Fifth Third Bank 2010 Annual Report Download - page 98

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
96 Fifth Third Bancorp
the Bancorp will make or receive payments based on
subsequent changes in the conversion rate of the Class B
shares into Class A shares. This total return swap is accounted
for as a free-standing derivative. See Note 28 for further
discussion of significant inputs and assumptions used in the
valuation of this instrument.
The Bancorp enters into certain derivatives (forwards,
futures and options) related to its foreign exchange business.
These derivative contracts are not designated against specific
assets or liabilities or to forecasted transactions. Therefore,
these instruments do not qualify for hedge accounting. The
Bancorp economically hedges the exposures related to these
derivative contracts by entering into offsetting contracts with
approved, reputable, independent counterparties with
substantially similar terms.
The net gains (losses) recorded in the Consolidated
Statements of Income relating to free-standing derivative
instruments used for risk management and other business
purposes are summarized in the following table:
For the year ended December 31, ($ in millions)
Consolidated Statements of
Income Caption 2010 2009 2008
Interest rate contracts:
Interest rate contracts related to MSR portfolio Mortgage banking net revenue $109 41 89
Forward contracts related to commercial mortgage loans held for sale Corporate banking revenue - - (8)
Forward contracts related to residential mortgage loans held for sale Mortgage banking net revenue 40 55 (17)
Interest rate swaps related to long-term debt Other noninterest income 2 3 1
Foreign exchange contracts:
Foreign exchange contracts for trading purposes Other noninterest income - (10) 29
Equity contracts:
Warrants associated with Processing Business Sale Other noninterest income 4 13 -
Put options associated with Processing Business Sale Other noninterest income 1 5 -
Swap associated with sale of Visa, Inc. Class B shares Other noninterest income (19) (2) -
Free-Standing Derivative Instruments – Customer
Accommodation
The majority of the free-standing derivative instruments the
Bancorp enters into are for the benefit of its commercial
customers. These derivative contracts are not designated against
specific assets or liabilities on the Bancorp’s Consolidated Balance
Sheets or to forecasted transactions and, therefore, do not qualify
for hedge accounting. These instruments include foreign
exchange derivative contracts entered into for the benefit of
commercial customers involved in international trade to hedge
their exposure to foreign currency fluctuations and commodity
contracts to hedge such items as natural gas and various other
derivative contracts. The Bancorp may economically hedge
significant exposures related to these derivative contracts entered
into for the benefit of customers by entering into offsetting
contracts with approved, reputable, independent counterparties
with substantially matching terms. The Bancorp hedges its
interest rate exposure on commercial customer transactions by
executing offsetting swap agreements with primary dealers.
Revaluation gains and losses on interest rate, foreign exchange,
commodity and other commercial customer derivative contracts
are recorded as a component of corporate banking revenue in the
Consolidated Statements of Income.
The Bancorp enters into risk participation agreements, under
which the Bancorp assumes credit exposure relating to certain
underlying interest rate derivative contracts. The Bancorp only
enters into these risk participation agreements in instances in
which the Bancorp has participated in the loan that the
underlying interest rate derivative contract was designed to hedge.
The Bancorp will make payments under these agreements if a
customer defaults on its obligation to perform under the terms of
the underlying interest rate derivative contract. As of December
31, 2010 and 2009, the total notional amount of the risk
participation agreements was $851 million and $810 million,
respectively, and the fair value was a liability of $1 million and $2
million, respectively, at December 31, 2010 and 2009, which is
included in interest rate contracts for customers. The Bancorp’s
maximum exposure in the risk participation agreements is
contingent on the fair value of the underlying interest rate
derivative contracts in an asset position at the time of default. The
Bancorp monitors the credit risk associated with the underlying
customers in the risk participation agreements through the same
risk grading system currently utilized for establishing loss reserves
in its loan and lease portfolio. Under this risk rating system as of
December 31, 2010, $744 million in notional amount of the risk
participation agreements were classified pass; $37 million were
classified as special mention; $69 million were classified as
substandard; and $1 million were classified as doubtful. As of
December 31, 2010, the risk participation agreements had an
average life of 1.9 years.
The Bancorp previously offered its customers an equity-linked
certificate of deposit that had a return linked to equity indices.
Under U.S. GAAP, a certificate of deposit that pays interest
based on changes on an equity index is a hybrid instrument that
requires separation into a host contract (the certificate of deposit)
and an embedded derivative contract (written equity call option).
The Bancorp entered into offsetting derivative contracts to
economically hedge the exposure taken through the issuance of
equity-linked certificates of deposit. Both the embedded
derivative and the derivative contract entered into by the Bancorp
are recorded as free-standing derivatives and recorded at fair
value with offsetting gains and losses recognized within
noninterest income in the Consolidated Statements of Income.