Bank of America 2009 Annual Report Download - page 165

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 varia-
bility 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 vehicle’s obligation to the Corporation under
the above-referenced derivatives. In addition, the Corporation has entered
into derivative contracts, typically total return swaps, with certain vehicles
which obligate the Corporation to purchase securities held as collateral at
the vehicle’s cost, typically as a result of ratings downgrades. These
exposures were obtained in connection with the Merrill Lynch acquisition.
The underlying securities are senior securities and substantially all of the
Corporation’s exposures are insured. Accordingly, the Corporation’s
exposure to loss consists principally of counterparty risk to the insurers.
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
December 31, 2009, the notional amount of such derivative contracts
with unconsolidated vehicles was $1.4 billion. This amount is included in
the $2.8 billion notional amount of derivative contracts through which the
Corporation obtains funding from unconsolidated SPEs, described in Note
14 – Commitments and Contingencies. The Corporation also has approx-
imately $628 million of other liquidity commitments, including written put
options and collateral value guarantees, with credit-linked and equity-
linked vehicles at December 31, 2009.
Repackaging vehicles are created to provide an investor with a
specific risk profile. The vehicles typically hold a security and a derivative
that modify 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 the Corporation under the total return swap. The Corpo-
ration’s risk may be mitigated by collateral or other arrangements.
Other Vehicles
Other consolidated vehicles primarily include asset acquisition conduits
and real estate investment vehicles. 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 its 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 on a leveraged basis, which consist principally of liquid exchange-
traded equity securities. The consolidated conduit holds subordinated
debt securities for the Corporation’s 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 swaps between the Corporation and the conduits and for
unconsolidated conduits the Corporation is reimbursed through total
return swaps with its customers. The weighted-average maturity of
commercial paper issued by the conduits at December 31, 2009 was 68
days. The Corporation receives fees for serving as commercial paper
placement agent and for providing administrative services to the conduits.
At December 31, 2009 and 2008, the Corporation did not hold any
commercial paper issued by the asset acquisition conduits other than
incidentally and in its role as a commercial paper dealer.
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 Corporation’s 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 Corporation’s cus-
tomers, 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 Corporation’s perform-
ance under the derivatives is collateralized by the underlying assets and
as such the third party investors are exposed primarily to the credit risk of
the Corporation. The Corporation’s 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 Corporation’s behalf and the Corporation absorbs the market risk
of the assets, it consolidates the conduit. Derivatives related to uncon-
solidated conduits are carried at fair value with changes in fair value
recorded in trading account profits (losses).
Other corporate conduits at December 31, 2008 included several
commercial paper conduits which held primarily high-grade, long-term
municipal, corporate and mortage-backed securities. During the second
quarter of 2009, the Corporation was unable to remarket the conduits’
commercial paper and, in accordance with existing contractual arrange-
ments, the conduits were liquidated. Due to illiquidity in the financial
markets, the Corporation purchased a majority of these assets. At
December 31, 2009, the Corporation held $207 million of assets
acquired from the liquidation of other corporate conduits and previous
mandatory sales of assets out of the conduits. These assets are
recorded on the Consolidated Balance Sheet in trading account assets.
Bank of America 2009 163