Fifth Third Bank 2012 Annual Report Download - page 59

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
57 Fifth Third Bancorp
approved by the management governance committees are also
reviewed and approved by the Risk and Compliance Committee of
the Board of Directors.
Credit Risk Review is an independent function responsible for
evaluating the sufficiency of underwriting, documentation and
approval processes for consumer and commercial credits; the
accuracy of risk grades assigned to commercial credit exposure;
nonaccrual status; specific reserves and monitoring of charge-offs.
Credit Risk Review reports directly to the Risk and Compliance
Committee of the Board of Directors and administratively to the
Chief Auditor.
CREDIT RISK MANAGEMENT
The objective of the Bancorp’s credit risk management strategy is to
quantify and manage credit risk on an aggregate portfolio basis, as
well as to limit the risk of loss resulting from an individual customer
default. The Bancorp's credit risk management strategy is based on
three core principles: conservatism, diversification and monitoring.
The Bancorp believes that effective credit risk management begins
with conservative lending practices. These practices include
conservative exposure and counterparty limits and conservative
underwriting, documentation and collection standards. The
Bancorp's credit risk management strategy also emphasizes
diversification on a geographic, industry and customer level as well
as regular credit examinations and timely management reviews of
large credit exposures and credits experiencing deterioration of
credit quality. Credit officers with the authority to extend credit are
delegated specific authority amounts, the utilization of which is
closely monitored. Underwriting activities are centrally managed,
and ERM manages the policy and the authority delegation process
directly. The Credit Risk Review function provides objective
assessments of the quality of underwriting and documentation, the
accuracy of risk grades and the charge-off, nonaccrual and reserve
analysis process. The Bancorp’s credit review process and overall
assessment of the adequacy of the allowance for credit losses is
based on quarterly assessments of the probable estimated losses
inherent in the loan and lease portfolio. The Bancorp uses these
assessments to promptly identify potential problem loans or leases
within the portfolio, maintain an adequate reserve and take any
necessary charge-offs. The Bancorp defines potential problem
loans as those rated substandard that do not meet the definition of a
nonperforming asset or a restructured loan. See Note 6 of the
Notes to the Consolidated Financial Statements for further
information on the Bancorp’s credit grade categories, which are
derived from standard regulatory rating definitions.
The following tables provide a summary of potential problem loans as of December 31:
TABLE 28: POTENTIAL PROBLEM LOANS
Unpaid
Carrying Principal
A
s of December 31, 2012 ($ in millions) Value Balance Exposure
Commercial and industrial $ 1,015 1,017 1,212
Commercial mortgage 848 849 851
Commercial construction 87 87 100
Commercial leases 9 9 9
Total $ 1,959 1,962 2,172
TABLE 29: POTENTIAL PROBLEM LOANS
Unpaid
Carrying Principal
A
s of December 31, 2011 ($ in millions) Value Balance Exposure
Commercial and industrial $ 1,376 1,376 1,744
Commercial mortgage 1,215 1,216 1,223
Commercial construction 239 240 258
Commercial leases 33 33 33
Total $ 2,863 2,865 3,258
In addition to the individual review of larger commercial loans that
exhibit probable or observed credit weaknesses, the commercial
credit review process includes the use of two risk grading systems.
The risk grading system currently utilized for reserve analysis
purposes encompasses ten categories. The Bancorp also maintains a
dual risk rating system for credit approval and pricing, portfolio
monitoring and capital allocation that includes a “through-the-cycle”
rating philosophy for modeling expected losses. The dual risk rating
system includes thirteen probabilities of default grade categories and
an additional six grade categories for estimating losses given an
event of default. The probability of default and loss given default
evaluations are not separated in the ten-category risk rating system.
The Bancorp has completed significant validation and testing of the
dual risk rating system as a commercial credit risk management tool.
The Bancorp is assessing the necessary modifications to the dual
risk rating system outputs to develop a GAAP compliant ALLL
model and will make a decision on the use of modified dual risk
ratings for purposes of determining the Bancorp’s ALLL once the
FASB has issued a final standard regarding proposed methodology
changes to the determination of credit impairment as outlined in the
FASB’s proposed Accounting Standard Update—Financial
Instruments–Credit Losses (Subtopic 825-15) issued on December 20,
2012. Scoring systems, various analytical tools and delinquency
monitoring are used to assess the credit risk in the Bancorp’s
homogenous consumer and small business loan portfolios.