Fifth Third Bank 2005 Annual Report Download - page 59

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fifth Third Bancorp 57
value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following
assumptions used for grants in 2005, 2004 and 2003: expected
option lives ranging from six to nine years for all three years;
expected dividend yield of 3.5%, 2.3% and 1.6%, respectively;
expected volatility of 26%, 28%, and 28%, respectively, and risk-
free interest rates of 4.3%, 3.9% and 4.4%, respectively.
In December 2004, the FASB issued SFAS No. 123 (Revised
2004), “Share-Based Payment.” This Statement requires
measurement of the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair
value of the award with the cost to be recognized over the service
period. This Statement is effective for financial statements as of
the beginning of the first interim or annual reporting period of the
first fiscal year that begins after June 15, 2005. As the Bancorp has
previously adopted the fair value recognition provisions of SFAS
No. 123 and the retroactive restatement method described in SFAS
No. 148, the adoption of this Statement will not have a material
impact on the Bancorp’s Consolidated Financial Statements. For
further information on stock-based compensation see Note 18.
In January 2003, the FASB issued Interpretation No. 46
(“FIN 46”), “Consolidation of Variable Interest Entities.” This
Interpretation clarifies the application of ARB No. 51,
“Consolidated Financial Statements,” for certain entities in which
equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated
support from other parties. This Interpretation requires variable
interest entities (“VIEs”) to be consolidated by the primary
beneficiary which represents the enterprise that will absorb the
majority of the VIE’s expected losses if they occur, receive a
majority of the VIE’s residual returns if they occur, or both.
Qualifying Special Purpose Entities (“QSPEs”) are exempt from
the consolidation requirements of FIN 46. This Interpretation was
effective for VIEs created after January 31, 2003 and for VIEs in
which an enterprise obtains an interest after that date.
In December 2003, the FASB issued Interpretation No. 46R
(“FIN 46R”), “Consolidation of Variable Interest Entities-an
interpretation of ARB 51 (revised December 2003),” which
replaces FIN 46. FIN 46R was primarily issued to clarify the
required accounting for interests in VIEs. Additionally, this
Interpretation exempts certain entities from its requirements and
provides for special effective dates for enterprises that have fully or
partially applied FIN 46 as of December 24, 2003. Application of
FIN 46R is required in financial statements of public enterprises
that have interests in structures that are commonly referred to as
special-purpose entities, or SPEs, for periods ending after
December 15, 2003. Application by public enterprises, other than
small business issuers, for all other types of VIEs (i.e., non-SPEs) is
required in financial statements for periods ending after March 15,
2004, with earlier adoption permitted. The Bancorp early adopted
the provisions of FIN 46 on July 1, 2003. The Bancorp provided
full credit recourse to an unrelated and unconsolidated asset-
backed SPE in conjunction with the sale and subsequent leaseback
of leased autos. The unrelated and unconsolidated asset-backed
SPE was formed for the sole purpose of participating in the sale-
leaseback transactions with the Bancorp. Based on this credit
recourse, the Bancorp is deemed to be the primary beneficiary as it
maintains the majority of the variable interests in this SPE and was
therefore required to consolidate the entity. Early adoption of FIN
46 required the Bancorp to consolidate these operating lease assets
and a corresponding liability as well as recognize an after-tax
cumulative effect charge of $11 million ($.02 per diluted share)
representing the difference between the carrying value of the leased
autos sold and the carrying value of the newly consolidated
obligation as of July 1, 2003. As of December 31, 2005, the
outstanding balance of leased autos sold was approximately $54
million. Consolidation of these operating lease assets did not
impact risk-based capital ratios or net income trends; however lease
payments on the operating lease assets are now reflected as a
component of noninterest income and depreciation expense is now
reflected as a component of noninterest expense. The Bancorp also
early adopted the provisions of FIN 46 related to the consolidation
of two wholly-owned finance entities involved in the issuance of
trust preferred securities. Effective July 1, 2003, the Bancorp
deconsolidated the wholly owned issuing trust entities resulting in a
recharacterization of the underlying consolidated debt obligation
from the previous trust preferred securities obligations to the
junior subordinated debenture obligations that exist between the
Bancorp and the issuing trust entities. See Note 14 for discussion
of certain guarantees that the Bancorp has provided for the benefit
of the wholly-owned issuing trust entities related to their debt
obligations.
In May 2003, the FASB issued SFAS No. 150, “Accounting
for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity.” This Statement establishes standards for
how an entity classifies and measures certain financial instruments
with characteristics of both liabilities and equity. This Statement
requires that an issuer classify a financial instrument that is within
its scope as a liability. Many of those instruments were previously
classified as equity, or in some cases, presented between the
liabilities section and the equity section of the statement of
financial position. This Statement was effective for financial
instruments entered into or modified after May 31, 2003, and
otherwise was effective at the beginning of the first interim period
beginning after June 15, 2003. Adoption of this Statement on July
1, 2003 required a reclassification of a minority interest to long-
term debt and its corresponding minority interest expense to
interest expense, relating to preferred stock issued during 2001 by a
subsidiary of the Bancorp. The existence of the mandatory
redemption feature of this issue upon its mandatory conversion to
trust preferred securities necessitated these reclassifications and did
not result in any change in bottom line income statement trends.
In December 2003, the Accounting Standards Executive
Committee of the American Institute of Certified Public
Accountants issued Statement of Position (“SOP”) 03-3,
“Accounting for Certain Loans and Debt Securities Acquired in a
Transfer.” SOP 03-3 addresses the accounting for acquired loans
that show evidence of having deteriorated in terms of credit quality
since their origination and for which a loss is deemed probable of
occurring. SOP 03-3 requires acquired loans to be recorded at
their fair value, defined as the present value of future cash flows
including interest income, to be recognized over the life of the
loan. SOP 03-3 prohibits the carryover of an allowance for loan
loss on certain acquired loans within its scope considered in the
future cash flows assessment. SOP 03-3 was effective for loans
acquired in fiscal years beginning after December 15, 2004 and has
not had a material effect on the Bancorp’s Consolidated Financial
Statements.
In March 2004, the Securities and Exchange Commission staff
released Staff Accounting Bulletin (“SAB”) No. 105, “Application
of Accounting Principles to Loan Commitments.” This SAB
disallows the inclusion of expected future cash flows related to the
servicing of a loan in the determination of the fair value of a loan
commitment. Further, no other internally developed intangible
asset should be recorded as part of the loan commitment
derivative. Recognition of intangible assets would only be
appropriate in a third-party transaction, such as a purchase of a
loan commitment or in a business combination. The SAB is
effective for all loan commitments entered into after March 31,
2004, but does not require retroactive adoption for loan
commitments entered into on or before March 31, 2004. Adoption
of this SAB did not have a material effect on the Bancorp’s
Consolidated Financial Statements.
In March 2004, the Emerging Issues Task Force (“EITF”)
reached a consensus on Issue 03-1, “The Meaning of Other-Than-