SunTrust Banks 10-K 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
2008 FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008
¨ 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)
303 Peachtree Street, N.E., Atlanta, Georgia 30308
(Address of principal executive offices) (Zip Code)
(Registrants telephone number, including area code)
Securities registered pursuant to section 12(b) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
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. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the voting Common Stock held by non-affiliates at June 30, 2008 was approximately $12.7 billion, based on the New York Stock Exchange closing price for such shares on that date. For purposes of this calculation, the Registrant has assumed that its directors and executive officers are affiliates.
At February 18, 2009, 356,681,867 shares of the Registrants Common Stock, $1.00 par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III information is incorporated herein by reference, pursuant to Instruction G of Form 10-K, to SunTrusts Definitive Proxy Statement for its 2008 Annual Shareholders Meeting, which will be filed with the Commission no later than April 30, 2009 (the Proxy Statement).
TABLE OF CONTENTS
SunTrust Banks, Inc. (SunTrust, the Company, we, us, or our), one of the nations largest commercial banking organizations, is a diversified financial services holding company whose businesses provide a broad range of financial services to consumer and corporate clients. SunTrust was incorporated in 1984 under the laws of the State of Georgia. The principal executive offices of the Company are located in the SunTrust Plaza, Atlanta, Georgia 30308.
Additional information relating to our businesses and our subsidiaries is included in the information set forth in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations (the MD&A), and Note 22, Business Segment Reporting, to the Consolidated Financial Statements in Item 8 of this report.
Primary Market Areas
Through its flagship subsidiary SunTrust Bank, the Company provides deposit, credit, and trust and investment services. Additional subsidiaries provide mortgage banking, asset management, securities brokerage, capital market services and credit-related insurance. SunTrust enjoys strong market positions in some of the most attractive markets in the United States and operates primarily within Florida, Georgia, Maryland, North Carolina, South Carolina, Tennessee, Virginia, and the District of Columbia. Within the geographic footprint, SunTrust operated under four business segments during 2008. These business segments were: Retail & Commercial, Wholesale Banking, Mortgage, and Wealth and Investment Management. In addition, SunTrust provides clients with a selection of technology-based banking channels, including the Internet, automated teller machines, PC and twenty-four hour telebanking. SunTrusts client base encompasses a broad range of individuals and families, businesses, institutions, and governmental agencies.
Acquisition and Disposition Activity
As part of its operations, the Company regularly evaluates the potential acquisition of, and holds discussions with, various financial institutions and other businesses of a type eligible for financial holding company ownership or control. In addition, the Company regularly analyzes the values of, and may submit bids for, the acquisition of customer-based funds and other liabilities and assets of such financial institutions and other businesses. The Company may also consider the potential disposition of certain of its assets, branches, subsidiaries or lines of businesses.
We completed the sale of our minority interest in Lighthouse Investment Partners, LLC on January 2, 2008 and effective May 1, 2008, we acquired GB&T Bancshares, Inc. (GB&T). On May 30, 2008, we sold our interests in First Mercantile Trust Company (First Mercantile), a retirement plan services subsidiary. Moreover, on September 2, 2008, we sold our fuel card business, TransPlatinum to Fleet One Holdings LLC. Additional information on these and other acquisitions and dispositions is included in Note 2, Acquisitions/Dispositions, to the Consolidated Financial Statements in Item 8, which are incorporated herein by reference.
Government Supervision and Regulation
As a bank holding company and a financial holding company, the Company is subject to the regulation and supervision of the Board of Governors of the Federal Reserve System (the Federal Reserve) and, in limited circumstances described herein, the United States Department of the Treasury (the Treasury). The Companys principal banking subsidiary, SunTrust Bank, is a Georgia state chartered bank with branches in Georgia, Florida, the District of Columbia, Maryland, Virginia, North Carolina, South Carolina, Tennessee, Alabama, West Virginia, Mississippi and Arkansas. SunTrust Bank is a member of the Federal Reserve System, and is regulated by the Federal Reserve, the Federal Deposit Insurance Corporation (the FDIC) and the Georgia Department of Banking and Finance.
The Companys banking subsidiary is subject to various requirements and restrictions under federal and state law, including requirements to maintain cash reserves against deposits, restrictions on the types and amounts of loans that may be made, and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of the bank and its subsidiaries. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve as it attempts to control the money supply and credit availability in order to influence the economy.
Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, bank holding companies from any state may acquire banks located in any other state, subject to certain conditions, including concentration limits. In addition, a bank may establish branches across state lines by merging with a bank in another state, subject to certain restrictions. A bank
holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve. Moreover, a bank and its affiliates may not, after the acquisition of another bank, control more than 10% of the amount of deposits of insured depository institutions in the United States. In addition, certain states may have limitations on the amount of deposits any bank may hold within that state.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance fund in the event the depository institution becomes in danger of default or is in default. For example, under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the cross-guarantee provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized as such terms are defined under regulations issued by each of the federal banking agencies.
The Federal Reserve and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to United States banking organizations. In addition, these regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels, whether because of its financial condition or actual or anticipated growth. The Federal Reserve risk-based guidelines define a tier-based capital framework. Tier 1 capital includes common shareholders equity, trust preferred securities, minority interests and qualifying preferred stock, less goodwill (net of any qualifying deferred tax liability) and other adjustments. Tier 2 capital consists of preferred stock not qualifying as Tier 1 capital, mandatorily convertible debt, limited amounts of subordinated debt, other qualifying term debt, the allowance for credit losses up to a certain amount and a portion of the unrealized gain on equity securities. The sum of Tier 1 and Tier 2 capital represents the Companys qualifying total capital. Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. Assets and off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit risk. In addition, the Company, and any bank with significant trading activity, must incorporate a measure for market risk in their regulatory capital calculations. The leverage ratio is determined by dividing Tier 1 capital by adjusted average total assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective federal regulatory agencies to implement systems for prompt corrective action for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An undercapitalized bank must develop a capital restoration plan and its parent holding company must guarantee that banks compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the banks assets at the time it became undercapitalized or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parents general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality, and executive compensation and permits regulatory action against a financial institution that does not meet such standards.
The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized. Under the regulations, a well capitalized institution must have a Tier 1 risk-based capital ratio of at least six percent, a total risk-based capital ratio of at least ten percent and a leverage ratio of at least five percent and not be subject to a capital directive order.
Regulators also must take into consideration: (a) concentrations of credit risk; (b) interest rate risk (when the interest rate sensitivity of an institutions assets does not match the sensitivity of its liabilities or its off-balance-sheet position); and (c) risks from non-traditional activities, as well as an institutions ability to manage those risks, when determining the adequacy of an institutions capital. This evaluation will be made as a part of the institutions regular safety and soundness examination.
There are various legal and regulatory limits on the extent to which the Companys subsidiary bank may pay dividends or otherwise supply funds to the Company. In addition, federal and state bank regulatory agencies also have the authority to prevent a bank or bank holding company from paying a dividend or engaging in any other activity that, in the opinion of the agency, would constitute an unsafe or unsound practice. The Federal Deposit Insurance Act provides that, in the event of the liquidation or other resolution of an insured depository institution, the claims of depositors of the institution (including the claims of the FDIC as subrogee of insured depositors) and certain claims for administrative expenses of the FDIC as a receiver will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, nondeposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.
The FDIC merged the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) to form the Deposit Insurance Fund (DIF) on March 31, 2006 in accordance with the Federal Deposit Insurance Reform Act of 2005. The FDIC maintains the DIF by assessing depository institutions an insurance premium. The amount each institution is assessed is based upon statutory factors that include the balance of insured deposits as well as the degree of risk the institution poses to the insurance fund. The FDIC recently increased the amount of deposits it insures from $100,000 to $250,000. This increase is temporary and will continue through December 31, 2009. Additionally, under the temporary liquidity guarantee program (the TLGP), transactional accounts are fully insured, as described below. The Companys banking subsidiary pays an insurance premium into the DIF based on the total amount in each individual deposit account held at the Companys banking subsidiary, up to $250,000 for each account. The FDIC uses a risk-based premium system that assesses higher rates on those institutions that pose greater risks to the DIF. The FDIC places each institution in one of four risk categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory group assignment). Recently, the FDIC increased the amount assessed from financial institutions by increasing its risk-based deposit insurance assessment scale uniformly by seven (7) basis points for first quarter 2009. The assessment scale for first quarter 2009 will range from twelve (12) basis points of assessable deposits for the strongest institutions to fifty (50) basis points for the weakest.
On October 14, 2008, the FDIC announced the TLGP that guarantees certain debt issued and the transactional accounts of financial institutions. The Company has opted to participate in both the FDICs debt guarantee and transaction account guarantee programs. The FDIC assesses insurance premiums from participating depository institutions to fund the FDICs obligations under both the debt guarantee program and the transaction account guarantee program. With respect to the debt guarantee program, the FDIC insures all senior, unsecured debt with a maturity of 31 days or more until the earlier of (i) June 30, 2012 or (ii) the maturity of the debt. The FDIC assesses a fee, payable upon issuance, for participation in the debt guarantee program (a) for debt with a maturity of 180 days or less, an amount equal to the product of the total amount of the debt issued, the term of the debt expressed in years and 50 basis points; (b) for debt with a maturity of 181 days to 364 days, an amount equal to the product of the total amount of the debt issued, the term of the debt expressed in years and 75 basis points; and (c) for debt with a maturity of greater than 365 days, an amount equal to the product of the total amount of the debt issued, the term of the debt expressed in years and 100 basis points. With respect to the transaction account guarantee program, the FDIC insures the funds in all non-interest bearing transactional accounts greater than $250,000 until December 31, 2009. The FDIC assesses a quarterly annualized fee equal to the product of 10 basis points and the sum of the amount by which the non-interest bearing transactional accounts of the Companys banking subsidiary have funds greater than $250,000 in each account.
FDIC regulations require that management report annually on its responsibility for preparing its institutions financial statements, establishing and maintaining an internal control structure and procedures for financial reporting, and compliance with designated laws and regulations concerning safety and soundness.
On November 12, 1999, financial modernization legislation known as the Gramm-Leach-Bliley Act (the GLB Act) was signed into law. Under the GLB Act, a bank holding company which elects to become a financial holding company may engage in expanded securities activities, insurance sales, and underwriting activities, and other financial activities, and may also acquire securities firms and insurance companies, subject in each case to certain conditions. The Company has elected to become a financial holding company under the GLB Act. If any of our banking subsidiaries ceases to be well capitalized or well managed under applicable regulatory standards, the Federal Reserve may, among other things, place limitations on our ability to conduct these broader financial activities or, if the deficiencies persist, require us to divest the banking subsidiary. In order to become and maintain its status as a financial holding company, the Company and all of its affiliated depository institutions must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act of 1977 (CRA) rating. Furthermore, if the Federal Reserve determines that a financial holding company has not maintained a satisfactory CRA rating, the Company will not be able to commence any new financial activities or acquire a company that engages in such activities, although the Company will still be allowed to engage in activities closely related to banking and make investments in the ordinary course of conducting merchant banking activities.
The USA Patriot Act of 2001 (Patriot Act) substantially broadens existing anti-money laundering legislation and the extraterritorial jurisdiction of the United States; imposes new compliance and due diligence obligations; creates new crimes and penalties; compels the production of documents located both inside and outside the United States, including those of non-U.S. institutions that have a correspondent relationship in the United States; and clarifies the safe harbor from civil liability to clients. The Treasury has issued a number of regulations that further clarify the Patriot Acts requirements or provide more specific guidance on their application. The Patriot Act requires all financial institutions, as defined, to establish certain anti-money laundering compliance and due diligence programs. The Patriot Act requires financial institutions that maintain correspondent accounts for non-U.S. institutions, or persons that are involved in private banking for non-United States persons or their representatives, to establish, appropriate, specific and, where necessary, enhanced due diligence policies, procedures, and controls that are reasonably designed to detect and report instances of money laundering through those accounts. Bank regulators are focusing their examinations on anti-money laundering compliance, and the Company continues to enhance its anti-money laundering compliance programs.
Federal banking regulators, as required under the GLB Act, have adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The privacy provisions of the GLB Act affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors.
The Company is subject to the rules and regulations promulgated under the Emergency Economic Stabilization Act of 2008 (EESA) by virtue of the Companys sale of preferred stock to the Treasury. The statute and regulations include certain limitations on compensation for senior executives, dividend payments, and payments to senior executives upon termination of employment. Additional information relating to the restrictions on dividends and redemptions is included in the information set forth in Item 7 of this report under the caption, Liquidity Risk. Furthermore, under rules and regulations of EESA to which the Company is subject, no dividends may be declared or paid on the Companys common stock and the Company may not repurchase or redeem any common stock unless dividends due with respect to Senior Preferred Shares have been paid in full. Moreover, the consent of the Treasury will be required for any increase in the per share dividends on the Companys common stock, beyond the per share dividend declared prior to October 14, 2008 ($0.77 per share per quarter) until the third anniversary of the date of Treasurys investment; unless prior to the third anniversary, the Senior Preferred Shares are redeemed in whole or the Treasury has transferred all of its shares to third parties. Under this provision the Company could reduce its dividend and subsequently restore it to no more than $0.77 per share per quarter at any time. Additionally, if the Company pays a dividend in excess of $0.54 per share before the tenth anniversary then the anti-dilution provisions of the U.S. Treasurys warrants will reduce its exercise price and increase the number of shares issuable upon exercise of the warrant.
Because of the Companys participation in EESA, the Treasury is permitted to determine whether the public disclosure required for the Company with respect to the Companys off-balance sheet transactions, derivative instruments, contingent liabilities and similar sources of exposure are adequate to provide the public sufficient information as to the true financial position of the Company. If the Treasury were to determine that such disclosure is not adequate for such purpose, the Treasury will make additional recommendations for additional disclosure requirements to the Federal Reserve, the Companys primary federal regulator.
Because of the Companys participation in EESA, the Company is subject to certain restrictions on its executive compensation practices, which are discussed in Item 11 of this report.
The Companys non-banking subsidiaries are regulated and supervised by various regulatory bodies. For example, SunTrust Robinson Humphrey, Inc. is a broker-dealer registered with the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority, Inc. (FINRA). SunTrust Investment Services, Inc. is also a broker-dealer and investment adviser registered with the SEC and a member of the FINRA. RidgeWorth Capital Management, Inc. (RidgeWorth; formerly Trusco Capital Management, Inc.) and several of Ridgeworths subsidiaries are investment advisers registered with the SEC.
In addition, there have been a number of legislative and regulatory proposals that would have an impact on the operation of bank/financial holding companies and their bank and non-bank subsidiaries. It is impossible to predict whether or in what form these proposals may be adopted in the future and, if adopted, what their effect will be on us.
SunTrust operates in a highly competitive industry that could become even more competitive as a result of legislative, regulatory, economic, and technological changes, as well as continued consolidation. The Company also faces aggressive competition from other domestic and foreign lending institutions and from numerous other providers of financial services. The ability of non-banking financial institutions to provide services previously limited to commercial banks has intensified
competition. Because non-banking financial institutions are not subject to the same regulatory restrictions as banks and bank holding companies, they can often operate with greater flexibility and lower cost structures. Although non-banking financial institutions may not have the same access to government programs enacted under EESA or the TLGP, those non-banking financial institutions may elect to become financial holding companies and gain such access. Securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. This may significantly change the competitive environment in which the Company conducts business. Some of the Companys competitors have greater financial resources or face fewer regulatory constraints. As a result of these various sources of competition, the Company could lose business to competitors or be forced to price products and services on less advantageous terms to retain or attract clients, either of which would adversely affect the Companys profitability.
As a result of recent economic events, there has been an increase in the number of failures and acquisitions of commercial and investment banks, including large commercial and investment banks. This has allowed certain larger financial institutions to acquire a presence in our footprint. Additionally, certain large financial institutions that were formerly engaged primarily in investment banking activities have amended their charters to become regulated commercial banks, thereby increasing the direct competitors to the Company. Consequently, merger activity has increased within the banking industry.
The Companys ability to expand into additional states remains subject to various federal and state laws. See Government Supervision and Regulation for a more detailed discussion of interstate banking and branching legislation and certain state legislation.
As of December 31, 2008, there were 29,333 full-time equivalent employees within SunTrust. None of the domestic employees within the Company are subject to a collective bargaining agreement. Management considers its employee relations to be good.
See also the following additional information which is incorporated herein by reference: Business Segments (under the captions Business Segments in Item 7, the MD&A, and Business Segment Reporting in Note 22 to the Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data); Net Interest Income (under the captions Net Interest Income/Margin in the MD&A and Selected Financial Data in Item 6); Securities (under the caption Securities Available for Sale in the MD&A and Note 5 to the Consolidated Financial Statements); Outstanding Loans and Leases (under the caption Loans in the MD&A and Note 6 to the Consolidated Financial Statements); Deposits (under the caption Deposits in the MD&A); Short-Term Borrowings (under the captions Liquidity Risk and Other Short-Term Borrowings and Long-Term Debt in the MD&A and Note 10 Other Short-Term Borrowings and Contractual Commitments to the Consolidated Financial Statements); Trading Activities in the MD&A and Trading Assets and Liabilities (under the caption Trading Assets and Liabilities in the MD&A and Trading Assets and Liabilities and Fair Value Election and Measurement in Notes 4 and 20, respectively, to the Consolidated Financial Statements); Market Risk Management (under the caption Market Risk Management in the MD&A); Liquidity Risk Management (under the caption Liquidity Risk in the MD&A); and Operational Risk Management (under the caption Operational Risk Management in the MD&A).
SunTrusts Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act) are available on the Companys website at www.suntrust.com under the Investor Relations Section as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to the SEC. The public may read and copy any materials the Company files with the SEC at the SEC Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy, and information statements, and other information regarding issuers that file electronically with the SEC. The SECs website address is www.sec.gov. In addition, SunTrust makes available on its website at www.suntrust.com under the heading Corporate Governance its: (i) Code of Ethics; (ii) Corporate Governance Guidelines; and (iii) the charters of SunTrust Board committees, and also intends to disclose any amendments to its Code of Ethics, or waivers of the Code of Ethics on behalf of its Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer, on its website. These corporate governance materials are also available free of charge in print to shareholders who request them in writing to: SunTrust Banks, Inc., Attention: Investor Relations, P.O. Box 4418, Mail Code GA-ATL-634, Atlanta, Georgia 30302-4418.
The Companys Annual Report on Form 10-K is being distributed to shareholders in lieu of a separate annual report containing financial statements of the Company and its consolidated subsidiaries.
Possible Additional Risks
The risks listed here are not the only risks we face. Additional risks that are not presently known, or that we presently deem to be immaterial, also could have a material adverse effect on our financial condition, results of operations, business, and prospects.
Recent Market, Legislative, and Regulatory Events
Difficult market conditions have adversely affected our industry.
Dramatic declines in the housing market over the past two years, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs, initially of asset-backed securities (ABS) but spreading to other securities and loans, have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected our business, financial condition and results of operations. Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit and fraud losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and disruption for more than 12 months. Recently, volatility and disruption have reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
Numerous facts and circumstances are considered when evaluating the carrying value of our goodwill. One of those considerations is the market capitalization of the Company, evaluated over a reasonable period of time, in relation to the aggregate estimated fair value of the reporting units. While this comparison provides some relative market information regarding the estimated fair value of the reporting units, it is not determinative and needs to be evaluated in the context of the current economic and political environment. However, significant and/or sustained declines in the Companys market capitalization, especially in relation to the Companys book value, could be an indication of potential impairment of goodwill.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
There can be no assurance that enacted legislation or any proposed federal programs will stabilize the U.S. financial system and such legislation and programs may adversely affect us.
On October 3, 2008, President George W. Bush signed into law the EESA. The legislation was the result of a proposal by Treasury Secretary Henry Paulson to the U.S. Congress in response to the financial crises affecting the banking system and financial markets and threats to investment banks and other financial institutions. Pursuant to the EESA, the Treasury will have the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities (MBS) and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the
U.S. financial markets. Also on October 14, 2008, the Treasury announced a program under the EESA pursuant to which it would make senior preferred stock investments in participating financial institutions (the Capital Purchase Program). On October 14, 2008, the Federal Deposit Insurance Corporation announced the TLGP under the systemic risk exception to the Federal Deposit Act (FDA) pursuant to which the FDIC would offer a guarantee of certain financial institution indebtedness in exchange for an insurance premium to be paid to the FDIC by issuing financial institutions.
We have participated in the Capital Purchase Program and issued debt under the TLGP. There can be no assurance, however, as to the actual impact that the EESA and its implementing regulations, the FDIC programs, or any other governmental program will have on the financial markets or our participation in either program on our results. The failure of the EESA, the FDIC, or the U.S. government to stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, and access to credit or the trading price of our common stock.
Contemplated and proposed legislation, state and federal programs, and increased government control or influence may adversely affect us by increasing the uncertainty in our lending operations and expose us to increased losses, including legislation that would allow bankruptcy courts to permit modifications to mortgage loans on a debtors primary residence, moratoriums on a mortgagors right to foreclose on property, and requirements that fees be paid to register other real estate owned property. Statutes and regulations may be altered that may potentially increase our costs to service and underwrite mortgage loans. Additionally, federal intervention and operation of formerly private institutions may adversely affect our rights under contracts with such institutions and the way in which we conduct business in certain markets.
The impact on us of recently enacted legislation, in particular the EESA and its implementing regulations, and actions by the FDIC, cannot be predicted at this time.
The programs established or to be established under the EESA and Troubled Asset Relief Program may have adverse effects upon us. Because we participate in the Capital Purchase Program, we are subject to increased regulation, and we may face additional regulations or changes to regulations to which we are subject as a result of our participation. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities. For example, participation in the Capital Purchase Program limits (without the consent of the Treasury) our ability to increase our dividend or to repurchase our common stock for so long as any securities issued under such program remain outstanding. Also, the cumulative dividend payable under the preferred stock that we issued to the Treasury pursuant to the Capital Purchase Program increases from 5% to 9% after 5 years. Please also refer to our discussions of Liquidity Risk and Capital Resources in Item 7 of this report. Additionally, we may not deduct interest paid on our preferred stock for income tax purposes. Participating in the Capital Purchase Program also subjects us to additional executive compensation restrictions. We discuss these in greater detail in our proxy statement, which we incorporate by reference into Item 11 of this report.
Similarly, any program established by the FDIC under the systemic risk exception of the FDA, may adversely affect us whether we participate or not. Our participation in the TLGP requires we pay additional insurance premiums to the FDIC. Additionally, the FDIC has increased premiums on insured accounts because market developments, including the increase of failures in the banking industry, have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.
Treasury Stress Tests and Other Actions may Adversely Affect Bank Operations and Value of Shares.
On February 10, 2009, the U.S. Treasury Secretary outlined a plan to restore stability to the financial system. This announcement included reference to a plan by the Treasury to conduct stress tests of banks which received funds under the Capital Purchase Program and similar Treasury programs. The methods and procedures to be used by the Treasury in conducting its stress tests, how these methods and procedures will be applied, and the significance or consequence of such tests presently are not known. Any of these or their consequences could adversely affect us, our bank operations and the value of SunTrust shares, among other things.
When we loan money, commit to loan money or enter into a letter of credit or other contract with a counterparty, we incur credit risk, or the risk of losses if our borrowers do not repay their loans or our counterparties fail to perform according to the terms of their contracts. A number of our products expose us to credit risk, including loans, leases and lending commitments, derivatives, trading account assets, insurance arrangements with respect to such products, and assets held for sale. As one of the nations largest lenders, the credit quality of our portfolio can have a significant impact on our earnings. We estimate and establish reserves for credit risks and credit losses inherent in our credit exposure (including unfunded credit commitments). This process, which is critical to our financial results and condition, requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to
repay their loans. As is the case with any such assessments, there is always the chance that we will fail to identify the proper factors or that we will fail to accurately estimate the impacts of factors that we identify.
Weakness in the economy and in the real estate market, including specific weakness within our geographic footprint, has adversely affected us and may continue to adversely affect us.
If the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations decline, or continue to decline, this could result in, among other things, a deterioration of credit quality or a reduced demand for credit, including a resultant effect on our loan portfolio and allowance for loan and lease losses. A significant portion of our residential mortgages and commercial real estate loan portfolios are composed of borrowers in the Southeastern and Mid-Atlantic regions of the United States, in which certain markets have been particularly adversely affected by declines in real estate value, declines in home sale volumes, and declines in new home building. These factors could result in higher delinquencies and greater charge-offs in future periods, which would materially adversely affect our financial condition and results of operations.
Weakness in the real estate market, including the secondary residential mortgage loan markets, has adversely affected us and may continue to adversely affect us.
Significant ongoing disruptions in the secondary market for residential mortgage loans have limited the market for and liquidity of many mortgage loans. The effects of ongoing mortgage market challenges, combined with the ongoing correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans that we hold, mortgage loan originations and profits on sales of mortgage loans. Declining real estate prices have caused higher delinquencies and losses on certain mortgage loans, particularly Alt-A mortgages and home equity lines of credit and mortgage loans sourced from brokers that are outside our branch bank network. These trends could continue. These conditions have resulted in losses, write downs and impairment charges in our mortgage and other lines of business. Continued declines in real estate values, home sales volumes, financial stress on borrowers as a result of job losses, interest rate resets on adjustable rate mortgage loans or other factors could have further adverse effects on borrowers that could result in higher delinquencies and greater charge-offs in future periods, which adversely affect our financial condition or results of operations. Additionally, counterparties to insurance arrangements used to mitigate risk associated with increased foreclosures in the real estate market are stressed by weaknesses in the real estate market and a commensurate increase in the number of claims. Additionally, decreases in real estate values might adversely affect the creditworthiness of state and local governments, and this might result in decreased profitability or credit losses from loans made to such governments. A decline in home values or overall economic weakness could also have an adverse impact upon the value of real estate or other assets which we own upon foreclosing a loan and our ability to realize value on such assets.
Weakness in the real estate market may adversely affect our reinsurance subsidiary.
The Company has a subsidiary (Twin Rivers Insurance Company) which provides mortgage reinsurance on certain mortgage loans through contracts with several primary mortgage insurance companies. Under these contracts, Twin Rivers Insurance Company (Twin Rivers) provides aggregate excess loss coverage in a mezzanine layer in exchange for a portion of the pools mortgage insurance premiums. The reinsurance contracts are intended to place limits on Twin Rivers maximum exposure to losses by defining the loss amounts ceded to Twin Rivers, as well as by establishing trust accounts for each contract. The trust accounts, which are comprised of funds contributed by Twin Rivers plus premiums earned under the reinsurance contracts, are maintained to fund claims made under the specific reinsurance contracts with individual primary mortgage insurers and are independent of each other. If claims exceed funds held in the trust accounts, Twin Rivers does not expect to make additional contributions beyond future premiums earned under the existing contracts. Twin Rivers maintains a reserve for estimated losses under its reinsurance contracts, which is an estimate of losses resulting from claims to be paid by the trusts. On an ongoing basis, Twin Rivers assesses the sufficiency of future revenues, including premiums and investment income on funds held in the trusts, to cover future claims.
Due to the deterioration of the real estate market and an increase in defaults under mortgage contracts, the funds in certain trusts may be less than the obligations created under such contracts. Twin Rivers does not believe it is required nor does it intend to make additional capital contributions to cover obligations in excess of funds held by the trusts; however, Twin Rivers profitability could be adversely affected if the primary mortgage insurance companies pursue Twin Rivers for such shortfalls.
As a financial services company, adverse changes in general business or economic conditions could have a material adverse effect on our financial condition and results of operations.
A sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which we do business could have one or more of the following adverse impacts on our business:
Changes in market interest rates or capital markets could adversely affect our revenue and expense, the value of assets and obligations, and the availability and cost of capital or liquidity.
Given our business mix, and the fact that most of the assets and liabilities are financial in nature, we tend to be sensitive to market interest rate movements and the performance of the financial markets. In addition to the impact of the general economy, changes in interest rates or in valuations in the debt or equity markets could directly impact us in one or more of the following ways:
The fiscal and monetary policies of the federal government and its agencies could have a material adverse effect on our earnings.
The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine in large part the cost of funds for lending and investing and the return earned on those loans and investments, both of which affect the net interest margin. They can also materially decrease the value of financial assets we hold, such as debt securities and mortgage servicing rights (MSRs). Its policies can also adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans. Changes in Federal Reserve Board policies are beyond our control and difficult to predict; consequently, the impact of these changes on our activities and results of operations is difficult to predict.
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.
When we sell mortgage loans, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our whole loan sale agreements require us to repurchase or substitute mortgage loans in the event we breach any of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower fraud or in the event of early payment default of the borrower on a mortgage loan. Likewise, we are required to repurchase or substitute mortgage loans if we breach a representation or warranty in connection with our securitizations. The remedies available to us against the originating broker or correspondent may not be as broad as the remedies available to a purchaser of mortgage loans against us, and we face the further risk that the originating broker or correspondent may not have the financial capacity to perform remedies that otherwise may be available to us. Therefore, if a purchaser enforces its remedies against us, we may not be able to recover our losses from the originating broker or correspondent. Recently, we have received an increased number of repurchase and indemnity demands from purchasers as a result of borrower fraud. This increase in repurchase demands, combined with an increase in expected loss severity on repurchased loans due to deteriorating real estate values and liquidity for impaired loans, has resulted in a significant increase in the amount of accrued losses for repurchases as of December 31, 2008. While we have taken steps to enhance our underwriting policies and procedures, there can be no assurance that these steps will be effective or reduce risk associated with loans sold in the past. If repurchase and indemnity demands increase, our liquidity, results of operations and financial condition will be adversely affected.
Clients could pursue alternatives to bank deposits, causing us to lose a relatively inexpensive source of funding.
Checking and savings account balances and other forms of client deposits could decrease if clients perceive alternative investments, such as the stock market, as providing superior expected returns. When clients move money out of bank deposits in favor of alternative investments, we can lose a relatively inexpensive source of funds, increasing our funding costs.
Consumers may decide not to use banks to complete their financial transactions, which could affect net income.
Technology and other changes now allow parties to complete financial transactions without banks. For example, consumers can pay bills and transfer funds directly without banks. This process could result in the loss of fee income, as well as the loss of client deposits and the income generated from those deposits.
We have businesses other than banking which subject us to a variety of risks.
We are a diversified financial services company. This diversity subjects earnings to a broader variety of risks and uncertainties.
Hurricanes and other natural disasters may adversely affect loan portfolios and operations and increase the cost of doing business.
Large scale natural disasters may significantly affect loan portfolios by damaging properties pledged as collateral and by impairing the ability of certain borrowers to repay their loans. The nature and level of natural disasters cannot be predicted and may be exacerbated by global climate change. The ultimate impact of a natural disaster on future financial results is difficult to predict and will be affected by a number of factors, including the extent of damage to the collateral, the extent to which damaged collateral is not covered by insurance, the extent to which unemployment and other economic conditions caused by the natural disaster adversely affect the ability of borrowers to repay their loans, and the cost of collection and foreclosure moratoriums, loan forbearances and other accommodations granted to borrowers and other clients.
Negative public opinion could damage our reputation and adversely impact business and revenues.
As a financial institution, our earnings and capital are subject to risks associated with negative public opinion. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, the failure of any product or service sold by us to meet our clients expectations or applicable regulatory requirements, corporate governance and acquisitions, or from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract and/or retain clients and can expose us to litigation and regulatory action. Actual or alleged conduct by one of our businesses can result in negative public opinion about our other businesses. Negative public opinion could also affect our credit ratings, which are important to its access to unsecured wholesale borrowings. Significant changes in these ratings could change the cost and availability of these sources of funding.
We rely on other companies to provide key components of our business infrastructure.
Third parties provide key components of our business infrastructure such as banking services, processing, and Internet connections and network access. Any disruption in such services provided by these third parties or any failure of these third parties to handle current or higher volumes of use could adversely affect our ability to deliver products and services to clients and otherwise to conduct business. Technological or financial difficulties of a third party service provider could adversely affect our business to the extent those difficulties result in the interruption or discontinuation of services provided by that party. We may not be insured against all types of losses as a result of third party failures and our insurance coverage may be inadequate to cover all losses resulting from system failures or other disruptions. Failures in our business infrastructure could interrupt the operations or increase the costs of doing business.
We rely on our systems, employees, and certain counterparties, and certain failures could materially adversely affect our operations.
We are exposed to many types of operational risk, including the risk of fraud by employees and outsiders, clerical and record-keeping errors, and computer/telecommunications systems malfunctions. Our businesses are dependent on our ability to process a large number of increasingly complex transactions. If any of our financial, accounting, or other data processing systems fail or have other significant shortcomings, we could be materially adversely affected. We are similarly dependent on our employees. We could be materially adversely affected if one of our employees causes a significant operational break-down or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. Third parties with which we do business could also be sources of operational risk to us, including relating to break-downs or failures of such parties own systems or employees. Any of these occurrences could result in a diminished ability of us to operate one or more of our businesses, potential liability to clients, reputational damage and regulatory intervention, which could materially adversely affect us.
We may also be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control, which may include, for example, computer viruses or electrical or telecommunications outages or natural disasters, or events arising from local or regional politics, including terrorist acts. Such disruptions may give rise to losses in service to clients and loss or liability to us. In addition there is the risk that our controls and procedures as well as business continuity and data security systems prove to be inadequate. Any such failure could affect our operations and could materially adversely affect our results of operations by requiring us to expend significant resources to correct the defect, as well as by exposing us to litigation or losses not covered by insurance.
We depend on the accuracy and completeness of information about clients and counterparties.
In deciding whether to extend credit or enter into other transactions with clients and counterparties, we may rely on information furnished by or on behalf of clients and counterparties, including financial statements and other financial information. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors.
Regulation by federal and state agencies could adversely affect the business, revenue, and profit margins.
We are heavily regulated by federal and state agencies. This regulation is to protect depositors, the federal deposit insurance fund and the banking system as a whole. Congress and state legislatures and federal and state regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including interpretation or implementation of statutes, regulations, or policies, could affect us adversely, including limiting the types of financial services and products we may offer and/or increasing the ability of nonbanks to offer competing financial services and products. Also, if we do not comply with laws, regulations, or policies, we could receive regulatory sanctions and damage to our reputation.
Competition in the financial services industry is intense and could result in losing business or reducing margins.
We operate in a highly competitive industry that could become even more competitive as a result of legislative, regulatory and technological changes, and continued consolidation. We face aggressive competition from other domestic and foreign lending institutions and from numerous other providers of financial services. The ability of non-banking financial institutions to provide services previously limited to commercial banks has intensified competition. Because non-banking financial institutions are not subject to the same regulatory restrictions as banks and bank holding companies, they can often operate with greater flexibility and lower cost structures. Securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. This may significantly change the competitive environment in which we conduct business. Some of our competitors have greater financial resources and/or face fewer regulatory constraints. As a result of these various sources of competition, we could lose business to competitors or be forced to price products and services on less advantageous terms to retain or attract clients, either of which would adversely affect our profitability.
Future legislation could harm our competitive position.
Federal, state, and local legislatures increasingly have been considering proposals to substantially change the financial institution regulatory system and to expand or contract the powers of banking institutions and bank holding companies. Various legislative bodies have also recently been considering altering the existing framework governing creditors rights, including legislation that would result in or allow loan modifications of various sorts. Such legislation may change banking statutes and the operating environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether new legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our activities, financial condition, or results of operations.
Maintaining or increasing market share depends on market acceptance and regulatory approval of new products and services.
Our success depends, in part, on the ability to adapt products and services to evolving industry standards. There is increasing pressure to provide products and services at lower prices. This can reduce net interest income and noninterest income from fee-based products and services. In addition, the widespread adoption of new technologies could require us to make substantial capital expenditures to modify or adapt existing products and services or develop new products and services. We may not be successful in introducing new products and services in response to industry trends or development in technology, or those new products may not achieve market acceptance. As a result, we could lose business, be forced to price products and services on less advantageous terms to retain or attract clients, or be subject to cost increases.
We may not pay dividends on your common stock.
Holders of our common stock are only entitled to receive such dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically declared cash dividends on our common stock, we are not required to do so and may reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of our common stock. Also, our ability to increase our dividend or to make other distributions is restricted due to our participation in the Capital Purchase Program, which limits (without the consent of the Treasury) our ability to increase our dividend or to repurchase our common stock for so long as any securities issued under such program remain outstanding.
Our ability to receive dividends from our subsidiaries accounts for most of our revenue and could affect our liquidity and ability to pay dividends.
We are a separate and distinct legal entity from our subsidiaries, including SunTrust Bank. We receive substantially all of our revenue from dividends from our subsidiaries. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends that our bank and certain of our nonbank subsidiaries may pay us. Also, our right to participate in a distribution of assets upon a subsidiarys liquidation or reorganization is subject to the prior claims of the subsidiarys creditors.
Limitations on our ability to receive dividends from our subsidiaries could have a material adverse effect on our liquidity and on our ability to pay dividends on common stock. Additionally, if our subsidiaries earnings are not sufficient to make dividend payments to us while maintaining adequate capital levels, we may not be able to make dividend payments to our common stockholders.
Significant legal actions could subject us to substantial uninsured liabilities.
We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve large monetary claims and significant defense costs. Substantial legal liability or significant regulatory action against us could have material adverse financial effects or cause significant reputational harm to us, which in turn could seriously harm our business prospects. We may be exposed to substantial uninsured liabilities, which could adversely affect our results of operations and financial condition.
Recently declining values of real estate, increases in unemployment, and the related effects on local economies may increase our credit losses, which would negatively affect our financial results.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area. A major change in the real estate market, such as deterioration in the value of this collateral, or in the local or national economy, could adversely affect our customers ability to pay these loans, which in turn could adversely impact us. Additionally, increases in unemployment also may adversely affect the ability of certain clients to pay loans and the financial results of commercial clients in localities with higher unemployment, which may result in loan defaults and foreclosures and which may impair the value of our collateral. Risk of loan defaults and foreclosures are unavoidable in the banking industry, and we try to limit our exposure to this risk by monitoring our extensions of credit carefully. We cannot fully eliminate credit risk, and as a result credit losses may occur or increase in the future.
Deteriorating credit quality, particularly in real estate loans, has adversely impacted us and may continue to adversely impact us.
We have experienced a downturn in credit performance, which became significant in the third and fourth quarters of 2007 and continues. We expect credit conditions and the performance of our loan portfolio to continue to deteriorate in the near term.
This deterioration has resulted in an increase in our loan loss reserves throughout 2008, which increases were driven primarily by residential and commercial real estate and home equity portfolios. Additional increases in loan loss reserves may be necessary in the future. Deterioration in the quality of our credit portfolio can have a material adverse effect on our capital, financial condition, and results of operations.
Disruptions in our ability to access global capital markets may negatively affect our capital resources and liquidity.
In managing our consolidated balance sheet, we depend on access to global capital markets to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, and to accommodate the transaction and cash management needs of our clients. Other sources of funding available to us, and upon which we rely as regular components of our liquidity risk management strategy, include inter-bank borrowings, repurchase agreements, and borrowings from the Federal Reserve discount window. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, our depositors or counterparties participating in the capital markets, or a downgrade of our debt rating, may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity.
Any reduction in our credit rating could increase the cost of our funding from the capital markets.
Although our long-term debt is currently rated investment grade by the major rating agencies, the ratings of that debt was downgraded during 2009 by one of the major rating agencies. These rating agencies regularly evaluate us and their ratings of our long-term debt are based on a number of factors, including our financial strength as well as factors not entirely within our control, including conditions affecting the financial services industry generally. In light of the difficulties in the financial services industry and the housing and financial markets, there can be no assurance that we will maintain our current ratings. Our failure to maintain those ratings could adversely affect the cost and other terms upon which we are able to obtain funding and increase our cost of capital.
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 have historically pursued an acquisition strategy, and intend to continue to seek additional acquisition opportunities. We may not be able to successfully identify suitable candidates, negotiate appropriate acquisition terms, complete proposed acquisitions, successfully integrate acquired businesses into the existing operations, or expand into new markets. Once integrated, acquired operations may not achieve levels of revenues, profitability, or productivity comparable with those achieved by our existing operations, or otherwise perform as expected.
Acquisitions involve numerous risks, including difficulties in the integration of the operations, technologies, services and products of the acquired companies, and the diversion of managements attention from other business concerns. We may not properly ascertain all such risks prior to an acquisition or prior to such a risk impacting us while integrating an acquired company. As a result, difficulties encountered with acquisitions could have a material adverse effect on the business, financial condition, and results of operations.
Furthermore, we must generally receive federal regulatory approval before we can acquire a bank or bank holding company. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, financial condition, future prospects, including current and projected capital levels, the competence, experience, and integrity of management, compliance with laws and regulations, the convenience and needs of the communities to be served, including the acquiring institutions record of compliance under the Community Reinvestment Act, and the effectiveness of the acquiring institution in combating money laundering activities. In addition, we cannot be certain when or if, or on what terms and conditions, any required regulatory approvals will be granted. Consequently, we might be required to sell portions of the acquired institution as a condition to receiving regulatory approval or we may not obtain regulatory approval for a proposed acquisition on acceptable terms or at all, in which case we would not be able to complete the acquisition despite the time and expenses invested in pursuing it.
We depend on the expertise of key personnel. If these individuals leave or change their roles without effective replacements, operations may suffer.
The success of our business has been, and the continuing success will be, dependent to a large degree on the continued services of executive officers, especially our Chairman and Chief Executive Officer, James M. Wells III, and other key personnel who have extensive experience in the industry. We do not carry key person life insurance on any of the executive officers or other key personnel. If we lose the services of any of these integral personnel and fail to manage a smooth transition to new personnel, the business could be impacted.
We may not be able 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 success depends upon the ability to attract and retain highly motivated, well-qualified personnel. We face significant competition in the recruitment of qualified employees. Our ability to execute the business strategy and provide high quality service may suffer if we are unable to recruit or retain a sufficient number of qualified employees or if the costs of employee compensation or benefits increase substantially.
Our accounting policies and processes are critical to how we report our financial condition and results of operations. They require management to make estimates about matters that are uncertain.
Accounting policies and processes are fundamental to how we record and report the financial condition and results of operations. Management must exercise judgment in selecting and applying many of these accounting policies and processes so they comply with Generally Accepted Accounting Principles in the United States (U.S. GAAP).
Management has identified certain accounting policies as being critical because they require managements judgment to ascertain the valuations of assets, liabilities, commitments, and contingencies. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, valuing an asset or liability, or reducing a liability. We have established detailed policies and control procedures that are intended to ensure these critical accounting estimates and judgments are well controlled and applied consistently. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. Because of the uncertainty surrounding our judgments and the estimates pertaining to these matters, we cannot guarantee that we will not be required to adjust accounting policies or restate prior period financial statements. See the Critical Accounting Policies in the MD&A and Note 1, Accounting Policies, to the Consolidated Financial Statements, in our annual report on Form 10-K for the year ended December 31, 2008 for more information.
Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition.
From time to time, the Financial Accounting Standards Board (FASB) and SEC change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in us restating prior period financial statements.
Our stock price can be volatile.
Our stock price can fluctuate widely in response to a variety of factors including:
General market fluctuations, industry factors, and general economic and political conditions and events, such as terrorist attacks, economic slowdowns or recessions, interest rate changes, credit loss trends, or currency fluctuations, also could cause our stock price to decrease regardless of operating results.
Our disclosure controls and procedures may not prevent or detect all errors or acts of fraud.
Our disclosure controls and procedures are designed to reasonably assure that information required to be disclosed by us in reports we file or submit under the Exchange Act is accurately accumulated and communicated to management, and recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms. We believe that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
These inherent limitations include the realities that judgments in decision-making can be faulty, that alternative reasoned judgments can be drawn, or that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected.
Our financial instruments carried at fair value expose us to certain market risks.
We maintain an available for sale securities portfolio and trading assets which include various types of instruments and maturities. In addition, we elected to record selected fixed-rate debt, mortgage loans, securitization warehouses and other trading assets at fair value. The changes in fair value of the financial instruments elected to be carried at fair value pursuant to the provisions of Statement of Financial Accounting Standards (SFAS) No. 159 are recognized in earnings. The financial instruments carried at fair value are exposed to market risks related to changes in interest rates, market liquidity, and our market-based credit spreads, as well as to the risk of default by specific borrowers. We manage the market risks associated with these instruments through active hedging arrangements or broader asset/liability management strategies. Changes in the market values of these financial instruments could have a material adverse impact on our financial condition or results of operations. We may classify additional financial assets or financial liabilities at fair value in the future.
Our revenues derived from our investment securities may be volatile and subject to a variety of risks.
We generally maintain investment securities and trading positions in the fixed income, currency, commodity, and equity markets. Unrealized gains and losses associated with our investment portfolio and mark to market gains and losses associated with our trading portfolio are affected by many factors, including our credit position, interest rate volatility, volatility in capital markets, and other economic factors. Our return on such investments and trading have in the past experienced, and will likely in the future experience, volatility and such volatility may materially adversely affect our financial condition and results of operations. Additionally, accounting regulations may require us to record a charge prior to the actual realization of a loss when market valuations of such securities are impaired and such impairment is considered to be other than temporary.
We may enter into transactions with off-balance sheet affiliates or our subsidiaries.
We engage in a variety of transactions with off-balance sheet entities with which we are affiliated. While we have no obligation, contractual or otherwise, to do so, under certain limited circumstances, these transactions may involve providing some form of financial support to these entities. Any such actions may cause us to recognize current or future gains or losses. Depending on the nature and magnitude of any transaction we enter into with off-balance sheet entities, accounting rules may require us to consolidate the financial results of these entities with our financial results.
We are subject to market risk associated with our asset management and commercial paper conduit businesses.
During 2007 and 2008, we recorded market valuation losses related to securities that we purchased from certain money market funds managed by our subsidiary RidgeWorth as well as Three Pillars Funding, LLC (Three Pillars), a multi-seller commercial paper conduit sponsored by us. At the time of purchase, these securities were predominantly AAA or AA-rated, residential MBS, structured investment vehicle (SIVs) securities, and corporate and consumer collateralized debt obligations. We cannot provide assurance that we will not sustain additional losses in the future related to these securities or
the purchase of similar securities. The value of such securities may be affected by, among other things, a lack of liquidity in the market for these securities, deterioration in the credit quality of the underlying collateral, risks associated with the financial guarantees insuring the securities, and/or the fact that the respective investment vehicle enters restructuring proceedings. Such occurrences may materially adversely affect our financial condition, capital adequacy, and results of operations.
The Companys headquarters is located in Atlanta, Georgia. As of December 31, 2008, SunTrust Bank owned 578 of its 1,692 full-service banking offices and leased the remaining banking offices. (See Note 8, Premises and Equipment, to the Consolidated Financial Statements.)
The Company and its subsidiaries are parties to numerous claims and lawsuits arising in the normal course of its business activities, some of which involve claims for substantial amounts. Although the ultimate outcome of these suits cannot be ascertained at this time, it is the opinion of management that none of these matters, when resolved, will have a material effect on the Companys consolidated results of operations or financial position.
There were no matters submitted to a vote of shareholders during the quarter ended December 31, 2008.
The principal market in which the common stock of the Company is traded is the New York Stock Exchange (NYSE). See Item 6 and Table 18 in the MD&A for information on the high and the low sales prices of the SunTrust Banks, Inc. common stock on the NYSE, which is incorporated herein by reference. During the twelve months ended December 31, 2008 we paid a quarterly dividend on common stock of $0.77 for the first three quarters and $0.54 in the fourth quarter compared to $0.73 per common share during each quarter of 2007. Our common stock is held of record by approximately 38,125 holders as of December 31, 2008. See Table 24 in the MD&A for information on the monthly share repurchases activity, including total common shares repurchased and announced programs, weighted average per share price, and the remaining buy-back authority under the announced programs, which is incorporated herein by reference.
Please also refer to Item 1, Business, for a discussion of legal restrictions which affect our ability to pay dividends; Item 1A, Risk Factors, for a discussion of some risks related to our dividend, and Item 7, Managements Discussion and Analysis of Financial Condition and Results of OperationCapital Resources, for a discussion of the dividend payable in the first quarter of 2009 and factors that may affect the future level of dividends.
The information under the caption Equity Compensation Plans in our definitive proxy statement to be filed with the Commission is incorporated by reference into this Item 5.
Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on our common stock against the cumulative total return of the S&P Composite-500 Stock Index, and the S&P Commercial Bank Industry Index for the five years commencing December 31, 2003 and ending December 31, 2008.
1 See Non-GAAP reconcilements in Tables 22 and 23 of the Managements Discussion and Analysis of Financial Condition and Results of Operations.
Important Cautionary Statement About Forward-Looking Statements
This report may contain forward-looking statements. Statements regarding future levels of charge-offs, provision expense, and income are forward-looking statements. Also, any statement that does not describe historical or current facts, including statements about beliefs and expectations, is a forward-looking statement. 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. Such statements are based upon the current beliefs and expectations of management and on information currently available to management. Such statements speak as of the date hereof, and we do 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 are subject to 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 Item 1A of Part I of this report and include risks discussed in this MD&A and in other periodic reports that we file with the SEC. Those factors include: difficult market conditions have adversely affected our industry; current levels of market volatility are unprecedented; the soundness of other financial institutions could adversely affect us; there can be no assurance that recently enacted legislation ,or any proposed federal programs, will stabilize the U.S. financial system, and such legislation and programs may adversely affect us; the impact on us of recently enacted legislation, in particular the EESA and its implementing regulations, and actions by the FDIC, cannot be predicted at this time; credit risk; weakness in the economy and in the real estate market, including specific weakness within our geographic footprint, has adversely affected us and may continue to adversely affect us; weakness in the real estate market, including the secondary residential mortgage loan markets, has adversely affected us and may continue to adversely affect us; weakness in the real estate market may adversely affect our reinsurance subsidiary; as a financial services company, adverse changes in general business or economic conditions could have a material adverse effect on our financial condition and results of operations; changes in market interest rates or capital markets could adversely affect our revenue and expense, the value of assets and obligations, and the availability and cost 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; 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; clients could pursue alternatives to bank deposits, causing us to lose a relatively inexpensive source of funding; consumers may decide not to use banks to complete their financial transactions, which could affect net income; we have businesses other than banking which subject 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 and revenues; we rely on other companies to provide 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, revenue, and profit margins; competition in the financial services industry is intense and could result in losing business or reducing 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; we may not pay dividends on our common stock; our ability to receive dividends from our subsidiaries accounts for most of our revenue and could affect our liquidity and ability to pay dividends; significant legal actions could subject us to substantial uninsured liabilities; recently declining values of residential real estate, increases in unemployment, and the related effects on local economics may increase our credit losses, which would negatively affect our financial results; deteriorating credit quality, particularly in real estate loans, has adversely impacted us and may continue to adversely impact us; disruptions in our ability to access global capital markets may negatively affect our capital resources and liquidity; any reduction in our credit rating could increase the cost of our funding from the capital markets; 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. If these individuals leave or change their roles without effective replacements, operations may suffer; we may not be able 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 processes are critical to how we report our financial condition and results of operations, and these require us to make estimates about matters that are uncertain; changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition; our stock price can be volatile; our disclosure controls and procedures may not prevent or detect all errors or acts of fraud; our financial instruments carried at fair value expose us to certain market risks; our revenues derived from our investment securities may be volatile and subject to a variety of risks; we may enter into
transactions with off-balance sheet affiliates or our subsidiaries; and we are subject to market risk associated with our asset management and commercial paper conduit businesses.
This narrative will assist readers in their analysis of the accompanying consolidated financial statements and supplemental financial information. It should be read in conjunction with the Consolidated Financial Statements and Notes.
When we refer to SunTrust, the Company, we, our and us in this narrative, we mean SunTrust Banks, Inc. and Subsidiaries (consolidated). Effective October 1, 2004, National Commerce Financial Corporation (NCF) merged with SunTrust. The results of operations for NCF were included with our results beginning October 1, 2004. Additionally, effective May 1, 2008, we acquired GB&T Bancshares, Inc. (GB&T) and the results of operations for GB&T were included with our results beginning on that date. Periods prior to the acquisition date do not reflect the impact of the merger.
In the MD&A, net interest income, net interest margin, and the efficiency ratio are presented on a fully taxable-equivalent (FTE) basis and the quarterly ratios are presented on an annualized basis. The FTE basis adjusts for the tax-favored status of income from certain loans and investments. We believe 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. We also present diluted earnings per common share excluding merger expense and an efficiency ratio excluding merger charges related to the NCF acquisition. We believe the exclusion of the merger charges, which represent incremental costs to integrate NCFs operations, is more reflective of normalized operations. The merger charges related to the acquisition of GB&T were insignificant. Additionally, we present a return on average realized common shareholders equity, as well as a return on average common shareholders equity (ROE). We also present a return on average assets less net realized and 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 realized and unrealized securities gains/losses exclude realized securities gains and losses and the Coca-Cola Company (Coke) dividend, from the numerator, and net unrealized securities gains from the denominator. We present a tangible efficiency ratio and a tangible equity to tangible assets ratio, which excludes the cost of and the other effects of intangible assets resulting from merger and acquisition (M&A) activity. We believe these measures are useful to investors because, by removing the effect of intangible asset costs and M&A activity (the level of which may vary from company to company), it allows investors to more easily compare our efficiency and capital adequacy to other companies in the industry. We also present a tangible common equity to tangible assets ratio which, in addition to the items described above, excludes the preferred stock. These measures are utilized by management to assess our financial performance and capital adequacy. We provide reconcilements in Tables 22 and 23 in the MD&A for all non-U.S. GAAP measures. Certain reclassifications may be made to prior period financial statements and related information to conform them to the 2008 presentation.
We are one of the nations largest commercial banking organizations and our headquarters are located in Atlanta, Georgia. Our 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 our geographic footprint, we operate under four business segments: Retail and Commercial, Wholesale Banking, Wealth and Investment Management, and Mortgage. In addition to traditional deposit, credit, and trust and investment services offered by SunTrust Bank, our other subsidiaries provide mortgage banking, credit-related insurance, asset management, securities brokerage, and capital market services.
During 2008, macro-economic conditions negatively impacted liquidity and credit quality across the financial markets, especially in the consumer sector, as the U.S. economy experienced a recession. The National Bureau of Economic Research published a report in December indicating that the U.S. has been in a recession since December 2007 as indicated most prominently, in their view, by the declining labor market since that time. Since December 2007, in addition to deterioration in the labor market, the recession has caused rising unemployment, volatile equity markets, and declining home values, all of which are weighing negatively on consumer sentiment as evidenced by weak spending throughout the year, especially during the fourth quarter. During the year, financial markets experienced unprecedented events, and the market exhibited extreme volatility and evaporating liquidity as credit quality concerns, sharp fluctuations in commodity prices, volatility in rate indices such as Prime and LIBOR, and illiquidity persisted. Concerns regarding increased credit losses from the weakening economy negatively affected the capital and earnings levels of most financial institutions. In addition, certain financial institutions failed or merged with stronger institutions and two government sponsored enterprises entered into conservatorship with the U.S. government. Liquidity in the debt markets was extremely low despite the Treasury and Federal Reserve efforts to inject capital and liquidity into financial institutions, and as a result, asset values continued to be under pressure.
In October 2008, the United States government established the EESA in response to instability in the financial markets. The specific implications of the EESA include the authorization given to the Secretary of the Treasury to establish the Troubled Asset Relief Program to purchase troubled assets from financial institutions. The definition of troubled assets is broad but includes residential and commercial mortgages, as well as mortgage-related securities originated on or before March 14, 2008, if the Secretary determines the purchase promotes financial market stability. To date, the Treasury has not purchased troubled assets under its authority to do so under the EESA.
Alternatively, the Treasury has focused on providing assistance through the associated Capital Purchase Program (CPP) and Targeted Investment Program by purchasing preferred equity interests in the countrys largest financial institutions. In an attempt to revitalize the struggling economy and inject necessary liquidity and capital into the banking system, the government purchased $207.5 billion dollars in preferred stock in certain institutions during 2008. During the fourth quarter of 2008, we sold $4.9 billion in preferred stock and related warrants, the maximum amount allowed under the CPP, to the Treasury. Our decision to participate was made to enhance our already solid capital position and to allow us to further expand our business. We believe that our decision to sell the maximum shares was prudent in order to bolster capital as a result of increasingly adverse economic results. Upon receipt of the funds, we developed strategies and tactics to deploy the capital in a fashion that balances supporting economic stability, safety and soundness, and earnings. Specifically, the additional capital has been deployed thus far by increasing our agency MBS and loans, as well as by decreasing short-term borrowings. We recognize our responsibility to use proceeds from the CPP in a manner that is consistent with the public interest and are committed to providing timely public disclosure of our deployment of the CPP proceeds. See additional discussion in the Capital Resources and Liquidity Risk sections of this MD&A.
The degree of government intervention through the purchase of direct investments in private and public companies is unprecedented. As a result, the complete effect and impact from these actions is uncertain. In addition, several federal, state, and local legislative proposals are pending that may affect our business. It is unclear whether these will be enacted, and if so, the impact they will have on our industry. We remain active and vigilant in monitoring these developments and supporting the interests of our shareholders, while also supporting the broader economy.
In addition, during October 2008, the FDIC announced the TLGP, under which it would temporarily guarantee certain new debt issued by insured banks and qualifying bank holding companies and temporarily expand its insurance to cover all noninterest-bearing transaction accounts. It was also announced that the Federal Reserve would serve as a buyer of commercial paper. These actions, among others, were anticipated to stimulate consumer confidence in the economy and financial institutions, as well as encourage financial institutions to continue lending to businesses, consumers, and each other. We have issued $3.0 billion in debt under the TLGP, which provides us with a lower cost of funding due to narrower credit spreads realized in association with the FDIC guarantee. See additional discussion in the Other Short-Term Borrowings and Long-Term Debt section of this MD&A.
In December, the Federal Reserve (Fed) took unprecedented action in lowering the federal funds rate by 75 basis points to a targeted range of zero to one-quarter percent. The Board of Governors also lowered the discount rate 75 basis points to one-half percent. This action was the seventh rate cut of the year causing the Prime rate to decline 400 basis points since January 1, 2008 to 3.25% at year end. Further, the Fed increased its Term Auction Facility (TAF) program offerings during the year by $445 billion, which are similar borrowing instruments to term federal funds. In addition, due to the continuing strain on the financial markets, the Fed has offered numerous temporary liquidity facilities in an effort to stabilize credit markets and improve the access to credit of businesses and households. See the Liquidity Risk section in this MD&A for additional discussion of the Feds actions.
While our most immediate priority is to maintain the fundamental financial strength of the organization, we continue to run a successful organization serving clients, making sound credit decisions, generating deposits, and operating as efficiently as possible. To this end, during the year we grew average loans and consumer and commercial deposits 4.5% and 3.4%, respectively, and improved our loan and deposit mix while maintaining our net interest income at levels comparable to the prior year. We also experienced growth in certain fee income associated with our core businesses. Further, we tightly managed growth of core operating expenses, which reflected the continuing success of our ongoing program to improve efficiency and productivity, although expenses continue to be pressured by increased credit-related costs. We solidified our capital position during the year through the preferred stock issuance discussed above and also completed three separate transactions to optimize our long-term holdings of Coke common stock. See Investment in Common Shares of The Coca-Cola Company in this MD&A for additional discussion. We are pursuing initiatives that will expand our revenue generation capacity, improve efficiency, increase profitability on a risk adjusted basis, and prudently manage credit. To that end, the most important factors upon which management has and will continue to focus include prudent lending practices, credit loss mitigation, expense management, growing customer relationships, and increasing brand awareness.
Successfully managing through the current credit cycle is of critical importance. Given the significant downturn in the economy during 2008, we expect this credit cycle to be protracted. Credit quality deteriorated significantly in 2008 due to the
decline in the residential real estate markets and broader recessionary economic conditions. As such, we took steps to assure continued prudent lending practices were followed by extending credit to clients that met our underwriting standards as well as instituted certain loss mitigation steps. Furthering our already strong lending practices, in 2008, we evaluated our underwriting standards based on the current economic conditions, discontinued originating home equity lines through third party channels that tend to be riskier with higher loan-to-values at origination, and implemented revised loan-to-value guidelines in certain declining markets. As a result of the tumultuous economy during 2008, we took action to assist in mitigating potential losses that included reducing or closing high risk accounts, improving our on-going portfolio monitoring, and completing extensive loan workout programs. Our workout programs are designed to help clients stay in their homes by re-working residential mortgages and home equity loans to achieve payment structures that they could afford. Through this workout program we have helped over 18,000 clients who were at risk of foreclosure to stay in their homes. See additional discussion of our prudent lending initiatives and loss mitigation steps in the Loans, Allowance for Loans and Lease Losses, Provision for Loan Losses, and Nonperforming Assets sections of this MD&A.
As the economy worsened and credit-related losses increased in 2008, our continued vigilance over expenses became an important focus. Our Excellence in Execution Efficiency and Productivity Program (E2 Program) began in 2007, well before the recession, to lower our cost structure and drive higher financial performance. This successful program allowed us to reduce expense run rates by $560 million in 2008 and is expected to provide total savings of $600 million in 2009. In addition, we have taken additional extraordinary steps to manage expenses including the elimination of annual merit based salary increases in 2009 for our senior management team, comprised of over 4,000 individuals, as well as paying no bonuses to selected members of the executive management team. We have also lowered the expected average wage increase for those receiving a merit increase by one-third, reduced the amount available for promotion increases, eliminated our annual sales conference and sales award trips for our top producers, and have placed further restriction on travel and meal related expenses.
The prevailing economic conditions and the resulting destabilization of many other financial institutions present an opportunity for us to establish new customer relationships and expand existing ones by increasing our brand awareness. As a result of these difficult economic times, we found that consumers are looking for a stable banking partner that mirrors their values of being cautious and prudent with their finances, which is the source of our new branding Live Solid. Bank Solid. Our focus is on providing that stability to our current and future clients with core business products. Our objectives include increasing core business revenues while obtaining lower funding costs through growth in customer deposits. The Live Solid. Bank Solid. brand compliments the My Cause deposit campaign, which ended in October 2008. During 2008, My Cause generated total household deposit growth of approximately 8%, with checking account households growing approximately 10%. Deposit growth continued during the fourth quarter of 2008, where we grew our average consumer and commercial deposits by 2.0% over the third quarter of 2008. In 2009, we will continue our focus on growing customer deposits.
We reported net income available to common shareholders at December 31, 2008 of $746.9 million, or $2.13 per average common diluted share, compared to $1.6 billion, or $4.55 per average common diluted share, at December 31, 2007. Fully taxable-equivalent net interest income was $4.7 billion for the year ended December 31, 2008, compared to $4.8 billion for the year ended December 31, 2007. Net interest margin in 2008 decreased only one basis point when compared to the prior year. Provision for loan losses was $2.5 billion for the year ended 2008, an increase of $1.8 billion from the prior year. The provision for loan losses was $909.9 million higher than net charge-offs of $1.6 billion for the year. The allowance for loan and lease losses increased $1.1 billion, or 83.3%, from December 31, 2007 and was 1.86% of total loans not carried at fair value compared to 1.05% as of December 31, 2007. Net charge-offs to average loans were 1.25% for the year ended 2008 compared to 0.35% for 2007. Nonperforming assets rose significantly during the year to $4.5 billion at year end compared to $1.6 billion at the end of last year. The Tier 1 Capital and total capital ratios improved from 6.93% and 10.30%, respectively, at December 31, 2007 to 10.87% and 14.04% at December 31, 2008. The tangible equity to tangible assets ratio improved from 6.31% at December 31, 2007 to 8.40% at December 31, 2008, while the tangible common equity to tangible assets ratio declined to 5.53% from 6.02% during this same time. See additional discussion of our financial performance in the Consolidated Financial Results section of this MD&A.
CONSOLIDATED FINANCIAL RESULTS
Table 1- Consolidated Daily Average Balances, Income/Expense And Average Yields Earned And Rates Paid
Table 2 - Analysis of Changes in Net Interest Income1
Net Interest Income/Margin
Fully-taxable net interest income for 2008 was $4,737.2 million, a decrease of $85.0 million, or 1.8%, from 2007. Net interest margin decreased 1 basis point from 3.11% in 2007 to 3.10% in 2008. Earning asset yields declined 100 basis points from 6.53% in 2007 to 5.53% in 2008, while the cost of interest-bearing liabilities over the same period decreased 119 basis points. The decrease in net interest income was due in part to a decline in market interest rates, the increase in nonperforming assets, a reduction in Coke and Federal Home Loan Bank (FHLB) dividend income, and LIBOR rate volatility. Due to the adoption of SFAS No. 157 and SFAS No. 159, the net interest payments on $6.6 billion of receive fixed swaps are reflected in trading income versus net interest income. Prior to adoption, this reclassification would have contributed approximately 9 basis points to net interest margin based on the 2008 decline in LIBOR.
The net interest margin increased from 3.07% for the third quarter of 2008 to 3.14% for the fourth quarter of 2008. The effects of lower floating rate loan yields and an increase in nonaccrual loans were more than offset by an aggressive reduction in deposit pricing, lower wholesale funding costs, and the issuance of $4.9 billion of preferred securities to the Treasury. Proceeds from the preferred stock issuance have been invested in interest earning assets which positively impact the margin while the dividend payments on the preferred stock are not recorded in net interest income.
For 2008, average earning assets decreased $2.5 billion, or 1.6%, from 2007 while average interest-bearing liabilities decreased $1.8 billion, or 1.3%, compared to 2007. Total average loans increased $5.4 billion, or 4.5%, due largely to an increase of $5.1 billion, or 10.9%, in the commercial and commercial real estate loan portfolios and $1.2 billion, or 8.4%, in
real estate home equity lines. The increase in commercial loan balances was driven by increased utilization of lines of credit by our larger corporate clients due to dislocation in commercial paper and bond markets during 2008. The increases in commercial, commercial real estate, and real estate home equity lines were partially offset by the decline in real estate construction loans of $2.7 billion, or 19.9%, due to our efforts to reduce our exposure to construction loans and transfers to nonaccrual status. Average loans held for sale were $5.1 billion, a decrease of $5.7 billion, or 52.7%, as mortgage loan originations declined 37.6%. Production shifted to predominantly agency products and efficiency improved in loan delivery. Average investment securities available for sale increased $1.9 billion, or 17.1%, while average interest earning trading assets declined by $4.4 billion, or 36.6%. Despite the decline in trading assets, we have continued to actively use this portfolio as part of our overall asset/liability management.
Average consumer and commercial deposits increased $3.3 billion, or 3.4%, year over year. This included increases of $3.9 billion, or 17.1%, in money market accounts and $1.0 billion, or 5.2%, in NOW accounts. These were partially offset by decreases of $0.8 billion, or 18.2%, in savings and $0.7 billion, or 3.4%, in demand deposits. The change in deposit mix represents a migration among clients from lower yielding accounts to higher yielding accounts in response to the decline in market rates. The growth in money market accounts was influenced by sales strategies in which money market products were used as a lead product to help retain a greater portion of maturing time deposits and other account balances. The overall growth in consumer and commercial deposits, coupled with the $2.2 billion, or 10.6%, increase in lower cost long-term debt, enabled a reduction in higher cost funding sources of $8.0 billion, or 23.4%. The decline in funding sources is primarily related to a $5.6 billion decrease in brokered deposits and a $1.5 billion decrease in average foreign deposits. We continue to pursue deposit growth initiatives utilizing product promotions to increase our presence in specific markets within our footprint. Overall, competition for deposits remains strong as our competitors attempt to satisfy funding needs in light of the liquidity issues prevailing in the market. As a result, we are facing significant deposit pricing pressure across our footprint. Despite these challenging market conditions, we have used a combination of regional and product-specific pricing initiatives to reduce our rates more aggressively than our peer banks, while still growing our average deposit balances.
The 2008 market environment began with a flat yield curve and steepened throughout the year. The Fed Funds target rate averaged 2.08% for 2008, a decrease of 297 basis points compared to 2007. One-month LIBOR decreased 257 basis points to 2.68%, three-month LIBOR decreased 237 basis points to 2.93%, five-year swaps decreased 132 basis points to 3.69% and ten-year swaps decreased 100 basis points to 4.24% compared to prior year. Deposit rates, our most significant funding source, tend to track movements in one-month LIBOR, while our fixed loan yields tend to track movements in the five-year swap rate.
Foregone interest income from nonperforming loans had a negative impact of 14 basis points on net interest margin in 2008 compared to four basis points of negative impact in 2007, as average nonaccrual loans increased $1.9 billion, or 228.4%, over 2007. Table 1 contains more detailed information concerning average loans, yields and rates paid.
Predicting the movement in net interest margin during 2009 would be difficult given the continued volatility in interest rates, the relatively low level of interest rates, and competitive dynamics for raising deposits. However, we believe the risks to the net interest margin in 2009 of deposit pricing, rate compression, nonperforming asset levels, and asset mix will outweigh the primary opportunity associated with deposit volume and mix.
Table 3 - Noninterest Income
Noninterest income increased by $1.0 billion, or 30.5%, in 2008, compared to 2007, driven largely by an increase in net securities gains, including a non-taxable gain on the contribution of a portion of our investment in Coke common stock, and mark to market gains on our public debt and related hedges along with gains from the sale of certain non-strategic businesses. These gains were partially offset by impairment of our MSRs portfolio, mark to market losses on illiquid trading securities and loan warehouses, losses related to our decision to purchase certain auction rate securities (ARS) from our clients, and other-than-temporary impairment charges on securities recorded during the year. In the short-run, we do not foresee any catalysts that will materially improve the core level of fee income generation, with the exception of mortgage production related income, which may increase significantly along with loan volume in the first quarter of 2009 if the sharp reduction in interest rates on conforming mortgages continues during the quarter.
Transaction fee-related income, which includes service charges on deposit accounts, card fees, and other charges and fees, increased $141.5 million, or 8.9%, compared to 2007, driven by an increase in both consumer and business deposit account activity, primarily due to growth in the number of accounts, higher non-sufficient fund rates, and an increase in the occurrence of non-sufficient fund fees.
Trust and investment management income decreased $92.7 million, or 13.5%, compared to 2007, driven by lower market valuations on managed assets due to the decline in the equity markets, as well as a decline in revenue as a result of the sales of our remaining interest in Lighthouse Investment Partners on January 2, 2008 and First Mercantile on May 30, 2008.
Trading account profits/(losses) and commissions increased $399.9 million, or 110.6%, compared to 2007, primarily due to $431.7 million in mark to market gains on our public debt and related hedges during 2008 compared with gains of $140.9 million in 2007. These gains were related to the widening of credit spreads across the entire financial market as a result of the global credit crisis. When stability in the debt market returns, spreads are expected to tighten, and if this occurs then these valuation gains will reverse. The increase in trading income during 2008 was also due to strong performance in fixed income sales and trading, direct finance, and foreign exchange within our broker/dealer subsidiary offset by weaker performance in fixed income derivatives, structured leasing, and equity offerings due to volatile market conditions. The gains recorded during 2008 were partially offset by $255.9 million in mark to market losses on illiquid trading securities acquired during the fourth quarter of 2007 as a result of the continuing declines in home values and increasing consumer real estate delinquency levels, which affected liquidity and technical pricing in the broader market during the year related to ABS. Also offsetting these gains were $177.7 million in losses related to our decision to purchase certain ARS from our clients, along with associated fines, and a $63.8 million loss on a $70 million (par value) Lehman Brothers Holdings, Inc. (Lehman Brothers) bond we purchased from an affiliated money market mutual fund. As of December 31, 2008, the fair value of this bond was $6.7 million. See additional discussion of this security that was purchased in the Trading Assets and Liabilities section of this MD&A. The fair value of the illiquid securities acquired in the fourth quarter of 2007 declined to approximately $250.0 million as of December 31, 2008, down from an acquisition cost of approximately $3.5 billion, primarily due to sales. During 2007, we recorded $527.7 million in negative mark to market valuations on collateralized debt obligations, MBS, SIV securities, and collateralized loan obligations, which were partially offset by $81.0 million in gains related to the adoption of fair value for certain trading assets and liabilities and related hedges.
During 2008, the $177.7 million loss in trading account profits and commissions related to ARS was recognized because we determined that we had a probable loss pursuant to the provisions of SFAS No. 5 that could be reasonably estimated as the difference between the par amount and the estimated fair value of ARS that we believe we will likely purchase from investors. As of December 31, 2008, we have completed the repurchase of roughly one-third of the approximately $743 million face value of the securities. Approximately $643 million of these securities are either government sponsored or where the issuer has indicated support of the underlying assets. The remaining $100 million of securities pertains to a senior tranche within a securitization of trust preferred securities. Our cash flow projections under even a stressed scenario indicate full collection of principal and interest on these securities. The volume of repurchase activity increased in early 2009, and through mid-February, we have completed approximately three-fourths of the expected repurchases.
Combined mortgage-related income decreased $326.8 million, or 114.1%, compared to 2007. Mortgage servicing related income decreased $407.2 million, or 208.4%, compared to 2007, primarily due to $370.0 million in impairment charges on our MSRs portfolio, all carried at amortized cost, that was caused by an increase in expected loan prepayments due to declining interest rates during the fourth quarter of 2008. The decrease in 2008 was also driven by higher amortization of MSRs driven by growth in the servicing portfolio from $114.6 billion as of December 31, 2007 to $130.5 billion as of December 31, 2008, and lower gains on the sale of mortgage servicing assets when compared to 2007. These declines were offset by higher servicing fee income driven by the aforementioned growth in the servicing portfolio.
Mortgage production related income increased $80.4 million, or 88.4%, compared to 2007, despite a 37.6% decline in loan production volume to $36.4 billion in 2008, due to lower valuation losses resulting from spread widening on loans held for
sale, in part due to the elimination of Alt-A loans from the warehouse. The increase was also a result of lower valuation losses on illiquid and delinquent warehouse loans and the earlier recognition of servicing value and origination fees resulting from our election to record certain mortgage loans at fair value beginning in May 2007. The prior period also included $42.2 million of income reductions recorded in conjunction with our election to record certain loans held for sale at fair value. These increases in income when compared with 2007 were offset by an increase in our reserve for write-downs on mortgage loans that we anticipate we will have to repurchase from prior sales. This reserve is established at the time of the sale based on expectations for the volume of repurchases and the severity of losses upon ultimate disposition. In the current environment, higher customer default rates, heightened scrutiny of loan documentation by investors, and larger write-downs upon repurchase are all impacting the level of required reserves. In addition to this offset to mortgage production related income, we also incurred negative valuation adjustments on our portfolio loans and loans held for sale carried at fair value and lower fee income associated with lower production volume. While loan production is down, the percentage of agency eligible secondary market production increased to approximately 98% of secondary market production compared to approximately 85% in 2007. Agency eligible loans, also known as conforming loans, are defined as mortgage loans eligible for secondary market purchase by GNMA, FNMA, or FHLMC. To be considered eligible, loans must adhere to maximum loan amount guidelines, debt-to-income ratio limits, and stricter documentation requirements. In addition, dramatically lower mortgage rates near the end of 2008 drove a significant increase in application activity, which has continued into early 2009.
Investment banking income increased $21.6 million, or 10.1%, compared to 2007, due to increases in direct finance and bond underwriting fees. These increases were partially offset by a decrease in M&A fees.
Net gain on the sale of businesses consists of an $89.4 million gain on the sale of our remaining interest in Lighthouse Investment Partners during the first quarter of 2008, an $81.8 million gain on the sale of TransPlatinum, our former fuel card and fleet management subsidiary in the third quarter of 2008, a $29.6 million gain on the sale of First Mercantile, a retirement plan services subsidiary, during the second quarter of 2008, and a $2.7 million loss on the sale of a majority interest in Zevenbergen Capital Investments during the fourth quarter of 2008. A gain of $32.3 million was recognized in 2007 upon the merger of Lighthouse Partners.
During the first quarter of 2008, Visa completed its IPO and upon the closing, approximately 2 million of our Class B shares were mandatorily redeemed for $86.3 million, which was recorded as a gain in noninterest income.
Net securities gains of $1.1 billion for 2008 included a $732.2 million gain on the sale and contribution of a portion of our investment in Coke common stock in addition to a $413.1 million gain on the sale of MBS held in conjunction with our risk management strategies associated with economically hedging the value of MSRs. These gains were partially offset by the recognition through earnings of $83.8 million in charges related to certain ABS that were determined in 2008 to be other-than-temporarily impaired. The net securities gains of $243.1 million for 2007 included a $234.8 million gain on the sale of 4.5 million shares of Coke common stock. For additional information on transactions related to our holdings in Coke common stock, refer to Investment in Common Shares of The Coca-Cola Company within this MD&A.
During the fourth quarter of 2007, we completed multiple sale/leaseback transactions, consisting of over 300 of our branch properties and various individual office buildings. In total, we sold and concurrently leased back $545.9 million in land and buildings with associated accumulated depreciation of $285.7 million. For the year ended December 31, 2007, we recognized $118.8 million of the gain immediately while the remaining $385.4 million in gains were deferred and will be recognized ratably over the expected term of the respective leases, predominantly 10 years, as an offset to net occupancy expense. During 2008, we completed sale/leaseback transactions, consisting of 152 branch properties and various individual office buildings. In total, we sold and concurrently leased back $201.9 million in land and buildings with associated accumulated depreciation of $110.3 million. For the year ended December 31, 2008, we recognized $37.0 million of the gain immediately while the remaining $160.3 million in gains were deferred and will be recognized ratably over the expected term of the respective leases, predominantly as an offset to net occupancy expense.
Other income decreased $110.3 million, or 31.5%, compared to 2007. The decline was primarily due to gains in 2007 on private equity transactions that did not recur in 2008.
Table 4 - Noninterest Expense
Noninterest expense increased by $656.6 million, or 12.5%, in 2008 compared to 2007. This was primarily the result of increased costs of $624.9 million associated with the current credit cycle compared to 2007 along with a $183.4 million contribution of Coke common stock that we made to our charitable foundation in the third quarter of 2008. The remaining components of noninterest expense decreased on an overall basis because of the success achieved in reducing expenses through our E2 Program.
Personnel expenses in 2008 decreased $9.0 million, or 0.3%, from the same period in 2007. The decrease in personnel expense is due primarily to the decline in salaries expense of $34.8 million from 2007 to 2008 reflecting a reduction of approximately 3,000 full time equivalent employees since December 31, 2007 to 29,333 as of December 31, 2008. Due primarily to our fair value election for certain mortgage loans held for sale beginning in May of 2007, we deferred $79.7 million less in loan origination costs in 2008 than 2007, which partially offset the decline in personnel expense. As a consequence of the current market conditions and the reduction in plan participants, expense related to incentive plans was also lower by $53.9 million. In addition, to mitigate increases in personnel expenses in 2009, the following initiatives have been employed: no merit increases for senior management, comprising over 4,000 people, the lowering of average raise targets for the remainder of the workforce by one-third, and a reduction in the amount of promotional salary increases.
Credit-related costs include operating losses, credit and collection services, other real estate expense, and mortgage reinsurance expense. These expenses increased $624.9 million, or 238.2%, over 2007. Operating losses increased $312.2 million, or 233.0%, compared to 2007. These increases include a $206.9 million reserve recorded during 2008 for borrower misrepresentations and insurance claim denials. Approximately $139 million of this reserve relates to insured prime second lien loans and home equity lines of credit. Other real estate expense increased $88.9 million, or 562.7%, in 2008 compared to 2007. This increase was due to a $316.7 million, or 172.4%, increase in other real estate holdings, coupled with additional valuation losses in 2008 on residential loan-related properties as a result of increased inventory of foreclosures and deteriorating home values. Credit and collection services expense increased $43.9 million, or 39.0%, in 2008 compared to 2007 due to increased collection and loss mitigation activity offset by decreased loan closing expenses.
Marketing and customer development expense increased $177.2 million, or 90.9%, in 2008, compared to the same period in 2007. The increase was due to our contribution of $183.4 million, in the form of 3.6 million shares of Coke common stock, to our charitable foundation in the third quarter of 2008. Additionally, media advertising increased during the fourth quarter of 2008, when compared to 2007, in relation to our Live Solid. Bank Solid. campaign.
Mortgage reinsurance expense increased $179.9 million in 2008 compared to 2007 due to an increase in the mortgage reinsurance reserve which pertains to our mortgage reinsurance guaranty subsidiary, Twin Rivers. This increase in reserves was due primarily to the declining credit performance of the underlying loans. Twin Rivers loss exposure arises from third
party mortgage insurers transferring a portion of their first loss exposure when losses by mortgage origination year exceed certain thresholds. Effective January 1, 2009, Twin Rivers stopped reinsuring mortgage guaranty insurance on new loans originated or purchased in 2009 by its parent or affiliate companies. As a result, in the future the reinsurance premiums assumed by Twin Rivers will be lower than the level in 2008, and Twin Rivers will not experience any claims losses for the 2009 book year business.
Outside processing and software increased $81.7 million, or 19.9%, compared to 2007 due to higher processing costs associated with higher transaction volumes in addition to higher software amortization costs and the outsourcing of certain back-office operations during the third quarter of 2008, which was offset by the corresponding decrease in employee compensation and benefits.
Amortization/impairment of intangible assets increased $24.6 million, or 25.4%, in 2008. In the second quarter of 2008, we recorded an impairment charge of $45.0 million related to a customer relationship intangible asset. This change was partially offset by a decline in amortization of customer intangible assets.
Other staff expense decreased $62.2 million, or 46.9%, in 2008 compared to 2007 primarily related to our E2 Program savings produced in 2008 versus a $45.0 million accrual related to severance costs recorded in the third quarter of 2007 related to the program. For the year ended December 31, 2008, we achieved gross run rate savings of approximately $560.0 million related to our efficiency and productivity initiatives. Further, with the progress obtained in 2008, we believe we are on target to attain $600 million of cumulative gross savings by the end of 2009. Key contributors to achieving the 2009 goal include supplier management, outsourcing, and process engineering. Additionally in connection with our E2 Program, consulting and legal expense decreased by 42.1%, or $42.6 million, primarily within the consulting fees and data processing consulting fees accounts.
Regulatory assessments expense grew from $22.4 million in 2007 to $54.9 million in 2008 as FDIC insurance premiums increased due to the exhaustion of previously established premium credits and higher premiums. In an attempt by the FDIC to further strengthen its reserves, future regulatory assessment expense will increase significantly from the level recognized in 2008 due to an increase in the annual FDIC premium rate as well as a special FDIC assessment in 2009.
Visa litigation expense decreased by $110.4 million, or 143.6%, in 2008 compared to the same period in 2007. We increased reserves related to the Visa litigation $20.0 million in the third quarter of 2008. However, offsetting the Visa litigation accrual were reversals totaling $53.5 million related to our portion of the funding by Visa of the litigation escrow account.
Other noninterest expense decreased $51.1 million, or 13.5%, in 2008 compared to 2007. The decrease was due primarily to write-downs of $19.9 million related to Affordable Housing properties as compared to $63.4 million of related charges in 2007.
Provision for Income Taxes
The provision for income taxes includes both federal and state income taxes. In 2008, the provision for income taxes was a benefit of $67.3 million, compared to tax expense of $615.5 million in 2007. The provision represents a negative 9.2% effective tax rate for 2008 compared to a positive 27.4% for 2007. The decrease in the effective tax rate was primarily attributable to the lower level of earnings, a higher proportion of tax-exempt income, state tax benefits resulting from subsidiaries net operating losses and tax credits for the year ended December 31, 2008. Additionally, in July 2008, we contributed 3.6 million shares of Coke common stock to our SunTrust Foundation. This contribution resulted in a release of the deferred tax liability of approximately $65.8 million (net of valuation allowance) and provided an additional decrease in the effective tax rate. For additional information on this and the other transactions related to our holdings in Coke, refer to Investment in Common Shares of The Coca-Cola Company within this MD&A.
As of December 31, 2008, our gross cumulative unrecognized tax benefits (UTBs) amounted to $330.0 million, of which $266.7 million (net of federal tax benefit) would affect our effective tax rate, if recognized. As of December 31, 2007, our gross cumulative UTBs amounted to $325.4 million. Additionally, we recognized a gross liability of $70.9 million and $80.0 million for interest related to our UTBs as of December 31, 2008 and December 31, 2007, respectively. Interest expense related to UTBs was $22.4 million for the year ended December 31, 2008, compared to $27.7 million for the same period in 2007. We continually evaluate the UTBs associated with our uncertain tax positions. It is reasonably possible that the total UTBs could significantly increase or decrease during the next 12 months due to completion of tax authority examinations and the expiration of statutes of limitations. However, an estimate of the range of the reasonably possible change in the total amount of UTBs cannot currently be made.
We file consolidated and separate income tax returns in the United States federal jurisdiction and in various state jurisdictions. Our federal returns through 2004 have been examined by the Internal Revenue Service (IRS) and issues for
tax years 1997 through 2004 are still in dispute. We have paid the amounts assessed by the IRS in full for tax years 1997 and 1998 and have filed refund claims with the IRS related to the disputed issues for those two years. An IRS examination of our 2005 and 2006 federal income tax returns is currently in progress. Generally, the state jurisdictions in which we file income tax returns are subject to examination for a period from three to seven years after returns are filed.
Table 5 - Loan Portfolio by Types of Loans
Table 6 - Funded Exposures by Selected Industries1
Total loans as of December 31, 2008 were $127.0 billion, an increase of $4.7 billion, or 3.8%, from December 31, 2007. The increase was primarily driven by growth in commercial loans, commercial real estate, and home equity lines. These increases were partially offset by a decrease in real estate construction loans. We believe that our portfolio is well diversified by product, client, and geography throughout our footprint, and has relatively low exposure to unsecured consumer loan products. A portion of the increase, approximately $1.0 billion as of December 31, 2008, came as a result of the loans acquired in the GB&T purchase during the second quarter of 2008.
Commercial loans were $41.0 billion, an increase of $5.1 billion, or 14.2%, from December 31, 2007, and comprise 32.3% of the total loan portfolio at December 31, 2008. The commercial loan portfolio is well diversified by industry, collateral, and geography. The primary reason for the increase was the disruption in the short-term corporate funding markets during the second half of 2008, resulting in certain commercial and large corporate clients accessing bank lines for funding. As such, beginning in the third quarter of 2008 in particular, we experienced an increase in the utilization levels of our outstanding commercial loan facilities. Overall, the portfolio has performed well but, depending on the economy, losses could increase in future periods.
Residential mortgages were $32.1 billion, or 25.2% of the total loan portfolio, as of December 31, 2008, down 2.2% from December 31, 2007. The residential mortgage portfolio is comprised of core mortgages (prime first liens), prime second lien mortgages, home equity loans, lot loans, and Alt-A first and second mortgages. There are minimal negative amortizing option adjustable rate mortgages (ARMs) and virtually no subprime loans in the core portfolio. The residential portfolio is mainly dispersed over four states: Florida (29.9%), Georgia (15.2%), Virginia (10.5%), and California (8.0%). The core mortgage portfolio was $23.2 billion, or 18.2% of total loans, as of December 31, 2008 and deteriorated somewhat due to current market conditions. Delinquency levels of 60 days or more increased to 2.6% as of December 31, 2008. The core mortgage portfolio consists of two-thirds prime jumbo loans. The core first mortgage portfolio included $14.3 billion in interest-only ARMs. The weighted average combined loan to value (LTV) at origination of the core portfolio was 73%, and the portfolio has a current weighted average FICO score of 721. Prime second mortgages were $3.9 billion, or 3.1%, of total loans as of December 31, 2008 and are comprised of purchase money second liens or combo loans with a current weighted average FICO of 708. Home equity loans comprise $2.5 billion, or 2.0%, of the total loan portfolio as of December 31, 2008 and have a current weighted average FICO score of 713 and a 75% weighted average combined LTV at origination. Thirty-two percent of the home equity loans are in a first lien position. Lot loans were $1.4 billion, or approximately 1.1% of total loans, as of December 31, 2008 and have a current weighted average FICO score of 700. Alt-A loans were $1.2 billion, or 1.0% of total loans, as of December 31, 2008. Of the Alt-A loans, $0.9 billion are first liens and well secured with a weighted average combined LTV of 75% at origination. The remaining $0.3 billion of Alt-A loans are second lien loans with a weighted average combined LTV of 97% at origination and a current weighted average FICO score of 601.
The home equity line portfolio was $16.5 billion, or 13.0% of total loans, as of December 31, 2008, an increase of 10.3% from December 31, 2007, and it has a 74% weighted average combined LTV at origination and current FICO score of 727. The growth in this portfolio is in the low risk segment and results from a slow down of payoff/paydown attrition and normal line utilization on lines originated in late 2007 and 2008 under more conservative underwriting guidelines. The growth was predominantly in the less than 90% LTV and higher than 720 FICO scores segments. The weighted average FICO score of our new production is 772 with a weighted average combined LTV of 60%. Third party originated home equity lines continue to perform poorly; however, only 11.3% of the home equity lines were originated through that channel. We have eliminated origination of home equity product through third party channels, eliminated greater than 85% LTV originations, implemented market specific LTV guidelines in certain declining markets, and have been aggressively reducing line commitments in higher risk situations. Approximately 23% of our home equity lines are in a first lien position. We continue to enhance our collections and default management processes and where possible, reduce outstanding line commitments; however, we expect the home equity line portfolio to continue to show elevated nonaccrual and charge-off levels in the near future.
The construction portfolio was $9.9 billion, or 7.8% of total loans, at December 31, 2008, down $3.9 billion, or 28.4%, from December 31, 2007. The construction portfolio consists of residential construction to perm loans ($1.7 billion), residential construction loans ($2.0 billion), commercial construction loans ($2.4 billion), acquisition and development loans ($2.5 billion), and raw land loans ($1.3 billion). Approximately one third of this portfolio is owner-occupied, which provides additional sources of repayment and helps mitigate risk of loss. We have reduced the level of risk in the construction portfolio by prudently managing our construction exposure. This is evident by the declines in outstanding balances since December 2007 in the construction to perm (down 52.0%), residential construction (down 27.7%), commercial construction (down 27.1%), and acquisition and development (down 14.0%) portfolios. Further, these net decreases include the addition of construction loans from the GB&T acquisition that occurred in the second quarter 2008. Commercial-related construction loans represent 24.3% of the total construction portfolio and continue to perform well. Overall performance of residential construction related loans has deteriorated since the fourth quarter of 2007 consistent with the general decline in the economy. We continue to be proactive in our credit monitoring and management processes to provide early warning for problem loans in the portfolio. For example, we use an expanded liquidity and contingency analysis to provide a thorough view of borrower capacity and their ability to service obligations in a steep market decline. We have strict limits and have exposure caps on specific projects and borrowers for risk diversification. In some cases, the maturity date of certain residential real estate related loans, namely construction to perm and lot loans, has been extended as a result of market delays in completing the build-out phase of the home. These borrowers continue to perform; consequently, the loans remain on accruing status. It is possible that these borrowers could experience varying degrees of financial difficulties, resulting potentially in more significant loan modifications.
The commercial real estate portfolio was $15.0 billion, or 11.8% of total loans, an increase of $2.3 billion, or 18.6%, from December 31, 2007. Of this increase, $603.4 million was due to the acquisition of GB&T. This portfolio includes both owner-occupied and income producing collateral, with approximately 60% being owner occupied properties. The primary source of loan repayment for owner-occupied properties is business income and not real estate operations, which diversifies the risk or sources of repayment. Although we have not seen a significant deterioration on the fundamentals in our income property or owner-occupied products, recent market conditions have presented some rising vacancies among retail, office, and industrial products.
The indirect consumer portfolio was $6.5 billion, or 5.1% of total loans, at December 31, 2008, down $986.5 million, or 13.2%, from December 31, 2007. This portfolio primarily consists of automobile loans generated through dealerships and has a current weighted average FICO of 699. The decrease is largely attributable to the recent slowdown in automobile sales and our specific decision to reduce exposure in this portfolio. This portfolio is experiencing a higher level of net charge-offs compared to the fourth quarter of 2007, driven by declining auto auction prices, especially for SUVs and large pick-up trucks.
The direct consumer portfolio was $5.1 billion, or 4.0% of total loans, at December 31, 2008, up $1.2 billion, or 29.7% from December 31, 2007, almost entirely due to growth in student loans. Student loans, which are mostly government supported, made up $2.9 billion, or 55.4%, of the direct consumer portfolio. This portfolio also consists of loans and lines to individuals for personal or family uses.
The decrease in loans held for sale from December 31, 2007 to December 31, 2008 of $4.8 billion was due primarily to a decline in total loan production of $21.9 billion, or 37.6% from 2007 to 2008. During 2008 and 2007, we transferred $656.1 million and $837.4 million, respectively, in loans from held for sale to held for investment. The transfer included loans that we determined could not be sold due to underwriting defects or payment defaults, as well as non-agency residential loans for which deteriorating market conditions impacted our ability to sell these loans. The loans transferred included loans that are carried at fair value under SFAS No. 159 and continue to be reported at fair value while classified as held for investment, as well as loans transferred at the lower of cost or market value.
Table 7 - Allowance for Loan and Lease Losses
Table 8 - Summary of Loan and Lease Losses Experience