Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

or

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

Commission File Number 001-08918

SUNTRUST BANKS, INC.

(Exact name of registrant as specified in its charter)

 

Georgia   58-1575035

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

303 Peachtree Street, N.E., Atlanta, Georgia 30308

(Address of principal executive offices)    (Zip Code)

(404) 588-7711

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x                    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x                    Accelerated filer  ¨                    Non-accelerated filer   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.

Yes  ¨                    No  x

At July 31, 2007, 349,294,880 shares of the Registrant’s Common Stock, $1.00 par value, were outstanding.

 



Table of Contents
               Page

PART I  FINANCIAL INFORMATION

  
  

Item 1.

  

Financial Statements (Unaudited)

   3
     

Consolidated Statements of Income

   3
     

Consolidated Balance Sheets

   4
     

Consolidated Statements of Shareholders’ Equity

   5
     

Consolidated Statements of Cash Flow

   6
     

Notes to Consolidated Financial Statements

   7
  

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   37
  

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   88
  

Item 4.

  

Controls and Procedures

   89

PART II  OTHER INFORMATION

  
  

Item 1.

  

Legal Proceedings

  

89

  

Item 1A.

  

Risk Factors

  

89

  

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   92
  

Item 3.

  

Defaults Upon Senior Securities

   92
  

Item 4.

  

Submission of Matters to a Vote of Security Holders

   92
  

Item 5.

  

Other Information

   93
  

Item 6.

  

Exhibits

   93

SIGNATURES

   94

PART I - FINANCIAL INFORMATION

The following unaudited financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and accordingly do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary to comply with Regulation S-X have been included. Operating results for the three and six months ended June 30, 2007 are not necessarily indicative of the results that may be expected for the full year 2007.

 

2


Table of Contents

Item 1.  FINANCIAL STATEMENTS (UNAUDITED)

SunTrust Banks, Inc.

Consolidated Statements of Income

 

     Three Months Ended
June 30
   Six Months Ended
June 30

(In thousands, except per share data)

   2007    2006    2007    2006

Interest Income

           

Interest and fees on loans

   $1,977,571    $1,910,834    $3,970,788    $3,676,719

Interest and fees on loans held for sale

   200,403    163,693    374,131    341,575

Interest and dividends on securities available for sale

           

Taxable interest

   137,324    263,761    214,703    514,600

Tax-exempt interest

   10,701    9,639    21,433    19,078

Dividends1

   30,388    31,090    61,664    63,337

Interest on funds sold and securities purchased under agreements to resell

   13,235    15,199    26,124    27,161

Interest on deposits in other banks

   345    318    750    2,736

Trading account interest

   173,903    28,553    402,334    56,594
                   

Total interest income

   2,543,870    2,423,087    5,071,927    4,701,800
                   

Interest Expense

           

Interest on deposits

   931,241    844,278    1,887,134    1,549,888

Interest on funds purchased and securities sold under agreements to repurchase

   126,614    133,565    267,346    245,773

Interest on other short-term borrowings

   32,658    18,033    58,675    43,214

Interest on long-term debt

   258,073    258,468    498,929    515,141
                   

Total interest expense

   1,348,586    1,254,344    2,712,084    2,354,016
                   

Net Interest Income

   1,195,284    1,168,743    2,359,843    2,347,784

Provision for loan losses

   104,680    51,759    161,121    85,162
                   

Net interest income after provision for loan losses

   1,090,604    1,116,984    2,198,722    2,262,622
                   

Noninterest Income

           

Service charges on deposit accounts

   196,844    191,645    385,879    377,830

Trust and investment management income

   164,620    175,811    338,938    343,900

Retail investment services

   71,785    58,441    135,328    113,430

Other charges and fees

   118,358    113,948    236,495    226,330

Investment banking income

   61,999    60,481    112,156    112,296

Trading account profits and commissions

   16,437    46,182    106,638    83,057

Card fees

   68,580    61,941    132,775    118,544

Mortgage production related income

   64,322    56,579    55,667    119,616

Mortgage servicing related income

   45,527    31,401    80,930    76,111

Gain on sale upon merger of Lighthouse Partners

   -    -    32,340    -

Other noninterest income

   109,738    73,082    179,950    149,799

Net securities gains

   236,412    5,858    236,432    5,962
                   

Total noninterest income

   1,154,622    875,369    2,033,528    1,726,875
                   

Noninterest Expense

           

Employee compensation

   608,834    572,984    1,161,203    1,129,514

Employee benefits

   101,779    116,089    248,410    264,524

Outside processing and software

   100,730    98,447    200,406    193,339

Net occupancy expense

   84,650    81,710    170,907    162,754

Equipment expense

   53,823    48,107    103,232    97,555

Marketing and customer development

   43,326    49,378    89,031    92,024

Amortization of intangible assets

   24,904    25,885    48,446    53,130

Other noninterest expense

   233,148    221,493    465,556    447,744
                   

Total noninterest expense

   1,251,194    1,214,093    2,487,191    2,440,584
                   

Income before provision for income taxes

   994,032    778,260    1,745,059    1,548,913

Provision for income taxes

   312,601    234,258    542,332    473,384
                   

Net income

   681,431    544,002    1,202,727    1,075,529

Preferred stock dividends

   7,519    -    14,882    -
                   

Net Income Available to Common Shareholders

   $673,912    $544,002    $1,187,845    $1,075,529
                   

Net income per average common share

           

Diluted

   $1.89    $1.49    $3.33    $2.96

Basic

   1.91    1.51    3.37    2.98

Average common shares - diluted

   356,008    364,391    356,608    363,917

Average common shares - basic

   351,987    361,267    352,713    360,604

1   Includes dividends on common stock of The Coca-Cola Company

   $14,852    $14,962    $31,234    $29,925

See notes to Consolidated Financial Statements (unaudited).

           

 

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Table of Contents

SunTrust Banks, Inc.

Consolidated Balance Sheets

 

     As of  

(Dollars in thousands)

  

June 30

2007

    December 31
2006
 

Assets

    

Cash and due from banks

   $4,254,430     $4,235,889  

Interest-bearing deposits in other banks

   25,991     21,810  

Funds sold and securities purchased under agreements to resell

   1,143,995     1,050,046  

Trading assets

   13,044,972     2,777,629  

Securities available for sale1

   14,725,957     25,101,715  

Loans held for sale (loans at fair value: $6,494,602 at June 30, 2007)

   12,474,932     11,790,122  

Loans

   118,787,722     121,454,333  

Allowance for loan and lease losses

   (1,050,362 )   (1,044,521 )
            

Net loans

   117,737,360     120,409,812  

Premises and equipment

   1,930,551     1,977,412  

Goodwill

   6,897,050     6,889,860  

Other intangible assets

   1,290,460     1,181,984  

Customers’ acceptance liability

   27,879     15,878  

Other assets

   6,760,795     6,709,452  
            

Total assets

   $180,314,372     $182,161,609  
            

Liabilities and Shareholders’ Equity

    

Noninterest-bearing consumer and commercial deposits

   $22,725,654     $22,887,176  

Interest-bearing consumer and commercial deposits

   75,096,318     76,888,712  
            

Total consumer and commercial deposits

   97,821,972     99,775,888  

Brokered deposits (CDs at fair value: $282,889 as of June 30, 2007; $97,370 as of December 31, 2006)

   16,659,978     18,150,059  

Foreign deposits

   8,408,752     6,095,682  
            

Total deposits

   122,890,702     124,021,629  

Funds purchased

   3,405,459     4,867,591  

Securities sold under agreements to repurchase

   6,081,096     6,950,426  

Other short-term borrowings

   2,083,518     2,062,636  

Long-term debt (debt at fair value: $6,757,188 as of June 30, 2007)

   20,604,933     18,992,905  

Acceptances outstanding

   27,879     15,878  

Trading liabilities

   2,156,279     1,634,097  

Other liabilities

   5,695,653     5,802,841  
            

Total liabilities

   162,945,519     164,348,003  
            

Preferred stock, no par value (liquidation preference of $100,000 per share)

   500,000     500,000  

Common stock, $1.00 par value

   370,578     370,578  

Additional paid in capital

   6,589,387     6,627,196  

Retained earnings

   10,739,449     10,541,152  

Treasury stock, at cost, and other

   (1,751,449 )   (1,151,269 )

Accumulated other comprehensive income

   920,888     925,949  
            

Total shareholders’ equity

   17,368,853     17,813,606  
            

Total liabilities and shareholders’ equity

   $180,314,372     $182,161,609  
            

Common shares outstanding

   349,052,800     354,902,566  

Common shares authorized

   750,000,000     750,000,000  

Preferred shares outstanding

   5,000     5,000  

Preferred shares authorized

   50,000,000     50,000,000  

Treasury shares of common stock

   21,525,598     15,675,832  

1   Includes net unrealized gains on securities available for sale

   $2,035,623     $2,103,362  

See notes to Consolidated Financial Statements (unaudited).

    

 

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Table of Contents

SunTrust Banks, Inc.

Consolidated Statements of Shareholders’ Equity

 

(Dollars and shares in thousands)

   Preferred
Stock
   Common
Shares
Outstanding
    Common
Stock
   Additional
Paid in
Capital
    Retained
Earnings
    Treasury
Stock and
Other1
    Accumulated
Other
Comprehensive
Income
    Total  

Balance, January 1, 2006

   $-    361,984     $370,578    $6,761,684     $9,310,978     ($493,936 )   $938,091     $16,887,395  

Net income

   -    -     -    -     1,075,529     -     -     1,075,529  

Other comprehensive income:

                  

Change in unrealized gains (losses) on derivatives, net of taxes

   -    -     -    -     -     -     6,317     6,317  

Change in unrealized gains (losses) on securities, net of taxes

   -    -     -    -     -     -     (168,712 )   (168,712 )

Change in accumulated other comprehensive income related to employee benefit plans

   -    -     -    -     -     -     824     824  
                      

Total comprehensive income

   -    -     -    -     -     -     -     913,958  

Common stock dividends, $1.22 per share

   -    -     -    -     (443,352 )   -     -     (443,352 )

Exercise of stock options and stock compensation element expense

   -    1,657     -    7,834     -     102,894     -     110,728  

Acquisition of treasury stock

   -    (1,535 )   -    -     -     (108,622 )   -     (108,622 )

Performance and restricted stock activity

   -    956     -    (10,968 )   -     8,167     -     (2,801 )

Amortization of compensation element of performance and restricted stock

   -    -     -    -     -     7,154     -     7,154  

Issuance of stock for employee benefit plans

   -    864     -    (8,837 )   -     53,297     -     44,460  

Issuance of stock for BancMortgage contingent consideration

   -    203     -    2,216     -     12,784     -     15,000  
                                              

Balance, June 30, 2006

   $-    364,129     $370,578    $6,751,929     $9,943,155     ($418,262 )   $776,520     $17,423,920  
                                              

Balance, January 1, 2007

   $500,000    354,903     $370,578    $6,627,196     $10,541,152     ($1,151,269 )   $925,949     $17,813,606  

Net income

   -    -     -    -     1,202,727     -     -     1,202,727  

Other comprehensive income:

                  

Change in unrealized gains (losses) on derivatives, net of taxes

   -    -     -    -     -     -     (75,256 )   (75,256 )

Change in unrealized gains (losses) on securities, net of taxes

   -    -     -    -     -     -     (191,381 )   (191,381 )

Change in accumulated other comprehensive income related to employee benefit plans

   -    -     -    -     -     -     34,495     34,495  
                      

Total comprehensive income

                   970,585  

Common stock dividends, $1.46 per share

   -    -     -    -     (518,929 )   -     -     (518,929 )

Preferred stock dividends

   -    -     -    -     (14,882 )   -     -     (14,882 )

Exercise of stock options and stock compensation element expense

   -    2,227     -    (4,103 )   -     166,146     -     162,043  

Acquisition of treasury stock

   -    (9,296 )   -    (47,163 )   -     (806,223 )   -     (853,386 )

Performance and restricted stock activity

   -    780     -    9,189     (2,496 )   (8,953 )   -     (2,260 )

Amortization of compensation element of performance and restricted stock

   -    -     -    -     -     15,971     -     15,971  

Issuance of stock for employee benefit plans

   -    433     -    4,205     -     32,468     -     36,673  

Adoption of SFAS No. 159

   -    -     -    -     (388,604 )   -     147,374     (241,230 )

Adoption of SFAS No. 157

   -    -     -    -     (10,943 )   -     -     (10,943 )

Adoption of FIN 48

   -    -     -    -     (41,844 )   -     -     (41,844 )

Adoption of FSP FAS 13-2

   -    -     -    -     (26,273 )   -     -     (26,273 )

Pension plan changes and resulting remeasurement

   -    -     -    -     -     -     79,707     79,707  

Other

   -    6     -    63     (459 )   411     -     15  
                                              

Balance, June 30, 2007

   $500,000    349,053     $370,578    $6,589,387     $10,739,449     ($1,751,449 )   $920,888     $17,368,853  
                                              

 

1

Balance at June 30, 2007 includes $1,638,106 for treasury stock and $113,343 for compensation element of restricted stock.

 

Balance at June 30, 2006 includes $349,370 for treasury stock and $68,892 for compensation element of restricted stock.

See notes to Consolidated Financial Statements (unaudited).

 

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Table of Contents

SunTrust Banks, Inc.

Consolidated Statements of Cash Flow

 

     Six Months Ended June 30  

(Dollars in thousands)

   2007     2006  

Cash Flows from Operating Activities:

    

Net income

   $1,202,727     $1,075,529  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Net gain on sale upon merger of Lighthouse Partners

   (32,340 )   -  

Depreciation, amortization and accretion

   396,336     394,128  

Gain on sale of mortgage servicing rights

   (11,650 )   (41,720 )

Origination of mortgage servicing rights

   (335,096 )   (243,781 )

Provisions for loan losses and foreclosed property

   166,149     86,614  

Amortization of compensation element of performance and restricted stock

   15,971     7,154  

Stock option compensation

   12,220     13,119  

Excess tax benefits from stock-based compensation

   (10,238 )   (16,471 )

Net securities gains

   (236,432 )   (5,962 )

Net gain on sale of assets

   (22,413 )   (26,462 )

Originated and purchased loans held for sale

   (29,644,677 )   (23,920,775 )

Sales and securitizations of loans held for sale

   30,122,885     25,813,626  

Net (increase) decrease in other assets

   (1,513,218 )   111,140  

Net increase (decrease) in other liabilities

   246,960     (1,684 )
            

Net cash provided by operating activities

   357,184     3,244,455  
            

Cash Flows from Investing Activities:

    

Seix contingent consideration payout

   (42,287 )   -  

Proceeds from maturities, calls and repayments of securities available for sale

   524,472     1,724,250  

Proceeds from sales of securities available for sale

   983,546     591,800  

Purchases of securities available for sale

   (6,270,734 )   (2,524,434 )

Proceeds from maturities, calls and repayments of trading securities

   3,501,450     -  

Proceeds from sales of trading securities

   15,116,736     -  

Purchases of trading securities

   (11,922,354 )   -  

Loan originations net of principal collected

   (3,827,841 )   (5,931,097 )

Proceeds from sale of loans

   4,956,475     1,147,170  

Proceeds from sale of mortgage servicing rights

   127,306     125,087  

Capital expenditures

   (63,778 )   (155,496 )

Proceeds from the sale of other assets

   42,675     26,885  
            

Net cash provided by (used) in investing activities

   3,125,666     (4,995,835 )
            

Cash Flows from Financing Activities:

    

Net (decrease) increase in consumer and commercial deposits

   (1,950,918 )   1,474,709  

Net increase in foreign and brokered deposits

   822,989     1,329,920  

Net (decrease) increase in funds purchased and other short-term borrowings

   (2,310,580 )   812,987  

Proceeds from the issuance of long-term debt

   1,794,320     1,589  

Repayment of long-term debt

   (495,143 )   (2,554,091 )

Proceeds from the issuance of preferred stock

   290     -  

Proceeds from the exercise of stock options

   149,822     102,955  

Acquisition of treasury stock

   (853,386 )   (108,622 )

Excess tax benefits from stock-based compensation

   10,238     16,471  

Common and preferred dividends paid

   (533,811 )   (443,352 )
            

Net cash (used in) provided by financing activities

   (3,366,179 )   632,566  
            

Net increase (decrease) in cash and cash equivalents

   116,671     (1,118,814 )

Cash and cash equivalents at beginning of year

   5,307,745     6,305,606  
            

Cash and cash equivalents at end of period

   $5,424,416     $5,186,792  
            

Supplemental Disclosures:

    

Interest paid

   $2,699,431     $2,331,670  

Income taxes paid

   288,250     345,340  

Income taxes refunded

   (9,931 )   (11,650 )

Securities transferred from available for sale to trading

   15,374,452     -  

Loans transferred from loans to loans held for sale

   4,054,246     -  

See notes to consolidated financial statements (unaudited).

 

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Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 1-Accounting Policies

Principles of Consolidation and Basis of Presentation

The consolidated financial statements include the accounts of SunTrust Banks, Inc. (“SunTrust” or “the Company”), its majority-owned subsidiaries, and variable interest entities (“VIEs”) where the Company is the primary beneficiary. All significant intercompany accounts and transactions have been eliminated. Results of operations of companies purchased are included from the date of acquisition. Results of operations associated with companies or net assets sold are included through the date of disposition. Assets and liabilities of purchased companies are generally stated at estimated fair values at the date of acquisition. Investments in companies which are not VIEs, or where SunTrust is not the primary beneficiary in a VIE, that the Company owns a voting interest of 20% to 50%, and for which it may have significant influence over operating and financing decisions are accounted for using the equity method of accounting. These investments are included in other assets, and the Company’s proportionate share of income or loss is included in noninterest income.

The consolidated interim financial statements of SunTrust are unaudited. The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“US GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could vary from these estimates. Certain reclassifications may be made to prior period amounts to conform to the current period presentation. These financial statements should be read in conjunction with the Annual Report on Form 10-K for the year ended December 31, 2006. Except for accounting policies recently adopted as described below, there have been no significant changes to the Company’s Accounting Policies as disclosed in the Annual Report on Form 10-K for the year ended December 31, 2006.

Accounting Policies Recently Adopted and Pending Accounting Pronouncements

In March 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”), No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140.” SFAS No. 156 requires that all separately recognized servicing rights be initially measured at fair value. Subsequently, an entity may either recognize its servicing rights at fair value or amortize its servicing rights over an estimated life and assess for impairment at least quarterly. SFAS No. 156 also amends how gains and losses are computed in transfers or securitizations that qualify for sale treatment in which the transferor retains the right to service the transferred financial assets. Additional disclosures for all separately recognized servicing rights are also required. In accordance with SFAS No. 156, SunTrust is initially measuring servicing rights at fair value and will continue to subsequently amortize its servicing rights based on estimated future net servicing income with at least quarterly assessments for impairment. The Company adopted the provisions of SFAS No. 156 effective January 1, 2007. The adoption did not have a material impact on the Company’s financial position and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which clarifies how companies should use fair value measurements in accordance with US GAAP for recognition and disclosure. SFAS No. 157 establishes a common definition of fair value and a framework for measuring fair value under US GAAP, along with expanding disclosures about fair value measurements to eliminate differences in current practice that exist in measuring fair value under the existing accounting standards. The definition of fair value in SFAS No. 157 retains the notion of exchange price; however, it focuses on the price that would be received to sell the asset or paid to transfer the liability (i.e., an exit price), rather than the price that would be paid to acquire the asset or received to assume the liability (i.e., an entry price). Under SFAS No. 157, a fair value measure should reflect all of the assumptions that market participants would use in pricing the asset or liability, including assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset, and the risk of nonperformance. To increase consistency and comparability in fair value measures, SFAS No. 157 establishes a three-level fair value hierarchy to prioritize the inputs used in valuation techniques between observable inputs that reflect quoted prices in active markets, inputs other than quoted prices with observable market data, and unobservable data (e.g., a company’s own data). SFAS No. 157 requires disclosures detailing the extent to which companies measure assets and liabilities at fair value, the methods and assumptions used to measure fair value, and the effect of fair value measurements on earnings. In February 2007, the FASB issued SFAS No.159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits companies to elect on an instrument-by-instrument basis to fair value certain financial assets and financial liabilities with changes in fair value recognized in earnings as they occur. The election to fair value is generally irrevocable. SFAS No. 157 and SFAS No. 159 are effective January 1, 2008 for calendar year companies with the option to early adopt as of January 1, 2007. The Company elected to early adopt the provisions of these statements effective January 1, 2007. See Note 12, “Fair Value” to the Consolidated Financial Statements for related disclosures.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

In July 2006, the FASB issued FASB Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of SFAS No. 109, “Accounting for Income Taxes.” FIN 48 provides a single model to address accounting for uncertainty in tax positions by prescribing a minimum recognition threshold a tax benefit can be recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted FIN 48 effective January 1, 2007. The cumulative effect adjustment recorded upon adoption resulted in an increase to unrecognized tax benefits of $46.0 million, a reduction to opening retained earnings of $41.9 million, and an increase to goodwill of $4.1 million. Additionally, in connection with its adoption of FIN 48, the Company elected to classify interest and penalties related to unrecognized tax positions as a component of income tax expense.

In July 2006, the FASB issued FASB Staff Position (“FSP”) FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (“FSP FAS 13-2”). The Internal Revenue Service (“IRS”) has challenged companies on the timing and amount of tax deductions generated by certain leveraged lease transactions, commonly referred to as Lease-In, Lease-Out transactions (“LILOs”) and Sale-In, Lease-Out transactions (“SILOs”). As a result, some companies have settled with the IRS, resulting in a change to the estimated timing of cash flows and income on these types of leases. The Company believes that its tax treatment of certain investments in LILO and SILO leveraged lease transactions is appropriate based on its interpretation of the tax regulations and legal precedents; however, a court or other judicial authority could disagree. FSP FAS 13-2 indicates that a change in the timing or projected timing of the realization of tax benefits on a leveraged lease transaction requires the lessor to recalculate that lease. The Company adopted FSP FAS 13-2 effective January 1, 2007. The one-time after tax reduction to opening retained earnings resulting from adoption was $26.3 million, which will be accreted into income on an effective yield basis over the remaining terms of the affected leases in accordance with FSP FAS 13-2.

In September 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” The guidance clarifies the accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that is not limited to the employee’s active service period and concluded that an employer should recognize a liability for future benefits based on the substantive agreement with the employee since the postretirement benefit obligation is not effectively settled through the purchase of the endorsement split-dollar life insurance policy. Also, in March 2007, the EITF reached a consensus on EITF Issue No. 06-10, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements.” This Issue clarifies the accounting for collateral split-dollar life insurance arrangements that provide a benefit to an employee that extends into postretirement periods and clarifies the accounting for assets related to collateral split-dollar insurance assignment arrangements. This Issue requires that an employer recognize a liability for future benefits based on the substantive agreement with the employee and concluded that the asset recorded should also be measured based on the nature and substance of the collateral assignment split-dollar life insurance arrangement. EITF No. 06-4 and EITF No. 06-10 are effective for SunTrust beginning January 1, 2008 and any resulting adjustment will be recorded as a change in accounting principle through a cumulative effect adjustment to equity. SunTrust is currently evaluating the impact these Issues will have on its financial position and results of operations.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

In September 2006, the EITF reached a consensus on EITF Issue No. 06-5, “Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.” This Issue clarifies how a company should determine “the amount that could be realized” from a life insurance contract, which is the measurement amount for the asset in accordance with Technical Bulletin 85-4, and requires policyholders to determine the amount that could be realized under a life insurance contract assuming individual policies are surrendered, unless all policies are required to be surrendered as a group. This EITF became effective for the Company on January 1, 2007 and the adoption did not have an impact on its financial position and results of operations.

Note 2-Acquisitions/Dispositions

In the second quarter of 2007 AMA Holdings, Inc. (“AMA Holdings”), a 100%-owned subsidiary of SunTrust, exercised its right to call 0.4 million minority member owned interests in AMA, LLC, resulting in $5.2 million of goodwill and $1.2 million of other intangibles related to client relationships, which were both deductible for tax purposes. An additional 2.5 million member interests were issued to employees in the second quarter of 2007. Effective March 27, 2007, the 1,228 outstanding member interests of AMA, LLC were converted into 10 million member interests, a split of 8,141.7975 to one. On January 31, 2007, AMA Holdings exercised its right to call 4 minority member owned interests in AMA, LLC, resulting in $0.5 million of goodwill and $0.1 million of other intangibles related to client relationships which were both deductible for tax purposes. On January 28, 2006, AMA Holdings exercised its right to call 98 minority member owned interests in AMA, LLC, resulting in $6.9 million of goodwill and $4.5 million of other intangibles related to client relationships which were both deductible for tax purposes.

As of June 30, 2007, AMA Holdings owned 7.9 million member interests, or 64%, and 4.6 million member interests, or 36%, of AMA, LLC were owned by employees. The employee interests are subject to certain vesting requirements. If the employee interests vest, they may be called by AMA Holdings (and some of the interests may be put to AMA Holdings by the employees) at certain dates in the future in accordance with the applicable plan or agreement pursuant to which they were granted.

On March 30, 2007, SunTrust merged its wholly-owned subsidiary, Lighthouse Partners, with and into Lighthouse Investment Partners, LLC, the entity that was serving as the sub-advisor to Lighthouse Partners and the Lighthouse Partners’ managed funds. SunTrust holds a 24.9% minority interest in the combined entity and it also has a revenue sharing arrangement with Lighthouse Investment Partners. This merger resulted in a gain of $32.3 million, which was recorded in the Consolidated Statements of Income as a component of noninterest income. This transaction resulted in a net increase in intangible assets of $24.1 million and a decrease in goodwill of $48.5 million. On July 24, 2007, SunTrust signed a “merger implementation agreement” with HFA Holdings Ltd., an Australian fund manager, to sell Lighthouse Investment Partners, the combined entity to HFA Holdings Ltd. This agreement is essentially a non-binding letter of intent, and HFA Holdings Ltd.’s obligations are conditioned upon obtaining financing, among other things. Under the current terms of this agreement, SunTrust is expected to receive approximately $155 million cash, upon closing, for its interest in Lighthouse Investment Partners, which exceeds the carrying value of its investment.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

On March 12, 2007, SunTrust paid $7.0 million in cash to the former owners of Prime Performance, Inc. (“Prime Performance”), a company acquired by National Commerce Financial Corporation (“NCF”) in March 2004. NCF and its subsidiaries were purchased by SunTrust in October 2004. Payment of the contingent consideration was made pursuant to the original purchase agreement between NCF and the former owners of Prime Performance and was considered a tax-deductible adjustment to goodwill. The payment made on March 12, 2007 fulfilled all of the Company’s obligations to the former owners of Prime Performance. On April 4, 2006, SunTrust paid $1.3 million in cash to the former owners of Prime Performance pursuant to this same agreement.

On February 23, 2007, SunTrust paid $42.3 million to the former owners of Seix Investment Advisors, Inc. (“Seix”) that was contingent on the performance of Seix. This transaction resulted in $42.3 million of goodwill that was deductible for tax purposes.

On February 13, 2007, SunTrust paid $1.4 million to the former owners of SunAmerica Mortgage (“SunAmerica”) that was pursuant to the original purchase agreement and contingent on the performance of SunAmerica. This transaction resulted in $1.4 million of goodwill that was deductible for tax purposes. On March 10, 2006, SunTrust paid $3.9 million to the former owners of SunAmerica that was contingent on the performance of SunAmerica. This resulted in $3.9 million of goodwill that was deductible for tax purposes.

On March 31, 2006, SunTrust sold its 49% interest in First Market Bank, FSB (“First Market”). The sale of its approximately $79 million net investment resulted in a gain of $3.6 million which was recorded in other income in the Consolidated Statements of Income.

On March 30, 2006, SunTrust issued $15.0 million of common stock, or 202,866 shares, and $7.5 million in cash as contingent consideration to the former owners of BancMortgage Financial Corporation, a company acquired by NCF in 2002. NCF and its subsidiaries were purchased by SunTrust in October 2004. Payment of the contingent consideration was made pursuant to the original purchase agreement between NCF and BancMortgage and was considered an adjustment to goodwill.

On March 17, 2006, SunTrust acquired 11 Florida Wal-Mart banking branches from Community Bank of Florida (“CBF”), based in Homestead, Florida. The Company acquired approximately $5.1 million in assets and $56.4 million in deposits and related liabilities. The transaction resulted in $1.1 million of other intangible assets which were deductible for tax purposes.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

Note 3-Allowance for Loan and Lease Losses

Activity in the allowance for loan and lease losses is summarized in the table below:

 

     Three Months Ended
June 30
   

%

Change

    Six Months Ended
June 30
   

%

Change

 

(Dollars in thousands)

   2007     2006       2007     2006    

Balance at beginning of period

   $1,033,939     $1,039,247     (0.5 )   $1,044,521     $1,028,128     1.6  

Allowance associated with loans at fair value 1

   -     -     -     (4,100 )   -     (100.0 )

Provision for loan losses

   104,680     51,759     102.2     161,121     85,162     89.2  

Loan charge-offs

   (111,722 )   (55,649 )   100.8     (196,669 )   (109,915 )   78.9  

Loan recoveries

   23,465     26,505     (11.5 )   45,489     58,487     (22.2 )
                            

Balance at end of period

   $1,050,362     $1,061,862     (1.1 )   $1,050,362     $1,061,862     (1.1 )
                            

 

1

Amount removed from the allowance for loan losses related to the Company’s election to record $4.1 billion of residential mortgages at fair value.

Note 4-Intangible Assets

Goodwill

Goodwill is tested for impairment on an annual basis and as events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company completed its 2006 annual review as of September 30, 2006, and determined there was no impairment of goodwill as of this date. No events or circumstances have occurred during the year that would more likely than not reduce the fair value of a reporting unit below its carrying value. In the fourth quarter, the Company will complete its 2007 annual review as of September 30, 2007. The changes in the carrying amount of goodwill by reportable segment for the six months ended June 30, 2007 and 2006 are as follows:

 

(Dollars in thousands)

   Retail     Commercial     Corporate and
Investment
Banking
    Mortgage     Wealth and
Investment
Management
    Corporate
Other and
Treasury
    Total  

Balance, January 1, 2006

   $4,873,158     $1,261,363     $147,470     $247,985     $297,857     $7,335     $6,835,168  

NCF purchase adjustments 1

   26,473     3,480     124     571     218     (481 )   30,385  

BancMortgage contingent consideration

   -     -     -     22,500     -     -     22,500  

Purchase of AMA, LLC minority shares

   -     -     -     -     6,930     -     6,930  

SunAmerica contingent consideration

   -     -     -     3,906     -     -     3,906  

Prime Performance contingent consideration

   1,333     -     -     -     -     -     1,333  
                                          

Balance, June 30, 2006

   $4,900,964     $1,264,843     $147,594     $274,962     $305,005     $6,854     $6,900,222  
                                          

Balance, January 1, 2007

   $4,891,473     $1,262,174     $147,469     $274,524     $307,390     $6,830     $6,889,860  

NCF purchase adjustments 1

   (3,548 )   (980 )   (46 )   (161 )   (80 )   (9 )   (4,824 )

Purchase of AMA, LLC minority shares

   -     -     -     -     5,664     -     5,664  

SunAmerica contingent consideration

   -     -     -     1,368     -     -     1,368  

Prime Performance contingent consideration

   7,034     -     -     -     -     -     7,034  

Seix contingent consideration

   -     -     -     -     42,287     -     42,287  

Sale upon merger of Lighthouse Partners

   -     -     -     -     (48,474 )   -     (48,474 )

FIN 48 adoption adjustment

   3,042     840     39     138     69     7     4,135  
                                          

Balance, June 30, 2007

   $4,898,001     $1,262,034     $147,462     $275,869     $306,856     $6,828     $6,897,050  
                                          

1

US GAAP requires net assets acquired in a business combination to be recorded at their estimated fair value. Adjustments to the estimated fair value of acquired assets and liabilities generally occur within one year of the acquisition. However, tax related adjustments are permitted to extend beyond one year due to the degree of estimation and complexity. The purchase adjustments in the above table represent adjustments to the estimated fair value of the acquired net assets within the guidelines under US GAAP.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

Mortgage Servicing Rights (“MSRs”)

MSRs represent the discounted present value of future net cash flows that are expected to be received from the mortgage servicing portfolio. The value of the MSRs asset is based upon the estimated future net cash flows from servicing mortgage loans and is highly dependent upon service fees and the assumed prepayment speed of the mortgage servicing portfolio. Future expected net cash flows from servicing a loan in the mortgage servicing portfolio would not be realized if the loan pays off earlier than anticipated. Accordingly, prepayment risk subjects the MSRs to impairment risk. The Company does not specifically hedge the MSRs portfolio for the potential impairment risk; however, it does employ a business strategy using the natural counter-cyclicality of servicing and production to mitigate earnings volatility, and may employ other financial instruments, including economic hedges, to manage the performance of the business. As of June 30, 2007 and December 31, 2006, the fair values of MSRs were $1.4 billion and $1.1 billion, respectively. Contractually specified mortgage servicing fees and late fees earned for the three and six months ended June 30, 2007 and 2006 were $77.9 million and $152.0 million, and $58.0 million and $120.1 million, respectively. These amounts are reported in mortgage servicing related income in the Consolidated Statements of Income. During the first six months of 2007, the Company sold $115.7 million of mortgage servicing rights compared to $90.7 million for the first six months of 2006. For the three and six months ended June 30, 2007 the sale/securitization of servicing rights resulted in a gain of $11.7 million, compared to $17.3 million and $41.7 million for the three and six months ended June 30, 2006, respectively. Since SunTrust does not discretely hedge its MSRs portfolio, the Company actively manages the size of the MSR and evaluates the market value in relation to holding the MSRs.

Other Intangible Assets

The changes in the carrying amounts of other intangible assets for the six months ended June 30, 2007 and 2006 are as follows:

 

(Dollars in thousands)

   Core Deposit
Intangible
    Mortgage
Servicing
Rights
    Other     Total  

Balance, January 1, 2006

   $324,743     $657,604     $140,620     $1,122,967  

Amortization

   (43,632 )   (90,343 )   (9,498 )   (143,473 )

Servicing rights originated

   -     243,781     -     243,781  

Community Bank of Florida branch acquisition

   1,085     -     -     1,085  

Reclass investment to trading assets

   -     -     (1,050 )   (1,050 )

Purchase of AMA, LLC minority shares

   -     -     4,473     4,473  

Sale/securitization of mortgage servicing rights

   -     (90,668 )   -     (90,668 )

Issuance of noncompete agreement

   -     -     4,231     4,231  
                        

Balance, June 30, 2006

   $282,196     $720,374     $138,776     $1,141,346  
                        

Balance, January 1, 2007

   $241,614     $810,509     $129,861     $1,181,984  

Amortization

   (36,040 )   (87,937 )   (12,407 )   (136,384 )

Servicing rights originated

   -     335,096     -     335,096  

Intangible assets obtained from sale upon merger of Lighthouse Partners, net

   -     -     24,142     24,142  

Purchase of AMA, LLC minority shares

   -     -     1,278     1,278  

Sale of mortgage servicing rights

   -     (115,656 )   -     (115,656 )
                        

Balance, June 30, 2007

   $205,574     $942,012     $142,874     $1,290,460  
                        

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

The estimated amortization expense for intangible assets, excluding amortization of mortgage servicing rights, for the full year 2007 and the subsequent years is as follows:

 

(Dollars in thousands)

   Core Deposit
Intangible
   Other    Total

Full year 2007

   $68,959    $27,142    $96,101

2008

   53,616    22,428    76,044

2009

   36,529    16,347    52,876

2010

   28,781    12,632    41,413

2011

   22,552    9,983    32,535

Thereafter

   31,177    66,749    97,926
              

Total

   $241,614    $155,281    $396,895
              

Note 5-Securitizations

The Company has sold or securitized various asset classes, including student loans, residential mortgages, commercial loans, trust preferred securities, and asset-backed debt securities, that were either originated by the Company or purchased in the market and warehoused prior to the sale or securitization. These securitization activities involve selling all or a portion of a pool of assets to Company-sponsored or third-party securitization vehicles and may result in the Company retaining residual or other interests. Interests that continue to be held by the Company as a result of these transactions, excluding servicing assets, if any, are typically recorded as securities available for sale or trading assets at their allocated carrying amounts based on the relative fair value at time of securitization for transactions closed prior to January 1, 2007 and at fair value for those closed thereafter. Gains or losses upon securitization as well as structuring fees, servicing fees and collateral management fees are recorded in noninterest income.

In June 2007, the Company sold trust preferred securities into a securitization in exchange for proceeds of $158.8 million. In addition, the Company received $4.5 million in structuring fees related to the transaction. The Company did not retain any interests in the securitization.

Additionally in June 2007, the Company sold residential mortgage loans into a securitization in exchange for proceeds of $361.5 million. A pre-tax gain of $0.4 million was recognized as a result of the sale of these loans. In addition to certain rated, debt securities, the Company also holds residual interests in the securitization that are classified on the Consolidated Balance Sheets as trading securities with a fair value of $14.4 million at June 30, 2007.

In May 2007, the Company was involved in a securitization transaction of commercial loans and bonds. The Company received $1.0 million in structuring fees and holds a residual interest that is accounted for as a trading security with a fair value of $3.0 million at June 30, 2007.

In March 2007, the Company sold a portion of commercial loans in a structured asset sale in exchange for proceeds of $1.9 billion. The Company recognized a pre-tax gain of $4.9 million and holds a residual interest that is accounted for as a trading security with a fair value of $57.3 million at June 30, 2007.

In March 2007, the Company sold commercial mortgage loans into a securitization in exchange for proceeds of $195.7 million. A pre-tax gain of $2.1 million was recognized as a result of the sale of these loans. The Company did not retain any interests in the securitization.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

The following table shows the fair value at June 30, 2007 of the residual interests that the Company continues to hold in its securitization transactions.

 

(Dollars in millions)

Securitized/Sold

  

Net Proceeds

  

Fair Value of
Interests Held by
the Company at
June 30, 2007

  

Classified As

Commercial loans and bonds

   $1,054.9    $25.3    Trading Asset

Corporate loans

   1,857.5    57.3    Trading Asset

Debt securities

   472.6    1.1    Trading Asset

Mortgage loans

   361.5    14.4    Trading Asset

Student loans

   750.1    19.8    Trading Asset

Note 6-Earnings per Share Reconciliation

Net income is the same in the calculation of basic and diluted EPS. There were no antidilutive shares for the quarter ended June 30, 2007. Equivalent shares of 0.3 million related to stock options for the period ended June 30, 2006 were excluded from the computation of diluted EPS because they would have been antidilutive. A reconciliation of the difference between average basic common shares outstanding and average diluted common shares outstanding for the three and six months ended June 30, 2007 and 2006 is included in the following table:

 

     Three Months Ended
June 30
   Six Months Ended
June 30

(In thousands, except per share data)

   2007    2006    2007    2006

Diluted

           

Net income

   $681,431    $544,002    $1,202,727    $1,075,529

Preferred stock dividends

   7,519    -    14,882    -
                   

Net income available to common shareholders

   $673,912    $544,002    $1,187,845    $1,075,529
                   

Average basic common shares

   351,987    361,267    352,713    360,604

Effect of dilutive securities:

           

Stock options

   3,056    1,988    2,944    2,064

Performance and restricted stock

   965    1,136    951    1,249
                   

Average diluted common shares

   356,008    364,391    356,608    363,917
                   

Earnings per average common share - diluted

   $1.89    $1.49    $3.33    $2.96
                   

Basic

           

Net income

   $681,431    $544,002    $1,202,727    $1,075,529

Preferred stock dividends

   7,519    -    14,882    -
                   

Net income available to common shareholders

   $673,912    $544,002    $1,187,845    $1,075,529
                   

Average basic common shares

   351,987    361,267    352,713    360,604
                   

Earnings per average common share - basic

   $1.91    $1.51    $3.37    $2.98
                   

Note 7-Income Taxes

SunTrust adopted FIN 48 effective January 1, 2007. The cumulative effect adjustment recorded upon adoption resulted in an increase to unrecognized tax benefits of $46.0 million, with offsetting adjustments to equity and goodwill. The Company classifies interest and penalties related to its tax positions as a component of income tax expense. As of June 30, 2007, the Company’s cumulative unrecognized tax benefits amounted to $354.9 million, of which $293.1 million would affect the Company’s effective tax rate, if recognized, and the remaining $61.8 million of which is expected to impact goodwill, if recognized. Interest expense related to unrecognized tax benefits was $5.7 million and $11.0 million for the three and six months ended June 30, 2007, respectively. Cumulative unrecognized tax benefits included interest on an after-tax basis of $48.0 million as of June 30, 2007. The Company continually evaluates the unrecognized tax benefits associated with its uncertain tax positions; however, the Company does not currently anticipate that the total amount of unrecognized tax benefits will significantly increase or decrease during the next twelve months. The Company files consolidated and separate income tax returns in the United States Federal jurisdiction and in various state jurisdictions. The Company’s Federal returns through 1998 have been examined and the returns for tax years 1997 and 1998 are pending resolution at the Internal Revenue Service Appeals Division. The Company’s 1999 through 2004 Federal income tax returns are currently under examination by the Internal Revenue Service. Generally, the state jurisdictions in which the Company files income tax returns are subject to examination for a period from three to seven years after returns are filed.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

Note 8-Employee Benefit Plans

Stock Based Compensation

The Company provides stock-based awards through the SunTrust Banks, Inc. 2004 Stock Plan (“Stock Plan”) under which the Compensation Committee (“Committee”) has the authority to grant stock options, restricted stock, and performance-based restricted stock (“performance stock”) to key employees of the Company. Under the 2004 Stock Plan, a total of 14 million shares of common stock is authorized and reserved for issuance, of which no more than 2.8 million shares may be issued as restricted stock. Stock options are granted at a price which is no less than the fair market value of a share of SunTrust common stock on the grant date and may be either tax-qualified incentive stock options or non-qualified stock options. Stock options typically vest over three years and generally have a maximum contractual life of ten years and upon option exercise, shares are issued to employees from treasury stock.

Shares of restricted stock may be granted to employees and directors and typically cliff vest after three years. Restricted stock grants may be subject to one or more objective employment, performance or other grant conditions as established by the Committee at the time of grant. Any shares of restricted stock that are forfeited will again become available for issuance under the Plan. An employee or director has the right to vote the shares of restricted stock after grant until they are forfeited or vested. Compensation cost for restricted stock is equal to the fair market value of the shares at the date of the award and is amortized to compensation expense over the vesting period. Dividends are paid on awarded but unvested restricted stock, and participants may exercise voting privileges on such shares.

With respect to currently outstanding performance stock, shares must be granted, awarded and vested before participants take full title. After performance stock is granted by the Committee, specified portions are awarded based on increases in the average price of SunTrust common stock above the initial price specified by the Committee. Awards are distributed, subject to continued employment, on the earliest of (i) fifteen years after the date shares are awarded to participants; (ii) the participant attaining age 64; (iii) death or disability of a participant; or (iv) a change in control of the Company as defined in the Stock Plan. Dividends are paid on awarded but unvested performance stock, and participants may exercise voting privileges on such shares.

The compensation element for performance stock (which is deferred and shown as a reduction of shareholders’ equity) is equal to the fair market value of the shares at the date of the award and is amortized to compensation expense over the period from the award date to the participant attaining age 64 or the 15th anniversary of the award date whichever comes first. Approximately 40% of performance stock awarded became fully vested on February 10, 2000 and is no longer subject to the forfeiture condition set forth in the original agreements. This early-vested performance stock was converted into an equal number of “Phantom Stock Units” as of that date. Payment of Phantom Stock Units will be made to participants in shares of SunTrust common stock upon the earlier to occur of (1) the date on which the participant would have vested in his or her performance stock or (2) the date of a change in control. Dividend equivalents will be paid at the same rate as the shares of performance stock; however, these units will not carry voting privileges.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

The fair value of each stock option award is estimated on the date of grant using a Black-Scholes valuation model. Expected volatility is based on the historical volatility of the Company’s stock, using daily price observations over the expected term of the stock options. The expected term represents the period of time that stock options granted are expected to be outstanding and is derived from historical data which is used to evaluate patterns such as stock option exercise and employee termination. The expected dividend yield is based on recent dividend history, given that yields are reasonably stable. The risk-free interest rate is derived from the U.S. Treasury yield curve in effect at the time of grant based on the expected life of the option.

The weighted average fair values of options granted during the first six months of 2007 and 2006 were $16.75 and $16.53 per share, respectively. There were no new stock options granted during the second quarter of 2007 and 2006. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

 

     Six Months Ended June 30  
     2007     2006  

Expected dividend yield

   3.01   %   3.18   %

Expected stock price volatility

   20.08       25.76    

Risk-free interest rate (weighted average)

   4.70       4.51    

Expected life of options

   6 years       6 years    

The following table presents a summary of stock option and performance and restricted stock activity:

 

     Stock Options    Performance and Restricted Stock

(Dollars in thousands except per share data)

   Shares    

Price

Range

   Weighted-
Average
Exercise Price
   Shares     Deferred
Compensation
    Weighted-
Average
Grant Price

Balance, January 1, 2007

   18,680,710     $14.56-83.74    $64.39    1,870,604     $60,487     $57.12

Granted

   715,284     85.06-85.06    85.06    971,377     82,552     84.98

Exercised/vested

   (2,298,796 )   14.56-76.50    60.95    (212,668 )   -         39.23

Cancelled/expired/forfeited

   (212,839 )   32.76-85.06    72.95    (167,381 )   (10,400 )   62.13

Amortization of compensation element of performance and restricted stock

   -         -        -        -         (16,450 )   -    

Repurchase of AMA member interests

   -         -        -        -         (2,846 )   -    
                                

Balance, June 30, 2007

   16,884,359     $14.56-$85.06    $65.63    2,461,932     $113,343     $69.32
                                

Exercisable, June 30, 2007

   12,129,312        $62.16       
                    

Available for Additional Grant, June 30, 2007 1

   8,280,854              
                  

 

1

Includes 0.9 million shares available to be issued as restricted stock.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

The following table presents information on stock options by ranges of exercise price at June 30, 2007:

 

(Dollars in thousands except per share data)

                                  
     Options Outstanding    Options Exercisable

Range of Exercise Prices

   Number
Outstanding at
June 30, 2007
   Weighted-
Average
Exercise Price
   Weighted-
Average
Remaining
Contractual Life
(Years)
   Aggregate
Intrinsic
Value
   Number
Exercisable at
June 30, 2007
   Weighted-
Average Exercise
Price
   Weighted-
Average
Remaining
Contractual
Life (Years)
   Aggregate
Intrinsic
Value

$14.56 to $49.46

   812,820    $43.30    3.95    $34,495    812,820    $43.30    3.95    $34,495

$49.47 to $64.57

   6,359,733    56.44    4.58    186,365    6,359,733    56.44    4.58    186,365

$64.58 to $85.06

   9,711,806    73.52    6.33    118,724    4,956,759    72.59    4.66    65,185
                                         
   16,884,359    $65.63    5.56    $339,584    12,129,312    $62.16    4.57    $286,045
                                       

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the second quarter of 2007 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2007. This amount changes based on the fair market value of the Company’s stock. Total intrinsic value of options exercised for the three and six months ended June 30, 2007 was $28.7 million and $56.9 million, respectively. Total intrinsic value of options exercised for the three and six months ended June 30, 2006 was $13.8 million and $37.4 million, respectively. Total fair value of performance and restricted shares vested was $5.2 million and $1.3 million and $8.3 million and $14.4 million for the three months and six months ended June 30, 2007 and 2006, respectively.

As of June 30, 2007, there was $137.4 million unrecognized stock-based compensation expense related to nonvested stock options, and performance and restricted stock, which is expected to be recognized over a weighted average period of 2.37 years.

 

     Three Months Ended
June 30
   Six Months Ended
June 30

(In thousands)

   2007    2006    2007    2006

Stock-based compensation expense:

           

Stock options

   $3,929    $5,551    $8,857    $11,780

Performance and restricted stock

   10,597    4,743    16,450    7,154
                   

Total stock-based compensation expense

   $14,526    $10,294    $25,307    $18,934
                   

The recognized tax benefit amounted to $5.5 million and $3.9 million for the three months ended June 30, 2007 and 2006, respectively. For the six months ended June 30, 2007 and 2006, the recognized tax benefit was $9.6 million and $7.2 million, respectively.

Retirement Plans

On February 13, 2007, the Retirement Benefits plans, Supplemental Benefits plans and the Postretirement Welfare plans were amended. The effective date for changes impacting the Retirement Benefits plans and the Supplemental Benefits plans is January 1, 2008. The effective date for changes impacting the Postretirement Welfare plans is January 1, 2010.

 

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Retirement Plan participants who are Company employees as of December 31, 2007 (“Affected Participants”) will cease to accrue additional benefits under the existing pension benefit formula after that date and all their accrued benefits will be frozen. Beginning January 1, 2008, Affected Participants who have fewer than 20 years of service and future participants will accrue future pension benefits under a cash balance formula that provides compensation and interest credits to a Personal Pension Account. Affected Participants with 20 or more years of service as of December 31, 2007 will be given the opportunity to choose between continuing a traditional pension benefit accrual under a reduced formula or participating in the new Personal Pension Account. Effective January 1, 2008, the vesting schedule will also change from the current 5-year cliff to a 3-year cliff for participants employed by the Company on and after that date.

The NCF Retirement Plan was amended to completely freeze benefits for those Affected Participants who do not elect, or are not eligible to elect, the traditional pension benefit formula in the SunTrust Retirement Plan.

The SunTrust Supplemental Executive Retirement Plan (“SERP”), was amended to change the benefit formula for future service accruals. Current participants in the SunTrust SERP will continue to earn future accruals under a reduced final average earnings formula. All future participants and ERISA Excess Plan participants will accrue benefits under benefit formulas that mirror the revised benefit formulas in the SunTrust Retirement Plan.

The Postretirement Welfare Plan was amended to discontinue its subsidy of medical coverage for retirees under age 65 unless such retirees have attained at least age 55 with 10 years of service before January 1, 2010.

The adoption of these amendments required a remeasurement of the benefit obligation under US GAAP. The Retirement Benefits plans, Supplemental Benefits plans and Postretirement Welfare plans were remeasured on February 13, 2007. For purposes of valuing the Retirement Benefits plans and Supplemental Benefits plans, it was assumed that all employees eligible to choose the reduced final average pay formula would do so.

As of February 13, 2007, all plans impacted by plan amendments were remeasured using the following discount rates:

 

 

·

 

6.00% for the SunTrust Retirement Plan,

 

·

 

5.90% for the NCF Retirement Plan,

 

·

 

5.91% for the SunTrust SERP and Excess Plan,

 

·

 

5.85% for the Crestar SERP and Excess Plan and

 

·

 

5.80% for the Postretirement Welfare Plans.

No remeasurement was required for the NCF SERP since the benefit changes did not impact this plan. All other assumptions and methods used in the February 13, 2007 measurement were consistent with those used as of December 31, 2006.

Effective January 1, 2008, the Company’s matching contribution under the 401(k) plan will be increased to 100% of the first 5% of eligible pay that a participant, including executive participants, elects to defer to the 401(k) plan.

SunTrust did not contribute to either of its noncontributory qualified retirement plans (“Retirement Benefits” plans) in 2007. The expected long-term rate of return on plan assets is 8.5% for 2007.

Anticipated employer contributions/benefit payments for 2007 are $15.5 million for the Supplemental Retirement Benefit plans. For the second quarter of 2007, the actual employer contributions/benefit payments totaled $2.3 million. Actual employer contributions/benefit payments for the six months ended June 30, 2007 were $5.4 million.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

SunTrust contributed $0.2 million to the Postretirement Welfare Plan in the second quarter of 2007, and $0.3 million for the six months ended June 30, 2007. The expected long-term rate of return on plan assets is 7.5% for 2007.

 

     Three Months Ended June 30  
     2007     2006  

(Dollars in thousands)

   Retirement
Benefits
    Supplemental
Retirement
Benefits
   Other
Postretirement
Benefits
    Retirement
Benefits
    Supplemental
Retirement
Benefits
   Other
Postretirement
Benefits
 

Service cost

   $16,298     $502    $251     $18,864     $620    $777  

Interest cost

   26,372     1,665    2,834     25,898     1,670    2,720  

Expected return on plan
assets

   (46,977 )   -    (2,051 )   (41,276 )   -    (2,026 )

Amortization of prior
service cost

   (3,663 )   644    (391 )   (123 )   883    -  

Recognized net actuarial
loss

   7,801     877    3,773     14,238     1,349    2,472  

Amortization of initial
transition obligation

   -     -    -     -     -    579  
                                  

Net periodic benefit cost

   ($169 )   $3,688    $4,416     $17,601     $4,522    $4,522  
                                  
     Six Months Ended June 30  
     2007     2006  

(Dollars in thousands)

   Retirement
Benefits
    Supplemental
Retirement
Benefits
   Other
Postretirement
Benefits
    Retirement
Benefits
    Supplemental
Retirement
Benefits
   Other
Postretirement
Benefits
 

Service cost

   $33,717     $1,018    $738     $36,873     $1,239    $1,557  

Interest cost

   52,508     3,357    5,671     50,623     3,339    5,448  

Expected return on plan
assets

   (92,401 )   -    (4,092 )   (80,681 )   -    (4,057 )

Amortization of prior
service cost

   (5,560 )   1,431    (587 )   (240 )   1,765    -  

Recognized net actuarial
loss

   15,779     1,763    6,738     27,829     2,700    4,949  

Amortization of initial
transition obligation

   -     -    280     -     -    1,159  

Partial settlement

   60     -    -     312     54    -  

Curtailment charge

   -     -    11,586     -     -    -  
                                  

Net periodic benefit cost

   $4,103     $7,569    $20,334     $34,716     $9,097    $9,056  
                                  

Note 9-Variable Interest Entities

SunTrust assists in providing liquidity to select corporate clients by directing them to a multi-seller commercial paper conduit, Three Pillars Funding LLC (“Three Pillars”). Three Pillars provides financing for direct purchases of financial assets originated and serviced by SunTrust’s corporate clients. Three Pillars finances this activity by issuing A-1/P-1 rated commercial paper. The result is a favorable funding arrangement for these clients.

In 2004, Three Pillars issued a subordinated note to a third party. According to the debt agreement, the holder absorbs the majority of Three Pillars’ expected losses. Therefore, the subordinated note investor is Three Pillars’ primary beneficiary, and thus the Company is not required to consolidate Three Pillars. As of June 30, 2007 and December 31, 2006, Three Pillars had assets not included on the Company’s Consolidated Balance Sheets of approximately $5.3 billion and $5.4 billion, respectively, consisting primarily of secured loans and marketable asset-backed securities.

Activities related to the Three Pillars relationship generated net fee revenue for the Company of approximately $7.6 million and $8.6 million for the three months ended June 30, 2007 and 2006, respectively and $14.6 million and $14.4 million for the six months ended June 30, 2007 and 2006, respectively. These activities include: client referrals and investment recommendations to Three Pillars; the issuing of letters of credit, which provides partial credit protection to the commercial paper holders; and providing a majority of the temporary liquidity arrangements that would provide funding to Three Pillars in the event it can no longer issue commercial paper or in certain other circumstances.

Off-balance sheet liquidity commitments and other credit enhancements made by the Company to Three Pillars, the sum of which represents the Company’s maximum exposure to potential loss, totaled $7.7 billion and $683.0 million, respectively, as of June 30, 2007 compared to $8.0 billion and $697.8 million, respectively, as of December 31, 2006. The Company manages the credit risk associated with these commitments by subjecting them to the Company’s normal credit approval and monitoring processes.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

The Company has significant variable interests in certain other securitization vehicles that are variable interest entities (“VIEs”) that are not consolidated because the Company is not the primary beneficiary. In such cases, the Company does not absorb the majority of the entities’ expected losses nor does it receive a majority of the expected residual returns. At June 30, 2007, total assets of these entities not included on the Company’s Consolidated Balance Sheets were approximately $2.8 billion compared to $2.2 billion at December 31, 2006. At June 30, 2007, the Company’s maximum exposure to loss related to these VIEs was approximately $31.6 million, which represents the Company’s investment in preference shares, compared to $32.2 million as of December 31, 2006.

As part of its community reinvestment initiatives, the Company invests in multi-family affordable housing properties throughout its footprint as a limited and/or general partner. The Company receives affordable housing federal and state tax credits for these investments. Partnership assets of approximately $722.8 million and $756.9 million in partnerships where SunTrust is only a limited partner were not included in the Consolidated Balance Sheets at June 30, 2007 and December 31, 2006, respectively. The Company’s maximum exposure to loss for these limited partner investments totaled $295.9 million and $330.6 million at June 30, 2007 and December 31, 2006, respectively. The Company’s maximum exposure to loss related to its affordable housing limited partner investments consists of the limited partnership equity investments, unfunded equity commitments, and debt issued by the Company to the limited partnerships.

SunTrust is the managing general partner of a number of non-registered investment limited partnerships which have been established to provide alternative investment strategies for its clients. In reviewing the partnerships for consolidation, SunTrust determined that these were voting interest entities and accordingly considered the consolidation guidance contained in EITF Issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.” Under the terms of SunTrust’s non-registered investment limited partnerships, the limited partners have certain rights, such as the right to remove the general partner, or “kick-out rights”, as indicated in EITF Issue No. 04-5. Therefore, SunTrust, as the general partner, is precluded from consolidating the limited partnerships.

Note 10-Guarantees

The Company has undertaken certain guarantee obligations in the ordinary course of business. In following the provisions of FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” (“FIN 45”) the Company must consider guarantees that have any of the following four characteristics: (i) contracts that contingently require the guarantor to make payments to a guaranteed party based on changes in an underlying factor that is related to an asset, a liability, or an equity security of the guaranteed party; (ii) contracts that contingently require the guarantor to make payments to a guaranteed party based on another entity’s failure to perform under an obligating agreement; (iii) indemnification agreements that contingently require the indemnifying party to make payments to an indemnified party based on changes in an underlying factor that is related to an asset, a liability, or an equity security of the indemnified party; and (iv) indirect guarantees of the indebtedness of others. The issuance of a guarantee imposes an obligation for the Company to stand ready to perform, and should certain triggering events occur, it also imposes an obligation to make future payments. Payments may be in the form of cash, financial instruments, other assets, shares of stock, or provisions of the Company’s services. The following is a discussion of the guarantees that the Company has issued as of June 30, 2007, which have characteristics as specified by FIN 45.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

Letters of Credit

Letters of credit are conditional commitments issued by the Company generally to guarantee the performance of a client to a third party in borrowing arrangements, such as commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients and may be reduced by selling participations to third parties. The Company issues letters of credit that are classified as financial standby, performance standby or commercial letters of credit. Commercial letters of credit are specifically excluded from the disclosure and recognition requirements of FIN 45.

As of June 30, 2007 and December 31, 2006, the maximum potential amount of the Company’s obligation was $12.2 billion and $12.9 billion, respectively, for financial and performance standby letters of credit. The Company has recorded $107.1 million and $104.8 million in other liabilities for unearned fees related to these letters of credit as of June 30, 2007 and December 31, 2006, respectively. The Company’s outstanding letters of credit generally have a term of less than one year but may extend longer than one year. If a letter of credit is drawn upon, the Company may seek recourse through the client’s underlying line of credit. If the client’s line of credit is also in default, the Company may take possession of the collateral securing the line of credit, where applicable.

Loan Sales

SunTrust Mortgage, Inc. (“STM”), a consolidated subsidiary of SunTrust, originates consumer residential mortgage loans, a portion of which are sold to outside investors in the normal course of business. When mortgage loans are sold, representations and warranties regarding certain attributes of the loans sold are made to the third party purchaser. These representations and warranties may extend through the life of the mortgage loan, generally 25 to 30 years. Subsequent to the sale, if inadvertent underwriting deficiencies or documentation defects are discovered in individual mortgage loans, STM will be obligated to repurchase the respective mortgage loan if such deficiencies or defects cannot be cured by STM within the specified period following discovery. STM maintains a liability for estimated losses on mortgage loans that may be repurchased due to general representations and warranties or purchasers’ rights under early payment default provisions. As of June 30, 2007 and December 31, 2006, $20.3 million and $13.0 million, respectively were accrued for these repurchases. The increase in the liability primarily relates to loan sales that occurred during the first half of 2007 and experienced an early payment default event, as well as adjustments based on recent experience to the estimated loss factors used to calculate the liability.

Contingent Consideration

The Company has contingent payment obligations related to certain business combination transactions. Payments are calculated using certain post-acquisition performance criteria. The potential liability associated with these arrangements was approximately $20.8 million and $82.8 million as of June 30, 2007 and December 30, 2006, respectively. As contingent consideration in a business combination is not subject to the recognition and measurement provisions of FIN 45, the Company currently has no amounts recorded for these guarantees as of June 30, 2007. If required, these contingent payments will be payable within the next two years.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

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 underwriting agreements, merger and acquisition agreements, loan sales, contractual commitments, 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.

Third party investors hold Series B Preferred Stock in STB Real Estate Holdings (Atlanta), Inc. (“STBREH”), a subsidiary of SunTrust. The contract between STBREH and the third party investors contains an automatic exchange clause which, under certain circumstances, requires the Series B preferred shares to be automatically exchanged for guaranteed preferred beneficial interest in debentures of the Company. The guaranteed preferred beneficial interest in debentures is guaranteed to have a liquidation value equal to the sum of the issue price, $350.0 million, and an approximate yield of 8.5% per annum subject to reduction for any cash or property dividends paid to date. As of June 30, 2007 and December 31, 2006, $561.7 million and $538.7 million was accrued in other liabilities for the principal and interest, respectively. This exchange agreement remains in effect as long as any shares of Series B Preferred Stock are owned by the third party investors, not to exceed 30 years from the February 25, 2002 date of issuance.

SunTrust Investments Services, Inc., “STIS” and SunTrust Capital Markets, Inc. (“STCM”), broker-dealer affiliates of SunTrust, 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 STCM 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 STCM 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 three and six months ended June 30, 2007 and June 30, 2006, STIS and STCM experienced minimal net losses as a result of the indemnity. The clearing agreements expire in May 2010 for both STIS and STCM.

The Company has guarantees associated with credit derivatives, an agreement in which the buyer of protection pays a premium to the seller of the credit derivatives for protection against an event of default. Events constituting default under such agreements that would result in the Company making a guaranteed payment to a counterparty may include (i) default of the referenced asset; (ii) bankruptcy of the client; or (iii) restructuring or reorganization by the client. The maximum guarantee outstanding as of June 30, 2007 and December 31, 2006 was $309.1 million and $345.6 million, respectively. As of June 30, 2007, the maximum guarantee amounts expire as follows: $87.0 million in 2008, $37.8 million in 2009, $76.5 million in 2010, $44.6 million in 2011, and $63.2 million thereafter. In the event of default under the contract, the Company would make a cash payment to the holder of credit protection and would take delivery of the referenced asset from which the Company may recover a portion of the credit loss. There were no cash payments made during 2006 or in the six months ended June 30, 2007. In addition, there are certain purchased credit derivative contracts that mitigate a portion of the Company’s exposure on written contracts. Such contracts are not included in this disclosure since they represent benefits to, rather than obligations of, the Company. The Company records purchased and written credit derivative contracts at fair value.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

SunTrust Community Development Corporation (“CDC”), a SunTrust subsidiary, obtains state and federal tax credits through the construction and development of low income housing properties. CDC or its subsidiaries are limited and/or general partners in various partnerships established for the properties. If the partnerships generate tax credits, those credits may be sold to outside investors. As of June 30, 2007, the CDC had completed six tax credit sales containing guarantee provisions stating that the CDC will make payment to the outside investors if the tax credits become ineligible. The CDC also guarantees that the general partner under the transaction will perform on the delivery of the credits. The guarantees are expected to expire within a ten year period. As of June 30, 2007, the maximum potential amount that the CDC could be obligated to pay under these guarantees is $37.0 million; however, the CDC can seek recourse against the general partner. Additionally, the CDC can seek reimbursement from cash flow and residual values of the underlying low income housing properties provided that the properties retain value. As of June 30, 2007 and December 31, 2006, $14.1 million and $15.3 million were accrued, respectively, representing the remainder of tax credits to be delivered, and were recorded in Other Liabilities on the Consolidated Balance Sheets.

Note 11-Concentrations of Credit Risk

Credit risk represents the maximum accounting loss that would be recognized at the reporting date if borrowers failed to perform as contracted and any collateral or security proved to be of no value. Concentrations of credit risk (whether on- or off-balance sheet) arising from financial instruments can exist in relation to individual borrowers or groups of borrowers, certain types of collateral, certain types of industries, certain loan products, or certain regions of the country.

Credit risk associated with these concentrations could arise when a significant amount of loans, related by similar characteristics, are simultaneously impacted by changes in economic or other conditions that cause their probability of repayment to be adversely affected. The Company does not have a significant concentration of risk to any individual client except for the U.S. government and its agencies. The major concentrations of credit risk for the Company arise by collateral type in relation to loans and credit commitments. The only significant concentration that exists is in loans secured by residential real estate. At June 30, 2007, the Company owned $45.1 billion in residential real estate loans and home equity lines, representing 37.9% of total loans, and an additional $20.3 billion in commitments to extend credit on home equity loans and $10.5 billion in mortgage loan commitments. At December 31, 2006, the Company had $47.9 billion in residential real estate loans and home equity lines, representing 39.5% of total loans, and an additional $19.0 billion in commitments to extend credit on home equity loans and $28.2 billion in mortgage loan commitments. The Company originates and retains certain residential mortgage loan products that include features such as interest only loans, high loan to value loans and low initial interest rate loans, which comprised approximately 42% and 37% of loans secured by residential real estate at June 30, 2007 and December 31, 2006, respectively. The risk in each loan type is mitigated and controlled by managing the timing of payment shock, private mortgage insurance and underwriting guidelines and practices. A geographic concentration arises because the Company operates primarily in the Southeastern and Mid-Atlantic regions of the United States.

SunTrust engages in limited international banking activities. The Company’s total cross-border outstandings were $719.8 million and $693.1 million as of June 30, 2007 and December 31, 2006, respectively.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

Note 12-Fair Value

As discussed in Note 1, “Accounting Policies”, to the Consolidated Financial Statements, SunTrust early adopted the recently issued fair value financial accounting standards SFAS Nos. 157 and 159 on January 1, 2007. In certain circumstances, fair value enables a company to more accurately align its financial performance with the economic value of actively traded or hedged assets or liabilities. Fair value enables a company to mitigate the non-economic earnings volatility caused from financial assets and financial liabilities being carried at different bases of accounting, as well as to more accurately portray the active and dynamic management of a company’s balance sheet. The objectives of the new fair value standards align very closely with the Company’s recent balance sheet management strategies.

In conjunction with adopting SFAS No. 159, the Company elected to record specific financial assets and financial liabilities at fair value. These instruments include all, or a portion, of the following: debt, available for sale debt securities, adjustable rate residential mortgage portfolio loans, securitization warehouses and trading loans. In the second quarter of 2007, the Company elected to record at fair value certain newly-originated mortgage loans held for sale based upon defined product criteria.

The following is a description of each asset and liability class for which fair value has been elected, including the specific reasons for electing fair value and the strategies for managing the assets and liabilities on a fair value basis. See the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007 for more information regarding the Company’s initial evaluation of SFAS Nos. 157 and 159 and rationale for early adoption.

Fixed Rate Debt

The debt that the Company elected to carry at fair value was all of its fixed rate debt that had previously been designated in qualifying fair value hedges using receive fixed/pay floating interest rate swaps, pursuant to the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This population specifically included $3.5 billion of fixed-rate Federal Home Loan Bank (“FHLB”) advances and $3.3 billion of publicly-issued debt. The Company elected to record this debt at fair value in order to align the accounting for the debt with the accounting for the derivative without having to account for the debt under hedge accounting, thus avoiding the complex and time consuming fair value hedge accounting requirements of SFAS No. 133. The reduction to opening retained earnings from recording the debt at fair value was $197.2 million. This move to fair value introduces potential earnings volatility due to changes in the Company’s credit spread that were not required to be valued under the SFAS No. 133 hedge designation. All of the debt, along with the interest rate swaps previously designated as hedges under SFAS No. 133, continues to remain outstanding. As of June 30, 2007, the Company had not issued any new fixed rate debt since January 1, 2007.

Available for Sale and Trading Securities

The available for sale debt securities that were transferred to trading were substantially all of the debt securities within specific assets classes, whether the securities were valued at an unrealized loss or unrealized gain. The Company elected to reclassify approximately $15.4 billion of securities to trading at January 1, 2007, as well as an additional $600 million of purchases of similar assets that occurred during the first quarter. The reduction to opening retained earnings related to reclassifying the $15.4 billion of securities to trading was $147.4 million. The Company’s entire securities portfolio is of high credit quality, such that the opening retained earnings adjustment was not significantly impacted by the credit risk embedded in the assets but rather due to interest rates. This net unrealized loss was already reflected in accumulated other comprehensive income and, therefore, upon reclassification to retained earnings, there was no net impact to total shareholders’ equity.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

The Company elected to move these available for sale securities to trading securities in order to be able to more actively trade a more significant portion of its investment portfolio and reduce the overall size of the available for sale portfolio. In determining the assets to be sold, the Company considered economic factors, such as yield and duration, in relation to its balance sheet strategy for the securities portfolio. In evaluating its total available for sale portfolio of approximately $23 billion at January 1, 2007, the Company determined that approximately $3 billion of securities were not available or were not practical to be fair valued and reclassified to trading under SFAS No. 159, as these securities had matured or been called during the quarter, were subject to business restrictions, were privately placed or had nominal principal amounts. Approximately $5 billion of securities aligned with the Company’s recent balance sheet strategy, due to the nature of the assets (such as 30-year fixed rate mortgage backed securities (“MBS”), 10/1 adjustable rate mortgages (“ARMs”), floating rate asset backed securities (“ABS”) and municipal bonds); therefore, the securities continued to be classified as available for sale. These securities yielded over 5.6%, had a duration over 4.0%, and were in a $6.7 million net unrealized gain position as of January 1, 2007. The remaining $15.4 billion of securities, which included hybrid ARMs, collateralized mortgage backed securities (“CMBS”), collateralized mortgage obligations (“CMO”) and MBS (excluding those classes of mortgage-backed securities that remained classified as securities available for sale), yielded approximately 4.5% and had a duration under 3.0%. The approximate $600 million of securities that were purchased in the first quarter and originally classified as available for sale were similar to the securities reclassified to trading on January 1, 2007 upon adoption of SFAS No. 159; accordingly, the Company reclassified these securities to trading pursuant to the provisions of SFAS No. 159.

During the first quarter of 2007, in connection with the Company’s decision to early adopt SFAS No. 159, the Company purchased approximately $1.7 billion of treasury bills, which were classified as trading securities, and approximately $3.2 billion of 30-year fixed rate MBS, which were classified as securities available for sale. The Company entered into approximately $13.5 billion of interest rate derivatives to mitigate the fair value volatility of the available for sale securities that had been reclassified to trading. Finally, as part of its asset/liability strategies, the Company executed an additional $7.5 billion notional receive-fixed interest rate swaps that were designated as cash flow hedges under SFAS No. 133 on floating rate commercial loans.

During the second quarter of 2007, the Company sold substantially all of the $16.0 billion in securities transferred to trading at prices that, in the aggregate and including the hedging gains and losses, approximated the fair value of the securities at March 31, 2007, and terminated the interest rate derivatives it had entered into as hedges of the fair value. During the second quarter of 2007, the Company made additional purchases of approximately $5.4 billion of treasury bills and $4.3 billion of agency notes classified as trading and approximately $2.0 billion of 30-year fixed-rate MBS classified as securities available for sale. The 30-year fixed-rate MBS that were purchased during the second quarter were a similar asset type to the securities that remained classified as available for sale. These securities yield over 5.6% and have an effective duration of approximately 5.7%. As of June 30, 2007, $9.5 billion of treasury bills and agency notes classified as trading and approximately $7.5 billion of 30-year fixed-rate MBS classified as securities available for sale were outstanding.

 

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Table of Contents

Notes to Consolidated Financial Statements (Unaudited) - Continued

Mortgage Loans Held for Sale

In connection with the early adoption of SFAS No. 159, the Company elected to carry $4.1 billion of prime quality, mid-term adjustable rate, highly commoditized, conforming agency and nonagency conforming residential mortgage portfolio loans at fair value as of January 1, 2007 and transferred these loans to held for sale at fair value at the end of the first quarter. These loans were all performing loans and virtually all had not been past due 30 days or more over the prior 12 month period. The reduction to opening retained earnings related to these loans was $44.2 million, which was net of a $4.1 million reduction in the allowance for loan losses related to these loans. In order to moderate the growth of earning assets, the Company decided in the second quarter of 2006 to no longer portfolio new originations of these types of loans, but had not undertaken plans to sell or securitize any of these portfolio loans. In connection with the final issuance of SFAS No. 159, the Company evaluated the composition of the mortgage loan portfolio, particularly in light of its plans to no longer hold the above mentioned mortgage loans in its portfolio. In addition, the Company reviewed certain business restrictions on loans that are held by real estate investment trusts (“REITs”). Based on this evaluation, the Company elected to record $4.1 billion of mortgage loans at fair value. The loans that the Company elected to move to fair value were not owned by a REIT and had a weighted average coupon rate of approximately 4.94%. In connection with recording these loans at fair value, the Company entered into hedging activities to mitigate the earnings volatility from changes in the loans’ fair value. As of June 30, 2007, $1.2 billion of the $4.1 billion in fair valued mortgage loans remained outstanding. During the second quarter of 2007, the Company sold $2.9 billion of the $4.1 billion of mortgage loans transferred to loans held for sale that, in the aggregate and including the hedging gains and losses, approximated the fair value of the mortgage loans at March 31, 2007, and terminated the interest rate derivatives it had entered into as hedges of the fair value.

In the second quarter of 2007, the Company began recording at fair value certain newly-originated mortgage loans held for sale based upon defined product criteria. SunTrust chose to fair value these mortgage loans held for sale in order to eliminate the complexities and inherent difficulties of achieving hedge accounting and to better align reported results with the underlying economic changes in value of the loans and related hedge instruments. During the second quarter of 2007, $5.2 billion of newly-originated mortgage loans held for sale were recorded at fair value. This election impacts the timing and recognition of origination fees and costs, as well as servicing value. Specifically, origination fees and costs, which had been appropriately deferred under SFAS No. 91 and recognized as part of the gain/loss on sale of the loan, are now recognized in earnings at the time of origination. For the three months ended June 30, 2007, approximately $11.9 million in loan origination fees and approximately $12.4 million in loan origination costs were recognized due to this fair value election. The servicing value, which had been recorded at the time the loan was sold as a mortgage servicing right, is now included in the fair value of the loan and recognized at origination of the loan. The Company began using derivatives to economically hedge changes in servicing value as a result of including the servicing value in the fair value of the loan. The estimated impact from recognizing servicing value, net of related hedging costs, as part of the fair value of the loan is captured in the overall change in mortgage production income.

Securitization and Trading Loans

As part of its securitization and trading activities, the Company often warehouses assets prior to sale or securitization, retains interests in securitizations, and maintains a portfolio of loans that it trades in the secondary market. At January 1, 2007, the Company transferred to trading assets approximately $600 million of loans, substantially all of which were purchased from the market for the purpose of sales into securitizations, which were previously classified as loans held for sale. In addition, the Company owns approximately $9 million of residual interests from securitizations that were previously classified as securities available for sale, which were transferred to trading assets. Pursuant to the provisions of SFAS No. 159, the Company elected to carry warehoused and trading loans at fair value in order to align the economics of these instruments with the hedges that the Company typically executes on certain of these loans and to reclassify its residual interests to trading assets, consistent with other residual positions the Company owns. During the second quarter of 2007, approximately $200 million of the $600 million of trading loans transferred into trading assets as of January 1, 2007 were sold as part of the Company’s loan trading and securitization activities and additional loans were purchased and recorded at fair value.

 

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Table of Contents

Notes to Consolidated Financial Statements (Unaudited) - Continued

The most significant financial impacts of adopting the provisions of SFAS No. 157 related to valuing mortgage loans held for sale, and mortgage loan commitments (related to loans intended to be held for sale) that are derivatives under the provisions of SFAS No. 133, as amended by SFAS No. 149. Under SFAS No. 157, the fair value of a closed loan includes the embedded cash flows that are ultimately realized as servicing value either through retention of the servicing asset or through the sale of a loan on a servicing released basis. The valuation of loan commitments includes assumptions related to the likelihood that a commitment will ultimately result in a closed loan (“pull-through rates”). These pull-through rates are based on the Company’s historical data, which is a significant unobservable assumption. Prior accounting requirements under EITF 02-03, “Accounting for Contracts involved in Energy Trading and Risk Managements Activities,” precluded the recognition of any day one gains and losses if fair value was not based on market observable data. Rather, these deferred gains and losses were recognized when the rate lock expired or when the underlying loan was ultimately sold. The change in valuation methodology under SFAS No. 157 accelerates the recognition of these day one gains and losses, excluding the servicing value. As a result of adopting SFAS No. 157, the Company recorded a $10.9 million reduction to opening retained earnings during the first quarter of 2007.

Upon adoption of SFAS No. 157, the Company applied the following fair value hierarchy:

Level 1 - Assets or liabilities for which the identical item is traded on an active exchange, such as publicly-traded instruments or futures contracts.

Level 2 - Assets and liabilities valued based on observable market data for similar instruments.

Level 3 - Assets or liabilities for which significant valuation assumptions are not readily observable in the market; instruments valued based on the best available data, some of which is internally-developed, and considers risk premiums that a market participant would require.

The Company measures or monitors many of its assets and liabilities on a fair value basis. Fair value is used on a recurring basis for those assets and liabilities that were elected under SFAS No. 159 as well as for certain assets and liabilities in which fair value is the primary basis of accounting. Examples of these include derivative instruments, available for sale and trading securities, fixed rate debt, certain loans held for sale and certain residual interests from Company-sponsored securitizations. Additionally, fair value is used on a non-recurring basis to evaluate assets or liabilities for impairment or for disclosure purposes in accordance with SFAS No. 107, “Disclosures about Fair Value of Financial Instruments.” Examples of these non-recurring uses of fair value include certain loans held for sale accounted for on a lower of cost or market basis, mortgage servicing rights, goodwill, and long-lived assets. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating the instrument’s fair value. These valuation techniques and assumptions are in accordance with SFAS No. 157.

 

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Table of Contents

Notes to Consolidated Financial Statements (Unaudited) - Continued

Fair value is defined as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at and/or marked to fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Company looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to market observable data for similar assets and liabilities. Nevertheless, certain assets and liabilities are not actively traded in observable markets and the Company must use alternative valuation techniques to derive a fair value measurement.

The majority of the fair value amounts included in current period earnings resulted from Level 2 fair value methodologies. This result is reflective of the Company’s overall risk management views and business initiatives, such that products with significant unobservable data inputs (i.e., Level 3) are not prevalent in the Company’s balance sheet management strategies.

The most significant instruments that the Company fair values include securities, derivative instruments, fixed rate debt and loans, almost all of which fall into Level 2 in the fair value hierarchy. Other than derivative instruments, the majority of the securities in the Company’s trading and available for sale portfolios, along with the publicly issued debt are priced via independent providers, whether those are pricing services or quotations from market-makers in the specific instruments. In obtaining such valuation information from third parties, the Company has evaluated the valuation methodologies used to develop the fair values in order to determine whether such valuations are representative of an exit price in the Company’s principal markets. Further, the Company has developed an internal, independent price verification function that performs testing on valuations received from third parties. The Company’s principal markets for its securities portfolios are the secondary institutional markets, with an exit price that is predominantly reflective of bid level pricing in those markets. Debt that the Company has fair valued is priced based on observable market data in the institutional markets, which is its principal market. 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 under SFAS No. 157, 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. These valuation adjustments were not significant to the first or second quarters of 2007. For loans where quoted market prices are not available, the fair value of loans is based on securities prices of similar products and when appropriate includes adjustments to account for credit spreads, interest rates, collateral type and costs that would be incurred to transform a loan into a security when sold. The principal market for loans is the secondary loan market in which loans trade as either whole loans or securities. The Company employs the same valuation techniques in the determination of fair value for loans accounted for under fair value as those accounted for under the lower of cost or fair value.

 

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Table of Contents

Notes to Consolidated Financial Statements (Unaudited) - Continued

For loan products and issued liabilities that the Company has elected to carry at fair value, the Company has considered the component of the fair value changes due to instrument-specific credit risk, which is intended to be an approximation of the fair value change attributable to changes in borrower-specific credit risk. As only an insignificant percentage of the loans carried at fair value are on nonaccrual status, are past due or have other characteristics that would be attributable to borrower-specific credit risk, the Company does not ascribe any significant fair value changes to instrument-specific credit risk as of June 30, 2007. Further, the allowance for loan losses that was removed due to electing to carry certain mortgage loans at fair value did not include any specific credit reserves for those loans. However, when estimating the fair value of its loans, interest rates and general conditions in the principal markets for the loans are the most significant underlying variables that will drive changes in the fair values of the loans, not borrower-specific credit risk. For its fixed rate debt, the Company estimated credit spreads above LIBOR rates, based on trading levels of its debt in the market as of June 30, 2007 and as of March 31, 2007. Based on this methodology, the Company estimates that it recognized a $3.0 million and $6.6 million loss for the three and six months ended June 30, 2007, respectively, due to its own credit as part of the total change in the fair value of its fixed rate public debt.

The following table presents financial assets and financial liabilities measured at fair value on a recurring basis:

 

         

Fair Value Measurements at

June 30, 2007,

Using

(Dollars in thousands)

   Fair Value
Measurements
June 30, 2007
   Quoted
Prices In
Active
Markets
for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)

Trading assets

   $13,044,972    $5,057,277    $7,910,672    $77,023

Securities available for sale

   $14,725,957    2,709,745    11,308,170    708,042

Loans held for sale

   6,494,602    -        6,494,602    -    

Brokered deposits

   282,889    -        282,889    -    

Trading liabilities

   2,156,279    572,491    1,583,788    -    

Long-term debt

   6,757,188    -        6,757,188    -    

Other liabilities

   17,508    -        -        17,508

The following table presents the change in fair value for the three and six month periods ended June 30, 2007 for those specific financial instruments in which fair value has been elected. The table does not reflect the change in fair value attributable to the related economic hedges the Company used to mitigate the interest rate risk associated with the financial instruments. The changes in the fair value of economic hedges were also recorded in trading account profits and commissions or mortgage production related income, as appropriate, and substantially offset the change in fair value of the financial instruments referenced in the table below. The Company’s economic hedging activities are deployed at both the instrument and portfolio level.

 

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Table of Contents

Notes to Consolidated Financial Statements (Unaudited) - Continued

    

Fair Value gain/(loss) for the 3-month Period Ended

June 30, 2007, for Items Measured at Fair Value Pursuant

to Election of the Fair Value Option

        

Fair Value gain/(loss) for the 6-month Period Ended

June 30, 2007, for Items Measured at Fair Value Pursuant

to Election of the Fair Value Option

 

(Dollars in thousands)

  

Trading Account

Profits and

Commissions

   

Mortgage

Production

Related

Income

   

Total

Changes in

Fair Values

Included in

Current-

Period

Earnings1

        

Trading Account

Profits and

Commissions

  

Mortgage

Production

Related

Income

   

Total

Changes in

Fair Values

Included in

Current-

Period

Earnings1

 
 

Trading assets

   ($22,352 )   $-             ($22,352 )      $48,989    $-             $48,989  

Loans held for sale

   -         (12,684 )   (12,684 )      -        (16,809 )   (16,809 )

Brokered deposits

   4,418     -         4,418        6,147    -         6,147  

Long-term debt

   139,691     -         139,691        120,541    -         120,541  

1 Changes in fair value for the three and six months ended June 30, 2007 exclude accrued interest for the period then ended. Interest income or interest expense on trading assets, loans held for sale, brokered deposits and long-term debt that have been elected to be carried at fair value under the provisions of SFAS No. 159 or SFAS No. 155 are recorded in interest income or interest expense in the Consolidated Statements of Income based on their contractual coupons. Certain trading assets do not have a contractually stated coupon and, for these securities, the Company records interest income based on the effective yield calculated upon acquisition of those securities. For the three and six months ended June 30, 2007, the change in fair value related to accrued interest income on loans held for sale was an increase of $9.7 million and $9.9 million, respectively and the change in fair value related to accrued interest expense on brokered deposits and long-term debt was an increase of $2.3 million and $3.9 million and a decrease of $25.2 million and $252 thousand, respectively.

The following table presents the change in carrying value of those financial assets measured at fair value on a non-recurring basis, for which impairment was recognized in the current period. The table does not reflect the change in fair value attributable to the related economic hedges the Company used to mitigate the interest rate risk associated with these financial assets. The changes in fair value of the economic hedges were also recorded in mortgage production related income, and substantially offset the change in fair value of the financial assets referenced in the table below. The Company’s economic hedging activities are deployed at the portfolio level.

 

         

Fair Value Measurement at

June 30, 2007,

Using

        

(Dollars in thousands)

  

Fair Value

Measurements

June 30, 2007

  

Quoted
Prices In
Active

Markets

for

Identical

Assets

(Level 1)

  

Significant

Other

Observable

Inputs

(Level 2)

  

Significant

Unobservable

Inputs
(Level 3)

  

Total losses recorded in

mortgage production related income for the

               three months
ended June 30, 2007
  six months
ended June 30, 2007

Loans Held for Sale 1

   $4,790,286    $-    $4,790,286    $-    ($68,004)   ($105,142)

1 These balances were not impacted by the election of the fair value option and are measured at fair value on a non-recurring basis in accordance with applicable accounting policies.

As of June 30, 2007, approximately $119.9 million of leases held for sale were included in loans held for sale in the Consolidated Balance Sheets and were not eligible for fair value election under SFAS No. 159.

SunTrust used significant unobservable inputs (Level 3) to fair-value certain trading assets, securities available for sale and other liabilities as of June 30, 2007. The trading securities are residual interests that the Company retained from certain securitization and/or structured asset sale transactions. The significant assumptions that are not observable in the market, due to illiquidity and the uniqueness of the asset classes, relate to prepayment speeds, discount rates and credit spreads. Available for sale securities consist of instruments that are not readily marketable and may only be redeemed with the issuer at par. The Company classifies interest rate lock commitments on residential mortgage loans, which are derivatives under SFAS No. 133, within other liabilities or other assets. The fair value of these commitments, while based in part, on interest rates observable in the market, is highly dependent on the ultimate closing of the loans. These pull-through rates are based on the Company’s historical data and reflect an estimate of the likelihood of a commitment that will ultimately result in a closed loan.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

The following table shows a reconciliation of the beginning and ending balances for fair value measurements using significant unobservable inputs:

 

    

Fair Value Measurements

Using Significant Unobservable Inputs

 

(Dollars in thousands)

   Trading
Assets
    Securities
Available
for Sale
    Other
Liabilities
 

Beginning balance January 1, 2007

   $24,393       $734,633     $29,633  

Total gains or losses (realized/unrealized):

      

Included in earnings

   (4,406 )     -         (12,125 )

Included in other comprehensive income

   -           497     -      

Purchases and issuances

   61,853       507     155,563  

Settlements

   (4,817 )     (27,595 )   (114,333 )

Expirations

   -           -         (41,230 )
                    

Ending balance June 30, 2007

   $77,023       $708,042     $17,508  
                    

The amount of total gains or (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the June 30, 2007.

   ($4,406 )   $ -     ($17,508 )
                    

For the trading assets and other liabilities fair-valued using Level 3 inputs, the realized and unrealized gains and losses included in earnings for the three and six months ended June 30, 2007 are reported in trading account profits and commissions and mortgage production related income as follows:

 

    

Three months ended

June 30, 2007

  

Six months ended

June 30, 2007

 
     Trading
Account Profits
and Comissions
   Mortgage
Production
Related
Income
   Trading
Account Profits
and Comissions
    Mortgage
Production
Related
Income
 

Total change in earnings

   $ -        $3,626    ($4,406 )   ($12,125 )
                        

Change in unrealized gains or losses relating to assets and liabilities still held at June 30, 2007

   $ -        $3,626    ($4,406 )   ($17,508 )
                        

The following table presents the difference between the aggregate fair value and the aggregate unpaid principal balance of loans, brokered deposits, and long-term debt instruments for which the fair value option has been elected. For loans held for sale for which the fair value option has been elected, the table also includes the difference between aggregate fair value and the aggregate unpaid principal balance of loans that are 90 days or more past due, as well as loans in nonaccrual status.

 

(Dollars in thousands)

   Aggregate
Fair Value
June 30, 2007
   Aggregate
Unpaid Principal
Balance under FVO
June 30, 2007
  

Fair value
carrying amount
over/(under)

unpaid principal

 

Trading assets

   $1,349,505    $864,355    $485,150  

Loans held for sale

   6,492,416    6,594,831    (102,415 )

Past due loans of 90 days or more

   1,208    1,439    (231 )

Nonaccrual loans

   978    1,164    (186 )

Brokered deposits

   282,889    288,670    (5,781 )

Long-term debt

   6,757,188    6,816,750    (59,562 )

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

Note 13 - Business Segment Reporting

The Company uses a line of business management structure to measure business activities. The Company has five primary lines of business (“LOBs”): Retail, Commercial, Corporate and Investment Banking, Wealth and Investment Management, and Mortgage.

The Retail line of business includes loans, deposits, and other fee-based services for consumers and business clients with less than $5 million in sales (up to $10 million in sales in larger metropolitan markets). Clients are serviced through an extensive network of traditional and in-store branches, ATMs, the Internet and the telephone.

The Commercial line of business provides enterprises with a full array of financial products and services including commercial lending, financial risk management, and treasury and payment solutions including commercial card services. This line of business primarily serves business clients between $5 million and $250 million in annual revenues and clients specializing in commercial real estate activities.

Corporate and Investment Banking provides advisory services, debt and equity capital raising solutions, financial risk management capabilities, and debt and equity sales and trading for the Corporation’s clients as well as traditional lending, leasing, treasury management services and institutional investment management to middle and large corporate clients.

Wealth and Investment Management provides a full array of wealth management products and professional services to both individual and institutional clients. Wealth and Investment Management’s primary segments include Private Wealth Management (brokerage and individual wealth management), AMA Holdings, and Institutional Investment Management and Administration. On March 30, 2007, SunTrust merged its wholly-owned subsidiary, Lighthouse Partners, with and into Lighthouse Investment Partners, LLC, the entity that was serving as the sub-advisor to Lighthouse Partners and the Lighthouse Partners’ managed funds. SunTrust holds a minority interest in the combined entity and it also has a revenue sharing arrangement with Lighthouse Investment Partners. On July 24, 2007, SunTrust signed a “merger implementation agreement” with HFA Holdings Ltd., an Australian fund manager, to sell Lighthouse Investment Partners, the combined entity to HFA Holdings Ltd. For further discussion surrounding this transaction see Note 2, “Acquisitions/Dispositions” to the Consolidated Financial Statements.

The Mortgage line of business offers residential mortgage products nationally through its retail, broker and correspondent channels. These products are either sold in the secondary market primarily with servicing rights retained or held as whole loans in the Company’s residential loan portfolio. The line of business services loans for its own residential mortgage portfolio as well as for others. Additionally, the line of business generates revenue through its tax service subsidiary (ValuTree Real Estate Services, LLC) and the Company’s captive reinsurance subsidiary (Twin Rivers Insurance Company, formerly Cherokee Insurance Company).

In addition, the Company reports a Corporate Other and Treasury segment which includes the investment securities portfolio, long-term debt, capital, short-term liquidity and funding activities, balance sheet risk management including derivative hedging activities, and certain support activities not currently allocated to the aforementioned lines of business. Because the business segment results are presented based on management accounting practices, the transition to generally accepted accounting principles creates differences which are reflected in Reconciling Items.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

For business segment reporting purposes, the basis of presentation in the accompanying financial tables includes the following:

 

 

·

 

Net interest income - All net interest income is presented on a fully taxable-equivalent (“FTE”) basis. The revenue gross up has been applied to tax-exempt loans and investments to make them comparable to other taxable products. The segments have also been matched-maturity funds transfer priced, generating credits or charges based on the economic value or cost created by the assets and liabilities of each segment. The mismatch between funds credits and funds charges at the segment level resides in Reconciling Items. The change in the matched-maturity funds mismatch is generally attributable to the corporate balance sheet management strategies.

 

·

 

Provision for loan losses - Represents net loan charge-offs by segment. The difference between the segment net charges-offs and consolidated provision for loan losses is reported in reconciling items.

 

·

 

Provision for income taxes - Calculated using a nominal income tax rate for each segment. The calculation includes the impact of various income adjustments, such as the reversal of the fully taxable-equivalent gross up on tax-exempt assets, tax adjustments and credits that are unique to each business segment. The difference between the calculated provision for income taxes at the segment level and the consolidated provision for income taxes is reported in Reconciling Items.

The Company continues to augment its internal management reporting methodologies. Currently, the lines of business’ financial performance is comprised of direct financial results as well as various allocations that for internal management reporting purposes provide an enhanced view of analyzing the line of business’ financial performance. The internal allocations include the following:

 

 

·

 

Operational Costs – Expenses are charged to the LOBs based on various statistical volumes multiplied by activity based cost rates. As a result of the activity based costing process, planned residual expenses are also allocated to the LOBs. The recoveries for the majority of these costs are in the Corporate Other and Treasury LOB.

 

·

 

Support and Overhead Costs – Expenses not directly attributable to a specific LOB are allocated based on various drivers (e.g., number of full-time equivalent employees and volume of loans and deposits). The recoveries for these allocations are in the Corporate Other and Treasury LOB.

 

·

 

Sales and Referral Credits – LOBs may compensate another LOB for referring or selling certain products. The majority of the revenue resides in the LOB where the product is ultimately managed.

The application and development of management reporting methodologies is a dynamic process and is subject to periodic enhancements. The implementation of these enhancements to the internal management reporting methodology may materially affect the net income disclosed for each segment with no impact on consolidated amounts. Whenever significant changes to management reporting methodologies take place, the impact of these changes is quantified and prior period information is reclassified wherever practicable. The Company will reflect these reclassified changes in the current period and will update historical results.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

 

     Three Months Ended June 30, 2007

(Dollars in thousands)

   Retail    Commercial    Corporate and
Investment
Banking
    Mortgage    Wealth and
Investment
Management
   Corporate Other
and Treasury
    Reconciling
Items
    Consolidated

Average total assets

   $37,734,467    $35,683,882    $23,722,665     $47,866,786    $8,941,690    $24,380,284     $1,666,683     $179,996,457

Average total liabilities

   69,605,990    18,856,568    8,564,146     3,209,740    10,450,872    51,269,511     111,528     162,068,355

Average total equity

   -    -    -     -    -    -     17,928,102     17,928,102
                                          

Net interest income

   $580,514    $220,089    $42,456     $135,485    $86,975    ($52,636 )   $182,401     $1,195,284

Fully taxable-equivalent adjustment (FTE)

   35    9,359    10,995     -    12    4,237     30     24,668
                                          

Net interest income (FTE)1

   580,549    229,448    53,451     135,485    86,987    (48,399 )   182,431     1,219,952

Provision for loan losses2

   48,620    7,776    14,600     13,051    2,951    1,259     16,423     104,680
                                          

Net interest income after provision for loan
losses

   531,929    221,672    38,851     122,434    84,036    (49,658 )   166,008     1,115,272

Noninterest income

   267,672    74,212    199,155     136,931    249,028    232,638     (5,014 )   1,154,622

Noninterest expense3

   550,350    165,311    132,116     197,174    248,244    (37,006 )   (4,995 )   1,251,194
                                          

Net income before provision for income
taxes

   249,251    130,573    105,890     62,191    84,820    219,986     165,989     1,018,700

Provision for income taxes4

   90,305    29,945    39,806     20,064    31,485    76,166     49,498     337,269
                                          

Net income

   $158,946    $100,628    $66,084     $42,127    $53,335    $143,820     $116,491     $681,431
                                          
     Three Months Ended June 30, 2006
     Retail    Commercial   

Corporate and

Investment

Banking

    Mortgage   

Wealth and

Investment
Management

   Corporate Other
and Treasury
    Reconciling
Items
    Consolidated

Average total assets

   $37,904,665    $35,290,908    $23,765,119     $41,088,776    $8,853,497    $31,846,533     $1,994,648     $180,744,146

Average total liabilities

   70,386,015    18,088,613    8,872,756     2,164,676    9,689,484    54,341,882     (103,732 )   163,439,694

Average total equity

   -    -    -     -    -    -     17,304,452     17,304,452
                                          

Net interest income

   $590,499    $232,037    $49,706     $149,361    $91,215    ($33,729 )   $89,654     $1,168,743

Fully taxable-equivalent adjustment (FTE)

   21    9,971    7,500     -    17    3,774     -     21,283
                                          

Net interest income (FTE)1

   590,520    242,008    57,206     149,361    91,232    (29,955 )   89,654     1,190,026

Provision for loan losses2

   18,871    6,656    (435 )   2,128    751    1,173     22,615     51,759
                                          

Net interest income after provision for loan
losses

   571,649    235,352    57,641     147,233    90,481    (31,128 )   67,039     1,138,267

Noninterest income

   265,747    70,825    159,274     100,322    251,088    32,736     (4,623 )   875,369

Noninterest expense3

   547,752    167,875    116,916     152,957    249,626    (16,924 )   (4,109 )   1,214,093
                                          

Net income before provision for income
taxes

   289,644    138,302    99,999     94,598    91,943    18,532     66,525     799,543

Provision for income taxes4

   105,673    31,161    37,621     32,667    34,447    (6,250 )   20,222     255,541
                                          

Net income

   $183,971    $107,141    $62,378     $61,931    $57,496    $24,782     $46,303     $544,002
                                          

 

1

Net interest income is fully taxable equivalent and is presented on a matched maturity funds transfer price basis for the line of business.

2

Provision for loan losses represents net charge-offs for the lines of business.

3

For Corporate Other and Treasury, allocations exceeded actual expenses incurred.

4

Includes regular income tax provision and taxable-equivalent income adjustment reversal.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

     Six Months Ended June 30, 2007

(Dollars in thousands)

   Retail    Commercial    Corporate and
Investment
Banking
    Mortgage    Wealth and
Investment
Management
   Corporate Other
and Treasury
    Reconciling
Items
    Consolidated

Average total assets

   $37,708,718    $35,476,602    $23,844,914     $46,076,743    $9,002,749    $26,870,067     $1,767,448     $180,747,241

Average total liabilities

   69,877,778    18,876,856    8,415,681     2,748,331    10,436,881    52,549,590     17,307     162,922,424

Average total equity

   -    -    -     -    -    -     17,824,817     17,824,817
                                          

Net interest income

   $1,156,774    $439,427    $84,465     $266,163    $176,050    ($94,673 )   $331,637     $2,359,843

Fully taxable-equivalent adjustment (FTE)

   70    18,886    20,946     -    28    8,421     30     48,381
                                          

Net interest income (FTE)1

   1,156,844    458,313    105,411     266,163    176,078    (86,252 )   331,667     2,408,224

Provision for loan losses2

   93,606    10,722    16,863     23,260    4,011    2,723     9,936     161,121
                                          

Net interest income after provision for loan
losses

   1,063,238    447,591    88,548     242,903    172,067    (88,975 )   321,731     2,247,103

Noninterest income

   526,634    144,814    344,475     175,412    533,527    317,619     (8,953 )   2,033,528

Noninterest expense3

   1,086,953    334,947    258,339     349,503    514,593    (48,232 )   (8,912 )   2,487,191
                                          

Net income before provision for income
taxes

   502,919    257,458    174,684     68,812    191,001    276,876     321,690     1,793,440

Provision for income taxes4

   182,792    58,680    65,337     19,184    70,290    86,598     107,832     590,713
                                          

Net income

   $320,127    $198,778    $109,347     $49,628    $120,711    $190,278     $213,858     $1,202,727
                                          
     Six Months Ended June 30, 2006
     Retail    Commercial    Corporate and
Investment
Banking
    Mortgage    Wealth and
Investment
Management
   Corporate Other
and Treasury
    Reconciling
Items
    Consolidated

Average total assets

   $38,198,537    $34,662,079    $23,518,942     $40,335,162    $8,874,153    $31,399,413     $2,201,563     $179,189,849

Average total liabilities

   69,223,914    18,043,042    9,364,062     1,954,111    9,632,596    53,833,275     (39,978 )   162,011,022

Average total equity

   -    -    -     -    -    -     17,178,827     17,178,827
                                          

Net interest income

   $1,165,937    $458,575    $110,489     $298,197    $181,178    ($58,213 )   $191,621     $2,347,784

Fully taxable-equivalent adjustment (FTE)

   42    19,935    14,107     -    34    7,503     -     41,621
                                          

Net interest income (FTE)1

   1,165,979    478,510    124,596     298,197    181,212    (50,710 )   191,621     2,389,405

Provision for loan losses2

   38,589    5,559    (830 )   5,000    943    2,167     33,734     85,162
                                          

Net interest income after provision for loan
losses

   1,127,390    472,951    125,426     293,197    180,269    (52,877 )   157,887     2,304,243

Noninterest income

   523,260    141,472    315,386     220,668    489,400    45,806     (9,117 )   1,726,875

Noninterest expense3

   1,091,736    339,110    250,180     298,804    503,229    (34,407 )   (8,068 )   2,440,584
                                          

Net income before provision for income
taxes

   558,914    275,313    190,632     215,061    166,440    27,336     156,838     1,590,534

Provision for income taxes4

   204,101    64,664    71,249     75,449    62,037    (16,537 )   54,042     515,005
                                          

Net income

   $354,813    $210,649    $119,383     $139,612    $104,403    $43,873     $102,796     $1,075,529
                                          

 

1

Net interest income is fully taxable equivalent and is presented on a matched maturity funds transfer price basis for the line of business.

2

Provision for loan losses represents net charge-offs for the lines of business.

3

For Corporate Other and Treasury, allocations exceeded actual expenses incurred.

4

Includes regular income tax provision and taxable-equivalent income adjustment reversal.

 

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Notes to Consolidated Financial Statements (Unaudited) - Continued

Note 14-Accumulated Other Comprehensive Income

 

(Dollars in thousands)

   Pre-tax
Amount
     Income Tax
(Expense)
Benefit
     After-tax
Amount
 

Accumulated Other Comprehensive Income, Net

        

Accumulated other comprehensive income, January 1, 2006

   $1,513,050      ($574,959 )    $938,091  

Unrealized net losses on securities

   (276,583 )    105,101      (171,482 )

Unrealized net gains on derivatives

   6,765      (2,571 )    4,194  

Change related to employee benefit plans

   1,329      (505 )    824  

Reclassification adjustment for realized net gains on securities

   4,467      (1,697 )    2,770  

Reclassification adjustment for realized net losses on derivatives

   3,424      (1,301 )    2,123  
                    

Accumulated other comprehensive income, June 30, 2006

   $1,252,452      ($475,932 )    $776,520  
                    

Accumulated other comprehensive income, January 1, 2007

   $1,398,409      ($472,460 )    $925,949  

Unrealized net losses on securities

   (58,491 )    22,227      (36,264 )

Unrealized net losses on derivatives

   (113,971 )    43,309      (70,662 )

Change related to employee benefit plans

   55,637      (21,142 )    34,495  

Adoption of SFAS No. 159

   237,700      (90,326 )    147,374  

Pension plan changes and resulting remeasurement

   128,560      (48,853 )    79,707  

Reclassification adjustment for realized net gains on securities

   (250,188 )    95,071      (155,117 )

Reclassification adjustment for realized net gains on derivatives

   (7,410 )    2,816      (4,594 )
                    

Accumulated other comprehensive income, June 30, 2007

   $1,390,246      ($469,358 )    $920,888  
                    

Comprehensive income for the three and six months ended June 30, 2007 and 2006 was calculated as follows:

 

    

Three Months Ended

June 30

    

Six Months Ended

June 30

 

(Dollars in thousands)

   2007      2006      2007      2006  

Comprehensive income:

           

Net income

   $681,431      $544,002      1,202,727      1,075,529  

Other comprehensive income:

           

Change in unrealized gains (losses) on securities, net of taxes

   (190,759 )    (119,800 )    (191,381 )    (168,712 )

Change in unrealized gains (losses) on derivatives, net of taxes

   (79,184 )    1,960      (75,256 )    6,317  

Change related to employee benefit plans, net of taxes

   5,605      -      34,495      824  
                           

Total comprehensive income

   $417,093      $426,162      970,585      913,958  
                           

The components of accumulated other comprehensive income at June 30 were as follows:

 

(Dollars in thousands)

   2007      2006  

Unrealized net gain on available for sale securities

   $1,258,581      $803,106  

Unrealized net loss on derivative financial instruments

   (56,361 )    (11,023 )

Employee benefit plans

   (281,332 )    (15,563 )
             

Total accumulated other comprehensive income

   $920,888      $776,520  
             

 

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Table of Contents

Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

SunTrust Banks, Inc. (“SunTrust” or “the Company”), one of the nation’s largest commercial banking organizations, is a financial holding company with its headquarters in Atlanta, Georgia. SunTrust’s principal banking subsidiary, SunTrust Bank, offers a full line of financial services for consumers and businesses through its branches located primarily in Florida, Georgia, Maryland, North Carolina, South Carolina, Tennessee, Virginia, and the District of Columbia. Within its geographic footprint, the Company operates under five business segments: Retail, Commercial, Corporate and Investment Banking (“CIB”), Wealth and Investment Management, and Mortgage. In addition to traditional deposit, credit, and trust and investment services offered by SunTrust Bank, other SunTrust subsidiaries provide mortgage banking, credit-related insurance, asset management, securities brokerage and capital market services. As of June 30, 2007, SunTrust had 1,685 full-service branches, including 347 in-store branches, and continues to leverage technology to provide customers the convenience of banking on the Internet, through 2,533 automated teller machines and via twenty-four hour telebanking.

The following analysis of the financial performance of SunTrust for the second quarter of 2007 should be read in conjunction with the financial statements, notes and other information contained in this document and the 2006 Annual Report found on Form 10-K. Certain reclassifications may be made to prior year financial statements and related information to conform them to the 2007 presentation. In Management’s Discussion and Analysis, net interest income, net interest margin and the efficiency ratios are presented on a fully taxable-equivalent (“FTE”) and annualized basis. The FTE basis adjusts for the tax-favored status of net interest income from certain loans and investments. The Company believes this measure to be the preferred industry measurement of net interest income and it enhances comparability of net interest income arising from taxable and tax-exempt sources.

The Company presents a return on average realized common shareholders’ equity, as well as a return on average common shareholders’ equity (“ROE”). The Company also presents a return on average assets less net unrealized securities gains/losses and a return on average total assets (“ROA”). The return on average realized common shareholders’ equity and return on average assets less net unrealized securities gains/losses exclude realized securities gains and losses, The Coca-Cola Company (“Coke”) dividend, and net unrealized securities gains. Due to its ownership of approximately 43.7 million shares of common stock of The Coca-Cola Company, resulting in an unrealized net gain of $2.3 billion as of June 30, 2007, the Company believes ROA and ROE excluding these impacts from the Company’s securities available for sale portfolio is the more comparative performance measure when being evaluated against other companies. The Company also presents net income available to common shareholders, diluted net income per average common share, an efficiency ratio and noninterest income excluding the gain on sale of shares of The Coca-Cola Company. The Company believes these measures are more indicative of the Company’s performance because they exclude a large securities gain that is not a customer relationship or customer driven transaction. SunTrust presents a tangible efficiency ratio and a tangible equity to tangible assets ratio which exclude the cost of and the other effects of intangible assets resulting from merger and acquisition (“M&A”) activity. The Company provides reconcilements on pages 42 through 43 for all non-US GAAP measures.

The information in this report may contain forward-looking statements. Statements that do not describe historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “targets,” “initiatives,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future conditional verbs such as “may,” “will,” “should,” “would,” and “could.”

 

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Table of Contents

Such statements are based upon the current beliefs and expectations of SunTrust’s management and on information currently available to management. The forward-looking statements are intended to be subject to the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements speak as of the date hereof, and SunTrust does not assume any obligation to update the statements made herein or to update the reasons why actual results could differ from those contained in such statements in light of new information or future events.

Forward-looking statements involve significant risks and uncertainties. Investors are cautioned against placing undue reliance on such statements. Actual results may differ materially from those set forth in the forward-looking statements. Factors that could cause actual results to differ materially from those described in the forward-looking statements can be found in the Company’s 2006 Annual Report on Form 10-K, in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007, and in this Quarterly Report on Form 10-Q (at Part II, Item 1A). Those factors include: changes in general business or economic conditions, including customers’ ability to repay debt obligations, could have a material adverse effect on our financial condition and results of operations; our trading assets and financial instruments carried at fair value expose the Company to certain market risks; changes in market interest rates or capital markets could adversely affect our revenues and expenses, the values of assets and obligations, costs of capital, or liquidity; the fiscal and monetary policies of the federal government and its agencies could have a material adverse effect on our earnings; significant changes in securities markets or markets for residential or commercial real estate could harm our revenues and profitability; customers could pursue alternatives to bank deposits, causing us to lose a relatively inexpensive source of funding; customers may decide not to use banks to complete their financial transactions, which could affect net income; we have businesses other than banking, which subjects us to a variety of risks; hurricanes and other natural disasters may adversely affect loan portfolios and operations and increase the cost of doing business; negative public opinion could damage our reputation and adversely impact our business; we rely on other companies for key components of our business infrastructure; we rely on our systems, employees, and certain counterparties, and certain failures could materially adversely affect our operations; we depend on the accuracy and completeness of information about clients and counterparties; regulation by federal and state agencies could adversely affect our business, revenues, and profit margins; competition in the financial services industry is intense and could result in losing business or reducing profit margins; future legislation could harm our competitive position; maintaining or increasing market share depends on market acceptance and regulatory approval of new products and services; our ability to receive dividends from our subsidiaries accounts for most of our revenues and could affect our liquidity and ability to pay dividends; significant legal actions could subject us to substantial uninsured liabilities; we have in the past and may in the future pursue acquisitions, which could affect costs and from which we may not be able to realize anticipated benefits; we depend on the expertise of key personnel without whom our operations may suffer; we may be unable to hire or retain additional qualified personnel and recruiting and compensation costs may increase as a result of turnover, both of which may increase costs and reduce profitability and may adversely impact our ability to implement our business strategy; our accounting policies and methods are key to how we report financial condition and results of operations, and may require management to make estimates about matters that are uncertain; our stock price can be volatile; changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition; and our disclosure controls and procedures may fail to prevent or detect all errors or acts of fraud; weakness in residential property and mortgage markets could adversely affect us; and we may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, borrower fraud, or certain borrower defaults, which could harm our liquidity, results of operations and financial condition.

 

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EARNINGS OVERVIEW

SunTrust reported net income available to common shareholders of $673.9 million for the second quarter of 2007, an increase of $129.9 million, or 23.9%, compared to the same period of the prior year. Diluted earnings per average common share were $1.89 for the three months ended June 30, 2007, an increase of 26.8% as compared to $1.49 for the three months ended June 30, 2006. Net income available to common shareholders for the first six months of 2007 was $1,187.8 million, an increase of $112.3 million, or 10.4%, compared to the same period of the prior year. Reported diluted earnings per average common share were $3.33 and $2.96 for the six months ended June 30, 2007 and 2006, respectively. Excluding the $145.6 million after-tax gain on sale of shares of The Coca-Cola Company, net income available to common shareholders was $528.3 million and $1,042.3 million for the three and six months ended June 30, 2007. Diluted earnings per average common share excluding the Coke stock gain were $1.48 and $2.92 for the three and six months ended June 30, 2007, which is a decline in diluted earnings per common share of $0.01, or 0.7%, and $0.04, or 1.4%, compared to the respective three and six month periods ended June 30, 2006. For further discussion regarding the Coke stock gain and management’s strategy surrounding the Coke stock, refer to the “Securities Available for Sale” section of Management’s Discussion and Analysis.

Fully taxable-equivalent net interest income was $1,220.0 million for the second quarter of 2007, an increase of $30.0 million or 2.5%, from the second quarter of 2006. Net interest margin increased 10 basis points from 3.00% in the second quarter of 2006 to 3.10% in the second quarter of 2007. The increases in fully taxable-equivalent net interest income and net interest margin were largely the result of the balance sheet management strategies executed in the first and second quarters of 2007, which have resulted in improved yields on earning assets, as well as deleveraging the balance sheet and reducing the level of higher-cost wholesale funding.

Fully taxable-equivalent net interest income for the six months ended June 30, 2007 was $2,408.2, an increase of $18.8 million or 0.8%, from the same period in the previous year due to the same factors that impacted the quarter over quarter increase described above. The net interest margin remained flat at 3.06% for the first six months of 2006 and the first six months of 2007.

Provision for loan losses was $104.7 million in the second quarter of 2007, an increase of $52.9 million, or 102.1%, from the same period of the prior year. The provision for loan losses was $16.5 million higher than net charge-offs of $88.2 million for the second quarter of 2007 as the level of net charge-offs and nonperforming and past due loans has increased. The allowance for loan and lease losses (“ALLL”) decreased $11.5 million, or 1.1%, from June 30, 2006. The decrease in the ALLL corresponded to a 1.2% decrease in period-end loans compared to June 30, 2006, which is attributable to the Company’s balance sheet management strategies. Annualized net charge-offs to average loans were 0.30% for the second quarter of 2007 compared to 0.10% for the same period last year. The second quarter of 2006 was a historically low quarter for net charge-offs, and the year over year increase reflects the trend toward normalization of net charge-off levels as well as some deterioration in certain segments of the consumer real estate market. For the six months ended June 30, 2007, the provision for loan losses was $161.1 million, an increase of $75.9 million, or 89.1%, from the same period of the prior year. The increase in the provision was primarily attributable to the same factors that impacted the quarter over quarter increase.

Noninterest income increased $279.2 million, or 31.9%, from the second quarter of 2006, driven in large part by the $234.8 million pre-tax gain on sale of Coke stock. Noninterest income excluding the gain on sale of Coke stock increased $44.4 million, or 5.2%, compared to the second quarter of 2006. Other drivers of the increase were growth in retail investment services, card fees, mortgage production and servicing-related income, and other noninterest income mainly due to gains generated on private equity investments and structured leasing transactions. These increases were offset by a decline in trading income due to negative market value adjustments on assets and liabilities carried at fair value, as well as a decline in trust income.

 

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For the first six months of 2007, noninterest income was $2,033.5 million, up $306.6 million, or 17.8%, from $1,726.9 million for the same period in 2006. A significant portion of the increase was related to the gain on sale of Coke stock. Excluding the gain on sale of Coke stock, noninterest income increased $71.8 million, or 4.2%, compared to the six months ended June 30, 2006. Also contributing to the increase were strong card fees, retail investment services, trading account profits and commissions, as well as the $32.3 million gain on sale upon the merger of Lighthouse Partners recognized in the first quarter of 2007.

Total noninterest expense was $1,251.2 million for the second quarter of 2007, an increase of $37.1 million, or 3.1%, from the same period of the prior year. The increase was primarily due to the Company’s election to record certain newly-originated mortgage loans held for sale at fair value during the second quarter of 2007, which resulted in an approximate $12.4 million increase in compensation expense, as origination costs associated with these loans are no longer deferred, and the reversal of a leverage lease-related reserve in the second quarter of 2006 that reduced noninterest expense by $10.9 million. Considering the impact of these two factors, the remaining slight increase in noninterest expense was primarily in personnel and occupancy related expenses. This low level of core expense growth demonstrates the initial success of the Company’s E2 Efficiency and Productivity initiatives. For further details surrounding the Company’s Excellence in Execution, (“E2”) Efficiency and Productivity initiatives, refer to the “Noninterest Expense” section of Management’s Discussion and Analysis.

For the first six months of 2007, noninterest expense was $2,487.2 million, up $46.6 million, or 1.9%, from $2,440.6 million for the same period in 2006. The factors causing this increase were similar to those noted in the quarter over quarter discussion above.

 

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Selected Quarterly Financial Data

   Table 1

 

     Three Months Ended
June 30
   

Six Months Ended

June 30

 

(Dollars in millions, except per share data) (Unaudited)

   2007     2006     2007     2006  

Summary of Operations

        

Interest, fees and dividend income

   $2,543.9       $2,423.1       $5,071.9       $4,701.8    

Interest expense

   1,348.6       1,254.3       2,712.1       2,354.0    
                        

Net interest income

   1,195.3       1,168.8       2,359.8       2,347.8    

Provision for loan losses

   104.7       51.8       161.1       85.2    
                        

Net interest income after provision for loan losses

   1,090.6       1,117.0       2,198.7       2,262.6    

Noninterest income

   1,154.6       875.4       2,033.5       1,726.9    

Noninterest expense

   1,251.2       1,214.1       2,487.2       2,440.6    
                        

Income before provision for income taxes

   994.0       778.3       1,745.0       1,548.9    

Provision for income taxes

   312.6       234.3       542.3       473.4    
                        

Net income

   681.4       544.0       1,202.7       1,075.5    

Preferred stock dividends

   7.5       -       14.9       -    
                        

Net income available to common shareholders

   $673.9       $544.0       $1,187.8       $1,075.5    
                        

Net income available to common shareholders excluding gain on sale of Coke stock

   $528.3       $544.0       $1,042.3       $1,075.5    

Net interest income-FTE

   1,220.0       1,190.0       2,408.2       2,389.4    

Total revenue - FTE

   2,374.6       2,065.4       4,441.7       4,116.3    

Noninterest income excluding gain on sale of Coke stock

   919.8       875.4       1,798.7       1,726.9    

Net income per average common share:

        

Diluted

   1.89       1.49       3.33       2.96    

Diluted excluding gain on sale of Coke stock

   1.48       1.49       2.92       2.96    

Basic

   1.91       1.51       3.37       2.98    

Dividends paid per average common share

   0.73       0.61       1.46       1.22    

Book value per common share

   48.33       47.85        

Market price:

        

High

   94.18       78.33       94.18       78.33    

Low

   78.16       72.56       78.16       69.68    

Close

   85.74       76.26       85.74       76.26    

Selected Average Balances

        

Total assets

   $179,996.5       $180,744.1       $180,747.2       $179,189.8    

Earning assets

   157,594.2       158,888.8       158,528.7       157,324.5    

Loans

   118,164.6       120,144.5       119,830.5       118,214.1    

Consumer and commercial deposits

   97,926.3       97,172.3       97,859.6       96,237.6    

Brokered and foreign deposits

   23,983.4       27,194.3       25,341.2       25,930.0    

Total shareholders’ equity

   17,928.1       17,304.4       17,824.8       17,178.8    

Average common shares-diluted (thousands)

   356,008       364,391       356,608       363,917    

Average common shares-basic (thousands)

   351,987       361,267       352,713       360,604    

Financial Ratios (Annualized)

        

Return on average total assets

   1.52   %   1.21   %   1.34   %   1.21   %

Return on average assets less net unrealized securities gains

   1.18       1.18       1.16       1.19    

Return on average common shareholders’ equity

   15.51       12.61       13.83       12.63    

Return on average realized common shareholders’ equity

   12.71       12.90       12.63       12.98    

Net interest margin

   3.10       3.00       3.06       3.06    

Efficiency ratio

   52.69       58.78       56.00       59.29    

Efficiency ratio excluding gain on sale of Coke stock

   58.47       58.78       59.12       59.29    

Tangible efficiency ratio

   51.64       57.53       54.91       58.00    

Tangible equity to tangible assets

   5.85       5.81        

Total average shareholders’ equity to average assets

   9.96       9.57       9.86       9.59    

Capital Adequacy

        

Tier 1 capital ratio

   7.49   %   7.31   %    

Total capital ratio

   10.67       10.70        

Tier 1 leverage ratio

   7.11       6.82        

 

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Selected Quarterly Financial Data, continued

   Table 1

 

     Three Months Ended
June 30
   

Six Months Ended

June 30

 

(Dollars in millions, except per share data) (Unaudited)

   2007     2006     2007     2006  

Reconcilement of Non US GAAP Financial Measures

        

Net income

   $681.4       $544.0       $1,202.7       $1,075.5    

Securities (gains)/losses, net of tax

   (146.6)       (3.6)       (146.6)       (3.7)    
                        

Net income excluding net securities (gains)/losses

   534.8       540.4       1,056.1       1,071.8    

Coke stock dividend, net of tax

   (13.2)       (13.3)       (27.8)       (26.6)    
                        

Net income excluding net securities (gains)/losses and the Coke stock dividend

   521.6       527.1       1,028.3       1,045.2    

Preferred stock dividends

   7.5       -           14.9       -        
                        

Net income available to common shareholders excluding net securities (gains)/losses and the Coke stock dividend

   $514.1       $527.1       $1,013.4       $1,045.2    
                        

Net income available to common shareholders

   $673.9       $544.0       $1,187.8       $1,075.5    

Gain on sale of Coke stock, net of tax

   (145.6)       -       (145.6)       -    
                        

Net income available to common shareholders excluding gain on sale of Coke stock 1

   $528.3       $544.0       $1,042.2       $1,075.5    
                        

Diluted net income per average common share

   $1.89       $1.49       $3.33       $2.96    

Impact of excluding gain on sale of Coke stock

   (0.41)       -           (0.41)       -        
                        

Diluted net income per average common share excluding gain on sale of Coke stock 1

        
   $1.48       $1.49       $2.92       $2.96    
                        

Efficiency ratio 2

   52.69   %   58.78   %   56.00   %   59.29   %

Impact of excluding amortization of intangible assets

   (1.05)       (1.25)       (1.09)       (1.29)    
                        

Tangible efficiency ratio 3

   51.64   %   57.53   %   54.91   %   58.00   %
                        

Efficiency ratio 2

   52.69   %   58.78   %   56.00   %   59.29   %

Impact of gain on sale of Coke stock

   5.78       -           3.12       -        
                        

Efficiency ratio excluding gain on sale of Coke stock 1

   58.47   %   58.78   %   59.12   %   59.29   %
                        

Total average assets

   $179,996.5       $180,744.1       $180,747.2       $179,189.8    

Average net unrealized securities gains

   (2,398.7)       (1,528.0)       (2,352.2)       (1,570.2)    
                        

Average assets less net unrealized securities gains

   $177,597.8       $179,216.1       $178,395.0       $177,619.6    
                        

Total average common shareholders’ equity

   $17,428.1       $17,304.4       $17,324.8       $17,178.8    

Average accumulated other comprehensive income

   (1,206.5)       (915.9)       (1,140.9)       (939.7)    
                        

Total average realized common shareholders’ equity

   $16,221.6       $16,388.5       $16,183.9       $16,239.1    
                        

Return on average total assets

   1.52   %   1.21   %   1.34   %   1.21   %

Impact of excluding net realized and unrealized securities (gains)/losses and the Coke stock dividend

   (0.34)       (0.03)       (0.18)       (0.02)    
                        

Return on average total assets less net unrealized securities gains 4

   1.18   %   1.18   %   1.16   %   1.19   %
                        

Return on average common shareholders’ equity

   15.51   %   12.61   %   13.83   %   12.63   %

Impact of excluding net realized and unrealized securities (gains)/losses and the Coke stock dividend

   (2.80)       0.29       (1.20)       0.35    
                        

Return on average realized common shareholders’ equity 5

   12.71   %   12.90   %   12.63   %   12.98   %
                        

Net interest income

   $1,195.3       $1,168.8       $2,359.8       $2,347.8    

FTE adjustment

   24.7       21.2       48.4       41.6    
                        

Net interest income-FTE

   1,220.0       1,190.0       2,408.2       2,389.4    

Noninterest income

   1,154.6       875.4       2,033.5       1,726.9    
                        

Total revenue-FTE

   $2,374.6       $2,065.4       $4,441.7       $4,116.3    
                        

Noninterest income

   $1,154.6       $875.4       $2,033.5       $1,726.9    

Impact of gain on sale of Coke stock

   (234.8)       -           (234.8)       -        
                        

Noninterest income excluding gain on sale of Coke stock 1

   $919.8       $875.4       $1,798.7       $1,726.9    
                        

 

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Selected Quarterly Financial Data, continued

   Table 1

 

     As of June 30  

(Dollars in millions) (Unaudited)

   2007     2006  

Total shareholders’ equity

   $17,368.9        $17,423.9    

Goodwill

   (6,897.1)       (6,900.2)  

Other intangible assets including mortgage servicing rights (“MSRs”)

   (1,290.5)       (1,141.3)  

Mortgage servicing rights

   942.0        720.4    
            

Tangible equity

   $10,123.3        $10,102.8    
            

Total assets

   $180,314.4        $181,143.4    

Goodwill

   (6,897.1)       (6,900.2)  

Other intangible assets including MSRs

   (1,290.5)       (1,141.3)  

Mortgage servicing rights

   942.0        720.4    
            

Tangible assets

   $173,068.8        $173,822.3    
            

Tangible equity to tangible assets

   5.85    %   5.81   %

 

1

SunTrust presents net income available to common shareholders, noninterest income, diluted net income per average common share, and efficiency ratio excluding the gain on sale of Coke stock. The Company believes these measures are more indicative of the Company’s performance because they exclude a large securities gain that is not a customer relationship or customer driven transaction.

2

Computed by dividing noninterest expense by total revenue - FTE. The efficiency ratios are presented on an FTE basis. The FTE basis adjusts for the tax-favored status of net interest income from certain loans and investments. The Company believes this measure to be the preferred industry measurement of net interest income and it enhances comparability of net interest income arising from taxable and tax-exempt sources.

3

SunTrust presents a tangible efficiency ratio which excludes the cost of intangible assets. The Company believes this measure is useful to investors because, by removing the effect of intangible asset costs (the level of which may vary from company to company) it allows investors to more easily compare the Company’s efficiency to other companies in the industry. This measure is utilized by management to assess the efficiency of the Company and its lines of business.

4

Computed by dividing annualized net income, excluding tax effected net securities gains/losses and the Coke stock dividend, by average assets less net unrealized gains/losses on securities.

5

Computed by dividing annualized net income available to common shareholders, excluding tax effected net securities gains/losses and the Coke stock dividend, by average realized common shareholders’ equity.

CONSOLIDATED FINANCIAL PERFORMANCE

Financial Assets and Liabilities Carried at Fair Value

Adoption of Fair Value Accounting Standards

During the first quarter of 2007, the Company evaluated the provisions of the recently issued fair value accounting standards, SFAS Nos. 157 and 159. SFAS No. 157 clarifies how to measure fair value when such measurement is otherwise required by US GAAP, and SFAS No. 159 provides companies with the option to elect to carry specific financial assets and financial liabilities at fair value. While the provisions of SFAS No. 157 establish clearer and more consistent criteria for measuring fair value, the primary objective of SFAS No. 159 is to expand the use of fair value in US GAAP, with the focus on eligible financial assets and financial liabilities. As a means to expand the use of fair value, SFAS No. 159 allows companies to avoid some of the complexities of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and more closely align the economics of their business with their results of operations without having to explain a mixed attribute accounting model. Based on the Company’s evaluation of these standards and its balance sheet management strategies and objectives, the Company early adopted these fair value standards as of January 1, 2007.

In certain circumstances, fair value enables a company to more accurately align its financial performance with the economic value of actively traded or hedged assets or liabilities. Fair value enables a company to mitigate the non-economic earnings volatility caused from financial assets and financial liabilities being carried at different bases of accounting, as well as to more accurately portray the active and dynamic management of a company’s balance sheet.

 

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The following is a description of each asset and liability class for which fair value has been elected, including the specific reasons for electing fair value and the strategies for managing the assets and liabilities on a fair value basis. See the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007 for more information regarding the Company’s initial evaluation of SFAS Nos. 157 and 159 and rationale for early adoption.

Fixed Rate Debt

The debt that the Company elected to carry at fair value was all of its fixed rate debt that had previously been designated in qualifying fair value hedges using receive fixed/pay floating interest rate swaps, pursuant to the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This population specifically included $3.5 billion of fixed-rate Federal Home Loan Bank (“FHLB”) advances and $3.3 billion of publicly-issued debt. The Company elected to record this debt at fair value in order to align the accounting for the debt with the accounting for the derivative without having to account for the debt under hedge accounting, thus avoiding the complex and time consuming fair value hedge accounting requirements of SFAS No. 133. The reduction to opening retained earnings from recording the debt at fair value was $197.2 million. This move to fair value introduces potential earnings volatility due to changes in the Company’s credit spread that were not required to be valued under the SFAS No. 133 hedge designation. All of the debt, along with the interest rate swaps previously designated as hedges under SFAS No. 133, continues to remain outstanding. As of June 30, 2007, the Company had not issued any new fixed rate debt since January 1, 2007.

Available for Sale and Trading Securities

The available for sale debt securities that were transferred to trading were substantially all of the debt securities within specific assets classes, whether the securities were valued at an unrealized loss or unrealized gain. The Company elected to reclassify approximately $15.4 billion of securities to trading at January 1, 2007, as well as an additional $600 million of purchases of similar assets that occurred during the first quarter. The reduction to opening retained earnings related to reclassifying the $15.4 billion of securities to trading was $147.4 million. The Company’s entire securities portfolio is of high credit quality, such that the opening retained earnings adjustment was not significantly impacted by the credit risk embedded in the assets but rather due to interest rates. This net unrealized loss was already reflected in accumulated other comprehensive income and, therefore, upon reclassification to retained earnings, there was no net impact to total shareholders’ equity.

The Company elected to move these available for sale securities to trading securities in order to be able to more actively trade a more significant portion of its investment portfolio and reduce the overall size of the available for sale portfolio. In determining the assets to be sold, the Company considered economic factors, such as yield and duration, in relation to its balance sheet strategy for the securities portfolio. In evaluating its total available for sale portfolio of approximately $23 billion at January 1, 2007, the Company determined that approximately $3 billion of securities were not available or were not practical to be fair valued and reclassified to trading under SFAS No. 159, as these securities had matured or been called during the quarter, were subject to business restrictions, were privately placed or had nominal principal amounts. Approximately $5 billion of securities aligned with the Company’s recent balance sheet strategy, due to the nature of the assets (such as 30-year fixed rate MBS, 10/1 ARMs, floating rate ABS and municipal bonds); therefore, the securities continued to be classified as available for sale. These securities yielded over 5.6%, had a duration over 4.0%, and were in a $6.7 million net unrealized gain position as of January 1, 2007. The remaining $15 billion of securities, which included hybrid ARMs, CMBS, CMO and MBS (excluding those classes of mortgage-backed securities that remained classified as securities available for sale), yielded approximately 4.5% and had a duration under 3.0%. The approximate $600 million of securities that were purchased in the first quarter and originally classified as available for sale were similar to the securities reclassified to trading on January 1, 2007 upon adoption of SFAS No. 159; accordingly, the Company reclassified these securities to trading pursuant to the provisions of SFAS No. 159.

 

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During the first quarter of 2007, in connection with the Company’s decision to early adopt SFAS No. 159, the Company purchased approximately $1.7 billion of treasury bills, which were classified as trading securities, and approximately $3.2 billion of 30-year fixed rate MBS, which were classified as securities available for sale. The Company entered into approximately $13.5 billion of interest rate derivatives to mitigate the fair value volatility of the available for sale securities that had been reclassified to trading. Finally, as part of its asset/liability strategies, the Company executed an additional $7.5 billion notional receive-fixed interest rate swaps that were designated as cash flow hedges under SFAS No. 133 on floating rate commercial loans.

During the second quarter of 2007, the Company sold substantially all of the $16.0 billion in securities transferred to trading at prices that, in the aggregate and including the hedging gains and losses, approximated the fair value of the securities at March 31, 2007, and terminated the interest rate derivatives it had entered into as hedges of the fair value. During the second quarter of 2007, the Company made additional purchases of approximately $5.4 billion of treasury bills and $4.3 billion of agency notes classified as trading and approximately $2.0 billion of 30-year fixed-rate MBS classified as securities available for sale. The 30-year fixed-rate MBS that were purchased during the second quarter were a similar asset type to the securities that remained classified as available for sale. These securities yield over 5.6% and have an effective duration of approximately 5.7%. As of June 30, 2007 $9.5 billion of treasury bills and agency notes classified as trading and approximately $7.5 billion of 30-year fixed-rate MBS classified as securities available for sale were outstanding.

Mortgage Loans Held for Sale

In connection with the early adoption of SFAS No. 159, the Company elected to carry $4.1 billion of prime quality, mid-term adjustable rate, highly commoditized, conforming agency and nonagency conforming residential mortgage portfolio loans at fair value as of January 1, 2007 and transferred these loans to held for sale at fair value at the end of the first quarter. These loans were all performing loans and virtually all had not been past due 30 days or more over the prior 12 month period. The reduction to opening retained earnings related to these loans was $44.2 million, which was net of a $4.1 million reduction in the allowance for loan losses related to these loans. In order to moderate the growth of earning assets, the Company decided in the second quarter of 2006 to no longer portfolio new originations of these types of loans, but had not undertaken plans to sell or securitize any of these portfolio loans. In connection with the final issuance of SFAS No. 159, the Company evaluated the composition of the mortgage loan portfolio, particularly in light of its plans to no longer hold the above mentioned mortgage loans in its portfolio. In addition, the Company reviewed certain business restrictions on loans that are held by real estate investment trusts (“REITs”). Based on this evaluation, the Company elected to record $4.1 billion of mortgage loans at fair value. The loans that the Company elected to move to fair value were not owned by a REIT and had a weighted average coupon rate of approximately 4.94%. In connection with recording these loans at fair value, the Company entered into hedging activities to mitigate the earnings volatility from changes in the loans’ fair value. As of June 30, 2007, $1.2 billion of the $4.1 billion in fair valued mortgage loans remained outstanding. During the second quarter of 2007, the Company sold $2.9 billion of the $4.1 billion of mortgage loans transferred to loans held for sale that, in the aggregate and including the hedging gains and losses, approximated the fair value of the mortgage loans at March 31, 2007, and terminated the interest rate derivatives it had entered into as hedges of the fair value.

 

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In the second quarter of 2007, the Company began recording at fair value certain newly-originated mortgage loans held for sale based upon defined product criteria. SunTrust chose to fair value these mortgage loans held for sale in order to eliminate the complexities and inherent difficulties of achieving hedge accounting and to better align reported results with the underlying economic changes in value of the loans and related hedge instruments. During the second quarter of 2007, $5.2 billion of newly-originated mortgage loans held for sale were recorded at fair value. This election impacts the timing and recognition of origination fees and costs, as well as servicing value. Specifically, origination fees and costs, which had been appropriately deferred under SFAS No. 91 and recognized as part of the gain/loss on sale of the loan, are now recognized in earnings at the time of origination. For the three months ended June 30, 2007, approximately $11.9 million in loan origination fees and approximately $12.4 million in origination loan costs were recognized due to this fair value election. The servicing value, which had been recorded at the time the loan was sold as a mortgage servicing right, is now included in the fair value of the loan and recognized at origination of the loan. The Company began using derivatives to economically hedge changes in servicing value as a result of including the servicing value in the fair value of the loan in accordance with provisions of SFAS No. 157. The estimated impact from recognizing servicing value, net of related hedging costs, as part of the fair value of the loan is captured in the overall change in mortgage production income.

The Company’s mortgage loans held for sale (i.e., mortgage warehouse) are carried at either the lower of cost or market or fair value. Under either accounting basis, the value of these loans is susceptible to declines in market value. Recent market events have affected the value and liquidity of mortgage loans, but to varying degrees depending on the nature and credit quality of the mortgage loans. The carrying value of the Company’s mortgage warehouse was $11.7 billion as of June 30, 2007. The warehouse contained no subprime mortgage loans and approximately $500 million of Alt-A loans, of which 97% were 1st lien loans with credit characteristics very similar to our 1st lien mortgage portfolio and reflect the Company’s recently more stringent underwriting guidelines. The Company’s Alt-A warehouse production in the second quarter declined to 2% of total production, all of which was 1st lien product that is being actively sold into the secondary market. In addition, the Company is no longer originating 2nd lien Alt-A product. The new production in the mortgage warehouse includes improved loan to value ratios, higher credit scores, and tighter documentation standards, which have resulted in increased levels of full documentation loans and minimized the amount of stated income/stated asset production. However, similar to the first quarter, the Company continued to experience a degree of losses from early payment default repurchases, price adjustments in lieu of repurchases, and marking-to-market and selling loans held in the warehouse at current market prices, which currently reflect a liquidity and pricing discount due to the residual impact of the subprime mortgage situation. Similar losses could occur in future periods if current market conditions continue or worsen.

 

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Securitization and Trading Assets

As part of its securitization and trading activities, the Company often warehouses assets prior to sale or securitization, retains interests in securitizations, and maintains a portfolio of loans that it trades in the secondary market. At January 1, 2007, the Company transferred to trading assets approximately $600 million of loans, substantially all of which were purchased from the market for the purpose of sales into securitizations, which were previously classified as loans held for sale. In addition, the Company owned approximately $9 million of residual interests from securitizations that were previously classified as securities available for sale, which were transferred to trading assets. Pursuant to the provisions of SFAS No. 159, the Company elected to carry warehoused and trading loans at fair value, in order to reflect the active management of these positions and, in certain cases, to align the economics of these instruments with the hedges that the Company executes on certain of these loans and to reclassify its residual interests to trading assets, consistent with other residual positions the Company owns. During the second quarter of 2007, approximately $200 million of the $600 million of trading loans transferred into trading assets as of January 1, 2007 were sold as part of the Company’s loan trading and securitization activities and additional loans were purchased and recorded at fair value. The following is a complete listing of the fair value of the residual interests from securitizations and/or structured asset sales retained by the Company:

 

(Dollars in millions) (Unaudited)

         

Commercial loans and bonds

   $25.3   

Corporate loans

   57.3   

Debt securities

   1.1   

Student loans

   19.8   

Mortgage loans

   14.4   

The Company employed stringent underwriting criteria related to the underlying collateral of these residual interests. The assets securing these residual interests are primarily residential, commercial, corporate, and government sponsored student loans, along with asset-backed and trust preferred securities. The securitizations are performing as anticipated and have not experienced significant residual effects from the recent deterioration in the loan market. Despite the performance of these securitizations, the market values as of June 30, 2007 began to reflect some of the stress in the market and future prices could potentially reflect further pricing pressure. Currently, the Company intends to hold these residual interests to maturity as we believe that the current market valuations do not reflect the economic value of securities.

The total value of the Company’s securitization warehouses that it has elected to carry at fair value, excluding certain mortgage loan warehouses, was approximately $1.1 billion as of June 30, 2007. The assets held in the warehouses at June 30, 2007 include Small Business Association loans (“SBA”), collateralized debt obligation (“CDO”) and collateralized loan obligation (“CLO”) securities, and residential and commercial loans. These warehouses were marked-to-market as of June 30, 2007 and reflect the Company’s best estimate of fair value taking into consideration the markets into which these assets will be securitized and the credit quality of the assets held in the warehouse. These products are susceptible to the market values which have recently been volatile and declining due to the residual effect of the credit related issues impacting the mortgage loan market. The value of these loans could be adversely impacted by further declines in market prices. Management limits the size and the Company’s overall exposure to these warehouses, as well as actively monitors the estimated market and economic value of these assets and determines the most advantageous approach to managing these assets.

 

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Securities Available for Sale

The securities portfolio is managed as part of the overall asset and liability management process to optimize income and market performance over an entire interest rate cycle while mitigating risk. The Company continued the balance sheet management strategies begun in 2006 to improve the yield, reduce the size, extend the duration, and enhance the quality of the securities portfolio.

The average yield for the second quarter of 2007 improved to 6.07% compared to 4.83% in the second quarter of 2006. The size of the securities portfolio, based on fair value, was $14.7 billion as of June 30, 2007, a decrease of $10.4 billion, or 41.3% from December 31, 2006. This decrease resulted from the transfer of approximately $16.0 billion in available for sale securities to trading assets during the first quarter of 2007 in conjunction with the Company’s adoption of SFAS No. 159. During the second quarter of 2007, the fair value of the securities portfolio increased $1.6 billion from March 31, 2007 to June 30, 2007 as longer duration, high quality mortgage-backed securities issued by Federal Agencies were purchased. The portfolio’s effective duration increased to 5.2% as of June 30, 2007 from 3.1% as of December 31, 2006. Effective duration is a measure of price sensitivity of a bond portfolio to an immediate change in interest rates, taking into consideration embedded options. An effective duration of 5.2% suggests an expected price change of 5.2% for a one percent instantaneous change in interest rates. The increase in duration was primarily the result of reclassifying shorter duration securities to trading in the first quarter of 2007, and purchasing longer duration securities in the second quarter. The credit quality of the securities portfolio has improved, as reflected in significant reductions in asset-backed securities and corporate bonds. As of June 30, 2007, approximately 97% of the securities were rated “AAA,” the highest possible rating, by nationally recognized rating agencies. The current mix of securities as of June 30, 2007 and December 31, 2006 is shown in Table 2 below.

Net securities gains of $236.4 million were recognized in the second quarter of 2007, virtually all from the sale of 4.5 million shares, or approximately 9% of the Company’s holdings, of the common stock of The Coca-Cola Company. As part of its capital management strategies, SunTrust sold a portion of the Coke holdings which were considered capital inefficient, meaning they could not be leveraged in our businesses, were not pledged for collateral purposes, and did not receive capital credit from regulatory or rating agencies. The Company is evaluating alternatives, including tax advantaged strategies for the remaining 43.7 million shares it owns. The carrying value of available for sale securities reflected $2.0 billion in net unrealized gains as of June 30, 2007, comprised of a $2.3 billion unrealized gain from the Company’s remaining shares of The Coca-Cola Company and a $0.3 billion net unrealized loss on the remainder of the portfolio. The Company reviews all of its securities with unrealized losses for other-than-temporary impairment at least quarterly. As a result of these reviews in the second quarter of 2007, the Company determined that no impairment charges were deemed necessary this quarter, since as of June 30, 2007, it has the ability and intent to hold the remaining securities with unrealized losses until recovery.

 

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Securities Available for Sale

   Table 2

 

     June 30, 2007    December 31, 2006

(Dollars in millions) (Unaudited)

   Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value

U.S. Treasury and other U.S. government agencies and corporations

   $257.1    $251.1    $1,608.0    $1,600.5

States and political subdivisions

   1,038.9    1,034.6    1,032.3    1,041.1

Asset-backed securities

   287.3    288.6    1,128.0    1,112.3

Mortgage-backed securities

   9,974.7    9,730.8    17,337.3    17,130.9

Corporate bonds

   27.3    26.6    468.9    462.8

Common stock of The Coca-Cola Company

   0.1    2,282.7    0.1    2,324.8

Other securities1

   1,104.9    1,111.6    1,423.8    1,429.3
                   

Total securities available for sale

   $12,690.3    $14,726.0    $22,998.4    $25,101.7
                   

1 Includes $702.3 million and $729.4 million as of June 30, 2007 and December 31, 2006, respectively, of Federal Home Loan Bank and Federal Reserve Bank stock stated at par value.

Trading Assets and Liabilities

The increase in the fair value of trading assets from $2.8 billion at December 31, 2006 to $13.0 billion at June 30, 2007 was primarily related to the purchases of $11.4 billion of shorter duration trading securities, namely treasury bills and agency notes, which had been purchased to satisfy customer collateral requirements and to reduce the amount of potential market volatility. During the first quarter of 2007 the Company transferred approximately $16.0 billion in securities which were previously classified as available for sale to trading securities as part of the Company’s balance sheet management strategies. The decision to reclassify certain securities available for sale to trading assets was determined based on the characteristics of the security. The considerations included significantly altering the mix and size of the portfolio’s assets, reducing credit-related exposure, reducing low-yielding assets and efficient capital consumption, while maintaining the overall balance sheet duration target. Substantially all of the following security types were reclassified to trading assets: treasury notes, agency debentures, fixed-rate asset-backed securities, corporate bonds, and mortgage-backed securities (except for longer duration adjustable-rate and fixed-rate pass-through securities). During the second quarter of 2007, substantially all of the $16.0 billion of reclassified trading assets were sold and additional trading securities were purchased. The Company intends to maintain an active trading portfolio carried at fair value for balance sheet management purposes and will manage the potential market volatility of these securities with appropriate duration and/or hedging strategies.

 

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Trading Assets and Liabilities

   Table 3

 

(Dollars in millions) (Unaudited)

   June 30
2007
   December 31
2006
 

Trading Assets

     

U.S. government and agency securities

   $9,531.8    $838.3  

Corporate and other debt securities

   398.0    409.0  

Equity securities

   322.2    2.3  

Mortgage-backed securities

   263.5    140.5  

Derivative contracts

   1,075.1    1,064.3  

Municipal securities

   282.2    293.3  

Commercial paper

   82.5    29.9  

Securitization warehouses

   958.7    -     1

Other securities

   131.0    -      
           

Total trading assets

   $13,045.0    $2,777.6  
           

Trading Liabilities

     

U.S. government and agency securities

   $512.0    $382.8  

Corporate and other debt securities

   20.8    -      

Equity securities

   0.4    0.1  

Mortgage-backed securities

   26.9    -      

Derivative contracts

   1,596.2    1,251.2  
           

Total trading liabilities

   $2,156.3    $1,634.1  
           

1 Prior to adopting SFAS No. 159, the balance of assets held in securitization warehouses as of December 31, 2006 was $869.0 million; $542.5 million of these assets were classified as loans held for sale and the remainder was included in the “U.S. government and agency securities” balance in trading assets.

Net Interest Income/Margin

Fully-taxable net interest income was $1,220.0 million for the second quarter of 2007, an increase of $30.0 million, or 2.5%, from the second quarter of 2006. The increase in net interest income was primarily the result of balance sheet management strategies implemented late in the first quarter of 2007 and during the second quarter of 2007. Lower yielding loans and available for sale securities were reclassified to loans held for sale and trading securities, respectively, and subsequently sold to enable a repositioning of the investment portfolio and a reduction in the higher cost funding supporting these assets. As a result, total earning assets declined $1.3 billion, or 0.8%, in the second quarter of 2007 compared to the second quarter of 2006.

During the second quarter of 2007, loans averaged $118.2 billion, a decline of $2.0 billion, or 1.6%, from the same period of 2006. This decline was a result of balance sheet management strategies over the past twelve months, including the sale of $5.9 billion in mortgage loans, $1.2 billion in student loans, and $1.9 billion in corporate loans. Average securities available for sale were $12.1 billion in the second quarter of 2007, a decrease of $13.5 billion from the second quarter of 2006. In the first quarter of 2007, approximately $16.0 billion of securities available for sale were reclassified to trading to more actively trade a significant portion of this portfolio and to reduce the overall size of the available for sale investments.

Average consumer and commercial deposits increased $0.8 billion or 0.8% in the second quarter of 2007, compared to the second quarter of 2006, with the increase primarily driven by the $3.3 billion increase in NOW account balances and $2.7 billion of growth in higher cost certificates of deposits, partially offset by lower money market accounts of $3.3 billion and demand deposits of $1.5 billion. The Company continues to pursue deposit growth initiatives aimed at product promotions, as well as increasing our presence in specific markets within our footprint.

 

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The net interest margin increased 10 basis points from 3.00% in the second quarter of 2006 to 3.10% in the second quarter of 2007. The decline in average earning assets enabled a reduction in higher cost funding, thus improving the margin. The earning asset yield improved 37 basis points from 6.17% in the second quarter of 2006 to 6.54% in the second quarter of 2007, while the cost of interest-bearing liabilities increased 28 basis points from 3.82% to 4.10% for the periods ending the second quarter of 2006 and the second quarter of 2007, respectively.

This improvement in net interest margin was despite the continued flat yield curve. The Federal Reserve Bank Fed Funds rate averaged 5.25% for the second quarter of 2007, an increase of 34 basis points over the second quarter of 2006 average, and one-month LIBOR increased 16 basis points from the second quarter of 2006 to 5.32% in the second quarter of 2007. In contrast, the five-year swap averaged 5.25%, a decrease of 24 basis points over the second quarter 2006 average, and the ten-year swap rate decreased 21 basis points over the same time period to an average of 5.40% in the second quarter of 2007.

For the first six months of 2007, net interest income was $2,408.2 million, an increase of $18.8 million, or 0.8% from the first six months of 2006. The primary contributor to the increase was the 0.8% growth in earning assets, as the margin remained unchanged at 3.06% for the first six months of 2007 compared to 2006. Average earning assets increased $1.2 billion, or 0.8% during the first six months of 2007 compared to 2006 as increases in trading assets of $13.5 billion, loans of $1.6 billion and loans held for sale of $1.7 billion were partially offset by a decrease in investment securities of $15.3 billion. The earning asset yield improved 43 basis points from 6.08% for the six months ended June 30, 2006 to 6.51% for the six months ended June 30, 2007, while the cost of interest bearing liabilities over the same period increased 46 basis points. The changes in the balance sheet were the result of management’s strategies that began in the second quarter of 2006 and were accelerated in the first half of 2007, resulting in a stabilization of the margin from the six months ended 2006 to the same period of 2007.

Average consumer and commercial deposits increased $1.6 billion, or 1.7%, for the first six months of 2007 compared to the first six months of 2006. The increase was primarily due to growth in higher cost certificates of deposit of $4.0 billion and NOW accounts of $3.0 billion, partly offset by declines in money market accounts of $3.4 billion and demand deposits of $1.7 billion.

Interest income that the Company was unable to recognize on nonperforming loans had a negative impact on net interest margin of four basis points for the second quarter of 2007 and three basis points for the first six months of 2007 as nonaccrual loans increased $99.5 million, or 15.6%, from March 31, 2007 and $233.0 million, or 46.3%, from December 31, 2006. There was a negative impact of two and one basis points for the three and six months ended June 30, 2006, respectively. Table 4 contains more detailed information concerning average loans, yields and rates paid.

 

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Consolidated Daily Average Balances, Income/Expense and Average Yields Earned and Rates Paid

Table 4

 

     Three Months Ended  
     June 30, 2007     June 30, 2006  

(Dollars in millions; yields on taxable-equivalent basis) (Unaudited)

   Average
Balances
    Income/
Expense
   Yields/
Rates
    Average
Balances
    Income/
Expense
   Yields/
Rates
 

Assets

              

Loans:1

              

Real estate 1-4 family

   $30,754.4     $493.2    6.42   %   $34,348.0     $515.1    6.00   %

Real estate construction

   13,710.1     259.4    7.59       12,180.6     226.4    7.45    

Real estate home equity lines

   13,849.7     272.4    7.89       13,517.5     253.6    7.52    

Real estate commercial

   12,731.8     220.8    6.95       12,840.8     215.5    6.73    

Commercial - FTE2

   33,607.7     539.6    6.44       33,993.0     516.7    6.10    

Credit card

   403.7     5.9    5.80       307.0     4.6    5.96    

Consumer - direct

   4,347.5     78.2    7.21       4,251.1     75.9    7.16    

Consumer - indirect

   8,063.6     123.1    6.12       8,385.8     117.0    5.60    

Nonaccrual and restructured

   696.1     4.8    2.76       320.7     3.1    3.88    
                                  

Total loans

   118,164.6     1,997.4    6.78       120,144.5     1,927.9    6.44    

Securities available for sale:

              

Taxable

   11,014.3     167.7    6.09       24,621.2     294.8    4.79    

Tax-exempt - FTE2

   1,041.2     15.2    5.85       933.6     13.7    5.85    
                                  

Total securities available for sale - FTE

   12,055.5     182.9    6.07       25,554.8     308.5    4.83    

Funds sold and securities purchased under agreements to resell

   1,038.1     13.2    5.04       1,244.1     15.2    4.83    

Loans held for sale

   13,454.3     200.4    5.96       9,929.3     163.7    6.59    

Interest-bearing deposits

   24.1     0.3    5.74       27.0     0.3    4.73    

Interest earning trading assets

   12,857.6     174.3    5.44       1,989.1     28.7    5.78    
                                  

Total earning assets

   157,594.2     2,568.5    6.54       158,888.8     2,444.3    6.17    

Allowance for loan and lease losses

   (1,037.6 )        (1,050.1 )     

Cash and due from banks

   3,427.7          3,899.6       

Premises and equipment

   1,980.1          1,908.0       

Other assets

   14,646.8          14,660.1       

Noninterest earning trading assets

   986.6          909.7       

Unrealized gains on securities available for sale

   2,398.7          1,528.0       
                      

Total assets

   $179,996.5          $180,744.1       
                      

Liabilities and Shareholders’ Equity

              

Interest-bearing deposits:

              

NOW accounts

   $20,065.8     $119.0    2.38   %   $16,811.2     $67.0    1.60   %

Money market accounts

   21,773.3     142.0    2.62       25,091.3     163.4    2.61    

Savings

   4,786.7     14.8    1.24       5,161.0     16.2    1.26    

Consumer time

   16,942.3     190.5    4.51       15,471.7     146.7    3.80    

Other time

   11,962.4     144.5    4.85       10,779.1     114.8    4.27    
                                  

Total interest-bearing consumer and commercial deposits

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