2003 Annual Report: Financial Review: Statements and Notes: Note 9 Special Purpose Financing Entities

The Corporation securitizes assets and may retain a portion or all of the securities, subordinated tranches, interest-only strips and, in some cases, a cash reserve account, all of which are considered retained interests in the securitized assets. Those assets may be serviced by the Corporation or by third parties to whom the servicing has been sold. See Note 1 of the consolidated financial statements for a more detailed discussion of securitizations.

Mortgage-related Securitizations

For 2003, the Corporation reported $2.4 billion in gains on loans converted into securities and sold, of which $2.0 billion was from loans originated by the Corporation and $381 million was from loans originated by other entities on behalf of the Corporation. For 2002, the Corporation reported $480 million in gains on loans converted into securities and sold, of which $408 million was from loans originated by the Corporation and $72 million was from loans originated by other entities on behalf of the Corporation. At December 31, 2003, the Corporation had recourse obligations of $531 million with varying terms up to seven years on loans that had been securitized and sold.

In addition to the retained interests in the securities, the Corporation has retained the servicing asset and the Certificates from securitized mortgage loans (see the Mortgage Banking Assets section of Note 1 of the consolidated financial statements). Mortgage Certificate and servicing fee income on all loans serviced, including securitizations, was $738 million and $944 million in 2003 and 2002, respectively.

The Certificates of $2.3 billion at December 31, 2003 and $1.6 billion at December 31, 2002 are classified as MBAs and marked to market with gains or losses recorded in trading account profits. At December 31, 2003, key economic assumptions and the sensitivities of the valuations of the Certificates and MSRs to immediate changes in those assumptions were analyzed. The sensitivity analysis included the impact on fair value of modeled prepayment and discount rate changes under favorable and adverse conditions. A decrease of 10 percent and 20 percent in modeled prepayments would result in an increase in value ranging from $134 million to $282 million, and an increase in modeled prepayments of 10 percent and 20 percent would result in a decrease in value ranging from $122 million to $234 million. A decrease of 100 and 200 basis points (bps) in the discount rate would result in an increase in value ranging from $119 million to $248 million, and an increase in the discount rate of 100 and 200 bps would result in a decrease in value ranging from $110 million to $211 million. See Note 1 of the consolidated financial statements for additional disclosures related to the Certificates.

Other Securitizations

The Corporation has provided protection on a subset of one consumer finance securitization in the form of a guarantee with a maximum payment of $220 million that is only paid out if overcollateralization is not sufficient to absorb losses and certain other conditions are met. The Corporation projects no payments will be due over the life of the contract, which is approximately two years.

Key economic assumptions used in measuring the fair value of certain residual interests (included in other assets) in securitizations and the sensitivity of the current fair value of residual cash flows to changes in those assumptions are as follows:

The sensitivities in the preceding table and related to the Certificates 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 the retained interest 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.

Static pool net credit losses are considered in determining the value of retained interests. Static pool net credit losses include actual losses incurred plus projected credit losses divided by the original balance of each securitization pool. Expected static pool net credit losses at December 31, 2003 were 5.83 percent, 9.91 percent, 8.22 percent, 5.50 percent and 10.83 percent for 2001, 1999, 1998, 1997 and 1995, respectively. Expected static pool net credit losses at December 31, 2002 were 6.86 percent, 8.28 percent, 6.69 percent, 5.30 percent, 4.87 percent and 6.27 percent for 2001, 1999, 1998, 1997, 1996 and 1995, respectively.

Proceeds from collections reinvested in revolving credit card securitizations were $14.7 billion and $16.1 billion in 2003 and 2002, respectively. Other cash flows received from retained interests that represent amounts received on retained interests by the transferor other than servicing fees such as cash flows from interest-only strips, were $279 million and $451 million in 2003 and 2002, respectively, for credit card securitizations.

The Corporation reviews its loans and leases portfolio on a managed basis. Managed loans and leases are defined as on-balance sheet loans and leases as well as securitized credit card loans. New advances under previously securitized accounts will be recorded on the Corporation's balance sheet after the revolving period of the securitization, which has the effect of increasing loans on the Corporation's balance sheet and increasing net interest income and charge-offs, with a corresponding reduction in noninterest income. Portfolio balances, delinquency and historical loss amounts of the managed loans and leases portfolio for 2003 and 2002 were as follows:

Variable Interest Entities

Additionally, the Corporation had significant involvement with other VIEs that it did not consolidate because it was not deemed to be the primary beneficiary. In such cases, the Corporation does not absorb the majority of the entities' expected losses nor does it receive a majority of the entities' expected residual returns, or both. These entities facilitate client transactions, and the Corporation functions as administrator for all of these and provides either liquidity and letters of credit or derivatives to the VIE. The Corporation typically obtains variable interests in these types of entities at the inception of the transaction. Total assets of these entities at December 31, 2003 and 2002 were approximately $28.7 billion and $11.1 billion, respectively; revenues associated with administration, liquidity, letters of credit and other services were approximately $334 million in 2003 and $341 million in 2002. At December 31, 2003 and 2002, the Corporation's loss exposure associated with these VIEs was approximately $17.7 billion and $5.1 billion, respectively, which is net of amounts syndicated.

Additionally, the Corporation had contractual relationships with other VIEs that engaged in leasing or lending activities and were consolidated by the Corporation prior to FIN 46. The amount of assets of these entities as of December 31, 2003 was $1.5 billion and the Corporation's maximum possible loss exposure was $1.3 billion.

Management does not believe losses resulting from its involvement with the entities discussed above will be material. See Note 1 of the consolidated financial statements for additional discussion of special purpose financing entities.