Quarterly report pursuant to Section 13 or 15(d)

Derivative Financial Instruments

v2.4.0.8
Derivative Financial Instruments
3 Months Ended
Sep. 30, 2013
Derivative Financial Instruments [Abstract]  
DERIVATIVE FINANCIAL INSTRUMENTS

15. 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

 

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 arranged to receive hedge accounting treatment and is classified as either fair value or cash flow hedges. Fair value hedges are purchased to convert deposits and subordinated and other long-term debt from fixed-rate obligations to floating rate. 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 the floating-rate debt to a fixed-rate debt. Cash flow hedges are also used to convert floating rate loans made to customers into fixed rate loans.

 

The following table presents the gross notional values of derivatives used in Huntington's asset and liability management activities at September 30, 2013, identified by the underlying interest rate-sensitive instruments:

      Fair Value     Cash Flow      
(dollar amounts in thousands )   Hedges     Hedges     Total
Instruments associated with:                
  Loans $ ---   $ 7,366,000   $ 7,366,000
  Deposits   162,500     ---     162,500
  Subordinated notes   598,000     ---     598,000
  Other long-term debt   385,000     ---     385,000
Total notional value at September 30, 2013 $ 1,145,500   $ 7,366,000   $ 8,511,500

The following table presents additional information about the interest rate swaps used in Huntington's asset and liability management activities at September 30, 2013:

          Average         Weighted-Average
      Notional   Maturity     Fair   Rate
(dollar amounts in thousands )   Value   (years)     Value   Receive Pay
Asset conversion swaps                        
  Receive fixed - generic $ 7,366,000   2.9   $ (16,753)   0.91 % 0.38 %
Total asset conversion swaps   7,366,000   2.9     (16,753)   0.91   0.38  
Liability conversion swaps                        
  Receive fixed - generic   1,145,500   3.8     71,411   2.94   0.35  
Total liability conversion swaps   1,145,500   3.8     71,411   2.94   0.35  
Total swap portfolio $ 8,511,500   3.0   $ 54,658   1.18 % 0.38 %

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 $23.1 million and $28.8 million for the three-month periods ended September 30, 2013, and 2012, respectively. For the nine-month periods ended September 30, 2013 and 2012, the net amounts resulted in an increase to net interest income of $73.2 million and $81.2 million, respectively.

 

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, 2013, 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, 2013 and December 31, 2012 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)   2013     2012
Interest rate contracts designated as hedging instruments $ 65,574   $ 169,222
Interest rate contracts not designated as hedging instruments   195,673     296,295
Foreign exchange contracts not designated as hedging instruments   11,271     5,605
Commodities contracts not designated as hedging instruments   1,809     ---
Total contracts $ 274,327   $ 471,122
             
Liability derivatives included in accrued expenses and other liabilities:
      September 30,     December 31,
(dollar amounts in thousands)   2013     2012
Interest rate contracts designated as hedging instruments $ 10,916   $ ---
Interest rate contracts not designated as hedging instruments   126,068     228,757
Foreign exchange contracts not designated as hedging instruments   12,037     4,655
Commodities contracts not designated as hedging instruments   1,491     ---
Total contracts $ 150,512   $ 233,412

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, 2013 and 2012:

      Three Months Ended     Nine Months Ended
      September 30,     September 30,
(dollar amounts in thousands)   2013     2012     2013     2012
Interest rate contracts                      
  Change in fair value of interest rate swaps hedging deposits (1) $ (336)   $ (417)   $ (3,650)   $ (852)
  Change in fair value of hedged deposits (1)   340     428     3,645     840
  Change in fair value of interest rate swaps hedging subordinated notes (2)   (2,358)     2,448     (34,378)     8,207
  Change in fair value of hedged subordinated notes (2)   2,358     (2,448)     34,378     (8,207)
  Change in fair value of interest rate swaps hedging other long-term debt (2)   466     205     (1,106)     489
  Change in fair value of hedged other long-term debt (2)   (316)     (205)     1,255     (489)
                         
(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, 2013 and 2012 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) 2013   2012       2013   2012  
Interest rate contracts                      
  Loans $ 17,337 $ 14,027   Interest and fee income - loans and leases $ (3,078) $ (13,428)  
  Investment Securities   ---   ---   Noninterest income - other income   (7)   ---  
  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  
  Other long term debt   ---   ---   Interest expense - subordinated notes and other long-term debt   ---   ---  
Total $ 17,337 $ 14,027     $ (3,085) $ (13,298)  
                         
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) 2013   2012       2013   2012  
Interest rate contracts                      
  Loans $ (46,526) $ 4,031   Interest and fee income - loans and leases $ (11,367) $ 13,285  
  Investment Securities   ---   (702)   Interest and fee income - investment securities   (202)   ---  
  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  
  Other long term debt   ---   ---   Interest expense - subordinated notes and other long-term debt   ---   ---  
Total $ (46,526) $ 3,329     $ (11,569) $ 13,428  
                         

During the next twelve months, Huntington expects to reclassify to earnings $24.8 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, 2013 and 2012.

 

      Three Months Ended     Nine Months Ended
      September 30,     September 30,
(dollar amounts in thousands)   2013     2012     2013     2012
                         
Derivatives in cash flow hedging relationships                      
Interest rate contracts                      
  Loans $ (13)   $ (215)   $ 895   $ (146)
  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 and commodity contracts. 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, 2013 and December 31, 2012, were $ 67.5 million and $63.4 million, respectively. The total notional values of derivative financial instruments used by Huntington on behalf of customers, including offsetting derivatives, were $12.9 billion and $12.0 billion at September 30, 2013 and December 31, 2012, respectively. Huntington's credit risks from derivative financial instruments used for trading purposes were $187.3 million and $296.1 million at the same dates, respectively.

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

 

Huntington records derivatives at fair value as further described in Note 14. Huntington records these derivatives net of any master netting arrangement in the Unaudited Condensed Consolidated Balance Sheets. Collateral agreements are regularly entered into as part of the underlying derivative agreements with Huntington's counterparties to mitigate counterparty credit risk.

 

All derivatives are carried on the Unaudited Condensed Consolidated Balance Sheets at fair value. Derivative balances are presented on a net basis taking into consideration the effects of legally enforceable master netting agreements. Cash 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 bilateral collateral and master netting agreements with these counterparties, and routinely exchange cash and high quality securities collateral with these counterparties. 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 generally enters into master netting agreements with customer counterparties, however collateral is generally not exchanged with customer counterparties.

 

At September 30, 2013 and December 31, 2012, aggregate credit risk associated with these derivatives, net of collateral that has been pledged by the counterparty, was $19.0 million and $17.4 million, respectively. The credit risk associated with interest rate swaps is calculated after considering master netting agreements with broker-dealers and banks.

 

At September 30, 2013, Huntington pledged $133.2 million of investment securities and cash collateral to counterparties, while other counterparties pledged $100.4 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 September 30, 2013 and December 31, 2012:

Offsetting of Financial Assets and Derivative Assets                
                    Gross amounts not offset in the condensed consolidated balance sheets    
(dollar amounts in thousands) Gross amounts of recognized assets   Gross amounts offset in the condensed consolidated balance sheets   Net amounts of assets presented in the condensed consolidated balance sheets   Financial instruments   cash collateral received   Net amount
Offsetting of Financial Assets and Derivative Assets                
                             
September 30, 2013 Derivatives $ 311,580 $ (103,945) $ 207,635 $ (30,889) $ (322) $ 176,424
                             
December 31, 2012 Derivatives   473,374   (101,620)   371,754   (62,409)   (755)   308,590
                             

Offsetting of Financial Liabilities and Derivative Liabilities                
                    Gross amounts not offset in the condensed consolidated balance sheets    
(dollar amounts in thousands) Gross amounts of recognized liabilities   Gross amounts offset in the condensed consolidated balance sheets   Net amounts of assets presented in the condensed consolidated balance sheets   Financial instruments   cash collateral received   Net amount
Offsetting of Financial Liabilities and Derivative Liabilities                
                             
September 30, 2013 Derivatives $ 187,766 $ (69,008) $ 118,758 $ (100,522) $ 1,595 $ 19,831
                             
December 31, 2012 Derivatives   235,664   (85,667)   149,997   (97,233)   (455)   52,309

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 commitments to deliver mortgage-backed 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)   2013     2012
             
Derivative assets:          
  Interest rate lock agreements $ 8,127   $ 13,180
  Forward trades and options   260     763
Total derivative assets   8,387     13,943
             
Derivative liabilities:          
  Interest rate lock agreements   (99)     (33)
  Forward trades and options   (10,227)     (2,158)
Total derivative liabilities   (10,326)     (2,191)
Net derivative asset (liability) $ (1,939)   $ 11,752

The total notional value of these derivative financial instruments at September 30, 2013 and December 31, 2012, was $0.6 billion and $2.3 billion, respectively. The total notional amount at September 30, 2013, corresponds to trading assets with a fair value of $2.1 million. Total MSR hedging gains and (losses) for the three-month periods ended September 30, 2013 and 2012, were $0.1 million and $15.4 million, respectively and $(23.5) million and $33.0 million for the nine-month periods ended September 30, 2013 and 2012, respectively. Included in total MSR hedging gains and losses for the three-month periods ended September 30, 2013 and 2012 were net gains and (losses) related to derivative instruments of $0.1 million and $ 15.4 million, respectively, and $(23.5) million and $33.0 million for the nine-month periods ended September 30, 2013 and 2012, respectively. These amounts are included in mortgage banking income in the Unaudited Condensed Consolidated Statements of Income.