Fifth Third Bank 2011 Annual Report Download - page 114

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
112 Fifth Third Bancorp
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 sale of the processing business in 2009,
the Bancorp received warrants and issued put options, which are
accounted for as free-standing derivatives. Refer to Note 27 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 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 27 for further discussion of significant inputs
and assumptions used in the valuation of this instrument.
The Bancorp entered into certain derivatives (forwards, futures
and options) related to its foreign exchange business. These
derivative contracts were not designated against specific assets or
liabilities or to forecasted transactions. Therefore, these instruments
did not qualify for hedge accounting. The Bancorp economically
hedged the exposures related to these derivative contracts by
entering into offsetting contracts with approved, reputable,
independent counterparties with substantially similar terms.
Revaluation gains and losses on these foreign currency derivative
contracts were recorded within other noninterest income in the
Consolidated Statements of Income. 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:
Consolidated Statements of Income
Caption For the year ended December 31 ($ in millions) 2011 2010 2009
Interest rate contracts:
Forward contracts related to residential mortgage loans held for sale Mortgage banking net revenue $ (128) 40 55
Interest rate swaps and swaptions related to MSR portfolio Mortgage banking net revenue 345 109 41
Interest rate swaps related to long-term debt Other noninterest income 7 2 3
Foreign exchange contracts:
Foreign exchange contracts for trading purposes Other noninterest income - - (10)
Equity contracts:
Warrants associated with sale of the processing business Other noninterest income 32 4 13
Put options associated with sale of the processing business Other noninterest income 7 1 5
Swap associated with sale of Visa, Inc. Class B shares Other noninterest income (83) (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 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. 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, 2011 and 2010 the total notional amount of the risk
participation agreements was $808 million and $851 million,
respectively, and the fair value was a liability of $2 million at
December 31, 2011 and $1 million at December 31, 2010, which is
included in interest rate contracts for customers. As of December
31, 2011, the risk participation agreements had an average life of 2.5
years.
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.