Fifth Third Bank 2009 Annual Report Download - page 93

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fifth Third Bancorp 91
The Bancorp monitors the credit risk associated with the standby
letters of credit using the same dual risk rating system utilized for
estimating probabilities of default within its loan and lease
portfolio. Under this risk rating as of December 31, 2009,
approximately $5.0 billion of the standby letters of credit were
classified as average or better; approximately $1.3 billion were
classified as watch-list or special mention; and approximately $357
million were classified as either substandard or doubtful.
At December 31, 2009 and 2008, the Bancorp had
outstanding letters of credit that were supporting certain securities
issued as variable rate demand notes (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. As of December 31, 2009 and 2008,
Fifth Third Securities, Inc. (FTS) acted as the remarketing agent to
issuers on approximately $3.4 billion and $4.2 billion, respectively,
of VRDNs. 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 $936 million and
$2.0 billion in VRDNs remarketed by third parties at December
31, 2009 and 2008, respectively. These letters of credit are
included in the total letters of credit balance provided in the
previous table. At December 31, 2009 and 2008, FTS held $47
million and $388 million, respectively, of these VRDN’s in its
portfolio and classified them as trading securities. The Bancorp
purchased $188 million and $752 million of the VRDNs from the
market, through FTS, and held them in its trading securities
portfolio at December 31, 2009 and 2008, respectively. 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 $45
million and $173 million of letters of credit issued by the Bancorp
at December 31, 2009 and 2008, respectively. The Bancorp
recorded these draws as commercial loans in its Consolidated
Balance Sheets.
Forward contracts to sell mortgage loans
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 $3.6 billion and $3.2
billion as of December 31, 2009 and December 31, 2008,
respectively.
Noncancelable lease obligations
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
Private mortgage reinsurance
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 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 $182 million and
$170 million, respectively, at December 31, 2009 and 2008. As of
December 31, 2009 and 2008, the Bancorp maintained a reserve
of $44 million and $13 million, respectively, related to exposures
within the reinsurance portfolio. During the second quarter of
2009, the Bancorp suspended the practice of providing
reinsurance of private mortgage insurance for newly originated
mortgage loans.
Legal claims
There are legal claims pending against the Bancorp and its
subsidiaries that have arisen in the normal course of business. See
Note 17 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 as discussed in the following sections.
Residential mortgage loans sold with recourse
The Bancorp previously sold certain residential mortgage loans in
the secondary market with credit recourse. In the event of any
customer default, pursuant to the credit recourse provided, the
Bancorp is required to reimburse the third party. The maximum
amount of credit risk in the event of nonperformance by the
underlying borrowers is equivalent to the total outstanding
balance. In the event of nonperformance, the Bancorp has rights
to the underlying collateral value securing the loan. At December
31, 2009 and 2008, the outstanding balances on these loans sold
with credit recourse were approximately $1.1 billion and $1.3
billion, respectively, and the delinquency rates were approximately
8.10% and 6.40%, respectively. At December 31, 2009 and 2008,
the Bancorp maintained an estimated credit loss reserve on these
loans sold with credit recourse of approximately $21 million and
$20 million, respectively, 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 of
residential mortgage loans held in its loan portfolio. In addition,
conforming residential mortgage loans sold to unrelated third
parties are generally sold with representation and warranty
recourse provisions. Under these provisions, the Bancorp is
required to repurchase any previously sold loan for which the
representation or warranty of the Bancorp proves to be
inaccurate, incomplete or misleading. As of December 31, 2009
and 2008, the Bancorp maintained a reserve related to these loans
sold with the representation and warranty recourse provision of
$17 million and $6 million, respectively.
Liquidity support and credit enhancement provided to an unconsolidated
QSPE
Through 2008, the Bancorp had transferred at par, 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 Bancorp
did not transfer any new loans to the QSPE during the year ended
December 31, 2009. No gains or losses were recognized on the
transfers to the QSPE for the year December 31, 2008. Generally,
the loans transferred provide a lower yield due to their investment
grade nature and, therefore, transferring these loans to the QSPE
allows the Bancorp to reduce its interest rate exposure to these
lower yielding loan assets while maintaining the customer
relationships. The outstanding balance of these loans at December
31, 2009 and 2008 was $771 million and $1.9 billion, respectively.
As of December 31, 2009, the loans transferred had a weighted