Fifth Third Bank 2011 Annual Report Download - page 70

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
68 Fifth Third Bancorp
decrease scenarios; therefore, those scenarios were omitted from the
interest rate risk analyses at December 31, 2011. In accordance with
the current policy, the rate movements are assumed to occur over
one year and are sustained thereafter.
At December 31, 2011, the Bancorp’s interest rate risk profile
reflects a neutral position in year one and slight asset sensitivity in
year two. The following table shows the Bancorp's estimated net
interest income sensitivity profile and ALCO policy limits as of
December 31:
TABLE 51: ESTIMATED NII SENSITIVITY PROFILE
2011 2010
Percent Change in NII (FTE) Percent Change in NII (FTE) ALCO Policy Limits
12 Months
13 to 24
Months 12 Months
13 to 24
Months 12 Months
13 to 24
Months Change in Interest Rates (bps)
+200 0.35 % 5.61 1.02 % 4.99 (5.00) (7.00)
+100 - 2.64 0.49 2.73 - -
The 12 months net interest income at risk reported as of December
31, 2011 for the +200 and +100 basis point scenarios shows a
modest decline in asset sensitivity compared with December 31,
2010. The primary factors contributing to this change are an
increase in fixed-rate loans partially offset by growth in deposits.
Economic Value of Equity
The Bancorp also utilizes EVE as a measurement tool in managing
interest rate risk. Whereas the net interest income simulation model
highlights exposures over a relatively short time horizon, the EVE
analysis incorporates all cash flows over the estimated remaining life
of all balance sheet and derivative positions. The EVE of the
balance sheet, at a point in time, is defined as the discounted present
value of asset and net derivative cash flows less the discounted value
of liability cash flows. The sensitivity of EVE to changes in the level
of interest rates is a measure of longer-term interest rate risk. EVE
values only the current balance sheet and does not incorporate the
growth assumptions used in the earnings simulation model. As with
the earnings simulation model, assumptions about the timing and
variability of existing balance sheet cash flows are critical in the
EVE analysis. Particularly important are assumptions driving
prepayments and the expected changes in balances and pricing of
transaction deposit portfolios. The following table shows the
Bancorp’s EVE sensitivity profile as of December 31:
TABLE 52: ESTIMATED EVE SENSITIVITY PROFILE
2011 2010
Change in Interest Rates (bps) Change in EVE Change in EVE ALCO Policy Limits
+200 1.37 % (1.62)% (15.00) %
+100 1.22 (0.50)
+25 0.32 (0.09)
-25 (0.25) (0.13)
The EVE at risk profile suggests slight asset sensitivity from market
rate increases through the +200 bps scenario. The EVE at risk
reported at December 31, 2011 for the +200 basis points scenario
shows a change to a modest asset sensitive position compared to
December 31, 2010. The primary factors contributing to the change
are the decline in market interest rates over the course of 2011 and
growth in core deposits, partially offset by the impact of the increase
in fixed-rate loans.
While an instantaneous shift in interest rates is used in this
analysis to provide an estimate of exposure, the Bancorp believes
that a gradual shift in interest rates would have a much more modest
impact. Since EVE measures the discounted present value of cash
flows over the estimated lives of instruments, the change in EVE
does not directly correlate to the degree that earnings would be
impacted over a shorter time horizon (e.g., the current fiscal year).
Further, EVE does not take into account factors such as future
balance sheet growth, changes in product mix, changes in yield
curve relationships and changing product spreads that could
mitigate the adverse impact of changes in interest rates. The NII
simulation and EVE analyses do not necessarily include certain
actions that management may undertake to manage this risk in
response to anticipated changes in interest rates.
The Bancorp regularly evaluates its exposures to LIBOR and
Prime basis risks, nonparallel shifts in the yield curve and embedded
options risk. In addition, the impact on NII and EVE of extreme
changes in interest rates is modeled, wherein the Bancorp employs
the use of yield curve shocks and environment-specific scenarios.
Use of Derivatives to Manage Interest Rate Risk
An integral component of the Bancorp’s interest rate risk
management strategy is its use of derivative instruments to minimize
significant fluctuations in earnings caused by changes in market
interest rates. Examples of derivative instruments that the Bancorp
may use as part of its interest rate risk management strategy include
interest rate swaps, interest rate floors, interest rate caps, forward
contracts, principal only swaps, options, swaptions and TBA’s.
As part of its overall risk management strategy relative to its
mortgage banking activity, the Bancorp enters into forward
contracts accounted for as free-standing derivatives to economically
hedge interest rate lock commitments that are also considered free-
standing derivatives. Additionally, the Bancorp economically hedges
its exposure to mortgage loans held for sale through the use of
forward contracts and mortgage options.
The Bancorp also establishes derivative contracts with major
financial institutions to economically hedge significant exposures
assumed in commercial customer accommodation derivative
contracts. Generally, these contracts have similar terms in order to
protect the Bancorp from market volatility. Credit risk arises from
the possible inability of counterparties to meet the terms of their
contracts, which the Bancorp minimizes through collateral
arrangements, approvals, limits and monitoring procedures. For
further information including the notional amount and fair values of
these derivatives, see Note 13 of the Notes to Consolidated
Financial Statements.