Fifth Third Bank 2014 Annual Report Download - page 27

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
25 Fifth Third Bancorp
exception reports based on certain analytical criteria, comparison to
previous trades and overall review and assessments for
reasonableness. The following is a summary of valuation techniques
utilized by the Bancorp for its significant assets and liabilities
measured at fair value on a recurring basis.
Available-for-sale and trading securities
Where quoted prices are available in an active market,
securities are classified within Level 1 of the valuation
hierarchy. Level 1 securities include government bonds
and exchange traded equities. If quoted market prices are
not available, then fair values are estimated using pricing
models, quoted prices of securities with similar
characteristics, or DCFs. Examples of such instruments,
which are classified within Level 2 of the valuation
hierarchy, include federal agencies, obligations of states
and political subdivisions, agency residential mortgage-
backed securities, agency and non-agency commercial
mortgage-backed securities and asset-backed securities
and other debt securities. Corporate bonds are included
in asset-backed securities and other debt securities.
Federal agencies, obligations of states and political
subdivisions, agency residential mortgage-backed
securities, agency and non-agency commercial mortgage-
backed securities and asset-backed securities and other
debt securities are generally valued using a market
approach based on observable prices of securities with
similar characteristics.
Residential mortgage loans held for sale and held
for investment
For residential mortgage loans held for sale for which
the fair value election has been made, fair value is
estimated based upon mortgage-backed securities prices
and spreads to those prices or, for certain ARM loans,
DCF models that may incorporate the anticipated
portfolio composition, credit spreads of asset-backed
securities with similar collateral, and market conditions.
The anticipated portfolio composition includes the effect
of interest rate spreads and discount rates due to loan
characteristics such as the state in which the loan was
originated, the loan amount and the ARM margin.
Residential mortgage loans held for sale that are valued
based on mortgage-backed securities prices are classified
within Level 2 of the valuation hierarchy as the valuation
is based on external pricing for similar instruments.
ARM loans classified as held for sale are also classified
within Level 2 of the valuation hierarchy due to the use
of observable inputs in the DCF model. These
observable inputs include interest rate spreads from
agency mortgage-backed securities market rates and
observable discount rates. For residential mortgage loans
in which the fair value election has been made that are
subsequently reclassified from held for sale to held for
investment, the fair value estimation is based on
mortgage-backed securities prices, interest rate risk and
an internally developed credit component. Therefore,
these loans are classified within Level 3 of the valuation
hierarchy.
Derivatives
Exchange-traded derivatives valued using quoted prices
and certain over-the-counter derivatives valued using
active bids are classified within Level 1 of the valuation
hierarchy. Most of the Bancorp’s derivative contracts are
valued using DCF or other models that incorporate
current market interest rates, credit spreads assigned to
the derivative counterparties, and other market
parameters and, therefore, are classified within Level 2
of the valuation hierarchy. Such derivatives include basic
and structured interest rate swaps and options.
Derivatives that are valued based upon models with
significant unobservable market parameters are classified
within Level 3 of the valuation hierarchy. At
December 31, 2014, derivatives classified as Level 3,
which are valued using an option-pricing model
containing unobservable inputs, consisted primarily of
the warrant associated with the initial sale of the
Bancorp’s 51% interest in Vantiv Holding, LLC to
Advent International and a total return swap associated
with the Bancorp’s sale of its Visa, Inc. Class B shares.
Level 3 derivatives also include IRLCs, which utilize
internally generated loan closing rate assumptions as a
significant unobservable input in the valuation process.
In addition to the assets and liabilities measured at fair value
on a recurring basis, the Bancorp measures servicing rights, certain
loans and long-lived assets at fair value on a nonrecurring basis.
Refer to Note 27 of the Notes to Consolidated Financial Statements
for further information on fair value measurements.
Goodwill
Business combinations entered into by the Bancorp typically include
the acquisition of goodwill. U.S. GAAP requires goodwill to be
tested for impairment at the Bancorp’s reporting unit level on an
annual basis, which for the Bancorp is September 30, and more
frequently if events or circumstances indicate that there may be
impairment. The Bancorp has determined that its segments qualify
as reporting units under U.S. GAAP.
Impairment exists when a reporting unit’s carrying amount of
goodwill exceeds its implied fair value. In testing goodwill for
impairment, U.S. GAAP permits the Bancorp to first assess
qualitative factors to determine whether it is more likely than not
that the fair value of a reporting unit is less than its carrying amount.
In this qualitative assessment, the Bancorp evaluates events and
circumstances which may include, but are not limited to, the general
economic environment, banking industry and market conditions,
the overall financial performance of the Bancorp, the performance
of the Bancorp’s stock, the key financial performance metrics of the
reporting units, and events affecting the reporting units. If, after
assessing the totality of events and circumstances, the Bancorp
determines it is not more likely than not that the fair value of a
reporting unit is less than its carrying amount, then performing the
two-step impairment test would be unnecessary. However, if the
Bancorp concludes otherwise, it would then be required to perform
the first step (Step 1) of the goodwill impairment test, and continue
to the second step (Step 2), if necessary. Step 1 compares the fair
value of a reporting unit with its carrying amount, including
goodwill. If the carrying amount of the reporting unit exceeds its
fair value, Step 2 of the goodwill impairment test is performed to
measure the amount of impairment loss, if any.
The fair value of a reporting unit is the price that would be
received to sell the unit as a whole in an orderly transaction between
market participants at the measurement date. Since none of the
Bancorp’s reporting units are publicly traded, individual reporting
unit fair value determinations cannot be directly correlated to the
Bancorp’s stock price. To determine the fair value of a reporting
unit, the Bancorp employs an income-based approach, utilizing the