Fifth Third Bank 2011 Annual Report Download - page 25

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp 23
reasonableness. The following is a summary of valuation techniques
utilized by the Bancorp for its significant assets and liabilities
measured at fair value on a recurring basis.
Available-for-sale and trading securities
Where quoted prices are available in an active market,
securities are classified within Level 1 of the valuation
hierarchy. Level 1 securities include government bonds
and exchange traded equities. If quoted market prices are
not available, then fair values are estimated using pricing
models, quoted prices of securities with similar
characteristics, or discounted cash flows. Examples of
such instruments, which are classified within Level 2 of
the valuation hierarchy, include agency and non-agency
mortgage-backed securities, other asset-backed securities,
obligations of U.S. Government sponsored agencies, and
corporate and municipal bonds. Agency mortgage-backed
securities, obligations of U.S. Government sponsored
agencies, and corporate and municipal bonds are generally
valued using a market approach based on observable
prices of securities with similar characteristics. Non-
agency mortgage-backed securities and other asset-backed
securities are generally valued using an income approach
based on discounted cash flows, incorporating
prepayment speeds, performance of underlying collateral
and specific tranche-level attributes. In certain cases where
there is limited activity or less transparency around inputs
to the valuation, securities are classified within Level 3 of
the valuation hierarchy. Trading securities classified as
Level 3 consist of auction rate securities. Due to the
illiquidity in the market for these types of securities, the
Bancorp measures fair value using a discount rate based
on the assumed holding period.
Residential mortgage loans held for sale and held for
investment
For residential mortgage loans held for sale, fair value is
estimated based upon mortgage-backed securities prices
and spreads to those prices or, for certain ARM loans,
discounted cash flow models that may incorporate the
anticipated portfolio composition, credit spreads of asset-
backed securities with similar collateral, and market
conditions. The anticipated portfolio composition
includes the effect of interest rate spreads and discount
rates due to loan characteristics such as the state in which
the loan was originated, the loan amount and the ARM
margin. Residential mortgage loans held for sale that are
valued based on mortgage-backed securities prices are
classified within Level 2 of the valuation hierarchy as the
valuation is based on external pricing for similar
instruments. ARM loans classified as held for sale are also
classified within Level 2 of the valuation hierarchy due to
the use of observable inputs in the discounted cash flow
model. These observable inputs include interest rate
spreads from agency mortgage-backed securities market
rates and observable discount rates. For residential
mortgage loans reclassified from held for sale to held for
investment, the fair value estimation is based primarily on
the underlying collateral values. Therefore, these loans are
classified within Level 3 of the valuation hierarchy.
Derivatives
Exchange-traded derivatives valued using quoted prices
and certain over-the-counter derivatives valued using
active bids are classified within Level 1 of the valuation
hierarchy. Most of the Bancorp’s derivative contracts are
valued using discounted cash flow or other models that
incorporate current market interest rates, credit spreads
assigned to the derivative counterparties, and other market
parameters and, therefore, are classified within Level 2 of
the valuation hierarchy. Such derivatives include basic and
structured interest rate swaps and options. Derivatives
that are valued based upon models with significant
unobservable market parameters are classified within
Level 3 of the valuation hierarchy. At December 31, 2011,
derivatives classified as Level 3, which are valued using an
option-pricing model containing unobservable inputs,
consisted primarily of warrants and put rights associated
with the sale of Vantiv Holding, LLC and a total return
swap associated with the Bancorp’s sale of its Visa, Inc.
Class B shares. Level 3 derivatives also include interest
rate lock commitments, which utilize internally generated
loan closing rate assumptions as a significant unobservable
input in the valuation process.
In addition to the assets and liabilities measured at fair value on
a recurring basis, the Bancorp measures servicing rights, certain
loans and long-lived assets at fair value on a nonrecurring basis.
Refer to Note 27 of the Notes to Consolidated Financial Statements
for further information on fair value measurements.
Goodwill
Business combinations entered into by the Bancorp typically include
the acquisition of goodwill. U.S. GAAP requires goodwill to be
tested for impairment at the Bancorp’s reporting unit level on an
annual basis, which for the Bancorp is September 30, and more
frequently if events or circumstances indicate that there may be
impairment. The Bancorp has determined that its segments qualify
as reporting units under U.S. GAAP. Impairment exists when a
reporting unit’s carrying amount of goodwill exceeds its implied fair
value, which is determined through a two-step impairment test. The
first step (Step 1) compares the fair value of a reporting unit with its
carrying amount, including goodwill. If the carrying amount of the
reporting unit exceeds its fair value, the second step (Step 2) of the
goodwill impairment test is performed to measure the impairment
loss amount, if any.
The fair value of a reporting unit is the price that would be
received to sell the unit as a whole in an orderly transaction between
market participants at the measurement date. Since none of the
Bancorp’s reporting units are publicly traded, individual reporting
unit fair value determinations cannot be directly correlated to the
Bancorp’s stock price. To determine the fair value of a reporting
unit, the Bancorp employs an income-based approach, utilizing the
reporting unit’s forecasted cash flows (including a terminal value
approach to estimate cash flows beyond the final year of the
forecast) and the reporting unit’s estimated cost of equity as the
discount rate. Additionally, the Bancorp determines its market
capitalization based on the average of the closing price of the
Bancorp's stock during the month including the measurement date,
incorporating an additional control premium, and compares this
market-based fair value measurement to the aggregate fair value of
the Bancorp's reporting units in order to corroborate the results of
the income approach.
When required to perform Step 2, the Bancorp compares the
implied fair value of a reporting unit’s goodwill with the carrying
amount of that goodwill. If the carrying amount exceeds the implied
fair value, an impairment loss equal to that excess amount is
recognized. An impairment loss recognized cannot exceed the
carrying amount of that goodwill and cannot be reversed even if the
fair value of the reporting unit recovers.
During Step 2, the Bancorp determines the implied fair value
of goodwill for a reporting unit by assigning the fair value of the
reporting unit to all of the assets and liabilities of that unit (including