Fifth Third Bank 2014 Annual Report Download - page 161

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
159 Fifth Third Bancorp
A
s of December 31, 2013 ($ in millions)
Significant Unobservable Ranges of
Financial Instrument Fair Value Valuation Technique Inputs Inputs Weighted-Average
Commercial loans held for sale $ 3
A
ppraised value
A
ppraised value N
M
NM
Cost to sell N
M
10.0%
Commercial and industrial loans 443
A
ppraised value Collateral value N
M
NM
Commercial mortgage loans 61
A
ppraised value Collateral value N
M
NM
Commercial construction loans 16
A
ppraised value Collateral value N
M
NM
MSRs 967 Discounted cash flow Prepayment speed 0 - 100%
(Fixed) 10.3%
(Adjustable) 25.6%
Discount rates 9.4 - 18.0%
(Fixed) 10.4%
(Adjustable) 11.6%
OREO 87
A
ppraised value
A
ppraised value N
M
NM
Bank premises 8
A
ppraised value
A
ppraised value N
M
NM
Private equity investment funds 44(a) Liquidity discount applied
to fund's net asset value Liquidity discount 0-18.0% 3.0%
(a) Includes funds the Bancorp will be prohibited from retaining after the July 21, 2016 end of the conformance period for the final rules, adopted under the BHCA, that implemented the provision of the
Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as the Volcker Rule.
Commercial loans held for sale
During 2014 and 2013, the Bancorp transferred $28 million and $5
million, respectively, of commercial loans from the portfolio to
loans held for sale that upon transfer were measured at lower of
cost or fair value. These loans had fair value adjustments in 2014
and 2013 totaling $10 million and $4 million, respectively, and were
generally based on appraisals of the underlying collateral and were
therefore, classified within Level 3 of the valuation hierarchy.
Additionally, during 2014 and 2013 there were fair value
adjustments on existing commercial loans held for sale of $2 million
and $3 million, respectively. The fair value adjustments were also
based on appraisals of the underlying collateral and were therefore
classified within Level 3 of the valuation hierarchy. An adverse
change in the fair value of the underlying collateral would result in a
decrease in the fair value measurement.
The Accounting Department determines the procedures for
valuation of commercial HFS loans which may include a
comparison to recently executed transactions of similar type loans.
A monthly review of the portfolio is performed for reasonableness.
Quarterly, appraisals approaching a year old are updated and the
Real Estate Valuation group, which reports to the Chief Risk
Officer, in conjunction with the Commercial Line of Business
review the third party appraisals for reasonableness. Additionally,
the Commercial Line of Business Finance Department, which
reports to the Bancorp Chief Financial Officer, in conjunction with
Accounting review all loan appraisal values, carrying values and
vintages.
Residential mortgage loans held for sale
During 2014, the Bancorp transferred $720 million of restructured
residential mortgage loans from the portfolio to loans held for sale
that upon transfer were measured at lower of cost or fair value using
significant unobservable inputs. These loans had fair value
adjustments in 2014 totaling $87 million. The fair value adjustments
were based on estimated third-party valuations utilizing recent sales
data from similar transactions. Broker opinion statements were also
obtained as additional evidence to support the third-party
valuations. The Treasury Department worked with the third-party
advisor to estimate the fair value adjustments. The discounts taken
were intended to represent the perspective of a market participant,
considering among other things, required investor returns which
include liquidity discounts reflected in similar bulk transactions. An
adverse change in the fair value of the underlying collateral would
result in a decrease in the fair value measurement.
Commercial loans held for investment
During 2014 and 2013, the Bancorp recorded nonrecurring
impairment adjustments to certain commercial and industrial,
commercial mortgage and commercial construction loans held for
investment. Larger commercial loans included within aggregate
borrower relationship balances exceeding $1 million that exhibit
probable or observed credit weaknesses are subject to individual
review for impairment. The Bancorp considers the current value of
collateral, credit quality of any guarantees, the guarantor’s liquidity
and willingness to cooperate, the loan structure and other factors
when evaluating whether an individual loan is impaired. When the
loan is collateral dependent, the fair value of the loan is generally
based on the fair value of the underlying collateral supporting the
loan and therefore these loans were classified within Level 3 of the
valuation hierarchy. In cases where the carrying value exceeds the
fair value, an impairment loss is recognized.
An adverse change in the fair value of the underlying collateral
would result in a decrease in the fair value measurement. The fair
values and recognized impairment losses are reflected in the
previous table. Commercial Credit Risk, which reports to the Chief
Risk Officer, is responsible for preparing and reviewing the fair
value estimates for commercial loans held for investment.
MSRs
Mortgage interest rates decreased during the year ended December
31, 2014 and the Bancorp recognized temporary impairment in
certain classes of the MSR portfolio and the carrying value was
adjusted to the fair value. The Bancorp recognized a recovery of
temporary impairment on servicing rights during the year ended
December 31, 2013. MSRs do not trade in an active, open market
with readily observable prices. While sales of MSRs do occur, the
precise terms and conditions typically are not readily available.
Accordingly, the Bancorp estimates the fair value of MSRs using
internal DCF models with certain unobservable inputs, primarily
prepayment speed assumptions, discount rates and weighted average
lives, resulting in a classification within Level 3 of the valuation
hierarchy. Refer to Note 11 for further information on the
assumptions used in the valuation of the Bancorp’s MSRs. The
Secondary Marketing Department and Treasury Department are
responsible for determining the valuation methodology for MSRs.
Representatives from Secondary Marketing, Treasury, Accounting
and Risk Management are responsible for reviewing key
assumptions used in the internal DCF model. Two external