Fifth Third Bank 2008 Annual Report Download - page 84

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
82 Fifth Third Bancorp
estimating probabilities of default within its loan and lease
portfolio. Under this risk rating as of December 31, 2008,
approximately $7.4 billion of the standby letters of credit were
classified as average or better; approximately $1.2 billion were
classified as watch-list or special mention; and approximately $300
million were classified as substandard.
At December 31, 2008, the Bancorp had outstanding letters
of credit that were supporting certain securities issued as VRDNs.
The Bancorp facilitates financing for its commercial customers,
which consist of companies and municipalities, by marketing the
VRDNs to investors. The VRDNs pay interest to holders at a
rate of interest that fluctuates based upon market demand. The
VRDNs generally have long-term maturity dates, but can be
tendered by the holder for purchase at par value upon proper
advance notice. When the VRDNs are tendered, a remarketing
agent generally finds another investor to purchase the VRDNs to
keep the securities outstanding in the market. FTS acts as the
remarketing agent to issuers on approximately $4.2 billion of
VRDNs at December 31, 2008. As remarketing agent, FTS is
responsible for finding purchasers for VRDNs that are put by
investors. The Bancorp issues letters of credit, as a credit
enhancement, to the VRDNs remarketed by FTS, in addition to
approximately $2.0 billion in VRDNs remarketed by third parties
at December 31, 2008. These letters of credit are included in the
total letters of credit balance provided in the previous table. At
December 31, 2008, FTS held $388 million of these securities in
its portfolio and classified them as trading securities. The
Bancorp purchased $756 million of the VRDNs from the market,
through FTS, and held them in its trading securities portfolio at
December 31, 2008. For the VRDNs remarketed by third parties,
in some cases, the remarketing agent has failed to remarket the
securities and has instructed the indenture trustee to draw upon
approximately $173 million of letters of credit issued by the
Bancorp. The Bancorp recorded these draws as commercial loans
in its Consolidated Balance Sheets at December 31, 2008.
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 outstanding
notional amounts of these forward contracts were $3.2 billion, and
$1.5 billion as of December 31, 2008 and 2007, respectively.
The Bancorp’s subsidiaries have entered into a number of
noncancelable lease agreements. The minimum rental
commitments under noncancelable lease agreements are shown in
the previous table. The Bancorp or its subsidiaries have also
entered into a limited number of agreements for work related to
banking center construction and to purchase goods or services.
Contingent Liabilities
The Bancorp, through its electronic payment processing division,
processes VISA® and MasterCard® merchant card transactions.
Pursuant to VISA® and MasterCard® rules, the Bancorp assumes
certain contingent liabilities relating to these transactions which
typically arise from billing disputes between the merchant and
cardholder that are ultimately resolved in the cardholder’s favor.
In such cases, these transactions are “charged-back” to the
merchant and disputed amounts are refunded to the cardholder. If
the Bancorp is unable to collect these amounts from the
merchant, it will bear the loss for refunded amounts. The
likelihood of incurring a contingent liability arising from
chargebacks is relatively low, as most products or services are
delivered when purchased and credits are issued on returned
items. For the years ended December 31, 2008 and 2007, the
Bancorp processed approximately $133 million and $126 million,
respectively, of chargebacks presented by issuing banks, resulting
in no material losses to the Bancorp. The Bancorp accrues for
probable losses based on historical experience and did not carry a
credit loss reserve related to such chargebacks at December 31,
2008 and 2007.
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.
There are legal claims pending against the Bancorp and its
subsidiaries that have arisen in the normal course of business. See
Note 16 for additional information regarding these proceedings.
Guarantees
The Bancorp has performance obligations upon the occurrence of
certain events under financial guarantees provided in certain
contractual arrangements.
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.
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.
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