Fifth Third Bank 2008 Annual Report Download - page 79

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fifth Third Bancorp 77
earnings and cash flows caused by interest rate volatility. The
gains and losses on these derivative contracts are recorded within
other noninterest income in the Consolidated Statements of
Income.
The net gains (losses) recorded in the Consolidated
Statements of Income relating to free-standing derivative
instruments used for risk management are summarized below:
For the year ended December 31, ($ in millions)
Consolidated Statements of
Income Caption 2008 2007 2006
Interest rate contracts:
Forward contracts related to commercial mortgage loans held for sale Corporate banking revenue ($8) (6) -
Forward contracts related residential mortgage loans held for sale Mortgage banking net revenue (17) (8) 7
Derivative instruments related to MSR portfolio Mortgage banking net revenue 89 23 (9)
Derivative instruments related to interest rate risk Other noninterest income 1(1) (20)
Foreign exchange contracts:
Foreign exchange contracts Other noninterest income 29 (19) 3
The following table reflects the notional amount and market value of free-standing derivatives used for risk management included in the
Consolidated Balance Sheets:
2008 2007
($ in millions)
Notional
Amount Fair Value
Notional
Amount Fair Value
Interest rate contracts included in other assets:
Derivative instruments related to MSR portfolio $6,028 $218 3,062 70
Derivative instruments related to held for sale mortgage loans 1,830 6 229 1
Derivative instruments related to interest rate risk 446 5 1 -
Foreign exchange contracts included in other assets:
Foreign exchange contracts 40 1 - -
Total included in other assets $230 71
Interest rate contracts included in other liabilities:
Derivative instruments related to MSR portfolio $2,505 $77 1,280 16
Derivative instruments related to held for sale mortgage loans 3,987 42 588 9
Derivative instruments related to interest rate risk 440 4 - -
Foreign exchange contracts included in other liabilities:
Foreign exchange contracts 136 2 153 1
Total included in other liabilities $125 26
Free-Standing Derivative Instruments – Customer
Accommodation
The majority of the free-standing derivative instruments the
Bancorp enters into are for the benefit of commercial customers.
These derivative contracts are not designated against specific
assets or liabilities on the Consolidated Balance Sheets or to
forecasted transactions and, therefore, do not qualify for hedge
accounting. These instruments include foreign exchange derivative
contracts entered into for the benefit of commercial customers
involved in international trade to hedge their exposure to foreign
currency fluctuations, commodity contracts to hedge such items
as natural gas and various other derivative contracts. The
Bancorp may economically hedge significant exposures related to
these derivative contracts entered into for the benefit of
customers by entering into offsetting contracts with approved,
reputable, independent counterparties with substantially matching
terms. The Bancorp hedges its interest rate exposure on
commercial customer transactions by executing offsetting swap
agreements with primary dealers. Revaluation gains and losses on
foreign exchange, commodity and other commercial customer
derivative contracts are recorded as a component of corporate
banking revenue in the Consolidated Statements of Income.
The Bancorp enters into risk participation agreements, under
which the Bancorp assumes credit exposure relating to certain
underlying interest rate derivative contracts. The Bancorp only
enters into these risk participation agreements in instances in
which the Bancorp has participated in the loan that the underlying
interest rate derivative contract was designed to hedge. The
Bancorp will make payments under these agreements if a
customer defaults on its obligation to perform under the terms of
the underlying interest rate derivative contract. As of December
31, 2008, the total notional amount was approximately $1.0 billion
and the fair value was a liability of $2 million, which is included in
interest rate contracts for customers. The Bancorp’s maximum
exposure in the risk participation agreements is contingent on the
fair value of the underlying interest rate derivative contracts in an
asset position at the time of default. The Bancorp monitors the
credit risk associated with the underlying customers in the risk
participation agreements through the same risk grading system
currently utilized for establishing loss reserves in its loan and lease
portfolio. Under this risk rating system as of December 31, 2008,
approximately $959 million in notional amount of the risk
participation agreements were classified average or better;
approximately $42 million were classified as watch-list or special
mention; and approximately $16 million were classified as
substandard. As of December 31, 2008, the risk participation
agreements had an average life of approximately 3.3 years.
The Bancorp previously offered its customers an equity-
linked certificate of deposit that had a return linked to equity
indices. Under SFAS No. 133, a certificate of deposit that pays
interest based on changes on an equity index is a hybrid
instrument that requires separation into a host contract (the
certificate of deposit) and an embedded derivative contract
(written equity call option). The Bancorp entered into an
offsetting derivative contract to economically hedge the exposure
taken through the issuance of equity-linked certificates of deposit.
Both the embedded derivative and derivative contract entered into
by the Bancorp were recorded as free-standing derivatives and
recorded at fair value with offsetting gains and losses recognized
within noninterest income in the Consolidated Statements of
Income.