Fifth Third Bank 2010 Annual Report Download - page 61

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp 59
strategy include interest rate swaps, interest rate floors, interest
rate caps, forward contracts, principal only swaps, options and
swaptions.
As part of its overall risk management strategy relative to its
mortgage banking activity, the Bancorp enters into forward
contracts accounted for as free-standing derivatives to
economically hedge interest rate lock commitments that are also
considered free-standing derivatives. Additionally, the Bancorp
economically hedges its exposure to mortgage loans held for sale.
The Bancorp also establishes derivative contracts with major
financial institutions to economically hedge significant exposures
assumed in commercial customer accommodation derivative
contracts. Generally, these contracts have similar terms in order to
protect the Bancorp from market volatility. Credit risk arises from
the possible inability of counterparties to meet the terms of their
contracts, which the Bancorp minimizes through collateral
arrangements, approvals, limits and monitoring procedures. See
Note 14 of the Notes to Consolidated Financial Statements for
further information on these derivatives.
Portfolio Loans and Leases and Interest Rate Risk
Although the Bancorp’s portfolio loans and leases contain both
fixed and floating/adjustable rate products, the rates of interest
earned by the Bancorp on the outstanding balances are generally
established for a period of time. The interest rate sensitivity of
loans and leases is directly related to the length of time the rate
earned is established. Table 44 displays the expected principal cash
flows of the Bancorp’s portfolio loans and leases as of December
31, 2010. Table 45 displays a summary of expected principal cash
flows occurring after one year as of December 31, 2010.
Residential Mortgage Servicing Rights and Interest Rate Risk
The net carrying amount of the residential MSR portfolio was
$822 million and $699 million as of December 31, 2010 and 2009,
respectively. The value of servicing rights can fluctuate sharply
depending on changes in interest rates and other factors.
Generally, as interest rates decline and loans are prepaid to take
advantage of refinancing, the total value of existing servicing
rights declines because no further servicing fees are collected on
repaid loans. The Bancorp maintains a non-qualifying hedging
strategy relative to its mortgage banking activity in order to
manage a portion of the risk associated with changes in the value
of its MSR portfolio as a result of changing interest rates.
Mortgage rates declined during 2010 and 2009. The decrease
in rates caused prepayment assumptions to increase and led to $36
million in temporary impairment of servicing rights during the
year ended December 31, 2010 compared to $24 million in
temporary impairment in 2009. Servicing rights are deemed
temporarily impaired when a borrower’s loan rate is distinctly
higher than prevailing rates. Temporary impairment on servicing
rights is reversed when the prevailing rates return to a level
commensurate with the borrower’s loan rate. Offsetting the
mortgage servicing rights valuation, the Bancorp recognized net
gains of $123 million and $98 million on its non-qualifying
hedging strategy for the years ended December 31, 2010 and
2009, respectively. The net gains from the Bancorp’s non-
qualifying hedging strategy for 2010 and 2009 include $14 million
and $57 million, respectively, of net gains on the sale of securities.
See Note 13 of the Notes to Consolidated Financial Statements
for further discussion on servicing rights.
Foreign Currency Risk
The Bancorp enters into foreign exchange derivative contracts to
economically hedge certain foreign denominated loans. The
derivatives are classified as free-standing instruments with the
revaluation gain or loss being recorded in other noninterest
income in the Consolidated Statements of Income. The balance of
the Bancorp’s foreign denominated loans at December 31, 2010
and 2009 was approximately $283 million and $272 million,
respectively. The Bancorp also enters into foreign exchange
contracts for the benefit of commercial customers involved in
international trade to hedge their exposure to foreign currency
fluctuations. The Bancorp has internal controls in place to help
ensure excessive risk is not being taken in providing this service to
customers. These controls include an independent determination
of currency volatility and credit equivalent exposure on these
contracts, counterparty credit approvals and country limits.
TABLE 44: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS
A
s of December 31, 2010 ($ in millions) Less than 1 year 1-5 years Over 5 years Total
Commercial and industrial loans $9,755 14,794 2,642 27,191
Commercial mortgage loans 5,414 4,390 1,041 10,845
Commercial construction loans 1,146 655 247 2,048
Commercial leases 522 1,365 1,491 3,378
Subtotal – commercial 16,837 21,204 5,421 43,462
Residential mortgage loans 1,437 3,544 3,975 8,956
Home equity 1,656 4,241 5,616 11,513
Automobile loans 4,324 6,399 260 10,983
Credit card 191 1,705 - 1,896
Other consumer loans and leases 517 160 4 681
Subtotal – consumer 8,125 16,049 9,855 34,029
Total $24,962 37,253 15,276 77,491
TABLE 45: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS OCCURRING AFTER ONE YEAR
Interest Rate
A
s of December 31, 2010 ($ in millions) Fixed Floating or Adjustable
Commercial and industrial loans $3,350 14,086
Commercial mortgage loans 1,934 3,497
Commercial construction loans 259 643
Commercial leases 2,856 -
Subtotal - commercial 8,399 18,226
Residential mortgage loans 5,127 2,392
Home equity 1,472 8,385
Automobile loans 6,601 58
Credit card 770 935
Other consumer loans and leases 128 36
Subtotal – consumer 14,098 11,806
Total $22,497 30,032