Fifth Third Bank 2008 Annual Report Download - page 63

NOTES TO CONSOLIDATED FINABCIAL STATEMENTS
Fifth Third Bancorp 61
marks are recorded to income in mortgage banking revenue. The
Bancorp generally has commitments to sell residential mortgage
loans held for sale in the secondary market. Gains or losses on
sales are recognized in mortgage banking net revenue upon
delivery.
Impaired loans and leases are measured based on the present
value of expected future cash flows discounted at the loan’s
effective interest rate, the fair value of the underlying collateral or
readily observable secondary market values. The Bancorp
evaluates the collectibility of both principal and interest when
assessing the need for a loss accrual.
Other Real Estate Owned
Other real estate owned (OREO), which is included in other
assets, represents property acquired through foreclosure or other
proceedings. OREO is carried at the lower of cost or fair value,
less costs to sell. All property is periodically evaluated and
reductions in carrying value are recognized in other noninterest
expense in the Consolidated Statements of Income.
Allowance for Loan and Lease Losses
The Bancorp maintains an allowance to absorb probable loan and
lease losses inherent in the portfolio. The allowance is maintained
at a level the Bancorp considers to be adequate and is based on
ongoing quarterly assessments and evaluations of the collectibility
and historical loss experience of loans and leases. Credit losses
are charged and recoveries are credited to the allowance.
Provisions for loan and lease losses are based on the Bancorp’s
review of the historical credit loss experience and such factors
that, in management’s judgment, deserve consideration under
existing economic conditions in estimating probable credit losses.
In determining the appropriate level of the allowance, the
Bancorp estimates losses using a range derived from “base” and
“conservative” estimates.
Larger commercial loans that exhibit probable or observed
credit weaknesses are subject to individual review. When
individual loans are impaired, allowances are allocated based on
management’s estimate of the borrower’s ability to repay the loan
given the availability of collateral, other sources of cash flow, as
well as evaluation of legal options available to the Bancorp. The
review of individual loans includes those loans that are impaired as
provided in SFAS No. 114. Any allowances for impaired loans
are measured based on the present value of expected future cash
flows discounted at the loan’s effective interest rate, fair value of
the underlying collateral or readily observable secondary market
values. The Bancorp evaluates the collectibility of both principal
and interest when assessing the need for a loss accrual. Historical
loss rates are applied to commercial loans, which are not impaired
or are impaired but smaller than an established threshold, and thus
not subject to specific allowance allocations. The loss rates are
derived from a migration analysis, which tracks the historical net
charge-off experience sustained on loans according to their
internal risk grade. The risk grading system currently utilized for
allowance analysis purposes encompasses ten categories.
Homogenous loans and leases, such as consumer installment
and residential mortgage loans, are not individually risk graded.
Rather, standard credit scoring systems and delinquency
monitoring are used to assess credit risks. Allowances are
established for each pool of loans based on the expected net
charge-offs. Loss rates are based on the average net charge-off
history by loan category.
Historical loss rates for commercial and consumer loans may
be adjusted for significant factors that, in management’s judgment,
are necessary to reflect losses inherent in the portfolio. Factors
that management considers in the analysis include the effects of
the national and local economies; trends in the nature and volume
of delinquencies, charge-offs and nonaccrual loans; changes in
mix; credit score migration comparisons; asset quality trends; risk
management and loan administration; changes in the internal
lending policies and credit standards; collection practices; and
examination results from bank regulatory agencies and the
Bancorp’s internal credit examiners.
The Bancorp’s current methodology for determining the
allowance for loan and lease losses is based on historical loss rates,
current credit grades, specific allocation on impaired commercial
credits above specified thresholds and other qualitative
adjustments. Allowances on individual loans and historical loss
rates are reviewed quarterly and adjusted as necessary based on
changing borrower and/or collateral conditions and actual
collection and charge-off experience. An unallocated allowance is
maintained to recognize the imprecision in estimating and
measuring loss when evaluating allowances for individual loans or
pools of loans.
Loans acquired by the Bancorp through a purchase business
combination are evaluated for possible credit impairment at
acquisition. Reductions to the carrying value of the acquired loans
as a result of credit impairment are recorded as an adjustment to
goodwill. The Bancorp does not carry over the acquired
company’s allowance for loan and lease losses, nor does the
Bancorp add to its existing allowance for the acquired loans as
part of purchase accounting.
The Bancorp’s primary market areas for lending are the
Midwestern and Southeastern regions of the United States. When
evaluating the adequacy of allowances, consideration is given to
these regional geographic concentrations and the closely
associated effect changing economic conditions have on the
Bancorp’s customers.
In the current year, the Bancorp has not substantively
changed any material aspect to its overall approach to determining
its allowance for loan and lease losses. There have been no
material changes in criteria or estimation techniques as compared
to prior periods that impacted the determination of the current
period allowance for loan and lease losses.
Reserve for Unfunded Commitments
The reserve for unfunded commitments is maintained at a level
believed by management to be sufficient to absorb estimated
probable losses related to unfunded credit facilities and is included
in other liabilities in the Consolidated Balance Sheets. The
determination of the adequacy of the reserve is based upon an
evaluation of the unfunded credit facilities, including an
assessment of historical commitment utilization experience, credit
risk grading and credit grade migration. Net adjustments to the
reserve for unfunded commitments are included in other
noninterest expense in the Consolidated Statements of Income.
Loan Sales and Securitizations
When the Bancorp sells loans through either securitizations or
individual loan sales in accordance with its investment policies, it
may obtain one or more subordinated tranches, servicing rights,
interest-only strips, credit recourse, other residual interests and in
some cases, a cash reserve account, all of which are considered
interests that continue to be held by the Bancorp in the securitized
or sold loans. Gains or losses on sale or securitization of the
loans depend in part on the previous carrying amount of the
financial assets sold or securitized. At the date of transfer,
obtained servicing rights are recorded at fair value and the
remaining carrying value of the transferred financial assets is
allocated between the assets sold and remaining interests that
continue to be held by the Bancorp based on their relative fair
values at the date of sale or securitization. To obtain fair values,
quoted market prices are used, if available. If quotes are not
available for interests that continue to be held by the Bancorp, the
Bancorp calculates fair value based on the present value of future
expected cash flows using management’s best estimates for the
key assumptions, including credit losses, prepayment speeds,