Fifth Third Bank 2010 Annual Report Download - page 65

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp 63
OFF-BALANCE SHEET ARRANGEMENTS
In the ordinary course of business, the Bancorp enters into
financial transactions to extend credit and various forms of
commitments and guarantees that may be considered off-balance
sheet arrangements. These transactions involve varying elements
of market, credit and liquidity risk.
Residential Mortgage Loan Sales
Conforming residential mortgage loans sold to unrelated third
parties are generally sold with representation and warranty
recourse provisions. Such provisions include the loan’s
compliance with applicable loan criteria, including certain
documentation standards per agreements with the unrelated third
parties. Additional reasons for the Bancorp having to repurchase
the loans include appraisal standards with the collateral, fraud
related to the loan application and the rescission of mortgage
insurance. 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, 2010, and 2009, the Bancorp
maintained reserves related to these loans sold with the
representation and warranty recourse provisions totaling $85
million and $37 million, respectively.
For the years ended December 31, 2010 and 2009, the
Bancorp paid $47 million and $19 million, respectively, in the
form of make whole payments and repurchased approximately
$83 million and $61 million, respectively, of loans to satisfy third
party representation and warranty claims. Total repurchase
demand requests during 2010 were $365 million compared to
$210 million during 2009. Total outstanding repurchase demand
inventory was $162 million at December 31, 2010, compared to
$119 million at December 31, 2009.
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, 2010 and 2009, the outstanding balances on these loans sold
with credit recourse were approximately $916 million and $1.1
billion, respectively. At December 31, 2010 and 2009, the Bancorp
maintained an estimated credit loss reserve on these loans sold
with credit recourse of approximately $16 million and $21 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. For further information
on residential mortgage loans sold with recourse, see Note 18 of
the Notes to Consolidated Financial Statements.
Private Mortgage Insurance
For certain mortgage loans originated by the Bancorp, borrowers
may be required to obtain 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. During the second quarter of 2009, the
Bancorp suspended the practice of providing reinsurance of
private mortgage insurance for newly originated mortgage loans.
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 $122
million and $182 million, respectively, at December 31, 2010 and
2009. As of December 31, 2010 and 2009, the Bancorp
maintained a reserve of $42 million and $44 million, respectively,
related to exposures within the reinsurance portfolio. The reserve
was flat year over year as increases to the reserve resulting from
estimated losses outpacing paid claims were offset by a decrease
relating to a reinsurance agreement termination. In the third
quarter of 2010, the Bancorp allowed one of its third-party
insurers to terminate its reinsurance agreement with the Bancorp.
This resulted in the Bancorp releasing collateral to the insurer in
the form of investment securities and other assets with a carrying
value of $19 million, and the insurer assuming the Bancorp’s
obligations under the reinsurance agreement, resulting in a
decrease to the Bancorp’s reserve liability of $20 million and a
decrease to the Bancorp’s maximum exposure of $53 million.
Loan Securitizations
The Bancorp utilizes securitization trusts, formed by independent
third parties to facilitate the securitization process of residential
mortgage loans, certain automobile loans and other consumer
loans. During 2008, the Bancorp sold $2.7 billion of automobile
loans in three separate transactions. Each transaction isolated the
related loans through the use of a securitization trust or a conduit,
formed as QSPEs, to facilitate the securitization process in
accordance with U.S. GAAP. The QSPEs issued asset-backed
securities with varying levels of credit subordination and payment
priority. The investors in these securities have no credit recourse
to the Bancorp’s other assets for failure of debtors to pay when
due. During 2008 and 2009, required repurchases of previously
transferred automobile loans from the QSPE were immaterial to
the Bancorp’s Consolidated Financial Statements. For further
information on these automobile securitizations, see Note 12 of
the Notes to Consolidated Financial Statements.
Upon adoption on January 1, 2010 of the FASB guidance on
the accounting for QSPEs and VIEs, the Bancorp determined it
was the primary beneficiary (and therefore consolidator) of these
QSPEs. Refer to Note 1 of the Notes to Consolidated Financial
Statements for further details regarding the guidance and the
related impact of adoption by the Bancorp.
Commercial Loan Sales to a QSPE
Through 2008, the Bancorp had transferred at par, subject to
credit recourse, certain primarily floating-rate, short-term
investment grade commercial loans to a VIE, which prior to
January 1, 2010, was an unconsolidated QSPE that was wholly
owned by an independent third-party. Generally, the loans
transferred to the VIE provided a lower yield due to their
investment grade nature and, therefore, transferring these loans
allowed 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 was $771 million. These loans may have been transferred
back to the Bancorp upon the occurrence of certain specified
events. These events included borrower default on the loans
transferred, ineligible loans transferred by the Bancorp to the VIE,
the inability of the VIE to issue commercial paper, and in certain
circumstances, bankruptcy preferences initiated against underlying
borrowers. The maximum amount of credit risk in the event of
nonperformance by the underlying borrowers was approximately
equivalent to the total outstanding balance. At December 31,
2009, the Bancorp’s loss reserve related to the credit enhancement
provided to the VIE was $45 million and was recorded in other
liabilities in the Consolidated Balance Sheets. During the year