BB&T 10-Q 2009
Documents found in this filing:
Quarterly Report Pursuant to Section 13 or 15(d)
For the quarterly period ended:
March 31, 2009
Commission file number: 1-10853
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 þ NO ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). YES þ NO ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO þ
At April 30, 2009, 560,640,875 shares of the Registrant's common stock, $5 par value, were outstanding.
Item 1. Financial Statements
BB&T CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
BB&T CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
BB&T CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements.
BB&T CORPORATION AND SUBSIDIARIES
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The accompanying notes are an integral part of these consolidated financial statements.
NOTE 1. Basis of Presentation
In the opinion of management, the accompanying unaudited Consolidated Balance Sheets, Consolidated Statements of Income, Consolidated Statements of Changes in Shareholders Equity, and Consolidated Statements of Cash Flows of BB&T Corporation and subsidiaries (referred to herein as BB&T, the Corporation or the Company), are a fair statement of BB&Ts financial position at March 31, 2009 and December 31, 2008, and BB&Ts results of operations, changes in shareholders equity and cash flows for the three month periods ended March 31, 2009 and 2008. In the opinion of management, all normal recurring adjustments necessary for a fair statement of the consolidated financial position and consolidated results of operations have been made.
These consolidated financial statements and notes are presented in accordance with the instructions for Form 10-Q. The information contained in the financial statements and footnotes included in BB&Ts Annual Report on Form 10-K for the year ended December 31, 2008 should be referred to in connection with these unaudited interim consolidated financial statements.
Nature of Operations
BB&T is a financial holding company headquartered in Winston-Salem, North Carolina. BB&T conducts operations through its principal bank subsidiary, Branch Banking and Trust Company (Branch Bank), a federally chartered thrift institution, BB&T Financial, FSB (BB&T FSB) and its nonbank subsidiaries. Branch Bank has offices in North Carolina, South Carolina, Virginia, Maryland, Georgia, West Virginia, Tennessee, Kentucky, Florida, Alabama, Indiana and Washington, D.C. Branch Bank provides a wide range of banking services to individuals and businesses, and offers a variety of loans to businesses and consumers. Such loans are made primarily to individuals residing in the market areas described above or to businesses located within BB&Ts geographic footprint. Branch Bank also markets a wide range of deposit services to individuals and businesses. Branch Bank offers, either directly, or through its subsidiaries, lease financing to businesses and municipal governments; factoring; discount brokerage services, annuities and mutual funds; life insurance, property and casualty insurance, health insurance and commercial general liability insurance on an agency basis and through a wholesale insurance brokerage operation; insurance premium financing; permanent financing arrangements for commercial real estate; loan servicing for third-party investors; direct consumer finance loans to individuals; and trust and comprehensive wealth advisory services. BB&T FSB and the direct nonbank subsidiaries of BB&T provide a variety of financial services including credit card lending, automobile lending, equipment financing, full-service securities brokerage, payroll processing, asset management and capital markets services.
Principles of Consolidation
The consolidated financial statements of BB&T include the accounts of BB&T Corporation and those subsidiaries that are majority owned by BB&T and over which BB&T exercises control. In consolidation, all significant intercompany accounts and transactions are
eliminated. The results of operations of companies acquired are included only from the dates of acquisition. All material wholly owned and majority owned subsidiaries are consolidated unless accounting principles generally accepted in the United States of America require otherwise.
BB&T evaluates variable interests in entities for which voting interests are not an effective means of identifying controlling financial interests. Variable interests are those in which the value of the interest changes with the fair value of the net assets of the entity exclusive of variable interests. If the results of the evaluation indicate the existence of a primary beneficiary and the entity does not effectively disperse risks among the parties involved, that primary beneficiary is required to consolidate the entity. Likewise, if the evaluation indicates that the requirements for consolidation are not met and the entity has previously been consolidated, then the entity would be deconsolidated.
BB&T has variable interests in certain entities that were not required to be consolidated, including affordable housing partnership interests, historic tax credit partnerships, other partnership interests and trusts that have issued capital securities. Please refer to Note 6 for additional disclosures regarding BB&Ts significant variable interest entities.
BB&T accounts for unconsolidated partnership investments using the equity method of accounting. In addition to affordable housing partnerships, which represent the majority of unconsolidated investments in variable interest entities, BB&T also has investments and future funding commitments to venture capital and other entities. The maximum potential exposure to losses relative to investments in variable interest entities is generally limited to the sum of the outstanding balance and any related loans to the entity. Loans to these entities are underwritten in substantially the same manner as are other loans and are generally secured.
BB&T has investments in certain entities for which BB&T does not have controlling interest. For these investments, the Company records its interest using the equity method with its portion of income or loss being recorded in other noninterest income in the Consolidated Statements of Income. BB&T periodically evaluates these investments for impairment.
In December 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51, (SFAS No. 160). SFAS No. 160 requires that a noncontrolling interest in a subsidiary be accounted for as equity in the consolidated balance sheet and that net income include the amounts for both the parent and the noncontrolling interest, with a separate amount presented in the income statement for the noncontrolling interest share of net income. SFAS No. 160 also expands the disclosure requirements and provides guidance on how to account for changes in the ownership interest of a subsidiary. BB&T adopted the provisions of SFAS No. 160 on January 1, 2009. In accordance with SFAS No. 160, the presentation and disclosure provisions were applied retrospectively for all periods presented. The amounts reclassified in connection with the adoption of SFAS No. 160 were not material to the consolidated financial statements.
In certain other instances, amounts reported in prior periods consolidated financial statements have been reclassified to conform to the current presentation. Such reclassifications had no effect on previously reported cash flows, shareholders equity or net income.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change include the determination of the allowance for loan and lease losses and the reserve for unfunded lending commitments, determination of fair value for financial instruments, valuation of goodwill, intangible assets and other purchase accounting related adjustments, benefit plan obligations and expenses, and tax assets, liabilities and expense.
Changes in Accounting Principles and Effects of New Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, (SFAS No. 141(R)). SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition); establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to disclose to investors and other users all of the information needed to evaluate and understand the nature and financial effect of the business combination. SFAS No. 141(R) was effective for BB&T for business combinations entered into on or after January 1, 2009. BB&T has not entered into any material business combinations since adopting SFAS No. 141(R).
In April 2009, the FASB issued FASB Staff Position (FSP) FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, (FSP FAS 141(R)-1). FSP FAS 141(R)-1 amends and clarifies SFAS No. 141(R) to address application issues raised by preparers, auditors, and members of the legal profession on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. FSP FAS 141(R)-1 was effective for BB&T for business combinations entered into on or after January 1, 2009. BB&T has not entered into any material business combinations since adopting FSP FAS 141(R)-1.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activitiesan amendment of SFAS No. 133, (SFAS No. 161). SFAS No. 161 requires that an entity provide enhanced disclosures related to derivative and hedging activities. BB&T adopted SFAS No. 161 on January 1, 2009. The additional disclosures required by SFAS No. 161 are included in Note 12 to these consolidated financial statements.
In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets, (FSP FAS 142-3). FSP FAS 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under SFAS No. 142, Goodwill and Other Intangible Assets, (SFAS No. 142). The intent of FSP FAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R). BB&T adopted FSP FAS 142-3 on January 1, 2009. The adoption of FSP FAS 142-3 was not material to the consolidated financial statements.
In December 2008, the FASB issued FSP FAS 132(R)-1, Employers Disclosures about Postretirement Benefit Plan Assets, (FSP FAS 132(R)-1). The objectives of FSP FAS 132(R)-1 are to provide users of the financial statements with more detailed information related to the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets and the effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period, as well as how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies. The disclosures about plan assets required by FSP FAS 132(R)-1 are effective for BB&T on December 31, 2009.
In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, (FSP FAS 157-4). FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. FSP FAS 157-4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. In addition, FSP FAS 157-4 amends SFAS No. 157 to require additional disclosures of valuation inputs and techniques in interim periods and defines the major security types that are required to be disclosed. FSP FAS 157-4 will be effective for BB&T on June 30, 2009. BB&T is currently evaluating the provisions of FSP FAS 157-4.
In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, (FSP FAS 115-2 and FAS 124-2). FSP FAS 115-2 and FAS 124-2 amends the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP FAS 115-2 and FAS 124-2 will be effective for BB&T on June 30, 2009. BB&T is currently evaluating the provisions of FSP FAS 115-2 and FAS 124-2.
In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, (FSP FAS 107-1 and APB 28-1). FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments in interim periods, as well as in annual periods. The disclosures required by FSP FAS 107-1 and APB 28-1 will be effective for BB&T on June 30, 2009.
NOTE 2. Business Combinations and Intangible Assets
During the first three months of 2009, BB&T acquired certain assets of one insurance premium financing business. Approximately $8 million of goodwill and $6 million of identifiable intangibles were recorded in connection with this transaction.
Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill attributable to each of BB&Ts operating segments for the three months ended March 31, 2009, are as follows:
The following table presents the gross carrying amounts and accumulated amortization for BB&Ts identifiable intangible assets subject to amortization at the dates presented:
NOTE 3. Securities
The amortized cost and approximate fair values of securities available for sale were as follows:
The following tables reflect the gross unrealized losses and fair values of BB&Ts investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates presented.
BB&T periodically evaluates available-for-sale securities for other-than-temporary impairment. Based on its evaluations during 2009, BB&T recorded $36 million of other-than-temporary impairments related to certain debt and equity securities.
On March 31, 2009, BB&T also held certain investment securities having continuous unrealized loss positions for more than 12 months. As of March 31, 2009, the unrealized losses on these securities totaled $583 million. Substantially all of these losses were in non-agency mortgage-backed and municipal securities. At March 31, 2009, all of the available-for-sale debt securities were investment grade with the exception of two municipal bonds with the same issuer with a book value of $10 million and eight non-agency mortgage-backed securities, with a book value of $723 million. All of the non-investment grade securities referenced above were initially investment grade and have been downgraded since purchase. The unrealized losses on securities in a continuous unrealized loss position for more than 12 months are the result of changes in market interest rates and liquidity. BB&T has evaluated all of its debt securities for credit impairment. At March 31, 2009, there were no credit losses evident from these securities. Furthermore, BB&T had the ability and intent to retain these securities for a period of time sufficient to recover all unrealized losses.
BB&T conducts periodic reviews to identify and evaluate each investment that has an unrealized loss for other-than-temporary impairment. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. Unrealized losses that are determined to be temporary in nature are recorded, net of tax, in accumulated other comprehensive income for available-for-sale securities.
Factors considered in determining whether a loss is temporary include:
For certain U.S. mortgage-backed securities (and in particular for non-agency Alt-A, Prime and other mortgage-backed securities that have significant unrealized losses as a percentage of amortized cost), credit impairment is assessed using a cash flow model that estimates the cash flows on the underlying mortgage pools, using security-specific structure information. The model estimates cash flows from the underlying mortgage loan pools and distributes those cash flows to the various tranches of securities, considering the transaction structure and any subordination and credit enhancements that exist in each structure. The cash flow model projects the remaining cash flows using a number of assumptions, including default rates, prepayment rates and recovery rates (on foreclosed properties).
Management reviews the result of the cash flow model, the internal credit analysis and other market observable information in its estimation of possible future credit losses. If management believes that it is not probable that a mortgage-backed security will recover all principal and interest due, the Company records other-than-temporary impairment equal to the entire decline in fair value of the mortgage-backed security.
Where a mortgage-backed security is not deemed to be credit impaired, management performs additional analysis to assess whether it has the intent and ability to hold each security for a period of time sufficient for a forecasted recovery of fair value. In making this determination, BB&T considers its expected liquidity and capital needs, including its asset/liability management needs, forecasts, strategies and other relevant information.
NOTE 4. Loans and Leases
The following table provides a breakdown of BB&Ts loan portfolio as of March 31, 2009 and December 31, 2008.
An analysis of the allowance for credit losses for the three months ended March 31, 2009 and 2008 is presented in the following table:
The following table provides a summary of BB&Ts nonperforming and past due loans as of March 31, 2009 and December 31, 2008.
(1) Excludes mortgage loans guaranteed by GNMA that BB&T does not have the obligation to repurchase.
At March 31, 2009, BB&T had $103 million in loans under the terms of troubled debt restructurings. This amount consists of $42 million in revolving credit loans, $36 million in residential mortgage loans, and $25 million in commercial loans. Loan restructurings generally occur when a borrower is experiencing, or is expected to experience, financial difficulties in the near-term. Consequently, a modification that would otherwise not be considered is granted to the borrower. These loans continue to accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance with the modified terms.
NOTE 5. Long-Term Debt
Long-term debt is summarized as follows:
(1) Subordinated notes that qualify under the risk-based capital guidelines as Tier 2 supplementary capital, subject to certain limitations.
NOTE 6. Contractual Obligations, Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements
BB&T utilizes a variety of financial instruments to meet the financing needs of clients and reduce exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees, and derivatives. BB&T also has commitments to fund certain affordable housing investments and contingent liabilities of certain sold loans.
Standby letters of credit and financial guarantees written are unconditional commitments issued by BB&T to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper issuance, bond financing and similar transactions. The credit risk involved in the issuance of these guarantees is essentially the same as that involved in extending loans to clients and as such, the instruments are collateralized when necessary. As of March 31, 2009 and December 31, 2008, BB&T had issued standby letters of credit totaling $7.0 billion and $5.9 billion, respectively. The carrying amount of the liability for such guarantees was $22 million and $20 million at March 31, 2009 and December 31, 2008, respectively.
A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. These instruments include interest-rate swaps, swaptions, caps, floors, collars, financial forward and futures contracts, when-issued securities, foreign exchange contracts and options written and purchased. BB&T uses derivatives primarily to manage risk related to securities, business loans, Federal Funds purchased, other overnight funding, long-term debt, mortgage servicing rights, mortgage banking operations and certificates of deposit. BB&T also uses derivatives to facilitate transactions on behalf of its clients. BB&T held a variety of derivative financial instruments with notional values of $75.6 billion and $74.2 billion at March 31, 2009 and December 31, 2008, respectively. These instruments were in a net gain position of $486 million and $626 million at March 31, 2009 and December 31, 2008, respectively.
BB&T invests in certain affordable housing and historic building rehabilitation projects throughout its market area as a means of supporting local communities and receives tax credits related to these investments. BB&T typically acts as a limited partner in these investments and does not exert control over the operating or financial policies of the partnerships. Branch Bank typically provides financing during the construction and development of the properties; however, permanent financing is generally obtained from independent third parties upon completion of a project. As of March 31, 2009 and December 31, 2008, BB&T had investments of $907 million and $891 million, respectively, related to these projects, which are included in other assets on the Consolidated Balance Sheets. BB&Ts outstanding commitments to fund affordable housing investments totaled $393 million and $412 million at March 31, 2009 and December 31, 2008, respectively, which are included in other liabilities on the Consolidated Balance Sheets. As of March 31, 2009 and December 31, 2008, BB&T had outstanding loan commitments to these funds of $164 million and $161 million, respectively. Of this amount, $86 million and $81 million had been funded at March 31, 2009 and December 31, 2008, respectively, and were included in loans and leases on the Consolidated Balance Sheets. BB&Ts maximum risk
exposure related to these investments totaled $1.1 billion at March 31, 2009 and December 31, 2008, respectively.
In the ordinary course of business, BB&T indemnifies its officers and directors to the fullest extent permitted by law against liabilities arising from pending litigation. BB&T also issues standard representations and warranties in underwriting agreements, merger and acquisition agreements, loan sales, brokerage activities and other similar arrangements. Counterparties in many of these indemnification arrangements provide similar indemnifications to BB&T. Although these agreements often do not specify limitations, BB&T does not believe that any payments related to these guarantees would materially change the financial condition or results of operations of BB&T.
BB&T has sold certain mortgage-related loans that contain recourse provisions. These provisions generally require BB&T to reimburse the investor for a share of any loss that is incurred after the disposal of the property. At March 31, 2009 and December 31, 2008, BB&T had $782 million and $822 million, respectively, of residential mortgage loans sold with recourse. In the event of nonperformance by the borrower, BB&T has maximum recourse exposure of approximately $704 million and $741 million as of March 31, 2009 and December 31, 2008, respectively. In addition, BB&T has $3.6 billion and $3.3 billion in loans serviced for others that were covered by loss sharing agreements at March 31, 2009 and December 31, 2008, respectively. As of March 31, 2009 and December 31, 2008, BB&Ts maximum exposure to loss for these loans is approximately $920 million and $818 million, respectively.
BB&T has investments and future funding commitments to certain venture capital funds. As of March 31, 2009 and December 31, 2008, respectively, BB&T had investments of $176 million and $168 million, net of noncontrolling interest, related to these ventures and future funding commitments of $213 million and $222 million. BB&Ts risk exposure relating to such commitments is generally limited to the amount of investments and future funding commitments made.
BB&T has made loan commitments to qualified special purpose entities as a nontransferor lender. As of March 31, 2009 and December 31, 2008, BB&T had loan commitments to these entities totaling $400 million and $405 million, respectively. Of this amount, $282 million and $290 million had been funded at March 31, 2009 and December 31, 2008, respectively, and were included in loans and leases on the Consolidated Balance Sheets.
NOTE 7. Benefit Plans
BB&T provides various benefit plans to substantially all employees, including employees of acquired entities. Employees of acquired entities generally participate in existing BB&T plans after consummation of the business combinations. The plans of acquired institutions are typically merged into the BB&T plans after consummation of the mergers, and, under these circumstances, credit is usually given to these employees for years of service at the acquired institution for vesting and eligibility purposes. Please refer to BB&Ts Annual Report on Form 10-K for the year ended December 31, 2008 for descriptions and disclosures about the various benefit plans offered by BB&T.
The following table summarizes the components of net periodic benefit cost recognized for BB&Ts pension plans for the three month periods ended March 31, 2009 and 2008, respectively:
BB&T makes contributions to the qualified pension plan in amounts between the minimum required for funding standard accounts and the maximum amount deductible for federal income tax purposes. A discretionary contribution of $422 million was made to the qualified pension plan in the first quarter of 2009. Management currently has no plans to make any additional contributions to the qualified pension plan in 2009; however, management may elect to make additional contributions during 2009 if deemed appropriate.
NOTE 8. Computation of Earnings Per Common Share
BB&Ts basic and diluted earnings per common share amounts for the three month periods ended March 31, 2009 and 2008, respectively, were calculated as follows:
For the three months ended March 31, 2009 and 2008, the number of anti-dilutive awards was 43.4 million and 32.5 million shares, respectively. In addition, BB&T had a warrant outstanding for 13.9 million shares as of March 31, 2009 that was anti-dilutive.
NOTE 9. Comprehensive Income (Loss)
The balances in accumulated other comprehensive loss for the periods indicated are shown in the following tables:
NOTE 10. Equity-Based Compensation Plans
BB&T has options, restricted shares of common stock and restricted share units outstanding from the following equity-based compensation plans: the 2004 Stock Incentive Plan (2004 Plan), the 1995 Omnibus Stock Incentive Plan, the Non-Employee Directors Stock Option Plan, and plans assumed from acquired entities. All plans generally allow for accelerated vesting of awards for holders who retire and have met all retirement eligibility requirements and in connection with certain other events. BB&Ts shareholders have approved all equity-based compensation plans with the exception of plans assumed from acquired companies. As of March 31, 2009, the 2004 Plan is the only plan that has awards available for future grants. Please refer to BB&Ts Annual Report on Form 10-K for the year ended December 31, 2008 for further disclosures related to equity-based awards issued by BB&T.
BB&T measures the fair value of each option award on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants awarded during the first three months of 2009 and 2008.
BB&T measures the fair value of restricted shares based on the price of BB&Ts common stock on the grant date and the fair value of restricted share units based on the price of BB&Ts common stock on the grant date less the present value of expected dividends that are foregone during the vesting period.
The following table details the activity during the first three months of 2009 related to stock options awarded by BB&T:
The following table details the activity during the first three months of 2009 related to restricted shares and restricted share units awarded by BB&T:
NOTE 11. Fair Value Disclosures
BB&T carries various assets and liabilities at fair value based on applicable accounting standards. In addition, BB&T has elected to account for prime residential mortgage and commercial mortgage loans held for sale at fair value in accordance with SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities-including an amendment of FASB Statement No. 115, (the Fair Value Option). SFAS No. 157 established a framework for measuring fair value and defines fair value as the exchange price that would be received on the measurement date to sell an asset or the price paid to transfer a liability in the principal or most advantageous market available to the entity in an orderly transaction between market participants. SFAS No. 157 also established a three level fair value hierarchy that describes the inputs that are used to measure assets and liabilities.
Level 1 asset and liability fair values are based on quoted prices in active markets for identical assets and liabilities. Level 1 assets and liabilities include certain equity securities and derivative contracts that are traded in an active market.
Level 3 assets and liabilities are financial instruments whose value is calculated by the use of pricing models and/or discounted cash flow methodologies, as well as financial instruments for which the determination of fair value requires significant management
judgment or estimation. These methodologies may result in a significant portion of the fair value being derived from unobservable data. Level 3 assets and liabilities include certain trading securities, non-agency mortgage-backed securities, mortgage servicing rights, venture capital investments and certain derivative contracts.
Assets and liabilities measured at fair value on a recurring basis, including financial instruments for which BB&T has elected the Fair Value Option are summarized below:
(1) Loans held for sale are residential and commercial mortgage loans that were originated subsequent to December 31, 2007 for which the Company elected the fair value option under SFAS No. 159. Loans originated prior to January 1, 2008 and certain other loans held for sale are still accounted for at the lower of cost or market. There were $15 million and $28 million in loans held for sale that are not accounted for at fair value at March 31, 2009 and December 31, 2008, respectively.
The tables below present a reconciliation for the three month periods ended March 31, 2009 and 2008, respectively, for all Level 3 assets and liabilities that are measured at fair value on a recurring basis.
The tables below summarize unrealized and realized gains and losses recorded in earnings for Level 3 assets and liabilities for the three month periods ended March 31, 2009 and 2008, respectively.
The realized and unrealized losses reported for mortgage servicing rights assets are composed of a negative valuation adjustment of $46 million and $84 million plus the realization of expected residential mortgage servicing rights cash flows of $32 million and $23 million for the quarters ended March 31, 2009 and 2008, respectively. BB&T uses various derivative financial instruments to mitigate the income statement effect of changes in fair value due to its quarterly valuation. During the three months ended March 31, 2009 and 2008, respectively, the derivative instruments produced gains of $74 million and $82 million, which offset the negative valuation adjustment recorded.
The following table details the fair value and unpaid principal balance of loans held for sale at March 31, 2009 and December 31, 2008, that were elected to be carried at fair value.
(1) The change in fair value is reflected in mortgage banking income.
Also, BB&T may be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis. Assets measured at fair value on a nonrecurring basis for the quarter ended March 31, 2009 that were still held on the balance sheet at March 31, 2009 totaled $1.7 billion. This amount consists of $758 million for impaired loans and $958 million for foreclosed real estate that were classified as Level 3 assets. During the first quarter of 2009, BB&T recorded $86 million and $17 million, respectively, in losses related to write-downs of the loans and foreclosed real estate based on the appraised value of the underlying collateral.
NOTE 12. Derivative Financial Instruments
BB&T uses a variety of derivative instruments to manage interest rate and foreign exchange risks. These instruments consist of interest-rate swaps, swaptions, caps, floors, collars, financial forward and futures contracts, when-issued securities, foreign exchange contracts and options written and purchased. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. There are five areas of risk management: balance sheet management, mortgage banking operations, mortgage servicing rights, net investment in a foreign subsidiary and client-related and other risk management activities.
The following tables set forth certain information concerning BB&Ts derivative financial instruments and related hedged items at March 31, 2009: