SUNTRUST BANKS INC, 10-Q filed on 5/5/2010
Quarterly Report
Document and Entity Information
Apr. 29, 2010
3 Months Ended
Mar. 31, 2010
Document Type
 
10-Q 
Amendment Flag
 
FALSE 
Document Period End Date
 
03/31/2010 
Document Fiscal Year Focus
 
2010 
Document Fiscal Period Focus
 
Q1 
Trading Symbol
 
STI 
Entity Registrant Name
 
SUNTRUST BANKS INC 
Entity Central Index Key
 
0000750556 
Current Fiscal Year End Date
 
12/31 
Entity Filer Category
 
Large Accelerated Filer 
Entity Common Stock, Shares Outstanding
499,887,039 
 
Consolidated Statements of Income/(Loss) (USD $)
In Thousands, except Per Share data
3 Months Ended
Mar. 31,
2010
2009
Interest Income
 
 
Interest and fees on loans
$ 1,316,756 
$ 1,412,885 
Interest and fees on loans held for sale
33,177 
61,832 
Interest and dividends on securities available for sale
 
 
Taxable interest
175,902 
181,202 
Tax-exempt interest
8,928 
10,699 
Dividends
18,959 3
18,162 3
Interest on funds sold and securities purchased under agreements to resell
245 
937 
Interest on deposits in other banks
18 
113 
Trading account interest
19,701 
43,505 
Total interest income
1,573,686 
1,729,335 
Interest Expense
 
 
Interest on deposits
233,045 
423,873 
Interest on funds purchased and securities sold under agreements to repurchase
1,092 
2,733 
Interest on trading liabilities
6,135 
6,160 
Interest on other short-term borrowings
3,194 
5,155 
Interest on long-term debt
158,783 
229,316 
Total interest expense
402,249 
667,237 
Net interest income
1,171,437 
1,062,098 
Provision for credit losses
861,609 
994,098 
Net interest income after provision for credit losses
309,828 
68,000 
Noninterest Income
 
 
Service charges on deposit accounts
195,902 
206,394 
Other charges and fees
129,100 
124,321 
Trust and investment management income
122,087 
116,010 
Mortgage production related income/(loss)
(30,929)
250,470 
Mortgage servicing related income
70,504 
83,352 
Card fees
86,934 
75,660 
Investment banking income
55,916 
59,534 
Retail investment services
46,740 
56,713 
Trading account profits/(losses) and commissions
(7,268)
107,293 
Other noninterest income
27,631 
38,114 
Net securities gains
1,543 1
3,377 1
Total noninterest income
698,160 
1,121,238 
Noninterest Expense
 
 
Employee compensation
556,498 
573,022 
Employee benefits
135,295 
163,030 
Outside processing and software
148,703 
138,361 
Net occupancy expense
91,141 
87,417 
Regulatory assessments
64,335 
47,473 
Credit and collection services
73,790 
47,918 
Other real estate expense
46,008 
44,372 
Equipment expense
40,513 
43,540 
Marketing and customer development
34,127 
34,725 
Operating losses
13,797 
22,621 
Amortization/impairment of goodwill/intangible assets
13,187 
767,016 
Mortgage reinsurance
9,400 
70,039 
Net gain on extinguishment of debt
(9,307)
(25,304)
Other noninterest expense
143,056 
137,793 
Total noninterest expense
1,360,543 
2,152,023 
Income/(loss) before provision/(benefit) for income taxes
(352,555)
(962,785)
Provision/(benefit) for income taxes
(194,162)
(150,777)
Net income/(loss) including income attributable to noncontrolling interest
(158,393)
(812,008)
Net income attributable to noncontrolling interest
2,421 
3,159 
Net income/(loss)
(160,814)
(815,167)
Net income/(loss) available to common shareholders
(229,184)
(875,381)
Net income/(loss) per average common share
 
 
Diluted
(0.46)
(2.49)
Basic
(0.46)
(2.49)
Dividends declared per common share
0.01 
0.10 
Average common shares - diluted
494,871 2
351,352 2
Average common shares - basic
494,871 
351,352 
Consolidated Statements of Income/(Loss) (Parenthetical) (USD $)
In Thousands
3 Months Ended
Mar. 31,
2010
2009
Dividends on common stock of The Coca-Cola Company
$ 13,200 
$ 12,300 
Net securities gains, other-than-temporary impairment losses
$ 1,000 
$ 1,000 
Consolidated Balance Sheets (USD $)
In Thousands, except Share data
Mar. 31, 2010
Dec. 31, 2009
Assets
 
 
Cash and due from banks
$ 4,671,345 
$ 6,456,406 
Interest-bearing deposits in other banks
24,665 
24,109 
Funds sold and securities purchased under agreements to resell
1,613,663 
516,656 
Cash and cash equivalents
6,309,673 
6,997,171 
Trading assets
6,038,104 
4,979,938 
Securities available for sale
26,238,529 
28,477,042 
Loans held for sale (loans at fair value: $2,650,980 as of March 31, 2010; $2,923,375 as of December 31, 2009)
3,696,990 1
4,669,823 1
Loans (loans at fair value: $420,484 as of March 31, 2010; $448,720 as of December 31, 2009)
113,979,448 2
113,674,844 2
Allowance for loan and lease losses
(3,176,000)
(3,120,000)
Net loans
110,803,448 
110,554,844 
Premises and equipment
1,553,786 
1,551,794 
Goodwill
6,322,878 
6,319,078 
Other intangible assets (MSRs at fair value: $1,641,188 as of March 31, 2010; $935,561 as of December 31, 2009)
1,799,919 
1,711,299 
Customers' acceptance liability
5,912 
6,264 
Other real estate owned
627,639 
619,621 
Other assets
8,399,377 
8,277,861 
Total assets
171,796,255 
174,164,735 
Liabilities and Shareholders' Equity
 
 
Noninterest-bearing consumer and commercial deposits
25,148,837 
24,244,041 
Interest-bearing consumer and commercial deposits
90,994,812 
92,059,411 
Total consumer and commercial deposits
116,143,649 
116,303,452 
Brokered deposits (CDs at fair value: $1,241,806 as of March 31, 2010; $1,260,505 as of December 31, 2009)
2,350,846 
4,231,530 
Foreign deposits
254,941 
1,328,584 
Total deposits
118,749,436 
121,863,566 
Funds purchased
1,158,713 
1,432,581 
Securities sold under agreements to repurchase
2,794,195 
1,870,510 
Other short-term borrowings
2,387,640 
2,062,277 
Long-term debt (debt at fair value: $3,944,137 as of March 31, 2010; $3,585,892 as of December 31, 2009)
16,531,380 3
17,489,516 3
Acceptances outstanding
5,912 
6,264 
Trading liabilities
3,246,890 
2,188,923 
Other liabilities
4,302,163 
4,720,243 
Total liabilities
149,176,329 
151,633,880 
Preferred stock
4,923,292 
4,917,312 
Common stock, $1.00 par value
514,667 
514,667 
Additional paid in capital
8,446,209 
8,521,042 
Retained earnings
8,419,219 
8,562,807 
Treasury stock, at cost, and other
(989,840)
(1,055,136)
Accumulated other comprehensive income, net of tax
1,306,379 
1,070,163 
Total shareholders' equity
22,619,926 
22,530,855 
Total liabilities and shareholders' equity
171,796,255 
174,164,735 
Common shares outstanding
499,857,812 
499,156,858 
Common shares authorized
750,000,000 
750,000,000 
Preferred shares outstanding
50,225 
50,225 
Preferred shares authorized
50,000,000 
50,000,000 
Treasury shares of common stock
14,808,783 
15,509,737 
Consolidated Balance Sheets (Parenthetical) (USD $)
In Thousands, except Per Share data
Mar. 31, 2010
Dec. 31, 2009
Loans held for sale, loans at fair value
$ 2,650,980 
$ 2,923,375 
Loans,loans at fair value
420,484 
448,720 
Other intangible assets,MSRs at fair value
1,641,188 
935,561 
Brokered deposits,CDs at fair value
1,241,806 
1,260,505 
Long-term debt, fair value
3,944,137 
3,585,892 
Common stock, par value
1.00 
1.00 
Loans held for sale of consolidated VIEs
310,899 
 
Loans of consolidated VIEs
1,544,856 
 
Long-term debt, debt of consolidated VIEs
$ 284,728 
 
Consolidated Statements of Shareholders' Equity (USD $)
In Thousands
Preferred Stock
Common Stock
Additional Paid in Capital
Retained Earnings
Treasury Stock and Other
Accumulated Other Comprehensive Income
Total
1/1/2009 - 3/31/2009
 
 
 
 
 
 
 
Beginning Balance (in shares)
 
354,515 
 
 
 
 
 
Beginning Balance
5,221,703 
372,799 
6,904,644 
10,388,984 
(1,368,450)1
981,125 
22,500,805 
Net loss
 
 
 
(815,167)
 
 
(815,167)
Other comprehensive income:
 
 
 
 
 
 
 
Change in unrealized gains (losses) on securities, net of taxes
 
 
 
 
 
48,968 
48,968 
Change in unrealized gains (losses) on derivatives, net of taxes
 
 
 
 
 
(18,993)
(18,993)
Change related to employee benefit plans
 
 
 
 
 
22,915 
22,915 
Total Comprehensive income (loss)
 
 
 
 
 
 
(762,277)
Change in noncontrolling interest
 
 
 
 
(679)1
 
(679)
Common stock dividends, $0.01 in 2010 and $0.10 in 2009 per share
 
 
 
(35,621)
 
 
(35,621)
Series A preferred stock dividends, $1,000 in 2010 and $1,000 in 2009 per share
 
 
 
(5,000)
 
 
(5,000)
U.S. Treasury preferred stock dividends, $1,250 in 2010 and $1,250 in 2009 per share
 
 
 
(60,625)
 
 
(60,625)
Accretion of discount associated with U.S. Treasury preferred stock
5,654 
 
 
(5,654)
 
 
 
Exercise of stock options and stock compensation expense
 
 
3,285 
 
 
 
3,285 
Restricted stock activity (in shares)
 
1,658 
 
 
 
 
 
Restricted stock activity
 
 
(161,571)
 
138,995 1
 
(22,576)
Amortization of restricted stock compensation
 
 
 
 
20,283 1
 
20,283 
Issuance of stock for employee benefit plans and other (in shares)
 
520 
 
 
 
 
 
Issuance of stock for employee benefit plans and other
 
 
(32,822)
(3)
40,856 1
 
8,031 
Fair value election of MSRs
 
 
 
 
 
 
 
Adoption of VIE consolidation guidance
 
 
 
 
 
 
 
Ending Balance (in shares)
 
356,693 
 
 
 
 
 
Ending Balance
5,227,357 
372,799 
6,713,536 
9,466,914 
(1,168,995)1
1,034,015 
21,645,626 
1/1/2010 - 3/31/2010
 
 
 
 
 
 
 
Beginning Balance (in shares)
 
499,157 
 
 
 
 
 
Beginning Balance
4,917,312 
514,667 
8,521,042 
8,562,807 
(1,055,136)1
1,070,163 
22,530,855 
Net loss
 
 
 
(160,814)
 
 
(160,814)
Other comprehensive income:
 
 
 
 
 
 
 
Change in unrealized gains (losses) on securities, net of taxes
 
 
 
 
 
39,123 
39,123 
Change in unrealized gains (losses) on derivatives, net of taxes
 
 
 
 
 
121,936 
121,936 
Change related to employee benefit plans
 
 
 
 
 
75,157 
75,157 
Total Comprehensive income (loss)
 
 
 
 
 
 
75,402 
Change in noncontrolling interest
 
 
 
 
(2,479)1
 
(2,479)
Common stock dividends, $0.01 in 2010 and $0.10 in 2009 per share
 
 
 
(4,992)
 
 
(4,992)
Series A preferred stock dividends, $1,000 in 2010 and $1,000 in 2009 per share
 
 
 
(1,725)
 
 
(1,725)
U.S. Treasury preferred stock dividends, $1,250 in 2010 and $1,250 in 2009 per share
 
 
 
(60,625)
 
 
(60,625)
Accretion of discount associated with U.S. Treasury preferred stock
5,980 
 
 
(5,980)
 
 
 
Exercise of stock options and stock compensation expense
 
 
5,669 
 
 
 
5,669 
Restricted stock activity (in shares)
 
492 
 
 
 
 
 
Restricted stock activity
 
 
(67,535)
 
39,748 1
 
(27,787)
Amortization of restricted stock compensation
 
 
 
 
12,268 1
 
12,268 
Issuance of stock for employee benefit plans and other (in shares)
 
209 
 
 
 
 
 
Issuance of stock for employee benefit plans and other
 
 
(12,967)
1,975 
15,759 1
 
4,767 
Fair value election of MSRs
 
 
 
88,995 
 
 
88,995 
Adoption of VIE consolidation guidance
 
 
 
(422)
 
 
(422)
Ending Balance (in shares)
 
499,858 
 
 
 
 
 
Ending Balance
$ 4,923,292 
$ 514,667 
$ 8,446,209 
$ 8,419,219 
$ (989,840)1
$ 1,306,379 
$ 22,619,926 
Consolidated Statements of Shareholders' Equity (Parenthetical) (USD $)
In Thousands, except Per Share data
3 Months Ended
Mar. 31,
2010
2009
Common stock dividends, per share
$ 0.01 
$ 0.10 
Series A preferred stock dividends, per share
1,000 
1,000 
U.S. Treasury preferred stock dividends, per share
1,250 
1,250 
Treasure stock, Ending Balance
(1,030,156)
(1,173,026)
Ending Balance, compensation element of restricted stock
(65,401)
(107,985)
Ending Balance, noncontrolling interest
$ 105,717 
$ 112,016 
Consolidated Statements of Cash Flows (USD $)
In Thousands
3 Months Ended
Mar. 31,
2010
2009
Cash Flows from Operating Activities:
 
 
Net income/(loss) including income attributable to noncontrolling interest
$ (158,393)
$ (812,008)
Adjustments to reconcile net income/(loss) to net cash provided by/(used in) operating activities:
 
 
Depreciation, amortization and accretion
197,944 
234,985 
Goodwill impairment
 
751,156 
MSRs impairment Recovery
 
(31,298)
Origination of MSRs
(66,300)
(146,290)
Provisions for credit losses and foreclosed property
903,653 
1,026,917 
Amortization of restricted stock compensation
12,268 
20,283 
Stock option compensation
5,669 
3,285 
Excess tax benefits from stock-based compensation
16 
(181)
Net gain on extinguishment of debt
(9,307)
(25,304)
Net securities gains
(1,543)1
(3,377)1
Net gain on sale of assets
(8,439)
(6,913)
Net decrease/(increase) in loans held for sale
1,422,737 
(2,937,455)
Contributions to retirement plans
(2,603)
(1,286)
Net (increase)/decrease in other assets
(857,066)
739,273 
Net increase/(decrease) in other liabilities
380,449 
(547,123)
Net cash provided by/(used in) operating activities
1,819,085 
(1,735,336)
Cash Flows from Investing Activities:
 
 
Proceeds from maturities, calls and paydowns of securities available for sale
1,106,359 
780,575 
Proceeds from sales of securities available for sale
2,726,341 
6,488,762 
Purchases of securities available for sale
(1,570,269)
(9,500,312)
Proceeds from maturities, calls and paydowns of trading securities
44,114 
23,577 
Proceeds from sales of trading securities
 
2,009,051 
Purchases of trading securities
 
(85,965)
Net decrease in loans
8,438 
2,072,094 
Proceeds from sales of loans held for investment
229,848 
181,379 
Capital expenditures
(48,338)
(47,126)
Contingent consideration and other payouts related to acquisitions
(4,083)
(15,343)
Proceeds from the sale of other assets
155,547 
86,023 
Net cash provided by investing activities
2,647,957 
1,992,715 
Cash Flows from Financing Activities:
 
 
Net (decrease)/increase in deposits
(3,113,062)
5,198,430 
Assumption of deposits, net
 
445,482 
Net decrease in funds purchased, securities sold under agreements to repurchase, and other short-term borrowings
(1,048,123)
(1,863,316)
Proceeds from the issuance of long-term debt
 
574,560 
Repayment of long-term debt
(925,997)
(4,090,686)
Excess tax benefits from stock-based compensation
(16)
181 
Common and preferred dividends paid
(67,342)
(98,433)
Net cash (used in)/provided by financing activities
(5,154,540)
166,218 
Net (decrease)/increase in cash and cash equivalents
(687,498)
423,597 
Cash and cash equivalents at beginning of period
6,997,171 
6,637,402 
Cash and cash equivalents at end of period
6,309,673 
7,060,999 
Supplemental Disclosures:
 
 
Loans transferred from loans held for sale to loans
2,769 
8,565 
Loans transferred from loans to loans held for sale
184,901 
 
Loans transferred from loans to other real estate owned
181,628 
213,287 
Accretion on U.S. Treasury preferred stock
5,980 
5,654 
Total assets of consolidated VIEs at January 1, 2010
$ 2,049,392 
 
Significant Accounting Policies
Significant Accounting Policies

Note 1 – Significant Accounting Policies

Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of operations in these financial statements, have been made.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could vary from these estimates. Certain reclassifications have been made to prior period amounts to conform to the current period presentation.

The Company evaluated subsequent events through the date its financial statements were issued.

These financial statements should be read in conjunction with the Annual Report on Form 10-K for the year ended December 31, 2009. Except for accounting policies that have been modified or recently adopted as described below, there have been no significant changes to the Company’s accounting policies as disclosed in the Annual Report on Form 10-K for the year ended December 31, 2009.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are considered held for investment. The Company’s loan balance is comprised of loans held in portfolio, including commercial loans, consumer loans, real estate loans and lines, credit card receivables, direct financing leases, leveraged leases, and nonaccrual and restructured loans. Interest income on all types of loans is accrued based upon the outstanding principal amounts, except those classified as nonaccrual loans. The Company typically classifies commercial and commercial real estate loans as nonaccrual when one of the following events occurs: (i) interest or principal has been in default 90 days or more, unless the loan is secured by collateral having realizable value sufficient to discharge the debt in full and the loan is in the legal process of collection; (ii) collection of recorded interest or principal is not anticipated; or (iii) income for the loan is recognized on a cash basis due to the deterioration in the financial condition of the debtor. Consumer and residential mortgage loans are typically placed on nonaccrual when payments have been in default for 90 and 120 days or more, respectively.

When a loan is placed on nonaccrual, unpaid interest is reversed against interest income. Interest income on nonaccrual loans, if recognized, is either recorded using the cash basis method of accounting or recognized at the end of the loan after the principal has been reduced to zero, depending on the type of loan. If and when borrowers demonstrate the ability to repay a loan in accordance with the contractual terms of a loan classified as nonaccrual, the loan may be returned to accrual status. See “Allowance for Loan and Lease Losses” section of this Note for further discussion of impaired loans.

TDRs are loans in which the borrower is experiencing financial difficulty and the Company has granted an economic concession to the borrower. To date, the Company’s TDRs have been almost exclusively first and second lien residential mortgages and home equity lines of credit. Prior to modifying a borrower’s loan terms, the Company performed a careful evaluation of the borrower’s financial condition and ability to service the modified loan terms. The types of concessions granted are generally interest rate reductions and/or term extensions. If a loan is accruing at the time of modification, the loan remains on accrual status and is subject to the Company’s charge-off and nonaccrual policies. See the “Allowance for Loans and Lease Losses” section within this Note for further information regarding these policies. If a loan is on nonaccrual before it is determined to be a TDR then the loan remains on nonaccrual. TDRs may be returned to accrual status if there has been at least a six month sustained period of repayment performance by the borrower. Upon sustained performance and classification as a TDR over the Company’s year end, the loan will be removed from TDR status as long as the modified terms were market based at the time of modification. Generally, once a single 1-4 family residential related loan becomes a TDR, it is probable that the loan will likely continue to be reported as a TDR until it ultimately pays off.

 

For loans accounted for at amortized cost, fees and incremental direct costs associated with the loan origination and pricing process, as well as premiums and discounts, are deferred and amortized as level yield adjustments over the respective loan terms. Premiums for purchased credit cards are amortized on a straight-line basis over one year. Fees received for providing loan commitments that result in loans are recognized over the term of the loan as an adjustment of the yield. If a loan is never funded, the commitment fee is recognized into noninterest income at the expiration of the commitment period. Origination fees and costs are recognized in noninterest income and expense at the time of origination for newly originated loans that are accounted for at fair value.

Allowance for Loan and Lease Losses

The Company’s ALLL is the amount considered adequate to absorb probable losses within the portfolio based on management’s evaluation of the size and current risk characteristics of the loan portfolio. Such evaluation considers numerous factors, including, but not limited to net charge-off trends, internal risk ratings, changes in internal risk ratings, loss forecasts, collateral values, geographic location, borrower FICO scores, delinquency rates, nonperforming and restructured loans, origination channel, product mix, underwriting practices, industry conditions and economic trends.

Specific allowances for loan and lease losses are established for large commercial, corporate, and commercial real estate nonaccrual loans that are evaluated on an individual basis and certain consumer, commercial, corporate, and commercial real estate loans whose terms have been modified in a TDR. The specific allowance established for these loans and leases is based on a thorough analysis of the most probable source of repayment, including the present value of the loan’s expected future cash flows, the loan’s estimated market value, or the estimated fair value of the underlying collateral depending on the most likely source of repayment.

General allowances are established for loans and leases grouped into pools based on similar characteristics. In this process, general allowance factors established are based on an analysis of historical charge-off experience, portfolio trends, regional and national economic conditions, and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the ALLL after an assessment of internal and external influences on credit quality that are not fully reflected in the historical loss or other risk rating data.

The Company’s charge-off policy meets or is more stringent than regulatory minimums. Losses on unsecured consumer loans are recognized at 90-days past due compared to the regulatory loss criteria of 120 days past due. Secured consumer loans, including residential real estate, are typically charged-off between 120 and 180 days past due, depending on the collateral type, in compliance with the FFIEC guidelines.

For commercial real estate loans secured by property, an acceptable appraisal or other form of evaluation is obtained prior to the origination of the loan. Updated evaluations of the collateral’s value are obtained at least annually, or earlier if the credit quality of the loan deteriorates. Changes in collateral value affect the ALLL through the risk rating process.

For mortgage loans secured by residential property where we are proceeding with a foreclosure action, we obtain a new valuation prior to 180 days past due and, if required, write the loan down to fair value, net of estimated selling and holding costs. Estimated valuations are based on appraisals, broker price opinions, recent sales of foreclosed properties, or automated valuation models. The value estimate is based on an orderly disposition and marketing period of the property. In the event we decide not to proceed with a foreclosure action, we charge-off the full balance of the loan. If a loan remains in the foreclosure process for 12 months past the original charge-off, typically at 180 days past due, we obtain a new valuation and, if required, write the loan down to the new valuation, less estimated selling and holding costs. At foreclosure, a new valuation is obtained and the loan is transferred to OREO at the new valuation less estimated selling and holding costs; any loan balance in excess of the transfer value is charged-off. Estimated declines in value of the residential collateral are captured in the ALLL based on changes in the house price index at the metropolitan statistical area or other market information.

In addition to the ALLL, the Company also estimates probable losses related to unfunded lending commitments, such as letters of credit and binding unfunded loan commitments. Unfunded lending commitments are analyzed and segregated by risk similar to funded loans based on the Company’s internal risk rating scale. These risk classifications, in combination with an analysis of historical loss experience, probability of commitment usage, and any other pertinent information, result in the estimation of the reserve for unfunded lending commitments. The reserve for unfunded lending commitments is reported on the Consolidated Balance Sheets in other liabilities and the provision associated with changes in the unfunded lending commitment reserve is reported in the Consolidated Statements of Income/(Loss) in noninterest expense through the third quarter of 2009. Beginning in the fourth quarter of 2009, the Company began recording changes in the unfunded lending commitment reserve in the provision for credit losses.

 

Accounting Policies Recently Adopted and Pending Accounting Pronouncements

In June 2009, the FASB issued ASU 2009-16, an update to ASC 860-10, “Transfers and Servicing,” and ASU 2009-17, an update to ASC 810-10, “Consolidation.” These updates are effective for the first interim reporting period of 2010. The update to ASC 860-10 amends the guidance to eliminate the concept of a QSPE and changes some of the requirements for derecognizing financial assets. The amendments to ASC 810-10: (a) eliminate the exemption for existing QSPEs from U.S. GAAP, (b) shift the determination of which enterprise should consolidate a VIE to a current control approach, such that an entity that has both the power to make decisions and right to receive benefits or absorb losses that could potentially be significant to the VIE will consolidate a VIE, and (c) change when it is necessary to reassess who should consolidate a VIE.

The Company has analyzed the impacts of these amendments on all QSPEs and VIE structures with which it is involved. Based on this analysis, the Company consolidated its multi-seller conduit, Three Pillars, and a CLO entity. The Company consolidated these entities because certain subsidiaries of the Company have significant decision-making rights and own VIs that could potentially be significant to these VIEs. The primary balance sheet impacts from consolidating Three Pillars and the CLO on January 1, 2010, were increases in loans and leases, the related allowance for loan losses, LHFS, long-term debt, and other short-term borrowings. The consolidations of Three Pillars and the CLO had no impact on the Company’s earnings or cash flows that result from its involvement with these VIEs, but the Company’s Consolidated Statements of Income/(Loss) reflect a reduction in noninterest income and increases in net interest income and noninterest expense due to the consolidations. For additional information on the Company’s VIE structures, refer to Note 6, “Certain Transfers of Financial Assets, Mortgage Servicing Rights and Variable Interest Entities,” to the Consolidated Financial Statements.

The combined impact of consolidating Three Pillars and the CLO on January 1, 2010 were incremental total assets and total liabilities of $2.0 billion, respectively, and an insignificant impact on shareholders’ equity. No additional funding requirements with respect to these entities are expected to significantly impact the liquidity position of the Company. Upon adoption, the Company consolidated the assets and liabilities of Three Pillars at their unpaid principal amounts and subsequently accounted for these assets and liabilities on an accrual basis. The Company consolidated the assets and liabilities of the CLO based on their estimated fair values upon adoption, and made an irrevocable election to carry all of the financial assets and financial liabilities of the CLO at fair value. The impact on certain of the Company’s regulatory capital ratios as a result of consolidating Three Pillars and the CLO was not significant.

 

The Company does not currently believe that it is the primary beneficiary of any other significant off-balance sheet entities with which it is involved; however, the accounting guidance requires an entity to reassess whether it is the primary beneficiary at least quarterly. The Company does not currently expect to consolidate additional VIEs in future periods.

In January 2010, the FASB issued ASU 2010-06, an update to ASC 820-10, “Fair Value Measurements.” This update adds a new requirement to disclose transfers in and out of level 1 and level 2, along with the reasons for the transfers, and requires a gross presentation of purchases and sales of level 3 activities. Additionally, the update clarifies that entities provide fair value measurement disclosures for each class of assets and liabilities and that entities provide enhanced disclosures around level 2 valuation techniques and inputs. The Company adopted the disclosure requirements for level 1 and level 2 transfers and the expanded fair value measurement and valuation disclosures effective January 1, 2010. The disclosure requirements for level 3 activities are effective for the Company on January 1, 2011. The adoption of the disclosure requirements for level 1 and level 2 transfers and the expanded qualitative disclosures, had no impact on the Company’s financial position, results of operations, and EPS. The Company does not expect the adoption of the level 3 disclosure requirements to have an impact on its financial position, results of operations, and EPS.

In February 2010, the FASB issued ASU 2010-09, an update to ASC 855-10, “Subsequent Events.” This update amends the guidance to remove the requirement for SEC filers to disclose the date through which subsequent events have been evaluated. SEC filers must continue to evaluate subsequent events through the date the financial statements are issued. The amendment was effective and has been adopted by the Company upon issuance.

In February 2010, the FASB issued ASU 2010-10, an update to ASC 810-10, “Consolidation.” This update defers the amendments to the consolidation requirements of ASC 810-10 for a reporting entity’s interest in entities that have the attributes of investment companies or for which it is acceptable based on industry practice to apply measurement principles that are consistent with those followed by investment companies. The deferral also applies to a reporting entity’s interest in an entity that is required to comply with or operate in accordance with requirements that are similar to those included in Rule 2a-7 of the Investment Company Act of 1940 for registered MMMFs. Certain of the Company’s wholly-owned subsidiaries provide investment advisor services for various private placement and publicly registered investment funds. The deferral applies to all of these funds.

In March 2010, the FASB issued ASU 2010-11, an update to ASC 815-15, “Derivatives and Hedging–Embedded Derivatives.” This update clarifies that the scope exception for potential bifurcation and separate accounting in ASC 815-15 applies to contracts containing an embedded credit derivative that is only in the form of subordination of one financial instrument to another. Other contracts containing embedded credit derivatives do not qualify for the scope exception. This update is effective for the Company on July 1, 2010. The Company is currently evaluating the impact that this update will have on its financial position, results of operations, and EPS.

Trading Assets and Liabilities
Trading Assets and Liabilities

Note 2 – Trading Assets and Liabilities

The fair values of the components of trading assets and liabilities at March 31, 2010 and December 31, 2009 were as follows:

 

(Dollars in thousands) (Unaudited)    March 31
2010
   December  31
2009

Trading Assets

     

U.S. Treasury securities

   $856,962      $498,781  

Federal agency securities

   418,466      474,188  

U.S. states and political subdivisions

   209,501      58,520  

Residential mortgage-backed securities - agency

   159,547      94,164  

Residential mortgage-backed securities - private

   5,288      6,463  

Collateralized debt obligations

   158,252      174,942  

Corporate and other debt securities

   530,742      465,637  

Commercial paper

   44,704      639  

Asset backed securities

   50,908      50,775  

Equity securities

   250,375      256,096  

Derivative contracts

   2,628,972      2,610,288  

Trading loans

   724,387      289,445  
         

Total trading assets

       $6,038,104          $4,979,938  
         

Trading Liabilities

     

U.S. Treasury securities

   $1,348,719      $189,461  

Federal agency securities

   3,813      3,432  

Corporate and other debt securities

   161,307      144,142  

Equity securities

   248      7,841  

Derivative contracts

   1,732,803      1,844,047  
         

Total trading liabilities

   $3,246,890      $2,188,923  
         
Securities Available for Sale
Securities Available for Sale

Note 3 – Securities Available for Sale

Securities AFS at March 31, 2010 and December 31, 2009 were as follows:

 

     March 31, 2010
(Dollars in thousands) (Unaudited)    Amortized
Cost
   Unrealized
Gains
   Unrealized
Losses
   Fair
Value

U.S. Treasury securities

   $5,204,825      $2,501      $1,826      $5,205,500  

Federal agency securities

   1,982,052      19,685      488      2,001,249  

U.S. states and political subdivisions

   895,947      26,920      7,093      915,774  

Residential mortgage-backed securities - agency

   13,435,188      301,264      25,544      13,710,908  

Residential mortgage-backed securities - private

   445,662      711      77,167      369,206  

Asset-backed securities

   1,002,540      10,724      9,465      1,003,799  

Corporate bonds and other debt securities

   495,971      14,551      1,364      509,158  

Common stock of The Coca-Cola Company

   69      1,649,931      -      1,650,000  

Other equity securities1

   871,999      936      -      872,935  
                   

Total securities available for sale

   $24,334,253      $2,027,223      $122,947      $26,238,529  
                   
     December 31, 2009
(Dollars in thousands) (Unaudited)    Amortized
Cost
   Unrealized
Gains
   Unrealized
Losses
   Fair
Value

U.S. Treasury securities

   $5,206,383      $719      $30,576      $5,176,526  

Federal agency securities

   2,733,534      12,704      8,653      2,737,585  

U.S. states and political subdivisions

   927,887      27,799      10,629      945,057  

Residential mortgage-backed securities - agency

   15,704,594      273,207      61,724      15,916,077  

Residential mortgage-backed securities - private

   471,583      1,707      95,207      378,083  

Asset-backed securities

   309,611      10,559      5,423      314,747  

Corporate bonds and other debt securities

   505,185      9,989      3,373      511,801  

Common stock of The Coca-Cola Company

   69      1,709,931      -      1,710,000  

Other equity securities1

   786,248      918      -      787,166  
                   

Total securities available for sale

   $26,645,094      $2,047,533      $215,585      $28,477,042  
                   

1Includes $343 million and $343 million of FHLB of Cincinnati and FHLB of Atlanta stock stated at par value, $360 million and $360 million of Federal Reserve Bank stock stated at par value and $168 million and $82 million of mutual fund investments stated at fair value as of March 31, 2010 and December 31, 2009, respectively.

See Note 14, “Contingencies”, to the Consolidated Financial Statements for information concerning ARS classified as securities AFS.

Securities AFS that were pledged to secure public deposits, repurchase agreements, trusts, and other funds had a fair value of $6.4 billion as of March 31, 2010. Further, under The Agreements, the Company pledged its shares of common stock of The Coca-Cola Company, which had a fair value of $1.7 billion as of March 31, 2010. See Note 10, “Derivative Financial Instruments”, to the Consolidated Financial Statements which further discusses this transaction. The Company has also pledged $1.2 billion of certain trading assets and cash equivalents to secure $1.2 billion of repurchase agreements as of March 31, 2010. Additionally, as of March 31, 2010, the Company had pledged $47.5 billion of net eligible loan collateral to support $28.8 billion in available borrowing capacity at either the Federal Reserve discount window or the FHLB of Atlanta. Of the available borrowing capacity, $8.6 billion was outstanding as of March 31, 2010.

The amortized cost and fair value of investments in debt securities at March 31, 2010 by estimated average life are shown below. Actual cash flows may differ from estimated average lives and contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(Dollars in thousands) (Unaudited)   

1 Year

or Less

  

1-5

Years

  

5-10

Years

  

After 10

Years

  

Total

Distribution of Maturities:

              

  Amortized Cost

              

U.S. Treasury securities

   $24,781      $5,180,044      $-      $-      $5,204,825  

Federal agency securities

   239,330      1,613,118      124,790       4,814       1,982,052  

U.S. states and political subdivisions

   214,621      435,806      129,103       116,417       895,947  

Residential mortgage-backed securities - agency

   192,433      10,895,155      636,563       1,711,037       13,435,188  

Residential mortgage-backed securities - private

   27,112      240,817      152,388       25,345       445,662  

Asset-backed securities

   361,607      622,835      18,098       -       1,002,540  

Corporate bonds and other debt securities

   11,935      305,583      152,733       25,720       495,971  
                        

Total debt securities

         $1,071,819            $19,293,358            $1,213,675             $1,883,333             $23,462,185  
                        

  Fair Value

              

U.S. Treasury securities

   $25,095      $5,180,405      $-      $-      $5,205,500  

Federal agency securities

   241,247      1,628,565      126,551       4,886       2,001,249  

U.S. states and political subdivisions

   217,971      455,051      132,173       110,579       915,774  

Residential mortgage-backed securities - agency

   197,873      11,157,137      664,003       1,691,895       13,710,908  

Residential mortgage-backed securities - private

   24,475      200,788      122,056       21,887       369,206  

Asset-backed securities

   365,088      621,958      16,753       -      1,003,799  

Corporate bonds and other debt securities

   12,222      310,724      161,856       24,356       509,158  
                        

Total debt securities

   $1,083,971      $19,554,628      $1,223,392       $1,853,603       $23,715,594  
                        

Gross realized gains and losses on sales and OTTI on securities AFS during the periods were as follows:

 

    

    Three Months Ended March 31    

(Dollars in thousands) (Unaudited)   

2010

  

2009

Gross realized gains

   $14,990       $4,193   

Gross realized losses

   (12,386)      (95)  

OTTI

   (1,061)      (721)  
         

Net securities gains

   $1,543       $3,377   
         

Securities in a continuous unrealized loss position at March 31, 2010 and December 31, 2009 were as follows:

 

     March 31, 2010
     Less than twelve months    Twelve months or longer    Total
(Dollars in thousands) (Unaudited)    Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses

Temporarily impaired securities

                 

U.S. Treasury securities

         $2,503,144      $1,823      $263      $3      $2,503,407      $1,826  

Federal agency securities

   190,631      488      -      -      190,631      488  

U.S. states and political subdivisions

   44,404      2,156      104,902      4,937      149,306      7,093  

Residential mortgage-backed securities - agency

   2,742,588      25,544      -      -      2,742,588      25,544  

Residential mortgage-backed securities - private

   52,119      5,064      6,919      357      59,038      5,421  

Asset-backed securities

   141,138      703      13,431      6,523      154,569      7,226  

Corporate bonds and other debt securities

   -      -      24,356      1,364      24,356      1,364  
                             

Total temporarily impaired securities

   5,674,024      35,778      149,871      13,184      5,823,895      48,962  

Other-than-temporarily impaired securities

                 

Residential mortgage-backed securities - private

   4,341      400      301,612      71,346      305,953      71,746  

Asset-backed securities

   3,285      2,239      -      -      3,285      2,239  
                             

Total other-than-temporarily impaired securities

   7,626      2,639      301,612      71,346      309,238      73,985  
                             

Total impaired securities

   $5,681,650            $38,417            $451,483            $84,530            $6,133,133            $122,947  
                             
     December 31, 2009
     Less than twelve months    Twelve months or longer    Total
(Dollars in thousands) (Unaudited)    Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses

Temporarily impaired securities

                 

U.S. Treasury securities

   $5,083,249      $30,571      $263      $5      $5,083,512      $30,576  

Federal agency securities

   1,341,330      $8,653      -      -      1,341,330      8,653  

U.S. states and political subdivisions

   125,524      5,711      64,516      4,918      190,040      10,629  

Residential mortgage-backed securities - agency

   5,418,226      61,724      -      -      5,418,226      61,724  

Residential mortgage-backed securities - private

   14,022      3,174      7,169      385      21,191      3,559  

Asset-backed securities

   10,885      1,205      16,334      4,218      27,219      5,423  

Corporate bonds and other debt securities

   19,819      2      30,416      3,371      50,235      3,373  
                             

Total temporarily impaired securities

         $12,013,055      $111,040      $118,698      $12,897      $12,131,753      $123,937  

Other-than-temporarily impaired securities

                 

Residential mortgage-backed securities - private

   646      906      304,493      90,742      305,139      91,648  
                             

Total other-than-temporarily impaired securities

   646      906      304,493      90,742      305,139      91,648  
                             

Total impaired securities

   $12,013,701            $111,946            $423,191            $103,639            $12,436,892            $215,585  
                             

 

On March 31, 2010, the Company held certain investment securities having unrealized loss positions. The Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities before their anticipated recovery. The Company has reviewed its portfolio for OTTI in accordance with the accounting policies outlined in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. Market changes in interest rates and credit spreads will result in unrealized losses as the market price of securities fluctuates. The economic environment and illiquidity in the financial markets since 2008 have increased market yields on securities resulting in unrealized losses on certain securities within the Company’s portfolio.

The Company records OTTI through earnings based on the credit impairment estimates generally derived from cash flow analyses. The remaining unrealized loss, due to factors other than credit, is recorded in OCI. The unrealized OTTI loss of $72 million in private residential MBS as of March 31, 2010 includes purchased and retained interests from securitizations that have been other-than-temporarily impaired in prior periods. The unrealized OTTI loss of $2 million in asset-backed securities is related to three securities within the portfolio that are home equity issuances and have also been other-than-temporarily impaired in prior periods. Based on the analysis of the underlying cash flows of these securities, there is no expectation of further credit impairment. As of March 31, 2010, approximately 94% of the total securities AFS portfolio are rated “AAA,” the highest possible rating by nationally recognized rating agencies.

All securities are reviewed quarterly for OTTI. For the three months ended March 31, 2010 and 2009, the Company recorded OTTI losses on AFS securities of $1 million through earnings. The securities with credit impairment for the three months ended March 31, 2010, are private residential MBS with a fair market value of less than $1 million as of March 31, 2010. Based on the cash flow analyses, the entire unrealized loss on these securities was recorded in earnings. There is no portion of the loss that is recognized in other comprehensive income as of March 31, 2010. In addition, for the three months ended March 31, 2010, there is no change in the balance of the amount of credit losses recognized in earnings related to securities for which some portion of the impairment was recorded in other comprehensive income.

Credit impairment that is determined through the use of cash flow models is estimated using cash flows on security specific collateral and the transaction structure. Future expected credit losses are determined by using various assumptions, the most significant of which include current default rates, prepayment rates, and loss severities. For the majority of the securities that the Company has reviewed for OTTI, credit information is available and modeled at the loan level underlying each security and also considers information such as loan to collateral values, FICO scores, and geographic considerations such as home price appreciation/depreciation. These inputs are updated on a regular basis to ensure the most current credit and other assumptions are utilized in the analysis. If, based on this analysis, the Company does not expect to recover the entire amortized cost basis of the security, the expected cash flows are then discounted at the security’s initial effective interest rate to arrive at a present value amount. OTTI credit losses reflect the difference between the present value of cash flows expected to be collected and the amortized cost basis of these securities.

The following table presents a summary of the significant inputs used in determining the measurement of credit losses recognized in earnings for private residential MBS for the three months ended March, 31, 2010:

 

     Three Months Ended
March 31, 2010

Current default rate

   2 - 6%

Prepayment rate

   15 - 22%

Loss severity

   37 - 46%

The Company holds stock in the FHLB of Atlanta and FHLB of Cincinnati totaling $343 million as of both March 31, 2010 and December 31, 2009. The Company accounts for the stock based on industry guidance which requires that the investment be carried at cost and be evaluated for impairment based on the ultimate recoverability of the par value. The Company evaluated its holdings in FHLB stock at March 31, 2010 and believes its holdings in the stock are ultimately recoverable at par. In addition, the Company does not have operational or liquidity needs that would require a redemption of the stock in the foreseeable future and therefore determined that the stock was not other-than-temporarily impaired.

Allowance for Credit Losses
Allowance for Credit Losses

Note 4 – Allowance for Credit Losses

Activity in the allowance for credit losses is summarized in the table below:

 

     Three Months Ended
March 31
   %
    Change     
 
     
(Dollars in thousands) (Unaudited)    2010    2009   

Balance at beginning of period

       $3,234,900          $2,378,507      36 

Provision for loan losses

   875,909      994,098      (12)   

Provision for unfunded commitments1

   (14,300)     2,662      (637)   

Allowance from consolidation of VIE

   676      -     

Loan charge-offs

   (861,961)     (646,916)     33    

Loan recoveries

   41,377      36,822      12    
            

Balance at end of period

   $3,276,601      $2,765,173      18 
            

Components:

        

ALLL

   $3,176,000      $2,735,000      16 

Unfunded commitments reserve2

   100,601      30,173      233    
            

Allowance for credit losses

   $3,276,601      $2,765,173      18 
            

1Beginning in the fourth quarter of 2009, the Company recorded the provision for unfunded commitments within the provision for credit losses in the Consolidated Statements of Income/(Loss). Considering the immateriality of this provision prior to the fourth quarter of 2009, the provision for unfunded commitments remains classified within other noninterest expense in the Consolidated Statements of Income/(Loss).

2The unfunded commitments reserve is separately recorded in other liabilities in the Consolidated Balance Sheets.

Goodwill and Other Intangible Assets
Goodwill and Other Intangible Assets

Note 5 – Goodwill and Other Intangible Assets

Goodwill is required to be tested for impairment on an annual basis or as events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. In 2009 and the first quarter of 2010, the Company’s reporting units were comprised of Retail, Commercial, Commercial Real Estate, Household Lending, Corporate and Investment Banking, Wealth and Investment Management, and Affordable Housing.

Due to the continued recessionary environment and sustained deterioration in the economy during the first quarter of 2009, the Company performed a complete goodwill impairment analysis for all of its reporting units. The estimated fair value of the Retail, Commercial, and Wealth and Investment Management reporting units exceeded their respective carrying values as of March 31, 2009; however, the fair value of the Household Lending, Corporate and Investment Banking, Commercial Real Estate (included in Retail and Commercial segment), and Affordable Housing (included in Retail and Commercial segment) reporting units were less than their respective carrying values. The implied fair value of goodwill of the Corporate and Investment Banking reporting unit exceeded the carrying value of the goodwill, thus no goodwill impairment was recorded for this reporting unit. However, the implied fair value of goodwill applicable to the Household Lending, Commercial Real Estate, and Affordable Housing reporting units was less than the carrying value of the goodwill. As of March 31, 2009, an impairment loss of $751 million was recorded, which was the entire amount of goodwill carried by each of those reporting units. $677 million of the goodwill impairment charge was non-deductible for tax purposes. The goodwill impairment charge was a direct result of continued deterioration in the real estate markets and macro economic conditions that put downward pressure on the fair value of these businesses. The primary factor contributing to the impairment recognition was further deterioration in the actual and projected financial performance of these reporting units, as evidenced by the increase in net charge-offs and nonperforming loans. The decline in fair value of these reporting units was significantly influenced by the current economic downturn, which resulted in depressed earnings in these businesses and the significant decline in the Company’s market capitalization during the first quarter of 2009.

No events have occurred nor circumstances changed since the annual testing of the Company’s goodwill on September 30, 2009 that caused re-testing of goodwill during the first quarter of 2010.

The changes in the carrying amount of goodwill by reportable segment for the three months ended March 31 are as follows:

 

(Dollars in thousands) (Unaudited)   

Retail and
Commercial

  

Wholesale

  

Corporate

and

Investment
Banking

  

Household
Lending

  

Mortgage

  

Wealth and
Investment
Management

  

Total

Balance, January 1, 2009

     $5,911,990        $522,548      $-      $-        $278,254      $330,711        $7,043,503  

Intersegment transfers

   125,580      (522,548)     223,307      451,915      (278,254)     -      -  

Goodwill impairment

   (299,241)     -      -        (451,915)     -      -      (751,156) 

Seix contingent consideration

   -      -      -      -      -      12,722      12,722  

Purchase price adjustments

   535      -      -      -      -      3,827      4,362  
                                  

Balance, March 31, 2009

   $5,738,864      $-      $223,307      $-      $-          $347,260      $6,309,431  
                                  

Balance, January 1, 2010

   5,738,803      -      223,307      -      -      356,968      6,319,078  

Inlign contingent consideration

   -      -      -      -      -      3,465      3,465  

Purchase price adjustments

   -      -      -      -      -      335      335  
                                  

Balance, March 31, 2010

   $5,738,803      $-        $223,307      $-      $-      $360,768      $6,322,878  
                                  

Changes in the carrying amounts of other intangible assets for three months ended March 31 are as follows:

 

(Dollars in thousands) (Unaudited)        

Core Deposit
Intangibles

  

MSRs
Amortized Cost

  

MSRs

Fair Value

  

Other

  

Total

    

Balance, January 1, 2009

      $145,311          $810,474      $-      $79,642      $1,035,427     

Designated at fair value (transfers from amortized cost)

      -      (187,804)     187,804      -      -     

Amortization

      (11,881)     (67,467)     -      (4,108)     (83,456)    

MSRs originated

      -      -      146,290      -      146,290     

MSRs impairment recovery

      -      31,298      -      -      31,298     

Changes in fair value

                    

Due to changes in inputs or assumptions 1

      -      -      (9,054)     -      (9,054)    

Other changes in fair value 2

      -      -      (16,744)     -      (16,744)    

Cymric purchase price adjustment

      -      -      -      (428)     (428)    
                              

Balance, March 31, 2009

      $133,430      $586,501      $308,296      $75,106      $1,103,333     
                              

Balance, January 1, 2010

      $104,240      $603,821      $935,561      $67,677      $1,711,299     

Designated at fair value (transfers from amortized cost)

      -      (603,821)     603,821      -      -     

Amortization

      (9,774)     -      -      (3,412)     (13,186)    

MSRs originated

      -      -      66,300      -      66,300     

Changes in fair value

                    

Due to fair value election

      -      -      144,634      -      144,634     

Due to changes in inputs or assumptions 1

      -      -      (44,776)     -      (44,776)    

Other changes in fair value 2

      -      -      (64,352)     -      (64,352)    
                              

Balance, March 31, 2010

                  $94,466      $-              $1,641,188              $64,265              $1,799,919     
                              

1 Primarily reflects changes in discount rates and prepayment speed assumptions due to changes in interest rates.

2 Represents changes due to the collection of expected cash flows, net of accretion, due to passage of time.

The Company elected to create a second class of MSRs effective January 1, 2009. This new class of MSRs is reported at fair value and is being actively hedged as discussed in Note 10, “Derivative Financial Instruments,” to the Consolidated Financial Statements. The transfer of MSRs from LOCOM to fair value did not have a material effect on the Consolidated Financial Statements since the MSRs were effectively reported at fair value as of December 31, 2008 as a result of impairment losses recognized at the end of 2008. At December 31, 2009, MSRs associated with loans originated or sold prior to 2008 continued to be accounted for at LOCOM and managed through the Company’s overall asset/liability management process. Effective January 1, 2010, the Company elected to designate all remaining MSRs carried at LOCOM at fair value. Upon designating the remaining MSRs at fair value in January 2010, the Company recognized a cumulative effect increase to retained earnings, net of taxes, of $89 million.

Certain Transfers of Financial Assets, Mortgage Servicing Rights and Variable Interest Entities
Certain Transfers of Financial Assets, Mortgage Servicing Rights and Variable Interest Entities

Note 6 - Certain Transfers of Financial Assets, Mortgage Servicing Rights and Variable Interest Entities

Certain Transfers of Financial Assets and related Variable Interest Entities

The Company has transferred residential and commercial mortgage loans, student loans, commercial and corporate loans, and CDO securities in sale or securitization transactions in which the Company has, or had, continuing involvement. All such transfers have been accounted for as sales by the Company. The Company’s continuing involvement in such transfers includes owning certain beneficial interests, including senior and subordinate debt instruments as well as equity interests, servicing or collateral manager responsibilities, and guarantee or recourse arrangements. Except as specifically noted herein, the Company is not required to provide additional financial support to any of the entities to which the Company has transferred financial assets, nor has the Company provided any support it was not otherwise obligated to provide. Prior to January 1, 2010, interests that were held by the Company in transferred financial assets, excluding servicing and collateral management rights, were generally recorded as securities AFS or trading assets at their allocated carrying amounts based on their relative fair values at the time of transfer and were subsequently remeasured at fair value. In accordance with the new accounting guidance related to transfers of financial assets that became effective on January 1, 2010, upon completion of future transfers of assets that satisfy the conditions to be reported as a sale, the Company will derecognize the transferred assets and recognize at fair value any beneficial interests in the transferred financial assets such as trading assets or securities AFS, as well as servicing rights retained and guarantee liabilities incurred. See Note 13, “Fair Value Measurement and Election,” to the Consolidated Financial Statements for further discussion of the Company’s fair value methodologies.

 

When evaluating transfers and other transactions with VIEs for consolidation under the newly adopted VIE consolidation guidance, the Company first determines if it has a VI in the VIE. A VI is typically in the form of securities representing retained interests in the transferred assets and, at times, servicing rights and collateral manager fees. If the Company has a VI in the entity, it then evaluates whether or not it has both (1) the power to direct the activities that most significantly impact the economic performance of the VIE, and (2) the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. If the Company determines that it does not have power over the significant activities of the VIE, an analysis of the economics of the VIE is not necessary. If it is determined that the Company does have power over the significant activities of the VIE, the Company must determine if it also has an obligation to absorb losses and/or the right to receive benefits that could potentially be significant to the VIE.

Below is a summary of transfers of financial assets to VIEs for which the Company has retained some level of continuing involvement.

Residential Mortgage Loans

The Company typically transfers first lien residential mortgage loans in conjunction with Ginnie Mae, Fannie Mae, and Freddie Mac securitization transactions whereby the loans are exchanged for cash or securities that are readily redeemed for cash proceeds and servicing rights. The securities issued through these transactions are guaranteed by the issuer and, as such, under seller/servicer agreements the Company is required to service the loans in accordance with the issuers’ servicing guidelines and standards. For the three months ended March 31, 2010 and 2009, the Company sold residential mortgage loans to these entities, which resulted in pre-tax gains of $85 million and $226 million, respectively. As seller, the Company has made certain representations and warranties with respect to the originally transferred loans, including those transferred under Ginnie Mae, Fannie Mae, and Freddie Mac programs, which are discussed in Note 11, “Reinsurance Arrangements and Guarantees,” to the Consolidated Financial Statements.

In a limited number of securitizations, the Company has transferred loans to trusts, which previously qualified as QSPEs, sponsored by the Company. These trusts issue securities which are ultimately supported by the loans in the underlying trusts. In these transactions, the Company has received securities representing retained interests in the transferred loans in addition to cash and servicing rights in exchange for the transferred loans. The received securities are carried at fair value as either trading assets or securities AFS. As of March 31, 2010, the fair value of securities received totaled $218 million, of which $214 million was classified as securities AFS and $4 million was classified as trading assets. Securities AFS of $63 million relate to senior and subordinate securities retained from a 2003 securitization of prime fixed and floating rate loans. Subordinate level securities from this securitization of $22 million were valued by the Company using a discounted cash flow model based on historical performance. The Company analyzed two adverse changes in each of the key assumptions used to value these securities, which includes base case assumptions for CPR of 13% – 15%, expected credit losses of 0.77% – 0.91%, and yields ranging from 7% - 450%. These assumptions are either unchanged or slightly improved compared to the December 31, 2009 assumptions. At March 31, 2010, a 20% adverse change in the CPR and in credit loss assumptions would result in a decline in the fair value of the securities of less than $1 million, while a 20% increase in the assumed discount rate resulted in a decline in the fair value of the securities of approximately $1 million. In addition, the Company, as servicer, holds optional redemption rights on the underlying collateral at such time that the collateral pool reaches 10% of the original pool balance. At March 31, 2010, the portfolio balance was approximately 13% of the original pool balance.

The remaining $155 million of securities retained from securitizations of residential mortgage loans are interests from 2007 securitizations of prime jumbo fixed rate mortgage loans as well as securitizations of adjustable rate loans. The Company owns portions of senior and subordinate retained interests from these securitizations. As discussed in Note 13, “Fair Value Measurement and Election”, the Company was able to price the majority of these securities at March 31, 2010, using a third party pricing service. Retained interests of approximately $12 million not priced using a third party pricing service were valued using a discounted cash flow model. The Company analyzed two adverse changes in each of the key assumptions used to value these securities, which includes base case assumptions for CPR of 12% – 16%, expected credit losses of 2.5% – 15.8%, and yields ranging from 14% – 30%. These assumptions are either unchanged or slightly improved compared to the December 31, 2009 assumptions. The result of a 20% adverse change in the CPR, a 20% adverse change in credit loss assumptions, and a 20% increase in the assumed discount rate each resulted in a decline in the fair value of the securities of less than $1 million.

 

The Company evaluated these securitization transactions for consolidation under the newly adopted VIE consolidation guidance. As servicer of the underlying loans, the Company is generally deemed to have power over the securitization. However, if a single party, such as the issuer or the master servicer, effectively controls the servicing activities or has the unilateral ability to terminate the Company as servicer without cause, then that party is deemed to have power. In almost all of its securitization transactions, the Company does not retain power over the securitization as a result of these restraints; therefore, an analysis of the economics of the securitization is not necessary. In certain transactions, the Company does have power as the servicer; however, the Company does not also have an obligation to absorb losses or the right to receive benefits that could potentially be significant to the securitization. The absorption of losses and the receipt of benefits would generally manifest itself through the retention of senior or subordinated interests. As of January 1, 2010, the Company determined that it was not the primary beneficiary of, and thus did not consolidate, any of these securitization transactions. No events occurred during the three months ended March 31, 2010 that would change the Company’s previous conclusion that it is not the primary beneficiary of any of these securitization transactions. Total assets as of March 31, 2010 and December 31, 2009 of the unconsolidated trusts in which the Company has a VI are $750 million and $780 million, respectively.

The Company’s maximum exposure to loss related to the unconsolidated VIEs in which it holds a VI is comprised of the loss of value of any interests it retains and any repurchase obligations it incurs as a result of a breach of its representations and warranties. Due to the uncertainty around its repurchase obligations, the Company’s maximum exposure to loss cannot be reasonably estimated.

Separately, the Company has accrued $76 million and $36 million as of March 31, 2010 and December 31, 2009 for contingent losses related to certain of its representations and warranties made in connection with other previous transfers. The Company did not repurchase any of these previously transferred loans during the three months ended March 31, 2010 or 2009.

Commercial and Corporate Loans

In 2007, the Company completed a $1.9 billion structured sale of corporate loans to multi-seller CP conduits, which are VIEs administered by unrelated third parties, from which it retained a 3% residual interest in the pool of loans transferred, which does not constitute a VI in the third party conduits as it relates to the unparticipated portion of the loans. During the three months ended March 31, 2009, the Company wrote this residual interest and related accrued interest to zero, resulting in a loss of approximately $17 million. This write off was the result of the deterioration in the performance of the loan pool to such an extent that the Company expects that it will no longer receive cash flows on the interest until the senior participation interest has been repaid in full. In conjunction with the transfer of the loans, the Company provided commitments in the form of liquidity facilities to these conduits; the sum of these commitments, which represents the Company’s maximum exposure to loss under the facilities, totaled $322 million at December 31, 2009. Due to deterioration in the loans that collateralize these facilities, the Company recorded a contingent loss reserve of $16 million on the facilities during the year ended December 31, 2009. In January 2010, the administrator of the conduits drew on these commitments in full, resulting in a funded loan to the conduits that is recorded on the Company’s Consolidated Balance Sheets. This event did not modify the Company’s sale accounting treatment or conclusion that it is not the primary beneficiary of these VIEs. In addition, no other events have occurred during the three months ended March 31, 2010 that would call into question either the Company’s sale accounting or the Company’s conclusions that it is not the primary beneficiary of these VIEs.

The Company has involvement with CLO entities that own commercial leveraged loans and bonds, certain of which were transferred by the Company to the CLOs. In addition to retaining certain securities issued by the CLOs, the Company also acts as collateral manager for these CLOs. The securities retained by the Company and the fees received as collateral manager represent a VI in the CLOs, which are considered to be VIEs.

Beginning January 1, 2010, upon adoption of the new VIE consolidation guidance, the Company determined that it was the primary beneficiary of, and thus, would consolidate one of these CLOs as it has both the power to direct the activities that most significantly impact the entity’s economic performance and the obligation to absorb losses and the right to receive benefits from the entity that could potentially be significant to the CLO. In addition to fees received as collateral manager, including eligibility for performance incentive fees, and owning certain preference shares, the Company’s multi-seller conduit, Three Pillars, owns a senior interest in the CLO, resulting in economics that could potentially be significant to the VIE. Accordingly, on January 1, 2010, the Company consolidated $307 million in total assets and $279 million in net liabilities, after the impacts of the intercompany elimination of this senior interest. The Company elected to consolidate the CLO at fair value and to carry the financial assets and financial liabilities of the CLO at fair value subsequent to adoption. The initial consolidation of the CLO had no impact on the Company’s Consolidated Statements of Shareholders’ Equity. Substantially all of the assets and liabilities of the CLO are loans and issued debt, respectively. The loans are classified within loans held for sale at fair value and the debt is included with long-term debt at fair value on the Company’s Consolidated Balance Sheets (see Note 13, “Fair Value Measurement and Election”, to the Consolidated Financial Statements for a discussion of the Company’s methodologies for estimating the fair values of these financial instruments). The Company is not obligated, contractually or otherwise, to provide financial support to this VIE nor has it previously provided support to this VIE. Further, creditors of the VIE have no recourse to the general credit of the Company, as the liabilities of the CLO are paid only to the extent of available cash flows from the CLO’s assets.

 

For the remaining CLOs, which are also considered to be VIEs, the Company has determined that it is not the primary beneficiary as it does not have an obligation to absorb losses or the right to receive benefits from the entities that could potentially be significant to the VIE. During the three months ended March 31, 2009, the Company recognized losses of $7 million which represented the complete write off of the preference shares in certain of the VIEs due to the continued deterioration in the performance of the collateral in those vehicles. The Company does not expect to receive any significant cash distributions on those preference shares in the foreseeable future; therefore, the carrying value of the Company’s investment in the preference shares was zero as of March 31, 2010 and December 31, 2009. The Company has no ongoing involvement with these vehicles other than the fees that it receives as a result of managing the assets of these vehicles. These fees are considered adequate compensation and are commensurate with the level of effort required to provide such services. The fees received by the Company from these entities are recorded as trust and investment management income in the Consolidated Statements of Income/(Loss) and totaled approximately $3 million for the three months ended March 31, 2010 and 2009. Senior fees earned by the Company are generally not considered at risk; however, subordinate fees earned by the Company are subject to the availability of cash flows and to the priority of payments. These subordinate fees are not expected to be significant. The total assets and liabilities of these entities that were not included on the Company’s Consolidated Balance Sheets were approximately $2.2 billion and $2.2 billion, respectively, at March 31, 2010 and $2.3 billion and $2.2 billion, respectively, at December 31, 2009. The Company is not obligated to provide any support to these entities, nor has it previously provided support to these entities. No events occurred during the three months ended March 31, 2010 that would change the Company’s previous conclusion that it is not the primary beneficiary of any of these securitization transactions.

Student Loans

In 2006, the Company completed a securitization of government guaranteed student loans through a transfer of loans to a securitization SPE, which previously qualified as a QSPE, and retained the corresponding residual interest in the SPE. The residual interest represents the Company’s maximum exposure to loss as a result of its involvement with the VIE and is classified within trading assets on the Company’s Consolidated Balance Sheets. The fair value of the residual interest at both March 31, 2010 and December 31, 2009 was less than $25 million. The key assumptions and inputs used by the Company in valuing this retained interest include prepayment speeds and the discount rate. The Company did not significantly modify the assumptions used to value the retained interest at March 31, 2010 from the assumptions used to value the retained interest at December 31, 2009. For both periods, analyses of the impact on the fair values of two adverse changes from the key assumptions were performed and the resulting amounts were insignificant for each key assumption and in the aggregate.

The total assets and liabilities of this VIE that were not included in the Company’s Consolidated Balance Sheets were approximately $516 million and $510 million, respectively, at March 31, 2010 and $532 million and $522 million, respectively, at December 31, 2009. The Company is not obligated to provide any support to this entity, nor has it previously provided support to this entity. All of the student loans that were securitized are U.S. government guaranteed student loans. As such, the Company has agreed to service each loan consistent with the guidelines determined by the applicable government agencies. Accordingly, the Company believes that it does not have the power to direct activities that most significantly impact the economic performance of the VIE that holds these student loans, and it is therefore not the primary beneficiary of the VIE under the new VIE consolidation guidance. No events occurred during the three months ended March 31, 2010 that would change the Company’s previous conclusion that it is not the primary beneficiary of this VIE.

 

CDO Securities

The Company has transferred bank trust preferred securities in securitization transactions. The majority of these transfers occurred between 2002 and 2005 with one transaction completed in 2007. The Company retained equity interests in certain of these entities and also holds certain senior interests that were acquired during 2007 and 2008 in conjunction with its acquisition of assets from Three Pillars and the ARS transactions discussed in Note 14, “Contingencies,” to the Consolidated Financial Statements. During 2009, the Company sold its senior interest related to the acquisition of assets from Three Pillars. The Company continues to hold, at March 31, 2010, senior interests related to the ARS purchases.

The Company did not significantly modify the assumptions used to value the retained interest at March 31, 2010 from the assumptions used to value the interest at December 31, 2009. The Company analyzed the impact on the fair values of two adverse changes from the key assumptions. Due to the seniority of the interests in the structure, current estimates of credit losses in the underlying collateral could withstand a 20% adverse change without the securities incurring a loss. In addition, while all the underlying collateral is currently eligible for repayment by the obligor, given the nature of the collateral and the current repricing environment, the Company assumed no prepayment would occur before the final maturity, which is approximately 24 years on a weighted average basis. Therefore, the key assumption in valuing these securities was the assumed discount rate, which was estimated to be 14% over LIBOR. A 20% adverse change in the assumed discount rate results in a decline of approximately $4 million in the fair value of these securities.

The Company is not obligated to provide any support to these entities and its maximum exposure to loss at March 31, 2010 and December 31, 2009 was limited to (i) the current senior interests held in trading securities, which had a fair value of $26 million, and (ii) the remaining senior interests expected to be purchased in conjunction with the ARS issue, which had a total fair value of approximately $2 million. The total assets of the trust preferred CDO entities in which the Company has remaining exposure to loss was $1.3 billion at March 31, 2010 and December 31, 2009. The Company determined that it was not the primary beneficiary of any of these VIEs under the new VIE consolidation guidance, as the Company lacks the power to direct the significant activities of any of the VIEs. No events occurred during the three months ended March 31, 2010 that called into question either the Company’s sale accounting or the Company’s conclusions that it is not the primary beneficiary of these VIEs.

The following tables present certain information related to the Company’s asset transfers in which it has continuing economic involvement for the three months ended March 31:

 

     Three Months Ended March 31, 2010
(Dollars in thousands) (Unaudited)      Residential  
  Mortgage Loans  
     Commercial and  
  Corporate Loans  
     Student Loans        CDO Securities      Total

Cash flows on interests held

   $14,346    $899    $2,924    $397    $18,566

Servicing or management fees

   1,069    3,952    191    -          5,212
     Three Months Ended March 31, 2009
(Dollars in thousands) (Unaudited)      Residential  
  Mortgage Loans  
     Commercial and  
  Corporate Loans  
     Student Loans        CDO Securities      Total

Cash flows on interests held

   $26,127    $394    $338    $439            $27,298

Servicing or management fees

   1,336    2,983    204    -          4,523  

 

Portfolio balances and delinquency balances based on 90 days or more past due (including accruing and nonaccrual loans) as of March 31, 2010 and December 31, 2009, and net charge-offs related to managed portfolio loans (both those that are owned by the Company and those that have been transferred) for three months ended March 31, 2010 and 2009 are as follows:

 

     Principal Balance    Past Due    Net Charge-offs
(Dollars in millions) (Unaudited)        March 31,            December 31,            March 31,          December 31,          For the Three Months Ended    
               March 31,
   2010    2009    2010    2009    2010    2009

Type of loan:

                 

Commercial

   $33,394      $32,494      $396      $508      $96      $132  

Residential mortgage and home equity

   46,481      46,743      3,715      4,065      574      339  

Commercial real estate and construction

   21,018      21,721      2,086      1,902      94      83  

Consumer

   12,046      11,649      446      428      29      40  

Credit card

   1,040      1,068      17      -        28      16  
                             

Total loan portfolio

   113,979      113,675      6,660      6,903      821      610  

Managed securitized loans

                 

Commercial

   3,272      3,460      55      64      -          7  

Residential mortgage

   1,421      1,482      132      123      11      9  

Other

   496      506      26      25      -          -      
                             

Total managed loans

           $119,168              $119,123              $6,873              $7,115              $832              $626  
                             

Residential mortgage loans securitized through Ginnie Mae, Fannie Mae, and Freddie Mac have been excluded from the tables above since the Company does not retain any beneficial interests or other continuing involvement in the loans other than servicing responsibilities on behalf of Ginnie Mae, Fannie Mae, and Freddie Mac and repurchase contingencies under standard representations and warranties made with respect to the transferred mortgage loans. The total amount of loans serviced by the Company as a result of such securitization transactions totaled $128.1 billion and $127.8 billion at March 31, 2010 and December 31, 2009, respectively. Related servicing fees received by the Company during the three months ended March 31, 2010 and 2009 were $92 million and $76 million, respectively.

Mortgage Servicing Rights

In addition to other interests that continue to be held by the Company in the form of securities, the Company also retains MSRs from certain of its sales or securitizations of residential mortgage loans. MSRs on residential mortgage loans are the only servicing assets capitalized by the Company. Previously, the Company maintained two classes of MSRs: MSRs related to loans originated and sold after January 1, 2008, which were reported at fair value, and MSRs related to loans sold before January 1, 2008, which were reported at amortized cost, net of any allowance for impairment losses. Beginning January 1, 2010, the Company elected to account for all MSRs at fair value. See Note 5, “Goodwill and Other Intangible Assets”, to the Consolidated Financial Statements for the rollforward of MSRs. As of December 31, 2009, the Company had established MSRs valuation allowances of $7 million. No permanent impairment losses were recorded against the allowance for MSRs carried at amortized cost during the year ended December 31, 2009.

Income earned by the Company on its MSRs is derived primarily from contractually specified mortgage servicing fees and late fees, net of curtailment costs. Such income earned for the three months ended March 31, 2010 and 2009, was $99 million, and $82 million, respectively. These amounts are reported in mortgage servicing related income in the Consolidated Statements of Income/(Loss).

As of March 31, 2010 and December 31, 2009, the total unpaid principal balance of mortgage loans serviced was $178.1 billion and $178.9 billion, respectively. Included in these amounts were $146.1 billion and $146.7 billion as of March 31, 2010 and December 31, 2009, respectively, of loans serviced for third parties.

 

A summary of the key characteristics, inputs, and economic assumptions used to estimate the fair value of the Company’s MSRs as of March 31, 2010 and December 31, 2009, and the sensitivity of the fair values to immediate 10% and 20% adverse changes in those assumptions are as follows:

 

    March 31, 2010   December 31, 2009
(Dollars in millions) (Unaudited)   Fair Value         Fair Value             Lower of Cost    
or Market

Fair value of retained MSRs

  $1,641     $936     $749  

Prepayment rate assumption (annual)

  15%    10%    17% 

Decline in fair value of 10% adverse change

  $62     $30     $30  

Decline in fair value of 20% adverse change

  119     58     58  

Discount rate (annual)

  11%    10%    12% 

Decline in fair value of 10% adverse change

  $63     $39     $27  

Decline in fair value of 20% adverse change

  121     75     51  

Weighted-average life (in years)

  5.86     7.50     4.84  

Weighted-average coupon

  5.67     5.24     6.11  

The above sensitivities 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, in this table, 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.

Other Variable Interest Entities

In addition to the Company’s involvement with certain VIEs, which is discussed herein under “Certain Transfers of Financial Assets and related Variable Interest Entities”, the Company also has involvement with VIEs from other business activities.

Three Pillars Funding, LLC

SunTrust assists in providing liquidity to select corporate clients by directing them to a multi-seller CP conduit, Three Pillars. Three Pillars provides financing for direct purchases of financial assets originated and serviced by SunTrust’s corporate clients by issuing CP.

The Company has determined that Three Pillars is a VIE as Three Pillars has not issued sufficient equity at risk. Previously, Three Pillars had issued a subordinated note to a third party, which would have absorbed the first dollar of loss in the event of nonpayment of any of Three Pillars’ assets. The outstanding and committed amounts of the subordinated note were $20 million at December 31, 2009 and no losses had been incurred through December 31, 2009. In January 2010, Three Pillars repaid and extinguished the subordinated note in full. In accordance with the provisions of the new VIE consolidation guidance, the Company has determined that it is the primary beneficiary of Three Pillars, as certain subsidiaries have both the power to direct the significant activities of Three Pillars and own potentially significant VIs, as discussed further herein. No losses on any of Three Pillars’ assets were incurred during the three months ended March 31, 2010.

The Company’s involvement with Three Pillars includes the following activities: services related to the administration of Three Pillars’ activities and client referrals to Three Pillars; the issuing of letters of credit, which provide partial credit protection to the CP holders; and providing liquidity arrangements that would provide funding to Three Pillars in the event it can no longer issue CP or in certain other circumstances. The Company’s activities with Three Pillars generated total revenue for the Company, net of direct salary and administrative costs, of approximately $15 million and $18 million for the three months ended March 31, 2010 and 2009, respectively.

At March 31, 2010, the Company’s Consolidated Balance Sheets reflected approximately $1.5 billion of secured loans held by Three Pillars, which are included within commercial loans, and $317 million of CP issued by Three Pillars, excluding intercompany liabilities, which is included within other short-term borrowings; other assets and liabilities were de minimis to the Company’s Consolidated Balance Sheets. The assets and liabilities of Three Pillars were consolidated by the Company at their unpaid principal amounts at January 1, 2010; upon consolidation, the Company recorded an allowance for loan losses on $1.7 billion of secured loans that were consolidated at that time, resulting in a transition adjustment of less than $1 million, which is presented as “Adoption of VIE consolidation guidance” on the Company’s Consolidated Statements of Shareholders’ Equity.

 

Funding commitments extended by Three Pillars to its customers totaled $3.5 billion at March 31, 2010, almost all of which renew annually. At December 31, 2009, Three Pillars had $1.8 billion of assets not included on the Company’s consolidated balance sheet and funding commitments and outstanding receivables totaled $3.7 billion and $1.7 billion, respectively. The majority of the commitments are backed by trade receivables and commercial loans that have been originated by companies operating across a number of industries. Trade receivables and commercial loans collateralize 53% and 20%, respectively, of the outstanding commitments, as of March 31, 2010, compared to 50% and 18%, respectively, as of December 31, 2009. Total assets supporting outstanding commitments have a weighted average life of 1.12 years and 1.25 years at March 31, 2010 and December 31, 2009, respectively.

Each transaction added to Three Pillars is typically structured to a minimum implied A/A2 rating according to established credit and underwriting policies as approved by credit risk management and monitored on a regular basis to ensure compliance with each transaction’s terms and conditions. Typically, transactions contain dynamic credit enhancement features that provide increased credit protection in the event asset performance deteriorates. If asset performance deteriorates beyond predetermined covenant levels, the transaction could become ineligible for continued funding by Three Pillars. This could result in the transaction being amended with the approval of credit risk management, or Three Pillars could terminate the transaction and enforce any rights or remedies available, including amortization of the transaction or liquidation of the collateral. In addition, Three Pillars has the option to fund under the liquidity facility provided by the Bank in connection with the transaction and may be required to fund under the liquidity facility if the transaction remains in breach. In addition, each commitment renewal requires credit risk management approval. The Company is not aware of unfavorable trends related to Three Pillars’ assets for which the Company expects to suffer material losses. For the three months ended March 31, 2010 and 2009, there were no write-downs of Three Pillars’ assets.

At March 31, 2010, Three Pillars’ outstanding CP used to fund its assets had remaining weighted average lives of 10.7 days and maturities through May 14, 2010. The assets of Three Pillars generally provide the sources of cash flows for the CP. However, the Company has issued commitments in the form of liquidity facilities and other credit enhancements to support the operations of Three Pillars. Due to the Company’s consolidation of Three Pillars as of January 1, 2010, these commitments now eliminate in consolidation for U.S. GAAP purposes. The liquidity commitments are revolving facilities that are sized based on the current commitments provided by Three Pillars to its customers. The liquidity facilities may generally be used if new CP cannot be issued by Three Pillars to repay maturing CP. However, the liquidity facilities are available in all circumstances, except certain bankruptcy-related events with respect to Three Pillars. Draws on the facilities are subject to the purchase price (or borrowing base) formula that, in many cases, excludes defaulted assets to the extent that they exceed available over-collateralization in the form of non-defaulted assets, and may also provide the liquidity banks with loss protection equal to a portion of the loss protection provided for in the related securitization agreement. Additionally, there are transaction specific covenants and triggers that are tied to the performance of the assets of the relevant seller/servicer that may result in a transaction termination event, which, if continuing, would require funding through the related liquidity facility. Finally, in a termination event of Three Pillars, such as if its tangible net worth falls below $5,000 for a period in excess of 15 days, Three Pillars would be unable to issue CP, which would likely result in funding through the liquidity facilities. Draws under the credit enhancement are also available in all circumstances, but are generally used to the extent required to make payment on any maturing CP if there are insufficient funds from collections of receivables or the use of liquidity facilities. The required amount of credit enhancement at Three Pillars will vary from time to time as new receivable pools are purchased or removed from its asset portfolio, but is generally equal to 10% of the aggregate commitments of Three Pillars.

Due to the consolidation of Three Pillars, the Company’s maximum exposure to potential loss was $3.6 billion as of March 31, 2010, which represents the Company’s exposure to the lines of credit that Three Pillars had extended to its clients. Prior to consolidation, the Company had $3.8 billion and $371 million, respectively, of liquidity facilities and other credit enhancements outstanding as of December 31, 2009. The Company did not recognize any liability on its Consolidated Balance Sheets related to these liquidity facilities and other credit enhancements as of March 31, 2010 or December 31, 2009, as no amounts had been drawn, nor were any draws probable to occur, such that a loss should have been accrued. In addition, no losses were recognized by the Company in connection with these commitments during the three months ended March 31, 2010 or 2009.

Total Return Swaps

The Company has had involvement with various VIEs related to its TRS business. The Company had unwound prior transactions during 2009, such that no such transactions were outstanding at December 31, 2009. However, during the three months ended March 31, 2010, the Company began to execute new TRS transactions.

Under the matched book TRS business model, the VIEs purchase assets (typically loans) from the market that serve as the underlying reference assets for a TRS between the VIE and the Company and a mirror TRS between the Company and its third party clients. The TRS between the VIEs and the Company hedge the Company’s exposure to the TRS with its third party clients. These third parties are not related parties to the Company, nor are they and the Company de facto agents of each other. In order for the VIEs to purchase the reference assets, the Company provides senior financing, in the form of demand notes, to these VIEs. The TRS contracts pass through interest and other cash flows on the assets owned by the VIEs to the third parties, along with exposing the third parties to depreciation on the assets and providing them with the rights to appreciation on the assets. The terms of the TRS contracts require the third parties to post initial margin, in addition to ongoing margin as the fair values of the underlying assets change. There is no legal obligation between the Company and its third party clients for the Company to purchase the reference assets or for the Company to cause the VIEs to purchase the assets.

 

Prior to January 1, 2010, the Company had concluded it was not the primary beneficiary of the VIEs, as the VIEs were designed for the benefit of the third parties. Specifically, the third parties had implicit VIs in the VIEs via their TRS contracts with the Company, whereby these third parties absorbed the majority of the expected losses and were entitled to the majority of the expected residual returns of the VIEs. The Company has considered the new VIE consolidation guidance with respect to the new VIEs established subsequent to January 1, 2010. Specifically, the Company has evaluated the nature of all VIs and other interests and involvement with the VIEs, in addition to the purpose and design of the VIEs, relative to the risks they were designed to create. Based on this evaluation, the Company has determined that it is not the primary beneficiary of the VIEs, as the design of the TRS business results in the Company having limited power to direct the significant activities of the VIEs. The purpose and design of a VIE are key components of a consolidation analysis and any power should be analyzed based on the substance of that power relative to other facts and circumstances. As discussed herein, the VIEs would not exist if the Company did not enter into the TRS contracts with the third parties.

At March 31, 2010, the Company had $399 million in senior financing outstanding to VIEs, which was classified within trading assets on the Consolidated Balance Sheets; the carrying values and fair values of the senior financing arrangements are the same. These VIEs had entered into TRS contracts with the Company with outstanding notional amounts of $395 million at March 31, 2010 and the Company had entered into mirror TRS contracts with its third parties with the same outstanding notional amounts. At March 31, 2010, the fair values of these TRS assets and liabilities were $12 million and $11 million, respectively. The notional amounts of the TRS contracts with the VIEs represent the Company’s maximum exposure to loss, although such exposure to loss has been mitigated via the TRS contracts with the third parties. The Company has not provided any support that it was not contractually obligated to for the three months ended March 31, 2010. For additional information on the Company’s TRS with these VIEs, see Note 10, “Derivative Financial Instruments” to the Consolidated Financial Statements.

Community Development Investments

As part of its community reinvestment initiatives, the Company invests almost exclusively within its footprint in multi-family affordable housing developments and other community development entities as a limited and/or general partner and/or a debt provider. The Company receives tax credits for its partnership investments. The Company has determined that these partnerships are VIEs when it does not own 100% of the entity because the holders of the equity investment at risk do not have the power through voting rights or similar rights to direct the activities of the entity that most significantly impact the entity’s economic performance. Accordingly, the Company’s general partner, limited partner, and/or debt interests are VIs that the Company evaluates for purposes of determining whether the Company is the primary beneficiary. During 2010 and 2009, the Company did not provide any financial or other support to its consolidated or unconsolidated investments that it was not previously contractually required to provide.

For some partnerships, the Company operates strictly as a general partner and, as such, has both (1) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of and the right to receive benefits from the entity that could potentially be significant to the VIE. Accordingly, the Company consolidates these partnerships on its Consolidated Balance Sheets. As the general partner, the Company typically guarantees the tax credits due to the limited partner and are responsible for funding construction and operating deficits. As of March 31, 2010 and December 31, 2009, total assets, which consist primarily of fixed assets and cash attributable to the consolidated partnerships, were $11 million and $14 million, respectively, and total liabilities, excluding intercompany liabilities, were $1 million and $3 million, respectively. Security deposits from the tenants are recorded as liabilities on the Company’s Consolidated Balance Sheets. The Company maintains separate cash accounts to fund these liabilities and these assets are considered restricted. The tenant liabilities and corresponding restricted cash assets were de minimis as of March 31, 2010 and December 31, 2009. While the obligations of the general partner are generally non-recourse to the Company, as the general partner, the Company may from time to time step in when needed to fund deficits. During 2010 and 2009, the Company did not provide any significant amount of funding as the general partner or to cover any deficits the partnerships may have generated.

 

For other partnerships, the Company acts only in a limited partnership capacity. The Company has determined that it is not the primary beneficiary of these partnerships because it does not have the power to direct the activities of entity that most significantly impact the entity’s economic performance. The Company accounts for its limited partner interests in accordance with the accounting guidance for investments in affordable housing projects. The general partner or an affiliate of the general partner provide guarantees to the limited partner which protect the Company from losses attributable to operating deficits, construction deficits and tax credit allocation deficits. Partnership assets of approximately $1.1 billion and $1.1 billion in these partnerships were not included in the Consolidated Balance Sheets at March 31, 2010 and December 31, 2009, respectively. These limited partner interests had carrying values of $216 million and $218 million at March 31, 2010 and December 31, 2009, respectively, and are recorded in other assets on the Company’s Consolidated Balance Sheets. The Company’s maximum exposure to loss for these limited partner investments totaled $468 million at March 31, 2010 and December 31, 2009. The Company’s maximum exposure to loss would be borne by the loss of the limited partnership equity investments along with $227 million and $219 million of loans issued by the Company to the limited partnerships at March 31, 2010 and December 31, 2009, respectively. The difference between the maximum exposure to loss and the investment and loan balances is primarily attributable to the unfunded equity commitments. Unfunded equity commitments are amounts that the Company has committed to the partnerships upon the partnerships meeting certain conditions. When these conditions are met, the Company will invest these additional amounts in the partnerships.

When the Company owns both the limited partner and general partner or acts as the indemnifying party, the Company consolidates the partnerships and does not consider these partnerships VIEs because, as owner of the partnerships, the Company has the ability to directly and indirectly make decisions that have a significant impact on the business. As of March 31, 2010 and December 31, 2009, total assets, which consist primarily of fixed assets and cash, attributable to the consolidated, non-VIE partnerships were $418 million and $425 million, respectively, and total liabilities, excluding intercompany liabilities, primarily representing third-party borrowings, were $107 million and $209 million, respectively. See Note 13, “Fair Value Measurement and Election,” to the Consolidated Financial Statements for further discussion on the impact of impairment charges on affordable housing partnership investments recorded during 2009.

Registered and Unregistered Funds Advised by RidgeWorth

RidgeWorth, a registered investment advisor and wholly-owned subsidiary of the Company, serves as the investment advisor for various private placement and publicly registered investment funds (collectively the “Funds”). The Company evaluates these Funds to determine if the Funds are voting interest entities or VIEs, as well as monitors the nature of its interests in each Fund to determine if the Company is required to consolidate any of the Funds. In February 2010, the FASB issued guidance that defers the application of the new VIE consolidation guidance for investment funds meeting certain criteria. All of the registered and unregistered Funds advised by RidgeWorth meet the scope exception criteria and thus are not evaluated for consolidation under the new guidance. Accordingly, the Company continues to apply the consolidation guidance in effect prior to the issuance of the new guidance to interests in funds that qualify for the deferral. Further, funds that were determined to be VIEs under the previous accounting guidance and are still considered VIEs under the new accounting guidance are required to comply with the new disclosure requirements.

The Company has concluded that some of the Funds are VIEs because the equity investors lack decision making rights. However, the Company has concluded that it is not the primary beneficiary of these funds as the Company does not absorb a majority of the expected losses nor expected returns of the funds. The Company’s exposure to loss is limited to the investment advisor and other administrative fees it earns and if applicable, any equity investments. Payment on fees is received from the individual investor accounts. The total unconsolidated assets of these funds as of March 31, 2010 and December 31, 2009 were $3.1 billion and $3.3 billion, respectively.

The Company does not have any contractual obligation to provide monetary support to any of the Funds and did not provide any support, contractual or otherwise, to the Funds during the periods ended March 31, 2010 and December 31, 2009.

Loss Per Share
Loss Per Share

Note 7 – Loss Per Share

Net loss is the same in the calculation of basic and diluted loss per average common share. Equivalent shares of 32 million and 33 million related to common stock options and common stock warrants outstanding as of March 31, 2010 and 2009, respectively, were excluded from the computations of diluted loss per average common share because they would have been antidilutive. A reconciliation of the difference between average basic common shares outstanding and average diluted common shares outstanding for the three months ended March 31, 2010 and 2009 is included below. For EPS calculation purposes, the impact of dilutive securities are excluded from the diluted share count during periods that the Company has recognized a net loss available to common shareholders because the impact would be antidilutive. Additionally, included below is a reconciliation of net loss to net loss available to common shareholders.

 

     Three Months Ended
March 31
(In thousands, except per share data) (Unaudited)    2010    2009

Net loss

       ($160,814)       ($815,167) 

Series A preferred dividends

   (1,726)     (5,000) 

U.S. Treasury preferred dividends and accretion of discount

   (66,605)     (66,279) 

Dividends and undistributed earnings allocated to unvested shares

   (39)     11,065  
         

Net loss available to common shareholders

   ($229,184)     ($875,381) 
         

Average basic common shares

   494,871      351,352  

Effect of dilutive securities:

     

Stock options

   908      -  

Restricted stock

   2,459      545  
         

Average diluted common shares

   498,238      351,897  
         

Loss per average common share - diluted

   ($0.46)     ($2.49) 
         

Loss per average common share - basic

   ($0.46)     ($2.49) 
         
Income Taxes
Income Taxes

Note 8 - Income Taxes

The provision for income taxes was a benefit of $194 million and $151 million for the three months ended March 31, 2010 and 2009, respectively, representing effective tax rates of (54.7%) and (15.6%), respectively, during those periods. The Company calculated the benefit for income taxes for the three months ended March 31, 2010 and 2009 based on the discrete methodology using actual year-to-date results. The Company moved from an insignificant net deferred tax asset at December 31, 2009 to a net deferred tax liability at March 31, 2010 after the carryback of the 2009 federal net operating loss.

As of March 31, 2010, the Company’s gross cumulative UTBs amounted to $106 million, of which $71 million (net of federal tax benefit) would affect the Company’s effective tax rate, if recognized. As of December 31, 2009, the Company’s gross cumulative UTBs amounted to $161 million. The reduction in UTBs was primarily attributable to the settlement of an examination by a taxing authority and the related payments and reversal of the liability. Additionally, the Company recognized a gross liability of $31 million and $39 million for interest related to its UTBs as of March 31, 2010 and December 31, 2009, respectively. Interest related to UTBs was income of approximately $5 million for the three months ended March 31, 2010, compared to an expense of approximately $8 million, for the same period in 2009. The Company continually evaluates the UTBs associated with its uncertain tax positions. It is reasonably possible that the total UTBs could decrease during the next 12 months by up to $18 million due to completion of tax authority examinations and the expiration of statutes of limitations.

The Company files consolidated and separate income tax returns in the United States federal jurisdiction and in various state jurisdictions. As of March 31, 2010, the Company’s federal returns through 2006 have been examined by the IRS. All issues have been resolved for tax years through 2004. Only one issue remains in dispute for tax years 2005 and 2006. Generally, the state jurisdictions in which the Company files income tax returns are subject to examination for a period from three to seven years after returns are filed.

Employee Benefit Plans
Employee Benefit Plans

Note 9 - Employee Benefit Plans

The Company sponsors various short and LTI plans for eligible employees. The Company delivers LTIs through various incentive programs, including stock options, restricted stock, LTI cash plan, and salary shares. Certain employees received long-term deferred cash awards which are subject to a three year vesting requirement. The accrued liability related to these deferred cash grants was $34 million and $28 million as of March 31, 2010 and December 31, 2009, respectively.

An important new compensation development that had the characteristics of both base salary and equity emerged as part of the U.S. Treasury’s Interim Final Rule on TARP Standards for Compensation and Corporate Governance. This compensation development became known as salary shares. Specifically, the Interim Rule prohibits the payment of short-term incentives (annual bonus) and stock options to the Senior Executive Officers and to the next 20 most highly compensated employees. Effective January 1, 2010, the Company chose to use the salary share concept because it is specifically authorized by EESA to address the constraints on the annual cash bonus and equity awards; and the Company believes it is necessary that it use this approach to remain competitive and to minimize the risk of talent flight to other companies with whom it competes. Specifically, the Company will pay additional base salary amounts in the form of stock (salary shares) to the NEOs and other employees who are among the next 20 most highly-compensated employees. The Company will do this each pay period in the form of stock units under the SunTrust Banks, Inc. 2009 Stock Plan. The stock units will not include any rights to receive dividends or dividend equivalents. As required by EESA, each salary share will be non-forfeitable upon grant but may not be sold or transferred until the expiration of a holding period. As a result, the NEO is at risk for the value of our stock price until the stock unit is settled. The stock units will be settled in cash; one half on March 31, 2011 and one half on March 31, 2012, unless settled earlier due to the executive’s death. The amount to be paid on settlement of the stock units will be equal to the value of a share of SunTrust common stock on the settlement date. Benefit plan determinations and limits were established to ensure that the salary shares were accounted for equitably within relevant benefit plans. As of March 31, 2010, the accrual related to salary shares is $2 million.

Stock-Based Compensation

The weighted average fair values of options granted during the first three months of 2010 and 2009 were $12.75 per share and $4.73 per share, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

 

     Three Months Ended March 31  
(Unaudited)    2010     2009  

Dividend yield

   0.17   4.42

Expected stock price volatility

   56.23      84.20   

Risk-free interest rate (weighted average)

   2.84      1.99   

Expected life of options

   6 years      6 years   

The following table presents a summary of stock option and restricted stock activity:

 

     Stock Options    Restricted Stock
(Dollars in thousands except per share data) (Unaudited)    Shares    Price
Range
   Weighted
Average
Exercise Price
     Shares      Deferred
  Compensation  
   Weighted
Average
  Grant Price  

Balance, January 1, 2010

   17,661,216     $9.06 - $150.45     $53.17     4,770,172     $59,161     $37.02 

Granted

   1,163,138     22.69 - 23.70     23.53     892,965     20,354     22.80 

Exercised/vested

            (1,035,574)       72.77 

Cancelled/expired/forfeited

   (319,000)    22.75 - 79.73     59.08     (56,503)    (1,846)    32.68 

Amortization of restricted stock compensation

               (12,268)   
                             

Balance, March 31, 2010

           18,505,354     $9.06 - $150.45                 $51.20                 4,571,060                 $65,401                 $26.20 
                             
                 
                     

Exercisable, March 31, 2010

   12,324,920        $65.97          
                     

Available for additional grant, March 31, 2010 1

   7,189,953                
                   

 

1

Includes 3,637,785 shares available to be issued as restricted stock.

The following table presents information on stock options by ranges of exercise price at March 31, 2010:

(Dollars in thousands except per share data) (Unaudited)

 

     Options Outstanding    Options Exercisable
Range of Exercise
Prices
   Number
Outstanding at
March 31,
2010
   Weighted
Average
 Exercise Price 
  

Weighted

Average
Remaining
  Contractual Life  
(Years)

   Total
  Aggregate  
Intrinsic
Value
   Number
Exercisable at
  March 31, 2010  
   Weighted
Average
Exercise Price
   Weighted
Average
Remaining
Contractual
  Life (Years)  
   Total
  Aggregate  
Intrinsic
Value
                                    

$9.06 to $49.46

   5,634,618     $16.07     8.53     $69,783     454,384     $45.52     2.31     $31 

$49.47 to $64.57

   4,821,757     56.44     2.10        4,821,757     56.44     2.10    

$64.58 to $150.45

   8,048,979     72.66     4.69        7,048,779     73.81     4.23    
                                    
           18,505,354             $51.20                 5.18             $69,783             12,324,920             $65.97             3.33                 $31 
                                       

 

Stock-based compensation expense recognized in noninterest expense was as follows:

 

     Three Months Ended
March 31
(Dollars in thousands) (Unaudited)    2010    2009

Stock-based compensation expense:

     

Stock options

   $3,609     $2,913 

Restricted stock

   12,268     20,283 
         

Total stock-based compensation expense

           $15,877             $23,196 
         

The recognized stock-based compensation tax benefit amounted to $6 million and $9 million for the three months ended March 31, 2010 and 2009, respectively.

Retirement Plans

SunTrust did not contribute to either of its noncontributory qualified retirement plans (“Retirement Benefits” plans) in the first quarter of 2010. The expected long-term rate of return on plan assets for the Retirement Benefit Plans is 8.00% for 2010.

Anticipated employer contributions/benefit payments for 2010 are $12 million for the Supplemental Retirement Benefit plans. For the first quarter of 2010, the actual contributions/benefit payments totaled $3 million.

SunTrust contributed less than $1 million to the Postretirement Welfare Plan in the first quarter of 2010. Additionally, SunTrust expects to receive a Medicare Part D Subsidy reimbursement for 2010 in the amount of $2 million. The expected pre-tax long-term rate of return on plan assets for the Postretirement Welfare plan is 6.75% for 2010.

 

     Three Months Ended March 31
     2010    2009
(Dollars in thousands) (Unaudited)    Pension
    Benefits    
   Other
  Postretirement  
Benefits
   Pension
    Benefits    
   Other
  Postretirement  
Benefits

Service cost

   $17,331      $-      $18,856      $73  

Interest cost

   32,007      2,436      30,063      2,803  

Expected return on plan assets

   (45,723)     (1,806)     (37,558)     (1,758) 

Amortization of prior service cost

   (2,792)     (95)     (2,721)     (390) 

Recognized net actuarial loss

   15,027      245      32,456      4,648  
                   

Net periodic benefit cost

       $15,850          $780          $41,096          $5,376  
                   

During March 2010, a comprehensive health care reform legislation was signed into law under the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (the “Acts”). Included among the major provisions of the law is a change in tax treatment of the federal drug subsidy paid with respect to Medicare-eligible retirees. The effect of the Acts on the Company’s Other Postretirement Benefits obligation and cost depends on finalization of related regulatory requirements; however, the impact is not expected to be material. The Company will continue to monitor and assess the effect of the Acts as the regulatory requirements are finalized.

 

Derivative Financial Instruments
Derivative Financial Instruments

Note 10 - Derivative Financial Instruments

The Company enters into various derivative financial instruments, both in a dealer capacity to facilitate client transactions and as an end user as a risk management tool. Where derivatives have been entered into with clients, the Company generally manages the risk associated with these derivatives within the framework of its VAR approach that monitors total exposure daily and seeks to manage the exposure on an overall basis. Derivatives are used as a risk management tool to hedge the Company’s exposure to changes in interest rates or other identified market or credit risks, either economically or in accordance with the hedge accounting provisions. The Company may also enter into derivatives, on a limited basis, in consideration of trading opportunities in the market. In addition, as a normal part of its operations, the Company enters into IRLCs on mortgage loans that are accounted for as freestanding derivatives and has certain contracts containing embedded derivatives that are carried, in their entirety, at fair value. All freestanding derivatives and any embedded derivatives that the Company bifurcates from the host contracts are carried at fair value in the Consolidated Balance Sheets in trading assets, other assets, trading liabilities, or other liabilities. The associated gains and losses are either recorded in OCI, net of tax, or within the Consolidated Statements of Income/(Loss) depending upon the use and designation of the derivatives.

Credit and Market Risk Associated with Derivatives

Derivatives expose the Company to credit risk. If the counterparty fails to perform, the credit risk at that time would be equal to the net derivative asset position, if any, for that counterparty. The Company minimizes the credit or repayment risk in derivatives by entering into transactions with high credit-quality counterparties that are reviewed periodically by the Company’s Credit Risk Management division. The Company’s derivatives may also be governed by an ISDA; depending on the nature of the derivative transactions, bilateral collateral agreements may be in place as well. When the Company has more than one outstanding derivative transaction with a single counterparty and there exists a legally enforceable master netting agreement with the counterparty, the Company considers its exposure to the counterparty to be the net market value of all positions with that counterparty, if such net value is an asset to the Company, and zero, if such net value is a liability to the Company. As of March 31, 2010, net derivative asset positions to which the Company was exposed to risk of its counterparties were $1.7 billion, representing the net of $2.5 billion in net derivative gains by counterparty, netted by counterparty where formal netting arrangements exist, adjusted for collateral of $0.8 billion that the Company holds in relation to these gain positions. As of December 31, 2009, net derivative asset positions to which the Company was exposed to risk of its counterparties were $1.8 billion, representing the net of $2.5 billion in derivative gains by counterparty, netted by counterparty where formal netting arrangements exist, adjusted for collateral of $0.7 billion that the Company holds in relation to these gain positions.

The Company adjusted the fair value of its net derivative asset position for estimates of counterparty credit risk by approximately $21 million and $25 million as of March 31, 2010 and December 31, 2009, respectively. See Note 13, “Fair Value Measurement and Election,” to the Consolidated Financial Statements for further discussion on quantification of counterparty credit risk.

The majority of the Company’s derivatives contain contingencies that relate to the creditworthiness of the Bank. These are contained in industry standard master trading agreements as events of default. Should the Bank be in default under any of these provisions, the Bank’s counterparties would be permitted under such master agreements to close-out net at amounts that would approximate the then-fair values of the derivatives and the netting of the amounts would produce a single sum due by one party to the other. The counterparties would have the right to apply any collateral posted by the Bank against any net amount owed by the Bank. In addition, of the Company’s total derivative liability positions, approximately $1.3 billion in fair value, contain provisions conditioned on downgrades of the Bank’s credit rating. These provisions, if triggered, would either give rise to an ATE that permits the counterparties to close-out net and apply collateral or, where a CSA is present, require the Bank to post additional collateral. Collateral posting requirements generally result from differences in the fair value of the net derivative liability compared to specified collateral thresholds at different ratings levels of the Bank, both of which are negotiated provisions within each CSA. At March 31, 2010, the Bank carried senior long-term debt ratings of BBB+/A1 from two of the major ratings agencies. For illustrative purposes, if the Bank were downgraded to BBB-/Baa3, ATEs would be triggered in derivative liability contracts that had a fair value of approximately $23 million at March 31, 2010, against which the Bank had posted collateral of approximately $10 million; ATEs do not exist at lower ratings levels. At March 31, 2010, approximately $1.2 billion in fair value of derivative liabilities are subject to CSAs, against which the Bank has posted approximately $1.1 billion in collateral. If requested by the counterparty per the terms of the CSA, the Bank would be required to post estimated additional collateral against these contracts of approximately $627 million if the Bank were downgraded to BBB-/Baa3, and any further downgrades to BB+/Ba1 or below would require the posting of an additional $19 million. Such collateral posting amounts may be more or less than the Bank’s estimates based on the specified terms of each CSA as to the timing of a collateral calculation and whether the Bank and its counterparties differ on their estimates of the fair values of the derivatives or collateral.

 

Derivatives also expose the Company to market risk. Market risk is the adverse effect that a change in market factors, such as interest rates, currency rates, equity prices, or implied volatility, has on the value of a derivative. The Company manages the market risk associated with its derivatives by establishing and monitoring limits on the types and degree of risk that may be undertaken. The Company continually measures this risk by using a VAR methodology.

The table below presents the Company’s derivative positions at March 31, 2010. The notional amounts in the table are presented on a gross basis and have been classified within Asset Derivatives or Liability Derivatives based on the estimated fair value of the individual contract at March 31, 2010. On the Consolidated Balance Sheets, the fair values of derivatives with counterparties with master netting agreements are recorded on a net basis. However, for purposes of the table below, the gross positive and gross negative fair value amounts associated with the respective notional amounts are presented without consideration of any netting agreements. For contracts constituting a combination of options that contain a written component and a purchased component (such as a collar), the notional amount of each component is presented separately, with the purchased component being presented as an Asset Derivative and the written component being presented as a Liability Derivative. The fair value of each combination of options is presented with the purchased component if the combined fair value of the components is positive, and with the written component if the combined fair value is negative.

 

     Asset Derivatives    Liability Derivatives  
(Dollars in thousands) (Unaudited)    Balance Sheet
    Classification    
   Notional
       Amounts      
        Fair Value            Balance Sheet    
Classification
   Notional
      Amounts      
        Fair Value      

Derivatives designated in cash flow hedging relationships 5

            

Equity contracts hedging:

               

Securities available for sale

   Trading assets    $1,546,752        $21,460      Trading liabilities    $1,546,752        $-     

Interest rate contracts hedging:

               

Floating rate loans

   Trading assets    16,350,000        832,026         -        -     
                             

Total

      17,896,752        853,486         1,546,752        -     
                             

Derivatives not designated as hedging instruments 6

               

Interest rate contracts covering:

               

Fixed rate debt

   Trading assets    3,223,085        230,347      Trading liabilities    295,000        13,121     

Corporate bonds and loans

      -        -      Trading liabilities    44,575        3,536     

MSRs

   Other assets    8,910,000        50,315      Other liabilities    6,520,000        26,028     

LHFS, IRLCs, LHFI-FV

   Other assets    5,076,192   3    13,365      Other liabilities    1,982,843        7,054     

Trading activity

   Trading assets    109,775,247   1    3,434,455      Trading liabilities    88,287,718        3,306,993     

Foreign exchange rate contracts covering:

               

Foreign-denominated debt and commercial loans

   Trading assets    1,094,810        29,050      Trading liabilities    507,124        146,142     

Trading activity

   Trading assets    1,754,169        88,058      Trading liabilities    1,938,991        90,477     

Credit contracts covering:

               

Loans

   Trading assets    125,000        461      Trading liabilities    175,750        2,581     

Trading activity

   Trading assets    556,237   2    16,350      Trading liabilities    540,501   2    13,717     

Equity contracts - Trading activity

   Trading assets    3,722,363   1    481,543      Trading liabilities    6,919,091        660,945     

Other contracts:

               

IRLCs and other

   Other assets    3,412,603        32,682      Other liabilities    736,600   4    42,132   4 

Trading activity

   Trading assets    73,535        6,712      Trading liabilities    86,245        6,781     
                             

Total

      137,723,241        4,383,338         108,034,438        4,319,507     
                             

Total derivatives

              $155,619,993                $5,236,824                 $109,581,190                $4,319,507     
                             

1 Amounts include $21.8 billion and $0.5 billion of notional related to interest rate futures and equity futures, respectively. These futures contracts settle in cash daily and therefore no derivative asset or liability is recorded.

2 Asset and liability amounts include $2 million and $10 million, respectively, of notional from purchased and written interest rate swap risk participation agreements, respectively, which notional is calculated as the notional of the interest rate swap participated adjusted by the relevant risk weighted assets conversion factor.

3 Amount includes $1.6 billion of notional amounts related to interest rate futures. These futures contracts settle in cash daily and therefore no derivative asset or liability is recorded.

4 Includes a $40 million derivative liability recorded in other liabilities in the Consolidated Balance Sheets, related to a notional amount of $134 million. This derivative was established upon the sale of Visa Class B shares in the second quarter of 2009 as discussed in Note 11, “Reinsurance Arrangements and Guarantees,” to the Consolidated Financial Statements.

5 See “Cash Flow Hedges” in this Note for further discussion.

6 See “Economic Hedging and Trading Activities” in this Note for further discussion.

 

The table below presents the Company’s derivative positions at December 31, 2009.

 

     Asset Derivatives    Liability Derivatives  
(Dollars in thousands) (Unaudited)        Balance Sheet    
Classification
   Notional
       Amounts      
        Fair Value            Balance Sheet    
Classification
   Notional
       Amounts      
        Fair Value      

Derivatives designated in cash flow hedging relationships 5

            

Equity contracts hedging:

               

Securities available for sale

   Trading assets    $1,546,752        $-      Trading liabilities    $1,546,752        $45,866     

Interest rate contracts hedging:

               

Floating rate loans

   Trading assets    15,550,000        865,391      Trading liabilities    3,000,000        22,202     
                             

Total

      17,096,752        865,391         4,546,752        68,068     
                             

Derivatives not designated as hedging instruments 6

               

Interest rate contracts covering:

               

Fixed rate debt

   Trading assets    3,223,085        200,183      Trading liabilities    295,000        10,335     

Corporate bonds and loans

      -        -      Trading liabilities    47,568        4,002     

MSRs

   Other assets    3,715,000        61,719      Other liabilities    3,810,000        57,048     

LHFS, IRLCs, LHFI-FV

   Other assets    7,461,935   3    75,071      Other liabilities    1,425,858        20,056     

Trading activity

   Trading assets    94,139,597   1    3,289,667      Trading liabilities    83,483,088        3,242,861     

Foreign exchange rate contracts covering:

               

Foreign-denominated debt and commercial loans

   Trading assets    1,164,169        96,143      Trading liabilities    656,498        144,203     

Trading activity

   Trading assets    2,059,097        107,065      Trading liabilities    2,020,240        96,266     

Credit contracts covering:

               

Loans

   Trading assets    115,000        771      Trading liabilities    240,750        4,051     

Trading activity

   Trading assets    170,044   2    6,344      Trading liabilities    156,139   2    3,837     

Equity contracts - Trading activity

   Trading assets    3,344,875   1    446,355      Trading liabilities    6,907,657        672,221     

Other contracts:

               

IRLCs and other

   Other assets    1,870,040        13,482      Other liabilities    1,560,337   4    48,134   4 

Trading activity

   Trading assets    39,117        7,095      Trading liabilities    51,546        6,929     
                             

Total

      117,301,959        4,303,895         100,654,681        4,309,943     
                             

Total derivatives

              $134,398,711                $5,169,286                 $105,201,433                $4,378,011     
                             

1 Amounts include $18.2 billion and $0.5 billion of notional related to interest rate futures and equity futures, respectively. These futures contracts settle in cash daily and therefore no derivative asset or liability is recorded.

2 Asset and liability amounts include $3.6 million and $8.7 million, respectively, of notional from purchased and written interest rate swap risk participation agreements, respectively, which notional is calculated as the notional of the interest rate swap participated adjusted by the relevant risk weighted assets conversion factor.

3 Amount includes $2.0 billion of notional amounts related to interest rate futures. These futures contracts settle in cash daily and therefore no derivative asset or liability is recorded.

4 Includes a $40.4 million derivative liability recorded in other liabilities in the Consolidated Balance Sheets, related to a notional amount of $134.3 million. This derivative was established upon the sale of Visa Class B shares in the second quarter of 2009 as discussed in Note 18, “Reinsurance Arrangements and Guarantees,” to the Consolidated Financial Statements.

5 See “Cash Flow Hedges” in this Note for further discussion.

6 See “Economic Hedging and Trading Activities” in this Note for further discussion.

The impacts of derivative financial instruments on the Consolidated Statements of Income/(Loss) and the Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2010 and 2009 are presented below. The impacts are segregated between those derivatives that are designated in hedging relationships and those that are used for economic hedging or trading purposes, with further identification of the underlying risks in the derivatives and the hedged items, where appropriate. The tables do not disclose the financial impact of the activities that these derivative instruments are intended to hedge, for both economic hedges and those instruments designated in formal, qualifying hedging relationships.

 

 

     Three Months Ended March 31, 2010

(Dollars in thousands) (Unaudited)

Derivatives in cash flow hedging relationships

   Amount of pre-tax gain recognized in
OCI on Derivatives (Effective
Portion)
   Classification of gain reclassified
from AOCI into Income  (Effective
Portion)
   Amount of pre-tax gain reclassified
from AOCI into Income  (Effective

Portion)1

Equity contracts hedging:

          

Securities available for sale

   $60,589          

Interest rate contracts hedging:

          

Floating rate loans

   288,051      Interest and fees on loans      $126,873  
              

Total

           $348,640                   $126,873  
              

 

(Dollars in thousands) (Unaudited)

Derivatives not designated as hedging instruments

  

Classification of gain/(loss) recognized in Income on

Derivatives

 

Amount of gain/(loss) recognized in

Income on Derivatives for the three
months ended March 31, 2010

Interest rate contracts covering:

      

Fixed rate debt

  

Trading account profits/(losses) and commissions

    $45,421  

Corporate bonds and loans

  

Trading account profits/(losses) and commissions

    (732) 

MSRs

  

Mortgage servicing related income

    76,344  

LHFS, IRLCs, LHFI-FV

  

Mortgage production related income

    (69,834) 

Trading activity

  

Trading account profits/(losses) and commissions

    29,803  

Foreign exchange rate contracts covering:

      

Foreign-denominated debt and commercial loans

  

Trading account profits/(losses) and commissions

    (95,631) 

Trading activity

  

Trading account profits/(losses) and commissions

    6,964  

Credit contracts covering:

      

Loans

  

Trading account profits/(losses) and commissions

    (343) 

Trading activity

  

Trading account profits/(losses) and commissions

    382  

Equity contracts - trading activity

  

Trading account profits/(losses) and commissions

    6,804  

Other contracts:

      

IRLCs

  

Mortgage production related income

    92,156  

Trading activity

  

Trading account profits/(losses) and commissions

    22  
        

Total

       $91,356  
        

1 During the three months ended March 31, 2010, the Company reclassified $29 million in pre-tax gains from AOCI into net interest income. These gains related to hedging relationships that have been previously terminated or de-designated.

 

     Three Months Ended March 31, 2009

(Dollars in thousands) (Unaudited)

Derivatives in SFAS No. 133 cash flow hedging relationships

   Amount of pre-tax gain/(loss)
Recognized in

OCI on Derivative
(Effective Portion)
  

Classification of gain/(loss)
Reclassified from

AOCI into Income

(Effective Portion)

   Amount of pre-tax gain/(loss)
Reclassified from
AOCI into Income
(Effective Portion)1

Equity contracts hedging the following:

        

Securities available for sale

   $9,982        $-  

Interest rate contracts hedging the following:

        

Floating rate loans

   53,049    

Interest and fees on loans

   109,031  

Floating rate certificates of deposits

   (821)   

Interest on deposits

   (22,988) 

Floating rate debt

   (15)   

Interest on long-term debt

   (1,333) 
            

Total

   $62,195        $84,710  
            

(Dollars in thousands) (Unaudited)

Derivatives not designated as hedging instruments under SFAS No. 133

   Classification of gain/(loss)
Recognized  in

Income on Derivative
  

Amount of gain/(loss)
Recognized in Income on
Derivatives for the three
months ended
March 31, 2009

    

Interest rate contracts hedging the following:

        

Fixed rate public debt

   Trading account profits and commissions    ($27,944)    

Corporate bond holdings

   Trading account profits and commissions    2,410     

Loans

   Trading account profits and commissions    (5)    

MSRs

   Mortgage servicing income    61,211     

LHFS, IRLCs, LHFI-FV

   Mortgage production income    (106,631)    

N/A - Trading activity

   Trading account profits and commissions    11,195     

Foreign exchange rate contracts hedging the following:

        

Foreign-denominated debt

   Trading account profits and commissions    (79,189)    

Commercial loans

   Trading account profits and commissions    450     

N/A - Trading activity

   Trading account profits and commissions    35,119     

Credit contracts hedging the following:

        

Loans

   Trading account profits and commissions    (2,761)    

Other

   Trading account profits and commissions    7,868     

Other contracts:

        

IRLCs

   Mortgage production income    277,622     

Other

   Trading account profits and commissions    33     

Trading activity

   Trading account profits and commissions    33,538     
          

Total

      $212,916     
          

1 During the quarter ending March 31, 2009, the Company also reclassified $8.4 million in pre-tax gains from AOCI into net interest income. These gains related to hedging relationships under SFAS No. 133 that have been previously terminated or de-designated.

 

Credit Derivatives

As part of its trading businesses, the Company enters into contracts that are, in form or substance, written guarantees: specifically, CDS, swap participations, and TRS. The Company accounts for these contracts as derivative instruments and, accordingly, records these contracts at fair value, with changes in fair value recorded in trading account profits and commissions.

The Company writes CDS, which are agreements under which the Company receives premium payments from its counterparty for protection against an event of default of a reference asset. In the event of default under the CDS, the Company would either net cash settle or make a cash payment to its counterparty and take delivery of the defaulted reference asset, from which the Company may recover all, a portion, or none of the credit loss, depending on the performance of the reference asset. Events of default, as defined in the CDS agreements, are generally triggered upon the failure to pay and similar events related to the issuer(s) of the reference asset. As of March 31, 2010, all written CDS contracts reference single name corporate credits or corporate credit indices. When the Company has written CDS, it has generally entered into offsetting CDS for the underlying reference asset, under which the Company paid a premium to its counterparty for protection against an event of default on the reference asset. The counterparties to these purchased CDS are of high creditworthiness and have ISDA agreements in place that subject the CDS to master netting provisions, thereby mitigating the risk of non-payment to the Company. As such, at March 31, 2010, the Company does not have any significant risk of making a non-recoverable payment on any written CDS. During 2010 and 2009, the only instances of default on written CDS were driven by credit indices with constituent credit default. In all cases where the Company made resulting cash payments to settle, the Company collected like amounts from the counterparties to the offsetting purchased CDS. At March 31, 2010, the written CDS had remaining terms of approximately nine months to five years. The maximum guarantees outstanding at March 31, 2010 and December 31, 2009, as measured by the gross notional amounts of written CDS, were $118 million and $130 million, respectively. At March 31, 2010 and December 31, 2009, the gross notional amounts of purchased CDS contracts, which represent benefits to, rather than obligations of, the Company, were $170 million and $185 million, respectively. The fair values of the written CDS were $1 million and $2 million at March 31, 2010 and December 31, 2009, respectively, and the fair values of the purchased CDS were $1 million and $4 million at March 31, 2010, and December 31, 2009, respectively.

The Company writes risk participations, which are credit derivatives whereby the Company has guaranteed payment to a dealer counterparty in the event that the counterparty experiences a loss on a derivative instrument, such as an interest rate swap, due to a failure to pay by the counterparty’s customer (the “obligor”) on that derivative instrument. The Company monitors its payment risk on its risk participations by monitoring the creditworthiness of the obligors, which is based on the normal credit review process the Company would have performed had it entered into the derivative instruments directly with the obligors. The obligors are all corporations or partnerships. However, the Company continues to monitor the creditworthiness of its obligors and the likelihood of payment could change at any time due to unforeseen circumstances. To date, no material losses have been incurred related to the Company’s written swap participations. At March 31, 2010, the remaining terms on these risk participations generally ranged from four months to eight years, with a weighted average on the maximum estimated exposure of 3.0 years. The Company’s maximum estimated exposure to written swap participations, as measured by projecting a maximum value of the guaranteed derivative instruments based on interest rate curve simulations and assuming 100% default by all obligors on the maximum values, was approximately $91 million and $83 million at March 31, 2010 and December 31, 2009, respectively. The fair values of the written swap participations were de minimis at March 31, 2010 and December 31, 2009. As part of its trading activities, the Company may enter into purchased swap participations, but such activity is not matched, as discussed herein related to CDS or TRS.

The Company has also entered into TRS contracts on loans. The Company’s TRS business consists of matched trades, such that when the Company pays depreciation on one TRS, it receives the same depreciation on the matched TRS. As such, the Company does not have any long or short exposure, other than credit risk of its counterparty, which is mitigated through collateralization. The Company typically receives initial cash collateral from the counterparty upon entering into the TRS and is entitled to additional collateral as the fair value of the underlying reference assets deteriorate. The Company temporarily suspended this business and unwound its positions as of December 31, 2009 without incurring losses. Trading resumed during 2010 and at March 31, 2010, there were $395 million of outstanding and offsetting TRS notional balances. The fair values of the TRS derivative assets and liabilities were $12 million and $11 million at March 31, 2010, respectively, and related collateral held at March 31, 2010 was $156 million.

 

Cash Flow Hedges

The Company utilizes a comprehensive risk management strategy to monitor sensitivity of earnings to movements in interest rates. Specific types of funding and principal amounts hedged are determined based on prevailing market conditions and the shape of the yield curve. In conjunction with this strategy, the Company may employ various interest rate derivatives as risk management tools to hedge interest rate risk from recognized assets and liabilities or from forecasted transactions. The terms and notional amounts of derivatives are determined based on management’s assessment of future interest rates, as well as other factors. The Company establishes parameters for derivative usage, including identification of assets and liabilities to hedge, derivative instruments to be utilized, and notional amounts of hedging relationships. At March 31, 2010, the Company’s only outstanding interest rate hedging relationships involve interest rate swaps that have been designated as cash flow hedges of probable forecasted transactions related to recognized floating rate loans.

Interest rate swaps have been designated as hedging the exposure to the benchmark interest rate risk associated with floating rate loans. The maximum range of hedge maturities for hedges of floating rate loans is approximately one to five years, with the weighted average being approximately 3.7 years. Ineffectiveness on these hedges was de minimis during the three months ended March 31, 2010. As of March 31, 2010, $358 million, net of tax, of the deferred net gains on derivatives that are recorded in AOCI are expected to be reclassified to net interest income over the next twelve months in connection with the recognition of interest income on these hedged items.

During the third quarter of 2008, the Company executed The Agreements on 30 million common shares of Coke. A consolidated subsidiary of SunTrust owns approximately 22.9 million Coke common shares and a consolidated subsidiary of SunTrust Bank owns approximately 7.1 million Coke common shares. These two subsidiaries entered into separate derivative contracts on their respective holdings of Coke common shares with a large, unaffiliated financial institution (the “Counterparty”). Execution of The Agreements (including the pledges of the Coke common shares pursuant to the terms of The Agreements) did not constitute a sale of the Coke common shares under U.S. GAAP for several reasons, including that ownership of the common shares was not legally transferred to the Counterparty. The Agreements were zero cost equity collars at inception, which caused the Agreements to be derivatives in their entirety. The Company has designated The Agreements as cash flow hedges of the Company’s probable forecasted sales of its Coke common shares, which are expected to occur in approximately six and a half and seven years from The Agreements’ effective date, for overall price volatility below the strike prices on the floor (purchased put) and above the strike prices on the ceiling (written call). Although the Company is not required to deliver its Coke common shares under The Agreements, the Company has asserted that it is probable that it will sell all of its Coke common shares at or around the settlement date of The Agreements. The Federal Reserve’s approval for Tier 1 capital was significantly based on this expected disposition of the Coke common shares under The Agreements or in another market transaction. Both the sale and the timing of such sale remain probable to occur as designated. At least quarterly, the Company assesses hedge effectiveness and measures hedge ineffectiveness with the effective portion of the changes in fair value of The Agreements recorded in AOCI and any ineffective portions recorded in trading account profits and commissions. None of the components of The Agreements’ fair values are excluded from the Company’s assessments of hedge effectiveness. Potential sources of ineffectiveness include changes in market dividends and certain early termination provisions. Ineffectiveness was de minimis during the three months ended March 31, 2009, but the Company did recognize approximately $7 million of ineffectiveness during the three months ended March 31, 2010, which was recorded in trading account profits and commissions. Other than potential measured hedge ineffectiveness, no amounts will be reclassified from AOCI over the next twelve months and any remaining amounts recorded in AOCI will be reclassified to earnings when the probable forecasted sales of the Coke common shares occur.

Economic Hedging and Trading Activities

In addition to designated hedging relationships, the Company also enters into derivatives as an end user as a risk management tool to economically hedge risks associated with certain non-derivative and derivative instruments, along with entering into derivatives in a trading capacity with its clients.

The primary risks that the Company economically hedges are interest rate risk, foreign exchange risk, and credit risk. The economic hedging activities are accomplished by entering into individual derivatives or by using derivatives on a macro basis, and generally accomplish the Company’s goal of mitigating the targeted risk. To the extent that specific derivatives are associated with specific hedged items, the notional amounts, fair values, and gains/(losses) on the derivatives are illustrated in the tables in this footnote.

 

   

The Company utilizes interest rate derivatives to mitigate exposures from various instruments.

 

  ¡  

The Company is subject to interest rate risk on its fixed rate debt. As market interest rates move, a portion of the fair value of the Company’s debt is affected. To protect against this risk on certain debt issuances that the Company has elected to carry at fair value, the Company has entered into pay variable-receive fixed interest rate swaps (in addition to entering into certain non-derivative instruments on a macro basis) that decrease in value in a rising rate environment and increase in value in a declining rate environment.

 

  ¡  

The Company is exposed to interest rate risk associated with MSRs, which the Company hedges with a combination of derivatives, including MBS forward and option contracts, and interest rate swap and swaption contracts. At January 1, 2010, the Company elected fair value for MSRs previously accounted for at LOCOM which resulted in an increase in associated hedging activity during the current year.

 

  ¡  

The Company enters into MBS forward and option contracts, interest rate swap and swaption contracts, futures contracts, and eurodollar options to mitigate interest rate risk associated with IRLCs, mortgage LHFS, and mortgage loans held for investment reported at fair value.

 

   

The Company is exposed to foreign exchange rate risk associated with certain senior notes denominated in euros and pound sterling. This risk is economically hedged with cross currency swaps, which receive either euros or pound sterling and pay U.S. dollars. Interest expense on the Consolidated Statements of Income/(Loss) reflects only the contractual interest rate on the debt based on the average spot exchange rate during the applicable period, while fair value changes on the derivatives and valuation adjustments on the debt are both recorded within trading account profits and commissions.

 

   

The Company enters into CDS to hedge credit risk associated with certain loans held within its Corporate and Investment Banking line of business.

 

   

Trading activity, in the tables in this footnote, primarily includes interest rate swaps, equity derivatives, CDS, futures, options and foreign currency contracts. These derivatives are entered into in a dealer capacity to facilitate client transactions or are utilized as a risk management tool by the Company as an end user in certain macro-hedging strategies. The macro-hedging strategies are focused on managing the Company’s overall interest rate risk exposure that is not otherwise hedged by derivatives or in connection with specific hedges and, therefore, the Company does not specifically associate individual derivatives with specific assets or liabilities.

Reinsurance Arrangements and Guarantees
Reinsurance Arrangements and Guarantees

Note 11 - Reinsurance Arrangements and Guarantees

Reinsurance

The Company provides mortgage reinsurance on certain mortgage loans through contracts with several primary mortgage insurance companies. Under these contracts, the Company provides aggregate excess loss coverage in a mezzanine layer in exchange for a portion of the pool’s mortgage insurance premium. As of March 31, 2010, approximately $14.6 billion of mortgage loans were covered by such mortgage reinsurance contracts. The reinsurance contracts are intended to place limits on the Company’s maximum exposure to losses by defining the loss amounts ceded to the Company as well as by establishing trust accounts for each contract. The trust accounts, which are comprised of funds contributed by the Company plus premiums earned under the reinsurance contracts, are maintained to fund claims made under the reinsurance contracts. If claims exceed funds held in the trust accounts, the Company does not intend to make additional contributions beyond future premiums earned under the existing contracts.

At March 31, 2010, the total loss exposure ceded to the Company was approximately $638 million; however, the maximum amount of loss exposure based on funds held in each separate trust account, including net premiums due to the trust accounts, was limited to $287 million. Of this amount, $284 million of losses have been reserved for as of March 31, 2010, reducing the Company’s net remaining loss exposure to $3 million. Future reported losses may exceed $3 million, since future premium income will increase the amount of funds held in the trust; however, future cash losses, net of premium income, are not expected to exceed $3 million. The amount of future premium income is limited to the population of loans currently outstanding since additional loans are not being added to the reinsurance contracts; future premium income could be further curtailed to the extent the Company agrees to relinquish control of individual trusts to the mortgage insurance companies. Premium income, which totaled $11 million and $13 million for the three month periods ended March 31, 2010 and March 31, 2009, respectively, are reported as part of noninterest income. The related provision for losses, which totaled $9 million and $70 million for the three month periods ended March 31, 2010 and March 31, 2009, respectively, is reported as part of noninterest expense.

 

The reserve for estimated losses incurred under its reinsurance contracts totaled $284 million at March 31, 2010 and $285 million at December 31, 2009. The Company’s evaluation of the required reserve amount includes an estimate of claims to be paid by the trust related to loans in default and an assessment of the sufficiency of future revenues, including premiums and investment income on funds held in the trusts, to cover future claims.

Guarantees

The Company has undertaken certain guarantee obligations in the ordinary course of business. The issuance of a guarantee imposes an obligation for the Company to stand ready to perform, and should certain triggering events occur, it also imposes an obligation to make future payments. Payments may be in the form of cash, financial instruments, other assets, shares of stock, or provisions of the Company’s services. The following is a discussion of the guarantees that the Company has issued as of March 31, 2010. In addition, the Company has entered into certain contracts that are similar to guarantees, but that are accounted for as derivatives (see Note 10, “Derivative Financial Instruments,” to the Consolidated Financial Statements).

Visa

The Company issues and acquires credit and debit card transactions through Visa. The Company is a defendant, along with Visa U.S.A. Inc. and MasterCard International (the “Card Associations”), as well as several other banks, in one of several antitrust lawsuits challenging the practices of the Card Associations (the “Litigation”). The Company has entered into judgment and loss sharing agreements with Visa and certain other banks in order to apportion financial responsibilities arising from any potential adverse judgment or negotiated settlements related to the Litigation. Additionally, in connection with Visa’s restructuring in 2007, a provision of the original Visa By-Laws, Section 2.05j, was restated in Visa’s certificate of incorporation. Section 2.05j contains a general indemnification provision between a Visa member and Visa, and explicitly provides that after the closing of the restructuring, each member’s indemnification obligation is limited to losses arising from its own conduct and the specifically defined Litigation. The maximum potential amount of future payments that the Company could be required to make under this indemnification provision cannot be determined as there is no limitation provided under the By-Laws and the amount of exposure is dependent on the outcome of the Litigation. Since 2008, Visa has funded $4.8 billion into an escrow account, established for the purpose of funding judgments in, or settlements of, the Litigation. Agreements associated with Visa’s IPO have provisions that Visa will first use the funds in the escrow account to pay for future settlements of, or judgments in the Litigation. If the escrow account is insufficient to cover the Litigation losses, then Visa will issue additional Class A shares (“loss shares”). The proceeds from the sale of the loss shares would then be deposited in the escrow account. The issuance of the loss shares will cause a dilution of Visa’s Class B common stock as a result of an adjustment to lower the conversion factor of the Class B common stock to Class A common stock. Visa USA’s members are responsible for any portion of the settlement or loss on the Litigation after the escrow account is depleted and the value of the Class B shares is fully-diluted.

In May 2009, the Company sold its 3.2 million shares of Class B Visa Inc. common stock to another financial institution (“the Counterparty”) and entered into a derivative with the Counterparty. The Company received $112 million and recognized a gain of $112 million in connection with these transactions. Under the derivative, the Counterparty will be compensated by the Company for any decline in the conversion factor as a result of the outcome of the Litigation. Conversely, the Company will be compensated by the Counterparty for any increase in the conversion factor. The Counterparty, as a result of its ownership of the Class B common stock, will be impacted by dilutive adjustments to the conversion factor of the Class B common stock caused by the Litigation losses. A high degree of subjectivity was used in estimating the fair value of the derivative liability, and the ultimate cost to the Company could be significantly higher or lower than the $40 million recorded as of March 31, 2010 and December 31, 2009.

Letters of Credit

Letters of credit are conditional commitments issued by the Company generally to guarantee the performance of a client to a third party in borrowing arrangements, such as CP, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients and may be reduced by selling participations to third parties. The Company issues letters of credit that are classified as financial standby, performance standby, or commercial letters of credit. Commercial letters of credit are specifically excluded from the disclosure and recognition requirements.

As of March 31, 2010 and December 31, 2009, the maximum potential amount of the Company’s obligation was $7.9 billion and $8.9 billion, respectively, for financial and performance standby letters of credit. The Company has recorded $119 million and $131 million in other liabilities for unearned fees related to these letters of credit as of March 31, 2010 and December 31, 2009, respectively. The Company’s outstanding letters of credit generally have a term of less than one year but may extend longer than one year. If a letter of credit is drawn upon, the Company may seek recourse through the client’s underlying obligation. If the client’s line of credit is also in default, the Company may take possession of the collateral securing the line of credit, where applicable. The Company monitors its credit exposure under standby letters of credit in the same manner as it monitors other extensions of credit in accordance with credit policies. Some standby letters of credit are designed to be drawn upon and others are drawn upon only under circumstances of dispute or default in the underlying transaction to which the Company is not a party. In all cases, the Company holds the right to reimbursement from the applicant and may or may not also hold collateral to secure that right. An internal assessment of the probability of default and loss severity in the event of default is assessed consistent with the methodologies used for all commercial borrowers and the management of risk regarding letters of credit leverages the risk rating process to focus higher visibility on the higher risk and higher dollar letters of credit. The associated reserve is a component of the unfunded commitment reserve included in the allowance for credit losses as disclosed in Note 4, “Allowance for Credit Losses,” to the Consolidated Financial Statements.

 

Loan Sales

STM, a consolidated subsidiary of SunTrust, originates and purchases residential mortgage loans, a portion of which are sold to outside investors in the normal course of business. When mortgage loans are sold, representations and warranties regarding certain attributes of the loans sold are made to the third party purchaser. These representations and warranties may extend through the life of the mortgage loan, up to 25 to 30 years. Subsequent to the sale, if an inadvertent underwriting deficiency or documentation defect is discovered, STM may be obligated to reimburse the investor for losses incurred or to repurchase the mortgage loan if such deficiency or defect cannot be cured by STM within the specified period following discovery. STM’s risk of loss under its representations and warranties is largely driven by borrower payment performance since investors will perform extensive reviews of delinquent loans as a means of mitigating losses.

STM maintains a liability for this loss contingency, which is initially based on the estimated fair value of the Company’s contingency at the time loans are sold and the guarantee liability is created. Subsequently, STM estimates losses that have been incurred and increases the liability if estimated incurred losses exceed the guarantee liability. As of March 31, 2010 and December 31, 2009, the liability for contingent losses related to sold loans totaled $210 million and $200 million, respectively. STM also maintains a liability for contingent losses related to MSR sales, which totaled $2 million and $3 million as of March 31, 2010 and December 31, 2009, respectively.

The unpaid principal balance related to investor demands resolved by either reimbursing the investor for losses incurred or repurchasing the loan during the three months ended March 31, 2010 and 2009, totaled $204 million and $71 million, respectively. As of March 31, 2010 and December 31, 2009, the carrying value of outstanding repurchased nonperforming mortgage loans, exclusive of any allowance for loan losses, totaled $190 million and $146 million, respectively.

Contingent Consideration

The Company has contingent payment obligations related to certain business combination transactions. Payments are calculated using certain post-acquisition performance criteria. Arrangements entered into prior to January 1, 2009 are not recorded as liabilities; whereas arrangements entered into subsequent to that date are recorded as liabilities. The potential obligation associated with these arrangements was approximately $6 million and $13 million as of March 31, 2010 and December 31, 2009, respectively, of which $4 million was recorded as liabilities representing the fair value of the contingent payments as of March 31, 2010 and December 31, 2009. If required, these contingent payments will be payable at various times over the next five years.

Public Deposits

The Company holds public deposits of various states in which it does business. Individual state laws require banks to collateralize public deposits, typically as a percentage of their public deposit balance in excess of FDIC insurance and may also require a cross-guarantee among all banks holding public deposits of the individual state. The amount of collateral required varies by state and may also vary by institution within each state, depending on the individual state’s risk assessment of depository institutions. Certain of the states in which the Company holds public deposits use a pooled collateral method, whereby in the event of default of a bank holding public deposits, the collateral of the defaulting bank is liquidated to the extent necessary to recover the loss of public deposits of the defaulting bank. To the extent the collateral is insufficient, the remaining public deposit balances of the defaulting bank are recovered through an assessment, from the other banks holding public deposits in that state. The maximum potential amount of future payments the Company could be required to make is dependent on a variety of factors, including the amount of public funds held by banks in the states in which the Company also holds public deposits and the amount of collateral coverage associated with any defaulting bank. Individual states appear to be monitoring risk relative to the current economic environment and evaluating collateral requirements and therefore, the likelihood that the Company would have to perform under this guarantee is dependent on whether any banks holding public funds default as well as the adequacy of collateral coverage.

 

Other

In the normal course of business, the Company enters into indemnification agreements and provides standard representations and warranties in connection with numerous transactions. These transactions include those arising from securitization activities, underwriting agreements, merger and acquisition agreements, loan sales, contractual commitments, payment processing sponsorship agreements, and various other business transactions or arrangements. The extent of the Company’s obligations under these indemnification agreements depends upon the occurrence of future events; therefore, the Company’s potential future liability under these arrangements is not determinable.

STIS and STRH, broker-dealer affiliates of SunTrust, use a common third party clearing broker to clear and execute their customers’ securities transactions and to hold customer accounts. Under their respective agreements, STIS and STRH agree to indemnify the clearing broker for losses that result from a customer’s failure to fulfill its contractual obligations. As the clearing broker’s rights to charge STIS and STRH have no maximum amount, the Company believes that the maximum potential obligation cannot be estimated. However, to mitigate exposure, the affiliate may seek recourse from the customer through cash or securities held in the defaulting customers’ account. For the three month periods ended March 31, 2010 and March 31, 2009, STIS and STRH experienced minimal net losses as a result of the indemnity. The clearing agreements expire in May 2015 for both STIS and STRH.

SunTrust Community Capital, a SunTrust subsidiary, previously obtained state and federal tax credits through the construction and development of affordable housing properties and continues to obtain state and federal tax credits through investments as a limited partner in affordable housing developments. SunTrust Community Capital or its subsidiaries are limited and/or general partners in various partnerships established for the properties. If the partnerships generate tax credits, those credits may be sold to outside investors. As of March 31, 2010, SunTrust Community Capital has completed six tax credit sales containing guarantee provisions stating that SunTrust Community Capital will make payment to the outside investors if the tax credits become ineligible. SunTrust Community Capital also guarantees that the general partner under the transaction will perform on the delivery of the credits. The guarantees are expected to expire within a ten year period from inception. As of March 31, 2010, the maximum potential amount that SunTrust Community Capital could be obligated to pay under these guarantees is $39 million; however, SunTrust Community Capital can seek recourse against the general partner. Additionally, SunTrust Community Capital can seek reimbursement from cash flow and residual values of the underlying affordable housing properties provided that the properties retain value. As of March 31, 2010 and December 31, 2009, $9 million was accrued representing the remainder of tax credits to be delivered, and were recorded in other liabilities on the Consolidated Balance Sheets.

Concentrations of Credit Risk
Concentrations of Credit Risk

Note 12 - Concentrations of Credit Risk

Credit risk represents the maximum accounting loss that would be recognized at the reporting date if borrowers failed to perform as contracted and any collateral or security proved to be of no value. Concentrations of credit risk (whether on- or off-balance sheet) arising from financial instruments can exist in relation to individual borrowers or groups of borrowers, certain types of collateral, certain types of industries, certain loan products, or certain regions of the country.

Credit risk associated with these concentrations could arise when a significant amount of loans, related by similar characteristics, are simultaneously impacted by changes in economic or other conditions that cause their probability of repayment to be adversely affected. The Company does not have a significant concentration of risk to any individual client except for the U.S. government and its agencies. The major concentrations of credit risk for the Company arise by collateral type in relation to loans and credit commitments. The only significant concentration that exists is in loans secured by residential real estate. At March 31, 2010, the Company owned $46.5 billion in residential mortgage loans and home equity lines, representing 41% of total loans, $3.4 billion of residential construction loans, representing 3% of total loans, and an additional $14.8 billion in commitments to extend credit on home equity loans and $10.2 billion in mortgage loan commitments. At December 31, 2009, the Company had $46.7 billion in residential mortgage loans and home equity lines, representing 41% of total loans, $3.8 billion of residential construction loans, representing 3% of total loans and an additional $15.2 billion in commitments to extend credit on home equity loans and $12.2 billion in mortgage loan commitments. The Company originates and retains certain residential mortgage loan products that include features such as interest only loans, high LTV loans, and low initial interest rate loans. As of March 31, 2010, the Company owned $14.9 billion of interest only loans, primarily with a 10 year interest only period. Approximately $2.5 billion of those loans had combined original LTV ratios in excess of 80% with no mortgage insurance. Additionally, the Company owned approximately $3.0 billion of amortizing loans with combined original LTV ratios in excess of 80% with no mortgage insurance. The Company attempts to mitigate and control the risk in each loan type through private mortgage insurance and underwriting guidelines and practices. A geographic concentration arises because the Company operates primarily in the Southeastern and Mid-Atlantic regions of the United States.

 

SunTrust engages in limited international banking activities. The Company’s total cross-border outstanding loans were $513 million and $572 million as of March 31, 2010 and December 31, 2009, respectively.

Fair Value Measurement and Election
Fair Value Measurement and Election

Note 13 - Fair Value Measurement and Election

The Company carries certain assets and liabilities at fair value on a recurring basis and appropriately classifies them as level 1, level 2 or level 3 within the fair value hierarchy. The Company’s recurring fair value measurements are based on a requirement to carry such assets and liabilities at fair value or the Company’s election to carry certain financial assets and financial liabilities at fair value. Assets and liabilities that are required to be carried at fair value on a recurring basis include trading securities, securities AFS, and derivative financial instruments. Assets and liabilities that the Company has elected to carry at fair value on a recurring basis include certain loans and LHFS, MSRs and certain issuances of fixed rate debt.

In certain circumstances, fair value enables a company to more accurately align its financial performance with the economic value of actively traded or hedged assets or liabilities. Fair value also enables a company to mitigate the non-economic earnings volatility caused from financial assets and financial liabilities being carried at different bases of accounting, as well as to more accurately portray the active and dynamic management of a company’s balance sheet. In cases where the Company believed that fair value was more representative of the results of its activities, the Company elected to carry certain financial instruments at fair value, as discussed further herein.

The classification of an instrument as level 3 versus level 2 involves judgment and is based on a variety of subjective factors. A market is considered “inactive” if significant decreases in the volume and level of activity for the asset or liability have been observed. In determining whether a market is inactive, the Company evaluates such factors as the number of recent transactions in either the primary or secondary markets, whether price quotations are current, the nature of the market participants, the variability of price quotations, the significance of bid/ask spreads, declines in (or the absence of) new issuances and the availability of public information. Inactive markets necessitate the use of additional judgment when valuing financial instruments, such as pricing matrices, cash flow modeling and the selection of an appropriate discount rate. The assumptions used to estimate the value of an instrument where the market was inactive were based on the Company’s assessment of the assumptions a market participant would use to value the instrument in an orderly transaction and included considerations of illiquidity in the current market environment. Where the Company determined that a significant decrease in the volume and level of activity had occurred, the Company was then required to evaluate whether significant adjustments were required to market data to arrive at an exit price.

Beginning January 1, 2010, the Company changed its policy for recording transfers into and out of the fair value hierarchy levels in response to amended U.S. GAAP. All such transfers are now assumed to be as of the end of the quarter in which the transfer occurred, whereas, previously, the Company assumed transfers into levels to occur at the beginning of a period and transfers out of levels to occur at the end of a period. None of the transfers into or out of level 3 have been the result of using alternative valuation approaches to estimate fair values.

 

Recurring Fair Value Measurements

 

          Fair Value Measurements at
March 31, 2010
Using
(Dollars in thousands) (Unaudited)        Assets/Liabilities        Quoted
Prices In
Active
Markets
for
Identical
Assets/Liabilities
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Assets

           

Trading assets

           

U.S. Treasury securities

   $856,962      $856,962      $-      $-  

Federal agency securities

   418,466      -      418,466      -  

U.S. states and political subdivisions

   209,501      -      202,773      6,728  

Residential mortgage-backed securities - agency

   159,547      -      159,547      -  

Residential mortgage-backed securities - private

   5,288      -      -      5,288  

Collateralized debt obligations

   158,252      -      -      158,252  

Corporate and other debt securities

   530,742      -      530,742      -  

Commercial paper

   44,704      -      44,704      -  

Asset-backed securities

   50,908      -      282      50,626  

Equity securities

   250,375      23      105,093      145,259  

Derivative contracts

   2,628,972      146,250      2,461,262      21,460  

Trading loans

   724,387      -      724,387      -  
                   

Total trading assets

               6,038,104                  1,003,235                  4,647,256                  387,613  
                   

Securities available for sale

           

U.S. Treasury securities

   5,205,500      5,205,500      -      -  

Federal agency securities

   2,001,249      -      2,001,249      -  

U.S. states and political subdivisions

   915,774      -      784,764      131,010  

Residential mortgage-backed securities - agency

   13,710,908      -      13,710,908      -  

Residential mortgage-backed securities - private

   369,206      -      -      369,206  

Corporate and other debt securities

   509,158      -      504,608      4,550  

Asset-backed securities

   1,003,799      -      895,886      107,913  

Common stock of The Coca-Cola Company

   1,650,000      1,650,000      -      -  

Other equity securities 3

   872,935      197      167,940      704,798  
                   

Total securities available for sale

   26,238,529      6,855,697      18,065,355      1,317,477  
                   

Loans held for sale

           

Residential loans

   2,330,681      -      2,178,919      151,762  

Corporate and other loans

   320,299      -      310,899      9,400  

Loans

   420,484      -      -      420,484  

Other intangible assets 2

   1,641,188      -      -      1,641,188  

Other assets 1

   96,362      -      63,679      32,683  

Liabilities

           

Trading liabilities

           

U.S. Treasury securities

   1,348,719      1,348,719      -      -  

Federal agency securities

   3,813      -      3,813      -  

Corporate and other debt securities

   161,307      -      161,307      -  

Equity securities

   248      248      -      -  

Derivative contracts

   1,732,803      81,895      1,650,908      -  
                   

Total trading liabilities

   3,246,890      1,430,862      1,816,028      -  
                   

Brokered deposits

   1,241,806      -      1,241,806      -  

Long-term debt

   3,944,137      -      3,944,137      -  

Other liabilities 1

   75,214      -      33,082      42,132  

1 These amounts include IRLCs and derivative financial instruments entered into by the Household Lending line of business to hedge its interest rate risk along with a derivative associated with the Company’s sale of Visa shares during the quarter ended June 30, 2009.

2 This amount includes MSRs carried at fair value.

3 Includes $343 million of FHLB of Cincinnati and FHLB of Atlanta stock stated at par value and $360 million of Federal Reserve Bank stock stated at par value.

 

          Fair Value Measurements  at
December 31, 2009,
Using
(Dollars in thousands) (Unaudited)      Assets/Liabilities      Quoted
Prices  In
Active
Markets
for
Identical
  Assets/Liabilities  
(Level 1)
     Significant  
Other
Observable
Inputs
(Level 2)
   Significant
  Unobservable  
Inputs

(Level 3)

Assets

           

Trading assets

           

U.S. Treasury and federal agencies

   $1,150,323     $498,781     $651,542     $- 

U.S. states and political subdivisions

   58,520        51,119     7,401 

Residential mortgage-backed securities - agency

   94,164        94,164    

Residential mortgage-backed securities - private

   13,889           13,889 

Collateralized debt obligations

   174,886           174,886 

Corporate debt securities

   464,684        464,684    

Commercial paper

   639        639    

Other debt securities

   25,886        1,183     24,703 

Equity securities

   163,053     1,049     11,260     150,744 

Derivative contracts

   2,610,288     102,520     2,507,768    

Other

   223,606        205,136     18,470 
                   

Total trading assets

   4,979,938     602,350     3,987,495     390,093 
                   

Securities available for sale

           

U.S. Treasury and federal agencies

   7,914,111     5,176,525     2,737,586    

U.S. states and political subdivisions

   945,057        812,949     132,108 

Residential mortgage-backed securities - agency

   15,916,077        15,916,077    

Residential mortgage-backed securities - private

   407,228           407,228 

Other debt securities

   797,403        719,449     77,954 

Common stock of The Coca-Cola Company

   1,710,000     1,710,000       

Other equity securities 3

   787,166     182     82,187     704,797 
                   

Total securities available for sale

   28,477,042     6,886,707     20,268,248     1,322,087 
                   

Loans held for sale

   2,923,375        2,771,890     151,485 

Loans

   448,720           448,720 

Other intangible assets 2

   935,561           935,561 

Other assets 1

   150,272        136,790     13,482 

Liabilities

           

Brokered deposits

   1,260,505        1,260,505    

Trading liabilities

   2,188,923     259,103     1,883,954     45,866 

Long-term debt

   3,585,892        3,585,892    

Other liabilities 1

   125,239        77,105     48,134 

1 These amounts include IRLCs and derivative financial instruments entered into by the Household Lending line of business to hedge its interest rate risk along with a derivative associated with the Company’s sale of Visa shares during the quarter ended June 30, 2009.

2 This amount includes MSRs carried at fair value.

3 Includes $343 million of FHLB of Cincinnati and FHLB of Atlanta stock stated at par value and $360 million of Federal Reserve Bank stock stated at par value.

The following tables present the difference between the aggregate fair value and the aggregate unpaid principal balance of trading assets, loans, LHFS, brokered deposits, and long-term debt instruments for which the FVO has been elected. For loans and LHFS for which the FVO has been elected, the tables also include the difference between aggregate fair value and the aggregate unpaid principal balance of loans that are 90 days or more past due, as well as loans in nonaccrual status.

 

(Dollars in thousands) (Unaudited)    Aggregate
Fair Value
March 31,  2010
   Aggregate
Unpaid Principal
Balance under FVO
March 31, 2010
   Fair Value
Over/(Under)
Unpaid Principal

Trading assets

   $724,387     $704,981     $19,406  

Loans

   390,994     441,569     (50,575) 

Past due loans of 90 days or more

   353     694     (341) 

Nonaccrual loans

   29,137     54,988     (25,851) 

Loans held for sale

   2,598,356     2,588,358     9,998 

Past due loans of 90 days or more

   1,806     2,242     (436) 

Nonaccrual loans

   50,818     110,992     (60,174) 

Brokered deposits

   1,241,806     1,264,894     (23,088) 

Long-term debt

   3,944,137     3,902,259     41,878 
(Dollars in thousands) (Unaudited)    Aggregate
Fair Value
     December 31, 2009    
   Aggregate
Unpaid Principal
Balance under  FVO
    December 31, 2009    
   Fair Value
Over/(Under)
     Unpaid Principal    

Trading assets

   $286,544     $261,693     $24,851  

Loans

   397,764     453,751     (55,987) 

Past due loans of 90 days or more

   4,697     8,358     (3,661) 

Nonaccrual loans

   46,259     83,396     (37,137) 

Loans held for sale

   2,889,111     2,874,578     14,533 

Past due loans of 90 days or more

   3,288     4,929     (1,641) 

Nonaccrual loans

   30,976     52,019     (21,043) 

Brokered deposits

   1,260,505     1,319,901     (59,396) 

Long-term debt

   3,585,892     3,613,085     (27,193) 

 

The following tables present the change in fair value during the three months ended March 31, 2010 and 2009 of financial instruments for which the FVO has been elected.

 

     Fair Value Gain/(Loss) for the Three Months  Ended
March 31, 2010, for Items Measured at Fair Value Pursuant
to  Election of the Fair Value Option
(Dollars in thousands) (Unaudited)    Trading Account
Profits/(losses) and
Commissions
   Mortgage
    Production    
Related
Income
2
       Mortgage    
Servicing
Related
Income
   Total
Changes in
Fair Values
    Included in    
Current-

Period
Earnings
1

Assets

           

Trading assets

   $898      $-           $-           $898  

Loans held for sale

   10,711      92,194      -           102,905  

Loans, net

   (107)     (362)     -           (469) 

Other intangible assets

   -           3,864      (109,128)     (105,264) 

Liabilities

           

Brokered deposits

   (30,790)     -           -           (30,790) 

Long-term debt

   (85,553)     -           -           (85,553) 

 

1 Changes in fair value for the quarter ended March 31, 2010, exclude accrued interest for the periods then ended. Interest income or interest expense on trading assets, loans, loans held for sale, brokered deposits and long-term debt that have been elected to be carried at fair value are recorded in interest income or interest expense in the Consolidated Statements of Income/(Loss) based on their contractual coupons. Certain trading assets do not have a contractually stated coupon and, for these securities, the Company records interest income based on the effective yield calculated upon acquisition of those securities.

2 For the quarter ended March 31, 2010, income related to LHFS, includes $62 million related to MSRs recognized upon the sale of loans reported at fair value. For the quarter ended March 31, 2010, income related to other intangible assets includes $4 million of MSRs recognized upon the sale of loans reported at LOCOM. These MSRs are included in the table since the Company elected to report MSRs recognized in 2009 using the fair value method. Previously, MSRs were reported under the amortized cost method.

 

     Fair Value Gain/(Loss) for the Three Months  Ended
March 31, 2009, for Items Measured at Fair Value Pursuant
to Election of the Fair Value  Option
(Dollars in thousands) (Unaudited)    Trading Account
Profits  and
Commissions
   Mortgage
    Production    
Related
Income
2
       Mortgage    
Servicing
Related
Income
   Total
Changes in

    Fair  Values    
Included in
Current-
Period
Earnings1

Assets

           

Trading assets

   ($155)     $-              $-              ($155) 

Loans held for sale

   -      287,198      -      287,198  

Loans

   1,859      (5,129)     -      (3,270) 

Other intangible assets

   -      4,572      (25,798)     (21,226) 

Liabilities

           

Brokered deposits

   17,452      -      -      17,452  

Long-term debt

   168,666      -      -      168,666  

 

1 Changes in fair value for the three months ended March 31, 2009, exclude accrued interest for the periods then ended. Interest income or interest expense on trading assets, loans, loans held for sale, brokered deposits and long-term debt that have been elected to be carried at fair value are recorded in interest income or interest expense in the Consolidated Statements of Income/(loss) based on their contractual coupons. Certain trading assets do not have a contractually stated coupon and, for these securities, the Company records interest income based on the effective yield calculated upon acquisition of those securities.

2 For the three months ended March 31, 2009, income related to LHFS, net includes $142 million related to MSRs recognized upon the sale of loans reported at fair value. For the three months ended March 31, 2009, income related to other intangible assets includes $5 million of MSRs recognized upon the sale of loans reported at LOCOM. These MSRs are included in the table since the Company elected to report MSRs recognized in 2009 using the fair value method. Previously, MSRs were reported under the amortized cost method.

The following is a discussion of the valuation techniques and inputs used in developing fair value measurements for assets and liabilities classified as level 2 or level 3 that are measured at fair value on a recurring basis, based on the class as determined by the nature and risks of the instrument.

Trading Assets and Securities Available for Sale

Federal agency securities

The Company includes in this classification securities issued by federal agencies and GSEs. Agency securities consist of debt obligations issued by HUD, the FHFA and other agencies, or collateralized by loans that are guaranteed by the SBA and are, therefore, backed by the full faith and credit of the U.S. government. In the case of securities issued by GSEs such as Fannie Mae, Freddie Mac, and FHLB, the obligations are not guaranteed by the U.S. government; however, the GSEs are AAA rated and may be required to maintain such rating through its agency agreement. In certain instances, the U.S. Treasury owns the senior preferred stock of these enterprises and has made a commitment under that stock purchase agreement to provide these GSEs with funds to maintain a positive net worth. The majority of Federal agency securities are valued by an independent pricing service that is widely used by market participants. The Company has determined that this pricing service is using similar instruments that are trading in the markets as the basis for its estimates of fair value and, as such, the Company appropriately classifies these instruments as level 2. For SBA instruments, the Company estimates fair value based on pricing from observable trading activity for similar securities or obtains fair values from a third party pricing service; accordingly, the Company has also classified these instruments as level 2. These SBA instruments were transferred out of level 3 during the second quarter of 2009. The Company began to observe marginal increases in the volume and level of observable trading activity during the first quarter of 2009 and significant increases in such activity during the second quarter of 2009. This level of activity provided the Company with sufficient market evidence of pricing, such that the Company did not have to make any significant adjustments to observed pricing, nor was the Company’s pricing based on unobservable data.

 

U.S. states and political subdivisions

The Company’s investments in U.S. states and political subdivisions (collectively “municipals”) include obligations of county and municipal authorities and agency bonds, which are general obligations of the municipality or are supported by a specified revenue source. The majority of these obligations are priced by an independent pricing service using pricing observed on trades of similar bonds and, therefore, are classified as level 2 in the fair value hierarchy.

Level 3 municipal securities are primarily ARS purchased since the auction rate market began failing in February 2008 and have been considered level 3 securities due to the significant decrease in the volume and level of activity in these markets, which has necessitated the use of significant unobservable inputs into the Company’s valuations. Municipal ARS are classified as securities AFS or trading securities. The Company’s securities AFS and trading securities relating to municipal ARS at March 31, 2010 totaled $83 million and $7 million, respectively. These securities were valued using comparisons to similar ARS securities for which auctions are currently successful and/or to longer term, non-ARS securities issued by similar municipalities. The Company also looks at the relative strength of the municipality and makes appropriate downward adjustments in price based on the credit rating of the municipality as well as the relative financial strength of the insurer on those bonds. Although auctions for several municipal ARS continue to operate successfully, ARS owned by the Company at March 31, 2010 continue to be classified as level 3 as they are those ARS in which the auctions continue to fail and, therefore, due to the uncertainty around the success rates for auctions and the absence of any successful auctions for these identical securities, the Company continues to price the ARS below par.

Level 3 AFS municipal bond securities also include approximately $48 million of bonds that are only redeemable with the issuer at par and cannot be traded in the market. As such, no significant observable market data for these instruments is available. In order to estimate pricing on these securities, the Company utilizes a third party municipal bond yield curve for the lowest investment grade bonds (BBB rated) and prices each bond based on the yield associated with that maturity.

Residential mortgage-backed securities – agency

RMBS – agency include pass-through securities and collateralized mortgage obligations issued by GSEs and U.S. government agencies, such as Fannie Mae, Freddie Mac and Ginnie Mae. Each security contains a guarantee by the issuing GSE or agency. These securities are valued by an independent pricing service that is widely used by market participants. The Company has determined that this pricing service is using similar instruments that are trading in the market as the basis for its estimates of fair value and, as such, the Company appropriately classifies these instruments as level 2.

Residential mortgage-backed securities – private

RMBS – private includes purchased interests in third party securitizations as well as retained interests in Company-sponsored securitizations of residential mortgages. Generally, the Company attempts to obtain pricing for its securities from an independent pricing service or third party brokers who have experience in valuing certain investments. This pricing may be used as either direct support for the Company’s valuations or used to validate outputs from its own proprietary models. The Company evaluates third party pricing to determine the reasonableness of the information relative to changes in market data, such as any recent trades we executed, market information received from outside market participants and analysts, and/or changes in the underlying collateral performance. When actual trades are not available to corroborate pricing information received, the Company uses industry-standard or proprietary models to estimate fair value and considers assumptions that are generally not observable in the current markets or that are not specific to the securities that the Company owns, such as relevant market indices that correlate to the underlying collateral, prepayment speeds, default rates, loss severity rates and discount rates. During the quarter ended March 31, 2010, the Company began to observe a return of liquidity to the markets, resulting in the availability of more pricing information from third parties and a reduction in the need to use internal pricing models to estimate fair value. Even though limited third party pricing has been available, the Company continues to classify private RMBS as level 3, as the Company believes that this third party pricing relies on a significant amount of unobservable assumptions.

Certain vintages of private RMBS have suffered from deterioration in credit quality leading to downgrades. At March 31, 2010, the Company’s private RMBS contained approximately $306 million and $5 million of 2006 to 2007 vintage securities AFS and trading securities, respectively, and approximately $63 million of 2003 vintage securities AFS. All but a de minimis amount of the 2006 to 2007 vintage securities AFS and trading securities had been downgraded to non-investment grade levels by at least one nationally recognized rating agency. The vast majority of these securities had high investment grade ratings at the time of origination or purchase. The 2006 to 2007 vintage collateral is primarily comprised of prime jumbo fixed and floating rate loans. The 2003 vintage securities are interests retained from a securitization of prime first-lien fixed and floating rate loans and are primarily all investment grade rated, with the exception of a small amount of support bonds. The majority of these securities have maintained their original ratings, with a small amount of upgrades and only one bond downgraded since inception of the deal. Securities that are classified as AFS and are in an unrealized loss position are included as part of our quarterly OTTI evaluation process. See Note 3, “Securities Available for Sale,” to the Consolidated Financial Statements for details regarding assumptions used to assess impairment and impairment amounts recognized through earnings on private RMBS during the three months ended March 31, 2010.

 

Collateralized debt obligations

The Company’s investments in SIVs comprise the majority of the Company’s CDOs, along with senior ARS interests in Company-sponsored securitizations of trust preferred collateral. The Company had approximately $133 million and $149 million in SIV investments at March 31, 2010 and December 31, 2009, respectively. One SIV investment totaling $25 million matured and was paid in full, resulting in a gain of $5 million during the three months ended March 31, 2010. Two of the remaining three SIV investments totaling $129 million are in receivership at March 31, 2010. The Company’s trust preferred securitization interests totaled $26 million at March 31, 2010 and December 31, 2009. Because secondary market trading is not observable for any of these instruments and market data is generally not available for significant assumptions that would be used to estimate fair values, the Company has appropriately classified these instruments as level 3 within the fair value hierarchy.

To estimate the fair values of the SIV investments that are under receivership, the Company developed an internal model using cusip-specific information where the inputs are based on the best market information available. In addition, the Company has applied a liquidity discount to recognize the illiquid and unique nature of these investments, which was based on historical spreads between the estimated internal value and transaction prices for those investments the Company has been able to sell or settle. For the more liquid securities, such as corporate securities, the Company is able to use pricing from independent pricing services; however, for most of the tranches, fair values are estimated based on the most relevant market data available, such as vintage, rating, structure and monoline insurance wraps. In addition to individual security valuations, the fair values of the SIV investments include a cash component, which represents cash that the SIVs have received on the underlying assets prior to distribution.

CDOs related to trust preferred ARS purchased since the auction rate market began failing in February 2008 have been considered level 3 securities. The significant decrease in the volume and level of activity in these markets has necessitated the use of significant unobservable inputs into the Company’s valuations. The auctions for these ARS continue to fail and, therefore, actual trades are not available to corroborate pricing estimates. There are also no comparable or relevant indices for regional trust preferred collateral or CDOs, nor is indicative broker pricing or third party pricing available. The Company does have visibility into the underlying collateral in the CDOs and, therefore, can model expected cash flows using estimated discount rates based on pricing and/or spread levels seen on trades of similarly structured securities for valuation purposes.

Corporate and other debt securities

Corporate debt securities are predominantly comprised of senior and subordinate debt obligations of domestic corporations. These securities are valued by an independent pricing service that is widely used by market participants. The Company has determined that this pricing service is using similar instruments, or in some cases the same instruments, that are trading in the markets as the basis for its estimates of fair value. Because the Company does not have direct access to the pricing service’s valuation sources, the Company has determined that classification of these instruments as level 2 is appropriate.

Commercial paper

From time to time, the Company trades third party CP that is generally short-term in nature (less than 30 days) and highly rated (A-1/P-1). The Company estimates the fair value of the CP that it trades based on observable pricing from executed trades of similar instruments.

Asset-backed securities

Level 2 ABS includes $896 million of securities AFS that are collateralized by 2009 and 2010 vintage third party securitizations of auto loans. These ABS are either publicly traded or are 144A privately placed bonds. The Company utilizes an independent pricing service to obtain fair values for publicly traded securities and similar securities for estimating the fair value of the privately placed bonds. No significant unobservable assumptions are used in pricing the auto loan ABS and, therefore, the Company classifies these bonds as level 2.

 

Level 3 AFS ABS includes interests in third party securitizations of auto loans, home equity lines of credit that are vintage 2006 and prior, and ARS collateralized by student loans. Level 3 trading ABS includes the Company’s retained interest in a student loan securitization and ARS collateralized by student loans. These ARS have been considered level 3 securities due to the significant decrease in the volume and level of activity in these markets, which has necessitated the use of significant unobservable inputs into the Company’s valuations. Student loan ABS held by the Company are generally collateralized by FFELP student loans, the majority of which benefit from a 97% guarantee of principal and interest by U.S. government agencies. The Company utilizes a pricing matrix to value the student loan ABS for which base pricing is determined by market trades and bids for similar senior-level securities. Valuations are adjusted up or down from the base pricing matrix based on timing of the issuer’s ability to refinance, a security’s subordination level in the structure and/or perceived risk of the issuer as determined by ratings or total leverage of the trust.

Generally, the Company attempts to obtain pricing for these level 3 securities from an independent pricing service or third party brokers who have experience in valuing certain investments. This pricing may be used as either direct support for the valuations or used to validate outputs from the Company’s own proprietary models. The Company evaluates third party pricing to determine the reasonableness of the information relative to changes in market data, such as any recent trades, market information received from outside market participants and analysts, and/or changes in the underlying collateral performance. When actual trades are not available to corroborate pricing information, the Company uses industry-standard or proprietary models to estimate fair value and considers assumptions that are generally not observable in the current markets for the specific securities, such as relevant market indices that correlate to the underlying collateral, prepayment speeds, default rates, loss severity rates and discount rates. During the three months ended March 31, 2010, the Company began to observe a return of liquidity to the markets, resulting in the availability of more pricing information from third parties and a reduction in the need to use internal pricing models to estimate fair value. Even though limited third party pricing has been available, the Company continues to classify certain ABS as level 3, as the Company believes that pricing relies on a significant amount of unobservable assumptions.

Equity securities

Level 2 equity securities, both trading and AFS, consist primarily of MMMFs that trade at a $1 net asset value, which is considered the fair market value of those fund shares.

Level 3 equity securities classified as trading include nonmarketable preferred shares in municipal funds issued as ARS that the Company has purchased since the auction rate market began failing in February 2008. These ARS have been considered level 3 securities due to the significant decrease in the volume and level of activity in these markets, which has necessitated the use of significant unobservable inputs into the Company’s valuations. Valuation of these shares is based on the level of issuer redemptions at par that have occurred as well as discussions with the dealer community. During the three months ended March 31, 2010, approximately $13 million of the fund shares were redeemed by the issuer at face value resulting in a gain of $2 million. Due to the continued redemptions of these shares, the Company increased its estimated fair value at March 31, 2010 from its December 31, 2009 estimated fair value, resulting in an unrealized gain of $5 million at March 31, 2010.

Level 3 equity securities classified as securities AFS include, as of March 31, 2010, $343 million of FHLB stock and $360 million of Federal Reserve Bank stock, which are redeemable with the issuer at par and cannot be traded in the market. As such, no significant observable market data for these instruments is available. As discussed in Note 3, “Securities Available for Sale, the Company accounts for the stock based on the industry guidance, which requires these investments to be carried at cost and evaluated for impairment based on the ultimate recovery of par value.

Derivative contracts (trading assets or trading liabilities)

With the exception of one derivative contract discussed herein and certain instruments discussed under ‘Other assets/liabilities, net’ that qualify as derivative instruments, the Company’s derivative instruments are level 1 or level 2 instruments. Level 1 derivative contracts generally include exchange-traded futures or option contracts for which pricing is readily available.

The Company’s level 2 instruments are predominantly standard over-the-counter swaps, options and forwards, with underlying market variables of interest rates, foreign exchange, equity and credit. Because fair values for OTC contracts are not readily available, the Company estimates fair values using internal, but standard, valuation models that incorporate market-observable inputs. The valuation model will be driven by the type of contract: for option-based products, the Company will use an appropriate option pricing model, such as Black-Scholes; for forward-based products, the Company’s valuation methodology is generally a discounted cash flow approach. The primary drivers of the fair values of derivative instruments are the underlying variables, such as interest rates, exchange rates or credit. As such, the Company uses market-based assumptions for all of it significant inputs, such as interest rate yield curves, quoted exchange rates and spot prices, market implied volatilities and credit curves.

 

The Agreements the Company entered into related to its Coke stock are level 3 instruments, due to the unobservability of a significant assumption used to value these instruments. Because the value is primarily driven by the embedded equity collars on the Coke shares, a Black-Scholes model is the appropriate valuation model. Most of the assumptions are directly observable from the market, such as the per share market price of Coke common stock, interest rates, and the dividend rate on the Coke common stock. Volatility is a significant assumption and is impacted both by the unusually large size of the trade and the long tenor until settlement. Because the derivatives carry scheduled terms of approximately six and a half and seven years from the effective date and are on a significant number of Coke shares, the observable and active options market on Coke does not provide for any identical or similar instruments. As such, the Company receives estimated market values from a market participant who is knowledgeable about Coke equity derivatives and is active in the market. Based on inquiries of the market participant as to their procedures, as well as the Company’s own valuation assessment procedures, the Company has satisfied itself that the market participant is using methodologies and assumptions that other market participants would use in estimating the fair value of The Agreements. At March 31, 2010 and December 31, 2009, The Agreements’ fair value was in an asset position of approximately $21 million and a liability position of approximately $46 million.

Derivative instruments are primarily transacted in the institutional dealer market and priced with observable market assumptions at a mid-market valuation point, with appropriate valuation adjustments for liquidity and credit risk. For purposes of valuation adjustments to its derivative positions, the Company has evaluated liquidity premiums that may be demanded by market participants, as well as the credit risk of its counterparties and its own credit. The Company has considered factors such as the likelihood of default by itself and its counterparties, its net exposures, and remaining maturities in determining the appropriate fair value adjustments to record. Generally, the expected loss of each counterparty is estimated using the Company’s proprietary internal risk rating system. The risk rating system utilizes counterparty-specific probabilities of default and loss given default estimates to derive the expected loss. For counterparties that are rated by national rating agencies, those ratings are also considered in estimating the credit risk. In addition, counterparty exposure is evaluated by netting positions that are subject to master netting arrangements, as well as considering the amount of marketable collateral securing the position. Specifically approved counterparties and exposure limits are defined. Creditworthiness of the approved counterparties is regularly reviewed and appropriate business action is taken to adjust the exposure to certain counterparties, as necessary. This approach used to estimate exposures to counterparties is also used by the Company to estimate its own credit risk on derivative liability positions. To date, no material losses due to a counterparty’s inability to pay any net uncollateralized position have been incurred.

See Note 10, “Derivative Financial Instruments, to the Consolidated Financial Statements, for additional information on the Company’s derivative contracts.

Trading loans

The Company engages in certain businesses whereby the election to carry loans at fair value for financial reporting aligns with the underlying business purposes. Specifically, the loans that are included within this classification are: (i) loans made in connection with the Company’s TRS business (see Note 10, “Derivative Financial Instruments”, to the Consolidated Financial Statements for further discussion of this business), (ii) loans backed by the SBA and (iii) the loan sales and trading business within the Company’s CIB line of business. All of these loans have been classified as level 2 within the fair value hierarchy, due to the market data that the Company uses in its estimates of fair value.

The loans made in connection with the Company’s TRS business are short-term, demand loans, whereby the repayment is senior in priority and whose value is collateralized. While these loans do not trade in the market, the Company believes that the par amount of the loans approximates fair value and no unobservable assumptions are made by the Company to arrive at this conclusion. At March 31, 2010, the Company had approximately $399 million of such short-term loans carried at fair value and none were outstanding at December 31, 2009.

SBA loans are similar to SBA securities discussed herein under “Federal agency securities”, except for their legal form. In both cases, the Company trades instruments that are 97% guaranteed by the U.S. government and has sufficient observable trading activity upon which to base its estimates of fair value.

 

The loans from the Company’s sales and trading business are commercial and corporate leveraged loans that are either traded in the market or for which similar loans trade. The Company elected to carry these loans at fair value in order to reflect the active management of these positions. The Company is able to obtain fair value estimates for substantially all of these loans using a reputable, third-party valuation service that is broadly used by market participants. While most of the loans are traded in the markets, the Company does not believe that trading activity qualifies the loans as level 1 instruments within the fair value hierarchy, as the volume and level of trading activity is subject to variability and the loans are not exchange-traded, such that the Company believes that level 2 is a more appropriate presentation of the underlying market activity for the loans. At March 31, 2010 and December 31, 2009, approximately $323 million and $287 million, respectively, of loans related to the Company’s trading business were outstanding.

Loans and Loans Held for Sale

Residential loans

Current U.S. GAAP generally does not require loans to be measured at fair value on a recurring basis, but does provide for an election to do so. As such, in the second quarter of 2007, the Company began recording at fair value certain newly-originated mortgage LHFS based upon defined product criteria. The Company chose to fair value these mortgage LHFS in order to eliminate the complexities and inherent difficulties of achieving hedge accounting and to better align reported results with the underlying economic changes in value of the loans and related hedge instruments. This election impacts the timing and recognition of origination fees and costs, as well as servicing value. Specifically, origination fees and costs, which had been appropriately deferred and recognized as part of the gain/loss on sale of the loan, are now recognized in earnings at the time of origination. The servicing value, which had been recorded as MSRs at the time the loan was sold, is now included in the fair value of the loan and initially recognized at the time the Company enters into IRLCs with borrowers. The Company began using derivatives to economically hedge changes in servicing value as a result of including the servicing value in the fair value of the loan. The mark to market adjustments related to LHFS and the associated economic hedges are captured in mortgage production income.

Level 2 loans held for sale are primarily agency loans which trade in active secondary markets and are priced using current market pricing for similar securities adjusted for servicing and risk. Level 3 loans are primarily non-agency residential mortgage loans held for investment or LHFS for which there is little to no observable trading activity of similar instruments in either the new issuance or secondary loan markets as either whole loans or as securities. Prior to the non-agency residential loan market disruption, which began during the third quarter of 2007 and continues, the Company was able to obtain certain observable pricing from either the new issuance or secondary loan market. However, as the markets deteriorated and certain loans were not actively trading as either whole loans or as securities, the Company began employing the same alternative valuation methodologies used to value level 3 residential MBS to fair value the loans.

During the three months ended March 31, 2010, the Company transferred $160 million of nonperforming loans that were previously designated as held for investment to held for sale as the Company intends to sell these loans during the second quarter of 2010. These loans were predominantly reported at amortized cost prior to transferring to held for sale; however, a portion of the portfolio was carried at fair value. As a result, the incremental charge-off recorded upon transfer to held for sale primarily related to recording the amortized cost loans at the lower of cost or market. These nonperforming loans are classified as level 3 instruments and were valued at a discount of the estimated underlying collateral value consistent with how current investors are valuing such loans. In applying this methodology, the underlying collateral value was determined through broker price opinions and the discounts applied to the broker price opinions were based on market indications received from an independent third party broker that had analyzed these loans. There were no similar transfers during the three months ended March 31, 2009.

As disclosed in the tabular level 3 rollforwards, transfers of certain mortgage LHFS into level 3 during 2009 were largely due to borrower defaults or the identification of other loan defects impacting the marketability of the loans.

For residential loans that the Company has elected to carry at fair value, the Company has considered the component of the fair value changes due to instrument-specific credit risk, which is intended to be an approximation of the fair value change attributable to changes in borrower-specific credit risk. For the three months ended March 31, 2010 and 2009, the Company recognized losses in the Consolidated Statements of Income/(Loss) of approximately $5 million and $9 million, respectively, due to changes in fair value attributable to borrower-specific credit risk. In addition to borrower-specific credit risk, there are other, more significant, variables that drive changes in the fair values of the loans, including interest rates and general conditions in the principal markets for the loans.

 

Corporate and other loans

As discussed in Note 6, “Certain Transfers of Financial Assets, Mortgage Servicing Rights and Variable Interest Entities”, the Company has determined that it is the primary beneficiary of a CLO vehicle, which resulted in the Company consolidating the loans of that vehicle. Because the CLO trades its loans from time to time and in order to fairly present the economics of the CLO, the Company elected to carry the loans of the CLO at fair value. The Company is able to obtain fair value estimates for substantially all of these loans using a reputable, third party valuation service that is broadly used by market participants. While most of the loans are traded in the markets, the Company does not believe the loans qualify as level 1 instruments, as the volume and level of trading activity is subject to variability and the loans are not exchange-traded, such that the Company believes that level 2 is a fairer presentation of the general market activity for the loans.

Level 3 loans include $11 million of loans that were acquired through the acquisition of GB&T. The loans the Company elected to account for at fair value are primarily nonperforming commercial real estate loans, which do not trade in an active secondary market. As these loans are classified as nonperforming, cash proceeds from the sale of the underlying collateral is the expected source of repayment for a majority of these loans. Accordingly, the fair value of these loans is derived from internal estimates, incorporating market data when available, of the value of the underlying collateral.

Other Intangible Assets

Other intangible assets that the Company records at fair value are the Company’s MSR assets. As further discussed in Note 6, “Certain Transfers of Financial Assets, Mortgage Servicing Rights and Variable Interest Entities”, beginning January 1, 2010, the Company elected to account for all MSRs at fair value. The fair values of MSRs are determined by projecting cash flows, which are then discounted to estimate an expected fair value. The fair values of MSRs are impacted by a variety of factors, including prepayment assumptions, discount rates, delinquency rates, contractually specified servicing fees, and underlying portfolio characteristics. The underlying assumptions and estimated values are corroborated by values received from independent third parties based on their review of the servicing portfolio. Because these inputs are not transparent in market trades, MSRs are considered to be level 3 assets.

Other Assets/Liabilities, net

The Company’s other assets/liabilities that are carried at fair value on a recurring basis include IRLCs that satisfy the criteria to be treated as derivative financial instruments, derivative financial instruments that are used by the Company to economically hedge certain loans and MSRs, and the derivative that the Company obtained as a result of its sale of Visa Class B shares.

The fair value of IRLCs on residential mortgage LHFS, while based on interest rates observable in the market, is highly dependent on the ultimate closing of the loans. These “pull-through” rates are based on the Company’s historical data and reflect the Company’s best estimate of the likelihood that a commitment will ultimately result in a closed loan. Beginning in the first quarter of 2008, servicing value was included in the fair value of IRLCs in accordance with changes in accounting guidance. The fair value of servicing value is determined by projecting cash flows which are then discounted to estimate an expected fair value. The fair value of servicing value is impacted by a variety of factors, including prepayment assumptions, discount rates, delinquency rates, contractually specified servicing fees and underlying portfolio characteristics. Because these inputs are not transparent in market trades, IRLCs are considered to be level 3 assets.

During the three months ended March 31, 2010, the Company transferred $67 million of IRLCs out of level 3 as the associated loans were closed.

The Company is exposed to interest rate risk associated with MSRs, IRLCs, mortgage LHFS, and mortgage loans held for investment reported at fair value. The Company hedges these exposures with a combination of derivatives, including MBS forward and option contracts, interest rate swap and swaption contracts, futures contracts, and eurodollar options. The Company estimates the fair values of such derivative instruments consistent with the methodologies discussed herein under “Derivative contracts” and accordingly these derivatives are considered to be level 2 instruments.

During the second quarter of 2009, in connection with its sale of Visa Class B shares, the Company entered into a derivative contract whereby the ultimate cash payments received or paid, if any, under the contract are based on the ultimate resolution of litigation involving Visa. The value of the derivative was estimated based on the Company’s expectations regarding the ultimate resolution of that litigation, which involved a high degree of judgment and subjectivity. Accordingly, the value of the derivative liability was classified as a level 3 instrument. See Note 11, “Reinsurance Arrangements and Guarantees”, to the Consolidated Financial Statements for further discussion.

 

Liabilities

Trading liabilities

Trading liabilities are primarily comprised of derivative contracts, but also include various contracts involving U.S. Treasury securities, Federal agency securities and corporate debt securities that the Company uses in certain of its trading businesses. The Company employs the same valuation methodologies for these derivative contracts and securities as are discussed within the corresponding sections herein under “Trading Assets and Securities Available for Sale”.

Brokered deposits

The Company has elected to measure certain CDs at fair value. These debt instruments include embedded derivatives that are generally based on underlying equity securities or equity indices, but may be based on other underlyings that may or may not be clearly and closely related to the host debt instrument. The Company elected to carry these instruments at fair value in order to remove the mixed attribute accounting model for the single debt instrument or to better align the economics of the CDs with the Company’s risk management strategies. Prior to 2009, the Company had elected to carry substantially all newly-issued CDs at fair value; however, in 2009, given the continued dislocation in the credit markets, the Company evaluated, on an instrument by instrument basis, whether a new issuance would be carried at fair value.

The Company has classified these CDs as level 2 instruments due to the Company’s ability to reasonably measure all significant inputs based on observable market variables. The Company employs a discounted cash flow approach to the host debt component of the CD, based on observable market interest rates for the term of the CD and an estimate of the Bank’s credit risk. For the embedded derivative features, the Company uses the same valuation methodologies as if the derivative were a standalone derivative, as discussed herein under “Derivative contracts”.

For brokered deposits carried at fair value, the Company estimated credit spreads above LIBOR, based on credit spreads from actual or estimated trading levels of the debt, or other relevant market data. The Company recognized a loss of approximately $16 million for the three months ended March 31, 2010, and a gain of approximately $11 million for the three months ended March 31, 2009, due to changes in its own credit spread on its brokered deposits carried at fair value.

Long-term debt

The Company has elected to carry at fair value certain fixed rate debt issuances of public debt in which it has entered into derivative financial instruments that economically converted the interest rate on the debt from fixed to floating. The election to fair value the debt is made in order to align the accounting for the debt with the accounting for the derivatives without having to account for the debt under hedge accounting, thus avoiding the complex and time consuming fair value hedge accounting requirements.

The publicly-issued, fixed rate debt that the Company has elected to carry at fair value is valued by obtaining quotes from a third party pricing service and utilizing broker quotes to corroborate the reasonableness of those marks. In addition, information from market data of recent observable trades and indications from buy side investors, if available, are taken into consideration as additional support for the value. Due to the availability of this information, the Company determined that the appropriate classification for the debt was level 2.

For the publicly-traded fixed rate debt carried at fair value, the Company estimated credit spreads above U.S. Treasury rates based on credit spreads from actual or estimated trading levels of the debt, or other relevant market data. The Company recognized a loss of approximately $80 million for the three months ended March 31, 2010, and a gain of approximately $93 million for the three months ended March 31, 2009, due to changes in its own credit spread on its public debt carried at fair value.

The Company also carries approximately $285 million of issued securities contained in a CLO that have been consolidated under newly issue accounting guidance at fair value in order to recognize the nonrecourse nature of these liabilities to the Company (see Note 6, “Certain Transfers of Financial Assets, Mortgage Servicing Rights and Variable Interest Entities,” to the Consolidated Financial Statements for a discussion of this consolidation). Specifically, the holders of the liabilities are only paid interest and principal to the extent of the cash flows from the assets of the vehicle and the Company has no current or future obligations to fund any of the CLO vehicle’s liabilities. The Company has classified these securities as level 2, as the primary driver of their fair values are the loans owned by the CLO, which the Company has also elected to carry at fair value, as discussed herein under “Loans and Loans Held for Sale – Corporate and other loans”.

 

The following tables show a reconciliation of the beginning and ending balances for fair valued assets and liabilities measured on a recurring basis using significant unobservable inputs (other than MSRs which are disclosed in Note 5, “Goodwill and Other Intangible Assets”, to the Consolidated Financial Statements):

 

    Fair Value Measurements
Using Significant Unobservable Inputs
 
(Dollars in thousands) (Unaudited)   Ending
balance
  December 31,
2009  
    Reclassifications      Beginning
balance 
January 1,
2010
      Included in    
earnings
    Other
comprehensive
income
    Purchases,
sales,
issuances,
settlements,
maturities
paydowns, net
  Transfers
to/from other
balance sheet
line items
  Transfers
into
Level 37
  Transfers
out of
Level 37
  Fair value
March 31,
2010
  Change in
unrealized
gains/ (losses)
included in
earnings

for the three
months ended
March 31, 2010

related to
financial

assets still held
at March 31,
2010
 

Assets

                     

Trading assets

                     

U.S. states and political subdivisions

  $7,401    $-    $7,401    $127    5    $-           ($800)   $-        $-        $-        $6,728    ($374)   

Residential mortgage-backed securities - private

  13,889    (7,426)   6,463    215       -           (1,390)   -        -        -        5,288    (31)   

Collateralized debt obligations

  174,886    55    174,941    10,403    5    -           (27,092)   -        -        -        158,252    5,403    

Corporate and other debt securities

  24,703    (24,703)   -             -           -        -        -        -        -        -        

Asset-backed securities

  -        50,544    50,544    3,906    5    -           (3,824)   -        -        -        50,626    2,872    

Equity securities

  150,744    -        150,744    6,334    5    -           (11,819)   -        -        -        145,259    4,789    

Derivative contracts

  -        -        -        6,737       14,723    6    -        -        -        -        21,460    -        

Other

  18,470    (18,470)   -        -           -           -        -        -        -        -        -        
                                                 

Total trading assets

  390,093    -        390,093    27,722    1    14,723       (44,925)   -        -        -        387,613    12,659    1 
                                                 

Securities available for sale

                     

U.S. states and political subdivisions

  132,108    -        132,108    88    5    (141)      (1,045)   -        -        -        131,010    -        

Residential mortgage-backed securities - private

  407,228    (29,145)   378,083    (1,061)      17,077       (24,893)   -        -        -        369,206    (1,061)   

Corporate and other debt securities

  77,954    (73,404)   4,550    -