008 | |||||||||||||||||||||||||||||||
(Dollars in millions) | Trading Account Profits |
Other Revenues (1) |
Net Interest Income |
Total | Trading Account Profits (Losses) |
Other Revenues (1) |
Net Interest Income |
Total | ||||||||||||||||||||||||
Interest rate risk |
$ | 2,792 | $ | 6 | $ | 311 | $ | 3,109 | $ | 352 | $ | 11 | $ | 1 | $ | 364 | ||||||||||||||||
Foreign exchange risk |
452 | - | (8 | ) | 444 | 326 | - | 7 | 333 | |||||||||||||||||||||||
Equity risk |
785 | 564 | 53 | 1,402 | 2 | 206 | 91 | 299 | ||||||||||||||||||||||||
Commodity risk |
663 | (67 | ) | (60 | ) | 536 | 8 | - | 1 | 9 | ||||||||||||||||||||||
Credit risk |
191 | (1,216 | ) | 1,432 | 407 | (2,281 | ) | (1,235 | ) | 927 | (2,589) | |||||||||||||||||||||
Other risk |
36 | 48 | (81 | ) | 3 | (9 | ) | 21 | 9 | 21 | ||||||||||||||||||||||
Total sales and trading revenue |
4,919 | (665 | ) | 1,647 | 5,901 | (1,602 | ) | (997 | ) | 1,036 | (1,563) | |||||||||||||||||||||
Non-sales and tradingrelated revenue (2) |
282 | n/a | n/a | 282 | (181 | ) | n/a | n/a | (181) | |||||||||||||||||||||||
Total |
$ | 5,201 | $ | (665 | ) | $ | 1,647 | $ | 6,183 | $ | (1,783 | ) | $ | (997 | ) | $ | 1,036 | $ | (1,744) | |||||||||||||
(1) |
Represents investment and brokerage services and other income that is recorded in Global Markets that the Corporation includes in its definition of sales and trading revenue. |
(2) |
Includes certain trading account profits (losses) that are not included in Global Markets. |
19
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 predefined 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 in which the Corporation is the seller of credit protection and their expiration at March 31, 2009 and December 31, 2008 are summarized as follows. These instruments have been classified as investment and non-investment grade based on the credit quality of the underlying reference obligation.
March 31, 2009 | |||||||||||||||
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 (1) |
$ | 2,763 | $ | 22,614 | $ | 64,078 | $ | 68,483 | $ | 157,938 | |||||
Non-investment grade (2) |
6,014 | 39,499 | 75,995 | 71,554 | 193,062 | ||||||||||
Total |
8,777 | 62,113 | 140,073 | 140,037 | 351,000 | ||||||||||
Total return swaps/other: |
|||||||||||||||
Investment grade (1) |
18 | 505 | 235 | 3,826 | 4,584 | ||||||||||
Non-investment grade (2) |
60 | 192 | 519 | 5,859 | 6,630 | ||||||||||
Total |
78 | 697 | 754 | 9,685 | 11,214 | ||||||||||
Total credit derivatives |
$ | 8,855 | $ | 62,810 | $ | 140,827 | $ | 149,722 | $ | 362,214 | |||||
Maximum Payout/Notional | |||||||||||||||
Credit default swaps: |
|||||||||||||||
Investment grade (1) |
$ | 106,872 | $ | 321,023 | $ | 872,816 | $ | 545,709 | $ | 1,846,420 | |||||
Non-investment grade (2) |
78,168 | 229,527 | 326,543 | 292,722 | 926,960 | ||||||||||
Total |
185,040 | 550,550 | 1,199,359 | 838,431 | 2,773,380 | ||||||||||
Total return swaps/other: |
|||||||||||||||
Investment grade (1) |
1,271 | 1,885 | 1,653 | 13,184 | 17,993 | ||||||||||
Non-investment grade (2) |
623 | 883 | 1,067 | 21,808 | 24,381 | ||||||||||
Total |
1,894 | 2,768 | 2,720 | 34,992 | 42,374 | ||||||||||
Total credit derivatives |
$ | 186,934 | $ | 553,318 | $ | 1,202,079 | $ | 873,423 | $ | 2,815,754 | |||||
December 31, 2008 | |||||||||||||||
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 (1) |
$ | 1,039 | $ | 13,062 | $ | 32,594 | $ | 29,153 | $ | 75,848 | |||||
Non-investment grade (2) |
1,483 | 9,222 | 19,243 | 13,012 | 42,960 | ||||||||||
Total |
2,522 | 22,284 | 51,837 | 42,165 | 118,808 | ||||||||||
Total return swaps/other: |
|||||||||||||||
Investment grade (1) |
- | - | - | - | - | ||||||||||
Non-investment grade (2) |
36 | 8 | - | 13 | 57 | ||||||||||
Total |
36 | 8 | - | 13 | 57 | ||||||||||
Total credit derivatives |
$ | 2,558 | $ | 22,292 | $ | 51,837 | $ | 42,178 | $ | 118,865 | |||||
Maximum Payout/Notional | |||||||||||||||
Credit default swaps: |
|||||||||||||||
Investment grade (1) |
$ | 49,535 | $ | 169,508 | $ | 395,768 | $ | 187,075 | $ | 801,886 | |||||
Non-investment grade (2) |
17,217 | 48,829 | 89,650 | 42,452 | 198,148 | ||||||||||
Total |
66,752 | 218,337 | 485,418 | 229,527 | 1,000,034 | ||||||||||
Total return swaps/other: |
|||||||||||||||
Investment grade (1) |
- | - | - | - | - | ||||||||||
Non-investment grade (2) |
1,178 | 628 | 37 | 4,360 | 6,203 | ||||||||||
Total |
1,178 | 628 | 37 | 4,360 | 6,203 | ||||||||||
Total credit derivatives |
$ | 67,930 | $ | 218,965 | $ | 485,455 | $ | 233,887 | $ | 1,006,237 | |||||
(1) The Corporation considers ratings of BBB- or higher as meeting the definition of investment grade. (2) Includes non-rated credit derivative instruments. |
For most credit derivatives, the notional value represents the maximum amount payable by the Corporation. However, the Corporation does not exclusively monitor its exposure to credit derivatives based on notional value because this measure does not take into consideration the probability of occurrence. As such, the notional value is not a reliable indicator of the Corporations 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, predefined 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 value and notional value of written credit protection for which the Corporation held purchased protection with identical underlying referenced names at March 31, 2009 was $307.2 billion and $2.4 trillion compared to $92.4 billion and $819.4 billion at December 31, 2008.
20
Credit Risk Management of Derivatives and Credit-related Contingent Features
The Corporation executes the majority of its derivative positions in the over-the-counter 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 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 discussed above, 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 Corporations derivative contracts contain credit risk-related contingent features, primarily in the form of International Swaps and Derivatives Association, Inc. (ISDA) master agreements that aid in enhancing the creditworthiness of these instruments as 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 in respect to changes in the Corporations creditworthiness. At March 31, 2009, the Corporation had received cash and securities collateral of $85.7 billion and posted cash and securities collateral of $105.4 billion in the normal course of business under derivative agreements.
The Corporation records counterparty credit risk valuation adjustments on certain derivatives assets, including our credit default protection purchased, in order to properly reflect the credit quality of the counterparty in accordance with SFAS 157. 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 risk valuation adjustments can be reversed or otherwise adjusted in future periods due to changes in the value of the derivative contract, collateral, and creditworthiness of the counterparty. During the three months ended March 31, 2009 and 2008, valuation adjustments of $185 million and $762 million were recognized as trading account losses for counterparty credit risk. At March 31, 2009, the cumulative counterparty credit risk valuation adjustment that was netted against the derivative asset balance was $13.5 billion.
In addition, the fair value of the Corporation or its subsidiaries derivative liabilities is adjusted to reflect the impact of the Corporations credit quality. During the three months ended March 31, 2009 and 2008, valuation adjustments of $1.7 billion and $153 million were recognized as trading account profits for changes in the Corporation or its subsidiaries credit risk. At March 31, 2009, the Corporations cumulative credit risk valuation adjustment that was netted against the derivative liabilities balance was $3.2 billion.
21
NOTE 5 Securities
|
The amortized cost, gross unrealized gains and losses, and fair value of AFS debt and marketable equity securities at March 31, 2009 and December 31, 2008 were:
(Dollars in millions) | Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value | |||||||||
Available-for-sale debt securities, March 31, 2009 |
|||||||||||||
U.S. Treasury securities and agency debentures |
$ | 4,353 | $ | 249 | $ | (9 | ) | $ | 4,593 | ||||
Mortgage-backed securities: |
|||||||||||||
Agency MBSs |
136,194 | 3,116 | (130 | ) | 139,180 | ||||||||
Agency collateralized mortgage obligations |
20,842 | 365 | (51 | ) | 21,156 | ||||||||
Non-agency MBSs |
58,129 | 1,649 | (10,941 | ) | 48,837 | ||||||||
Foreign securities |
5,363 | 5 | (940 | ) | 4,428 | ||||||||
Corporate/Agency bonds |
5,588 | 37 | (1,142 | ) | 4,483 | ||||||||
Other taxable securities (1) |
22,539 | 61 | (653 | ) | 21,947 | ||||||||
Total taxable securities |
253,008 | 5,482 | (13,866 | ) | 244,624 | ||||||||
Tax-exempt securities |
10,142 | 83 | (655 | ) | 9,570 | ||||||||
Total available-for-sale debt securities |
$ | 263,150 | $ | 5,565 | $ | (14,521 | ) | $ | 254,194 | ||||
Available-for-sale marketable equity securities (2) |
$ | 17,456 | $ | 5,705 | $ | (1,340 | ) | $ | 21,821 | ||||
Available-for-sale debt securities, December 31, 2008 |
|||||||||||||
U.S. Treasury securities and agency debentures |
$ | 4,540 | $ | 121 | $ | (14 | ) | $ | 4,647 | ||||
Mortgage-backed securities: |
|||||||||||||
Agency MBSs |
191,913 | 3,064 | (146 | ) | 194,831 | ||||||||
Non-agency MBSs |
43,224 | 860 | (9,337 | ) | 34,747 | ||||||||
Foreign securities |
5,675 | 6 | (678 | ) | 5,003 | ||||||||
Corporate/Agency bonds |
5,560 | 31 | (1,022 | ) | 4,569 | ||||||||
Other taxable securities (1) |
24,832 | 11 | (1,300 | ) | 23,543 | ||||||||
Total taxable securities |
275,744 | 4,093 | (12,497 | ) | 267,340 | ||||||||
Tax-exempt securities |
10,501 | 44 | (981 | ) | 9,564 | ||||||||
Total available-for-sale debt securities |
$ | 286,245 | $ | 4,137 | $ | (13,478 | ) | $ | 276,904 | ||||
Available-for-sale marketable equity securities (2) |
$ | 18,892 | $ | 7,717 | $ | (1,537 | ) | $ | 25,072 |
(1) |
Includes ABS. |
(2) |
Represents those AFS marketable equity securities that are recorded in other assets on the Consolidated Balance Sheet. At March 31, 2009 and December 31, 2008, approximately $16.8 billion and $19.7 billion of the fair value balance, including $5.7 billion and $7.7 billion of unrealized gain on the restricted shares, represents China Construction Bank (CCB) shares. |
At March 31, 2009, the amortized cost and fair value of held-to-maturity debt securities was $8.4 billion and $6.6 billion, which includes asset-backed securities that were issued by the Corporations credit card securitization trust and retained by the Corporation with an amortized cost of $7.8 billion and a fair value of $5.9 billion. At December 31, 2008, both the amortized cost and fair value of held-to-maturity debt securities was $685 million. The accumulated net unrealized gains (losses) on AFS debt and marketable equity securities included in accumulated OCI were $(2.9) billion and $(2.0) billion, net of the related income tax expense (benefit) of $(1.7) billion and $(1.1) billion. At March 31, 2009 and December 31, 2008, the Corporation had nonperforming AFS debt securities of $270 million and $291 million.
The Corporation obtained certain securities as part of the Merrill acquisition with evidence of deterioration and for which it was probable that all contractually required payments would not be collected. The securities par value was approximately $6.6 billion and fair value was approximately $1.8 billion as of the merger date.
The Corporation adopted the provisions of FSP FAS 115-2 as of January 1, 2009. As prescribed by FSP FAS 115-2, for the three months ended March 31, 2009, the Corporation recognized the credit component of an other-than-temporary impairment of its debt securities in earnings and the noncredit component in OCI for those securities in which the Corporation does not intend to sell the security and it is more likely than not that the Corporation will not be required to sell the security prior to recovery. Had the Corporation not adopted FSP FAS 115-2, the Corporation would have recognized an additional $277 million, pre-tax, in other-than-temporary impairment charges during the three months ended March 31, 2009. In addition, $71 million, net-of-tax, of other-than-temporary impairment charges previously recorded through earnings were reclassified to OCI with an offset to retained earnings as a cumulative-effect adjustment.
22
During the three months ended March 31, 2009, the Corporation recorded other-than-temporary impairment losses on AFS debt securities as follows:
(Dollars in millions) | Non-agency MBSs | CDOs (1) | Other | Total | ||||||||||||
Total other-than-temporary impairment losses (unrealized and realized) |
$ | (361 | ) | $ | (308 | ) | $ | (45 | ) | $ | (714 | ) | ||||
Unrealized other-than-temporary impairment losses recognized in OCI (2) |
343 | - | - | 343 | ||||||||||||
Net impairment losses recognized in earnings (3) |
$ | (18 | ) | $ | (308 | ) | $ | (45 | ) | $ | (371 | ) |
(1) |
Includes CDOs and CDO related securities repurchased from liquidating vehicles. |
(2) |
Represents the noncredit component impact of the other-than-temporary impairment on AFS debt securities. |
(3) |
Represents the credit component of the other-than-temporary impairment on AFS debt securities. |
Activity related to the credit component recognized in earnings on debt securities held by the Corporation for which a portion of other-than-temporary impairment was recognized in OCI for the three months ended March 31, 2009 is as follows:
(Dollars in millions) | Total | ||
Balance, January 1, 2009 |
$ | - | |
Credit component of other-than-temporary impairment not reclassified to OCI in conjunction with the cumulative effect transition adjustment (1) |
22 | ||
Additions for the credit component on debt securities in which other-than-temporary impairment was not previously recognized |
18 | ||
Balance, March 31, 2009 |
$ | 40 |
(1) |
As of January 1, 2009, the Corporation had securities with $134 million of other-than-temporary impairment previously recognized in earnings of which $22 million represented the credit component and $112 million represented the noncredit component which was reclassified back to OCI through a cumulative-effect transition adjustment. |
As of March 31, 2009, those debt securities with other-than-temporary impairment in which only the amount of loss related to credit was recognized in earnings consisted entirely of non-agency mortgage-backed securities. The Corporation estimates the portion of loss attributable to credit using a discounted cash flow model. The Corporation estimates the cash flows of the underlying collateral using internal credit risk, interest rate and prepayment risk models that incorporate managements best estimate of current key assumptions, such as default rates, loss severity and prepayment rates. Assumptions used can vary widely from loan to loan, and are influenced by such factors as loan interest rate, geographical location of the borrower, borrower characteristics and collateral type. The Corporation then uses a third party vendor to obtain information about the structure in order to determine how the underlying collateral cash flows will be distributed to each security issued from the structure. Expected principal and interest cash flows on the impaired debt security are discounted using an observable discount rate for similar instruments with adjustments that management believes a market participant would consider in determining fair value for the specific security.
The Corporations discounted cash flow model utilizes relevant assumptions such as prepayment rate, default rate, and loss severity on a loan level basis. Based on the expected cash flows derived from the model, the Corporation expects to recover the remaining unrealized losses on non-agency mortgage-backed securities. Significant assumptions used in the valuation of non-agency mortgage-backed securities were as follows as of March 31, 2009.
Range | |||||||||
Weighted average |
Minimum | Maximum | |||||||
Prepayment rates |
11.6 | % | 1.5 | % | 25.7 | % | |||
Default rates |
17.5 | 3.6 | 46.8 | ||||||
Loss severity |
43 | 13 | 62 |
During the three months ended March 31, 2009 and 2008, the Corporation recognized $326 million and $14 million of other-than-temporary impairment losses on AFS marketable equity securities.
23
The following table presents the current fair value and the associated gross unrealized losses only on investments in securities with gross unrealized losses at March 31, 2009 and December 31, 2008 including debt securities for which a portion of other-than-temporary impairment has been recognized in OCI. The table also discloses whether these securities have had gross unrealized losses for less than twelve months, or for twelve months or longer.
Less than twelve months | Twelve months or longer | Total | |||||||||||||||||||
(Dollars in millions) | Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
Fair Value |
Gross Unrealized Losses |
|||||||||||||||
Temporarily-impaired available-for-sale debt securities as of March 31, 2009 |
|||||||||||||||||||||
U.S. Treasury securities and agency debentures |
$ | 321 | $ | (9 | ) | $ | - | $ | - | $ | 321 | $ | (9 | ) | |||||||
Mortgage-backed securities: |
|||||||||||||||||||||
Agency MBSs |
4,764 | (128 | ) | 222 | (2 | ) | 4,986 | (130 | ) | ||||||||||||
Agency collateralized mortgage obligations |
4,586 | (51 | ) | - | - | 4,586 | (51 | ) | |||||||||||||
Non-agency MBSs |
30,198 | (7,102 | ) | 7,499 | (3,496 | ) | 37,697 | (10,598 | ) | ||||||||||||
Foreign securities |
942 | (792 | ) | 1,933 | (148 | ) | 2,875 | (940 | ) | ||||||||||||
Corporate/Agency bonds |
2,364 | (992 | ) | 891 | (150 | ) | 3,255 | (1,142 | ) | ||||||||||||
Other taxable securities |
10,881 | (583 | ) | 505 | (70 | ) | 11,386 | (653 | ) | ||||||||||||
Total taxable securities |
54,056 | (9,657 | ) | 11,050 | (3,866 | ) | 65,106 | (13,523 | ) | ||||||||||||
Tax-exempt securities |
1,203 | (84 | ) | 6,200 | (571 | ) | 7,403 | (655 | ) | ||||||||||||
Total temporarily-impaired available-for-sale debt securities |
55,259 | (9,741 | ) | 17,250 | (4,437 | ) | 72,509 | (14,178 | ) | ||||||||||||
Temporarily-impaired available-for-sale marketable equity securities |
4,077 | (422 | ) | 1,109 | (918 | ) | 5,186 | (1,340 | ) | ||||||||||||
Total temporarily-impaired available-for-sale securities |
$ | 59,336 | $ | (10,163 | ) | $ | 18,359 | $ | (5,355 | ) | $ | 77,695 | $ | (15,518 | ) | ||||||
Other-than-temporarily impaired available-for-sale debt securities |
|||||||||||||||||||||
Mortgage-backed securities: |
|||||||||||||||||||||
Non-agency MBSs |
575 | (159 | ) | 331 | (184 | ) | 906 | (343 | ) | ||||||||||||
Total temporarily-impaired and other-than-temporarily impaired available-for-sale securities |
$ | 59,911 | $ | (10,322 | ) | $ | 18,690 | $ | (5,539 | ) | $ | 78,601 | $ | (15,861 | ) | ||||||
Temporarily-impaired available-for-sale debt securities as of December 31, 2008 |
|||||||||||||||||||||
U.S. Treasury securities and agency debentures |
$ | 306 | $ | (14 | ) | $ | - | $ | - | $ | 306 | $ | (14 | ) | |||||||
Mortgage-backed securities: |
|||||||||||||||||||||
Agency MBSs |
2,282 | (12 | ) | 7,508 | (134 | ) | 9,790 | (146 | ) | ||||||||||||
Non-agency MBSs |
20,068 | (6,776 | ) | 4,141 | (2,561 | ) | 24,209 | (9,337 | ) | ||||||||||||
Foreign securities |
3,491 | (562 | ) | 1,126 | (116 | ) | 4,617 | (678 | ) | ||||||||||||
Corporate/Agency bonds |
2,573 | (934 | ) | 666 | (88 | ) | 3,239 | (1,022 | ) | ||||||||||||
Other taxable securities |
12,870 | (1,077 | ) | 501 | (223 | ) | 13,371 | (1,300 | ) | ||||||||||||
Total taxable securities |
41,590 | (9,375 | ) | 13,942 | (3,122 | ) | 55,532 | (12,497 | ) | ||||||||||||
Tax-exempt securities |
6,386 | (682 | ) | 1,540 | (299 | ) | 7,926 | (981 | ) | ||||||||||||
Total temporarily-impaired available-for-sale debt securities |
47,976 | (10,057 | ) | 15,482 | (3,421 | ) | 63,458 | (13,478 | ) | ||||||||||||
Temporarily-impaired available-for-sale marketable equity securities |
3,431 | (499 | ) | 1,555 | (1,038 | ) | 4,986 | (1,537 | ) | ||||||||||||
Total temporarily-impaired available-for-sale securities |
$ | 51,407 | $ | (10,556 | ) | $ | 17,037 | $ | (4,459 | ) | $ | 68,444 | $ | (15,015 | ) |
24
At March 31, 2009, the amortized cost of approximately 16,000 AFS securities, including securities with other-than-temporary impairment in which a portion of the impairment remains in OCI, exceeded their fair value by $15.9 billion. Included in the $15.9 billion of gross unrealized losses on these AFS securities at March 31, 2009, was $10.3 billion of gross unrealized losses that have existed for less than twelve months and $5.5 billion of gross unrealized losses that have existed for a period of twelve months or longer. Of the gross unrealized losses existing for twelve months or more, $3.7 billion, or 66 percent, of the gross unrealized loss is related to approximately 200 mortgage-backed securities primarily due to continued deterioration in non-agency MBS values driven by a lack of market liquidity. The Corporation does not intend to sell these securities and it is more likely than not that the Corporation will not be required to sell these securities before recovery of its amortized cost basis. In addition, $918 million, or 17 percent, of the gross unrealized loss is related to approximately 300 AFS marketable equity securities primarily due to the overall decline in the market during the three months ended March 31, 2009 as well as the full year of 2008. The Corporation has the ability and intent to hold these securities for a period of time sufficient to recover all gross unrealized losses.
The Corporation had investments in AFS mortgage-backed securities from Fannie Mae, Freddie Mac and Ginnie Mae that exceeded 10 percent of consolidated shareholders equity as of March 31, 2009. These investments had market values of $83.8 billion, $29.9 billion and $25.5 billion at March 31, 2009 and total amortized costs of $82.1 billion, $29.2 billion and $24.9 billion, respectively. The Corporation had investments in AFS debt securities from Fannie Mae, Freddie Mac and Ginnie Mae that exceeded 10 percent of consolidated shareholders equity as of December 31, 2008. These investments had market values of $104.1 billion, $46.9 billion and $44.6 billion at December 31, 2008 and total amortized costs of $102.9 billion, $46.1 billion and $43.7 billion, respectively.
Securities are pledged or assigned to secure borrowed funds, government and trust deposits and for other purposes. The carrying value of pledged securities was $127.2 billion and $158.9 billion at March 31, 2009 and December 31, 2008.
The expected maturity distribution of the Corporations mortgage-backed securities and the contractual maturity distribution of the Corporations other debt securities, and the yields of the Corporations AFS debt securities portfolio at March 31, 2009 are summarized in the following table. Actual maturities may differ from the contractual or expected maturities since borrowers may have the right to prepay obligations with or without prepayment penalties.
March 31, 2009 | ||||||||||||||||||||||||||||||||
Due in one year or less | Due after one year through five years |
Due after five years through ten years |
Due after ten years | Total | ||||||||||||||||||||||||||||
(Dollars in millions) | Amount | Yield (1) | Amount | Yield (1) | Amount | Yield (1) | Amount | Yield (1) | Amount | Yield (1) | ||||||||||||||||||||||
Fair value of available-for-sale debt securities |
||||||||||||||||||||||||||||||||
U.S. Treasury securities and agency debentures |
$ | 151 | 2.44 | % | $ | 1,090 | 4.93 | % | $ | 2,393 | 5.10 | % | $ | 959 | 5.40 | % | $ | 4,593 | 5.03 | % | ||||||||||||
Mortgage-backed securities: |
||||||||||||||||||||||||||||||||
Agency MBSs |
13 | 6.08 | 29,641 | 5.40 | 102,504 | 5.12 | 7,022 | 5.24 | 139,180 | 5.18 | ||||||||||||||||||||||
Agency collateralized mortgage obligations |
139 | 1.19 | 10,153 | 1.95 | 10,773 | 1.77 | 91 | 1.44 | 21,156 | 1.86 | ||||||||||||||||||||||
Non-agency MBSs |
2,885 | 5.30 | 22,422 | 11.46 | 13,993 | 9.39 | 9,537 | 4.90 | 48,837 | 9.21 | ||||||||||||||||||||||
Foreign securities |
1,081 | 4.88 | 3,009 | 6.12 | 22 | 3.30 | 316 | 5.98 | 4,428 | 5.83 | ||||||||||||||||||||||
Corporate/Agency bonds |
281 | 4.79 | 1,824 | 5.14 | 2,234 | 10.91 | 144 | 6.37 | 4,483 | 8.46 | ||||||||||||||||||||||
Other taxable securities |
10,196 | 1.30 | 11,098 | 6.25 | 41 | 4.23 | 612 | 3.27 | 21,947 | 3.78 | ||||||||||||||||||||||
Total taxable securities |
14,746 | 2.53 | 79,237 | 7.08 | 131,960 | 5.44 | 18,681 | 5.01 | 244,624 | 5.86 | ||||||||||||||||||||||
Tax-exempt securities (2) |
217 | 5.53 | 1,464 | 6.02 | 2,590 | 6.49 | 5,299 | 6.89 | 9,570 | 6.64 | ||||||||||||||||||||||
Total available-for-sale debt securities |
$ | 14,963 | 2.57 | $ | 80,701 | 7.06 | $ | 134,550 | 5.52 | $ | 23,980 | 5.42 | $ | 254,194 | 5.82 | |||||||||||||||||
Amortized cost of available-for-sale debt securities |
$ | 15,871 | $ | 84,886 | $ | 134,955 | $ | 27,438 | $ | 263,150 | ||||||||||||||||||||||
(1) |
Yields are calculated based on the amortized cost of the securities. |
(2) |
Yields of tax-exempt securities are calculated on a fully taxable-equivalent (FTE) basis. |
25
The components of realized gains and losses on sales of debt securities for the three months ended March 31, 2009 and 2008 were:
Three months ended March 31 | ||||||||||
(Dollars in millions) | 2009 | 2008 | ||||||||
Gross gains |
$ | 1,537 | $ | 246 | ||||||
Gross losses |
(39 | ) | (21 | ) | ||||||
Net gains on sales of debt securities |
$ | 1,498 | $ | 225 | ||||||
The income tax expense attributable to realized net gains on debt securities sales was $554 million and $83 million for the three months ended March 31, 2009 and 2008.
Certain Corporate and Strategic Investments
At March 31, 2009 and December 31, 2008, the Corporation owned approximately 16.7 percent, or 39.1 billion common shares and 19 percent, or 44.7 billion common shares of CCB. During January 2009, the Corporation sold 5.6 billion common shares of our initial investment of 19.1 billion common shares in CCB for a pre-tax gain of approximately $1.9 billion. The remaining initial investment of 13.5 billion common shares is accounted for at fair value and recorded as AFS marketable equity securities in other assets with an offset, net-of-tax, to accumulated OCI. These shares became transferable in October 2008. During 2008, under the terms of the purchase option the Corporation increased its ownership by purchasing approximately 25.6 billion common shares, or $9.2 billion of CCB. These recently purchased shares are accounted for at cost, are recorded in other assets and are non-transferable until August 2011. At March 31, 2009 and December 31, 2008, the cost of the CCB investment was $11.1 billion and $12.0 billion and the carrying value was $16.8 billion and $19.7 billion. Dividend income on this investment is recorded in equity investment income.
Additionally, the Corporation owned approximately 171.3 million of preferred shares and 51.3 million of common shares of Banco Itaú Holding Financeira S.A. (Banco Itaú) at March 31, 2009 and December 31, 2008. The Banco Itaú investment is accounted for at fair value and recorded as AFS marketable equity securities in other assets with an offset, net-of-tax, to accumulated OCI. Dividend income on this investment is recorded in equity investment income. At both March 31, 2009 and December 31, 2008, the cost of this investment was $2.6 billion and the fair value was $2.5 billion.
At March 31, 2009 and December 31, 2008, the Corporation had a 24.9 percent, or $2.2 billion and $2.1 billion, investment in Grupo Financiero Santander, S.A., the subsidiary of Grupo Santander, S.A. This investment is recorded in other assets and is accounted for under the equity method of accounting with income being recorded in equity investment income.
As part of the acquisition of Merrill Lynch, the Corporation acquired an economic ownership in BlackRock, a publicly traded investment company. At March 31, 2009, the Corporation had an approximate 50 percent, or $8.6 billion, economic ownership in BlackRock. This economic ownership is recorded in other assets and is accounted for under the equity method of accounting with income being recorded in equity investment income.
For additional information on securities, see Note 1 Summary of Significant Accounting Principles to the Consolidated Financial Statements of the Corporations 2008 Annual Report on Form 10-K.
26
NOTE 6 Outstanding Loans and Leases |
Outstanding loans and leases at March 31, 2009 and December 31, 2008 were:
(Dollars in millions) | March 31 2009 |
December 31 2008 |
||||||
Consumer |
||||||||
Residential mortgage (1) |
$ | 261,583 | $ | 248,063 | ||||
Home equity |
157,645 | 152,483 | ||||||
Discontinued real estate (2) |
19,000 | 19,981 | ||||||
Credit card domestic |
51,309 | 64,128 | ||||||
Credit card foreign |
16,651 | 17,146 | ||||||
Direct/Indirect consumer (3) |
99,696 | 83,436 | ||||||
Other consumer (4) |
3,297 | 3,442 | ||||||
Total consumer |
609,181 | 588,679 | ||||||
Commercial |
||||||||
Commercial domestic (5) |
229,779 | 219,233 | ||||||
Commercial real estate (6) |
75,269 | 64,701 | ||||||
Commercial lease financing |
22,017 | 22,400 | ||||||
Commercial foreign |
33,407 | 31,020 | ||||||
Total commercial loans |
360,472 | 337,354 | ||||||
Commercial loans measured at fair value (7) |
7,355 | 5,413 | ||||||
Total commercial |
367,827 | 342,767 | ||||||
Total loans and leases |
$ | 977,008 | $ | 931,446 | ||||
(1) |
Includes foreign residential mortgages of $651 million at March 31, 2009. |
(2) |
Includes $17.3 billion and $18.2 billion of pay option loans and $1.7 billion and $1.8 billion of subprime loans at March 31, 2009 and December 31, 2008 obtained as part of the acquisition of Countrywide. The Corporation no longer originates these products. |
(3) |
Includes foreign consumer loans of $7.5 billion and $1.8 billion at March 31, 2009 and December 31, 2008. |
(4) |
Includes consumer finance loans of $2.5 billion and $2.6 billion, and other foreign consumer loans of $618 million and $618 million at March 31, 2009 and December 31, 2008. |
(5) |
Includes small business commercial domestic loans, primarily card related, of $18.8 billion and $19.1 billion at March 31, 2009 and December 31, 2008. |
(6) |
Includes domestic commercial real estate loans of $73.0 billion and $63.7 billion, and foreign commercial real estate loans of $2.2 billion and $979 million at March 31, 2009 and December 31, 2008. |
(7) |
Certain commercial loans are measured at fair value in accordance with SFAS 159 and include commercial domestic loans of $4.8 billion and $3.5 billion, commercial foreign loans of $2.5 billion and $1.7 billion, and commercial real estate loans of $89 million and $203 million at March 31, 2009 and December 31, 2008. See Note 16 Fair Value Disclosures for additional discussion of fair value for certain financial instruments. |
The Corporation mitigates a portion of its credit risk in the residential mortgage portfolio through cash collateralized synthetic securitizations which provide mezzanine risk protection and are designed to reimburse the Corporation in the event that losses exceed 10 bps of the original pool balance. As of March 31, 2009 and December 31, 2008, $104.7 billion and $109.3 billion of mortgage loans were protected by these agreements. During the three months ended March 31, 2009, $388 million was recognized in other income for amounts that will be reimbursed under these structures. As of March 31, 2009, the Corporation had a receivable of $874 million for credit and other related costs recognized on referenced loans from these structures. In addition, the Corporation has entered into credit protection agreements with government-sponsored enterprises on $9.1 billion and $9.6 billion as of March 31, 2009 and December 31, 2008, providing full protection on conforming residential mortgage loans that become severely delinquent. Combined these structures provided risk mitigation for approximately 44 percent and 48 percent of the residential mortgage portfolio at March 31, 2009 and December 31, 2008.
27
Nonperforming Loans and Leases
The following table presents the Corporations nonperforming loans and leases at March 31, 2009 and December 31, 2008. This table excludes Countrywide loans that are accounted for under SOP 03-3. See the discussion that follows on the SOP 03-3 loan portfolio.
Nonperforming Loans and Leases (1)
(Dollars in millions) | March 31 2009 |
December 31 2008 |
||||||
Consumer (2) |
||||||||
Residential mortgage |
$ | 10,807 | $ | 7,044 | ||||
Home equity |
3,598 | 2,670 | ||||||
Discontinued real estate |
178 | 77 | ||||||
Direct/Indirect consumer |
29 | 26 | ||||||
Other consumer |
91 | 91 | ||||||
Total consumer |
14,703 | 9,908 | ||||||
Commercial |
||||||||
Commercial domestic (3) |
3,246 | 2,245 | ||||||
Commercial real estate |
5,662 | 3,906 | ||||||
Commercial lease financing |
104 | 56 | ||||||
Commercial foreign |
300 | 290 | ||||||
Total commercial |
9,312 | 6,497 | ||||||
Total nonperforming loans and leases |
$ | 24,015 | $ | 16,405 | ||||
(1) |
Only real estate secured accounts are generally placed into nonaccrual status and classified as nonperforming at 90 days past due. These loans may be restored to performing status when all principal and interest is current and full repayment of the remaining contractual principal and interest is expected, or when the loan otherwise becomes well-secured and is in the process of collection. Troubled debt restructurings are generally reclassified as performing after six consecutive, on-time payments. |
(2) |
The definition of nonperforming does not include consumer credit card and consumer non-real estate loans and leases. These loans are charged off no later than the end of the month in which the account becomes 180 days past due. |
(3) |
Includes small business commercial domestic loans of $224 million and $205 million at March 31, 2009 and December 31, 2008. |
SFAS 114 and Troubled Debt Restructurings
SFAS No. 114, Accounting by Creditors for Impairment of a Loan (SFAS 114) defines a loan as impaired when based on current information and events, it is probable that the Corporation will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings (TDRs) where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. These amounts exclude all commercial leases and purchased loans that are accounted for under SOP 03-3. See the discussion that follows on the SOP 03-3 loan portfolio.
Included in certain loan categories in the nonperforming table above are TDRs that were classified as nonperforming. At March 31, 2009 and December 31, 2008, the Corporation had $810 million and $209 million of residential mortgages, $718 million and $302 million of home equity, $165 million and $44 million of commercial domestic loans, and $6 million and $5 million of discontinued real estate loans that were nonperforming and modified in TDRs. In addition to these amounts the Corporation had performing TDRs of $691 million and $320 million of residential mortgage, $3 million and $1 million of home equity, $71 million and $66 million of discontinued real estate, and $3 million and $13 million of commercial domestic loans at March 31, 2009 and December 31, 2008.
At March 31, 2009 and December 31, 2008, the recorded investment in impaired loans as defined by SFAS 114 (commercial nonperforming loans, commercial accruing TDRs and consumer accruing and non-accruing TDRs) requiring an allowance for loan and lease losses was $10.8 billion and $6.9 billion, and the related allowance for loan and lease losses was $1.5 billion and $720 million.
28
The Corporation seeks to assist customers that are experiencing financial difficulty through renegotiating credit card and consumer lending loans, while ensuring compliance with Federal Financial Institutions Examination Council guidelines. At March 31, 2009 and December 31, 2008, the Corporation had renegotiated credit card domestic held loans of $2.8 billion and $2.3 billion, credit card foreign held loans of $574 million and $527 million, and consumer lending loans of $1.6 billion and $1.4 billion. These renegotiated loans are not considered nonperforming.
SOP 03-3
Loans acquired with evidence of credit quality deterioration since origination and for which it is probable at purchase that the Corporation will be unable to collect all contractually required payments are accounted for under SOP 03-3. For additional information on the accounting in accordance with SOP 03-3 see the Loans and Leases section of Note 1 Summary of Significant Accounting Principles to the Consolidated Financial Statements of the Corporations 2008 Annual Report on Form 10-K.
As of January 1, 2009, the Merrill Lynch acquired consumer and commercial loans within the scope of SOP 03-3 had an unpaid principal balance of $2.7 billion and $2.9 billion and a fair value of $2.3 billion and $2.1 billion. At March 31, 2009, the unpaid principal balance on consumer and commercial loans was $2.6 billion and $2.9 billion and the carrying value on these loans was $2.3 billion and $2.1 billion. The following table provides details on loans obtained in connection with the Merrill Lynch acquisition within the scope of SOP 03-3.
Acquired Loan Information for Merrill Lynch, as of January 1, 2009
(Dollars in millions) | Merrill Lynch | |||||
Contractually required payments including interest |
$ | 6,205 | ||||
Less: Nonaccretable difference |
(1,158 | ) | ||||
Cash flows expected to be collected (1) |
5,047 | |||||
Less: Accretable yield |
(627 | ) | ||||
Fair value of loans acquired |
$ | 4,420 | ||||
(1) |
Represents undiscounted expected principal and interest cash flows at acquisition. |
Under SOP 03-3, the excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. Changes in the expected cash flows from the date of acquisition will either impact the accretable yield or result in a charge to the provision for credit losses. Subsequent decreases to expected principal cash flows will result in a charge to provision for credit losses and a corresponding increase to allowance for loan and lease losses. Subsequent increases in expected principal cash flows will result in recovery of any previously recorded allowance for loan and lease losses, to the extent applicable, and a reclassification from nonaccretable difference to accretable yield for any remaining increase. All changes in expected interest cash flows will result in reclassifications to/from nonaccretable differences.
Loans in the SOP 03-3 population that are modified subsequent to acquisition are reviewed to compare modified contractual cash flows to the SOP 03-3 carrying value. If modified cash flows are lower than the carrying value, the loan is removed from the SOP 03-3 pool at its carrying value, as well as the related allowance for loan and lease losses, and classified as a TDR. SOP 03-3 troubled debt restructurings totaled $970 million at March 31, 2009, of which $788 million were on accrual status. The carrying basis of these loans was approximately 71 percent of the unpaid principal balance.
During the three months ended March 31, 2009, the Corporation recorded an $853 million charge to the provision for credit losses for deterioration that occurred in the Countrywide SOP 03-3 portfolio subsequent to December 31, 2008. The amount of the allowance for loan and lease losses associated with the Countrywide SOP 03-3 portfolio was $1.6 billion at March 31, 2009 and $750 million at December 31, 2008. There was no allowance for loans and lease losses associated with the Merrill Lynch SOP 03-3 portfolio as of March 31, 2009.
29
The following table provides activity for the accretable yield of loans acquired from Countrywide and Merrill Lynch within the scope of SOP 03-3 for the three months ended March 31, 2009. The reclassification from nonaccretable difference of $2.1 billion is primarily attributable to slower prepayment speeds, which extends the expected life of the loan and therefore results in an increase in expected cash flows.
Accretable Yield Activity
(Dollars in millions) |
Three Months Ended |
|||
Accretable yield, December 31, 2008 |
$ | 12,860 | ||
Merrill Lynch balance, January 1, 2009 |
627 | |||
Accretions |
(911 | ) | ||
Disposals/Transfers (1) |
(562 | ) | ||
Reclassifications from nonaccretable difference (2) |
2,058 | |||
Accretable yield, March 31, 2009 |
$ | 14,072 |
(1) |
Includes $487 million in accretable yield related to loans restructured in TDRs in which the modified cash flows were lower than the carrying value. |
(2) |
Nonaccretable difference represents gross contractually required payments including interest less expected cash flows. |
NOTE 7 Allowance for Credit Losses |
The following table summarizes the changes in the allowance for the three months ended March 31, 2009 and 2008.
Three Months Ended March 31 | ||||||||
(Dollars in millions) | 2009 | 2008 | ||||||
Allowance for loan and lease losses, January 1 |
$ | 23,071 | $ | 11,588 | ||||
Loans and leases charged off |
(7,356 | ) | (3,086 | ) | ||||
Recoveries of loans and leases previously charged off
|
414 | 371 | ||||||
Net charge-offs
|
(6,942 | ) | (2,715 | ) | ||||
Provision for loan and lease losses
|
13,352 | 6,021 | ||||||
Other (1)
|
(433 | ) | (3 | ) | ||||
Allowance for loan and lease losses, March 31 |
29,048 | 14,891 | ||||||
Reserve for unfunded lending commitments, January 1
|
421 | 518 | ||||||
Provision for unfunded lending commitments |
28 | (11 | ) | |||||
Other (2) |
908 | - | ||||||
Reserve for unfunded lending commitments, March 31 |
1,357 | 507 | ||||||
Allowance for credit losses, March 31 |
$ | 30,405 | $ | 15,398 |
(1) |
For the three months ended March 31, 2009, amount includes a $750 million reduction in the allowance for loan and lease losses related to credit card loans of $8.5 billion which were exchanged for a $7.8 billion held-to-maturity debt security that was issued by the Corporations U.S. credit card securitization trust and retained by the Corporation. This reduction was partially offset by a $340 million increase associated with the reclassification of the December 31, 2008 receivable expected to be reimbursable under residential mortgage cash collateralized synthetic securitizations from the allowance for loan and lease losses to other assets. |
(2) |
For the three months ended March 31, 2009, this amount represents the fair value of the acquired Merrill Lynch unfunded lending commitments excluding those accounted for in accordance with SFAS 159. |
30
NOTE 8 Securitizations |
The Corporation routinely securitizes loans and debt securities. These securitizations are a source of funding for the Corporation in addition to transferring the economic risk of the loans or debt securities to third parties. In a securitization, various classes of debt securities may be issued and are generally collateralized by a single class of transferred assets which most often consist of residential mortgages, but may also include commercial mortgages, credit card receivables, home equity loans, automobile loans, municipal bonds or mortgage-backed securities. The securitized loans may be serviced by the Corporation or by third parties. With each securitization, the Corporation may retain a portion of the securities, subordinated tranches, interest-only strips, subordinated interests in accrued interest and fees on the securitized receivables, and, in some cases, overcollateralization and cash reserve accounts, all of which are called retained interests. These retained interests are recorded in other assets, AFS debt securities, trading account assets or derivative assets and are carried at fair value or amounts that approximate fair value with changes recorded in income or accumulated OCI. Changes in the fair value of credit card related interest-only strips are recorded in card income. In addition, the Corporation may enter into derivatives with the securitization trust to mitigate the trusts interest rate or foreign exchange risk. These derivatives are entered into at market terms and are generally senior in payment. The Corporation also may serve as the underwriter and distributor of the securitization, serve as the administrator of the trust, and from time to time, make markets in securities issued by the securitization trusts. For more information related to derivatives, see Note 4 Derivatives.
First Lien Mortgage-related Securitizations
As part of its mortgage banking activities, the Corporation securitizes a portion of the residential mortgage loans it originates or purchases from third parties in conjunction with or shortly after loan closing or purchase. In addition, the Corporation may, from time to time, securitize commercial mortgages and first lien residential mortgages that it originates or purchases from other entities.
The following tables summarize selected information related to mortgage securitizations for the three months ended March 31, 2009 and 2008 and at March 31, 2009 and December 31, 2008.
Residential Mortgage | |||||||||||||||||||||||||||||||||
Non-Agency | |||||||||||||||||||||||||||||||||
Agency | Prime | Subprime | Alt-A | Commercial Mortgage |
|||||||||||||||||||||||||||||
Three Months Ended March 31 | |||||||||||||||||||||||||||||||||
(Dollars in millions) | 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||||||||
Cash proceeds from new securitizations (1) |
$ | 74,858 | $ | 17,303 | $ | - | $ | 848 | $ | - | $ | - | $ | - | $ | - | $ | 3,557 | $ | 1,968 | |||||||||||||
Gains on securitizations (2, 3) |
- | 13 | - | 1 | - | - | - | - | 29 | 11 | |||||||||||||||||||||||
Cash flows received on residual interests |
- | - | 6 | - | 16 | - | 2 | - | 6 | - | |||||||||||||||||||||||
(1) |
The Corporation sells residential mortgage loans to government-sponsored agencies in the normal course of business and receives mortgage-backed securities in exchange. These mortgage-backed securities are then subsequently sold into the market to third party investors for cash proceeds. |
(2) |
Net of hedges |
(3) |
Substantially all of the residential mortgages securitized are initially classified as LHFS and recorded at fair value under SFAS 159. As such, gains are recognized on these LHFS prior to securitization. During the three months ended March 31, 2009 and 2008, the Corporation recognized $954 million and $199 million of gains on these LHFS. |
31
Residential Mortgage | ||||||||||||||||||||||||||||||||||
Non-Agency | ||||||||||||||||||||||||||||||||||
Agency | Prime | Subprime | Alt-A | Commercial Mortgage | ||||||||||||||||||||||||||||||
(Dollars in millions) | March 31 2009 |
December 31 2008 |
March 31 2009 |
December 31 2008 |
March 31 2009 |
December 31 2008 |
March 31 2009 |
December 31 2008 |
March 31 2009 |
December 31 2008 |
||||||||||||||||||||||||
Principal balance outstanding (1) |
$ | 1,135,213 | $ | 1,123,916 | $ | 108,183 | $ | 111,683 | $ | 97,789 | $ | 57,933 | $ | 131,832 | $ | 136,027 | $ | 62,450 | $ | 55,403 | ||||||||||||||
Residual interests held |
- | - | 15 | - | 7 | 13 | - | - | 68 | 7 | ||||||||||||||||||||||||
Senior securities (2, 3): |
||||||||||||||||||||||||||||||||||
Trading account assets |
$ | 1,122 | $ | 1,308 | $ | 792 | $ | 367 | $ | 3 | $ | - | $ | 408 | $ | 278 | $ | 181 | $ | 168 | ||||||||||||||
Available-for-sale debt securities |
9,899 | 12,507 | 4,691 | 4,559 | 240 | 121 | 635 | 569 | 781 | 16 | ||||||||||||||||||||||||
Total senior securities |
$ | 11,021 | $ | 13,815 | $ | 5,483 | $ | 4,926 | $ | 243 | $ | 121 | $ | 1,043 | $ | 847 | $ | 962 | $ | 184 | ||||||||||||||
Subordinated securities (2, 4): |
||||||||||||||||||||||||||||||||||
Trading account assets |
$ | - | $ | - | $ | 15 | $ | 23 | $ | 1 | $ | 3 | $ | 2 | $ | 1 | $ | 98 | $ | 136 | ||||||||||||||
Available-for-sale debt securities |
- | - | 19 | 20 | 98 | 1 | 15 | 17 | 11 | - | ||||||||||||||||||||||||
Total subordinated securities |
$ | - | $ | - | $ | 34 | $ | 43 | $ | 99 | $ | 4 | $ | 17 | $ | 18 | $ | 109 | $ | 136 | ||||||||||||||
(1) |
Generally, the Corporation as transferor will service the sold loans and thus recognize an MSR upon securitization. See additional information to follow related to the Corporations role as servicer and Note 17 Mortgage Servicing Rights. |
(2) |
As a holder of these securities, the Corporation receives scheduled interest and principal payments accordingly. During the three months ended March 31, 2009 and 2008, there were no significant impairments recorded on those securities classified as AFS debt securities. |
(3) |
Substantially all of the residential mortgage senior securities were valued using quoted market prices at March 31, 2009 and December 31, 2008. At March 31, 2009, substantially all of the commercial mortgage senior securities were valued using quoted market prices while substantially all were valued using model valuations at December 31, 2008. |
(4) |
At March 31, 2009, substantially all of the residential mortgage subordinated securities were valued using quoted market prices while substantially all were valued using model valuations at December 31, 2008. Substantially all of the commercial mortgage subordinated securities were valued using model valuations at March 31, 2009 and December 31, 2008. |
The Corporation sells loans with various representations and warranties related to, among other things, the ownership of the loan, validity of the lien securing the loan, absence of delinquent taxes or liens against the property securing the loan, the process used in selecting the loans for inclusion in a transaction, the loans compliance with any applicable loan criteria established by the buyer, and the loans compliance with applicable local, state and federal laws. Under the Corporations representations and warranties, the Corporation may be required to either repurchase the mortgage loans with the identified defects or indemnify the investor or insurer. In such cases, the Corporation bears any subsequent credit loss on the mortgage loans. During the three months ended March 31, 2009, the Corporation repurchased $360 million of loans from securitization trusts as a result of the Corporations representations and warranties. The Corporations representations and warranties are generally not subject to stated limits. However, the Corporations contractual liability arises only when the representations and warranties are breached. The Corporation attempts to limit its risk of incurring these losses by structuring its operations to ensure consistent production of quality mortgages and servicing those mortgages at levels that meet secondary mortgage market standards. In addition, certain of the Corporations securitizations include a corporate guarantee, which are contracts written to protect purchasers of the loans from credit losses up to a specified amount. The losses to be absorbed by the guarantees are recorded when the Corporation sells the loans with guarantees. The Corporation records its liability for representations and warranties, and corporate guarantees in accrued expenses and other liabilities and records the related expense through mortgage banking income. In addition to the repurchases as a result of representations and warranties, the Corporation repurchased $760 million of loans from the securitization trusts as a result of modifications, loan delinquencies or optional clean-up calls during the three months ended March 31, 2009.
In addition to the amounts included in the table above, during both the three months ended March 31, 2009 and 2008, the Corporation purchased $4.2 billion of mortgage-backed securities from third parties and resecuritized them. Net gains, which include net interest income earned during the holding period, totaled $25 million and $22 million for the three months ended March 31, 2009 and 2008. At March 31, 2009 and December 31, 2008, the Corporation retained $1.2 billion and $1.0 billion of the senior securities issued in these transactions which were valued using quoted market prices and recorded in trading account assets.
The Corporation has consumer MSRs from the sale or securitization of mortgage loans. Servicing fee and ancillary fee income on consumer mortgage loans serviced, including securitizations where the Corporation still has continued involvement, were $1.5 billion and $221 million during the three months ended March 31, 2009 and 2008. Servicing advances on consumer mortgage loans, including securitizations where the Corporation still has continuing involvement, were $11.4 billion and $8.8 billion at March 31, 2009 and December 31, 2008. In addition, the Corporation has retained commercial MSRs from the sale or securitization of commercial mortgage loans. Servicing fee and ancillary fee income on commercial mortgage loans serviced, including securitizations where the Corporation still has continued involvement, were $11 million and $6 million during the three months ended March 31, 2009 and 2008. Servicing advances on commercial mortgage loans, including securitizations where the Corporation still has continuing involvement, were $77 million and $14 million at March 31, 2009 and December 31, 2008. For more information on MSRs, see Note 17 Mortgage Servicing Rights.
32
Credit Card Securitizations |
The Corporation securitizes originated and purchased credit card loans. The Corporations primary continuing involvement includes servicing the receivables, retaining an undivided interest (the sellers interest) in the receivables, and holding certain retained interests (e.g., senior and subordinated securities, interest-only strips, discount receivables, subordinated interests in accrued interest and fees on the securitized receivables and cash reserve accounts) in credit card securitization vehicles. The securitization trusts legal documents require the Corporation to maintain a minimum sellers interest of four percent to five percent, and the Corporation is in compliance with this requirement. At March 31, 2009 and December 31, 2008, the Corporation had $9.9 billion and $14.8 billion related to its undivided interests in the trusts. The sellers interest in the trusts represents the Corporations undivided interests in the receivables transferred to the trust and is pari pasu to the investors interest. The sellers interest is not represented by security certificates, is carried at historical cost, and is classified within loans on the Corporations Balance Sheet. The following tables summarize selected information related to credit card securitizations for the three months ended March 31, 2009 and 2008 and at March 31, 2009 and December 31, 2008.
Credit Card | ||||||
Three Months Ended March 31 | ||||||
(Dollars in millions) | 2009 | 2008 | ||||
Cash proceeds from new securitizations |
$ | - | $ | 7,623 | ||
Gains on securitizations |
- | 36 | ||||
Collections reinvested in revolving period securitizations |
35,630 | 45,626 | ||||
Cash flows received on residual interests |
1,427 | 1,703 | ||||
Credit Card | ||||||
(Dollars in millions) | March 31, 2009 | December 31, 2008 | ||||
Principal balance outstanding (1) |
$ | 114,806 | $ | 114,141 | ||
Senior securities held (2, 3) |
4,389 | 4,965 | ||||
Subordinated securities held (2, 3) |
9,798 | 1,837 | ||||
Residual interests held (4) |
3,145 | 2,233 | ||||
(1) |
Principal balance outstanding represents the principal balance of credit card receivables that have been legally isolated from the Corporation including those loans that are still held on the Corporations Balance Sheet (i.e., sellers interest). |
(2) |
As a holder of these securities, the Corporation receives scheduled interest and principal payments accordingly. Included in the subordinated securities is a $7.8 billion held-to-maturity debt security that does not receive interest. During the three months ended March 31, 2009, there were no impairments recorded on those securities classified as AFS debt securities. |
(3) |
At March 31, 2009 and December 31, 2008, held senior securities issued by credit card securitization vehicles were valued using quoted market prices and were all classified as AFS debt securities. At March 31, 2009, $7.8 billion of held subordinated securities were measured at amortized cost and classified as held-to-maturity debt securities and $2.0 billion were valued using quoted market prices and classified as AFS debt securities. At December 31, 2008, all of the held subordinated securities were valued using quoted market prices and classified as AFS debt securities. |
(4) |
Residual interests include interest-only strips of $40 million and $74 million at March 31, 2009 and December 31, 2008. The remainder of the residual interests are discount receivables, subordinated interests in accrued interest and fees on the securitized receivables and cash reserve accounts which are carried at fair value or amounts that approximate fair value and are not sensitive to favorable and adverse fair value changes in payment rates, expected credit losses and residual cash flows discount rates. The residual interests were valued using model valuations and are primarily classified in other assets. |
At March 31, 2009 and December 31, 2008, there were no recognized servicing assets or liabilities associated with any of these credit card securitization transactions. The Corporation recorded $504 million and $533 million in servicing fees related to credit card securitizations during the three months ended March 31, 2009 and 2008.
During the second half of 2008, the Corporation entered into a liquidity support agreement related to the Corporations commercial paper program that obtains financing by issuing tranches of commercial paper backed by credit card receivables to third party investors from a trust sponsored by the Corporation. If certain conditions set forth in the legal documents governing the trust are not met, such as not being able to reissue the commercial paper due to market illiquidity, the commercial paper maturity dates will be extended to 390 days from the original issuance date. This extension would cause the outstanding commercial paper to convert to an interest-bearing note and subsequent credit card receivable collections would be applied to the outstanding note balance. If any of the investor notes are still outstanding at the end of the extended maturity period, our liquidity commitment obligates the Corporation to purchase maturity notes from the trust in order to retire the investor interest-bearing notes. As a maturity note holder, the Corporation would be entitled to the remaining cash flows from the collateralizing credit card receivables. At March 31, 2009 and December 31, 2008, there were no maturity notes outstanding and the Corporation held $4.4 billion and $5.0 billion of investment grade securities in AFS debt securities issued by the trust due to illiquidity in the marketplace.
33
As specifically permitted by the terms of the transaction documents, and in an effort to address the recent decline in the excess spread due to the performance of the underlying credit card receivables in the U.S. credit card securitization trust, an additional subordinated security was issued by the trust to the Corporation in the first quarter of 2009. As the issuance was not treated as a sale, the security was recorded at $7.8 billion, which represents the $8.5 billion book value of the loans exchanged less the associated $750 million allowance for loan and lease losses, and was classified as held-to-maturity. In addition, as permitted by the transaction documents, the Corporation specified that from March 1, 2009 through September 30, 2009 a percentage of new receivables transferred to the trust will be deemed discount receivables and collections thereon will be applied to finance charges, which is expected to increase the yield in the trust. These actions did not have a significant impact on the Corporations results of operations.
Other Securitizations |
The Corporation also maintains interests in other securitization vehicles. These retained interests include senior and subordinated securities and residual interests. The following table summarizes selected information related to home equity, automobile loan and municipal bond securitizations for the three months ended March 31, 2009 and 2008 and at March 31, 2009 and December 31, 2008. There were no securitizations of home equity, automobile loans or municipal bonds during the three months ended March 31, 2009 and 2008.
Home Equity | Automobile | Municipal Bonds | ||||||||||||||
Three Months Ended March 31 |
||||||||||||||||
(Dollars in millions) | 2009 | 2008 | 2009 | 2008 | 2009 | |||||||||||
Collections reinvested in revolving period securitizations |
$ | 73 | $ | - | $ | - | $ | - | $ | - | ||||||
Repurchase of loans from trust (1) |
27 | - | - | 180 | - | |||||||||||
Cash flows received on residual interests |
11 | 6 | 11 | - | 112 | |||||||||||
(1)The repurchases of loans from the trust for home equity loans are typically a result of the Corporations representations and warranties, modifications, loan delinquencies or the exercise of an optional clean-up call. The repurchases of automobile loans during the three months ended March 31, 2008 was substantially due to the exercise of an optional clean-up call. |
| |||||||||||||||
Home Equity | Automobile | Municipal Bonds (1) | ||||||||||||||
(Dollars in millions) | March 31 2009 |
December 31 2008 |
March 31 2009 |
December 31 2008 |
March 31 2009 |
|||||||||||
Principal balance outstanding |
$ | 33,441 | $ | 34,169 | $ | 4,617 | $ | 5,385 | $ | 10,864 | ||||||
Senior securities held (2, 3) |
17 | - | 3,597 | 4,102 | 1,377 | |||||||||||
Subordinated securities held (2, 4) |
9 | 3 | 394 | 383 | - | |||||||||||
Residual interests held (5) |
88 | 93 | 71 | 84 | 370 | |||||||||||
(1) |
For additional information on municipal bond securitization vehicles see Note 9 Variable Interest Entities. |
(2) |
As a holder of these securities, the Corporation receives scheduled interest and principal payments accordingly. During the three months ended March 31, 2009, there were no significant impairments recorded on those securities classified as AFS debt securities. |
(3) |
At March 31, 2009, all of the held senior securities issued by the home equity securitization vehicles were valued using model valuations and classified as AFS debt securities. At March 31, 2009 and December 31, 2008, substantially all of the held senior securities issued by the automobile securitization vehicles were valued using quoted market prices and classified as AFS debt securities. At March 31, 2009, all of the held senior securities issued by municipal bond securitization vehicles were valued using quoted market prices and classified as trading account assets. |
(4) |
At March 31, 2009 and December 31, 2008, substantially all of the held subordinated securities issued by the home equity securitization vehicles were valued using model valuations and classified as trading account assets. At March 31, 2009 and December 31, 2008, substantially all of the subordinated securities issued by the automobile securitization vehicles were valued using quoted market prices and classified as AFS debt securities. |
(5) |
Residual interests include the residual asset, overcollateralization and cash reserve accounts, which are carried at fair value or amounts that approximate fair value. The residual interests were valued using model valuations and substantially all are classified in other assets or derivative assets. |
34
Under the terms of the Corporations home equity securitizations, advances are made to borrowers when they make a subsequent draw on their line of credit and the Corporation is reimbursed for those advances from the cash flows in the securitization. During the revolving period of the securitization, this reimbursement normally occurs within a short period after the advance. However, when the securitization transaction has begun its rapid amortization period, reimbursement of the Corporations advance occurs only after other parties in the securitization have received all of the cash flows to which they are entitled. This has the effect of extending the time period for which the Corporations advances are outstanding. In particular, if loan losses requiring draws on monoline insurers policies (which protect the bondholders in the securitization) exceed a specified threshold or duration, the Corporation may not receive reimbursement for all of the funds advanced to borrowers, as the senior bondholders and the monoline insurer have priority for repayment. As of March 31, 2009 and December 31, 2008, the reserve for losses on expected future draw obligations on the home equity securitizations in or expected to be in rapid amortization was $305 million and $345 million.
The Corporation has retained consumer MSRs from the sale or securitization of home equity loans. The Corporation recorded $35 million servicing fees related to home equity securitizations during the three months ended March 31, 2009 and did not record any servicing fees for the same period in 2008. For more information on MSRs, see Note 17 Mortgage Servicing Rights. At March 31, 2009 and December 31, 2008, there were no recognized servicing assets or liabilities associated with any of the automobile securitization transactions. The Corporation recorded $13 million and $4 million in servicing fees related to automobile securitizations during the three months ended March 31, 2009 and 2008.
Key economic assumptions are used in measuring the fair value of certain residual interests that continue to be held by the Corporation in municipal bond securitizations. The carrying amount of residual interests for municipal bond securitizations was $370 million and the weighted-average discount rate was 4.07 percent at March 31, 2009. A 10 percent and 25 percent adverse change to the discount rate would have caused a decrease of $71 million and $177 million to the residual interests at March 31, 2009. These sensitivities are hypothetical and should be used with caution. As the amounts indicate, changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Additionally, the Corporation has the ability to hedge interest rate risk associated with retained residual positions. The above sensitivities do not reflect any hedge strategies that may be undertaken to mitigate such risk.
NOTE 9 Variable Interest Entities |
In addition to the securitization vehicles described in Note 8 Securitizations and Note 17 Mortgage Servicing Rights, which are typically structured as QSPEs, the Corporation utilizes SPEs in the ordinary course of business to support its own and its customers financing and investing needs. These SPEs are typically structured as VIEs and are thus subject to consolidation by the reporting enterprise that absorbs the majority of the economic risks and rewards of the VIE. To determine whether it must consolidate a VIE, the Corporation qualitatively analyzes the design of the VIE to identify the creators of variability within the VIE, including an assessment as to the nature of the risks that are created by the assets and other contractual arrangements of the VIE, and identifies whether it will absorb a majority of that variability.
In addition to the VIEs discussed below, the Corporation uses VIEs such as trust preferred securities trusts in connection with its funding activities, as described in more detail in Note 12 Short-term Borrowings and Long-term Debt to the Consolidated Financial Statements to the Corporations 2008 Annual Report on Form 10-K. The Corporation also uses VIEs in the form of synthetic securitization vehicles to mitigate a portion of the credit risk on its residential mortgage loan portfolio as described in Note 6 Outstanding Loans and Leases. The Corporation has also provided support to or has loss exposure resulting from its involvement with other VIEs, including certain cash funds managed within Global Wealth & Investment Management (GWIM), as described in more detail in Note 12 Commitments and Contingencies.
35
The table below presents the assets and liabilities of VIEs which have been consolidated on the Corporations Balance Sheet at March 31, 2009, total assets of consolidated VIEs at December 31, 2008, and the Corporations maximum exposure to loss resulting from its involvement with consolidated VIEs as of March 31, 2009 and December 31, 2008. The Corporations maximum exposure to loss is based on the unlikely event that all of the assets in the VIEs become worthless and incorporates not only potential losses associated with assets recorded on the Corporations Balance Sheet but also potential losses associated with off-balance sheet commitments such as unfunded liquidity commitments and other contractual arrangements.
Consolidated VIEs | ||||||||||||||||||
(Dollars in millions) | Multi-Seller Conduits |
Loan & Other Investment |
CDOs | Leveraged Lease Trusts |
Other Vehicles |
Total | ||||||||||||
Consolidated VIEs, March 31, 2009 (1) |
||||||||||||||||||
Maximum loss exposure (2) |
$ | 10,152 | $ | 10,084 | $ | 2,494 | $ | 5,629 | $ | 1,777 | $ | 30,136 | ||||||
Consolidated Assets (3) |
||||||||||||||||||
Trading account assets |
$ | - | $ | 170 | $ | 14 | $ | - | $ | 736 | $ | 920 | ||||||
Derivative assets |
- | 430 | - | - | 987 | 1,417 | ||||||||||||
Available-for-sale debt securities |
6,886 | 1,793 | 2,271 | - | - | 10,950 | ||||||||||||
Held-to-maturity debt securities |
333 | - | - | - | - | 333 | ||||||||||||
Loans and leases |
- | 4,316 | 239 | 5,679 | - | 10,234 | ||||||||||||
All other assets |
843 | 2,561 | 93 | - | 185 | 3,682 | ||||||||||||
Total |
$ | 8,062 | $ | 9,270 | $ | 2,617 | $ | 5,679 | $ | 1,908 | $ | 27,536 | ||||||
Consolidated Liabilities |
||||||||||||||||||
Commercial paper and other short-term borrowings |
$ | 8,133 | $ | 4,128 | $ | - | $ | - | $ | 1,439 | $ | 13,700 | ||||||
All other liabilities |
- | 4,733 | 449 | 50 | 131 | 5,363 | ||||||||||||
Total |
$ | 8,133 | $ | 8,861 | $ | 449 | $ | 50 | $ | 1,570 | $ | 19,063 | ||||||
Consolidated VIEs, December 31, 2008 (1) |
||||||||||||||||||
Maximum loss exposure (2) |
$ | 11,304 | $ | 3,189 | $ | 2,443 | $ | 5,774 | $ | 1,497 | $ | 24,207 | ||||||
Total assets (3) |
9,368 | 4,449 | 2,443 | 5,829 | 1,631 | 23,720 | ||||||||||||
(1) |
Cash flows generated by the assets of the consolidated VIEs must generally be used to settle the specific obligations of the VIEs before they are available to the Corporation for general purposes. |
(2) |
Maximum loss exposure for consolidated VIEs includes on-balance sheet assets, net of non-recourse liabilities, plus off-balance sheet exposures. It does not include losses previously recognized through write-downs of assets. |
(3) |
Total assets of consolidated VIEs are reported net of intercompany balances that have been eliminated in consolidation. |
At March 31, 2009, the Corporations total maximum loss exposure to consolidated VIEs was $30.1 billion, which includes $7.5 billion attributable to the addition of Merrill Lynch, primarily loan and other investment vehicles.
36
The table below presents total assets of unconsolidated VIEs in which the Corporation holds a significant variable interest and Corporation-sponsored unconsolidated VIEs in which the Corporation holds a variable interest, even if not significant, at March 31, 2009 and December 31, 2008. The table also presents the Corporations maximum exposure to loss resulting from its involvement with these VIEs at March 31, 2009 and December 31, 2008. The Corporations maximum exposure to loss is based on the unlikely event that all of the assets in the VIEs become worthless and incorporates not only potential losses associated with assets recorded on the Corporations Balance Sheet but also potential losses associated with off-balance sheet commitments such as unfunded liquidity commitments and other contractual arrangements. Certain QSPEs in which the Corporation has continuing involvement but that are not discussed in Note 8 Securitizations are also included in the table. Assets and liabilities of unconsolidated VIEs recorded on the Corporations Balance Sheet at March 31, 2009 are also summarized below.
Unconsolidated VIEs | ||||||||||||||||||||||||
(Dollars in millions) | Multi-Seller Conduits |
Loan & Investment |
Real Estate Investment Vehicles |
Municipal Bond Trusts |
CDOs | Customer Vehicles |
Other Vehicles |
Total | ||||||||||||||||
Unconsolidated VIEs, March 31, 2009 (1) |
||||||||||||||||||||||||
Maximum loss exposure (2) |
$ | 40,238 | $ | 3,643 | $ | 5,525 | $ | 14,413 | $ | 8,567 | $ | 16,357 | $ | 2,531 | $ | 91,274 | ||||||||
Total assets of VIEs |
25,643 | 9,274 | 5,951 | 16,301 | 55,062 | 18,117 | 2,400 | 132,748 | ||||||||||||||||
On-Balance Sheet Assets |
||||||||||||||||||||||||
Trading account assets |
$ | 1 | $ | 113 | $ | - | $ | 1,640 | $ | 1,182 | $ | 3,304 | $ | 70 | $ | 6,310 | ||||||||
Derivative assets |
- | 354 | 4 | 277 | 2,455 | 9,489 | 131 | 12,710 | ||||||||||||||||
Available-for-sale debt securities |
- | 4 | - | - | 768 | - | - | 772 | ||||||||||||||||
Loans and leases |
359 | 943 | - | - | - | - | - | 1,302 | ||||||||||||||||
All other assets |
53 | 2,035 | 4,821 | - | - | - | - | 6,909 | ||||||||||||||||
Total |
$ | 413 | $ | 3,449 | $ | 4,825 | $ | 1,917 | $ | 4,405 | $ | 12,793 | $ | 201 | $ | 28,003 | ||||||||
On-Balance Sheet Liabilities |
||||||||||||||||||||||||
Derivative liabilities |
$ | - | $ | 200 | $ | - | $ | 583 | $ | 509 | $ | 325 | $ | 151 | $ | 1,768 | ||||||||
All other liabilities |
- | 386 | 1,498 | - | - | 679 | - | 2,563 | ||||||||||||||||
Total |
$ | - | $ | 586 | $ | 1,498 | $ | 583 | $ | 509 | $ | 1,004 | $ | 151 | $ | 4,331 | ||||||||
Unconsolidated VIEs, December 31, 2008 (1) |
||||||||||||||||||||||||
Maximum loss exposure (2) |
$ | 42,046 | $ | 2,789 | $ | 5,696 | $ | 7,145 | $ | 2,383 | $ | 5,741 | $ | 4,170 | $ | 69,970 | ||||||||
Total assets of VIEs |
27,922 | 5,691 | 5,980 | 7,997 | 2,570 | 6,032 | 4,211 | 60,403 | ||||||||||||||||
(1) |
Includes unconsolidated VIEs and certain municipal bond trusts which are QSPEs and are also included in Note 8 Securitizations. |
(2) |
Maximum loss exposure for unconsolidated VIEs includes on-balance sheet assets plus off-balance sheet exposures. It does not include losses previously recognized through write-downs of assets or the establishment of derivative or other liabilities. |
At March 31, 2009, the Corporations total maximum loss exposure to unconsolidated VIEs was $91.3 billion, which includes $26.0 billion attributable to the addition of Merrill Lynch, primarily customer vehicles, municipal bond trusts and CDOs.
Except as described below, we have not provided financial or other support to consolidated or unconsolidated VIEs that we were not previously contractually required to provide, nor do we intend to do so.
Multi-Seller Conduits
The Corporation administers four multi-seller conduits which provide a low-cost funding alternative to its customers by facilitating their access to the commercial paper market. These customers sell or otherwise transfer assets to the conduits, which in turn issue short-term commercial paper that is rated high-grade and is collateralized by the underlying assets. The Corporation receives fees for providing combinations of liquidity and standby letters of credit (SBLCs) or similar loss protection commitments to the conduits. The Corporation also receives fees for serving as commercial paper placement agent and for providing administrative services to the conduits. The Corporations liquidity commitments are collateralized by various classes of assets which incorporate features such as overcollateralization and cash reserves that are designed to provide credit support to the conduits at a level equivalent to investment grade as determined in accordance with internal risk rating guidelines. Third parties participate in a small number of the liquidity facilities on a pari passu basis with the Corporation.
37
The Corporation determines whether it must consolidate a multi-seller conduit based on an analysis of projected cash flows using Monte Carlo simulations which are driven principally by credit risk inherent in the assets of the conduits. Interest rate risk is not included in the cash flow analysis because the conduits are not designed to absorb and pass along interest rate risk to investors. Instead, the assets of the conduits pay variable rates of interest based on the conduits funding costs. The assets of the conduits typically carry a risk rating of AAA to BBB based on the Corporations current internal risk rating equivalent, which reflects structural enhancements of the assets, including third party insurance. Projected loss calculations are based on maximum binding commitment amounts, probability of default based on the average one year Moodys Corporate Finance transition table, and recovery rates of 90 percent, 65 percent and 45 percent for senior, mezzanine and subordinate exposures. Approximately 97 percent of commitments in the unconsolidated conduits and 70 percent of commitments in the consolidated conduit are supported by senior exposures. Certain assets funded by one of the unconsolidated conduits benefit from embedded credit enhancement provided by the Corporation. Credit risk created by these assets is deemed to be credit risk of the Corporation, which is absorbed by third party investors.
The Corporation does not consolidate three conduits as it does not expect to absorb a majority of the variability created by the credit risk of the assets held in the conduits. On a combined basis, these three conduits have issued approximately $123 million of capital notes and equity interests to third parties, $118 million of which were outstanding at March 31, 2009. These instruments will absorb credit risk on a first loss basis. The Corporation consolidates the fourth conduit, which has not issued capital notes or equity interests to third parties.
At March 31, 2009, liquidity commitments to the consolidated conduit were mainly collateralized by credit card loans (26 percent), auto loans (nine percent), equipment loans (nine percent), corporate and commercial loans (eight percent), and trade receivables (seven percent). None of these assets are subprime residential mortgages. In addition, 31 percent of the Corporations liquidity commitments were collateralized by projected cash flows from long-term contracts (e.g., television broadcast contracts, stadium revenues and royalty payments) which, as mentioned above, incorporate features that provide credit support. Amounts advanced under these arrangements will be repaid when cash flows due under the long-term contracts are received. Approximately 74 percent of this exposure is insured. At March 31, 2009, the weighted-average life of assets in the consolidated conduit was estimated to be 3.3 years and the weighted-average maturity of commercial paper issued by this conduit was 27 days. Assets of the Corporation are not available to pay creditors of the consolidated conduit except to the extent the Corporation may be obligated to perform under the liquidity commitments and SBLCs. Assets of the consolidated conduit are not available to pay creditors of the Corporation.
At March 31, 2009, the Corporations liquidity commitments to the unconsolidated conduits were mainly collateralized by credit card loans (22 percent), student loans (17 percent), auto loans (15 percent), trade receivables (11 percent), and equipment loans (eight percent). In addition, 21 percent of the Corporations commitments were collateralized by the conduits short-term lending arrangements with investment funds, primarily real estate funds, which, as mentioned above, incorporate features that provide credit support. Amounts advanced under these arrangements are secured by a diverse group of high quality equity investors. Outstanding advances under these facilities will be repaid when the investment funds issue capital calls. At March 31, 2009, the weighted-average life of assets in the unconsolidated conduits was estimated to be 3.7 years and the weighted-average maturity of commercial paper issued by these conduits was 28 days.
The Corporations liquidity, SBLCs and similar loss protection commitments obligate us to purchase assets from the conduits at the conduits cost. Subsequent realized losses on assets purchased from the unconsolidated conduits would be reimbursed from restricted cash accounts that were funded by the issuance of capital notes and equity interests to third party investors. The Corporation would absorb losses in excess of such amounts. If a conduit is unable to re-issue commercial paper due to illiquidity in the commercial paper markets or deterioration in the asset portfolio, the Corporation is obligated to provide funding subject to the following limitations. The Corporations obligation to purchase assets under the SBLCs and similar loss protection commitments are subject to a maximum commitment amount which is typically set at eight to 10 percent of total outstanding commercial paper. The Corporations obligation to purchase assets under the liquidity agreements, which comprise the remainder of our exposure, is generally limited to the amount of non-defaulted assets. Although the SBLCs are unconditional, we are not obligated to fund under other liquidity or loss protection commitments if the conduit is the subject of a voluntary or involuntary bankruptcy proceeding.
One of the unconsolidated conduits holds CDO investments with aggregate outstanding funded amounts of $359 million and $388 million and unfunded commitments of $190 million and $162 million at March 31, 2009 and December 31, 2008. The underlying collateral of the CDO investments includes middle market loans held in an insured CDO (76 percent) and subprime residential mortgages (eight percent), with the remainder of the collateral consisting primarily of investment grade securities. All of the unfunded commitments are revolving commitments to the insured CDO. During 2008 and the first quarter of 2009, these investments were downgraded or threatened with a downgrade by the rating agencies. In accordance with the terms of our existing liquidity obligations, the conduit had transferred the funded investments to the Corporation in a transaction that was accounted for as a financing transaction in accordance with SFAS 140 due to the conduits continuing exposure to credit losses of the investments. As a result of the transfer, the CDO investments no longer serve as collateral for commercial paper issuances.
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The transfers were performed in accordance with existing contractual requirements. The Corporation did not provide support to the conduit that was not contractually required nor does it intend to provide support that is not contractually required in the future. The Corporation performs reconsideration analyses for the conduit in accordance with FIN 46(R) at least quarterly, and the CDO investments are included in these analyses. The Corporation will be reimbursed for any realized credit losses on these CDO investments up to the amount of capital notes issued by the conduit, which totaled $92 million at March 31, 2009 and $66 million at December 31, 2008. Any realized losses on the CDO investments that are caused by market illiquidity or changes in market rates of interest will be borne by the Corporation. The Corporation will also bear any credit-related losses in excess of the amount of capital notes issued by the conduit. The Corporations maximum exposure to loss from the CDO investments was $457 million at March 31, 2009 and $484 million at December 31, 2008, based on the combined funded amounts and unfunded commitments less the amount of cash proceeds from the issuance of capital notes which are held in a segregated account.
There were no other significant downgrades or losses recorded in earnings from writedowns of assets held by any of the conduits during the three months ended March 31, 2009.
The liquidity commitments and SBLCs provided to unconsolidated conduits are included in Note 12 Commitments and Contingencies.
Loans and Other Investment Vehicles
Loans and other investment vehicles at March 31, 2009 and December 31, 2008 include loan securitization trusts that did not meet QSPE status, loan financing arrangements, and vehicles that invest in financial assets, typically debt securities or loans. The Corporation determines whether it is the primary beneficiary of and must consolidate these investment vehicles based principally on a determination as to which party is expected to absorb a majority of the credit risk or market risk created by the assets of the vehicle. Typically, the party holding subordinated or residual interests in a vehicle will absorb a majority of the risk.
Certain loan securitization trusts are designed to meet QSPE requirements but fail to do so, typically as a result of derivatives entered into by the trusts that pertain to interests held by the Corporation. As a result of the illiquidity in the securitization markets, the Corporation has been unable to sell certain securities, which has prevented these trusts from being considered QSPEs. Given that these trusts have been designed to meet the QSPE requirements, the Corporation has no control over the assets held by these trusts, which have been pledged to the investors in the trusts. The Corporation consolidates these loan securitization trusts if it retains the residual interest in the trust and expects to absorb a majority of the variability in cash flows created by the loans held in the trust. Investors in consolidated loan securitization trusts have no recourse to the general credit of the Corporation as their investments are repaid solely from the assets of the vehicle.
The Corporation uses financing arrangements with SPEs administered by third parties to obtain low-cost funding for certain financial assets, principally commercial loans and debt securities. The third party SPEs, typically commercial paper conduits, hold the specified assets subject to total return swaps with the Corporation. If the assets are transferred to the third party from the Corporation, the transfer is accounted for as a secured borrowing. If the third-party commercial paper conduit issues a discrete series of commercial paper whose only source of repayment is the specified asset and the total return swap with the Corporation, thus creating a silo structure within the conduit, we consolidate that silo.
The Corporation has made investments in alternative investment funds that are considered to be VIEs because they do not have sufficient legal form equity at risk to finance their activities or the holders of the equity at risk do not have control over the activities of the vehicles. The Corporation consolidates these funds if it holds a majority of the investment in the fund. The Corporation also sponsors funds that provide a guaranteed return to investors at the maturity of the fund. This guarantee may include a guarantee of the return of an initial investment or of the initial investment plus an agreed upon return depending on the terms of the fund. Investors in certain of these funds have recourse to the Corporation to the extent that the value of the assets held by the funds at maturity is less than the guaranteed amount. The Corporation consolidates these funds if the Corporations guarantee is expected to absorb a majority of the variability created by the assets of the fund.
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Real Estate Investment Vehicles
The Corporations investment in real estate investment vehicles at March 31, 2009 and December 31, 2008 consisted principally of limited partnership investments in unconsolidated limited partnerships that finance the construction and rehabilitation of affordable rental housing. The Corporation earns a return primarily through the receipt of tax credits allocated to the affordable housing projects.
The Corporation determines whether it must consolidate these limited partnerships based on a determination as to which party is expected to absorb a majority of the risk created by the real estate held in the vehicle, which may include construction, market and operating risk. Typically, the general partner in a limited partnership will absorb a majority of this risk due to the legal nature of the limited partnership structure, which the Corporation does not consolidate. The Corporations risk of loss is mitigated by policies requiring that the project qualify for the expected tax credits prior to making its investment. The Corporation may from time to time be asked to invest additional amounts to support a troubled project. Such additional investments have not been and are not expected to be significant.
Municipal Bond Trusts
The Corporation administers municipal bond trusts that hold highly-rated, long-term, fixed-rate municipal bonds, some of which are callable prior to maturity. The vast majority of the bonds are rated AAA or AA and some of the bonds benefit from insurance provided by monolines. The trusts obtain financing by issuing floating-rate trust certificates that reprice on a weekly or other basis to third party investors. The Corporation may serve as remarketing agent and/or liquidity provider for the trusts. The floating-rate investors have the right to tender the certificates at specified dates, often with as little as seven days notice. Should the Corporation be unable to remarket the tendered certificates, it is generally obligated to purchase them at par under standby liquidity facilities. The Corporation is not obligated to purchase the certificates under the standby liquidity facilities if a bonds credit rating declines below investment grade or in the event of certain defaults or bankruptcy of the issuer and insurer. The weighted average remaining life of bonds held in the trusts at March 31, 2009 was 9.9 years. There were no material writedowns or downgrades of assets or issuers during the three months ended March 31, 2009.
In addition to standby liquidity facilities, the Corporation also provides default protection or credit enhancement to investors in securities issued by certain municipal bond trusts. Interest and principal payments on floating-rate certificates issued by these trusts are secured by an unconditional guarantee issued by the Corporation. In the event that the issuer of the underlying municipal bond defaults on any payment of principal and/or interest when due, the Corporation will make any required payments to the holders of the floating-rate certificates. Additional information regarding these guarantees is included in Note 12 Commitments and Contingencies.
Some of these trusts are QSPEs and, as such, are not subject to consolidation by the Corporation. The Corporation consolidates those trusts that are not QSPEs if it holds the residual interests or otherwise expects to absorb a majority of the variability created by changes in market value of assets in the trusts and changes in market rates of interest. The Corporation does not consolidate a trust if the customer holds the residual interest and the Corporation is protected from loss in connection with its liquidity obligations. For example, the Corporation may have the ability to trigger the liquidation of a trust that is not a QSPE if the market value of the bonds held in the trust declines below a specified threshold which is designed to limit market losses to an amount that is less than the customers residual interest, effectively preventing the Corporation from absorbing the losses incurred on the assets held within the trust.
The Corporations liquidity commitments to consolidated and unconsolidated trusts totaled $13.0 billion and $7.2 billion at March 31, 2009 and December 31, 2008. The increase is due principally to the addition of unconsolidated trusts acquired through the Merrill acquisition. Liquidity commitments to unconsolidated trusts are included in Note 12 Commitments and Contingencies.
Collateralized Debt Obligation Vehicles
CDO vehicles hold diversified pools of fixed income securities, typically corporate debt or asset-backed securities, which they fund by issuing multiple tranches of debt and equity securities. Synthetic CDOs enter into a portfolio of credit default swaps to synthetically create exposure to fixed income securities. Collateralized loan obligations (CLOs) are a subset of CDOs which hold pools of loans, typically corporate loans or commercial mortgages. CDOs are typically managed by third party portfolio managers. The Corporation transfers assets to these CDOs, holds securities issued by the CDOs, and may be a derivative counterparty to the CDOs, including credit default swap counterparty for synthetic CDOs. The Corporation receives fees for structuring CDOs and providing liquidity support for super senior tranches of securities issued by certain CDOs. The Corporation has also entered into total return swaps with certain CDOs whereby the Corporation will absorb the economic returns generated by specified assets held by the CDO. No third parties provide a significant amount of similar commitments to these CDOs.
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The Corporation evaluates whether it must consolidate a CDO based principally on a determination as to which party is expected to absorb a majority of the credit risk created by the assets of the CDO. The Corporation does not typically retain a significant portion of debt securities issued by a CDO. When the Corporation structured certain CDOs, it acquired the super senior tranches issued by the CDOs or provided commitments to support the issuance of super senior commercial paper to third parties. When the CDOs were first created, the Corporation did not expect its investments or its liquidity commitments to absorb a significant amount of the variability driven by the credit risk within the CDOs and did not consolidate the CDOs. When the Corporation subsequently acquired commercial paper or term securities issued by certain CDOs during 2008 and the first quarter of 2009, principally as a result of our liquidity obligations, we performed updated consolidation analyses. Due to credit deterioration in the pools of securities held by the CDOs, the updated analyses indicated that the Corporation would now be expected to absorb a majority of the variability and, accordingly, we consolidated these CDOs. Consolidation did not have a significant impact on net income, as the Corporations investments and liquidity obligations were recorded at fair value prior to consolidation. The creditors of the consolidated CDOs have no recourse to the general credit of the Corporation.
The March 31, 2009 balances include a portfolio of CDO-related liquidity exposures obtained in connection with the Merrill Lynch acquisition, including $2.6 billion notional amount of liquidity support provided to certain synthetic CDOs in the form of unfunded lending commitments. These commitments pertain to super senior securities which are the most senior class of securities issued by the CDOs and benefit from the subordination of all other securities issued by the CDOs. The lending commitments obligate us to purchase the super senior CDO securities at par value if the CDOs need cash to make payments due under credit default swaps held by the CDOs. This portfolio also includes an additional $2.1 billion notional amount of liquidity exposure to non-SPE third parties which hold super senior cash positions on our behalf. Our net exposure to loss on these positions, after writedowns and insurance, was $512 million at March 31, 2009.
Liquidity-related commitments also include $5.5 billion notional amount of derivative contracts with unconsolidated SPEs, principally CDO vehicles, which hold non-super senior CDO debt securities or other debt securities on our behalf. These derivatives are typically in the form of total return swaps which obligate us to purchase the securities at the SPEs cost to acquire the securities, generally as a result of ratings downgrades. The underlying securities are senior securities and substantially all of our exposures are insured. Accordingly, our exposure to loss consists principally of counterparty risk to the insurers. The $10.2 billion of liquidity exposure is included in the table above titled Unconsolidated VIEs to the extent that our involvement with the CDO vehicle meets the requirements for disclosure under FIN 46R. For example, if the Corporation did not sponsor a CDO vehicle and does not hold a significant variable interest, the vehicle is not included in the table.
Including the liquidity commitments described above that meet the FIN 46R criteria, the portfolio of CDO investments obtained in connection with the Merrill Lynch acquisition and included in the table above titled Unconsolidated VIEs pertain to CDO vehicles with total assets of $53.2 billion. The Corporations maximum exposure to loss with regard to these positions is $6.7 billion. This amount is significantly less than the total assets of the CDO vehicles because the Corporation typically has exposure to only a portion of the total assets. The Corporation has also purchased credit protection from some of the same CDO vehicles in which it invested, thus reducing our net exposure to future loss.
At December 31, 2008, liquidity commitments provided to CDOs included written put options with a notional amount of $542 million. All of these written put options were terminated in the first quarter of 2009.
Leveraged Lease Trusts
The Corporations net involvement with consolidated leveraged lease trusts totaled $5.6 billion and $5.8 billion at March 31, 2009 and December 31, 2008. The trusts hold long-lived equipment such as rail cars, power generation and distribution equipment, and commercial aircraft. The Corporation consolidates these trusts because it holds a residual interest which is expected to absorb a majority of the variability driven by credit risk of the lessee and, in some cases, by the residual risk of the leased property. The net investment represents the Corporations maximum loss exposure to the trusts in the unlikely event that the leveraged lease investments become worthless. Debt issued by the leveraged lease trusts is nonrecourse to the Corporation. The Corporation has no liquidity exposure to these leveraged lease trusts.
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Customer Vehicles
Customer vehicles include credit-linked and equity-linked note vehicles, repackaging vehicles, and asset acquisition vehicles, which are typically created on behalf of customers who wish to obtain market or credit exposure to a specific company or financial instrument.
Credit-linked and equity-linked note vehicles issue notes which pay a return that is linked to the credit or equity risk of a specified company or debt instrument. The vehicles purchase high-grade assets as collateral and enter into credit default swaps or equity derivatives to synthetically create the credit or equity risk to pay the specified return on the notes. The Corporation is typically the counterparty for some or all of the credit and equity derivatives and, to a lesser extent, it may invest in securities issued by the vehicles. The Corporation may also enter into interest rate or foreign currency derivatives with the vehicles. The Corporation does not typically consolidate the vehicles because the derivatives create variability which is absorbed by the third party investors. The Corporation is exposed to loss if the collateral held by the vehicle declines in value and is insufficient to cover the vehicles obligation to the Corporation under the above derivatives. In addition, the Corporation has entered into total return swaps with certain vehicles through which the Corporation absorbs any gains or losses generated by the collateral held in the vehicles. The Corporation consolidates these vehicles if the variability in cash flows expected to be generated by the collateral is greater than the variability in cash flows expected to be generated by the credit or equity derivatives. At March 31, 2009, the notional amount of such derivative contracts with unconsolidated vehicles was $2.3 billion.
Repackaging vehicles are created to provide an investor with a specific risk profile. The vehicles typically hold a security and a derivative that modifies the interest rate or currency of that security, and issues one class of notes to a single investor. These vehicles are generally QSPEs and, as such, are not subject to consolidation by the Corporation.
Asset acquisition vehicles acquire financial instruments, typically loans, at the direction of a single customer and obtain funding through the issuance of structured notes to the Corporation. At the time the vehicle acquires an asset, the Corporation enters into a total return swap with the customer such that the economic returns of the asset are passed through to the customer. As a result, the Corporation does not consolidate the vehicles. The Corporation is exposed to counterparty credit risk if the asset declines in value and the customer defaults on its obligation to us under the total return swap. The Corporations risk may be mitigated by collateral or other arrangements.
Other Vehicles
Other consolidated vehicles include real estate investment vehicles, municipal bond trusts and asset acquisition conduits. Other unconsolidated vehicles include asset acquisition conduits and other corporate conduits.
The Corporation administers three asset acquisition conduits which acquire assets on behalf of the Corporation or our customers. Two of the conduits, which are unconsolidated, acquire assets at the request of customers who wish to benefit from the economic returns of the specified assets, which consist principally of liquid exchange-traded equity securities and some leveraged loans, on a leveraged basis. The consolidated conduit holds subordinated debt securities for the Corporations benefit. The conduits obtain funding by issuing commercial paper and subordinated certificates to third party investors. Repayment of the commercial paper and certificates is assured by total return swap contracts between the Corporation and the conduits and, for unconsolidated conduits the Corporation is reimbursed through total return swap contracts with its customers. The weighted average maturity of commercial paper issued by the conduits at March 31, 2009 was 67 days. The Corporation receives fees for serving as commercial paper placement agent and for providing administrative services to the conduits.
The Corporation determines whether it must consolidate an asset acquisition conduit based on the design of the conduit and whether the third party investors are exposed to the Corporations credit risk or the market risk of the assets. Interest rate risk is not included in the cash flow analysis because the conduits are not designed to absorb and pass along interest rate risk to investors, who receive current rates of interest that are appropriate for the tenor and relative risk of their investments. When a conduit acquires assets for the benefit of the Corporations customers, the Corporation enters into back-to-back total return swaps with the conduit and the customer such that the economic returns of the assets are passed through to the customer. The Corporations performance under the derivatives is collateralized by the underlying assets and, as such, the third party investors are exposed primarily to credit risk of the Corporation. The Corporations exposure to the counterparty credit risk of its customers is mitigated by the aforementioned collateral arrangements and the ability to liquidate an asset held in the conduit if the customer defaults on its obligation. When a conduit acquires assets on the Corporations behalf and the Corporation absorbs the market risk of the assets, it consolidates the conduit. Derivative activity related to unconsolidated conduits is carried at fair value with changes in fair value recorded in trading account profits (losses).
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Other corporate conduits are commercial paper conduits, which hold primarily