Bank of America 2009 Annual Report Download - page 100

We use interest rate derivative instruments to hedge the variability in
the cash flows of our assets and liabilities, and other forecasted trans-
actions (cash flow hedges). From time to time, we also utilize equity-
indexed derivatives accounted for as derivatives designated as cash flow
hedges to minimize exposure to price fluctuations on the forecasted
purchase or sale of certain equity investments. The net losses on both
open and terminated derivative instruments recorded in accumulated OCI,
net-of-tax, were $2.5 billion and $3.5 billion at December 31, 2009 and
2008. These net losses are expected to be reclassified into earnings in
the same period when the hedged cash flows affect earnings and will
decrease income or increase expense on the respective hedged cash
flows. Assuming no change in open cash flow derivative hedge positions
and no changes to prices or interest rates beyond what is implied in
forward yield curves at December 31, 2009, the pre-tax net losses are
expected to be reclassified into earnings as follows: $937 million, or 23
percent within the next year, 66 percent within five years, and 88 percent
within 10 years, with the remaining 12 percent thereafter. For more
information on derivatives designated as cash flow hedges, see Note 4 –
Derivatives to the Consolidated Financial Statements.
In addition to the derivatives disclosed in Table 46 we hedge our net
investment in consolidated foreign operations determined to have func-
tional currencies other than the U.S. dollar using forward foreign
exchange contracts that typically settle in 90 days, cross currency basis
swaps and by issuing foreign currency-denominated debt. We recorded
after-tax losses from derivatives and foreign currency-denominated debt in
accumulated OCI associated with net investment hedges which was off-
set by after-tax unrealized gains in accumulated OCI associated for
changes in the value of our net investments in consolidated foreign enti-
ties at December 31, 2009.
Mortgage Banking Risk Management
We originate, fund and service mortgage loans, which subject us to credit,
liquidity and interest rate risks, among others. We determine whether
loans will be held for investment or held for sale at the time of commit-
ment and manage credit and liquidity risks by selling or securitizing a
portion of the loans we originate.
Interest rate and market risk can be substantial in the mortgage busi-
ness. Fluctuations in interest rates drive consumer demand for new mort-
gages and the level of refinancing activity, which in turn affects total
origination and service fee income. Typically, a decline in mortgage inter-
est rates will lead to an increase in mortgage originations and fees and a
decrease in the value of the MSRs driven by higher prepayment expect-
ations. Hedging the various sources of interest rate risk in mortgage
banking is a complex process that requires complex modeling and
ongoing monitoring. IRLCs and the related residential first mortgage LHFS
are subject to interest rate risk between the date of the IRLC and the
date the loans are sold to the secondary market. To hedge interest rate
risk, we utilize forward loan sale commitments and other derivative
instruments including purchased options. These instruments are used as
economic hedges of IRLCs and residential first mortgage LHFS. At
December 31, 2009 and 2008, the notional amount of derivatives eco-
nomically hedging the IRLCs and residential first mortgage LHFS was
$161.4 billion and $97.2 billion.
MSRs are nonfinancial assets created when the underlying mortgage
loan is sold to investors and we retain the right to service the loan. We
use certain derivatives such as interest rate options, interest rate swaps,
forward settlement contracts, euro dollar futures, as well as mortgage-
backed and U.S. Treasury securities as economic hedges of MSRs. The
notional amounts of the derivative contracts and other securities des-
ignated as economic hedges of MSRs at December 31, 2009 were $1.3
trillion and $67.6 billion, for a total notional amount of $1.4 trillion. At
December 31, 2008, the notional amounts of the derivative contracts
and other securities designated as economic hedges of MSRs were $1.0
trillion and $87.5 billion, for a total notional amount of $1.1 trillion. In
2009, we recorded losses in mortgage banking income of $3.8 billion
related to the change in fair value of these economic hedges as com-
pared to gains of $8.6 billion for 2008. For additional information on
MSRs, see Note 22 – Mortgage Servicing Rights to the Consolidated
Financial Statements and for more information on mortgage banking
income, see the Home Loans & Insurance discussion beginning on page
43.
Compliance Risk Management
Compliance risk is the risk posed by the failure to manage regulatory,
legal and ethical issues that could result in monetary damages, losses or
harm to our reputation or image. The Seven Elements of a Compliance
Program
®
provides the framework for the compliance programs that are
consistently applied across the enterprise to manage compliance risk.
This framework includes a common approach to commitment and
accountability, policies and procedures, controls and supervision, monitor-
ing, regulatory change management, education and awareness and
reporting.
We approach compliance risk management on an enterprise and line
of business level. The Operational Risk Committee provides oversight of
significant compliance risk issues. Within Global Risk Management,
Global Compliance Risk Management develops and guides the strategies,
policies and practices for assessing and managing compliance risks
across the organization. Through education and communication efforts, a
culture of compliance is emphasized across the organization. We also
mitigate compliance risk through a broad-based approach to process
management and improvement.
The lines of business are responsible for all the risks within the busi-
ness line, including compliance risks. Compliance Risk executives, work-
ing in conjunction with senior line of business executives, have developed
key tools to address and measure compliance risks and to ensure com-
pliance with laws and regulations in each line of business.
Operational Risk Management
Operational risk is the risk of loss resulting from inadequate or failed
internal processes, people, systems or external events. Successful
operational risk management is particularly important to diversified finan-
cial services companies because of the nature, volume and complexity of
the financial services business. Under the Basel II Rules, an operational
loss event is an event that results in loss and is associated with any of
the following seven operational loss event categories: internal fraud;
external fraud; employment practices and workplace safety; clients, prod-
ucts and business practices; damage to physical assets; business dis-
ruption and system failures; and execution, delivery and process
management. Losses in these categories are captured and mapped to
four overall risk categories: people, process, systems and external
events. Specific examples of loss events include robberies, internal fraud,
processing errors and physical losses from natural disasters.
We approach operational risk management from two perspectives: the
enterprise and line of business. The Operational Risk Committee, which
reports to the Audit Committee of the Board, is responsible for opera-
tional risk policies, measurement and management, and control proc-
esses. Within Global Risk Management, Global Operational Risk
Management develops and guides the strategies, policies, practices,
controls and monitoring tools for assessing and managing operational
risks across the organization.
For selected risks, we use specialized support groups, such as Enter-
prise Information Management and Supply Chain Management, to
98 Bank of America 2009