Fifth Third Bank 2012 Annual Report Download - page 77

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
75 Fifth Third Bancorp
standards, borrower credit characteristics and home price values
have had a greater impact on prepayment speeds. Thus, the
predictive power of traditional prepayment models that are based
solely on the historical dependency of prepayment speeds on market
interest rates may not be reliable for these loans. As a result, the
Bancorp has considered these additional factors as it models
prepayment speeds when valuing the MSRs. The Bancorp utilizes
valuation opinions from servicing brokers, peer surveys and its
historical prepayment experience in validating the modeled
prepayment speeds utilized in the fair value measurement of the
MSRs. As these additional factors have had an impact on
prepayment speeds, the effectiveness of traditional hedging
strategies utilizing benchmark interest rate based derivatives has
been reduced. In addition to the market factors that impact
prepayment speeds, the Bancorp is exposed to prepayment risk on
these loans in the event borrowers refinance at higher than expected
levels due to government intervention or other factors. The
Bancorp continues to monitor the performance of these MSRs and
may decide to hedge this portion of the MSR portfolio in future
periods. See Note 11 of the Notes to Consolidated Financial
Statements for further discussion on servicing rights and the
instruments used to hedge interest rate risk on MSRs.
Foreign Currency Risk
The Bancorp may enter into foreign exchange derivative contracts
to economically hedge certain foreign denominated loans. The
derivatives are classified as free-standing instruments with the
revaluation gain or loss being recorded in other noninterest income
in the Consolidated Statements of Income. The balance of the
Bancorp’s foreign denominated loans at December 31, 2012 and
2011 was $549 million and $374 million, respectively. The Bancorp
also enters into foreign exchange contracts for the benefit of
commercial customers involved in international trade to hedge their
exposure to foreign currency fluctuations. The Bancorp has internal
controls in place to help ensure excessive risk is not being taken in
providing this service to customers. These controls include an
independent determination of currency volatility and credit
equivalent exposure on these contracts, counterparty credit
approvals and country limits.
LIQUIDITY RISK MANAGEMENT
The goal of liquidity management is to provide adequate funds to
meet changes in loan and lease demand, unexpected levels of
deposit withdrawals and other contractual obligations. Mitigating
liquidity risk is accomplished by maintaining liquid assets in the
form of investment securities, maintaining sufficient unused
borrowing capacity in the debt markets and delivering consistent
growth in core deposits. A summary of certain obligations and
commitments to make future payments under contracts is included
in Note 16 of the Notes to Consolidated Financial Statements.
The Bancorp maintains a contingency funding plan that
assesses the liquidity needs under various scenarios of market
conditions, asset growth and credit rating downgrades. The plan
includes liquidity stress testing which measures various sources and
uses of funds under the different scenarios. The contingency plan
provides for ongoing monitoring of unused borrowing capacity and
available sources of contingent liquidity to prepare for unexpected
liquidity needs and to cover unanticipated events that could affect
liquidity.
Sources of Funds
The Bancorp’s primary sources of funds relate to cash flows from
loan and lease repayments, payments from securities related to sales
and maturities, the sale or securitization of loans and leases and
funds generated by core deposits, in addition to the use of public
and private debt offerings.
Projected contractual maturities from loan and lease
repayments are included in Table 56 of the Market Risk
Management section of MD&A. Of the $15.2 billion of securities in
the Bancorp’s available-for-sale portfolio at December 31, 2012,
$3.8 billion in principal and interest is expected to be received in the
next 12 months and an additional $2.2 billion is expected to be
received in the next 13 to 24 months. For further information on
the Bancorp’s securities portfolio, see the Securities section of
MD&A.
Asset-driven liquidity is provided by the Bancorp’s ability to
sell or securitize loan and lease assets. In order to reduce the
exposure to interest rate fluctuations and to manage liquidity, the
Bancorp has developed securitization and sale procedures for
several types of interest-sensitive assets. A majority of the long-
term, fixed-rate single-family residential mortgage loans
underwritten according to FHLMC or FNMA guidelines are sold
for cash upon origination. Additional assets such as residential
mortgages, certain commercial loans, home equity loans, automobile
loans and other consumer loans are also capable of being securitized
or sold. For the years ended December 31, 2012 and 2011, the
Bancorp sold loans totaling $21.7 billion and $15.2 billion,
respectively. For further information on the transfer of financial
assets, see Note 11 of the Notes to Consolidated Financial
Statements.
Core deposits have historically provided the Bancorp with a
sizeable source of relatively stable and low cost funds. The
Bancorp’s average core deposits and shareholders’ equity funded
82% of its average total assets during 2012, compared to 81% in
2011. In addition to core deposit funding, the Bancorp also accesses
a variety of other short-term and long-term funding sources, which
include the use of the FHLB system. Certificates of deposit carrying
a balance of $100,000 or more and deposits in the Bancorp’s foreign
branch located in the Cayman Islands are wholesale funding tools
utilized to fund asset growth. Management does not rely on any one
source of liquidity and manages availability in response to changing
balance sheet needs.
The Bancorp has a shelf registration in place with the SEC
permitting ready access to the public debt markets and qualifies as a
“well-known seasoned issuer” under the SEC rules. As of 2012, $5.6
billion of debt or other securities were available for issuance under
the current Bancorp’s Board of Directors’ authorizations, however,
access to these markets may depend on market conditions. The
Bancorp also has $19.0 billion of funding available for issuance
through private offerings of debt securities pursuant to its bank note
program and currently has approximately $33.7 billion of borrowing
capacity available through secured borrowing sources including the
FHLB and FRB. Additionally, from time to time the Bancorp may
change the terms of the bank note program, including by increasing
its size.
On March 7, 2012, the Bancorp issued $500 million in
aggregate principal amount of 3.50% Senior Notes due March 15,
2022. On August 8, 2012, the Bancorp redeemed all $862.5 million
of the outstanding TruPS issued by Fifth Third Capital Trust VI. In
addition, on August 15, 2012, the Bancorp redeemed all $575
million of the outstanding TruPS issued by Fifth Third Capital Trust
V. On December 7, 2012, the Bancorp terminated a $1.0 billion
FHLB advance with a fixed rate of 4.56% and a maturity date of
January 5, 2016. See Note 15 of the Notes to Consolidated Financial
Statements for additional information regarding the Senior Notes,
TruPS and FHLB advances.