SunTrust 2014 Annual Report Download - page 152

Notes to Consolidated Financial Statements, continued
129
state. The maximum potential amount of future payments the
Company could be required to make is dependent on a variety
of factors, including the amount of public funds held by banks
in the states in which the Company also holds public deposits
and the amount of collateral coverage associated with any
defaulting bank. Individual states appear to be monitoring this
risk and evaluating collateral requirements; therefore, the
likelihood that the Company would have to perform under this
guarantee is dependent on whether any banks holding public
funds default as well as the adequacy of collateral coverage.
Other
In the normal course of business, the Company enters into
indemnification agreements and provides standard
representations and warranties in connection with numerous
transactions. These transactions include those arising from
securitization activities, underwriting agreements, merger and
acquisition agreements, swap clearing agreements, loan sales,
contractual commitments, payment processing, sponsorship
agreements, and various other business transactions or
arrangements. The extent of the Company's obligations under
these indemnification agreements depends upon the occurrence
of future events; therefore, the Company's potential future
liability under these arrangements is not determinable.
STIS and STRH, broker-dealer affiliates of the Company,
use a common third party clearing broker to clear and execute
their customers' securities transactions and to hold customer
accounts. Under their respective agreements, STIS and STRH
agree to indemnify the clearing broker for losses that result from
a customer's failure to fulfill its contractual obligations. As the
clearing broker's rights to charge STIS and STRH have no
maximum amount, the Company believes that the maximum
potential obligation cannot be estimated. However, to mitigate
exposure, the affiliate may seek recourse from the customer
through cash or securities held in the defaulting customers'
account. For the years ended December 31, 2014, 2013, and
2012, STIS and STRH experienced minimal net losses as a result
of the indemnity. The clearing agreements expire in May 2020
for both STIS and STRH.
NOTE 17 - DERIVATIVE FINANCIAL INSTRUMENTS
The Company enters into various derivative financial
instruments, both in a dealer capacity to facilitate client
transactions and as an end user as a risk management tool. ALCO
monitors all derivative activities. When derivatives have been
entered into with clients, the Company generally manages the
risk associated with these derivatives within the framework of
its VAR methodology that monitors total daily exposure and
seeks to manage the exposure on an overall basis. Derivatives
are also used as a risk management tool to hedge the Company’s
balance sheet exposure to changes in identified cash flow and
fair value risks, either economically or in accordance with hedge
accounting provisions. The Company’s Corporate Treasury
function is responsible for employing the various hedge
accounting strategies to manage these objectives. Additionally,
as a normal part of its operations, the Company enters into IRLCs
on mortgage loans that are accounted for as freestanding
derivatives and has certain contracts containing embedded
derivatives that are carried, in their entirety, at fair value. All
freestanding derivatives and any embedded derivatives that the
Company bifurcates from the host contracts are carried at fair
value in the Consolidated Balance Sheets in trading assets and
derivatives and trading liabilities and derivatives. The associated
gains and losses are either recognized in AOCI, net of tax, or
within the Consolidated Statements of Income, depending upon
the use and designation of the derivatives.
Credit and Market Risk Associated with Derivatives
Derivatives expose the Company to counterparty credit risk if
counterparties to the derivative contracts do not perform as
expected. The Company minimizes the credit risk of derivatives
by entering into transactions with counterparties with defined
exposure limits based on credit quality that are reviewed
periodically by the Company’s Credit Risk Management
division. The Company’s derivatives may also be governed by
an ISDA or other master agreement, and depending on the nature
of the derivative, bilateral collateral agreements. The Company
is subject to OTC derivative clearing requirements as a registered
swap dealer, which requires certain derivatives to be cleared
through central clearing members in which the Company is
required to post initial margin. To further mitigate the risk of
non-payment, variation margin is received or paid daily based
on the net asset or liability position of the contracts. When the
Company has more than one outstanding derivative transaction
with a single counterparty and there exists a legal right of offset
with that counterparty, the Company considers its exposure to
the counterparty to be the net market value of its derivative
positions with that counterparty. If the net market value is
positive, then the counterparty asset value also reflects held
collateral. At December 31, 2014, these net derivative asset
positions were $1.1 billion, representing the $1.5 billion of
derivative net gains adjusted for cash and other collateral of $386
million that the Company held in relation to these gain positions.
At December 31, 2013, net derivative asset positions were $1.0
billion, representing $1.5 billion of derivative net gains, adjusted
for cash and other collateral of $523 million that the Company
held in relation to these gain positions.
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, commodity prices,
or implied volatility, has on the value of a derivative. Under an
established risk governance framework, the Company
comprehensively 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 associated with its derivatives
designated as trading instruments using a VAR methodology.
Other tools and risk measures are also used to actively manage
derivatives risk including scenario analysis and stress testing.
Derivative instruments are 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