Fifth Third Bank 2014 Annual Report Download - page 78

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
76 Fifth Third Bancorp
prevailing rates return to a level commensurate with the borrower’s
loan rate. In addition to the mortgage servicing rights valuation, the
Bancorp recognized net gains of $95 million and net losses of $17
million on its non-qualifying hedging strategy for the years ended
2014 and 2013, respectively. These amounts include net gains on
securities related to the Bancorp’s non-qualifying hedging strategy
which were zero during 2014 and $13 million during 2013. The
Bancorp may adjust its hedging strategy to reflect its assessment of
the composition of its MSR portfolio, the cost of hedging and the
anticipated effectiveness of the hedges given the economic
environment. Refer to Note 11 of the Notes to Consolidated
Financial Statements for further discussion on servicing rights and
the instruments used to hedge interest rate risk on MSRs.
Foreign Currency Risk
The Bancorp may enter into foreign exchange derivative contracts
to economically hedge certain foreign denominated loans. The
derivatives are classified as free-standing instruments with the
revaluation gain or loss being recorded in other noninterest income
in the Consolidated Statements of Income. The balance of the
Bancorp’s foreign denominated loans at December 31, 2014 and
December 31, 2013 was $720 million and $581 million, respectively.
The Bancorp also enters into foreign exchange contracts for the
benefit of commercial customers involved in international trade to
hedge their exposure to foreign currency fluctuations. The Bancorp
has internal controls in place to help ensure excessive risk is not
being taken in providing this service to customers. These controls
include an independent determination of currency volatility and
credit equivalent exposure on these contracts, counterparty credit
approvals and country limits.
LIQUIDITY RISK MANAGEMENT
The goal of liquidity management is to provide adequate funds to
meet changes in loan and lease demand, unexpected levels of
deposit withdrawals and other contractual obligations. Mitigating
liquidity risk is accomplished by maintaining liquid assets in the
form of investment securities, maintaining sufficient unused
borrowing capacity in the debt markets and delivering consistent
growth in core deposits. A summary of certain obligations and
commitments to make future payments under contracts is included
in Note 17 of the Notes to Consolidated Financial Statements.
The Bancorp maintains a contingency funding plan that
assesses the liquidity needs under various scenarios of market
conditions, asset growth and credit rating downgrades. The plan
includes liquidity stress testing which measures various sources and
uses of funds under the different scenarios. The contingency plan
provides for ongoing monitoring of unused borrowing capacity and
available sources of contingent liquidity to prepare for unexpected
liquidity needs and to cover unanticipated events that could affect
liquidity.
Sources of Funds
The Bancorp’s primary sources of funds relate to cash flows from
loan and lease repayments, payments from securities related to sales
and maturities, the sale or securitization of loans and leases and
funds generated by core deposits, in addition to the use of public
and private debt offerings.
Expected maturities from loan and lease repayments are
included in Table 58 of the Market Risk Management section of
MD&A. Of the $22.4 billion of securities in the Bancorp’s available-
for-sale and other portfolio at December 31, 2014, $3.3 billion in
principal and interest is expected to be received in the next 12
months and an additional $3.5 billion is expected to be received in
the next 13 to 24 months. For further information on the Bancorp’s
securities portfolio, refer to the Investment Securities subsection of
the Balance Sheet Analysis of MD&A.
Asset-driven liquidity is provided by the Bancorp’s ability to
sell or securitize loans and leases. In order to reduce the exposure to
interest rate fluctuations and to manage liquidity, the Bancorp has
developed securitization and sale procedures for several types of
interest-sensitive assets. A majority of the long-term, fixed-rate
single-family residential mortgage loans underwritten according to
FHLMC or FNMA guidelines are sold for cash upon origination.
Additional assets such as certain other residential mortgages, certain
commercial loans, home equity loans, automobile loans and other
consumer loans are also capable of being securitized or sold. For the
years ended December 31, 2014 and 2013, the Bancorp sold or
securitized loans totaling $9.4 billion and $23.4 billion, respectively.
For further information on the transfer of financial assets, refer to
Note 11 of the Notes to Consolidated Financial Statements.
Core deposits have historically provided the Bancorp with a
sizeable source of relatively stable and low cost funds. The
Bancorp’s average core deposits and shareholders’ equity funded
82% of its average total assets during 2014 and 2013. In addition to
core deposit funding, the Bancorp also accesses a variety of other
short-term and long-term funding sources, which include the use of
the FHLB system. Certificates of deposit with a balance of $100,000
or more and deposits in the Bancorp’s foreign branch located in the
Cayman Islands are wholesale funding tools utilized to fund asset
growth. Management does not rely on any one source of liquidity
and manages availability in response to changing balance sheet
needs.
On February 25, 2014, the Bancorp issued and sold $500
million of unsecured senior fixed-rate notes. On June 5, 2014, The
Bancorp issued in a registered public offering 300,000 depositary
shares, representing 12,000 shares of 4.90% fixed-to-floating rate
non-cumulative Series J perpetual preferred stock, for net proceeds
of $297 million. As of December 31, 2014, $3.0 billion of debt or
other securities were available for issuance under the current
Bancorp’s Board of Directors’ authorizations and the Bancorp is
authorized to file any necessary registration statements with the SEC
to permit ready access to the public securities markets; however,
access to these markets may depend on market conditions. At
December 31, 2014, the Bancorp has approximately $41.7 billion of
borrowing capacity available through secured borrowing sources
including the FHLB and FRB.
In 2013, the Bancorp’s banking subsidiary updated and
amended its existing global bank note program to increase the
capacity from $20 billion to $25 billion. On April 25, 2014, the Bank
issued and sold $1.5 billion in aggregate principal amount of
unsecured senior bank notes. On September 5, 2014, the Bank
issued and sold $850 million of unsecured senior fixed-rate bank
notes. The Bancorp has $19.1 billion of funding available for
issuance under the global bank note program as of December 31,
2014.
For the year ended December 31, 2014, the Bancorp
transferred approximately $3.8 billion in consumer automobile loans
to bankruptcy remote trusts which were deemed to be VIEs. The
Bancorp concluded that it is the primary beneficiary of these VIEs
and, therefore, has consolidated these VIEs. The assets of these
VIEs are restricted to the settlement of the notes and other
obligations of the VIEs. Third-party holders of the notes do not
have recourse to the general assets of the Bancorp.