Fifth Third Bank 2010 Annual Report Download - page 97

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fifth Third Bancorp 95
The following table reflects the change in fair value of interest rate contracts, designated as fair value hedges, as well as the change in fair value
of the related hedged items, included in the Consolidated Statements of Income:
For the year ended December 31, ($ in millions)
Consolidated Statements of
Income Caption 2010 2009 2008
Interest rate contracts:
Change in fair value of interest rate swaps hedging long-term debt Interest on long-term debt $167 (548) (776)
Change in fair value of hedged long-term debt Interest on long-term debt (168) 538 765
Change in fair value of interest rate swaps hedging time deposits Interest on deposits 6 4 (19)
Change in fair value of hedged time deposits Interest on deposits (6) (3) 19
Cash Flow Hedges
The Bancorp may enter into interest rate swaps to convert
floating-rate assets and liabilities to fixed rates or to hedge certain
forecasted transactions. The assets or liabilities are typically
grouped and share the same risk exposure for which they are
being hedged. The Bancorp may also enter into interest rate caps
and floors to limit cash flow variability of floating rate assets and
liabilities. As of December 31, 2010, all hedges designated as cash
flow hedges are assessed for effectiveness using regression
analysis. Ineffectiveness is generally measured as the amount by
which the cumulative change in the fair value of the hedging
instrument exceeds the present value of the cumulative change in
the hedged item’s expected cash flows. Ineffectiveness is reported
within other noninterest income in the Consolidated Statements
of Income. The effective portion of the gains or losses on cash
flow hedges are reported within accumulated other
comprehensive income and are reclassified from accumulated
other comprehensive income to current period earnings when the
forecasted transaction affects earnings. As of December 31, 2010,
the maximum length of time over which the Bancorp is hedging
its exposure to the variability in future cash flows related to the
forecasted issuance of floating rate debt is 27 months.
Reclassified gains and losses on interest rate floors and
swaps related to commercial loans and interest rate caps and
swaps related to debt are recorded within interest income and
interest expense, respectively. As of December 31, 2010 and
2009, $67 million and $105 million, respectively, of deferred
gains, net of tax, on cash flow hedges were recorded in
accumulated other comprehensive income. As of December 31,
2010, $45 million in net deferred gains, net of tax, recorded in
accumulated other comprehensive income are expected to be
reclassified into earnings during the next twelve months.
The following table presents the net gains recorded in the
Consolidated Statements of Income and accumulated other
comprehensive income relating to interest rate contracts
designated as cash flow hedges. Included in the ineffectiveness
for the year ended December 31, 2010 are certain terminated
interest rate caps previously designated as cash flow hedges on
debt. In conjunction with these terminations, the Bancorp
reclassified $17 million of losses from accumulated other
comprehensive income into earnings as it was determined that the
original forecasted transaction was no longer probable of
occurring by the end of the originally specified time period or
within the additional period of time as defined by U.S. GAAP.
Free-Standing Derivative Instruments – Risk Management
and Other Business Purposes
As part of its overall risk management strategy relative to its
mortgage banking activity, the Bancorp may enter into various
free-standing derivatives (principal-only swaps, swaptions,
floors, options and interest rate swaps) to economically hedge
changes in fair value of its largely fixed-rate MSR portfolio.
Principal-only swaps hedge the mortgage-LIBOR spread
because these swaps appreciate in value as a result of tightening
spreads. Principal-only swaps also provide prepayment
protection by increasing in value when prepayment speeds
increase, as opposed to MSRs that lose value in a faster
prepayment environment. Receive fixed/pay floating interest
rate swaps and swaptions increase in value when interest rates
do not increase as quickly as expected.
The Bancorp enters into forward contracts to
economically hedge the change in fair value of certain
residential mortgage loans held for sale due to changes in
interest rates. The Bancorp may also enter into forward swaps
to economically hedge the change in fair value of certain
commercial mortgage loans held for sale due to changes in
interest rates. Interest rate lock commitments issued on
residential mortgage loan commitments that will be held for
sale are also considered free-standing derivative instruments
and the interest rate exposure on these commitments is
economically hedged primarily with forward contracts.
Revaluation gains and losses from free-standing derivatives
related to mortgage banking activity are recorded as a
component of mortgage banking net revenue in the
Consolidated Statements of Income.
The Bancorp previously entered into foreign exchange
derivative contracts to economically hedge certain foreign
denominated loans. Derivative instruments that the Bancorp
may use to economically hedge these foreign denominated
loans include foreign exchange swaps and forward contracts.
The Bancorp does not designate these instruments against the
foreign denominated loans, and therefore, does not obtain
hedge accounting treatment. Revaluation gains and losses on
these foreign currency derivative contracts are recorded within
other noninterest income in the Consolidated Statements of
Income, as are revaluation gains and losses on foreign
denominated loans.
Additionally, the Bancorp may enter into free-standing
derivative instruments (options, swaptions and interest rate
swaps) in order to minimize significant fluctuations in earnings
and cash flows caused by interest rate and prepayment
volatility. The gains and losses on these derivative contracts are
recorded within other noninterest income in the Consolidated
Statements of Income.
In conjunction with the Processing Business Sale in 2009,
the Bancorp received warrants and issued put options, which
are accounted for as free-standing derivatives. Refer to Note 28
for further discussion of significant inputs and assumptions
used in the valuation of these instruments.
In conjunction with the sale of Visa, Inc. Class B shares in
2009, the Bancorp entered into a total return swap in which
For the year ended December 31: ($ in millions) 2010 2009 2008
A
mount of gain recognized in OCI $2 75 100
A
mount of gain reclassified from OCI into net interest income 60 49 3
A
mount of ineffectiveness recognized in other noninterest income 6 (1) 1