Fifth Third Bank 2014 Annual Report Download - page 95

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
93 Fifth Third Bancorp
whether an individual loan is impaired. Other factors may include
the industry and geographic region of the borrower, size and
financial condition of the borrower, cash flow and leverage of the
borrower, and the Bancorp’s evaluation of the borrower’s
management. When individual loans are impaired, allowances are
determined based on management’s estimate of the borrower’s
ability to repay the loan given the availability of collateral and other
sources of cash flow, as well as an evaluation of legal options
available to the Bancorp. Allowances for impaired loans are
measured based on the present value of expected future cash flows
discounted at the loan’s effective interest rate, fair value of the
underlying collateral or readily observable secondary market values.
The Bancorp evaluates the collectability of both principal and
interest when assessing the need for a loss accrual.
Historical credit loss rates are applied to commercial loans that
are not impaired or are impaired, but smaller than the established
threshold of $1 million and thus not subject to specific allowance
allocations. The loss rates are derived from a migration analysis,
which tracks the historical net charge-off experience sustained on
loans according to their internal risk grade. The risk grading system
utilized for allowance analysis purposes encompasses ten categories.
Homogenous loans and leases in the residential mortgage and
consumer portfolio segments are not individually risk graded.
Rather, standard credit scoring systems and delinquency monitoring
are used to assess credit risks, and allowances are established based
on the expected net charge-offs. Loss rates are based on the trailing
twelve month net charge-off history by loan category. Historical loss
rates may be adjusted for certain prescriptive and qualitative factors
that, in management’s judgment, are necessary to reflect losses
inherent in the portfolio. Factors that management considers in the
analysis include the effects of the national and local economies;
trends in the nature and volume of delinquencies, charge-offs and
nonaccrual loans; changes in loan mix; credit score migration
comparisons; asset quality trends; risk management and loan
administration; changes in the internal lending policies and credit
standards; collection practices; and examination results from bank
regulatory agencies and the Bancorp’s internal credit reviewers.
The Bancorp’s primary market areas for lending are the
Midwestern and Southeastern regions of the Unites States. When
evaluating the adequacy of allowances, consideration is given to
these regional geographic concentrations and the closely associated
effect changing economic conditions have on the Bancorp’s
customers.
In the current year, the Bancorp has not substantively changed
any material aspect to its overall approach to determining its ALLL
for any of its portfolio segments. There have been no material
changes in criteria or estimation techniques as compared to prior
periods that impacted the determination of the current period
ALLL for any of the Bancorp’s portfolio segments.
Reserve for Unfunded Commitments
The reserve for unfunded commitments is maintained at a level
believed by management to be sufficient to absorb estimated
probable losses related to unfunded credit facilities and is included
in other liabilities in the Consolidated Balance Sheets. The
determination of the adequacy of the reserve is based upon an
evaluation of the unfunded credit facilities, including an assessment
of historical commitment utilization experience, credit risk grading
and historical loss rates based on credit grade migration. This
process takes into consideration the same risk elements that are
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.
Loan Sales and Securitizations
The Bancorp periodically sells loans through either securitizations
or individual loan sales in accordance with its investment policies.
The sold loans are removed from the balance sheet and a net gain or
loss is recognized in the Bancorp’s Consolidated Financial
Statements at the time of sale. The Bancorp typically isolates the
loans through the use of a VIE and thus is required to assess
whether the entity holding the sold or securitized loans is a VIE and
whether the Bancorp is the primary beneficiary and therefore
consolidator of that VIE. If the Bancorp holds the power to direct
activities most significant to the economic performance of the VIE
and has the obligation to absorb losses or right to receive benefits
that could potentially be significant to the VIE, then the Bancorp
will generally be deemed the primary beneficiary of the VIE. If the
Bancorp is determined not to be the primary beneficiary of a VIE
but holds a variable interest in the entity, such variable interests are
accounted for under the equity method of accounting or other
accounting standards as appropriate. Refer to Note 10 for further
information on consolidated and non-consolidated VIEs.
The Bancorp’s loan sales and securitizations are generally
structured with servicing retained. As a result, servicing rights
resulting from residential mortgage loan sales are initially recorded
at fair value and subsequently amortized in proportion to and over
the period of estimated net servicing revenues and are reported as a
component of mortgage banking net revenue in the Consolidated
Statements of Income. 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, 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. Fees received for servicing
loans owned by investors are based on a percentage of the
outstanding monthly principal balance of such loans and are
included in noninterest income in the Consolidated Statements of
Income as loan payments are received. Costs of servicing loans are
charged to expense as incurred.
Reserve for Representation and Warranty Provisions
Conforming residential mortgage loans sold to unrelated third
parties are generally sold with representation and warranty
provisions. A contractual liability arises only in the event of a breach
of these representations and warranties and, in general, only when a
loss results from the breach. The Bancorp may be required to
repurchase any previously sold loan or indemnify (make whole) the
investor or insurer for which the representation or warranty of the
Bancorp proves to be inaccurate, incomplete or misleading. The
Bancorp establishes a residential mortgage repurchase reserve
related to various representations and warranties that reflects
management’s estimate of losses based on a combination of factors.
The Bancorp’s estimation process requires management to
make subjective and complex judgments about matters that are
inherently uncertain, such as future demand expectations, economic
factors and the specific characteristics of the loans subject to
repurchase. Such factors incorporate historical investor audit and
repurchase demand rates, appeals success rates, historical loss