Form 10-K
building an even better tomorrow.
2006 ANNUAL REPORT
Traverse City
Grand Rapids
Detroit
Chicago
Toledo
Cleveland
Pittsburgh
Columbus
Indianapolis
Dayton
Cincinnati
St. Louis
Evansville
Florence
Huntington
Louisville
Lexington
Nashville
Tampa Bay
Orlando
Naples
Corporate Profile
Fifth Third Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. The Company has $101 billion in assets and operates 19 affiliates with 1,150 full-service banking centers, including 111 Bank
Mart® locations open seven days a week inside select grocery stores, and 2,096 Jeanie® ATMs in Ohio, Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West Virginia, Pennsylvania and Missouri. The financial strength of Fifth
Thirds Ohio and Michigan banks continues to be recognized by rating agencies with deposit ratings of Aa2 from Moodys, AA from Fitch and DBRS, and AA- from Standard & Poors. Fifth Third operates five main businesses: Commercial
Banking; Branch Banking; Consumer Lending; Investment Advisors; and Fifth Third Processing Solutions. Fifth Third is among the largest money managers in the Midwest and, as of December 31, 2006, has $220 billion in assets under care, of which it
manages $34 billion for individuals, corporations and not-for-profit organizations. Investor information and press releases can be viewed at www.53.com.
Fifth
Thirds common stock is traded through the NASDAQ® Global Select Market System under the symbol FITB.
Fifth Third Bancorp FINANCIAL HIGHLIGHTS
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For the years ended December 31 |
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2006 |
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2005 |
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Percent Change |
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$ in millions, except per share data |
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Earnings and Dividends |
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Net Income |
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$ |
1,188 |
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$ |
1,549 |
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(23 |
) |
Common Dividends Declared |
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880 |
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810 |
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9 |
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Per Share |
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Earnings |
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$ |
2.14 |
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$ |
2.79 |
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(23 |
) |
Diluted Earnings |
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2.13 |
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2.77 |
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(23 |
) |
Cash Dividends |
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1.58 |
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1.46 |
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8 |
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Book Value |
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18.02 |
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17.00 |
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6 |
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At Year-End |
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Assets |
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$ |
100,669 |
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$ |
105,225 |
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(4 |
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Total Loans and Leases |
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75,503 |
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71,229 |
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6 |
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Deposits |
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69,380 |
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67,434 |
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3 |
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Shareholders Equity |
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10,022 |
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9,446 |
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6 |
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Year-End Market Price |
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40.93 |
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37.72 |
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9 |
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Market Capitalization |
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22,767 |
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20,958 |
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9 |
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Key Ratios (percent) |
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Return on Average Assets (ROA) |
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1.13 |
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1.50 |
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(25 |
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Return on Average Equity (ROE) |
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12.1 |
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16.6 |
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(27 |
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Net Interest Margin |
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3.06 |
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3.23 |
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(5 |
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Efficiency Ratio |
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60.5 |
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53.2 |
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14 |
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Average Shareholders Equity to Average Assets |
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9.32 |
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9.06 |
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3 |
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Actuals |
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Common Shares Outstanding (in thousands) |
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556,253 |
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555,623 |
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Banking Centers |
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1,150 |
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1,119 |
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3 |
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Full-Time Equivalent Employees |
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21,362 |
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21,681 |
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(1 |
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Deposit and Debt Ratings |
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Moodys |
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Standard & Poors |
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Fitch |
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Fifth Third Bancorp |
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Commercial Paper |
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Prime-1 |
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A-1 |
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F1+ |
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Senior Debt |
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Aa3 |
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A+ |
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AA- |
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Fifth Third Bank and Fifth Third Bank (Michigan) |
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Short-Term Deposit |
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Prime-1 |
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A-1+ |
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F1+ |
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Long-Term Deposit |
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Aa2 |
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AA- |
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AA |
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1
Dear Shareholders and Friends,
2006 marked an important transition year for Fifth Third, one that I believe has us positioned well as we head into 2007 and beyond.
First, and perhaps
foremost, we added a number of new executives to our team, and promoted others. This gives us the strongest slate of leaders, I believe, in the Companys history. This team reflects a mix of long and successful tenures at Fifth Third,
complemented by a number of executives brought in from other large and successful competitors, giving us a nice balance of outside perspective, continuity, and entrepreneurial drive.
Second, I point to the actions we chose to take in the fourth quarter of 2006 to address the positioning of our balance sheet during the current difficult interest rate environment, characterized by an inverted yield curve (an
environment in which short-term rates are higher than long-term rates). From June 2004 to 2006, the Federal Reserve raised rates 17 consecutive times totaling 4.25 percentage points, which created significant headwinds obscuring core performance in
our businesses. In November of 2006, we made the decision to reduce the size of our balance sheet and neutralize our exposure to significant future adverse changes in interest rates. This decision was costly, but we believe it was the right thing to
do, and I believe it represents the final step in resolving the issues that developed following the regulatory difficulties we experienced in 2002 and 2003.
Over
the last several years, weve made significant investments in our information technology platform, in our risk management capabilities and personnel, and in our core operations capabilities. These steps are substantially complete, although we
continue to make new additions to front-end technologies and improvements to infrastructure to make the Company more responsive to customer needs.
The actions weve taken relative to the balance sheet, combined with
a stabilization of the interest rate environment, should create the conditions for our historically strong core performance to re-emerge. Fifth Thirds competitive position is very strong. Our tangible capital levels are among the highest in
the industry. I have tremendous confidence in the strength and depth of our management team.
As a result, I have made the decision to step down as Chief Executive
Officer. I couldnt feel more comfortable in handing over the chief executive position to Kevin Kabat, our current president, whom our Board has chosen to succeed me effective April 17, 2007, the date of our annual shareholders meeting.
Kevin is absolutely the right person to head this Company. Kevin has been a terrific leader at Fifth Third since joining us with the Old Kent acquisition in 2001, serving as head of our Western Michigan affiliate, head of Retail Banking and
Affiliate Administration, and then most recently taking on the role of President last year. I have asked him to address you with his views on our future in a separate letter following this one.
I am very proud of my years with Fifth Third and my 16 years as Fifth Thirds Chief Executive Officer, and it has been an honor to serve the Company in this important role. I
will continue to hold the position of Chairman, but I believe its time for a new generation of leadership to provide the Company with a new vitality, a new level of energy, and a new direction.
2006 Results
2006 was a challenging year for the industry and for Fifth
Third. In June the Federal Reserve concluded its most significant tightening campaign since the early 1980s, which resulted in an inverted yield curve for most of the second half of 2006. As a result, our borrowing costs rose for much of the year
while the yield on our investment securities portfolio was relatively flat.
In November, we decided to reduce the size of our balance sheet in order to reduce our
exposure to this interest rate environment and to future potential adverse rate movements. These actions resulted in the realization of a pre-tax loss of $454 million, or $291 million after tax ($0.52 per share). We expect net interest income to
benefit from our improved positioning by $110 million to $120 million on an annualized basis, before hedging costs. Additionally, we realized a 65 basis points benefit to our already very strong tangible equity to tangible assets ratio.
The interest rate environment, combined with the loss resulting from our balance sheet actions, took a toll on reported results for the year. Earnings per diluted share for
2006 were $2.13, down from $2.77 in 2005. Return on average assets and return on
2
Fifth Third Bancorp LETTER FROM THE CHAIRMAN & CEO
average equity were 1.13 percent and 12.1 percent, respectively, significantly below what we would normally expect and below the 1.50 percent and 16.6 percent, respectively, that we realized in 2005.
Net interest income of $2.9 billion on a tax-equivalent basis declined 3 percent from 2005. This result reflected our previous negative sensitivity to rising short-term rates,
offset by solid average loan and core deposit growth of 8 percent and 5 percent, respectively. During 2006, we saw a continuation of strong average commercial loan growth, up 10 percent. Average consumer loan growth remained solid, up 6 percent,
though below the levels we and the industry experienced several years ago with a more favorable rate environment. Going forward, we expect continued strong loan and core deposit growth, combined with the benefits of our balance sheet actions, to
drive improved net interest income performance despite an expected continued flat to inverted yield curve.
Noninterest income of $2.2 billion declined 14 percent
from 2005, reflecting net securities losses of $364 million in 2006 primarily the result of our fourth-quarter balance sheet actions compared with net securities gains of $39 million in 2005. We continued to experience strong growth in
electronic payment processing revenue our largest noninterest income category up 15 percent from 2005. Corporate banking revenue also grew a solid 7 percent.
Noninterest expense of $3.1 billion grew 4 percent from 2005 levels, despite the inclusion of $49 million in expenses related to the extinguishment of financing agreements in the third and fourth quarters to reduce interest rate
sensitivity. Expense growth was otherwise held to 3 percent, reflecting continued strong growth in our processing business offset by expense controls.
Credit costs
remained consistent with the levels of 2005, with provision expense up 4 percent over the prior year and net chargeoffs up 6 percent, though declining slightly as a percentage of average loans to 0.44 percent from 0.45 percent in 2005.
As we look into 2007, we would expect to see upward pressure on credit. We dont have a crystal ball, but at this point we dont see significant economic
deterioration on the near horizon, and dont expect a significant upward move in credit costs. Given Fifth Thirds strong presence in Midwest markets, we have been experiencing slower economic growth and higher levels of credit losses than
banks in other regions for some time. Fifth Third is a lending company, and we are in the risk business. The ebbs and flows of the credit cycle are to be expected and do not change our attitude on that front.
Commitment to our Shareholders and our Communities
We at Fifth Third are deeply aware that you, our shareholders, own the Company,
and that we are accountable to you. Thus, we are proud to maintain among the very highest corporate governance ratings in the industry. Our Corporate Governance Quotient, as published by Institutional Shareholder Services, is in the top 4 percent of
companies in the S&P 500 and in the top 1 percent of all U.S. banks.
I have always believed that Fifth Third and the cities and regions it serves are mutually
dependent and we have always acted upon that belief. Thus, I am especially proud that Fifth Thirds Ohio and Michigan banks each received an Outstanding rating on our most recent Community Reinvestment Act performance
evaluation by the Federal Reserve Bank.
Commitment to the Future
Id like to take this opportunity to express my deep appreciation to all the constituents that make Fifth Third a great company our customers, our 21,362 employees, our board members, and the citizens of the communities served
by our 19 affiliates. Our employees, in particular, have accomplished tremendous things at Fifth Third during my tenure, never more so than during the past year.
2006 was a difficult year for Fifth Third make no mistake about it. But I believe the Company as it enters 2007 is in its strongest position ever. Our balance sheet is very strong and well-capitalized. We have the broadest and
deepest management team weve ever had. Our technology platform is robust and scalable. And we have strong positions in our Midwest markets, with solid footholds in growth markets. We are better positioned to deliver organic growth than ever
before in our history, through our strong sales culture and increased focus on customer service and satisfaction, and through our successful de novo activities. And we are well positioned to participate in what will continue to be a consolidating
industry for many years ahead.
Thank you for the opportunity to have served you for the last 36 years.
Sincerely,
George A. Schaefer, Jr.
Chairman & Chief
Executive Officer
February 2007
3
Dear Shareholders and Friends,
I am deeply honored to address you as President of Fifth Third Bancorp and as George Schaefers successor. Having competed with him earlier in my career, and then having the good fortune to work for him the past five years, I believe
he is one of the giants of the banking industry. We are fortunate that he will remain with us as Chairman, to provide us with his wise counsel and good sense.
When
George became President and Chief Executive Officer of Fifth Third at the end of 1990, the Company had $8 billion in assets and a market capitalization of a little over $1 billion. Weve grown to over $100 billion in assets in the succeeding 16
years with a market value of nearly $23 billion. During that period, Fifth Third has generated a total shareholder return of 17.5 percent on a compound annual basis, driven by strong growth in originally reported earnings per share and rising
dividends. That return compares with 12 percent for the S&P 500 over that period. This is truly an enviable track record, one that we aspire to continue.
Building an Even Better Tomorrow
The title of this years annual report Building an Even Better Tomorrow aptly
describes what we are about here at Fifth Third. The title is adapted from the new brand that we introduced this February.
Thats what we are aiming for
building an even better tomorrow. This Company was built upon an incredibly strong sales culture, a winning attitude and very high standards and expectations. We dont play for average. During the past 16 years, our performance topped the
industry, even when you include the past three sub-par years. Whether measured by originally reported earnings per share, asset growth, market capitalization growth or total return, weve outperformed our peers.
But the last three years we havent met our own expectations, or
yours. We know it is time to show results, and thats what we are prepared to do. We have the right team in place, having promoted or hired new leaders who are bringing a fresh perspective and new energy. We are united as a team and feel an
urgency to return to the head of the pack.
Our Model
We
are fortunate to have many strengths to build on. Our affiliate model allows us to deliver big-company results on a local scale. We have local management with full accountability in each market, making decisions locally that affect our customers.
This model may not be the least expensive way to organize a company. But efficiencies, standardization and a common technology platform combine with personal, high-touch service in each affiliate to create real benefit. This is perhaps our biggest
competitive differentiator. Where decentralization does not add value, for us or for our customers, we will continue to look for ways to enhance efficiency, but we remain committed to the essence of the model. We provide more information on our
affiliate model, our regions and affiliates, and their leadership on page 10 of this report.
Overlaying our affiliate structure are five lines of business: Branch
Banking; Commercial Banking; Processing Solutions; Consumer Lending; and Investment Advisors. These lines of business are areas of expertise whose products and services are delivered to customers through the affiliates in a way that ensures that
customer relationships are viewed as a whole. Below I discuss some of the key strategies under way in our lines of business. Our businesses are described in more detail on pages 11 through 15.
Key Strategies and Focus Areas
One of our key strategies is our
commitment to Everyday Great Rates, implemented in the summer of 2005. We believe this strategy for deposit growth strikes an optimal balance between growth and profitability. Everyday Great Rates is what it says very competitive rates, in
every product category, every day. Its simple but powerful. Its helped us attract new customers while also leading our existing customers to realize they dont need to shop for weekly rate promotions. That, in turn, has reduced
attrition and reduced the temptation for customers to shift to higher-rate, less liquid products like CDs, keeping our overall deposit costs low and in line with our competitors.
We believe Everyday Great Rates has significantly helped us with deposit growth. Based on FDIC data for the most recent reporting period ended June 2006, Fifth Third had the third highest deposit growth among large banks in
branches open more than one year.
4
Fifth Third Bancorp LETTER FROM THE PRESIDENT
Another important retail focus over the past three years
and one we are augmenting in 2007 has been de novo branching activity. Since 2003, we have built 212 new banking centers. These branches accounted for 36 percent of our core deposit growth in 2006. We conduct market segmentation
analysis and use predictive modeling to target locations in key growth markets with the demographics and business activity that has proven successful for us. Our success with our new locations has led us to plan to build approximately 70 new
branches in 2007, with expectations that they will break even in about 18 months and produce an internal rate of return of better than 20 percent. De novo activity is costly in the near term, but its the right thing to do to sustain organic
growth into the future.
Im enthusiastic about recent developments in our business banking efforts. We are already pretty good at this business and were
proud to be ranked fifth among large U.S. banks in J. D. Powers 2006 Small Business Banking Satisfaction Study but we can become much better. As a next step, we are assigning most of our customers to a designated business banking
relationship manager, armed with customized and bundled product offerings, a standardized underwriting process, and automated portfolio management.
Commercial
Banking has long been one of our strengths. We enjoy a strong position with middle-market commercial customers (companies with $10 million to $500 million in sales) within our footprint. Fifth Third gained more new customers over the past two years
among middle-market companies in our footprint than any competitor, with more than two-thirds of our affiliates increasing penetration in the middle market. Fifteen percent of such companies are Fifth Third customers, and we are the lead bank for
nearly two-thirds of them.
An exciting development during the past year has been the electronic deposit product. This is an important area in which Fifth Third has
taken a leadership position in commercial banking. This product transforms the payment landscape, enabling truncation of paper checks at the point of receipt. Our business customers no longer need to take checks to a branch to make a deposit. And,
in driving paper to electronic transformation, we are able to gain control over one of the most manual processes remaining in cash management. Customers using this product are able to save time, optimize their working capital and consolidate their
banking relationships. Weve experienced rapid growth in 2006, particularly the latter half, and are receiving deposits from locations in 35 states. Continuing to capitalize on this opportunity is a priority for 2007.
We continue to experience increased demand among our middlemarket
customers for capital markets products as Fifth Third has expanded in size and capabilities. Weve recently introduced, or are introducing a number of such products to meet this demand, and were going after industry sectors and
geographies where we are under-represented given our market position.
Our Processing Solutions business continues to produce strong results. The industry is seeing
increasing adaptation of electronic payment vehicles and Check 21 electronic item processing. Our industry leadership in providing value-added processing solutions through consultation with customers will continue to allow us to outperform our
peers. And weve seen strong growth in our credit card business, with average receivables growth of 18 percent during 2006.
However, despite our success over
the past several years, only 13 percent of our retail customers have our credit cards. We are taking steps to expand our penetration through improved point-of-sale technology, bundled product offerings through banking centers and call centers, and
enhanced sales management processes. Were also modestly expanding our risk spectrum where we can achieve attractive risk-adjusted returns. Current portfolio FICO scores average over 740, with a very low 3.49 percent charge-off rate, so we have
the ability to better align our offerings with our current clients while, at the same time, maintaining high credit quality standards.
The Consumer Lending business
had a very difficult year, given the drop-off in mortgage originations industry-wide and more sluggish auto sales. We believe improved industry conditions and new products weve launched will lead us toward better results in 2007. For example,
in the latter part of the year, we launched an Alt-A nonconforming mortgage product that accounted for over $350 million in originations in just a few months. These loans are being sold following origination to third parties for distribution to the
capital markets, allowing us to originate volume that weve been unwilling to hold historically.
Our Investment Advisors business had a mixed 2006. Our largest
investment business, the Private Client Group, continues to perform very well. Brokerage results have not been as strong, primarily reflecting net attrition of financial advisors. We recently instituted a targeted recruiting program that we expect
to result in net hiring going forward. And we are in the process of rolling out new financial planning and customer relationship management tools, which we expect to be key catalysts for results in 2007. In the asset management business, our
continued efforts to open our architecture across all client segments have made growth of Fifth Third managed funds more challenging. Meeting our customers
5
needs is
paramount to success in this business and broadening our offerings is the right thing to do. Weve recently brought in new leadership to drive improved results, and we are already seeing a positive impact to our strategies.
Technology for Tomorrow
As weve discussed here for the past
several years, Fifth Third has taken significant strides in elevating the level of our infrastructure and front-end technology. Frankly, we were underinvested in our infrastructure three or four years ago. Today, we have the systems, security and
capabilities that are necessary for an institution of our size, and that will allow us to continue to grow.
During the past 36 months, weve replaced or
upgraded 80 percent of our technology systems. With much of our infrastructure investments behind us, further progress in this area will be evolutionary. We are leveraging our technology spending into improvements in our product offerings and our
services. Examples would include our placement of more than 1,000 remote-capture deposit scanners with our business customers, deploying an enterprise problem resolution platform, developing a new customer experience portal, and creating performance
management tools and dashboards.
A Better Customer Experience and a New Brand Promise
Customers are more demanding than ever, and we must continue to meet and exceed a bar that is continually being raised by customers and our competitors. Fifth Third has long
been known for our sales culture and our ability to bring customers in the door. But we have not been world-class in keeping them. This is one of our biggest opportunities.
And, while our sales culture is terrific, there has been a large dose of hard work and hustle associated with that. Historically, weve been more transaction-oriented than is ideal. Focusing on our relationships with customers
not just todays relationship, but our future relationship will help us increase retention and increase wallet share with our customers.
What our customers tell us they need is a trusted advisor for the long
haul. To deliver, we must understand our customers needs tomorrow to properly address the need today that brought them into our banking center or caused them to pick up the phone. In our service delivery, we must prove we care about our
relationship tomorrow when were dealing with todays issues.
In February 2007, we began rolling out a new brand a brand that will encompass visual
changes in Fifth Thirds marketing but, more important, a brand that changes the promises we make to our customers. We are aligning everything toward fulfilling our brand commitment and building a better tomorrow. Later in this report, you will
see further discussion of developments at Fifth Third related to consultative sales training, customer experience enhancements and key brand elements.
Ultimately, I
believe our renewed focus on the customer experience, and a brand that supports it, are the most exciting developments under way at Fifth Third.
Closing
Im excited about our prospects for 2007 and the future. And Im honored to have been chosen to lead Fifth Third into that
future. This is a great company a company full of people who are hard-working, passionate about Fifth Third and passionate about winning and I have every confidence that we will deliver for you, for our employees and for our
communities
That is what Fifth Third is all about.
Sincerely,
Kevin T. Kabat
President
February 2007
6
Fifth Third Bancorp CORPORATE LEADERSHIP
Bottom row, left to right: George A. Schaefer, Jr., chairman and Chief Executive Officer, Fifth Third Bancorp; Kevin T. Kabat,
president, Fifth Third Bancorp; Paul L. Reynolds, executive vice president and General Counsel; Terry E. Zink, executive vice president, Affiliate Administration.
Second row, left to right: Christopher G. Marshall, executive vice president and Chief Financial Officer; Malcolm D. Griggs, executive vice president, Enterprise Risk Management. Third row,
left to right: Charles Drucker, executive vice president and president, Fifth Third Processing Solutions;
Greg D. Carmichael,
executive vice president and Chief Operating Officer; Carlos Winston Wilkinson, executive vice president, Consumer and Retail Banking; Daniel T. Poston, executive vice president, Audit. Fourth row: Bruce K. Lee, executive vice
president, Commercial Banking.
Fifth row: Robert A. Sullivan, senior executive vice president and
president, Fifth Third Bank (Cincinnati).
Creating a higher standard.
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We have publicly disclosed governance guidelines. |
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Independent outside directors constitute 13 of 15 directors (87 percent), with a named lead independent director. |
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The Nominating and Corporate Governance, Compensation, Audit, and Risk and Compliance committees are comprised solely of independent outside directors.
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Outside directors meet regularly without the CEO present. |
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Directors receive a significant portion of their compensation in the form of equity. |
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Directors and executives are subject to stock ownership guidelines, with mandatory holding periods for restricted stock and stock acquired through the
exercise of options. |
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Our board is declassified all directors are elected annually. |
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We have eliminated the super-majority voting provision in our Code of Regulations. |
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We have no poison pill. |
7
Branding & Customer Experience
Moving ahead with you.
As you glance at the cover of this years annual
report, you may notice that something looks different. The traditional red and blue logo that has been the symbol of Fifth Third for nearly 20 years is gone, replaced by a new mark and a new color palette a brighter shade of blue, signaling
dependability and trust, and green that emphasizes growth and optimism. The new mark also is symbolic of a horizon, the place where today and tomorrow converge. It reminds us to look beyond todays transaction and find ways to widen our
relationship with our customers.
This updated mark is just one outcome of a nearly two-year brand development process undertaken by Fifth Third and conducted by
Cincinnati-based Deskey, one of the countrys leading branding firms.
A brand is a collection of experiences, the sum total or cumulative effect of many touch
points over a period of time. Successful brands engage customers, and engaged customers buy much more from the brands they prefer. Successful brands are aligned with and in fact are part of a business strategy to produce results.
To develop a relevant brand, it was important that we understand our customers, understand our competitors and understand
ourselves. The brand development process involved extensive research with
consumers and business customers across the Fifth Third footprint and with all levels of Fifth Third employees. We also conducted research to understand exactly how the existing brand is perceived today.
We learned much from this process, including that our customers dont feel they are spending enough time or taking the right steps to address their future needs.
And both consumers and businesses want their bank to shoulder some of the responsibility for suggesting smart ways to protect their future.
The outcome of this
research is that we intend to be the bank for today and for tomorrow. We want to help our customers gain confidence in their financial decisions because, with our help, they understand how their current decisions affect them over the long haul.
An important cornerstone of our new brand development is customer engagement. In order to be our customers bank today and tomorrow, we must provide excellent
customer service with each and every transaction.
8
In
recognition of this, weve begun implementing consultative sales training for our retail and call center employees. This training and ongoing sales coaching is designed around four key drivers customers find important. They include
friendliness, ease of doing business, individualized attention, and the degree of knowledge about the banks products and services. The goal is to ensure that the totality of our customers needs are being evaluated and met every time we
interact with them. This, we hope and expect, will lead to stronger relationships with our customers and will earn us trusted advisor status with our customers.
We
also are implementing a new performance management system in 2007, again focused on key customer demands and requirements for satisfaction. Compensation will be tied to how well employees perform on the four key drivers mentioned previously. They
also will be evaluated on sales production and net income growth measured down to the individual level. In addition, beginning this year, we will track every banking centers Gallup customer satisfaction and loyalty scores, with branch
personnel compensation tied directly to these measures.
Finally and it may prove the most important step we take in this
area in 2007 we will roll out a problem resolution platform that extends first to the retail and call center channels, then later across all lines of business. There is nothing that tests a customers loyalty more than the way you handle
issues. We need to be able to track, to respond, and ideally to correct on first contact, such problems as they arise in a way that demonstrates we value our relationship with our customers.
To deliver on our new brand promise, the customer experience is vital. We are developing technological requirements necessary to deliver an outstanding customer experience. We are
establishing customer experience councils in every affiliate and line of business, consisting of senior executives throughout the Company. And, weve done a great deal of work over the past two years to survey the engagement levels of our
employees and align their goals with the goals and objectives of the Company and its customers. Engaged employees are the most critical aspect of delivering a customer experience that is satisfying.
9
Affiliate Model
Maintaining competitive advantage.
The affiliate model is at the core of Fifth Third and is
what differentiates us from other large financial institutions. We operate each affiliate with local management. Each affiliate has an experienced president and senior management team, resident in each market, driving the business. And each
affiliate has a board of directors comprised of local business and community leaders. This means that we have local decision-makers, able to view customer relationships in holistic ways, making local decisions.
This model gives us a tremendous competitive advantage in our responsiveness to customers; in attracting employees who want to control the customer relationship locally; and in
giving us 19 mini-incubators for new ideas and best practices. Our entrepreneurial and sales cultures are at the heart of the affiliate model, and contribute tremendously to Fifth Thirds success.
Overlaying the affiliate structure are our lines of business. These are essentially areas of product expertise Branch Banking, Consumer Lending, Commercial Banking, Processing Solutions and Investment Advisors whose products
and services are delivered to customers through the affiliates in a way that ensures customer relationships are viewed as a whole.
As an example of the kind of
success we can produce with this model, we have 19 affiliates plus our Pittsburgh and St. Louis de novo markets. For the year ended June 2006 (most recent FDIC data), 20 of these 21 markets (including the de novo markets) grew deposits. Excluding
branches with over $1 billion in deposits, all 21 markets grew deposits and 17 of the 21 markets grew deposit market share (18 of 21 excluding $1 billion branches).
Affiliate Leadership
* Bancorp deposits also include $4 billion in National and non-affiliate deposits.
10
Branch Banking
Exceeding customer expectations.
Business Description
Fifth Third Bank provides a full range of deposit and lending products to individuals and small businesses in 10 states in the Midwest, Tennessee and Florida. Our 2.7 million
households can transact business 24 hours a day, seven days a week through our Jeanie® ATM network and our comprehensive online banking service. Through these channels, Fifth Third strives to provide exceptional products, convenience and service to our customers.
2006 Highlights
Customer Focus
Branch Banking provides deposit, lending and investing
products and services for customers at every stage in life or career. Branch Bankings 9,000 employees provide knowledgeable and reliable guidance, whether customers meet with them personally or via any of our automated banking solutions. Our
business bankers can provide full solutions to a small business customer including loans, treasury management products, employee savings plans, or employee banking needs. Whether saving for a home, a childs education, planning for retirement
or building a business, our associates consult with our customers, help determine their needs and provide solutions that meet todays goals as well as tomorrows.
Strategy
Fifth Third expects to continue recent de novo branch banking expansion activities with the planned addition of
approximately 50 net new de novos in 2007. Areas of heaviest de novo activity continue to be primarily in the Florida, Chicago, Detroit and Nashville markets. Our business banking business now incorporates 341 business bankers calling on customers
with up to $10 million in sales throughout our footprint, and we are adding relationship managers in this area. We continue to make improvements in sales management processes and customer service to build productivity and customer satisfaction and
to enhance client retention.
11
Consumer Lending
Evolving with the marketplace.
Business Description
Consumer Lending provides loan products to branch and other customers, primarily within Fifth Thirds footprint. Consumer Lending partners with a network of auto dealers that
originate loans on the Banks behalf, otherwise know as indirect lending.
Additionally, Consumer Lending provides loan and lease products to individuals
including mortgages and home equity loans and lines, as well as federal and private student education loans.
2006 Highlights
Customer Focus
Recognizing that personal loans are often a vital element for the prosperity of our customers, we offer a broad range of loans
that correspond to the financial situation of our customers. Whether for a first car or a retirement home, Fifth Third provides loans that fit our customers needs, today and tomorrow.
Strategy
Fifth Third understands that not every customer needs the same
loan product to fulfill his or her needs. In order to evolve with the marketplace and meet the changing needs of customers as they progress through life, we continue to refine and develop our lending solutions. Whether customers need a first
mortgage or a loan to send their children to college, we intend to be there with the right solution for them. And by using products like our new Alt-A mortgage product we have been able to facilitate home ownership for a larger segment of our
customer population. Weve also expanded our auto dealer network to 24 states, including the 10 in our banking footprint, with an expectation that well continue to add states over the next several years.
12
Investment Advisors
Strengthening relationships.
Business Description
With over 100 years of experience helping our clients build and manage their wealth, Fifth Third Investment Advisors provides integrated solutions to meet the financial goals of
individuals, families and institutional investors. Investment Advisors provides wealth management, asset management and brokerage services to retail and institutional clients, as well as retirement plan and custody services to businesses, pension
and profit-sharing plans, foundations and endowments.
2006 Highlights
Customer Focus
Clients receive specialized advice from one or more of our
four business lines: Fifth Third Securities, Private Client Group, Fifth Third Institutional Client Group and Fifth Third Asset Management. Fifth Thirds Private Client Group uses specialized teams to leverage our clients financial
resources and provide holistic strategies in wealth planning, investment services, trust services, private banking and wealth protection. Fifth Third Securities offers a suite of products from full-service brokerage to self-managed investing to
provide our clients customized programs to meet todays needs, as well as tomorrows. Fifth Third Asset Management provides asset management services to institutional clients and also advises the Companys proprietary family of mutual
funds, Fifth Third Funds. Fifth Thirds Institutional Client Group, in conjunction with Fifth Third Asset Management, provides advisory services for 379 institutional clients including states and municipalities, Taft-Hartley plans, pension and
profit-sharing plans, and foundations and endowments.
Strategy
Fifth Third continues to strengthen customer relationships by providing an open architecture framework to ensure that clients have access to the best products to meet their needs, whether those products are Fifth Thirds or from
another financial service provider. We continue to employ new technologies to improve client access to their accounts and products. We provide complete financial solutions to Fifth Third clients by leveraging partnerships throughout the Company to
provide powerful solutions across the financial spectrum.
13
Commercial Banking
Committed to innovation.
Business Description
Fifth Thirds 1,100 commercial bankers serve clients ranging from middle-market companies with $10 million in annual revenue to some of the largest companies in the world. In
addition to the traditional lending and depository offerings, our products and services include cash management, foreign exchange and international trade finance, derivatives and capital markets services, asset-based lending, real estate finance,
public finance, commercial leasing and syndicated finance.
Customer Focus
Fifth Third has over 150 years of commercial banking experience, and throughout our history we have always believed in keeping decision-making local. Through our affiliate model, keeping close to the communities we serve, Fifth
Third is able to offer the high level of service of a local bank while maintaining the financial strength and capabilities that come with being one of the largest banks in the country.
We strive to offer complete financial solutions to our clients and we believe that the focus should be on our total relationship with our clients not just meeting todays needs but working with clients to identify
tomorrows requirements as they grow.
Strategy
Fifth Third remains committed to offering innovative and
effective solutions for our customers. We recently began offering electronic depository services that allow customers to scan checks and deposit them electronically from whatever location they choose. This has allowed our clients to focus more time
on improving their business rather than on routine banking tasks and has permitted us to serve as our customers depository anywhere in the country. During 2006, we processed 5.7 million electronic deposit transactions totaling $10.4
billion. We received deposits from 944 locations as of year-end. We continue to add value to all of our relationships by combining our depth of experience with complete solutions that will best meet our clients evolving needs.
2006 Highlights
14
Processing Solutions
Creating solutions and reducing costs.
Business Description
Fifth Third Processing Solutions provides electronic funds transfer, debit, credit and merchant transaction processing for Fifth Third and Fifth Third customers. Processing
Solutions specializes in providing our clients with the highest quality transaction solutions available through a complete global payments solution. Our in-house systems and development teams continue to create new technology to offer unmatched
flexibility and customization to not only fulfill our clients current needs, but their future needs as well. Processing Solutions also manages Fifth Thirds debit and credit card businesses and operates the Jeanie® ATM network.
2006 Highlights
* excluding pre-tax gains on sale
of MasterCard®
stock of $78 million
Customer Focus
Fifth Third Processing Solutions operates three primary
businesses Merchant Services, Financial Institutions Services and Card Services. For more than three decades, the nations top retailers and businesses have trusted Fifth Thirds Merchant Services Group to provide superior card
acceptance solutions. We have developed flexible system architecture with a wealth of technological options and processing features capable of meeting the individual requirements of any business. Our Financial Institution and Card Services groups
combine to provide a complete global payments solution delivered with a consultative approach from one of the nations leading financial institutions. We act as a business advisor to our clients, forging strategic partnerships and creating
solutions that enable revenue enhancements while simultaneously reducing costs. Customers are provided with a full array of capabilities including correspondent banking services, Check 21 processing and support, automated teller machine processing,
credit and debit card management, network gateway access, fraud monitoring services and international banking.
Strategy
Fifth Third is able to leverage our significant market position and distribution capabilities to assist existing customers and gain new ones. We are creating a more effective
cross-selling and product-bundling platform to strengthen current customer relationships and capture the complete processing business from new customers. We are able to demonstrate exceptional value by leveraging our in-house expertise and working
with clients to help them run their merchant and electronic funds transfer businesses more efficiently and productively, while our scale enables us to be highly price-competitive.
15
Community Giving
Supporting our communities.
The Foundation Office administers grants on behalf of the
Fifth Third Foundation and the eight charitable trusts for which the Bank serves as trustee. The Fifth Third Foundation made over 560 grants totaling $4 million in the areas of arts & culture, community development, education and
health & human services in 2006. The Fifth Third Foundation also funded 17 scholarships of $2,500 each to children of Fifth Third employees and matched $122,000 in employees personal gifts to institutes of higher learning.
In 2006, grants from the Fifth Third Foundation, the George and Betty Ann Schaefer Foundation and Fifth Third Bank provided funding for a Veterans Day performance of the
United States Military Academy at West Point Cadet Gospel Choir at the National Underground Railroad Freedom Center in Cincinnati. The event was one part of day-long festivities to honor military veterans.
Fifth Thirds Community Development Corporation (CDC) invests in low-income housing, historic tax credits and economic development projects to support community revitalization
in neighborhoods throughout the Fifth Third footprint. In 2006, the CDC approached a milestone the lending of nearly $1 billion since its inception in 1989.
Our Community Affairs department identified lending and real estate
opportunities in traditionally underserved markets, such as ethnically diverse, urban and low- to moderate-income census tracts. This group also champions financial literacy by providing homebuyer training, credit counseling and college savings
programs, and through the creation of the Young Bankers Club, a nationally recognized program that promotes financial literacy in elementary schools across our footprint.
2006 Employee & Corporate Giving
16
FORWARD-LOOKING STATEMENTS
This report may contain forward-looking statements about Fifth Third Bancorp and/or the company as combined acquired entities within the meaning of Sections 27A of the Securities Act of 1933, as
amended, and Rule 175 promulgated thereunder, and 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder, that involve inherent risks and uncertainties. This report may contain certain forward-looking statements
with respect to the financial condition, results of operations, plans, objectives, future performance and business of Fifth Third Bancorp and/or the combined company including statements preceded by, followed by or that include the words or phrases
such as believes, expects, anticipates, plans, trend, objective, continue, remain or similar expressions or future or conditional verbs such as
will, would, should, could, might, can, may or similar expressions. There are a number of important factors that could cause future results to differ materially from
historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) general economic conditions, either national or in the states in which Fifth Third, one or more
acquired entities and/or the combined company do business, are less favorable than expected; (2) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions;
(3) changes in the interest rate environment reduce interest margins; (4) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions; (5) changes and trends in capital markets; (6) competitive
pressures among depository institutions increase significantly; (7) effects of critical accounting policies and judgments; (8) changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or
other regulatory agencies; (9) legislative or regulatory changes or actions, or significant litigation, adversely affect Fifth Third, one or more acquired entities and/or the combined company or the businesses in which Fifth Third, one or more
acquired entities and/or the combined company are engaged; (10) ability to maintain favorable ratings from rating agencies; (11) fluctuation of Fifth Thirds stock price; (12) ability to attract and retain key personnel;
(13) ability to receive dividends from its subsidiaries; (14) potentially dilutive effect of future acquisitions on current shareholders ownership of Fifth Third; (15) difficulties in combining the operations of acquired
entities; (16) ability to secure confidential information through the use of computer systems and telecommunications network; and (17) the impact of reputational risk created by these developments on such matters as business generation and
retention, funding and liquidity. Fifth Third undertakes no obligation to release revisions to these forward-looking statements or reflect events or circumstances after the date of this report.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is managements
discussion and analysis of certain significant factors that have affected Fifth Third Bancorps (the Bancorp or Fifth Third) financial condition and results of operations during the periods included in the Consolidated
Financial Statements, which are a part of this report. Reference to the Bancorp incorporates the parent holding company and all consolidated subsidiaries.
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TABLE 1: SELECTED FINANCIAL DATA |
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|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions,
except per share data) |
|
2006 |
|
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Income Statement Data |
|
|
|
|
|
|
|
|
|
|
|
Net interest income (a) |
|
$2,899 |
|
|
2,996 |
|
3,048 |
|
2,944 |
|
2,738 |
Noninterest income |
|
2,153 |
|
|
2,500 |
|
2,465 |
|
2,483 |
|
2,183 |
Total revenue (a) |
|
5,052 |
|
|
5,496 |
|
5,513 |
|
5,427 |
|
4,921 |
Provision for loan and lease losses |
|
343 |
|
|
330 |
|
268 |
|
399 |
|
246 |
Noninterest expense |
|
3,056 |
|
|
2,927 |
|
2,972 |
|
2,551 |
|
2,337 |
Net income |
|
1,188 |
|
|
1,549 |
|
1,525 |
|
1,665 |
|
1,531 |
Common Share Data |
|
|
|
|
|
|
|
|
|
|
|
Earnings per share, basic |
|
$2.14 |
|
|
2.79 |
|
2.72 |
|
2.91 |
|
2.64 |
Earnings per share, diluted |
|
2.13 |
|
|
2.77 |
|
2.68 |
|
2.87 |
|
2.59 |
Cash dividends per common share |
|
1.58 |
|
|
1.46 |
|
1.31 |
|
1.13 |
|
.98 |
Book value per share |
|
18.02 |
|
|
17.00 |
|
16.00 |
|
15.29 |
|
14.98 |
Dividend payout ratio |
|
74.2 |
% |
|
52.7 |
|
48.9 |
|
39.4 |
|
37.8 |
Financial Ratios |
|
|
|
|
|
|
|
|
|
|
|
Return on average assets |
|
1.13 |
% |
|
1.50 |
|
1.61 |
|
1.90 |
|
2.04 |
Return on average equity |
|
12.1 |
|
|
16.6 |
|
17.2 |
|
19.0 |
|
18.4 |
Average equity as a percent of average assets |
|
9.32 |
|
|
9.06 |
|
9.34 |
|
10.01 |
|
11.08 |
Tangible equity |
|
7.79 |
|
|
6.87 |
|
8.35 |
|
8.56 |
|
9.54 |
Net interest margin (a) |
|
3.06 |
|
|
3.23 |
|
3.48 |
|
3.62 |
|
3.96 |
Efficiency (a) |
|
60.5 |
|
|
53.2 |
|
53.9 |
|
47.0 |
|
47.5 |
Credit Quality |
|
|
|
|
|
|
|
|
|
|
|
Net losses charged off |
|
$316 |
|
|
299 |
|
252 |
|
312 |
|
187 |
Net losses charged off as a percent of average loans and leases |
|
.44 |
% |
|
.45 |
|
.45 |
|
.63 |
|
.43 |
Allowance for loan and lease losses as a percent of loans and leases (b) |
|
1.04 |
|
|
1.06 |
|
1.19 |
|
1.33 |
|
1.49 |
Allowance for credit losses as a percent of loans and leases (b) |
|
1.14 |
|
|
1.16 |
|
1.31 |
|
1.47 |
|
1.49 |
Nonperforming assets as a percent of loans, leases and other assets, including other
real estate owned |
|
.61 |
|
|
.52 |
|
.51 |
|
.61 |
|
.59 |
Average Balances |
|
|
|
|
|
|
|
|
|
|
|
Loans and leases, including held for sale |
|
$73,493 |
|
|
67,737 |
|
57,042 |
|
52,414 |
|
45,539 |
Total securities and other short-term investments |
|
21,288 |
|
|
24,999 |
|
30,597 |
|
28,947 |
|
23,585 |
Total assets |
|
105,238 |
|
|
102,876 |
|
94,896 |
|
87,481 |
|
75,037 |
Transaction deposits |
|
48,946 |
|
|
47,929 |
|
43,175 |
|
40,370 |
|
35,819 |
Core deposits |
|
59,446 |
|
|
56,420 |
|
49,383 |
|
46,796 |
|
44,674 |
Wholesale funding |
|
32,423 |
|
|
33,863 |
|
33,714 |
|
28,814 |
|
19,086 |
Shareholders equity |
|
9,811 |
|
|
9,317 |
|
8,860 |
|
8,754 |
|
8,317 |
Regulatory Capital Ratios |
|
|
|
|
|
|
|
|
|
|
|
Tier I capital |
|
8.39 |
% |
|
8.35 |
|
10.31 |
|
10.97 |
|
11.70 |
Total risk-based capital |
|
11.07 |
|
|
10.42 |
|
12.31 |
|
13.42 |
|
13.51 |
Tier I leverage |
|
8.44 |
|
|
8.08 |
|
8.89 |
|
9.11 |
|
9.73 |
(a) |
Amounts presented on a fully taxable equivalent basis (FTE). The taxable equivalent adjustments for years ending December 31, 2006, 2005,
2004, 2003 and 2002 are $26 million, $31 million, $36 million, $39 million and $39 million, respectively. |
(b) |
At December 31, 2004, the reserve for unfunded commitments was reclassified from the allowance for loan and lease losses to other liabilities. The 2003
year-end reserve for unfunded commitments has been reclassified to conform to the current year presentation. The allowance for credit losses is the sum of the allowance for loan and lease losses and the reserve for unfunded commitments.
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|
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|
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TABLE 2: QUARTERLY INFORMATION |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
For the three months ended ($ in millions, except per share data) |
|
12/31 |
|
9/30 |
|
6/30 |
|
3/31 |
|
12/31 |
|
9/30 |
|
6/30 |
|
3/31 |
Net interest income (FTE) |
|
$744 |
|
719 |
|
716 |
|
718 |
|
735 |
|
745 |
|
758 |
|
759 |
Provision for loan and lease losses |
|
107 |
|
87 |
|
71 |
|
78 |
|
134 |
|
69 |
|
60 |
|
67 |
Noninterest income |
|
219 |
|
662 |
|
655 |
|
617 |
|
636 |
|
622 |
|
635 |
|
607 |
Noninterest expense |
|
798 |
|
767 |
|
759 |
|
731 |
|
763 |
|
732 |
|
728 |
|
705 |
Income before cumulative effect |
|
66 |
|
377 |
|
382 |
|
359 |
|
332 |
|
395 |
|
417 |
|
405 |
Cumulative effect of change in accounting principle, net of tax |
|
- |
|
- |
|
- |
|
4 |
|
- |
|
- |
|
- |
|
- |
Net income |
|
66 |
|
377 |
|
382 |
|
363 |
|
332 |
|
395 |
|
417 |
|
405 |
Earnings per share, basic |
|
.12 |
|
.68 |
|
.69 |
|
.66 |
|
.60 |
|
.71 |
|
.75 |
|
.73 |
Earnings per share, diluted |
|
.12 |
|
.68 |
|
.69 |
|
.65 |
|
.60 |
|
.71 |
|
.75 |
|
.72 |
18 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
This overview of managements discussion and analysis highlights selected information in the financial results of the Bancorp and may not contain all
of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting policies and estimates, you should carefully read this entire
document. Each of these items could have an impact on the Bancorps financial condition and results of operations.
The
Bancorp is a diversified financial services company headquartered in Cincinnati, Ohio. At December 31, 2006, the Bancorp had $100.7 billion in assets, operated 19 affiliates with 1,150 full-service Banking Centers including 111 Bank Mart® locations open seven days a week inside select grocery
stores and 2,096 Jeanie® ATMs in Ohio, Kentucky,
Indiana, Michigan, Illinois, Florida, Tennessee, West Virginia, Pennsylvania and Missouri. The Bancorp reports on five business segments: Commercial Banking, Branch Banking, Consumer Lending, Investment Advisors and Fifth Third Processing Solutions
(FTPS). During the first quarter of 2006, the Bancorp began separating its Retail line of business into the Branch Banking and Consumer Lending business segments. All prior year information has been updated to reflect this presentation.
The Bancorp believes that banking is first and foremost a relationship business where the strength of the competition and
challenges for growth can vary in every market. Its affiliate operating model provides a competitive advantage by keeping the decisions close to the customer and by emphasizing individual relationships. Through its affiliate operating model,
individual managers from the banking center to the executive level are given the opportunity to tailor financial solutions for their customers.
The Bancorps revenues are fairly evenly dependent on net interest income and noninterest income. During 2006, net interest income, on a fully taxable equivalent (FTE) basis, and noninterest income
provided 57% and 43% of total revenue, respectively. Excluding fourth quarter balance sheet actions discussed later in this section, net interest income (FTE) and noninterest income provided 53% and 47% of total revenue, respectively; comparison
being provided to supplement an understanding of fundamental revenue trends. Therefore, changes in interest rates, credit quality, economic trends and the capital markets are primary factors that drive the performance of the Bancorp. As discussed
later in the Risk Management section, risk identification, measurement, monitoring, control and reporting are important to the management of risk and to the financial performance and capital strength of the Bancorp.
Net interest income is the difference between interest income earned on assets such as loans, leases and securities, and interest expense
paid on liabilities such as deposits and borrowings. Net interest income is affected by the general level of interest rates, the relative level of short-term and long-term interest rates, changes in interest rates and changes in the amount and
composition of interest-earning assets and interest-bearing liabilities. Generally, the rates of interest the Bancorp earns on its assets and owes on its liabilities are established for a period of time. The change in market interest rates over time
exposes the Bancorp to interest rate risk through potential adverse changes to net interest income and financial position. The Bancorp manages this risk by continually analyzing and adjusting the composition of its assets and liabilities based on
their payment streams and interest rates, the timing of their maturities and their sensitivity to changes in market interest rates. Additionally, in the ordinary course of business, the Bancorp enters into certain derivative transactions as part of
its overall strategy to manage its interest rate and prepayment risks. The Bancorp is also exposed to the risk of losses on its loan and lease portfolio as a result of changing
expected cash flows caused by loan defaults and
inadequate collateral, among other factors.
Net interest income, net interest margin, net interest rate spread and the
efficiency ratio are presented in Managements Discussion and Analysis of Financial Condition and Results of Operations on an FTE basis. The FTE basis adjusts for the tax-favored status of income from certain loans and securities held by the
Bancorp that are not taxable for federal income tax purposes. The Bancorp believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts.
Noninterest income is derived primarily from electronic funds transfer (EFT) and merchant transaction
processing fees, card interchange, fiduciary and investment management fees, corporate banking revenue, service charges on deposits and mortgage banking revenue.
Earnings Summary
The Bancorps net income was $1.19 billion or $2.13 per diluted share
in 2006, a 23% decrease compared to $1.55 billion and $2.77 per diluted share in 2005. These results reflect the impact of the balance sheet actions announced and completed during the fourth quarter of 2006, which resulted in a pretax loss of $454
million. Specifically, these balance sheet actions included:
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Sale of $11.3 billion in available-for-sale securities with a weighted-average yield of 4.30%; |
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|
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Reinvestment of approximately $2.8 billion in available-for-sale securities that are more efficient when used as collateral for pledging purposes;
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|
|
Repayment of $8.5 billion in wholesale borrowings at a weighted-average rate paid of 5.30%; and |
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|
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Termination of approximately $1.1 billion of repurchase and reverse repurchase agreements. |
These actions were taken to improve the asset/liability profile of the Bancorp and reduce the size of the Bancorps available-for-sale securities
portfolio to a size that is more consistent with its liquidity, collateral and interest rate risk management requirements; improve the composition of the balance sheet with a lower concentration in fixed-rate assets; lower wholesale borrowings to
reduce leverage; and better position the Bancorp for an uncertain economic and interest rate environment. The pretax losses consisted of:
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|
|
$398 million in losses on the sale of securities; |
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|
|
$17 million in losses on derivatives to hedge the price of the securities sold, recorded in other noninterest income; and |
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|
|
$39 million in charges related to the termination of certain repurchase and reverse repurchase financing agreements, recorded in other noninterest expense.
|
Net interest income (FTE) decreased three percent compared to 2005. Net interest margin decreased to 3.06% in 2006 from
3.23% in 2005 largely due to rising short-term interest rates, the impact of the primarily fixed-rate securities portfolio and mix shifts within the core deposit base from demand deposit and interest checking categories to savings, money market and
other time deposit categories paying higher rates of interest.
Noninterest income decreased 14% in 2006 compared to 2005
primarily due to the securities and related derivative losses from the balance sheet actions taken in the fourth quarter of 2006 totaling $415 million. Excluding these losses, noninterest income increased $68 million, or three percent, compared to
2005 due to continued strong growth in electronic payment processing and corporate banking revenue offset by a $19 million decline in mortgage banking revenue. Noninterest expense increased four percent compared to 2005 primarily due to increases in
volume-related bankcard expenditures, equipment expenditures and
Fifth Third Bancorp 19
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
occupancy expense related to the addition of de novo banking centers, investments in technology and the $39 million in charges related to the termination of
certain repurchase and reverse repurchase agreements. Excluding the $39 million, noninterest expense increased by three percent.
In 2006, net charge-offs as a percent of average loans and leases were 44 basis points (bp) compared to 45 bp in 2005. At December 31, 2006, nonperforming assets as a percent of loans and leases increased to .61% from .52%
at December 31, 2005.
The Bancorps capital ratios exceed the well-capitalized guidelines as defined
by the Board of Governors of the Federal Reserve System (FRB). As of December 31, 2006, the Tier I capital ratio was 8.39% and the total risk-based capital ratio was 11.07%.
The Bancorp continues to invest in the geographic areas that offer the best growth prospects, as it believes this investment is the most
cost efficient method of expansion within its largest affiliate markets. During 2006, the Bancorp opened 51 net new banking centers (excluding relocations and consolidations of existing facilities) with plans to add a similar amount in high-growth
markets during 2007.
2007 Outlook
The following outlook represents managements expectations for key financial statement results in 2007. The outlook reflects expectations for growth rates in 2007 compared to the full year 2006 or for a range of
expected results in 2007. Our outlook is based on current expectations as of the date of this report for results within our businesses; prevailing views related to economic growth, inflation, unemployment and other economic factors; and market
forward interest rate
expectations. These expectations are inherently subject to risks and uncertainties. Please refer to the forward-looking statements on page 17 and the risk
factors on pages 22-24 for more information.
Management expects that the annualized net charge-off ratio in the first
quarter of 2007 will be below the range expected for the full year 2007. Management also expects that noninterest expense in the first quarter of 2007 will include a seasonal increase of approximately $15 million to $20 million in FICA and
unemployment insurance expense compared to the fourth quarter of 2006. These first quarter expectations are included in the full-year outlook provided below.
|
|
|
Category |
|
Growth, Percentage or bp range |
Net interest income |
|
High single digits |
Net interest margin |
|
3.35-3.45% |
Noninterest income* |
|
High single digits |
Noninterest expense** |
|
Mid single digits |
Loans |
|
High single digits |
Core deposits |
|
Mid single digits |
Net charge-offs |
|
Low to mid 50 bp |
Effective tax rate |
|
29-30% |
Tangible equity/tangible asset ratio |
|
2007 year-end target 7% |
* |
Comparison with the prior year excludes $415 million of losses recorded in noninterest income related to fourth quarter of 2006 balance sheet actions.
|
** |
Comparison with the prior year excludes $49 million of charges: $10 million in third quarter of 2006 related to the early retirement of debt and $39 million
in fourth quarter of 2006 related to termination of financing agreements. |
RECENT ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS)
No. 123 (Revised 2004), Share-Based Payment. This Statement requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award with the cost
to be recognized over the service period. As the Bancorp has previously adopted the fair value recognition provisions of SFAS No. 123 using the retroactive restatement method described in SFAS No. 148, Accounting for Stock-Based
Compensation Transition and Disclosure an Amendment of FASB Statement No. 123. The adoption of this Statement did not have a material impact on the Bancorps Consolidated Financial Statements.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other
Postretirement Plans An Amendment of FASB Statements No. 87, 88, 106, and 132(R). This Statement amends the current accounting for pensions and postretirement benefits by requiring an entity to recognize the overfunded or
underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that
funded status in the year in which the changes occur through comprehensive income. This Statement also requires recognition, as a component of other comprehensive income (net of tax), of the actuarial gains and losses and the prior service costs and
credits that arise during the period, but are not recognized as components of net periodic benefit cost pursuant to SFAS No. 87 and No. 106. Additionally, this Statement requires an entity to measure defined benefit plan assets and
obligations as of the date of the employers fiscal year-end statement of financial position. The Bancorp adopted this Statement on December 31, 2006. The effect of this Statement was to recognize $59 million, after-tax, of net actuarial
losses and prior service cost as a reduction to accumulated other comprehensive income.
See Note 1 of the Notes to
Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.
CRITICAL ACCOUNTING POLICIES
Allowance for Loan and Lease Losses
The Bancorp maintains an allowance to absorb probable loan and lease losses inherent in the portfolio. The allowance is maintained at a level the Bancorp considers to be adequate and is based on ongoing quarterly assessments and evaluations
of the collectibility and historical loss experience of loans and leases. Credit losses are charged and recoveries are credited to the allowance. Provisions for loan and lease losses are based on the Bancorps review of the historical credit
loss experience and such factors that, in managements judgment, deserve consideration under existing economic conditions in estimating probable credit losses. In determining the appropriate level of the allowance, the Bancorp estimates losses
using a range derived from base and conservative estimates. The Bancorps strategy for credit risk management includes a combination of conservative exposure limits
significantly below legal lending limits and conservative underwriting, documentation and collections standards. The strategy also emphasizes diversification
on a geographic, industry and customer level, regular credit examinations and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality.
Larger commercial loans that exhibit probable or observed credit weakness are subject to individual review. When individual loans are
impaired, allowances are allocated based on managements estimate of the borrowers ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Bancorp. The review of
individual loans includes those loans that are impaired as provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan. Any allowances for impaired loans are measured based on the present value of expected future cash
flows discounted at the loans effective interest rate or the fair value of the underlying
20 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
collateral. The Bancorp evaluates the collectibility of both principal and interest when assessing the need for loss accrual. Historical loss rates are
applied to other commercial loans, which are not impaired and thus not subject to specific allowance allocations. The loss rates are derived from a migration analysis, which tracks the net charge-off experience sustained on loans according to their
internal risk grade. The risk grading system currently utilized for allowance analysis purposes encompasses ten categories.
Homogenous loans and leases, such as consumer installment, residential mortgage and automobile leases are not individually risk graded. Rather, standard credit scoring systems and delinquency monitoring are used to assess credit risks.
Allowances are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category.
Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in managements judgment,
reflect the impact of any current conditions on loss recognition. Factors that management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and
nonaccrual loans), changes in 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 Bancorps internal credit examiners.
The Bancorps current methodology for
determining the allowance for loan and lease losses is based on historical loss rates, current credit grades, specific allocation on impaired commercial credits and other qualitative adjustments. Allowances on individual loans and historical loss
rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience. An unallocated allowance is maintained to recognize the imprecision in estimating and
measuring loss when evaluating allowances for individual loans or pools of loans.
Loans acquired by the Bancorp through a
purchase business combination are evaluated for possible credit impairment. Reduction to the carrying value of the acquired loans as a result of credit impairment is recorded as an adjustment to goodwill. The Bancorp does not carry over the acquired
companys allowance for loan and lease losses nor does the Bancorp add to its existing allowance for the acquired loans as part of purchase accounting.
The Bancorps determination of the allowance for commercial loans is sensitive to the risk grade it assigns to these loans. In the event that 10% of commercial loans in each risk category
would experience a downgrade of one risk category, the allowance for commercial loans would increase by approximately $76 million at December 31, 2006. The Bancorps determination of the allowance for residential and retail loans is
sensitive to changes in estimated loss rates. In the event that estimated loss rates would increase by 10%, the allowance for residential and retail loans would increase by approximately $30 million at December 31, 2006. As several quantitative
and qualitative factors are considered in determining the allowance for loan and lease losses, these sensitivity analyses do not necessarily reflect the nature and extent of future changes in the allowance for loan and lease losses. They are
intended to provide insights into the impact of adverse changes in risk grades and inherent losses and do not imply any expectation of future deterioration in the risk rating or loss rates. Given current processes employed by the Bancorp, management
believes the risk grades and inherent loss rates currently assigned are appropriate.
The Bancorps primary market
areas for lending are Ohio, Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West Virginia, Pennsylvania and Missouri. When evaluating the adequacy of allowances, consideration is given
to this regional geographic concentration and the closely associated effect changing economic conditions have on the Bancorps customers.
In the current year, the Bancorp has not substantively changed any material aspect of its overall approach to determine its allowance for
loan and lease losses. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance for loan and lease losses. Based on the procedures
discussed above, the Bancorp is of the opinion that the allowance of $771 million was adequate, but not excessive, to absorb estimated credit losses associated with the loan and lease portfolio at December 31, 2006.
Valuation of Securities
Securities are classified as held-to-maturity, available-for-sale or trading on the date of purchase. Only those securities classified as held-to-maturity are reported at amortized cost. Available-for-sale and trading securities are
reported at fair value with unrealized gains and losses included in accumulated other comprehensive income, net of related deferred income taxes, on the Consolidated Balance Sheets and noninterest income in the Consolidated Statements of Income,
respectively. The fair value of a security is determined based on quoted market prices. If quoted market prices are not available, fair value is determined based on quoted prices of similar instruments. Realized securities gains or losses are
reported within noninterest income in the Consolidated Statements of Income. The cost of securities sold is based on the specific identification method. Available-for-sale and held-to-maturity securities are reviewed quarterly for possible
other-than-temporary impairment. The review includes an analysis of the facts and circumstances of each individual investment such as the severity of loss, the length of time the fair value has been below cost, the expectation for that
securitys performance, the creditworthiness of the issuer and the Bancorps intent and ability to hold the security to recovery. A decline in value that is considered to be other-than-temporary is recorded as a loss within noninterest
income in the Consolidated Statements of Income. At December 31, 2006, 95% of the unrealized losses in the available-for-sale security portfolio were comprised of securities issued by U.S. Treasury and Government agencies, U.S. Government
sponsored agencies and states and political subdivisions as well as agency mortgage-backed securities. The Bancorp believes the price movements in these securities are dependent upon the movement in market interest rates. The Bancorps
management also maintains the intent and ability to hold securities in an unrealized loss position to the earlier of the recovery of losses or maturity.
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. 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 credit grade migration. Net adjustments to the reserve for unfunded commitments are included in other noninterest expense.
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.
Fifth Third Bancorp 21
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Deferred income tax assets and liabilities are determined using the balance sheet method and are reported in accrued taxes, interest and expenses 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 recognizes 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 managements judgment that 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 periods income
tax expense and can be significant to the operating results of the Bancorp. See Note 1 of the Notes to Consolidated Financial Statements for a discussion of the recently issued accounting statement, which clarifies the accounting for uncertainty in
income taxes. As described in greater detail in Note 13 of the Notes to Consolidated Financial Statements, the Internal Revenue Service is currently challenging the Bancorps tax treatment of certain leasing transactions. For additional
information, see Note 21 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 retains
servicing rights. Servicing rights resulting from loan sales are amortized in proportion to and over the period of estimated net servicing revenues. 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, the weighted-average coupon and the weighted-average default 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 any probable impairment in the
portfolio. For purposes of measuring impairment, the servicing rights are stratified based on the financial asset type and interest rates. In addition, the Bancorp obtains an independent third-party valuation of mortgage servicing rights
(MSR) on a quarterly basis. 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 as loan payments are received.
Costs of servicing loans are charged to expense as incurred.
The change in the fair value of MSRs at December 31,
2006, due to immediate 10% and 20% adverse changes in the current prepayment assumption would be approximately $23 million and $45 million, respectively, and due to immediate 10% and 20% favorable changes in the current prepayment assumption would
be approximately $25 million and $53 million, respectively. The change in the fair value of the MSR portfolio at December 31, 2006, due to immediate 10% and 20% adverse changes in the discount rate assumption would be approximately $19 million
and $37 million, respectively, and due to immediate 10% and 20% favorable changes in the discount rate assumption would be approximately $20 million and $42 million, respectively. Sensitivity analysis related to other consumer and commercial
servicing rights is not material to the Bancorps Consolidated Financial Statements.
These sensitivities are
hypothetical and should be used with caution. As the figures indicate, change in fair value based on a 10% and 20% variation in assumptions typically cannot be extrapolated because the relationship of the change in assumptions to change in fair
value may not be linear. Also, the effect of variation in a particular assumption on the fair value of the retained interests is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another,
which might magnify or counteract the sensitivities. Additionally, the effect of the Bancorps non-qualifying hedging strategy, which is maintained to lessen the impact of changes in value of the MSR portfolio, is excluded from the above
analysis.
RISK FACTORS
Fifth Thirds results depend on general economic conditions within its operating markets.
Fifth Third is affected by general economic conditions in the United States as a whole and, in particular, the Midwest and Florida. An economic downturn
within these markets or the nation as a whole could negatively impact household and corporate incomes. This impact may lead to decreased demand for both loan and deposit products and increase the number of customers who fail to pay interest or
principal on their loans.
The revenues of FTPS are dependent on the transaction volume generated by its merchant and
financial institution customers. This transaction volume is largely dependent on consumer and corporate spending. If consumer confidence suffers and retail sales decline, FTPS will be negatively impacted. Similarly, if an economic downturn results
in a decrease in the overall volume of corporate transactions, FTPS will be negatively impacted. FTPS is also impacted by the financial stability of its merchant customers. FTPS assumes certain contingent liabilities related to the processing of
Visa® and MasterCard® merchant card transactions. These liabilities typically arise from billing
disputes between the merchant and the cardholder that are ultimately resolved in favor of the
cardholder. These transactions are charged back to the merchant and disputed amounts are returned to the cardholder. If FTPS is unable to collect these
amounts from the merchant, FTPS will bear the loss.
The fee revenue of Investment Advisors is largely dependent on the fair
market value of assets under care and trading volumes in the brokerage business. General economic conditions and their subsequent effect on the securities markets tend to act in correlation. When general economic conditions deteriorate, consumer and
corporate confidence in securities markets erodes, and Investment Advisors revenues are negatively impacted as asset values and trading volumes decrease. Neutral economic conditions can also negatively impact revenue when stagnant securities
markets fail to attract investors.
Changes in interest rates could affect Fifth Thirds income and cash flows.
Fifth Thirds income and cash flows depend to a great extent on the difference between the interest rates earned on
interest-earning assets such as loans and investment securities, and the interest rates paid on interest-bearing liabilities such as deposits and borrowings. These rates are highly sensitive to many factors that are beyond
22 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Fifth Thirds control, including general economic conditions and the policies of various governmental and regulatory agencies (in particular, the FRB).
Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the prepayment speed of loans, the purchase of investments, the generation of deposits and the rates received on loans and investment
securities and paid on deposits or other sources of funding. The impact of these changes may be magnified if Fifth Third does not effectively manage the relative sensitivity of its assets and liabilities to changes in market interest rates.
Fluctuations in these areas may adversely affect Fifth Third and its shareholders.
If Fifth Third does not adjust to rapid changes in
the financial services industry, its financial performance may suffer.
Fifth Thirds ability to deliver strong financial
performance and returns on investment to shareholders will depend in part on its ability to expand the scope of available financial services to meet the needs and demands of its customers. In addition to the challenge of competing against other
banks in attracting and retaining customers for traditional banking services, Fifth Thirds competitors also include securities dealers, brokers, mortgage bankers, investment advisors, specialty finance and insurance companies who seek to offer
one-stop financial services that may include services that banks have not been able or allowed to offer to their customers in the past or may not be currently able or allowed to offer. This increasingly competitive environment is primarily a result
of changes in regulation, changes in technology and product delivery systems, as well as the accelerating pace of consolidation among financial service providers.
Legislative or regulatory compliance, changes or actions or significant litigation, could adversely impact Fifth Third or the businesses in which Fifth Third is engaged.
Fifth Third is subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of its operations and limit
the businesses in which Fifth Third may engage. These laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. The impact of any changes to laws and
regulations or other actions by regulatory agencies may negatively impact Fifth Third or its ability to increase the value of its business. Additionally, actions by regulatory agencies or significant litigation against Fifth Third could cause it to
devote significant time and resources to defending itself and may lead to penalties that materially affect Fifth Third and its shareholders. Future changes in the laws, including tax laws, or regulations or their interpretations or enforcement may
also be materially adverse to Fifth Third and its shareholders or may require Fifth Third to expend significant time and resources to comply with such requirements.
Fifth Third is exposed to operational risk.
Fifth Third is exposed to many types of
operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees, customers or outsiders, unauthorized transactions by employees or operational errors.
Negative public opinion can result from Fifth Thirds actual or alleged conduct in activities, such as lending practices, data
security, corporate governance and acquisitions, and may damage Fifth Thirds reputation. Additionally, actions taken by government regulators and community organizations may also damage Fifth Thirds reputation. This negative public
opinion can adversely affect Fifth Thirds ability to attract and keep customers and can expose it to litigation and regulatory action.
Fifth Thirds necessary dependence upon automated systems to record and process its transaction volume poses the risk that technical system flaws or employee errors, tampering or manipulation of those systems
will result in losses and may
be difficult to detect. Fifth Third may also be subject to disruptions of its operating systems arising from events that are beyond its control (for example,
computer viruses or electrical or telecommunications outages). Fifth Third is further exposed to the risk that its outside service providers may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or
operational errors as Fifth Third). These disruptions may interfere with service to Fifth Thirds customers and result in a financial loss or liability.
Material breaches in security of Fifth Thirds systems may have a significant effect on Fifth Thirds business.
Fifth Third collects, processes and stores sensitive consumer data by utilizing computer systems and telecommunications networks operated by both Fifth Third and third party service providers. Fifth Third has
security, backup and recovery systems in place, as well as a business continuity plan to ensure the system will not be inoperable. Fifth Third also has security to prevent unauthorized access to the system. In addition, Fifth Third requires its
third party service providers to maintain similar controls. However, Fifth Third cannot be certain that the measures will be successful. A security breach in the system and loss of confidential information such as credit card numbers and related
information could result in losing the customers confidence and thus the loss of their business.
Changes and trends in the
capital markets may affect Fifth Thirds income and cash flows.
Fifth Third enters into and maintains trading and investment
positions in the capital markets on its own behalf and on behalf of its customers. These investment positions also include derivative financial instruments. The revenues and profits Fifth Third derives from its trading and investment positions are
dependent on market prices. If it does not correctly anticipate market changes and trends, Fifth Third may experience investment or trading losses that may materially affect Fifth Third and its shareholders. Losses on behalf of its customers could
expose Fifth Third to litigation, credit risks or loss of revenue from those customers. Additionally, substantial losses in Fifth Thirds trading and investment positions could lead to a loss with respect to those investments and may adversely
affect cash flows and funding costs.
Changes in accounting standards could impact reported earnings.
The accounting standard setters, including the FASB, SEC and other regulatory bodies, periodically change the financial accounting and reporting standards
that govern the preparation of Fifth Thirds consolidated financial statements. These changes can be hard to predict and can materially impact how Fifth Third records and reports its financial condition and results of operations. In some
changes, Fifth Third could be required to apply a new or revised standard retroactively, which would result in the restatement of Fifth Thirds prior period financial statements.
The preparation of Fifth Thirds financial statements requires the use of estimates that may vary from actual results.
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates
that affect the financial statements. Two of Fifth Thirds most critical estimates are the level of the allowance for loan and lease losses and the valuation of mortgage servicing rights. Due to the inherent nature of these estimates, Fifth
Third cannot provide absolute assurance that it will not significantly increase the allowance for loan and lease losses and/or sustain credit losses that are significantly higher than the provided allowance, nor that it will not
Fifth Third Bancorp 23
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
recognize a significant provision for impairment of its mortgage servicing rights. For more information on the sensitivity of these estimates, please refer
to the Critical Accounting Policies section.
Fifth Third could suffer if it fails to attract and retain skilled personnel.
As Fifth Third continues to grow, its success depends, in large part, on its ability to attract and retain key individuals.
Competition for qualified candidates in the activities and markets that Fifth Third serves is great and Fifth Third may not be able to hire these candidates and retain them. If Fifth Third is not able to hire or retain these key individuals, Fifth
Third may be unable to execute its business strategies and may suffer adverse consequences to its business, operations and financial condition.
Fifth Third and/or the holders of its securities could be adversely affected by unfavorable ratings from rating agencies.
Fifth Thirds ability to access the capital markets is important to its overall funding profile. This access is affected by the ratings assigned by rating agencies to Fifth Third, certain of its affiliates and particular classes of
securities they issue. The interest rates that Fifth Third pays on its securities are also influenced by, among other things, the credit ratings that it, its affiliates and/or its securities receive from recognized rating agencies. A downgrade to
Fifth Thirds, or its affiliates, credit rating will affect its ability to access the capital markets, increase its borrowing costs and negatively impact its profitability. A ratings downgrade to Fifth Third, its affiliates or their
securities could also create obligations or liabilities to Fifth Third under the terms of its outstanding securities that could increase Fifth Thirds costs or otherwise have a negative effect on Fifth Thirds results of operations or
financial condition. Additionally, a downgrade of the credit rating of any particular security issued by Fifth Third or its affiliates could negatively affect the ability of the holders of that security to sell the securities and the prices at which
any such securities may be sold.
Fifth Thirds stock price is volatile.
Fifth Thirds stock price has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These
factors include:
|
|
|
Actual or anticipated variations in earnings; |
|
|
|
Changes in analysts recommendations or projections; |
|
|
|
Fifth Thirds announcements of developments related to its businesses; |
|
|
|
Operating and stock performance of other companies deemed to be peers; |
|
|
|
Actions by government regulators; |
|
|
|
New technology used or services offered by traditional and non-traditional competitors; and |
|
|
|
News reports of trends, concerns and other issues related to the financial services industry. |
Fifth Thirds stock price may fluctuate
significantly in the future, and these fluctuations may be unrelated to Fifth Thirds performance. General market price declines or market volatility in the future could adversely affect the price of its common stock, and the current market
price of such stock may not be indicative of future market prices.
Fifth Thirds ability to receive dividends from its
subsidiaries accounts for most of its revenue and could affect its liquidity and ability to pay dividends.
Fifth Third Bancorp is
a separate and distinct legal entity from its subsidiaries. Fifth Third Bancorp receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on Fifth Third
Bancorps stock and interest and principal on its debt. Various federal and/or state laws and regulations limit the amount of dividends that Fifth Thirds bank and certain nonbank subsidiaries may pay. Also, Fifth Third Bancorps
right to participate in a distribution of assets upon a subsidiarys liquidation or reorganization is subject to the prior claims of that subsidiarys creditors. Limitations on Fifth Third Bancorps ability to receive dividends from
its subsidiaries could have a material adverse effect on Fifth Third Bancorps liquidity and ability to pay dividends on stock or interest and principal on its debt.
Future acquisitions may dilute current shareholders ownership of Fifth Third and may cause Fifth Third to become more susceptible to adverse economic events.
Future business acquisitions could be material to Fifth Third and it may issue additional shares of common stock to pay for those acquisitions, which
would dilute current shareholders ownership interest. Acquisitions also could require Fifth Third to use substantial cash or other liquid assets or to incur debt. In those events, it could become more susceptible to economic downturns and
competitive pressures.
Difficulties in combining the operations of acquired entities with Fifth Thirds own operations may
prevent Fifth Third from achieving the expected benefits from its acquisitions.
Inherent uncertainties exist in integrating the
operations of an acquired entity. Fifth Third may not be able to fully achieve its strategic objectives and operating efficiencies in an acquisition. In addition, the markets and industries in which Fifth Third and its potential acquisition targets
operate are highly competitive. Fifth Third may lose customers or the customers of acquired entities as a result of an acquisition. Future acquisition and integration activities may require Fifth Third to devote substantial time and resources and as
a result Fifth Third may not be able to pursue other business opportunities. These factors could contribute to Fifth Third not achieving the expected benefits from its acquisitions within desired time frames, if at all.
24 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
STATEMENTS OF INCOME ANALYSIS
Net Interest Income
Net
interest income is the interest earned on debt securities, loans and leases (including yield-related fees) and other interest-earning assets less the interest paid for core deposits and wholesale funding. The net interest margin is calculated by
dividing net interest income by average interest-earning assets. Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. Net interest margin is
greater than net interest rate spread due to the interest income earned on those assets that are funded by non-interest bearing liabilities, or free funding, such as demand deposits or shareholders equity.
The continued increases in short-term rates during the first half of 2006 and the subsequent inverted interest rate yield curve negatively
impacted Fifth Third as well as other financial institutions in 2006. The average interest rate spread between the 3-month Treasury bill and the 10-year Treasury note compressed from 107 bp in 2005 to negative 6 bp in 2006. At December 31,
2006, this interest rate spread declined to negative 31 bp. This significant decline illustrates the relative pressure between shorter-term and longer-term funding costs and general securities portfolio reinvestment opportunities.
Net interest income declined three percent to $2.9 billion as a result of the net interest margin contracting 17 bp to 3.06%. The decline
in the net interest margin occurred despite an increase in average loans and leases of eight percent and an increase in average core deposits of five percent. In terms of mix between volume and yield, net interest income decreased eight percent due
to the impact of changes in interest rates. The decline in net interest margin largely resulted from the decrease in net interest spread, from 2.76% in 2005 to 2.37% in 2006, attributable to the increased cost of deposits and wholesale funding, the
impact of the primarily fixed-rate securities portfolio and the change in mix within the core deposit base. The decrease in net interest spread was partially offset by an increased benefit from free funding of 69 bp in 2006, up 22 bp over 2005. The
relatively large increase in the benefit of free funding was the result of higher funding costs and an improvement in the net free funding position of the Bancorp, calculated as total noninterest-bearing liabilities and shareholders equity
less noninterest-earning assets, which increased two percent to $16.7 billion.
In light of the Bancorps
asset/liability considerations and changing market conditions, the Bancorps Board of Directors
approved several actions on November 20, 2006 to strategically shift the composition of its balance sheet. These actions reduced the size of the
Bancorps available-for-sale securities portfolio to a size that is more consistent with its liquidity, collateral and interest rate risk management requirements; improved the composition of the balance sheet with a lower concentration of
fixed-rate assets; lowered wholesale borrowings to reduce leverage; and better positioned the Bancorp for an uncertain economic and interest rate environment. Specifically, these actions included (i) the sale of $11.3 billion in
available-for-sale securities with a weighted-average yield of 4.30%; (ii) reinvestment of approximately $2.8 billion in available-for-sale securities that are more efficient when used as collateral; (iii) repayment of $8.5 billion in
wholesale borrowings at an average rate paid of 5.30%; and (iv) the termination of approximately $1.1 billion of repurchase and reverse repurchase agreements. These actions are expected to result in a benefit to net interest income in 2007,
given current market expectations, of approximately $110 million to $120 million, and a benefit to the net interest margin in 2007 of approximately 35-40 bp.
The growth in average loans and leases in 2006 outpaced core deposit growth by $2.7 billion. The funding shortfall was more than offset by a $4.0 billion reduction in the average
available-for-sale securities portfolio. In addition to the fourth quarter sale of available-for-sale securities mentioned above, throughout 2006, the Bancorp continued to use cash flows from its securities portfolio to reduce its reliance on
wholesale funding. In the third quarter of 2006, the Bancorp also sold approximately $726 million from its securities portfolio, which represented nearly all of its position in Federal Home Loan Mortgage Corporation (FHLMC) callable
debt, in order to manage its credit exposure to FHLMC. In 2006, wholesale funding represented 41% of interest-bearing liabilities, down from 44% in 2005.
During 2006, the Bancorp continued its deposit pricing strategy of moving away from promotional rates and towards highly competitive daily rates. As part of this strategy, the Bancorp maintains competitive deposit
rates in all of its affiliate markets and across all of its deposit products. Additionally, interest-checking balances have continued to migrate into money market, savings and time deposit accounts. During 2006, interest-checking balances were 36%
of average interest-bearing core deposits and savings and money market combined to represent 41%, compared to 44% and 36%, respectively, in 2005.
TABLE 3: CONDENSED CONSOLIDATED STATEMENTS OF INCOME
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions, except per share data) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Interest income (FTE) |
|
$5,981 |
|
5,026 |
|
4,150 |
|
4,030 |
|
4,168 |
Interest expense |
|
3,082 |
|
2,030 |
|
1,102 |
|
1,086 |
|
1,430 |
Net interest income (FTE) |
|
2,899 |
|
2,996 |
|
3,048 |
|
2,944 |
|
2,738 |
Provision for loan and lease losses |
|
343 |
|
330 |
|
268 |
|
399 |
|
246 |
Net interest income after provision for loan and lease losses (FTE) |
|
2,556 |
|
2,666 |
|
2,780 |
|
2,545 |
|
2,492 |
Noninterest income |
|
2,153 |
|
2,500 |
|
2,465 |
|
2,483 |
|
2,183 |
Noninterest expense |
|
3,056 |
|
2,927 |
|
2,972 |
|
2,551 |
|
2,337 |
Income from continuing operations before income taxes, minority interest and cumulative effect (FTE) |
|
1,653 |
|
2,239 |
|
2,273 |
|
2,477 |
|
2,338 |
Fully taxable equivalent adjustment |
|
26 |
|
31 |
|
36 |
|
39 |
|
39 |
Applicable income taxes |
|
443 |
|
659 |
|
712 |
|
786 |
|
734 |
Income from continuing operations before minority interest and cumulative effect |
|
1,184 |
|
1,549 |
|
1,525 |
|
1,652 |
|
1,565 |
Minority interest, net of tax |
|
- |
|
- |
|
- |
|
(20) |
|
(38) |
Income from continuing operations before cumulative effect |
|
1,184 |
|
1,549 |
|
1,525 |
|
1,632 |
|
1,527 |
Income from discontinued operations, net of tax |
|
- |
|
- |
|
- |
|
44 |
|
4 |
Income before cumulative effect |
|
1,184 |
|
1,549 |
|
1,525 |
|
1,676 |
|
1,531 |
Cumulative effect of change in accounting principle, net of tax |
|
4 |
|
- |
|
- |
|
(11) |
|
- |
Net income |
|
$1,188 |
|
1,549 |
|
1,525 |
|
1,665 |
|
1,531 |
Earnings per share, basic |
|
$2.14 |
|
2.79 |
|
2.72 |
|
2.91 |
|
2.64 |
Earnings per share, diluted |
|
2.13 |
|
2.77 |
|
2.68 |
|
2.87 |
|
2.59 |
Cash dividends declared per common share |
|
1.58 |
|
1.46 |
|
1.31 |
|
1.13 |
|
.98 |
Fifth Third Bancorp 25
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 4: CONSOLIDATED AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME (FTE)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 |
|
2006 |
|
|
2005 |
|
|
2004 |
|
($ in millions) |
|
Average Balance |
|
Revenue/ Cost |
|
Average Yield/Rate |
|
|
Average Balance |
|
Revenue/ Cost |
|
Average Yield/Rate |
|
|
Average Balance |
|
Revenue/ Cost |
|
Average Yield/Rate |
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans and leases (a): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$20,400 |
|
$1,479 |
|
7.25 |
% |
|
$18,241 |
|
$1,063 |
|
5.83 |
% |
|
$14,908 |
|
$682 |
|
4.57 |
% |
Commercial mortgage |
|
9,797 |
|
700 |
|
7.15 |
|
|
8,923 |
|
551 |
|
6.17 |
|
|
7,391 |
|
387 |
|
5.23 |
|
Commercial construction |
|
6,015 |
|
460 |
|
7.64 |
|
|
5,525 |
|
342 |
|
6.19 |
|
|
3,807 |
|
181 |
|
4.76 |
|
Commercial leases |
|
3,730 |
|
185 |
|
4.97 |
|
|
3,495 |
|
179 |
|
5.11 |
|
|
3,296 |
|
181 |
|
5.49 |
|
Subtotal - commercial |
|
39,942 |
|
2,824 |
|
7.07 |
|
|
36,184 |
|
2,135 |
|
5.90 |
|
|
29,402 |
|
1,431 |
|
4.87 |
|
Residential mortgage |
|
8,855 |
|
525 |
|
5.93 |
|
|
8,396 |
|
463 |
|
5.52 |
|
|
6,454 |
|
357 |
|
5.52 |
|
Residential construction |
|
719 |
|
43 |
|
6.02 |
|
|
586 |
|
32 |
|
5.48 |
|
|
347 |
|
17 |
|
4.99 |
|
Other consumer loans |
|
22,649 |
|
1,556 |
|
6.87 |
|
|
20,749 |
|
1,216 |
|
5.86 |
|
|
18,542 |
|
947 |
|
5.10 |
|
Consumer leases |
|
1,328 |
|
63 |
|
4.72 |
|
|
1,822 |
|
84 |
|
4.59 |
|
|
2,297 |
|
108 |
|
4.71 |
|
Subtotal - consumer |
|
33,551 |
|
2,187 |
|
6.52 |
|
|
31,553 |
|
1,795 |
|
5.69 |
|
|
27,640 |
|
1,429 |
|
5.17 |
|
Total loans and leases |
|
73,493 |
|
5,011 |
|
6.82 |
|
|
67,737 |
|
3,930 |
|
5.80 |
|
|
57,042 |
|
2,860 |
|
5.01 |
|
Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable |
|
20,306 |
|
904 |
|
4.45 |
|
|
24,017 |
|
1,032 |
|
4.30 |
|
|
29,365 |
|
1,217 |
|
4.15 |
|
Exempt from income taxes (a) |
|
604 |
|
45 |
|
7.38 |
|
|
789 |
|
58 |
|
7.39 |
|
|
917 |
|
68 |
|
7.44 |
|
Other short-term investments |
|
378 |
|
21 |
|
5.52 |
|
|
193 |
|
6 |
|
2.89 |
|
|
315 |
|
5 |
|
1.48 |
|
Total interest-earning assets |
|
94,781 |
|
5,981 |
|
6.31 |
|
|
92,736 |
|
5,026 |
|
5.42 |
|
|
87,639 |
|
4,150 |
|
4.73 |
|
Cash and due from banks |
|
2,495 |
|
|
|
|
|
|
2,758 |
|
|
|
|
|
|
2,216 |
|
|
|
|
|
Other assets |
|
8,713 |
|
|
|
|
|
|
8,102 |
|
|
|
|
|
|
5,763 |
|
|
|
|
|
Allowance for loan and lease losses |
|
(751) |
|
|
|
|
|
|
(720) |
|
|
|
|
|
|
(722) |
|
|
|
|
|
Total assets |
|
$105,238 |
|
|
|
|
|
|
$102,876 |
|
|
|
|
|
|
$94,896 |
|
|
|
|
|
Liabilities and Shareholders Equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest checking |
|
$16,650 |
|
$398 |
|
2.39 |
% |
|
$18,884 |
|
$314 |
|
1.66 |
% |
|
$19,434 |
|
$174 |
|
.89 |
% |
Savings |
|
12,189 |
|
363 |
|
2.98 |
|
|
10,007 |
|
176 |
|
1.76 |
|
|
7,941 |
|
58 |
|
.72 |
|
Money market |
|
6,366 |
|
261 |
|
4.10 |
|
|
5,170 |
|
140 |
|
2.71 |
|
|
3,473 |
|
39 |
|
1.12 |
|
Other time deposits |
|
10,500 |
|
433 |
|
4.12 |
|
|
8,491 |
|
263 |
|
3.09 |
|
|
6,208 |
|
162 |
|
2.62 |
|
Certificates -$100,000 and over |
|
5,795 |
|
278 |
|
4.80 |
|
|
4,001 |
|
129 |
|
3.22 |
|
|
2,403 |
|
48 |
|
1.99 |
|
Foreign office deposits |
|
3,711 |
|
177 |
|
4.76 |
|
|
3,967 |
|
126 |
|
3.17 |
|
|
4,449 |
|
58 |
|
1.31 |
|
Federal funds purchased |
|
4,148 |
|
208 |
|
5.02 |
|
|
4,225 |
|
138 |
|
3.26 |
|
|
5,896 |
|
77 |
|
1.30 |
|
Short-term bank notes |
|
- |
|
- |
|
- |
|
|
248 |
|
6 |
|
2.60 |
|
|
1,003 |
|
15 |
|
1.46 |
|
Other short-term borrowings |
|
4,522 |
|
194 |
|
4.28 |
|
|
5,038 |
|
138 |
|
2.74 |
|
|
6,640 |
|
78 |
|
1.14 |
|
Long-term debt |
|
14,247 |
|
770 |
|
5.40 |
|
|
16,384 |
|
600 |
|
3.66 |
|
|
13,323 |
|
393 |
|
2.95 |
|
Total interest-bearing liabilities |
|
78,128 |
|
3,082 |
|
3.94 |
|
|
76,415 |
|
2,030 |
|
2.66 |
|
|
70,770 |
|
1,102 |
|
1.56 |
|
Demand deposits |
|
13,741 |
|
|
|
|
|
|
13,868 |
|
|
|
|
|
|
12,327 |
|
|
|
|
|
Other liabilities |
|
3,558 |
|
|
|
|
|
|
3,276 |
|
|
|
|
|
|
2,939 |
|
|
|
|
|
Total liabilities |
|
95,427 |
|
|
|
|
|
|
93,559 |
|
|
|
|
|
|
86,036 |
|
|
|
|
|
Shareholders equity |
|
9,811 |
|
|
|
|
|
|
9,317 |
|
|
|
|
|
|
8,860 |
|
|
|
|
|
Total liabilities and shareholders equity |
|
$105,238 |
|
|
|
|
|
|
$102,876 |
|
|
|
|
|
|
$94,896 |
|
|
|
|
|
Net interest income margin |
|
|
|
$2,899 |
|
3.06 |
% |
|
|
|
$2,996 |
|
3.23 |
% |
|
|
|
$3,048 |
|
3.48 |
% |
Net interest rate spread |
|
|
|
|
|
2.37 |
|
|
|
|
|
|
2.76 |
|
|
|
|
|
|
3.17 |
|
Interest-bearing liabilities to interest-earning assets |
|
|
|
|
|
82.43 |
|
|
|
|
|
|
82.40 |
|
|
|
|
|
|
80.75 |
|
(a) |
The net taxable-equivalent adjustments included in the above table are $26 million, $31 million and $36 million for the years ended December 31, 2006,
2005 and 2004, respectively. |
The cost of
interest-bearing core deposits was 3.18% in 2006, up from 2.10% in 2005. Despite the increasing deposit rates, the relative cost advantage of interest-bearing core deposits compared to wholesale funding increased from 126 bp in 2005 to 183 bp in
2006. Due to the increasing relative cost advantage of core deposits, the Bancorp has continued to expand its branching network to increase its presence in markets that offer the best growth prospects. In 2006, the Bancorp added 51 net new banking
centers with plans to add a similar amount in 2007.
Interest income (FTE) from loans and leases increased $1.1 billion, or
28%, compared to 2005. The increase resulted from the growth in average loans and leases of eight percent as well as a 102 bp increase in average rates. Average commercial loans and leases grew 10% in 2006 due to growth in all subcategories. The
yield on commercial loans and leases expanded by 117 bp to 7.07% in 2006. The yield expansion was greatest in commercial loans and commercial construction due to the increase in short-term interest rates and the subsequent repricing. Average
consumer loans and leases increased by six percent in 2006 driven primarily by the 23% increase in residential construction and nine percent increase in other consumer loans. Other consumer loans primarily consist of direct and indirect home equity
lines and loans,
direct and indirect auto loans and credit cards. The average consumer loan and lease yield increased 83 bp to 6.52%.
Interest income (FTE) from investment securities and short-term investments decreased $126 million to $970 million in 2006 compared to
2005 due to the previously mentioned reduction of the investment securities portfolio. The average yield on taxable securities increased by only 15 bp as a result of the relative stability in longer-term interest rates.
The interest on core deposits increased $562 million, or 63%, in 2006 over 2005 due to increases in short-term interest rates and
increasing average balances. Average interest-bearing core deposits increased $3.2 billion, or seven percent, compared to 2005. The Bancorp continues to focus on growing its core deposit balances in order to improve the funding mix and improve net
interest margin trends. The growth in noninterest-bearing funds and other core deposits is a critical component in the growth of net interest income.
The interest on wholesale funding increased by $490 million, or 43%, in 2006 compared to 2005 due to increasing short-term interest rates partially offset by a $1.4 billion, or four percent, decrease in average
balances. Throughout 2006, the Bancorp used the proceeds from the securities portfolio to lessen its reliance on
26 Fifth Third
Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
wholesale funding in order to reduce leverage and better position the Bancorp for the uncertain rate environment.
Table 4 presents the components of net interest income, net interest margin and net interest spread for 2006, 2005 and 2004. Nonaccrual
loans and leases and loans held for sale have been included in the average loan and lease balances. Average
outstanding securities balances are based on amortized cost with any unrealized gains or losses on available-for-sale securities included in other assets.
Table 5 provides the relative impact of changes in the balance sheet and changes in interest rates on net interest income.
TABLE 5: CHANGES IN NET INTEREST INCOME (FTE) ATTRIBUTED TO VOLUME AND YIELD/RATE (a)
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 |
|
2006 Compared to 2005 |
|
2005 Compared to 2004 |
($ in millions) |
|
Volume |
|
Yield/Rate |
|
Total |
|
Volume |
|
Yield/Rate |
|
Total |
Increase (decrease) in interest income: |
|
|
|
|
|
|
|
|
|
|
|
|
Loans and leases: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$136 |
|
280 |
|
416 |
|
171 |
|
210 |
|
381 |
Commercial mortgage |
|
57 |
|
92 |
|
149 |
|
88 |
|
76 |
|
164 |
Commercial construction |
|
32 |
|
86 |
|
118 |
|
96 |
|
65 |
|
161 |
Commercial leases |
|
11 |
|
(5) |
|
6 |
|
10 |
|
(12) |
|
(2) |
Subtotal - commercial |
|
236 |
|
453 |
|
689 |
|
365 |
|
339 |
|
704 |
Residential mortgage |
|
26 |
|
36 |
|
62 |
|
106 |
|
- |
|
106 |
Residential construction |
|
8 |
|
3 |
|
11 |
|
13 |
|
2 |
|
15 |
Other consumer loans |
|
118 |
|
222 |
|
340 |
|
120 |
|
149 |
|
269 |
Consumer leases |
|
(23) |
|
2 |
|
(21) |
|
(22) |
|
(2) |
|
(24) |
Subtotal - consumer |
|
129 |
|
263 |
|
392 |
|
217 |
|
149 |
|
366 |
Total loans and leases |
|
365 |
|
716 |
|
1,081 |
|
$582 |
|
488 |
|
1,070 |
Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Taxable |
|
(164) |
|
36 |
|
(128) |
|
(228) |
|
43 |
|
(185) |
Exempt from income taxes |
|
(13) |
|
- |
|
(13) |
|
(10) |
|
- |
|
(10) |
Other short-term investments |
|
8 |
|
7 |
|
15 |
|
(2) |
|
3 |
|
1 |
Total change in interest income |
|
196 |
|
759 |
|
955 |
|
342 |
|
534 |
|
876 |
Increase (decrease) in interest expense: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest checking |
|
(41) |
|
125 |
|
84 |
|
(5) |
|
145 |
|
140 |
Savings |
|
45 |
|
142 |
|
187 |
|
18 |
|
100 |
|
118 |
Money market |
|
38 |
|
83 |
|
121 |
|
26 |
|
75 |
|
101 |
Other time deposits |
|
71 |
|
99 |
|
170 |
|
68 |
|
33 |
|
101 |
Certificates - $100,000 and over |
|
71 |
|
78 |
|
149 |
|
42 |
|
39 |
|
81 |
Foreign office deposits |
|
(9) |
|
60 |
|
51 |
|
(7) |
|
75 |
|
68 |
Federal funds purchased |
|
(3) |
|
73 |
|
70 |
|
(27) |
|
88 |
|
61 |
Short-term bank notes |
|
(6) |
|
- |
|
(6) |
|
(9) |
|
- |
|
(9) |
Other short-term borrowings |
|
(15) |
|
71 |
|
56 |
|
(23) |
|
83 |
|
60 |
Long-term debt |
|
(86) |
|
256 |
|
170 |
|
103 |
|
104 |
|
207 |
Total change in interest expense |
|
65 |
|
987 |
|
1,052 |
|
186 |
|
742 |
|
928 |
Total change in net interest income |
|
$131 |
|
(228) |
|
(97) |
|
156 |
|
(208) |
|
(52) |
(a) |
Changes in interest not solely due to volume or yield/rate are allocated in proportion to the absolute amount of change in volume or yield/rate.
|
Provision for Loan and Lease Losses
The Bancorp provides as an expense an amount for probable loan and lease losses within the loan portfolio that is based on factors discussed in the Critical Accounting Policies section. The provision is recorded to bring the allowance for
loan and lease losses to a level deemed appropriate by the Bancorp. Actual credit losses on loans and leases are charged against the allowance for loan and lease losses. The amount of loans actually removed from the Consolidated Balance Sheets is
referred to as charge-offs. Net charge-offs include current period charge-offs less recoveries in the current period on previously charged off assets.
The provision for loan and lease losses increased to $343 million in 2006 compared to $330 million in 2005. The $13 million increase from the prior year is due to both the increase in nonperforming assets from $361
million in 2005 to $455 million in 2006 and increased loan growth throughout the year. As of December 31, 2006, the allowance for loan and lease losses as a percent of loans and leases declined modestly to 1.04% from 1.06% at December 31,
2005.
Refer to the Credit Risk Management section for further information on the provision for loan and lease losses, net
charge-offs and other factors considered by the Bancorp in assessing the credit quality of the loan portfolio and the allowance for loan and lease losses.
Noninterest Income
In 2006, the Bancorp refined its presentation of noninterest income in
order to provide more granularity around its
revenue streams. The primary result of this refinement was the consolidation of the Bancorps interest rate derivative sales, international service
fees, institutional sales and loan and lease syndication fees into a new income statement line item titled corporate banking revenue.
Total noninterest income decreased 14% compared to 2005 primarily due to the impact of the previously mentioned balance sheet actions taken in the fourth quarter of 2006. Excluding the $415 million impact of these
actions, noninterest income increased $68 million, or three percent, over 2005. The components of noninterest income are shown in Table 6.
Electronic payment processing revenue increased $109 million, or 15%, in 2006 as FTPS realized growth in each of its three product lines. Merchant processing revenue increased $45 million, or 13%, to $395 million due
to the addition of new national merchant customers and resulting increases in merchant transaction volumes. EFT revenue increased $41 million, or 16%, to $297 million as a result of continued success in attracting financial institution customers.
Card issuer interchange increased $23 million, or 16%, to $165 million on sales volume increases of 15%. The Bancorp continues to see significant opportunities in attracting new financial institution customers and retailers. The Bancorp handles
electronic processing for over 142,000 merchant locations and 2,300 financial institutions worldwide, including The Kroger Co., Nordstrom, Inc., the Armed Forces Financial Network and, during 2006, added Talbots and Gregg Appliances, Inc.
Fifth Third Bancorp 27
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 6: NONINTEREST INCOME
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in
millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Electronic payment processing revenue |
|
$857 |
|
748 |
|
631 |
|
593 |
|
528 |
Service charges on deposits |
|
517 |
|
522 |
|
515 |
|
485 |
|
431 |
Mortgage banking net revenue |
|
155 |
|
174 |
|
178 |
|
302 |
|
188 |
Investment advisory revenue |
|
367 |
|
358 |
|
363 |
|
335 |
|
325 |
Corporate banking revenue |
|
318 |
|
299 |
|
228 |
|
241 |
|
195 |
Other noninterest income |
|
300 |
|
360 |
|
587 |
|
443 |
|
369 |
Securities gains (losses), net |
|
(364) |
|
39 |
|
(37) |
|
81 |
|
114 |
Securities gains, net non-qualifying hedges on mortgage servicing
rights |
|
3 |
|
- |
|
- |
|
3 |
|
33 |
Total noninterest income |
|
$2,153 |
|
2,500 |
|
2,465 |
|
2,483 |
|
2,183 |
TABLE 7: COMPONENTS OF MORTGAGE BANKING NET REVENUE |
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in
millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Origination fees and gains on loan sales |
|
$92 |
|
128 |
|
112 |
|
353 |
|
252 |
Servicing revenue: |
|
|
|
|
|
|
|
|
|
|
Servicing fees |
|
121 |
|
109 |
|
109 |
|
114 |
|
132 |
Servicing rights amortization |
|
(68) |
|
(73) |
|
(93) |
|
(176) |
|
(156) |
Net valuation adjustments on servicing rights and free-standing derivatives entered
into to economically hedge MSR |
|
10 |
|
10 |
|
50 |
|
11 |
|
(40) |
Net servicing revenue |
|
63 |
|
46 |
|
66 |
|
(51) |
|
(64) |
Mortgage banking net revenue |
|
$155 |
|
174 |
|
178 |
|
302 |
|
188 |
Service charges on deposits were relatively flat compared to 2005. Commercial deposit revenues were comparable to the prior year as the
overall growth in commercial account relationships was offset by a 34% increase in earnings credits on compensating balances as a result of the higher interest rate environment. Retail deposit revenues were flat in 2006 compared to 2005. Net new
consumer deposit account production increased by 40% during 2006 compared to 2005. However, the production increase was offset by lower consumer overdraft fees. Growth in the number of customer deposit account relationships and deposit generation
continues to be a primary focus of the Bancorp.
Mortgage banking net revenue decreased to $155 million in 2006 from $174
million in 2005. The components of mortgage banking net revenue are shown in Table 7. Origination fees and gains on loans sales decreased $36 million due to lower origination volume, the increasingly competitive nature of the business and the
effects of the inverted yield curve. Originations in 2006 were $9.4 billion compared to $9.9 billion in 2005.
Mortgage net
servicing revenue increased by $17 million compared to 2005. Net servicing revenue is comprised of gross servicing fees and related amortization as well as valuation adjustments on mortgage servicing rights and mark-to-market adjustments on both
settled and outstanding free-standing derivative financial instruments. The Bancorps total residential mortgage loans serviced at December 31, 2006 and 2005 were $37.9 billion and $34.0 billion, respectively, with $28.7 billion and $25.7
billion, respectively, of residential mortgage loans serviced for others.
The increase in interest rates and the resulting
decrease in changing prepayment speeds led to a recovery in temporary impairment of $19 million in 2006 and $33 million in 2005. Servicing rights are deemed temporarily impaired when a borrowers loan rate is distinctly higher than prevailing
rates. Temporary impairment on servicing rights is reversed when the prevailing rates return to a level commensurate with the borrowers loan rate. Further detail on the valuation of mortgage servicing rights can be found in Note 7 of the Notes
to Consolidated Financial Statements. The Bancorp maintains a non-qualifying hedging strategy to manage a portion of the risk associated with the impact of changes in interest rates on the MSR portfolio. The Bancorp recognized a net loss of $9
million and $23 million in 2006 and 2005, respectively, related to changes in fair value and settlement of free-standing
derivatives purchased to economically hedge the MSR portfolio. See Note 8 of the Notes to Consolidated Financial Statements for more information on the
free-standing derivatives used to hedge the MSR portfolio. In addition to the derivative positions used to economically hedge the MSR portfolio, the Bancorp began to acquire various securities (primarily principal-only strips) during 2005 as a
component of its non-qualifying hedging strategy. A gain of $3 million was recognized in 2006 on the sale of securities used to hedge the MSR portfolio.
Investment advisory revenues were up modestly in 2006 compared to 2005. Private client revenues increased $10 million, or eight percent due to growth in nearly all subcategories on the strength of cross-sell
initiatives within the private client group. This increase was partially offset by a decrease in mutual fund fees of $7 million, or 10%, reflecting the effects of a shift toward a greater open architecture framework where investors are provided with
other mutual fund options in addition to the family of Fifth Third Funds.* The Bancorp continues to focus its sales efforts on improving execution in retail brokerage and retail mutual funds and on growing the institutional money management business
by improving penetration and cross-sell in its large middle-market commercial customer base. The Bancorp is one of the largest money managers in the Midwest and as of December 31, 2006 had approximately $220 billion in assets under care, $34
billion in assets under management and $12 billion in its proprietary Fifth Third Funds.*
Compared to 2005, corporate
banking revenue increased $19 million primarily due to a $13 million, or 13%, increase in commercial syndication fees. Other increases included a $4 million, or five percent, increase in derivative product revenues and $2 million, or six percent,
increase in underwriting revenues. The Bancorp is committed to providing a comprehensive range of financial services to large and middle-market businesses and continues to see opportunities to expand its product offering.
The major components of other noninterest income for each of the last five years are shown in Table 8. Other noninterest income declined
17% compared to the prior year. The decrease was primarily attributable to the continued planned run off in the consumer operating lease portfolio and a $17 million loss in mark-to-market free-standing derivatives related to the balance sheet
actions taken in the fourth quarter. Operating lease revenues in
*FIFTH THIRD FUNDS® PERFORMANCE DISCLOSURE
Fifth Third
Funds investments are: NOT INSURED BY THE FDIC or any other government agency, are not deposits or obligations of, or guaranteed by, any bank, the distributor or of the Funds any of their respective affiliates, and involve investment risks,
including the possible loss of the principal amount invested. An investor should consider the funds investment objectives, risks and charges and expenses carefully before investing or sending money. The Funds prospectus contains
this and other important information about the Funds. To obtain a prospectus or any other information about Fifth Third Funds, please call 1-800-282-5706 or visit www.53.com. Please read the prospectus carefully before investing. Fifth Third
Funds are distributed by Fifth Third Funds Distributor, Inc., 3435 Stelzer Road, Columbus, Ohio 43219.
28 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
2006 consisted of commercial operating lease revenues that increased $10 million to $18 million and consumer operating lease revenues that decreased $39
million to $8 million compared to 2005. Operating lease revenues will moderate throughout 2007 as automobile leases continue to mature and are offset by originations of commercial operating leases.
The Bancorp recognized net securities losses of $364 million in 2006. Securities losses in 2006 primarily consisted of losses resulting from balance sheet
actions taken during the fourth quarter of 2006 partially offset by a $78 million gain from the sale of MasterCard, Inc. shares.
TABLE 8: COMPONENTS OF OTHER NONINTEREST INCOME
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Cardholder fees |
|
$49 |
|
46 |
|
39 |
|
41 |
|
36 |
Consumer loan and lease fees |
|
47 |
|
50 |
|
57 |
|
65 |
|
70 |
Operating lease income |
|
26 |
|
55 |
|
156 |
|
124 |
|
- |
Bank owned life insurance income |
|
86 |
|
91 |
|
61 |
|
62 |
|
62 |
Insurance income |
|
28 |
|
27 |
|
28 |
|
25 |
|
55 |
Gain on sales of third-party sourced merchant processing contracts |
|
- |
|
- |
|
157 |
|
- |
|
- |
Other |
|
64 |
|
91 |
|
89 |
|
126 |
|
146 |
Total other noninterest income |
|
$300 |
|
360 |
|
587 |
|
443 |
|
369 |
Noninterest Expense
The
Bancorp continued to focus on expense control during 2006 and expects growth in noninterest expenses to be consistent with recent trends through 2007. Cost savings initiatives will continue to be somewhat mitigated by investments in certain high
opportunity markets, as evidenced by the de novo banking centers added in 2006.
During 2006, the Bancorp continued its
investment in the expansion of the retail distribution network and in its information technology infrastructure. The efficiency ratio (noninterest expense divided by the sum of net interest income (FTE) and noninterest income) was 60.5% and 53.2%
for 2006 and 2005, respectively, and was affected by the balance sheet actions during the fourth quarter of 2006. Excluding fourth quarter balance sheet actions, the efficiency ratio for 2006 was 55.2%; comparison being provided to supplement an
understanding of fundamental trends. Total noninterest expense increased four percent in 2006 compared to 2005. This comparison is impacted by $49 million of debt and other financing agreement termination charges. Exclusive of these charges, total
noninterest expense increased by $80 million, or three percent, over 2005 primarily due to increases in volume-related bankcard costs and occupancy expenditures related to the addition of de novo banking centers.
Total personnel cost (salaries, wages and incentives plus employee benefits) increased by four percent in 2006 compared to 2005. The
increases are related to employee incentives, increased medical insurance costs and a change in
accounting for retirement eligible stock compensation as a result of the implementation of SFAS 123(R). See Note 18 of the Notes to Consolidated Financial
Statements for additional information regarding stock-based compensation. As of December 31, 2006, the Bancorp employed 22,385 employees, of which 6,140 were officers and 2,715 were part-time employees. Full time equivalent employees totaled
21,362 as of December 31, 2006 compared to 21,681 as of December 31, 2005.
Net occupancy expenses increased 11%
in 2006 over 2005 due to the addition of 51 net new banking centers. The Bancorp remains focused on expanding its retail franchise through de novo growth with plans to open approximately 50 net new banking centers in 2007.
Total other noninterest expense increased three percent in 2006 compared to 2005 primarily due to volume-related bankcard costs and
previously mentioned debt and other financing agreement termination charges. Exclusive of these termination charges, other noninterest income decreased $11 million, or one percent. Marketing expense was stable compared to the prior year and remains
primarily focused on deposit generation. Bankcard expense increased 16% compared to last year due to an increase in the number of merchant and retail customers as well as continuing growth in debit and credit card usage. Operating lease expense
declined 55% from 2005 as a result of the continued planned run off of the automobile operating lease portfolio as noted above.
TABLE 9: NONINTEREST EXPENSE
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Salaries, wages and incentives |
|
$1,174 |
|
1,133 |
|
1,018 |
|
1,031 |
|
1,029 |
Employee benefits |
|
292 |
|
283 |
|
261 |
|
240 |
|
201 |
Equipment expense |
|
122 |
|
105 |
|
84 |
|
82 |
|
79 |
Net occupancy expense |
|
245 |
|
221 |
|
185 |
|
159 |
|
142 |
Other noninterest expense |
|
1,223 |
|
1,185 |
|
1,424 |
|
1,039 |
|
886 |
Total noninterest expense |
|
$3,056 |
|
2,927 |
|
2,972 |
|
2,551 |
|
2,337 |
TABLE 10: COMPONENTS OF OTHER NONINTEREST EXPENSE |
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Marketing and communications |
|
$124 |
|
126 |
|
99 |
|
99 |
|
96 |
Postal and courier |
|
49 |
|
50 |
|
49 |
|
49 |
|
48 |
Bankcard |
|
317 |
|
271 |
|
224 |
|
197 |
|
170 |
Loan and lease |
|
93 |
|
89 |
|
82 |
|
106 |
|
91 |
Travel |
|
52 |
|
54 |
|
41 |
|
35 |
|
38 |
Information technology and operations |
|
112 |
|
114 |
|
87 |
|
76 |
|
54 |
Operating lease |
|
18 |
|
40 |
|
114 |
|
94 |
|
- |
Debt and other financing agreement termination |
|
49 |
|
- |
|
325 |
|
20 |
|
- |
Other |
|
409 |
|
441 |
|
403 |
|
363 |
|
389 |
Total other noninterest expense |
|
$1,223 |
|
1,185 |
|
1,424 |
|
1,039 |
|
886 |
Fifth Third Bancorp 29
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 11: APPLICABLE INCOME TAXES
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in
millions) |
|
2006 |
|
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Income from continuing operations before income taxes, minority interest and cumulative effect |
|
$1,627 |
|
|
2,208 |
|
2,237 |
|
2,438 |
|
2,299 |
Applicable income taxes |
|
443 |
|
|
659 |
|
712 |
|
786 |
|
734 |
Effective tax rate |
|
27.2 |
% |
|
29.9 |
|
31.8 |
|
32.3 |
|
31.9 |
Applicable Income Taxes
The
Bancorps income from continuing operations before income taxes, applicable income tax expense and effective tax rate for each of the periods indicated are shown in Table 11. Applicable income tax expense for all periods includes the benefit
from tax-exempt income, tax-advantaged investments and general business tax credits, partially offset by the effect of nondeductible expenses. In 2006, the lower pretax income combined with tax credits at a level consistent with the prior years and
favorable resolution of certain tax examinations resulted in a decrease in the effective tax rate. In 2007, the Bancorp expects the effective tax rate to be approximately 29%-30%.
Cumulative Effect of Change in Accounting Principle
In the first
quarter of 2006, the Bancorp recognized a benefit of approximately $4 million, net of $2 million of tax, related to the adoption of SFAS No. 123(R). The benefit recognized relates to the Bancorps estimate of forfeiture experience to be
realized for all unvested stock-based awards outstanding.
Comparison of 2005 with 2004
Net income in 2005 increased $24 million compared to 2004. Diluted earnings per common share were $2.77 compared to $2.68. In 2005, return on average
assets was 1.50% and return on average shareholders equity was 16.6% versus 1.61% and 17.2%, respectively, in 2004. Net income in 2004 was negatively impacted by balance sheet actions, which included debt termination charges and securities
losses totaling $404 million pretax. Earnings were positively impacted by a $157 million pretax gain resulting from the sale of certain third- party sourced merchant processing contracts in 2004 and securities gains totaling $39 million pretax in
2005.
Net
interest income (FTE) decreased $52 million in 2005 compared to 2004. The net interest margin decline to 3.23% in 2005 from 3.48% in 2004 was primarily attributable to the rise in short-term interest rates, the impact of the primarily fixed-rate
securities portfolio and mix shifts within the core deposit base. The decline in net interest margin occurred despite a six percent increase in average interest-earning assets from 2004 to 2005.
Noninterest income increased $35 million in 2005 compared to 2004. The comparison to 2004 is impacted by the gain on sale of certain
third-party sourced merchant processing contracts in 2004. Exclusive of this gain, noninterest income increased eight percent compared to 2005. The increase in noninterest income was attributable to increased electronic payment processing revenue
and corporate banking revenue offset by a decrease in operating lease revenue as a result of the run off of the automobile operating lease portfolio.
Noninterest expense decreased $45 million in 2005 compared to 2004. Increases in salaries, wages and incentives were offset by the previously discussed debt termination charges in 2004 totaling $325 million. The
increased salaries, wages and incentives were a result of the sales force expansion and the addition of employees from the acquisition of First National Bankshares of Florida, Inc. on January 1, 2005.
The provision for loan and lease losses was $330 million in 2005 compared to $268 million in 2004. The increase in the provision was due
to the increase in nonperforming assets as well as a 17% portfolio loan growth. The total allowance for loan and lease losses as a percent of total loans and leases was 1.06% at December 31, 2005 compared to 1.19% at December 31, 2004.
30 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS SEGMENT REVIEW
The Bancorp reports on five business segments: Commercial Banking, Branch Banking, Consumer Lending, Investment Advisors and Processing Solutions. During
the first quarter of 2006, the Bancorp began reporting its Retail line of business as two business segments, Branch Banking and Consumer Lending. All prior year information has been updated to reflect this presentation. Further detailed financial
information on each business segment is included in Note 28 of the Notes to Consolidated Financial Statements.
Results of
the Bancorps business segments are presented based on its management structure and management accounting practices. The structure and practices are specific to the Bancorp; therefore, the financial results of the Bancorps business
segments are not necessarily comparable with similar information for other financial institutions. The Bancorp refines its methodologies from time to time as management accounting practices are improved and businesses change. Revisions to the
Bancorps methodologies are applied on a retroactive basis. During the fourth quarter of 2006, the Bancorp changed its application of the provision for loan and lease losses to the segments to include only actual net charge-offs.
The Bancorp manages interest rate risk centrally at the corporate level by employing a funds transfer pricing (FTP)
methodology. This methodology insulates the business segments from interest rate volatility, enabling them to focus on servicing customers through loan originations and deposit taking. The FTP system assigns charge rates and credit rates to classes
of assets and liabilities, respectively, based on expected duration and the Treasury swap curve. Matching the duration, or the effective term until an instrument can be repriced, allocates interest income and interest expense to each segment so its
resulting net interest income is insulated from interest rate risk. In a rising rate environment, the Bancorp benefits from widening spread between deposit costs and wholesale funding costs. However, the Bancorps FTP system credits this
benefit to deposit providing businesses, such as Branch Banking and Investment Advisors, on a duration-adjusted basis. The net impact of the FTP methodology, including the benefit from the widening spread between deposit costs and wholesale funding,
is captured in Other/Eliminations. During the fourth quarter of 2006, the Bancorp made certain changes to the average duration of indeterminate-lived deposits and corresponding changes to the FTP crediting rates assigned to those deposits. This
change more closely aligns the crediting rates to the expected economic benefit while continuing to insulate the segments from interest rate volatility. Prior period results have been conformed to current period presentation.
The financial results of the business segments include allocations for shared services and headquarter expenses. Even with these
allocations, the financial results are not necessarily indicative of the business segments financial condition and results of operations as if they were to exist as independent entities. Additionally, the business segments form synergies by
taking advantage of cross-sell opportunities and when funding operations by accessing the capital markets as a collective unit. Net income by business segment is summarized in the table below.
TABLE 12: BUSINESS SEGMENT NET INCOME
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
Income Statement Data |
|
|
|
|
|
|
Commercial Banking |
|
$651 |
|
614 |
|
563 |
Branch Banking |
|
570 |
|
548 |
|
620 |
Consumer Lending |
|
137 |
|
160 |
|
211 |
Investment Advisors |
|
81 |
|
76 |
|
96 |
Processing Solutions |
|
180 |
|
117 |
|
204 |
Other/Eliminations |
|
(431) |
|
34 |
|
(157) |
Acquisitions |
|
- |
|
- |
|
(12) |
Net income |
|
$1,188 |
|
1,549 |
|
1,525 |
Commercial Banking
Commercial
Banking provides a comprehensive range of financial services and products to large and middle-market businesses, governments and professional customers. In addition to the traditional lending and depository offerings, Commercial Banking products and
services include, among others, cash management, foreign exchange and international trade finance, derivatives and capital markets services, asset-based lending, real estate finance, public finance, commercial leasing and syndicated finance. The
table below contains selected financial data for the Commercial Banking segment.
TABLE 13: COMMERCIAL BANKING
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
Income Statement Data |
|
|
|
|
|
|
Net interest income (FTE) (a) |
|
$1,254 |
|
1,190 |
|
1,104 |
Provision for loan and lease losses |
|
105 |
|
97 |
|
82 |
Noninterest income: |
|
|
|
|
|
|
Corporate banking revenue |
|
304 |
|
287 |
|
217 |
Service charges on deposits |
|
147 |
|
153 |
|
155 |
Other noninterest income |
|
64 |
|
54 |
|
37 |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
240 |
|
239 |
|
196 |
Other noninterest expenses |
|
521 |
|
478 |
|
414 |
Income before taxes |
|
903 |
|
870 |
|
821 |
Applicable income taxes (a) |
|
252 |
|
256 |
|
258 |
Net income |
|
$651 |
|
614 |
|
563 |
Average Balance Sheet Data |
|
|
|
|
|
|
Commercial loans |
|
$33,559 |
|
30,373 |
|
27,267 |
Demand deposits |
|
6,153 |
|
6,291 |
|
6,197 |
Interest checking |
|
3,888 |
|
3,165 |
|
2,455 |
Savings and money market |
|
5,181 |
|
4,958 |
|
3,642 |
Certificates over $100,000 |
|
1,734 |
|
1,099 |
|
647 |
(a) |
Includes taxable-equivalent adjustments of $13 million for 2006, 2005 and 2004. |
Net income increased $37 million, or six percent, compared to 2005 largely as a result of loan and deposit growth and success in the sale
of corporate banking services. Average loans and leases increased 11% over 2005, to $33.6 billion, with growth occurring across all loan categories. The moderate decrease in average demand deposits from the prior year primarily due to lower relative
compensating balance requirements was more than offset by increases in interest checking and savings and money market deposits. Average core deposits increased to $15.2 billion in 2006 from $14.4 billion in 2005. The increase in average core
deposits and loans and leases and the related net FTP impact led to a $64 million increase in net interest income compared to the prior year. The provision for loan and lease losses, which now equals net charge-offs, increased $8 million over 2005.
Net charge-offs as a percent of average loans remained flat at 31 bp in 2006 compared to 32 bp in 2005 and 30 bp in 2004.
Noninterest income increased $21 million, or four percent, compared to 2005 largely due to an increase in corporate banking revenue of $17 million, or six percent. Increases in corporate banking revenue occurred in nearly all sub captions.
Other noninterest income fee lines displayed mixed results compared to the prior year, as operating lease income grew from $8 million to $18 million, while service charges on deposits decreased four percent due largely to increased earnings credits.
Noninterest expense increased $44 million, or six percent, in 2006 compared to 2005 primarily due to volume-related
increases in loan, bankcard, operating lease and data processing expenses.
Fifth Third Bancorp 31
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Branch Banking
Branch Banking
provides a full range of deposit and loan and lease products to individuals and small businesses through 1,150 banking centers. Branch Banking offers depository and loan products, such as checking and savings accounts, home equity lines of credit,
credit cards and loans for automobile and other personal financing needs, as well as products designed to meet the specific needs of small businesses, including cash management services. The table below contains selected financial data for the
Branch Banking segment.
TABLE 14: BRANCH BANKING
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
Income Statement Data |
|
|
|
|
|
|
Net interest income |
|
$1,290 |
|
1,251 |
|
1,247 |
Provision for loan and lease losses |
|
101 |
|
91 |
|
70 |
Noninterest income: |
|
|
|
|
|
|
Electronic payment processing |
|
195 |
|
164 |
|
132 |
Service charges on deposits |
|
358 |
|
359 |
|
365 |
Investment advisory revenue |
|
87 |
|
86 |
|
86 |
Other noninterest income |
|
123 |
|
107 |
|
99 |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
451 |
|
456 |
|
398 |
Net occupancy and equipment expenses |
|
153 |
|
137 |
|
128 |
Other noninterest expenses |
|
468 |
|
437 |
|
393 |
Income before taxes |
|
880 |
|
846 |
|
940 |
Applicable income taxes |
|
310 |
|
298 |
|
320 |
Net income |
|
$570 |
|
548 |
|
620 |
Average Balance Sheet Data |
|
|
|
|
|
|
Consumer loans |
|
$11,391 |
|
10,687 |
|
9,382 |
Commercial loans |
|
4,297 |
|
3,995 |
|
3,416 |
Demand deposits |
|
5,602 |
|
5,649 |
|
5,048 |
Interest checking |
|
10,552 |
|
13,452 |
|
15,928 |
Savings and money market |
|
11,755 |
|
9,045 |
|
7,807 |
Time deposits |
|
11,352 |
|
9,173 |
|
7,554 |
Net income increased $22 million, or four percent, compared to 2005. Net interest
income increased $39 million as increases in average loans and leases and total deposits were partially offset by a deposit mix shift toward higher paying deposit account types. Average loans and leases increased seven percent to $15.7 billion, led
by growth in credit cards of 21% and small business loans of eight percent. Branch Banking continued to realize a shift to higher-rate deposit products throughout 2006. Interest checking and demand deposits decreased $2.9 billion, or 15%, and
savings, money market and other time deposits increased $4.9 billion, or 27%, compared to 2005. The provision for loan and lease losses increased $10 million over 2005. Net charge-offs as a percent of average loans and leases increased slightly from
62 bp to 64 bp.
Noninterest income increased seven percent from 2005. Electronic payment processing revenue increased due
to a $27 million, or 20%, increase in card issuer interchange and a $7 million, or 26%, increase in cardholder fees. The Bancorp expects interchange and cardholder fees to continue to grow due to the increased emphasis on cross-selling credit cards
to its existing customer base.
Noninterest expense increased by four percent compared to 2005 as costs were contained
despite the effect from the Bancorps continued de novo banking center growth strategy. Net occupancy and equipment expenses increased 11%
compared to 2005 as a result of the continued opening of new banking centers. 51 banking centers were opened in 2006, and 63 in 2005, that did not involve
the relocation or consolidation of existing facilities. The Bancorp will continue to position itself for sustained long-term growth through new banking center additions. Card processing expenses increased $15 million on greater sales volumes, and
marketing expenses increased $8 million primarily related to attracting new core deposit accounts.
Consumer Lending
Consumer Lending includes the Bancorps mortgage and home equity lending activities and other indirect lending activities.
Mortgage and home equity lending activities include the origination, retention and servicing of mortgage and home equity loans or lines of credit, sales and securitizations of those loans or pools of loans or lines of credit and all associated
hedging activities. Other indirect lending activities include loans to consumers through mortgage brokers, auto dealers and federal and private student education loans. The table below contains selected financial data for the Consumer Lending
segment.
TABLE 15: CONSUMER LENDING
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
Income Statement Data |
|
|
|
|
|
|
Net interest income |
|
$380 |
|
397 |
|
421 |
Provision for loan and lease losses |
|
94 |
|
90 |
|
84 |
Noninterest income: |
|
|
|
|
|
|
Mortgage banking net revenue |
|
148 |
|
165 |
|
167 |
Other noninterest income |
|
81 |
|
125 |
|
227 |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
101 |
|
98 |
|
102 |
Other noninterest expenses |
|
202 |
|
252 |
|
309 |
Income before taxes |
|
212 |
|
247 |
|
320 |
Applicable income taxes |
|
75 |
|
87 |
|
109 |
Net income |
|
$137 |
|
160 |
|
211 |
Average Balance Sheet Data |
|
|
|
|
|
|
Consumer loans |
|
$20,430 |
|
19,161 |
|
17,536 |
Net income decreased $23 million, or 14%, compared to 2005. Net interest income
decreased $17 million, or four percent, despite average loans and leases increasing seven percent, due to a 17 bp decline in the spread between loan yields and the related FTP charge as a result of the shift in the mix of loans and the increasingly
competitive environment in which this segment competes. The Bancorp is focused on meeting its customers varying financial needs by offering new consumer products while maintaining its current credit quality profile.
The Bancorp had mortgage originations of $9.4 billion, $9.9 and $8.4 billion in 2006, 2005 and 2004, respectively. As a result of the
decrease in originations and the corresponding decrease in gains on sales of mortgages, mortgage banking net revenue decreased $17 million, or 10%. Decreases in other noninterest income and expense were largely a result of the planned run off of the
consumer operating lease portfolios. Operating lease income and expense decreased from 2005 by $39 million and $29 million, respectively. As the operating lease portfolio is nearing maturity, operating lease income and expense should have an
immaterial effect on 2007 results.
32 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Investment Advisors
Investment
Advisors provides a full range of investment alternatives for individuals, companies and not-for-profit organizations. The Bancorps primary services include investments, trust, asset management, retirement plans and custody. Fifth Third
Securities, Inc., an indirect wholly-owned subsidiary of the Bancorp, offers full service retail brokerage services to individual clients and broker dealer services to the institutional marketplace. Fifth Third Asset Management, Inc., an indirect
wholly-owned subsidiary of the Bancorp, provides asset management services and also advises the Bancorps proprietary family of mutual funds. The table below contains selected financial data for the Investment Advisors segment.
TABLE 16: INVESTMENT ADVISORS
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
Income Statement Data |
|
|
|
|
|
|
Net interest income |
|
$125 |
|
131 |
|
129 |
Provision for loan and lease losses |
|
3 |
|
4 |
|
2 |
Noninterest income: |
|
|
|
|
|
|
Investment advisory revenue |
|
367 |
|
360 |
|
367 |
Other noninterest income |
|
19 |
|
16 |
|
19 |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
172 |
|
170 |
|
148 |
Other noninterest expenses |
|
211 |
|
215 |
|
220 |
Income before taxes |
|
125 |
|
118 |
|
145 |
Applicable income taxes |
|
44 |
|
42 |
|
49 |
Net income |
|
$81 |
|
76 |
|
96 |
Average Balance Sheet Data |
|
|
|
|
|
|
Loans and leases |
|
$3,068 |
|
2,684 |
|
2,176 |
Core deposits |
|
4,499 |
|
3,976 |
|
3,487 |
Net income increased $5 million, or six percent, compared to 2005 as a result of
modest growth in investment advisory revenue and a decline in noninterest expense. Net interest income declined four percent to $125 million due to the decline in interest rate spread as a result of the continued mix shift to higher cost deposit
products. The negative impact of the shift in deposit mix more than offset the $384 million, or 14%, increase in average loans and leases in 2006.
Noninterest income increased three percent from 2005 as the $7 million increase in private client revenues was mitigated by a decrease in mutual fund revenue of $3 million. The decrease in mutual fund revenue was
primarily the result of the deployment of an open architecture on proprietary fund sales. Noninterest expenses decreased modestly compared to the prior year due to the focus on expense control. Employee compensation is expected to increase in 2007
as the Bancorp looks to expand its sales force throughout its footprint, particularly in retail brokerage.
Processing Solutions
Fifth Third Processing Solutions provides electronic funds transfer, debit, credit and merchant transaction processing, operates
the Jeanie® ATM network and provides other data
processing services to affiliated and unaffiliated customers. The table below contains selected financial data for the Processing Solutions segment.
TABLE 17: PROCESSING SOLUTIONS
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
Income Statement Data |
|
|
|
|
|
|
Net interest income |
|
$33 |
|
28 |
|
29 |
Provision for loan and lease losses |
|
10 |
|
18 |
|
10 |
Noninterest income: |
|
|
|
|
|
|
Merchant processing |
|
397 |
|
351 |
|
305 |
EFT processing |
|
297 |
|
257 |
|
219 |
Other noninterest income |
|
88 |
|
25 |
|
173 |
Noninterest expense: |
|
|
|
|
|
|
Salaries, incentives and benefits |
|
71 |
|
53 |
|
50 |
Net occupancy and equipment expenses |
|
13 |
|
6 |
|
7 |
Transaction processing |
|
303 |
|
253 |
|
205 |
Other noninterest expenses |
|
140 |
|
150 |
|
145 |
Income before taxes |
|
278 |
|
181 |
|
309 |
Applicable income taxes |
|
98 |
|
64 |
|
105 |
Net income |
|
$180 |
|
117 |
|
204 |
Net income increased $63 million versus the prior year. Excluding the $78 million
of pretax securities gains from the sale of the Bancorps MasterCard, Inc. shares, included in other noninterest income, net income increased 10% compared to 2005, as electronic payment processing revenues continued to produce double-digit
increases. Merchant and EFT revenues increased by 13% and 15% primarily due to new customer additions and related increased volume. 2004 results are affected by the sale of certain third-party sourced merchant processing contracts that resulted in a
pretax gain of $157 million. The Bancorp continues to see opportunities to attract new financial institution customers and retailers within this business segment.
The strong increase in noninterest income was mitigated by a 14% increase in noninterest expense due to headcount additions, investment in information technology and transaction processing costs.
Salaries, incentives and benefits increased 33% with the addition of over 300 employees. The 20% increase in transaction processing costs compared to 2005 primarily resulted from network membership fees and volume-related costs as the number of
merchant transactions processed increased 17% over 2005.
Other/Eliminations
Other/Eliminations includes the unallocated portion of the investment securities portfolio, certain wholesale funding, unassigned equity and certain
support activities, provision expense in excess of net charge-offs and other items not attributed to the business segments.
The results of Other/Eliminations were primarily impacted by the balance sheet actions in the fourth quarter of 2006 and the related loss on the sale of securities. Other/Eliminations was also impacted by wholesale funding repricing at a
faster rate than securities as a result of rising short-term rates in the first half of 2006. The Bancorp experienced an increase in the average interest rate on wholesale funding from 3.36% in 2005 to 5.02% in 2006 compared to an increase in the
average interest rate on securities from 4.36% in 2005 to 4.56% in 2006.
Fifth Third Bancorp 33
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOURTH QUARTER REVIEW
The Bancorps 2006 fourth quarter earnings per diluted share were $.12 compared to $.60 per diluted share for the same period in 2005. Fourth quarter
net income totaled $66 million compared to $332 million in the same quarter last year. Fourth quarter 2006 earnings and ratios were negatively impacted by $454 million in total pretax losses and charges related to balance sheet actions taken to
improve the asset/liability profile of the Bancorp. The pretax losses and charges consisted of $398 million in losses on the sale of $11.3 billion in available-for-sale securities; $17 million in losses on derivatives related to the securities sold,
recorded in other noninterest income; and $39 million in charges related to the termination of the repurchase and reverse agreements, recorded in other noninterest expense. Return on average assets and return on average equity were .25% and 2.6%,
respectively, compared to 1.27% and 13.9% in 2005s fourth quarter. The Bancorps efficiency ratio was 82.9% in the fourth quarter compared to 55.6% last year and 55.5% in the previous quarter.
Compared to the fourth quarter of 2005, net interest income (FTE) increased one percent, reflecting a two percent decline in earning
assets and 5 bp improvement of the net interest margin (FTE). Compared to the third quarter of 2006, net interest income (FTE) increased by $25 million and was primarily driven by the sale of available-for-sale securities and repayment of $8.5
billion in wholesale borrowings. Solid trends in loan growth and greater stability in deposit pricing also contributed to the increase. The improvement in net interest margin in the fourth quarter was primarily due to the sales of securities,
stronger core deposit growth and improved loan yields.
Overall noninterest income, excluding balance sheet actions taken in
the fourth quarter, remained flat compared to the same quarter last year and increased three percent on a sequential basis.
Electronic payment processing revenues increased 14% over the same quarter last year reflecting double-digit growth in merchant processing and card interchange, though growth was mitigated by the effects of slower consumer spending
throughout 2006.
Deposit service revenue decreased eight percent compared to the same quarter last year. Retail deposit
revenue decreased 10% reflecting significantly lower consumer overdraft fees. The Bancorp has been encouraging its customers to enroll in overdraft protection as a means to establish stronger relationships and improve account retention. Commercial
deposit revenue decreased five percent due to increased earnings credits on compensating balances.
Mortgage banking net
revenue totaled $30 million in the fourth quarter compared to $42 million in the prior year fourth quarter. The decline was primarily due to decreased origination fees and lower gains on loan sales, reflecting lower market spreads. Mortgage
originations were $2.3 billion in the fourth quarter and $2.5 billion in the fourth quarter of last year. Fourth quarter mortgage banking net servicing revenue totaled $7 million and was comprised of $31 million in total mortgage servicing fees,
less $19 million in amortization and $5 million in net valuation adjustments on mortgage servicing rights.
Investment advisory revenues increased by four percent over the same quarter last year. The increase was driven by strong growth in
private banking and moderate growth in the retail securities and institutional businesses, partially offset by lower mutual fund fees reflecting the ongoing effect of open architecture on proprietary fund sales.
Corporate banking revenue for the fourth quarter 2006 decreased 11% compared to the same quarter last year. The decrease was primarily due
to unusually strong fourth quarter 2005 lease syndication fees, as well as lower letter of credit and customer interest rate derivative income.
Other noninterest income totaled $58 million in the fourth quarter compared to $77 million in the same quarter last year. The decrease from the prior year quarter was a result of the $17 million in losses on
derivatives related to securities sold as part of the balance sheet actions taken in this years fourth quarter. Other noninterest income decreased by $29 million compared to the third quarter of 2006. Comparisons to the third quarter reflect
the losses on derivatives mentioned above, in addition to $11 million in gains related to the third quarter sales of three Indiana branches and a small out-of-footprint credit card portfolio.
Total noninterest expense increased by five percent compared to the same quarter last year. Comparisons reflect a $39 million charge in
the fourth quarter of 2006 associated with the termination of financing agreements as part of the balance sheet actions taken and approximately $9 million in fraud-related expenses and approximately $10 million in tax-related expense in the fourth
quarter 2005. Excluding the above-mentioned items, noninterest expense increased two percent due to higher personnel expense and de novo related occupancy expense. Compared to the third quarter of 2006, total noninterest expense increased by $31
million primarily due to higher processing volume-related expenses and the $39 million in termination of financing agreements mentioned above, offset by $11 million in charges for the early retirement of debt and $8 million in pension settlement
expenses incurred in the third quarter.
Net charge-offs as a percentage of average loans and leases were 52 bp in the
fourth quarter, compared to 43 bp last quarter and 67 bp in the fourth quarter of 2005. Net charge-offs were $97 million in the fourth quarter, compared to $79 million in the third quarter of 2006 and $117 million in the same quarter last year. The
increase from the last quarter resulted from two large commercial credits totaling $9 million, higher small business charge-offs and higher indirect consumer losses. Fourth quarter 2005 numbers reflect an elevated level of net charge-offs associated
with approximately $27 million in losses from bankrupt commercial airline carriers and a $15 million increase in consumer loan and lease losses associated with increased personal bankruptcies declared prior to enacted reform legislation in 2005. The
provision for loan and lease losses totaled $107 million in the fourth quarter compared to $87 million in the third quarter of 2006 and $134 million in the same quarter last year.
34 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BALANCE SHEET ANALYSIS
|
|
|
|
|
|
|
|
|
|
|
|
TABLE 18: COMPONENTS OF TOTAL LOANS AND LEASES (INCLUDING HELD FOR
SALE) |
As of December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Commercial: |
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$ |
20,725 |
|
19,299 |
|
16,058 |
|
14,226 |
|
12,786 |
Commercial mortgage |
|
|
10,405 |
|
9,188 |
|
7,636 |
|
6,894 |
|
5,885 |
Commercial construction |
|
|
6,168 |
|
6,342 |
|
4,348 |
|
3,301 |
|
3,009 |
Commercial leases |
|
|
3,841 |
|
3,698 |
|
3,426 |
|
3,264 |
|
3,019 |
Total commercial loans and leases |
|
|
41,139 |
|
38,527 |
|
31,468 |
|
27,685 |
|
24,699 |
Consumer: |
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage |
|
|
9,226 |
|
8,296 |
|
7,533 |
|
5,530 |
|
6,804 |
Residential construction |
|
|
679 |
|
695 |
|
378 |
|
335 |
|
319 |
Credit card |
|
|
1,110 |
|
866 |
|
843 |
|
762 |
|
537 |
Home equity |
|
|
12,365 |
|
12,000 |
|
10,508 |
|
8,993 |
|
8,675 |
Other consumer loans |
|
|
9,911 |
|
9,250 |
|
7,586 |
|
8,436 |
|
5,909 |
Consumer leases |
|
|
1,073 |
|
1,595 |
|
2,051 |
|
2,448 |
|
2,343 |
Total consumer loans and leases |
|
|
34,364 |
|
32,702 |
|
28,899 |
|
26,504 |
|
24,587 |
Total loans and leases |
|
$ |
75,503 |
|
71,229 |
|
60,367 |
|
54,189 |
|
49,286 |
Loans and Leases
Total loans
and leases increased six percent compared to December 31, 2005. Table 18 presents the Bancorps total commercial and consumer loan and lease portfolio by the primary purpose of the loan. During 2006, the Bancorp reviewed its loan
classifications, which resulted in a reclassification of approximately $450 million of commercial loans to commercial mortgage. The impact to average loans was immaterial as the reclassification took place at the end of 2006. Prior year balances
were not restated. Total loans and leases grew in over half of its affiliates with double-digit growth in the Cleveland, Detroit, Lexington, Nashville, Orlando and Tampa markets.
Total commercial loans and leases increased $2.6 billion, or seven percent, compared to the prior year. Excluding the impact of the 2006
reclassification, commercial loans increased $1.9 billion or 10%, and commercial mortgage increased by approximately $800 million, or eight percent, compared to December 31, 2005. The mix of commercial loans was consistent with the prior year.
Total consumer loans and leases increased five percent compared to December 31, 2005 as a result of the introduction
of new residential mortgage products and increased promotion
of credit cards. Residential mortgage loans increased $930 million, or 11%, compared to 2005. Comparisons to prior years are dependent upon the volume and
timing of originations as well as the timing of loan sales. Residential mortgage originations totaled $9.4 billion in 2006 compared to $9.9 billion in 2005. Credit card balances increased 28% to $1.1 billion. A key focus for the Bancorp in 2007 is
increasing its penetration of credit cards within in its retail footprint. Consumer lease balances decreased 33% from December 31, 2005 largely due to continued competitive pricing from captive financing companies.
Average commercial loans and leases increased $3.8 billion, or 10%, compared to the December 31, 2005. The Bancorp experienced
double-digit growth in more than half of its affiliates, including 15% in the Florida markets, 18% in Tennessee and Chicago and 26% in Cleveland.
The growth in average consumer loans and leases was a result of strong growth in each category mitigated by a decline in consumer auto leases. Average consumer loans and leases increased $2.0 billion, or six percent,
compared to 2005, highlighted by 33% growth in both the Florida and Tennessee markets.
|
|
|
|
|
|
|
|
|
|
|
|
TABLE 19: COMPONENTS OF AVERAGE TOTAL LOANS AND LEASES |
As of December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Commercial: |
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$ |
20,400 |
|
18,241 |
|
14,908 |
|
13,672 |
|
11,665 |
Commercial mortgage |
|
|
9,797 |
|
8,923 |
|
7,391 |
|
6,299 |
|
5,834 |
Commercial construction |
|
|
6,015 |
|
5,525 |
|
3,807 |
|
3,097 |
|
3,023 |
Commercial leases |
|
|
3,730 |
|
3,495 |
|
3,296 |
|
3,037 |
|
2,640 |
Total commercial loans and leases (including held for
sale) |
|
|
39,942 |
|
36,184 |
|
29,402 |
|
26,105 |
|
23,162 |
Consumer: |
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage |
|
|
8,855 |
|
8,396 |
|
6,454 |
|
6,565 |
|
6,100 |
Residential construction |
|
|
719 |
|
586 |
|
347 |
|
315 |
|
277 |
Credit card |
|
|
942 |
|
797 |
|
787 |
|
591 |
|
478 |
Home equity |
|
|
12,268 |
|
11,463 |
|
9,797 |
|
9,084 |
|
8,444 |
Other consumer loans |
|
|
9,439 |
|
8,489 |
|
7,958 |
|
7,259 |
|
5,017 |
Consumer leases |
|
|
1,328 |
|
1,822 |
|
2,297 |
|
2,495 |
|
2,061 |
Total consumer loans and leases (including held for
sale) |
|
|
33,551 |
|
31,553 |
|
27,640 |
|
26,309 |
|
22,377 |
Total loans and leases (including held for sale) |
|
$ |
73,493 |
|
67,737 |
|
57,042 |
|
52,414 |
|
45,539 |
Total portfolio loans and leases (excluding held for
sale) |
|
$ |
72,447 |
|
66,685 |
|
55,951 |
|
49,700 |
|
43,529 |
Fifth Third Bancorp 35
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Investment Securities
As of
December 31, 2006, total investment securities were $11.6 billion compared to $22.4 billion at December 31, 2005. Securities are classified as available-for-sale when, in managements judgment, they may be sold in response to or in
anticipation of changes in market conditions. The Bancorps management has evaluated the securities in an unrealized loss position in the available-for-sale portfolio and maintains the intent and ability to hold these securities to the earlier
of the recovery of the losses or maturity.
During the fourth quarter of 2006, the Bancorp evaluated its overall balance
sheet composition and took certain actions with respect to its available-for-sale securities portfolio. The Bancorps objective was to improve the asset/liability profile of the Bancorp and reduce the size of its available-for-sale securities
portfolio to a size that is more consistent with its liquidity, collateral and interest rate risk management requirements, improve composition of the balance sheet with a lower concentration in fixed-rate assets, lower wholesale borrowings to reduce
leverage and better position the Bancorp for an uncertain economic and interest rate environment. On November 20, 2006, the Bancorps Board of Directors approved the following actions with respect to the Bancorps available-for-sale
securities portfolio: (i) sales of $11.3 billion in available-for-sale securities, with a weighted-average yield of approximately 4.30% and (ii) reinvestment of approximately $2.8 billion in available-for-sale securities that are more
efficient when used as collateral for pledging purposes. The subsequent sale of available-for-sale securities later in the fourth quarter resulted in pretax losses of $398 million. Additionally, during the third quarter of 2006, the
Bancorp sold $726 million of FHLMC callable debt, which represented nearly all of its position in these securities, in order to reduce its credit exposure as
a result of recent market events.
Net unrealized losses on the available-for-sale securities portfolio were $183 million at
December 31, 2006 compared to $609 million at December 31, 2005. As of December 31, 2006, 95% of the unrealized losses in the available-for-sale securities portfolio were comprised of securities issued by U.S. Treasury and Government
agencies, U.S. Government sponsored agencies and states and political subdivisions as well as agency mortgage-backed securities. The Bancorp believes the price movements in these securities were the result of movement in market interest rates.
On an amortized cost basis, at the end of 2006, available-for-sale securities decreased $11.3 billion since
December 31, 2005. At December 31, 2006, available-for-sale securities have decreased to 13% of interest-earning assets, compared to 24% at December 31, 2005. The estimated weighted-average life of the debt securities in the
available-for-sale portfolio was 4.3 years at December 31, 2006 and 2005. At December 31, 2006, the fixed-rate securities within the available-for-sale securities portfolio had a weighted-average yield of 5.13%.
Information presented in Table 20 is on a weighted-average life basis, anticipating future prepayments. Yield information is presented on
an FTE basis and is computed using historical cost balances. Maturity and yield calculations for the total available-for-sale portfolio exclude equity securities that have no stated yield or maturity.
TABLE 20: CHARACTERISTICS OF AVAILABLE-FOR-SALE AND OTHER SECURITIES
|
|
|
|
|
|
|
|
|
|
As of December 31, 2006 ($ in millions) |
|
Amortized Cost |
|
Fair Value |
|
Weighted-Average Life (in years) |
|
Weighted-Average Yield |
|
U.S. Treasury and Government agencies: |
|
|
|
|
|
|
|
|
|
Average life of one year or less |
|
$1,392 |
|
$1,392 |
|
.1 |
|
4.83 |
% |
Average life 1 5 years |
|
4 |
|
4 |
|
2.6 |
|
6.53 |
|
Average life 5 10 years |
|
- |
|
- |
|
- |
|
- |
|
Average life greater than 10 years |
|
- |
|
- |
|
- |
|
- |
|
Total |
|
1,396 |
|
1,396 |
|
.1 |
|
4.83 |
|
U.S. Government sponsored agencies: |
|
|
|
|
|
|
|
|
|
Average life of one year or less |
|
- |
|
- |
|
- |
|
- |
|
Average life 1 5 years |
|
100 |
|
95 |
|
4.9 |
|
4.20 |
|
Average life 5 10 years |
|
- |
|
- |
|
- |
|
- |
|
Average life greater than 10 years |
|
- |
|
- |
|
- |
|
- |
|
Total |
|
100 |
|
95 |
|
4.9 |
|
4.20 |
|
Obligations of states and political subdivisions (a): |
|
|
|
|
|
|
|
|
|
Average life of one year or less |
|
57 |
|
57 |
|
.5 |
|
7.81 |
|
Average life 1 5 years |
|
403 |
|
411 |
|
3.2 |
|
7.30 |
|
Average life 5 10 years |
|
106 |
|
109 |
|
6.4 |
|
7.12 |
(b) |
Average life greater than 10 years |
|
37 |
|
37 |
|
11.7 |
|
8.55 |
(b) |
Total |
|
603 |
|
614 |
|
4.0 |
|
7.33 |
|
Agency mortgage-backed securities: |
|
|
|
|
|
|
|
|
|
Average life of one year or less |
|
7 |
|
7 |
|
.7 |
|
6.73 |
|
Average life 1 5 years |
|
2,980 |
|
2,928 |
|
3.5 |
|
5.03 |
|
Average life 5 10 years |
|
5,012 |
|
4,881 |
|
5.9 |
|
5.09 |
|
Average life greater than 10 years |
|
- |
|
- |
|
- |
|
- |
|
Total |
|
7,999 |
|
7,816 |
|
5.0 |
|
5.07 |
|
Other bonds, notes and debentures (c): |
|
|
|
|
|
|
|
|
|
Average life of one year or less |
|
7 |
|
8 |
|
.6 |
|
35.56 |
(d) |
Average life 1 5 years |
|
155 |
|
153 |
|
2.7 |
|
5.59 |
|
Average life 5 10 years |
|
10 |
|
10 |
|
9.0 |
|
5.60 |
|
Average life greater than 10 years |
|
- |
|
- |
|
- |
|
- |
|
Total |
|
172 |
|
171 |
|
3.1 |
|
6.75 |
|
Other securities (e) |
|
966 |
|
961 |
|
|
|
|
|
Total available-for-sale and other
securities |
|
$11,236 |
|
$11,053 |
|
4.3 |
|
5.18 |
% |
(a) |
Taxable-equivalent yield adjustments included in the above table are 2.57%, 2.42%, 2.95%, 2.25% and 2.42% for securities with an average life of one year or
less, 1-5 years, 5-10 years, greater than 10 years and in total, respectively. |
(b) |
Weighted-average yield excludes $18 million and $35 million of securities with an average life of 5-10 years and greater than 10 years, respectively, related
to qualified zone academy bonds whose yields are realized through income tax credits. The weighted-average effective yield of these instruments is 6.77%. |
(c) |
Other bonds, notes, and debentures consist of non-agency mortgage backed securities, certain other asset backed securities (primarily automobile and
commercial loan backed securities) and corporate bond securities. |
(d) |
Amount includes residual interest in an auto securitization with a cost of $5 million and fair market value of $6 million, which is expected to mature in
2007. |
(e) |
Other securities consist of Federal Home Loan Bank (FHLB) and Federal Reserve Bank restricted stock holdings that are carried at cost, FHLMC
preferred stock holdings, certain mutual fund holdings and equity security holdings. |
36 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 21: COMPONENTS OF INVESTMENT SECURITIES (AMORTIZED COST BASIS)
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Available-for-sale and other: |
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury and Government agencies |
|
$ |
1,396 |
|
506 |
|
503 |
|
838 |
|
303 |
U.S. Government sponsored agencies |
|
|
100 |
|
2,034 |
|
2,036 |
|
3,877 |
|
2,308 |
Obligations of states and political subdivisions |
|
|
603 |
|
657 |
|
823 |
|
922 |
|
1,033 |
Agency mortgage-backed securities |
|
|
7,999 |
|
16,127 |
|
17,571 |
|
21,101 |
|
19,328 |
Other bonds, notes and debentures |
|
|
172 |
|
2,119 |
|
2,862 |
|
1,401 |
|
1,084 |
Other securities |
|
|
966 |
|
1,090 |
|
1,006 |
|
937 |
|
734 |
Total available-for-sale and other
securities |
|
$ |
11,236 |
|
22,533 |
|
24,801 |
|
29,076 |
|
24,790 |
Held-to-maturity: |
|
|
|
|
|
|
|
|
|
|
|
Obligations of states and political subdivisions |
|
$ |
345 |
|
378 |
|
245 |
|
126 |
|
52 |
Other bonds, notes and debentures |
|
|
11 |
|
11 |
|
10 |
|
9 |
|
- |
Total held-to-maturity |
|
$ |
356 |
|
389 |
|
255 |
|
135 |
|
52 |
TABLE 22: DEPOSITS
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Demand |
|
$ |
14,331 |
|
14,609 |
|
13,486 |
|
12,142 |
|
10,095 |
Interest checking |
|
|
15,993 |
|
18,282 |
|
19,481 |
|
19,757 |
|
17,878 |
Savings |
|
|
13,181 |
|
11,276 |
|
8,310 |
|
7,375 |
|
10,056 |
Money market |
|
|
6,584 |
|
6,129 |
|
4,321 |
|
3,201 |
|
1,044 |
Transaction deposits |
|
|
50,089 |
|
50,296 |
|
45,598 |
|
42,475 |
|
39,073 |
Other time |
|
|
10,987 |
|
9,313 |
|
6,837 |
|
6,201 |
|
7,638 |
Core deposits |
|
|
61,076 |
|
59,609 |
|
52,435 |
|
48,676 |
|
46,711 |
Certificates - $100,000 and over |
|
|
6,628 |
|
4,343 |
|
2,121 |
|
1,856 |
|
1,723 |
Foreign office |
|
|
1,676 |
|
3,482 |
|
3,670 |
|
6,563 |
|
3,774 |
Total deposits |
|
$ |
69,380 |
|
67,434 |
|
58,226 |
|
57,095 |
|
52,208 |
Deposits
Deposit balances
represent an important source of funding and revenue growth opportunity. The Bancorp is continuing to focus on transaction account deposit growth in its retail and commercial franchises by expanding its retail franchise, enhancing its product
offering and providing competitive rates. The Bancorps goal is to continue to grow the core deposit component of its funding profile. At December 31, 2006, core deposits represented 61% of the Bancorps asset funding base, compared
to 57% at December 31, 2005.
Core deposits grew two percent compared to December 31, 2005, but the Bancorp
continues to realize a mix shift as customers move from lower-yield transaction accounts to higher-yield time deposits. Overall, transaction deposits balances remained stable compared to the prior year.
Foreign office deposits
represent U.S. dollar denominated deposits of the Bancorps foreign branch located in the Cayman Islands. The Bancorp utilizes these deposit as well as certificates $100,000 and over as a method to fund earning asset growth.
On an average basis, core deposits increased five percent while continuing to realize a mix shift within core deposits compared to 2005.
The Bancorp realized strong double-digit growth in savings, money market and other time deposits mitigated by decreases in demand and interest checking deposits. The Bancorp experienced double-digit average transaction deposit increases in the
Indianapolis, Tampa, Orlando, Lexington and Louisville markets.
TABLE 23: AVERAGE DEPOSITS
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Demand |
|
$ |
13,741 |
|
13,868 |
|
12,327 |
|
10,482 |
|
8,953 |
Interest checking |
|
|
16,650 |
|
18,884 |
|
19,434 |
|
18,679 |
|
16,239 |
Savings |
|
|
12,189 |
|
10,007 |
|
7,941 |
|
8,020 |
|
9,465 |
Money market |
|
|
6,366 |
|
5,170 |
|
3,473 |
|
3,189 |
|
1,162 |
Transaction deposits |
|
|
48,946 |
|
47,929 |
|
43,175 |
|
40,370 |
|
35,819 |
Other time |
|
|
10,500 |
|
8,491 |
|
6,208 |
|
6,426 |
|
8,855 |
Core deposits |
|
|
59,446 |
|
56,420 |
|
49,383 |
|
46,796 |
|
44,674 |
Certificates - $100,000 and over |
|
|
5,795 |
|
4,001 |
|
2,403 |
|
3,832 |
|
2,237 |
Foreign office |
|
|
3,711 |
|
3,967 |
|
4,449 |
|
3,862 |
|
2,018 |
Total deposits |
|
$ |
68,952 |
|
64,388 |
|
56,235 |
|
54,490 |
|
48,929 |
Borrowings
During 2006, the
Bancorp reduced its reliance on wholesale borrowings. As a result of not reinvesting cash flows from the securities portfolio throughout the year and the balance sheet actions in the fourth quarter, the Bancorp reduced the amount of total borrowings
$8.0 billion, or 32%, compared to the prior year-end. As of December 31, 2006 and 2005 total borrowings as a percentage of interest-bearing liabilities were 22% and
29%, respectively. The Bancorp continues to explore additional alternatives regarding the level and cost of various other sources of funding. Refer to the
Liquidity Risk Management section for discussion on the Bancorps liquidity management and Note 11 of the Notes to Consolidated Financial Statements for a comprehensive listing of the components of long-term debt.
TABLE 24: BORROWINGS
|
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Federal funds purchased |
|
$1,421 |
|
5,323 |
|
4,714 |
|
6,928 |
|
4,748 |
Short-term bank notes |
|
- |
|
- |
|
775 |
|
500 |
|
- |
Other short-term borrowings |
|
2,796 |
|
4,246 |
|
4,537 |
|
5,742 |
|
4,075 |
Long-term debt |
|
12,558 |
|
15,227 |
|
13,983 |
|
9,063 |
|
8,179 |
Total borrowings |
|
$16,775 |
|
24,796 |
|
24,009 |
|
22,233 |
|
17,002 |
Fifth Third Bancorp 37
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RISK MANAGEMENT
Managing risk is an essential component of successfully operating a financial services company. The Bancorps risk management function is responsible
for the identification, measurement, monitoring, control and reporting of risk and mitigation of those risks that are inconsistent with the Bancorps risk profile. The Enterprise Risk Management division, led by the Bancorps Chief Risk
Officer, ensures consistency in the Bancorps approach to managing and monitoring risk within the structure of the Bancorps affiliate operating model. The risks faced by the Bancorp include, but are not limited to, credit, market,
liquidity, operational and regulatory compliance. In addition, the Internal Audit division provides an independent assessment of the Bancorps internal control structure and related systems and processes. The Enterprise Risk Management division
includes the following key functions:
|
|
|
Risk Policy - ensures consistency in the approach to risk management as the Bancorps clearinghouse for credit, market and operational risk policies,
procedures and guidelines; |
|
|
|
Operational Risk Management - responsible for the risk self-assessment process, the change control evaluation process, fraud prevention and detection, and root
cause analysis and corrective action plans relating to identified operational losses; |
|
|
|
Insurance Risk Management - responsible for all property, casualty and liability insurance policies including the claims administration process for the Bancorp;
|
|
|
|
Capital Markets Risk Management - responsible for establishing and monitoring proprietary trading limits, monitoring liquidity and interest rate risk and
utilizing value at risk and earnings at risk models; |
|
|
|
Credit Risk Review - responsible for evaluating the sufficiency of underwriting, documentation and approval processes for consumer and commercial credits,
counter-party credit risk, the accuracy of risk grades assigned to commercial credit exposures, and appropriate accounting for charge-offs, non-accrual status and specific reserves; |
|
|
|
Compliance Risk Management - responsible for oversight of compliance with all banking regulations; |
|
|
|
Risk Strategies and Reporting - responsible for quantitative analytics and Board of Directors and senior management reporting on credit, market and operational
risk metrics; and |
|
|
|
Investment Advisors Risk Management - responsible for trust compliance, fiduciary risk and trading risk in the Investment Advisors line of business.
|
Designated risk managers have been assigned to the business lines reporting directly to the Enterprise Risk Management division and indirectly to senior executives within the division or affiliate. Affiliate risk management is handled by
regional risk managers who are responsible for multiple affiliates and who report jointly to affiliate presidents and the Enterprise Risk Management division.
Risk management oversight and governance is provided by the Risk and Compliance Committee of the Board of Directors and through multiple management committees whose membership includes a broad
cross-section of line of business, affiliate and support representatives. The Risk and Compliance Committee of the Board of Directors consists of three outside directors and has the responsibility for the oversight of credit, market, operational,
regulatory compliance and strategic risk management activities for the Bancorp as well as for the Bancorps overall aggregate risk profile. The Risk and Compliance Committee of the Board of Directors has approved the formation of key management
governance committees that are responsible for evaluating risks and controls. These committees include the Market Risk Committee, the Credit Risk Committee, the Operational Risk Committee and the Executive Asset Liability Risk Committee. There are
also new products and initiatives processes applicable to every line of business to ensure an appropriate standard readiness assessment is performed before launching a new product or initiative. Significant risk policies approved by the management
governance committees are also reviewed and approved by the Risk and Compliance Committee of the Board of Directors.
38 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 25: COMMERCIAL LOAN AND LEASE PORTFOLIO EXPOSURE
(a)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
2005 |
As of December 31 ($ in millions) |
|
Outstanding |
|
|
Exposure |
|
Nonaccrual |
|
Outstanding |
|
Exposure |
|
Nonaccrual |
By industry: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate |
|
$10,652 |
|
|
13,196 |
|
50 |
|
9,503 |
|
11,689 |
|
32 |
Construction |
|
5,490 |
|
|
8,963 |
|
69 |
|
4,911 |
|
8,094 |
|
49 |
Manufacturing |
|
5,198 |
|
|
11,443 |
|
22 |
|
4,457 |
|
9,975 |
|
47 |
Retail trade |
|
3,655 |
|
|
6,515 |
|
27 |
|
3,602 |
|
5,962 |
|
18 |
Transportation and warehousing |
|
2,097 |
|
|
2,432 |
|
4 |
|
1,701 |
|
1,993 |
|
6 |
Business services |
|
1,862 |
|
|
3,640 |
|
16 |
|
1,886 |
|
3,351 |
|
13 |
Healthcare |
|
1,860 |
|
|
3,208 |
|
9 |
|
1,664 |
|
2,844 |
|
10 |
Wholesale trade |
|
1,827 |
|
|
3,642 |
|
11 |
|
1,879 |
|
3,540 |
|
9 |
Financial services and insurance |
|
1,509 |
|
|
4,855 |
|
8 |
|
1,111 |
|
3,069 |
|
1 |
Individuals |
|
1,364 |
|
|
1,785 |
|
13 |
|
1,840 |
|
2,371 |
|
12 |
Other services |
|
959 |
|
|
1,373 |
|
14 |
|
945 |
|
1,260 |
|
9 |
Accommodation and food |
|
860 |
|
|
1,323 |
|
10 |
|
997 |
|
1,396 |
|
9 |
Public administration |
|
792 |
|
|
930 |
|
- |
|
830 |
|
1,004 |
|
- |
Agribusiness |
|
609 |
|
|
782 |
|
8 |
|
569 |
|
752 |
|
2 |
Entertainment and recreation |
|
602 |
|
|
841 |
|
2 |
|
527 |
|
749 |
|
3 |
Other |
|
578 |
|
|
1,269 |
|
4 |
|
1,041 |
|
1,596 |
|
3 |
Communication and information |
|
567 |
|
|
1,073 |
|
1 |
|
544 |
|
1,119 |
|
4 |
Utilities |
|
370 |
|
|
1,187 |
|
- |
|
301 |
|
1,001 |
|
- |
Mining |
|
288 |
|
|
637 |
|
3 |
|
219 |
|
419 |
|
- |
Total |
|
$41,139 |
|
|
69,094 |
|
271 |
|
38,527 |
|
62,184 |
|
227 |
By loan size: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than $200,000 |
|
4 |
% |
|
3 |
|
13 |
|
5 |
|
4 |
|
14 |
$200,000 to $1 million |
|
16 |
|
|
12 |
|
34 |
|
19 |
|
15 |
|
34 |
$1 million to $5 million |
|
32 |
|
|
27 |
|
48 |
|
34 |
|
28 |
|
33 |
$5 million to $10 million |
|
17 |
|
|
16 |
|
5 |
|
18 |
|
20 |
|
8 |
$10 million to $25 million |
|
21 |
|
|
24 |
|
- |
|
18 |
|
19 |
|
- |
Greater than $25 million |
|
10 |
|
|
18 |
|
- |
|
6 |
|
14 |
|
11 |
Total |
|
100 |
% |
|
100 |
|
100 |
|
100 |
|
100 |
|
100 |
By state: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Ohio |
|
25 |
% |
|
28 |
|
36 |
|
26 |
|
29 |
|
30 |
Michigan |
|
22 |
|
|
19 |
|
19 |
|
22 |
|
21 |
|
21 |
Illinois |
|
10 |
|
|
10 |
|
8 |
|
10 |
|
10 |
|
8 |
Florida |
|
10 |
|
|
9 |
|
9 |
|
10 |
|
9 |
|
4 |
Indiana |
|
9 |
|
|
9 |
|
15 |
|
10 |
|
10 |
|
25 |
Kentucky |
|
6 |
|
|
6 |
|
8 |
|
6 |
|
6 |
|
6 |
Tennessee |
|
3 |
|
|
3 |
|
1 |
|
3 |
|
2 |
|
3 |
Pennsylvania |
|
1 |
|
|
2 |
|
- |
|
1 |
|
1 |
|
- |
Missouri |
|
1 |
|
|
1 |
|
- |
|
1 |
|
1 |
|
- |
West Virginia |
|
- |
|
|
- |
|
- |
|
- |
|
- |
|
1 |
Out-of-footprint |
|
13 |
|
|
13 |
|
4 |
|
11 |
|
11 |
|
2 |
Total |
|
100 |
% |
|
100 |
|
100 |
|
100 |
|
100 |
|
100 |
(a) |
Outstanding reflects total commercial customer loan and lease balances, including held for sale and net of unearned income, and exposure reflects total
commercial customer lending commitments. |
CREDIT RISK MANAGEMENT
The objective of the Bancorps credit risk management strategy is to quantify and manage credit risk on an aggregate portfolio
basis, as well as to limit the risk of loss resulting from an individual customer default. The Bancorps credit risk management strategy is based on three core principles: conservatism, diversification and monitoring. The Bancorp believes that
effective credit risk management begins with conservative lending practices. These practices include conservative exposure and counterparty limits and conservative underwriting, documentation and collection standards. The Bancorps credit risk
management strategy also emphasizes diversification on a geographic, industry and customer level, regular credit examinations and monthly management reviews of large credit exposures and credits experiencing deterioration of credit quality. Lending
officers with the authority to extend credit are delegated specific authority amounts, the utilization of which is closely monitored. Lending activities are largely decentralized, while the Enterprise Risk Management division manages the policy and
authority delegation process centrally. The Credit Risk Review function, within the Enterprise Risk Management division, provides objective assessments of the quality of underwriting and documentation, the accuracy of risk grades and the charge-off
and reserve analysis process.
The Bancorps credit review process and overall assessment of required allowances is based on ongoing quarterly assessments of the probable estimated losses inherent in the loan and lease portfolio. The Bancorp
uses these assessments to promptly identify potential problem loans or leases within the portfolio, maintain an adequate reserve and take any necessary charge-offs. In addition to the individual review of larger commercial loans that exhibit
probable or observed credit weaknesses, the commercial credit review process includes the use of two risk grading systems. The risk grading system currently utilized for reserve analysis purposes encompasses ten categories. The Bancorp also
maintains a dual risk rating system that provides for thirteen probability of default grade categories and an additional six grade categories for estimating actual losses given an event of default. The probability of default and loss given default
evaluations are not separated in the ten-grade risk rating system. The Bancorp is in the process of completing significant validation and testing of the dual risk rating system prior to implementation for reserve analysis purposes. The dual risk
rating system is expected to be consistent with Basel II expectations and allows for more precision in the analysis of commercial credit risk. Scoring systems and delinquency monitoring are used to assess the credit risk in the Bancorps
homogenous consumer loan portfolios.
Fifth Third Bancorp 39
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 26: SUMMARY OF NONPERFORMING ASSETS AND DELINQUENT LOANS
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2006 |
|
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Commercial loans and leases |
|
$ |
133 |
|
|
145 |
|
110 |
|
129 |
|
159 |
Commercial mortgages |
|
|
84 |
|
|
51 |
|
51 |
|
42 |
|
41 |
Commercial construction |
|
|
54 |
|
|
31 |
|
13 |
|
19 |
|
14 |
Residential mortgages and construction |
|
|
38 |
|
|
30 |
|
24 |
|
25 |
|
18 |
Consumer loans and leases |
|
|
43 |
|
|
37 |
|
30 |
|
27 |
|
15 |
Total nonaccrual loans and leases |
|
|
352 |
|
|
294 |
|
228 |
|
242 |
|
247 |
Renegotiated loans and leases |
|
|
- |
|
|
- |
|
1 |
|
8 |
|
- |
Other assets, including other real estate owned |
|
|
103 |
|
|
67 |
|
74 |
|
69 |
|
26 |
Total nonperforming assets |
|
$ |
455 |
|
|
361 |
|
303 |
|
319 |
|
273 |
Commercial loans and leases |
|
$ |
40 |
|
|
21 |
|
22 |
|
15 |
|
29 |
Commercial mortgages and construction |
|
|
23 |
|
|
14 |
|
13 |
|
12 |
|
18 |
Credit card receivables |
|
|
16 |
|
|
10 |
|
13 |
|
13 |
|
9 |
Residential mortgages and construction (a) |
|
|
68 |
|
|
53 |
|
43 |
|
51 |
|
60 |
Consumer loans and leases |
|
|
63 |
|
|
57 |
|
51 |
|
54 |
|
46 |
Total 90 days past due loans and leases |
|
$ |
210 |
|
|
155 |
|
142 |
|
145 |
|
162 |
Nonperforming assets as a percent of total loans, leases and other assets, including other real estate owned |
|
|
.61 |
% |
|
.52 |
|
.51 |
|
.61 |
|
.59 |
Allowance for loan and lease losses as a percent of nonperforming assets
(b) |
|
|
170 |
|
|
206 |
|
235 |
|
219 |
|
251 |
(a) |
Information for all periods presented excludes advances made pursuant to servicing agreements to Government National Mortgage Association (GNMA)
mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. As of December 31, 2006, 2005 and 2004, these advances were $14 million, $13 million and $23 million,
respectively. Information prior to December 31, 2004 was not available. |
(b) |
At December 31, 2004, the reserve for unfunded commitments was reclassified from the allowance for loan and lease losses to other liabilities. The 2003
year-end reserve for unfunded commitments has been reclassified to conform to the current year presentation. |
Portfolio Diversity
The Bancorps credit risk management strategy includes minimizing concentrations of risk through diversification. Table 25
provides breakouts of the commercial loan and lease portfolio, including held for sale, by major industry classification, by loan size and by state, illustrating the diversity and granularity of the Bancorps portfolio.
The commercial portfolio is characterized by 87% of outstanding balances and exposures concentrated within the Bancorps primary
market areas of Ohio, Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West Virginia, Missouri and Pennsylvania. Exclusive of a national large-ticket leasing business, the commercial portfolio is characterized by 94% of outstanding
balances and 91% of exposures concentrated within these ten states. The mortgage and construction segments of the commercial portfolio are characterized by 97% of outstanding balances and 96% of exposures concentrated within these ten states.
Analysis of Nonperforming Assets
Nonperforming assets include: (i) nonaccrual loans and leases for which ultimate collectibility of the full amount of the principal and/or interest is uncertain; (ii) loans and leases that have been
renegotiated to provide for a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower and (iii) other assets, including other real estate owned and repossessed equipment. Loans are
placed on nonaccrual status when the principal or interest is past due 90 days or more (unless the loan is both well secured and in process of collection) and payment of the full principal and/or interest under the contractual terms of the loan are
not expected. Additionally, loans are placed on nonaccrual status upon deterioration of the financial condition of the borrower. When a loan is placed on nonaccrual status, the accrual of interest, amortization of loan premium, accretion of loan
discount and amortization or accretion of deferred net loan fees or costs are discontinued and previously accrued but unpaid interest is reversed. Commercial loans on nonaccrual status are reviewed for impairment at least quarterly. If the principal
or a portion of principal is deemed a loss, the loss amount is charged off to the allowance for loan and lease losses.
Total nonperforming assets were $455 million at December 31, 2006, an increase of $94 million compared to $361 million at December 31, 2005. Nonperforming assets remain a small percentage of total loans, leases and other assets,
including other real estate owned at .61% as of
December 31, 2006, compared to .52% as of December 31, 2005.
Commercial nonaccrual credits as a percent of commercial loans increased from .59% in 2005 to .66% in 2006 primarily due to increases in the Indianapolis and Cleveland markets offset by a
decrease in the Cincinnati market. Consumer nonaccrual loans as a percent of loans increased slightly from .20% in 2005 to .24% in 2006. Overall, nonaccrual loans continue to represent a small portion of the portfolio at just .47% as of
December 31, 2006, compared to .41% as of December 31, 2005.
Total loans and leases 90 days past due have
increased from $155 million as of December 31, 2005 to $210 million as of December 31, 2006. The $55 million increase from the prior year was evenly distributed between commercial and consumer loans and leases.
At December 31, 2006, there were $24 million of loans and leases currently performing in accordance with contractual terms, but for
which there were serious doubts as to the ability of the borrower to comply with such terms. For the years 2006 and 2005, interest income of $10 million and $8 million, respectively, was recorded on nonaccrual and renegotiated loans and leases. For
the years ended 2006 and 2005, additional interest income of $85 million and $53 million, respectively, would have been recorded if the nonaccrual and renegotiated loans and leases had been current in accordance with the original terms.
Analysis of Net Loan Charge-offs
Net charge-offs as a percent of average loans and leases were 44 bp for 2006, compared to 45 bp for 2005. The ratio of commercial loan net charge-offs to average commercial loans outstanding increased to 53 bp in 2006 compared to 41 bp in
2005 due to increases in net charge-offs in the Indianapolis and Southern Indiana markets, partially offset by a decrease in the Cincinnati market. The net charge-off ratio for commercial mortgage loans increased 15 bp due to increased net
charge-offs in the Indianapolis, Chicago and Cleveland markets. The net charge-off ratio for commercial lease financing decreased 109 bp in 2006. The comparison to prior year is impacted by approximately $27 million in charge-offs related to
bankrupt commercial airline carriers during 2005. Consumer lease financing net losses charged off decreased to $5 million as a result of decreased net charge-offs in nearly all affiliate markets and lower averages balances. Overall, the level of net
charge-offs remains a small percentage of the total loan and lease portfolio. The Bancorp expects net charge-offs to be in the low to mid 50 bp range in 2007. Table 27 provides a summary of credit loss experience and net charge-offs as a
40 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 27: SUMMARY OF CREDIT LOSS EXPERIENCE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
|
2005 |
|
|
2004 |
|
|
2003 |
|
|
2002 |
|
Losses charged off: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$ |
(131 |
) |
|
(99 |
) |
|
(95 |
) |
|
(152 |
) |
|
(81 |
) |
Commercial mortgage loans |
|
|
(27 |
) |
|
(13 |
) |
|
(14 |
) |
|
(9 |
) |
|
(18 |
) |
Commercial lease financing |
|
|
(4 |
) |
|
(38 |
) |
|
(8 |
) |
|
(24 |
) |
|
(11 |
) |
Construction loans |
|
|
(8 |
) |
|
(5 |
) |
|
(7 |
) |
|
(3 |
) |
|
(6 |
) |
Residential mortgage loans |
|
|
(22 |
) |
|
(18 |
) |
|
(15 |
) |
|
(24 |
) |
|
(10 |
) |
Consumer loans |
|
|
(203 |
) |
|
(181 |
) |
|
(156 |
) |
|
(136 |
) |
|
(115 |
) |
Consumer lease financing |
|
|
(13 |
) |
|
(19 |
) |
|
(26 |
) |
|
(32 |
) |
|
(32 |
) |
Total losses |
|
|
(408 |
) |
|
(373 |
) |
|
(321 |
) |
|
(380 |
) |
|
(273 |
) |
Recoveries of losses previously charged off: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
|
24 |
|
|
24 |
|
|
14 |
|
|
16 |
|
|
20 |
|
Commercial mortgage loans |
|
|
3 |
|
|
4 |
|
|
5 |
|
|
2 |
|
|
5 |
|
Commercial lease financing |
|
|
5 |
|
|
1 |
|
|
1 |
|
|
2 |
|
|
2 |
|
Construction loans |
|
|
- |
|
|
1 |
|
|
- |
|
|
1 |
|
|
3 |
|
Residential mortgage loans |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
Consumer loans |
|
|
52 |
|
|
39 |
|
|
41 |
|
|
40 |
|
|
46 |
|
Consumer lease financing |
|
|
8 |
|
|
5 |
|
|
8 |
|
|
7 |
|
|
10 |
|
Total recoveries |
|
|
92 |
|
|
74 |
|
|
69 |
|
|
68 |
|
|
86 |
|
Net losses charged off: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
|
(107 |
) |
|
(75 |
) |
|
(81 |
) |
|
(136 |
) |
|
(61 |
) |
Commercial mortgage loans |
|
|
(24 |
) |
|
(9 |
) |
|
(9 |
) |
|
(7 |
) |
|
(13 |
) |
Commercial lease financing |
|
|
1 |
|
|
(37 |
) |
|
(7 |
) |
|
(22 |
) |
|
(9 |
) |
Construction loans |
|
|
(8 |
) |
|
(4 |
) |
|
(7 |
) |
|
(2 |
) |
|
(3 |
) |
Residential mortgage loans |
|
|
(22 |
) |
|
(18 |
) |
|
(15 |
) |
|
(24 |
) |
|
(10 |
) |
Consumer loans |
|
|
(151 |
) |
|
(142 |
) |
|
(115 |
) |
|
(96 |
) |
|
(69 |
) |
Consumer lease financing |
|
|
(5 |
) |
|
(14 |
) |
|
(18 |
) |
|
(25 |
) |
|
(22 |
) |
Total net losses charged off |
|
$ |
(316 |
) |
|
(299 |
) |
|
(252 |
) |
|
(312 |
) |
|
(187 |
) |
Net charge-offs as a percent of average loans and leases (excluding held for sale): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
|
.53 |
% |
|
.41 |
|
|
.54 |
|
|
1.00 |
|
|
.52 |
|
Commercial mortgage loans |
|
|
.25 |
|
|
.10 |
|
|
.12 |
|
|
.10 |
|
|
.23 |
|
Commercial lease financing |
|
|
(.03 |
) |
|
1.06 |
|
|
.21 |
|
|
.72 |
|
|
.35 |
|
Construction loans |
|
|
.11 |
|
|
.07 |
|
|
.15 |
|
|
.09 |
|
|
.12 |
|
Residential mortgage loans |
|
|
.28 |
|
|
.25 |
|
|
.27 |
|
|
.57 |
|
|
.23 |
|
Consumer loans |
|
|
.67 |
|
|
.68 |
|
|
.63 |
|
|
.58 |
|
|
.49 |
|
Consumer lease financing |
|
|
.37 |
|
|
.78 |
|
|
.81 |
|
|
.98 |
|
|
1.04 |
|
Total net losses charged off |
|
|
.44 |
|
|
.45 |
|
|
.45 |
|
|
.63 |
|
|
.43 |
|
percentage of average loans and leases outstanding by loan category.
Allowance for Credit Losses
The allowance for credit losses is comprised of the allowance for loan and lease losses and the reserve for unfunded commitments.
The allowance for loan and lease losses provides coverage for probable and estimable losses in the loan and lease portfolio. The Bancorp evaluates the allowance each quarter to determine its adequacy to cover inherent losses. Several factors are
taken into consideration in the determination of the overall allowance for loan and lease losses, including the unallocated component. These factors include, but are not limited to, the overall risk profile of the loan and lease portfolios, net
charge-off experience, the extent of impaired loans and leases, the level of nonaccrual loans and leases, the level of 90 days past due loans and leases and the overall percentage level of the allowance for loan and lease losses. The Bancorp also
considers overall asset quality trends, credit administration and portfolio management practices, risk identification practices, credit policy and underwriting practices, overall portfolio growth, portfolio concentrations and current
national and local economic conditions that might impact the portfolio.
In 2006, the Bancorp has not substantively changed any material aspect to its overall approach in the determination of the allowance for loan and lease losses and there have been no material
changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance. In addition to the allowance for loan and lease losses, the Bancorp maintains a reserve for unfunded
commitments. The methodology used to determine the adequacy of this reserve is similar to the Bancorps methodology for determining the allowance for loan and lease losses. The provision for unfunded commitments is included in other noninterest
expense on the Consolidated Statements of Income. Table 28 shows the changes in the allowance for credit losses during 2006.
Certain inherent but undetected losses are probable within the loan and lease portfolio. An unallocated component to the allowance for loan and lease losses is maintained to recognize this imprecision in estimating and measuring loss. The
Bancorps current methodology for determining this measure is based on historical loss rates, current credit grades, specific allocation on
TABLE 28: CHANGES IN ALLOWANCE FOR CREDIT LOSSES
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
2005 |
|
2004 |
|
2003 |
|
2002 |
Balance, beginning of year |
|
$814 |
|
785 |
|
770 |
|
683 |
|
624 |
Net losses charged off |
|
(316) |
|
(299) |
|
(252) |
|
(312) |
|
(187) |
Provision for loan and lease losses |
|
343 |
|
330 |
|
268 |
|
399 |
|
246 |
Net change in reserve for unfunded commitments |
|
6 |
|
(2) |
|
(1) |
|
- |
|
- |
Balance, end of year |
|
$847 |
|
814 |
|
785 |
|
770 |
|
683 |
Components of allowance for credit losses (a): |
|
|
|
|
|
|
|
|
|
|
Allowance for loan and lease losses |
|
$771 |
|
744 |
|
713 |
|
697 |
|
|
Reserve for unfunded commitments |
|
76 |
|
70 |
|
72 |
|
73 |
|
|
Total allowance for credit losses |
|
$847 |
|
814 |
|
785 |
|
770 |
|
|
(a) |
At December 31, 2004, the reserve for unfunded commitments was reclassified from the allowance for loan and lease losses to other liabilities. The 2003
year-end reserve for unfunded commitments has been reclassified to conform to the current period presentation. |
Fifth Third Bancorp
41
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 29: ATTRIBUTION OF ALLOWANCE FOR LOAN AND LEASE
LOSSES TO PORTFOLIO LOANS AND LEASES
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31 ($ in millions) |
|
2006 |
|
|
2005 |
|
2004 |
|
2003 |
|
2002(a) |
Allowance attributed to: |
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$252 |
|
|
201 |
|
210 |
|
234 |
|
159 |
Commercial mortgage loans |
|
95 |
|
|
78 |
|
73 |
|
77 |
|
117 |
Construction loans |
|
52 |
|
|
47 |
|
43 |
|
34 |
|
41 |
Residential mortgage loans |
|
48 |
|
|
37 |
|
44 |
|
29 |
|
43 |
Consumer loans |
|
247 |
|
|
183 |
|
160 |
|
146 |
|
141 |
Lease financing |
|
29 |
|
|
56 |
|
47 |
|
64 |
|
132 |
Unallocated |
|
48 |
|
|
142 |
|
136 |
|
113 |
|
50 |
Total allowance for loan and lease
losses |
|
$771 |
|
|
744 |
|
713 |
|
697 |
|
683 |
Portfolio loans and leases: |
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
$20,725 |
|
|
19,174 |
|
16,058 |
|
14,209 |
|
12,743 |
Commercial mortgage loans |
|
10,405 |
|
|
9,188 |
|
7,636 |
|
6,894 |
|
5,885 |
Construction loans |
|
6,847 |
|
|
7,037 |
|
4,726 |
|
3,636 |
|
3,327 |
Residential mortgage loans |
|
8,151 |
|
|
7,152 |
|
6,988 |
|
4,425 |
|
3,495 |
Consumer loans |
|
23,311 |
|
|
22,084 |
|
18,923 |
|
17,432 |
|
15,116 |
Lease financing |
|
4,914 |
|
|
5,290 |
|
5,477 |
|
5,712 |
|
5,362 |
Total portfolio loans and leases |
|
$74,353 |
|
|
69,925 |
|
59,808 |
|
52,308 |
|
45,928 |
Attributed allowance as a percent of respective portfolio loans: |
|
|
|
|
|
|
|
|
|
|
|
Commercial loans |
|
1.21 |
% |
|
1.05 |
|
1.31 |
|
1.65 |
|
1.24 |
Commercial mortgage loans |
|
.91 |
|
|
.85 |
|
.96 |
|
1.12 |
|
1.98 |
Construction loans |
|
.77 |
|
|
.67 |
|
.90 |
|
.94 |
|
1.24 |
Residential mortgage loans |
|
.59 |
|
|
.51 |
|
.63 |
|
.66 |
|
1.24 |
Consumer loans |
|
1.06 |
|
|
.83 |
|
.85 |
|
.84 |
|
.93 |
Lease financing |
|
.59 |
|
|
1.06 |
|
.86 |
|
1.12 |
|
2.46 |
Unallocated (as a percent of total portfolio loans and leases) |
|
.06 |
|
|
.20 |
|
.23 |
|
.22 |
|
.11 |
Total portfolio loans and leases |
|
1.04 |
% |
|
1.06 |
|
1.19 |
|
1.33 |
|
1.49 |
(a) |
The allowance for loan and lease losses in 2002 includes funded and unfunded commitments. At December 31, 2004, the reserve for unfunded commitments was
reclassified from the allowance for loan and lease losses to other liabilities. The 2003 year-end reserve for unfunded commitments has been reclassified to conform to the current period presentation. |
impaired commercial credits and other qualitative adjustments. Approximately 85% of the required reserves come from the baseline historical loss rates, specific reserve estimates and current
credit grades; while 15% comes from qualitative adjustments. As a result, the required reserves tend to slightly lag the deterioration in the portfolio due to the heavy reliance on realized historical losses and the credit grade rating process.
Consequently, a larger unallocated reserve is required towards the end of the stronger part of the credit cycle. As the credit cycle deteriorates and the actual loss rates and downgrades increase, the Bancorps methodology will result in a
lower unallocated reserve as the incurred losses get reflected into the main components of the methodology that drive the majority of the required reserve calculations. Unallocated reserves as a percent of total portfolio loans and leases for the
year ended December 31, 2006 were .06% compared to .20% for the year ended December 31, 2005.
The allowance for
loan and lease losses at December 31, 2006 decreased to 1.04% of the total portfolio loans and leases compared to 1.06% at December 31, 2005. Overall, the Bancorps long history of low exposure limits, minimal exposure to national or
sub-prime lending businesses, centralized risk management and its diversified portfolio reduces the likelihood of significant unexpected credit losses. Table 29 provides the amount of the allowance for loan and lease losses by category.
Residential Mortgage
Portfolio
Certain mortgage products have contractual features that may increase credit exposure to the Bancorp in the event of a
decline in housing prices. These types of mortgage products offered by the Bancorp include high loan-to-value (LTV) ratios, multiple loans on the same collateral that when combined result in a high LTV (80/20) and
interest-only loans. Table 30 shows the Bancorps originations of these products in 2006 and 2005. The Bancorp does not currently originate mortgage loans that permit principal payment deferral or payments that are less than the accruing
interest. Table 31 provides the amount of these loans as a percent of the residential mortgage loans in the Bancorps portfolio and the delinquency rates of these loan products as of December 31, 2006 and 2005, respectively.
The Bancorp also sells certain of these mortgage products in the secondary market with recourse. The outstanding balances and delinquency
rates for these loans sold with recourse as of December 31, 2006 and 2005 were $1.2 billion and 1.74% and $1.2 billion and 1.24%, respectively.
The Bancorp manages credit risk in the mortgage portfolio through conservative underwriting and documentation standards and geographic and product diversification. The Bancorp may also package and sell loans in the
portfolio without recourse or may purchase mortgage insurance for the loans sold in order to mitigate credit risk.
42 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 30: RESIDENTIAL MORTGAGE ORIGINATIONS
|
|
|
|
|
|
|
|
|
|
|
|
For the years ended December 31 ($ in millions) |
|
2006 |
|
Percent of total |
|
|
2005 |
|
Percent of total |
|
Greater than 80% LTV with no mortgage insurance |
|
$679 |
|
7 |
% |
|
$ |
1,245 |
|
13 |
% |
Interest-only |
|
1,283 |
|
14 |
|
|
|
1,240 |
|
13 |
|
Greater than 80% LTV and interest-only |
|
180 |
|
2 |
|
|
|
408 |
|
4 |
|
80/20 loans |
|
431 |
|
5 |
|
|
|
445 |
|
5 |
|
TABLE 31: RESIDENTIAL MORTGAGE OUTSTANDINGS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006 |
|
|
2005 |
|
As of December 31 ($ in millions) |
|
Balance |
|
Percent of total |
|
|
Delinquency Ratio |
|
|
Balance |
|
Percent of total |
|
|
Delinquency Ratio |
|
Greater than 80% LTV with no mortgage insurance |
|
$ |
1,893 |
|
23 |
% |
|
3.79 |
% |
|
$ |
1,773 |
|
25 |
% |
|
3.11 |
% |
Interest-only |
|
|
1,227 |
|
15 |
|
|
.14 |
|
|
|
899 |
|
13 |
|
|
.41 |
|
Greater than 80% LTV and interest-only |
|
|
560 |
|
7 |
|
|
1.15 |
|
|
|
361 |
|
5 |
|
|
.07 |
|
80/20 loans |
|
|
28 |
|
- |
|
|
.72 |
|
|
|
28 |
|
- |
|
|
- |
|
MARKET RISK MANAGEMENT
Market risk
arises from the potential for fluctuations in interest rates, foreign exchange rates and equity prices that may result in the potential reduction of net income. Interest rate risk, a component of market risk, is the exposure to adverse changes in
net interest income or financial position due to changes in interest rates. Management considers interest rate risk a prominent market risk in terms of its potential impact on earnings. Interest rate risk can occur for any one or more of the
following reasons:
|
|
|
Assets and liabilities may mature or reprice at different times; |
|
|
|
Short-term and long-term market interest rates may change by different amounts; or |
|
|
|
The remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change. |
In addition to the direct impact of interest rate changes on net interest income, interest rates can indirectly impact earnings through their effect on
loan demand, credit losses, mortgage origination fees, the value of servicing rights and other sources of the Bancorps earnings. Consistency of the Bancorps net interest income is largely dependent upon the effective management of
interest rate risk.
As a result of the ongoing analysis of the Bancorps interest rate risk profile, management
recommended and the Bancorps Board of Directors approved a decision on November 20, 2006 to reduce the size of the available-for-sale securities portfolio. This action was undertaken in order to, among other reasons, improve the
composition of the Bancorps balance sheet with a lower concentration of fixed-rate assets and better position the Bancorp for an uncertain economic and interest rate environment. Management continues to review the Bancorps balance sheet
composition
and to model the interest rate risk, and possible actions to reduce this risk, given numerous future interest rate scenarios.
Net Interest Income Simulation Model
The Bancorp employs a variety of measurement techniques to identify and manage its interest rate risk, including the use of an earnings simulation model to analyze net interest income sensitivity to changing interest
rates. The model is based on actual cash flows and repricing characteristics for all of the Bancorps financial instruments and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of
certain assets and liabilities. The model also includes senior management projections of the future volume and pricing of each of the product lines offered by the Bancorp as well as other pertinent assumptions on the balance sheet. Actual results
will differ from these simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies.
The Bancorps Executive Asset Liability Committee (ALCO), which includes senior management representatives and is accountable to the Risk and Compliance Committee of the
Board of Directors,
monitors and manages interest rate risk within Board approved policy limits. In addition to the risk management activities of ALCO, the Bancorp has a Market Risk Management function as part of the Enterprise Risk Management division that provides
independent oversight of market risk activities. The Bancorps current interest rate risk policy limits are determined by measuring the anticipated change in net interest income over 12-month and 24-month horizons assuming a 200 bp parallel
ramped increase or decrease in market interest rates. In accordance with the current policy, the rate movements are assumed to occur over one year and are sustained thereafter. The following table shows the Bancorps estimated earnings
sensitivity profile and the ALCO policy limits on the asset and liability positions as of December 31, 2006:
TABLE 32: ESTIMATED
EARNINGS SENSITIVITY PROFILE
|
|
|
|
|
|
|
|
|
|
|
Change in Net Interest Income (FTE) |
|
ALCO Policy Limits |
Change in Interest Rates (bp) |
|
12 Months |
|
13 to 24 Months |
|
12 Months |
|
13 to 24 Months |
+200 |
|
(.29)% |
|
.45 |
|
(5.00) |
|
(7.00) |
+100 |
|
.01 |
|
.20 |
|
- |
|
- |
-100 |
|
.07 |
|
(.43) |
|
- |
|
- |
-200 |
|
.41 |
|
(2.27) |
|
(5.00) |
|
(7.00) |
Economic Value of Equity
The Bancorp also employs economic value of equity (EVE) as a measurement tool in managing interest rate sensitivity. Whereas net interest income simulation highlights exposures over a
relatively short time horizon, the EVE analysis incorporates all cash flows over the estimated remaining life of all balance sheet and derivative positions. The EVE of the balance sheet, at a point in time, is defined as the discounted present value
of asset and derivative cash flows less the discounted value of liability cash flows. The sensitivity of EVE to changes in the level of interest rates is a measure of longer-term interest rate risk. In contrast to the net interest income simulation,
which assumes interest rates will change over a period of time, EVE uses instantaneous changes in rates. EVE values only the current balance sheet and does not incorporate the growth assumptions that are used in the net interest income simulation
model. As with the net interest income simulation model, assumptions about the timing and variability of balance sheet cash flows are critical in the EVE analysis. Particularly important are the assumptions driving prepayments and the expected
changes in balances and pricing of the transaction deposit portfolios. The following table shows the Bancorps EVE sensitivity profile as of December 31, 2006:
TABLE 33: ESTIMATED EVE SENSITIVITY PROFILE
|
|
|
|
|
|
|
Change in EVE |
Change in Interest Rates (bp) |
|
2006 |
|
ALCO Policy Limits |
+200 |
|
(3.98)% |
|
(20.0) |
-200 |
|
2.52 |
|
(20.0) |
Fifth Third Bancorp 43
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
At December 31, 2006, the Bancorp has reduced its sensitivity, relative to December 31, 2005, to the impact of an instantaneous rate movement as a
result of the balance sheet actions taken during the fourth quarter of 2006. While an instantaneous shift in interest rates is 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 (i.e., 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 the
adverse impact of changes in interest rates. The net interest income simulation and EVE analyses do not necessarily include certain actions that management may undertake to manage this risk in response to anticipated changes in interest rates.
Use of Derivatives to Manage Interest Rate Risk
An integral component of the Bancorps interest rate risk management strategy is its use of derivative instruments to minimize significant unplanned fluctuations in earnings and cash flows 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, principal-only swaps,
options and swaptions.
As part of its overall risk management strategy relative to its mortgage banking activity, the
Bancorp enters into forward contracts accounted for as free-standing derivatives to economically hedge interest rate lock commitments that are also considered free-standing derivatives.
The Bancorp also establishes derivative contracts with reputable third parties to economically hedge significant exposures assumed in
commercial customer accommodation derivative contracts. Generally, these contracts have similar terms in order to protect the Bancorp from market volatility. Credit risks arise from the possible inability of counterparties to meet the terms of their
contracts, which the Bancorp minimizes through approvals, limits and monitoring procedures. The notional amount and fair values of these derivatives as of December 31, 2006 are included in Note 8 of the Notes to Consolidated Financial
Statements.
Portfolio Loans and Leases and Interest Rate Risk
Although the Bancorps portfolio loans and leases contain both fixed and floating/adjustable rate products, the rates of interest
earned by the Bancorp on the outstanding balances are generally established for a period of time. The interest rate sensitivity of loans and leases is
directly related to the length of time the rate earned is established. Table 34 shows a summary of the expected principal cash flows of the Bancorps portfolio loans and leases as of December 31, 2006. Additionally, Table 35 shows a
summary of expected principal cash flows occurring after one year as of December 31, 2006.
Mortgage Servicing Rights and
Interest Rate Risk
The net carrying amount of the MSR portfolio was $519 million as of December 31, 2006 compared to $433
million as of December 31, 2005. The Bancorp maintains a non-qualifying hedging strategy relative to its mortgage banking activity, including consultation with an independent third-party specialist, in order to manage a portion of the risk
associated with changes in value of its MSR portfolio as a result of changing interest rates. The value of servicing rights can fluctuate sharply depending on changes in interest rates and other factors. Generally, as interest rates decline and
loans are prepaid to take advantage of refinancing, the total value of existing servicing rights declines because no further servicing fees are collected on repaid loans.
The increase in interest rates and the resulting impact of changing prepayment speeds led to recoveries of $19 million and $33 million of temporary impairment in 2006 and 2005, respectively.
Servicing rights are deemed temporarily impaired when a borrowers loan rate is distinctly higher than prevailing market rates. See Note 7 of the Notes to Consolidated Financial Statements for further discussion on servicing rights.
Foreign Currency Risk
The
Bancorp enters 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 within other noninterest
income on the Consolidated Statements of Income. The balance of the Bancorps foreign denominated loans at December 31, 2006 was approximately $196 million compared to approximately $130 million at December 31, 2005. The Bancorp also
enters into foreign exchange contracts for the benefit of commercial customers involved in international trade to hedge their exposure to foreign currency fluctuations. The Bancorp has several internal controls in place to ensure excessive risk is
not being taken in providing this service to customers. These include an independent determination of currency volatility and credit equivalent exposure on these contracts, counterparty credit approvals and country limits.
TABLE 34: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS
|
|
|
|
|
|
|
|
|
As of December 31, 2006 ($ in millions) |
|
Less than 1 year |
|
1-5 years |
|
Greater than 5 years |
|
Total |
Commercial loans |
|
$11,953 |
|
7,539 |
|
1,233 |
|
20,725 |
Commercial mortgage loans |
|
3,841 |
|
5,048 |
|
1,516 |
|
10,405 |
Commercial construction loans |
|
4,206 |
|
1,680 |
|
282 |
|
6,168 |
Commercial lease financing |
|
1,054 |
|
1,878 |
|
909 |
|
3,841 |
Residential mortgage and construction loans |
|
2,576 |
|
4,045 |
|
2,209 |
|
8,830 |
Consumer loans |
|
6,405 |
|
12,717 |
|
4,189 |
|
23,311 |
Consumer lease financing |
|
415 |
|
651 |
|
7 |
|
1,073 |
Total |
|
$30,450 |
|
33,558 |
|
10,345 |
|
74,353 |
TABLE 35: PORTFOLIO LOAN AND LEASE PRINCIPAL CASH FLOWS OCCURRING AFTER ONE YEAR
|
|
|
|
|
|
|
Interest Rate |
As of December 31, 2006 ($ in millions) |
|
Fixed |
|
Floating or Adjustable |
Commercial loans |
|
$2,508 |
|
6,264 |
Commercial mortgage loans |
|
2,237 |
|
4,327 |
Commercial construction loans |
|
351 |
|
1,611 |
Commercial lease financing |
|
2,787 |
|
- |
Residential mortgage and construction loans |
|
3,293 |
|
2,961 |
Consumer loans |
|
7,894 |
|
9,012 |
Consumer lease financing |
|
658 |
|
- |
Total |
|
$19,728 |
|
24,175 |
44 Fifth Third Bancorp
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 36: MATURITY DISTRIBUTION OF CERTIFICATES -
$100,000 AND OVER
|
|
|
|
As of December 31, 2006 ($ in millions) |
|
|
Three months or less |
|
$ |
2,673 |
Over three months through six months |
|
|
1,544 |
Over six months through one year |
|
|
1,032 |
Over one year |
|
|
1,379 |
Total |
|
$ |
6,628 |
TABLE 37: AGENCY RATINGS
|
|
|
|
|
|
|
As of December 31, 2006 |
|
Moodys |
|
Standard and Poors |
|
Fitch |
Fifth Third Bancorp: |
|
|
|
|
|
|
Commercial paper |
|
Prime-1 |
|
A-1 |
|
F1+ |
Senior debt |
|
Aa3 |
|
A+ |
|
AA- |
Subordinated debt |
|
A1 |
|
A |
|
A+ |
Fifth Third Bank and Fifth Third Bank (Michigan): |
|
|
|
|
|
|
Short-term deposit |
|
Prime-1 |
|
A-1+ |
|
F1+ |
Long-term deposit |
|
Aa2 |
|
AA- |
|
AA |
Senior debt |
|
Aa2 |
|
AA- |
|
AA- |
|