Fifth Third Bank 2014 Annual Report Download - page 125

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
123 Fifth Third Bancorp
Fair Value Hedges
The Bancorp may enter into interest rate swaps to convert its fixed-
rate funding to floating-rate. Decisions to convert fixed-rate funding
to floating are made primarily through consideration of the
asset/liability mix of the Bancorp, the desired asset/liability
sensitivity and interest rate levels. As of December 31, 2014 and
2013, certain interest rate swaps met the criteria required to qualify
for the shortcut method of accounting. Based on this shortcut
method of accounting treatment, no ineffectiveness is assumed. For
interest rate swaps that do not meet the shortcut requirements, an
assessment of hedge effectiveness using regression analysis was
performed and such swaps were accounted for using the “long-
haul” method. The long-haul method requires a quarterly
assessment of hedge effectiveness and measurement of
ineffectiveness. For interest rate swaps accounted for as a fair value
hedge using the long-haul method, ineffectiveness is the difference
between the changes in the fair value of the interest rate swap and
changes in fair value of the related hedged item attributable to the
risk being hedged. The ineffectiveness on interest rate swaps
hedging fixed-rate funding is reported within interest expense in the
Consolidated Statements of Income.
The following table reflects the change in fair value of interest rate contracts, designated as fair value hedges, as well as the change in fair value o
f
the related hedged items attributable to the risk being hedged, included in the Consolidated Statements of Income:
Consolidated Statements of Income
Caption For the year ended December 31 ($ in millions) 2014 2013 2012
Interest rate contracts:
Change in fair value of interest rate swaps hedging long-term debt Interest on long-term debt $ 120 (279) (104)
Change in fair value of hedged long-term debt attributable to the risk being hedged Interest on long-term debt (126) 276 107
Cash Flow Hedges
The Bancorp may enter into interest rate swaps to convert floating-
rate assets and liabilities to fixed rates or to hedge certain forecasted
transactions. The assets or liabilities may be grouped in
circumstances where they share the same risk exposure that the
Bancorp desires to hedge. The Bancorp may also enter into interest
rate caps and floors to limit cash flow variability of floating rate
assets and liabilities. As of December 31, 2014, all hedges designated
as cash flow hedges were assessed for effectiveness using regression
analysis. Ineffectiveness is generally measured as the amount by
which the cumulative change in the fair value of the hedging
instrument exceeds the present value of the cumulative change in
the hedged item’s expected cash flows attributable to the risk being
hedged. Ineffectiveness is reported within other noninterest income
in the Consolidated Statements of Income. The effective portion of
the cumulative gains or losses on cash flow hedges are reported
within AOCI and are reclassified from AOCI to current period
earnings when the forecasted transaction affects earnings. As of
December 31, 2014, the maximum length of time over which the
Bancorp is hedging its exposure to the variability in future cash
flows is 60 months.
Reclassified gains and losses on interest rate contracts related
to commercial and industrial loans are recorded within interest
income in the Consolidated Statements of Income. As of December
31, 2014 and 2013, $23 million and $13 million, respectively, of net
deferred gains, net of tax, on cash flow hedges were recorded in
AOCI in the Consolidated Balance Sheets. As of December 31,
2014, $33 million in net deferred gains, net of tax, recorded in
AOCI are expected to be reclassified into earnings during the next
twelve months. This amount could differ from amounts actually
recognized due to changes in interest rates, hedge de-designations,
and the addition of other hedges subsequent to December 31, 2014.
During 2014 and 2013, there were no gains or losses
reclassified from accumulated AOCI into earnings associated with
the discontinuance of cash flow hedges because it was probable that
the original forecasted transaction would no longer occur by the end
of the originally specified time period or within the additional period
of time as defined by U.S. GAAP.
The following table presents the pretax net gains (losses) recorded in the Consolidated Statements of Income and the Consolidated Statements o
f
Comprehensive Income relating to derivative instruments designated as cash flow hedges:
For the year ended December 31 ($ in millions) 2014 2013 2012
A
mount of pretax net gains (losses) recognized in OCI $ 60 (13) 37
A
mount of pretax net gains reclassified from OCI into net income 44 44 83
Free-Standing Derivative Instruments – Risk Management
and Other Business Purposes
As part of its overall risk management strategy relative to its
mortgage banking activity, the Bancorp may enter into various free-
standing derivatives (principal-only swaps, interest rate swaptions,
interest rate floors, mortgage options, TBAs and interest rate swaps)
to economically hedge changes in fair value of its largely fixed-rate
MSR portfolio. Principal-only swaps hedge the mortgage-LIBOR
spread because these swaps appreciate in value as a result of
tightening spreads. Principal-only swaps also provide prepayment
protection by increasing in value when prepayment speeds increase,
as opposed to MSRs that lose value in a faster prepayment
environment. Receive fixed/pay floating interest rate swaps and
swaptions increase in value when interest rates do not increase as
quickly as expected.
The Bancorp enters into forward contracts and mortgage
options to economically hedge the change in fair value of certain
residential mortgage loans held for sale due to changes in interest
rates. IRLCs issued on residential mortgage loan commitments that
will be held for sale are also considered free-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