Fifth Third Bank 2012 Annual Report Download - page 120

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
118 Fifth Third Bancorp
Fair Value Hedges
The Bancorp may enter into interest rate swaps to convert its fixed-
rate funding to floating-rate. Decisions to convert fixed-rate funding
to floating are made primarily through consideration of the
asset/liability mix of the Bancorp, the desired asset/liability
sensitivity and interest rate levels. As of December 31, 2012 and
2011, certain interest rate swaps met the criteria required to qualify
for the shortcut method of accounting. Based on this shortcut
method of accounting treatment, no ineffectiveness is assumed. For
interest rate swaps that do not meet the shortcut requirements, an
assessment of hedge effectiveness using regression analysis was
performed and such swaps were accounted for using the “long-
haul” method. The long-haul method requires a quarterly
assessment of hedge effectiveness and measurement of
ineffectiveness. For interest rate swaps accounted for as a fair value
hedge using the long-haul method, ineffectiveness is the difference
between the changes in the fair value of the interest rate swap and
changes in fair value of the related hedged item attributable to the
risk being hedged. The ineffectiveness on interest rate swaps
hedging fixed-rate funding is reported within interest expense in the
Consolidated Statements of Income.
The following table reflects the change in fair value of interest rate contracts, designated as fair value hedges, as well as the change in fair value o
f
the related hedged items attributable to the risk being hedged, included in the Consolidated Statements of Income:
Consolidated Statements of Income
Caption For the year ended December 31 ($ in millions) 2012 2011 2010
Interest rate contracts:
Change in fair value of interest rate swaps hedging long-term debt Interest on long-term debt $ (104) 220 167
Change in fair value of hedged long-term debt attributable to the risk being hedged Interest on long-term debt 107 (227) (168)
Change in fair value of interest rate swaps hedging time deposits Interest on deposits - - 6
Change in fair value of hedged time deposits Interest on deposits - - (6)
Cash Flow Hedges
The Bancorp may enter into interest rate swaps to convert floating-
rate assets and liabilities to fixed rates or to hedge certain forecasted
transactions. The assets or liabilities may be grouped in
circumstances where they share the same risk exposure for which
the Bancorp desired to hedge. The Bancorp may also enter into
interest rate caps and floors to limit cash flow variability of floating
rate assets and liabilities. As of December 31, 2012, all hedges
designated as cash flow hedges are assessed for effectiveness using
regression analysis. Ineffectiveness is generally measured as the
amount by which the cumulative change in the fair value of the
hedging instrument exceeds the present value of the cumulative
change in the hedged item’s expected cash flows attributable to the
risk being hedged. Ineffectiveness is reported within other
noninterest income in the Consolidated Statements of Income. The
effective portion of the cumulative gains or losses on cash flow
hedges are reported within accumulated other comprehensive
income and are reclassified from accumulated other comprehensive
income to current period earnings when the forecasted transaction
affects earnings. As of December 31, 2012, the maximum length of
time over which the Bancorp is hedging its exposure to the
variability in future cash flows is 38 months.
Reclassified gains and losses on interest rate contracts related
to commercial and industrial loans are recorded within interest
income while reclassified gains and losses on interest rate contracts
related to long-term debt are recorded within interest expense in the
Consolidated Statements of Income. As of December 31, 2012 and
2011, $50 million and $80 million, respectively, of deferred gains,
net of tax, on cash flow hedges were recorded in accumulated other
comprehensive income in the Consolidated Balance Sheets. As of
December 31, 2012, $20 million in net deferred gains, net of tax,
recorded in accumulated other comprehensive income are expected
to be reclassified into earnings during the next twelve months
primarily due to the benefit of interest rate floors that mature during
the second quarter of 2013. During 2012, there were no gains or
losses reclassified from accumulated other comprehensive income
into earnings associated with the discontinuance of cash flow
hedges because it was probable that the original forecasted
transaction would not occur. During 2011, $11 million of losses
were reclassified from accumulated other comprehensive income
into noninterest expense as it was determined that the original
forecasted transaction was no longer probable of occurring by the
end of the originally specified time period or within the additional
period of time as defined by U.S. GAAP.
The following table presents the net gains recorded in the Consolidated Statements of Income and the Consolidated Statements o
f
Comprehensive Income relating to derivative instruments designated as cash flow hedges:
For the year ended December 31 ($ in millions) 2012 2011 2010
A
mount of net gain recognized in OCI $ 37 89 2
A
mount of net gain reclassified from OCI into net income 83 69 60
A
mount of ineffectiveness recognized in other noninterest income - 1 6
Free-Standing Derivative Instruments – Risk Management
and Other Business Purposes
As part of its overall risk management strategy relative to its
mortgage banking activity, the Bancorp may enter into various free-
standing derivatives (principal-only swaps, interest rate swaptions,
interest rate floors, mortgage options, TBAs and interest rate swaps)
to economically hedge changes in fair value of its largely fixed-rate
MSR portfolio. Principal-only swaps hedge the mortgage-LIBOR
spread because these swaps appreciate in value as a result of
tightening spreads. Principal-only swaps also provide prepayment
protection by increasing in value when prepayment speeds increase,
as opposed to MSRs that lose value in a faster prepayment
environment. Receive fixed/pay floating interest rate swaps and
swaptions increase in value when interest rates do not increase as
quickly as expected.
The Bancorp enters into forward contracts and mortgage
options to economically hedge the change in fair value of certain
residential mortgage loans held for sale due to changes in interest
rates. Interest rate lock commitments issued on residential mortgage
loan commitments that will be held for sale are also considered free-