SunTrust 2015 Annual Report Download - page 159

Notes to Consolidated Financial Statements, continued
131
Credit Derivative Instruments
As part of SunTrust's trading businesses, the Company enters
into contracts that are, in form or substance, written guarantees:
specifically, CDS, risk participations, and TRS. The Company
accounts for these contracts as derivatives and, accordingly,
records these contracts at fair value, with changes in fair value
recognized in trading income in the Consolidated Statements of
Income.
The Company writes CDS, which are agreements under
which the Company receives premium payments from its
counterparty for protection against an event of default of a
reference asset. In the event of default under the CDS, the
Company would either settle its obligation net in cash or make
a cash payment to its counterparty and take delivery of the
defaulted reference asset, from which the Company may recover
all, a portion, or none of the credit loss, depending on the
performance of the reference asset. Events of default, as defined
in the CDS agreements, are generally triggered upon the failure
to pay and similar events related to the issuer(s) of the reference
asset. When the Company has written CDS, all written CDS
contracts reference single name corporate credits or corporate
credit indices. The Company generally enters into offsetting
CDS for the underlying reference asset, under which the
Company pays a premium to its counterparty for protection
against an event of default on the reference asset. The
counterparties to these purchased CDS are generally of high
creditworthiness and typically have ISDA master netting
agreements in place that subject the CDS to master netting
provisions, thereby mitigating the risk of non-payment to the
Company. As such, at December 31, 2015, the Company did not
have any material risk of making a non-recoverable payment on
any written CDS. During 2015 and 2014, the only instances of
default on written CDS were driven by credit indices with
constituent credit default. In all cases where the Company made
resulting cash payments to settle, the Company collected like
amounts from the counterparties to the offsetting purchased
CDS.
There were no written CDS at December 31, 2015. At
December 31, 2014, written CDS had remaining terms of four
years. The fair value of written CDS was $1 million at
December 31, 2014. The maximum guarantees outstanding at
December 31, 2014, as measured by the gross notional amount
of written CDS, was $20 million. At December 31, 2015 and
2014, the gross notional amounts of purchased CDS contracts,
which protect the Company against default of a reference asset,
were $150 million and $190 million, respectively. The fair values
of purchased CDS were $1 million and $5 million at December
31, 2015 and 2014, respectively.
The Company has also entered into TRS contracts on loans.
The Company’s TRS business consists of matched trades, such
that when the Company pays depreciation on one TRS, it receives
the same amount on the matched TRS. To mitigate its credit risk,
the Company typically receives initial cash collateral from the
counterparty upon entering into the TRS and is entitled to
additional collateral if the fair value of the underlying reference
assets deteriorates. There were $2.2 billion and $2.3 billion of
outstanding TRS notional balances at December 31, 2015 and
2014, respectively. The fair values of these TRS assets and
liabilities at December 31, 2015 were $57 million and $52
million, respectively, and related collateral held at December 31,
2015 was $492 million. The fair values of the TRS assets and
liabilities at December 31, 2014 were $19 million and $14
million, respectively, and related collateral held at December 31,
2014 was $373 million. For additional information on the
Company's TRS contracts, see Note 10, "Certain Transfers of
Financial Assets and Variable Interest Entities," as well as Note
18, "Fair Value Election and Measurement."
The Company writes risk participations, which are credit
derivatives, whereby the Company has guaranteed payment to
a dealer counterparty in the event the counterparty experiences
a loss on a derivative, such as an interest rate swap, due to a
failure to pay by the counterparty’s customer (the “obligor”) on
that derivative. The Company monitors its payment risk on its
risk participations by monitoring the creditworthiness of the
obligors, which is based on the normal credit review process the
Company would have performed had it entered into a derivative
directly with the obligors. The obligors are all corporations or
partnerships. The Company continues to monitor the
creditworthiness of the obligors and the likelihood of payment
could change at any time due to unforeseen circumstances. To
date, no material losses have been incurred related to the
Company’s written risk participations. At December 31, 2015
and 2014, the remaining terms on these risk participations
generally ranged from less than one year to eight years and from
one to nine years, respectively, with a weighted average on the
maximum estimated exposure of 5.6 and 5.2 years, respectively.
The Company’s maximum estimated exposure to written risk
participations, as measured by projecting a maximum value of
the guaranteed derivative instruments based on interest rate
curve simulations and assuming 100% default by all obligors on
the maximum values, was approximately $55 million and $31
million at December 31, 2015 and 2014, respectively. The fair
values of the written risk participations were immaterial at both
December 31, 2015 and 2014. As part of its trading activities,
the Company may enter into purchased risk participations to
mitigate credit exposure to a derivative counterparty.
Cash Flow Hedging Instruments
The Company utilizes a comprehensive risk management
strategy to monitor sensitivity of earnings to movements in
interest rates. Specific types of funding and principal amounts
hedged are determined based on prevailing market conditions
and the shape of the yield curve. In conjunction with this strategy,
the Company may employ various interest rate derivatives as
risk management tools to hedge interest rate risk from recognized
assets and liabilities or from forecasted transactions. The terms
and notional amounts of derivatives are determined based on
management’s assessment of future interest rates, as well as other
factors.
Interest rate swaps have been designated as hedging the
exposure to the benchmark interest rate risk associated with
floating rate loans. At December 31, 2015 and 2014, the
maturities for hedges of floating rate loans ranged from less than
one year to seven years and from less than one year to four years,
respectively, with the weighted average being 3.3 and 1.9 years,
respectively. These hedges have been highly effective in
offsetting the designated risks, yielding an immaterial amount
of ineffectiveness for the year ended December 31, 2015 and
2014. At December 31, 2015, $229 million of deferred net pre-
tax gains on derivative instruments designated as cash flow