Huntington Bancshares Incorporated Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

DERIVATIVE FINANCIAL INSTRUMENTS

DERIVATIVE FINANCIAL INSTRUMENTS

3 Months Ended

Mar. 31, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative financial instruments are recorded in the Unaudited Condensed Consolidated Balance Sheets as either an asset or a liability (in other assets or other liabilities, respectively) and measured at fair value.

Derivative financial instruments can be designated as accounting hedges under GAAP. Designating a derivative as an accounting hedge allows Huntington to recognize gains and losses on the hedging instruments in same income statement line item where the gains and losses on the hedged item are recognized. Gains and losses on derivatives that are not designated to an effective hedge relationship under GAAP immediately impact earnings within the period they occur.

The following table presents the fair values of all derivative instruments included in the Unaudited Condensed Consolidated Balance Sheets at March 31, 2019 and December 31, 2018. Amounts in the table below are presented gross without the impact of any net collateral arrangements.



	March 31, 2019				December 31, 2018
(dollar amounts in millions)	Asset		Liability		Asset		Liability
Derivatives designated as Hedging Instruments
Interest rate contracts	$	95	$	30	$	44	$	42
Derivatives not designated as Hedging Instruments
Interest rate contracts	276		188		261		165
Foreign exchange contracts	18		16		23		19
Commodities contracts	133		131		172		168
Equity contracts	—		6		—		10
Total Contracts	$	522	$	371	$	500	$	404

The following table presents the amount of gain or loss recognized in income for derivatives not designated as hedging instruments under ASC Subtopic 815-10 in the Unaudited Condensed Consolidated Income Statement for the three-month periods ended March 31, 2019 and March 31, 2018, respectively.



	Location of Gain or (Loss) Recognized in Income on Derivative	Amount of Gain or (Loss) Recognized in Income on Derivative
		Three months ended March 31,
(dollar amounts in millions)		2019			2018
Interest rate contracts:
Customer	Capital markets fees	$	10		$	7
Mortgage Banking	Mortgage banking income	12			(8		)
Foreign exchange contracts	Capital markets fees	8			6
Commodities contracts	Capital markets fees	(6		)	2
Equity contracts	Other noninterest expense	(1		)	(1		)
Total		$	23		$	6

Derivatives used in asset and liability management activities

Huntington engages in balance sheet hedging activity, principally for asset liability management purposes, to convert fixed rate assets or liabilities into floating rate or vice versa. Balance sheet hedging activity is generally arranged to receive hedge accounting treatment that can be classified as either fair value or cash flow hedges. Fair value hedges are executed to convert fixed rate liabilities to floating rate. Cash flow hedges are used to convert floating rate assets into fixed rate assets.

The following table presents the gross notional values of derivatives used in Huntington’s asset and liability management activities at March 31, 2019 and December 31, 2018, identified by the underlying interest rate-sensitive instruments.



	March 31, 2019
(dollar amounts in millions)	Fair Value Hedges		Cash Flow Hedges		Economic Hedges		Total
Instruments associated with:
Loans	$	—	$	2,750	$	—	$	2,750
Investment securities	—		12		—		12
Long-term debt	5,790		—		—		5,790
Unassigned (1)	—		—		1,000		1,000
Total notional value at March 31, 2019	$	5,790	$	2,762	$	1,000	$	9,552

			December 31, 2018
(dollar amounts in millions)			Fair Value Hedges		Cash Flow Hedges		Total
Instruments associated with:
Investment securities			$	—	$	12	$	12
Long-term debt			4,865		—		4,865
Total notional value at December 31, 2018			$	4,865	$	12	$	4,877


(1)	Huntington purchased $1.0 billion of interest rate floors in the first quarter to economically hedge the impact of potential interest rate decreases. These contracts will be measured at fair value with changes in fair value recognized in other noninterest income.

The following table presents additional information about the interest rate swaps and floors used in Huntington’s asset and liability management activities at March 31, 2019 and December 31, 2018.



	March 31, 2019
						Weighted-Average Rate
(dollar amounts in millions)	Notional Value		Average Maturity (years)	Fair Value		Receive		Pay
Asset conversion swaps
Receive fixed—generic	$	12	1.0	$	—	2.20	%	2.48		%
Liability conversion swaps
Receive fixed—generic	5,790		2.5	53		2.24		2.54
Total swap portfolio at March 31, 2019	$	5,802	2.5	$	53	2.24	%	2.54		%

	March 31, 2019

(dollar amounts in millions)	Notional Value			Average Maturity (years)				Fair Value
Purchased floors
Purchased interest rate floors	$	3,750		1.8				$	12
Total floors portfolio at March 31, 2019	$	3,750		1.8				$	12

	December 31, 2018
						Weighted-Average Rate
(dollar amounts in millions)	Notional Value		Average Maturity (years)	Fair Value		Receive		Pay
Asset conversion swaps
Receive fixed—generic	$	12	1.2	$	—	2.20	%	2.46		%
Liability conversion swaps
Receive fixed—generic	$	4,865	2.6	$	2	2.24	%	2.54		%
Total swap portfolio at December 31, 2018	$	4,877	2.6	$	2	2.24	%	2.54		%

These derivative financial instruments were entered into for the purpose of managing the interest rate risk of assets and liabilities. With the exception of $1.0 billion of interest rate floors that are economically hedging interest rate decreases, net amounts receivable or payable on contracts hedging either interest earning assets or interest bearing liabilities were accrued as an adjustment to either interest income or interest expense. The net amounts resulted in an increase (decrease) to net interest income of $(14) million and $1 million for the three-month periods ended March 31, 2019, and 2018, respectively.

Fair Value Hedges

The changes in fair value of the fair value hedges are recorded through earnings and offset against changes in the fair value of the hedged item.

The following table presents the change in fair value for derivatives designated as fair value hedges as well as the offsetting change in fair value on the hedged item for the three-month periods ended March 31, 2019 and 2018.



	Three Months Ended March 31,
(dollar amounts in millions)	2019			2018
Interest rate contracts
Change in fair value of interest rate swaps hedging long-term debt (1)	$	41		$	(68	)
Change in fair value of hedged long term debt (1)	(41		)	71


(1)	Recognized in Interest expense—long-term debt in the Unaudited Condensed Consolidated Statements of Income.

As of March 31, 2019 and December 31, 2018, the following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges.



	Carrying Amount of the Hedged Liabilities				Cumulative Amount of Fair Value Hedging Adjustment To Hedged Liabilities
(dollar amounts in millions)	March 31, 2019		December 31, 2018		March 31, 2019		December 31, 2018
Long-term debt	$	6,498	$	4,845	$	29	$	(12	)

The cumulative amount of fair value hedging adjustments remaining for any hedged assets and liabilities for which hedge accounting has been discontinued was $(119) million and $(127) million at March 31, 2019 and December 31, 2018, respectively.

Cash Flow Hedges

During the first quarter of 2019, Huntington purchased $2.8 billion of interest rate floors and designated them as cash flow hedges for variable rate commercial loans indexed to LIBOR. These interest rate floors will reduce the potential adverse effect of interest rate decreases on future interest income. Huntington will receive interest payments when the interest rate indexed to LIBOR falls below the strike price mentioned in the contracts. The contracts are measured at fair value with any change in fair value related to intrinsic value recognized in OCI and reclassified into earnings when the cash flows related to the hedged item impact earnings. Any change in fair value related to time value is recognized in OCI. The initial premium paid for these contracts represents the time value of the contracts and is not included in the measurement of hedge effectiveness. The premium is amortized on straight line basis as a reduction to interest income over the contractual life of these contracts.

Gains and losses on derivatives instruments related to loans and investment securities are recorded in interest income and interest expense, respectively.

Derivatives used in mortgage banking activities

Mortgage loan origination hedging activity

Huntington’s mortgage origination hedging activity is related to economically hedging Huntington's mortgage pricing commitments to customers and the secondary sale to third parties. The value of a newly originated mortgage is not firm until the interest rate is committed or locked. The net asset (liability) position of these derivatives at March 31, 2019 and December 31, 2018 are less than one million and $(4) million, respectively. At March 31, 2019 and December 31, 2018, Huntington had commitments to sell residential real estate loans of $0.9 billion and $0.8 billion, respectively. These contracts mature in less than 1 year.

MSR hedging activity

Huntington’s MSR economic hedging activity uses securities and derivatives to manage the value of the MSR asset and to mitigate the various types of risk inherent in the MSR asset, including risks related to duration, basis, convexity, volatility, and yield curve. The hedging instruments include forward commitments, interest rate swaps, and options on interest rate swaps.

The notional value of the derivative financial instruments, corresponding trading assets and liabilities, and net trading gains (losses) related to MSR hedging activity is summarized in the following table:



(dollar amounts in millions)	March 31, 2019		December 31, 2018
Notional Value	$	650	$	—
Trading Assets	4		—
Trading Liabilities	1		—

	Three months ended March 31,
(dollar amounts in millions)	2019		2018
Trading gains (losses)	$	7	$	—

Trading gains (losses) are included in mortgage banking income in the Unaudited Condensed Consolidated Statement of Income.

Derivatives used in customer related activities

Various derivative financial instruments are offered to enable customers to meet their financing and investing objectives and for their risk management purposes. Derivative financial instruments used in trading activities consist of commodity, interest rate, and foreign exchange contracts. Huntington enters into offsetting third-party contracts with approved, reputable counterparties with substantially matching terms and currencies in order to economically hedge significant exposure related to derivatives used in trading activities.

The interest rate or price risk of customer derivatives is mitigated by entering into similar derivatives having offsetting terms with other counterparties. The credit risk to these customers is evaluated and included in the calculation of fair value. Foreign currency derivatives help the customer hedge risk and reduce exposure to fluctuations in exchange rates. Transactions are primarily in liquid currencies with Canadian dollars and Euros comprising a majority of all transactions. Commodity derivatives help the customer hedge risk and reduce exposure to fluctuations in the price of various commodities. Hedging of energy-related products and base metals comprise the majority of all transactions.

The net fair values of these derivative financial instruments, for which the gross amounts are included in other assets or other liabilities at both March 31, 2019 and December 31, 2018, were $82 million and $92 million, respectively. The total notional values of derivative financial instruments used by Huntington on behalf of customers, including offsetting derivatives, were $28 billion and $26 billion at March 31, 2019 and December 31, 2018, respectively. Huntington’s credit risk from customer derivatives was $237 million and $132 million at the same dates, respectively.

Visa^®-related Swaps

In connection with the sale of Huntington’s Class B Visa^® shares, Huntington entered into a swap agreement with the purchaser of the shares. The swap agreement adjusts for dilution in the conversion ratio of Class B shares resulting from changes in the Visa^® litigation. In connection with the FirstMerit acquisition, Huntington acquired an additional Visa^®related swap agreement. At March 31, 2019, the combined fair value of the swap liabilities of $3 million is an estimate of the exposure liability based upon Huntington’s assessment of the potential Visa^® litigation losses and timing of the litigation settlement.

Financial assets and liabilities that are offset in the Unaudited Condensed Consolidated Balance Sheets

Huntington records derivatives at fair value as further described in Note 11 "Fair Values of Assets and Liabilities".

Derivative balances are presented on a net basis taking into consideration the effects of legally enforceable master netting agreements. Additionally, collateral exchanged with counterparties is also netted against the applicable derivative fair values. Huntington enters into derivative transactions with two primary groups: broker-dealers and banks, and Huntington’s customers. Different methods are utilized for managing counterparty credit exposure and credit risk for each of these groups.

Huntington enters into transactions with broker-dealers and banks for various risk management purposes. These types of transactions generally are high dollar volume. Huntington enters into collateral and master netting agreements with these counterparties, and routinely exchanges cash and high quality securities collateral. Huntington enters into transactions with customers to meet their financing, investing, payment and risk management needs. These types of transactions generally are low dollar volume. Huntington enters into master netting agreements with customer counterparties; however, collateral is generally not exchanged with customer counterparties.

At March 31, 2019 and December 31, 2018, aggregate credit risk associated with these derivatives, net of collateral that has been pledged by the counterparty, was $21 million and $37 million, respectively. The credit risk associated with interest rate swaps is calculated after considering master netting agreements with broker-dealers and banks.

At March 31, 2019, Huntington pledged $80 million of investment securities and cash collateral to counterparties, while other counterparties pledged $76 million of investment securities and cash collateral to Huntington to satisfy collateral netting agreements. In the event of credit downgrades, Huntington would not be required to provide additional collateral.

The following tables present the gross amounts of these assets and liabilities with any offsets to arrive at the net amounts recognized in the Unaudited Condensed Consolidated Balance Sheets at March 31, 2019 and December 31, 2018.



Offsetting of Financial Assets and Derivative Assets
				Gross amounts offset in the unaudited condensed consolidated balance sheets			Net amounts of assets presented in the unaudited condensed consolidated balance sheets		Gross amounts not offset in the unaudited condensed consolidated balance sheets
(dollar amounts in millions)		Gross amounts of recognized assets							Financial instruments			Cash collateral received			Net amount
March 31, 2019	Derivatives	$	522	$	(259	)	$	263	$	(4	)	$	(21	)	$	238
December 31, 2018	Derivatives	500		(291		)	209		(4		)	(53		)	152



Offsetting of Financial Liabilities and Derivative Liabilities
				Gross amounts offset in the unaudited condensed consolidated balance sheets			Net amounts of liabilities presented in the unaudited condensed consolidated balance sheets		Gross amounts not offset in the unaudited condensed consolidated balance sheets
(dollar amounts in millions)		Gross amounts of recognized liabilities							Financial instruments		Cash collateral received			Net amount
March 31, 2019	Derivatives	$	371	$	(284	)	$	87	$	—	$	(15	)	$	72
December 31, 2018	Derivatives	404		(217		)	187		—		(12		)	175