Fifth Third Bank 2014 Annual Report Download - page 26

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
24 Fifth Third Bancorp
analyzed in the determination of the adequacy of the Bancorp’s
ALLL, as discussed above. Net adjustments to the reserve for
unfunded commitments are included in other noninterest expense
in the Consolidated Statements of Income.
Income Taxes
The Bancorp estimates income tax expense based on amounts
expected to be owed to the various tax jurisdictions in which the
Bancorp conducts business. On a quarterly basis, management
assesses the reasonableness of its effective tax rate based upon its
current estimate of the amount and components of net income, tax
credits and the applicable statutory tax rates expected for the full
year. The estimated income tax expense is recorded in the
Consolidated Statements of Income.
Deferred income tax assets and liabilities are determined using
the balance sheet method and the net deferred tax asset or liability is
reported in other assets or accrued taxes, interest and expenses,
respectively, in the Consolidated Balance Sheets. Under this
method, the net deferred tax asset or liability is based on the tax
effects of the differences between the book and tax basis of assets
and liabilities, and reflects enacted changes in tax rates and laws.
Deferred tax assets are recognized to the extent they exist and are
subject to a valuation allowance based on management’s judgment
that realization is more likely than not. This analysis is performed on
a quarterly basis and includes an evaluation of all positive and
negative evidence, such as the limitation on the use of any net
operating losses, to determine whether realization is more likely
than not.
Accrued taxes represent the net estimated amount due to
taxing jurisdictions and are reported in accrued taxes, interest and
expenses in the Consolidated Balance Sheets. The Bancorp
evaluates and assesses the relative risks and appropriate tax
treatment of transactions and filing positions after considering
statutes, regulations, judicial precedent and other information and
maintains tax accruals consistent with its evaluation of these relative
risks and merits. Changes to the estimate of accrued taxes occur
periodically due to changes in tax rates, interpretations of tax laws,
the status of examinations being conducted by taxing authorities
and changes to statutory, judicial and regulatory guidance that
impact the relative risks of tax positions. These changes, when they
occur, can affect deferred taxes and accrued taxes as well as the
current period’s income tax expense and can be significant to the
operating results of the Bancorp. For additional information on
income taxes, refer to Note 20 of the Notes to Consolidated
Financial Statements.
Valuation of Servicing Rights
When the Bancorp sells loans through either securitizations or
individual loan sales in accordance with its investment policies, it
often obtains servicing rights. Servicing rights resulting from loan
sales are initially recorded at fair value and subsequently amortized
in proportion to, and over the period of, estimated net servicing
revenue. Servicing rights are assessed for impairment monthly,
based on fair value, with temporary impairment recognized through
a valuation allowance and permanent impairment recognized
through a write-off of the servicing asset and related valuation
allowance. Key economic assumptions used in measuring any
potential impairment of the servicing rights include the prepayment
speeds of the underlying loans, the weighted-average life, the
discount rate and the weighted-average coupon rate, as applicable.
The primary risk of material changes to the value of the servicing
rights resides in the potential volatility in the economic assumptions
used, particularly the prepayment speeds. The Bancorp monitors
risk and adjusts its valuation allowance as necessary to adequately
reserve for impairment in the servicing portfolio. For purposes of
measuring impairment, the mortgage servicing rights are stratified
into classes based on the financial asset type (fixed-rate vs.
adjustable rate) and interest rates. For additional information on
servicing rights, refer to Note 11 of the Notes to Consolidated
Financial Statements.
Fair Value Measurements
The Bancorp measures certain financial assets and liabilities at fair
value in accordance with U.S. GAAP, which defines fair value as the
price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date. Valuation techniques the Bancorp uses to
measure fair value include the market approach, income approach
and cost approach. The market approach uses prices or relevant
information generated by market transactions involving identical or
comparable assets or liabilities. The income approach involves
discounting future amounts to a single present amount and is based
on current market expectations about those future amounts. The
cost approach is based on the amount that currently would be
required to replace the service capacity of the asset.
U.S. GAAP establishes a fair value hierarchy, which prioritizes
the inputs to valuation techniques used to measure fair value into
three broad levels. The fair value hierarchy gives the highest priority
to quoted prices in active markets for identical assets or liabilities
(Level 1) and the lowest priority to unobservable inputs (Level 3). A
financial instrument’s categorization within the fair value hierarchy
is based upon the lowest level of input that is significant to the
instrument’s fair value measurement. The three levels within the fair
value hierarchy are described as follows:
Level 1 – Quoted prices (unadjusted) in active markets
for identical assets or liabilities that the Bancorp has the
ability to access at the measurement date.
Level 2 – Inputs other than quoted prices included within
Level 1 that are observable for the asset or liability,
either directly or indirectly. Level 2 inputs include:
quoted prices for similar assets or liabilities in active
markets; quoted prices for identical or similar assets or
liabilities in markets that are not active; inputs other than
quoted prices that are observable for the asset or liability;
and inputs that are derived principally from or
corroborated by observable market data by correlation
or other means.
Level 3 – Unobservable inputs for the asset or liability for
which there is little, if any, market activity at the
measurement date. Unobservable inputs reflect the
Bancorp’s own assumptions about what market
participants would use to price the asset or liability. The
inputs are developed based on the best information
available in the circumstances, which might include the
Bancorp’s own financial data such as internally
developed pricing models and DCF methodologies, as
well as instruments for which the fair value
determination requires significant management
judgment.
The Bancorp’s fair value measurements involve various
valuation techniques and models, which involve inputs that are
observable, when available. Valuation techniques and parameters
used for measuring assets and liabilities are reviewed and validated
by the Bancorp on a quarterly basis. Additionally, the Bancorp
monitors the fair values of significant assets and liabilities using a
variety of methods including the evaluation of pricing runs and