Fifth Third Bank 2009 Annual Report Download - page 71

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fifth Third Bancorp 69
Loan and lease origination and commitment fees and direct
loan and lease origination costs are deferred and the net amount is
amortized over the estimated life of the related loans, leases or
commitments as a yield adjustment.
Direct financing leases are carried at the aggregate of lease
payments plus estimated residual value of the leased property, less
unearned income. Interest income on direct financing leases is
recognized over the term of the lease to achieve a constant
periodic rate of return on the outstanding investment. Interest
income on leveraged leases is recognized over the term of the
lease to achieve a constant rate of return on the outstanding
investment in the lease, net of the related deferred income tax
liability, in the years in which the net investment is positive.
Conforming fixed rate residential mortgage loans are typically
classified as held for sale upon origination based upon
management’s intent to sell all the production of these loans. The
Bancorp has elected to measure residential mortgage loans held
for sale under the fair value option as allowed under U.S. GAAP.
Management’s intent to sell residential mortgage loans classified as
held for sale may change over time due to such factors as changes
in the overall liquidity in markets or changes in characteristics
specific to certain loans held for sale. Consequently, these loans
may be reclassified to loans held for investment and maintained in
the Bancorp’s loan portfolio. In such cases, the loans will continue
to be measured at fair value. All other loans held for sale continue
to be valued at the lower of cost or market. For residential
mortgage loans held for sale, fair value is estimated based upon
mortgage-backed securities prices and spreads to those prices or,
for certain loans, discounted cash flow models that may
incorporate the anticipated portfolio composition, credit spreads
of asset-backed securities with similar collateral, and market
conditions. These fair value marks are recorded to income in
mortgage banking net revenue. The Bancorp generally has
commitments to sell residential mortgage loans held for sale in the
secondary market. Gains or losses on sales are recognized in
mortgage banking net revenue upon delivery.
Impaired loans and leases are measured based on the present
value of expected future cash flows discounted at the loan’s
effective interest rate, the fair value of the underlying collateral or
readily observable secondary market values. The Bancorp
evaluates the collectibility of both principal and interest when
assessing the need for a loss accrual.
Other Real Estate Owned
Other real estate owned (OREO), which is included in other
assets, represents property acquired through foreclosure or other
proceedings. OREO is carried at the lower of cost or fair value,
less costs to sell. All property is periodically evaluated and
decreases in carrying value are recognized as reductions in other
noninterest income in the Consolidated Statements of Income.
Allowance for Loan and Lease Losses
The Bancorp maintains an allowance to absorb probable loan and
lease losses inherent in the portfolio. The allowance is maintained
at a level the Bancorp considers to be adequate and is based on
ongoing quarterly assessments and evaluations of the collectibility
and historical loss experience of loans and leases. Credit losses are
charged and recoveries are credited to the allowance. Provisions
for loan and lease losses are based on the Bancorp’s review of the
historical credit loss experience and such factors that, in
management’s judgment, deserve consideration under existing
economic conditions in estimating probable credit losses. In
determining the appropriate level of the allowance, the Bancorp
estimates losses using a range derived from “base” and
“conservative” estimates. The Bancorp's strategy for credit risk
management includes a combination of conservative exposure
limits significantly below legal lending limits and conservative
underwriting, documentation and collections standards. The
strategy also emphasizes diversification on a geographic, industry
and customer level, regular credit examinations and quarterly
management reviews of large credit exposures and loans
experiencing deterioration of credit quality.
Larger commercial loans that exhibit probable or observed
credit weaknesses are subject to individual review. When
individual loans are impaired, allowances are determined based on
management’s estimate of the borrower’s ability to repay the loan
given the availability of collateral, other sources of cash flow, as
well as evaluation of legal options available to the Bancorp. Any
allowances for impaired loans are measured based on the present
value of expected future cash flows discounted at the loan’s
effective interest rate, fair value of the underlying collateral or
readily observable secondary market values. The Bancorp
evaluates the collectibility of both principal and interest when
assessing the need for a loss accrual. Historical credit loss rates
are applied to commercial loans that are not impaired or are
impaired, but smaller than an established threshold and thus not
subject to individual review. The loss rates are derived from a
migration analysis, which tracks the historical net charge-off
experience sustained on loans according to their internal risk
grade. The risk grading system currently utilized for allowance
analysis purposes encompasses ten categories.
Homogenous loans and leases, such as consumer installment,
revolving and residential mortgage loans, are not individually risk
graded. Rather, standard credit scoring systems and delinquency
monitoring are used to assess credit risks. Allowances are
established for each pool of loans based on the expected net
charge-offs. Loss rates are based on the average net charge-off
history by loan category. Historical loss rates for commercial and
consumer loans may be adjusted for significant factors that, in
management’s judgment, are necessary to reflect losses inherent in
the portfolio. Factors that management considers in the analysis
include the effects of the national and local economies; trends in
the nature and volume of delinquencies, charge-offs and
nonaccrual loans; changes in loan mix; credit score migration
comparisons; asset quality trends; risk management and loan
administration; changes in the internal lending policies and credit
standards; collection practices; and examination results from bank
regulatory agencies and the Bancorp’s internal credit examiners.
The Bancorp’s current methodology for determining the
allowance for loan and lease losses is based on historical loss rates,
current credit grades, specific allocation on impaired commercial
credits above specified thresholds and other qualitative
adjustments. Allowances on individual loans and historical loss
rates are reviewed quarterly and adjusted as necessary based on
changing borrower and/or collateral conditions and actual
collection and charge-off experience. An unallocated allowance is
maintained to recognize the imprecision in estimating and
measuring losses when evaluating allowances for individual loans
or pools of loans.
Loans acquired by the Bancorp through a purchase business
combination are evaluated for possible credit impairment at
acquisition. Reductions to the carrying value of the acquired loans
as a result of credit impairment are recorded as an adjustment to
goodwill. The Bancorp does not carry over the acquired
company’s allowance for loan and lease losses, nor does the
Bancorp add to its existing allowance for the acquired loans as
part of purchase accounting.
The Bancorp’s primary market areas for lending are the
Midwestern and Southeastern regions of the United States. When
evaluating the adequacy of allowances, consideration is given to
these regional geographic concentrations and the closely
associated effect changing economic conditions have on the
Bancorp’s customers.
In the current year, the Bancorp has not substantively
changed any material aspect to its overall approach to determining
its allowance for loan and lease losses. There have been no
material changes in criteria or estimation techniques as compared