Fifth Third Bank 2010 Annual Report Download - page 77

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fifth Third Bancorp 75
referenced above were carried at fair value and included in
available-for-sale securities. The fair value of such interests were
based on quoted market prices, if available. If quoted prices were
not available, fair value was based on the present value of future
expected cash flows using management’s best estimates for the
key assumptions, including credit losses, prepayment speeds,
forward yield curves and discount rates commensurate with the
risks involved. Gains or losses recognized on the sale or
securitization of such loans prior to January 1, 2010 were reported
as a component of noninterest income in the Consolidated
Statements of Income and were based on the previous carrying
amount of the loans sold or securitized, as well as the fair value of
the servicing rights and other interests obtained by the Bancorp at
the date of sale or securitization. Adjustments to the fair value of
such interests prior to January 1, 2010 were included in
accumulated other comprehensive income in the Consolidated
Balance Sheets or in noninterest income in the Consolidated
Statements of Income if the fair value had declined below the
carrying amount and such decline was determined to be other-
than-temporary.
Servicing rights resulting from residential mortgage and
commercial loan sales are initially recorded at fair value and
subsequently amortized in proportion to and over the period of
estimated net servicing revenues and are reported as a component
of mortgage banking net revenue and corporate banking revenue,
respectively, in the Consolidated Statements of Income. Servicing
rights are assessed for impairment monthly, based on fair value,
with temporary impairment recognized through a valuation
allowance and permanent impairment recognized through a write-
off of the servicing asset and related valuation allowance. Key
economic assumptions used in measuring any potential
impairment of the servicing rights include the prepayment speeds
of the underlying loans, the weighted-average life, the discount
rate, the weighted-average coupon and the weighted-average
default rate, as applicable. The primary risk of material changes to
the value of the servicing rights resides in the potential volatility in
the economic assumptions used, particularly the prepayment
speeds. The Bancorp monitors risk and adjusts its valuation
allowance as necessary to adequately reserve for impairment in the
servicing portfolio. For purposes of measuring impairment, the
mortgage servicing rights are stratified into classes based on the
financial asset type (fixed-rate vs. adjustable-rate) and interest
rates. Fees received for servicing loans owned by investors are
based on a percentage of the outstanding monthly principal
balance of such loans and are included in noninterest income in
the Consolidated Statements of Income as loan payments are
received. Costs of servicing loans are charged to expense as
incurred.
Bank Premises and Equipment
Bank premises and equipment, including leasehold improvements,
are carried at cost less accumulated depreciation and amortization.
Depreciation is calculated using the straight-line method based on
estimated useful lives of the assets for book purposes, while
accelerated depreciation is used for income tax purposes.
Amortization of leasehold improvements is computed using the
straight-line method over the lives of the related leases or useful
lives of the related assets, whichever is shorter. The Bancorp tests
its long-lived assets for impairment through both a probability-
weighted and primary-asset approach whenever events or changes
in circumstances dictate. Maintenance, repairs and minor
improvements are charged to noninterest expense in the
Consolidated Statements of Income as incurred.
Derivative Financial Instruments
The Bancorp accounts for its derivatives as either assets or
liabilities measured at fair value through adjustments to
accumulated other comprehensive income and/or current
earnings, as appropriate. On the date the Bancorp enters into a
derivative contract, the Bancorp designates the derivative
instrument as either a fair value hedge, cash flow hedge or as a
free-standing derivative instrument. For a fair value hedge,
changes in the fair value of the derivative instrument and changes
in the fair value of the hedged asset or liability or of an
unrecognized firm commitment attributable to the hedged risk are
recorded in current period net income. For a cash flow hedge,
changes in the fair value of the derivative instrument, to the extent
that it is effective, are recorded in accumulated other
comprehensive income and subsequently reclassified to net
income in the same period(s) that the hedged transaction impacts
net income. For free-standing derivative instruments, changes in
fair values are reported in current period net income.
Prior to entering into a hedge transaction, the Bancorp
formally documents the relationship between hedging instruments
and hedged items, as well as the risk management objective and
strategy for undertaking various hedge transactions. This process
includes linking all derivative instruments that are designated as
fair value or cash flow hedges to specific assets or liabilities on the
balance sheet or to specific forecasted transactions, along with a
formal assessment at both inception of the hedge and on an
ongoing basis as to the effectiveness of the derivative instrument
in offsetting changes in fair values or cash flows of the hedged
item. If it is determined that the derivative instrument is not
highly effective as a hedge, hedge accounting is discontinued and
the adjustment to fair value of the derivative instrument is
recorded in net 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
reflects 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.
Accrued taxes represent the net estimated amount due to
taxing jurisdictions and are reported in accrued taxes, interest and
expenses in the Consolidated Balance Sheets. The Bancorp
evaluates and assesses the relative risks and appropriate tax
treatment of transactions and filing positions after considering
statutes, regulations, judicial precedent and other information and
maintains tax accruals consistent with its evaluation of these
relative risks and merits. Changes to the estimate of accrued taxes
occur periodically due to changes in tax rates, interpretations of
tax laws, the status of examinations being conducted by taxing
authorities and changes to statutory, judicial and regulatory
guidance that impact the relative risks of tax positions. These
changes, when they occur, can affect deferred taxes and accrued
taxes as well as the current period’s income tax expense and can
be significant to the operating results of the Bancorp. For
additional information on income taxes, see Note 21.