SunTrust 2011 Annual Report Download - page 194
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Please find page 194 of the 2011 SunTrust annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.Notes to Consolidated Financial Statements (Continued)
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Level 3 equity securities classified as trading as of December 31, 2010 included nonmarketable preferred shares in
municipal funds issues as ARS that the Company purchased as a result of the ARS market failing in 2008 and the resulting
FINRA settlement described in Note 20, "Contingencies." During the year ended December 31, 2011, the issuers of these
ARS had redeemed at par all of the remaining shares that were held by the Company.
Level 3 equity securities classified as securities AFS include, as of December 31, 2011 and 2010, $740 million and $689
million, respectively, of FHLB stock and 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. The
Company accounts for the stock based on the industry guidance that requires these investments 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 2 instruments.
Level 1 derivative contracts generally include exchange-traded futures or option contracts for which pricing is readily
available. See Note 17, “Derivative Financial Instruments,” for additional information on the Company’s derivative
contracts.
The Company’s level 2 instruments are predominantly standard OTC 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 is driven by the type of contract: for option-based products, the Company uses
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, equity, or credit. As such, the Company uses market-
based assumptions for all of its significant inputs, such as interest rate yield curves, quoted exchange rates and spot prices,
market implied volatilities and credit curves.
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 LGD 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.
The Agreements the Company entered into related to its Coke common 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 6.5
years and 7 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 December 31, 2011 and 2010,
The Agreements’ combined fair value was a liability of $189 million and $145 million, respectively.
See Note 17, “Derivative Financial Instruments,” to the Consolidated Financial Statements, for additional information
on the Company's derivative contracts.