Bank of America 2011 Annual Report Download - page 173

Bank of America 2011 171
The notional amount represents the maximum amount payable
by the Corporation for most credit derivatives. However, the
Corporation does not solely monitor its exposure to credit
derivatives based on notional amount because this measure does
not take into consideration the probability of occurrence. As such,
the notional amount is not a reliable indicator of the Corporation’s
exposure to these contracts. Instead, a risk framework is used to
define risk tolerances and establish limits to help ensure that
certain credit risk-related losses occur within acceptable, pre-
defined limits.
The Corporation economically hedges its market risk exposure
to credit derivatives by entering into a variety of offsetting derivative
contracts and security positions. For example, in certain instances,
the Corporation may purchase credit protection with identical
underlying referenced names to offset its exposure. The carrying
value and notional amount of written credit derivatives for which
the Corporation held purchased credit derivatives with identical
underlying referenced names and terms at December 31, 2011
was $48.0 billion and $1.0 trillion compared to $43.7 billion and
$1.4 trillion at December 31, 2010.
Credit-related notes in the table on page 170 include
investments in securities issued by CDO, collateralized loan
obligation (CLO) and credit-linked note vehicles. These instruments
are primarily classified as trading securities. The carrying value of
these instruments equals the Corporation’s maximum exposure
to loss. The Corporation is not obligated to make any payments
to the entities under the terms of the securities owned. The
Corporation discloses internal categorizations of investment grade
and non-investment grade consistent with how risk is managed
for these instruments.
Credit-related Contingent Features and Collateral
The Corporation executes the majority of its derivative contracts
in the OTC market with large, international financial institutions,
including broker/dealers and, to a lesser degree, with a variety of
non-financial companies. Substantially all of the derivative
transactions are executed on a daily margin basis. Therefore,
events such as a credit rating downgrade (depending on the
ultimate rating level) or a breach of credit covenants would typically
require an increase in the amount of collateral required of the
counterparty, where applicable, and/or allow the Corporation to
take additional protective measures such as early termination of
all trades. Further, as previously discussed on page 164, the
Corporation enters into legally enforceable master netting
agreements which reduce risk by permitting the closeout and
netting of transactions with the same counterparty upon the
occurrence of certain events.
A majority of the Corporation’s derivative contracts contain
credit risk related contingent features, primarily in the form of
International Swaps and Derivatives Association, Inc. (ISDA)
master netting agreements and credit support documentation that
enhance the creditworthiness of these instruments compared to
other obligations of the respective counterparty with whom the
Corporation has transacted. These contingent features may be for
the benefit of the Corporation as well as its counterparties with
respect to changes in the Corporation’s creditworthiness and the
mark-to-market exposure under the derivative transactions. At
December 31, 2011 and 2010, the Corporation held cash and
securities collateral of $87.7 billion and $86.1 billion, and posted
cash and securities collateral of $86.5 billion and $66.9 billion in
the normal course of business under derivative agreements.
In connection with certain OTC derivative contracts and other
trading agreements, the Corporation can be required to provide
additional collateral or to terminate transactions with certain
counterparties in the event of a downgrade of the senior debt
ratings of the Corporation or certain subsidiaries. The amount of
additional collateral required depends on the contract and is
usually a fixed incremental amount and/or the market value of the
exposure.
At December 31, 2011, the amount of collateral, calculated
based on the terms of the contracts, that the Corporation and
certain subsidiaries could be required to post to counterparties
but had not yet posted to counterparties was approximately $5.0
billion. That amount includes collateral that could be required to
be posted as a result of the downgrades by the rating agencies in
2011.
Some counterparties are able to unilaterally terminate certain
contracts, or the Corporation or certain subsidiaries may be
required to take other action such as find a suitable replacement
or obtain a guarantee. At December 31, 2011, the current liability
recorded for these derivative contracts was $947 million, against
which the Corporation and certain subsidiaries had posted $1.0
billion of collateral.
In addition, under the terms of certain OTC derivative contracts
and other trading agreements, in the event of a further downgrade
of the Corporation’s or certain subsidiaries’ credit ratings,
counterparties to those agreements may require the Corporation
or certain subsidiaries to provide additional collateral, terminate
these contracts or agreements, or provide other remedies. At
December 31, 2011, if the rating agencies had downgraded their
long-term senior debt ratings for the Corporation or certain
subsidiaries by one incremental notch, the amount of additional
collateral contractually required by derivative contracts and other
trading agreements would have been approximately $1.6 billion
comprised of $1.2 billion for BANA and approximately $375 million
for Merrill Lynch and certain of its subsidiaries. If the agencies
had downgraded their long-term senior debt ratings for these
entities by a second incremental notch, approximately $1.1 billion
in additional collateral comprised of $871 million for BANA and
$269 million for Merrill Lynch and certain subsidiaries, would have
been required.
Also, if the rating agencies had downgraded their long-term
senior debt ratings for the Corporation or certain subsidiaries by
one incremental notch, the derivative liability that would be subject
to unilateral termination by counterparties as of December 31,
2011 was $2.9 billion, against which $2.7 billion of collateral has
been posted. If the rating agencies had downgraded their long-
term senior debt ratings for the Corporation and certain
subsidiaries by a second incremental notch, the derivative liability
that would be subject to unilateral termination by counterparties
as of December 31, 2011 was an incremental $5.6 billion, against
which $5.4 billion of collateral has been posted.
Derivative Valuation Adjustments
The Corporation records counterparty credit risk valuation
adjustments on derivative assets in order to properly reflect the
credit quality of the counterparties. 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