Fifth Third Bank 2012 Annual Report Download - page 121

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
119 Fifth Third Bancorp
standing derivative instruments and the interest rate exposure on
these commitments is economically hedged primarily with forward
contracts. Revaluation gains and losses from free-standing
derivatives related to mortgage banking activity are recorded as a
component of mortgage banking net revenue in the Consolidated
Statements of Income.
Additionally, as part of the Bancorp’s overall risk management
strategy with respect to minimizing significant fluctuations in
earnings and cash flows caused by interest rate and prepayment
volatility, the Bancorp may enter into free-standing derivative
instruments (options, swaptions and interest rate swaps). 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. The put options expired
as a result of the Vantiv, Inc. initial public offering in March of
2012. Refer to Note 26 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 26 for further discussion of significant inputs
and assumptions used in the valuation of this instrument.
The net gains (losses) recorded in the Consolidated Statements of Income relating to free-standing derivative instruments used for ris
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management and other business purposes are summarized in the following table:
Consolidated Statements of Income
Caption For the year ended December 31 ($ in millions) 2012 2011 2010
Interest rate contracts:
Forward contracts related to mortgage loans held for sale Mortgage banking net revenue $ 28 (128) 40
Interest rate contracts related to MSRs Mortgage banking net revenue 63 345 109
Interest rate swaps related to long-term debt Other noninterest income 2 7 2
Equity contracts:
Stock warrants associated with sale of the processing business Other noninterest income 66 32 4
Put options associated with sale of the processing business Other noninterest income 1 7 1
Swap associated with sale of Visa, Inc. Class B shares Other noninterest income (45) (83) (19)
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 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, 2012 and 2011, the total
notional amount of the risk participation agreements was $1.0
billion and $808 million, respectively, and the fair value was a
liability of $2 million at both December 31, 2012 and 2011, which is
included in interest rate contracts for customers. As of December
31, 2012, the risk participation agreements had an average life of 3.0
years.
The Bancorp’s maximum exposure in the risk participation
agreements is contingent on the fair value of the underlying interest
rate derivative contracts in an asset position at the time of default.
The Bancorp monitors the credit risk associated with the underlying
customers in the risk participation agreements through the same risk
grading system currently utilized for establishing loss reserves in its
loan and lease portfolio.
Risk ratings of the notional amount of risk participation agreements under this risk rating system are summarized in the following table:
A
t December 31 ($ in millions) 2012 2011
Pass $ 993 772
Special mention - 14
Substandard 13 18
Doubtful - 4
Total $ 1,006 808