Fifth Third Bank 2008 Annual Report Download - page 54

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
52 Fifth Third Bancorp
OFF-BALANCE SHEET ARRANGEMENTS
The Consolidated Financial Statements include the accounts of
the Bancorp and its majority-owned subsidiaries and variable
interest entities (VIEs) in which the Bancorp has been determined
to be the primary beneficiary. Other entities, including certain
joint ventures, in which the Bancorp has the ability to exercise
significant influence over operating and financial policies of the
investee, but upon which the Bancorp does not possess control,
are accounted for by the equity method and not consolidated.
Those entities in which the Bancorp does not have the ability to
exercise significant influence are generally carried at the lower of
cost or fair value.
In the ordinary course of business, the Bancorp enters into
financial transactions to extend credit and various forms of
commitments and guarantees that may be considered off-balance
sheet arrangements. These transactions involve varying elements
of market, credit and liquidity risk. The nature and extent of these
transactions are provided in Note 15 of the Notes to Consolidated
Financial Statements. In addition, the Bancorp uses conduits,
asset securitizations and certain defined guarantees to provide a
source of funding. The use of these investment vehicles involves
differing degrees of risk. A summary of these transactions is
provided below.
Through December 31, 2008 and 2007, the Bancorp had
transferred, subject to credit recourse, certain primarily floating-
rate, short-term, investment grade commercial loans to an
unconsolidated QSPE that is wholly owned by an independent
third-party. The outstanding balance of these loans at December
31, 2008 and 2007 was $1.9 billion and $3.0 billion, respectively.
These loans may be transferred back to the Bancorp upon the
occurrence of certain specified events. These events include
borrower default on the loans transferred, bankruptcy preferences
initiated against underlying borrowers, ineligible loans transferred
by the Bancorp to the QSPE and the inability of the QSPE to
issue commercial paper. The maximum amount of credit risk in
the event of nonperformance by the underlying borrowers is
approximately equivalent to the total outstanding balance. During
the years ended December 31, 2008 and 2007, the QSPE did not
transfer any loans back to the Bancorp as a result of a credit event.
The QSPE issues commercial paper and uses the proceeds to
fund the acquisition of commercial loans transferred to it by the
Bancorp. The ability of the QSPE to issue commercial paper is a
function of general market conditions and the credit rating of the
liquidity provider. In the event the QSPE is unable to issue
commercial paper, the Bancorp has agreed to provide liquidity
support to the QSPE in the form of purchases of commercial
paper, a line of credit to the QSPE and the repurchase of assets
from the QSPE. As of December 31, 2008 and 2007, the liquidity
asset purchase agreement was $2.8 billion and $5.0 billion,
respectively. During 2008, dislocation in the short-term funding
market caused the QSPE difficulty in obtaining sufficient funding
through the issuance of commercial paper. As a result, the
Bancorp provided liquidity support to the QSPE during 2008
through purchases of commercial paper, a line of credit to the
QSPE and the repurchase of assets from the QSPE under the
liquidity asset purchase agreement. As of December 31, 2008, the
Bancorp held approximately $143 million of asset-backed
commercial paper issued by the QSPE, representing 7% of the
total commercial paper issued by the QSPE. Due to continued
difficulty in obtaining sufficient funding through the issuance of
commercial paper in the first quarter of 2009, the Bancorp held
approximately $836 million of asset-backed commercial paper
issued by the QSPE, representing 43% of the total commercial
paper issued by the QSPE.
During 2008, the Bancorp repurchased $686 million of
commercial loans at par from the QSPE under the liquidity asset
purchase agreement. Fair value adjustment charges of $3 million
were recorded on these loans upon repurchase. As of December
31, 2008, there were no outstanding balances on the line of credit
from the Bancorp to the QSPE. At December 31, 2008 and 2007,
the Bancorp’s loss reserve related to the liquidity support and
credit enhancement provided to the QSPE was $37 million and
$18 million, respectively, and was recorded in other liabilities in
the Consolidated Balance Sheets. To determine the credit loss
reserve, the Bancorp used an approach that is consistent with its
overall approach in estimating credit losses for various categories
of commercial loans held in its loan portfolio. For further
information on the QSPE, see Note 10 of the Notes to
Consolidated Financial Statements.
The Bancorp utilizes securitization trusts, formed by
independent third parties to facilitate the securitization process of
residential mortgage loans, certain automobile loans and other
consumer loans. During 2008 the Bancorp recognized pretax
gains of $15 million on the sale of $2.7 billion of automobile loans
in three separate transactions. Each transaction isolated the related
loans through the use of a securitization trust or a conduit,
formed as QSPEs, to facilitate the securitization process in
accordance with SFAS No. 140, “Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities.”
The QSPEs issue asset-backed securities with varying levels of
credit subordination and payment priority. The investors in these
securities have no recourse to the Bancorp’s other assets for
failure of debtors to pay when due. During 2008, the Bancorp did
not repurchase any previously transferred automobile loans from
the QSPEs. For further information on these automobile
securitizations, see Note 10 of the Notes to Consolidated
Financial Statements.
At December 31, 2008 and 2007, the Bancorp had provided
credit recourse on residential mortgage loans sold to unrelated
third parties of approximately $1.3 billion and $1.5 billion,
respectively. In the event of any customer default, pursuant to the
credit recourse provided, the Bancorp is required to reimburse the
third party. The maximum amount of credit risk in the event of
nonperformance by the underlying borrowers is equivalent to the
total outstanding balance. For further information on the
residential mortgage loans sold with credit recourse, see Note 10
of the Notes to Consolidated Financial Statements.
For certain mortgage loans originated by the Bancorp,
borrowers may be required to obtain Private Mortgage Insurance
(PMI) provided by third-party insurers. In some instances, these
PMI insurers cede a portion of the PMI premiums to the
Bancorp, and the Bancorp provides reinsurance coverage within a
specified range of the total PMI coverage. The Bancorp’s
reinsurance coverage typically ranges from 5% to 10% of the total
PMI coverage. The Bancorp's maximum exposure in the event of
nonperformance by the underlying borrowers is equivalent to the
Bancorp's total outstanding reinsurance coverage, which was $170
million at December 31, 2008. As of December 31, 2008, the
Bancorp maintained a reserve of approximately $13 million related
to exposures within the reinsurance portfolio. No reserve was
deemed necessary as of December 31, 2007.