Fifth Third Bank 2014 Annual Report Download - page 162

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
160 Fifth Third Bancorp
valuations of the MSR portfolio are obtained from third parties that
use valuation models in order to assess the reasonableness of the
internal DCF model. Additionally, the Bancorp participates in peer
surveys that provide additional confirmation of the reasonableness
of key assumptions utilized in the MSR valuation process and the
resulting MSR prices.
OREO
During 2014 and 2013, the Bancorp recorded nonrecurring
adjustments to certain commercial and residential real estate
properties classified as OREO and measured at the lower of
carrying amount or fair value. These nonrecurring losses are
primarily due to declines in real estate values of the properties
recorded in OREO. For the years ended December 31, 2014 and
2013, these losses include $12 million and $19 million, respectively,
recorded as charge-offs, on new OREO properties transferred from
loans during the respective periods and $14 million and $26 million,
respectively, recorded as negative fair value adjustments on OREO
in other noninterest income subsequent to their transfer from loans.
As discussed in the following paragraphs, the fair value amounts are
generally based on appraisals of the property values, resulting in a
classification within Level 3 of the valuation hierarchy. In cases
where the carrying amount exceeds the fair value, less costs to sell,
an impairment loss is recognized. The previous tables reflect the fair
value measurements of the properties before deducting the
estimated costs to sell.
The Real Estate Valuation department, which reports to the
Chief Risk Officer, is solely responsible for managing the appraisal
process and evaluating the appraisal for all commercial properties
transferred to OREO. All appraisals on commercial OREO
properties are updated on at least an annual basis.
The Real Estate Valuation department reviews the BPO data
and internal market information to determine the initial charge-off
on residential real estate loans transferred to OREO. Once the
foreclosure process is completed, the Bancorp performs an interior
inspection to update the initial fair value of the property. These
properties are reviewed at least every 30 days after the initial interior
inspections are completed. The Asset Manager receives a monthly
status report for each property which includes the number of
showings, recently sold properties, current comparable listings and
overall market conditions.
Bank Premises
The Bancorp monitors consumer preferences for banking
interactions and related customer behavior patterns in an effort to
ensure that its retail distribution network is both responsive to such
trends and efficient. As part of this ongoing assessment, the
Bancorp determined that certain components of its Bank Premises
would no longer be held for or used for their intended purposes and
therefore these properties were written down to their lower of cost
or market value. At least annually thereafter, the Bancorp will review
these properties for market fluctuations. The fair value amounts
were generally based on appraisals of the property values, resulting
in a classification within Level 3 of the valuation hierarchy. For
further information, refer to Note 7.
Private equity investment funds
The Volcker Rule, was approved by the respective federal agencies
on December 10, 2013 and prohibits the Bancorp from retaining an
interest in certain of its private equity fund investments. Therefore,
while the Bancorp has not approved a formal plan to sell any of the
private equity funds, the Bancorp has determined that it may be
forced to sell certain of these funds prior to their scheduled
redemption dates to comply with the Volcker Rule conformance
period. As a result, the Bancorp has performed nonrecurring fair
value measurements on a fund by fund basis to determine whether
OTTI exists. The Bancorp estimated the fair value of a fund by
using the net asset value reported by the fund manager, and in some
cases, applying an estimated market discount to the reported net
asset value of the fund. Because the length of time until the
investment will become redeemable is generally not certain, these
funds were classified within Level 3 of the valuation hierarchy. The
Bancorp recognized $4 million of OTTI on its investments in
private equity funds during 2013. The Bancorp recognized no OTTI
on its investments in private equity funds during 2014. An adverse
change in the reported net asset values or estimated market
discounts where applicable, would result in a decrease in the fair
value estimate. In cases where the carrying value exceeds the fair
value, an impairment loss is recognized. The Bancorp’s private
equity department, which reports to the Chief Operating Officer, in
conjunction with Accounting, is responsible for preparing and
reviewing the fair value estimates.
Fair Value Option
The Bancorp elected to measure certain residential mortgage loans
held for sale under the fair value option as allowed under U.S.
GAAP. Electing to measure residential mortgage loans held for sale
at fair value reduces certain timing differences and better matches
changes in the value of these assets with changes in the value of
derivatives used as economic hedges for these assets. Management’s
intent to sell residential mortgage loans classified as held for sale
may change over time due to such factors as changes in the overall
liquidity in markets or changes in characteristics specific to certain
loans held for sale. Consequently, these loans may be reclassified to
loans held for investment and maintained in the Bancorp’s loan
portfolio. In such cases, the loans will continue to be measured at
fair value.
Fair value changes recognized in earnings for instruments held
at December 31, 2014 and 2013 for which the fair value option was
elected as well as the changes in fair value of the underlying IRLCs,
included gains of $26 million and $20 million, respectively. These
gains are reported in mortgage banking net revenue in the
Consolidated Statements of Income.
Valuation adjustments related to instrument-specific credit risk
for residential mortgage loans measured at fair value negatively
impacted the fair value of those loans by $2 million at both
December 31, 2014 and 2013. Interest on residential mortgage loans
measured at fair value is accrued as it is earned using the effective
interest method and is reported as interest income in the
Consolidated Statements of Income.