Fifth Third Bank 2009 Annual Report Download - page 72

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
70 Fifth Third Bancorp
to prior periods that impacted the determination of the current
period allowance for loan and lease losses.
Reserve for Unfunded Commitments
The reserve for unfunded commitments is maintained at a level
believed by management to be sufficient to absorb estimated
probable losses related to unfunded credit facilities and is included
in other liabilities in the Consolidated Balance Sheets. The
determination of the adequacy of the reserve is based upon an
evaluation of the unfunded credit facilities, including an
assessment of historical commitment utilization experience, credit
risk grading and credit grade migration. Net adjustments to the
reserve for unfunded commitments are included in other
noninterest expense in the Consolidated Statements of Income.
Loan Sales and Securitizations
When the Bancorp sells loans through either securitizations or
individual loan sales in accordance with its investment policies, it
may obtain one or more subordinated tranches, servicing rights,
interest-only strips, credit recourse, other residual interests and in
some cases, a cash reserve account, all of which are considered
interests that continue to be held by the Bancorp in the securitized
or sold loans. Gains or losses recognized on the sale or
securitization of the loans depend in part on the previous carrying
amount of the financial assets sold or securitized. At the date of
transfer, obtained servicing rights are recorded at fair value and
the remaining carrying value of the transferred financial assets is
allocated between the assets sold and remaining interests that
continue to be held by the Bancorp based on their relative fair
values at the date of sale or securitization. See the Accounting and
Reporting Developments section of this Note for further
discussion on developments in the accounting for transfers of
financial assets.
Interests that continue to be held by the Bancorp from
securitized or sold loans, excluding servicing rights, are carried at
fair value. To obtain fair value of such interests, quoted market
prices are used, if available. If quoted prices are not available, the
Bancorp calculates fair value based on the present value of future
expected cash flows using management’s best estimates for the
key assumptions, including credit losses, prepayment speeds,
forward yield curves and discount rates commensurate with the
risks involved. Gain or loss on sale or securitization of loans is
reported as a component of noninterest income in the
Consolidated Statements of Income. Adjustments to fair value for
interests that continue to be held by the Bancorp classified as
available-for-sale securities are included in accumulated other
comprehensive income in the Consolidated Balance Sheets or in
noninterest income in the Consolidated Statements of Income if
the fair value has declined below the carrying amount and such
decline has been determined to be other-than-temporary.
Adjustments to fair value for interests that continue to be held by
the Bancorp classified as trading securities are recorded within
other noninterest income in the Consolidated Statements of
Income.
Servicing rights resulting from residential mortgage and
commercial loan sales are initially recorded at fair value and
subsequently amortized in proportion to and over the period of
estimated net servicing revenues and are reported as a component
of mortgage banking net revenue and corporate banking revenue,
respectively, in the Consolidated Statements of Income. Servicing
rights are assessed for impairment monthly, based on fair value,
with temporary impairment recognized through a valuation
allowance and permanent impairment recognized through a write-
off of the servicing asset and related valuation allowance. Key
economic assumptions used in measuring any potential
impairment of the servicing rights include the prepayment speeds
of the underlying loans, the weighted-average life, the discount
rate, the weighted-average coupon and the weighted-average
default rate, as applicable. The primary risk of material changes to
the value of the servicing rights resides in the potential volatility in
the economic assumptions used, particularly the prepayment
speeds. The Bancorp monitors risk and adjusts its valuation
allowance as necessary to adequately reserve for impairment in the
servicing portfolio. For purposes of measuring impairment, the
mortgage servicing rights are stratified into classes based on the
financial asset type (fixed-rate vs. adjustable-rate) and interest
rates. Fees received for servicing loans owned by investors are
based on a percentage of the outstanding monthly principal
balance of such loans and are included in noninterest income in
the Consolidated Statements of Income as loan payments are
received. Costs of servicing loans are charged to expense as
incurred.
Bank Premises and Equipment
Bank premises and equipment, including leasehold improvements,
are carried at cost less accumulated depreciation and amortization.
Depreciation is calculated using the straight-line method based on
estimated useful lives of the assets for book purposes, while
accelerated depreciation is used for income tax purposes.
Amortization of leasehold improvements is computed using the
straight-line method over the lives of the related leases or useful
lives of the related assets, whichever is shorter. The Bancorp tests
its long-lived assets for impairment through both a probability-
weighted and primary-asset approach whenever events or changes
in circumstances dictate. Maintenance, repairs and minor
improvements are charged to noninterest expense in the
Consolidated Statements of Income as incurred.
Derivative Financial Instruments
The Bancorp accounts for its derivatives as either assets or
liabilities measured at fair value through adjustments to
accumulated other comprehensive income and/or current
earnings, as appropriate. On the date the Bancorp enters into a
derivative contract, the Bancorp designates the derivative
instrument as either a fair value hedge, cash flow hedge or as a
free-standing derivative instrument. For a fair value hedge,
changes in the fair value of the derivative instrument and changes
in the fair value of the hedged asset or liability or of an
unrecognized firm commitment attributable to the hedged risk are
recorded in current period net income. For a cash flow hedge,
changes in the fair value of the derivative instrument, to the extent
that it is effective, are recorded in accumulated other
comprehensive income and subsequently reclassified to net
income in the same period(s) that the hedged transaction impacts
net income. For free-standing derivative instruments, changes in
fair values are reported in current period net income.
Prior to entering into a hedge transaction, the Bancorp
formally documents the relationship between hedging instruments
and hedged items, as well as the risk management objective and
strategy for undertaking various hedge transactions. This process
includes linking all derivative instruments that are designated as
fair value or cash flow hedges to specific assets or liabilities on the
balance sheet or to specific forecasted transactions, along with a
formal assessment at both inception of the hedge and on an
ongoing basis as to the effectiveness of the derivative instrument
in offsetting changes in fair values or cash flows of the hedged
item. If it is determined that the derivative instrument is not
highly effective as a hedge, hedge accounting is discontinued and
the adjustment to fair value of the derivative instrument is
recorded in net income.
Income Taxes
The Bancorp estimates income tax expense based on amounts
expected to be owed to the various tax jurisdictions in which the
Bancorp conducts business. On a quarterly basis, management
assesses the reasonableness of its effective tax rate based upon its
current estimate of the amount and components of net income,
tax credits and the applicable statutory tax rates expected for the