Fifth Third Bank 2009 Annual Report Download - page 58

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
56 Fifth Third Bancorp
contracts accounted for as free-standing derivatives to
economically hedge interest rate lock commitments that are also
considered free-standing derivatives. Additionally, the Bancorp
economically hedges its exposure to mortgage loans held for sale.
The Bancorp also establishes derivative contracts with major
financial institutions to economically hedge significant exposures
assumed in commercial customer accommodation derivative
contracts. Generally, these contracts have similar terms in order to
protect the Bancorp from market volatility. Credit risk arises from
the possible inability of counterparties to meet the terms of their
contracts, which the Bancorp minimizes through collateral
arrangements, approvals, limits and monitoring procedures. The
notional amount and fair values of these derivatives as of
December 31, 2009 are included in Note 12 of the Notes to
Consolidated Financial Statements.
Portfolio Loans and Leases and Interest Rate Risk
Although the Bancorp’s portfolio loans and leases contain both
fixed and floating/adjustable rate products, the rates of interest
earned by the Bancorp on the outstanding balances are generally
established for a period of time. The interest rate sensitivity of
loans and leases is directly related to the length of time the rate
earned is established. Table 47 summarizes the expected principal
cash flows of the Bancorp’s portfolio loans and leases as of
December 31, 2009. Additionally, Table 48 displays a summary of
expected principal cash flows occurring after one year, as of
December 31, 2009.
Residential Mortgage Servicing Rights and Interest Rate
Risk
The net carrying amount of the residential MSR portfolio was
$699 million and $496 million as of December 31, 2009 and 2008,
respectively. The value of servicing rights can fluctuate sharply
depending on changes in interest rates and other factors.
Generally, as interest rates decline and loans are prepaid to take
advantage of refinancing, the total value of existing servicing
rights declines because no further servicing fees are collected on
repaid loans. The Bancorp maintains a non-qualifying hedging
strategy relative to its mortgage banking activity in order to
manage a portion of the risk associated with changes in the value
of its MSR portfolio as a result of changing interest rates.
Mortgage rates declined slightly during 2009 compared to
2008. The decrease in rates caused prepayment assumptions to
increase and led to $24 million in temporary impairment of
servicing rights during the year ended December 31, 2009
compared to the $207 million in temporary impairment in 2008.
Servicing rights are deemed temporarily impaired when a
borrower’s loan rate is distinctly higher than prevailing rates.
Temporary impairment on servicing rights is reversed when the
prevailing rates return to a level commensurate with the
borrower’s loan rate. Offsetting the mortgage servicing rights
valuation, the Bancorp recognized net gains of $98 million and
$209 million on its non-qualifying hedging strategy for the years
ended December 31, 2009 and 2008, respectively. The net gains
on non-qualifying hedging strategy for 2009 and 2008 include $57
million and $120 million, respectively, of net gains on the sale of
securities. See Note 11 of the Notes to Consolidated Financial
Statements for further discussion on servicing rights and the
instruments used to hedge interest rate risk on MSRs.
Foreign Currency Risk
The Bancorp enters into foreign exchange derivative contracts to
economically hedge certain foreign denominated loans. The
derivatives are classified as free-standing instruments with the
revaluation gain or loss being recorded in other noninterest
income in the Consolidated Statements of Income. The balance of
the Bancorp’s foreign denominated loans at December 31, 2009
and 2008 was approximately $272 million and $307 million,
respectively. The Bancorp also enters into foreign exchange
contracts for the benefit of commercial customers involved in
international trade to hedge their exposure to foreign currency
fluctuations. The Bancorp has internal controls in place to help
ensure excessive risk is not being taken in providing this service to
customers. These controls include an independent determination
of currency volatility and credit equivalent exposure on these
contracts, counterparty credit approvals and country limits.
TABLE 47: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS
A
s of December 31, 2009 ($ in millions) Less than 1 year 1-5 years
Greater than 5
years Total
Commercial loans $13,178 10,245 2,260 25,683
Commercial mortgage loans 4,421 5,264 2,118 11,803
Commercial construction loans 2,081 953 750 3,784
Commercial leases 540 1,448 1,547 3,535
Subtotal - commercial 20,220 17,910 6,675 44,805
Residential mortgage loans 1,938 2,711 3,386 8,035
Home equity 1,911 5,190 5,073 12,174
Automobile loans 3,284 5,254 457 8,995
Credit card 163 1,827 - 1,990
Other consumer loans and leases 417 356 7 780
Subtotal - consumer 7,713 15,338 8,923 31,974
Total $27,933 33,248 15,598 76,779
TABLE 48: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS OCCURRING AFTER ONE YEAR
Interest Rate
A
s of December 31, 2009 ($ in millions) Fixed Floating or Adjustable
Commercial loans $3,851 8,654
Commercial mortgage loans 2,610 4,772
Commercial construction loans 733 970
Commercial leases 2,995 -
Subtotal - commercial 10,189 14,396
Residential mortgage loans 3,740 2,357
Home equity 1,831 8,432
Automobile loans 5,663 48
Credit card 1,032 795
Other consumer loans and leases 349 14
Subtotal – consumer 12,615 11,646
Total $22,804 26,042