Fifth Third Bank 2014 Annual Report Download - page 76

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
74 Fifth Third Bancorp
The Bancorp’s interest rate risk exposure is evaluated by
measuring the anticipated change in net interest income over 12-
month and 24-month horizons assuming 100 bps and 200 bps
parallel ramped increases in interest rates. In accordance with
internal policy, rate movements are assumed to occur over one year
and are sustained thereafter. The analysis would typically include
100 bps and 200 bps parallel ramped decreases in interest rates;
however, this analysis is currently omitted due to the current low
levels of certain interest rates. Applying the ramps would result in
certain interest rates becoming negative in the parallel ramped
decrease scenarios.
The following table shows the Bancorp’s estimated NII sensitivity profile and ALCO policy limits as of December 31:
TABLE 56: ESTIMATED NII SENSITIVITY PROFILE
2014 2013
Percent Change in NII
(FTE) ALCO Policy Limits
Percent Change in NII
(FTE) ALCO Policy Limits
12 Months
13 to 24
Months 12 Months
13 to 24
Months 12 Months
13 to 24
Months 12 Months
13 to 24
Months Change in Interest Rates (bps)
+200 2.19 %6.49 (4.00) (6.00) 1.73 % 6.89 (4.00) (6.00)
+100 1.16 4.18 - - 0.77 3.37 - -
At December 31, 2014, the Bancorp’s net interest income would
benefit in year one and year two under these parallel ramp increases.
The benefit was attributable to the combination of floating-rate
assets, including the predominantly floating-rate commercial loan
portfolio, and certain intermediate-term fixed-rate liabilities. The
benefit was up modestly compared to December 31, 2013 with the
exception of the +200 scenario from 13 to 24 months, which was
down slightly. Improvements in the NII benefit were attributable to
continued growth in commercial loans and core deposits, and the
issuance of fixed-rate debt securities. The modest decline in the
+200 scenario from 13 to 24 months compared to December 31,
2013 was primarily due to changes in expected loan and security
prepayment speeds.
Economic Value of Equity Sensitivity
The Bancorp also uses EVE as a measurement tool in managing
interest rate risk. Whereas the net interest income sensitivity analysis
highlights the impact on forecasted NII over one and two year time
horizons, the EVE analysis is a point in time analysis of the current
positions that incorporates all cash flows over their estimated
remaining lives. The EVE of the balance sheet is defined as the
discounted present value of all asset and net derivative cash flows
less the discounted value of all liability cash flows. Due to this
longer horizon, the sensitivity of EVE to changes in the level of
interest rates is a measure of longer-term interest rate risk. EVE
values only the current balance sheet and does not incorporate the
growth assumptions used in the NII sensitivity analysis. As with the
NII simulation model, assumptions about the timing and variability
of existing balance sheet cash flows are critical in the EVE analysis.
Particularly important are assumptions driving loan and security
prepayments and the expected balance attrition and pricing of
transaction deposits.
The following table shows the Bancorp’s EVE sensitivity profile as of December 31:
TABLE 57: ESTIMATED EVE SENSITIVITY PROFILE
2014 2013
Change in Interest Rates (bps) Change in EVE ALCO Policy Limit Change in EVE ALCO Policy Limit
+200 (2.21)%(12.00) (5.78)%(12.00)
+100 (0.62) (2.91)
+25 (0.06) (0.70)
-25 (0.05) 0.63
The EVE sensitivity was modestly negative at December 31, 2014
and has improved from the EVE sensitivity at December 31, 2013.
The lower level of EVE risk since December 31, 2013 was
attributable to continued growth in commercial loans and core
deposits, and the issuance of fixed-rate debt securities.
While an instantaneous shift in interest rates was used in this
analysis to provide an estimate of exposure, the Bancorp believes
that a gradual shift in interest rates would have a much more modest
impact. Since EVE measures the discounted present value of cash
flows over the estimated lives of instruments, the change in EVE
does not directly correlate to the degree that earnings would be
impacted over a shorter time horizon (e.g., the current fiscal year).
Further, EVE does not take into account factors such as future
balance sheet growth, changes in product mix, changes in yield
curve relationships and changing product spreads that could
mitigate or exacerbate the impact of changes in interest rates. The
NII simulations and EVE analyses do not necessarily include certain
actions that management may undertake to manage risk in response
to anticipated changes in interest rates.
The Bancorp regularly evaluates its exposures to LIBOR and
Prime basis risks, nonparallel shifts in the yield curve and embedded
options risk. In addition, the impact on NII and EVE of extreme
changes in interest rates is modeled, wherein the Bancorp employs
the use of yield curve shocks and environment-specific scenarios.
Use of Derivatives to Manage Interest Rate Risk
An integral component of the Bancorp’s interest rate risk
management strategy is its use of derivative instruments to minimize
significant fluctuations in earnings caused by changes in market
interest rates. Examples of derivative instruments that the Bancorp
may use as part of its interest rate risk management strategy include
interest rate swaps, interest rate floors, interest rate caps, forward
contracts, options, swaptions and TBA securities.