SunTrust 2011 Annual Report Download - page 33
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The amount and type of earning assets we hold can affect our yield and net interest margin. We hold earning assets in the form of
loans and investment securities, among other assets. As noted above, if current economic conditions persist, we may continue to
see lower demand for loans by creditworthy customers, reducing our yield. In addition, we may invest in lower yielding investment
securities for a variety of reasons.
Changes in the slope of the “yield curve” - or the spread between short-term and long-term interest rates - could also reduce our
net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because
our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, our net interest margin
could decrease as our cost of funds increases relative to the yield we can earn on our assets.
The interest we earn on our assets may be tied to U.S.-denominated interest rates such as the Fed funds rate, while the interest we
pay on our liabilities may be based on international rates such as LIBOR. If the Fed funds rate were to fall without a corresponding
decrease in LIBOR, we might earn less on our assets without any offsetting decrease in our funding costs. This could lower our
net interest margin and our net interest income.
We assess our interest rate risk by estimating the effect on our earnings under various scenarios that differ based on assumptions
about the direction, magnitude and speed of interest rate changes and the slope of the yield curve. We hedge some of that interest
rate risk with interest rate derivatives. We also rely on the “natural hedge” from our mortgage loan originations.
We may not hedge all of our interest rate risk. There is always the risk that changes in interest rates could reduce our net interest
income and our earnings in material amounts, especially if actual conditions turn out to be materially different than what we
assumed. For example, if interest rates rise or fall faster than we assumed or the slope of the yield curve changes, we may incur
significant losses on debt securities we hold as investments. To reduce our interest rate risk, we may rebalance our investment and
loan portfolios, refinance our debt and take other strategic actions. We may incur losses when we take such actions. For additional
information, see the “Enterprise Risk Management” section in the MD&A in this Form 10-K.
Changes in interest rates could also reduce the value of our MSRs and mortgages held for sale, reducing our earnings.
We have a sizable portfolio of MSRs. An MSR is the right to service a mortgage loan - collect principal, interest and escrow
amounts - for a fee. We acquire MSRs when we keep the servicing rights after we sell or securitize the loans we have originated
or when we purchase the servicing rights to mortgage loans originated by other lenders. We initially measure all and carry
substantially all our residential MSRs using the fair value measurement method. Fair value is the present value of estimated future
net servicing income, calculated based on a number of variables, including assumptions about the likelihood of prepayment by
borrowers.
Changes in interest rates can affect prepayment assumptions and thus fair value. When interest rates fall, borrowers are usually
more likely to prepay their mortgage loans by refinancing them at a lower rate. As the likelihood of prepayment increases, the fair
value of our MSRs can decrease. Each quarter we evaluate the fair value of our MSRs and any related hedges, and any decrease
in fair value reduces earnings in the period in which the decrease occurs.
We measure at fair value prime mortgages held for sale for which an active secondary market and readily available market prices
exist. We also measure at fair value certain other interests we hold related to residential loan sales and securitizations. Similar to
other interest-bearing securities, the value of these mortgages held for sale and other interests may be adversely affected by changes
in interest rates. For example, if market interest rates increase relative to the yield on these mortgages held for sale and other
interests, their fair value may fall. We may not hedge this risk, and even if we do hedge the risk with derivatives and other instruments
we may still incur significant losses from changes in the value of these mortgages held for sale and other interests or from changes
in the value of the hedging instruments.
For additional information, see “Enterprise Risk Management - Other Market Risk” and “Critical Accounting Policies” in the
MD&A, and Note 9, "Goodwill and Other Intangible Assets," to the Consolidated Financial Statements in this Form 10-K.
The fiscal and monetary policies of the federal government and its agencies could have a material adverse effect on our
earnings.
The Federal Reserve regulates the supply of money and credit in the U.S. Its policies determine in large part the cost of funds for
lending and investing and the return earned on those loans and investments, both of which affect the net interest margin. They can
also materially decrease the value of financial assets we hold, such as debt securities and MSRs. In particular, programs to facilitate
loan refinancing, such as the recently expanded HARP, may cause us to reevaluate repayment assumptions related to the prepayment
speed assumptions related to loans that we service, and this may adversely affect the fair value of our MSR asset. Federal Reserve
policies can also adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in