Fifth Third Bank 2010 Annual Report Download - page 105

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fifth Third Bancorp 103
million of commercial paper issued by the VIE, representing 87%
of the VIE’s total commercial paper then outstanding. Effective
January 1, 2010 with the adoption of amended accounting
guidance regarding the consolidation of VIEs, the Bancorp was
required to consolidate the assets and liabilities of this VIE. See
Note 1 for further information on the amended accounting
guidance.
Margin accounts
FTS, a subsidiary of the Bancorp, guarantees the collection of all
margin account balances held by its brokerage clearing agent for
the benefit of its customers. FTS is responsible for payment to its
brokerage clearing agent for any loss, liability, damage, cost or
expense incurred as a result of customers failing to comply with
margin or margin maintenance calls on all margin accounts. The
margin account balance held by the brokerage clearing agent was
$10 million and $8 million at December 31, 2010 and 2009,
respectively. In the event of any customer default, FTS has rights
to the underlying collateral provided. Given the existence of the
underlying collateral provided and negligible historical credit
losses, the Bancorp does not maintain a loss reserve related to the
margin accounts.
Long-term borrowing obligations
The Bancorp had fully and unconditionally guaranteed certain
long-term borrowing obligations issued by wholly-owned issuing
trust entities with a carrying value of $2.9 billion and $2.8 billion
as of December 31, 2010 and 2009, respectively. See Note 17 for
further information on these long-term borrowing obligations.
Visa litigation
The Bancorp, as a member bank of Visa prior to Visa’s
reorganization and initial public offerings of its Class A common
shares in 2008, had certain indemnification obligations pursuant to
Visa’s certificate of incorporation and by-laws and in accordance
with their membership agreements. In accordance with Visa’s by-
laws prior to the IPO, the Bancorp could have been required to
indemnify Visa for the Bancorp’s proportional share of losses
based on the pre-IPO membership interests. As part of its
reorganization and IPO, the Bancorp’s indemnification obligation
was modified to include only certain known litigation (the
“Covered Litigation”) as of the date of the restructuring. This
modification triggered a requirement to recognize a $3 million
liability for the year ended December 31, 2007 equal to the fair
value of the indemnification obligation. Additionally during 2007,
the Bancorp recorded $169 million for its share of litigation
formally settled by Visa and for probable future litigation
settlements. In conjunction with the IPO, the Bancorp received
10.1 million of Visa’s Class B shares based on the Bancorp’s
membership percentage in Visa prior to the IPO. The Class B
shares are not transferable (other than to another member bank)
until the later of the third anniversary of the IPO closing or the
date which the Covered Litigation has been resolved; therefore,
the Bancorp’s Class B shares were classified in other assets and
accounted for at their carryover basis of $0. Visa deposited $3
billion of the proceeds from the IPO into a litigation escrow
account, established for the purpose of funding judgments in, or
settlements of, the Covered Litigation. If Visa’s litigation
committee determines that the escrow account is insufficient, then
Visa will issue additional Class A shares and deposit the proceeds
from the sale of the shares into the litigation escrow account.
When Visa funds the litigation escrow account, the Class B shares
are subject to dilution through an adjustment in the conversion
rate of Class B shares into Class A shares. During 2008, the
Bancorp recorded additional reserves of $71 million for probable
future settlements related to the Covered Litigation and recorded
its proportional share of $169 million of the Visa escrow account
net against the Bancorp’s litigation reserve.
During 2009, Visa announced it had deposited an additional
$700 million into the litigation escrow account. As a result of this
funding, the Bancorp recorded its proportional share of $29
million of these additional funds as a reduction to its net Visa
litigation reserve liability and a reduction to noninterest expense.
Later in 2009, the Bancorp completed the sale of its Visa, Inc.
Class B shares for proceeds of $300 million. As part of this
transaction the Bancorp entered into a total return swap in which
the Bancorp will make or receive payments based on subsequent
changes in the conversion rate of the Class B shares into Class A
shares. The swap terminates on the later of the third anniversary
of Visa’s IPO or the date on which the Covered Litigation is
finally settled. The Bancorp calculates the fair value of the swap
based on its estimate of the probability and timing of certain
Covered Litigation settlement scenarios and the resulting
payments related to the swap. The counterparty to the swap as a
result of its ownership of the Class B shares will be impacted by
dilutive adjustments to the conversion rate of the Class B shares
into Class A shares caused by any Covered Litigation losses in
excess of the litigation escrow account. If actual judgments in, or
settlements of, the Covered Litigation significantly exceed current
expectations, then additional funding by Visa of the litigation
escrow account and the resulting dilution of the Class B shares
could result in a scenario where the Bancorp’s ultimate exposure
associated with the Covered Litigation (the “Visa Litigation
Exposure”) exceeds the value of the Class B shares owned by the
swap counterparty (the “Class B Value”). In the event the
Bancorp concludes that it is probable that the Visa Litigation
Exposure exceeds the Class B Value, the Bancorp would record a
litigation reserve liability and a corresponding amount of other
noninterest expense for the amount of the excess. Any such
litigation reserve liability would be separate and distinct from the
fair value derivative liability associated with the total return swap.
As of the date of the Bancorp’s sale of Visa Class B shares
and through December 31, 2010, the Bancorp has concluded that
it is not probable that the Visa Covered Litigation Exposure will
exceed the Class B Value. Based on this determination, upon the
sale of Class B shares, the Bancorp reversed its net Visa litigation
reserve liability and recognized a free-standing derivative liability
associated with the total return swap with an initial fair value of
$55 million. The sale of the Class B shares, recognition of the
derivative liability and reversal of the net litigation reserve liability
resulted in a pre-tax benefit of $288 million ($187 million after-
tax) recognized by the Bancorp for the year ended December 31,
2009. In the second quarter of 2010, Visa funded an additional
$500 million into the escrow account which resulted in further
dilution in the conversion of Class B shares into Class A shares
and required the Bancorp to make a $20 million cash payment
(which reduced the swap liability) to the swap counterparty in
accordance with the terms of the swap contract. In the fourth
quarter of 2010, Visa funded an additional $800 million into the
litigation escrow account which resulted in further dilution in the
conversion of Class B shares into Class A shares and required the
Bancorp to make a $35 million cash payment (which reduced the
swap liability) to the swap counterparty in accordance with the
terms of the swap contract. The fair value of the swap liability was
$18 million and $55 million as of December 31, 2010 and 2009,
respectively.