SunTrust 2007 Annual Report Download - page 130

SUNTRUST BANKS, INC.
Notes to Consolidated Financial Statements (Continued)
decrease or become more costly to settle. The contract/notional amounts of financial instruments, which are not included in
the Consolidated Balance Sheets, do not necessarily represent credit or market risk. However, they can be used to measure
the extent of involvement in various types of financial instruments.
The Company manages the credit risk of its derivatives and unfunded commitments by limiting the total amount of
arrangements outstanding by individual counterparty, by monitoring the size and maturity structure of the portfolio, by
obtaining collateral based on management’s credit assessment of the counterparty, and by applying uniform credit standards
maintained for all activities with credit risk. Collateral held varies but may include marketable securities, accounts
receivable, inventory, property, plant and equipment, and income-producing commercial properties. Collateral may cover the
entire expected exposure for transactions or may be called for when credit exposure exceeds defined thresholds of credit risk.
In addition, the Company enters into master netting agreements which incorporate the right of setoff to provide for the net
settlement of covered contracts with the same counterparty in the event of default or other termination of the agreement.
Derivatives
The Company enters into various derivatives both in a dealer capacity, to facilitate client transactions, and as a risk
management tool. Where contracts have been created for clients, the Company typically enters into transactions with dealers
to offset its risk exposure. Derivatives entered into in a dealer capacity and those that either do not qualify for, or for which
the Company has elected not to apply, hedge accounting are accounted for as free standing derivatives. As such, those
derivatives are carried at fair value in the Consolidated Balance Sheets, with changes in fair value recorded in noninterest
income. Derivatives designated in hedging transactions are accounted for in accordance with the provisions of SFAS
No. 133.
The Company’s risk management derivatives are based on underlying risks primarily related to interest rates, equities,
foreign exchange rates or credit, and include swaps, options, and futures and forwards. Swaps are contracts in which a series
of net cash flows, based on a specific notional amount that is related to an underlying risk, are exchanged over a prescribed
period. Options, generally in the form of caps and floors, are contracts that transfer, modify, or reduce an identified risk in
exchange for the payment of a premium when the contract is issued. Futures and forwards are contracts for the delayed
delivery or net settlement of an underlying, such as a security or interest rate index, in which the seller agrees to deliver on a
specified future date, either a specified instrument at a specified price or yield or the net cash equivalent of an underlying.
Derivatives expose the Company to credit risk. If the counterparty fails to perform, the credit risk is equal to the fair value gain
of the derivative. The credit exposure for swaps and options is the replacement cost of contracts that have become favorable to
the Company. The credit risk inherent in futures is the risk that the exchange party may default and, because futures contracts
settle in cash daily, the Company is exposed to minimal credit risk. The credit risk inherent in forwards arises from the potential
inability of counterparties to meet the terms of their contracts. The Company minimizes the credit or repayment risk in
derivative instruments by entering into transactions with high quality counterparties that are reviewed periodically by the
Company’s credit committee. The Company also maintains a policy of requiring that all derivatives be governed by an
International Swaps and Derivatives Associations Master Agreement; depending on the nature of the derivative transactions,
bilateral collateral agreements may be required 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. The net market position with a
particular counterparty represents a reasonable measure of credit risk when the net market position is an asset to the Company
and there is a legally enforceable master netting agreement, including a legal right of offset of receivable and payable
derivatives between the Company and a counterparty. As of December 31, 2007, total counterparty credit risk associated with
outstanding derivative positions was $1.4 billion, representing the net of $1.9 billion in derivative gains, netted by counterparty
where formal netting arrangements exist, adjusted for collateral of $0.5 billion that the Company holds in relation to these gain
positions.
Derivatives also expose the Company to market risk. Market risk is the adverse effect that a change in interest rates, currency
rates or implied volatility has on the value of a derivative. The Company manages the market risk associated with its
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