SunTrust 2010 Annual Report Download - page 166

SUNTRUST BANKS, INC.
Notes to Consolidated Financial Statements (Continued)
counterparties were $1.6 billion, representing the net of $2.8 billion in net derivative gains by counterparty, netted by
counterparty where formal netting arrangements exist, adjusted for collateral of $1.2 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.
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. The
approved counterparties are 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. The Company adjusted the net fair value of its derivative
contracts for estimates of net counterparty credit risk by approximately $33 million and $25 million as of December 31, 2010
and December 31, 2009 respectively.
The majority of the Company’s derivatives contain contingencies that relate to the creditworthiness of the Bank. These
contingencies contained in industry standard master trading agreements may be considered 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 at net 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, certain of the Company’s derivative
liability positions, totaling $1.1 billion and $1.3 billion in fair value at December 31, 2010 and 2009, respectively, 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 December 31, 2010 and 2009, the Bank carried senior long-term debt ratings of A3/BBB+
and A2/A-, respectively, from two of the major ratings agencies. For illustrative purposes, if the Bank were further
downgraded to Baa3/BBB-, ATEs would be triggered in derivative liability contracts that had a total fair value of $17 million
and $26 million at December 31, 2010 and 2009, respectively, against which the Bank had posted collateral of $8 million and
$10 million, respectively; ATEs do not exist at lower ratings levels. At December 31, 2010 and 2009, $1.1 billion and $1.3
billion, respectively, in fair value of derivative liabilities were subject to CSAs, against which the Bank has posted $987
million and $1.1 billion, respectively, 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 at December 31, 2010 and 2009 of $26
million and $659 million, respectively, if the Bank were downgraded to Baa3/BBB-, and any further downgrades to Ba1/BB+
or below would require the posting of an additional $14 million and $20 million at December 31, 2010 and 2009,
respectively. 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.
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