Fifth Third Bank 2010 Annual Report Download - page 76

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
74 Fifth Third Bancorp
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.
The Bancorp maintains the ALLL to absorb probable loan
and lease losses inherent in its portfolio segments. The ALLL is
maintained at a level the Bancorp considers to be adequate and is
based on ongoing quarterly assessments and evaluations of the
collectibility and historical loss experience of loans and leases.
Credit losses are charged and recoveries are credited to the ALLL.
Provisions for loan and lease losses are based on the Bancorp’s
review of the historical credit loss experience and such factors
that, in management’s judgment, deserve consideration under
existing economic conditions in estimating probable credit losses.
In determining the appropriate level of the ALLL, the Bancorp
estimates losses using a range derived from “base” and
“conservative” estimates. The Bancorp’s strategy for credit risk
management includes a combination of conservative exposure
limits significantly below legal lending limits and conservative
underwriting, documentation and collections standards. The
strategy also emphasizes diversification on a geographic, industry
and customer level, regular credit examinations and quarterly
management reviews of large credit exposures and loans
experiencing deterioration of credit quality.
The Bancorp’s current methodology for determining the
ALLL is based on historical loss rates, current credit grades,
specific allocation on loans modified in a TDR and impaired
commercial credits above specified thresholds and other
qualitative adjustments. Allowances on individual commercial
loans, TDRs 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.
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 guarantor’s liquidity and
willingness to cooperate, the loan structure, and other factors
when evaluating whether an individual loan is impaired. Other
factors may include the industry and geographic region 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 collectibility 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 examiners.
The Bancorp’s primary market areas for lending are the
Midwestern and Southeastern regions of the Unites 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.
In the current year, the Bancorp has not substantively
changed any material aspect to its overall approach to determining
its ALLL for any of its portfolio segments. There have been no
material changes in criteria or estimation techniques as compared
to prior periods that impacted the determination of the current
period ALLL for any of the Bancorp’s portfolio segments.
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 credit grade migration. This process takes into
consideration the same risk elements that are analyzed in the
determination of the adequacy of the Bancorp’s ALLL, as
discussed above. Net adjustments to the reserve for unfunded
commitments are included in other noninterest expense in the
Consolidated Statements of Income.
Loan Sales and Securitizations
When the Bancorp sells loans through either securitizations or
individual loan sales in accordance with its investment policies, it
is required to assess whether the entity holding the sold or
securitized loans is a VIE and whether the Bancorp is the primary
beneficiary and therefore consolidator of that VIE. If the
Bancorp holds the power to direct activities most significant to
the economic performance of the VIE and has the obligation to
absorb losses or right to receive benefits that could potentially be
significant to the VIE, then the Bancorp will generally be deemed
the primary beneficiary of the VIE. When the Bancorp previously
sold loans into isolated trusts or conduits, it obtained one or more
subordinated tranches or other residual interests in these trusts or
conduits, as well as the servicing rights to the underlying loans. As
a result, effective with the January 1, 2010 adoption of the VIE
consolidation guidance further discussed in the Accounting and
Reporting Developments section below, the Bancorp was required
to consolidate these VIEs, and accordingly, the underlying loans
and other assets and liabilities of these VIEs are included in the
Bancorp’s Consolidated Balance Sheet as of December 31, 2010.
Prior to the January 1, 2010 adoption of the VIE
consolidation guidance referenced above, the subordinated
tranches and other residual interests in the trusts and conduits