Bank of America 2015 Annual Report Download - page 140

138 Bank of America 2015
All derivatives are recorded on the Consolidated Balance Sheet
at fair value, taking into consideration the effects of legally
enforceable master netting agreements that allow the Corporation
to settle positive and negative positions and offset cash collateral
held with the same counterparty on a net basis. For exchange-
traded contracts, fair value is based on quoted market prices in
active or inactive markets or is derived from observable market-
based pricing parameters, similar to those applied to over-the-
counter (OTC) derivatives. For non-exchange traded contracts, fair
value is based on dealer quotes, pricing models, discounted cash
flow methodologies or similar techniques for which the
determination of fair value may require significant management
judgment or estimation.
Valuations of derivative assets and liabilities reflect the value
of the instrument including counterparty credit risk. These values
also take into account the Corporation’s own credit standing.
Trading Derivatives and Other Risk Management
Activities
Derivatives held for trading purposes are included in derivative
assets or derivative liabilities on the Consolidated Balance Sheet
with changes in fair value included in trading account profits.
Derivatives used for other risk management activities are
included in derivative assets or derivative liabilities. Derivatives
used in other risk management activities have not been designated
in a qualifying accounting hedge relationship because they did not
qualify or the risk that is being mitigated pertains to an item that
is reported at fair value through earnings so that the effect of
measuring the derivative instrument and the asset or liability to
which the risk exposure pertains will offset in the Consolidated
Statement of Income to the extent effective. The changes in the
fair value of derivatives that serve to mitigate certain risks
associated with mortgage servicing rights (MSRs), interest rate
lock commitments (IRLCs) and first mortgage loans held-for-sale
(LHFS) that are originated by the Corporation are recorded in
mortgage banking income. Changes in the fair value of derivatives
that serve to mitigate interest rate risk and foreign currency risk
are included in other income (loss). Credit derivatives are also
used by the Corporation to mitigate the risk associated with various
credit exposures. The changes in the fair value of these derivatives
are included in other income (loss).
Derivatives Used For Hedge Accounting Purposes
(Accounting Hedges)
For accounting hedges, the Corporation formally documents at
inception all relationships between hedging instruments and
hedged items, as well as the risk management objectives and
strategies for undertaking various accounting hedges. Additionally,
the Corporation primarily uses regression analysis at the inception
of a hedge and for each reporting period thereafter to assess
whether the derivative used in an accounting hedge transaction is
expected to be and has been highly effective in offsetting changes
in the fair value or cash flows of a hedged item or forecasted
transaction. The Corporation discontinues hedge accounting when
it is determined that a derivative is not expected to be or has
ceased to be highly effective as a hedge, and then reflects changes
in fair value of the derivative in earnings after termination of the
hedge relationship.
The Corporation uses its accounting hedges as either fair value
hedges, cash flow hedges or hedges of net investments in foreign
operations. The Corporation manages interest rate and foreign
currency exchange rate sensitivity predominantly through the use
of derivatives.
Fair value hedges are used to protect against changes in the
fair value of the Corporation’s assets and liabilities that are
attributable to interest rate or foreign exchange volatility. Changes
in the fair value of derivatives designated as fair value hedges are
recorded in earnings, together and in the same income statement
line item with changes in the fair value of the related hedged item.
If a derivative instrument in a fair value hedge is terminated or the
hedge designation removed, the previous adjustments to the
carrying value of the hedged asset or liability are subsequently
accounted for in the same manner as other components of the
carrying value of that asset or liability. For interest-earning assets
and interest-bearing liabilities, such adjustments are amortized to
earnings over the remaining life of the respective asset or liability.
Cash flow hedges are used primarily to minimize the variability
in cash flows of assets or liabilities, or forecasted transactions
caused by interest rate or foreign exchange fluctuations. Changes
in the fair value of derivatives designated as cash flow hedges are
recorded in accumulated OCI and are reclassified into the line item
in the income statement in which the hedged item is recorded in
the same period the hedged item affects earnings. Hedge
ineffectiveness and gains and losses on the component of a
derivative excluded in assessing hedge effectiveness are recorded
in the same income statement line item. The Corporation records
changes in the fair value of derivatives used as hedges of the net
investment in foreign operations, to the extent effective, as a
component of accumulated OCI. If a derivative instrument in a
cash flow hedge is terminated or the hedge designation is removed,
related amounts in accumulated OCI are reclassified into earnings
in the same period or periods during which the hedged forecasted
transaction affects earnings. If it becomes probable that a
forecasted transaction will not occur, any related amounts in
accumulated OCI are reclassified into earnings in that period.
Interest Rate Lock Commitments
The Corporation enters into IRLCs in connection with its mortgage
banking activities to fund residential mortgage loans at specified
times in the future. IRLCs that relate to the origination of mortgage
loans that will be classified as held-for-sale are considered
derivative instruments under applicable accounting guidance. As
such, these IRLCs are recorded at fair value with changes in fair
value recorded in mortgage banking income, typically resulting in
recognition of a gain when the Corporation enters into IRLCs.
In estimating the fair value of an IRLC, the Corporation assigns
a probability that the loan commitment will be exercised and the
loan will be funded. The fair value of the commitments is derived
from the fair value of related mortgage loans which is based on
observable market data and includes the expected net future cash
flows related to servicing of the loans. Changes in the fair value
of IRLCs are recognized based on interest rate changes, changes
in the probability that the commitment will be exercised and the
passage of time. Changes from the expected future cash flows
related to the customer relationship are excluded from the
valuation of IRLCs.