Quarterly report pursuant to Section 13 or 15(d)

Derivative Financial Instruments

v2.4.0.6
Derivative Financial Instruments
3 Months Ended
Sep. 30, 2012
Derivative Financial Instruments [Abstract]  
DERIVATIVE FINANCIAL INSTRUMENTS

14. Derivative Financial Instruments

 

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

 

Derivatives used in Asset and Liability Management Activities

 

A variety of derivative financial instruments, principally interest rate swaps, caps, floors, and collars are used in asset and liability management activities to protect against the risk of adverse price or interest rate movements. These instruments provide flexibility in adjusting Huntington's sensitivity to changes in interest rates without exposure to loss of principal and higher funding requirements. Huntington records derivatives at fair value, as further described in Note 13. Collateral agreements are regularly entered into as part of the underlying derivative agreements with Huntington's counterparties to mitigate counterparty credit risk. At September 30, 2012 and December 31, 2011, aggregate credit risk associated with these derivatives, net of collateral that has been pledged by the counterparty, was $16.7 million and $36.4 million, respectively. The credit risk associated with interest rate swaps is calculated after considering master netting agreements.

 

At September 30, 2012, Huntington pledged $155.8 million of investment securities and cash collateral to counterparties, while other counterparties pledged $187.6 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 $0.0 million in additional collateral.

 

The following table presents the gross notional values of derivatives used in Huntington's asset and liability management activities at September 30, 2012, identified by the underlying interest rate-sensitive instruments:

      Fair Value     Cash Flow      
(dollar amounts in thousands )   Hedges     Hedges     Total
Instruments associated with:                
  Loans $ ---   $ 8,411,800   $ 8,411,800
  Deposits   691,875     ---     691,875
  Subordinated notes   598,000     ---     598,000
  Other long-term debt   35,000     ---     35,000
Total notional value at September 30, 2012 $ 1,324,875   $ 8,411,800   $ 9,736,675

The following table presents additional information about the interest rate swaps used in Huntington's asset and liability management activities at September 30, 2012:

          Average         Weighted-Average
      Notional   Maturity     Fair   Rate
(dollar amounts in thousands )   Value   (years)     Value   Receive Pay
Asset conversion swaps                        
  Receive fixed - generic $ 7,961,000   2.5   $ 72,841   1.11 % 0.53 %
  Pay fixed - generic   450,800   2.8     (3,413)   0.38   0.70  
Total asset conversion swaps   8,411,800   2.5     69,428   1.07   0.53  
Liability conversion swaps                        
  Receive fixed - generic   1,324,875   3.4     119,368   2.88   0.50  
Total liability conversion swaps   1,324,875   3.4     119,368   2.88   0.50  
Total swap portfolio $ 9,736,675   2.6   $ 188,796   1.31 % 0.53 %

These derivative financial instruments were entered into for the purpose of managing the interest rate risk of assets and liabilities. Consequently, 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 to net interest income of $28.8 million and $27.4 million for the three-month periods ended September 30, 2012, and 2011, respectively. For the nine-month periods ended September 30, 2012 and 2011, the net amounts resulted in an increase to net interest income of $81.2 million and $89.3 million, respectively.

 

In connection with securitization activities, Huntington purchased interest rate caps with a notional value totaling $0.7 billion. These purchased caps were assigned to the securitization trust for the benefit of the security holders. Interest rate caps were also sold totaling $0.7 billion outside the securitization structure. Both the purchased and sold caps are marked to market through income.

 

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 the Visa litigation. At September 30, 2012, the fair value of the swap liability of $0.4 million is an estimate of the exposure liability based upon Huntington's assessment of the probability-weighted potential Visa litigation losses and certain fixed payments required to be made through the term of the swap.

 

The following table presents the fair values at September 30, 2012 and December 31, 2011 of Huntington's financial instruments. Amounts in the table below are presented gross without the impact of any net collateral arrangements.

Asset derivatives included in accrued income and other assets:
      September 30,     December 31,
(dollar amounts in thousands)   2012     2011
Interest rate contracts designated as hedging instruments $ 188,796   $ 175,932
Interest rate contracts not designated as hedging instruments   337,092     309,496
Foreign exchange contracts not designated as hedging instruments   6,316     4,885
Total contracts $ 532,204   $ 490,313
             
Liability derivatives included in accrued expenses and other liabilities
      September 30,     December 31,
(dollar amounts in thousands)   2012     2011
Interest rate contracts designated as hedging instruments $ ---   $ ---
Interest rate contracts not designated as hedging instruments   256,306     252,962
Foreign exchange contracts not designated as hedging instruments   4,888     4,318
Total contracts $ 261,194   $ 257,280

Fair value hedges are established to convert deposits and subordinated and other long-term debt from fixed-rate obligations to floating rate. The changes in fair value of the derivative are, to the extent that the hedging relationship is effective, 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 and nine-month periods ended September 30, 2012 and 2011:

      Three Months Ended     Nine Months Ended
      September 30,     September 30,
(dollar amounts in thousands)   2012     2011     2012     2011
Interest rate contracts                      
  Change in fair value of interest rate swaps hedging deposits (1) $ (417)   $ 2,922   $ (852)   $ 3,831
  Change in fair value of hedged deposits (1)   428     (2,870)     840     (3,949)
  Change in fair value of interest rate swaps hedging subordinated notes (2)   2,448     41,170     8,207     46,407
  Change in fair value of hedged subordinated notes (2)   (2,448)     (41,170)     (8,207)     (46,407)
  Change in fair value of interest rate swaps hedging other long-term debt (2)   205     2,138     489     2,527
  Change in fair value of hedged other long-term debt (2)   (205)     (2,138)     (489)     (2,527)
(1) Effective portion of the hedging relationship is recognized in Interest expense - deposits in the Unaudited Condensed Consolidated Statements of Income. Any resulting ineffective portion of the hedging relationship is recognized in noninterest income in the Unaudited Condensed Consolidated Statements of Income.
                         
(2) Effective portion of the hedging relationship is recognized in Interest expense - subordinated notes and other long-term debt in the Unaudited Condensed Consolidated Statements of Income. Any resulting ineffective portion of the hedging relationship is recognized in noninterest income in the Unaudited Condensed Consolidated Statements of Income.

For cash flow hedges, interest rate swap contracts were entered into that pay fixed-rate interest in exchange for the receipt of variable-rate interest without the exchange of the contract's underlying notional amount, which effectively converts a portion of its floating-rate debt to a fixed-rate debt. This reduces the potentially adverse impact of increases in interest rates on future interest expense. Other LIBOR-based commercial and industrial loans as well as investment securities were effectively converted to fixed-rate by entering into contracts that swap certain variable-rate interest payments for fixed-rate interest payments at designated times.

 

To the extent these derivatives are effective in offsetting the variability of the hedged cash flows, changes in the derivatives' fair value will not be included in current earnings but are reported as a component of OCI in the Unaudited Condensed Consolidated Statements of Shareholders' Equity. These changes in fair value will be included in earnings of future periods when earnings are also affected by the changes in the hedged cash flows. To the extent these derivatives are not effective, changes in their fair values are immediately included in noninterest income.

 

The following table presents the gains and (losses) recognized in OCI and the location in the Unaudited Condensed Consolidated Statements of Income of gains and (losses) reclassified from OCI into earnings for the three-month and nine-month periods ended September 30, 2012 and 2011 for derivatives designated as effective cash flow hedges:

Derivatives in cash flow hedging relationships   Amount of gain or (loss) recognized in OCI on derivatives (effective portion) (after-tax)   Location of gain or (loss) reclassified from accumulated OCI into earnings (effective portion)   Amount of (gain) or loss reclassified from accumulated OCI into earnings (effective portion)
      Three Months Ended       Three Months Ended  
      September 30,       September 30,  
(dollar amounts in thousands) 2012   2011       2012   2011  
Interest rate contracts                      
  Loans $ 14,027 $ 16,091   Interest and fee income - loans and leases $ (13,428) $ (3,851)  
  Investment Securities   ---   379   Interest and fee income - investment securities   ---   ---  
  FHLB Advances   ---   ---   Interest expense - federal home loan bank advances   ---   ---  
  Deposits   ---   ---   Interest expense - deposits   ---   ---  
  Subordinated notes   ---   ---   Interest expense - subordinated notes and other long-term debt   130   7  
  Other long term debt   ---   ---   Interest expense - subordinated notes and other long-term debt   ---   ---  
Total $ 14,027 $ 16,470     $ (13,298) $ (3,844)  
                         
Derivatives in cash flow hedging relationships   Amount of gain or (loss) recognized in OCI on derivatives (effective portion) (after-tax)   Location of gain or (loss) reclassified from accumulated OCI into earnings (effective portion)   Amount of (gain) or loss reclassified from accumulated OCI into earnings (effective portion)
      Nine Months Ended       Nine Months Ended  
      September 30,       September 30,  
(dollar amounts in thousands) 2012   2011       2012   2011  
Interest rate contracts                      
  Loans $ 4,031 $ 12,880   Interest and fee income - loans and leases $ 13,285 $ 3,776  
  Investment Securities   (702)   847   Interest and fee income - investment securities   ---   ---  
  FHLB Advances   ---   ---   Interest expense - federal home loan bank advances   ---   ---  
  Deposits   ---   ---   Interest expense - deposits   ---   ---  
  Subordinated notes   ---   ---   Interest expense - subordinated notes and other long-term debt   143   20  
  Other long term debt   ---   ---   Interest expense - subordinated notes and other long-term debt   ---   ---  
Total $ 3,329 $ 13,727     $ 13,428 $ 3,796  
                         

During the next twelve months, Huntington expects to reclassify to earnings $35.7 million of after-tax unrealized gains on cash flow hedging derivatives currently in OCI.

 

The following table details the gains and (losses) recognized in noninterest income on the ineffective portion on interest rate contracts for derivatives designated as cash flow hedges for the three-month and nine-month periods ended September 30, 2012 and 2011.

 

      Three Months Ended     Nine Months Ended
      September 30,     September 30,
(dollar amounts in thousands)   2012     2011     2012     2011
                         
Derivatives in cash flow hedging relationships                      
Interest rate contracts                      
  Loans $ (215)   $ (261)   $ (146)   $ (147)
  FHLB Advances   ---     ---     ---     ---

Derivatives used in trading 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 consisted predominantly of interest rate swaps, but also included interest rate caps, floors, and futures, as well as foreign exchange options. Interest rate options grant the option holder the right to buy or sell an underlying financial instrument for a predetermined price before the contract expires. Interest rate futures are commitments to either purchase or sell a financial instrument at a future date for a specified price or yield and may be settled in cash or through delivery of the underlying financial instrument. Interest rate caps and floors are option-based contracts that entitle the buyer to receive cash payments based on the difference between a designated reference rate and a strike price, applied to a notional amount. Written options, primarily caps, expose Huntington to market risk but not credit risk. Purchased options contain both credit and market risk. The interest rate risk of these 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.

 

The net fair values of these derivative financial instruments, for which the gross amounts are included in accrued income and other assets or accrued expenses and other liabilities at September 30, 2012 and December 31, 2011, were $62.4 million and $53.2 million, respectively. The total notional values of derivative financial instruments used by Huntington on behalf of customers, including offsetting derivatives, were $22.6 billion and $10.6 billion at September 30, 2012 and December 31, 2011, respectively. Huntington's credit risks from interest rate swaps used for trading purposes were $336.9 million and $309.5 million at the same dates, respectively.

 

Derivatives used in mortgage banking activities

 

Huntington also uses certain derivative financial instruments to offset changes in value of its MSRs. These derivatives consist primarily of forward interest rate agreements and forward mortgage securities. The derivative instruments used are not designated as hedges. Accordingly, such derivatives are recorded at fair value with changes in fair value reflected in mortgage banking income. The following table summarizes the derivative assets and liabilities used in mortgage banking activities:

      September 30,     December 31,
(dollar amounts in thousands)   2012     2011
             
Derivative assets:          
  Interest rate lock agreements $ 18,418   $ 6,770
  Forward trades and options   199     1
Total derivative assets   18,617     6,771
             
Derivative liabilities:          
  Interest rate lock agreements   (5)     (109)
  Forward trades and options   (15,472)     (7,927)
Total derivative liabilities   (15,477)     (8,036)
Net derivative asset (liability) $ 3,140   $ (1,265)

The total notional value of these derivative financial instruments at September 30, 2012 and December 31, 2011, was $1.8 billion and $1.7 billion, respectively. The total notional amount at September 30, 2012, corresponds to trading assets with a fair value of $20.2 million and trading liabilities with a fair value of less than $0.1 million. Total MSR hedging gains and (losses) for the three-month periods ended September 30, 2012 and 2011, were $15.4 million and $30.3 million, respectively and $33.0 million and $39.1 million for the nine-month periods ended September 30, 2012 and 2011, respectively. Included in total MSR hedging gains and losses for the three-month periods ended September 30, 2012 and 2011 were net gains and (losses) related to derivative instruments of $15.4 million and $30.2 million, respectively, and $33.0 million and $39.2 million for the nine-month periods ended September 30, 2012 and 2011, respectively. These amounts are included in mortgage banking income in the Unaudited Condensed Consolidated Statements of Income.