Fifth Third Bank 2012 Annual Report Download - page 75

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
73 Fifth Third Bancorp
The Bancorp’s interest rate risk exposure is currently evaluated
by measuring the anticipated change in net interest income over 12-
month and 24-month horizons assuming a 100 bps and 200 bps
parallel ramped increase in interest rates. The Fed Funds interest
rate, targeted by the Federal Reserve at a range of 0% to 0.25%, is
currently set at a level that would be negative in parallel ramped
decrease scenarios; therefore, those scenarios were omitted from the
interest rate risk analyses at December 31, 2012. In accordance with
the current policy, the rate movements are assumed to occur over
one year and are sustained thereafter.
The following table shows the Bancorp’s estimated net interest income sensitivity profile and ALCO policy limits as of December 31:
TABLE 54: ESTIMATED NII SENSITIVITY PROFILE
2012 2011
Percent Change in NII
(FTE) ALCO Policy Limits
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 12 Months
13 to 24
Months Change in Interest Rates (bps)
+200 1.78 %7.75 (4.00) (6.00) 0.35 % 5.61 (5.00) (7.00)
+100 0.90 3.78 - - - 2.64 - -
At December 31, 2012, the Bancorp’s interest rate risk profile
reflects moderate asset sensitivity in year one in contrast to a
relatively neutral profile at December 31, 2011 with year two asset
sensitivity increases from year one at both December 31, 2012 and
2011. The higher asset sensitivity at December 31, 2012 compared
to December 31, 2011 is the result of growth in core deposit
balances and lower market interest rates, partially offset by increases
in fixed rate loan balances.
Economic Value of Equity
The Bancorp also utilizes EVE as a measurement tool in managing
interest rate risk. Whereas the NII 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 NII simulation model. As with the
NII 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 loan and security
prepayments and the expected balance attrition and pricing of
transaction deposit portfolios.
The following table shows the Bancorp’s EVE sensitivity profile as of December 31:
TABLE 55: ESTIMATED EVE SENSITIVITY PROFILE
2012 2011
Change in Interest Rates (bps) Change in EVE ALCO Policy Limit Change in EVE ALCO Policy Limit
+200 2.16 %(12.00) 1.37 %(15.00)
+100 1.50 1.22
+25 0.43 0.32
-25 (0.52) (0.25)
The EVE at risk profile suggests a positive impact from market rate
increases of +25 bps through the +200 bps scenarios for 2012. The
EVE at risk reported at December 31, 2012 for the +200 basis
points scenario shows a change to a slightly more asset sensitive
position compared to December 31, 2011. The primary factors
contributing to the change are the decline in market interest rates
over this time period, growth in core deposits and changes in the
MSR risk profile, partially offset by the impact of an increase in
fixed rate loan balances.
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 or exacerbate the impact of changes in interest rates. The
NII simulations and EVE analyses do not necessarily include certain
actions that management may undertake to manage 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, options, swaptions and TBA securities.
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-