Bank of America 2012 Annual Report Download - page 102

100 Bank of America 2012
provide a hedge benefit. We also have potential representations
and warranties exposure with the same counterparty.
Risk Mitigation
We purchase credit protection to cover the funded portion as well
as the unfunded portion of certain credit exposures. To lower the
cost of obtaining our desired credit protection levels, credit
exposure may be added within an industry, borrower or
counterparty group by selling protection.
At December 31, 2012 and 2011, net notional credit default
protection purchased in our credit derivatives portfolio to hedge
our funded and unfunded exposures for which we elected the fair
value option, as well as certain other credit exposures, was $14.7
billion and $19.4 billion. The mark-to-market effects resulted in
net losses of $1.0 billion in 2012 compared to net gains of $121
million in 2011. The gains and losses related to these instruments
are offset by gains and losses on the exposures. Table 50 presents
the average VaR for these derivatives. See Trading Risk
Management on page 110 for a description of our VaR calculation
for the market-based trading portfolio.
Table 50 Credit Derivative Value-at-Risk
(Dollars in millions) 2012 2011
Average $ 52 $ 60
Credit exposure average 79 74
Combined average (1) 24 38
(1) Reflects the diversification effect between net credit default protection hedging our credit
exposure and the related credit exposure.
Tables 51 and 52 present the maturity profiles and the credit
exposure debt ratings of the net credit default protection portfolio
at December 31, 2012 and 2011.
Table 51 Net Credit Default Protection by Maturity
December 31
2012 2011
Less than or equal to one year 21% 16%
Greater than one year and less than or equal to five
years 75 77
Greater than five years 47
Total net credit default protection 100% 100%
Table 52 Net Credit Default Protection by Credit Exposure Debt Rating
December 31
2012 2011
(Dollars in millions)
Net
Notional (1)
Percent of
Total
Net
Notional (1)
Percent of
Total
Ratings (2, 3)
AAA $ (120) 0.8% $ (32) 0.2%
AA (474) 3.2 (779) 4.0
A(5,861)40.0 (7,184) 37.1
BBB (6,067)41.4 (7,436) 38.4
BB (1,101) 7.5 (1,527) 7.9
B(937) 6.4 (1,534) 7.9
CCC and below (247) 1.7 (661) 3.4
NR (4) 150 (1.0)(203) 1.1
Total net credit default protection $ (14,657) 100.0% $ (19,356) 100.0%
(1) Represents net credit default protection (purchased) sold.
(2) Ratings are refreshed on a quarterly basis.
(3) Ratings of BBB- or higher are considered to meet the definition of investment grade.
(4) “NR” is comprised of names that have not been rated.
In addition to our net notional credit default protection
purchased to cover the funded and unfunded portion of certain
credit exposures, credit derivatives are used for market-making
activities for clients and establishing positions intended to profit
from directional or relative value changes. We execute the majority
of our credit derivative trades in the OTC market with large,
multinational financial institutions, including broker/dealers and,
to a lesser degree, with a variety of other investors. Because these
transactions are executed in the OTC market, we are subject to
settlement risk. We are also subject to credit risk in the event that
these counterparties fail to perform under the terms of these
contracts. In most cases, credit 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 us to take additional protective measures
such as early termination of all trades.