Fifth Third Bank 2011 Annual Report Download - page 71

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Third Bancorp 69
Portfolio Loans and Leases and Interest Rate Risk
Although the Bancorp’s portfolio loans and leases contain both
fixed and floating/adjustable rate products, the rates of interest
earned by the Bancorp on the outstanding balances are generally
established for a period of time. The interest rate sensitivity of loans
and leases is directly related to the length of time the rate earned is
established. Table 53 summarizes the expected principal cash flows
of the Bancorp’s portfolio loans and leases as of December 31,
2011. Additionally, Table 54 displays a summary of expected
principal cash flows occurring after one year for both fixed and
floating/adjustable rate loans, as of December 31, 2011.
TABLE 53: PORTFOLIO LOAN AND LEASE CONTRACTUAL MATURITIES
A
s of December 31, 2011 ($ in millions) Less than 1 year 1-5 years Over 5 years Total
Commercial and industrial loans $ 9,439 19,199 2,145 30,783
Commercial mortgage loans 4,412 4,652 1,074 10,138
Commercial construction loans 534 290 196 1,020
Commercial leases 575 1,498 1,458 3,531
Subtotal - commercial loans and leases 14,960 25,639 4,873 45,472
Residential mortgage loans 4,787 4,385 1,500 10,672
Home equity 1,494 3,171 6,054 10,719
Automobile loans 4,908 6,700 219 11,827
Credit card 556 1,422 - 1,978
Other consumer loans and leases 270 71 9 350
Subtotal - consumer loans and leases 12,015 15,749 7,782 35,546
Total $ 26,975 41,388 12,655 81,018
TABLE 54: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS OCCURING AFTER ONE YEAR
Interest Rate
A
s of December 31, 2011 ($ in millions) Fixed Floating or Adjustable
Commercial and industrial loans $ 3,683 17,661
Commercial mortgage loans 1,823 3,903
Commercial construction loans 181 305
Commercial leases 2,956 -
Subtotal - commercial loans and leases 8,643 21,869
Residential mortgage loans 3,835 2,050
Home equity 1,067 8,158
Automobile loans 6,868 51
Credit card 640 782
Other consumer loans and leases 31 49
Subtotal - consumer loans and leases 12,441 11,090
Total $ 21,084 32,959
Residential Mortgage Servicing Rights and Interest Rate Risk
The net carrying amount of the residential MSR portfolio was $681
million and $822 million as of December 31, 2011 and 2010,
respectively. The value of servicing rights can fluctuate sharply
depending on changes in interest rates and other factors. Generally,
as interest rates decline and loans are prepaid to take advantage of
refinancing, the total value of existing servicing rights declines
because no further servicing fees are collected on repaid loans. The
Bancorp maintains a non-qualifying hedging strategy relative to its
mortgage banking activity in order to manage a portion of the risk
associated with changes in the value of its MSR portfolio as a result
of changing interest rates.
Mortgage rates decreased during both 2011 and 2010. These
decreases caused modeled prepayment speeds to increase, which led
to $242 million in temporary impairment on servicing rights during
the year ended 2011, compared to $36 million in temporary
impairment in 2010. Servicing rights are deemed temporarily
impaired when a borrower’s loan rate is distinctly higher than
prevailing rates. Temporary impairment on servicing rights is
reversed when the prevailing rates return to a level commensurate
with the borrower’s loan rate. Offsetting the mortgage servicing
rights valuation, the Bancorp recognized net gains of $354 million
and $123 million on its non-qualifying hedging strategy for the years
ended 2011 and 2010, respectively. The net gains include net gains
from the sale of securities related to the Bancorp’s non-qualifying
hedging strategy of $9 million and $14 million for 2011 and 2010,
respectively. During the fourth quarter of 2011, the Bancorp
assessed the composition of its MSR portfolio, the cost of hedging
and the anticipated effectiveness of the hedges given the economic
environment. Based on this review, the Bancorp adjusted its MSR
hedging strategy to exclude the hedging of MSRs related to certain
mortgage loans originated in 2008 and prior, representing
approximately 25% of the carrying value of the MSR portfolio as of
December 31, 2011. The prepayment behavior of these loans is
expected to be less sensitive to changes in interest rates as borrower
credit characteristics and home price values have a greater impact
based on changes in the market and underwriting environment.
Thus, the predictive power of traditional prepayment models on
these loans may not be reliable, which reduces the effectiveness of
interest rate based hedge strategies. The Bancorp is exposed to
prepayment risk on these loans in the event borrowers refinance at
higher than expected levels due to government intervention or other
factors. The Bancorp continues to monitor the performance of
these MSRs and may decide to hedge this portion of the MSR
portfolio in future periods. See Note 12 of the Notes to
Consolidated Financial Statements for further discussion on
servicing rights and the instruments used to hedge interest rate risk
on MSRs.
Foreign Currency Risk
The Bancorp may enter into foreign exchange derivative contracts
to economically hedge certain foreign denominated loans. The
derivatives are classified as free-standing instruments with the
revaluation gain or loss being recorded in other noninterest income
in the Consolidated Statements of Income. The balance of the
Bancorp’s foreign denominated loans at December 31, 2011 and