Fifth Third Bank 2012 Annual Report Download - page 76

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
74 Fifth Third Bancorp
standing derivatives. Additionally, the Bancorp economically hedges
its exposure to mortgage loans held for sale through the use of
forward contracts and mortgage options.
The Bancorp also establishes derivative contracts with major
financial institutions to economically hedge significant exposures
assumed in commercial customer accommodation derivative
contracts. Generally, these contracts have similar terms in order to
protect the Bancorp from market volatility. Credit risk arises from
the possible inability of counterparties to meet the terms of their
contracts, which the Bancorp minimizes through collateral
arrangements, approvals, limits and monitoring procedures. For
further information including the notional amount and fair values of
these derivatives, see Note 12 of the Notes to Consolidated
Financial Statements.
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 56 summarizes the expected principal cash flows
of the Bancorp’s portfolio loans and leases as of December 31,
2012. Additionally, Table 57 displays a summary of expected
principal cash flows occurring after one year for both fixed and
floating/adjustable rate loans, as of December 31, 2012.

TABLE 56: PORTFOLIO LOAN AND LEASE CONTRACTUAL MATURITIES
A
s of December 31, 2012 ($ in millions) Less than 1 year 1-5 years Over 5 years Total
Commercial and industrial loans $ 9,822 23,971 2,245 36,038
Commercial mortgage loans 4,297 4,110 696 9,103
Commercial construction loans 299 369 30 698
Commercial leases 612 1,573 1,364 3,549
Subtotal - commercial loans and leases 15,030 30,023 4,335 49,388
Residential mortgage loans 3,213 4,879 3,925 12,017
Home equity 1,485 5,560 2,973 10,018
Automobile loans 4,798 6,945 229 11,972
Credit card 598 1,499 - 2,097
Other consumer loans and leases 232 55 3 290
Subtotal - consumer loans and leases 10,326 18,938 7,130 36,394
Total $ 25,356 48,961 11,465 85,782
TABLE 57: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS OCCURING AFTER ONE YEAR
Interest Rate
A
s of December 31, 2012 ($ in millions) Fixed Floating or Adjustable
Commercial and industrial loans $ 3,385 22,831
Commercial mortgage loans 1,319 3,487
Commercial construction loans 27 372
Commercial leases 2,937 -
Subtotal - commercial loans and leases 7,668 26,690
Residential mortgage loans 6,394 2,410
Home equity 1,058 7,475
Automobile loans 7,128 46
Credit card 627 872
Other consumer loans and leases 38 20
Subtotal - consumer loans and leases 15,245 10,823
Total $ 22,913 37,513
Residential Mortgage Servicing Rights and Interest Rate Risk
The net carrying amount of the residential MSR portfolio was $697
million and $681 million as of December 31, 2012 and 2011,
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 2012 and 2011. This
caused modeled prepayments speeds to increase, which led to $103
million in temporary impairment on servicing rights during the year
ended 2012, compared to $242 million in temporary impairment on
servicing rights during the year ended 2011. 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. In addition to the
mortgage servicing rights valuation, the Bancorp recognized net
gains of $66 million and $354 million on its non-qualifying hedging
strategy for the years ended 2012 and 2011, respectively. The net
gains include net gains on the sale of securities related to the
Bancorp’s non-qualifying hedging strategy of $3 million and $9
million for 2012 and 2011, 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 16% of the carrying
value of the MSR portfolio as of December 31, 2012. The
prepayment behavior of these loans is expected to be less sensitive
to changes in interest rates as tighter industry underwriting