SunTrust 2006 Annual Report Download - page 131

SUNTRUST BANKS, INC.
Notes to Consolidated Financial Statements (Continued)
changes in value of the mortgage inventory due to changes in market interest rates. A portion of the
forward contracts have been documented as fair value hedges of specific pools of loans that meet the
similar assets test, and the qualifying pools of hedged loans are recorded in the financial statements at
their fair value. The pools of loans are matched with a certain portion of the forward contracts so that the
expected changes in market value will inversely offset within a range of 80% to 125%. This hedging
strategy resulted in ineffectiveness that reduced earnings by $21.1 million and $40.4 million for the
years ended December 31, 2006 and 2005, respectively. The impact of the hedge ineffectiveness is
substantially offset by higher levels of net interest income from holding first mortgage loans.
The Company has designated interest rate swaps and options as cash flow hedges of probable forecasted
transactions related to recognized assets and liabilities. The Company recognized interest expense of
$40.9 million and interest income of $15.2 million for the years ended December 31, 2006 and 2005,
respectively, related to interest rate swaps and options accounted for as cash flow hedges. During the
years ended December 31, 2006 and 2005, $2.2 million and $2.4 million, respectively, were recognized
as trading losses from hedge ineffectiveness of swaps and options and amounts excluded from the
assessment of effectiveness of option hedges.
Gains and losses on derivatives that are reclassified from accumulated other comprehensive income to
current period earnings are included in net interest income. As of December 31, 2006, $14.2 million, net
of taxes, of the deferred net gains on derivatives that are recorded in accumulated other comprehensive
income are expected to be reclassified to interest expense in the next twelve months as derivatives
mature or as payments are made.
Trading Activities
The Company enters into various derivative contracts on behalf of its clients and for its own trading
account. These trading positions primarily include interest rate swaps, equity derivatives, credit default
swaps, futures, options, and foreign currency contracts. The Company maintains positions in interest
rate swaps for its own trading account as part of its overall interest rate risk management strategy.
Foreign exchange derivative contracts are used to manage the Company’s foreign currency exchange
risk and to provide derivative products to customers. The Company does not have any hedges of foreign
currency exposure within the guidelines of SFAS No. 133. The Company buys and sells credit
protection to customers and dealers using credit default swaps. These derivative instruments allow the
Company to pay or receive a stream of payments in return for receiving or providing protection in the
event of default. These derivatives are accounted for as trading assets and any gain or loss in market
value is recorded in trading income. As of December 31, 2006 and 2005, referenced assets covered by
these arrangements totaled $979.0 million and $1,567.0 million, respectively.
Credit-Related Arrangements
In meeting the financing needs of its clients, the Company issues commitments to extend credit, standby
and other letters of credit, and guarantees. For additional information regarding guarantees, which
includes standby and other letters of credit see Note 18, “Guarantees” to the Consolidated Financial
Statements. The Company also provides securities lending services. For these instruments, the
contractual amount of the financial instrument represents the maximum potential credit risk if the
counterparty does not perform according to the terms of the contract. A large majority of these contracts
expire without being drawn upon. As a result, total contractual amounts do not represent actual future
credit exposure or liquidity requirements.
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