Bank of America 2004 Annual Report Download - page 58

BANK OF AMERICA 2004 57
On-balance Sheet Commercial Paper Conduits
In addition to the off-balance sheet financing entities previously
described, we also utilize commercial paper conduits that have been
consolidated based on our determination that we are the primary
beneficiary of the entities in accordance with FIN 46R. At December
31, 2004 and 2003, the consolidated assets and liabilities of these
conduits were reflected in AFS Securities, Other Assets, and
Commercial Paper and Other Short-term Borrowings in the Global
Capital Markets and Investment Banking business segment. At
December 31, 2004 and 2003, we held $7.7 billion and $5.6 billion,
respectively, of assets of these entities while our maximum loss expo-
sure associated with these entities, including unfunded lending com-
mitments, was approximately $9.4 billion and $7.6 billion,
respectively.
Qualified Special Purpose Entities
In addition, to control our capital position, diversify funding sources and
provide customers with commercial paper investments, we will, from
time to time, sell assets to off-balance sheet commercial paper enti-
ties. The commercial paper entities are Qualified Special Purpose
Entities (QSPEs) that have been isolated beyond our reach or that of
our creditors, even in the event of bankruptcy or other receivership. The
accounting for these entities is governed by SFAS 140, “Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities – a replacement of FASB Statement No. 125” (SFAS 140),
which provides that QSPEs are not included in the consolidated finan-
cial statements of the seller. Assets sold to the entities consist of high-
grade corporate or municipal bonds, collateralized debt obligations and
asset-backed securities. These entities issue collateralized commercial
paper or notes with similar repricing characteristics to third party mar-
ket participants and passive derivative instruments to us. Assets sold
to the entities typically have an investment rating ranging from Aaa/AAA
to Aa/AA. We may provide liquidity, SBLCs or similar loss protection
commitments to the entity, or we may enter into derivatives with the
entity in which we assume certain risks. The liquidity facility and deriv-
atives have the same legal standing with the commercial paper.
The derivatives provide interest rate, currency and a pre-specified
amount of credit protection to the entity in exchange for the com-
mercial paper rate. These derivatives are provided for in the legal doc-
uments and help to alleviate any cash flow mismatches. In some
cases, if an asset’s rating declines below a certain investment qual-
ity as evidenced by its investment rating or defaults, we are no longer
exposed to the risk of loss. At that time, the commercial paper hold-
ers assume the risk of loss. In other cases, we agree to assume all
of the credit exposure related to the referenced asset. Legal docu-
ments for each entity specify asset quality levels that require the
entity to automatically dispose of the asset once the asset falls
below the specified quality rating. At the time the asset is disposed,
we are required to reimburse the entity for any credit-related losses
depending on the pre-specified level of protection provided.
We also receive fees for the services we provide to the entities,
and we manage any credit or market risk on commitments or deriva-
tives through normal underwriting and risk management processes.
Derivative activity related to these entities is included in Note 4 of the
Consolidated Financial Statements. At December 31, 2004 and
2003, the Corporation had off-balance sheet liquidity commitments,
SBLCs and other financial guarantees to the entities of $7.4 billion
and $7.3 billion, respectively. Substantially all of these liquidity com-
mitments, SBLCs and other financial guarantees mature within one
year. These amounts are included in Table 8. Net revenues earned
from fees associated with these entities were $61 million and $65
million in 2004 and 2003, respectively.
We generally do not purchase any of the commercial paper
issued by these types of financing entities other than during the
underwriting process when we act as issuing agent nor do we purchase
any of the commercial paper for our own account. Derivative instru-
ments related to these entities are marked to market through the
Consolidated Statement of Income. SBLCs are initially recorded at fair
value in accordance with FIN 45. Liquidity commitments and SBLCs
subsequent to inception are accounted for pursuant to SFAS 5 and are
discussed further in Note 12 of the Consolidated Financial Statements.
Credit and Liquidity Risks
Because we provide liquidity and credit support to the commercial
paper conduits and QSPEs described above, our credit ratings and
changes thereto will affect the borrowing cost and liquidity of these
entities. In addition, significant changes in counterparty asset valua-
tion and credit standing may also affect the liquidity of the commer-
cial paper issuance. Disruption in the commercial paper markets may
result in our having to fund under these commitments and SBLCs dis-
cussed above. We seek to manage these risks, along with all other
credit and liquidity risks, within our policies and practices. See Notes
1 and 8 of the Consolidated Financial Statements for additional dis-
cussion of off-balance sheet financing entities.
Other Off-balance Sheet Financing Entities
To improve our capital position and diversify funding sources, we also
sell assets, primarily loans, to other off-balance sheet QSPEs that
obtain financing primarily by issuing term notes. We may retain a por-
tion of the investment grade notes issued by these entities, and we
may also retain subordinated interests in the entities which reduce
the credit risk of the senior investors. We may provide liquidity support
in the form of foreign exchange or interest rate swaps. We generally
do not provide other forms of credit support to these entities. In addi-
tion to the above, we had significant involvement with VIEs other than
the commercial paper conduits. These VIEs were not consolidated
because we will not absorb a majority of the expected losses or
expected residual returns and are therefore not the primary benefici-
ary of the VIEs. These entities are described more fully in Note 8 of the
Consolidated Financial Statements.