Fifth Third Bank 2008 Annual Report Download - page 78

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
76 Fifth Third Bancorp
The Bancorp previously entered into forward contracts that met
the criteria for fair value hedge accounting to hedge its residential
mortgage loans held for sale. Upon adoption of SFAS No. 159 on
January 1, 2008 and the Bancorp’s election to carry residential
mortgage loans held for sale at fair value, all new forward
contracts held to hedge its residential mortgage loans held for sale
were held as free-standing derivative instruments. For the year
ended December 31, 2007, the ineffectiveness of the hedging
relationships related to residential mortgage loans held for sale
was immaterial to the Bancorp’s Consolidated Statements of
Income.
During 2006, the Bancorp terminated interest rate swaps
designated as fair value hedges and, in accordance with SFAS No.
133, an amount equal to the cumulative fair value adjustment to
the hedged items at the date of termination will be amortized as
an adjustment to interest expense over the remaining term of the
long-term debt. For the years ended December 31, 2008 and
2007, $6 million and $11 million in net deferred losses, net of tax,
on the terminated fair value hedges were amortized into interest
expense, respectively.
Cash Flow Hedges
The Bancorp may enter into interest rate swaps to convert
floating-rate assets and liabilities to fixed rates or to hedge certain
forecasted transactions. The assets or liabilities are typically
grouped and share the same risk exposure for which they are
being hedged. The Bancorp may also enter into interest rate caps
and floors to limit cash flow variability of floating rate assets and
liabilities. As of December 31, 2008, all hedges designated as cash
flow hedges are assessed for effectiveness using regression
analysis. Ineffectiveness is generally measured as the amount by
which the cumulative change in the fair value of the hedging
instrument exceeds the present value of the cumulative change in
the hedged item’s expected cash flows. Ineffectiveness is reported
within other noninterest income in the Consolidated Statements
of Income.
The effective portion of the gains or losses on derivative
contracts are reported within accumulated other comprehensive
income and are reclassified from accumulated other
comprehensive income to current period earnings when the
forecasted transaction affects earnings. Reclassified gains and
losses on interest rate floors related to commercial loans and
interest rate caps related to debt are recorded within interest
income and interest expense, respectively. As of December 31,
2008, $88 million of net deferred gains on cash flow hedges are
recorded in accumulated other comprehensive income. As of
December 31, 2008, $47 million in net deferred gains, net of tax,
recorded in accumulated other comprehensive income are
expected to be reclassified into earnings during the next twelve
months.
The following table presents the net gains (losses) recorded
in the Consolidated Statements of Income and accumulated other
comprehensive income relating to cash flow derivative
instruments. Included in the ineffectiveness for the year ended
December 31, 2007 are certain terminated interest rate swaps
previously designated as cash flow hedges. In conjunction with
this termination, the Bancorp reclassified $22 million of losses
into earnings as it was determined that the original forecasted
transaction was no longer probable of occurring by the end of the
originally specified time period or within the additional period of
time as defined in SFAS No. 133.
For the year ended December 31:
Amount of gain (loss)
recognized in OCI
Amount of gain (loss)
reclassified from OCI into net
interest income
Amount of ineffectiveness
recognized in other
noninterest income
($ in millions) 2008 2007 2006 2008 2007 2006 2008 2007 2006
Interest rate contracts $100 42 - 31 (20) 1 (21) -
The following table reflects cash flow hedges included in the Consolidated Balance Sheets as of December 31:
2008 2007
($ in millions)
Notional
Amount Fair Value
Notional
Amount Fair Value
Included in other assets:
Interest rate floors related to commercial loans $1,500 $216 1,500 107
Interest rate caps related to debt 1,750 1 1,750 11
Total included in other assets $217 118
Included in other liabilities:
Interest rate swaps related to commercial loans $3,000 $22 1,000 11
Total included in other liabilities $22 11
Free-Standing Derivative Instruments – Risk Management
The Bancorp enters into foreign exchange derivative contracts to
economically hedge certain foreign denominated loans.
Derivative instruments that the Bancorp may use to economically
hedge these foreign denominated loans include foreign exchange
swaps and forward contracts. The Bancorp does not designate
these instruments against the foreign denominated loans, and
therefore, does not obtain hedge accounting treatment.
Revaluation gains and losses on such foreign currency derivative
contracts are recorded within other noninterest income in the
Consolidated Statements of Income, as are revaluation gains and
losses on foreign denominated loans.
As part of its overall risk management strategy relative to its
mortgage banking activity, the Bancorp may enter into various
free-standing derivatives (principal-only swaps, swaptions, floors,
options and interest rate swaps) to economically hedge changes in
fair value of its largely fixed-rate MSR portfolio. Principal-only
swaps hedge the mortgage-LIBOR spread because these swaps
appreciate in value as a result of tightening spreads. Principal-only
swaps also provide prepayment protection by increasing in value
when prepayment speeds increase, as opposed to MSRs that lose
value in a faster prepayment environment. Receive fixed/pay
floating interest rate swaps and swaptions increase in value when
interest rates do not increase as quickly as expected. The Bancorp
enters into forward contracts to economically hedge the change in
fair value of certain residential mortgage loans held for sale due to
changes in interest rates. The Bancorp may also enter into
forward swaps to economically hedge the change in fair value of
certain commercial mortgage loans held for sale due to changes in
interest rates. Interest rate lock commitments issued on
residential mortgage loan commitments that will be held for resale
are also considered free-standing derivative instruments and the
interest rate exposure on these commitments is economically
hedged primarily with forward contracts. Revaluation gains and
losses from free-standing derivatives related to mortgage banking
activity are recorded as a component of mortgage banking net
revenue in the Consolidated Statements of Income.
Additionally, the Bancorp occasionally may enter into free-
standing derivative instruments (options, swaptions and interest
rate swaps) in order to minimize significant fluctuations in