Fifth Third Bank 2009 Annual Report Download - page 87

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fifth Third Bancorp 85
The following table reflects the change in fair value of interest rate contracts, designated as fair value hedges, as well as the change in fair value
of the related hedged items, included in the Consolidated Statements of Income:
For the year ended December 31, ($ in millions)
Consolidated Statements of
Income Caption 2009 2008 2007
Interest rate contracts:
Change in fair value of interest rate swaps hedging long-term debt Interest on long-term debt ($548) (776) 105
Change in fair value of hedged long-term debt Interest on long-term debt 538 765 (109)
Change in fair value of interest rate swaps hedging time deposits Interest on deposits 4 (19) -
Change in fair value of hedged time deposits Interest on deposits (3) 19 -
Cash Flow Hedges
The Bancorp may enter into interest rate swaps to convert
floating-rate assets and liabilities to fixed rates or to hedge certain
forecasted transactions. The assets or liabilities are typically
grouped and share the same risk exposure for which they are
being hedged. The Bancorp may also enter into interest rate caps
and floors to limit cash flow variability of floating rate assets and
liabilities. As of December 31, 2009, all hedges designated as cash
flow hedges are assessed for effectiveness using regression
analysis. Ineffectiveness is generally measured as the amount by
which the cumulative change in the fair value of the hedging
instrument exceeds the present value of the cumulative change in
the hedged item’s expected cash flows. Ineffectiveness is reported
within other noninterest income in the Consolidated Statements
of Income. The effective portion of the gains or losses on cash
flow hedges are reported within accumulated other
comprehensive income and are reclassified from accumulated
other comprehensive income to current period earnings when the
forecasted transaction affects earnings. As of December 31, 2009,
the maximum length of time over which the Bancorp is hedging
its exposure to the variability in future cash flows related to the
forecasted issuance of floating rate debt is 39 months.
Reclassified gains and losses on interest rate floors related to
commercial loans and interest rate caps related to debt are
recorded within interest income and interest expense,
respectively. As of December 31, 2009 and 2008, $105 million
and $88 million, respectively, of deferred gains, net of tax, on
cash flow hedges were recorded in accumulated other
comprehensive income. As of December 31, 2009, $73 million in
net deferred gains, net of tax, recorded in accumulated other
comprehensive income are expected to be reclassified into
earnings during the next twelve months. During the years ended
December 31, 2009 and 2008, there were no gains or losses
reclassified into earnings associated with the discontinuance of
cash flow hedges because it was probable that the original
forecasted transaction would not occur. During the year ended
December 31, 2007, $22 million of losses were reclassified into
earnings as it was determined that the original forecasted
transaction was no longer probable of occurring by the end of the
originally specified time period or within the additional period of
time as defined in U.S. GAAP.
The following table presents the net gains recorded in the
Consolidated Statements of Income and accumulated other
comprehensive income relating to derivative instruments
designated as cash flow hedges. Included in the ineffectiveness
for the year ended December 31, 2007 are certain terminated
interest rate swaps previously designated as cash flow hedges.
For the year ended December 31:
Amount of gain
recognized in OCI
Amount of gain reclassified
from OCI into net interest
income
Amount of ineffectiveness
recognized in other
noninterest income
($ in millions) 2009 2008 2007 2009 2008 2007 2009 2008 2007
Interest rate contracts $75 100 42 49 31 (1) 1 (21)
Free-Standing Derivative Instruments – Risk Management
and Other Business Purposes
The Bancorp enters into foreign exchange derivative contracts to
economically hedge certain foreign denominated loans. Derivative
instruments that the Bancorp may use to economically hedge these
foreign denominated loans include foreign exchange swaps and
forward contracts. The Bancorp does not designate these
instruments against the foreign denominated loans, and therefore,
does not obtain hedge accounting treatment. Revaluation gains and
losses on these foreign currency derivative contracts are recorded
within other noninterest income in the Consolidated Statements of
Income, as are revaluation gains and losses on foreign denominated
loans.
As part of its overall risk management strategy relative to its
mortgage banking activity, the Bancorp may enter into various free-
standing derivatives (principal-only swaps, swaptions, floors,
options and interest rate swaps) to economically hedge changes in
fair value of its largely fixed-rate MSR portfolio. Principal-only
swaps hedge the mortgage-LIBOR spread because these swaps
appreciate in value as a result of tightening spreads. Principal-only
swaps also provide prepayment protection by increasing in value
when prepayment speeds increase, as opposed to MSRs that lose
value in a faster prepayment environment. Receive fixed/pay
floating interest rate swaps and swaptions increase in value when
interest rates do not increase as quickly as expected.
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 Bancorp may also
enter into forward swaps to economically hedge the change in fair
value of certain commercial mortgage loans held for sale due to
changes in interest rates. Interest rate lock commitments issued on
residential mortgage loan commitments that will be held for sale are
also considered free-standing derivative instruments and the interest
rate exposure on these commitments is economically hedged
primarily with forward contracts. Revaluation gains and losses from
free-standing derivatives related to mortgage banking activity are
recorded as a component of mortgage banking net revenue in the
Consolidated Statements of Income.
Additionally, the Bancorp may enter into free-standing
derivative instruments (options, swaptions and interest rate swaps)
in order to minimize significant fluctuations in earnings and cash
flows caused by interest rate and prepayment volatility. The gains
and losses on these derivative contracts are recorded within other
noninterest income in the Consolidated Statements of Income.
In conjunction with the Processing Business Sale in 2009,
the Bancorp received warrants and issued put options, which are
accounted for as free-standing derivatives. Refer to Note 27 for
further discussion of significant inputs and assumptions used in the
valuation of these instruments.