Fifth Third Bank 2008 Annual Report Download - page 64

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
62 Fifth Third Bancorp
forward yield curves and discount rates commensurate with the
risks involved. Gain or loss on sale or securitization of loans is
reported as a component of noninterest income in the
Consolidated Statements of Income. Interests that continue to be
held by the Bancorp from securitized or sold loans, excluding
servicing rights, are carried at fair value. Adjustments to fair value
for interests that continue to be held by the Bancorp classified as
available-for-sale securities are included in accumulated other
comprehensive income in the Consolidated Balance Sheets or in
noninterest income in the Consolidated Statements of Income if
the fair value has declined below the carrying amount and such
decline has been determined to be other-than-temporary.
Adjustments to fair value for interests that continue to be held by
the Bancorp classified as trading securities are recorded within
other noninterest income in the Consolidated Statements of
Income.
Servicing rights resulting from residential mortgage and
commercial loan sales are amortized in proportion to and over the
period of estimated net servicing revenues and are reported as a
component of mortgage banking net revenue and corporate
banking revenue, respectively, in the Consolidated Statements of
Income. Servicing rights are assessed for impairment monthly,
based on fair value, with temporary impairment recognized
through a valuation allowance and permanent impairment
recognized through a write-off of the servicing asset and related
valuation allowance. Key economic assumptions used in
measuring any potential impairment of the servicing rights include
the prepayment speeds of the underlying loans, the weighted-
average life, the discount rate, the weighted-average coupon and
the weighted-average default rate, as applicable. The primary risk
of material changes to the value of the servicing rights resides in
the potential volatility in the economic assumptions used,
particularly the prepayment speeds. The Bancorp monitors risk
and adjusts its valuation allowance as necessary to adequately
reserve for impairment in the servicing portfolio. For purposes of
measuring impairment, the mortgage servicing rights are stratified
into classes based on the financial asset type (fixed-rate vs.
adjustable-rate) and interest rates. Fees received for servicing loans
owned by investors are based on a percentage of the outstanding
monthly principal balance of such loans and are included in
noninterest income in the Consolidated Statements of Income as
loan payments are received. Costs of servicing loans are charged
to expense as incurred.
Bank Premises and Equipment
Bank premises and equipment, including leasehold improvements,
are stated at cost less accumulated depreciation and amortization.
Depreciation is calculated using the straight-line method based on
estimated useful lives of the assets for book purposes, while
accelerated depreciation is used for income tax purposes.
Amortization of leasehold improvements is computed using the
straight-line method over the lives of the related leases or useful
lives of the related assets, whichever is shorter. In accordance
with SFAS No. 144, “Accounting for the Impairment or Disposal
of Long-Lived Assets,” the Bancorp tests its long-lived assets for
impairment through both a probability-weighted and primary-
asset approach whenever events or changes in circumstances
dictate. Maintenance, repairs and minor improvements are
charged to noninterest expense in the Consolidated Statements of
Income as incurred.
Derivative Financial Instruments
The Bancorp accounts for its derivatives under SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities,”
as amended. This Statement requires recognition of all derivatives
as either assets or liabilities in the balance sheet and requires
measurement of those instruments at fair value through
adjustments to accumulated other comprehensive income and/or
current earnings, as appropriate. On the date the Bancorp enters
into a derivative contract, the Bancorp designates the derivative
instrument as either a fair value hedge, cash flow hedge or as a
free-standing derivative instrument. For a fair value hedge,
changes in the fair value of the derivative instrument and changes
in the fair value of the hedged asset or liability or of an
unrecognized firm commitment attributable to the hedged risk are
recorded in current period net income. For a cash flow hedge,
changes in the fair value of the derivative instrument, to the extent
that it is effective, are recorded in accumulated other
comprehensive income and subsequently reclassified to net
income in the same period(s) that the hedged transaction impacts
net income. For free-standing derivative instruments, changes in
fair values are reported in current period net income.
Prior to entering into a hedge transaction, the Bancorp
formally documents the relationship between hedging instruments
and hedged items, as well as the risk management objective and
strategy for undertaking various hedge transactions. This process
includes linking all derivative instruments that are designated as
fair value or cash flow hedges to specific assets and liabilities on
the balance sheet or to specific forecasted transactions, along with
a formal assessment at both inception of the hedge and on an
ongoing basis as to the effectiveness of the derivative instrument
in offsetting changes in fair values or cash flows of the hedged
item. If it is determined that the derivative instrument is not
highly effective as a hedge, hedge accounting is discontinued and
the adjustment to fair value of the derivative instrument is
recorded in net income.
Income Taxes
The Bancorp estimates income tax expense based on amounts
expected to be owed to the various tax jurisdictions in which the
Bancorp conducts business. On a quarterly basis, management
assesses the reasonableness of its effective tax rate based upon its
current estimate of the amount and components of net income,
tax credits and the applicable statutory tax rates expected for the
full year. The estimated income tax expense is recorded in the
Consolidated Statements of Income.
Deferred income tax assets and liabilities are determined
using the balance sheet method and are reported in either other
assets or accrued taxes, interest and expenses in the Consolidated
Balance Sheets. Under this method, the net deferred tax asset or
liability is based on the tax effects of the differences between the
book and tax basis of assets and liabilities, and recognizes enacted
changes in tax rates and laws. Deferred tax assets are recognized
to the extent they exist and are subject to a valuation allowance
based on management’s judgment that realization is more-likely-
than-not.
Accrued taxes represent the net estimated amount due to
taxing jurisdictions and are reported in accrued taxes, interest and
expenses in the Consolidated Balance Sheets. The Bancorp
evaluates and assesses the relative risks and appropriate tax
treatment of transactions and filing positions after considering
statutes, regulations, judicial precedent and other information and
maintains tax accruals consistent with its evaluation of these
relative risks and merits. Changes to the estimate of accrued taxes
occur periodically due to changes in tax rates, interpretations of
tax laws, the status of examinations being conducted by taxing
authorities and changes to statutory, judicial and regulatory
guidance that impact the relative risks of tax positions. These
changes, when they occur, can affect deferred taxes and accrued
taxes as well as the current period’s income tax expense and can
be significant to the operating results of the Bancorp. As
described in greater detail in Note 16, the Internal Revenue
Service has challenged the Bancorp’s tax treatment of certain
leasing transactions. For additional information on income taxes,
see Note 22.