Form 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[ü] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2008

or

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the transition period from          to

Commission file number:

1-6523

Exact Name of Registrant as Specified in its Charter:

Bank of America Corporation

State or Other Jurisdiction of Incorporation or Organization:

Delaware

IRS Employer Identification Number:

56-0906609

Address of Principal Executive Offices:

Bank of America Corporate Center

100 N. Tryon Street

Charlotte, North Carolina 28255

Registrant’s telephone number, including area code:

(704) 386-5681

Former name, former address and former fiscal year, if changed since last report:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ü  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer  ü      Accelerated filer      Non-accelerated filer      Smaller reporting company  
            (do not check if a smaller reporting company)       

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).

  Yes        No  ü

On October 31, 2008, there were 5,017,579,321 shares of Bank of America Corporation Common Stock outstanding.

 

 


Table of Contents
  Bank of America Corporation
  September 30, 2008 Form 10-Q

 

INDEX

          
           Page

Part I.

    

Item 1.

  

Financial Statements:

  

Financial Information

       

Consolidated Statement of Income for the Three and Nine
Months Ended September 30, 2008 and 2007

   3
       

Consolidated Balance Sheet at September 30, 2008 and
December 31, 2007

   4
       

Consolidated Statement of Changes in Shareholders’
Equity for the Nine Months Ended September 30, 2008 and
2007

   5
       

Consolidated Statement of Cash Flows for the Nine
Months Ended September 30, 2008 and 2007

   6
       

Notes to Consolidated Financial Statements

   7
    

Item 2.

   Management’s Discussion and Analysis of Financial
Condition and Results of Operations
  
       

Table of Contents

   58
       

Discussion and Analysis

   59
    

Item 3.

   Quantitative and Qualitative Disclosures about Market
Risk
   174
    

Item 4.

   Controls and Procedures    174
          
                  

Part II.

          

Other Information

    

Item 1.

   Legal Proceedings    174
    

Item 1A.

   Risk Factors    174
    

Item 2.

   Unregistered Sales of Equity Securities
and the Use of Proceeds
   177
    

Item 6.

   Exhibits    178
    

Signature

   179
    

Index to Exhibits

   180

 

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Table of Contents

Part 1. Financial Information

Item 1. Financial Statements

               
  Bank of America Corporation and Subsidiaries        
  Consolidated Statement of Income                

 

     Three Months Ended September 30     Nine Months Ended September 30
  (Dollars in millions, except per share information)        2008             2007             2008             2007    

  Interest income

        

  Interest and fees on loans and leases

   $ 14,261     $ 14,111     $ 41,797     $ 40,318

  Interest on debt securities

     3,621       2,334       9,295       7,046

  Federal funds sold and securities purchased under agreements to resell

     912       1,839       2,920       5,974

  Trading account assets

     2,344       2,519       6,937       7,059

  Other interest income

     1,058       1,230       3,133       3,428

  Total interest income

     22,196       22,033       64,082       63,825

  Interest expense

        

  Deposits

     3,846       4,545       11,954       12,840

  Short-term borrowings

     3,223       5,519       10,452       16,369

  Trading account liabilities

     661       906       2,250       2,619

  Long-term debt

     2,824       2,446       7,172       6,721

  Total interest expense

     10,554       13,416       31,828       38,549

  Net interest income

     11,642       8,617       32,254       25,276

  Noninterest income

        

  Card income

     3,122       3,595       10,212       10,486

  Service charges

     2,722       2,221       7,757       6,493

  Investment and brokerage services

     1,238       1,378       3,900       3,720

  Investment banking income

     474       389       1,645       1,801

  Equity investment income (loss)

     (316 )     904       1,330       3,747

  Trading account profits (losses)

     (384 )     (1,388 )     (1,810 )     491

  Mortgage banking income

     1,674       155       2,564       516

  Insurance premiums

     678       235       1,092       548

  Gains on sales of debt securities

     10       7       362       71

  Other income (loss)

     (1,239 )     (16 )     (2,204 )     880

  Total noninterest income

     7,979       7,480       24,848       28,753

  Total revenue, net of interest expense

     19,621       16,097       57,102       54,029

  Provision for credit losses

     6,450       2,030       18,290       5,075

  Noninterest expense

        

  Personnel

     5,198       4,169       14,344       13,931

  Occupancy

     926       754       2,623       2,211

  Equipment

     440       336       1,208       1,018

  Marketing

     605       552       1,813       1,644

  Professional fees

     424       258       1,071       770

  Amortization of intangibles

     464       429       1,357       1,209

  Data processing

     755       463       1,905       1,372

  Telecommunications

     288       255       814       750

  Other general operating

     2,313       1,411       4,818       3,940

  Merger and restructuring charges

     247       84       629       270

  Total noninterest expense

     11,660       8,711       30,582       27,115

  Income before income taxes

     1,511       5,356       8,230       21,839

  Income tax expense

     334       1,658       2,433       7,125

  Net income

   $ 1,177     $ 3,698     $ 5,797     $ 14,714

  Preferred stock dividends

     473       43       849       129

  Net income available to common shareholders

   $ 704     $ 3,655     $ 4,948     $ 14,585

  Per common share information

        

  Earnings

   $ 0.15     $ 0.83     $ 1.11     $ 3.30

  Diluted earnings

     0.15       0.82       1.10       3.25

  Dividends paid

     0.64       0.64       1.92       1.76

  Average common shares issued and outstanding
(in thousands)

     4,543,963       4,420,616       4,469,517       4,424,269

  Average diluted common shares issued and
outstanding (in thousands)

     4,563,508       4,475,917       4,493,506       4,483,465

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents
  Bank of America Corporation and Subsidiaries          
  Consolidated Balance Sheet          
  (Dollars in millions)    September 30
2008
    December 31
2007
 

  Assets

    

  Cash and cash equivalents

   $ 39,341     $ 42,531  

  Time deposits placed and other short-term investments

     11,709       11,773  

  Federal funds sold and securities purchased under agreements to resell (includes $2,636 and $2,578 measured at fair value, and $86,722 and $128,887 pledged as collateral)

     87,038       129,552  

  Trading account assets (includes $134,775 and $88,745 pledged as collateral)

     174,859       162,064  

  Derivative assets

     45,792       34,662  

  Debt securities:

    

  Available-for-sale (includes $120,113 and $107,440 pledged as collateral)

     257,427       213,330  

  Held-to-maturity, at cost (fair value - $1,250 and $726)

     1,250       726  

  Total debt securities

     258,677       214,056  

  Loans and leases (includes $5,383 and $4,590 measured at fair value and $167,728 and $115,285 pledged as collateral)

     942,676       876,344  

  Allowance for loan and lease losses

     (20,346 )     (11,588 )

  Loans and leases, net of allowance

     922,330       864,756  

  Premises and equipment, net

     13,000       11,240  

  Mortgage servicing rights (includes $20,811 and $3,053 measured at fair value)

     21,131       3,347  

  Goodwill

     81,756       77,530  

  Intangible assets

     9,167       10,296  

  Loans held-for-sale (includes $15,610 and $15,765 measured at fair value)

     27,414       34,424  

  Other assets (includes $26,499 and $25,323 measured at fair value)

     138,963       119,515  

  Total assets

   $ 1,831,177     $ 1,715,746  

  Liabilities

    

  Deposits in domestic offices:

    

  Noninterest-bearing

   $ 201,025     $ 188,466  

  Interest-bearing (includes $1,737 and $2,000 measured at fair value)

     577,503       501,882  

  Deposits in foreign offices:

    

  Noninterest-bearing

     3,524       3,761  

  Interest-bearing

     91,999       111,068  

  Total deposits

     874,051       805,177  

  Federal funds purchased and securities sold under agreements to repurchase

     225,729       221,435  

  Trading account liabilities

     68,229       77,342  

  Derivative liabilities

     26,466       22,423  

  Commercial paper and other short-term borrowings

     145,812       191,089  

  Accrued expenses and other liabilities (includes $1,854 and $660 measured at fair value and $427 and $518 of reserve for unfunded lending commitments)

     72,141       53,969  

  Long-term debt

     257,710       197,508  

  Total liabilities

     1,670,138       1,568,943  

  Commitments and contingencies (Note 9 – Variable Interest Entities and Note 12Commitments and Contingencies)

    

  Shareholders’ equity

    

  Preferred stock, $0.01 par value; authorized – 100,000,000 shares; issued and outstanding – 7,602,067 and 185,067 shares

     24,151       4,409  

  Common stock and additional paid-in capital, $0.01 par value; authorized – 7,500,000,000 shares; issued and outstanding – 4,562,054,554 and 4,437,885,419 shares

     65,361       60,328  

  Retained earnings

     77,695       81,393  

  Accumulated other comprehensive income (loss)

     (5,647 )     1,129  

  Other

     (521 )     (456 )

  Total shareholders’ equity

     161,039       146,803  

  Total liabilities and shareholders’ equity

   $ 1,831,177     $ 1,715,746  

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents
  Bank of America Corporation and Subsidiaries
  Consolidated Statement of Changes in Shareholders’ Equity
     Preferred
Stock
  

Common Stock and

Additional Paid-in

Capital

    Retained
Earnings
   

Accumulated

Other

Comprehensive

Income (Loss) (1)

    Other    

Total

Shareholders’

Equity

   

Comprehensive

Income

 
  (Dollars in millions, shares in thousands)       Shares     Amount            

  Balance, December 31, 2006

   $ 2,851    4,458,151     $ 61,574     $ 79,024     $ (7,711 )   $ (466 )   $ 135,272          

  Cumulative adjustment for accounting changes (2):

                 

  Leveraged leases

            (1,381 )         (1,381 )  

  Fair value option and measurement

            (208 )         (208 )  

  Income tax uncertainties

            (146 )         (146 )  

  Net income

            14,714           14,714     $ 14,714  

  Net changes in available-for-sale debt and marketable equity securities

              (1,130 )       (1,130 )     (1,130 )

  Net changes in foreign currency translation adjustments

              156         156       156  

  Net changes in derivatives

              (22 )       (22 )     (22 )

  Employee benefit plan adjustments

              92         92       92  

  Cash dividends paid:

                 

  Common

            (7,847 )         (7,847 )  

  Preferred

            (129 )         (129 )  

  Issuance of preferred stock

     550                550    

  Common stock issued under employee plans and related tax benefits

      49,734       2,366           (113 )     2,253    

  Common stock repurchased

          (71,030 )     (3,664 )                             (3,664 )        

  Balance, September 30, 2007

   $ 3,401    4,436,855     $ 60,276     $ 84,027     $ (8,615 )   $ (579 )   $ 138,510     $ 13,810  

  Balance, December 31, 2007

   $ 4,409    4,437,885     $ 60,328     $ 81,393     $ 1,129     $ (456 )   $ 146,803    

  Net income

            5,797           5,797     $ 5,797  

  Net changes in available-for-sale debt and marketable equity securities

              (7,054 )       (7,054 )     (7,054 )

  Net changes in foreign currency translation adjustments

              (242 )       (242 )     (242 )

  Net changes in derivatives

              485         485       485  

  Employee benefit plan adjustments

              35         35       35  

  Cash dividends paid:

                 

  Common

            (8,646 )         (8,646 )  

  Preferred

            (849 )         (849 )  

  Issuance of preferred stock

     19,742                19,742    

  Stock issued in acquisition (3)

      106,776       4,201             4,201    

  Common stock issued under employee plans and related tax benefits

          17,394       832                       (65 )     767          

  Balance, September 30, 2008

   $ 24,151    4,562,055     $ 65,361     $ 77,695     $ (5,647 )   $ (521 )   $ 161,039     $ (979 )

 

 

(1)

Amounts shown are net-of-tax. For additional information on accumulated OCI, see Note 13 – Shareholders’ Equity and Earnings Per Common Share to the Consolidated Financial Statements.

 

 

(2)

Effective January 1, 2007, the Corporation adopted FSP 13-2, SFAS 157, SFAS 159 and FIN 48. For additional information on the adoption of these accounting pronouncements, see Note 1 – Summary of Significant Accounting Principles to the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on Form 10-K.

 

 

(3)

Includes adjustments for the fair value of certain Countrywide stock-based compensation awards of 507 thousand shares and $86 million.

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents
Bank of America Corporation and Subsidiaries          
Consolidated Statement of Cash Flows          
     Nine Months Ended September 30  
  (Dollars in millions)            2008                     2007          

  Operating activities

    

  Net income

   $ 5,797     $ 14,714  

  Reconciliation of net income to net cash provided by (used in) operating activities:

    

  Provision for credit losses

     18,290       5,075  

  Gains on sales of debt securities

     (362 )     (71 )

  Depreciation and premises improvements amortization

     1,074       836  

  Amortization of intangibles

     1,357       1,209  

  Deferred income tax benefit

     (1,429 )     (213 )

  Net increase in trading and derivative instruments

     (13,615 )     (14,252 )

  Net (increase) decrease in other assets

     6,422       (19,157 )

  Net increase in accrued expenses and other liabilities

     13,639       7,238  

  Other operating activities, net

     103       3,429  

  Net cash provided by (used in) operating activities

     31,276       (1,192 )

  Investing activities

    

  Net decrease in time deposits placed and other short-term investments

     64       5,135  

  Net decrease in federal funds sold and securities purchased under agreements to resell

     49,163       148  

  Proceeds from sales of available-for-sale debt securities

     69,218       10,956  

  Proceeds from paydowns and maturities of available-for-sale debt securities

     18,825       15,231  

  Purchases of available-for-sale debt securities

     (109,219 )     (7,217 )

  Proceeds from maturities of held-to-maturity debt securities

     176       547  

  Purchases of held-to-maturity debt securities

     (840 )     (116 )

  Proceeds from sales of loans and leases

     42,209       45,058  

  Other changes in loans and leases, net

     (62,464 )     (138,371 )

  Net purchases of premises and equipment

     (1,526 )     (1,318 )

  Proceeds from sales of foreclosed properties

     506       60  

  (Acquisition) divestiture of business activities, net

     6,650       (3,694 )

  Other investing activities, net

     (214 )     2,078  

  Net cash provided by (used in) investing activities

     12,548       (71,503 )

  Financing activities

    

  Net increase in deposits

     5,884       2,318  

  Net decrease in federal funds purchased and securities sold under agreements to repurchase

     (15,398 )     (18,809 )

  Net increase (decrease) in commercial paper and other short-term borrowings

     (45,277 )     59,928  

  Proceeds from issuance of long-term debt

     24,038       60,580  

  Retirement of long-term debt

     (26,559 )     (23,018 )

  Proceeds from issuance of preferred stock

     19,742       550  

  Proceeds from issuance of common stock

     229       1,022  

  Common stock repurchased

     -       (3,664 )

  Cash dividends paid

     (9,495 )     (7,976 )

  Excess tax benefits of share-based payments

     34       233  

  Other financing activities, net

     (85 )     (52 )

  Net cash provided by (used in) financing activities

     (46,887 )     71,112  

  Effect of exchange rate changes on cash and cash equivalents

     (127 )     110  

  Net decrease in cash and cash equivalents

     (3,190 )     (1,473 )

  Cash and cash equivalents at January 1

     42,531       36,429  

  Cash and cash equivalents at September 30

   $ 39,341     $ 34,956  

During the nine months ended September 30, 2008, the Corporation reclassified $12.6 billion of AFS debt securities to trading account assets in connection with the Countrywide acquisition.

The Corporation securitized $23.4 billion of residential mortgage loans into mortgage-backed securities and $4.9 billion of automobile loans into asset-backed securities which were retained by the Corporation during the nine months ended September 30, 2008.

The fair values of noncash assets acquired and liabilities assumed in the Countrywide acquisition were $157.6 billion and $158.0 billion.

Approximately 107 million shares of common stock, valued at approximately $4.2 billion were issued in connection with the Countrywide acquisition.

During the nine months ended September 30, 2007, the Corporation sold its operations in Chile and Uruguay for approximately $750 million in equity in Banco Itaú Holding Financeira S.A., and its assets in BankBoston Argentina for the assumption of its liabilities. The total assets and liabilities in these divestitures were $6.1 billion and $5.6 billion.

On January 1, 2007, the Corporation transferred $3.7 billion of AFS debt securities to trading account assets following the adoption of SFAS 159.

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents
  Bank of America Corporation and Subsidiaries
  Notes to Consolidated Financial Statements

On July 1, 2008, Bank of America Corporation and its subsidiaries (the Corporation) acquired Countrywide Financial Corporation (Countrywide) through its merger with a subsidiary of the Corporation in exchange for stock with a value of $4.2 billion. For more information related to our Countrywide acquisition, see Note 2 – Merger and Restructuring Activity to the Consolidated Financial Statements. On October 1, 2007, the Corporation acquired all the outstanding shares of ABN AMRO North America Holding Company, parent of LaSalle Bank Corporation (LaSalle), for $21.0 billion in cash. On July 1, 2007, the Corporation acquired all the outstanding shares of U.S. Trust Corporation for $3.3 billion in cash. These mergers were accounted for under the purchase method of accounting. Consequently, Countrywide’s, LaSalle’s and U.S. Trust Corporation’s results of operations were included in the Corporation’s results from their dates of acquisition.

The Corporation, through its banking and nonbanking subsidiaries, provides a diverse range of financial services and products throughout the U.S. and in selected international markets. At September 30, 2008, the Corporation operated its banking activities primarily under four charters: Bank of America, National Association (Bank of America, N.A.), FIA Card Services, N.A., LaSalle Bank, N.A. and Countrywide Bank, FSB. Effective October 17, 2008, LaSalle Bank, N.A. merged with and into Bank of America, N.A., with Bank of America, N.A. as the surviving entity.

 

  NOTE 1 – Summary of Significant Accounting Principles

 

Principles of Consolidation and Basis of Presentation

The Consolidated Financial Statements include the accounts of the Corporation and its majority-owned subsidiaries, and those variable interest entities (VIEs) where the Corporation is the primary beneficiary. All significant intercompany accounts and transactions have been eliminated. Results of operations of companies purchased are included from the dates of acquisition and for VIEs, from the dates that the Corporation became the primary beneficiary. Assets held in an agency or fiduciary capacity are not included in the Consolidated Financial Statements. The Corporation accounts for investments in companies for which it owns a voting interest of 20 percent to 50 percent and for which it has the ability to exercise significant influence over operating and financing decisions using the equity method of accounting. These investments are included in other assets and the Corporation’s proportionate share of income or loss is included in equity investment income.

The information contained in the Consolidated Financial Statements is unaudited. In the opinion of management, normal recurring adjustments necessary for a fair statement of the interim period results have been made.

Certain prior period amounts have been reclassified to conform to current period presentation.

 

Recently Proposed and Issued Accounting Pronouncements

On October 10, 2008 the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (FSP 157-3). FSP 157-3 clarifies how Statement of Financial Accounting Standards (SFAS) No. 157 “Fair Value Measurements” (SFAS 157) should be applied when valuing securities in markets that are not active. The adoption of FSP 157-3, effective September 30, 2008, did not impact the Corporation’s financial condition and results of operations.

On September 15, 2008 the FASB released exposure drafts which would amend SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities – a replacement of FASB Statement No. 125” (SFAS 140), and FASB Interpretation (FIN) No. 46 (revised December 2003) “Consolidation of Variable Interest Entities – an interpretation of ARB No. 51” (FIN 46R). As written, the proposed amendments would, among other things, eliminate the concept of a qualifying special purpose entity (QSPE) and change the standards for consolidation of variable interest entities (VIEs). The changes would be effective for both existing and newly-created entities as of January 1, 2010. If adopted as written, the amendments would likely result in the consolidation of certain QSPEs and VIEs that are not

 

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currently recorded on the Consolidated Balance Sheet of the Corporation. However, the impact on the Corporation cannot be determined with any degree of certainty until the FASB issues the final amendments to SFAS 140 and FIN 46R.

On September 12, 2008, the FASB issued FSP No. 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161” (FSP 133-1). FSP 133-1 requires expanded disclosures about credit derivatives and guarantees. The expanded disclosure requirements for FSP 133-1 are effective for the Corporation’s financial statements for the year ending December 31, 2008 and earlier adoption is not permitted. The adoption of FSP 133-1 will not impact the Corporation’s financial condition and results of operations.

On June 16, 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (FSP 03-6-1). FSP 03-6-1 defines unvested share-based payment awards that contain nonforfeitable rights to dividends as participating securities that should be included in computing earnings per share (EPS) using the two-class method under SFAS No. 128, “Earnings per Share.” FSP 03-6-1 is effective for the Corporation’s financial statements for the year beginning on January 1, 2009 and earlier adoption is not permitted. Additionally, all prior-period EPS data shall be adjusted retrospectively. The adoption of FSP 03-6-1 is not expected to have a material impact on the Corporation’s financial condition and results of operations.

On March 19, 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (SFAS 161) which requires expanded qualitative, quantitative and credit-risk disclosures about derivatives and hedging activities and their effects on the Corporation’s financial position, financial performance and cash flows. SFAS 161 is effective for the Corporation’s financial statements for the year beginning on January 1, 2009. The adoption of SFAS 161 will not impact the Corporation’s financial condition and results of operations.

On February 20, 2008, the FASB issued FSP No. FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (FSP 140-3). FSP 140-3 requires that an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously with, or in contemplation of, the initial transfer be evaluated together as a linked transaction under SFAS 140, unless certain criteria are met. FSP 140-3 is effective for the Corporation’s financial statements for the year beginning on January 1, 2009 and earlier adoption is not permitted. The adoption of FSP 140-3 will not have a material impact on the Corporation’s financial condition and results of operations.

On December 4, 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141R). SFAS 141R modifies the accounting for business combinations and requires, with limited exceptions, the acquirer in a business combination to recognize 100 percent of the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition-date fair value. In addition, SFAS 141R requires the expensing of acquisition-related transaction and restructuring costs, and certain contingent assets and liabilities acquired, as well as contingent consideration, to be recognized at fair value. SFAS 141R also modifies the accounting for certain acquired income tax assets and liabilities. SFAS 141R is effective for new acquisitions consummated on or after January 1, 2009 and earlier adoption is not permitted.

On December 4, 2007, the FASB also issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (SFAS 160). SFAS 160 requires all entities to report noncontrolling (i.e., minority) interests in subsidiaries as equity in the Consolidated Financial Statements and to account for transactions between an entity and noncontrolling owners as equity transactions if the parent retains its controlling financial interest in the subsidiary. SFAS 160 also requires expanded disclosure that distinguishes between the interests of the controlling owners and the interests of the noncontrolling owners of a subsidiary. SFAS 160 is effective for the Corporation’s financial statements for the year beginning on January 1, 2009 and earlier adoption is not permitted. Management is currently evaluating the impact of the adoption of SFAS 160 on the Corporation’s financial condition. The adoption of SFAS 160 will not have any impact on the Corporation’s results of operations.

On January 1, 2008, the Corporation adopted the Securities and Exchange Commission’s (SEC) Staff Accounting Bulletin (SAB) No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings” (SAB 109) for loan commitments measured at fair value through earnings which were issued or modified since adoption on a prospective basis. SAB 109 requires that the expected net future cash flows related to servicing of a loan be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. The adoption of SAB 109 generally has resulted in higher fair values being recorded upon initial recognition of derivative interest rate lock commitments.

 

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On January 1, 2008, the Corporation adopted Emerging Issues Task Force (EITF) consensus on Issue No. 06–11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards” (EITF 06-11) effective January 1, 2008. EITF 06–11 requires on a prospective basis that the tax benefit related to dividend equivalents paid on restricted stock and restricted stock units which are expected to vest be recorded as an increase to additional paid-in capital. The adoption of EITF 06–11 did not have a material impact on the Corporation’s financial condition and results of operations.

 

  NOTE 2 – Merger and Restructuring Activity

 

Merrill Lynch

In September 2008, the Corporation announced an agreement to acquire Merrill Lynch & Co., Inc. (Merrill Lynch) in an all-stock transaction. The transaction has been approved by the board of directors of each company. Merrill Lynch common shareholders would receive 0.8595 of a share of Bank of America Corporation common stock in exchange for one share of Merrill Lynch common stock. In addition, Merrill Lynch non-convertible preferred shareholders would receive Bank of America Corporation preferred stock having substantially identical terms. Merrill Lynch convertible preferred stock will remain outstanding and will thereafter be convertible into Bank of America common stock at an equivalent exchange ratio. The acquisition would add Merrill Lynch’s more than 16,000 financial advisors and its interest in BlackRock, Inc., a publicly traded investment management company. In addition, the acquisition is expected to increase the Corporation’s underwriting capabilities for debt and equity offerings, as well as its ability to advise on global mergers and acquisitions. The completion of this transaction is subject to closing conditions, and shareholder and regulatory approvals, and is expected to close on or around December 31, 2008.

 

Countrywide

On July 1, 2008, the Corporation acquired Countrywide through its merger with a subsidiary of the Corporation. Under the terms of the agreement, Countrywide shareholders received 0.1822 of a share of Bank of America Corporation common stock in exchange for one share of Countrywide common stock. The acquisition of Countrywide significantly improved the Corporation’s mortgage originating and servicing capabilities, while making us a leading mortgage originator and servicer.

As provided by the merger agreement, 583 million shares of Countrywide common stock were exchanged for 107 million shares of the Corporation’s common stock. This represents approximately two percent of the Corporation’s outstanding common stock at the date of acquisition. Countrywide shareholders also received cash of $346 thousand in place of any fractional shares of the Corporation’s common stock that would have otherwise been issued on July 1, 2008. The $2.0 billion of Countrywide’s Series B convertible preferred shares that were previously held by the Corporation were cancelled.

 

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The merger is being accounted for as a purchase in accordance with SFAS 141. Accordingly, the purchase price was preliminarily allocated to the acquired assets and liabilities based on their estimated fair values at the merger date as summarized below. The final allocation of the purchase price will be finalized upon completing the analysis of the fair values of Countrywide’s assets and liabilities.

 

  Countrywide Preliminary Purchase Price Allocation  

  (Dollars in billions)

  

  Purchase price (1)

   $ 4.2  

  Preliminary allocation of the purchase price

  

  Countrywide stockholders’ equity (2)

     8.4  

  Pre-tax adjustments to reflect acquired assets and liabilities at fair value:

  

  Loans (3)

     (9.3 )

  Investments in other financial instruments

     (0.3 )

  Mortgage servicing rights

     (1.5 )

  Other assets

     (0.7 )

  Deposits

     (0.2 )

  Notes payable and other liabilities

     (1.0 )

  Pre-tax total adjustments

     (13.0 )

  Deferred income taxes

     4.7  

  After-tax total adjustments

     (8.3 )

  Fair value of net assets acquired

     0.1  

  Preliminary goodwill resulting from the Countrywide merger (4)

   $ 4.1  

 

 

(1)

The value of the shares of common stock exchanged with Countrywide shareholders was based upon the average of the closing prices of the Corporation’s common stock for the period commencing two trading days before, and ending two trading days after January 11, 2008, the date of the Countrywide merger agreement.

 

 

(2)

Represents the remaining Countrywide shareholders’ equity as of the acquisition date after the cancellation of the $2.0 billion of Series B convertible preferred shares owned by the Corporation, as part of the merger.

 

 

(3)

Represents the loan portfolio credit adjustment of $14.3 billion less the allowance for loan and lease losses of $5.0 billion at the acquisition date and other miscellaneous adjustments.

 

 

(4)

No goodwill is expected to be deductible for federal income tax purposes. All the goodwill was allocated to Global Consumer and Small Business Banking.

 

LaSalle

On October 1, 2007, the Corporation acquired all the outstanding shares of LaSalle, for $21.0 billion in cash. As part of the acquisition, ABN AMRO Bank N.V. (the seller) capitalized approximately $6.3 billion as equity of intercompany debt prior to the date of acquisition. With this acquisition, the Corporation significantly expanded its presence in metropolitan Chicago, Illinois and Michigan by adding LaSalle’s commercial banking clients, retail customers and banking centers. LaSalle’s results of operations were included in the Corporation’s results beginning October 1, 2007.

 

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The LaSalle acquisition was accounted for under the purchase method of accounting in accordance with SFAS 141. The purchase price has been allocated to the assets acquired and the liabilities assumed based on their fair values at the LaSalle acquisition date as summarized in the following table.

 

  LaSalle Purchase Price Allocation  

  (Dollars in billions)

  

  Purchase price

   $ 21.0  

  Allocation of the purchase price

  

  LaSalle stockholders’ equity

     12.5  

  LaSalle goodwill and other intangible assets

     (2.7 )

  Adjustments to reflect assets acquired and liabilities assumed at fair value:

  

  Loans and leases

     (0.1 )

  Premises and equipment

     (0.2 )

  Identified intangibles (1)

     1.0  

  Other assets

     (0.3 )

  Exit and termination liabilities

     (0.4 )

  Fair value of net assets acquired

     9.8  

  Goodwill resulting from the LaSalle merger (2)

   $ 11.2  

 

 

(1)

Includes core deposit intangibles of $0.7 billion, and other intangibles of $0.3 billion. The amortization life for core deposit intangibles and other intangibles is 10 years. These intangibles are amortized on an accelerated basis.

 

 

(2)

No goodwill is deductible for federal income tax purposes. The goodwill has been allocated across all of the Corporation’s business segments.

 

U.S. Trust

On July 1, 2007, the Corporation acquired all the outstanding shares of U.S. Trust Corporation for $3.3 billion in cash. The Corporation allocated $1.7 billion to goodwill and $1.2 billion to intangible assets as part of the purchase price allocation. U.S. Trust Corporation’s results of operations were included in the Corporation’s results beginning July 1, 2007. The acquisition significantly increased the size and capabilities of the Corporation’s wealth management business and positions it as one of the largest financial services companies managing private wealth in the U.S.

 

MBNA

On January 1, 2006, the Corporation acquired 100 percent of the outstanding stock of MBNA Corporation (MBNA) and as a result, 1,260 million shares of MBNA common stock were exchanged for 631 million shares of the Corporation’s common stock. MBNA shareholders also received cash of $5.2 billion. MBNA’s results of operations were included in the Corporation’s results beginning January 1, 2006.

 

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Merger and Restructuring Charges

Merger and restructuring charges are recorded in the Consolidated Statement of Income and include incremental costs to integrate the operations of the Corporation and those of acquired entities. These charges represent costs associated with these one-time activities and do not represent ongoing costs of the fully integrated combined organization. The following table presents severance and employee-related charges, systems integrations and related charges, and other merger-related charges for the three and nine months ended September 30, 2008 and 2007.

 

     Three Months Ended September 30    Nine Months Ended September 30

(Dollars in millions)

     2008      2007      2008      2007

Severance and employee-related charges

   $ 15    $ 21    $ 90    $ 39

Systems integrations and related charges

     186      47      431      183

Other

     46      16      108      48

Total merger and restructuring charges (1)

   $ 247    $ 84    $ 629    $ 270

 

 

(1)

Included for the three and nine months ended September 30, 2008, are merger-related charges of $72 million for both periods related to the Countrywide merger, $159 million and $462 million related to the LaSalle merger and $16 million and $95 million related to the U.S. Trust Corporation merger.

 

 

Merger-related Exit Cost and Restructuring Reserves

The following table presents the changes in exit cost and restructuring reserves for the three and nine months ended September 30, 2008 and 2007.

 

     Exit Cost Reserves (1)     Restructuring Reserves (2)  

(Dollars in millions)

     2008       2007       2008       2007  

Balance, January 1

   $ 377     $ 125     $ 108     $ 67  

Exit cost and restructuring charges:

        

LaSalle

     87       -       46       -  

U.S. Trust Corporation

     -       -       26       -  

MBNA

     (2 )     -       -       16  

Cash payments

     (112 )     (45 )     (67 )     (47 )

Balance, June 30

     350       80       113       36  

Exit cost and restructuring charges:

        

Countrywide

     588       -       32       -  

LaSalle

     (56 )     -       (22 )     -  

U.S. Trust Corporation

     -       35       5       19  

MBNA

     (4 )     -       (3 )     2  

Cash payments

     (203 )     (12 )     (50 )     (7 )

Balance, September 30

   $ 675     $ 103     $ 75     $ 50  

 

 

(1)

Exit cost reserves were established in purchase accounting resulting in an increase in goodwill.

 

(2)

Restructuring reserves were established by a charge to merger and restructuring charges.

 

As of December 31, 2007, there were $377 million of exit cost reserves related to the MBNA, U.S. Trust Corporation and LaSalle mergers, including $187 million for severance, relocation and other employee-related costs and $190 million for contract terminations. During the three months ended September 30, 2008, $528 million was added to the exit cost reserves primarily related to the Countrywide acquisition, including $453 million for severance, relocation and other employee-related costs and $75 million for contract terminations. The $528 million included $56 million in exit cost reserve adjustments related to the LaSalle acquisition primarily due to lower than expected lease terminations with the offset being recorded as a reduction to goodwill. Cash payments of $203 million during the three months ended September 30, 2008 consisted of $160 million in severance, relocation and other employee-related costs and $43 million for contract

 

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terminations. During the nine months ended September 30, 2008, a net amount of $613 million was added to the exit cost reserves related to the Countrywide, LaSalle and MBNA mergers, including $538 million for severance, relocation and other employee-related costs and $75 million for contract terminations. Cash payments of $315 million during the nine months ended September 30, 2008 consisted of $260 million in severance, relocation and other employee-related costs and $55 million for contract terminations. As of September 30, 2008, exit cost reserves of $675 million included $465 million for Countrywide and $194 million for LaSalle.

As of December 31, 2007, there were $108 million of restructuring reserves related to the MBNA, U.S. Trust Corporation and LaSalle mergers, including $104 million related to severance and other employee-related costs and $4 million related to contract terminations. During the three and nine months ended September 30, 2008, $12 million and $84 million were added to the restructuring reserves, related to severance and other employee-related costs. Cash payments of $50 million during the three months ended September 30, 2008 were all related to severance and other employee-related costs. Cash payments of $117 million during the nine months ended September 30, 2008 consisted of $115 million in severance and other employee-related costs and $2 million in contract terminations.

Payments under exit cost and restructuring reserves associated with the MBNA merger were substantially completed in 2007 while payments associated with the U.S. Trust Corporation, LaSalle and Countrywide mergers will continue into 2009.

 

 

NOTE 3 – Trading Account Assets and Liabilities

The following table presents the fair values of the components of trading account assets and liabilities at September 30, 2008 and December 31, 2007.

 

(Dollars in millions)    September 30
2008
   December 31
2007

Trading account assets

     

U.S. Government and agency securities (1)

   $ 87,778    $ 48,240

Corporate securities, trading loans, and other

     47,542      55,360

Foreign sovereign debt

     14,610      17,161

Equity securities

     14,352      22,910

Mortgage trading loans and asset-backed securities

     10,577      18,393

Total trading account assets

   $ 174,859    $ 162,064

Trading account liabilities

     

U.S. Government and agency securities

   $ 37,366    $ 35,375

Equity securities

     17,842      25,926

Foreign sovereign debt

     7,373      9,292

Corporate securities and other

     5,648      6,749

Total trading account liabilities

   $ 68,229    $ 77,342

 

(1)

Includes $56.2 billion and $21.5 billion at September 30, 2008 and December 31, 2007 of government-sponsored enterprise obligations.

 

 

NOTE 4 – Derivatives

All derivatives are recognized on the Consolidated Balance Sheet at fair value, taking into consideration the effects of legally enforceable master netting agreements that allow the Corporation to settle positive and negative positions and offset cash collateral held with the same counterparty on a net basis. For exchange-traded contracts, fair value is based on quoted market prices. For non-exchange traded contracts, fair value is based on dealer quotes, pricing models or quoted prices for instruments with similar characteristics. These fair values are further adjusted to take into account the Corporation’s and counterparties’ credit risk. The Corporation designates at inception whether the derivative contract is considered hedging or non-hedging for SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133) accounting purposes. Derivatives held for trading purposes are included in derivative assets or derivative liabilities with

 

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changes in fair value reflected in trading account profits (losses). Other derivatives that are used as economic hedges, but not designated in a hedging relationship for accounting purposes, are also included in derivative assets or derivative liabilities with changes in fair value recorded in mortgage banking income or other income (loss). A detailed discussion of derivative trading activities and asset and liability management (ALM) activities is presented in Note 1 – Summary of Significant Accounting Principles and Note 4 – Derivatives to the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on Form 10-K.

The following table presents the contract/notional amounts and credit risk amounts at September 30, 2008 and December 31, 2007 of all the Corporation’s derivative positions. These derivative positions are primarily executed in the over-the-counter market. The credit risk amounts take into consideration the effects of legally enforceable master netting agreements, and on an aggregate basis have been reduced by the cash collateral applied against derivative assets. At September 30, 2008 and December 31, 2007, the cash collateral applied against derivative assets was $18.1 billion and $12.8 billion. In addition, at September 30, 2008 and December 31, 2007, the cash collateral applied against derivative liabilities was $10.0 billion. The average fair value of derivative assets, less cash collateral, for the three months ended September 30, 2008 and December 31, 2007 was $43.7 billion and $33.9 billion. The average fair value of derivative liabilities, less cash collateral, for the three months ended September 30, 2008 and December 31, 2007 was $22.1 billion and $20.7 billion.

 

       September 30, 2008      December 31, 2007
(Dollars in millions)      Contract/
Notional (1)
     Credit
Risk
     Contract/
Notional (1)
     Credit
Risk

Interest rate contracts

                   

Swaps

     $ 26,231,470      $ 22,692      $ 22,472,949      $ 15,368

Futures and forwards

       4,524,377        276        2,596,146        10

Written options

       1,655,861        -        1,402,626        -

Purchased options

       1,681,905        3,009        1,479,985        2,508

Foreign exchange contracts

                   

Swaps

       442,839        5,070        505,878        7,350

Spot, futures and forwards

       2,029,134        8,468        1,600,683        4,124

Written options

       241,301        -        341,148        -

Purchased options

       215,581        1,356        339,101        1,033

Equity contracts

                   

Swaps

       30,865        2,250        56,300        2,026

Futures and forwards

       20,900        318        12,174        10

Written options

       257,855        -        166,736        -

Purchased options

       282,074        8,175        195,240        6,337

Commodity contracts

                   

Swaps

       5,019        974        13,627        770

Futures and forwards

       11,756        64        14,391        12

Written options

       22,455        -        14,206        -

Purchased options

       19,335        390        13,093        372

Credit derivatives

       2,467,386        10,876        3,046,381        7,493
                           

Credit risk before cash collateral

            63,918             47,413

Less: Cash collateral applied

            18,126             12,751

Total derivative assets

              $ 45,792               $ 34,662

 

(1)

Represents the total contract/notional amount of the derivatives outstanding and includes both written and purchased protection.

 

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The Corporation executes the majority of its derivative positions in the over-the-counter market with large, international financial institutions, including broker/dealers and to a lesser degree with a variety of other investors. The Corporation is subject to counterparty credit risk in the event that these counterparties fail to perform under the terms of their contracts and records valuation adjustments against the derivative assets to reflect counterparty credit risk. Substantially all of the derivative transactions are executed on a daily margin basis. Therefore, events such as a credit downgrade (depending on the ultimate rating level) or a breach of credit covenants would typically require an increase in the amount of collateral required of the counterparty (where applicable), and/or allow the Corporation to take additional protective measures such as early termination of all trades. Further, as discussed above, the Corporation enters into legally enforceable master netting agreements which reduce risk by permitting the closeout and netting of transactions with the same counterparty upon the occurrence of certain events. During the three and nine months ended September 30, 2008, valuation adjustments of $467 million and $1.4 billion were recognized as trading account losses for counterparty credit risk. At September 30, 2008 the cumulative counterparty credit risk valuation adjustment that was netted against the derivative asset balance was $2.0 billion.

In addition, the fair value of the Corporation’s derivative liabilities is adjusted to reflect the impact of the Corporation’s credit quality. During the three and nine months ended September 30, 2008, valuation adjustments of $106 million and $346 million were recognized as trading account profits for changes in the Corporation’s credit risk. At September 30, 2008 the Corporation’s cumulative credit risk valuation adjustment that was netted against the derivative liabilities balance was $555 million.

 

Fair Value, Cash Flow and Net Investment Hedges

The Corporation uses various types of interest rate and foreign exchange derivative contracts to protect against changes in the fair value of its assets and liabilities due to fluctuations in interest rates and exchange rates (fair value hedges). The Corporation also uses these types of contracts to protect against changes in the cash flows of its assets and liabilities, and other forecasted transactions (cash flow hedges). During the next 12 months, net losses on derivative instruments included in accumulated OCI of approximately $1.5 billion ($947 million after-tax) are expected to be reclassified into earnings. These net losses reclassified into earnings are expected to reduce net interest income related to the respective hedged items.

The following table summarizes certain information related to the Corporation’s derivative hedges accounted for under SFAS 133 for the three and nine months ended September 30, 2008 and 2007.

 

     Three Months Ended September 30     Nine Months Ended September 30  
(Dollars in millions)    2008     2007     2008     2007  

Fair value hedges

        

Hedge ineffectiveness recognized in net interest income

   $ (10 )   $ 35     $ (8 )   $ (1 )

Cash flow hedges

        

Hedge ineffectiveness recognized in net interest income

     1       (8 )     (7 )     (1 )

Net losses on transactions which are probable of not occurring recognized in other income

     -       32       -       18  

 

The Corporation hedges its net investment in consolidated foreign operations determined to have functional currencies other than the U.S. dollar using forward foreign exchange contracts that typically settle in 90 days as well as by issuing foreign denominated debt. The Corporation recorded a net derivative gain of $1.4 billion in accumulated OCI associated with net investment hedges for both the three and nine months ended September 30, 2008 as compared to losses of $266 million and $568 million for the same periods in the prior year.

 

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NOTE 5 – Securities

The amortized cost, gross unrealized gains and losses, and fair value of available-for-sale (AFS) debt and marketable equity securities at September 30, 2008 and December 31, 2007 were:

 

(Dollars in millions)    Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair
Value

Available-for-sale debt securities, September 30, 2008

          

U.S. Treasury securities and agency debentures

   $ 906    $ 10    $ (5 )   $ 911

Mortgage-backed securities (1)

     221,390      129      (8,756 )     212,763

Foreign securities

     5,657      13      (112 )     5,558

Corporate/Agency bonds

     3,790      2      (574 )     3,218

Other taxable securities (2)

     26,469      9      (357 )     26,121

Total taxable securities

     258,212      163      (9,804 )     248,571

Tax-exempt securities

     9,896      1      (1,041 )     8,856

Total available-for-sale debt securities

   $ 268,108    $ 164    $ (10,845 )   $ 257,427

Available-for-sale marketable equity securities (3)

   $ 9,469    $ 10,733    $ (903 )   $ 19,299

Available-for-sale debt securities, December 31, 2007

          

U.S. Treasury securities and agency debentures

   $ 749    $ 10    $ -     $ 759

Mortgage-backed securities (1)

     166,768      92      (3,144 )     163,716

Foreign securities

     6,568      290      (101 )     6,757

Corporate/Agency bonds

     3,107      2      (76 )     3,033

Other taxable securities (2)

     24,608      69      (84 )     24,593

Total taxable securities

     201,800      463      (3,405 )     198,858

Tax-exempt securities

     14,468      73      (69 )     14,472

Total available-for-sale debt securities

   $ 216,268    $ 536    $ (3,474 )   $ 213,330

Available-for-sale marketable equity securities (3)

   $ 6,562    $ 13,530    $ (352 )   $ 19,740

 

(1)

Substantially all securities were issued by U.S. government-backed or government-sponsored enterprises.

 

(2)

Includes asset-backed securities.

 

(3)

Represents those AFS marketable equity securities that are recorded in other assets on the Consolidated Balance Sheet.

 

At September 30, 2008 and December 31, 2007, both the amortized cost and fair value of held-to-maturity debt securities was $1.3 billion and $726 million and the accumulated net unrealized gains (losses) on AFS debt and marketable equity securities included in accumulated OCI were $(518) million and $6.6 billion, net of the related income tax expense (benefit) of $(333) million and $3.7 billion.

The Corporation recognized $1.6 billion and $2.7 billion of other-than-temporary impairment losses on AFS debt, primarily CDO-related, and marketable equity securities during the three and nine months ended September 30, 2008. No such losses were recognized during the three and nine months ended September 30, 2007. At September 30, 2008 and December 31, 2007, the Corporation had nonperforming AFS debt securities of $436 million and $180 million.

The impairment of AFS debt and marketable equity securities is based on a variety of factors, including the length of time and extent to which the market value has been less than cost; the historical and implied volatility of the security; the financial condition of the issuer of the security; and the Corporation’s intent and ability to hold the security to recovery. Based on the Corporation’s evaluation of the above and other relevant factors, the Corporation does not believe that the AFS debt and marketable equity securities that are in an unrealized loss position at September 30, 2008 are other-than-temporarily impaired.

The Corporation obtained certain securities as part of the Countrywide acquisition with evidence of deterioration and for which it was probable that all contractually required payments would not be collected. The securities’ par value was approximately $4.2 billion and fair value was approximately $2.5 billion as of the merger date.

 

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Certain Corporate and Strategic Investments

 

At September 30, 2008 and December 31, 2007, the Corporation owned approximately 11 percent, or 25.1 billion common shares and eight percent, or 19.1 billion common shares, of China Construction Bank (CCB). On July 21, 2008, under the terms of the purchase option the Corporation increased its ownership by purchasing approximately $1.9 billion of the common shares of CCB. These recently purchased shares are accounted for at cost, recorded in other assets and are non-transferable until August 2011. The initial investment of 19.1 billion common shares is accounted for at fair value and recorded as AFS marketable equity securities in other assets with an offset to accumulated OCI. These shares became transferable in October 2008. At September 30, 2008 and December 31, 2007, the cost of the CCB investment was $4.9 billion and $3.0 billion and the carrying value was $14.5 billion and $16.4 billion. Dividend income on this investment is recorded in equity investment income. We also hold an option to increase our ownership interest in CCB to 19.1 percent. Additional shares received upon exercise of this option are restricted through August 2011. The strike price of the option is based on the greater of 1.2 times the book value per share for the most recent calendar year end or the IPO price that steps up on an annual basis and is currently at 107 percent of the IPO price. When based on the IPO price the strike price is capped at 118 percent.

Additionally, the Corporation owned approximately 171.3 million and 137.0 million of preferred shares, and 51.3 million and 41.1 million of common shares of Banco Itaú Holding Financeira S.A. (Banco Itaú) at September 30, 2008 and December 31, 2007. This investment in Banco Itaú is accounted for at fair value and recorded as AFS marketable equity securities in other assets with an offset to accumulated OCI. Prior to the second quarter of 2008, these shares were accounted for at cost. Dividend income on this investment is recorded in equity investment income. At September 30, 2008 and December 31, 2007, the cost of this investment was $2.6 billion and the fair value was $3.7 billion and $4.6 billion.

At September 30, 2008 and December 31, 2007, the Corporation had a 24.9 percent, or $2.9 billion and $2.6 billion, investment in Grupo Financiero Santander, S.A., the subsidiary of Grupo Santander, S.A. This investment is recorded in other assets and is accounted for under the equity method of accounting with income being recorded in equity investment income.

For additional information on securities, see Note 1 – Summary of Significant Accounting Principles to the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on Form 10-K.

 

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  NOTE 6 – Outstanding Loans and Leases

Outstanding loans and leases at September 30, 2008 and December 31, 2007 were:

 

(Dollars in millions)    September 30
2008
  

December 31

2007

Consumer

     

Residential mortgage

   $ 256,989    $ 274,949

Home equity

     151,938      114,820

Discontinued real estate (1)

     22,081      n/a

Credit card – domestic

     63,012      65,774

Credit card – foreign

     18,338      14,950

Direct/Indirect consumer (2)

     82,849      76,538

Other consumer (3)

     3,680      4,170

Total consumer

     598,887      551,201

Commercial

     

Commercial – domestic (4)

     219,303      208,297

Commercial real estate (5)

     63,736      61,298

Commercial lease financing

     22,416      22,582

Commercial – foreign

     32,951      28,376

Total commercial loans

     338,406      320,553

Commercial loans measured at fair value (6)

     5,383      4,590

Total commercial

     343,789      325,143

Total loans and leases

   $ 942,676    $ 876,344

 

(1)

Includes $20.1 billion of pay option loans and $1.9 billion of subprime loans obtained as part of the acquisition of Countrywide. The Corporation no longer originates these products.

 

(2)

Includes foreign consumer loans of $2.4 billion and $3.4 billion at September 30, 2008 and December 31, 2007.

 

(3)

Includes consumer finance loans of $2.7 billion and $3.0 billion, and other foreign consumer loans of $736 million and $829 million at September 30, 2008 and December 31, 2007.

 

(4)

Includes small business commercial – domestic loans, primarily card related, of $19.4 billion and $19.3 billion at September 30, 2008 and December 31, 2007.

 

(5)

Includes domestic commercial real estate loans of $62.7 billion and $60.2 billion, and foreign commercial real estate loans of $1.0 billion and $1.1 billion at September 30, 2008 and December 31, 2007.

 

(6)

Certain commercial loans are measured at fair value in accordance with SFAS 159 and include commercial – domestic loans of $4.0 billion and $3.5 billion, commercial – foreign loans of $1.2 billion and $790 million, and commercial real estate loans of $213 million and $304 million at September 30, 2008 and December 31, 2007. See Note 16 – Fair Value Disclosures to the Consolidated Financial Statements for additional discussion of fair value for certain financial instruments.

n/a = not applicable

 

Nonperforming Loans and Leases

At September 30, 2008 and December 31, 2007, nonperforming loans and leases, including impaired and nonaccrual consumer loans and excluding acquired loans that were accounted for under SOP 03-3, totaled $11.8 billion and $5.6 billion. In addition, included in other assets were consumer and commercial nonperforming loans held-for-sale of $848 million and $188 million at September 30, 2008 and December 31, 2007. Impaired loans also include loans that have been modified in troubled debt restructurings where concessions to borrowers who experienced financial difficulties have been granted.

 

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The following table presents the recorded loan amounts, without consideration for the specific component of the allowance for loan and lease losses, that were considered individually impaired in accordance with SFAS 114 at September 30, 2008 and December 31, 2007. SFAS 114 defines impairment to include performing loans which had previously been accounted for as a troubled debt restructuring and excludes all commercial leases.

Impaired Loans

 

  (Dollars in millions)    September 30
2008
   December 31
2007

  Commercial

     

      Commercial – domestic (1)

   $ 1,761    $ 1,018

      Commercial real estate

     3,090      1,099

      Commercial – foreign

     48      19

      Total impaired loans

   $ 4,899    $ 2,136

 

(1)

Includes small business commercial – domestic loans of $183 million and $152 million at September 30, 2008 and December 31, 2007.

 

SOP 03-3

Loans acquired with evidence of credit quality deterioration since origination and for which it is probable at purchase that the Corporation will be unable to collect all contractually required payments are accounted for under American Institute of Certified Public Accountants Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (SOP 03-3). Evidence of credit quality deterioration as of the purchase date may include statistics such as past due status, refreshed borrower credit scores, and refreshed loan-to-value (LTV), some of which are not immediately available as of the purchase date. The Corporation will continue to evaluate this information and other credit related information as it becomes available. SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from the Corporation’s initial investment in loans if those differences are attributable, at least in part, to credit quality. SOP 03-3 requires acquired impaired loans be recorded at fair value and prohibits “carrying over” or the creation of valuation allowances in the initial accounting for loans acquired in a transfer that are within the scope of this SOP.

The fair values for loans within the scope of SOP 03-3 are determined by discounting both principal and interest cash flows expected to be collected using an observable discount rate for similar instruments with adjustments that management believes a market participant would consider in determining fair value. The Corporation estimates the cash flows expected to be collected at acquisition using internal credit risk, interest rate and prepayment risk models that incorporate management’s best estimate of current key assumptions, such as default rates, loss severity and payment speeds.

As of July 1, 2008 and September 30, 2008 acquired loans within the scope of SOP 03-3 had an unpaid principal balance of $54.4 billion and $52.8 billion and carrying value of $41.1 billion and $39.9 billion. The following table provides details on loans obtained in connection with the Countrywide acquisition within the scope of SOP 03-3.

Acquired Loan Information

 

  (Dollars in millions)    As of July 1, 2008 (1)  

  Contractually required payments including interest

   $ 77,534  

  Less: Nonaccretable difference

     (19,574 )
        

  Cash flows expected to be collected (2)

     57,960  

  Less: Accretable yield

     (16,841 )
        

  Fair value of loans acquired

   $ 41,119  

(1)

Date of the Countrywide acquisition.

(2)

Represents undiscounted expected principal and interest cash flows at acquisition.

 

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Under SOP 03-3, the excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. Changes in the expected cash flows from the date of acquisition will either impact the accretable yield or result in a charge to the provision for credit losses. Subsequent decreases to the expected cash flows will generally result in a charge to the provision for credit losses resulting in an increase to the allowance for loan and lease losses, and a reclassification from accretable yield to nonaccretable difference. Subsequent increases in cash flows will result in a recovery of any previously recorded allowance for loan and lease losses, to the extent applicable, and a reclassification from nonaccretable difference to accretable yield. There was no allowance for loan and lease losses related to loans acquired within the scope of SOP 03-3 as of September 30, 2008. Disposals of loans, which may include sales of loans, receipt of payments in full by the borrower, foreclosure, or troubled debt restructurings result in removal of the loan from the SOP 03-3 portfolio at its carrying amount.

The following table provides activity for the accretable yield of loans acquired from Countrywide within the scope of SOP 03-3 for the three months ended September 30, 2008.

Accretable Yield Activity

 

  (Dollars in millions)   

Three Months Ended

September 30, 2008

 

  Accretable yield, beginning balance

   $ 16,841  

        Accretions

     (748 )

        Disposals

     (413 )

        Reclassifications (to)/from nonaccretable difference (1)

     -  

  Accretable yield, September 30

   $ 15,680  

 

(1)

Nonaccretable difference represents gross contractually required payments including interest less expected cash flows.

 

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  NOTE 7 – Allowance for Credit Losses

The following table summarizes the changes in the allowance for credit losses for the three and nine months ended September 30, 2008 and 2007.

 

     Three Months Ended September 30     Nine Months Ended September 30  
(Dollars in millions)            2008                     2007                     2008                     2007          

Allowance for loan and lease losses, beginning of period

   $ 17,130     $ 9,060     $ 11,588     $ 9,016  

Adjustment due to the adoption of SFAS 159

     -       -       -       (32 )

Loans and leases charged off

     (4,698 )     (1,897 )     (11,760 )     (5,445 )

Recoveries of loans and leases previously charged off

     342       324       1,070       950  

Net charge-offs

     (4,356 )     (1,573 )     (10,690 )     (4,495 )

Provision for loan and lease losses

     6,530       2,014       18,381       5,050  

Other (1)

     1,042       34       1,067       (4 )

Allowance for loan and lease losses, September 30

     20,346       9,535       20,346       9,535  

Reserve for unfunded lending commitments, beginning of period

     507       376       518       397  

Adjustment due to the adoption of SFAS 159

     -       -       -       (28 )

Provision for unfunded lending commitments

     (80 )     16       (91 )     25  

Other

     -       -       -       (2 )

Reserve for unfunded lending commitments, September 30

     427       392       427       392  

Allowance for credit losses, September 30

   $ 20,773     $ 9,927     $ 20,773     $ 9,927  

 

(1)

Includes the $1.3 billion addition of the Countrywide allowance for loan losses.

 

 

  NOTE 8 – Securitizations

The Corporation securitizes loans which may be serviced by the Corporation or by third parties. With each securitization, the Corporation may retain all or a portion of the securities, subordinated tranches, interest-only strips, subordinated interests in accrued interest and fees on the securitized receivables, and, in some cases, over-collateralization and cash reserve accounts, all of which are called retained interests. These retained interests are recorded in other assets, AFS debt securities, and/or trading account assets and are carried at fair value or amounts that approximate fair value with changes recorded in income or accumulated OCI. Changes in the fair value for credit card related interest-only strips are recorded in card income.

 

Mortgage-related Securitizations

The Corporation securitizes a portion of its residential mortgage loan originations in conjunction with or shortly after loan closing. In addition, the Corporation may, from time to time, securitize commercial mortgages and first lien residential mortgages that it originates or purchases from other entities. During the three and nine months ended September 30, 2008, the Corporation converted a total of $51.9 billion (including $525 million originated by other entities) and $116.7 billion (including $12.4 billion originated by other entities), compared to $24.9 billion (including $2.2 billion originated by other entities) and $62.8 billion (including $12.6 billion originated by other entities) during the same periods in 2007, of commercial mortgages and first lien residential mortgages into mortgage-backed securities issued through government sponsored entities (GSE) or through subsidiaries of the Corporation. At September 30, 2008 and December 31, 2007, the Corporation held senior securities issued by its securitization vehicles of $16.3 billion ($11.9 billion issued in 2008) and $9.2 billion ($5.9 billion issued in 2007), substantially all of which are valued using quoted market prices. Of these senior securities, $14.6 billion and $7.8 billion were classified as AFS debt securities and $1.7 billion and $1.4 billion were classified as trading account assets at September 30, 2008 and December 31, 2007. In addition, the Corporation retained

 

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subordinated securities, which totaled $42 million (none of which were issued in 2008) and $196 million ($137 million issued in 2007) at September 30, 2008 and December 31, 2007, which are typically valued using quantitative models, and are classified in trading account assets.

During the three and nine months ended September 30, 2008, the Corporation reported $740 million and $1.3 billion in gains, net of hedges, on loans converted into securities and sold, as compared to $30 million and $273 million during the same periods in 2007. At September 30, 2008 and December 31, 2007, the Corporation had recourse obligations of $158 million and $150 million with varying terms up to seven years on loans that had been securitized and sold.

Included in the information above for the third quarter of 2008 are mortgage-related securitizations related to Countrywide. During the three months ended September 30, 2008, $37.3 billion of first lien residential mortgages were converted into mortgage-backed securities issued through a GSE or through subsidiaries of the Corporation. In addition, the Corporation reported $525 million in gains, net of hedges, on these loans converted into securities and sold.

The Corporation sells loans with various representations and warranties related to among other things, the ownership of the loan, validity of the lien securing the loan, absence of delinquent taxes or liens against the property securing the loan, process used in selecting the loans for inclusion in a transaction, the loan’s compliance with any applicable loan criteria established by the buyer, and the loan’s compliance with applicable local, state and federal laws. In the event of a breach of the Corporation’s representations and warranties, the Corporation may be required to either repurchase the mortgage loans with the identified defects or indemnify the investor or insurer. In such cases, the Corporation bears any subsequent credit loss on the mortgage loans. The Corporation’s representations and warranties are generally not subject to stated limits. However, the Corporation’s contractual liability arises only when the representations and warranties are breached. The Corporation attempts to limit its risk of incurring these losses by structuring its operations to ensure consistent production of quality mortgages and servicing those mortgages at levels that meet secondary mortgage market standards. In addition, certain of our securitizations include a corporate guarantee, which are contracts written to protect purchasers of our loans from credit losses up to a specified amount. We estimate the losses to be absorbed by the guarantees when we sell loans with guarantees and update our estimates every quarter. The Corporation records its liability for representations and warranties, and corporate guarantees in accrued expenses and other liabilities and records the related expense through mortgage banking income.

During the three and nine months ended September 30, 2008, the Corporation purchased $3.8 billion and $11.1 billion of mortgage-backed securities from third parties and resecuritized them, as compared to $2.8 billion and $16.4 billion during the same periods in 2007. Net gains, which include net interest income earned during the holding period, totaled $26 million and $64 million for the three and nine months ended September 30, 2008, as compared to net losses of $4 million and net gains of $10 million during the same periods in 2007. At September 30, 2008 and December 31, 2007 the Corporation retained $403 million and $540 million of the securities issued in these transactions which were recorded in trading account assets.

The Corporation has retained consumer MSRs from the sale or securitization of mortgage loans, including discontinued mortgage and home equity loans. Servicing fee and ancillary fee income on all consumer mortgage loans serviced, including securitizations, was $1.5 billion and $196 million during the three months ended September 30, 2008 and 2007 and $2.0 billion and $593 million during the nine months ended September 30, 2008 and 2007. For more information on MSRs, see Note 17 – Mortgage Servicing Rights to the Consolidated Financial Statements.

 

Home Equity and Other Securitizations Acquired

With the purchase of Countrywide, the Corporation acquired residual and other interests held in its home equity securitizations which totaled $128 million at September 30, 2008. The aggregate debt securities outstanding related to these securitizations totaled $30.8 billion at September 30, 2008. In addition, the Corporation acquired residual and other interests held by Countrywide in its subprime mortgage and Alt-A mortgage securitizations which totaled $20 million at September 30, 2008. The aggregate debt securities outstanding related to these securitizations totaled $39.6 billion at September 30, 2008.

At September 30, 2008, the Corporation held senior securities issued by its securitization vehicles of $896 million, all of which are valued using quoted market prices and which $111 million were classified as AFS debt securities and $785 million were classified as trading account assets. At September 30, 2008, the Corporation also held subordinated securities issued by its securitization vehicles of $19 million, all of which are valued using quoted market prices and classified as AFS debt securities.

 

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Under the terms of the Corporation’s home equity securitizations, advances are made to borrowers when they make a subsequent draw on their line of credit and the Corporation is reimbursed for those advances from the cash flows in the securitization. During the revolving period of the securitization, this reimbursement normally occurs within a short period after the advance. However, when the securitization transaction has begun its rapid amortization period, reimbursement of the Corporation’s advance occurs only after other parties in the securitization have received all of the cash flows to which they are entitled. This has the effect of extending the time period for which the Corporation’s advances are outstanding. In particular, if loan losses requiring draws on monoline insurer’s policies (which protect the bondholders in the securitization) exceed a specified threshold or duration, the Corporation may not receive reimbursement for all of the funds advanced to borrowers, as the senior bondholders and the monoline insurer have priority for repayment. The available credit lines for the securitizations that have triggered or are expected to trigger a rapid amortization event are approximately $1.2 billion at September 30, 2008. At September 30, 2008 the reserve for losses on expected future draw obligations on the home equity securitizations in or expected to be in rapid amortization was $422 million.

 

Credit Card Securitizations

For the three and nine months ended September 30, 2008, the Corporation securitized $3.3 billion and $16.3 billion of credit card receivables resulting in $14 million and $62 million in gains (net of securitization transaction costs of $3 million and $15 million) which were recorded in card income. For the three and nine months ended September 30, 2007, the Corporation securitized $4.6 billion and $14.3 billion of credit card receivables resulting in $29 million and $71 million in gains (net of securitization transaction costs of $1 million and $11 million) which were recorded in card income. At September 30, 2008 and December 31, 2007, the aggregate debt securities outstanding for the Corporation’s credit card securitization trusts were $100.5 billion and $101.3 billion.

At September 30, 2008, the Corporation held senior securities issued by its credit card securitization vehicles of $439 million (issued in 2008). There were no senior securities held at December 31, 2007. At September 30, 2008 and December 31, 2007, the Corporation held subordinated securities issued by its securitization vehicles of $2.2 billion ($1.8 billion issued in 2008) and $425 million (issued in 2007). All of these securities were classified as AFS debt securities and valued using quoted market prices at September 30, 2008 and December 31, 2007.

At September 30, 2008 and December 31, 2007, there were no recognized servicing assets or liabilities associated with any of these credit card securitization transactions.

 

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Key economic assumptions used in measuring the fair value of certain residual interests that continue to be held by the Corporation (included in other assets) in credit card securitizations and the sensitivity of the current fair value of residual cash flows to changes in those assumptions are as follows:

 

     Credit Card  
(Dollars in millions)   

        September 30        

2008

   

        December 31        

2007

 

Carrying amount of residual interests (at fair value) (1)

   $ 2,303     $ 2,766  

Balance of unamortized securitized loans

     102,048       102,967  

Weighted average life to call or maturity (in years)

     0.3       0.3  

Monthly payment rate

     10.3-14.3     %     11.6-16.6     %

Impact on fair value of 10% favorable change

   $ 20     $ 51  

Impact on fair value of 25% favorable change

     64       158  

Impact on fair value of 10% adverse change

     (14 )     (35 )

Impact on fair value of 25% adverse change

     (31 )     (80 )

Weighted average of expected credit losses (annual rate)

     7.0     %     5.3     %

Impact on fair value of 10% favorable change

   $ 209     $ 141  

Impact on fair value of 25% favorable change

     522       374  

Impact on fair value of 10% adverse change

     (165 )     (133 )

Impact on fair value of 25% adverse change

     (173 )     (333 )

Residual cash flows discount rate (annual rate)

     12.5     %     11.5     %

Impact on fair value of 100 bps favorable change

   $ 2     $ 9  

Impact on fair value of 200 bps favorable change

     2       13  

Impact on fair value of 100 bps adverse change

     (4 )     (12 )

Impact on fair value of 200 bps adverse change

     (10 )     (23 )

 

(1)

Residual interests include interest-only strips, subordinated interests in accrued interest and fees on the securitized receivables and cash reserve accounts which are carried at fair value or amounts that approximate fair value.

The sensitivities in the preceding table are hypothetical and should be used with caution. As the amounts indicate, changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of an interest that continues to be held by the Corporation is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Additionally, the Corporation has the ability to hedge interest rate risk associated with retained residual positions. The above sensitivities do not reflect any hedge strategies that may be undertaken to mitigate such risk.

Principal proceeds from collections reinvested in revolving credit card securitizations were $37.3 billion and $126.1 billion for the three and nine months ended September 30, 2008 compared to $45.7 billion and $135.0 billion for the same periods in 2007. Contractual credit card servicing fee income totaled $544 million and $1.6 billion for the three and nine months ended September 30, 2008 compared to $526 million and $1.5 billion for the same periods in 2007. Other cash flows received on retained interests, such as cash flow from interest-only strips, were $1.4 billion and $4.6 billion for the three and nine months ended September 30, 2008 compared to $1.7 billion and $4.9 billion for the same periods in 2007, for credit card securitizations.

 

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Table of Contents

 

Other Securitizations

 

 

In September 2008, the Corporation securitized $5.7 billion of automobile loans and recorded a loss of $33 million on the transaction. At September 30, 2008 aggregate debt securities outstanding for the Corporation’s automobile securitization vehicle were $5.6 billion. At September 30, 2008, the Corporation held debt securities of $4.9 billion of which $1.6 billion were senior and $3.3 billion were subordinated and all were classified as AFS debt securities and valued using quoted market prices. The Corporation also held a residual asset of $35 million pertaining to this securitization. The Corporation did not securitize any automobile loans during the three and nine months ended September 30, 2007.

 

 

Managed Asset Quality Indicators

 

 

Portfolio balances, delinquency and historical loss amounts of the managed loans and leases portfolios at September 30, 2008 and December 31, 2007 and for the three and nine months ended September 30, 2008 and 2007, are presented in the following tables.

 

     September 30, 2008    December 31, 2007
  (Dollars in millions)   

Total Loans

and Leases

   

Accruing

Loans and

Leases Past

  Due 90 Days  

or More (1)

   

Nonperforming  

Loans and  

Leases (1)  

  

Total Loans

and Leases

   

Accruing

Loans and

Leases Past

  Due 90 Days  

or More

   

Nonperforming  

Loans and  

Leases  

  Residential mortgage (2)

   $ 256,989     $ 268     $ 4,638      $ 274,949     $ 237     $ 1,999  

  Home equity

     151,938       -       2,049        114,820       -       1,340  

  Discontinued real estate

     22,081       -       33        n/a       n/a       n/a  

  Credit card – domestic

     151,118       4,545       n/a        151,862       4,170       n/a  

  Credit card – foreign

     32,280       743       n/a        31,829       714       n/a  

  Direct/Indirect consumer

     82,849       1,113       13        76,538       745       8  

  Other consumer

     3,680       4       89        4,170       4       95  

Total consumer

     700,935       6,673       6,822        654,168       5,870       3,442  

  Commercial – domestic (3, 4)

     219,303       850       1,749        208,297       546       1,004  

  Commercial real estate

     63,736       204       3,090        61,298       36       1,099  

  Commercial lease financing

     22,416       45       35        22,582       25       33  

  Commercial – foreign

     32,951       5       48        28,376       16       19  

Total commercial

     338,406       1,104       4,922        320,553       623       2,155  

Total managed loans and leases excluding loans measured at fair value (5)

     1,039,341       7,777       11,744        974,721       6,493       5,597  

  Total measured at fair value

     5,383       -       -        4,590       -       -  

  Managed loans in securitizations

     (102,048 )     (2,958 )     n/a        (102,967 )     (2,757 )     n/a  

Total held loans and leases

   $ 942,676     $ 4,819     $ 11,744      $ 876,344     $ 3,736     $ 5,597  

 

  (1)

Balances do not include loans accounted for in accordance with SOP 03-3 even though the customer may be contractually past due. Loans accounted for in accordance with SOP 03-3 were written down to fair value upon acquisition and accrete interest income over the remaining life of the loan.

 

  (2)

Accruing loans and leases past due 90 days or more represent residential mortgage loans related to repurchases pursuant to the Corporation’s servicing agreements with GNMA mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.

 

  (3)

Includes small business commercial – domestic loans.

 

  (4)

Includes small business – commercial domestic accruing loans and leases past due 90 days or more of $598 million and $427 million and nonperforming loans and leases of $183 million and $152 million at September 30, 2008 and December 31, 2007.

 

  (5)

Does not include first mortgage and home equity securitizations that were part of the Countrywide acquisition. As of September 30, 2008, the total loans and leases related to these securitizations were $71.1 billion, with $4.9 billion in nonperforming loans and leases. At September 30, 2008 and December 31, 2007, the remaining other consumer and commercial loan securitization vehicles were not material to the Corporation.

  n/a = not applicable

 

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         Three Months Ended September 30, 2008             Three Months Ended September 30, 2007      
  (Dollars in millions)   

  Average Loans  

and Leases

Outstanding

      Net Losses       Net Loss  
Ratio (1)
   

  Average Loans  

and Leases  
Outstanding  

      Net Losses       Net Loss
Ratio (1)
 

  Residential mortgage

   $ 260,748     $ 242     0.37     %     $ 274,385     $ 13     0.02     %

  Home equity

     151,142       964     2.53       98,611       50     0.20  

  Discontinued real estate

     22,031       (3 )   (0.05 )     n/a       n/a     n/a  

  Credit card – domestic

     153,037       2,643     6.87       142,369       1,707     4.76  

  Credit card – foreign

     33,371       353     4.21       29,633       317     4.24  

  Direct/Indirect consumer

     85,392       845     3.94       72,978       353     1.92  

  Other consumer

     3,723       106     11.36       4,322       78     7.18  
                

Total consumer

     709,444       5,150     2.89       622,298       2,518     1.61  
                

  Commercial – domestic (2)

     220,847       644     1.16       173,488       250     0.57  

  Commercial real estate

     63,013       262     1.65       38,732       28     0.28  

  Commercial lease financing

     22,585       8     0.13       20,044       (3 )   (0.07 )

  Commercial – foreign

     32,376       46     0.56       24,560       (4 )   (0.06 )
                

Total commercial

     338,821       960     1.13       256,824       271     0.42  
                

    Total managed loans and leases excluding loans measured at fair value (3)

     1,048,265       6,110     2.32       879,122       2,789     1.26  

  Total measured at fair value

     4,568       n/a     n/a       3,910       n/a     n/a  

  Managed loans in securitizations

     (105,919 )     (1,754 )   6.59       (102,516 )     (1,216 )   4.71  
                

    Total held loans and leases

   $ 946,914     $ 4,356     1.84     %     $ 780,516     $ 1,573     0.80     %
      Nine Months Ended September 30, 2008     Nine Months Ended September 30, 2007  
  (Dollars in millions)   

Average Loans

and Leases
Outstanding   

    Net Losses       Net Loss   
Ratio (1)   
   

Average Loans

and Leases
Outstanding

    Net Losses        Net Loss
Ratio (1)
 

  Residential mortgage

   $ 262,478     $ 459     0.23     %     $ 260,469     $ 30     0.02     %  

  Home equity

     129,402       2,383     2.46       94,179       95     0.13  

  Discontinued real estate

     7,397       (3 )   (0.05 )     n/a       n/a     n/a  

  Credit card – domestic

     152,495       7,125     6.24       140,074       5,144     4.91  

  Credit card – foreign

     32,763       994     4.06       28,931       932     4.31  

  Direct/Indirect consumer

     82,242       2,060     3.35       68,281       917     1.79  

  Other consumer

     3,908       275     9.45       4,614       182     5.29  
                

Total consumer

     670,685       13,293     2.65       596,548       7,300     1.64  
                

  Commercial – domestic (2)

     215,213       1,632     1.01       167,960       662     0.53  

  Commercial real estate

     62,516       505     1.08       37,148       30     0.11  

  Commercial lease financing

     22,364       29     0.17       19,828       (15 )   (0.10 )

  Commercial – foreign

     31,252       44     0.18       22,221       (1 )   (0.01 )
                

Total commercial

     331,345       2,210     0.89       247,157       676     0.37  
                

    Total managed loans and leases excluding loans measured at fair value (3)

     1,002,030       15,503     2.07       843,705       7,976     1.25  

  Total measured at fair value

     4,721       n/a     n/a       1,620       n/a     n/a  

  Managed loans in securitizations

     (106,177 )     (4,813 )   6.06       (100,163 )     (3,481 )   4.65  
                

    Total held loans and leases

   $ 900,574     $ 10,690     1.59     %     $ 745,162     $ 4,495     0.80     %  

 

  (1)

The net loss ratio is calculated by dividing annualized net losses by average outstanding loans and leases excluding loans measured at fair value for each loan and lease category.

 

  (2)

Includes small business – commercial domestic net losses of $527 million, or 10.64 percent, and $1.4 billion, or 9.23 percent, for the three and nine months ended September 30, 2008, compared to $239 million, or 5.38 percent, and $598 million, or 4.82 percent, for the same periods in 2007.

 

  (3)

Does not include first mortgage and home equity securitizations that were part of the Countrywide acquisition. For the three months ended September 30, 2008, average total loans and leases related to these securitizations were $72.4 billion with $1.5 billion in net losses, or 8.33 percent. For the nine months ended September 30, 2008, average total loans and leases related to these securitizations were $24.3 billion with $1.5 billion in net losses, or 8.33 percent. For the three and nine months ended September 30, 2008 and 2007, the remaining other consumer and commercial loan securitization vehicles were not material to the Corporation.

 

  n/a = not applicable

 

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  NOTE 9 – Variable Interest Entities

The following table presents total assets of those VIEs in which the Corporation holds a significant variable interest and, in the unlikely event that all of the assets in the VIEs become worthless, the Corporation’s maximum exposure to loss. The Corporation’s maximum exposure to loss incorporates not only potential losses associated with assets recorded on the Corporation’s balance sheet but also off-balance sheet commitments, such as unfunded liquidity and lending commitments and other contractual arrangements. In addition to the table below, the Corporation also provided support to certain cash funds managed within Global Wealth and Investment Management (GWIM) as described in more detail in Note 12 – Commitments and Contingencies to the Consolidated Financial Statements.

 

     Consolidated (1)    Unconsolidated
(Dollars in millions)    Total Assets    Loss Exposure    Total Assets    Loss Exposure

Variable interest entities, September 30, 2008

           

Corporation-sponsored multi-seller conduits

   $ 10,932    $ 13,110    $ 28,363    $ 42,440

Collateralized debt obligation vehicles

     4,756      4,756      2,543      1,913

Leveraged lease trusts

     5,769      5,769      -      -

Other

     9,176      7,388      9,147      7,607

Total variable interest entities

   $ 30,633    $ 31,023    $ 40,053    $ 51,960

Variable interest entities, December 31, 2007

           

Corporation-sponsored multi-seller conduits

   $ 11,944    $ 16,984    $ 29,363    $ 47,335

Collateralized debt obligation vehicles

     4,464      4,311      8,324      7,410

Leveraged lease trusts

     6,236      6,236      -      -

Other

     13,771      12,347      8,260      5,953

Total variable interest entities

   $ 36,415    $ 39,878    $ 45,947    $ 60,698

 

(1)

The Corporation consolidates VIEs when it is the primary beneficiary that will absorb the majority of the expected losses or expected residual returns of the VIEs or both.

 

Corporation-Sponsored Multi-Seller Conduits

The Corporation administers four multi-seller conduits, three of which are unconsolidated, which provide a low-cost funding alternative to its customers by facilitating their access to the commercial paper market. These customers sell or otherwise transfer assets to the conduits, which in turn issue short-term commercial paper that is rated high-grade and is collateralized by the underlying assets. The Corporation receives fees for providing combinations of liquidity and standby letters of credit (SBLCs) or similar loss protection commitments to the conduits. Third parties participate in a small number of the liquidity facilities on a pari passu basis with the Corporation. At September 30, 2008, the Corporation’s liquidity commitments to the conduits were collateralized by various classes of assets. Assets held in the conduits incorporate features such as overcollateralization and cash reserves which are designed to provide credit support to the conduits.

The Corporation is the primary beneficiary of one of the above conduits and consequently it is included in the Consolidated Financial Statements. The assets of this conduit are included in AFS and held-to-maturity debt securities, and other assets. At September 30, 2008, liquidity commitments to the conduit were mainly collateralized by credit card loans (25 percent), auto loans (11 percent), and both capital commitments and corporate and commercial loans (seven percent each). None of these assets are subprime residential mortgages. In addition, 33 percent of the Corporation’s liquidity commitments were collateralized by projected cash flows from long-term contracts (e.g., television broadcast contracts, stadium revenues and royalty payments) which, as mentioned above, incorporate features that provide credit support. Amounts advanced under these arrangements will be repaid when cash flows due under the long-term contracts are received. Approximately 65 percent of this exposure is insured. At September 30, 2008, the weighted average life of assets in the consolidated conduit was 5.5 years and the weighted average maturity of commercial paper issued by this conduit was 25 days. Assets of the Corporation are not available to pay creditors of the consolidated conduit except to the extent the Corporation may be obligated to perform under the liquidity commitments and SBLCs. Assets of the consolidated conduit are not available to pay creditors of the Corporation.

 

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The Corporation does not consolidate the other three conduits which issued capital notes and equity interests to independent third parties as it does not expect to absorb a majority of the variability of the conduits. At September 30, 2008, the Corporation’s liquidity commitments to the unconsolidated conduits were collateralized by credit card loans (24 percent), student loans (23 percent), auto loans (14 percent), and equipment loans (eight percent). Less than one percent of these assets are subprime residential mortgages. In addition, 17 percent of the Corporation’s commitments were collateralized by the conduits’ short-term lending arrangements with investment funds, primarily real estate funds, which, as mentioned above, incorporate features that provide credit support. Amounts advanced under these arrangements are secured by a diverse group of high quality equity investors. Outstanding advances under these facilities will be repaid when the investment funds issue capital calls. At September 30, 2008, the weighted average life of assets in the unconsolidated conduits was 2.7 years and the weighted average maturity of commercial paper issued by these conduits was 34 days.

Net revenues earned from fees associated with these commitments were $98 million and $245 million for the three and nine months ended September 30, 2008 compared to $51 million and $135 million for the same periods in 2007.

Collateralized Debt Obligation Vehicles

CDO vehicles hold diversified pools of fixed income securities. They issue multiple tranches of debt securities, including commercial paper, and equity securities. The Corporation also provides liquidity support to certain CDO vehicles.

The Corporation is the primary beneficiary of certain CDOs which are included in the Consolidated Financial Statements at September 30, 2008 and December 31, 2007. Assets held at fair value in the consolidated CDOs include AFS debt securities of $3.8 billion and $2.8 billion and trading account assets of $907 million and $1.3 billion at September 30, 2008 and December 31, 2007. Substantially all of these investments were acquired in connection with liquidity support in the form of written put options that had been provided to CDO vehicles and other liquidity support which had been provided to the CDO conduit which are discussed below. The creditors of the consolidated CDOs have no recourse to the general credit of the Corporation. The Corporation had no unrealized losses on super senior exposure in accumulated OCI at September 30, 2008.

The Corporation’s exposure to unconsolidated CDOs relates principally to liquidity support in the form of written put options with a notional amount of $1.1 billion and $6.8 billion at September 30, 2008 and December 31, 2007. The written put options pertain to commercial paper which is the most senior class of securities issued by the CDOs and benefits from the subordination of all other securities issued by the CDOs. The Corporation is obligated to provide funding to the CDOs by purchasing the commercial paper at predetermined contractual yields in the event of a severe disruption in the short-term funding market. The underlying collateral for commitments outstanding at September 30, 2008 consists principally of commercial mortgage-backed securities, ABS and other securities, including trust preferred securities. Subprime residential mortgage-backed securities comprise less than 20 percent of total collateral. These written put options are recorded as derivatives and are carried at fair value with changes in fair value recorded in trading account profits (losses).

Prior to the third quarter of 2008, the Corporation’s liquidity support to unconsolidated CDOs also included other liquidity support of $2.3 billion at December 31, 2007 to a CDO conduit administered by the Corporation that obtained funds by issuing commercial paper to third party investors. The conduit held $2.3 billion of assets at December 31, 2007 consisting of super senior tranches of debt securities issued by other CDOs. During the second quarter of 2008, the CDO conduit was liquidated due to a threatened downgrade of its commercial paper. In accordance with its liquidity obligation, the Corporation purchased the assets of the CDO conduit.

At September 30, 2008 and December 31, 2007, the Corporation held commercial paper with a carrying value of $686 million and $5.0 billion on the balance sheet that was issued by unconsolidated CDO vehicles related to these written put options. In addition, at December 31, 2007 the Corporation held commercial paper with a carrying value of $1.6 billion related to other liquidity support.

Leveraged Lease Trusts

The Corporation’s net investment in leveraged lease trusts totaled $5.8 billion and $6.2 billion at September 30, 2008 and December 31, 2007. These amounts, which were recorded in loans and leases, represent the Corporation’s maximum loss exposure to these entities in the unlikely event that the leveraged lease investments become worthless. Debt issued by

 

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the leveraged lease trusts is nonrecourse to the Corporation. The Corporation has no liquidity exposure to these leveraged lease trusts.

Other

Other consolidated VIEs at September 30, 2008 and December 31, 2007 consisted primarily of securitization vehicles, including an asset acquisition conduit that holds securities on the Corporation’s behalf and term securitization vehicles that did not meet QSPE status, as well as managed investment vehicles that invest in financial assets, primarily debt securities. Included within maximum exposure to loss of these VIEs was $4.1 billion and $7.4 billion of liquidity exposure to consolidated trusts that hold municipal bonds and $1.1 billion and $1.6 billion of liquidity exposure to the consolidated asset acquisition conduit at September 30, 2008 and December 31, 2007. The assets of these consolidated VIEs were recorded in trading account assets, AFS debt securities and other assets. Other unconsolidated VIEs at September 30, 2008 and December 31, 2007 consisted primarily of securitization vehicles, managed investment vehicles that invest in financial assets, primarily debt securities, and investments in affordable housing investment partnerships. Revenues associated with administration, asset management, liquidity, and other services were $2 million and $6 million for the three and nine months ended September 30, 2008 compared to $4 million and $13 million for the same periods in 2007.

 

 

NOTE 10 – Goodwill and Intangible Assets

The following tables present goodwill and intangible assets at September 30, 2008 and December 31, 2007, which includes approximately $4.1 billion of goodwill related to the acquisition of Countrywide. For more information on the Countrywide acquisition, see Note 2 – Merger and Restructuring Activity to the Consolidated Financial Statements.

 

(Dollars in millions)    September 30
2008
   December 31
2007

Global Consumer and Small Business Banking

   $ 44,538    $ 40,340

Global Corporate and Investment Banking

     29,569      29,648

Global Wealth and Investment Management

     6,505      6,451

All Other

     1,144      1,091

Total goodwill

   $ 81,756    $ 77,530

 

The gross carrying values and accumulated amortization related to intangible assets at September 30, 2008 and December 31, 2007 are presented below:

 

     September 30, 2008    December 31, 2007
(Dollars in millions)    Gross Carrying
Value
   Accumulated
Amortization
   Gross Carrying
Value
   Accumulated
Amortization

Purchased credit card relationships

   $ 7,193    $ 2,548    $ 7,027    $ 1,970

Core deposit intangibles

     4,594      3,173      4,594      2,828

Affinity relationships

     1,664      543      1,681      406

Other intangibles

     3,129      1,149      3,050      852

Total intangible assets

   $ 16,580    $ 7,413    $ 16,352    $ 6,056

 

Amortization of intangibles expense was $464 million and $429 million for the three months ended September 30, 2008 and 2007 and $1.4 billion and $1.2 billion for the nine months ended September 30, 2008 and 2007. The Corporation estimates that aggregate amortization expense is expected to be approximately $450 million for the fourth quarter of 2008. In addition, the Corporation estimates the aggregate amortization expense will be approximately $1.6 billion, $1.4 billion, $1.2 billion, $1.0 billion and $840 million for 2009 through 2013, respectively.

 

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Table of Contents
  NOTE 11 – Long-term Debt

The following table presents the balance of long-term debt, the related rates and maturity dates at September 30, 2008 obtained in connection with the Countrywide acquisition:

 

(Dollars in millions)    September 30
2008

Long-term debt issued by Countrywide Financial Corporation and subsidiaries

  

Advances from Federal Home Loan Banks

  

Fixed, with a weighted average rate of 4.86%, ranging from 2.91% to 5.52%, due 2008 to 2014

   $ 44,445

Senior notes:

  

Fixed, with a weighted average rate of 5.16%, ranging from 4.00% to 7.23%, due 2008 to 2036

     8,536

Floating, with a weighted average rate of 4.36%, ranging from 2.93% to 7.66%, due 2008 to 2012

     4,172

Convertible debentures:

  

Floating, with a weighted average rate of 0.28%, ranging from 0.00% to 0.55%, due 2037

     3,900

Junior subordinated notes (related to trust preferred securities):

  

Fixed, with a weighted average rate of 7.04%, ranging from 6.75% to 8.05%, due 2027 to 2036

     1,616

Subordinated notes:

  

Fixed, 6.25%, due 2016

     1,000

Total long-term debt issued by Countrywide Financial Corporation and subsidiaries

     63,669

Other long-term debt issued by Bank of America Corporation and subsidiaries

     194,041

Total long-term debt

   $ 257,710

 

Including the Countrywide acquisition, the Corporation has aggregate annual maturities on its long-term debt obligations of $9.0 billion for the fourth quarter of 2008 and $37.3 billion, $44.5 billion, $23.8 billion and $25.7 billion for 2009 through 2012, respectively, and $117.4 billion for all years thereafter.

 

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Table of Contents
  NOTE 12 – Commitments and Contingencies

In the normal course of business, the Corporation enters into a number of off-balance sheet commitments. These commitments expose the Corporation to varying degrees of credit and market risk and are subject to the same credit and market risk limitation reviews as those instruments recorded on the Corporation’s Consolidated Balance Sheet.

 

Credit Extension Commitments

The Corporation enters into commitments to extend credit such as loan commitments, SBLCs and commercial letters of credit to meet the financing needs of its customers. The unfunded legally binding lending commitments shown in the following table are net of amounts distributed (e.g., syndicated) to other financial institutions of $45.8 billion and $39.2 billion at September 30, 2008 and December 31, 2007. At September 30, 2008, the carrying amount of these commitments, excluding fair value adjustments, was $459 million, including deferred revenue of $32 million and a reserve for unfunded legally binding lending commitments of $427 million. At December 31, 2007, the comparable amounts were $550 million, $32 million and $518 million. The carrying amount of these commitments is recorded in accrued expenses and other liabilities. For information regarding the Corporation’s loan commitments accounted for at fair value, see Note 16 – Fair Value Disclosures to the Consolidated Financial Statements.

 

(Dollars in millions)    Expires in 1
year or less
   Expires after 1
year through 3
years
   Expires after 3
years through
5 years
   Expires after
5 years
   Total

Credit extension commitments, September 30, 2008

              

Loan commitments

   $ 165,291    $ 104,864    $ 89,504    $ 25,543    $ 385,202

Home equity lines of credit

     10,005      1,811      3,221      103,430      118,467

Standby letters of credit and financial guarantees

     32,709      21,921      8,307      12,710      75,647

Commercial letters of credit

     3,156      39      8      1,892      5,095

Legally binding commitments (1)

     211,161      128,635      101,040      143,575      584,411

Credit card lines

     857,633      22,832      -      -      880,465

Total credit extension commitments

   $ 1,068,794    $ 151,467    $ 101,040    $ 143,575    $ 1,464,876

Credit extension commitments, December 31, 2007

              

Loan commitments

   $ 178,931    $ 92,153    $ 106,904    $ 27,902    $ 405,890

Home equity lines of credit

     8,482      1,828      2,758      107,055      120,123

Standby letters of credit and financial guarantees

     31,629      14,493      7,943      8,731      62,796

Commercial letters of credit

     3,753      50      33      717      4,553

Legally binding commitments (1)

     222,795      108,524      117,638      144,405      593,362

Credit card lines

     876,393      17,864      -      -      894,257

Total credit extension commitments

   $ 1,099,188    $ 126,388    $ 117,638    $ 144,405    $ 1,487,619

 

(1)

Includes commitments to VIEs disclosed in Note 9 – Variable Interest Entities to the Consolidated Financial Statements, including $42.4 billion and $47.3 billion to corporation-sponsored multi-seller conduits and $0 and $2.3 billion to CDOs at September 30, 2008 and December 31, 2007. Also includes commitments to SPEs that are not disclosed in Note 9 – Variable Interest Entities to the Consolidated Financial Statements because the Corporation does not hold a significant variable interest or because they are QSPEs, including $7.8 billion and $6.1 billion to municipal bond trusts and $1.1 billion and $1.7 billion to customer-sponsored conduits at September 30, 2008 and December 31, 2007.

 

Legally binding commitments to extend credit generally have specified rates and maturities. Certain of these commitments have adverse change clauses that help to protect the Corporation against deterioration in the borrowers’ ability to pay.

 

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The Corporation also facilitates bridge financing (high grade debt, high yield debt and equity) to fund acquisitions, recapitalizations and other short-term needs as well as provide syndicated financing for clients. These concentrations are managed, in part, through the Corporation’s established “originate to distribute” strategy. These client transactions are sometimes large and leveraged. They can also have a higher degree of risk as the Corporation is providing offers or commitments for various components of the clients’ capital structures, including lower-rated unsecured and subordinated debt tranches and/or equity. In many cases, these offers to finance will not be accepted. If accepted, these conditional commitments are often retired prior to or shortly following funding via the placement of securities, syndication or the client’s decision to terminate. Where the Corporation has a commitment and there is a market disruption or other unexpected event, there may be heightened exposure in the portfolios, and higher potential for loss, unless an orderly disposition of the exposure can be made. These commitments are not necessarily indicative of actual risk or funding requirements as the commitments may expire unused, the borrower may not be successful in completing the proposed transaction or may utilize multiple financing sources, including other investment and commercial banks, as well as accessing the general capital markets instead of drawing on the commitment. In addition, the Corporation may reduce its portion of the commitment through syndications to investors and/or lenders prior to funding. Therefore, these commitments are generally significantly greater than the amounts the Corporation will ultimately fund. Additionally, the borrower’s ability to draw on the commitment may be subject to there being no material adverse change in the borrower’s financial condition, among other factors. Commitments also generally contain certain flexible pricing features to adjust for changing market conditions prior to closing.

At September 30, 2008 and December 31, 2007, the Corporation’s share of the leveraged finance forward calendar was $2.3 billion and $12.2 billion. During the nine months ended September 30, 2008, the Corporation had new transactions of $10.3 billion, syndications of $11.1 billion, closed but not yet syndicated of $5.8 billion, and client terminations and other transactions of $3.3 billion related to the leveraged finance forward calendar. The Corporation also had unfunded capital markets commercial real estate commitments of $700 million at September 30, 2008 compared to $2.2 billion at December 31, 2007 with the primary change resulting from $1.2 billion of transactions that were funded. There were no leveraged finance forward calendar pre-market disruption exposures (i.e., originated prior to September 30, 2007) at September 30, 2008 compared to $10.7 billion at December 31, 2007. The Corporation has not originated any material unfunded capital markets commercial real estate commitments subsequent to September 30, 2007.

 

Other Commitments

Principal Investing and Other Equity Investments

At September 30, 2008 and December 31, 2007, the Corporation had unfunded equity investment commitments of approximately $1.9 billion and $2.6 billion. These commitments relate primarily to the Strategic Investments portfolio, as well as equity commitments included in the Corporation’s Principal Investing business, which is comprised of a diversified portfolio of investments in privately-held and publicly-traded companies at all stages of their life cycle from start-up to buyout. These investments are made either directly in a company or held through a fund and are accounted for at fair value. Bridge equity commitments provide equity bridge financing to facilitate clients’ investment activities. These conditional commitments are often retired prior to or shortly following funding via syndication or the client’s decision to terminate. Where the Corporation has a binding equity bridge commitment and there is a market disruption or other unexpected event, there may be heightened exposure in the portfolio and higher potential for loss, unless an orderly disposition of the exposure can be made. At September 30, 2008, the Corporation did not have any unfunded bridge equity commitments and had previously funded $1.2 billion of equity bridges which are considered held for investment. During the three and nine months ended September 30, 2008, the Corporation recorded $34 million and $218 million in losses related to these investments through equity investment income.

U.S. Government Guaranteed Charge Cards

At September 30, 2008 and December 31, 2007, the unfunded lending commitments related to charge cards (nonrevolving card lines) to individuals and government entities guaranteed by the U.S. Government in the amount of $9.2 billion and $9.9 billion were not included in credit card line commitments in the previous table. The outstanding balances related to these charge cards were $266 million and $193 million at September 30, 2008 and December 31, 2007.

 

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Loan Purchases

In 2005, the Corporation entered into an agreement for the committed purchase of retail automotive loans over a five-year period, ending June 30, 2010. The Corporation purchased $9.0 billion of such loans under this agreement for the nine months ended September 30, 2008 compared to $4.5 billion of such loans for the year ended December 31, 2007. As of September 30, 2008, the Corporation was committed for additional purchases of up to $16.0 billion over the remaining term of the agreement of which $6.0 billion will be purchased by June 30, 2009. All loans purchased under this agreement are subject to a comprehensive set of credit criteria.

Operating Leases

The Corporation is a party to operating leases for certain of its premises and equipment. Commitments under these leases approximate $580 million for the remaining quarter of 2008, and $2.2 billion, $2.0 billion, $1.7 billion and $1.4 billion for 2009 through 2012, respectively, and $9.2 billion for all years thereafter.

Other Commitments

Beginning in the second half of 2007, the Corporation provided support to certain cash funds managed within GWIM. The funds for which the Corporation provided support typically invest in high quality, short-term securities with a portfolio weighted average maturity of 90 days or less, including securities issued by SIVs and senior debt holdings of financial service companies. Due to market disruptions, certain investments in SIVs and senior debt securities issued by financial services companies were downgraded by the rating agencies and experienced a decline in fair value. The Corporation entered into capital commitments, which required the Corporation to provide cash to these funds in the event the net asset value per unit of a fund declined below certain thresholds. The capital commitments expire no later than the third quarter of 2010. At September 30, 2008 and December 31, 2007, the Corporation had gross (i.e., funded and unfunded) capital commitments to the funds of $1.1 billion and $565 million. For the three and nine months ended September 30, 2008, the Corporation incurred losses of $358 million and $521 million related to these capital commitments. At September 30, 2008 and December 31, 2007, the remaining loss exposure was $160 million and $183 million. Additionally, during the three and nine months ended September 30, 2008, the Corporation purchased $525 million and $1.5 billion of certain investments from the funds and recorded losses of $272 million and $365 million.

The Corporation may from time to time, but is under no obligation to, provide additional support to funds managed within GWIM. Future support, if any, may take the form of additional capital commitments to the funds or the purchase of assets from the funds.

The Corporation does not consolidate the cash funds managed within GWIM because the subordinated support provided by the Corporation will not absorb a majority of the variability created by the assets of the funds. The cash funds had total assets under management of $174.9 billion and $189.5 billion at September 30, 2008 and December 31, 2007.

 

Other Guarantees

Written Put Options

At September 30, 2008 and December 31, 2007, the Corporation provided liquidity support in the form of written put options on $1.1 billion and $10.0 billion of commercial paper issued by CDOs, including $3.2 billion issued by a consolidated CDO and $6.8 billion issued by unconsolidated CDOs at December 31, 2007. These agreements have various maturities ranging from two to five years. For more information regarding written put options, see Note 9 – Variable Interest Entities to the Consolidated Financial Statements.

 

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Merchant Services

The Corporation provides credit and debit card processing services to various merchants by processing credit and debit card transactions on their behalf. In connection with these services, a liability may arise in the event of a billing dispute between the merchant and a cardholder that is ultimately resolved in the cardholder’s favor and the merchant defaults upon its obligation to reimburse the cardholder. A cardholder, through its issuing bank, generally has until the later of up to six months after the date a transaction is processed or the delivery of the product or service to present a chargeback to the Corporation as the merchant processor. If the Corporation is unable to collect this amount from the merchant, it bears the loss for the amount paid to the cardholder. For the three months ended September 30, 2008 and 2007, the Corporation processed $95.7 billion and $90.1 billion of transactions and recorded losses as a result of these chargebacks of $5 million and $2 million. For the nine months ended September 30, 2008 and 2007, the Corporation processed $279.0 billion and $264.5 billion of transactions and recorded losses as a result of these chargebacks of $15 million and $10 million.

At September 30, 2008 and December 31, 2007, the Corporation held as collateral $26 million and $19 million of merchant escrow deposits which the Corporation has the right to offset against amounts due from the individual merchants. The Corporation also has the right to offset any payments with cash flows otherwise due to the merchant. Accordingly, the Corporation believes that the maximum potential exposure is not representative of the actual potential loss exposure. The Corporation believes the maximum potential exposure for chargebacks would not exceed the total amount of merchant transactions processed through Visa and MasterCard for the last six months, which represents the claim period for the cardholder, plus any outstanding delayed-delivery transactions. As of September 30, 2008 and December 31, 2007, the maximum potential exposure totaled approximately $152.6 billion and $151.2 billion.

Other Guarantees

For additional information on other guarantees, see Note 13 – Commitments and Contingencies to the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on Form 10-K. For additional information on recourse obligations related to residential mortgage loans sold and other guarantees related to securitizations, see Note 8 – Securitizations to the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on Form 10-K.

 

Litigation and Regulatory Matters

The following supplements the disclosure in Note 13 – Commitments and Contingencies to the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on Form 10-K and in the Corporation’s Quarterly Report on Form 10-Q for the periods ended March 31, 2008 and June 30, 2008.

Auction Rate Securities Litigation and Investigations

The Bearman, Cattell and Ben-Tal putative class actions have been voluntarily dismissed. In September 2008, two civil antitrust putative class actions (City of Baltimore v. Citigroup et al., and Mayfield v. Citigroup et al.) were filed against the Corporation and other financial institutions. These antitrust actions allege that the defendants conspired to restrain trade in auction rate securities (ARS) by artificially supporting auctions and later withdrawing that support. Plaintiff in Bondar has petitioned the Judicial Panel on Multi-District Litigation to consolidate all of the ARS cases nationwide (including the remaining Bank cases and the industry-wide antitrust cases), into one legal proceeding in federal court. Additionally, approximately 26 separate Financial Industry Regulatory Authority arbitrations have been filed nationwide against Banc of America Investment Services, Inc., Banc of America Securities LLC (BAS) and LaSalle Financial Services.

On September 10, 2008, Bank of America announced an agreement in principle with the Massachusetts Securities Division, without admitting or denying allegations of wrongdoing, under which it will offer to purchase at par ARS held by certain customers. On October 8, 2008, Bank of America announced agreements in principle with the Securities and Exchange Commission (SEC), the Office of the New York State Attorney General (NYAG), and the North American Securities Administrators Association. The agreements are substantially similar except that the agreement with the NYAG requires the payment of a $50 million penalty to be allocated among and at the discretion of the settling states. In addition, the agreement with the SEC provides that the SEC reserves the right to seek an additional penalty in the event it concludes Bank of America has not satisfied its obligations under the agreement. Including the penalty discussed above, Bank of America recorded a pre-tax charge of $363 million in connection with the purchase of ARS from clients. Most of this charge results from the difference between the purchase price and the estimated value of the securities.

 

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Countrywide Bond Insurance Litigation

Countrywide Financial Corporation (CFC) and other Countrywide entities have been named as defendants in an action filed by MBIA Insurance Corporation (MBIA) in New York Supreme Court. The action relates to bond insurance policies provided by MBIA with regard to certain securitized pools of home equity lines of credit and fixed-rate second lien mortgage loans. MBIA allegedly has paid claims as a result of defaults in the underlying loans, and claims that these defaults are the result of improper underwriting. The complaint alleges misrepresentation and breach of contract, among other claims, and seeks unspecified actual and punitive damages, and attorneys’ fees.

Countrywide Consolidated Securities Litigation

Argent Classic Convertible Arbitrage Fund L.P. v. Countrywide Financial Corp. et al., was filed in U. S. District Court for the Central District of California allegedly on behalf of purchasers of certain Series A and B debentures issued in various private placements pursuant to a May 16, 2007 CFC offering memorandum. This matter makes allegations similar to the allegations in the In re Countrywide Financial Corporation Securities Litigation case and seeks unspecified damages.

Countrywide Mortgage-Backed Securities Litigation

CFC and certain other Countrywide entities, as well as BAS, have been named as defendants in two putative securities class actions (Luther v. Countrywide Home Loans Servicing LP, et al. and Washington State Plumbing & Pipefitting Pension Trust v. Countrywide Financial Corporation, et al.) filed in Los Angeles Superior Court relating to the public offering of various mortgage-backed securities. These cases have been consolidated. The cases have been allegedly brought on behalf of purchasers of certain mortgage-backed securities for which certain Countrywide entities filed registration statements and prospectus supplements. The consolidated complaint alleges, among other things, that the mortgage loans underlying these securities were improperly underwritten and failed to comply with the guidelines and processes described in the applicable registration statements and prospectus supplements. The consolidated complaint seeks unspecified compensatory damages, among other relief. In addition, a complaint has been filed in the First Judicial Court for the County of Santa Fe by three New Mexico governmental entities that allegedly acquired certain of these securities, which asserts similar claims and also seeks unspecified monetary damages and other forms of relief.

Countrywide State and Local Enforcement Actions

The state lawsuits have been settled in principle, except for substantially similar lawsuits brought by West Virginia and Indiana. The settlement provides for a loan modification program, principally for subprime and pay option ARM borrowers, and a nationwide fund of up to $150 million for foreclosure relief programs designated by certain settling states and for payments to individuals whose property was foreclosed and, prior to foreclosure, had made few mortgage payments. The settlements are subject to the negotiation and execution of agreements and the court’s approval of such agreements.

Heilig-Meyers Litigation

In AIG Global Securities Lending Corp., et al. v. Banc of America Securities LLC, pending in the U. S. District Court for the Southern District of New York, the plaintiffs purchased asset-backed securities issued by a trust formed by Heilig-Meyers Co., and allege that BAS, as underwriter, made misrepresentations in connection with the sale of those securities. The plaintiffs are asserting claims against BAS for violations of Section 10(b) of the Securities Exchange Act of 1934, Rule 10 b-5 and common law fraud. Plaintiffs seek approximately $200 million in compensatory damages as well as punitive damages. The trial in the case commenced on October 27, 2008.

Interchange Antitrust Litigation and Visa-Related Litigation

Discover

The case Discover Financial Services v. Visa USA, et al., has been settled. The Corporation expects that the escrow that was initially funded in connection with the Visa IPO will pay, in whole or in part, the liabilities resulting from the settlement.

 

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Lehman Brothers Holdings, Inc.

In September 2008, BAS, along with a number of other underwriters and individuals, was named as a defendant in a putative class action complaint filed in the U.S. District Court for the Southern District of New York, captioned Fogel Capital Management, Inc. v. Richard S. Fuld, Jr., et al. Plaintiffs allege that BAS and the other underwriter defendants violated Section 11 of the Securities Act of 1933 by making false or misleading disclosures in connection with a February 2008 offering of preferred stock of Lehman Brothers Holdings, Inc. Plaintiffs seek unspecified damages.

Parmalat Finanziaria S.p.A

On August 12, 2008, the District Court dismissed the class action entitled In re Parmalat Securities Litigation against the Corporation in its entirety.

On October 9, 2008 the Public Prosecutor of the Court of Parma, Italy filed a notice of intent to file criminal charges against twelve former and current employees of the Corporation in connection with the insolvency of Parmalat S.p.A. The notice of intent to file charges alleges that the Corporation’s transactions with Parmalat contributed to the insolvency of Parmalat, that certain transactions violated the Italian usury laws, and that certain former employees of the Corporation wrongly diverted funds in connection with certain transactions.

Pension Plan Matters

Richards

On October 15, 2008, the Court granted final approval of the settlement.

 

 

NOTE 13 – Shareholders’ Equity and Earnings Per Common Share

In October 2008, the Corporation issued common stock, preferred stock and warrants to purchase common stock. For additional information, see Note 19 – Subsequent Events to the Consolidated Financial Statements.

 

Common Stock

The Corporation may repurchase shares, subject to certain restrictions, from time to time, in the open market or in private transactions through the Corporation’s approved repurchase program. For the nine months ended September 30, 2008, the Corporation did not repurchase any shares of common stock and issued 107 million shares in connection with the Countrywide acquisition and 17.4 million shares under employee stock plans. The declaration of common stock dividends and the repurchase of common shares are subject to certain restrictions. For more information see Note 19 – Subsequent Events to the Consolidated Financial Statements.

In October 2008, the Board declared a quarterly cash dividend of $0.32 per common share payable on December 26, 2008 to common shareholders of record on December 5, 2008. In July 2008, the Board declared a third quarter cash dividend of $0.64 per common share which was paid on September 26, 2008 to common shareholders of record on September 5, 2008. In April 2008, the Board declared a second quarter cash dividend of $0.64 per common share which was paid on June 27, 2008 to shareholders of record on June 6, 2008. In January 2008, the Board declared a first quarter cash dividend of $0.64 per common share which was paid on March 28, 2008 to shareholders of record on March 7, 2008.

 

Preferred Stock

During the first, second and third quarters of 2008, the aggregate dividends declared on preferred stock were $190 million, $186 million and $473 million. The declaration of preferred stock dividends and the repurchase of preferred shares is subject to certain restrictions. For more information see Note 19 – Subsequent Events to the Consolidated Financial Statements.

 

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In May and June 2008, the Corporation issued 117 thousand shares of Bank of America Corporation 8.20% Non-Cumulative Preferred Stock, Series H (Series H Preferred Stock) with a par value of $0.01 per share for $2.9 billion. Ownership is held in the form of depositary shares, each representing a 1/1,000th interest in a share of Series H Preferred Stock, paying a quarterly cash dividend on the liquidation preference of $25,000 per share of Series H Preferred Stock at an annual rate of 8.20 percent. On any dividend date on or after May 1, 2013, the Corporation may redeem Series H Preferred Stock, in whole or in part, at its option, at $25,000 per share, plus declared and unpaid dividends. The Series H Preferred Stock is not convertible.

In April 2008, the Corporation issued 160 thousand shares of Bank of America Corporation Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series M (Series M Preferred Stock) with a par value of $0.01 per share for $4.0 billion. The fixed rate is 8.125 percent through May 14, 2018 and then adjusts to three-month LIBOR plus 364 basis points (bps) thereafter. Ownership is held in the form of depositary shares, each representing a 1/25th interest in a share of Series M Preferred Stock, paying a semiannual cash dividend through May 14, 2018 then adjusts to a quarterly cash dividend, on the liquidation preference of $25,000 per share of Series M Preferred Stock. On any dividend date on or after May 15, 2018, the Corporation may redeem the Series M Preferred Stock, in whole or in part, at its option, at $25,000 per share, plus declared and unpaid dividends. The Series M Preferred Stock is not convertible.

In January 2008, the Corporation issued 240 thousand shares of Bank of America Corporation Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series K (Series K Preferred Stock) with a par value of $0.01 per share for $6.0 billion. The fixed rate is 8.00 percent through January 29, 2018 and then adjusts to three-month LIBOR plus 363 bps thereafter. Ownership is held in the form of depositary shares, each representing a 1/25 th interest in a share of Series K Preferred Stock, paying a semiannual cash dividend through January 29, 2018 then adjusts to a quarterly cash dividend, on the liquidation preference of $25,000 per share of Series K Preferred Stock. On any dividend date on or after January 30, 2018, the Corporation may redeem the Series K Preferred Stock, in whole or in part, at its option, at $25,000 per share, plus declared and unpaid dividends. The Series K Preferred Stock is not convertible.

Also in January 2008, the Corporation issued 6.9 million shares of Bank of America Corporation 7.25% Non-Cumulative Perpetual Convertible Preferred Stock, Series L (Series L Preferred Stock) with a par value of $0.01 per share for $6.9 billion, paying a quarterly cash dividend on the liquidation preference of $1,000 per share of Series L Preferred Stock at an annual rate of 7.25 percent. Each share of the Series L Preferred Stock may be converted at any time, at the option of the holder, into 20 shares of the Corporation’s common stock plus cash in lieu of fractional shares. On or after January 30, 2013, the Corporation may cause some or all of the Series L Preferred Stock, at its option, at any time or from time to time, to be converted into shares of common stock at the then-applicable conversion rate if, for 20 trading days during any period of 30 consecutive trading days, the closing price of common stock exceeds 130 percent of the then-applicable conversion price of the Series L Preferred Stock. If the Corporation exercises its right to cause the automatic conversion of Series L Preferred Stock on January 30, 2013, it will still pay any accrued dividends payable on January 30, 2013 to the applicable holders of record.

The shares of the series of preferred stock discussed above are not subject to the operation of a sinking fund and have no participation rights. The holders of these series have no general voting rights. If any dividend payable on these series is in arrears for three or more semiannual or six or more quarterly dividend periods, as applicable (whether consecutive or not), the holders of these series and any other class or series of preferred stock ranking equally as to payment of dividends and upon which equivalent voting rights have been conferred and are exercisable (voting as a single class) will be entitled to vote for the election of two additional directors. These voting rights terminate when the Corporation has paid in full dividends on these series for at least two semiannual or four quarterly dividend periods, as applicable, following the dividend arrearage.

For a more detailed discussion of the Corporation’s preferred stock, see Note 14 – Shareholders’ Equity and Earnings per Common Share to the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on Form 10-K.

 

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Accumulated OCI

The following table presents the changes in accumulated OCI for the nine months ended September 30, 2008 and 2007, net-of-tax.

 

(Dollars in millions)    Securities (1)     Derivatives (2)     Employee
Benefit Plans
   

Foreign

Currency (4)

    Total  

Balance, December 31, 2007

   $ 6,536     $ (4,402 )   $ (1,301 )   $ 296     $ 1,129  

Net change in fair value recorded in accumulated OCI

     (8,405 )     (95 )     -       (242 )     (8,742 )

Net realized losses reclassified into earnings (3)

     1,351       580       35       -       1,966  

Balance, September 30, 2008

   $ (518 )   $ (3,917 )   $ (1,266 )   $ 54     $ (5,647 )

Balance, December 31, 2006

   $ (2,733 )   $ (3,697 )   $ (1,428 )   $ 147     $ (7,711 )

Net change in fair value recorded in accumulated OCI

     (792 )     (409 )     -       149       (1,052 )

Net realized (gains) losses reclassified into earnings (3)

     (338 )     387       92       7       148  

Balance, September 30, 2007

   $ (3,863 )   $ (3,719 )   $ (1,336 )   $ 303     $ (8,615 )

 

(1)

For the nine months ended September 30, 2008 and 2007, the Corporation reclassified net realized (gains) losses into earnings on the sale and other-than-temporary impairments of AFS debt securities of $1.1 billion and $(45) million, net-of-tax, and net realized (gains) losses on the sales and other-than-temporary impairments of AFS marketable equity securities of $206 million and $(293) million, net-of-tax.

 

(2)

The amounts included in accumulated OCI for terminated interest rate derivative contracts were losses of $3.8 billion and $3.2 billion, net-of-tax, at September 30, 2008 and 2007.

 

(3)

Included in this line item are amounts related to derivatives used in cash flow hedge relationships. These amounts are reclassified into earnings in the same period or periods during which the hedged forecasted transactions affect earnings. This line item also includes (gains) losses on AFS debt and marketable equity securities and impairment charges. These amounts are reclassified into earnings upon sale of the related security or when the other-than-temporary impairment charge is recognized.

 

(4)

For the nine months ended September 30, 2008, the net change in fair value recorded in accumulated OCI represented $1.6 billion in losses associated with the Corporation’s foreign currency translation adjustments on its net investment in consolidated foreign operations partially offset by gains of $1.4 billion on the related foreign currency exchange hedging results.

 

Earnings per Common Share

Earnings per common share is computed by dividing net income available to common shareholders by the weighted average common shares issued and outstanding. For diluted earnings per common share, net income available to common shareholders can be affected by the conversion of the registrant’s convertible preferred stock. Where the effect of this conversion would have been dilutive, net income available to common shareholders is adjusted by the associated preferred dividends. This adjusted net income is divided by the weighted average number of common shares issued and outstanding for each period plus amounts representing the dilutive effect of stock options outstanding, restricted stock, restricted stock units and the dilution resulting from the conversion of the registrant’s convertible preferred stock, if applicable. The effects of convertible preferred stock, restricted stock, restricted stock units and stock options are excluded from the computation of diluted earnings per common share in periods in which the effect would be antidilutive.

 

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The calculation of earnings per common share and diluted earnings per common share for the three and nine months ended September 30, 2008 and 2007 is presented below.

 

     Three Months Ended September 30     Nine Months Ended September 30  
(Dollars in millions, except per share information; shares in thousands)            2008                     2007                     2008                     2007          

Earnings per common share

        

Net income

   $ 1,177     $ 3,698     $ 5,797     $ 14,714  

Preferred stock dividends

     (473 )     (43 )     (849 )     (129 )

Net income available to common shareholders

   $ 704     $ 3,655     $ 4,948     $ 14,585  

Average common shares issued and outstanding

     4,543,963       4,420,616       4,469,517       4,424,269  

Earnings per common share

   $ 0.15     $ 0.83     $ 1.11     $ 3.30  

Diluted earnings per common share

        

Net income available to common shareholders

   $ 704     $ 3,655     $ 4,948     $ 14,585  

Average common shares issued and outstanding

     4,543,963       4,420,616       4,469,517       4,424,269  

Dilutive potential common shares (1, 2)

     19,545       55,301       23,989       59,196  

Total diluted average common shares issued and outstanding

     4,563,508       4,475,917       4,493,506       4,483,465  

Diluted earnings per common share

   $ 0.15     $ 0.82     $ 1.10     $ 3.25  

 

(1)

For the three and nine months ended September 30, 2008, average options to purchase 211 million and 176 million shares were outstanding but not included in the computation of earnings per common share because they were antidilutive. For the three and nine months ended September 30, 2007, average options to purchase 33 million and 27 million shares were outstanding but not included in the computation of earnings per common share because they were antidilutive. For the three and nine months ended September 30, 2008, 138 million and 124 million average dilutive potential common shares associated with the convertible Series L Preferred Stock issued in January of 2008 were excluded from the diluted share count because the result would have been antidilutive under the “if-converted” method.

 

(2)

Includes incremental shares from restricted stock units, restricted stock shares and stock options.

 

 

NOTE 14 – Pension and Postretirement Plans

The Corporation sponsors noncontributory trusteed qualified pension plans that cover substantially all officers and employees, a number of noncontributory nonqualified pension plans, and postretirement health and life plans. The Bank of America Pension Plan (the Pension Plan) provides participants with compensation credits, generally based on years of service. For account balances based on compensation credits prior to January 1, 2008, the Pension Plan allows participants to select from various earnings measures, which are based on the returns of certain funds or common stock of the Corporation. For account balances based on compensation credits subsequent to December 31, 2007, the account balance earnings rate is based on a benchmark rate. A detailed discussion of these plans is presented in Note 16 – Employee Benefit Plans to the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on Form 10-K.

 

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As a result of the Countrywide acquisition, the Corporation assumed the obligations related to the Countrywide plans.

Net periodic benefit cost (income) of the Corporation’s plans including Countrywide plans, for the three and nine months ended September 30, 2008 and 2007 included the following components:

 

     Three Months Ended September 30  
     Qualified Pension Plans     Nonqualified Pension Plans     Postretirement Health and
Life Plans
 
(Dollars in millions)    2008 (1)     2007     2008 (1)     2007     2008 (1)     2007  

Components of net periodic benefit cost (income)

            

Service cost

   $ 92     $ 78     $ 2     $ 2     $ 4     $ 4  

Interest cost

     213       186       20       18       22       21  

Expected return on plan assets

     (364 )     (322 )     -       -       (3 )     (2 )

Amortization of transition obligation

     -       -       -       -       8       8  

Amortization of prior service cost (credits)

     8       12       (2 )     (2 )     -       -  

Recognized net actuarial loss (gain)

     19       38       3       4       (18 )     (16 )

Net periodic benefit cost (income)

   $ (32 )   $ (8 )   $ 23     $ 22     $ 13     $ 15  
     Nine Months Ended September 30  
     Qualified Pension Plans     Nonqualified Pension Plans     Postretirement Health and
Life Plans
 
(Dollars in millions)    2008 (1)     2007     2008 (1)     2007     2008 (1)     2007  

Components of net periodic benefit cost (income)

            

Service cost

   $ 249     $ 229     $ 5     $ 6     $ 12     $ 11  

Interest cost

     624       546       58       52       65       62  

Expected return on plan assets

     (1,080 )     (950 )     -       -       (9 )     (5 )

Amortization of transition obligation

     -       -       -       -       24       24  

Amortization of prior service cost (credits)

     25       36       (6 )     (6 )     -       -  

Recognized net actuarial loss (gain)

     57       114       10       13       (54 )     (47 )

Recognized loss due to settlements and curtailments

     -       -       -       13       -       -  

Net periodic benefit cost (income)

   $ (125 )   $ (25 )   $ 67     $ 78     $ 38     $ 45  

 

(1)

Includes the results of Countrywide. The net periodic benefit cost of the Countrywide Qualified Pension Plan was $15 million for the three and nine months ended September 30, 2008. The net periodic benefit cost of the Countrywide Nonqualified Pension Plan was not material and Countrywide did not have a Postretirement Health and Life Plan.

During 2008, the Corporation expects to contribute $147 million and $101 million to its nonqualified pension plans and postretirement health and life plans. For the nine months ended September 30, 2008, the Corporation contributed $125 million and $76 million to these plans. The Corporation does not expect to contribute to its qualified pension plans during 2008.

 

 

NOTE 15 – Income Taxes

In August 2008, the Internal Revenue Service (IRS) announced a settlement initiative related to lease-in, lease-out (LILO) and sale-in, lease-out (SILO) leveraged lease transactions. Pursuant to the settlement initiative, the Corporation received offers to settle its LILOs and SILOs and accepted these offers. According to the terms of the settlement initiative, an acceptance will not be binding until a closing agreement is executed by both parties.

The Corporation revised the assumptions associated with the projected cash flows of the relevant leases to reflect its expectation as of September 30, 2008 of receiving the tax treatment offered by the leasing settlement initiative. The recalculation resulted in an after-tax charge of $107 million, which included a reduction of $40 million, after tax, of accrued interest expense associated with income taxes expected to be due upon settlement.

 

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As of September 30, 2008 and December 31, 2007, the balance of the Corporation’s unrecognized tax benefits was $3.7 billion and $3.1 billion. This increase resulted primarily from the acquisition of Countrywide and the evaluation of new information in the remeasurement of prior period tax positions relating to both temporary and permanent differences.

 

 

Note 16 – Fair Value Disclosures

 

 

Fair Value Option

 

Corporate Loans and Loan Commitments

The Corporation accounts for certain large corporate loans and loan commitments which exceeded the Corporation’s single name credit risk concentration guidelines at fair value in accordance with SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). Lending commitments, both funded and unfunded, are actively managed and monitored, and, as appropriate, credit risk for these lending relationships may be mitigated through the use of credit derivatives, with the Corporation’s credit view and market perspectives determining the size and timing of the hedging activity. These credit derivatives do not meet the requirements for hedge accounting under SFAS 133 and are therefore carried at fair value with changes in fair value recorded in other income. SFAS 159 allows the Corporation to account for these loans and loan commitments at fair value, which is more consistent with the manner in which they are managed. In addition, accounting for these loans and loan commitments at fair value reduces the accounting asymmetry that would otherwise result from carrying the loans at historical cost and the credit derivatives at fair value.

At September 30, 2008 and December 31, 2007, funded loans that the Corporation fair values had an aggregate fair value of $5.38 billion and $4.59 billion recorded in loans and leases and an aggregate outstanding principal balance of $5.85 billion and $4.82 billion. At September 30, 2008 and December 31, 2007, unfunded loan commitments that the Corporation fair values had an aggregate fair value of $716 million and $660 million recorded in accrued expenses and other liabilities and an aggregate committed exposure of $17.3 billion and $20.9 billion. Interest income on these loans and commitment fees on these loan commitments are recorded in interest and fees on loans and leases. At September 30, 2008 and December 31, 2007, none of these loans were 90 days or more past due and still accruing interest or have been placed on nonaccrual status. Net losses resulting from changes in fair value of these loans and loan commitments of $187 million and $140 million were recorded in other income during the three months ended September 30, 2008 and 2007 while net losses of $314 million and $180 million were recorded during the nine months ended September 30, 2008 and 2007. These gains and losses were primarily attributable to changes in instrument-specific credit risk. These changes in fair value were predominately offset by hedging activities.

 

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Loans Held-for-Sale

The Corporation also accounts for certain LHFS at fair value. Using fair value allows a better offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting under SFAS 133. The Corporation does not fair value other LHFS primarily because these loans are floating rate loans that are not economically hedged using derivative instruments. Fair values for LHFS are based on quoted market prices, where available, or are determined by discounting estimated cash flows using interest rates approximating the Corporation’s current origination rates for similar loans and adjusted to reflect the inherent credit risk. At September 30, 2008 and December 31, 2007, residential mortgage loans, commercial mortgage loans, and other LHFS that the Corporation fair values had an aggregate fair value of $15.61 billion and $15.77 billion and an aggregate outstanding principal balance of $17.32 billion and $16.72 billion, primarily within GCSBB. Interest income on LHFS is recorded in other interest income. Net gains resulting from changes in fair value of these loans during the three months ended September 30, 2008 and 2007, including realized gains (losses) on sale, of $520 million and $81 million were recorded in mortgage banking income, $(176) million and $59 million were recorded in trading account profits (losses), and $(38) million and $(46) million were recorded in other income. Approximately $87 million of losses were attributable to instrument-specific credit risk during the three months ended September 30, 2008. During the nine months ended September 30, 2008 and 2007 net gains (losses), including realized gains on sale, of $637 million and $120 million were recorded in mortgage banking income, $(673) million and $(186) million were recorded in trading account profits (losses), and $(56) million and $(53) million were recorded in other income. Approximately $137 million of losses were attributable to instrument-specific credit risk during the nine months ended September 30, 2008. These changes in fair value were predominately offset by hedging activities.

Structured Reverse Repurchase Agreements

The Corporation fair values certain structured reverse repurchase agreements which are hedged with derivatives. Using fair value allows the Corporation to reduce volatility in earnings without the burden of complying with the requirements of hedge accounting under SFAS 133. At September 30, 2008 and December 31, 2007, these instruments had an aggregate fair value of $2.64 billion and $2.58 billion and a principal balance of $2.64 billion and $2.54 billion recorded in federal funds sold and securities purchased under agreements to resell. Interest earned on these instruments continues to be recorded in interest income. Net gains (losses) resulting from changes in fair value of these instruments of $(8) million and $8 million were recorded in other income for the three months ended September 30, 2008 and 2007, while gains (losses) of $(15) million and $16 million were recorded for the nine months ended September 30, 2008 and 2007. The Corporation does not fair value other financial instruments within the same balance sheet category because they were not economically hedged using derivatives.

Long-term Deposits

The Corporation fair values certain long-term fixed rate deposits which are economically hedged with derivatives. At September 30, 2008 and December 31, 2007, these instruments had an aggregate fair value of $1.74 billion and $2.00 billion and a principal balance of $1.75 billion and $1.99 billion recorded in interest-bearing deposits. Interest paid on these instruments continues to be recorded in interest expense. Net gains (losses) resulting from changes in fair value of these instruments of $43 million and $(25) million were recorded in other income for the three months ended September 30, 2008 and 2007 while net gains (losses) of $22 million and $(4) million were recorded for the nine months ended September 30, 2008 and 2007. Using fair value allows the Corporation to reduce the accounting volatility that would otherwise result from the accounting asymmetry created by accounting for the financial instruments at historical cost and the economic hedges at fair value. The Corporation does not fair value other financial instruments within the same balance sheet category because they were not economically hedged using derivatives.

 

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Fair Value Measurement

 

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Corporation determines the fair values of its financial instruments based on the fair value hierarchy established in SFAS 157 which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. The Corporation carries certain corporate loans and loan commitments, LHFS, structured reverse repurchase agreements, and long-term deposits at fair value in accordance with SFAS 159. The Corporation also carries at fair value trading account assets and liabilities, derivative assets and liabilities, AFS debt securities, mortgage servicing rights (MSRs), and certain other assets. A detailed discussion on how the Corporation measures fair value is presented in Note 1 – Summary of Significant Accounting Principles to the Consolidated Financial Statements of the Corporation’s 2007 Annual Report on Form 10-K.

Level 1, 2 and 3 Valuation Techniques

Financial instruments are considered Level 1 when valuation can be based on quoted prices in active markets for identical assets or liabilities. Level 2 financial instruments are valued using quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data of substantially the full term of the assets or liabilities. Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable and when determination of the fair value requires significant management judgment or estimation.

The Corporation also uses market indices for direct inputs to certain models, where the cash settlement is directly linked to appreciation or depreciation of that particular index (primarily in the context of structured credit products). In those cases, no material adjustments are made off of the index-based values. In other cases, market indices are also used as inputs to valuation, but are adjusted for trade specific factors such as rating, credit quality, vintage and other factors.

Corporate Loans and Loan Commitments

The fair values of loans and loan commitments are based on market prices, where available, or discounted cash flows using market-based credit spreads of comparable debt instruments or credit derivatives of the specific borrower or comparable borrowers. Results of discounted cash flow calculations may be adjusted, as appropriate, to reflect other market conditions or the perceived credit risk of the borrower.

Structured Reverse Repurchase Agreements and Long-term Deposits

The fair values of structured reverse repurchase agreements and long-term deposits are determined using quantitative models, including discounted cash flow models, that require the use of multiple market inputs including interest rates and spreads to generate continuous yield or pricing curves and volatility factors, which are used to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services. The Corporation does incorporate, consistent with the requirements of SFAS 157, within its fair value measurements of long-term deposits the net credit differential between the counterparty credit risk and our own credit risk. The value of the net credit differential is determined by reference to existing direct market reference costs of credit, or where direct references are not available, a proxy is applied consistent with direct references for other counterparties that are similar in credit risk. An estimate of severity of loss is also used within the determination of fair value, primarily based on historical experience, adjusted for any more recent name specific expectations.

Trading Account Assets and Liabilities and Available-for-Sale Debt Securities

The fair values of trading account assets and liabilities are primarily based on actively traded markets where prices are based on either direct market quotes or observed transactions. The fair values of AFS debt securities are generally based on quoted market prices or market prices for similar assets. Liquidity is a significant factor in the determination of the fair values of trading account assets or liabilities and AFS debt securities. Market price quotes may not be readily available for some positions, or positions within a market sector where trading activity has slowed significantly or ceased such as certain CDO positions and other ABS. Some of these instruments are valued using a net asset value approach, which considers the value of the underlying securities. Underlying assets are valued using external pricing services, where available, or matrix

 

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pricing based on the vintages and ratings. Situations of illiquidity generally are triggered by the market’s perception of credit uncertainty regarding a single company or a specific market sector. In these instances, fair value is determined based on limited available market information and other factors, principally from reviewing the issuer’s financial statements and changes in credit ratings made by one or more rating agencies.

Derivative Assets and Liabilities

The fair values of derivative assets and liabilities traded in the over-the-counter market are determined using quantitative models that require the use of multiple market inputs including interest rates, prices, and indices to generate continuous yield or pricing curves and volatility factors, which are used to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services. Estimation risk is greater for derivative asset and liability positions that are either option-based or have longer maturity dates where observable market inputs are less readily available or are unobservable, in which case, quantitative-based extrapolations of rate, price or index scenarios are used in determining fair values. The fair values of derivative assets and liabilities include adjustments for market liquidity, counterparty credit quality and other deal specific factors, where appropriate. Consistent with the way the Corporation fair values long-term deposits as discussed above, the Corporation incorporates, within its fair value measurements of over-the-counter derivatives, the net credit differential between the counterparty credit risk and our own credit risk.

Mortgage Servicing Rights

The fair values of MSRs are determined using models which depend on estimates of prepayment rates, the resultant weighted average lives of the MSRs and the option adjusted spread levels. For more information on MSRs, see Note 17—Mortgage Servicing Rights to the Consolidated Financial Statements.

Loans Held-for-Sale

The fair values of LHFS are based on quoted market prices, where available, or are determined by discounting estimated cash flows using interest rates approximating the Corporation’s current origination rates for similar loans adjusted to reflect the inherent credit risk.

Other Assets

The Corporation fair values certain other assets including AFS equity securities and certain retained residual interests in securitization vehicles. The fair values of AFS equity securities are generally based on quoted market prices or market prices for similar assets. However, non-public investments are initially valued at transaction price and subsequently adjusted when evidence is available to support such adjustments. Retained residual interests in securitization vehicles are based on certain observable inputs such as interest rates and credit spreads, as well as unobservable inputs such as estimated net charge-off and payment rates.

 

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Assets and liabilities measured at fair value on a recurring basis, including financial instruments that the Corporation accounts for at fair value in accordance with SFAS 159, are summarized below:

 

     September 30, 2008
     Fair Value Measurements Using    Netting     Assets/Liabilities
  (Dollars in millions)    Level 1    Level 2    Level 3    Adjustments (1)     at Fair Value

 

  Assets

             

Federal funds sold and securities purchased under agreements to resell

   $ -    $ 2,636    $ -    $ -     $ 2,636

Trading account assets

     38,777      128,371      7,711      -       174,859

Derivative assets

     935      614,063      9,071      (578,277 )     45,792

Available-for-sale debt securities

     3,224      244,474      9,729      -       257,427

Loans and leases (2)

     -      -      5,383      -       5,383

Mortgage servicing rights

     -      -      20,811      -       20,811

Loans held-for-sale

     -      12,123      3,487      -       15,610

Other assets (3)

     21,408      1,356      3,735      -       26,499

Total assets

   $ 64,344    $ 1,003,023    $ 59,927    $ (578,277 )   $ 549,017

  Liabilities

             

Interest-bearing deposits in domestic offices

   $ -    $ 1,737    $ -    $ -     $ 1,737

Trading account liabilities

     53,091      15,138      -      -       68,229

Derivative liabilities

     1,160      588,093      7,359      (570,146 )     26,466

Accrued expenses and other liabilities

     -      -      1,854      -       1,854

Total liabilities

   $ 54,251    $ 604,968    $ 9,213    $ (570,146 )   $ 98,286
     December 31, 2007

  Assets

             

Federal funds sold and securities purchased under agreements to resell

   $ -    $ 2,578    $ -    $ -     $ 2,578

Trading account assets

     42,986      115,051      4,027      -       162,064

Derivative assets

     516      442,471      8,972      (417,297 )     34,662

Available-for-sale debt securities

     2,089      205,734      5,507      -       213,330

Loans and leases (2)

     -      -      4,590      -       4,590

Mortgage servicing rights

     -      -      3,053      -       3,053

Loans held-for-sale

     -      14,431      1,334      -       15,765

Other assets (3)

     19,796      1,540      3,987      -       25,323

Total assets

   $ 65,387    $ 781,805    $ 31,470    $ (417,297 )   $ 461,365

  Liabilities

             

Interest-bearing deposits in domestic offices

   $ -    $ 2,000    $ -    $ -     $ 2,000

Trading account liabilities

     57,331      20,011      -      -       77,342

Derivative liabilities

     534      426,223      10,175      (414,509 )     22,423

Accrued expenses and other liabilities

     -      -      660      -       660

Total liabilities

   $ 57,865    $ 448,234    $ 10,835    $ (414,509 )   $ 102,425

  (1)

Amounts represent the impact of legally enforceable master netting agreements that allow the Corporation to settle positive and negative positions and also cash collateral held or placed with the same counterparties.

 

  (2)

Loans and leases at September 30, 2008 and December 31, 2007 included $22.4 billion and $22.6 billion of leases that were not eligible for the fair value option as leases are specifically excluded from fair value option election in accordance with SFAS 159.

 

  (3)

Other assets include equity investments held by Principal Investing, AFS equity securities and certain retained residual interests in securitization vehicles, including interest-only strips. Substantially all of other assets are eligible for, and the Corporation has not chosen to elect, fair value accounting at September 30, 2008 and December 31, 2007.

 

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The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three and nine months ended September 30, 2008 and 2007, including realized and unrealized gains (losses) included in earnings and OCI.

 

  Level 3 - Fair Value Measurements                  
  (Dollars in millions)    Three Months Ended September 30, 2008  
     Net
Derivatives(1)
    Trading
Account
Assets
    Available-for-
Sale Debt
Securities
    Loans
and
Leases(2)
    Mortgage
Servicing
Rights
   

Loans

Held-for-Sale(2)

    Other
Assets(3)
    Accrued
Expenses
and Other
Liabilities(2)
 

 

  Balance, June 30, 2008

   $ 1,317     $ 5,646     $ 8,324     $ 5,014     $ 4,250     $ 2,011     $ 4,013     $ (723 )

 

Countrywide acquisition

     (185 )     1,407       528       -       17,188       1,425       -       (1,212 )

 

Included in earnings

     1,795       (1,332 )     (802 )     (179 )     (179 )     (275 )     (344 )     22  

Included in other comprehensive income

     -       -       (556 )     -       -       -       -       -  

Purchases, issuances, and settlements

     (425 )     (642 )     1,468       548       (448 )     (219 )     66       59  

 

Transfers in to (out of) Level 3

     (790 )     2,632       767       -       -       545       -       -  

 

  Balance, September 30, 2008

   $ 1,712     $ 7,711     $ 9,729     $ 5,383     $ 20,811     $ 3,487     $ 3,735     $ (1,854 )
    

 

Three Months Ended September 30, 2007

 

 

  Balance, June 30, 2007

   $ (1,301 )   $ 289     $ 226     $ 3,606     $ 3,269     $ 507     $ 6,163     $ (391 )

 

Included in earnings

     411       (248 )     -       (79 )     (151 )     (45 )     273       (63 )

Included in other comprehensive income

     -       -       (83 )     -       -       -       (10 )     -  

Purchases, issuances, and settlements

     207       412       385       998       61       (41 )     (1,878 )     -  

 

Transfers in to (out of) Level 3

     61       3,258       -       -       -       1,952       (40 )     -  

 

  Balance, September 30, 2007

   $ (622 )   $ 3,711     $ 528     $ 4,525     $ 3,179     $ 2,373     $ 4,508     $ (454 )
    

 

Nine Months Ended September 30, 2008

 

 

  Balance, January 1, 2008

   $ (1,203 )   $ 4,027     $ 5,507     $ 4,590     $ 3,053     $ 1,334     $ 3,987     $ (660 )

 

Countrywide acquisition

     (185 )     1,407       528       -       17,188     <