Quarterly report pursuant to Section 13 or 15(d)

Derivative Financial Instruments

v2.4.1.9
Derivative Financial Instruments
3 Months Ended
Mar. 31, 2015
Derivative Financial Instruments [Abstract]  
DERIVATIVE FINANCIAL INSTRUMENTS

16. 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. 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 March 31, 2015, identified by the underlying interest rate-sensitive instruments:

Fair Value Cash Flow
(dollar amounts in thousands ) Hedges Hedges Total
Instruments associated with:
Loans $ --- $ 10,034,750 $ 10,034,750
Deposits 69,100 --- 69,100
Long-term debt 3,760,000 --- 3,760,000
Total notional value at March 31, 2015 $ 3,829,100 $ 10,034,750 $ 13,863,850

The following table presents additional information about the interest rate swaps used in Huntington’s asset and liability management activities at March 31, 2015:

Average Weighted-Average
Notional Maturity Fair Rate
(dollar amounts in thousands ) Value (years) Value Receive Pay
Asset conversion swaps
Receive fixed - generic $ 9,289,000 1.7 $ 12,412 0.80 % 0.26 %
Pay fixed - generic 745,750 1.6 (1,422) - 0.79
Total asset conversion swaps 10,034,750 1.7 10,990 0.74 0.30
Liability conversion swaps
Receive fixed - generic 3,829,100 3.2 80,587 1.67 0.27
Total liability conversion swaps 3,829,100 3.2 80,587 1.67 0.27
Total swap portfolio $ 13,863,850 2.1 $ 91,577 1.00 % 0.29 %

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 $24.7 million and $24.6 million for the three-month periods ended March 31, 2015, and 2014, 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 March 31, 2015, 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 potential Visa litigation losses.

The following table presents the fair values at March 31, 2015 and December 31, 2014 of Huntington’s derivatives that are designated and not designated as hedging 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:
March 31, December 31,
(dollar amounts in thousands) 2015 2014
Interest rate contracts designated as hedging instruments $ 92,019 $ 53,114
Interest rate contracts not designated as hedging instruments 223,830 183,610
Foreign exchange contracts not designated as hedging instruments 59,029 32,798
Commodities contracts not designated as hedging instruments 194,859 180,218
Total contracts $ 569,737 $ 449,740
Liability derivatives included in accrued expenses and other liabilities:
March 31, December 31,
(dollar amounts in thousands) 2015 2014
Interest rate contracts designated as hedging instruments $ 442 $ 12,648
Interest rate contracts not designated as hedging instruments 149,186 110,627
Foreign exchange contracts not designated as hedging instruments 50,228 29,754
Commodities contracts not designated as hedging instruments 192,572 179,180
Total contracts $ 392,428 $ 332,209

The changes in fair value of the fair value hedges 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 periods ended March 31, 2015 and 2014:

Three Months Ended
March 31,
(dollar amounts in thousands) 2015 2014
Interest rate contracts
Change in fair value of interest rate swaps hedging deposits (1) $ (213) $ (267)
Change in fair value of hedged deposits (1) 214 266
Change in fair value of interest rate swaps hedging subordinated notes (2) 3,231 1,066
Change in fair value of hedged subordinated notes (2) (3,231) (1,066)
Change in fair value of interest rate swaps hedging other long-term debt (2) 20,025 (4,051)
Change in fair value of hedged other long-term debt (2) (19,645) 6,474
(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.

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 periods ended March 31, 2015 and 2014 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
March 31, March 31,
(dollar amounts in thousands) 2015 2014 2015 2014
Interest rate contracts
Loans $ 18,294 $ 1,823 Interest and fee income - loans and leases $ (133) $ (2,892)
Investment Securities --- --- Noninterest income - other income 10 ---
Subordinated notes --- --- Interest expense - subordinated notes and other long-term debt --- ---
Total $ 18,294 $ 1,823 $ (123) $ (2,892)

Reclassified gains and losses on swaps related to loans and investment securities and swaps related to subordinated debt are recorded within interest income and interest expense, respectively. During the next twelve months, Huntington expects to reclassify to earnings $22.2 million 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 periods ended March 31, 2015 and 2014:

Three Months Ended
March 31,
(dollar amounts in thousands) 2015 2014
Derivatives in cash flow hedging relationships
Interest rate contracts:
Loans $ (163) $ 132

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 of commodity, interest rate, and foreign exchange contracts. The derivative contracts grant the option holder the right to buy or sell an underlying financial instrument for a predetermined price before the contract expires. Huntington may enter 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.

Commodity derivatives help the customer hedge risk and reduce exposure to price changes in commodities. Activity related to commodity derivatives is concentrated in large corporate, middle market, and energy sectors. Commodities markets trade and include oil, refined products, natural gas, coal, as well as industrial and precious metals. The energy sector focuses on oil, gas, and coal. Based on policy limits and the relatively small notional amounts of commodity activity, we do not anticipate any meaningful price risk for our commodity derivatives. 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. 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.

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 March 31, 2015 and December 31, 2014, were $82.7 million and $74.4 million, respectively. The total notional values of derivative financial instruments used by Huntington on behalf of customers, including offsetting derivatives, were $15.2 billion and $14.4 billion at March 31, 2015 and December 31, 2014, respectively. Huntington’s credit risks from interest rate swaps used for trading purposes were $267.5 million and $219.3 million at the same dates, respectively.

Huntington manages credit risk of its derivative positions by diversifying its positions among various counterparties, entering into master netting arrangements where possible with its counterparties, requiring collateral and, in certain cases, transferring the counterparty credit risk related to interest rate swaps to and from other financial institutions through the use of risk participation arrangements. Huntington's notional exposure for interest rate swaps originated by other financial institutions was $446.3 million and $456.7 million at March 31, 2015 and December 31, 2014, respectively. The fair value of these risk participations was $9.3 million and $7.2 million at March 31, 2015 and December 31, 2014, respectively. Huntington will make payments under these agreements if a customer defaults on its obligation to perform under the terms of the underlying interest rate derivative contract. These contracts mature between 2015 and 2043 and are deemed investment grade.

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

Huntington records derivatives at fair value as further described in Note 15. 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 March 31, 2015 and December 31, 2014, aggregate credit risk associated with these derivatives, net of collateral that has been pledged by the counterparty, was $16.0 million and $19.5 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, 2015, Huntington pledged $120.6 million of investment securities and cash collateral to counterparties, while other counterparties pledged $176.6 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 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, 2015 and December 31, 2014:

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
March 31, 2015 Derivatives $ 590,994 $ (145,650) $ 445,344 $ (41,303) $ (2,086) $ 401,955
December 31, 2014 Derivatives 480,803 (128,161) 352,642 (27,744) (1,095) 323,803

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 liabilities presented in the condensed consolidated balance sheets Financial instruments Cash collateral delivered Net amount
Offsetting of Financial Liabilities and Derivative Liabilities
March 31, 2015 Derivatives $ 409,003 $ (59,262) $ 349,741 $ (73,305) $ (461) $ 275,975
December 31, 2014 Derivatives 363,192 (78,937) 284,255 (78,654) (111) 205,490

Derivatives used in mortgage banking activities

Huntington also uses certain derivative financial instruments to offset changes in value of its residential 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

March 31, December 31,
(dollar amounts in thousands) 2015 2014
Derivative assets:
Interest rate lock agreements $ 8,472 $ 4,064
Forward trades and options 366 35
Total derivative assets 8,838 4,099
Derivative liabilities:
Interest rate lock agreements (202) (259)
Forward trades and options (3,954) (3,760)
Total derivative liabilities (4,156) (4,019)
Net derivative asset (liability) $ 4,682 $ 80

The total notional value of these derivative financial instruments at March 31, 2015 and December 31, 2014, was $0.7 billion and $0.6 billion, respectively. The total notional amount at March 31, 2015, corresponds to trading assets with a fair value of $3.5 million and no trading liabilities. Net trading gains and (losses) related to MSR hedging for the three-month periods ended March 31, 2015 and 2014, were $4.7 million and $0.8 million, respectively. These amounts are included in mortgage banking income in the Unaudited Condensed Consolidated Statements of Income.