Fifth Third Bank 2007 Annual Report Download - page 48

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp
46
Portfolio Loans and Leases and Interest Rate Risk
Although the Bancorp’s portfolio loans and leases contain both
fixed and floating/adjustable rate products, the rates of interest
earned by the Bancorp on the outstanding balances are generally
established for a period of time. The interest rate sensitivity of
loans and leases is directly related to the length of time the rate
earned is established. Table 37 shows a summary of the expected
principal cash flows of the Bancorp’s portfolio loans and leases as
of December 31, 2007. Additionally, Table 38 shows a summary
of expected principal cash flows occurring after one year as of
December 31, 2007.
Mortgage Servicing Rights and Interest Rate Risk
The net carrying amount of the MSR portfolio was $610 million
as of December 31, 2007 compared to $519 million as of
December 31, 2006. The Bancorp maintains a non-qualifying
hedging strategy relative to its mortgage banking activity in order
to manage a portion of the risk associated with changes in the
value of its MSR portfolio as a result of changing interest rates.
The value of servicing rights can fluctuate sharply depending on
changes in interest rates and other factors. Generally, as interest
rates decline and loans are prepaid to take advantage of
refinancing opportunities, the total value of existing servicing
rights declines because no further servicing fees are collected on
repaid loans.
The decrease in interest rates, particularly during the fourth
quarter of 2007, led to the recognition of $22 million in temporary
impairment of servicing rights during 2007, compared to a
recovery of temporary impairment of $19 million in 2006.
Servicing rights are deemed temporarily impaired when a
borrower’s loan rate is distinctly higher than prevailing market
rates. Impairment on servicing rights is reversed when the
prevailing rates return to a level commensurate with the
borrower’s loan rate. The Bancorp recognized a gain of $29
million in 2007 and a loss of $6 million in 2006 on free-standing
derivatives and the sale of securities used to economically hedge
the MSR portfolio. See Note 9 of the Notes to Consolidated
Financial Statements for further discussion on servicing rights.
Foreign Currency Risk
The Bancorp enters into foreign exchange derivative contracts to
economically hedge certain foreign denominated loans. The
derivatives are classified as free-standing instruments with the
revaluation gain or loss being recorded within other noninterest
income on the Consolidated Statements of Income. The balance
of the Bancorp’s foreign denominated loans at December 31,
2007 was approximately $329 million compared to approximately
$219 million at December 31, 2006. The Bancorp also enters into
foreign exchange contracts for the benefit of commercial
customers involved in international trade to hedge their exposure
to foreign currency fluctuations. The Bancorp has several internal
controls in place to ensure excessive risk is not being taken in
providing this service to customers. These include an
independent determination of currency volatility and credit
equivalent exposure on these contracts, counterparty credit
approvals and country limits.
LIQUIDITY RISK MANAGEMENT
The goal of liquidity management is to provide adequate funds to
meet changes in loan and lease demand, unexpected deposit
withdrawals and other contractual obligations. A summary of
certain obligations and commitments to make future payments
under contracts is included in Table 42. Mitigating liquidity risk is
accomplished by maintaining liquid assets in the form of
investment securities, maintaining sufficient unused borrowing
capacity in the national money markets and delivering consistent
growth in core deposits. The estimated weighted-average life of
the available-for-sale portfolio was 6.8 years at December 31,
2007, based on current prepayment expectations. Of the $10.7
billion (fair value basis) of securities in the available-for-sale
portfolio at December 31, 2007, $2.0 billion in principal and
interest is expected to be received in the next 12 months, and an
additional $1.5 billion is expected to be received in the next 13 to
24 months. In addition to available-for-sale securities, asset-
driven liquidity is provided by the Bancorp’s ability to sell or
securitize loan and lease assets. In order to reduce the exposure
to interest rate fluctuations and to manage liquidity, the Bancorp
has developed securitization and sale procedures for several types
of interest-sensitive assets. A majority of the long-term, fixed-rate
single-family residential mortgage loans underwritten according to
FHLMC or Federal National Mortgage Association (“FNMA”)
guidelines are sold for cash upon origination. Additional assets
such as jumbo fixed-rate residential mortgages, certain floating
rate short-term commercial loans, certain floating-rate home
equity loans, certain automobile loans and other consumer loans
are also capable of being securitized, sold or transferred off-
balance sheet. For the year ended December 31, 2007 and 2006,
TABLE 37: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS
As of December 31, 2007 ($ in millions) Less than 1 year 1-5 years
Greater than 5
years Total
Commercial loans $13,266 10,035 1,512 24,813
Commercial mortgage loans 5,154 4,946 1,762 11,862
Commercial construction loans 3,860 1,302 399 5,561
Commercial leases 615 1,523 1,599 3,737
Residential mortgage loans 2,795 4,066 3,679 10,540
Home equity 2,300 4,878 4,696 11,874
Automobile loans 3,305 5,377 519 9,201
Credit card 191 1,400 - 1,591
Other consumer loans and leases 486 536 52 1,074
Total $31,972 34,063 14,218 80,253
TABLE 38: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS OCCURRING AFTER ONE YEAR
Interest Rate
As of December 31, 2007 ($ in millions) Fixed Floating or Adjustable
Commercial loans $2,546 9,001
Commercial mortgage loans 2,339 4,369
Commercial construction loans 432 1,269
Commercial leases 3,122 -
Residential mortgage loans 4,217 3,528
Home equity 1,673 7,901
Automobile loans 5,896 -
Credit card 470 930
Other consumer loans and leases 579 9
Total $21,274 27,007