Fifth Third Bank 2010 Annual Report Download - page 22

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
20 Fifth Third Bancorp
CRITICAL ACCOUNTING POLICIES
The Bancorp’s Consolidated Financial Statements are prepared in
accordance with U.S. GAAP. Certain accounting policies require
management to exercise judgment in determining methodologies,
economic assumptions and estimates that may materially affect
the value of the Bancorp’s assets or liabilities and results of
operations and cash flows. The Bancorp's critical accounting
policies include the accounting for the ALLL, reserve for
unfunded commitments, income taxes, valuation of servicing
rights, fair value measurements and goodwill. No material changes
were made to the valuation techniques or models described below
during the year ended December 31, 2010.
ALLL
The Bancorp disaggregates its portfolio loans and leases into
portfolio segments for purposes of determining the ALLL. The
Bancorp’s portfolio segments include commercial, residential
mortgage, and consumer. The Bancorp further disaggregates its
portfolio segments into classes for purposes of monitoring and
assessing credit quality based on certain risk characteristics.
Classes within the commercial portfolio segment include
commercial & industrial, commercial mortgage owner-occupied,
commercial mortgage nonowner-occupied, commercial
construction, and commercial leasing. The residential mortgage
portfolio segment is also considered a class. Classes within the
consumer segment include home equity, automobile, credit card,
and other consumer loans and leases. For an analysis of the
Bancorp’s ALLL by portfolio segment and credit quality
information by class, see Note 7 of the Notes to Consolidated
Financial Statements.
Larger commercial loans included within aggregate borrower
relationship balances exceeding $1 million that exhibit probable or
observed credit weaknesses, as well as loans that have been
modified in a TDR, are subject to individual review for
impairment. The Bancorp considers the current value of collateral,
credit quality of any guarantees, the loan structure, and other
factors when evaluating whether an individual loan is impaired.
Other factors may include the industry of the borrower, size and
financial condition of the borrower, cash flow, leverage of the
borrower, and the Bancorp’s evaluation of the borrower’s
management. 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. 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 collectability 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 the
established threshold of $1 million and thus not subject to specific
allowance allocations. 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 in the residential mortgage and
consumer portfolio segments are not individually risk graded.
Rather, standard credit scoring systems and delinquency
monitoring are used to assess credit risks, and allowances are
established based on the expected net charge-offs. Loss rates are
based on the average net charge-off history by loan category.
Historical loss rates 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 reviewers.
The Bancorp’s current methodology for determining the
ALLL is based on historical loss rates, current credit grades,
specific allocation on TDRs and impaired commercial credits
above specified thresholds and other qualitative adjustments.
Allowances on individual commercial 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 recorded at fair value as of the acquisition date.
The Bancorp does not carry over the acquired company’s ALLL,
nor does the Bancorp add to its existing ALLL 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.
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 historical loss rates based on credit grade
migration. Net adjustments to the reserve for unfunded
commitments are included in other noninterest expense in the
Consolidated Statements of 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
full year. The estimated income tax expense is recorded in the
Consolidated Statements of Income.
Deferred income tax assets and liabilities are determined
using the balance sheet method and are reported in other assets
and accrued taxes, interest and expenses, respectively in the
Consolidated Balance Sheets. Under this method, the net deferred
tax asset or liability is based on the tax effects of the differences
between the book and tax basis of assets and liabilities, and
recognizes enacted changes in tax rates and laws. Deferred tax
assets are recognized to the extent they exist and are subject to a
valuation allowance based on management’s judgment that
realization is more-likely-than-not. This analysis is performed on a
quarterly basis and includes an evaluation of all positive and
negative evidence to determine whether realization is more-likely-
than-not.